Option Investor
Newsletter

Daily Newsletter, Monday, 9/13/2010

Table of Contents

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

Market Wrap

Stocks Continue To Defy September History

by Todd Shriber

Click here to email Todd Shriber
September 2010 apparently did not get the memo about what a glum month this usually is for stocks as news of the Basel III banking accords helped lift financials on both sides of the Atlantic and further evidence that China's economic growth story remains provided a boost to the broader market. Here in the U.S., technology issues led the way with the Nasdaq gaining almost 2%, the best performance among the major U.S. indexes. By the time the closing bell rang, U.S. stocks settled at a one-month high.

Stats Table

The Basel III banking accords were viewed as a positive by investors as both U.S. and European financials moved to the upside on the news. At the heart of the matter, banks will now have more time (up to 2019) to raise more capital if needed. European Central Bank President Jean-Claude Trichet called the agreements ''a fundamental strengthening of global capital standards'' and that Basel III's ''contribution to long-term financial stability and growth will be substantial.''

The timeframe of over eight years for banks to raise additional capital is probably intended to accommodate the weakest links of the bunch, for example Greek banks. The strongest European and U.S. banks have already shown they do not need that much time to raise fresh capital. Deutsche Bank (DB) is meeting the challenge head-on after announcing a capital raising plan last week and while a Swiss press report said over the weekend that Credit Suisse (CS) and UBS (UBS) may need to raise a combined sum of nearly $20 billion, analysts believe the banks earnings should be sufficient to cover the new capital requirements.

Bottom line: The Basel news was viewed in a positive light as major U.S. banks enjoyed a solid a day. The Financial Select Sector SPDR (XLF) finished the day higher by more than 2%, closing above its 200-day moving average for the first time since early August.

XLF Chart

China chimed in with some strong economic news that aided the rally in U.S. equities. Over the weekend, China said industrial output in August jumped 13.9% in August compared to a 13.4% increase in July. The bullish news out of China did not stop there. Retail sales surged 18.4% on the year and fixed asset investment in China cities came in at a robust 24.8%.

Of course, good news out of China usually means positive price action in the commodities complex and that was the result today. Copper surged 7.25 cents, or 2.1%, to settle at $3.4790 per pound, settling near the intraday high of $3.4935. The red metal is now within striking distance of four-month high of $3.5345, which was set last week.

The most recent London Mercantile Exchange data shows copper stockpiles have been drawn down by 950 tons to 390,450 tons, the lowest level since November and down 150,000 tons since February, according to Reuters.

Copper Chart

Oil was no slouch either, popping 74 cents, or 1%, to close at $77.19 per barrel on the New York Mercantile Exchange. That is good for the highest closing price since August 11. China's economic news certainly helped, as did news of a shutdown of an Enbridge Energy Partners pipeline in the Chicago area. A leak was discovered at that pipeline last Thursday and since the pipeline moves 670,000 barrels per day from Canada to the U.S., near-term supply concerns also helped prop oil up today.

Oil Chart

Speaking of oil, there were a couple of analyst notes out today that said the legal claims BP (BP) is facing from the Gulf of Mexico oil spill may be less than the $20 billion the company set aside in the independent claims fund it formed at the behest of the White House earlier this year. Citigroup said the $32 billion provision BP took to cover spill costs is the most reasonable estimate of the financial obligations BP faces for the largest oil spill in U.S. history.

The Citi note went onto to say BP's fourth-quarter financials may be strong enough to support the company's dividend being reinstated in that quarter. BP previously suspended shareholder dividends to conserve cash. Managing Director Robert Dudley, who will become BP's CEO on October 1, has not been all that encouraging about the dividend, saying in July that the company would not be in a hurry to reinstate the dividend.

Dudley did not indicate that the dividend would be reinstated this year in a recent meeting with analysts. Bernstein analysts said that BP would probably need to complete $30 billion in planned asset sales over the next 18 months before restoring the dividend. ''BP's cashflow position should be just strong enough to support restoration of dividends by the first quarter of 2011, under an $80 barrel price scenario based on estimates,'' Bernstein said.

