Option Investor
Newsletter

Daily Newsletter, Monday, 10/17/2011

Table of Contents

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

Market Wrap

What Should Have Been

by Todd Shriber

Click here to email Todd Shriber
What probably should have been a decent day at the very least for U.S. stocks turned ugly as Germany threw a wet dish towel on the rally by saying a speedy resolution to the Euro zone's debt woes probably is not in the cards. I am not sure why that is a surprise since we are well into year two of dealing with this issue, but all the major U.S. indexes plunged as a result, ignoring some decent earnings news and some big deals in the energy sector.

Market Stats

European Union policymakers had been shooting for a resolution to be unveiled at an Oct. 23 gathering in Brussels, but that dream has fallen by the wayside thanks to Germany. The reality is Germany does not need to do what the EU's problem children want it to do and the Germans certainly do not need to obey anyone's time line but their own.

Yet that was only part of the problem today. U.S. economic data was only tepid at best. The Federal Reserve said industrial production rose a seasonally adjusted 0.2% in September, but the August number was revised down to no growth from an initial reading of an increase of 0.2%. Economists expected a gain of 0.1% in September.

The New York Federal Reserve said manufacturing activity in the region showed an October reading of -8.5, only slightly better than the September reading of -8.8. The Empire State Index has labored below zero for five consecutive months.

Europe and lingering concerns about the U.S. recovery obfuscated some good news at the stock level. For starters, shares of El Paso (EP) surged xx% after Kinder Morgan (KMI) agreed to buy the company for about $38 billion, creating the largest U.S. pipeline operator. The combined company would own 80,000 miles of pipeline across the U.S. and the transaction appears to be one generated by the boom in various U.S. shale plays.

You may have seen $21 billion floated around as the price tag for this deal, but Kinder Morgan is assuming $17 billion in El Paso debt and that is where $38 billion comes from. That sounds like a debt and it is, something Kinder Morgan acknowledged in its press statement, but the company also said ''the sale of EP's exploration and production business, dropdown transactions to KMP and EPB, and excess cash flows should allow for a rapid reduction in debt levels.''

Good news if you are invested in KMI for the dividend: ''If this transaction were to close at the beginning of 2012 and factoring in KMI's normal expected annual growth, KMI would expect to pay a dividend per share of approximately $1.45 in 2012, up substantially from its current annual rate of $1.20 per share,'' according to the statement.

Overall, the market appears to be sweet on this deal, which is the second-largest announced takeover in the U.S. this year behind only AT&T's (T) $39 billion offer for Deutsche Telekom's T-Mobile unit. Kinder Morgan expects the El Paso transaction to close in the second quarter of 2012.

El Paso Chart

Speaking of acquisitions spurred by the North American shale boom, Statoil (STO), Norway's largest oil company, said it will acquire Brigham Exploration (BEXP) for $4.4 billion in cash in a move by the Norwegian company to bolster its shale exposure due to declining output in the North Sea. Actually, Statoil announced two major North Sea discoveries in the summer, but the company has been moving to expand its shale exposure in recent years.

In 2008, Statoil bought almost $3.4 billion in shale assets from Chesapeake Energy (CHK) and paid $225 million for some Eagle Ford Shale acreage in June. By acquiring Brigham, Statoil becomes a major player in the Bakken Shale. The deal will give Statoil more than 375,000 net acres in the Williston Basin, where the Bakken and Three Forks are located, according to Bloomberg News. The deal makes Statoil one of the top-10 Bakken producers along U.S. oil giants Exxon Mobil (XOM) and ConocoPhillips (COP), Bloomberg added.

Statoil estimated the risked resource base at 300-500 million barrels. Brigham's current Bakken production is 21,000 barrels per day, but Statoil forecast an increase to 60,000-100,000 barrels per day in the next five years. The deal is expected to close in the first quarter next year.

Brigham Chart

Keeping with the shale theme, Halliburton (HAL), the world's second-largest provider of oilfield services, said its third-quarter profit jumped to $683 million, or 74 cents per share, from $544 million or 60 cents per share a year earlier. Revenue surged 40% to $6.55 billion. Excluding one-time items, Halliburton earned 94 cents a share. Analysts expected 92 cents on revenue of $6.39 billion.

That didn't keep the stock from tumbling nearly 8% on heavy volume. Halliburton's problem wasn't the third-quarter numbers. It was some comments from CEO Dave Lesar that prompted some analysts to opine the company might need to lower its fourth-quarter guidance of $1.03 a per share. Operational delays in Iraq and Libya also hampered Halliburton's Q3 numbers, but the more pressing issue is how robust demand in North American shale plays will remain.

