Option Investor
Newsletter

Daily Newsletter, Tuesday, 1/12/2010

Table of Contents

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

Market Wrap

Where Did the Earnings Go?

by Jim Brown

Click here to email Jim Brown

This is supposed to be the start of a bullish earnings cycle but instead we are seeing earnings misses and earnings warnings. If this week is a preview of this cycle the bulls are going to be very disappointed.

Market Stats Table

This earnings cycle has started off with a thud instead of a bang. Alcoa missed estimates of six-cents and posted only a penny profit saying higher costs for power and raw materials were a factor as well as continued weakness in aerospace and construction. Alcoa shares fell over 10% on the news.

Chevron warned that Q4 results would be sharply lower than previously forecast due to pressures in the refining sector. KB Homes reported a profit but shares dropped nearly 5% after they said sales of homes came in much lower than expected. The also said profits would be flat in Q1.

Aetna (AET) fell more than 5% after warning 2010 earnings were "likely to be modestly lower." The SEC filing said earnings would be below the $2.76 estimate for 2009. Analysts were already expecting 2010 earnings to be in the range of $3.09 so the expected drop "modestly lower" than $2.76 was a major change.

Amgen (AMGN) warned today that earnings would be at the low end of their prior forecast of $4.90 to $5.05 per share. Analysts were expecting $5.04 per share. A Sanford Bernstein analyst said it looked like AMGN accelerated some expenses into 2009 so they could show some profit growth in 2010. In other words they decided to take the haircut in share price this year by forcing lower earnings so they could show better earnings in 2010 despite higher costs. This is legal book cooking. AMGN lost -2% on the news.

Electronic Arts (ERTS) slashed its earnings forecast after the close on Monday saying there was no increase in sales over the holidays. ERTS said sales were down as much as 15% in some countries. They cut full year profit estimates from $0.70-1.00 per share to 40-55 cents. The cut Q4 estimates to 31-cents and analysts were expecting 56-cents. ERTS shares fell 8% on the news.

The ERTS news crushed the semiconductor sector because investors decided the sales of video game cds are related to sales of PCs, Xboxes and PlayStations. The Semiconductor Index fell a whopping -4%.

It is not so much that traders are afraid of weak earnings from Intel or the other chips but the market was priced to perfection with everyone expecting blowout numbers. With the first couple reports negative and a sudden burst of negative pre-announcements those expectations are not being met.

News that President Obama may try to levy a new $120 billion levy on banks to pay for TARP losses to companies like AIG and GM was another drag on the market. Several of the banks did not want the TARP funds but were forced to take the money with instructions to boost lending. Then they had to pay it back in full and buy back the preferred shares. Now the president wants to tax the banks for bailing out the banking system as a way to boost the 2011 budget he will present in February. This is on top of the strong increase in fees from the FDIC. The banking index was down -2% on the news.

In my opinion this is ridiculous. The government forces tarp loans on the top 20 banks to disguise the bailouts to the banks that really needed them. Everyone was then forced to raise additional billions in capital before they were allowed to pay back the TARP loans. They had to use some of that new capital to buyback the preferred shares giving the Treasury a strong profit on the deal. The government told them to lend the remaining money to stimulate the economy. Last week regulators again warned banks not to hoard money but loan it out. This week the president wants to impose a levy on banks for another $120 billion to pay for "administrative expenses" and to recover TARP losses to companies like AIG and GM. The banks will pass that tax on to consumers and we will pay to repay the losses that we the taxpayer incurred in the TARP to start with.

Chain store sales fell -3% last week after four weeks of gains. Consumer wallets slammed shut after the holidays. Also dragging on sales was a limited amount of clearance inventory left over from holiday sales. Retailers had ordered less and discounted it heavily so there was little left for the post holiday sales.

Job openings declined for the second month and separations increased according to the Job Openings and Labor Turnover Survey (JOLTS) released today. This is a lagging report for the November period but it clearly showed the stress that led to the drop in payrolls in December. Job openings declined from 2.571 million to 2.415 million. This was the second month of decline. Separations increased to 4.34 million from 4.223 million. The number of people who quit their jobs increased to 1.96 million and the highest rate since January 2009. Layoffs fell to 2.05 million and the lowest level since September 2008. Layoffs peaked in Q1.

JOLTS Chart

The Trade Deficit for November widened more than expected to -$36.4 billion. Exports increased +0.9% and imports increased +2.6% and both to their highest levels for 2009. In order to return to pre-crash highs in July 2008 exports would need to increase another +19% and imports another +31%. The continued rebound of trade is proof that the U.S. and the global economy are in recovery mode.

