Option Investor
Newsletter

Daily Newsletter, Monday, 8/1/2011

Table of Contents

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

Market Wrap

Debt Deal Awaits, Stocks Still Fall

by Todd Shriber

Click here to email Todd Shriber
On the eve of the expiration of the U.S. debt ceiling, politicians appear close to ratifying a deal that is less bad than the alternative: A default on U.S. debt. ''Less bad'' is also an appropriate way of measuring the performance of stocks today as last week's declines seeped into this week, providing a gloomy start to the new month, but the S&P 500 and the Nasdaq were both down less than half a percent and the Dow's loss was negligible.

Stats Table

The debt ceiling, currently $14.3 trillion, will be raised by at least $2.1 trillion while federal spending will be slashed to the tune of $2.4 trillion. Perhaps the best feature of the legislation being considered is the fact that the debt ceiling issue will not need to be considered again until 2013. Vice President Biden touted this virtue to the press today, but it also underscores just how toxic the partisan environment is on Capitol Hill.

The debt ceiling was raised multiple times under the previous administration and dozens of times before with little difficulty. Bragging about putting off the debate for another two years just highlights how difficult it is to do business in D.C. these days.

No matter what your personal politics are, it is doubtful the debt ceiling agreement will truly thrill you. Some will be disappointed that the agreement does not address tax reform (increases) in any substantive fashion. Others will not be happy to learn that entitlement reform has once again been put off until another day. There you have it: Not good or great, but just less bad than defaulting.

If there was any overnight enthusiasm regarding the debt ceiling news on Sunday evening, it was short-lived because investors across the globe woke up to a spate of disappointing economic data Monday morning. China's PMI Manufacturing number fell to a 29-month low at 50.7, though that actually topped the 50.2 consensus estimate.

Taiwan's HSBC Manufacturing PMI number hinted at contraction with a reading of 46.1. Russia's reading was also below the important 50 level, coming in at 49.8. The Eurozone's final July PMI manufacturing number matched the 50.4 expected while the U.K. reported 49.1, below the 51 expected and good for the lowest reading since June 2009.

Here in the U.S., the Institute for Supply Management said the July manufacturing report was 50.9, well below the 55.3 seen last month and sharply below the 54.3 economists were forecasting. New orders slid to 49.3 and backlog orders fell to 45. Overall readings above 50 are considered positive and that is probably the best thing that can be said of this ISM update.

ISM Chart

Losers at the hands of the debt ceiling debate have been pretty easy to identify for the past couple of weeks now, but with the debate looking like its drawing to a close, the sectors and stocks that will be truly impacted by Uncle Sam's flirtation with austerity are coming to light. With politicians looking to save more than trillion over a decade, defense spending is a prime candidate for some trimming and it will see a haircut.

By some estimates, $325 billion could be cut from the Defense Department budget over 10 years, according to Bloomberg News. Somehow Boeing (BA) escaped a big decline today, but that is just one aerospace/defense name. The PowerShares Aerospace & Defense ETF (PPA) was down nearly 1.3% on volume that was roughly 14 times the daily average today.

PPA Chart

One sector that was home to some major declines today at the hands of government spending cuts is one that does not get much attention: Skilled nursing providers. On Friday, the Centers for Medicare and Medicaid Services issued its final ruling, resulting in an 11.1% haircut to Medicare skilled nursing facility rates.

The cuts go into effect on Oct. 1 and analysts were predictably pessimistic on the group as a result. Oppenheimer called the cuts a ''worst case scenario'' while downgrading Sun Healthcare Group (SUNH) to ''underperform'' from ''outperform.'' That stock plunged 52% on volume that was nearly 80 times the daily average. Skilled Healthcare Group (SKH) tumbled 42.5% on volume that was nearly 12 times the daily average after Morgan Keegan downgraded the stock to ''market perform'' from ''outperform.''

In a note to clients, Morgan Keegan analyst Robert Mains called the CMS cuts to skilled nursing providers ''a stinging setback'' and while noting the cuts were ''considerably worse'' than the industry or analysts were expecting, according to the Associated Press.

Sun Healthcare Chart

Over in the energy patch, there was some M&A news that kind of flew under the radar, though it was not of the announced or completed deal variety. Peabody Energy (BTU), the largest U.S. coal producer, and ArcelorMittal (MT), the world's largest steelmaker, have taken their $5.2 billion takeover bid for Australia's Macarthur Coal directly to the Australian company's shareholders, marking the start of a hostile bid.