BP Chart

Speaking of dividends, Microsoft (MSFT) surged by more than 5% on news that the company may sell debt to fund dividends and share repurchases. Mr. Softie is among a dozen tech giants that are sitting on mounds of cash that also are not rewarding their shareholders with any, or in the case of Microsoft, not much of that cash. To be fair, Microsoft does currently pay an annual dividend of 52 cents, good for a paltry yield of 2.2%.

Microsoft has $36.8 billion in cash and short-term investments, so selling debt to fund a higher regular dividend or a special dividend and share buybacks is a curious move, but sources close to the matter say the company is choosing to sell debt because too much of its cash is held overseas, Bloomberg News reported. The debt offering could come as soon as this calendar year, according to Bloomberg.

Whether or not this prompts other tech companies to juice their payouts remains to be seen. Barron's addressed the issue of big tech companies with big wads of cash who aren't sharing that cash with investors. With data from Morgan Keegan, the Barron's piece shows that if Microsoft opted to go big and have a payout ratio of 70%, the shares would yield 7.2%. Even a payout ratio of 40% would result in a respectable 3.9% yield.

Still, Microsoft's current 2.2% yield is better than the 0.8% Hewlett-Packard (HPQ) and Oracle (ORCL) offer and 0.8% is better than what Apple (AAPL), Cisco (CSCO), EMC (EMC) and Google (GOOG) offer because those companies pay no dividends at all despite the fact that they could easily afford to. A payout ratio of 40% would take HP's yield to a solid 4.6%, but HP chooses to spend its money in other ways, a point I will address in momentarily.

For now, the chorus of those calling Microsoft a value play is likely to grow louder. I am not so sure, but the shares did move above the 50-day moving average.

Microsoft Chart

Staying in the tech world, HP continues to be an investment banker's dream. A shakeup at the top of HP that has the company operating under the guidance of an interim CEO who has said she does not want the top job is not enough to deter the computer giant from its acquisitive ways. The latest apple of HP's eye is network security provider ArcSight (ARST), which surged more than 25% on news that HP would buy the company for $1.5 billion.

ArcSight Chart

HP sure is not shy about paying up for its targets. The $2.07 billion price tag for 3Par (PAR) is about 10 times annual revenue and paying $1.5 billion for ArcSight, which posted $181 million in sales in its most recent fiscal year, does no exactly represent a big discount. HP is a tad late to the network security business party, where it will find itself competing directly with rivals like EMC and IBM, but analysts seem to agree that the ArcSight Acquisition makes sense.

Whether or not these deals make financial sense for HP is another matter altogether. At least one analyst voiced this concern on HP's conference call today. Something else to consider with regards to investing in HP: The stock is down more than 10% in the past two years while IBM is up 10% and given that 90% of all acquisitions fail to create shareholder value, it is highly probable that HP is making a mistake or two with all these deals, at least statistically speaking. All this begs the question: Why is HP not using some of its cash to boost its dividend?

Looking at the charts, the S&P 500 took out resistance at its 200-day moving average at 1115 today and with a close just below 1122, the index is in prime position to start dealing with resistance in the 1127-1130 area, also known as the August highs. With today's gain of 1.1%, the S&P 500 is now up 6.8% in September and that includes just one day of negative trade.

S&P 500 Chart

The Dow was able to ease its way above its 200-day moving average at 10,450 on Friday and that put the blue chip index in position to break through resistance at 10,475, a feat that was easily accomplishd today. Basel III helped the financials and the Microsoft dividend news provided a boost as well. The close above 10,475 turns attention to resistance at 10,700. Dow Chart

As I mentioned at the start of the wrap, the Nasdaq was the real juggernaut today, easily taking out resistance at 2270 to move comfortably above the 200-day moving average. Now 2300 becomes the big hurdle, an area the Nasdaq has not closed above since late July. I am not saying it is going to happen soon and I highly doubt it will happen this week, but a Cisco dividend would be a useful catalyst for the Nasdaq.

Nasdaq Chart

Do not forget about the Russell 2000, which turned in an impressive 2.5% run today. I saw a piece over the weekend where a pundit said small caps looked ready to roll over. That thesis may prove true, but it is a difficult bet to make right, especially since the Russell 2000 took out resistance at 650 today. The big event would be a move above 675.

