Option Investor
Newsletter

Daily Newsletter, Thursday, 9/22/2011

Table of Contents

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

Market Wrap

Significant Market Risk

by Jim Brown

Click here to email Jim Brown
The Fed said there was significant risk in the economy and that translated to a significant risk for traders in the equity and commodity markets.

Market Statistics

Last week I warned that the FOMC post meeting announcement could become the mother of all sell the news events. The Operation Twist program was already priced into the market and given the weakening global economy and the problems in Europe, traders were hoping for some new program to provide some real stimulus for the markets. Unfortunately the Fed is out of bullets for their big guns and was forced to use only the twist option, which was the equivalent to rearranging the deck chairs on the Titanic.

Bernanke may have wanted to go nuclear but with three dissenters on the FOMC he was forced to stick with the more mundane option. If the lack of good news was not bad enough the Fed had to put the adjective "significant" in the risk statement. "There are significant risks to the economic outlook, including strains in global financial markets."

That put the markets in motion on Wednesday and overnight events in Europe and China added fuel to the fire. HSBC's preliminary Purchasing Managers Index (PMI) for China for September fell to a two month low of 49.4, down from 49.9 in August. The final revision of the PMI will be out on Sept 30th. The data suggests there is a 25% chance China will have a hard landing but that is seen as remote by most analysts.

When you add in the earnings warning from Wednesday by Alpha Natural Resources (ANR) that coal demand from Chinese steel makers was weakening you start to get a broader picture suggesting economic growth is not as strong as the 8% to 9% seen in recent reports. China has been the growth leader that supported the global GDP estimates. If the leader is starting to lag it is not a good sign.

Global markets were already heading lower on Wednesday's drop in the U.S. markets, the Fed's significant risk statement, no resolution on Greece and then the China news added fuel to the fire. Asian and European markets were down an average of -4% overnight. That put our futures deep into the red well before the open.

When FedEx warned at the open that earnings would be lower than expected because of weak global demand, especially in Asia, the futures fell off the cliff. FDX only lowered their estimate by 10-cents but they said shipments had now fallen for two consecutive quarters due to a weakening economy. Notably demand dropped for Asian technology products, which hurt the express international division. International shipments fell -4%. However, shipments inside other countries rose +38% but that is more a factor of gaining market share than surging economics. CEO Fred Smith said the "primary driver of the reduce demand was lower sales of electronic products and we expect that sluggish economic growth will continue." Smith said retailers were not stocking up for the holidays and keeping inventory levels low. Smith also said jet fuel was up 40% for the quarter over the same period in 2010. United Continental and Delta also reported sagging cargo shipments.

FedEx Chart

In other economic reports the weekly Jobless Claims declined by -9,000 to 423,000 but last week's numbers were revised higher to 432,000 from 428,000. The claims for the week were slightly higher than analysts had expected. Jobless claims are not going in the right direction. Last week was the highest claims since May 7th at 438,000. Pennsylvania, Puerto Rico and North Carolina led the list and reported more than 1,000 new claims each.

Jobless Claims Chart

Mass Layoffs for August rose to 1,587 events from 1,579 in July. The number of workers rose to 165,547 from 145,000 in the prior month. Manufacturing saw an increase of +13,000 layoffs to 48,997 for the month. Private layoffs rose to 150,136 from 124,745. These numbers are now at 18 month highs. This is not painting a rosy picture of the September nonfarm payrolls due out on October 7th.

The only bright point in the economics was a better than expected FHFA Purchase-Only House Price Index. The July headline number was -3.3% and that was an improvement of +0.8% over June at -4.5%. The number represents the price difference compared to the same period in 2010. April and May were -6.2% so prices are improving. That is certainly not an improvement that will reduce the pain felt by sellers but it is still an improvement.

There are no major economic reports due out on Friday.

The situation in Europe has not changed since Tuesday when the troika said they were not going back to Greece until October. This creates a real chance of a worsening of conditions and Greece said they would have to start issuing IOUs if they did not get money soon. Numerous companies have halted shipments of things like drugs to Greek hospitals because of non-payment. Greece is circling the drain and nobody is coming to their aid.

