Option Investor
Newsletter

Daily Newsletter, Monday, 7/12/2010

Table of Contents

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

Market Wrap

Small Gains Before Earnings Season

by Todd Shriber

Click here to email Todd Shriber
In the final trading day before second-quarter earnings season kicks into high gear, U.S. stocks extended last week's gains on Monday, though only by narrow margins. The Dow Jones Industrial Average added 18 points to close at 10,216 while the Nasdaq gained less than two points before settling at 2198. The S&P 500 could not even manage a gain of single point, but still closed up on the day at 1078.76. Small-caps were losers on the day with the Russell 2000 shedding almost eight points to finish the session at 621.61.

Stats Table

By all appearances, Monday should have been a strong day for the tech sector. Barclays Wealth and UBS said before the market opened that computer and software names have fallen to their lowest valuations in 20 years, signaling that those companies are poised to rebound as they start spending some of their massive hoards of free cash. UBS said those declining valuations and the possibility of increased spending should combine for some good news for the tech sector even in the face of slowing U.S. growth. Share prices for tech names have fallen to 15.6 times annual income, making the group cheaper than it has been at any point since 1992, according to Bloomberg data.

SanDisk (SNDK), the maker of flash storage products for consumer electronic devices, surged almost 7% on volume that was nearly 25% above the daily average after UBS touted the stock. Even beaten down Qualcomm (QCOM) popped 3.51% on better-than-average volume after Goldman Sachs added the stock to its closely followed ''conviction buy list.'' Yet the Nasdaq could muster only a meager gain on Monday.

Finding a reason for Monday's Nasdaq disappointment is not that hard. Just look at Apple (AAPL). While the Nasdaq's juggernaut lost less than 1% on the day, concern may be growing that design problems with the new iPhone 4 could turn into headwinds for the stock. Consumer Reports said it will not recommend the phone amid complaints about a wrap-around antenna that if touched the wrong way, severely hampers the phone's reception.

It should be noted that while Consumer Reports is not a tech industry group, the magazine has been around for a long time and as CNBC put it, this is an ''influential nonprofit organization.'' So they have no skin in the game regarding the performance of Apple's stock. Beyond that, Consumer Reports said it tested ''many'' iPhone rivals and did not discover similar reception problems with those phones. The bottom line is that this issue probably will not be a long-term drag on Apple shares, but it does at least partially explain why the Nasdaq disappointed today.

iPhone

There was some M&A news worth noting, of both legitimate and speculative nature. First, the legitimate news. Insurance giant Aon (AON) said it will acquire Hewitt Associates (HEW) for $4.9 billion in cash and stock in a move that will almost triple the size of Aon's consulting business. Hewitt focuses on consulting services in the human resources arena and the acquisition is Aon's way of challenging rival Marsh & McLennan (MMC) on this front.

Aon will pay $50 per share for Hewitt, a 41% premium over where the stock closed on Friday. Hewitt shares surged $11.39, or 32%, to $46.79 after touching a new 52-week high at $47.42. Hewitt shareholders will receive $25.61 in cash 0.64% of an Aon share for each Hewitt share they own. The deal is expected to be finalized in November.

While Aon said the acquisition will boost earnings starting next year and begin saving the company $355 million a year starting in 2013, but at least one analyst voiced concern that Aon is overpaying. Shares of the acquiring company usually decline on takeover news, but the sell-off was pronounced in Aon as the shares tumbled 7% to close at $35.62 after moving to a new 52-week low at $35.10 earlier in the trading day.

Aon Chart

On the rumor-charged M&A front, BP (BP) continued its impressive run higher after London's Sunday Times reported yesterday that Exxon Mobil (XOM), the largest U.S. oil company, is preparing a bid for its beleaguered British rival. Exxon has reportedly asked the Obama Administration for permission to make a move on BP and that permission has apparently been granted.

Of course Exxon, the largest publicly traded oil company in the world, is not commenting on the news. Then again, everyone that follows the energy sector knows that list of legitimate suitors for BP, assuming the company really wants to sell itself, is very small and Exxon is on that list.

Another catalyst working in BP's favor on Monday was speculation that Apache (APA), the largest U.S. independent oil and gas firm, may acquire up to $12 billion worth of assets from BP, including part of BP's stake in Alaska's Prudhoe Bay. A $12 billion purchase for a company with a market cap of less than $30 billion had investors punishing Apache to the tune of a 3.2% drop on the day, but BP shares continued an impressive run. The stock is now up 20% in the past five days and traded as high as $37 today after trading around $27 on June 28.