Russell 2000 Chart

This September continues to defy the historical precedent set by this month and any good economic news, Chinese or otherwise, is just going to send the shorts running for cover. Retail sales could get the ball rolling tomorrow and if investors start to pull cash out of bond funds to chase this September rally, the path of least resistance will remain up, at least in the near-term.


New Option Plays

Index Puts Are In Order

by Scott Hawes

Click here to email Scott Hawes


NEW DIRECTIONAL PUT PLAYS

SPDR S&P 500 ETF - SPY - close 112.72 change +1.23 stop 116.25

Company Description:
SPDR S&P 500 ETF (the Trust) generally corresponds to the price and yield performance of the S&P 500 Index. The S&P 500 Index consists of 500 selected stocks, all of which are listed on the exchange, the NYSE or NASDAQ, and spans over 24 separate industry groups.

Target(s): 110.62, 109.60
Key Support/Resistance Areas: 115.00, 113.00, 110.60, 50-day, 20-day
Time Frame: 1 week

Why We Like It:
The market is overbought and needs a healthy pullback to regain its energy. SPY has rallied right into resistance from its June and August highs. I'm looking for the S&P 500 to turn lower here, fill a few open gaps, and test its rising 20-day and 50-day SMA's from above. I suggest readers open short positions at current levels and look for a $2 to $3 pullback in the coming days (equivalent to 20 to 30 S&P 500 points). Our profit targets should produce +40% and +60% gains.

Suggested Position: Buy October $109.00 PUT, current ask $1.56

Annotated chart:

Entry on September xx
Earnings: N/A (unconfirmed)
Average Daily Volume: 198 million
Listed on September 13, 2010


In Play Updates and Reviews

Two Big Winners Closed

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:


CALL Play Updates

ConocoPhillips - COP - close 55.38 change +0.63 stop 52.30

Target(s): 55.85, 56.90, 57.75
Key Support/Resistance Areas: 58.50, 57.00, 53.00 to 53.50
Current Gain/Loss: +9%
Time Frame: 1 to 3 weeks
New Positions: Yes, on a pullback

Comments:
9/13: COP is nearing our first target. Considering the overbought conditions in the broader market readers should considering taking profits or tightening stops to protect at this level.

9/11: Nothing has changed from my previous comments.

9/9: COP is consolidating above support, all of its moving averages, and is maintaining and upward trend line from 8/31. The broader market is at resistance and is probably due for a pullback so we may need to exhibit a little patience. However, if we breakout higher first I suggest readers be quick to take profits or tighten stops to protect them. I've adjusted the targets down slightly to account for this scenario.

Suggested Position: Buy November $57.50 CALL, entry was at $1.05

Entry on September xx
Earnings 10/28/2010 (unconfirmed)
Average Daily Volume: 8.9 million
Listed on September 4, 2010


iShares Russell 2000 - IWM - close 65.27 change +1.55 stop 59.80

Target(s): 66.50, 67.75
Key Support/Resistance Areas: 68.00, 67.00, 64.50, 62.00
Time Frame: 2 to 4 weeks

Comments:
9/13: IWM has left the train station without us and is now well above our trigger to enter long positions. I still like the play on a pullback but the question is how far will it come. This could get tricky considering its OPEX week but I do believe a pullback to the 50-day SMA will hold. Let's raise the trigger to $63.15. The 50-day is currently just under $63.00.

9/9 & 9/11: IWM is backing off from its 200-day SMA near $64.50. Our trigger to enter long positions at $62.50 is below the 50-day and above the 20-day moving averages. I like the long set-up, now we need to get triggered. More nimble traders may want to try to time an entry near $62.00 which is closer to the 20-day SMA which is starting to turn up.

9/8: We are waiting for our trigger of $62.50 to enter long positions in IWM. We are going to need a strong down day which could come at anytime, perhaps after tomorrow's jobless claims report. I suggest being ready to take advantage of the dip. My comments from below remain the same. Note: I incorrectly listed the wrong November strike price in the play release last night. It has been corrected and I apologize for the error.