The situation in Europe is deteriorating. A senior French official said 16 EU banks would need to be recapitalized immediately because they were nearing critical levels. Seven of the banks were Spanish, two each from Germany, Greece and Portugal and one each from Italy, Cyprus and Slovenia. These banks "nearly failed" the stress test and are now considered fragile as the European conditions worsened. Consumers are still withdrawing cash from European banks on fears the system will crash.

The IMF and the World Bank are holding meetings on Friday over Greece but it appears the troika (EU, ECB, IMF) washed their hands of Greece on Tuesday when two days of conference calls ended without an agreement.

Pimco's CEO El-Erian said we are on the verge of a global financial crisis and Europe must act quickly and forcefully to halt the deterioration or risk falling "into a full-blown banking crisis that aggravates the sovereign debt trap, renders certain another economic recession, and significantly worsens the outlook for the global economy." President Obama met with British Prime Minister David Cameron and French president Sarkozy at the U.N. and called for "forceful and decisive" action on the crisis.

Do you get the feeling like it is 2008 all over again? That is what is troubling investors and the fears are mounting. In the 2008 meltdown everything was always ok at the headquarters of the various players until suddenly it wasn't. There were plenty of assurances despite the increasing number of alarms but the end came suddenly and unexpectedly in every case.

The markets are reacting to that possibility. European officials could stop the merry-go-round by announcing 100% unequivocal funding for Greece and that would isolate them from the current set of problems. Europe would have to bite the bullet and raise the cash while knowing they would never get it back but to not raise it could cause even more harm to their economies. Greece can't pay its debts and will never be able to pay its debts so a default and restructuring is eventually going to happen. Rip off the band-aid and start the healing process otherwise this is going to turn into a bad case of gangrene and they could lose several limbs before it is over.

The global sell off was massive and there were no safe havens except maybe for the U.S. bonds and the dollar. Even the normal flight to quality commodities were crushed. Gold fell -4% and silver -11%. Crude oil was down -6%. The dollar rose more than 1.4%. Traders and investors alike were selling anything with value to cover margin calls. When the Dow declines more than 500 points in a single day and after a -283 point decline the day before the margin calls are severe.

Bonds were the safe haven with the yield on the ten-year falling to 1.695% and a level not seen since the 1950s and the 30-year falling to 2.79% and a three year low.

Ten Year Note Yield Chart

Dollar Index Chart

Gold Chart

Silver Chart

Crude Oil Chart

The selling in commodities was two-fold. First, traders had to raise cash to cover margin calls and that meant selling anything liquid. Secondly, lower global growth suggests lower demand for things like copper and oil. I personally believe this is a buying opportunity in the metals, especially silver. There is risk to $33.50 but the story on silver has not changed. Stronger hands will see this as a buying opportunity at the expense of those who were forced to sell today. The SLV ETF would be my choice along with Silver Wheaton (SLW).

In stock news United Technology (UTX) finally announced it was buying Goodrich for $16.5 billion or $127.50 per share. The deal had been widely rumored for several days but the final price was still more than expected. UTX shares fell -9% on fears they overpaid and the decision to sell was easy since upside in UTX over the coming weeks could be minimal with the deal hanging over them.

UTX Chart

Hewlett Packard (HPQ) surprised everyone by naming Meg Whitman, former CEO of Ebay, as CEO. She had been rumored to be a temporary CEO if Hewlett kicked the current CEO Leo Apotheker to the curb. The board said it had been deliberating on the move for the last three months because Apotheker was not performing and many decisions had been handled badly. You may remember the HP Touchpad tablet was canceled almost immediately after it was released. Whitman was on the board of Hewlett Packard so she is no stranger to the company and the recent challenges.

