Option Investor
Newsletter

Daily Newsletter, Monday, 5/17/2010

Table of Contents

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

Market Wrap

Stocks Erase Losses, Book Small Gains

by Todd Shriber

Click here to email Todd Shriber
It was another volatile day on Wall Street as Europe's debt woes continued to be a thorn in the side of the bulls with the Euro falling to a four-year low intraday. That helped the Dow Jones Industrial Average plunge as much as 184 points before reversing course to notch a gain of almost six points to finish the day at 10,625.83. The S&P 500 gained just over a point to settle at 1136.94 while the Nasdaq added about 7.4 points to close at 2354.23. Small-caps saw some positive trade as well with the Russell 2000 adding 1.73 points to finish the day at 695.71.

Stats Table

Showing how fragile investor sentiment is these days and how deep the impact of the European imbroglio really is, there were really no negative headlines or news events to encourage such a steep sell-off this morning. Lowe's (LOW), the second-largest U.S. home improvement retailer, said its first-quarter profit rose 2.7% to $489 million, or 34 cents a share, from 32 cents a share a year earlier. Sales jumped 4.7% to $12.39 billion. The North Carolina-based company raised its 2010 outlook, but the forecast stilled missed analyst estimates and Lowe's shares finished the day lower by 3.1%. So in the search for negative Monday catalysts, the Lowe's profit report may have been among them.

Lowe's Chart

There were a couple of economic data points that probably would have had stocks trading much higher in a more docile market environment, but with volatility being the order of the day recently, bullish news from the likes of the National Association of Home Builders is easy for investors to gloss over. The NAHB said its home builders confidence index rose to 22 in May from 18 in April, the highest level in almost three years as builders are feeling more optimistic for the market for single-family homes.

The latest survey shows about 20% of builders feel the market is ''good.'' A reading of 22 is a far cry from the all-time of 72 seen in June 2005, the go-go days of the real estate bubble, but 22 is also a lot better than the eight the index registered in January 2009. It should be noted that the $8,000 home buyer tax credit expires in June and that may impact the confidence of builders going forward.

The May Empire State Manufacturing Index was also released on Monday, and while the index showed manufacturing activity in the New York region continues to increase, it did so at a slower pace in May, falling to 19.1 from 31.9 in April. While new orders and shipments trended lower, the index of the number of employees rose to its highest level in six years. Overall, investors did not appear to be impressed by the report and this is not the market environment in which to attach the word '''slower'' to the word ''growth.''

Empire State Manufacturing Index

A spate of mergers and acquisitions news was also overshadowed by declining risk appetite. Three deals each worth over $1 billion were announced on Monday. Astellas Pharma, Japan's second-biggest drugmaker, said it will acquire OSI Pharmaceuticals (OSIP) for $4 billion in cash. United Health Services (UHS) agreed to by Psychiatric Solutions (PSYS), an operator of mental health facilities for $2 billion in cash and Man Group said it will purchase hedge fund GLG Partners (GLG) for $1.6 billion.

The Wall Street Journal reported that private equity firm Apollo Group is interested in acquiring Pactiv (PTV), the maker of Hefty trash bags. No price tag was reported, but with today's jump of almost 19%, Pactiv is now sporting a market cap of almost $3.80 billion. Pactiv shares had been flat this year and some analysts had applied the ''undervalued'' tag to the stock, but the shares may have some more upside in them if Apollo announces a bid above $30 per share. One media report did note that anything above $33 a share might be a bit rich.

Pactiv Chart

So even with a vibrant M&A market, stocks still managed to post only meager gains, showing that they are still in fact held hostage to substantial declines in risk appetite. High-beta, risky fare, whatever label one chooses to use are places to avoid these days. Among the riskiest of that risky fare is oil and the Euro. Crude and the Euro are seemingly joined at the hip these days, which is only good news if you are a Dollar bull.