The big report due out on Wednesday is the Fed Beige Book at 2:PM.

So where do we go from here? Earnings misses and negative pre announcements seem to be the trend for the week but will this trend continue? I believe today was a sample but a very small sample of what is to come. I believe the vast majority of earnings reports will be positive and the market has already priced this into equities. If we do get further negative surprises it will be very negative to the market as investors adjust their expectations.

It would be nearly impossible for 2009-Q4 earnings not to improve since 2008-Q4 posted a 10-cent per share loss for the S&P-500. That was the first earnings loss ever for the S&P. Earnings for the current cycle are expected to increase +34% to +37%. We may not be off to a flying start but at least we are in motion.

The Intel earnings on Thursday should be very bullish. We have seen the beginning of the corporate upgrade cycle and PC demand in China is exploding. Reportedly there are chip shortages everywhere and the recent CES show in Vegas highlighted the reason why. Computer usage is exploding but not specifically to desktops. The variety of computing products expands daily and every one has dozens of chips of every flavor.

I believe Intel should knock the cover off the ball and post some of its best gross margins ever at 61%. Intel declined to $20.50 on Tuesday in response to the ERTS warning but it was a sector day not an Intel day. I don't normally recommend holding long positions over an earnings report but I would on Intel this quarter.

The downside risk is the sector in general. The Semiconductor Index has risen +50% in the last six months on expectations the chips will lead us out of the recession. The -4% drop intraday was only light profit taking and with a couple more earnings challenges we could see it decline sharply. I would be a buyer of the dip today but only for a short-term trade of a couple weeks.

I believe the Alcoa earnings were much ado about nothing. Alcoa attracts attention because it is the first Dow component to report but is it really relative. When you compare it to other Dow components like IBM, MMM, HD, MSFT, INTC, HPQ, CSCO and WMT, AA is a sector specific $15 billion lightweight compared to those others with market caps in the hundreds of billions. Those other stocks give us a much better read on the global economy than Alcoa. When the ledger is closed on Q4 earnings six weeks from now Alcoa won't even rate a footnote.

To be fair the hysteria today wasn't just about Alcoa. Chevron tanked the energy sector because of refining margin declines due to lack of demand. Nobody focused on their +9% production increase for the quarter. That is huge for a major oil company where increases are measured in low single digits. Exxon had a -1.2% production loss and nobody noticed.

These companies were pilloried today because there was nothing else to talk about. This time next week and there will be dozens of companies reporting every day. Once the big cap reporting is over in about two weeks we will have something to worry about if the market turns negative.

Not every earnings announcement on Tuesday was negative. Infosys (INFY) posted better than expected earnings and raised estimates for the entire year. The CEO said the "global economic recovery seems to be led by the U.S. and the financial services sector. He also said INFY was having to hire internationally because they could not get enough qualified people to handle their new projects. INFY rose +5% on the news to $57.67.

INFY Chart

Tiffany (TIF) reported that sales surged in November by +16% and December by +10%. This was coming on top of some lousy comps where sales fell -35% in the same period in 2008 but still good news. In Q4 sales rose +15% in the Americas, +11% in Asia Pacific and +30% in Europe. Tiffany now expects Q4 earnings to be in the range of $2.07 to $2.12 and up from earlier forecasts of $1.88 to $1.98 per share. Analysts were expecting $1.92 per share.

Hartford (HIG) raised earnings estimates to nearly double prior estimates and shares rallied nearly 7% at the open. Hartford said earnings were now expected in the range of $1.45 to $1.60 for Q4 compared to prior estimates of $.65 to $.80 per share. Analysts were expecting 82-cents. Shares ended up only +3.6% because Hartford was already up +15% for the last week.

Oil prices finally broke with a dip to $79.91 after hitting $83.95 early Monday. Analysts blamed it on news from China that banks would have to set aside a larger proportion of deposits as reserves. This was the first increase since 2008 and is supposed to suppress new loans and keep the economy from overheating. The rise in warmer weather was also blamed on the decline in oil prices. I believe oil declined like the market because of the decline in year-end retirement funds as we approach the middle of January. The threat of an inventory gain on Wednesday's EIA report was also to blame as is the approaching futures expiration next week.

