Option Investor
Newsletter

Daily Newsletter, Tuesday, 10/4/2011

Table of Contents

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

Market Wrap

Bear Market Short Squeeze

by Jim Brown

Click here to email Jim Brown
The market officially dipped into bear market territory with the S&P down -21.2% intraday at 1,074 but a large buy program hit the market at 3:15 to force a major short squeeze and a +49 point rebound in the S&P for an outside reversal day.

Market Statistics

Traders were shocked by the magnitude of the rebound that began at 3:15. The Dow had declined to 10,430 and was threatening the lows of the day at 10,404 when the buy program hit. The Dow rebounded to 10,808 at the close for a +404 point rebound in only 45 minutes. What do we do now?

That was the question James and I were pondering right after the close. Does this signal the start of a lasting rebound or just a bear market bounce? Do we go long or sell the rally? This is the kind of day that causes indigestion for traders. Futures and commodities are still rising in after hours and I am sure there are shorts that were caught off guard and are still short. That would suggest a continued rally at the open on Wednesday but I doubt it will continue much higher. Even if the bounce is going to stick there should be periods of profit taking. Too many people still have bearish views of the future.

The news from Europe early in the day was not good. The decision on the next payment to Greece has been delayed and the date of the payment has been delayed to mid November. That is a month later than the deadline for a Greek default that was previously discussed. Greece said it could last to mid November with the cash on hand without a default. That was contrary to its desperate warning last week that it would default if the money was not received by mid October. Greece has been known to stretch the truth in the past and it appears they were trying to create some urgency to get the payment sooner rather than later. When the euro zone ministers said they were going to delay to mid November it caused a panic in the market on Monday but after Greece said "no problem" the tensions eased.

One reason given for the afternoon rally was a story in the Financial Times about an European plan to recapitalize their banks. EU Ministers said details of the plan were still under discussion but they concluded they had not done enough convince financial markets that Europe's banks could withstand the debt crisis. Olli Rehn, European commissioner for economic affairs told FT "There is an increasingly shared view that we need a concerted, coordinated approach in Europe although many individual actions are done in the member states. There is a sense of urgency among ministers and we need to move on. Capital positions of European banks must be reinforced to provide additional safety margins and reduce uncertainty. This should be regarded as an integral part of the EU's comprehensive strategy to restore confidence and overcome the crisis."

German finance minister, Wolfgang Schauble, said Berlin could reactivate the support mechanisms put in place in 2008 to recapitalize banks. The program had expired but it could be reactivated to recapitalize German banks.

A troubled French-Belgium lender, Dexia, has been struggling to get enough cash to run its day to day business after a run on the bank on worries over its European exposure. Today Dexia announced it was going to create a bad bank to hold 180 billion euros of problem loans and sovereign debt. The bank would be backed by the French and Belgium governments. The bank currently owns E3.5 billion in Greek debt and E15 billion in Italian debt plus an unknown quantity of Spanish debt. By spinning off the problem assets with the help of France and Belgium governments the short term funding crisis should end.

The sudden flurry of recapitalization actions and proposed actions suggests the EU has finally realized they need to stop the bleeding and put a fence around their banks before taking drastic action on Greece. This is the right thing to do. Fix the banks, insure adequate funding for the coming debt restructuring before it happens then when Greek defaults it won't be an earth shaking event.

Several analysts believe this flurry is banking news was responsible for the rally. That could easily have been the case because the worry over the banks has been the biggest challenge to the markets. At our extreme oversold levels it would not have taken much of a spark to cause some serious short covering and some stock chasing. I wrote on Sunday that we would likely have a strong short covering rally in the days ahead. Having the S&P drop into bear market territory and make new lows from just before the comments came out just increased the oversold conditions. The spring was compressed about as far as it would go.

The U.S. economics don't justify a continued bear market. In the U.S. the banking sector closed at a new post recession low with a decline of nearly -5% on Monday. The S&P declined sharply despite good economic news in the USA. The ISM for September rose unexpectedly to 51.6 from 50.6 and the highest level since June. Analysts were expecting a decline.

