Option Investor
Newsletter

Daily Newsletter, Tuesday, 11/3/2009

Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews

Market Wrap

Calm Before the Storm

by Jim Brown

Click here to email Jim Brown

The markets wandered aimlessly on Tuesday and alternated between gains and losses as we await the results of the Fed meeting on Wednesday.

Market Stats Table

The markets could not make up their mind about direction today with longs exiting ahead the Fed on worries that the event could turn negative. Shorts were also exiting on worries the Fed statement would be market positive. Basically there was a huge cloud of indecision hanging over the market with the Fed and Payroll events just ahead.

There was little on the economics calendar today to stimulate traders. The weekly chain store sales were flat at +0.1% and completely ignored. The Factory Orders for September rose +0.9% to offset the -0.8% decline in August. This was a lagging report and was also ignored despite some relative good news. The gain in September pushed orders to an annualized rate of +8.8% in Q3 compared to only 2.3% in Q2. Inventories continued to decline sharply with a -1.0% drop and the 13th consecutive monthly decline. Capacity utilization was 67.7% and hovering near the postwar low set in June. The pre-recession level was 79%. The low capacity utilization will keep inflation levels low and increase the odds that the Fed will remain on hold for several more months.

The last report for the day was the auto sales for October. Sales actually increased in October to an annual pace of 10.46 million units compared to the 9.22 million pace in September. The annual rate for August was 14.1 million due to cash for clunkers. Chrysler was the drag on the sector with a sales drop of -30% year over year but they still managed to post a 6% gain from September. Chrysler said it would implement another zero percent sales drive in November. Chrysler normally posts decent sales in Nov/Dec because SUV sales pickup as winter arrives with nasty driving conditions. The Jeep brand is one of the most popular SUV brands in the USA.

GM said sales rose +4% year over year and the first YOY gain since Jan 2008. On a monthly basis sales rose 13% from September. The month-month gains in sales were due to the horrible September sales after the cash for clunkers ended in August. September sales were so low it would have been hard not to beat those levels. GM said its four core brands accounted for 95% of its sales.

Ford said sales rose +3.1% YOY and +21% from September. This was the third monthly increase in Ford sales. Ford also said it gained market share for the 12th time in the last 13 months. The Taurus sedan and crossover SUVs were the reason. Ford said 80% of sales were coming from new 2010 models. Ford posted an earnings surprise of nearly $1 billion for Q3 and said it would be solidly profitable by 2011. Ford was the only one of the big three to avoid bankruptcy and a government bailout.

Economic reports for Wednesday include the Mortgage Applications, Challenger Employment, ISM Services, Oil & Gas Inventories and the Fed statement. Obviously the biggest one is the Fed statement at 2:15. Nobody expects a rate change but there is a real possibility there could be a bias change in the statement. The "exceptionally low -- for an extended period" statement is the cause for concern. Once that statement changes the Fed conversations will take on an entirely different context.

In the last statement the FOMC members indicated they thought the recession was over but mentioned constraints on growth of the labor market, weak income growth, lost housing wealth and tight credit. The statement also said "substantial resource slack" would limit price increases and prevent inflation. That should not have changed given the data in the factory orders today. The Fed completed the purchase of $300 billion of long-term treasuries in October. Analysts are wondering if they will add to that total with another announcement this week. The purchase of treasuries keeps mortgage rates low. The Fed still has a planned $1.25 trillion purchase of mortgage backed securities and up to $200 billion in GSE debt that has been lengthened from "before year-end" to the "end of Q1-2010." It will be very interesting to see how the Fed crafts its statement this week and what impact it will have on the market.

The big news on Tuesday and probably the biggest support for the market came from news that Warren Buffett was buying Burlington Northern (BNI) for $26 billion. The deal would value BNSF at $34 billion but Berkshire already owns a significant amount of BNSF stock. This is the biggest deal Buffett has ever done and could force him to liquidate some other assets to raise the cash. Buffett said BNSF would benefit from a recovering U.S. economy. Buffett said it was an all out bet on the economic future of the USA. Buffett will pay $100 per share in cash and stock and a premium of 31.5% over Monday's closing stock price BNSF stock spiked +$21 to close at $97. It is rare for Berkshire to do a deal for stock. The proceeds will be paid from $16 billion in cash, $8B from its own funds and the rest from debt. Berkshire also owns 1.9% of UNP and .5% of NSC. The American Funds mutual fund family owned 9.5% of BNSF so shareholders in those funds woke up to a nice surprise.

