Option Investor
Newsletter

Daily Newsletter, Wednesday, 5/26/2010

Table of Contents

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

Market Wrap

Was that the bottom?

by John Gray

Click here to email John Gray
Yesterday's strong rally after a gap down move to support at 1040 (SPX) was impressive. It's unclear to me whether it was short covering or genuine buyers who perceived a rare buying opportunity. In reality, it was probably a little of both. At any rate, it was welcome relief for embattled bulls who have been bludgeoned unmercifully by the manic selling and high volatility over the past three weeks.

Futures continued to trudge higher overnight and opened positively this morning along with bourses around the globe. Sentiment was helped this morning at 8:30 AM when the U.S. Census Bureau reported that Durable Goods sales in April surged $5.6 billion (2.9%) to $193.9 billion, the fourth increase in the last five months. March was revised to no change. The surge was led by Transportation.

Later in the morning the Commerce Department reported that New Home Sales rose 14.8% in April to their highest level since May, 2008. New homes sales are up 47.8% compared with a year ago. This number needs to be taken with a grain of salt because much of the surge could be credited to the government's tax credit which has now expired. Toll Brothers shares jumped by 3% after reporting a narrower than expected loss and the company saying that new orders have increased by 41%.


Toll Brothers

All eyes will be focused on the Gulf of Mexico over the next two days as BP begins the so-called "Top Kill" procedure in an attempt to stop the flow of oil from the ruptured well. In a memo released to Congress BP admitted that there were a "series of underlying failures" and that there were "indications of very large anomalies". It is not clear who was responsible for failure to act on these warnings. Everybody is pointing their fingers at the other guy. The Obama Administration is catching an enormous amount of flak from both the left and the right. The White has vowed to keep "a boot on the neck of BP". Suffice it to say that BP shareholders are not enjoying this fiasco.


BP PLC

Mark Hulbert, who writes a newsletter that tracks the sentiment of market-timers (among other things), has noticed an interesting phenomenon. In the short span of 13 trading days the market-timers' that he tracks have gone from full-blown bullish to full-blown bearish. Prior to May 6th, most were recommending an 80% exposure to equities (the highest level since 2000). Now, they are recommending a MINUS 45% exposure to equities. In other words, they are recommending that their clients remain in short positions. What makes this so unusual is that in previous market tops most advisory services continued to remain stubbornly bullish well past the time that it was obvious that they were wrong. In a strange, contrarian sort of way, this could actually be interpreted as bullish since these guys are rarely right at the top or the bottom.

The European Union proposed today that member states should establish "bank resolution funds" which would be used to pay for the orderly wind down of any future failed banks. This would be paid for by a levy on the banks. The proposal was a little short on details i.e. how it was to be collected or how big the fund needed to be. This comes on the heels of the US Senate's recently-passed financial reform legislation which contains similar language. Its purpose, of course, is to avert the type of meltdown Lehman's bankruptcy caused.

While we are on the subject of the financial reform legislation, one of the provisions contained therein is a ban on so-called "proprietary trading" by banks. This, of course, refers to banks speculating and trading with their own funds as opposed to trading their client's funds. This is aimed at about five or six of our largest banks that are heavily involved in this practice. Probably the largest "offender" is Goldman Sachs.


GS

In a May 26, 2010 article in the Huffington Post staff writer Shahien Nasiripour reported the following: "Of the 63 trading days in the three-month period ending in March, Goldman Sachs generated revenue of at least $25 million on EVERY SINGLE DAY, according to its latest quarterly filing with the Securities and Exchange Commission. On three of every five days, Wall Street's most profitable firm, generated revenues exceeding $100 million trading stocks and bonds, and creating and entering into derivatives contracts". How about you? Did you do that well? When you combine Goldman's assets with those of the other behemoths, is it any wonder that they can control the market? Do you see why these guys drive Keene and me into a state of apoplexy?


Trading Revenue

Just because we have not had another crisis du jour out of Europe(that seems to roil the markets on a daily basis), does not necessarily mean that all is calm on our eastern flank. Reports out of Europe indicate that the French and the Brits are furious with Germany about the ban on "naked" short sales. First, they are annoyed that Germany took the action unilaterally without consulting them and, secondly, they don't believe the move will accomplish anything (and I agree). In fact, the Brits have let it be known that if anybody wants to short German bonds they are welcome to do it on the British Exchanges. This is not exactly what I would call Continental unity.