As I have noted about this bid in the past, Missouri-based Peabody tried to acquire Macarthur last year for $3.4 billion on its own, but was rejected. Macarthur makes for an alluring takeover target not only because it is the world's largest maker of pulverized coal for use in steel production, but also because of Australia's proximity to China, India and other key emerging markets.

Obviously, Macarthur knows these things about itself and that apparently makes for a difficult negotiating partner. Macarthur rejected an offer from Peabody and ArcelorMittal of about $17 a share, saying it wanted an offer closer to $19.80 a share. Peabody and ArcelorMittal are willing to pay the equivalent of $27 for each ton of Macarthur's coal reserves and $3 a ton of its coal resources, Bloomberg News reported, citing a Morgan Stanley report.

Crucial to appealing to Macarthur shareholders for Peabody and ArcelorMittal is getting China's Citic Group, which owns 24% of Macarthur, to go along with the deal. If the deal is successful, it would be the second-largest takeover in the coal sector this year behind the $7.1 billion Alpha Natural Resources (ANR) paid for Massey Energy. For more news and commentary on the energy sector, sign up for a free trial of the OilSlick daily newsletter (HERE).

Peabody Energy Chart

Looking at the charts, by the time the market closed, the S&P 500 barely closed above its 200-day moving average just over 1285, though that support was violated by 11 points on an intraday basis. The index remains well below resistance in the 1310, though 1295 would have to be conquered first before 1310 can be addressed. If 1285 does not hold, 1265 is the next stopping point. Below there, it is time to drop long positions.

S&P 500 Chart

At least the Dow did not drop below its 200-day line today and it did close more than 50 points above that area, but the chart is only barely more attractive than that of the S&P 500. Another source of encouragement could be the fact that the Dow found psychological support at 12,000 and never came close to more critical support at 11,925. Resistance can be found around 12,320 and then again at 12,500. Pfizer (PFE) and Procter & Gamble (PG) are the big Dow earnings reports for the week, though I doubt either will materially impact the index.

Dow Chart

The Nasdaq finished the day in decent shape today, all things considered, and made a valiant effort to reclaim its 50-day moving average. While falling short of that mark by just seven points, the Nasdaq is at least a comfortable distance removed from support at 2700 and if it can clear the 50-day line, can run another 25 points to next resistance. After that, resistance is of the round number variety at 2800. There are enough brand-name earnings reports this week to help or hinder the Nasdaq.

Nasdaq Chart

The Russell 2000 fell through its 200-day line on Friday with hardly any fight, but the small-cap index made a decent effort to get back there today. There are two ways to look at Monday's action on the Russell 2000. First, it can be viewed as disappointing the index did not close above 800 after trading as high as 808. Or it can be said at least support at 775 was never an issue. I am cautiously leaning in the former camp as the Russell held up decently at the end of last week.

Russell 2000 Chart

Alright, so I will work on the assumption that a debt ceiling deal will pass, if not tonight, then sometime on Tuesday, but I am not convinced it will deliver the required euphoria for the market to make substantial headway toward erasing more than a week's worth of losses. There might be some initial positivity, but the harsh reality is even if a debt ceiling accord is reached, investors still have to contend with poor economic data. The ISM number today got that ball rolling and it is doubtful Friday's jobs report will surprise to the upside.


New Option Plays

Ask Yourself

by James Brown

Click here to email James Brown

Editor's Note:

The market's failure to hold its early morning gains on the debt deal news was a shock for a lot of investors. I know that a lot of traders have exited the market as they wait to see what happens next. That's not a bad plan. There may be a debt deal but it hasn't been voted on in congress yet, nor has it passed.

The S&P 500 saw an intraday violation under its simple 200-dma but it bounced at the exponential 200-dma. This is also a test of its long-term trendline of higher lows. Essentially the market is at support. You have to ask yourself, will you buy the dip to support expecting a bounce? Or do you adjust your strategy and expect a breakdown? While there is plenty of negative economic news lately I am going to argue that support remains support until its broken. Thus we are adding a new bullish trade tonight.

FYI: While looking for candidates tonight I noticed that the tobacco stocks BTI and PM were showing relative strength. BTI looks like a better trade but the option spreads are a little too wide. I also noticed that the TMF ETF was in rally mode. The TMF is the triple-leveraged (3x) bond ETF focused on long-term U.S. treasuries and it does have options.

- James


NEW DIRECTIONAL CALL PLAYS

Energizer Holdings Inc. - ENR - close: 81.50 change: +0.86

Stop Loss: 79.25
Target(s): 84.85, 88.50
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
ENR reported earnings last week that were well above analysts' estimates. The earnings news pushed the stock past resistance a $80 and ENR hit new two-year highs. In spite of the market's recent weakness ENR has managed to hold near new support at the $80.00 level. The stock was showing relative strength today.

