Option Investor
Newsletter

Daily Newsletter, Monday, 5/24/2010

Table of Contents

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

Market Wrap

The Bears Now Have Their Claws Into Mondays

by Todd Shriber

Click here to email Todd Shriber
Monday is usually a pretty reliable day of the week for U.S. stocks, reliable in the sense that stocks usually go up on the first day of the week. That is what makes today's trade one part concerning and one part disappointing. After moving higher on 10 of the past 12 Monday, stocks traded lower today with the Dow Jones Industrial Average erasing Friday's gains, losing 127 points, or 1.24%, to settle at 10066.57. The S&P 500 could not keep its head above water at 1085, tumbling 14 points, or 1.3%, to close at 1073.65 while the Nasdaq lost 15.5 points to finish the day at 2213.55. Small-caps did not help the cause either with the Russell 2000 shedding 8 points, or 1.24%, to finish at 641.21.

Stats Table

Most of the losses were accumulated in another one of those infamous late day-sell offs as the Dow shed roughly 80 points in the last 30 minutes of trading. On the other hand, consider that Chinese stocks were up overnight, oil finally traded higher and there was really no news, good or bad, out of Europe and the fact that U.S. equities could not build on Friday's gains might highlight the point that the path of least resistance is down.

I mentioned in the weekend wrap that perhaps the only reason to explain the bullish trade in financials on Friday was news that Congress is inching closer to passing the financial regulatory reform bill. I stated that while I was personally surprised this sector moved higher on Friday, it may have been a case of the banks at least knowing what they have to contend with now that passage of the reform bill is imminent.

Well, that trend was short-lived as financials were the biggest losers among the 10 industry groups tracked by the S&P 500. Bank of America (BAC) and JPMorgan Chase (JPM), the two largest U.S. banks, dragged the Dow lower, losing 3.69% and 3.57%, respectively. Those losses pale in comparison to the punished dealt out to Wells Fargo (WFC). California-based Wells Fargo traded lower by 4.65% after Goldman Sachs trimmed its rating on the bank to ''neutral'' from ''buy.''

Wells closed just below its 200-day moving average and it looks there might be several more dollars on the downside to be had here. Goldman cited valuation as the reason for the downgrade, noting that it sees more value in Bank of America, JPMorgan and Citigroup (C) than it does in Wells.

Wells Fargo Chart

It was a disappointing weekend at the box office, at least for one entertainment company that failed to meet expectations with the latest edition of a popular film franchise.

Shrek

That is right, the fourth installment of the popular Shrek franchise, ''Shrek Forever After,'' made its debut this weekend grossing $70.8 million, beating ''Iron Man 2'' by a wide margin. I do not have kids, but I do not live in a cave either, so I have heard how popular the Shrek movies are with children and the new film was being shown in 3-D in select markets. That allowed some theaters to charge as much as $20 per ticket.

Shares of DreamWorks (DWA), the film's producer, were hammered on news that the weekend's receipts fell short of Paramount's $80 million estimate. Paramount, a unit of Viacom (VIA), distributes the Shrek films. Dreamworks traded lower by as much as 13% before closing down 11%. The stock was already showing considerable weakness, trading below its 50- and 200-day lines going into the weekend and news that this version of Shrek significantly lagged the last two installments in terms of opening weekend receipts had the bears in prime position to punish the stock. Volume was more than six times the daily average.

Last week, Thomas Weisel analyst Benjamin Mogil lowered his rating on DreamWorks in anticipation of a rough opening weekend for Shrek and that sent the stock tumbling. On Monday, he lowered his revenue expectations for the film to $260 million from $315 million and cut his price target on the stock to $34 from $38. Ouch.

DreamWorks Chart

Even so-called defensive names are offering little in the way of protection. The Utilities Select SPDR ETF (XLU) was down almost 1% today and individual defensive names like Coca-Cola (KO), Johnson & Johnson (JNJ) and Procter & Gamble (PG) all weighed on the Dow today. Campbell Soup (CPB), the epitome of a defensive stock, was down fractionally today on almost double the average daily volume after the company delivered its fiscal third-quarter earnings.

Campbell said it earned $168 million, or 49 cents a share, for the quarter ended May 2, compared with $174 million, or 49 cents a share, a year earlier. Excluding items, the company earned 54 cents, beating the consensus estimate of 51 cents a share. Revenue did rise almost 7% to $1.8 billion from $1.69 billion, but the revenue increase was merely inline with analysts' forecasts.

Campbell Soup Chart

One stock that bucked the negative trend today was Sprint-Nextel (S). The telecom sector is another defensive realm, but Dow components AT&T (T) and Verizon (VZ) are basically flat in the past three months. For ages, Sprint was kind of the laughing stock of telecom stocks, but the company deserves some credit as its shares are up more than 40% in the past three months.

The bullishness continued on Monday as Sprint gained almost 9% on nearly twice its average daily volume on the back of a bullish write up in Barron's over the weekend and a Goldman Sachs upgrade. Goldman upgraded Sprint to ''buy'' from ''neutral'' while Citigroup reiterated its ''buy'' rating on the stock.

