Option Investor
Newsletter

Daily Newsletter, Monday, 8/2/2010

Table of Contents

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

Market Wrap

August Starts With A Bang

by Todd Shriber

Click here to email Todd Shriber
Stocks ended July in sluggish fashion, but that was forgotten on Monday as European bank earnings and renewed economic optimism lifted the S&P 500 to to gain of 24 points, or 2.2%, helping the index extend an almost 7% gain notched in July. The close at 1125.86 is the best for the index since May 17. The Dow Jones Industrial Average surged 208 points, or almost 2%, to settle at 10.674 and the Nasdaq added almost 41 points to close at 2295. Small-caps enjoyed a decent day as well with the Russell 2000 gaining nearly 11 points to close at 661.86.

Stats Table

The economic data points released were a big contributor to the rally enjoyed by equities. Construction spending surprisingly rose by 0.1% in June, according to data released by the Commerce Department. Economists had been expecting a decline of 0.5%. For 2010, total construction spending is basically flat, but some noteworthy gains have been seen on the residential side and that might be a sign that things are not as bad as some worry warts would like to believe.

Construction Spending

The Institute for Supply Management released its manufacturing reading for July and that number fell to 55.5 from 56.2 in June, beating the median forecast of 54.5. Despite the fact that the ISM booking metric, viewed as one of the more important indicators, fell to a one-year a low, investors seemed more impressed with the fact that the July number came in above 50, which is considered a bullish reading. New orders slumped to 53.5 in July from 58.5 in June and inventories rose, neither being good signs, but for one day at least, the ISM report was viewed as positive.

ISM Chart

Speculation that the global economic recovery is for real is big news for copper as the red metal continues on a torrid pace. Copper for September delivery traded on the New York Mercantile Exchange rose 7.8 cents, or 2.36%, to $3.3895 per pound after earlier touching $3.3965, good for the highest closing price since April 28. Keep in mind that copper put in this rally just two days after China said manufacturing contracted in July. That is the first time China has seen a manufacturing contraction since March 2009.

Analysts believe copper caught a bid from, believe it or not, western economies. The ISM number certainly helped today as did news that the Eurozone manufacturing purchasing managers index rose to 56.7 in July from 55.6 June. Not surprisingly, Germany was a big reason, but Italy also factored into that equation.

There are more reasons to like copper. The London Mercantile Exchange said inventories fell by 425 tons today to 413,075 tons. In the U.S., COMEX copper stocks lost 102 short tons to 100,727 tons as of last Friday and the Commodity Futures Trading Commission is reporting that speculators doubled their net long exposure to copper for the week ending July 27.

Copper Chart

Spurred by the jovial economic news and the Dollar finding its way to a three-month low, crude oil found its way to a close above $80 a barrel, the first time that has happened since May. Some analysts maintain the view that oil needs to move above $82.50 a barrel to finally leave the $70-$80 range in the dust, but Monday's trade is a step in the right direction for oil bulls.

Oil Chart

Speaking of oil, a combination of news that BP (BP) is preparing to start its latest attempt to plug the Macondo well, a $498 million asset sale and overall bullish sentiment sent Anadarko Petroleum (APC) to a gain of $4.11, or 8.36%, for a close at $53.27. Anadarko, the second-largest U.S. independent oil and gas exploration firm, said it will sell $498 million in Colorado assets to Texas-based Western Gas (WES), a master limited partnership.

Anadarko and Western Gas apparently have a cordial relationship as this is the third deal between the two companies in the past year. In February, Anadarko sold $254.4 million in assets to Western and that transaction was preceded by a $107 million deal in July 2009. In the essence of full disclosure, count me among those that was not happy to see Anadarko soaring today. I am short a straddle that involves the August 57.50 calls and with Anadarko reporting second-quarter earnings tomorrow after the close, I expect to be quite nervous over the next couple of days.

Anadarko Chart

Finding losers among the energy and materials sectors was difficult to do today and of course on a day when copper was so strong, I would be remiss if I did not mention Freeport McMoRan (FCX). A lot of companies have soundly beat earnings estimates and gone on to stay flat or even trade lower following those reports, reducing the number of post-earnings trades from the long side.