BP Chart

As I mentioned earlier, we have arrived at the dawn of another earnings season and with the reports that were delivered after the bell today, there might be some holes in the double-dip recession thesis. Personally, I feel that to have a true double-dip recession, of which there has only been one in the past 70 years, the economy has to emerge from the first recession to begin with and I am not convinced that ever happened and the employment picture underscores that theory, but I digress.

Dow component Alcoa (AA), always the lead-off batter during earnings season, said it posted a second-quarter profit of $136 million, or 13 cents a share compared with a loss of $454 million, or 47 cents a share, a year earlier. The top line also looked solid as sales jumped to $5.19 billion from $4.24 billion. Analysts had been expecting a profit of 12 cents a share on revenue of $5.05 billion.

When Alcoa delivered its first-quarter update three months ago, it forecast a 10% increase in global aluminum demand this year. Buoyed by demand from automotive customers in North America and China, certainly positive signs, Alcoa said today that aluminum demand should rise 12% this year. Not surprisingly, Alcoa said China will account for the bulk of this year's aluminum consumption as commercial construction demand in North America tumbles and Europe's economic recovery remains challenged.

Alcoa Chart

I know I said this last quarter because I remember Alcoa's earnings coming out on a Monday, so I had the privilege of addressing the report then as well, but this is not the marquee report many pundits would have us believe it is. Alcoa's earnings get hyped up simply because the company is always the first of the 30 Dow stocks to report. And as I mentioned last quarter, the Dow is a price-weighted index and Alcoa is the lowest priced stock in the group, so do not expect a triple-digit gain for the Dow on Tuesday solely on the back of Alcoa's numbers.

In other words, there was another after-the-bell report today that was probably more important than Alcoa and that came from railroad operator CSX (CSX). In the essence of full disclosure, I am not long (or short) CSX shares, options or any ETF where this stock or any other railroad is held, so hopefully you will believe I am being impartial when I say this report looked pretty impressive.

CSX said it earned $414 million, or $1.07 a share, compared $305 million, or 77 cents a share, a year earlier. Revenue surged 22% to $2.66 billion. Analysts had been expecting a profit of 98 cents a share on revenue of $2.63 billion.

Florida-based CSX, the third-largest U.S. railroad, said it saw increased shipping volumes in every category that moves goods for, except for food and consumer staples, which were flat. Shipments of vehicles and auto parts surged 63% while shipments of metals used in the auto and construction markets jumped 44%, according to the Associated Press. Shipments of products used to build residential houses even saw a 2% gain.

CSX said ''the economy remains dynamic'' and that is seeing continued improvement in key markets. Transportation companies are often viewed as temperature checks on the broader economy and if you are bullish on U.S. stocks, the CSX report could be something to cheer. The shares are up 33 cents to $52.79 in after hours trading as of this writing.

CSX Chart

Looking at the charts, the S&P 500 has gained almost 6% in the past five days and is going to have to contend with resistance at 1080, but on the Alcoa and CSX earnings may be enough for the index above 1080 on Tuesday morning. A close above 1080 turns attention to resistance in the 1110 area. I know a lot of folks have been talking about the ''death cross'' on the S&P 500, the 50-day moving average crossing below the 200-day line, but the losses may not be as bad as expected.

On a historical basis, death crosses on the S&P 500 are followed by small losses over the next month and then the index moves higher over the three- and six-month time horizons following the death cross.

S&P 500 Chart

This could be a big week for the Dow as the blue chip index tries to conquer 10,250 and then 10,365. Alcoa has already reported, Intel (INTC) reports after the close on Tuesday while JPMorgan Chase (JPM), Bank of America (BAC) and General Electric (GE) follow later this week. The Dow is overbought after the five-day rally we have just seen, but if the market likes the Alcoa and CSX reports and Intel blows out the way it has the last two quarters, traders may have no choice but to chase the index higher this week.

Dow Chart

The Nasdaq could encounter some resistance at 2220 and then again just a few points away 2235 with support looking firm at 2150. The earnings calendar for the Nasdaq is light this week with Google (GOOG) the only other noteworthy tech name to report in addition to Intel, so I would not expect much in the way of excitement unless Intel and Google report truly extraordinary (or disappointing) results.

Nasdaq Chart

I have been unimpressed with the Russell 2000 for a while now and see no reason to change my tune. Support can be found at 590 and resistance at 650 and 670, though I would not expect either of those levels to come into play this week.

