Option Investor
Newsletter

Daily Newsletter, Tuesday, 4/27/2010

Table of Contents

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

Market Wrap

Portugal Catches Greek Debt Flu

by Jim Brown

Click here to email Jim Brown

Greece problems worsened today when their debt was cut to junk status and the contagion spread to Portugal with their debt cut two notches.

Market Stats Table

S&P cut Portugal's debt two notches from A+ to A- and warned that further downgrades were possible. This followed the S&P downgrade on Greece long and short-term debt to non-investment status (B and BB+) and warned that anyone who owned Greek bonds faced a dwindling chance of getting their money back. S&P said that Greece's ability to cut spending and increase austerity measures was "materially weakened by domestic political opposition." They were referring to the continued riots and nationwide strikes protesting the austerity plans. Even their air force went on strike. The odds that Greece would eventually restructure its debt are increasing. This strong language was the only excuse needed for equity investors to dump stocks and the Dow closed on its lows for the second consecutive day.

The dollar soared to a new 52-week high and the Euro fell to a new 52-week low. Even the British pound was crushed and lost more than two full points to close at 151.85. The price of gold rocketed higher to $1,173 for a +$18.80 gain at the close and a new five month high.

Foreign markets imploded with the London FTSE falling -2.61% and the CAC-40 in Paris fell -3.83%. On this side of the pond Mexico lost more than 3% and Brazil's Bovespa was down -2.7% at midday.

With the dollar soaring the price of commodities other than gold fell sharply. Prices for crude oil fell to a low of $81.70 intraday and -$3.12. There was a slight rebound at the close to end down -2.40 at $82.42. Copper prices dropped -4.6% for the day. Energy and commodity stocks also fell sharply. Stocks with large recent gains were crushed as the profit taking accelerated.

It did not help that CNBC was 100% coverage of the testimony of Goldman executives to the Senate committee. Investors and traders who wanted to know why the markets were dropping and how it impacted their various positions were greeted with eight hours of testimony with only short breaks during recesses and those breaks were used to summarize the prior hour of testimony. This was not helpful to people who wanted to know why the market was down triple digits and what was powering the decline.

On the economic front the news was excellent but it did not make the headlines given the Greece and Goldman news blanket. The Richmond Fed Manufacturing Survey exploded higher to 30.0 for April after a reading of 6.0 in March. This is the highest level on record! The shipments component rose from 5.0 to 30.0 and the highest level since March 2004. New orders rose from 31.0 to 41.0 and the highest level on record. The employment index rose to 13 and the highest level since December 1994. The Richmond Fed Survey was very bullish and suggests the economic activity at least in the Richmond area is accelerating rapidly.

Richmond Fed Survey

The Consumer Confidence reading for April rose sharply to 57.9 from 52.3 in March. After several months of erratic readings on confidence the April reading was the highest reading since September 2008. The majority of the gains came from the expectations component, which rose from 70.4 to 77.4. The present conditions component also rose from 25.2 to 28.6.

Those planning on buying an auto rose to 5.1% from 3.9% and those considering an appliance purchase rose to 27.4% from 25.5%. However, those planning on buying a home fell to 2.0% from 2.8%. Obviously the consumer is feeling more confident about the state of the economy and this is shown in their purchase plans. The decline in plans to buy a home is simply a factor of the sell forward over the last three months in order to capture the tax credit. Now that the credit expires in three days there are very few people left with purchase plans. If they had a plan they have already acted on those plans.

Despite the sharp rise in confidence the level remains at recessionary levels. As recently as late 2007 the confidence level was over 110. Today's 57.9 is barely over half the levels we saw before the crash and barely over the highs of the last 12 months.

Despite the rise in confidence over a quarter of the respondents expect the stock market to decline in 2010. The majority of respondents still expressed concerns over high unemployment, problems getting credit and higher gasoline prices.

Consumer Confidence Chart

The Case Shiller Home Price Indexes for February showed an actual gain in prices of +0.6% compared to a -0.7% decline in the prior month. Considering the rising number of repossessions and foreclosures the rebound in home prices is moving much slower than expected. This is a lagging indicator covering the February period and as such would have been ignored without the Greek news and the Goldman grilling.

Case Shiller Chart

Economic reports due out on Wednesday include the Mortgage Applications, Oil and Gas Inventories and the FOMC announcement. Obviously the biggest of those events is the FOMC. The announcement at 2:15 is not expected to produce any change in rates other than a potential for another discount rate hike. The key to the statement will be the retention or the discarding of the "extended period" language. There have been dissentions in the recent past and I am sure there will be dissentions again this week. Whether there were enough dissenting votes to change the language is the question.