As I opined last week, the solution to Europe's sovereign debt problem is not to just keep moving debt from one balance sheet to another. As painful as it may be, debt destruction is the only answer and that may, indeed, involve a period of deflation. Todd Harrison (Minyanville) had this to say on the subject: "There are two alternative forward paths: On the one side, debt destruction, asset class deflation and an outside-in globalization once the dust settles. On the other, we continue to give the global drunk another drink with hopes that he does not sober up. The sad truth is that one day he will, and our children will be forced to pick up the bar tab if we do not change our ways soon". Of course, he includes the United States in this (as well he should).

Gold continues to climb today and it looks like it wants to retest its high on May 12th and May 14th at 1250. A strong dollar is not deterring its advance.


Gold

Let's have a look at the charts and see if they give us any clues about what lies ahead. First, let's examine the SPX chart. We got a big gap up opening that peaked at 1090.75 about 10:40 AM. It retreated from that level and traded sideways for most of the day. I would anticipate that SPX will encounter stronger resistance at 1104 (200 DMA) and again at 1107 (50% retracement). If the bulls can successfully breach those levels I would look for more resistance to appear at 1115 (January's opening print) and 1122 (62% retracement). And lastly, the 50 DMA is at 1165. It dropped below this average on the "Flash Crash" on May 6th. It tested it from underneath the following Monday and promptly fell away. If the bulls can overcome all these obstacles, it would clear the way for new highs. It is a pretty daunting task in my opinion.


SPX

The Russell 2000 (RUT) has been something of a curiosity to me. Fund managers keep buying these small caps in the face of these uncertain times. Usually one would expect the funds to be rotating into the more liquid large caps. Either they know something I don't know, or they are not very bright. Unlike the others, the RUT has not dropped below its 200 DMA (yet). Today it gapped up (with the rest) and hit a high of 657.95 when the markets peaked just before 11:00 AM. I would expect stronger resistance at 667 (50% retracement) and even stronger resistance at the 678-685 area. The one thing I'm fairly certain of is that if the rest of the markets take dump RUT will not be far behind.


Russell 2000

And finally, the granddaddy of them all - the DOW. It jumped up today and hit 10,178.88 before retreating. Above at 10,283 lies its 200 DMA. If it does not stub its toe there, it will surely encounter some strong head winds at 10,357 (50%). Above 10,500 the DOW must contend with the previously broken 20 DMA (10,591) and its 50 DMA (10,830). I'm not saying the bulls can't do it, but it's a steep hill to climb.


DOW

Yesterday's strong rally off the lows, and today's continuation of the rally did not surprise me. The markets have gone from obscenely overbought in late April to grossly oversold (now). An oversold bounce (aided by short covering) is to be expected. However, I think it would be unwise to heed the advice that the cheerleaders in news media offer so freely. I am of the opinion that we had a major trend change in early May. A more likely strategy for profits going forward will be shorting the rallies - not buying the dips. Having said that, I would also caution that bear markets (if that's what we have entered) are not easy to trade either. They are characterized by sharp (sometimes vicious) rallies so you must remain ever-vigilant. Unless you are Goldman Sachs you can't make money every day of your life. The only thing us mortals can do is try to win more than we lose.

Remember, the markets are closed on Monday in observance of Memorial Day. Have a good long weekend.


New Option Plays

Long and Short Candidate

by Scott Hawes

Click here to email Scott Hawes


NEW DIRECTIONAL CALL PLAYS

Rino International - RINO - close 12.38 change +0.84 stop 10.50

Company Description:
RINO International Corporation is engaged in the business of designing, manufacturing, installing and servicing wastewater treatment and flue gas desulphurization equipment for use in China's iron and steel industry, and anti-oxidation products and equipment designed for use in the manufacture of hot rolled steel plate products. The Company has three principal products and product lines: the Lamella Inclined Tube Settler Waste Water Treatment System, the Circulating, Fluidized Bed, Flue Gas Desulphurization System and the High Temperature Anti-Oxidation System for Hot Rolled Steel. The Company's sole business activities are acting as a holding company of its direct and indirect subsidiaries, Innomind Group Limited, RINO Investment (Dalian) Co., Ltd. (RINO Investment), Dalian RINO Heavy Industries Co., Ltd. (RINO Heavy Industries) and Dalian Innomind Environment Engineering Co., Ltd. (Dalian Innomind).

Target(s): 14.50, 15.95, 16.90
Key Support Areas: 11.75, 11.50, 11.20
Key Resistance Areas: 12.75, 13.75
Time Frame: Several weeks

Why We Like It:
RINO has taken out to the woodshed recently and I believe it due for a turnaround. The appears to have found support in the $10.75 area which dates back to prior support in August 2009 and prior resistance in June of 2008. The stock bounced nicely off of this yesterday and followed through nicely today gaining +7.28%. In addition, the stock trades at a ridiculously low PE ratio of about 5. I think there is a lot of room to for this stock to run and I suggest readers take advantage of the building momentum. I'm going to place an initial wide stop at $10.50 which is below the key support level, but it will be adjusted as the trade develops. I think we can make $2 in this trade but there could be some volatility so please use proper position to manage risk.