Probably even more surprising was the announcement of a 50:1 stock split on Berkshire class B stock. (BRK.B) The stock closed at $3,325 so a 50:1 split would put it around $65 per share. The class A shares still trade for more than $100,000 per share. Buffett is not a fan of stock splits but needed to do this one to make the share exchange for BNSF easier to complete for small BNI shareholders. Berkshire can't do an all stock deal for BNSF because it would drop Berkshire capital below the regulatory requirements for his insurance company. BNSF is the number one railroad by revenue ($18 billion) and the company said recently that freight volumes were increasing.

This is also is a bet on the future of coal. The main BNSF east/west route runs from Chicago to San Francisco and right through the big coal fields in Wyoming. This allows coal to flow in both directions but the critical point is that it can flow to China from San Francisco. China completes 10 coal-fired plants a month and will have an even bigger appetite for coal as the growth continues. BNSF is also a key shipper of Asian goods into the heartland of the U.S. from those western ports.

Berkshire Class B Shares Chart

Dow Transports Chart

The increase in M&A activity suggests the corporate world believes strongly that the bottom is behind us. The BNSF deal today along with Stanley Works (SWK) buying Black and Decker (BDK) on Monday is putting a floor under the market. We just don't know yet if that floor is temporary or long-term.

It was another fun day for YRC Worldwide (YRCW) shareholders. Shares in the company fell another 7% after a -64% drop on Monday. The company is trying to survive after the recession cut their cash flow to nearly zero. YRCW is the surviving company from the Yellow Freight and Roadway merger. YRCW is proposing a debt to equity swap that will essentially turn the company over to the bondholders and wipeout the existing common shares by diluting them to nearly nothing. To execute the debt exchange YRCW would have to create/issue 1.6 billion shares. This dwarfs the current shares outstanding of only 60 million. That equates to about a 27:1 dilution on a stock that is worth barely more than a buck at today's close. YRCW traded over $64 just a couple years ago.

YRCW Chart

Gold broke over $1000 again back on September 8th and then struggled for a month to hold those gains. When October began the yellow metal finally broke free of that $1000 restraint and heading higher. $1065 became the next level to retard the upward progress but that ended today. The IMF announced it had sold 200 metric tonnes of gold to India for $6.7 billion. The sale was for an average price of $1045 per ounce. No volume discounts even on a monster sale. A metric tonne is 1,000 kilograms or 2204.63 pounds.

The IMF announced some time ago that it was selling 403.3 tonnes of gold or about one-eighth of its inventory. The news kept a lid on prices because investors did not know how the IMF would liquidate the position. If it was dumped on the market it would have had a significant impact on prices. Gold analysts were very bullish on the deal saying India's purchase at basically list prices would keep that 200 tonnes off the market and push India's central bank to the 10th largest gold owner in the world. The Reserve Bank of India said the gold will be held in reserve and not disseminated and was purchased as part of their reserve management program.

The purchase was important because it signaled a willingness by central banks to beef up reserves at the current price and that suggests $1000 gold s here to stay. Many people expect China to buy the other 200 tonnes. If they don't the IMF said it will sell it on the open market and that would be disruptive to prices. China recently announced it had raised its gold reserves to 1,054 tonnes from its 2003 level of 600 tonnes.

I view this as dollar negative even though analysts are mixed on the subject. If central banks are stocking up on gold it suggests some cautious central banker are not expecting some currency challenges ahead. The announcement about India this morning knocked the dollar index back after it traded at a high of 76.81 and a four-week high.

Gold Futures Chart

Chart of Dollar Index

Merck (MRK) and Schering Plough (SGP) completed their $41 billion merger today and SGP closed for trading at the bell this afternoon. They will begin operations as the combined company on Wednesday. Remaining SGP shareholders will receive 0.5767 shares of the combined company and $10.50 per share in cash.

Schering Plough Chart

Morgan Stanley put the squeeze on tech stocks today after the company downgraded chip stocks. The Semiconductor index moved even closer to support at 285 after the analyst downgraded the sector to cautious from attractive. The analyst said a lot of the good news is already baked into the price. He warned that inventory levels were rising and revenue growth could peak in early 2010. Stocks downgraded included Intel, Altera, Xilinx, Micron and Nvidia. He said there was pent up demand for IT equipment but businesses were still not buying.

Without a positive chip sector the Nasdaq will have trouble posting gains.

Semiconductor Index Chart

Research in Motion got a bounce today with a nearly $4 gain. The bounce came after analysts discussed the extreme under valuation now associated with RIMM and a forward PE of 12. Other stocks in the segment sport PEs from 35-50. RIMM was knocked for a loss on Monday when a Citi analyst downgraded RIMM due to expected stiff competition from smart phones running Google's android operating system. Investors should remember that RIMM still sells most of its phones in the $300 price range and that it has the only business email service of all the major smart phones. RIMM has plenty of value left and I believe once this week's volatility passes it would be worth a speculative position. I would be thrilled to see the current decline continue but today's short covering suggests bears are getting scared.