Concerns over Europe's debt situation abated for all of one day (last Monday). The region's debt woes make its common currency perhaps the most accurate temperature check on investors' willingness to incur risk and that temperature is quite low right now. Only Monday's late-day rally saved the Euro from finishing the U.S. trading session at a four-year low against the greenback.

If you watch enough CNBC, you are bound to hear more than a handful of pundits say that Euro is do for a near-term technical bounce. That would be good news for stocks because the Euro and the S&P 500 are 87% correlated to each other, according to Reuters. On the other hand, the Euro's fundamentals are still dubious, meaning any rally will probably only be technical in nature and short-lived at that.

Euro/Dollar Chart

Oil is not offering any shelter. NYMEX-traded crude for June delivery tumbled for a fifth straight session, trading as low as $69.27 a barrel on Monday. It seems like ages ago that oil traversed $87.15 a barrel, but in reality, that event took place two weeks ago today. With Monday's close at $70.08, oil has plunged almost 21% in two weeks and volatility should remain high this week ahead of the June contract's expiration on Thursday.

A couple of weeks ago, I wrote piece on Oilslick.com citing a technical analysis report that said if oil fell below $80, $65 could be the next stopping point. At the time, I was not sure that would actually happen. Now it looks like a matter of when, not if. Either way, Monday's closing price was crude's lowest since December 14, 2009 and speculation that Chinese demand may be topping out is not helping matters for oil bulls.

Oil Chart

Sure, the Dow finished last week in positive territory, but that was more a result of last Monday's European bailout rally than anything else. By the end of the week, that 400-point gain had been pared to 239 due to Friday's loss of 163 points. Given that the index spent a good part of Monday down by triple digits, it is hard to be excited by a gain of less than six points.

Support at 10,700 failed and the lower high at 10,900 may be near-term resistance, assuming the Dow can reclaim 10,700. Monday's close at 10,625.83 means support at 10,350 could become an issue as early as this week if European debt concerns continue to pressure stocks.

Dow Chart

Prior to this recent decline, I mentioned several times that analysts would probably have to adjust year-end targets for the S&P 500 because 1200 was taken out earlier than most investors had expected. With the index hovering around 1136, support at 1100 could be tested in the near-term and that is the 200-day moving average as well.

With ''sell in May and go away'' already at work, a violation of 1100 would test old support at 1085. Further declines in the Euro and oil could make either of those numbers a reality sooner rather than later and with resistance appearing firm in the 1175 neighborhood, the S&P 500 is going to have its work cut out if it wants to take out the April peak of 1219 by the time fourth quarter rolls around.

S&P 500 Chart

The Nasdaq had a couple of shots to break above 2400 last week, but it failed and Monday's close barely nudged the index above Fridy's close, which was the lowest since the crash. Leadership from big-cap tech names appears to be a broken theme and there is something else to consider regarding the Nasdaq's weakness. The index is home to a healthy amount of Chinese stocks and with that market officially in bear market territory, even names like Baidu (BIDU) could be more of a drag than a helping hand for the Nasdaq. A violation of 2300 brings 2215 into play.

Nasdaq Chart

Small-caps are showing signs of strength, a curious phenomenon given that most investors are shying away from risk. The Russell 2000 added to last week's gains today and the iShares S&P SmallCap 600 Index (IJR) was also up on more than triple its average daily volume. Closing at almost 696 puts the Russell 2000 well above support at 650, but that could mean a sell-off in small-caps could be fast and furious.

I am a believer that small-caps outperform large-caps coming out of a recession and the historical data supports this assertion, but running into this asset class right now may not be advisable, particularly when better prices may be right around the corner.

Russell 2000 Chart

Overall, I am far from impressed that stocks rallied off their lows on Monday and do not view that move as a sign to start buying. Enthusiasm for Europe's bailout package waned quickly and the unfortunate reality is that the Eurozone does not have much more in the way of good news to offer. I would not be running to buy much of anything beyond inverse ETFs and puts to protect existing profitable long positions.