Suggested Position: July $12.50 CALL, current ask $1.45

Annotated Weekly Chart:

Entry on May xx
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 926,000
Listed on May 26, 2010


NEW DIRECTIONAL PUT PLAYS

The Gymboree Corporation - GYMB - close 44.06 change -1.35 stop 46.60

Company Description:
The Gymboree Corporation is a specialty retailer operating stores selling apparel and accessories for children under the GYMBOREE, GYMBOREE OUTLET, JANIE AND JACK and Crazy 8 brands, as well as play programs for children under the GYMBOREE PLAY & MUSIC brand. The Company operates retail stores in the United States, Canada and Puerto Rico in regional shopping malls and in selected suburban and urban locations. As of January 30, 2010, the Company conducted its business through five divisions: Gymboree, Gymboree Outlet, Janie and Jack, Crazy 8, and Gymboree Play & Music. As of January 30, 2010, the Company operated a total of 953 retail stores, including 916 stores in the United States (593 Gymboree stores, 139 Gymboree Outlet stores, 119 Janie and Jack shops, and 65 Crazy 8 stores), 34 Gymboree stores in Canada, 2 Gymboree stores in Puerto Rico, and 1 Gymboree Outlet store in Puerto Rico. (source: company press release or website)

Target(s): 42.40, 40.25
Key Support Areas: 44.00, 43.60
Key Resistance Areas: 46.00, 46.30
Time Frame: 1 to 2 weeks

Why We Like It:
GYMB is forming a bearish pennant and I believe it will break lower. Retailers have been offering weak guidance for the remainder of 2010 and I think it is a matter of time before more selling starts. I would like to enter short positions if GYMB trades up near the $44.90 level. The pennant also provides a good reference point to place a protective stop at $44.60 which is above the 100-day SMA. GYMB has also been finding resistance at its 200-day SMA. NOTE: the bid/ask spread on GYMB options is a little wide. Place a limit order between the two and you should get filled.

Suggested Position: July $45.00 PUT, current ask $3.60, estimated ask at entry $3.00.

Annotated chart:

Entry on May xx
Earnings More than 2 months (unconfirmed)
Average Daily Volume: 1.1 million
Listed on May 26, 2010


In Play Updates and Reviews

MS and HPQ Closed

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:

Good evening. We closed MS and HPQ for relatively small losses today as the trades are simply not following through for us. The stocks could surge higher tomorrow or they could surge lower, but I wanted to preserve the time value remaining in the options so the positions were closed when our lowered targets were hit. As a result, our model portfolio has narrowed significantly. In this volatile environment we are releasing trades daily trying make quick profits by picking precise entry and exit points. Cash is also a position and protecting capital is not a bad idea. Please see the update on TEVA as I am recommending we exit this position soon due to today's news about the company. Please email me with any questions.

Current Portfolio:


CALL Play Updates

Teva Pharmaceuticals - TEVA - close 54.30 change -2.10 stop 53.75 *NEW*

Target(s): 54.70, 55.00, 55.30, 56.44 (hit), 57.40, 57.95
Key Support Areas: 54.25, 53.21
Key Resistance Areas: 56.44, 58.00
Current Gain/Loss: -15%
Time Frame: 1 to 2 weeks
New Positions: Yes, if there is a pullback

Comments:
We need to re-think our TEVA position as news broke today regarding Morgan Stanley removing Israel from its emerging markets index and adding it to its world index. I was surprised TEVA did not follow through higher today and was trying to find out what was going on, but to no avail. Then I heard Jim Cramer on CNBC talking about TEVA. TEVA is based in Israel so this is significant. Here is what he had to say and what is posted on CNBC's Web site: TEVA is "a great opportunity" right now, Cramer said. TEVA, a generic and proprietary drug company, was down about $1.90, or 3.4%, in today's trading session, but not because there's anything wrong with the company. As of Thursday, Morgan Stanley will remove Israel from its emerging-markets index and add it to its world index. As a result, funds that track Morgan's emerging-markets index have been forced to sell the stock, and that has hurt the share price. Cramer is still bullish on TEVA, citing its acquisition of Ratiopharm and ability to withstand the pressure from Europe right now. He expects the stock to pick back up "over time" as the funds that track Morgan's world index begin to buy the stock.