RIMM Chart

Cisco (CSCO) reports earnings after the close on Wednesday and hopefully the Fed will not have stirred up the market beforehand. Cisco is expected to report earnings of 31-cents on revenue of $8.75B. Of course the guidance will be the key. With the majority of big earnings reports behind us it would really help if John Chambers would say something really positive about the economy. Since he is normally a cheerleader any cautious comments will be magnified. I suspect he will try to focus on the new alliance with EMC and WMware in the $350 billion data center infrastructure market. This was announced on Tuesday. They also squelched rumors that Cisco might be readying an acquisition of EMC. The stock of both companies was flat on the day.

I thought today's market action was clearly indecision ahead of the FOMC announcement and Payrolls. The Dow closed down, the Nasdaq up and the S&P nearly flat. The star of the day was the Russell-2000, which posted a +1.5% gain. Obviously I am thrilled that the Russell is finding buyers. This means cash is rotating out of the blue chips where the money was safely stored for the October fiscal year end for funds. The money is leaving big caps, hence the Dow was down and the S&P flat. The Russell posted the largest gain of any index with the exception of transports and that was due to the Burlington acquisition not independent buying.

I view this buying in the Russell as a sign that we have reached a bottom in this correction. Fund managers would not be buying small caps if they feared the rest of Q4. This is a bullish sign. Now all we have to do is get past the FOMC announcement and Friday's payroll report. I wrote on Sunday that the Russell could test 550 and we needed to pray that if tested that support would hold. The intraday low on Monday was 553 and the Russell closed today at 570. At this point I would almost like to see some post FOMC volatility to give us another chance at buying the 555 level for a potential Q4 rally. Resistance is still well above at 625.

Russell Chart

The Dow was almost evenly split between winner and lowers with only two stocks losing more than 60 cents. (KO, HPQ) As I described above this was more of a cash rotation day than any material impact from an individual Dow stock. The Dow declined to initial support at the 50-day average on Friday and remains very close at today's close. This average produced a decent rebound back in early October but the coming earnings cycle was the main driver. That no longer exists as a motive force today. Support appears to be 9700-9750 with resistance at 9850.

Dow Chart

The S&P respected support at 1035 but has failed to produce any respectable gains. This is probably due to the cash rotating out of big caps and into the Russell.

S&P-500 Chart

The Nasdaq managed to post a minor gain despite the semiconductor downgrade. The RIMM gain helped! Tech stocks appear to be mixed with some sectors weak while others are stubbornly positive. Support at 2040 appears to have held and resistance is now in the 2100 range. The Nasdaq stocks are going to be motivated by positive comments in the Fed statement about the economy and by the Cisco earnings on Wednesday night. I would be surprised if the Nasdaq rallied much ahead of the Cisco news but it is possible. If initial support fails we still have that broad range of congestive support just below.

Nasdaq Chart

I am bullish tonight. Of course I want to get past the FOMC statement and the Payroll report on Friday before making a full commitment but I think the action in the Russell is positive confirmation that fund managers are not afraid of the market. The average 5% correction over the last week, -10% on the Russell, was a buying opportunity as long as the Fed does not do something stupid. Jobs are a toss up but as long as they did not implode I think almost everyone understand that 10% unemployment is a given and jobs may not improve until mid 2010. At least I hope everyone understand this. We saw an improvement in the manufacturing ISM on Monday and automakers actually sold come cars. I would view any material post FOMC dip as a buying opportunity.

Jim Brown


New Option Plays

Reluctant Rebound

by James Brown

Click here to email James Brown

Editor's Note:

The market's recovery off today's intraday low is bullish but I think it's only short-term bullish. Stocks look poised for an oversold bounce but I don't think the rebound goes very far. Thus I'm reluctant to add new positions either bullish or bearish. I am adding one new play but if you do choose to jump in use small positions to limit risk.

Wednesday could see a lot of volatility. The ADP employment report will be a precursor to Friday's jobs report. Plus the FOMC will conclude their two-day meeting. Their announcement on interest rates and their comments on the economy should be released around 2:15 p.m.


NEW DIRECTIONAL CALL PLAYS

Parker Hannifin - PH - close: 55.25 change: +1.66 stop: 52.39

Why We Like It:
PH appears to have found a new short-term bottom near $52.50 and its 50-dma. Today's close over $55.00 is a new bullish entry point but we're going to keep stops tight just under yesterday's low. Our first target is $58.50. We will cautiously set a second target at $62.00 but the $60.00 level could prove to be strong resistance. I would use small positions. The rest of this week could be very volatile due to economic data. Plus, PH is due to present at an industry conference tomorrow morning.

