Option Investor
Newsletter

Daily Newsletter, Wednesday, 8/11/2010

Table of Contents

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

Market Wrap

Worldwide Sell-Off

by James Brown

Click here to email James Brown

Market Stats

Stocks sold off sharply on renewed worries over an economic slowdown. Yesterday the Federal Reserve confirmed our fears about the U.S. economic recovery slowing down. While the initial reaction to the FOMC announcement was positive, investor sentiment changed overnight. The markets began to wonder, why didn't the Fed act more aggressively if the situation is getting worse. Weak economic data out of China and Japan, disappointing comments from the Bank of England, and U.S. trade numbers that were worse than expected all combined to deliver a bad day for stocks around the globe. The U.S. dollar and treasuries surged as money ran for safer securities. The yield on the 10-year note fell to 2.69% and the yield on the 2-year note hit a new all-time record low of 0.48% intraday before settling at 0.52%. Gold futures rose modestly with a $1.90 gain to $1,199.90 an ounce. Crude oil futures sold off sharply with a -3.6% decline to $77.34 a barrel.

Chart of the U.S. dollar ETF (UUP):

Chart of the Euro ETF (FXE):

Foreign markets are rolling over with big declines in Japan and Europe. While the dollar is rising against the euro it fell to a new 15-year low against the yen. This yen strength combined with a sharp drop in machinery orders sent the Japanese markets tumbling. The NIKKEI index lost -2.7%. Meanwhile in China the government said investment and factory output fell to its slowest pace in almost a year. Investors have been fearful that as China slams on the brakes to slow down its red hot economy it might go too far. Now that China is seeing success in their efforts to slow down their economy the world worries that the pullback will affect earnings for companies around the globe. The Hong Kong Hang Seng index lost -0.8% but the Shanghai index managed a +0.47% gain.

Wednesday saw painful declines in European stocks. The major indices posted their biggest one-day drop in six weeks and closed at three-week lows. Disappointment in the U.S. Fed's choice of actions on Tuesday was combined with worrisome comments from the Bank of England today. The BoE said the economic rebound in the U.K. was "highly uncertain" and the central bank might need to produce more stimulus and more quantitative easing. Exacerbating the bearish comments was a sharp drop in Britain's July consumer confidence index, which fell 7 points to 56. The flight to safety is also evident in the German bond market with the yield on the 10-year bund falling to 2.43%, the lowest level since 1989. At the end of the day the English FTSE lost -2.4%. The German DAX lost -2.1% and the French CAC-40 fell -2.7%.

The Commerce Department's report on U.S. trade for June was a market-moving event this morning. It was widely expected that the trade gap would worsen but no one expected the trade deficit widen to $49.9 billion. This was an 18.8% jump from May to June. Sales of American exports fell -1.3% to $150.5 billion while imports rose +3% to $200.3 billion. The problem here is the impact on GDP estimates. The trade gap is so much worse than expected that the U.S. estimates on Q2 GDP growth will probably get revised from an already disappointing +2.4% growth to +1.3%. This could spark a flurry of downgrades as Wall Street firms reduce their expectations for growth in the second half of 2010. The Commerce Department will release its revised Q2 GDP estimates on Friday, August 27th.

The U.S. Treasury Department was making headlines and not for the $24 billion auction of 10-year bonds. Just one day after Congress passed and President Obama signed into law the $26 billion jobs bill the Treasury said July's budget deficit rose to $165 billion. Thus far, for the 2010 fiscal year, U.S. government revenues are up 0.7% over 2009 levels at $1.75 trillion. Yet government spending is up to $2.92 trillion. That's actually down -2.8% from a year ago. Currently the Obama administration expects the 2010 deficit to hit a record-breaking $1.47 trillion.