I mentioned over the weekend that a statement change could actually be perceived as a positive event that would indicate the Fed is becoming more bullish on the economy. Since the bad news bulls have been buying every dip there is a growing chance that they would buy the language change as well.

It appears that the majority of analysts have shifted to a statement change position. If the Fed is aware of this fact then that increases the chance they will change the statement because it is basically a free move. If everyone thinks they are going to change then not changing could actually cause a new round of questions over what the Fed knows that analysts don't know. This should be a really interesting statement considering the chess moves leading up to it.

On the earnings front 3M (MMM) posted earnings of $1.40 per share if you exclude an 11-cent charge for the new health care program. Analysts were expecting $1.21 per share. That was a 79% increase from the year ago quarter. 3M raised its guidance for the full year to $5.40-$5.60 from $4.90-$5.10. However that guidance increase was not based on a rebounding U.S. economy. 3M CEO George Buckley said, "I don't think we should look to the U.S. for a big recovery in 2010." 3M is looking to a strong rebound in Asia and Latin America for the increased profits. 3M said the rebound in auto sales was helping their profits since they make over 1,000 products for cars including paints. Sales of films for LCD TVs, cell phones and computers improved the most. MMM closed positive for the day but significantly off it highs of $90.25.

Ford (F) reported earnings of 50-cents compared to a loss of 60-cents in the year ago quarter. Ford said it expected to be solidly profitable in 2010 and that is a year earlier than their prior guidance. Ford's market share gains took the largest jump in 33 years but analysts were afraid the company could not maintain those gains. Another factor worrying analysts was a large $528 million profit from the finance division but that is expected to decline later this year as cars financed before the recession are traded and paid off and the lack of cars sold during the recession lead to lower finance profits.

Ford's CFO took issue with analysts whining about potential pitfalls ahead and said "We would not have improved our guidance if we thought this was just a wild quarter." Ford saw $1 billion in gains from higher pricing and lower incentives. Ford expects U.S. vehicles sales in 2010 of between 11.5 and 12.5 million compared to sales of 10.4 million in 2009 and 16 million in 2005. Ford shares lost -6% after their earnings release.

Ford Chart

Lexmark (LXK) posted earnings of $1.20 per share compared to 75-cents in the year ago quarter. Analysts were expecting 89-cents. The strong earnings came on an increase in sales and continued cost cuts. Printer sales rose +20% including a 27% spike in revenue from laser printers. Lexmark upgraded guidance to 85-95 cents for Q2 compared to analyst estimates of 73-cents. Gross margins rose to 36.9%. Moody's raised their ratings outlook to stable from negative. LXK rallied to a new 52-week high but collapsed back to close only fractionally positive on market weakness.

Lexmark Chart

UPS reported earnings of 71-cents that beat analyst estimates of 57 cents. UPS said the international package segment posted an 18% jump in revenue on an 18% jump in daily volume. UPS also raised estimates for 2010 but not substantially. UPS prewarned of the earnings beat earlier in April. The positive comments about increased daily volume have been echoed by FedEx. UPS shares lost-3.4% on Tuesday.

ADP reported earnings that beat the street by two cents but offered cautious guidance. ADP said 2010 earnings would probably be little changed from 2009 due to the low levels of employment. "It is going o be a gradual upswing" according to the CFO on the conference call. ADP declined -2% on the news.

Yesterday Caterpillar (CAT) reported earnings of $233 million for Q1 and reversed a loss in the comparison quarter. Before a health care charge of $90 million their earnings were 50-cents per share. After the charge their earnings were 36-cents. The CAT CFO said, "We are in a revival. There is no doubt about it." CAT spiked to $72.83 on the news on Monday but was a significant drag on the Dow today with a -4.3% decline to $68.60.

After the close today Broadcom (BRCM) reported earnings of 57-cents compared to analyst estimates of 47-cents. Broadcom also raised guidance for revenue of $1.5b to $1.6B. Analysts were expecting $1.4B. Broadcom said sales to businesses were improving and demand is strong and improving. They are building chips for Samsung cell phones as well as those from Apple and Nokia. They said supply was tight but they were able to keep up with demand. This was similar to the Texas Instruments earnings on Monday. BRCM declined -3.3% on Tuesday and rebounded +2% in afterhours.

The best earnings for the day came from BP. The oil company reported earnings of $1.94 compared to estimates of $1.57 and year ago earnings of 82-cents. Profits rose +135% to $5.6 billion for the quarter. Were it not for the growing oil spill in the gulf I am sure the results on the stock price would have been a lot better. BP fell -2.7% today after a huge drop on Monday as the oil spill news turned for the worse.