Freeport McMoRan flies in the face of that logic. Just days before its July 22 second-quarter update, Freeport was trading below $60. The bulls ran into the stock in a big way from July 19 through July 22, sending it over $66. The shares traded over $75 today before closing at $74.80, just below the 200-day moving average. Dwindling copper stockpiles and rising prices are a sweet recipe for Freeport shares, that is a given.

If market sentiment stays positive and copper inventories keep falling, Freeport could challenge it's April peak just below $90 in the near-term. I have included the Freeport chart below, but will recommend another equity-based copper play for readers that choose not to be involved with copper futures or thinly-traded copper ETNs: The iShares MSCI Chile Investable Market Index Fund (ECH). ECH is the lone country-specific ETF for Chile and Chile is the largest copper exporter in the world. ECH hit a new 52-week high today on more than twice the average daily volume.

Freeport McMoRan Chart

A world away from the commodities realm, health insurance provider Humana (HUM) was another one of Monday's juggernauts, jumping $1.71, or 3.64%, to $48.73 on volume that was about 50% higher than the daily average. The company said its second-quarter profit rose 21% to $340.1 million, or $2 a share, form $281.8 million, or $1.67 a share, a year earlier. Revenue surged 9.5% to $8.65 billion from $7.9 billion. Analysts had been expecting a profit of $1.67 a share on revenue of $8.61 billion.

Better yet, Humana raised its full-year guidance to $5.65 to $5.75 a share from previous guidance of $5.55 to $5.65 a share. Analysts had been forecasting a full-year profit of $5.71 a share.

Humana Chart

Taking a look at the charts, the S&P 500 closed right at support at 1100 last Friday, but blasted higher from there on Monday and was able to move above resistance at 1115. The close above 1125 is another encouraging sign as it puts the index within earshot of 1130, an area that if taken out on a strong volume, could induce plenty of sideline dwellers to get into the game. There are plenty of big-names reporting earnings this week, but the economic calendar will probably play a bigger roll in the S&P 500's weekly result. The ISM services report is due out on Wednesday and this Friday is the first Friday of the month, meaning non-farm payrolls are due out before the market opens.

S&P 500 Chart

A 200-point move for the Dow is usually an impressive feat, particularly on a day with no earnings news and that is just what the Dow delivered on Monday. Trading just below 10,675, the blue chip index barreled through resistance at 10,500. Support is still the 200-day moving average at 10,415. Most Dow members have already delivered earnings report, but Pfizer (PFE) and Procter & Gamble (PG) report on Tuesday.

Not to be trite, but I do not expect the Pfizer report to do much for the Dow, especially on the upside. It takes an act of God to move this stock and since Procter & Gamble has already raised its dividend, I would not be depending on that name to spark the Dow higher by a substantial margin either. Kraft (KFT) and Walt Disney (DIS) report on Thursday.

Dow Chart

The Nasdaq flirted with resistance at 2300 today before settling just below that number at 2295, but it has to be noted that the Nasdaq's strength has been impressive in the wake of several downgrades of the semiconductor sector. There is other news to watch with the Nasdaq this week that does not involve earnings (the Nasdaq earnings calendar is pretty light this week).

I would be keeping an eye on Research In Motion (RIMM) as it locks horns with Saudi Arabia and the United Arab Emirates on Blackberry service in those two countries. Beyond that, biotech will be in play as news crossed the wires on Monday evening that French pharma giant Sanofi-Aventis (SNY) has made a $69 per share to acquire Genzyme (GENZ). Genzyme is the biggest maker of drugs to treat rare genetic disorders and given the complex formulas the company uses to make those treatments, it is not overly vulnerable to generic competition, making Genzyme particularly appealing to a traditional pharma suitor.

Support on the Nasdaq is 2225.

Nasdaq Chart

Sure, the Russell 2000 was higher today, but the index could not make its way above resistance at 668, so I maintain my stance that only a move above 675 would be truly exciting for small-caps. Support looks firm at 640.

Russell 2000 Chart

After Monday's move, the S&P 500 is close to being overbought and that is not unreasonable to expect after July's 6.9% run. A move above 1130, which could happen as soon as tomorrow, would only bolster the bulls further. As I said last week, my gut tells me economic data points, not earnings, are going to drive stocks for the next few weeks and that puts a lot of emphasis on Friday's job report. A positive number that includes some signs of private sector job growth could lead to a strong August. A disappointing number will have the opposite impact.


