Option Investor
Newsletter

Daily Newsletter, Tuesday, 6/15/2010

Table of Contents

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

Market Wrap

Europe Finds A Bid

by Jim Brown

Click here to email Jim Brown

Investors started back into Europe with Spain, Belgium and Ireland selling debt into a suddenly healthy demand.

Market Stats Table

Look up in the sky, is it a bird, a plane, no it’s the Euro. The Euro has risen sharply for the last week and today's close at 123.06 was a two-week high. After the break under 119 last week the euro found traction in the form of numerous upgrades for European economic estimates and the successful debt sales. The U.S. market rally owes its strength to the sudden rise in the euro and the corresponding decline in the dollar.

Chart of Euro

Chart of Dollar Index

The improved outlook for global growth even overcame bad news from the NAHB Housing Market Index this morning. The index fell to 17 for June compared to the revised May level of 22. That is a 22.7% drop. Obviously the decline was directly related to the end of the tax credit qualification period on April 30th. The decline was expected but only about a fourth of the actual decline. The single-family sales component declined from 23 to 17. Expectations declined from 27 to 23. However, the buyer traffic component fell only slightly from 16 to 14. The short-term volatility in this index may be big news today but in the longer-term scheme of things the 17 reading for June is still way below the last cycle high at 72. There is a long way to go before we return to anything resembling a normal reading. This can be seen in the mortgage applications index, which is reported weekly. The purchase applications index has fallen to 167 from well over 500 in the last boom cycle. New home sales are going to continue to decline until the economy recovers and the market works through the 5-7 million foreclosures now on the market and heading to market.

NAHB Index Chart

I don't normally report on weekly Chain Store sales because of the noise in the weekly numbers but sales are trending down. The decline for the week was -0.7%. This was confirmed by a weak earnings report by Best Buy. The company said TV sales were weak in Q1 but probably because of the major sales ahead of the digital conversion last year. They said they sold fewer flat screen TVs because price declines were becoming less dramatic. The average price of a TV fell -19% in April to $669 compared to $776 in the prior April. Best Buy said the decline was the least of the last eight months.

Best Buy also benefited from the demise of Circuit City last year and volume picked up sharply. There has not been any similar events in 2010. The big event for Best Buy was the ramp up by Wal-Mart into the flat screen market and that has cost Best Buy some sales. MasterCard's Spending Pulse report showed that sales of consumer electronics declined -0.8% for the entire month of May.

The NY Empire State Manufacturing Survey rose only fractionally to 19.6 from 19.1 for June. However, the index is still down sharply from the 31.9 reading in April. New orders picked up slightly from14.3 to 17.5 and backorders declined for the third consecutive month but that was not the highlight of the survey. The biggest problem was a drop in the employment component from 22.4 to 12.4. This is a clear warning that employers are beginning to worry about future economic conditions. The capital expenditure component also fell sharply by -25% to 28.4 from 38.2.

The Empire report normally tracks pretty well with the Philly Fed Survey due out later this week but the Empire report has been the stronger of the two lately. This could be a warning that the Philly Fed Survey is going to come in weaker than expected.

Economic reports due out on Wednesday include the Producer Price Index, New Residential Construction, Industrial Production and Oil and Gas Inventories.

Risk aversion is slowly turning back to risk appetite now that analysts are turning positive again on the global economy. Stocks linked to global growth rallied strongly. Those included Caterpillar and Boeing, which gained +4.1% and was the biggest impact on the Dow.

A positive indicator was the surge by the CBOE on their first day of trading. The $339 million IPO was the biggest so far this year. CBOE gained +12% even though it closed near the low of the day. They definitely got the luck of the draw on a good day to go public.

The Semiconductor Index ($SOX) rallied more than 5% to a six-week high on comments from Best Buy and the global economic improvement. Best Buy said PC sales and especially laptops, netbooks and other PC gadgets were selling strongly. Smart phones were also moving briskly. This implied blessing of all things chip related helped to power the SOX higher. I was in a Microcenter on Sunday and had to wait in line for 20 min to check out because of the crowds.

The real news in the chip world came from Taiwan Semiconductor, the world's largest contract chipmaker. TSM said chip sales would rise +7% annually from 2011 through 2016. Strong demand from China plus the new wave of electronic devices like the iPad will fuel the growth. There are actually many more new devices coming in our near future than have been released in the last five years. This is the age of portable electronics. Chipmaker United Microelectronics (UMC) said that chip demand would exceed supply in the third quarter and they have seen no impact to demand from the Eurozone problems.