BP has been unable to activate the valves on the blowout preventer on the ocean floor. The plan now is to lower a dome over the leak and attempt to pipe the oil to the surface to prevent a greater spill. BP says the dome should be completed in 2-4 weeks. BP said they were spending $6-10 million a day to mitigate the spill. The Development Driller III rig has been moved into position to begin drilling a relief well that will close off the first well. That is expected to cost another $100 million and could take two months. They are considering drilling a second relief well with another rig at the same time just in case the first relief well failed. That would cost an additional $100 million according to BP. The company is self-insured and will have to bear the full cost of all the mitigation efforts. The stock price has declined about $4.50 since the explosion but the majority of that has been this week. The real losses did not occur until the Coast Guard reversed their original claim that the well was not leaking. The oil slick is now 49 miles by 100 miles and continues to grow.

Chart of BP

In my comments about the bank closures over the weekend I erroneously stated that the total bank closures so far in 2010 were 140. That was the total for 2009. The total for 2010 is now 57. At this rate we will exceed the 2009 total.

The debt downgrade to Greece and Portugal was simply a perfect excuse for profit taking. The impact to the U.S. will be negligible with the dollar strengthening and a slightly larger bid for our debt at auction. The Greek bailout package may have to be increased because of the inability of Greece to sell debt in the future. Already the IMF is looking to add €10bn to the previously announced €45bn package. This is likely to continue to grow as the year progresses. Greece already has more than €300bn of euro debt in the market. The addition of Portugal and Spain to the endangered species list is likely to mean that the EU and the IMF will eventually be called upon to lend them some money as well. This story is not going away for a very long time. However, it really has little impact on the U.S. economy or markets. It was an excuse to sell and nothing more.

The Goldman Grilling was the perfect public flogging. Goldman CEO Lloyd Blankfein was beaten up for more than three hours by senators that were able to perfectly phrase their accusatory questions and then not allow an answer in any form they did not like. The eleven hours of testimony was the equivalent of a kangaroo court. The hearing had no bearing on anything except the further demonization of Goldman and big banks in general and possibly lifted the election hopes of a couple senators. Shares of Goldman closed the day with a gain of +$1.

If nothing else the Goldman grilling provided lawmakers with a high profile podium from which to lobby for passage of the financial reform bill. Some topics in the bill were repeatedly used as talking points by the Senators on the panel. Do they really think we are so stupid that we can't see though the haze and understand their underlying political motives?

The Dow lost -213 to close just under 11,000 and right on decent support. Despite all the smoke circling the markets there was no fire. Had the Goldman assassination not been televised for nearly 11 straight hours without commercials and only a minimum of voice over with market tidbits the market outcome would have been significantly different. When the markets are dropping and investors don't know why the tendency is to sell first and ask questions later.

Market volume was very heavy with 12.6 billion shares traded after a 9.2 billion share day on Monday. This was stops being hit and selling on uncertainty ahead of the FOMC announcement on Wednesday. Volume was 10:1 negative.

Ordinarily I would be suggesting we buy this dip. I believe we will see a rebound but possibly not until after the FOMC announcement. When selling accelerates on uncertainty as it did today it sometimes becomes a self-fulfilling process. Selling sometimes begets more selling. When you look at the huge losses by some or the prior high flyers it was evident that momentum traders were running scared.

I think the initial Dow support at 11,000 should hold but we know that Europe is going to trade down overnight and Asia will probably be down as well because of our decline. That could cause some follow on selling on our markets. If the Dow moves lower the next support is around 10,850. I would expect that level to be bought. Earnings are still good and the FOMC is not expected to do anything stupid otherwise all bets are off.

Dow Chart

The S&P-500 fell -2.3% and stopped right in the 1180-1185 support range where you would have expected it to stop. The next material support is 1165 and we could easily test that on an early morning intraday dip. The day's decline was the largest drop since Feb-4th and without any material change in the U.S. economy it is a dip that should be bought.

S&P-500 Chart

The Nasdaq declined -2% or -51 points but the decline halted exactly where you would have expected it to stop. Apple gave back -2.7% but that decline failed to reach even initial support at $258. Tech traders were not running for cover even on a grossly overbought stock like Apple. Now for the qualification. If the Nasdaq does decline under 2470 the next real support is well below at 2400. I think the Nasdaq has a clear line in the sand and one that will trigger additional selling if it is violated.