New Option Plays

Short Play on the Industrials

by Scott Hawes

Click here to email Scott Hawes
Editor's Note:
Good evening. Today's huge rally has created overbought conditions and we are entering levels where short positions look more attractive. There is still some earnings noise that the market is working through but the focus is starting to shift towards Friday's employment report which will probably set the tone in trading for the remainder of August. I expect trading to be choppy and there is bound to be large swings in both directions. I've chosen a short play on the DJIA (via DIA) for tonight. This will balance our model portfolio and enable us to take advantage of an ensuing pullback. Please email me with any questions.


NEW DIRECTIONAL PUT PLAYS

SPDR DJIA ETF - DIA - close 106.73 change +2.03 stop 108.75

Company Description:
The investment seeks to provide investment results that, before expenses, generally correspond to the price and yield performance of the Dow Jones Industrial Average (DJIA). The fund holds the Portfolio and cash, and is not actively "managed" by traditional methods. To maintain the correspondence between the composition and weightings of stocks held by the Trust and component stocks of the DJIA, the Trustee adjusts the portfolio from time to time to conform to periodic changes in the identity and/or relative weightings of index securities, typically within three business days before or after the day on which such changes are scheduled to take effect.

Target(s): 104.85, 104.25, 103.65
Key Support/Resistance Areas: 108.00, 107.00, 105.90, 104.75, 104.20, 103.50
Time Frame: 1 week

Comments:
The DJIA has rallied right into prior resistance from its January highs and is forming a bearish rising wedge pattern. This pattern calls for a sharp decline but may bounce around a little near current levels first. In addition, today's +2% gain in equities has created overbought conditions and I believe DIA will turn back to at least fill the gap higher from today. We'll use a tight stop of $108.75 and I have offered three very realistic near term targets, along with a more aggressive target should things get moving to the downside in earnest. The stop is above a gap down from 5/15 so if DIA closes the gap we have a some room. If DIA makes it up to close this gap (5/13 close was $108.10) I would be very surprised to see it go any higher before heading towards our targets. I suggest readers be quick to tighten stops as targets approach because the drop could come quick.

Suggested Position: Buy September $106.00 PUTS, current ask $2.60

Annotated chart:

Entry on August xx
Earnings: N/A (unconfirmed)
Average Daily Volume: 14 million
Listed on August 2, 2010


In Play Updates and Reviews

Biotech Play Closed for Gain

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:


CALL Play Updates

Netflix, Inc. - NFLX - close 101.88 change -0.67 stop 100.80

Target(s): 106.25, 108.50, 111.35
Key Support/Resistance Areas: 114.00, 112.00, 108.50, 105.50, 103.00, 102.00,
Current Gain/Loss: -14%
Time Frame: 1 week
New Positions: Yes, with a tight stop

Comments:
8/2: NFLX gapped higher at the open this morning and quickly sold off to fill the gap. This isn't the price action I was expecting on such a strong tape as traders quickly took profits from gains on Thursday and Friday. I believe the stock can still bounce from here as it closed above its intraday downtrend line and the downtrend line that started on 7/22. In addition, the stock has built quite a base in the $101 to $102 area where it is currently finding solid support. However, if the broader market can not break higher from here NFLX will likely hit our stop. I have tightened the targets and suggest readers be quick to close positions or tighten stops as these areas approach.

7/31: NFLX got hammered and has lost more than -15% since the company reported earnings on 7/21. The stock bottomed on Thursday and has bounced nicely. On the intraday charts NFLX has broken out of its recent downtrend line and is forming a bull flag in the $102.00 area which is a key support/resistance level over the past week. If NFLX can break higher I believe the stock should trade up towards $108.50 which is our second target. If the broader market is strong the stock could head up towards its 20-day and 50-day SMA's which are above our most aggressive target of $111.35. I have also listed an immediate target of $106.35 which was a prior support level in early July. The stock may find some resistance at this level so this is good area to tighten stops. I suggest we initiate long positions if the stock trades to $103.35 which is above Friday's highs. Aggressive traders may consider initiating long positions on weakness. We'll use a tight stop at $100.80 which is below the bull flag. If we are wrong I suggest we get out of the trade quick. NOTE: I consider this trade aggressive and it could be quick so I suggest readers use small position size and be ready to take profits when presented with the opportunity.