Suggested Position: Buy November $65.00 CALL, current ask $2.55, estimated ask at entry $2.00

Entry on September xx
Earnings N/A (unconfirmed)
Average Daily Volume: 60 million
Listed on September 7, 2010


NVIDIA Corp. - NVDA - close 10.64 change +0.57 stop 9.55 *NEW*

Target(s): 10.75, 11.10, 11.80
Key Support/Resistance Areas: 11.85, 11.45, 11.00, 10.25, 10.00 9.45
Current Gain/Loss: +33%
Time Frame: 1 to 2 weeks
New Positions: Yes, on a pullback

Comments:
9/13: NVDA surged +5.66% today and looks poised to test its 100-day SMA which is declining. We have a +33% gain so protecting profits is advised. I've raised the stop to $9.55 and lowered the 2nd target $11.10. If we head higher prior to pulling back be ready to take profits or tighten stops.

9/9 & 9/11: NVDA remains above $10.00 and its 20-day and 50-day SMA's. Any pullback to these areas would be good long set-ups for new entries.

9/8: NVDA hit our breakout trigger to enter long positions. The stock has now officially printed a higher high which confirms the higher low made last week. The stock has closed above its 50-day SMA and its 20-day SMA is rising. We also have an upward trend line as a good reference point to manage the trade going forward. I think pullbacks can be bought for readers who do not have open positions. $10.00 is a solid support level but I'm not convinced NVDA will trade there unless broader market weakness surfaces in earnest, which is certainly a possibility.

Current Position: Long October $10.00 CALL, entry was at $0.72

Entry on August xx
Earnings 11/4/2010 (unconfirmed)
Average Daily Volume: 23.5 million
Listed on August 28, 2010


Stillwater Mining - SWC - close 14.63 change +0.15 stop 13.78 *NEW*

Target(s): 15.45, 15.90, 16.30, 16.95
Key Support/Resistance Areas: 14.40 to 14.70
Current Gain/Loss: -33%
Time Frame: 1 to 3 weeks
New Positions: Yes

Comments:
9/13: My comments below remain the same. 9/11: I've lowered the stop 12 cents to 13.78 which is just underneath the 20-day moving average. The 14.40 level is the logical place for SWC to bounce but we are going to need the broader market strength to continue. My comments from below remain the same.

9/9: SWC is at a critical support level and if it breaks I am concerned SWC could head towards $13.00. As such, I suggest we tighten the stop to $13.90 and step aside if it gets hit. I've lowered the targets to take advantage of higher highs should SWC turn back higher from here.

9/8: SWC is consolidating recent gains and is maintaining an upward trend line that began on 8/25. The stock has strong support all the way down to the $14.00 level. We're looking for SWC to find support soon and make another higher high.

Current Position: Long October $15.00 CALL, entry was at $1.20

Entry on September 3, 2010
Earnings 11/4/2010 (unconfirmed)
Average Daily Volume: 1.62 million
Listed on September 2, 2010


Transocean Ltd - RIG - close 58.84 change +0.02 stop 53.40

Target(s): 62.95, 64.50, 66.50
Key Support/Resistance Areas: 55.50, 58.35, 63.90, 64.90
Current Gain/Loss: -13%
Time Frame: 2 to 4 weeks
New Positions: Yes

Comments:
9/13: We are long RIG calls as of this morning. The stock retraced some of Friday's gains and is holding above a prior resistance level of $58.35. RIG is also forming a bull flag on its hourly chart. My comments from below remain the same.

9/11: RIG exploded on Friday after BP's new CEO said that BP does not intend to seek compensation from RIG for the oil spill disaster unless the DOJ finds gross negligence on their part. Reports from FBR and BofA/Merrill state that they don't believe the DOJ will be able prove gross negligence. RIG is also a cheap stock trading at a PE below 7. Technically, the stock broke out of a downward trend line on heavy volume that started on May 27th. The stock has made a series higher lows and higher highs which I think will continue. I suggest we open positions at current levels. More nimble traders may want to time an entry on a retracement of some of Friday's gains or a breakout above Friday's highs. Our initial stop will be $53.40.