Nasdaq Chart

The Russell declined an equal amount in percentage terms as the big cap indexes. If the Russell had corrected more than the other indexes I would be more bearish. Instead I think this was just a news driven, actually a news blackout driven, decline that will be bought. By that I mean that the Goldman grilling blacked out all the other news in a busy market day.

The next support on the Russell is 700 and we could easily trade there without breaking the longer-term uptrend.

Russell Chart

In summary, I think the dip will be bought but possibly not until after the FOMC statement at 2:15. If the dip is not bought and the FOMC statement is neutral then we have seen a major shift in market sentiment. I had been expecting a decline prior to the FOMC announcement but today's news blackout drop exceeded my expectations.

I would be a buyer of any opening dip with a stop under the morning lows. After the FOMC announcement there will probably be additional volatility regardless of what they say. Remember, that the market historically declines the day after the FOMC meeting on a sell the news trade. Today's dip should have negated that normal decline and that is why I would be a dip buyer on Wednesday.

Jim Brown


New Option Plays

New Plays After FOMC Announcement

by Scott Hawes

Click here to email Scott Hawes
Editor's Note: I think it is smarter to wait until we see how the market reacts to the FOMC announcement tomorrow prior to initiating new plays. This market has been tough enough to navigate over the past week or two and initiating a new play by guessing what happens tomorrow at 2:15 PM EDT is simply that, guessing. If the quantitative easing language remains we have plenty of longs to benefit, however, if the language changes or there is a surprise rate increase we may have already seen the highs of the year. And I will be ready with biased positions for either direction in tomorrow's newsletter.

Here is a trade idea for those of you who are interested: Long ATPG - the stock has been thrown back to horizontal support from early January highs and also has upward trend line support from February lows. The stock is sitting right on its 20-day SMA.



In Play Updates and Reviews

BCR is a Big Winner, SPY is a Small Loser

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:

Good evening traders. BCR hit our target today (twice actually) and we are flat for a healthy gain. SPY also gave us what we were looking for today by trading down to its 20-day SMA. We closed this position for a very small loss. The question now is what will happen after the FOMC announcement tomorrow. If the language changes it could spark some serious selling, but if the language remains consistent it may give the markets an excuse to continue this rally. I am not releasing new plays tonight ahead of the announcement. Please stay nimble with any positions tomorrow as there is bound to be some volatility in the afternoon beginning at about 2:15 PM sharp. We are still waiting for long entries in WFT and HANS. TOL has gotten off to a good start as well.

Current Portfolio:


CALL Play Updates

Hanson Natural Corp. - HANS - close 42.56 change -0.48 stop 40.45 *NEW*

We are still waiting to be triggered on HANS. The stock held up rather well today considering the broader market sell-off. I still like the set-up of this trade and suggest readers buy calls if HANS trades down to our trigger. I am looking for HANS to retrace about half of Friday's gain to $42.30. I suggest readers initiate call positions as outlined below. HANS is still above its 20-day SMA and the stock is forming a longer term ascending triangle. It is currently in the middle of an upward channel that has been intact since mid 2009. I believe the stock is poised to breakout higher or at least trade to $43.75 which is our first target. Our second target is $44.95. The company reports earnings on May 6 so we will be out of this trade prior to the report if we get triggered. There was some unusual call buying late last week so traders may be expecting a good earnings report, but this is just speculation. The stock has good support at about $40.70 so I would like to use a stop just under this at $40.45 if we get triggered. Our time frame is 1 to 2 weeks.

Trigger to buy calls if HANS trades to $42.30

Suggested Position: Buy MAY $43.00 CALL, current ask $1.60, estimated ask at entry $1.45

Entry on April xx at $ xx.xx
Earnings Date 5/06/10
Average Daily Volume = 854,000
Listed on April 21, 2010


Weatherford International - WFT - close 17.97 change -0.32 stop 15.90

WFT was strong again this morning, trading higher by +2.7%, before profit takers the stock stepped in and the stock closed lower by -1.75%. I mentioned last night that I did not suggest chasing the stock, rather be patient and wait for WFT to retrace. We are getting close to our trigger and I still like the trade set-up. I am not trying to hit a homerun here; I'm simply trying to catch another upward leg in the stock after a normal healthy retracement. WFT almost traded down to our aggressive entry at $17.85 which is near a recent swing high. Depending on the price action tomorrow we may initiate positions at this level. But ideally I would like to wait until $17.55. The volume on WFT's pullback today was higher than yesterday so I anticipate some pressure tomorrow on the stock. But I also believe that as soon as the selling subsides WFT can resume the recent gains seen over the last week or so. I like the story behind WFT so I'll leave my comments from Saturday for readers who may not have read them. On the intraday charts WFT double bottomed last week on April 19 and 22 and has since exploded. This was probably due to data released late last week regarding oil rig count activity which is through the roof. Rig counts are near all time highs in many parts of the United States. We are talking about 25%+ sequential quarterly growth in both oil and gas. This should bode well for WFT and their sector. And I would like to participate in this momentum on the first WFT pullback. I suggest traders buy June calls if WFT trades to $17.55. There is some resistance at $17.80 but I think it's only a matter of time before it busts through this level. I am going to place a wide stop on this trade at $15.90. I think this trade has some potential but we may need to give it some time and room to work which is why I want to buy June calls.

