Option Investor
Newsletter

Daily Newsletter, Monday, 10/4/2010

Table of Contents

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

Market Wrap

Dow Downgrades Lead To Gloomy Monday

by Todd Shriber

Click here to email Todd Shriber
The first full trading week of October, another month not known for being kind to the bulls, got off to a sluggish start as a couple of downgrades for some Dow stocks and negative earnings revisions led to a weak-volume sell-off that sent the S&P 500 lower by 0.8%. The Dow Jones Industrial Average was hardly better, absorbing a loss of 0.72% and the Nasdaq really took it on the chin, slipping by 1.11%.

Stats Table

Monday brought another day of so-so economic data. For those wearing rose-colored glasses, the data was certainly less bad, but it certainly did not motivate buyers to do much buying. Capital good orders, excluding planes, jumped 5.1% in September, well above the expected rise of 4.1%, good for the biggest monthly gain since March, according to the Commerce Department.

Factory orders may have contributed to the sell-off in stocks. New orders for manufactured goods fell $2.2 billion, or 0.5%, to $480.9 billion in August, the Census Bureau reported. That is good for the third decline in the past four months. Shipments dropped $2.5 billion, or 0.6%, to $415.1 billion in August, also the third drop in the past four months.

The National Association of Realtors (NAR) chimed in with August Pending Home Sales Data, telling us that the number was up 4.3% on a seasonally adjusted basis in August. Sounds good, right? Not so fast. That reading is still 20.1% below the level seen in August 2009. On a non-seasonally adjusted basis, pending home sales were up 6.4% in August, but still 18.4% below where they were in August 2009.

The NAR said that while ''attractive'' pricing and record low mortgage interest rates are helping bring some buyers back into the market, ''the pace of a home sales recovery still depends on job creation and the accompanying rise in job creation.'' I seriously doubt that qualifies as surprising information.

Home Sales Chart

It was an ideal day for the dollar to rise and that is exactly what the greenback did, fueled by lingering sovereign debt concerns in the Eurozone. If you think the economic data here in the U.S. is glum, try 4 million unemployed in Spain, a country with a population of less than 46 million. The Bank of Ireland added to the pain by paring its growth forecast for Ireland. Gold and oil took breathers on Monday and that helped the dollar cacth a bid, as did speculation about what the Bank of Japan will do at its upcoming meeting to weaken the yen.

Dollar Index Chart

All of those factors contributed to a tough day for stocks, but the big problem was analysts paring their ratings on individual stocks along with earnings estimates on the S&P 500. Analysts are cutting forecasts for S&P 500 companies for the first time in a more than a year, which would jeopardize the impressive gains notched by equities last month, Bloomberg News reported.

Estimates for the combined 2011 profits of S&P 500 constituents fell to as low as $95.17 a share from an August peak of $96.16, representing the first quarterly reduction since June 2009, according to Bloomberg data. That was enough to send all 10 industry groups in the S&P 500 lower on the day.

Earnings season gets rolling in earnest on Thursday when aluminum giant and Dow component Alcoa (AA) delivers third-quarter results and in what has become some kind of sport, a Wall Street firm lowered its rating on Alco just days before the earnings report. Seriously, this seems to happen almost every quarter.

Today it was Deutsche Bank adding shares of the biggest U.S. aluminum maker to the bank's short-term sell list. That sent Alcoa shares lower by 2.5% and helped materials producers to a loss of 1.4% as a group, making them the worst performers in the S&P 500.

Speaking of Dow components that were hit by a downgrade, Microsoft (MSFT) tumbled almost 2% after Goldman Sachs pared its rating on the software maker to ''neutral'' from ''buy,'' citing Mr. Softy's inability to claim noteworthy market share in the mobile device market. The Goldman report also noted that PCs are not being replaced at a rapid pace and tablet devices using software not made by Microsoft present another problem for the company.

Microsoft Chart

Staying in the tech sector, there was an interesting rumor floating around today involving AOL (AOL) and Yahoo (YHOO). The Silicon Alley Insider reported, citing what it deemed an unidentified ''plugged -in source'' that private equity firms have approached AOL CEO Tim Armstrong about leading a combined AOL/Yahoo which said PE firms would take private.

