Option Investor
Newsletter

Daily Newsletter, Tuesday, 6/7/2011

Table of Contents

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

Market Wrap

Bear Feast

by Jim Brown

Click here to email Jim Brown
The bulls ventured out of the barn this morning with a +88 point gain in the Dow by 2:PM but their time in the sun was short lived as the bears charged in at the close for a -19 point loss and -107 points off the high.

Market Statistics

Despite the swan dive at the close the internals were actually positive as you can see in the graphic above. The NYSE Composite Index and the Russell actually closed with a gain. The big problem facing the market was the Ben Bernanke speech late in the afternoon.

Bernanke sounded more nervous about employment than inflation and the Fed head did not inspire confidence among investors. He reiterated the Fed would not raise rates until job creation strengthened for a "sustained" period.

Investors had wanted Bernanke to specifically address the end of QE2 and possibly some indications of what the Fed would do once QE2 ends. Will there be a QE Light in the form of continued runoff purchases?

Bernanke disappointed investors by not providing any hint of future stimulus plans. He also said economic growth had been "somewhat slower" than expected but gave no indications of any plan to correct that situation. He blamed higher fuel prices and the break in the supply chain after the Japan earthquake as the reason for the recent drop in economic activity.

"Overall the economic recovery appears to be continuing at a moderate pace, albeit at a rate that is both uneven across sectors and frustratingly slow from the perspective of millions of unemployed and underemployed workers." He also said he would not consider the recovery to be well established "until we see a sustained period of stronger job creation." That is the key indicator the Fed will not raise rates any time soon. He emphasized that with the much used phrase saying the Fed would continue to keep rates low for "an extended period."

He fired back at the inflation hawks that have been blaming the Fed for the inflation in food and energy. He said consumer inflation has risen +3.5% for the six months ending in April but that was caused mostly by higher oil prices, which have been creeping down in recent weeks. Excluding food and energy inflation remains well below Fed targets.

Bernanke is still toeing the party line that growth will pickup in the second half of the year to something in the +3% range. However, he said he was concerned the economy was still producing at levels well below its potential.

He call on lawmakers to address the deficit on a long term basis but cautioned against making any drastic cuts in the short term that could derail the recovery. "Sharp cuts could be self-defeating. Consequently, the appropriate response is to move quickly to enact a credible long-term plan for fiscal consolidation."

Dallas Fed President Richard Fisher, said this morning he was personally pleased to see the end of QE2 this month and he could not envision a scenario where the Fed would add further liquidity to the system in the coming months. He said the economic gas tank is full. Now we just need somebody to step on the gas and that is not the Feds job. He was pretty specific the QE2 program would end in June saying everyone on the FOMC agreed with that date.

Basically Bernanke and Fisher slammed the door on investor hopes for another stimulus program of some sort that would keep equities moving higher. They said the Fed has done its job and now it was up to businesses to quit cowering in the closet and get back to work. That was not exactly what investors wanted to hear and there was a mad dash for the exits. If the market had been open another 30 minutes we could have been down triple digits.

In the economic reports today the Job Openings, Labor Turnover Survey (JOLTS) showed that job openings fell -2.3%. This was for the April/May period and showed that job openings had fallen from 3.12 million in March to 2.97 million in April. The number of unemployed workers per available job has fallen from 7 at the height of the recession to 4.5 per opening but it was as low as 1.5 per opening prior to the recession. The monthly pace of hiring has fallen -27% from the pre-recession rate.

Moody's Job Openings Chart

The only other reports were weekly Chain Store Sales, flat at +0.4% and Consumer Credit for April also flat at $6.2 billion.

Reports due out the rest of the week will be led by the Fed Beige Book on Wednesday. This should tell us if regional conditions in the 12 Fed regions are improving or declining. The rest of the reports for the week are not normally market movers.

Economic Calendar

OPEC will meet officially on Wednesday but rumors are rampant that they will be raising their stated quotas by 1.0 to 1.5 million barrels per day. Since they are already producing more than that over their official quotas it will be strictly political theater designed to show the world they feel our pain of high fuel prices.