Trigger to buy June Calls if WFT trades to $17.55, or a more aggressive entry at $17.85

Suggested Position: JUNE $17.00 CALL, current ask $1.83, estimated ask at entry $1.40

Entry on April xxth at $ xx.xx
Earnings Date Over 2 months
Average Daily Volume = 14.9 million
Listed on April 24 2010


PUT Play Updates

Toll Brothers - TOL - close 22.16 change -0.63 stop 24.25

We initiated TOL in the portfolio this morning and are now long PUTS at $1.40. After briefly peeking its head into positive territory, the stock sold off the remainder of the day. Our $1.40 PUTS are now worth about $1.75 for a +25% unrealized gain. There will inevitably be a bounce in the coming days but this will probably just be a bounce that makes a lower high on the daily chart. On November 11 TOL made an intraday high of $21.80. This level might act as support, especially if there is not a bounce prior to the price reaching this level. I suggest readers tighten stops and protect profits at this level just in case a reversal starts.

My thesis on this position remains the same so I will leave my comments from last night. TOL surged higher last week along with the other homebuilders, setting new 52-week highs. The surge was credited to a sharp increase in new home sales which many feel was a result of the homebuyer tax credit expiring this week. This probably created pent-up demand and the builders could suffer from it in the future. In addition, TOL is a builder of luxury homes and the tax credit phases out for married persons making more than $225K per year. So TOL may not have benefitted like the other builders. I believe the rally in TOL may have been "dragged along for the ride" and I am expecting a pullback. From a technical standpoint TOL has reached resistance from August 2009 which I think will hold and give us the pullback we are looking for to make a quick profit. Our stop is $24.25 which is above the recent highs. Our target is $21.50, but if $21.80 is reached before a bounce I suggest readers take profits. Our time frame is a couple of days to about two weeks, depending on price action.

Current Position: JUNE $23.00 PUT, entry @ $1.40

Entry on April xx at $ 1.40
Earnings Date Over 2 months
Average Daily Volume = 3.2 million
Listed on April 26, 2010


CLOSED BEARISH PLAYS

Bard (CR), Inc – BCR – close 84.63 change -0.24 stop 90.10

BCR hit our target today at $84.60 and we are now flat on the position for a nice gain. Our $1.45 PUTS were sold for $2.50 for a +70% gain. The stock seems to have found support right at $84.50. I recommend readers who may still have positions to tighten stops or take profits. BCR continues to look bearish to me but it is still hanging on to its 50-day SMA. I initially thought this trade was going to last about 2 weeks but I am glad to take profits here and move on to the next trade.

Closed Position: JUNE $85.00 PUT @ $2.50, entry was at $1.45

Annotated Chart:

Entry on April 23 at $ 1.45
Earnings Date Greater than 1 month
Average Daily Volume = 1.5 million
Listed on April 22


SPDR S&P 500 Index - SPY - close: 118.48 change: -2.87 stop: 123.05

Finally, we got the intraday sell-off we were anticipating today. Our SPY position was closed as instructed in last night updates. We listed a couple of different potential targets for possible exits because we thought that at some point SPY would have a significant intraday correction before tomorrow's FOMC meeting. Well, that's what happened today except the indices never really saw the dip buyers follow through with any real strength. SPY kept going through our first target and when it hit our second target it was our queue to go flat. The surge in volatility (VIX was up +30%) helped increase the value of our PUT which was sold for $2.00, representing a small loss of -2.5%. Readers who still have positions, congratulations as the PUTS closed the day at $2.50 so you now have a gain. Please don't let this position reverse on you and protect profits. I have listed several support areas on the chart below. I would not be surprised to see SPY curl back upward to test its broken 20-day SMA.

Closed Position: SPY PUT MAY $119.00 @ $2.00, entry at $2.05

Annotated Chart:

Entry on April 13th at $ 2.05
Earnings Date Not Applicable
Average Daily Volume = 164 million
Listed on April 12th, 2010