Suggested Options:
I'm suggesting the November calls. This should be a short-term trade. My preference is for the $55 strike.

BUY CALL NOV 55.00 PH-KK open interest=1482 current ask $1.70

Annotated Chart:

Picked on  November 03 at $ 55.25
Change since picked:       + 0.00
Earnings Date            01/20/09 (unconfirmed)
Average Daily Volume =        1.6 million  
Listed on  November 03, 2009         



In Play Updates and Reviews

Gold Hits New High

by James Brown

Click here to email James Brown


CALL Play Updates

Gold ETF - GLD - close: 106.46 change: +2.51 stop: 99.75 *new*

News that India had purchased about 200 metric tons of gold in the last month sent gold prices soaring. Back in September the IMF announced it would sell 403 tons of gold to raise cash. No one expected India to buy half of it. The idea of stronger demand from various nations trying to diversify against the U.S. dollar pushed gold up more than $30. Gold futures hit a new all-time high at more than $1,085 an ounce.

This pushed the GLD to a new high today. I am raising our stop loss to $99.75. If you have November calls I would plan on exiting near $110. If you have the January calls consider selling half at $110. I'm setting a secondary target at $119.00 but my timeframe is several more weeks.

Picked on   October 06 at $102.28
Change since picked:       + 4.18
Earnings Date            00/00/00
Average Daily Volume =       14.2 million  
Listed on   October 06, 2009         


UltraShort Treasury ETF - TBT - close: 46.98 change: +0.98 stop: 43.90

Bond yields were on the rise and the TBT gained 2.1%. I am still suggesting that readers wait for a move over $47.50 before initiating new positions.

Our first target is $54.50. Our second target is $58.50. Our time frame is several weeks (possibly year end).

Note: This same trade in reverse is puts on the TLT. The TLT will go down as yields rise.

Picked on   October 26 at $ 47.89 (1/2 position)
Change since picked:       - 0.91

2nd entry on   October 30 at $ 45.50 (1/2 position)
Change since picked:          + 1.48

Earnings Date            --/--/--
Average Daily Volume =        6.0 million  
Listed on   October 26, 2009         


PUT Play Updates

BIOGEN IDEC - BIIB - close: 43.25 change: +0.66 stop: 47.25

The BTK biotech index rallied sharply for the second day in a row. This time BIIB participated and gained 1.5%. The stock is oversold and due for a bounce. Look for resistance near $45.00 and again near $46.50. I'm not suggesting new positions at this time. Our second and final target to exit is $40.50.

Picked on   October 03 at $ 48.89
Change since picked:       - 5.64
                               /1st target hit @ 44.50 (-8.9%)
Earnings Date            10/20/09 (confirmed)
Average Daily Volume =        2.6 million  
Listed on   October 03, 2009         


Bank of Montreal - BMO - close: 47.53 change: +1.01 stop: 51.25

Financials were initially weak this morning. Negative news from UBS and RBS in Europe sent the banks lower. Yet BMO managed to rebound. Today's session is technically a bullish reversal. Keep an eye on the $49.00 and $50.00 levels as overhead resistance. A failed rally near these levels can be used as a new entry point to buy puts. Our first target is $42.75. Our second target is $40.50.

Picked on   October 27 at $ 47.37
Change since picked:       + 0.16
Earnings Date            11/24/09 (unconfirmed)
Average Daily Volume =        539 thousand 
Listed on   October 27, 2009         


UltraDow30 - DDM - close: 38.32 change: -0.12 stop: 41.26

This is the second day in a row that the DDM has been churning sideways near $38 and its 50-dma. I would still consider new positions here but readers may want to wait for a bounce or failed rally near $40.00 to buy puts. I'm suggesting readers use small positions to limit risk.

Our first target is $35.25. The 100-dma near $35.00 could be technical support. I am considering a second target at $32.50 but for now we'll exit 100% at $35.25.

Picked on   October 31 at $ 37.82 (1/2 position size)
Change since picked:       + 0.50
Earnings Date            --/--/--
Average Daily Volume =        3.2 million  
Listed on   October 31, 2009         


Intuitive Surgical - ISRG - close: 247.99 change: +1.61 stop: 261.00

ISRG is still drifting sideways near its 50-dma. I would look for a new lower high near $255 or a new relative low under $240 before opening new position at this time.