Semiconductor Index Chart

It would not be a day in the market without another round of BP bashing. The heads of the top five oil companies were grilled by Congress and the other companies tried to distance themselves from BP as much as possible. Several said specifically that BP's procedures on the Macondo well were not the same procedures a responsible company would have employed. Lawmakers repeatedly fired questions at the head of BP USA and then refused to let him answer unless the answer was phrased they way they wanted to hear it. BP deserves the hostility because of the blatant errors in judgment they made on the Macondo well. The rest of the industry does not. The Exxon CEO pointed out that there have been nearly 15,000 deepwater wells drilled in the gulf with no material errors when the correct procedures were followed. Tillerson said "this incident represents a dramatic departure from the industry norm in deepwater drilling."

BP was forced to halt oil collection today when a fire broke out on the collection ship Enterprise due to a lightning strike. That is all Transocean needs is to have another rig catch fire and sink.

A team of government scientists raised their leak estimates for the third time in three weeks to between 35,000 to 60,000 barrels per day. The last estimate just a week ago was 20,000 to 40,000 barrels. That was nearly double the prior estimate of 12,000-19,000 barrels. To put it bluntly nobody knows because they have never seen this type of unrestricted leak before. The Ixtoc One blowout in 1979 off the coast of Mexico was thought to be flowing at 30,000 bpd but even at only 160 feet deep we did not have the technology back then to see what was happening in real time. That well took ten months to cap and continued flowing for three months after the relief wells were drilled.

President Obama will speak from the Oval Office tonight on the BP spill and will use the spill as another attempt to pass a carbon cap and tax bill. The BP CEO is scheduled to meet with Obama on Wednesday and then testify before Congress on Thursday. Not a good week for BP.

Anadarko (APC) and Transocean (RIG) are preparing to do battle. Anadarko leases a deepwater rig called the Discoverer Spirit from Transocean. Anadarko filed a notice of force majeure last week in an attempt to halt the lease payments and cancel the lease because of the moratorium. They also did this with two other rigs on lease from other companies. (DO and NE) Transocean rejected the Anadarko claim of force majeure saying a temporary drilling moratorium was not a valid reason for the filing. Noble (NE) also rejected an Anadarko filing. Both companies claim the moratorium is not one of the valid reasons covered by the lease contracts. With lease rates of $500,000 per day you can bet those are some seriously boiler-plated contracts.

Anadarko was quick on the trigger to file the FM claims on three rigs because it is also a 25% owner of the Macondo well with BP. In theory they could be liable for 25% of the cleanup expenses now estimated at $75 billion. Anadarko only has $500 million in cleanup insurance. Anadarko has received some favorable opinions this week because they were a "passive" investor in the well and BP was the 100% operator. Again, in theory, BP should be liable for all the expenses. Secondly, since there is so much evidence that BP knowingly screwed up multiple times in the cost saving decisions they made, Anadarko should have reasonable grounds to sue BP for any liabilities and for any lost revenue due to BP's negligence.

BP has been found criminally negligent twice before in recent U.S. accidents. Once in an Alaska pipeline spill and once in a refinery explosion in Texas. This repeat performance means BP is going to have to pay up when the time comes because the prosecution is going to use those prior negligence findings against them.

BP claimed it would have a second containment system running today but the shutdown due to the fire may have slowed that effort. The second system will pump oil to the Helix Q4000 rig where it will be burned at the rate of up to 15,000 bpd using a Schlumberger system. The Helix Q4000 does not have the ability to store oil. BP has ships in route that will add 50,000 bpd of processing and storage capability but they will not arrive until early July. I would love to see an overhead shot of the ocean above the well. It is turning into quite a parking lot for heavy iron.

In the "you can't make this up category" BP has ordered 32 oil recovery machines from Kevin Costner. The actor has been working on creating a device that will separate oil from water ever since the Exxon Valdez spill. Costner said he has spent nearly $20 million in development and marketing of the systems over the last 20 years. His brother is a scientist who helped him design the equipment. The 4,000-pound machines contain a centrifuge that separates oil from water at the rate of 200 gallons per minute with the oil being piped away to a barge while the water is returned to the ocean.