She immediately vowed to get the company back on track. Shares of HPQ rose after the announcement but ended flat in after hours. I believe this will be a plus for Hewlett Packard because Whitman is a known commodity that had a great run at Ebay. Her mentor at Ebay was Ray Lane who was just named Executive Chairman of the HP board. Apotheker has now been fired from two high profile jobs in less than two years. His days as CEO material just ended but he leaves with a tidy severance package of nearly $10 million. I could live on that. I would buy HPQ shares or at least LEAPS at the current level.

Hewlett Packard Chart

August volume returns. After several weeks of mediocre volume today was a real scorcher with volume of 13.1 billion shares. That is still than the 15-16 billion shares we saw on four days in August but it definitely ranks in the top ten days. The Moody's downgrade of Bank America, Wells Fargo and Citibank on Wednesday helped to push the sector to a -6% loss over the last two days and definitely added to the negative volume.

Today was a day of stop losses getting hit and rampant margin calls. The Dow was down -531 points at its lows and the Nasdaq was down more than 100. The down volume was 12:1 over advancing volume with decliners of 6,040 and advancers only 921. This would be a textbook example of a washout day with declines to critical support. Unfortunately it was a Thursday and not a Friday.

I fear we could see another dip on Friday as additional margin calls are cleaned up in the morning and then worries over a default event in Europe over the weekend cause traders to hold off on buying the dip until Monday. However, futures are up +8 late tonight so evidently there are some bargain hunters on the prowl.

The indexes hit some key support levels and those events don't go unnoticed. The S&P declined to 1120 and the closing low from August was 1119. That level was tested seven times in August and always held. In theory today's retest should attract bargain hunters. The intraday low in August was 1101 so that is also a possibility but I like to use the closing lows since a convergence of events can occur intraday to create an artificial low.

Initial resistance is now 1140 on the S&P with 1120 as initial support.

S&P Chart

The Dow declined to 10,597 intraday and that was six points below the August intraday low. Solid support at 10,800 was broken but buyers did rush in at the 10,600 level. It is technically a new low but the instant rebound was positive. However, the 10,800 level is now resistance. The Dow has declined -8.1% from the 11,540 highs on Tuesday. That is a huge decline but it is also down -16.8% from the July highs at 12,750. We are right on the edge of bear market territory and it is time for a critical decision by the market. If we rally from here then it was a successful retest but a rally could be weak given the cloud of worries hanging over the market.

The $64 question will be whether the convergence of events gave us a bottom or those events are about to push us off the edge of the current cliff at 10,600.

Dow Chart

The Nasdaq chart, despite its -100 point intraday decline, is much more positive than the Dow/SPX. The Nasdaq is well off the highs from Tuesday but still well off critical support at 2340. It would take a couple more days like Thursday to test that support.

Not all Nasdaq stocks were severely negative. Apple lost $10 but it is a $400 stock. Apple's close is still a gain for the week. That suggests not every trader hit the flush button on every position. I would be a buyer of Apple on this dip. An ideal entry would be the 50-day at $383 but on a $400 stock that is a minor amount of fluctuation. If the market were to suddenly turn positive Apple could explode over $420 in mere minutes.

Nasdaq Chart

The Russell failed. The Russell 2000 made a new intraday low at 634 compared to the 639 low from August. The close at 643 was below strong support at 650 and it looks like a failure for the small caps. With continued worries over economics and the potential impact from the European credit crisis, fund managers are definitely bailing from the small caps. Liquidity is the key and dividend paying blue chips are the only place to find that safety.

Any further decline in the Russell would be significantly bearish.

Russell Chart

To summarize, the Fed played its hand yesterday and they had no trumps left. They are not going to be a material factor in the coming weeks unless they suddenly come up with a new strategy. A QE3 plan would have limited impact. It is no longer an environment where lower interest rates will have a material impact.

The weekend event risk could be huge for both bulls and bears. There are plenty of rumors circulating about a potential Greek deal over the weekend but you have to wonder how many of those were started by traders praying for a bounce to liquidate their long positions.

The weekend event risk could go either way. If Greece decides the troika demands are simply too extreme they could throw up their hands and announce they are giving up. While I don't see that as a possibility because of their urgent need of additional cash to pay salaries and keep government facilities open you never know what pressures a crisis can create.