President Obama has not been very successful in his attempts to slow down the tide of foreclosures. The latest plan involves the Treasury providing $3 billion to unemployed homeowners. I hate the idea of people losing their homes and I certainly don't want to argue politics but this seems to be delaying the inevitable. This morning the Treasury Department said it would provide $2 billion to 17 states that have the worst unemployment levels. The remaining $1 billion would be given to the Department of Housing and Urban Development for a new program that provides zero-percent interest rate loans up to $50,000 for up to 24 months. Part of the money to fund this comes from the $700 billion Wall Street bailout that has been returned to the Treasury. As yet there are no estimates on how many homeowners this might help. Without knowing the details it certainly seems like the government is trying to push the foreclosure problem down the road until either housing values rebound or jobs rebound.

Government agencies were also in the news as regulators reported on a review of the May 6th, 2010 "flash crash" where the Dow Jones Industrial Average lost more than 700 points in just a few minutes. There has been a number of changes since the May 6th event, most notably trading curbs on individual stocks, but in spite of the changes put in place by the SEC and the exchanges we remain at risk. After questioning industry analysts and insiders over the still not fully understood market breakdown CFTC Commissioner Michael Dun said not only can the crash happen again, several of the people the panel questioned believe it will happen again. Another follow up report is expected in September and the advisory committee will likely make recommendations in October.

Earnings reports continue to trickle in. Today's biggest headline in corporate earnings was technology giant Cisco Systems (CSCO). Wall Street was looking for a profit of 42 cents a share on revenues of $10.88 billion. The company beat by a penny with 43 cents a share on revenues of only $10.8 billion. CSCO is the major player when it comes to IT spending on routers and switches for Internet traffic and networking. Their results are a reflection of the health of the entire industry. The $10.8 billion in sales was a record-setting pace for CSCO and up +27% from a year ago but it also proves that CSCO and the tech sector is not immune to the global slowdown. Investors are worried that a drop in government spending across the U.S. and around the world could have a negative impact on CSCO.

This afternoon CNBC said that CSCO normally beats estimates by 14%. While the company beat on the bottom line it was a narrow win and the revenue miss was very disappointing for Wall Street. CSCO said orders remain strong with most of their big markets seeing orders up +20% and emerging markets up +35% year over year. Last quarter the company generated $3.2 billion in cash, lifting its cash hoard to $39.9 billion. CEO John Chambers said the company still expects +18% growth this quarter in spite of the cautious attitudes pervading so many of his customers. CSCO lost 2.3% during normal trading and fell another -8% in after hours to $21.85 a share.

Chart of the Cisco Systems (CSCO):

Technically the market looks pretty ugly. It's not very often we see the S&P 500 lose -2.8% in one session. It was a very widespread decline with every sector in the red. Here is a list of some of the worst performers:

-4.8% Banking Index (BIX)
-4.5% Airline Index (XAL)
-4.3% Dow Jones Railroad Index (DJUSRR)
-4.2% Dow Jones Casino Index (DJUSCA)
-4.2% Semiconductor Index (SOX)
-4.2% Dow Jones Transportation Index ($TRAN)
-4.0% Healthcare index (HMO)
-3.8% Cyclicals (CYC)
-3.8% Defense Sector (DFI)
-3.6% Oil Services Index (OSX)
-3.4% Biotech Index (BTK)
-3.0% Oil Index (OIX)
-2.5% Goldminers ETF (GDX)
-2.0% Retail Index (RLX)

We were expecting the market decline with the bear-wedge pattern stalling under resistance. The S&P 500 managed to stop at its 50-dma on Wednesday afternoon. If the market does see an oversold bounce I would expect it to fail in the 1110-1120 zone and short-term traders could use any bounce as a new entry point for bearish positions. Once the S&P 500 breaks the 50-dma we can look for short-term support near 1160, 1140 and the July lows in the 1020-1010 zone. Whether it takes two weeks or six weeks I would expect a retest of the July lows.

Chart of the S&P 500 index:

The NASDAQ doesn't look any better. The index gapped open lower at its 50-dma and then continued to fall from there. This is a very ugly breakdown and while we might see an oversold bounce look for the top of the gap near 2250 to be new overhead resistance. On a short-term basis we can look for support near 2150-2140 near the late May-early June lows. However, I would expect a correction toward the July lows over the next few weeks. We have been warning readers to keep an eye on the SOX semiconductor index. Today that index fell toward significant support in the 330-325 zone. A close under 325 would be very bearish and help lead the NASDAQ lower.