File this under ''two Internet has beens don't make a right'' because investors did not seemed to be impressed by this news. You might think that at least one of AOL or Yahoo would have closed higher on this news and that was the case. Yahoo gained a whole penny while AOL slipped by 3.2%. Somewhere in the valley Google (GOOG) is laughing and probably hoping that AOL and Yahoo find their way to the altar because the bottom line is that combined these two companies are doubtful to be anymore of a problem for a Google than they are on their own.

AOL Chart

Keeping with the private equity theme, there is the curious case of Sara Lee (SLE). I am not going to make any puns related to the old Sara Lee ad campaigns that said ''Nobody doesn't like Sara Lee,'' which by the way is a double negative, but is clear that Sara Lee is well-liked in the private equity world.

Sara Lee has been shedding non-essential businesses to perhaps make it more attractive to potential suitors surged 7.2% today on volume that was more than quadruple the daily average after the New York Post reported that Sara Lee rebuffed a $12 billion takeover from private equity giant KKR. The Post also said Anglo-Dutch consumer products firm Unilever (UN) could be interested in Sara Lee as well. Remember, Unilever is looking to bolster its presence in North America as highlighted by last week's announcement that it will acquire Alberto Culver (ACV) for $3.7 billion.

Adding to the intrigue is a Bloomberg report that says Sara Lee held talks with private equity firm Apollo Global Management. What is odd about all this is that Sara Lee did not disclose these talks sooner, something that I would find perturbing if I was long the stock. I will give Sara Lee this much: In the past year, it has sharply outperformed other food-related stocks like Unilever, PepsiCo (PEP), General Mills (GIS), Kellogg (K) and Smucker (SJM).

On the other hand, take the holding period out to two years, and Sara Lee shares are flat. Take the holding period out to five years and Sara Lee is down more than 20% while the rest of the aforementioned rivals are up at least 20%. The point being is that consumer staples like these are often held by investors for lengthy periods of time and I find it odd that Sara Lee did not brag a little more about the interest it is receiving from potential suitors. I am sure Sara Lee shareholders would have appreciated it.

Sara Lee Chart

In after-hours news, Mosaic (MOS), the second-largest North American fertilizer maker, said its fiscal first-quarter profit nearly tripled to $297.7 million, or 67 cents a share, from $100.6 million, or 23 cents a share, a year earlier. Revenue jumped 50% to $2.19 billion. Analysts were expecting a profit of 70 cents a share on sales of $1.97 billion.

Mosaic said phosphate prices rose in the quarter, but potash prices slumped. The company said it is seeing strong demand for crop nutrients, ''creating a positive outlook for Mosaic.'' Mosaic said it sold 3.1 million tons of phosphate and 1.7 million tons of potash during the quarter. Investors do not appear to be impressed as the stock is down almost 1.4% in the after-hours session.

Mosaic Chart

Looking at the charts, the S&P 500 could not even muster a run at 1150 today and is now hovering just above near-term support at 1135. The more important support level is 1120. There are a couple of big names reporting earnings this week, Marriott (MAR), Monsanto (MON) and PepsicCo (PEP) to name a few, that could help the S&P 500 regroup for another run at 1150. A close above that important level puts the bulls firmly in charge.

S&P 500 Chart

The situation is similar with the Dow as today's sell-off has the index flirting with near-term support at 10,750, but the more important number is 10,550. Alcoa's earnings report and its ensuing impact on the Dow is always overrated because this is the lowest-priced stock in a price-weighted index, so I do not expect that stock to lift the index, regardless of how good the numbers are.

The Dow could get a small pop tomorrow on news that Chevron (CVX) will start repurchasing $500 million to $1 billion of its own stock in the current quarter in what will be an ongoing buyback plan. Resistance for the Dow is still 10,875.

Dow Chart

The Nasdaq showed signs of slowing last week, failing at 2400 and the sellers took the index below initial support at 2350 today. Now 2325 becomes a concern, but perhaps the bigger issue is the fact that the Nasaq-100 has violated support at 1985, closing just over 1975 today. I would be careful with tech here.

Nasdaq Chart

What a tease the Russell 2000. The small-cap index pushed above resistance at 675 on Friday to close near 680, but gave up all those gains on Monday to drop below 670. So we are back to 675-680 as resistance and 650 as support.