ISM Chart

The vehicle sales for September rose sharply to an annual rate of 13.1 million units compared to the August rate of 12.1 million. September was the strongest vehicle sales since April. Sales of SUVs and pickups were especially strong. Dealers reported pent up demand with expectations for continued strong sales through year-end.

Construction Spending for August rose unexpectedly by +1.4% compared to a -1.3% decline in July. Analysts were expecting another decline. Overall spending rose +0.9% over its 2010 level and the first time in three years it has been positive year over year.

There were no material economic reports on Tuesday.

The U.S. is NOT heading into a recession unless conditions worsen appreciably. Europe is going to get resolved. The global equity markets are going to rally when Europe is resolved and it finally appears the EU is headed in the right direction. This could provide further relief to the oversold conditions.

Unfortunately we still have some potential tape bombs on the calendar for this week. The ADP Employment report on Wednesday could be a challenge but the real problem could be the Nonfarm Payrolls on Friday. I have heard estimates now from -75,000 jobs to +125,000. Obviously a number close to either of those extremes would be a shock to the market and we could see a major move.

With the recent events in Europe those dates I listed in the weekend calendar no longer apply.

Economic Calendar

Bernanke's testimony today was a nonevent. There was an initial bounce when he said the Fed stood ready to increase monetary stimulus if needed but no new facts or plans were mentioned. It was a boring Q&A and the markets began selling off again once it was over.

There was a lot of stock news today. Apple (AAPL) was probably the most discussed after they failed to announce the iPhone 5. Instead they announced the iPhone 4S, which had a processor that was seven times faster than the old one. They also unveiled a voice operated personal assistant with multiple languages but Spanish was not one of them. The phone has a beefed up camera and will run the new iOS 5, which will be available on Oct 12th. The presentation was criticized by attendees with CEO Cook leading the show. Steve Jobs did not appear. Apple shares declined nearly $30 off its intraday highs post announcement but recovered to close nearly flat but still in negative territory.

Apple Chart

Research in Motion (RIMM) was very volatile after rumors circulated the company had hired an investment banker to advise on strategic options. RIMM declined to comment on the speculation. RIMM shares rose last week on speculation Carl Icahn was interested in the company. Shares were up sharply at the open but declined to hit new lows after they declined comment on the rumor. Another headline from the 4S announcement quoted Apple CEO Tim Cook as saying 93% of the Fortune 500 were testing the iPhone to replace the BlackBerry.

RIMM Chart

Sprint Nextel (S) shares were hammered at the open after the company said it would buy $20 billion in iPhones over the next four years. Sprint has been shut out of the iPhone frenzy with AT&T and Verizon getting the initial deals. Shareholders of Sprint were shocked at the price of entry into the iPhone market. Sprint said it would not make any money until 2014 because they would sell them at a loss of $500 per phone, like other carriers, in hopes of making up the loss on data sales, texting and long distance. Sprint will buy 30.5 million iPhones.

Sprint Chart

Shares of Acme Packet (APKT) declined from $42 at the close to $27 in after hours when they gave a disappointing outlook for Q3. Revenue is now expected to be $70 million, down from $79.7 million. Earnings are now expected to be 20-22 cents compared to prior estimates of 29-cents. The company said it was impacted by a major order at one of its major customers that was delayed into the current quarter. The CEO affirmed full year targets of $315-$320 million and earnings of $1.14-$1.18. The market is very nervous and warnings like this are met with instant reaction. However, before the close of afterhours trading the stock rebounded to $38.53.

Acme Packet Chart

U.S. banks recovered strongly in the last few minutes of trading. Hedge funds and institutions have not been able to short European banks to hedge against European holdings so they have been shorting U.S. banks. That backfired on them today when the EU news broke about possible recapitalization. JP Morgan (JPM) rebounded +10% intraday to close up 6%. After falling -7% at the open Morgan Stanley (MS) rebounded to close up +12% at $13.85. Morgan Stanley again reiterated it had no exposure to Greece. The KBW Bank Index ($BKX) rallied +4.5%.