Friday for me is a tossup. There will be more margin selling at the open. They could be selling into a bounce but it will still be selling. If the S&P moved over 1140 I would buy it for a trade. Under 1120 would be bearish but I would buy a dip to 1100 and the August lows. I don't want to catch a falling knife so wait for signs of a rebound before pulling the trigger.

Jim Brown

Send Jim an email


New Option Plays

Biotech, Tech, Silver, Groceries

by James Brown

Click here to email James Brown

Editor's Note:

In addition to tonight's new candidate, consider these stocks as possible trades:

The DIA and IWM both fell to their August lows. This could be a good spot to buy calls with a stop loss under today's low.

I would also check these stocks out for potential bullish trades: COST, WPI, TJX, ILMN, HANS, CERN, RRC, and CVX.

Did you notice that NFLX did not sell off during the market's two-day decline. Has it found a bottom? This might be a good spot to speculate on a bounce. Plus, shares of RL are testing support near $140.

- James


NEW DIRECTIONAL CALL PLAYS

Celgene Corp. - CELG - close: 63.54 change: -0.26

Stop Loss: 60.75
Target(s): 69.00
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
CELG was making headlines on Tuesday when the stock surged from under resistance at $62 to new 52-week highs close to $66. The move was fueled by bullish speculation that CELG would receive a positive report from EU regulators on CELG's Revlimid drug, a new cancer treatment. CELG plans to submit the drug to U.S. regulators next year. The review is supposed to be this week but I could not find an actual date. That makes this trade somewhat dangerous since EU could turn down the Revlimid application. Of course trading biotech stocks is always dangerous because you do not know when a drug trial or drug application headline will come out and whether or not the results are bullish or bearish.

The relative strength in CELG today is encouraging. Traders bought the dip at $61.05. I am suggesting small bullish positions now but only if CELG and the S&P 500 index both open positive tomorrow. We'll use a stop loss at $60.75. Our target is $69.00.

*See Entry Point Details Above*

- Suggested Positions -

buy the OCT $65 call (CELG1122J65) current ask $1.92

Annotated Chart:

Entry on September xx at $ xx.xx
Earnings Date 10/27/11 (unconfirmed)
Average Daily Volume = 4.0 million
Listed on September 22, 2011


Hewlett Packard - HPQ - close: 22.80 change: -1.18

Stop Loss: 19.75
Target(s): 29.50
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
Yesterday HPQ was surging on speculation that the company would replace its CEO. Today, after the closing bell, HPQ announced that Leo Apotheker was stepping down as President and CEO immediately and the company has hired Meg Whitman to replace him. Whitman was previously president of Ebay. Many analysts believe that HPQ's decision to replace Apotheker was done too quickly. The after hours rally in HPQ was tempered by mixed guidance. HPQ reaffirmed their EPS numbers but cautioned that their revenue outlook was cloudy.

We suspect that the low is in for HPQ but we're going to give this trade a wide (aggressive) stop loss at $19.75 since the market could see more volatility. The newsletter is suggesting new positions now. More conservative traders may want to wait and see the market breaks down under its August lows, which might lead HPQ toward the $20.00 level. Our multi-week target is $29.50.

- Suggested Positions -

buy the 2012 Jan. $24 call (HPQ1221A24) current ask $2.27

Annotated Chart:

Entry on September 23 at $ xx.xx
Earnings Date 11/21/11 (unconfirmed)
Average Daily Volume = 26.6 million
Listed on September 22, 2011


ishares Silver ETF - SLV - close: 34.92 change: -3.64

Stop Loss: 33.45
Target(s): 39.50, 42.50
Current Option Gain/Loss: Unopened
Time Frame: 5 to 8 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
Base metals like copper are plunging on worries that the global economy is slowing. Copper actually fell into a new bear market (-20% from its recent highs) with today's drop. Yet if stocks continue to plunge we could see another stampede into gold and silver as alternative "safe haven" trades. It has been argued that gold and silver move too fast to actually be considered true safe havens these days. Yet that doesn't mean they won't catch a bid if the stock market starts to break down.