Chart of the NASDAQ index:

Chart of the SOX Semiconductor index:

We like to look at the Russell 2000 small cap index as a measure of fund manager sentiment. The index has broken down under its 50-dma and 200-dma again. It has also closed under the short-term trendline of higher lows. Overall the trend of lower highs and lower lows is back in play.

Chart of the small cap Russell 2000 index:

Looking ahead I don't see a lot of compelling reasons for traders to buy stocks at this time. August and September are traditionally the worst months of the year for stocks. The Q2 earnings season was generally positive but the optimism was short lived, which is exactly what we expected. After weeks and weeks of economic data as evidence of our slowing momentum the Fed just confirmed for us that we are in "soft patch". The double-dip recession camp has lots of ammunition and many are placing odds of a double dip in the U.S at 50%. Europe remains weak and now there are renewed worries that China may be slowing down too fast. I do think there is a chance we'll see a late fall rally higher. However, I would prefer to look for bullish positions on a bounce from the July lows. We may not see that entry point for several more weeks.

-James


New Option Plays

Precious Metal Play

by Scott Hawes

Click here to email Scott Hawes
Editor's Note:
Good evening. I've released a new long play in GLD below which I think will do very well in the coming weeks. We have several short positions to take advantage of continued market weakness and I plan to release more short plays once the market retraces some the recent declines. I anticipate continued selling in the next day or two and I would be protecting profits against a hard reversal on short positions. We will be able to re-enter short positions at a better price. Please email me with any questions.


NEW DIRECTIONAL CALL PLAYS

SPDR Gold Trust - GLD - close 117.34 change -0.39 stop 112.50

Company Description:
SPDR Gold Trust (the Trust) is an investment trust. The Trust holds gold, and from time to time, issues SPDR Gold Shares (Shares) in Baskets, in exchange for deposits of gold and distributes gold in connection with redemptions of Baskets. A Basket equals a block of 100,000 Shares. The investment objective of the Trust is for the Shares to reflect the performance of the price of gold bullion.

Target(s): 121.60, 123.00, 125.00
Key Support/Resistance Areas: 123.00, 118.50, 116.50, 113.50
Time Frame: Several weeks

Why We Like It:
I'm not necessarily a longer term bull on gold, but if the Fed is going to monetize our country's debt gold is going to catch a bid, and I believe now is a perfect time to get in via GLD. Considering the events of the past few days gold and gold miners should catch a bid here and act as a defensive play. From a technical perspective GLD bounced perfectly off of its upward trend line from its lows on 8/17 to 2/5 to 7/28. And I think GLD will print new all time highs within the next several of weeks. I suggest readers enter long positions now. I've provided three realistic targets that will produce good winning trades if reached. Our stop is below the 200-day SMA at 112.50.

Suggested Position: Buy September $120.00 CALL, current ask is $1.43

Annotated Chart:

Entry on August xx
Earnings Date N/A (unconfirmed)
Average Daily Volume: 12.4 million
Listed on August 11, 2010


In Play Updates and Reviews

Short Plays Hitting Targets

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:


CALL Play Updates

Volatility Index - VIX - close: 25.39 change: +3.02 stop: 19.60

Target(s): 25.95 (hit), 27.30, 28.90, 31.50, 35.00
Key Support/Resistance Areas: 20.00, 22.00, 24.00, 26.00, 28.00
Current Gain/Loss: +13.50%
Time Frame: 1 week
New Positions: Yes, on weakness

Comments:
8/11: I spoke too soon thinking we caught a break yesterday when the VIX traded to within 1 penny of our trigger before backing off. It turns out it was a bad break as the SPX gapped lower today and hence the VIX gapped higher. So we would have gotten a better a fill yesterday had we been triggered. Nonetheless, it appears the market has spoken and this trade has some potential. We are long September 30 calls at $2.95. The VIX is now almost at its 50-day SMA and actually hit our first target this afternoon. Considering the massive sell-off today this trade is shaping up to be quicker than I thought.

