Option Investor
Newsletter

Daily Newsletter, Wednesday, 6/16/2010

Table of Contents

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

Market Wrap

Traders Indecisive on Economic Data & Corporate News

by James Brown

Click here to email James Brown

Market Stats:

Stocks were off to a poor start this morning as investors digested disappointing Fedex earnings and shockingly low housing starts. News that BP chose to cut its dividend and fund a $20 billion escrow account helped remove some uncertainty over the embattled oil giant and the market rebounded. Unfortunately the gains were short-lived and stocks closed virtually flat on the session following Tuesday's big rally. The market also sifted through the industrial output numbers, PPI report, and news that WPO triggered the new circuit breakers and Fannie Mae and Freddie Mac would be delisted from the NYSE.

Intraday Chart of the S&P 500 (5-minute):

Foreign markets were mostly higher with Japan leading the way in Asia. The Japanese NIKKEI index surged 1.8% to a one-month high on what looks like short covering. The Chinese Shanghai index closed up 0.29% and the Hong Kong Hang Seng rose just 0.05%. Gains were more even across Europe but stocks struggled on the disappointing housing start numbers in the U.S. Mobile phone maker Nokia (NOK) also disappointed the market with an earnings warning and shares of NOK plunged almost 9%. The economic data in the U.K. was mixed with consumer confidence falling to its lowest levels in almost a year. At the same time the number of initial jobless claims fell in May to a new one-year low. The England FTSE managed to keep the winning streak alive with its sixth gain in a row, up +0.39% for the session. The French CAC-40 gained +0.39% and the German DAX rose +0.26%.

After yesterday's big moves in the currency market the euro and the dollar both drifted sideways on Wednesday. The lack of action in currencies left commodities to trade on their own. The results were mixed. Gold futures slipped almost $4 to $1,230.50 an ounce. Copper prices hit some profit taking with a 1.3% drop following a six-day rebound. Crude oil futures ignored the bearish weekly oil inventory report in the U.S. and rose 0.9% to $77.67 a barrel. This is somewhat surprising and could be a reaction to the BP news or hope that global economic activity won't slow down too much. The inventory numbers this morning were certainly a surprise. Analysts were expecting a drop of 1.75 million barrels of oil and an increase of 640,000 barrels of gasoline. Instead the Energy Information Administration said oil inventories rose 1.7 million barrels and gasoline supplies sank by 600,000 barrels. U.S. refineries operations fell 1.2% to 87.9% of capacity.

The economic data flow for the U.S. economy continues to be mixed. The housing starts number was the biggest surprise. The Commerce Department said housing starts fell 10% in May to an annual pace of 593,000 from 659,000 in April. This was the biggest drop since March 2009. The single-family home starts component plunged 17%, which was the largest decline since 1991. The number of building permits also saw an decline to a new one-year low. Home builders have a right to be cautious. Unemployment remains high and the qualification window for the homebuyer tax credit expired on April 30th. Odds are good the sale of existing home and new homes will continue to underperform. More than one market pundit is expecting residential real estate to see another 10% to 20% decline before home prices finally hit bottom.

On a brighter note the industrial production numbers were good. Output for U.S. factories, mines, and utilities rose 1.2% in May. This was the largest improvement since August 2009 and followed a 0.7% gain in April. Economists were only expecting +0.9% growth in output. Thus far U.S. output is up 10 out of the last 11 months but we're still down 7.8% from the high in December 2007.

The big drop in energy prices in May (gasoline -7%) helped push the headline PPI number lower. The Producer Price Index helps measure inflation at the wholesale level. This morning the Labor Department reported that prices paid to farmers and factories fell 0.3%. The core-PPI, which excludes more volatile energy and food prices, rose +0.2%. Economists were looking for a -0.5% drop in the headline number and a +0.1% gain for the core number.