I am suggesting we buy calls on ENR now but we only want to launch positions if both ENR and the S&P 500 open in positive territory tomorrow. Even then we still want to keep our position size small to limit our risk. I'm suggesting a stop loss at $79.25. Our targets are $84.85 and $88.50. If you're buying August calls I'd exit at the $84.85 target. Remember, August options expire in less than three weeks.

Buy calls if both ENR & S&P 500 open in positive territory tomorrow

- Suggested Positions -

buy the AUG $85 call (ENR1120H85) current ask $0.70

- or -

buy the SEP $85 call (ENR1117I85) current ask $1.60

Annotated Chart:

Entry on August xx at $ xx.xx
Earnings Date 11/02/11 (unconfirmed)
Average Daily Volume = 717 thousand
Listed on August 1, 2011



In Play Updates and Reviews

Stocks Fall Anyway!

by James Brown

Click here to email James Brown

Editor's Note:

The news on Sunday night and Monday morning was all about the debt ceiling deal reached by Democrats and Republicans. As expected the stock market gapped open higher on this news. Unfortunately there was no follow through. Stocks immediately reversed lower thanks to some bearish economic data and the fact that this new debt deal still has to be voted on and passed. The lack of follow through higher across the broader market is very bearish and definitely a warning signal.

Looking at our market neutral plays you'll notice that the premiums on the call options fell a lot more than the rise in the puts. Overall it was a negative day for these trades.

-James

Current Portfolio:


CALL Play Updates

Alliance Data Systems - ADS - close: 97.74 change: -0.60

Stop Loss: 95.75
Target(s): 104.50. 107.00
Current Option Gain/Loss: -42.8% & -40.0%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
08/01 update: Waiting for both the S&P 500 and ADS to open higher backfired on us given the stock market's bearish reversal from its opening highs this morning. ADS gapped open at $99.56 and then slipped back under the $98 level. Our trade was opened this morning. Unfortunately the lack of follow through higher is caution signal. If you're looking for a new position today I'd wait for another bounce from the $96.00 level. Keep in mind we have a stop loss at $95.75.

- Suggested Positions -

Long AUG $105 call (ADS1120H105) Entry $0.35

- or -

Long SEP $105 call (ADS1117I105) Entry $1.50*

08/01 Our trade is opened. ADS opened higher at $99.56
08/01 *entry price is an estimate. option did not trade today.
07/30 Try again.
07/27 Try again. buy calls if ADS and S&P 500 open positive on Friday. New stop loss at $95.75
07/27 Our trade was not opened. I am removing our entry point (no trade) until Thursday night and we'll re-evaluate.

Entry on August 01 at $99.56
Earnings Date 07/21/11
Average Daily Volume = 825 thousand
Listed on July 26, 2011


Caterpillar Inc. - CAT - close: 100.72 change: +1.93

Stop Loss: 96.45
Target(s): 104.00, 109.00
Current Option Gain/Loss: +24.1%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
08/01 update: As expected we saw some big moves in CAT. Shares gapped open higher at $102.43 and almost hit $103 before paring its gains. Shares actually dipped all the way back to its 200-dma before rebounding higher into the closing bell. The stock settled with a +1.9% gain on the session.

The lack of follow through higher in the broader market is a big concern. I would hesitate to launch new positions in CAT at this time.

- Suggested (SMALL) Positions -

Long AUG $100 call (CAT1120H100) entry @ $2.90

Entry on July 29 at $98.79
Earnings Date 10/20/11 (unconfirmed)
Average Daily Volume = 8.7 million
Listed on July 28, 2011


Noble Energy, Inc. - NBL - close: 99.62 change: -0.06

Stop Loss: 94.25
Target(s): 104.50, 109.00
Current Option Gain/Loss: + 1.4% & -22.0%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
08/01 update: NBL weathered the volatility today pretty well. Our trade has been opened. The stock gapped open higher at $101.04. The strength didn't last and NBL dipped to $98.28 before bouncing again. My comments in our CAT trade apply here as well. The lack of follow through higher across the broader market is a caution sign. Readers may want to wait for a new most past $101.00 or a close above the $100.00 level before considering new bullish positions. Cautious traders may want to raise their stop loss as well since our stop is a little wide here, especially given our entry point this morning.

Earlier Comments:
FYI: The Point & Figure chart for NBL is bullish with a $111 target. NOTE: August options expire in three weeks.