Current Position: Long September $105.00 CALL, entry was at $6.25.

Entry on August 2, 2010
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 3.5 million
Listed on 7/31/10


Oil Service HOLDRS - OIH - close 109.53 change +4.39 stop 107.90 *NEW*

Target(s): 108.50 (hit), 110.25, 111.20
Key Support/Resistance Areas: 110.50, 108.60, 107.00, 104.75, 102.80
Current Gain/Loss: +27%
Time Frame: 1 to 2 weeks
New Positions: No

Comments:
8/2: OIH gapped higher this morning and broke through the $107.00 resistance level of the ascending triangle mentioned in the play release. The sector never looked back and OIH posted +4.18% gains on the day. Call positions were initiated at the open and have already gained +27%. Our target of $108.50 was hit and OIH came within 2 cents of our reaching our $110.30 target before closing about 80 cents below its high of the day. I've adjusted the $110.30 target down 5 cents and have also added $111.20 which is below the 100-day SMA. If OIH breaks over today's high of $110.28 I recommend readers tighten stops to protect against a reversal. There is nothing wrong with booking gains at current levels as well. I've adjusted the stop up to $107.90 to protect capital but a tighter stop could be placed at $108.45.

7/31: I'm sticking with an ETF here to eliminate some of the earnings noise and mitigate risk in individual names. Oil service stocks have been beaten down and are now showing signs of life. OIH is forming an ascending triangle on its daily chart and has made a series of higher lows since it bottomed on 6/1. The ETF is above its 20-day and 50-day SMA's which is providing further support. I'm comfortable with positions at current levels with tight a stop of $102.30 which is below the low from 7/23. We will either be right or right out of this trade. We are playing for a breakout above $107.00 into the $108.50 to $110.00 area which is near our two targets. $108.50 was a prior support level in the fall of 2009 so OIH could see some resistance there. As OIH approaches our targets I suggest readers be quick to take profits or tighten stops.

Suggested Position: Long September $110.00 CALL, entry was at 3.65

Entry on August 2, 2010
Earnings N/A (unconfirmed)
Average Daily Volume: 8 million
Listed on July 31, 2010


ProShares UltraShort 20 YR Treasury - TBT - close 36.74 change +0.89 stop 35.55 *NEW*

Target(s): 36.90, 37.50 (hit), 38.00, 39.25, 40.50
Key Support/Resistance Areas: 42.00, 41,00, 39.70, 38.25, 37.55, 34.65
Current Gain/Loss: -1.6%
Time Frame: Several Weeks
New Positions: Yes

Comments:
8/2: It appears Friday's sell-off in TBT was short lived as I suspected. However, the price action in bonds and equities still seems somewhat disconnected. TBT looks like it is forming a higher low and has 20 more cents to go before closing the gap down on Friday. This will likely act as intraday resistance but I expect TBT to eventually break it and trade back up to our $37.50 target and possibly our more aggressive targets. I suggest readers begin to trail stops higher to see if we can catch a larger move. For now, I've moved the stop up to $35.55 which is below Friday's lows and the upward trend line on the daily chart.

7/31: The price action in bonds on Friday has me scratching my head in amazement. Bond yields tanked and bond prices surged (i.e. money was flowing into the bond market as traders were snatching up bonds at ridiculously low yields) which caused TBT to gap lower and close -2.98% on the day. This was an uncharacteristic huge move and is not normal. What's more interesting is that bonds never gave anything back throughout the day as equities surged higher on Friday morning after their gap lower. One of the two following scenarios has got to give here and the tone should be set in trading on Monday. Either money will flow out of stocks and into bonds creating a big sell off in equities (bad for TBT) or money will flow out of bonds and into equities creating a rally in equities (good for TBT). Medium to longer term I am bearish on equities but in the short term I think the latter is going to happen and we will see stocks rally, or at least hold up, with money flowing out of bonds. This will get our position in TBT moving back in the right direction. I really like new positions in TBT at these levels as well. Looking at a longer term weekly chart of bond prices (i.e. /ZN or TLT) one might think bonds have room to run to their fall 2008/spring 2009 highs. But this was the financial crises and money markets were failing and there is simply no crises like that right now. The other side of that argument is that maybe we are on the verge of a crises and we should listen to what the bond market is telling us. While I believe another crises is bound to happen I'm just not buying that argument quite yet. I believe there can be a sell-off in equities without a surge higher in bond prices or drop in yields. Nonetheless, we have to manage the trade and $36.90 is a level readers may want to consider exiting TBT. This would close the gap lower from today while also booking a winning trade. In the end, I think today's sell-off in TBT was an anomaly that will either be corrected early next week or we are on the verge of a bigger sell-off in equities. Unfortunately, today provided us very few clues as to what will happen. The above targets can be used as guide to tighten stops or simply take profits.