Crude Oil Chart

The CFTC is meeting on Thursday to decide on placing position limits on energy futures. This is a very controversial topic and it will be webcast at www.cftc.gov. Considering the recent buying frenzy by commodity funds that pushed prices to nearly $84 it appears nobody expects those limits to be imposed. In the most recent CFTC data contracts held by large speculators are at all time highs in oil, gasoline and heating oil. The Dow Jones Commodity Index will be rebalanced on Wednesday and managers are adding to natural gas holdings and trimming positions in oil and gasoline.

While on commodities the corn futures plunged limit down today after the government announced there was 13.5 billion bushels of corn being planted for the 2010 season. This a a record amount and should mean a record harvest assuming the dust bowl drought does not return in 2010. A record harvest means lower prices and that was reflected in the futures. It was also reflected in the fab five fertilizer stocks with a -4% or greater decline. If farmers expect a record harvest is going to lower prices then they won't lay out the extra money for a big fertilizer application.

Fitch ratings said 9.2% of prime jumbo mortgage loans were delinquent in December. That is almost 300% higher than the 3.2% delinquency rate in December 2008. Florida led the nation with a 16% delinquency rate followed by California at 10.8%. Fitch says more than one-third of prime jumbo borrowers that were still current on their loans are underwater and owe more than their house is worth but are still making payments.

The Mortgage Bankers Association said they expect the number of mortgages written in 2010 will decline -40%. Originations in 2010 are expected to be around $1.28 trillion and well below the $2.11 trillion in 2009. If this comes true it will be the lowest volume since $1.14 trillion in 2000. The MBA is expecting mortgage rates to rise sharply when the Fed gets out of the mortgage market in February. With more than 30% of homeowners currently underwater in their mortgage it makes moving to a new home really difficult without paying off that underwater premium.

Can you believe it is almost time for the Super Bowl? The recession has depressed prices for Super Bowl ads for only the second time in history. Media Intelligence said 30-second spots are selling this year between $2.5 and $2.8 million. That is a drop from last year's average of $3 million. Prior big spenders Pepsi and GM are opting out this year and smaller companies are bidding lower for the spots. This will be Pepsi's first absence in 23 years. As of Friday only four of the 62 commercial spots remained unsold. A newcomer this year will be Homeaway.com a vacation rental website. They are bringing back Chevy Chase ad Beverly D'Angelo as the Griswold family to star in the commercials.

For the rest of the week I think our fate is still tied to the Intel earning. Intel is the heartbeat of the tech sector and Thursday's EKG had better not show any signs of a heart attack in the making. I think traders will buy today's dip in anticipation of a good report by Intel. There are no material earnings due out on Wednesday and only the Fed Beige Book in the way of economic events.

The Dow to 10676 on Monday and dipped to 10568 intraday today. That dip was anemic at best and no real change in the trend. The Dow has resistance at 10750 and initial support at 10550. I do not expect that support to be tested without some new headline to disrupt sentiment.

Dow Chart

The S&P declined nearly three times as much as the Dow in percentage terms at -0.94% compared to -0.34%. I know that is splitting hairs but I have a point. Remember last week when I pointed out that the S&P and Russell were up much stronger than the Dow because the year-end retirement funds were primarily headed for index funds tracking the S&P and Russell. That year-end inflow of cash is fading and what we saw today was the result of that fade with stimulation by the earnings events. I don't think there was any real damage to the S&P with support at 1130 and again at 1115. A break under 1130 would have me start to worry.

S&P Chart

The Nasdaq dropped sharply with a =1.3% decline. Support at 2280 was tested all day and it was only because of an end of day buy program that the Nasdaq did not close under that level. This is critical support followed by even more critical support at 2250. A break of these levels would be very negative and produce dozens of sell programs as funds take profits from the 2009 rally.

Nasdaq Chart

The Russell declined to test very long term downtrend resistance, which was crossed back on Jan-4th and is now support. The Russell lost -1.3% but without some new market disaster it should not crack the 625-630 threshold. A more under 625 would be very bearish.

Russell 2000 Chart

As I said earlier, it is all about Intel this week. They are going to report earnings in a new format that is expected to unlock additional value in the stock by showing income from different operations. Let's hope this new structure is not cobbled together with chewing gum and bailing wire.

I would be a buyer of this dip as long as those support areas mentioned above are not violated.