Combine the fact that Halliburton expects to hire 12,000 new U.S. workers this year with Statoil's Brigham acquisition and the shale outlook still looks pretty solid.

Halliburton Chart

One last note from the energy sector: Shares of Anadarko Petroleum (APC), the second-largest U.S. independent oil and natural gas producer, is putting the Gulf of Mexico oil spill behind it by settling with BP (BP) for $4 billion. Texas-based Anadarko held a 25% non-operating interest in the Macondo well project and had been adamant in its belief that BP was primarily at fault for the largest oil spill in U.S. history.

BP saddled Anadarko with a bill for cleanup costs shortly after the spill and the two companies have been doing some legal wrangling ever since. Earlier this year, Anadarko CEO Jim Hackett said his company would consider coming to the table to talk settlement with BP under the right circumstances. Apparently, the circumstances are right and Anadarko will pay BP $4 billion using a $5 billion credit facility. The U.S. company is expected to sell some assets in Brazil to reduce that debt.

Investors liked the news as Anadarko 5.5% on volume that was roughly triple the daily average on a day that was otherwise nasty for energy stocks not tied to M&A chatter.

Anadarko Chart

There is a deluge of earnings news from the financial services sector this week and Citigroup (C) and Wells-Fargo (WFC) got the ball rolling today. Citi, the third-largest U.S. bank by assets, said its third-quarter profit rose to $3.77 billion, or $1.23 per share, from $2.17 billion, or 72 cents per share, a year earlier. On an adjusted basis, Citi earned $2.6 billion, or 84 cents per share. Revenue slipped 12% to $4.84 billion. Analysts expected a profit of 81 cents a share. Non-performing loans fell to $7.95 billion from $12.46 billion last year.

Shares of Citi opened the day in fine fashion, but could not hold those gains and finished down 1.7%. Monday was far more harsh to California-based Wells-Fargo as shares of that stock slid 8.4%. The bank reported a third-quarter profit of $4.06 billion, or 72 cents per share, compared with$3.34 billion, or 60 cents per share, a year earlier. However, revenue fell 4% to $19.63 billion, below the $20.24 billion analysts expected.

On days like today, it is hard to find bank stocks in the green and if the chart of the Financial Select Sector SPDR (XLF) is any guide, financials may be in for more downside.

XLF Chart

In the category of stocks that could be flirting with fallen star status, there is Green Mountain Coffee Roasters (GMCR). In February, GMCR was trading just over $30. Last month, the stock almost hit $116. Sounds fun, right? Not so much. At least not after today. GMCR fell 10.4% on volume that was more than five times the daily average after hedge fund manager David Einhorn criticized the company's disclosure methods and said the most recent quarterly numbers posted by Green Mountain were ''too good to be true.” The company has a ''litany of accounting questions,'' Einhorn said, according to Bloomberg News.

After news broke last year that GMCR was facing an SEC inquiry, accounting issues would probably be the last headlines investors in this stock would want to see. Einhorn added the GMCR has looming patent issue with its K-cups that must be dealt with. In other words, not a good day to be long GMCR.

Green Mountain Chart

Looking at the charts, the S&P 500 had put in a voracious rally over the previous nine days leading up to Monday, so a decline may have been order, but it probably was not a decline of this magnitude. With Monday's big drop, the S&P 500 closed right at support at 1200. From there, next support is 1190. We are back to eying resistance at 1220-1230 now.

S&P 500 Chart

If 11,500 on the Dow was supposed to be support, it did not hold up today. Below 11,400, 11,250 is back in play. IBM's Q3 numbers after the bell have the highest-priced Dow stock trading down by almost 4% in the after-hours session, so we might headed for a lower open for the blue-chip index. Four Dow stocks (BAC, JNJ, KO and INTC) report earnings on Tuesday.

Dow Chart

Even with a drop of nearly 2%, the Nasdaq was able to keep its ahead above water with water being 2600. Tuesday will be a key day for the Nasdaq as investors digest IBM earnings, which is not going well at this point, and Intel and Apple (AAPL) report. Next resistance is 2700 and a drop below 2600 could result in a run down to 2475-2500.

Nasdaq Chart

As I just mentioned, stocks may have been due for a pullback after an almost 14% jump in less than 10 days, but Monday was particularly ugly. The worst part about Monday's declines is not the magnitude. It is the ominous reminder that decent to very good stock-specific news, whether be earnings, M&A, etc., continues to be trumped by macroeconomic fears. As long as that remains the case, it will be hard for riskier assets to log any meaningful gains over longer time horizons.