Apple Inc said sales of the new iPhone 4 were so strong that the company suffered a systems failure and could not process orders. In some cases subscriber's personal data was revealed to strangers. Customers logged into the AT&T website suddenly found themselves inside other customers accounts. The new phone does not officially go on sale until June 24th but Apple started taking reservations today. All the iPhones available on the first day were sold out. Apple stores were also locked out from taking new reservations. The new phone reservation application on the current iPhones was also locked out.

Major credit card issuers reported improved results in May. The rate of payments that were 30 days or more past due declined for all six of the biggest card companies. Citigroup said delinquencies fell to 8.42% from 9.02% in April. All the other issuers said the declines were similar except for American Express. AXP said delinquencies fell to 3.1% from 3.3%. AXP typically has fewer problems because of the higher quality credits. Charge-offs declined to 6.3% from 6.7%. This is signs consumers are slowly digging out of their credit hole. However, it is also due to the worst credits being charged off over the last two years of stress. Those left with active accounts are the survivors.

The Dow rallied +213 points today for only the fifth 200+ point day of the year. The Dow closed over 10400 and over the 200-day average at 10320. Remember the Dow is not specifically moving average reactive but it was still positive. The Dow broke out of the 10250 range resistance and could have a ways to go before the rally fades. Support is now 10200.

Dow Chart

The S&P is the key index today. The S&P posted a clear breakout over the 200-day average and this is critical resistance for the S&P. It is also a clear technical signal for investors to start adding to longs. The end of day pause at 1115 was right on secondary resistance but the break over the 200-day should give it enough momentum to continue the move. Now the 200-day at 1108 should act as support on any future weakness. The case for the bears becomes even stronger on a decline back below 1100. That would be a clear signal to go short again.

S&P-500 Chart

The Nasdaq rallied +61 points on the back of the +5% chip sector gain plus a +$5 gain in Apple. The post iPhone announcement jinx of the last three years appears to have been broken. The Nasdaq has a little resistance right where it ended the day at 2300 but a continued technical breakout by the S&P should drag it higher. Support is now 2250.

Nasdaq Chart

Volume did not improve materially over Friday and Monday. At just over 8.3 billion shares it is just mediocre and not a confirmation of the move. I also said that in the weekend commentary when Friday's volume was the lowest since April 5th. Traders always want to see more volume on market rallies and we are not seeing it. That does not mean the rally is not for real it just means that the majority of investors have not signed on to the change in direction. We are now into the summer doldrums season where traders are spending more time at home or at the beach with the kids and less time watching a monitor.

However, the up volume was 7.5 billion shares compared to only 732 million of down volume. That is a significant sentiment reversal even on a medium volume day.

In the weekend commentary I was borderline bullish on the improving global economics. I warned that the 1100-1107 range (200-day at 1107) would be the key to the continued rally. On Monday the S&P rallied to 1105 and then fell off the cliff in a perfect swan dive to negative territory. There was no selling at the close today and it feels like the shorts are getting tired.

The key metric is the improving global outlook and the fact we broke over the 200-day on the S&P. That is technically significant and "should" lead to further gains. Last week I suggested we could see a breakout ahead of earnings but I did not think it would last out the summer. I expected a new range to form and for us to linger there throughout the summer. So far my expectations appear to be coming true.

Jim Brown


New Option Plays

A Long Play on Energy

by Scott Hawes

Click here to email Scott Hawes


NEW DIRECTIONAL CALL PLAYS

Ormat Technologies - ORA - close 29.66 change +0.94 stop 27.25

Company Description:
Ormat Technologies, Inc. (Ormat) is engaged in the geothermal and recovered energy power business. The Company designs, develops, builds, owns and operates geothermal recovered energy-based power plants, usually using equipment that it designs and manufactures. Ormat conducts its activities in two business segments: Electricity Segment and Product Segment. In the Electricity Segment, the Company develops, builds, owns and operates geothermal and recovered energy-based power plants in the United States and geothermal power plants in other countries worldwide, and sells the electricity they generate. In the Product Segment, Ormat designs, manufactures and sells equipment for geothermal and recovered energy-based electricity generation, remote power units and other power generating units, and provides services relating to the engineering, procurement, construction, operation and maintenance of geothermal and recovered energy power plants.