KBW Banking Index Chart

Alamai Technology (AKAM) rallied +10% after a tout sheet gave them a spin and shorts were caught off guard. There was no other news on AKAM but the shorts were crushed anyway.

AKAM Chart

Yahoo (YHOO) rallied again after Goldman Sachs said the company was sending out financial information to interested parties. One of those parties is Alibaba CEO Jack Ma but apparently he is only interested in the Asian side of the business. Several private equity firms are interested in partnering with Ma in an acquisition in hopes of getting control of the U.S. business. Microsoft is also rumored to be receiving financial data.

Yahoo Chart

Yum Brands (YUM) reported earnings after the close of 83-cents and in line with analyst estimates. Investors were interested in the China metrics on worries a slowdown in China could be underway. Yum makes more than 40% of its profit from China. Same store sales in China increased +19% in Q3 compared to +18% in Q2 and +12% estimates by the street. That does not appear to be slowing to me but those numbers were for the three months prior to August 31st. Some believe China declined significantly in September. Yum also said it raised prices in China at the end of the quarter in order to offset higher costs. Yum has 4,200 stores in China, mostly KFC outlets. Colonel Sanders would be proud! Yum shares lost $1 after the earnings.

The S&P dipped to 1074 intraday for a decline from the April highs of -21.2%. This was below material support but still well above numbers being discussed by technicians at 1065 and 1050. There was really no technical reason for the rebound. This was clearly a news event that triggered buy programs and a strong short covering rally. Futures after the close have been flat.

The S&P closed just over prior support at 1120 and despite the rebound this is still a lower low and lower high. One rebound does not make a rally. It will take a lot more news from Europe to make this rally stick. The next support target is 1050 if the rebound fails.

S&P Chart - 90 Min

S&P Chart - Daily

The Dow may have rebounded more than 400 points intraday but it was all in the last 45 minutes and the rest of the day was very negative. The rebound was clearly news driven short covering with a couple buy programs triggered as well. That is not enough to produce a lasting rally and there is a good chance we are going to retest the lows.

The interim support lows from today are not 10,440 with the intraday resistance at 10,600. If the Dow declines back below that 10,600 it could get ugly very quickly. A move back under 10,600 would suggest a target low of 10,000. I would expect the buyers to come roaring back if we get anywhere close to that level.

Dow Chart

The Nasdaq was the most bullish index and it traded in positive territory for most of the day even when the Dow was down triple digits. The morning low was 2300 and the afternoon low was 2300. That is not a specific support level other than round number psychological support plus a little congestion from August 2010.

Tech stocks are normally bullish in Q4 so it is no surprise to see traders bargain hunting after the big decline last week. The market recovered without support from Apple although Apple did close well off its lows. GOOG, NFLX and FFIV were winners but Amazon is still struggling with a sell the news cycle post tablet.

Nasdaq Chart - 3 Min

Nasdaq Chart - Daily

The Russell exploded higher with a rebound of nearly 50 points! However, it came to a dead stop at prior support at 650. The strong Russell rebound was simply evidence of how heavily the small caps were shorted. I don't see this as any indication of a change in fund manager sentiment. This was just short covering.

Russell Chart - 120 Min

Russell Chart - Weekly

One day does not make a trend. We are still at the mercy of whatever headline appears on the European front. Late this afternoon Moody's downgraded Italy by a full three notches to A2 from Aa2. They left the outlook at negative. This was overshadowed by the news article from the Financial Times but it is still evidence there are significant problems left to work through. We never know when the next headline will knock us back down again.

If investors actually thought through the European problem they would not be afraid. Based on the 10Q reports for the top five U.S. banks there is a total of $54 billion of exposure to Portugal, Ireland, Italy, Greece and Spain. Those same five banks have over $713 billion in capital. It is not an end of the world as we know it scenario.

For Wednesday I don't have any confidence we will move higher. I think the odds are higher we could see a decline but that depends on Europe and the ADP report. A positive ADP report could increase expectations for the Nonfarm Payrolls on Friday. Likewise a weak ADP could send traders back to the sidelines to avoid the Friday payroll risk.