8/10: VIX came within 1 penny of triggering our entry to buy calls. And it's a good thing we didn't get triggered because just after the FOMC announcement stocks took off and the VIX plummeted, so we caught a break on this one. Last night I mentioned aggressive traders may consider entering at current levels. But I just wasn't ready to officially make any changes to the play due to the FOMC announcement today. However, I'm suggesting we take advantage of any further weakness in the VIX which should happen if stocks rally from here. We may get a little further upside but the fact is we are in overbought conditions and the market is complacent, not to mention the seasonality. And it is not uncommon for stocks to reverse course from the initial FOMC reaction. In fact, on June 23rd the S&P 500 bounced hard intraday just like today, but then proceeded to sell off -80 points over the ensuing week. I realize the circumstances are completely different now but look at the daily S&P 500 chart. Currently we are just above the same levels as June 23rd and are also coming off of a strong rally. I suggest we enter positions now and look for a bounce up to its 50-day SMA which is above our first target of $25.95. We'll use a stop of $19.60 and if the market rolls over I suggest traders trail their stops. I've adjusted the targets.

NOTE: September VIX options expire on Wednesday, Sept. 15th, not Friday

Current Position: Long VIX September $30 CALL, entry was at $2.95

Entry on August 11, 2010
Earnings Date N/A
Average Daily Volume N/A
Listed on August 7, 2010


PUT Play Updates

SPDR DJIA ETF - DIA - close 104.13 change -2.53 stop 104.85 *NEW*

Target(s): 105.40 (hit), 104.75 (hit), 103.65, 103.05
Key Support/Resistance Areas: 108.00, 107.00, 105.90, 104.75, 104.20, 103.50
Current Gain/Loss: +46%
Time Frame: 1 week
New Positions: Yes

Comments:
8/11: DIA fell out of the rising wedge pattern and tanked lower today, hitting two targets. We now have a +46% gain which needs to be protected. I've lowered the stop to $104.85 which is above the intraday congestion area from today and the 20-day SMA. This should provide enough resistance to keep any bounces in check. I suspect DIA may head towards its 50-day SMA which is just below $103. We have two more targets: $103.65 which just above the low on 7/30, and $103.05 which is just above the 50-day SMA. These are the areas I suggest taking profits or tightening stops. If we get stopped out our gain should still be +30%.

8/10: DIA keeps getting close to hitting our target but the market keeps getting saved. Today in early trading this position could have been closed for a +10% gain but stocks rallied. I suspect we may have a spike in the markets over the next day or two but I do believe we will get a meaningful correction that could happen at anytime within the next week, and it could happen fast. DIA is forming a bearish rising wedge pattern and if it lets go we should see a $2 or $3 drop relatively quick. This is what we are positioned for and should the drop happen I suggest readers begin to tighten stops as our targets approach to protect capital and against a reversal.

Current Position: Long September $106.00 PUTS, entry was at $2.70

Entry on August 3, 2010
Earnings: N/A (unconfirmed)
Average Daily Volume: 14 million
Listed on August 2, 2010


Leggett & Platt - LEG - close 20.15 change -0.73 stop 21.75

Target(s): 19.85, 19.35, 18.70
Key Support/Resistance Areas: 21.50, 20.50, 19.80, 19.00, 18.50
Current Gain/Loss: +20%
Time Frame: 1 to 2 weeks

Comments:
8/11: LEG PUTS were initiated at the open for 75 cents as the stock traded below yesterday's low. LEG drifted down all day long and we currently have gain of +20%. Our targets are approaching which are near support areas so I suggest trailing or tightening stops on the way down to protect profits.

8/10: We are back with a short play in LEG. LEG is in the furniture & fixtures industry and purchases of these types of items are not on the minds of consumers. The stock continues to make lower highs on a descending trend line that began on 4/30 and is now on the verge of breaking an upward trend line that began 7/6. On its daily chart LEG closed below all of its moving averages today and if the broader market gets moving to the downside LEG should be one of the first to go. I suggest we enter short positions if LEG trades to $21.20 (below today's highs and the 50-day SMA) or to $20.70 (below today's low), whichever occurs first. We have realistic targets that are easily achievable and will produce a good winning trade if they are reached.