New Option Plays

Two New Long Candidates

by Scott Hawes

Click here to email Scott Hawes


NEW DIRECTIONAL CALL PLAYS

Becton Dickinson & Co. - BDX - close 73.78 change +0.52 stop 72.20

Company Description:
Becton, Dickinson and Company (BD) is a medical technology company engaged principally in the development, manufacture and sale of a range of medical supplies, devices, instrument systems and reagents used by healthcare institutions, life science researchers, clinical laboratories, the pharmaceutical industry and the general public. BD’s operations consist of three business segments: BD Medical, BD Diagnostics and BD Biosciences. On November 19, 2009, BD acquired 100% of HandyLab, Inc. (HandyLab), a company that develops and manufactures molecular diagnostic assays and automation platforms. (source: company press release or website)

Target(s): 77.50
Key Support Areas: 74.00, 72.50
Key Resistance Areas: 75.65, 76.70
Time Frame: Several weeks

Why We Like It:
BDX got some publicity after hours today as news came out that Berkshire Hathaway initiated a large stake in the company last quarter. I like the stock at these levels and believe it will trade up to the $77.50 area which is our target and near the 50-day SMA. BDX's prices have been coiling and it is sitting near an upward trend line that started on 5/5/09. The stock has a ways to go to get up to the downtrend line which sits near $79.00. I also believe this is a good defensive play that will do well if there is a relief rally in the broader market or a sideways consolidation. The stock is near a key pivot level at $74.00 dating back to early 2008 which should act as support if BDX can push up through it. I suggest readers initiate long positions at no more than $74.25. BDX traded at $75.00 in the after market so be patient and wait for the pullback near $74.00. Our stop is $79.20 and our time frame is several weeks.

Suggested Position: JUNE $75.00 CALL if BDX trades down near $74.25, current ask $1.45.

Annotated chart:

Entry on May xx at $xx
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 1.6 million
Listed on May 17, 2010


Steel Dynamics - STLD - close 14.86 change -0.38 stop 14.15

Company Description:
Steel Dynamics, Inc. is a steel producer and metals recycler. The primary sources of its revenues are from the manufacture and sale of steel products; processing and sale of recycled ferrous and nonferrous metals, and to a lesser degree, fabrication and sale of steel joist and decking products. The Company operates in three segments: steel operations, metals recycling and ferrous resources operations, and steel fabrication operations. (source: company press release or website)

Target(s): 16.25, 16.80
Key Support Areas: 14.50, 14.25
Key Resistance Areas: 15.50, 15.85
Time Frame: About 2 weeks

Why We Like It:
STLD has been trading in a sideways channel between $14.50 and $18.00 for the past 9 months and finds itself at the bottom of the channel (see dashed lines on chart). There have been times when the stock has peaked it head above and below the channel but these are key pivot levels that have been fairly reliable. In addition, the $14.50 price level is converging with an upward trend line that started on 7/8/2009 and we have a good reference point to place a stop just below these levels. I am looking for a relief bounce in this stock and the overall market and I suggest readers initiate call positions at current levels. Our first target is $16.25 which is about +9% higher than current levels. Our time frame is about 2 weeks. I also like the 2:1 risk reward ratio of this trade: we are risking about 70 cents to make $1.40.

Suggested Position: JUNE $15.00 CALL, current ask $0.95.

Annotated chart:

Entry on May xx at $xx
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 6.7 million
Listed on May 17, 2010


In Play Updates and Reviews

TPX Closed For Nice Gain

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:

We closed TPX today for nice gain as it plunged down to our target after breaking support. With our two new long plays and CELG we should be participating in any rally the market offers in the coming days. I am expecting a relief rally in the to potentially close the gap lower from Thursday to Friday. This is about +20 S&P 500 points from today's close. In reality, I think we may be in a sideways consolidation mode for weeks or months which will eventually resolve itself to the downside. The S&P range I'm focused on is 1,115 to 1,170. However, I believe there is much more downside risk than upside opportunity. I urge readers to take profits on positions when they can as getting chopped around is not fun. Stay on your toes.