Target(s): 30.45, 31.80
Key Support/Resistance Areas: 32.00, 30.60, 29.00, 27.50
Time Frame: Several weeks

Why We Like It:
ORA has broken through a long term primary downtrend line and a short term secondary downtrend line. Today the stock broke through and closed above a resistance area near $29.00. ORA is essentially a utility that is involved in the alternative energy business (i.e. geothermal) and may be in the right place at the right time with a push from the White House in this sector. I would like to see a retracement of some of today's gains and use $29.25 as an ideal entry point to initiate long positions. The stock closed near its 50-day SMA so I expect a pullback before a larger move to the upside. Our stop will be $27.25 which will give this trade some room to work.

Suggested Position: Buy July $30.00 CALL if ORA trades down near $29.25, current ask $1.25, estimated ask at entry $1.00

Annotated Chart:

Entry on June xx
Earnings Date 8/4/10 (unconfirmed)
Average Daily Volume: 345,000
Listed on 6/15/10


In Play Updates and Reviews

Stopped Out Of Our ETF Play

by Scott Hawes

Click here to email Scott Hawes

Editor's Note: Good Evening. The S&P 500 closed above its 200-day SMA today, but not by much. The major indexes have plenty of resistance above including the 100-day and 50-day SMA's. Volume has been light and I am having a hard time trusting this rally. Most of the economic news from today wasn't good but the market rallied in spite of it. It appeared to me that shorts were getting squeezed and when this stops we may turn right back down. Nonetheless, we have to deal with the conditions that our dealt to us and the recent spike through the 200-day SMA was barely enough to hit our stop in SPY. Cautiously bullish is the best term to describe my feelings on the market currently. One sector that I am interested in on the long side is energy.

My strategy in the coming days is to build more short positions, especially if the markets continue to melt-up. I will also continue to look for strategic long plays so that we are hedged and can participate on any further upside. I also want to reiterate that if you can not trade intraday the conditions remain difficult to manage swing trades. The markets are moving fast and furious in both directions and trying to pinpoint entries and exits without being able adjust them intraday is very difficult. I want to point readers to number 6 on the winning axioms list on the OptionInvestor.com web site. It basically says to always pick a sell price you would be happy to get before you buy an option. This is especially a good strategy for readers who do not have the ability to trade intraday and will give you a better chance to book winning trades.

Lastly, I want to address several emails I received over the weekend concerning the way we closed the ACI short trade last week. My intentions in the editor's note were to close long or short positions on Thursday as I suspected the market was going to gap and potentially make a large move. I just didn't know the direction. As a result when the markets gapped higher the right thing to do was to close ACI when the stock traded above its opening range. After reviewing my instructions I realize they were not clear and I am adjusting the results of this trade to the original stop. My sole intentions were to communicate some of the techniques and rules I use to protect capital and I apologize for the misguidance. I always encourage readers to email me if they have any questions.

Current Portfolio:


CALL Play Updates

Direct TV - DTV - close 39.25 change -0.68 stop 35.70

Target(s): 38.20, 38.50, 39.50, 41.50
Key Support/Resistance Areas: 38.60, 37.00, 36.30
Current Gain/Loss: N/A
Time Frame: Several weeks
New Positions: Waiting to be triggered

Comments:
DTV has ran away from us a bit here as we have waited 7 trading days and still haven't gotten filled. $37.20 is a key support area and the 50-day SMA is rising towards this level everyday. Let's use this as our trigger to enter positions. Essentially we are playing for a bounce near the stock's 50-day SMA which it has not touched since the flash crash. The stock also has two trend lines underneath our entry which should provide further support if we get filled. The 50-day SMA is currently $36.87 and it is rising but placing an order slightly above this is suggested.

Suggested Position: Buy July $37.00 CALL if DTV trades down near $37.20 which is just above its 50-day SMA, current ask $2.74, estimated ask at entry $1.40

Entry on June xx
Earnings Date 8/5/10 (unconfirmed)
Average Daily Volume: 12.3 million
Listed on 6/5/10


PUT Play Updates

Freeport McMoRan Copper & Gold - FCX - close 65.26 change +0.33 stop 68.80

Target(s): 63.10, 61.50, 58.30, 55.20
Key Support/Resistance Areas: 66.00, 65.00, 64.00, 58.00, 55.00, 52.00
Current Gain/Loss: -39%
Time Frame: 1 weeks
New Positions: Yes