Russell 2000 Chart

In summary, I am concerned that the Nasdaq failed at 2400 and the S&P 500 has consistently had problems at 1150. Economic data remains tepid and now analysts are taking down 2011 earnings estimates. Yes, there are some noteworthy earnings reports this week, but I think we are in for some sluggish, sideways trading heading into Friday's jobs numbers. Obviously, I am not going out on a limb when I say that will be the most important data point, earnings or otherwise, the market deals with this week.


New Option Plays

Long Play in Financial Services

by Scott Hawes

Click here to email Scott Hawes


NEW DIRECTIONAL CALL PLAYS

Visa, Inc. - V - close 73.24 change -0.08 stop 67.40

Target(s): 74.90, 76.90, 79.40
Key Support/Resistance Areas: 79.80, 77.50, 75.00, 70.50, 68.00
Time Frame: 3 to 5 weeks

Company Description:
Visa Inc. (Visa) operates the retail electronic payments network and manages a global payments brand. It facilitates global commerce through the transfer of value and information among financial institutions, merchants, consumers, businesses and government entities. Visa provides financial institutions with product platforms encompassing consumer credit, debit, prepaid and commercial payments.

Why We Like it:
V was taken out to the woodshed after FinReg and a Department of Justice anti-trust suit. The company, along with MasterCard, announced a non-monetary settlement has been made with the DOJ today which puts this issue behind them. There has been many analysts/brokerages defend the stock in recent weeks and I think V is on the verge of running higher into the company's earnings report on 10/27. Technically, the stock has made a higher high and closed above its 50-day and rising 20-day SMA. I would like to see V pullback a little more with the broader market and use $71.80 as our trigger to enter long positions. If triggered, our first two targets are estimated to produce +80% and +130% gains. This is a good addition to our model portfolio and will also provide more balance as we are currently firmly biased to the short side.

Suggested Position: Buy November $75.00 CALL, current ask $2.18, estimated ask at entry $1.60

Annotated chart:

Entry on October XX
Earnings 10/27/2010 (unconfirmed)
Average Daily Volume: 6.8 million
Listed on October 4, 2010


In Play Updates and Reviews

Positive Movement

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:
We had positive movement today in our positions. I continue to favor a healthy correction in the broader market but it could come fast so be prepared to take profits or tighten stops on bearish positions.

Current Portfolio:


CALL Play Updates

Petroleo Brasileiro - PBR - close 36.56 change +0.13 stop 33.70

Target(s): 37.40, 38.65
Key Support/Resistance Areas: 39.00, 37.50, 36.60, 34.00
Current Gain/Loss: +12%
Time Frame: 1 to 2 weeks
New Positions: Yes

Comments:
10/4: All things considered, PBR held up well today as the market sold off. The stock is hanging on to an intraday upward trend line that began last Monday, however, if a broader market correction gains momentum PBR will most likely head lower. I would view dips as buying opportunities. The comments below remain valid.

10/02: PBR is holding up relatively well. While everyone was impressed with the size of the company's recent secondary offering many analysts were worried it would depress the stock going forward. So far those worries seem to be unfounded. I agree with Scott that the broader market is overdue for a correction and PBR will likely trade lower if the market does pull back. More conservative traders may want to consider a tighter stop loss (maybe closer to $35.00). PBR looks poised to move higher but given my expectation for a market dip I would keep bullish positions very small. The Nov. $37 call closed with a bid at $1.37 on Friday.

Suggested Position: Long November $37.00 CALL, entry was at $1.25

Entry on September 25, 2010
Earnings 11/11/2010 (unconfirmed)
Average Daily Volume: 13 million
Listed on September 23, 2010


Volatility Index - VIX - close 23.53 change +1.03 stop 20.85 Target(s): 26.00, 27.25, 29.50
Key Support/Resistance Areas: 21.00, 24.00, 28.00, 30.00
Current Gain/Loss: +0%
Time Frame: 2 to 3 weeks
New positions: Yes

Comments:
10/4: We are long October $25.00 call options in VIX as of the open this morning. My primary targets are $26.00 and $27.25 (added today). The comments below remain valid.