Remember, this is an aggressive trade. ISRG can be very volatile and options aren't cheap. I would use very small positions about 25% your normal trade size. Our first target is $226.00. Our second target is $202.00.

Picked on   October 31 at $246.35
Change since picked:       + 1.64
Earnings Date            10/20/09 (confirmed)
Average Daily Volume =        939 thousand 
Listed on   October 31, 2009         


Russell 2000 iShares - IWM - close: 57.07 change: +0.85 stop: 62.55

The IWM is bouncing just like I expected. Today's session has produced a bullish engulfing candlestick pattern. I don't expect this rebound to make it past the $60.00 level. Nimble traders could try trading the bounce. Our plan is to buy puts when the IWM hits $59.00. If triggered our first target is $55.50. Our second target is $52.00 (or the 200-dma).

Picked on  November xx at $ xx.xx <-- TRIGGER @ 59.00
Change since picked:       + 0.00
Earnings Date            --/--/--
Average Daily Volume =       54.5 million  
Listed on  November 02, 2009         


iShares Transports - IYT - close: 67.71 chg: +3.45 stop: 70.60

A 27.5% rally in shares of railroad stock BNI on the Berkshire news lifted the railroad industry. This in turn sent the transports sharply higher. The IYT gapped open at $67.04 and closed with a 5.3% gain. I might consider new bearish positions on a failed rally near $70.00. IYT hit our first target last Wednesday. Our second target is $62.00.

Picked on   October 24 at $ 68.29
Change since picked:       - 0.58
                              /1st target hit @ 65.25 (-4.4%)
Earnings Date            --/--/--
Average Daily Volume =        664 thousand 
Listed on   October 24, 2009         


Life Tech. - LIFE - close: 48.10 change: +0.52 stop: 50.10

LIFE is still trying to bounce but shares are essentially churning sideways. Readers might want to consider waiting for a close under $46.50 before launching new positions.

The $45 and $44 levels remain support but our target is $41.00.

Picked on   October 28 at $ 45.83 /gap down entry point 10/29/09
                              /originally listed at $46.61
Change since picked:       + 2.27
Earnings Date            10/27/09 (confirmed)
Average Daily Volume =        2.1 million  
Listed on   October 28, 2009         


Precision CastParts - PCP - close: 96.05 change: +0.42 stop: 100.55

PCP may have formed a short-term bullish reversal today. I would expect a bounce toward $100. A failed rally near $100 can be used as a new entry point.

I'm suggesting small positions about 50% your normal trade size. Our only target is $90.25. More aggressive traders may want to aim lower but I'm concerned about the trendline off the March lows, which could be strong support.

Picked on   October 31 at $ 95.53
Change since picked:       + 0.52
Earnings Date            10/20/09 (confirmed)
Average Daily Volume =        1.3 million  
Listed on   October 31, 2009         


Research In Motion - RIMM - close: 59.61 change: +3.87 stop: 65.05

Hmmm... looks like we should have followed my own suggestion and exited on yesterday's decline. The stock rallied sharply with a +6.9% oversold bounce today. Shares stalled near $60, which coincidentally is very close to a 38.2% Fibonacci retracement of its October-November decline. I would expect RIMM to roll over here or in the $62-64 zone.

I am not suggesting new positions at this time.

Picked on   October 28 at $ 62.93 /gap open entry    
Change since picked:       - 3.32
                               /1st target hit @ 58.55 (-6.9%)
Earnings Date            12/17/09 (unconfirmed)
Average Daily Volume =       17.9 million  
Listed on   October 26, 2009         


CLOSED BEARISH PLAYS

DST Systems - DST - close: 42.31 change: +0.51 stop: 45.25

More aggressive traders may want to stay with DST but I'm giving up early and suggesting an exit now. The action over the last three days looks like a new bullish reversal. Let's get out now.

Chart:

Picked on   October 24 at $ 43.73
Change since picked:       - 1.42 <-- early exit @ 42.31 (-3.2%)
Earnings Date            10/21/09 (confirmed)
Average Daily Volume =        462 thousand 
Listed on   October 24, 2009         


Netease.com - NTES - close: 38.15 change: +0.46 stop: 40.15

I'm very surprised that NTES hasn't shown more weakness given the legal battle of its attempt to launch Activision's World of Warcraft in parts of China.

I cautioned readers last night that if NTES rises over $38.00 we'd close this play early. Sure enough a late afternoon rally pushed NTES over $38.00.

Chart:

Picked on   October 17 at $ 38.47
Change since picked:       - 0.32 <-- exit early @ 38.15 (-0.8%)
Earnings Date            11/12/09 (unconfirmed)
Average Daily Volume =        2.7 million  
Listed on   October 17, 2009