Sprint is gaining traction as the first mobile phone provider to offer 4G service, which can deliver speeds up to 10 times faster than existing 3G wireless networks, according to Barron's. Sprint currently offers its 4G service to 40 million people in 32 cities with aim of boosting that total to 100 million by the end of this year with new coverage in cities such as Boston, Los Angeles, New York, San Francisco and Washington, Barron's reported.

Sprint Chart

Looking at the charts, 10,000 is once again back in play on the Dow and as I have been saying, if 10,000 does not hold, 9850-9875 would be the next stopping point. From there, 9500 could become an issue.

Dow Chart

I have been keeping my eye on 1065 on the S&P 500 and while that level was not breached today, the index closed less than nine points that area. Assuming the S&P 500 cannot find support there or at 1050-1055, a return to 975 could become an unfortunate reality.

S&P 500 Chart

The Nasdaq reclaimed its 200-day line on Friday only to fall below it again today. I mentioned 2185 as a support area to watch on the downside and if that number is violated a return to the February low of 2100.17 is likely.

Nasdaq Chart

The 650 range is looking like new resistance for the Russell 2000 and the index only briefly traded above that level on Monday. Worse yet, the Russell 2000 closed barely above its low of the day. If the 200-day moving average at 629 does not prop up the Russell 2000, a move to the low 600 area could be in the offing.

Russell 2000 Chart

Stocks moved higher on Friday thanks in large part to a 20-minute rally into the close. On Monday, it was a 20- or 30-minute sell-off into the close that multiplied the losses. Wipe out those two days, which essentially result in a draw, and we are basically back to where we were on Thursday and that is not an alluring proposition.

Even worse regarding Monday's trade was Chinese stocks could not help their U.S. counterparts move higher and the downdraft was back for high-beta fare like energy, financials and materials names. I still see more downside before stocks resume their bullish ways.


New Option Plays

A Play on Generic Drugs

by Scott Hawes

Click here to email Scott Hawes


NEW DIRECTIONAL CALL PLAYS

Teva Pharmaceuticals - TEVA - close 55.68 change +1.09 stop 52.95

Company Description:
Teva Pharmaceutical Industries Limited (Teva) is a global pharmaceutical company that develops, produces and markets generic drugs covering all treatment categories. The Company has a pharmaceutical business, whose principal products are Copaxone for multiple sclerosis and Azilect for Parkinson’s disease, respiratory products and women’s health products. Teva’s active pharmaceutical ingredient (API) business provides vertical integration to Teva's own pharmaceutical production. The Company's global operations are conducted in North America, Europe, Latin America, Asia and Israel. Teva has operations in more than 60 countries, including 38 finished dosage pharmaceutical manufacturing sites in 17 countries, 15 generic research and development (R&D) centers operating mostly within certain manufacturing sites and 21 API manufacturing sites around the world. On January 29, 2009, the Company sold its Israeli animal health product line to Phibro Animal Health Corporation. (source: company press release or website)

Target(s): 56.44, 57.95
Key Support Areas: 54.25, 53.21
Key Resistance Areas: 56.44, 58.00
Time Frame: 1 to 2 weeks

Why We Like It:
TEVA has found an upward trend line dating back to October 2008 and a prior resistance level which should now act as support, both in the $54 to $55 price range. The market is oversold and I'm expecting a bounce from here. I've listed 2 possible entry points: the first is near today's lows at $54.80 and the second is near the low from 5/19 at $54.25. If TEVA can retrace some of today's gains it could form a bullish inverse head and shoulders pattern on its intraday charts. This may act as a catalyst for TEVA to move higher in the coming days. The futures are down in the after market as I write this so the entry point will need to be determined by the early price action tomorrow. Our initial stop will be $52.95.

Suggested Position: June $55.00 CALL if TEVA trades down near $54.80 or $54.25, current ask $2.17, estimated ask at entry $1.50

Annotated Chart:

Entry on May xx
Earnings Date: More than 2 months (unconfirmed)
Average Daily Volume: 3.7 million
Listed on 5/24/10


In Play Updates and Reviews

EMC Closed

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:


CALL Play Updates

Hewlett Packard Co - HPQ - close 45.69 change -0.89 stop 44.60

Target(s): 46.65, 48.20, 48.60, 49.70
Key Support Areas: 46.00, 45.11, 44.80
Key Resistance Areas: 46.75, 48.25, 48.70, 50.00
Current Gain/Loss: -37%
Time Frame: 1 to 2 weeks
New Positions: No

Comments:
There was simply no follow through in the markets today and HPQ fell apart late in the day, but I'm not giving up yet. I've listed a new target above at $46.65 which below the highs of the past few days. It would probably be a smart level to exit positions if HPQ trades up here. I'll leave my comments from the weekend as they have not changed. I am also keeping an eye on the declining 20-day SMA. HPQ has not touched this SMA since 4/27 and it is overdue to get there. It appears this is going to correspond nicely with our targets or $48.20 and $48.60. If HPQ can continue the bounce to these levels our options should be worth north of $2.00 which would represent a +40% to +50% gain. I will gladly take profits at those levels. HPQ closed right at a key level for the stock near $46.60. If it can breakout above this level we should be on way to reaching our target. HPQ is a quality company and that has great fundamentals and is trading at 11 times forward earnings estimates. I'm viewing the recent pullback as opportunity to enter a quality name that may catch a bid as investors flee from more speculative names.