An OPEC ministerial sub-committee met on Tuesday and recommended a hike of up to 1.5 mbpd according to two sources in Vienna. Saudi Arabia, Kuwait and the UAE are also lobbying for an increase of 1.5 mbpd. Iraq, Iran and Venezuela are against any production hikes.

The sudden decline in the U.S. economy appears to have worried some OPEC members that the high fuel prices could knock us back into a recession. Obviously simply legitimizing their current over quota production will not solve any supply issues but it could convince the uneducated public that OPEC is trying to help.

The price of crude did not react as you would have expected to the rumors of higher quotas. Crude prices rebounded from the morning low of $97.75 to $99.25 and apparently moving back to the $100 level where it as spent the last four weeks. The problem is that traders KNOW the potential quota raise at +1.5 mbpd is a political ploy and will have no actual impact on production. With demand expected to increase as the year progresses the price will rise.

OPEC is currently pumping around 29.0 million barrels per day. OPEC and the IEA both believe demand for OPEC oil will rise to 29.9 mbpd over the summer. If they don't increase production that will require refiners to dip into existing supplies and inventories will shrink and prices will rise. OPEC's official quota is currently 24.9 mbpd not counting Iraq, which does not have a quota. Subtracting Iraq's 2.7 mbpd of production that means the rest of OPEC is producing 27.3 mbpd or 1.4 mbpd over their actual quotas. OPEC's average price for a barrel of oil in April was $118.09 compared to the $82.33 they received the prior April. Given the windfall profits they are currently receiving by keeping supplies tight there is little or no chance they will voluntarily produce more oil so they can sell it cheaper.

All of the major brokers reiterated their price targets in the $120-$130 range for Brent for later this year.

Crude Oil Chart

In stock news Talbots (TLB) was crushed after the retailer warned of an ugly quarter ahead. The company said Q2 sales and margins would be significantly below 2010 levels. Shares of Talbots fell -40% on more than ten times the average volume. Talbots said it would close 110 stores with 83 in the current fiscal year. They currently have 568 stores in North America. Analysts raced to post downgrades and beat each other to the lowest target price on the stock. Ten of the 17 analysts covering the stock have a hold rating or worst on the stock with serious doubts they will be able to turn the ship around. This is their fifth consecutive quarter of declining sales.

Talbots Chart

Pep Boys (PBY) an automotive service chain, reported earnings of 23-cents compared to analyst estimates of 30-cents. The chain blamed it on bad weather early in the quarter and the rising cost of fuel. Constant rain during the quarter reduced sales of things like car wax and "appearance" products. They claimed the higher fuel prices were forcing consumers to delay maintenance items and hold off on discretionary purchases. Pep Boys operates more than 700 stores with 7,000 service bays. Shares of PBY dropped -17% on the news.

Pep Boys Chart

Apple shares declined to two week low and $20 off its $352 high from last week after the Developer Conference on Monday. While the conference was seen as extremely positive for Apple there were some problems. On the product side there was nothing announced that was not already known. That means a sell the news event because there was no new news to keep the rally going.

Also pressuring Apple shares was Steve Jobs health. He appeared frail and weak and as the savior of Apple and its guiding light any decline in his health is a challenge for the Apple faithful. Pictures and videos continue to surface on the web of him making routine visits to health clinics. His bones were clearly visible underneath his customary black T-shirt so it was easy to see his overall health had declined. This is weighing on the stock. Also several analysts expressed disappointment there was no announcement of a new iPhone that is expected to be available later this summer. Clearly Apple wanted to focus the media on the iCloud product and they will have a separate iPhone announcement later. Never let an opportunity to generate a press buzz go to waste.