Current Portfolio:


CALL Play Updates

Celgene Corp. - CELG - close 59.76 change +0.34 stop 39.50

Target(s): 62.95
Key Support Areas: 58.00, 57.00
Key Resistance Areas: 60.00, 61.25
Current Gain/Loss: +3%
Time Frame: Several weeks
New Positions: Yes

Comments:
CELG opened today and shot right up to $60.00 before immediately reversing down to $58.60. That's when the buying picked sending the stock back up to close near its highs and above its 20-day SMA. Buyers have been stepping into this stock on weakness and I feel it poised to move higher, especially if the overall market can get some legs here. I'll leave my comments from the play release over the weekend. The stock made a nice move on Friday as the overall market was under pressure. The stock also has upward trend line support but that trend line was violated during the plunge on May 6th. Remove that bar and the trend line looks solid. There is some resistance overhead at the 20-day SMA and 50-day SMA but I think the stock can overcome this. I believe the overall market will probably chop around for a few weeks and CELG could catch a bid as a defensive play. Our portfolio is short on long positions and this a good long to have with a good set up. We'll place as stop at $56.90 which is below the low on April 22nd and will adjust it higher if the trade get going in our direction.

Current Position: JUNE $60.00 CALL, entry at $2.58.

Entry on May 17, 2010
Earnings Date: More than 2 months (unconfirmed)
Average Daily Volume: 4.3 million
Listed on May 15, 2010


PUT Play Updates

Baidu, Inc. ADR - BIDU - close 73.98 change -1.66 stop 79.10

Target(s): 71.50, 65.10
Key Support Areas: 71.40, 68.50, 65.00
Key Resistance Areas: 75.64, 78.50, 82.25
Current Gain/Loss: +1.44%
Time Frame: Several Weeks
New Positions: Yes

Comments:
BIDU came very close to hitting our first target at $71.50 today. The stock traded down to $71.64 before buyers stepped in. I still think BIDU looks vulnerable from here but if there is a bounce in the overall market we may endure a little pain before its heads back down. We need BIDU to break below $71.50 to get moving towards our final target of $65.10. From a fundamental perspective BIDU trades at a PE ratio of about 100 which makes no sense when compared to its American counterpart GOOG which trades at a PE of about 23. Our stop is $79.10 which is above last Wednesday's high. This stock can be volatile and is prone to gaps so please be smart when considering position size.

Current Position: JUNE $73.00 PUT, entry at $4.65

Entry on May 14, 2010
Earnings July 15, 2010 (unconfirmed)
Average Daily Volume: 68 million
Listed on May 13, 2010


Leggett & Platt, Inc. - LEG - close 24.18 change +0.10 stop 25.35

Target(s): 22.25
Key Support Areas: 23.75, 23.00
Key Resistance Areas: 24.75, 25.15
Current Gain/Loss: -3%
Time Frame: Several Weeks
New Positions: Yes

Comments:
LEG traded as low as $23.42 at about noon today and our short position was rocking, however, buyers stepped in and the stock closed +3.2% off of its lows. This has created a huge bottom wick on its daily candlestick chart. We are still well below the highs from 4/30 and 5/13 which is the recent downward trend line. Today's price action has me a little concerned but I want to give this some room to develop. I'll leave my comments from the play release over the weekend. LEG is making a lower high on its daily chart and appears overextended at these levels. The stock has upward trend line support below but this support is about -8% lower from current levels. Resistance just overhead includes downward trend line resistance and recent highs at $24.75 and $25.15. I am looking for LEG to trade lower from here to about the $22.25 area which is our target. I suggest readers take advantage of this by initiating short positions in the stock. The overall market looks vulnerable here and LEG probably won't be spared. Our stop is $25.35.