Current Position: Long November $65.00 CALL, entry was at $2.25

Entry on September 13, 2010
Earnings 11/3/10 (unconfirmed)
Average Daily Volume: 8 million
Listed on September 11, 2010


Vale SA - VALE - close 28.36 change +0.93 stop 25.80

Target(s): 28.38 (hit), 28.75, 29.25, 29.70
Key Support/Resistance Areas: To Follow
Current Gain/Loss: +60%
Time Frame: 1 to 3 weeks
New Positions: Yes

Comments:
9/13: Vale surged +3.39% higher today and our first target has been hit. I'm looking for $28.75 and suggest we close positions or tighten stops at this level.

9/11: VALE traded right down $27.25 and bounced so we are now long October 29.00 calls at 50 cents. I've added a lower target right underneath the 200-day SMA. My primary targets on this trade are the first two. If the first target is reached our 50 cent options should be worth about 80 cents which is a +60% gain. As these targets approach I suggest we keep a tight leash on the trade get out with a winner.

9/9: We are waiting to be triggered at $27.25 which is just above the 50-day SMA and Tuesday's lows. I'm looking for this area as a bounce point in VALE back up towards its August highs. NOTE: I incorrectly listed the wrong monthly option as November in the play release last night. It should be October and has been corrected. I apologize for the error.

NOTE: I have chosen a further out of the money call than normal to reduce risk on the trade should the stock break lower.

Current Position: Long October $29.00 CALL at, entry was at $0.50

Entry on September 10, 2010
Earnings 10/28/10 (unconfirmed)
Average Daily Volume: 17 million
Listed on September 8, 2010


PUT Play Updates

McDonald's Corp. - MCD - close 74.57 change -0.44 stop 75.75

Target(s): 73.25, 72.05, 70.90
Key Support/Resistance Areas: 75.35, 73.60, 71.50, 70.50
Current Gain/Loss: -2.3%
Time Frame: 1 week
New Positions: Yes

Comments:
9/12: MCD lost -0.59% while the broader market surged higher today. The stock traded right up to $74.30 and sold off hard before bouncing late in the day. I'm looking for MCD break through its 20-day and head towards its 50-day SMA but we are most likely going to need to see a broader market pullback. I've added a target of $73.25 which will fill a gap higher on 9/1. This should give us nearly a +50% gain and is a good place to consider taking profits or tightening stops to protect them.

9/11: I expected MCD to fill some of the its gap lower on Thursday but was a little surprised the stock traded to $75.00. On the hourly chart MCD closed right on its 20 and 50 period moving averages which it is testing from below. This is a logical spot for the stock to turn lower but we will most likely need broader market weakness. If MCD heads higher first a nice short set-up would be in the $75.30 area. This would create a bearish head and shoulders pattern on the hourly chart.

9/9: MCD printed a new all-time high of $76.36 yesterday. The recent surge higher was due to the company reporting +7% y/y same store sales in early August. Today MCD reported that August same store sales were up only +4.9% y/y compared to the prior +7% gain. This wasn't good enough for investors as they began dumping the stock on heavy volume. I believe the selling will continue at least to a key support level near $72.00 which was prior resistance in May. I suggest readers initiate short positions to take advantage of the momentum and possible broader market pullback. The gap down today hasn't been filled but I don't think it will prior to breaking lower. Let's use a trigger of $74.60 or a breakdown to $73.55 to open positions. We'll use an initial tight stop of $75.75 which is below yesterday's high and get out early if we are wrong.

Current Position: Long October $72.50 PUT, entry was at $0.84

Entry on September 10, 2010
Earnings: 10/21/10 (unconfirmed)
Average Daily Volume: 6 million
Listed on September 9, 2010


CLOSED BULLISH PLAYS

Int'l Business Machines - IBM - close 129.61 change +1.62 stop 125.90 *NEW*

Target(s): 127.40 (hit), 128.90 (hit), 129.75 (hit)
Key Support/Resistance Areas: 132.00, 128.00, 127.50, 123.00
Final Gain/Loss: +81.3%
Time Frame: 1 to 2 weeks
New Positions: No

Comments:
9/13: IBM surged higher today and hit our final target so we are flat the position for a +81.3% gain. The stock is nearing overhead resistance from the 7 month long sideways channel. Protect profits.

9/11: Our gain is currently +35% as our first target was hit on Friday, so taking at least some profits off of the table is probably the smart thing to do. We're going to raise the stop to below Friday's low and I'm also adding another target of 128.90. I suggest closing the trade at this target or trailing the stop up to see how much more you can get out of it.