Russell 2000 Chart

The earnings reports that were delivered by Alcoa and CSX today are a double-edged sword. On one side, these reports may signal that things are not as bad with the U.S. economy as previously thought and if that sentiment holds, stocks could rally over the next couple of weeks. On the other side, strong earnings reports could be fuel on the fire for those that are saying we are in the midst of a jobless recovery. Earnings are important, but strong private sector job growth is what I need to see to become bullish for periods of longer than a week or two.


New Option Plays

Six Trade Set-ups

by Scott Hawes

Click here to email Scott Hawes
Editor's Note: Good Evening. I want to see how the market reacts tomorrow to Alcoa and CSX earnings reports prior to initiating new plays. Intel also reports after the bell tomorrow and we should get a good indication from the futures market after the bell what the tone will be on Wednesday. I have listed a couple of long trade set-ups in the tech sector that look promising, along with a couple of stocks on my watch list for short trades.

Long CIEN and Long NVDA - Both stocks appear to be breaking above downward trend lines and ready to test SMA's and resistance from below. If the market bounces these stocks could easily run 5% to 10% higher. I view these as aggressive and potentially quick trades.

Short Candidates include: BIDU, KRC, TGT, SPY



In Play Updates and Reviews

Quiet Day Ahead of Earnings

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:


CALL Play Updates

Merck & Co - MRK - close 36.09 change -0.21 stop 34.79 *corrected*

Target(s): 37.20, 37.75, 38.60, 39.35
Key Support/Resistance Areas: 39.50, 38.75, 38.00, 36.35, 35.80
Current Gain/Loss: +4%
Time Frame: 1 to 2 weeks
New Positions: Yes

Comments:
7/12: MRK traded down to $35.84 in early trading which triggered our long entry. The stock then drifted higher throughout the day. MRK appears to be forming a bull flag on its daily chart. A break above Thursday's high of $36.40 should get things moving higher relatively quick. Since we were able to get the lower entry trigger today I am going to offer a lowered 1st target of $37.20 which is a good place to consider at least consider tightening stops. I've also adjusted our primary target of $37.95 down 20 cents to $37.75.

7/10: MRK is building an ascending triangle on its daily chart with resistance near a key pivot level for the stock at $36.35. The stock formed a bullish inverse head and shoulders pattern that began with the left head in April (see large ovals on chart). If MRK trades above Friday's highs there is little resistance until about $38.00. Earnings are at the end of July and I expect this stock to make a run. I suggest we use any weakness to initiate long positions or a break above Friday's highs, whichever occurs first. The stock has closed above its 100-day, 200-day, and 20-day SMA's which are all converging so I don't expect too much pullback from here. Let's use a trigger of $36.50 and $35.85 to initiate long positions. Our stop will be $34.79 which is below all of the aforementioned SMA's and the lows from 6/21 and 6/23.

Current Position: August $36.00 CALLS, entry was at $1.21

Entry on July 12, 2010
Earnings Date 7/30/10 (unconfirmed)
Average Daily Volume: 18 million
Listed on 7/10/10


PUT Play Updates

Deere & Co. - DE - close 57.48 change -0.53 stop 60.05

Target(s): 56.30, 55.20, 53.25, 51.75
Key Support/Resistance Areas: 60.00, 57.50, 56.50, 56.00, 54.00, 52.70, 51.50
Current Gain/Loss: -37%
Time Frame: 1 to 2 weeks
New Positions: Yes, with a tight stop

Comments:
7/12: DE backed off and closed below its 20-day and 50-day SMA's today. The stock is also below the broken upward trend line that began in July 2009. We have two immediate targets below that could be hit intraday if there is any continued weakness in the stock. These targets are near intraday support levels and are good places to consider closing positions or to tighten stops to see if we can get a better exit. $59.30 is still a good level to place a tighter stop.

7/10: DE is not acting as I suspected and the position is moving against us. The stock has rallied to close its gap down on 6/29 which is also just underneath its broken upward trend line that began in July 2009. DE also closed right at its 20-day and 50-day SMA's from below. This the area where I thought any bounce in DE would stop and I think new bearish positions could be opened here with tight stops. The volume on this bounce has been significantly lighter than the pullback which is a bearish signal because it indicates that the stock is being more heavily distributed rather than accumulated. However, if the bounce doesn't stop here readers should consider getting out of the way and closing positions. A tighter stop could placed at $59.30 which is above the 100-day SMA and Friday's high. Officially, I am sticking with the original stop but have tightened the targets. These are near support/resistance and are places where I would suggest tightening stops.