- Suggested Positions -

Long AUG $105 call (NBL1120H105) Entry $0.69

- or -

Long SEP $105 call (NBL1117I105) Entry $2.50*
08/01 *entry price is an estimate. option did not trade today

Entry on August 1 at $101.04
Earnings Date 10/27/11 (unconfirmed)
Average Daily Volume = 1.3 million
Listed on July 30, 2011


PowerShares QQQ - QQQ - close: 57.73 change: -0.27

Stop Loss: 56.75
Target(s): 62.50, 64.75
Current Option Gain/Loss: -46.1% & -69.2%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
08/01 update: The Qs gapped open at $58.67 but the rally didn't last long. Shares quickly faded and slipped to short-term support near $57.00 before rebounding. The lack of follow through on news of a debt ceiling deal is very worrisome. Maybe investors are just being cautious since the deal has not been voted on yet. Plus, we had another day of bearish economic data. I am not suggesting new bullish positions at this time. We have a stop loss at $56.75, under the 50-dma.

Earlier Comments:
This is an aggressive entry point. We wanted to keep our position size small to limit our risk.

- Suggested Positions - (SMALL POSITIONS)

Long AUG $60 call (QQQ1120H60) entry @ $0.52

- or -

Long AUG $62 call (QQQ1120H62) entry @ $0.13

07/29 Trade opened with QQQ closing at $58.00
07/28 New strategy: buy calls on Friday at the closing bell
07/27 We are removing our entry point for Thursday. We'll re-evaluate our strategy on Thursday night.

Entry on July 29 at $58.00
Earnings Date --/--/--
Average Daily Volume = 61.7 million
Listed on July 23, 2011


Quality Systems, Inc. - QSII - close: 90.71 change: -0.65

Stop Loss: 87.40
Target(s): 99.50
Current Option Gain/Loss: -53.3% & -33.3%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
08/01 update: QSII set new all-time highs this morning with the gap open higher at $92.25 and its short-term spike to $93.64. Sadly the rally didn't last and QSII plunged back toward $89.50 before paring its intraday lows. Given the market's performance today I would be very cautious on launching new positions. Readers may want to wait for a new close over $92.00 before initiating trades.

Earlier Comments:
If QSII can rally past resistance at $92.00 there is a very good chance the stock will see a short squeeze. Traders will be interested to note that the most recent data listed short interest at 22.5% of the very small 19.4 million-share float. If triggered I'm suggesting a target at $99.50. More aggressive trades may want to aim higher. FYI: The Point & Figure chart for QSII is bullish with a $123 target. NOTE: August options expire in three weeks.

- Suggested Positions -

Long AUG $95 call (QSII1120H95) Entry $1.50*

- or -

Long SEP $95 call (QSII1117I95) Entry $2.70
08/01 *entry price is an estimate. option did not trade today

Entry on August 1 at $92.25
Earnings Date 10/31/11 (unconfirmed)
Average Daily Volume = 235 thousand
Listed on July 30, 2011


Market Neutral Play Updates

SPDR Dow Jones Industrial Average (ETF) - DIA - cls: 121.11 chg: -0.02

Stop Loss: n/a
Target(s): -----
Option Straddle Gain/Loss: - 8.9%
Option Strangle Gain/Loss: -18.2%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
08/01 update: After all the volatility today the DIA closed virtually unchanged for the session. If the debt deal doesn't pass the vote tomorrow we can expect a lot more weakness. I am not suggesting new positions at this time.

Earlier Comments:
I'm listing both a straddle and a strangle. We're using August options that expire in less than four weeks. Readers may want to consider September options instead.

Trade #1. Option Straddle (cost: $4.49, current: $4.09)

Long AUG $123 call (DIA1120H123) Entry @ $2.33, current bid $1.09
- and also buy -
Long AUG $122 put (DIA1120T122) Entry @ $2.16, current bid $3.00

- or -

Trade #2. Option Strangle (cost: $1.64, current: $1.34)

Long AUG $127 call (DIA1120H127) Entry @ $0.64, current bid $0.14
- and also buy -
Long AUG $117 PUT (DIA1120T117) Entry @ $1.00*, current bid $1.20

07/30 No new positions at this time
07/28 we got much better prices than expected on the entry this morning.
07/28 *entry price is an estimate. option did not trade today
07/27 NOTE: you may want to buy three calls for every two puts if you're trading the strangle due to the price difference.