Jim Brown

Send Jim an email


New Option Plays

Healthcare & Industrials

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:

DE, TIF, COG, NOV

We did see a LOT of bullish reversals today. I looked through the S&P500 components and nearly 50% of them had produced a bullish engulfing (reversal) candlestick pattern. Normally these patterns need to see confirmation but the widespread nature of the reversal is definitely bullish.

- James


NEW DIRECTIONAL CALL PLAYS

Alexion Pharmaceuticals - ALXN - close: 62.68 change: +1.81

Stop Loss: 59.90
Target(s): 67.90
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
In spite of the market's recent weakness shares of ALXN still have an up trend. The pull back over the last few days looks like a normal, and healthy correction. Traders bought the dip near $60.00, which is psychological support. Given this stock's relative strength we want to take advantage of today's bounce.

I am suggesting bullish positions now with a stop loss at $59.90. Today's low was $59.98. However, we do not want to open positions unless both ALXN and the S&P500 index both open positive tomorrow. I'm setting our target at $67.90, just under the recent highs. More aggressive traders could aim for the $70.00 area.

*See Entry Point Details Above*

- Suggested Positions -

buy the OCT $65 call (ALXN1122J65) current ask $2.00

Annotated Chart:

Entry on October xx at $ xx.xx
Earnings Date 10/20/11 (unconfirmed)
Average Daily Volume = 1.8 million
Listed on October 04, 2011


United Technologies - UTX - close: 69.54 change: +0.18

Stop Loss: 66.80
Target(s): 74.50
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
Shares of UTX are bouncing from support near their August lows. The intraday low today was $66.87. I am suggesting bullish positions now on today's intraday bounce with a stop loss at $66.80. However, we do not want to open positions unless both UTX and the S&P 500 index both open positive tomorrow morning. Conservative traders may want to exit/take profits at the 50-dma. I am setting our target at $74.50.

NOTE: We do not want to hold over UTX's earnings report on Oct. 19th.

*See Entry Point Details Above*

- Suggested Positions -

buy the OCT $70 call (UTX1122J70) current ask $2.56

Annotated Chart:

Entry on October xx at $ xx.xx
Earnings Date 10/19/11 (confirmed)
Average Daily Volume = 6.3 million
Listed on October 04, 2011



In Play Updates and Reviews

Big Reversal Day

by James Brown

Click here to email James Brown

Editor's Note:

The stock market produced a huge intraday reversal higher. We had multiple targets hit and we've updated several stop losses. We're suggesting an early exit on a few trades.

-James

Current Portfolio:


CALL Play Updates

Check Point Software - CHKP - close: 53.07 change: +1.37

Stop Loss: 50.80
Target(s): 55.75 , 57.75
Current Option Gain/Loss: -30.5%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
10/04 update: CHKP dipped under technical support at its exponential 200-dma but managed to bounce at $50.85. Our stop is at $50.80. The big rebound and close back above $51 and its 200-dma could be used as a bullish entry point.

- Suggested Positions -

Long OCT $55 call (CHKP1122J55) Entry $1.80

10/03 testing support near $51.00, consider an early exit
10/01 readers may want to consider an early exit now.
09/26 trade opened.

Entry on September 26 at $53.00
Earnings Date 10/20/11 (unconfirmed)
Average Daily Volume = 1.6 million
Listed on September 20, 2011


Hewlett Packard - HPQ - close: 23.02 change: +0.82

Stop Loss: 21.45
Target(s): 29.50
Current Option Gain/Loss: + 8.4%
Time Frame: 8 to 12 weeks
New Positions: see below

Comments:
10/04 update: It was an ugly open with HPQ gapping below what should have been support at $22.00. Fortunately, traders quickly bought the dip and shares surged from its intraday low of $21.84 to $23.02 (a +5.4% move). Readers can use this bounce as a new entry point to buy calls.