9/9: IBM has traded to just below our first target in 3 of the past 4 sessions, but keeps getting smacked down near some moving averages and resistance at $127.50. The stock is making higher lows but hasn't been able to breakout. I've lowered the first target 35 cents and suggest we take profits or tighten stops at this level if it is reached tomorrow. I would rather book a profit than sit through a pullback. I've also tightened the stop to $124.25.

Closed Position: Long October $130.00 CALL at $2.72, entry was $1.50

Annotated chart:

Entry on September 1, 2010
Earnings 10/18/2010 (unconfirmed)
Average Daily Volume: 5.5 million
Listed on August 28, 2010


Rackspace Hosting, Inc - RAX - close 22.48 change +0.74 stop 21.14 *NEW*

Target(s): 21.85 (hit), 22.30 (hit), 22.65 (hit)
Key Support/Resistance Areas: 23.50, 21.40, 20.00, 19.50, 19.00, 18.00
Final Gain/Loss: +100%
Time Frame: 3 to 5 weeks
New Positions: No

Comments:
9/13: RAX surged higher again today and our final targets were hit. We are flat the position for +100% gain. I'll reprint this comment from below: One of the reasons I released this play was takeover chatter circulating in the sector and around the company. We all saw what happened with 3Par. Hanging on to a small position could pay off but take profits off the table so you are at least playing with the houses money, per se.

9/11: RAX broke out of the ascending triangle I mentioned below and gained +3.5% today. The stock has gained more than +10% from our entry and our options have gained +60%. Taking at least some profits off of the table is the smart thing to do. It wouldn't surprise me to see RAX pull back to the $21.35 area before a continuation higher if the broader market strength continues this week. Regardless we are going to keep a tight leash on this trade and move the stop all the way up 21.14. I would also watch out for a possible double top with Friday's high at 21.86 so I have lowered the next target 10 cents to 21.85 and the final target is 22.30. Essentially, we are looking to book gains on this position n the coming days. One of the reasons I released this play was takeover chatter circulating in the sector and around the company. We all saw what happened with 3Par. Hanging on to a small position could pay off but take profits off the table so you are at least playing with the houses money, per se.

9/9: We currently have a +30% gain in RAX. Let's move our stop up to $18.95 which is just below the 200-day SMA and primary upward trend line. The stock is forming an ascending triangle over the past couple of weeks and a breakout, coupled with broader market strength, could catapult RAX to our more aggressive targets. If this happens be ready to take profits or tighten stops to protect them.

Closed Position: Long December $21.00 CALL at $2.80, entry was at $1.40

Annotated chart:

Entry on August 25, 2010
Earnings 11/9/2010 (unconfirmed)
Average Daily Volume: 1.75 million
Listed on August 25, 2010


CLOSED BEARISH PLAYS

Abercrombie & Fitch - ANF - close 35.48 change +0.63 stop 35.65

Target(s): 34.60 (hit), 34.20 (hit), 33.55
Key Support/Resistance Areas: 38.20, 37.25, 32.75, 34.00, 30.50
Final Gain/Loss: -40%
Time Frame: Several weeks
New Positions: No

Comments:
9/13: ANF hit our stop this morning so we are out of the position for a loss. Simply put, the broader market doesn't look ready for a meaningful drop so it will be difficult for ANF to reward us and we are protecting capital.

9/11: ANF just won't let go under $34.00 but if there is broader market weakness this week it could go quick. I'm leaving this open more as a hedge on our long positions with a tight stop above last week's highs. All of the targets above remain valid. My comments from below remain the same.

9/9: ANF hit our third target and we have one more. We have a tight stop at $35.65 and the broader market looks like it could pullback here. If it does ANF should head lower in earnest. Our final target is $33.55 which we will use to close positions if we are not stopped out first. Continue to use weakness to close positions.

Closed Position: Long October $34.00 PUT at $1.25, entry was at $2.10

Annotated chart:

Entry on August 25, 2010
Earnings: 11/11/10 (unconfirmed)
Average Daily Volume: 3.5 million
Listed on August 24, 2010