Current Position: JUNE $47.50 CALL, entry was at $1.47

Entry on May 19, 2010
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 16 million
Listed on May 18, 2010


Morgan Stanley - MS - close 25.75 change -1.36 stop 25.50

Target(s): 28.50
Key Support Areas: 26.40, 25.64
Key Resistance Areas: 27.25, 28.00
Current Gain/Loss: -32%
Time Frame: 1 to 2 weeks
New Positions: Yes, with a tight stop

Comments:
I was looking for a retracement in MS but I didn't think it would retrace almost all of Friday's gains. MS found support at our entry but it was short lived as the selling picked up steam in the overall market this afternoon. If the market is weak tomorrow we will most likely be stopped out. I use the following rule if there on positions with gaps. For long positions here is my rule of thumb: If a stock gaps down below the stop that has been established, wait for the first 15 minutes of trading before doing anything. Then place a new protective stop just under the low of that first 15 minutes of trading. Reverse the entire scenario for shorts. The reason I do this is because I want to measure the real strength or weakness in the stock. I don’t want a Good Til Cancelled (GTC) stop to be unnecessarily triggered at the open because often times stocks gap and reverse immediately, which keeps us in the position and looking for a better exit.

Current Position: June $27.00 CALL, entry at $1.15

Entry on May 24
Earnings Date: More than 2 months (unconfirmed)
Average Daily Volume: 25 million
Listed on 5/19/10


PUT Play Updates

IAC/Interactive Corp - IACI - close 22.16 change +0.68 stop 23.10

Target(s): 20.50, 20.05
Key Support Areas: 21.15, 200-day SMA
Key Resistance Areas: 22.04, 22.30, 22.80
Current Gain/Loss: +5%
Time Frame: Several Weeks
New Positions: Yes

Comments:
IACI closed the gap I referred to in the play release which triggered our entry to buy June $22.50 PUTS at 85 cents. My comments from the play release remain the same. IACI's chart looks bad and it is barely hanging on to an upward trend line that began in March 2009. I'm expecting a bounce in the stock but I think the bounce will be short lived and I suggest readers initiate short positions when that happens. I have listed two areas for possible entries of short positions: If IACI retests its highs from Thursday near $21.90 or if the stock fills the gap down from Wednesday to Thursday (5/19 to 5/20) near $22.25. I have listed 3 targets that I expect IACI to trade down to in the coming weeks: $20.50, $20.05, and $19.50. I also like the 2:1 risk/reward ratio of this trade set-up: depending on the entry/exit prices, we are essentially risking about $1.00 to make $2.00 or more. Our stop is $23.10 which is above its 50-day SMA. It will take a monumental effort for IACI to get back up to this level.

Current Position: June $22.50 PUT, entry at $0.85

Entry on May 24
Earnings More than 2 months (unconfirmed)
Average Daily Volume: 1.4 million
Listed on May 22, 2010


CLOSED BULLISH PLAYS

EMC Corp. - EMC - close 18.06 change +0.10 stop 16.95

Target(s): 18.20 (hit), 20-day SMA, 18.70
Key Support Areas: 17.65, 17.55, 17.45, 17.10
Key Resistance Areas: 17.80, 18.00, 18.50, 18.85
Current Gain/Loss: +23%
Time Frame: 1 to 2 weeks
New Positions: Closed

Comments:
We made a judgment call to close EMC at our first target of $18.20 today for a +23% gain. Lack of continued follow through on the market's early strength was the clue to close the position. I'll leave my comments from the weekend as they have not changed. The stock is now battling its long term pivot level dating back to June of 2007 at $18.00. EMC is finding support on a trend line that began with the 9/3/09 lows to 2/5/10 lows, and finally the flash crash lows on 5/6/10. But the stock still faces overhead congestion like many others. If EMC can get over $18.00 we should hit our first target at $18.20. Our more aggressive second target has been lowered to $18.70 which is just below the stock's 50-day and 20-day SMA's. I've also listed the 20-day SMA as a target and urge readers to exit positions or tighten stops if the stock trades anywhere near this level to protect capital and protect against a reversal. EMC could trade up to its 50-day SMA if the bounce in the overall market can continue this week. With the extreme up and down volatility and oversold conditions we could easily see a continued short covering rally creating a sharp move higher and if that happens we need to be taking profits.

Closed Position: June $18.00 CALL at $0.80, entry was at $0.65.

Annotated Chart:

Entry on May 20, 2010
Earnings Date: More than 2 months (unconfirmed)
Average Daily Volume: 25 million
Listed on 5/19/10