Current Position: Long September $37.00 CALL, entry was at $1.23

Entry on July 26, 2010
Earnings N/A (unconfirmed)
Average Daily Volume: 3.8 million
Listed on July 24, 2010


CLOSED BULLISH PLAYS

Human Genome Sciences - HGSI - close 26.33 change +0.39 stop 24.35

Target(s): 25.95 (hit), 26.50 (hit), 27.00, 27.50
Key Support/Resistance Areas: 28.00, 27.10, 26.60, 24.70, 24.25
Current Gain/Loss: +29.12%
Time Frame: 1 to 2 weeks
New Positions: Yes

Comments:
8/1: HGSI gapped higher at the open and immediately surged up to our 2nd target of $26.50. We are flat the position for a +29.12% gain. The stock traded in a tight range between $26.50 and $26.70 most of the morning which created a perfect reference point to trail stops up to protect profits. For readers who may still have positions I suggest tightening the stop to protect profits. $25.75 is just below a prior intraday resistance level and is below today's gap higher. This should give you enough room to endure a pullback and still protect capital. But I still suggest being quick to take profits if HGSI moves higher from here.

7/30: HGSI printed a bullish engulfing candlestick and gained +3.1% in Friday's session. Our position is now back in positive territory. Our $25.95 lowered target that was added on Thursday for readers who wanted to protect capital was hit on Friday. This level is where HGSI found resistance on Thursday so there could be some give back before the stock makes another attempt to break through it. If there is immediate follow through early next week we should be on the fast path to hitting our targets of $26.50 and possibly $27.50. I suggest taking profits at one of these levels, or at least tighten stops to protect profits. If there is follow though I would also suggest quickly tightening the stop to either $24.70 or $25.25. For now, I have moved it up to $24.35 and plan to tighten it further on any strength.

Closed Position: Long September $26.00 CALL at $2.35, entry was at $1.82

Annotated chart:

Entry on July 27, 2010
Earnings Date 10/25/10 (unconfirmed)
Average Daily Volume: 4.2 million
Listed on 7/24/10


ProShares Ultra Basic Materials - UYM - close 32.44 change +1.83 stop 27.20

Target(s): 30.35, 31.20
Key Support/Resistance Areas: 31.30, 30.50, 29.00, 28.00, 27.25
Time Frame: DROPPED

Comments:
8/2: I do not suggest chasing UYM at these levels. The ETF never let us in so we have dropped the play. The basic materials sector is gaining some serious momentum but we could not filled at our entry and have missed the move. For readers still interested in playing this sector I would look for UYM to fill its gap higher today prior to moving too much higher. A long entry near $30.75 is a logical area for UYM to pullback to but the conditions will need to be evaluated as that is happening.

7/31: My comments about a potential double bottom pattern in UYM worked perfectly today. It took a lot of guts to step in and buy anything Friday morning but if you bought UYM you were handsomely rewarded. UYM remains in a bull flag and every time there is weakness in the ETF buyer step in. We've come within 40 cents of our trigger to enter long positions but UYM just won't let us in. UYM will eventually trade to its rising 20-day SMA which should be near our $29.00 entry this week. As such, I'm going keep this play open for a few more days to see if we can get filled and take advantage of the momentum building in the basic materials sector.

7/30: UYM is not letting us in. The ETF hit a low of $29.50 today and bounced hard. This could also be considered as an entry which may set-up a double bottom pattern on another pullback. I'll reevaluate the play this weekend and come up with a game plan.

Suggested Position: September $30.00 CALL, current ask $2.95, estimated ask at entry $2.15

Annotated chart:

Entry on July xx (DROPPED)
Earnings Date N/A (unconfirmed)
Average Daily Volume: 1.9 million
Listed on 7/22/10