Apple Chart

Temple Inland (TIN) benefited from a hostile offer by International Paper for $30.60 after the stock closed at $21 on Monday. This was a 42% premium for the shares. Obviously the shares rallied to just under $30 on Tuesday to give shareholders a pleasant surprise. One trader was probably not as surprised as everyone else but he will be getting a surprise visit from the SEC soon. On May 25th someone launched a 6,700 contract call spread using the January 2012 $25/$30 strikes. The net premium was $1.10 and cost roughly $700,000 to initiate with TIN selling for $22.81 and moving lower when the trade was established. Since open interest in these strikes was in the range of 40 contracts at the time the sudden appearance of a 6,700 contract position only a week or so before the hostile bid is likely to draw the attention of the SEC. The trader has a paper profit today of roughly $1.5 million.

Temple Inland Options

Temple Chart

Despite the morning short squeeze and the afternoon crash the volume was very light at 6.5 billion shares and internals were positive. The advancers of 3,700 outnumbered the declines of 2,648 by a decent margin. However, new lows at 183 outnumbered new highs at 55. With the Bernanke speech not until 15 min before the market close there was little time to react to the worries expressed in his comments.

The Dow and S&P closed at new two month lows and recent support levels, regained intraday were broken again by the close. This is a not a good sign. With the market oversold after four consecutive days of declines and five weeks of losses I did expect a temporary rebound of sorts. However, I did not expect it to hold those gains. I also did not expect it to erase a +88 point gain in only a few minutes.

The continued negative economics and a Fed chairman who has apparently gone from cheerleading the economy to apologizing for its unexpected decline is not a recipe for market gains. We already know June is the third worst month of the year since 1957 so weakness is expected. How much weakness is the $64 question.

The S&P broke support at 1295 on Monday and then rebounded to find that prior support at 1295 had turned into resistance. On Friday the S&P rallied twice to that 1295 level only to be rebuffed with the afternoon decline rather sharp. The S&P has not closed below 1285 since March 18th and that is exactly where it closed today. This is the last line in the sand before heading for a retest of strong support at 1250. Futures are negative tonight and without a sudden improvement in the Fed Beige Book on Wednesday the odds are good we will see that 1250 level.

The bad news bulls have overdosed on bad news and are nowhere to be seen. The current soft patch in the market is pricing in the end of QE2, the break in the supply chain from Japan, European debt crisis, Middle East uprisings and Northern Africa conflicts plus the sharply slowing economy. If ever there was an opportunity to go against the grain and buy bad news this would be it but I suspect you would lose a few fingers trying to catch this falling knife. Investors need a little less uncertainty in their diet before they are willing to speculate on the future.

S&P-500 Chart

The Dow closed under its support low from April at 12,093 and only round number support at 12,000 is between the Dow and a real support test at 11,600. The correction appears to be gaining speed with the triple digit drop from the afternoon highs. There is nothing in the headlines at present to cheer up investors with earnings misses and earnings warnings adding to the negative economics. Resistance is not 12,175 and initial support 12,000.

Dow Chart

The Nasdaq closed at its lows at 2701. This is a new two-month low and clearly a breakdown in sentiment. Apple of course led the decline with a -$6 loss. Nasdaq 2675 would be the next pause point if 2700 breaks. The obvious target is still 2620 and the 200-day average.

Nasdaq Chart

The Russell has fallen -6% since May 31st high at 848. The Russell remains in its downtrend channel but only barely. The small gain today was due to a rebound in the energy sector and some positive gains in chip stocks. If the Dow and S&P continue their losing ways the Russell will be forced to tag along for the ride. The 200-day average on the Russell at 765 would be exactly a 10% correction. The odds remain good we will see that support test.

Russell Chart

The market has a solid cover of dark storm clouds and the only ray of sunlight the rest of this week might be from the Fed Beige Book on Wednesday afternoon. If the twelve Fed regions saw activity improving then there is hope for the markets. However, if they also show a decline in economic activity we could be in for a major blow.

How much bad news can a market withstand? I think we are reaching our limit. The end result will of course be an eventual rebound once all the news is stale and priced into the market but I doubt it will happen in June. Volume is slowing and we could trade under six billion shares on Friday. We are in the summer doldrums and investors have no reason to buy stocks. Until a reason appears the market action will be lackluster.

Definitely, enter passively and exit aggressively.