10/2 I really like Scott's play on the VXX. The market is very overbought with the huge rally off its August lows. Now upward momentum has stalled and we're about to move into earnings season after a very weak third quarter. Volatility is almost guaranteed. I think options on the VIX might offer an even better trade than the VXX. I'm suggesting bullish positions now. We'll plan on taking profits at $26.00 and at $29.50. I do consider this somewhat aggressive so consider keeping your positions small. Traders will also want to keep in mind that VIX options don't expire on the same schedule as normal equity options but it shouldn't matter since our time frame is only two to three weeks.

Current Position: Long October $25.00 CALL, entry was at $1.80

Entry on October 4, 2010
Earnings N/A (unconfirmed)
Average Daily Volume: N/A
Listed on October 2, 2010


iPath S&P 500 VIX ST Futures - VXX - close 17.37 change +0.33 stop 16.23

Target(s): 17.55, 18.45, 19.25
Key Support/Resistance Areas: 17.50, 19.75, 20.60
Current Gain/Loss: +8%
Time Frame: 1 to 2 weeks
New positions: Yes

Comments:
NOTE: I view this as an aggressive trade so small position size is recommended. Long VXX is a bearish play on equities, however, it is listed as long play because we are long the underlying instrument.

10/4: VXX is moving in our direction as the market sold off today. I suggest picking your exit and sticking with it. My primary targets are $18.45 and $19.25. If a market correction gains momentum VXX may surge higher than these targets, but tightening stops and protecting profits at these levels is suggested. Our comments below remain valid.

10/02: After September's huge gains in the stock market and a week of moving sideways, odds are pretty good the market will see a correction soon. That means the VXX has a lot of potential here. It is an aggressive trade but personally I would adjust the targets higher and plan to take profits near $18.75 and $19.90. FYI: The Nov. $18 call closed with a bid of $1.15.

9/30: As the market spiked higher this morning volatility never really budged which was a signal the spike could fail, and it did. The question now is whether or not there will be follow through lower in the coming days. I believe there will be but I also think trading could be choppy which may fake traders out of positions. If we are patient our targets should be reached as the market is need of healthy correction. I suggest readers use further spikes in VXX as opportunities to take profits or tighten stops to protect them. My primary targets are $18.45 and $19.25. Our stop is in place.

Current Position: Long November $18.00 CALL, entry was at $1.25

Entry on September 22, 2010
Earnings N/A (unconfirmed)
Average Daily Volume: 21 million
Listed on September 21, 2010


PUT Play Updates

Alliant Techsystems - ATK - close 72.19 change -1.54 stop 76.25

Target(s): 72.00, 71.25, 70.50
Key Support/Resistance Areas: 76.00, 74.00, 72.00, 71.25, 70.00
Current Gain/Loss: +38%
Time Frame: 1 to 2 weeks
New Positions: Yes

Comments:
10/4: ATK's slide continued today as the stock broke through its 20-day SMA. There is support near $71.00 so I have added this $71.25 as a target. Protecting profits is key here as we already have a nice profit in the trade.

10/2: The rally in this defense stock just failed at significant resistance near $76.00 and its simple 200-dma. Combine that with an overbought market that has seen its upward momentum stall and it looks like a good spot to speculate on some puts. Now the intermediate trend for ATK is still higher so we're only looking for a correction toward support. I'm suggesting bearish positions now. More cautious traders may want to wait for a little confirmation of Friday's bearish reversal pattern before initiating positions. I am targeting the 50-dma (currently $70.31).

Current Position: Long November $70.00 PUT, entry was at $1.45

Entry on October 4, 2010
Earnings: 11/11/2010 (unconfirmed)
Average Daily Volume: 310,000
Listed on October 2, 2010


Carbo Ceramics - CRR - close 77.98 change -0.37 stop 80.25

Target(s): 75.75, 74.25, 72.25
Key Support/Resistance Areas: 84.00, 82.00, 80.00, 78.00, 76.00, 74.00
Current Gain/Loss: +5%
Time Frame: 1 to 2 weeks
New Positions: Yes

Comments:
10/4: CRR hit our trigger to buy puts at the open this morning. The stock is approaching support with an upward trend line and its 100-day SMA converging. As such, I want to add a target of $75.75. Taking profits or tightening stops to protect them is suggested at the first target.