One of the biggest headlines today was the deal between oil giant BP and the White House. BP announced they would set up a $20 billion fund to help compensate victims of the Gulf oil spill. BP's management announced they would stop the upcoming June 21st quarterly dividend payment (about $2.6 billion) and all further quarterly dividends for the rest of the year. By ending their dividend payments, cutting back on spending, and selling some assets BP plans to put $10 billion into the fund by this time next year. President Obama pointed out that this $20 billion victim's compensation fund was not a limit on BP's potential exposure and it has no impact on what the final clean up cost totals might be. I found it interesting that BP plans a separate $100 million fund to help out of work oil rig workers following President Obama's moratorium on deep-water drilling.

The big question both short-term traders and long-term investors are asking a lot these days is whether or not BP is a buy at these levels (currently trading around $32). Shares did seem to find some support after falling 50% from the $60 level and it wouldn't surprise me to see BP produce a significant oversold bounce. The stock saw a 1.4% bounce today on hopes that the $20 billion victim fund helped, in a small way, define some of BP's risk. Yet long-term no one knows what BP's exposure to victim compensation, clean up costs, and penalties might be. This could end up being a black cloud over BP's stock price for a very long time. As long as you have a clearly defined stop loss to limit your risk you could always consider a speculative position on BP but it remains a very high-risk bet in my book.

Chart of BP:

Shares of FedEx (FDX) had an effect on the market today. The stock is a component in the Dow Jones Industrials, Dow Transportation average, S&P 100, and S&P 500 indices. Today shares were hammered for a 5.9% loss, completely erasing the last four days of gains. Prior to the opening bell FDX reported its Q4 earnings, which came in at $1.33 a share and a penny above estimates. Revenues soared +20% and came in better than expectations at $9.43 billion for the quarter. Management seemed to have good things to say. Internal volumes were at multi-year highs. International shipments roared with a +23% improvement thanks to strength in Asia, Latin America, India, China and Brazil. Yet investors were disappointed with the company's guidance when FDX offered 2011 guidance in the $4.40-5.00 range compared to Wall Street's estimates at $5.05. Many consider FDX to be a key bellwether company for the U.S. and global economy. Let's hope this isn't a sign of things to come for the second quarter earnings season that begins in July.

Chart of FDX:

Shares of Apple Inc. (AAPL) managed to outperform the market with a 2.9% gain to $267.25 a share. You may recall that after the company unveiled the new fourth generation iPhone this month there was a huge burst of sales for its rival, Google's Android phones. It almost seemed like the iPhone had lost its mojo and consumers were flocking to competing products. It seems that would have been a poor assumption. Yesterday AAPL and AT&T announced that the 4th generation iPhone set a record-breaking sales pace of more than 600,000 units - the highest ever for a single day of preorders. This was on top of an online ordering hiccup that prevented some consumers from actually getting their orders processed. The new iPhone is expected to hit stores on June 24th.

Washington Post made headlines on Wall Street today as the first stock to trigger the new SEC single-stock circuit breakers. The Security and Exchange Commission's new trading curbs began on June 11th and they're supposed to kick in whenever a stock rises or falls by more than 10% in less than five minutes. This afternoon shares of WPO jumped from $462 to $919-929, nearly doubling the stock price. There were three trades for a total of 766 shares, which were all cancelled.

Elsewhere in corporate news it was announced that shares of Fannie Mae (FNM) and Freddie Mac (FRE) would be delisted from the NYSE. These government-sponsored entities (GSEs) were bailed out by the U.S. government during the subprime crisis. The government now owns about 80% of these two companies. Shares of FRE fell 38% to $0.75 while FNM dropped 39% to 0.56 a share on this news. The move follows a directive by the Federal Housing Finance Agency telling both firms to delist their shares. The move from the NYSE to the pink sheets (OTC Bulletin Board) is expected to happen in the first half of July.

Technically the market looks a lot more bullish, at least on a short-term basis. The S&P 500 managed to hold Tuesday's close above the simple 200-dma in addition to short-term resistance near the 1,110 area. This certainly lends strength to the argument that the lows near 1,040 looks like a bullish double bottom. I would remain cautious since the S&P 500 has significant resistance near the 1,150 area. I also anticipate the 50-dma crossing under the 200-dma in the next two or three weeks, which is normally a very bearish development.