The key quote to this statement is "he expects the stock to pick back up over time." I also do not know how quickly the transition will take from one fund to another. But I know one thing for sure and that is time is not on our side when owning options. Our +50 gain yesterday has been wiped out and is now down -15%. Considering the circumstances the smart thing to do is exit TEVA tomorrow and wait for the dust to settle. I've listed 3 lowered targets above as logical exit points. All of these targets are within today's price range and I urge readers to tighten stops at these levels, assuming we hit them. And I have also listed a new stop at $53.75 to limit downside risk. Our initial first target was hit yesterday so if readers happened to exit congratulations. Technically TEVA has support and holding an upward trend line, but when institutions are involved these don't really matter.

Current Position: June $55.00 CALL, entry at $1.70

Entry on May 25, 2010
Earnings Date: More than 2 months (unconfirmed)
Average Daily Volume: 3.7 million
Listed on 5/24/10


Walter Energy - WLT - close 75.20 change +1.75 stop 72.65

Target(s): 77.25, 80.95
Key Support/Resistance Areas: 77.75, 74.50, 72.50, 70.00, 68.50
Current Gain/Loss: N/A
Time Frame: 1 week
New Positions: Waiting to be triggered

Comments:
WLT gapped higher this morning and almost traded to our first target. But we'll wait patiently for the proper entry point at $72.65 which would be a retest of the stock's 200-day SMA that I think will hold. My comments from the play release remain the same. I believe the sell off in coal stocks was overdone and they appear to be building momentum for a move higher. WLT has retaken its 200-day SMA at $72.50 and also has solid support at $67.85. Our stop will be just below at $66.50. The stock could find some resistance near it 20-day SMA but I believe it will bust through this level if the market has in fact found some footing. I would like to see some retracement in the recent gains and use $72.65 as a trigger to enter long positions. I am looking for a move up to $77.25 and possibly $80.95. I view this trade as aggressive and quick so please use small position size to manage risk.

Suggested Position: June $75.00 CALL if WLT trades down near $72.65, current ask $4.30, estimated ask at entry $3.60

Entry on May xx
Earnings Date: More than 2 months (unconfirmed)
Average Daily Volume: 3.4 million
Listed on 5/25/10


PUT Play Updates

IAC/Interactive Corp - IACI - close 22.57 change -0.04 stop 23.10

Target(s): 21.40, 20.90, 20.50, 20.05
Key Support Areas: 22.40, 21.15
Key Resistance Areas: 22.90
Current Gain/Loss: -23%
Time Frame: Several Weeks
New Positions: Yes, with tight stop

Comments:
I remain very surprised in the price action of IACI the last couple of days, but we are still in the position. But today's price action late in the day may be the end of the short covering which could get things heading south for us. This company has terrible fundamentals and I don't foresee a lot of new buyers stepping in at these levels. The stock peeked its head above the its downtrend line and the 50-day SMA but that was quickly sold into. I've listed a new target of $21.40 and $21.90 as potential exit point. If selling picks up in the market IACA could fall hard.

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

Hewlett Packard Co - HPQ - close 45.72 change -0.13 stop 44.60

Target(s): 46.65 (hit), 47.50, 48.20, 48.60
Key Support Areas: 45.25, 45.60, 45.11, 44.80
Key Resistance Areas: 46.75, 48.25, 48.70, 50.00
Current Gain/Loss: -38.7%
Time Frame: Closed
New Positions: No

Comments:
HPQ hit our target of $46.65 this morning so we are now flat the position at $0.90 for a loss. There was simply no follow though in the market so I think it is prudent to preserve capital and take the loss. I suggest readers protect the premium left in these options and come up with an exit strategy soon. The above targets and support/resistance areas are still valid and can be used as a guide.

Closed Position: JUNE $47.50 CALL at $0.90, entry was at $1.47

Annotated Chart:

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 26.11 change +0.36 stop 25.50

Target(s): 26.60 (hit), 27.25, 28.50
Key Support Areas: 26.40, 25.64
Key Resistance Areas: 27.25, 28.00
Current Gain/Loss: -4.34%
Time Frame: 1 to 2 weeks
New Positions: Closed

Comments:
Our lowered target on MS was hit today and we are taking a small loss on the position. We are flat June $27 CALLS at $1.10 for a 5 cent loss. I'm frustrated with the volatility and think it is prudent to exit positions when the opportunity presents itself. Today was that opportunity. MS may surge higher tomorrow but it may also surge lower. For readers who may still have positions I suggest selling into strength and also keeping a tight stop. The targets listed above are still valid as well as the support areas for possible tight stops.

Closed Position: June $27.00 CALL at $1.10, entry was at $1.15

Annotated Chart:

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