7/7: DE had a huge day and closed +3.61% higher. The stock closed right at a key support/resistance level at $56.50 and is entering a congestion zone, downtrend line, the backside of a broken upward trend line, and all of its SMA's from below. The stock could bounce a little further but I would be very surprised to see DE above $58.00. I suggest we use some patience and see how the this relief rally plays out in the coming days.

Current Position: August $55.00 PUTS, entry was at $3.00

Entry on July 6, 2010
Earnings 8/18/2010 (unconfirmed)
Average Daily Volume: 5.4 million
Listed on July 3, 2010


Ingersoll-Rand - IR - close 33.90 change -0.14 stop 36.60

Target(s): 33.25, 32.05, 31.25
Key Support/Resistance Areas: 37.00, 36.50, 35.70, 34.50, 33.11, 31.50, 30.12
Current Gain/Loss: +2%
Time Frame: 1 to 2 weeks
New Positions: Yes

Comments:
7/12: IR spiked higher this morning but was met with selling which sent the stock lower, and it never really recovered. If there is any weakness in the broader market I expect IR to break lower and easily trade down to our first target of $33.25. Our primary target is $32.05.

7/10: I am comfortable with the fill we got in IR on Thursday. The stock is forming a bear flag and I expect it break down when the oversold bounce in the market loses momentum. I've adjusted our targets and added one just below for readers looking for a quicker exit. If the first target is hit the gain should be 10% to 15%. This is good place to at least tighten stops to see if we get more out of the position.

Current Position: August $35.00 PUTS, entry was at $2.25

Entry on July 8, 2010
Earnings 7/19/2010 (unconfirmed)
Average Daily Volume: 5.4 million
Listed on July 7, 2010


Lululemon Athletica Inc. - LULU - close 38.87 change -0.02 stop 41.30 *NEW*

Target(s): 37.20, 35.80, 34.55, 33.50
Key Support/Resistance Areas: 42.25, 39.75, 37.00, 35.16, 32.75
Current Gain/Loss: +0.00%
Time Frame: 1 week
New Positions: Yes

Comments:
7/12: Finally, LULU hit our trigger of $39.15 to enter short positions. The stock immediately lost $1.25 and then recovered. One thing is clear on the intraday charts and that is the volume when the stock was declining this morning was much greater compared to its recovery. I like the volume pattern and think LULU retests its lows before breaking higher. Should it break higher the 50-day SMA sits at $39.87 which should keep things under control. I've also listed a target of $37.20 which is just above a key support/resistance area of $37.00. Some might view this level as forming an inverse head and shoulders pattern on the hourly chart so it would be prudent to consider tightening stops at this level. This level will also produce a decent gain in the position.

7/10: LULU is getting ever so close to our entry. The stock traded to within 8 cents on Friday and backed off. The bounce over the past few days has been on extremely light volume showing a lack of participation. This is one of the most bloated retail stocks out there trading at a P/E of 38. It is a novelty retailer and sometimes the P/E doesn't matter so I will keep a tight leash on this and use a stop of $41.30 which is just above the 20-day and 50-day SMA's. LULU has not tested them from below since breaking through them in June. I like the short set-up and want to lower the entry trigger to $39.15. I have also adjusted the targets. I'm looking for LULU to make quick trip back down to test its lows and possibly break them.

Current Position: Buy August $35.00, entry was at $1.30

Entry on July 12, 2010
Earnings 8/19/2010 (unconfirmed)
Average Daily Volume: 700,000
Listed on July 1, 2010


Polo Ralph Lauren - RL - close 76.12 change -1.04 stop 82.50

Target(s): 75.25, 73.50, 72.10
Key Support/Resistance Areas: 82.00, 80.00, 78.00, 75.00
Current Gain/Loss: +13%
Time Frame: 1 week
New Positions: No

Comments:
7/12: RL sold off at the open and never really recovered. I'm expecting RL to hit our first target relatively quick, possibly tomorrow. This would fill its gap higher on 7/8. My comments below haven't changed.

7/10: We initiated AUG $75 PUTS at the open for $3.00. The opening print was all RL could muster for the day as the stock drifted lower throughout the day. There is a lot of resistance to keep RL in check. I am looking to book a quick gain on this position and expect the stock to hit our first target of $75.25 relatively quick. This should give us a +20% gain on the position and is good place to tighten stops to protect profits. My primary target is $73.50 but that may take a bit longer depending on earnings, news, and how the market is reacting to it.