Jim Brown


New Option Plays

All Aboard!

by James Brown

Click here to email James Brown


NEW DIRECTIONAL CALL PLAYS

Union Pacific - UNP - close: 67.39 change: -0.20 stop: 64.90

Why We Like It:
The market's pull back on Tuesday has allowed us an entry point into the railroads. The sector broke out past resistance in just the last few days so this dip is a chance to hop on board. I'm suggesting we buy calls on UNP now. Our first target is $69.95. Our second target is $72.00 but that is very optimistic. Earnings are coming up this month and we plan to exit ahead of earnings. I'm listing our stop loss at $64.90 but more conservative traders might be able to get away with a stop closer to $66.25 or $66.50. The low today was $66.76. Our risk/reward is not super attractive here so consider smaller positions.

Suggested Options:
I am suggesting the February calls but we will plan to exit ahead of the January 21st earnings report. My preference is for the $70 strike.

BUY CALL FEB 70.00 UNP-BN open interest=5561 current ask $1.20

Annotated Chart:

Entry  on   January 12 at $ 67.39  
Change since picked: + 0.00
Earnings Date 01/21/10 (confirmed)
Average Daily Volume = 2.5 million
Listed on January 12, 2010



In Play Updates and Reviews

Widespread Decline

by James Brown

Click here to email James Brown

The stock market experienced a widespread pull back. A handful of our candidates are testing short-term support levels.


CALL Play Updates

AvalonBay Commty. - AVB - close: 78.59 change: -1.89 stop: 77.90

There was no follow through on AVB's bounce from Monday. The stock retreated back toward short-term support near $78.00. If the stock closes under $78 we might drop it as a bullish candidate. I'd start watching prior resistance in the $76-75 zone as potential support. Right now our plan is to buy calls if AVB hits our trigger at $82.05. If triggered our first target is $87.50. We will plan to exit ahead of the early February earnings report.

Entry  on   January xx at $ xx.xx <-- TRIGGER @ 82.05
Change since picked:       + 0.00
Earnings Date            02/03/10 (confirmed)
Average Daily Volume =        1.4 million  
Listed on   January 09, 2010         


Caterpillar - CAT - close: 62.24 change: -1.89 stop: 59.45

After yesterday's big move it was natural to see some profit taking in CAT. Shares gapped open lower at $63.01 but traders bought the dip near $61.20. Look for broken resistance near $60 to act as new support. Our second and final target is $67.00. Earnings are coming up quick and we plan to exit ahead of the report on January 26th.

Entry  on   January 09 at $ 60.95 /gap higher entry (small positions)     
Change since picked: + 3.18
/take profits early $ 64.13 (+5.2%) Earnings Date 01/26/10 (confirmed)
Average Daily Volume = 4.8 million
Listed on January 09, 2010


Express Scripts - ESRX - close: 89.17 change: -1.06 stop: 87.45

The pull back in ESRX continues with the market-wide decline on Tuesday. Prior resistance near $89.00 is offering a little bit of support. At this time I'd wait for a new bounce back above $90.00 before considering new bullish positions. Our first target is $95.75. Our second target is $99.75. We do not want to hold over the February earnings report.

Entry  on   January 09 at $ 91.65 (small positions)     
Change since picked: - 2.48
Earnings Date 02/24/10 (unconfirmed)
Average Daily Volume = 2.6 million
Listed on January 09, 2010


FUQI Intl. - FUQI - close: 21.15 change: -0.52 stop: 18.99

FUQI delivered a volatile morning with a gap down and immediate spike higher. Yet by the closing bell shares gave up 2.3%. Watch for broken resistance near $20.00 and its 50-dma to act as new support. Traders can use a dip or a bounce near $20 as a new entry point to buy calls. This was a very aggressive trade and I suggested very small positions. Our target to exit is $24.75 but more conservative traders may want to start taking profits early anywhere above $22.50.

Entry  on   January 06 at $ 20.51   (small positions 1/4)  
Change since picked: + 0.64
Earnings Date 03/31/10 (unconfirmed)
Average Daily Volume = 1.0 million
Listed on January 04, 2010


J.P.Morgan Chase - JPM - close: 43.49 change: -1.04 stop: 41.90

We have two days left. JPM is due to report earnings on Friday morning. I am tempted to hold over the report. The yield curve has been exceptionally steep, which gives banks a big profit margin on their lending. However, there are dozens of other factors and risks to consider. Thus, we'll play it safe and exit on Thursday at the closing bell to avoid holding over the earnings announcement. I'm not suggesting new positions at this time. Our second and final target is $46.90.