Current Position: June $25.00 PUT, entry at $1.60

Entry on May 17, 2010
Earnings More than 2 months (unconfirmed)
Average Daily Volume: 2 million
Listed on May 15, 2010


Range Resources Corp - RRC - close 46.57 change -1.40 stop 50.75

Target(s): $46.00 (hit), 45.00, 44.00, 42.50
Key Support Areas: 46.00, 45.00, 43.30
Key Resistance Areas: 47.25, 48.40, 49.00, 50.00
Current Gain/Loss: +11%
Time Frame: A couple of days
New Positions: No

RRC continues to test my patience and I am suggesting readers exit positions. Our conservative target of $46 was hit today so anyone who sold positions should have a decent winning trade under ther belt. I thought we were going to hit our $45 target but the stock reversed. We have been whipsawed around over the past week but we have made money and I think it is time to exit here. RRC still remains below a bunch of congestion near $49.00 that I don't think it can overcome, but I can't endure another trip back up to these levels which is why I think readers should take profits here. In addition, oil is definitely oversold and if oil gets some legs and the overall market bounces from here I don't want to be involved in the stock. If RRC is weak at the open we'll trail our stop down and if it is strong we'll exit early. A tight stop could be place at $47.25 if readers want to give this some room to play out. *NOTE: We chose further out of the money options than usual to reduce risk in the trade. Please use small positions due to the volatility in this stock and the recent sell off in oil looks oversold.

Current Position: JUNE $42.50 PUT, entry at $0.95

Entry on 5/11/2010
Earnings Date 7/22/2010 (unconfirmed)
Average Daily Volume: 3.1 million
Listed on 5/8/2010


Sina Corporation - SINA - close 34.85 change -0.26 stop $37.05

Target(s): 33.25 (hit), $33.50, 32.50, 30.50
Key Support Areas: $33.40 32.50, 30.50
Key Resistance Areas: 35.40, 36.00, 36.80
Current Gain/Loss: -5%
Time Frame: 1 week
New Positions: Aggressive traders only

Comments:
SINA reported earnings after the bell that were better than expected but their Q2 revenue forecast was lower than consensus estimates. The after hours reaction is fairly muted but it is well off its highs. I'm a little concerned that China's market sold off on hard Monday (-5%) but SINA hung in there relatively well. So if the overall market gets a relief bounce, including Chinese markets, SINA could go against us here. The stock opened at $34 and was immediately bought up to $34.34 which was near our anticipated resistance of $35.40. The stock sold off quickly but was bought up again at the close. I'd like to see how the stock reacts tomorrow and may be looking for a quick exit of SINA trades higher from here.

Current Position: JUNE $35.00 PUT, entry at $2.20

Entry on May 4th at $2.20
Earnings Date May 17, 2010 (unconfirmed)
Average Daily Volume: 1.1 million
Listed on May 1, 2010


CLOSED BEARISH PLAYS

Tempur-Pedic International - TPX - close 33.88 change +0.20 stop 36.35

Target(s): 32.50 (hit), 31.50, 30.25
Key Support Areas: 33.25, 32.40, 31.30, 30.00
Key Resistance Areas: 34.60, 35.10, 36.30
Current Gain/Loss: +50%
Time Frame: 1 to 2 weeks
New Positions: Closed

Comments:
When TPX broke our key support area at $33.25 it traded right down to our target of $32.50 so we are now flat June $32.50 PUTS at $2.10. We entered at $1.40 so our gain was +50%. The stock spent about an hour and half near $32.50 and at the end of the day retraced all of its losses and squeaked out a gain. Today's price action was very similar to our LEG short position. Maybe the late day action was short covering and if this stock rallies higher from here it is probably a good candidate to short again. I urge readers who still have positions to be careful here and not let this run away from you. I see resistance at $34.60 and $35.10. Placing stops just above these levels is probably a good idea to protect capital.

Closed Position: JUNE $32.50 PUT at $2.10, entry was at $1.40

Annotated Chart:

Entry on May 12, 2010
Earnings July 15, 2010 (unconfirmed)
Average Daily Volume: 1.1 million
Listed on May 11, 2010