- Suggested Positions -

Long 2012 Jan. $24 call (HPQ1221A24) Entry $2.14

09/27 new stop loss @ 21.45

Entry on September 23 at $22.52
Earnings Date 11/21/11 (unconfirmed)
Average Daily Volume = 26.6 million
Listed on September 22, 2011


PUT Play Updates

Panera Bread Co. - PNRA - close: 105.70 change: +4.53

Stop Loss: 107.25
Target(s): 98.00, 92.50
Current Option Gain/Loss: Oct$100: -30.0% & NOV$95: -17.3%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
10/04 update: The gains on our puts just evaporated into losses with PNRA's participation in the market's widespread rebound. The larger trend is still bearish but there is a good chance PNRA continues to bounce. More conservative traders will want to seriously consider an early exit right here. You could exit now and wait for a new failed rally as another entry point. The newsletter is choosing to lower our stop loss down to $107.25.

Earlier Comments:
FYI: I do need to caution readers that the most recent data listed short interest at about 10% of PNRA's small float of approximately 28 million shares. That's above average short interest and a widespread market bounce could spark some short covering.

- Suggested Positions -

Long OCT $100 PUT (PNRA1122V100) Entry $3.50

- or -

Long NOV $95 PUT (PNRA1119W95) Entry $4.60

10/04 new stop loss @ 107.25.

Entry on October 03 at $103.01
Earnings Date 10/25/11 (unconfirmed)
Average Daily Volume = 574 thousand
Listed on October 01, 2011


Regal-Beloit - RBC - close: 44.87 change: +1.90

Stop Loss: 46.25
Target(s): 43.50, 40.50
Option Gain/Loss: (wide spreads) Oct$45: +80.0% & Nov$45: +28.2%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
10/04 update: RBC spiked down to 41.65 this morning before managing to erase a good chunk of yesterday's losses. If RBC can clear the $45.00 level there is a good chance the bounce carries it toward the simple 10-dma near $48.35. More conservative traders may want to exit now to lock in gains or lower their stop loss near the $45.00 level. We are adjusting our stop down to $46.25.

Warning! The option spreads are a little wide. We want to keep our position size small to limit our capital at risk.

- Suggested Positions - (small positions)

Long OCT $45 PUT (RBC1122V45) Entry $1.00

- or -

Long NOV $45 PUT (RBC1119W45) Entry $2.30

10/04 new stop loss @ 46.25, readers may want to just exit early now
10/03 new stop loss @ 48.25
10/03 1st target hit @ 43.50
bid Oct $45 put @ $2.50 (+150%)
bid Nov $45 put @ $3.90 (+69.5%)
10/01 new stop loss @ 49.25

Entry on September 29 at $49.01
Earnings Date 11/02/11 (unconfirmed)
Average Daily Volume = 456 thousand
Listed on September 28, 2011


Walter Energy Inc. - WLT - close: 58.16 change: +1.26

Stop Loss: 62.05
Target(s): 50.50
Current Option Gain/Loss: -25.4%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
10/04 update: I cautioned readers that WLT was a volatile stock. The stock traded in a wide range today (53.41-58.19). Our put play opened this morning at $55.72. I am concerned that today's trading action looks like an intraday bullish double bottom near $54. We have a stop loss at $62.05. More conservative traders may want to lower their stops. Aggressive traders may want to place their stop above the 10-dma instead (currently 62.85).

*Small Positions* - Suggested Positions -

Long OCT $50 PUT (WLT1122V50) Entry $2.95

Entry on October 04 at $55.72
Earnings Date 10/26/11 (unconfirmed)
Average Daily Volume = 4.2 million
Listed on October 03, 2011


CLOSED BULLISH PLAYS

Gold ETF - GLD - close: 157.64 change: -3.32

Stop Loss: 155.90
Target(s): 169.00
Current Option Gain/Loss: -44.6%
Time Frame: 2 to 4 weeks
New Positions: see below

Comments:
10/04 update: The bounce in gold did not last long. Even though the U.S. dollar turned lower today it did not help gold prices. The GLD opened at $160.95 and quickly turned lower. The ETF plunged toward its recent lows near $155. Our stop loss was hit at $155.90.