Chart of the S&P 500 index (daily):

The NASDAQ Composite failed under its simple 100-dma this afternoon and is hovering near the 2300 level, which was the top of its range for the last three weeks. While the NASDAQ also has a possible bullish double bottom the index looks a little short-term overbought, you could probably say the S&P 500 looks a little bit overbought with a six-day bounce from the June 8th lows.

Chart of the NASDAQ Composite:

The small cap Russell 2000 index ($RUT) has seen a very nice bounce off its June lows but the rally has stalled at resistance near the 670 level. The index may need to retrace a few steps and build up some steam before actually breaking out.

Chart of the Russell 2000 index:

On a short-term basis I am encouraged by the market's recent strength. There is still a chance we could see some volatility surrounding option expiration this Friday but normally summer Fridays are pretty boring, low-volume affairs. After Friday odds have improved that the market could see some end of quarter window dressing. However, I would not get seduced by any market rebound. You can trade it but I would hesitate to make any long-term bets. I'm concerned that we might be in the "eye of the storm". The economic data from the U.S. continues to be mixed. I am still in the double-dip camp. Although I will note that the American Bankers Association reported that their economic advisory committee believes the U.S. will avoid a double-dip. Instead the ABA believes the U.S. will grow by 3.2% in 2010 and 3.0% in 2011 but only half of the jobs lost during the recession will return.

Longer-term Europe remains a problem. Their debt challenges are still here and will remain an extremely heavy burden for years to come. You may not like him but George Soros shared his opinion that a double-dip recession in Europe is "inevitable". I happen to agree. The strict austerity measures being enforced in Europe will severely hamper growth but they have no choice since they have to deal with their debt problems. Mr. Soros went on to say that flaws in the euro would prevent the EU from being able to solve their problems and has the potential to "destroy" the EU. The region would probably see years of stagnation and there is a real risk of rampant civil unrest.

- James


New Option Plays

Long Play On A Large Cap Tech

by Scott Hawes

Click here to email Scott Hawes


NEW DIRECTIONAL CALL PLAYS

Cisco Systems - CSCO - close 23.29 change -0.04 stop 22.20

Company Description:
Cisco Systems, Inc. designs, manufactures and sells Internet protocol (IP)-based networking and other products related to the communications and information technology (IT) industry, and provides services associated with these products and their use. The Company provides a line of products for transporting data, voice, and video within buildings, across campuses, and around the world. Its products are designed to transform how people connect, communicate and collaborate. The Company’s products are installed at enterprise businesses, public institutions, telecommunications companies, commercial businesses and personal residences. It has five segments: United States and Canada, European Markets, Emerging Markets, Asia Pacific, and Japan. The Emerging Markets theater consists of Eastern Europe, Latin America, the Middle East and Africa and Russia and the Commonwealth of Independent States. In December 2009, the Company completed its acquisition of Starent Networks..

Target(s): 23.55, 24.20
Key Support/Resistance Areas: 23.65, 22.55
Time Frame: Several weeks

Why We Like It:
CSCO has been building a nice base for the past 3 to 4 weeks and is trading in a $1 range (4.5%) between $22.55 and $23.55. $22.50 is key pivot level for the stock dating back to 2006. It appears the stock may want to break out of this base, but we don't necessarily need that to happen for a profitable trade. CSCO looks stable here with a lot of support and I suggest we take advantage of the reliable price pattern that is being built. I would like to use $22.85 as a trigger to enter long positions. If triggered readers should be able to purchase July $22.00 calls for about $1.30 (current ask is $1.64). If CSCO then proceeds to rally to the top of its base at $23.55 we should make about 55 cents on the position for a +40% gain. If CSCO breaks out it could rally to fill the a gap which is up near our more aggressive 2nd target of $24.40 and below the stock's 200-day SMA. Another entry could be considered at $23.05. Our Stop will be $22.20. NOTE: I view this trade as potentially being quick.