Comments:
FCX was weak this morning and was lifted by the overall strength in the market. Depending on how you draw it the stock appears to have closed above the downtrend line from its April highs and closed above its 20-day SMA. This has me concerned, however, the stock remains in a downtrend by making a series of lower highs and lower lows. Copper futures still have resistance overhead and so does FCX. However, the broader market needs to cooperate to get things moving lower. Conservative traders may want to consider placing a tighter stop or simply exiting positions to protect capital. This is a critical level for FCX. There could be a double top forming with highs from yesterday and today which may get the stock moving lower tomorrow. I listed two additional targets on Monday which are areas where I urge readers to tighten stops. The first target is at a level where FCX could form an inverse head and shoulders pattern which needs to be considered as a potential reversal point for the stock. I view this trade as aggressive and quick so proper position size should be used to limit risk. I am also choosing an out of the money option to limit capital at risk.

Current Position: July $60.00 PUT, entry was at $2.38

Entry on June 11, 2010
Earnings 7/21/2010 (unconfirmed)
Average Daily Volume: 19 million
Listed on June 10, 2010


Home Depot - HD - close 32.26 change +0.20 stop 33.65

Target(s): 31.75, 31.35, 30.10
Key Support/Resistance Areas: 33.25, 32.90, 32.15, 31.25, 29.95
Current Gain/Loss: +2.3%
Time Frame: 1 to 2 weeks
New Positions: Yes, but preferably on bounces

Comments:
HD opened higher and immediately sold off reaching a low of $31.55, which was only 15 cents from our first target. HD proceeded to bounce up to $31.78 off of its opening lows before proceeding lower. This was the perfect area to place a protective stop just above at $31.85. If you were able to trade intraday this is where I would have placed the stop to protect HD from reversing and protecting profits in the position. Our puts at this level could have been sold for $1.15 which would have represented a +35% gain. This is just an example of a stock that got close to our target only to reverse. Readers who do not have the ability to trade intraday may want to consider devising an exit strategy based on the option price as opposed to the stock price. For example, after you enter a position pick a realistic profit target you are happy with based on the option price and place a GTC limit order to sell. Even if you chose $1.05 or $1.10 you would have protected a nice profit today. This is listed as a winning axiom on OptionInvestor.com if you want to read more about it and I think this is a great strategy especially with the high volatility. I have listed a slightly higher target of $31.75, which is just above today's lows, for readers looking for a quicker exit. This is an area I suggest tightening stops. HD could just as easily reverse back down tomorrow. The stock did not make it above yesterday's highs unlike the broader market and continues to struggle with the resistance and congestion range from $32.15 to $32.90. The stock remains below its downtrend line that started on May 18th. I expect more downside in HD and it to retest its recent lows and possibly even make a trip down to its 200-day SMA. Our stop is $33.65 which is above the declining 20-day SMA. A tighter stop could be placed at $33.05 which would get you out of the trade if HD begins to fill the gap lower from 6/3 to 6/4.

Current Position: July $32.00 PUTS, entry was at $0.85

Entry on June 14, 2010
Earnings 8/18/2010 (unconfirmed)
Average Daily Volume: 23 million
Listed on June 12, 2010


CLOSED BEARISH PLAYS

SPDR S&P 500 ETF - SPY - close 112.00 change +2.49 stop 112.10

Target(s): 108.00, 107.50, 105.00, 103.50, 102.25
Key Support/Resistance Areas: 111.00, 110.00, 109.00, 108.00
Current Gain/Loss: -42.6%
Time Frame: 1 to 2 weeks
New Positions: Closed

Comments:
SPY flashed a $112.10 print late in the day so officially we are stopped out of this trade. I doubt there many sell orders filled so if readers still have positions I would suggest placing a new stop at $112.50 and see if SPY reverses lower. SPY broke through the resistance levels and the 200-day SMA that was the basis for taking the short position. As I mentioned in the Editor's note I do not trust this rally and SPY could easily turn back lower. Once the short covering quits the buying will most likely wane and markets should move lower. If you had the ability to trade intraday on this position I would have placed a protective stop above the opening 30 minute range which would have gotten you out at a better price and protected capital.

Closed Position: July $109.00 PUTS at $2.15, entry was at $3.75

Annotated chart:

Entry on June 11, 2010
Earnings N/A (unconfirmed)
Average Daily Volume: 340 million
Listed on June 10, 2010