Entry on July 28 at $122.82
Earnings Date --/--/--
Average Daily Volume = 6.6 million
Listed on July 27, 2011


iShares Russell 2000 Index - IWM - close: 79.22 change: -0.52

Stop Loss: n/a
Target(s): --
Option Straddle Gain/Loss: -15.1%
Option Strangle Gain/Loss: -23.3%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
08/01 update: News of a debt deal had the IWM gap open higher at $80.69 but the rally failed near $81.00. This small cap ETF closed under its simple 200-dma. We could see the IWM breakdown to new relative lows soon if the debt deal doesn't pass the vote tomorrow. I am not suggesting new positions at this time.

Trade #1. Option Straddle (cost: $4.43, current: $3.76)

Long AUG $80 call (IWM1120H80) Entry @ $2.17, current bid $1.40
- and also buy -
Long AUG $80 put (IWM1120T80) Entry @ $2.26, current bid $2.36

- or -

Trade #2. Option Strangle (cost: $1.50, current: $1.15)

Long AUG $84 call (IWM1120H84) Entry @ $0.52, current bid $0.21
- and also buy -
Long AUG $76 PUT (IWM1120T76) Entry @ $0.98, current bid $0.94

07/30 no new positions at this time
07/30 corrected the entry price to reflect the correct Aug. options
07/27 NOTE: you may want to buy three calls for every two puts if you're trading the strangle due to the price difference.

Entry on July 28 at $79.96
Earnings Date --/--/--
Average Daily Volume = 60 million
Listed on July 27, 2011


SPDR S&P 500 ETF - SPY - close: 128.78 change: -0.55

Stop Loss: n/a
Target(s): --
Option Straddle Gain/Loss: -10.5%
Option Strangle Gain/Loss: - 7.0%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
08/01 update: The gap higher and morning rally failed under the $131 level. The SPY traded below its simple 200-dma intraday but bounced at its exponential 200-dma instead. I am not suggesting new positions at this time.

Trade #1. Option Straddle (cost: $5.61, current: $5.02)

Long AUG $130 call (SPY1120H130) Entry @ $3.10 current bid $1.76
- and also buy -
Long AUG $130 put (SPY1120T130) Entry @ $2.51, current bid $3.26

- or -

Trade #2. Option Strangle (cost: $2.69, current: $2.50)

Long AUG $134 call (SPY1120H134) Entry @ $1.14, current bid $0.44
- and also buy -
Long AUG $127 PUT (SPY1120T127) Entry @ $1.55, current bid $2.06

07/30 no new positions at this time
07/30 corrected the entry price for August options
07/28 NOTE: you may want to buy three calls for every two puts if you're trading the strangle due to the price difference.

Entry on July 28 at $130.60
Earnings Date --/--/--
Average Daily Volume = xxx million
Listed on July 27, 2011


PUT Play Updates

FactSet Research - FDS - close: 91.43 change: -0.66

Stop Loss: 96.05
Target(s): 90.50, 86.00
Current Option Gain/Loss: -22.8% & -16.6%
2nd Position Gain/Loss: - 6.8% Time Frame: 4 to 6 weeks
New Positions: see below

Comments:
08/01 update: The gap open higher in FDS this morning was lower than I expected. Shares failed under the $93.50 level and then sank to new lows. I am lowering our stop loss down to $96.05. More conservative traders may want to consider a stop loss closer to $95 instead. I am not suggesting new positions at this time. The $90.00 level could be support. Our first target is $90.50. The intraday low this afternoon was $90.69.

NOTE: The spreads on the Aug. $95 puts have widened significantly again. The bid is $2.70 with an ask of $5.20. This is not tradable. You may want to consider a limit order when you exit instead of using a market order. We will not be trading FDS again if the spreads don't improve.

Earlier Comments:
Our targets are $90.50 and $86.00 but the $90.00 level is support and FDS will probably see a bounce from this level. The Point & Figure chart for FDS is bearish with a $64 target.

- Suggested (SMALL) Positions -

Long AUG $95 PUT (FDS1120T95) Entry @ $3.50

- or -

Long SEP $90 PUT (FDS1117U90) Entry @ $2.40

- 2nd Position, listed 7/26 -

Long Aug $95 PUT (FDS1120T95) Entry @ $2.90*

08/01 new stop loss @ 96.05
07/27 new stop loss @ 97.05
07/27 entry on the 2nd position (Aug.95 put) is an estimate
07/26 New stop loss @ 98.25, Adding positions

Entry on July 18 at $94.48
Earnings Date 09/21/11 (unconfirmed)
Average Daily Volume = 363 thousand
Listed on July 16, 2011