Todd Shriber


New Option Plays

Key Levels to Watch

by James Brown

Click here to email James Brown

Editor's Note:

The flood of Q3 earnings headlines has begun but the focus was on Europe. Cautious comments from a German official that a comprehensive plan to save the Eurozone by this coming weekend was unlikely helped spark some long overdue profit taking in equity markets. The major U.S. indices gave up -2%.

Overall earnings news was mixed but there were a couple of big headliners. Wells Fargo (WFC) disappointed today. IBM reported after the closing bell and while it beat on the bottom line the top line was weak. Shares of IBM are trading lower after hours and could lead the tech sector lower tomorrow.

The S&P 500 index closed at support near 1200 today. The next level of support is 1180. However, a normal 38.2% Fibonacci retracement of the October bounce would mean a dip back toward the 1170-1165 area. Nimble traders could buy a dip or a bounce in the S&P 500 ETF (symbol: SPY) at these key levels.

No new trades tonight. We do think a buy-the-dip strategy can work but after IBM's news tonight I suspect the dip isn't over yet. Speaking of buying the dip, a dip near $175 or the 50-dma in IBM might be a short-term bullish entry point.

- James


In Play Updates and Reviews

IBM Disappoints

by James Brown

Click here to email James Brown

Editor's Note:

Tech giant IBM disappointed investors with their earnings report tonight. The headline EPS number was better than expected but revenues were a miss on falling sales growth. The tech sector could gap open lower tomorrow morning.

Another surprise after the closing bell was an earnings warning from IM. Shares of IM are also poised to gap open lower.

We have removed IBM and IM as potential trades. Our SPW trade is on hold, no entry point for tomorrow.

If you have bullish positions open I would double check your stop loss placement. Odds are the market could see a sharp spike down at the open. You might want to raise your stop to protect profits or limit risk.

-James

Current Portfolio:


CALL Play Updates

Alexion Pharma - ALXN - close: 66.21 change: -0.59

Stop Loss: 64.90
Target(s): 74.00
Current Option Gain/Loss: -39.0%
Time Frame: exit on Wednesday 10/19 at the close
New Positions: see below

Comments:
10/17 update: ALXN held up pretty well today. Shares lost -0.8% versus -1.9% in the NASDAQ. We are running out of time though. The plan is to exit on Wednesday at the close to avoid holding over earnings on Thursday morning. I am not suggesting new positions at this time.

(Small Positions) - Suggested Positions -

Long NOV $70 call (ALXN1119K70) Entry $3.20

10/15 adjusted time frame. plan to exit on Wednesday
10/14 trade opened

Entry on October 14 at $68.08
Earnings Date 10/20/11 (confirmed)
Average Daily Volume = 1.9 million
Listed on October 13, 2011


Bed Bath & Beyond Inc. - BBBY - close: 60.25 change: -0.28

Stop Loss: 58.90
Target(s): 64.75
Current Option Gain/Loss: -20.0%
Time Frame: 2 to 4 weeks
New Positions: see below

Comments:
10/17 update: BBBY is providing a dip toward short-term support at $60.00 today. I would be tempted to buy calls right here but I'm concerned the market will drop tomorrow on disappointing earnings news (not from BBBY). If we see BBBY bounce near $60 or open positive then I would go ahead and buy calls.

*Small Positions*- Suggested Positions -

Long NOV $62.50 call (BBBY1119K62.5) Entry $1.50

Entry on October 14 at $61.00
Earnings Date 12/21/11 (unconfirmed)
Average Daily Volume = 3.4 million
Listed on October 12, 2011


Hewlett Packard - HPQ - close: 24.86 change: -1.25

Stop Loss: 24.45
Target(s): 29.50
Current Option Gain/Loss: +35.9%
Time Frame: 8 to 12 weeks
New Positions: see below

Comments:
10/17 update: Uh-oh! HPQ was an underperformer today. Shares dropped -4.7% and closed under what should have been support near $25.00. The reason is concern over flooding in Thailand, which will impact production of hard-disk drives by Western Digital (WDC), who is a major supplier to HPQ. WDC closed down -7.3%. On top of this investors are disappointed with IBM's results out tonight. This will put pressure on all the major tech stocks. Shares of HPQ could gap open lower tomorrow morning. There is a good chance that HPQ will hit our stop loss at $24.45 tomorrow. I am not suggesting new positions at this time.