Entry  on   January 04 at $ 42.85 (small positions 1/2)      
Change since picked: + 0.64
take profits on 01/09/10 @ 44.68 (+4.2%) Earnings Date 01/15/10 (confirmed)
Average Daily Volume = 31.6 million
Listed on January 04, 2010


L-3 Communications - LLL - close: 88.18 change: -0.46 stop: 86.90

LLL was not immune to the market's decline but traders were buying the dips both this morning and this afternoon. More conservative traders could bump their stops toward today's low (87.47). The trend for LLL is still up but if the market really starts to correct we can bet on LLL following it lower.

I did label this an aggressive, higher-risk trade. Our first target to take profits is at $89.95. Our second and final target is $94.00. We want to exit ahead of the late January earnings report. FYI: The Point & Figure chart is bullish with a $104 target.

Entry  on  December 28 at $ 86.80       
Change since picked: + 1.38
Earnings Date 01/28/10 (unconfirmed)
Average Daily Volume = 1.0 million
Listed on December 26, 2009


Precision Castparts - PCP - close: 114.49 change: -1.79 stop: 112.25

PCP is seeing some volatility with a high of $118.62 yesterday and a low at $112.92 today. If there is any follow through lower tomorrow we'll probably get stopped out. More conservative traders could exit early now. Traders did buy the dip this morning so I'm not willing to abandon ship just yet. I'm not suggesting new positions. More aggressive traders could aim higher. We'll keep our final exit at $118.75.

Picked on  December 01 at $107.35      
Change since picked: + 7.14
/1st target hit $112.45 (+4.7%)
Earnings Date 01/20/10 (unconfirmed)
Average Daily Volume = 817 thousand
Listed on November 28, 2009


TORO Co. - TTC - close: 43.22 change: -0.55 stop: 41.40

TTC is holding up reasonably well. The stock has traded in the $43-44 zone the last couple of days. The $44 level is resistance from late December. If shares actually reversed from here it will looks like a bearish double top. I would be tempted to buy calls on a new dip or a bounce near $42.00. Our exit target is $45.90. We don't want to hold over the February earnings report. The plan calls for small positions to limit our risk.

Entry  on   January 07 at $ 42.60 (small positions)      
Change since picked: + 0.62
Earnings Date 02/18/10 (unconfirmed)
Average Daily Volume = 289 thousand
Listed on January 05, 2010


UnitedHealth Group - UNH - close: 32.05 change: -0.87 stop: 29.90

Healthcare stocks are normally considered a defensive play but the group was not immune to today's market weakness. UNH gave up 2.6% with a plunge toward its 10 and 21-dma. If you were looking for an entry point near $32 you got it. Just be sure to use a relatively tight stop loss.

This was a "lottery ticket" style of play. We knew it was risky given all the political ups and downs for the healthcare bill. Our time frame was several weeks and we listed January and March calls. At this time if you choose to open new positions I'd use March calls but that would require holding over the late January earnings report (to get the most out of your March calls). Our first target is $34.00. Our longer-term target is $36.00.

Entry  on  December 10 at $ 30.31       
Change since picked: + 1.74
Earnings Date 01/21/10 (unconfirmed)
Average Daily Volume = 819 thousand
Listed on December 10, 2009


Whirlpool - WHR - close: 82.35 change: -1.67 stop: 79.90

Shares of WHR gapped open lower at $83.24 this morning. The stock managed a meager bounce from its 21-dma. If you were looking for a dip near $82 as an entry point you got it. Our original play suggested January calls so we'll need to exit before expiration.

WHR has already hit our first target at $84.75. Our second target is $89.00.

Entry  on  December 19 at $ 80.76 /gap higher entry      
Change since picked: + 1.59
/1st target hit $84.75 (+4.9%)
Earnings Date 02/08/10 (unconfirmed)
Average Daily Volume = 1.6 million
Listed on December 19, 2009


PUT Play Updates

Sears Holding - SHLD - close: 100.43 change: +0.99 stop: 102.05

Uh-oh! We could be in trouble here. The market produces a widespread decline and SHLD rallies? That's not the sort of relative strength we want to see in our put candidates. I am suggesting that more conservative traders exit early now. I'm not suggesting new positions. Our first target to exit is $95.25. Our second target to exit is $91.00.

Entry  on   January 09 at $ 99.17 (small positions) 
Change since picked: + 1.26
Earnings Date 02/25/10 (unconfirmed)
Average Daily Volume = 2.0 million
Listed on January 09, 2010