Current Position: Long September $20.00 PUT, entry was at $0.75

Entry on August 11, 2010
Earnings: 10/21/10 (unconfirmed)
Average Daily Volume: 1.45 million
Listed on August 10, 2010


Occidental Petrol. - OXY - close: 76.34 change: -1.47 stop: 81.05

Target(s): 70.50, 66.00
Key Support/Resistance Areas: 75-74.00, 70.00, 65.00
Current Gain/Loss: N/A
Time Frame: Several Weeks
New Positions: Yes, trigger at $77.50 or $73.90

Comments:
8/11: Considering today's broad based sell off I am inclined to suggest we take advantage of any strength in OXY to initiate short positions. The S&P 500 closed above its 50-day SMA today so we could get a bounce in equities before the selling continues. OXY's high on 8/10 was $78.14. All of the stock's major moving averages are also overhead and a downward trend line that started on 6/21. I am suggesting we use a bounce to $77.50 or a break weakness to $73.90 as a trigger to enter short positions, whichever occurs first.

8/10: OXY doesn't seem ready to break down just yet as the stock gained +1.12% today on a weak tape. The stock is approaching all of its major SMA's from below and a down trend line near the $80 level. This sets up a good short entry as opposed to waiting for a break down. I'm assessing this option and may change the trigger in the coming days.

Suggested Position: Buy September $70.00 PUT, current ask $1.14

Entry on August XX
Earnings Date 10/21/10 (unconfirmed)
Average Daily Volume = 4.4 million
Listed on August 7th, 2010


Procter & Gamble - PG - close: 60.27 change: -0.51 stop: 63.26

Target(s): 59.30, 58.05, 57.25
Key Support/Resistance Areas: 59.00, 61.00
Current Gain/Loss: +30%
Time Frame: 2 to 3 weeks
New Positions: Yes

Comments:
8/11: PG is a defensive stock so it did not suffer like the broader market today. I think we will see $59.30 and possibly lower in this stock in the next couple of weeks. We've made 11 cents on our 36 cents option so we have a nice gain already. Protect profits if the weakness in PG continues.

8/10: PG triggered our higher target to enter positions at $60.69. We are long $57.50 PUTS at 36 cents. This is a cheap out of the money option that shouldn't move too much with underlying price of PG. But if we get PG to retest its recent lows, which are below our first target of $59.30, we should easily make 25 cents on the position. This would represent a +69% gain. As such, I've removed the $55.00 target and added three closer targets that are very easily achievable.

Current Position: Long September $57.50 PUT, entry was at $0.36

Entry on August 10, 2010
Earnings Date 10/28/10 (unconfirmed)
Average Daily Volume 2.5 million
Listed on August 7th, 2010


CLOSED BULLISH PLAYS

SPDR KBW Bank ETF - KBE - close 24.05 change -0.14 stop 23.25

Target(s): 24.85, 25.30, 26.00
Key Support/Resistance Areas: 26.00, 25.50, 24.85, 23.75, 23.35
Final Gain/Loss: -27.8%
Time Frame: 1 to 2 weeks
New Positions: Closed

Comments:
8/11: The broad based weakness was too much for our bank play and our stop was hit this morning. The inverse head and shoulders pattern failed and the upward trend line was broken. In addition, the moving averages have been broken. These are the reasons the trade was initiated and they did not work so we have to get out of the way and are flat the position.

8/10: We are long KBE calls at the open at 90 cents and are looking for the bank ETF to bounce up towards its 100-day SMA which is above our first target of $25.30. A move up to this area should produce a +50% gain on this position. Readers may also want to consider an added target of $24.85 as an area to tighten stops or take profits. This will also produce a nice gain and is a resistance from late July/early August to consider.

Closed Position: Long September $24.00 CALL @ $0.65, entry was at $0.90

Annotated chart:

Entry on August 10. 2010
Earnings Date N/A (unconfirmed)
Average Daily Volume: 3.5 million
Listed on August 9, 2010