We see today's -9.4% drop in the SLV as an overreaction. Investors were selling anything they could to raise money (likely for margin calls). The SLV paused near technical support at its simple and exponential 200-dma. I am suggesting small bullish positions now with a stop loss at $33.45. More aggressive traders may want to put their stop loss under $32.00 instead. Personally, I'd rather close the trade at $33.45 and look to re-enter again later if we see SLV bounce near $32.00.

The SLV could see resistance near $38.00 but we're setting our multi-week targets at $39.50 and $42.50.

- Suggested Positions - (Small Positions)

buy the NOV $37 call (SLV1119K37) current ask $1.91

- or -

buy the 2012 Jan $40 call (SLV1221A40) current ask $2.00

Annotated Chart:

Entry on September 23 at $ xx.xx
Earnings Date --/--/--
Average Daily Volume = 24.4 million
Listed on September 22, 2011


Whole Foods Market - WFM - close: 67.63 change: -2.42

Stop Loss: 64.90
Target(s): 73.00, 77.50
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
We tried to play WFM earlier in the week but I suggested waiting for a dip back toward support near $68.00. Today's market sell-off has provided that opportunity. The intraday low was $66.60 but shares managed to trim their losses.

I am suggesting small bullish positions now but only if WFM and the S&P 500 index both open positive tomorrow morning. If triggered we'll use a stop loss at $64.90. More conservative traders may want to use a stop loss closer to $66.50 instead. Our first target is $73.00. Our second, more aggressive target is $77.50.

*See Entry Details Above*

- Suggested Positions - (Small Positions)

buy the OCT $70 call (WFM1122J70) current ask $2.54

- or -

buy the NOV $72.50 call (WFM1119K72.5) current ask $3.65

Annotated Chart:

Entry on September xx at $ xx.xx
Earnings Date 11/02/11 (unconfirmed)
Average Daily Volume = 2.2 million
Listed on September 22, 2011



In Play Updates and Reviews

Recession Fears Fuel Sell-off

by James Brown

Click here to email James Brown

Editor's Note:

Stocks plunged around the globe on renewed concerns that the world may be experiencing another recession. Lower earnings guidance from FedEx and disappointing economic data out of Europe and China all fueled fears over the economy. The DJIA fell to -500 intraday.

The DLTR and MJN trades were stopped out.

I am listing a new entry point on CHKP.

Our SWK put play exceeded our first target.

-James

Current Portfolio:


CALL Play Updates

Check Point Software - CHKP - close: 52.19 change: -4.17

Stop Loss: 50.80
Target(s): 55.75 , 57.75
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

Comments:
09/22 update: The market's sharp sell-off today is providing a new opportunity in CHKP. Shares gapped open lower under its 50-dma and 100-dma and then plunged to a -7.3% decline. Actually it was off -9.2% at its worst today. Yet CHKP managed a bounce off its exponential 200-dma, which is also near its September lows.

I am suggesting we take advantage of this pull back and bounce from support. We will buy calls now but only if CHKP and the S&P 500 index both open positive tomorrow morning. Our new stop loss is at $50.80. Today's low was $51.14 and the mid September low was $51.00. Our new targets are $55.75 and $57.75. More aggressive traders can aim higher.

NOTE: We have changed our strike price.

*See Entry Point Details Above*

- Suggested Positions -

buy the OCT $55 call (CHKP1122J55) current ask $1.65

chart:

Entry on September xx at $ xx.xx
Earnings Date 10/20/11 (unconfirmed)
Average Daily Volume = 1.6 million
Listed on September 20, 2011


PUT Play Updates

Stanley Black & Decker - SWK - close: 47.83 change: -3.08

Stop Loss: 562.5
Target(s): 50.25, 46.00
Current Option Gain/Loss: Oct$50: +110.5%, & Oct$55: +71.7%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
09/22 update: Nope, you're not seeing things. SWK lost $3.00 today and $3.00 yesterday. Shares actually gapped open lower at $49.12 this morning and then plunged to a -6.0% decline. Our first exit target was $50.25 so the gap open at $49.12 triggered the exit. Our second and final target is $46.00. More aggressive traders may want to aim lower. Please note our new stop loss at $52.25.