*Small Positions*

- Suggested Positions -

OCT $165 call (GLD1122J165) Entry $3.25, Exit $1.80 (-44.6%)

10/04 stopped out at $155.90
10/04 opened at $160.95

Annotated Chart:

Entry on October 4 at $160.95
Earnings Date --/--/--
Average Daily Volume = 24.3 million
Listed on October 03, 2011


Ultra S&P500 ETF - SSO - close: 37.23 change: +1.41

Stop Loss: 30.95
Target(s): 36.75, 39.00
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

Comments:
10/04 update: Sometimes the market does not want to cooperate. Yesterday we debated whether or not the entry point for this trade would be $35.00 or $34.00. We selected a trigger at $34.00. Unfortunately the low today was only $34.17. The SSO produced a +8.9% bounce off this low.

Our entry point was not hit so we're dropping SSO as a candidate.

buy-the-dip Trigger @ $34.00

- Suggested Positions -

Trade Did Not Open

Annotated Chart:

Entry on October xx at $ xx.xx
Earnings Date --/--/--
Average Daily Volume = 25.1 million
Listed on October 03, 2011


CLOSED BEARISH PLAYS

iShares Russell 2000 ETF - IWM - close: 64.79 change: +3.80

Stop Loss: 65.25
Target(s): 60.50, 57.00
Current Option Gain/Loss: Oct$60: -27.7% & Nov$60: -12.2%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
10/04 update: Target achieved. Wow! It was a crazy day for stocks with two big swings. The IWM gapped open lower at $60.32, which was under our first target of $60.50. The bid on the October $60 put was at $2.94 (+59.7%) and the bid on the November $60 put was at $4.40 (+37.9%). Then the IWM rebounded sharply off the $60.00 level and closed up with a big gain of +6.2%. While the bounce looks like a bounce back to resistance in the $64-65 area it also produced a bullish reversal pattern. We are electing to exit any remaining positions immediately.

- Suggested Positions - (Small Positions)

OCT $60 PUT (IWM1122V60) Entry $1.84, final exit $1.33 (-27.7%)

- or -

NOV $60 put (IWM1119W60) Entry $3.19, final exit $2.80 (-12.2%)

10/04 exit early on the big bounce
10/04 1st target exceeded on gap down at $60.32
bid Oct. $60 put @ 2.94 (+59.7%)
bid Nov. $60 put @ 4.40 (+37.9%)
10/03 new stop loss @ 65.25

chart:

Entry on October 03 at $63.81
Earnings Date --/--/--
Average Daily Volume = 83.2 million
Listed on October 01, 2011


Pioneer Natural Res. - PXD - close: 65.31 change: +3.49

Stop Loss: 68.05
Target(s): 60.50, 56.00
Current Option Gain/Loss: Oct$60: -36.0% & Nov$60: -18.1%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
10/04 update: Target exceeded. PXD gapped open lower at $60.23 this morning. That was below our first target of $60.50. The bid on the October $60 put was $3.87 (+54.8%) and the bid on the November $60 put was $5.00 (+13.6%). Shares proceeded to hit $58.63 and then reversed course to produce a +11.3% rally off its intraday low. This is too much of a rebound to stand in front of. We are suggesting an early exit immediately.

- Suggested Positions - (Small Positions)

Long OCT $60 PUT (PXD1122V60) Entry $2.50*, final exit $1.60 (-36.0%)

- or -

Long NOV $60 PUT (PXD1119W60) Entry $4.40, final exit $3.60 (-18.1%)

10/04 readers should exit remaining position on this bounce
10/04 1st target exceeded on gap down at $60.23
bid Oct $60 put @ 3.87 (+54.8%)
bid Nov $60 put @ 5.00 (+13.6%)
10/03 new stop loss @ 68.05
*Oct. $60 put entry price is an estimate. Option did not trade at the open that morning.

chart:

Entry on October 03 at $64.87
Earnings Date 11/01/11 (confirmed)
Average Daily Volume = 1.8 million
Listed on October 01, 2011