10/02: Oil service stocks have been surging on the strength in crude oil (oil has been moving on weakness in the dollar). Shares of CRR appeared to breakout from a consolidation pattern on September 28th but the rally reversed. Now shares are testing short-term support at $78.00 and the bottom of its previous trading range. The current failure also looks like a bearish double top pattern.

Current Position: Long November $70.00 PUT, entry was at $3.10

Entry on October 4, 2010
Earnings: 10/28/2010 (unconfirmed)
Average Daily Volume: 226,000
Listed on October 2, 2010


SPDR DJIA ETF - DIA - close 107.57 change -0.75 stop 110.55

Target(s): 106.55, 105.40
Key Support/Resistance Areas: 112.00, 110.00, 107.30, 106.40, 105.00
Current Gain/Loss: +20%

Time Frame: 1 to 3 weeks
New Positions: Yes

Comments:
10/4: DIA took out last weeks lows and looks like it is headed lower. My primary target is $105.40 but taking profits or tightening stops on any further weakness should also be considered. The 20-day SMA is just below which may provide a bounce.

10/02: Upward momentum in the market has clearly stalled. Stocks have been trading sideways for a week. Thursday's action looks like a bearish reversal but Friday did not confirm the signal. Instead Friday produced an inside day. While I remain bearish here more cautious traders may want to look for a move under Thursday's low (107.47) before initiating positions. Personally, I would target a correction toward $105.25 but keep an eye on the rising 50-dma, which could be support (currently $104.81). FYI: The November $105 put closed with a bid of $1.85.

Current Position: Long November $105.00 PUT, entry was at $1.75

Entry on September 30, 2010
Earnings: N/A (unconfirmed)
Average Daily Volume: 6.5 million
Listed on September 25, 2010


PNC Financial - PNC - close 52.10 change -0.74 stop 54.62

Target(s): 49.50, 48.75, 47.25
Key Support/Resistance Areas: 54.50, 53.50, 50.50, 49.50, 48.75, 47.00
Current Gain/Loss: -7%
Time Frame: 1 to 2 weeks
New Positions: Yes

Comments:
10/4: PNC reversed off of its declining 20-day SMA today and looks to be headed lower if the broader market correction continues. The comments from the weekend remain valid.

10/02: Financial stocks have been a drag on the market of late and the path of least resistance seems to be down. Yet Friday's action in PNC was uncomfortably bullish. Shares posted a +1.79% gain and closed above the simple 10-dma. I'm not saying we should panic yet but the relative strength is a warning sign. Look for short-term overhead resistance near $54.00. I would prefer to see a failed rally under $54.00 or a new close under $51.50 before launching new positions.

Current Position: Long November $48.00 PUT, entry was at $1.26

Entry on September 30, 2010
Earnings: 10/20/2010 (unconfirmed)
Average Daily Volume: 5 million
Listed on September 29, 2010


Charles Schwab - SCHW - close 14.02 change -0.11 stop 14.42

Target(s): 13.45, 13.10, 12.85
Key Support/Resistance Areas: 14.10, 13.35, 13.05, 12.65
Current Gain: -40%
Time Frame: 1 to 3 weeks
New Positions: Yes

Comments:
10/4: We need SCHW to get below $13.80 to get things moving in our direction. This should happen if the broader market correction continues. Our stop is in place if SCHW breaks higher.

10/02: I am somewhat surprised by the strength in shares of SCHW the last few days. I use the term strength somewhat loosely but you can see a trend of higher lows. Thus far the stock has been unable to breakout past technical resistance at its 50-dma. The third quarter has seen terribly low trading volumes and investors have been pulling money out of stock funds for weeks. It should not be a good quarter for the likes of SCHW so odds favor this oversold bounce in the stock rolling over. Personally, I would consider giving SCHW a little bit more room and placing the stop loss above $14.50 (maybe $14.51 or $14.55). I would prefer to see a drop or a close under $13.80 before launching new positions.

Current Position: Long November $13.00 PUT, entry was at $0.50

Entry on September 23, 2010
Earnings: 10/14/2010 (unconfirmed)
Average Daily Volume: 11 million
Listed on September 22, 2010