- Suggested Positions -

Long OCT $50 put (SWK1122V50) Entry $1.90

- or -

Long OCT $55 put (SWK1122V55) Entry $3.90

09/22 new stop loss @ 52.25
09/22 1st target exceeded on gap down at $49.12
bid Oct. $50 put @ 3.12 (+64.2%)
bid Oct. $55 put @ 5.75 (+47.4%)
09/21 new stop loss @ 56.25

chart:

Entry on September 12 at $54.78
Earnings Date 10/18/11 (unconfirmed)
Average Daily Volume = 1.8 million
Listed on September 10, 2011


CLOSED BULLISH PLAYS

Dollar Tree, Inc. - DLTR - close: 74.32 change: -1.68

Stop Loss: 73.75
Target(s): 76.00, 79.00
Current Option Gain/Loss: Oct$75: - 8.5%
Time Frame: 2 to 4 weeks
New Positions: see below

Comments:
09/22 update: The S&P 500 is down -6% in two days. DLTR is only down -1.8%. The stock did pull back to support near $74.00 as expected. Yet the intraday low was just enough to hit our stop loss at $73.75. I would definitely keep DLTR on your watch list for a new entry point. If the market continues to drop we could see DLTR testing support near $70 again.

- Suggested Positions -

OCT $75 call (DLTR1122J75) Entry $2.35, Exit $2.15 (-8.5%)

09/22 stopped out @ 73.75
09/21 new stop loss @ 73.75
09/19 new stop loss @ 72.25
09/17 new stop loss @ 71.75
09/15 new stop loss @ 71.45
09/15 1st Target hit at $76.00. Oct $75 call bid @ 3.20 (+36.1%)
09/15 planned exit for Sep. $75 call. bid $0.65 (+30%)
09/14 exit the September $75 calls ASAP (tomorrow morning)
09/07 trade is open. DLTR gapped open at $72.97
09/06 trade not open. Adjusted entry point strategy, stop loss, and targets.

chart:

Entry on September 7 at $72.97
Earnings Date 11/17/11 (unconfirmed)
Average Daily Volume = 2.2 million
Listed on September 3, 2011


Mead Johnson Nutrition - MJN - close: 72.99 change: -1.24

Stop Loss: 71.75
Target(s): 77.00, 79.50
Current Option Gain/Loss: Oct$70: -40.3% & Oct$75: -65.0%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
09/22 update: MJN managed to pare its losses and ended the session down -1.6% versus -3.1% for the S&P 500. Unfortunately the intraday low this morning at $70.42 was more than enough to close our play. We were stopped out pretty early at $71.75. The intraday bounce near $70 and the close back above potential support/resistance in the $72.00-72.50 area could be used as a new bullish entry point. Nimble traders may want to reload their call positions.

NOTE: The option spreads exploded as volatility soared. This exacerbated our losses on both of the options below.

Earlier Comments:
NOTE: The spreads on the Oct. $75 calls are a lot wider than the spreads on the $70s. Buying the $75s would be a riskier bet.

- Suggested Positions -

Long OCT $70 call (MJN1122J70) Entry $5.20*, Exit $3.10 (-40.3%)

- or -

Long OCT $75 call (MJN1122J75) Entry $3.15, Exit $1.10 (-65.0%)

09/21 stopped out @ 71.75
09/19 new stop loss @ 71.75
09/17 new stop loss @ 71.45
09/14 new stop loss @ 69.90
*09/14 entry price is an estimate

chart:

Entry on September 14 at $73.22
Earnings Date 10/27/11 (unconfirmed)
Average Daily Volume = 1.6 million
Listed on September 13, 2011