Suggested Position: Buy July $22.00 CALL if CSCO trades down near $22.85, current ask $1.64, estimated ask at entry $1.30

Annotated Chart:

Entry on June xx
Earnings Date 8/5/10 (unconfirmed)
Average Daily Volume: 69 million
Listed on 6/16/10


In Play Updates and Reviews

PUT Closed For Nice Gain

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:


CALL Play Updates

Direct TV - DTV - close 39.33 change +0.08 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:
We are patiently waiting for DTV to come to us. If it doesn't cooperate soon I will be removing the trade from the portfolio. My comments from last night remain the same. DTV has ran away from us a bit here as we have waited 8 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 $2.78, 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


Ormat Technologies - ORA - close 29.79 change +0.13 stop 27.25

Target(s): 30.45, 31.80
Key Support/Resistance Areas: 32.00, 30.60, 29.00, 27.50
Current Gain/Loss: +5%
Time Frame: Several weeks
New Positions: Yes

Why We Like It:
ORA traded down to our entry at $29.25 late this morning so we long July $30.00 calls at $1.00. The stock closed above its 50-day SMA and made new daily highs. All of this is good but there is some resistance overhead so there could be a pullback. The broader market strength or weakness is sure to influence the price of the stock. Our initial target is $30.45 with our more aggressive 2nd target at $31.80. I'll leave my comments from the play release. ORA has broken through a long term primary downtrend line and a short term secondary downtrend line. 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.

Current Position: July $30.00 CALL, entry was at $1.00

Entry on June 16, 2010
Earnings Date 8/4/10 (unconfirmed)
Average Daily Volume: 345,000
Listed on 6/15/10


PUT Play Updates

Freeport McMoRan Copper & Gold - FCX - close 67.03 change -0.02 stop 68.80

Target(s): 65.15, 64.00, 63.10, 61.50, 58.30
Key Support/Resistance Areas: 66.00, 65.00, 64.00, 58.00, 55.00, 52.00
Current Gain/Loss: -40%
Time Frame: 1 week
New Positions: No

Comments:
FCX was weak again this morning but buyers stepped in and the stock closed at about breakeven on the day. The stock traded down to our key support level at $66.00 and then reversed higher. On the intraday charts FCX has been in an uptrend the past 5 days and on the 30 minute chart FCX has bounced off of the 50-period SMA (currently $66.66) as support on the way up. This level needs to break convincingly to get the stock moving lower, and if it does I think we could see $65.00 relatively quick. Fundamentally, demand for copper should be weakening as evidenced by housing starts in the US and other countries like Australia, which came in overnight at 4.3% Q/Q compared to estimates of 7.0%. This has been a frustrating trade and I think it is prudent to consider exiting positions to preserve capital. As such, I have added $65.15 and $64.50 as additional targets. The estimated price of our options at these targets is about $1.75 and $1.90, respectively. These are good levels to either take profits or tighten stops to see if we can get more out of the trade. When FCX gets moving the moves tend to be big. On the daily charts, the stock remains in a downtrend and has made a series of lower highs and lower lows, but it has also stubbornly refused to give up any of the recent gains. Readers may want to consider placing a sell limit order based on the option (as opposed to the stock price) to simply exit positions. 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


CLOSED BEARISH PLAYS

Home Depot - HD - close 32.14 change -0.12 stop 33.65

Target(s): 31.75 (hit), 31.35, 30.10
Key Support/Resistance Areas: 33.25, 32.90, 32.30, 31.25, 29.95
Current Gain/Loss: +30.59%
Time Frame: 1 to 2 weeks
New Positions: Closed

Comments:
HD pulled a repeat of yesterday. The stock hit our target of $31.75 in early trading before reversing higher. We are flat the position for a +30.59% gain. The stock has still not broken previous days highs since last Friday while the market has showed strength. The stock remains below its downtrend line that started on May 18th and if the market turns down from here HD should be a big decliner. If that happens I think HD will retest its recent lows and possibly even make a trip down to its 200-day SMA. But protecting gains is the name of the game in this volatile environment. There is a formidable resistance and congestion range from $32.15 to $32.90. A tighter stop could be placed at $33.05 which is above the 20-day SMA and would get you out of the trade if HD begins to fill the gap lower from 6/3 to 6/4.

Closed Position: July $32.00 PUTS @ $1.11, entry was at $0.85

Annotated chart:

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