7/8: RL has rallied +8% off of its lows on Friday and is now approaching its 20-day SMA, two downtrend lines, and a price congestion area dating back to October 2009, all from below. The facts are that the consumer is not in good shape, jobs are hard to come to come by, and the housing market remains in the tank. This doesn't bode well for retailers and I believe we will see RL retest its lows before it breaks the downtrend lines. I've chosen $77.40 as the entry trigger which is just above today's closing price. I would like to buy August $75.00 PUTS for no more than $3.00 which is what they should be worth at $77.40. Our stop will be $82.50 which is below the 20-day and 200-day SMA's and will be below the 50-day SMA in a matter of couple of days.

Current Position: August $75.00 PUTS, entry was at $3.00

Entry on July 9, 2010
Earnings 8/5/2010 (unconfirmed)
Average Daily Volume: 1.8 million
Listed on July 8, 2010


PowerShares QQQQ Trust - QQQQ - close 44.75 change +0.13 stop 46.90

Target(s): 43.75, 42.55, 41.80, 41.05
Key Support/Resistance Areas: 46.77, 45.25, 44.46, 43.50, 42.50, 41.00
Current gain/loss: -18%
Time Frame: 1 to 2 weeks
New Positions: Yes

Comments:
7/12: QQQQ backed off right at its 20-day SMA this morning which also corresponds to the ETF's February highs. This level is a logical reversal point for QQQQ, however, Intel reports earnings tomorrow after the bell so that is the wild card for the short term price direction. I've adjusted our near term target to $43.75 which is just above the lows on 7/8.

7/10: QQQQ is bouncing but I expect the selling to resume soon. In light of the choppy trading that I foresee I am going offer a near term target of $43.60 which is $1 lower than current levels. For readers in PUT positions they should be worth about $2.15 (entry was at $1.85) which would be a +16% gain. This target is near the June 8 low and may form an inverse head and shoulders pattern. I suggest being quick to tighten stops at this level to protect profits. QQQQ may bounce up to its 20-day or 50-day SMA just overhead before reversing so I suggest being patient. There was a lot of volume in the August PUT strikes on Friday and large blocks bought on the offer. This is a good sign for a move lower but earnings is the wild card.

7/7: QQQQ had a monster truck rally today but I believe this will be short lived. The ETF is nearing an important resistance level at $44.46 and has all of its SMA's and plenty of congestion overhead to act as resistance. The rectangle on the chart represents a gap that I suppose could get filled so conservative traders may consider waiting to enter at $45.00. I'm just not confidant the gap will get filled. Today was a relief rally and we may get a little more but I think the selling will resume again and QQQQ should easily retest its lows and possibly break them. Let's use a trigger of $44.30 to initiate short positions. Our stop is $46.90 and I do not see QQQQ trading up to this level prior to breaking down again.

Current Position: August $45.00 PUTS, entry was at $1.85

Entry on July 8, 2010
Earnings N/A (unconfirmed)
Average Daily Volume: 100 million
Listed on July 7, 2010


Starbucks Corp. - SBUX - close 25.27 change -0.03 stop 26.75

Target(s): 24.25, 23.70, 22.55, 21.30
Key Support/Resistance Areas: 26.50, 26.00, 25.25, 24.80, 24.00, 23.60, 22.50
Current Gain/Loss: -22%
Time Frame: 1 to 2 weeks
New Positions: Yes, with a tight stop

Comments:
7/12: SBUX sold off this morning but drifted higher the remainder of the day. SBUX has resistance at current levels and I am looking for the stock to make a lower high and reverse to retest its lows.

7/10: SBUX has retraced some of its recent decline as the market has bounced. The stock is testing its 100-day SMA from below and the backside of its broken upward trend line for the first time since breaking in late June. The 100-day SMA has been an important reference point for the stock in 2010. We are also near an important support/resistance level of $25.25 so this is a logical place for SBUX to reverse back down. However, the broader market direction will most determine our fate on this position. A tighter stop could be placed at $25.80 but the bounce may go a little further so patience is suggested. I am looking for SBUX to make a lower high and reverse back down to at least retest its lows. I like new positions at these levels.

Current Position: August $25.00 PUTS, entry was at $1.40

Entry on July 8, 2010
Earnings 7/21/2010 (unconfirmed)
Average Daily Volume: 10 million
Listed on July 3, 2010