Jim Brown

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New Option Plays

Oil Service Weakness & Watch List

by James Brown

Click here to email James Brown

Editor's Note:

The market is trending lower but there are a few pockets of strength. Here's a list of bullish and bearish candidates that caught my eye.

FFIV - The stock is bouncing and looks ready to rally to new multi-week highs. Shares are still building a trend of higher lows.

SODA - This stock displayed relative strength with a surge to new highs. I probably wouldn't chase it here but you can put it on your watch list and look for an entry point.

VRUS - Shares look poised to breakout past resistance at the top of its trading range near $110. My biggest concern is that the options on VRUS have wide spreads.

ILMN - This stock has not yet broken its bullish trend of higher lows. A rally past $73.00 might be a new bullish entry point.

WPI - This drug stock has been pretty resistant to profit taking. The stock has been consolidating sideways but the long-term trend is still up.

TDC - I've mentioned TDC before. Shares have a very consistent up trend and traders just bought the dip at support near its 40 and 50-dma again.

ANF - This teen retailer looks bearish. The stock has closed under its 50-dma but I wouldn't chase it here. Look for an oversold bounce into the $72-73 zone and then look for a potential entry point to buy puts.

AAPL - This tech titan is falling fast in spite of all the positive headlines. I do think there is opportunity to buy it on a dip near its rising 200-dma. We will probably add AAPL as a call trade very soon with a buy-the-dip trigger near $325.00 and a stop loss just under $320.00.

- James


NEW DIRECTIONAL PUT PLAYS

Diamond Offshore Drilling, Inc. - DO - close: 68.88 change: -0.36

Stop Loss: 72.65
Target(s): 64.50, 62.50
Current Option Gain/Loss: + 0.0%
Time Frame: 4 to 6 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
The OSX oil service index managed a bounce today but the sector looks poised to break down from its recent consolidation near the 260 area. Meanwhile DO has been under performing its peers. Shares broke down under technical support at its 200-dma and the $70.00 level yesterday. Today the oversold bounce failed at the $70.00 level and DO closed on its lows for the session. DO has found support in the $69.00-68.60 area in the past so more conservative traders may want to use a trigger to buy puts at $68.50. I am suggesting we go ahead and buy puts now. We'll use a stop loss at $72.65. Our targets are $64.50 and $62.50. The Point & Figure chart for DO is currently still bullish but the stock is on the verge of forming a new sell signal.

FYI: Traders should note that the most recent data listed short interest at more than 14% of the float. That does raise the risk of a short squeeze should the stock suddenly find strength.

- Suggested Positions -

buy the July $67.50 PUT (DO1116S67.5) current ask $1.97

Annotated Chart:

Weekly Chart:

Entry on June 8th at $ xx.xx
Earnings Date 07/21/11 (unconfirmed)
Average Daily Volume = 1.8 million
Listed on June 7th, 2011


In Play Updates and Reviews

Oversold Bounce Fades

by James Brown

Click here to email James Brown

Editor's Note:

The market's oversold bounce from this morning quickly faded lower late this afternoon. Our new put play on NKE has been triggered.

-James

Current Portfolio:


CALL Play Updates

Baker Hughes Inc. - BHI - close: 72.58 change: +0.35

Stop Loss: 69.90
Target(s): 79.00
Current Option Gain/Loss: -53.4%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
06/07 update: Oil stocks popped higher this morning but the rally didn't get very far. BHI was trimming its gains late in the day as the market rolled over. The bulls are at risk here as BHI flirts with support near $72.00. If this level breaks it will be a quick drop toward the next level of support near $70.00. More aggressive traders may want to move their stop loss so it's under the 100-dma or under the $68.00 level. I am not suggesting new positions at this time. A breakdown under $68.00 would look like BHI had produced a bearish H&S pattern.

Earlier Comments:
We wanted to keep our position size small to limit our risk.

-Small Positions - Suggested Positions -

Long June $75 call (BHI1118F75) Entry @ $1.61

06/04 new stop loss @ 69.90

Entry on May 26th at $73.34
Earnings Date 08/03/11 (unconfirmed)
Average Daily Volume = 2.2 million
Listed on May 25th, 2011


Fossil Inc. - FOSL - close: 101.79 change: +1.72

Stop Loss: 99.39
Target(s): 109.75, 114.00
Current Option Gain/Loss: -100.0% & -60.0%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
06/07 update: FOSL displayed relative strength today with traders buying the dip near $100 this morning. The stock closed up +1.7%. Normally I would be tempted to buy calls on this bounce from support but the action in the market's major averages this afternoon is ominous. I am not suggesting new positions at this time.

Earlier Comments:
We wanted to keep our position size small to limit our risk.

- Suggested (SMALL) Positions -

Long June $110 call (FOSL1118F110) Entry @ $1.38

- or -

Long July $110 call (FOSL1116G110) Entry @ $3.00

Entry on May 27th at $104.96
Earnings Date 08/09/11 (unconfirmed)
Average Daily Volume = 842 thousand
Listed on May 26th, 2011


Forest Labs Inc. - FRX - close: 37.00 change: +0.69

Stop Loss: 34.45
Target(s): 39.00, 42.50
Current Option Gain/Loss: - 7.6% & +21.4%
Time Frame: 4 to 6 weeks
New Positions: see below

Comments:
06/07 update: FRX continues to outperform the market. Shares rallied off their morning lows to close up +1.9% and set a new two-year high. While the rally is very encouraging I wouldn't chase it.

Our targets are the $39.00 level and the $42.50 mark but I'm starting to worry that FRX just doesn't move fast enough.

- Suggested Positions -

Long the June $37 call (FRX1118F37) Entry @ $0.65

- or -

Long the August $37 call (FRX1120H37) Entry @ $1.40

06/04 new stop loss @ 34.45
05/28 New stop loss @ 33.75

Entry on May 20th at $35.29
Earnings Date 07/21/11 (unconfirmed)
Average Daily Volume = 3.2 million
Listed on May 19th, 2011


Goldman Sachs - GS - close: 132.99 change: -0.91

Stop Loss: 128.45
Target(s): 134.00, 137.50
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see trigger

Comments:
06/07 update: Financial stocks continue to underperform. GS spent most of the day churning sideways but the stock looks poised to drop. We are speculating that GS will bounce at the $130 level but this is a very aggressive and high-risk trade.

Earlier Comments:
The 2010 lows are near $130. I am suggesting we launch very small bullish positions on a dip at $130.25. This is a very aggressive, higher-risk trade.

Trigger @ 130.25 (very small positions)

- Suggested Positions -

buy the June $135 call (GS1118F135)

Entry on May xxth at $ xx.xx
Earnings Date 07/19/11 (unconfirmed)
Average Daily Volume = 6.5 million
Listed on May 21st, 2011


Union Pacific - UNP - close: 100.67 change: +0.54

Stop Loss: 98.95
Target(s): 109.00, 114.00
Current Option Gain/Loss: -83.3%
Time Frame: 4 to 8 weeks
New Positions: see below

Comments:
06/07 update: UNP is trying to bounce from support near $100 and its 50-dma but it didn't get very far with a +0.5% gain. I am concerned that if the market continues to slide lower we'll see UNP break support near $100. We are definitely running out of time for our June calls. I am not suggesting new positions at this time.

- Suggested Positions -

Long the June $105 call (UNP1118F105) Entry @ $1.62

Entry on May 9th at $102.19
Earnings Date 07/21/11 (unconfirmed)
Average Daily Volume = 3.4 million
Listed on May 7th, 2011


PUT Play Updates

Amazon.com Inc. - AMZN - close: 187.55 change: +1.86

Stop Loss: 195.15
Target(s): 180.25, 175.00
Current Option Gain/Loss: - 8.5% & - 4.5%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
06/07 update: AMZN produced an oversold bounce this morning but the rebound attempt failed twice at resistance near the $190 level and its 50-dma. This move can be used as a new entry point to buy puts. I am adjusting our stop loss down to $195.15. More conservative traders may want to use a lower stop loss just remember that AMZN can be a volatile equity.

Earlier Comments:
The plan was to keep our position size small. Our first target is $180.25. Our second target is $175.00 (or the simple 200-dma, whichever one AMZN hits first).

- small bearish positions -

Long June $185 PUT (AMZN1118R185) Entry @ $2.89

- or -

Long July $180 PUT (AMZN1116S180) Entry @ $4.40

06/07 New stop loss @ 195.15.

Entry on June 6th at $188.01
Earnings Date 07/26/11 (unconfirmed)
Average Daily Volume = 4.5 million
Listed on June 4th, 2011


Nike Inc. - NKE - close: 79.77 change: -0.59

Stop Loss: 84.05
Target(s): 75.50
Current Option Gain/Loss: - 7.5%
Time Frame: 2 to 3 weeks
New Positions: see below

Comments:
06/07 update: Bingo! We didn't have to wait very long for NKE's oversold bounce. Shares rallied to resistance near $82 and its 200-dma and stalled. Our trigger to buy puts was hit at $81.75. I would still consider new positions now. Our target is $75.50 but we'll adjust the target as the trade progresses. NKE is due to report earnings on June 27th and we do not want to hold over the announcement.

- Suggested Positions -

Long July $80 PUT (NKE1116G80) Entry @ $2.00

chart:

Entry on June 7th at $81.75
Earnings Date 06/27/11 (confirmed)
Average Daily Volume = 2.3 million
Listed on June 6th, 2011


SanDisk Corp. - SNDK - close: 43.05 change: -0.19

Stop Loss: 47.70
Target(s): 40.50, 36.00
Current Option Gain/Loss: +35.4% & +23.1%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
06/07 update: Positive analyst comments from Goldman Sachs sent SNDK higher this morning but the rally stalled near $44. Shares closed on their lows for the session. I don't see any changes from my prior comments. You can open positions now or wait for a failed rally closer to $45 and its 200-dma.

Our targets are $40.50 and $36.00, given enough time. FYI: The P&F chart for SNDK is bearish with a $30 target.

- Suggested Positions -

Long July $42.00 PUT (SNDK1116S42) Entry @ $1.10

- or -

Long July $40.00 PUT (SNDK1116S40) Entry @ $0.69

Entry on June 6th at $44.31
Earnings Date 07/21/11 (unconfirmed)
Average Daily Volume = 5.8 million
Listed on June 4th, 2011


Stericycle Inc. - SRCL - close: 85.70 change: +0.15

Stop Loss: 90.05
Target(s): 84.00, 80.50
Current Option Gain/Loss: + 60.0% & +26.6%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
06/07 update: SRCL spent the day slowly climbing from its morning lows only to roll over late in the session. Cautious traders may want to take profits early, especially if you're holding June options. I am not suggesting new bearish positions at current levels.

- Suggested Positions -

Long June $85 PUT (SRCL1118R85) Entry @ $0.50

- or -

Long July $85 PUT (SRCL1116S85) Entry @ $1.50

06/04 new stop loss @ 90.05

Entry on May 31st at $88.78
Earnings Date 07/27/11 (unconfirmed)
Average Daily Volume = 502 thousand
Listed on May 28th, 2011


Whole Foods Market - WFM - close: 56.99 change: +1.04

Stop Loss: 60.15
Target(s): 55.10, 52.00
Current Option Gain/Loss: +45.4% & +33.3%
Time Frame: 4 to 6 weeks
New Positions: see below

Comments:
06/07 update: WFM saw an oversold bounce from $56 to almost $58 before rolling over this afternoon. Nimble traders could use this as a new entry point. Officially I'm not suggesting new positions at this time. We have a target at $55.10 and our secondary, more aggressive target is $52.00.

- Suggested Positions -

Long June $60 PUT (WFM1118R60) Entry @ $2.20

- or -

Long July $55 PUT (WFM1116S55) Entry @ $1.05

06/06 new stop loss @ 60.15
06/04 new stop loss @ 60.65

Entry on June 2 at $58.70
Earnings Date 08/11/11 (unconfirmed)
Average Daily Volume = 1.6 million
Listed on June 1st, 2011