- Suggested Positions -

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

10/17 HPQ could gap open lower tomorrow on IBM's earnings news
10/15 new stop loss @ 24.45
10/11 new stop loss @ 22.90
10/11 planned to sell half at the open
bid 2012 Jan. $24 call @ $3.60 (+68.2%)
10/10 Take some $$ off the table. Sell 1/2 at the open tomorrow
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


SPX Corp. - SPW - close: 50.71 change: -2.25

Stop Loss: 49.90
Target(s): 57.75
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
10/17 update: Our trade on SPW is not open yet. Both the stock and the S&P 500 index opened lower this morning. Shares of SPW underperformed with a -4.2% drop and a close under its 50-dma. The $50.00 level could be support but I'm not betting on it tonight. We will temporarily put our entry point strategy on hold as we wait to see how the market reacts to earnings news tomorrow (from IBM tonight and GS tomorrow morning).

Nimble traders may want to look for a dip near $48 or $47 as a potential entry point.

Repeat: No Entry Point for Tomorrow.

*See Entry Details Above* (Small Positions)

10/17 Trade not open. Remove entry point for 24 hours, then re-evaluate.

Entry on October xx at $ xx.xx
Earnings Date 11/02/11 (unconfirmed)
Average Daily Volume = 701 thousand
Listed on October 15, 2011


PUT Play Updates

Edwards Lifesciences - EW - close: 68.53 change: -3.47

Stop Loss: 72.30
Target(s): 66.00
Current Option Gain/Loss: +17.0%
Time Frame: exit prior to earnings on Oct. 19th
New Positions: see below

Comments:
10/17 update: It was a good day for bears. Shares of EW underperformed the market with a -4.8% drop and a close at its lows for the session. That's a good sign for tomorrow. Remember, we plan to exit on October 19th at the closing bell, assuming shares do not hit our target at $66.00 first.

New stop loss at $72.30.

- Suggested Positions -

Long NOV $65 PUT (EW1119W65) Entry $2.05

10/17 new stop loss @ 72.30
10/15 plan to exit before earnings on Oct. 19th.
10/13 EW gapped open lower at $70.29

Entry on October 13 at $70.29
Earnings Date 10/19/11 (confirmed)
Average Daily Volume = 1.3 million
Listed on October 12, 2011


Goldman Sachs - GS - close: 96.90 change: +0.17

Stop Loss: n/a
Target(s): TBD
Current Option Gain/Loss: +0.0%
Time Frame: less than 5 days
New Positions: see below

Comments:
10/17 update: GS managed to buck the market's downtrend today. Investors were not interested in selling or buying as they waited for results from GS' earnings report tomorrow morning. It was our plan to open bearish positions at the closing bell. GS will most likely gap open several points higher or lower as traders react to the earnings news tomorrow. More conservative traders will want to consider exiting early on the opening spike.

I will set our initial exit target at $86.00 and we'll readjust it tomorrow. No new positions at this time.

*Buy Puts at the CLOSE on Monday*

- Suggested Positions -

Long OCT $95 PUT (GS1122V95) Entry $2.30

- or -

Long OCT $90 PUT (GS1122V90) Entry $0.94

Entry on October 17 at $96.90
Earnings Date 10/18/11 (confirmed)
Average Daily Volume = 7.9 million
Listed on October 15, 2011


CLOSED BULLISH PLAYS

Ingram Micro - IM - close: 18.72 change: -0.38

Stop Loss: 18.25
Target(s): 21.00
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
10/17 update: Look out below! IM was not due to report earnings until October 27th. Yet the company released an earnings warning after the closing bell tonight. Earnings per share will be significantly below what Wall Street was looking for thanks to soft demand in the quarter. Shares of IM are trading under $17 in after hours markets.

I am removing IM as a candidate. Our trigger to open positions was not hit.

Trigger @ $19.25 (small positions!)

Trade Was Not OPEN.

10/17 IM issues earnings warning after the closing bell

chart:

Entry on October xx at $ xx.xx
Earnings Date 10/27/11 (unconfirmed)
Average Daily Volume = 1.6 million
Listed on October 13, 2011


CLOSED BEARISH PLAYS

Intl. Business Machines - IBM - close: 186.59 change: -3.94

Stop Loss: n/a
Target(s): TBD
Current Option Gain/Loss: Unopened
Time Frame: less than 5 days
New Positions: Yes, see below

Comments:
10/17 update: Our speculative trade on IBM will not be triggered tomorrow. Our plan was to buy puts on IBM if shares hit $199.50 on a post-earnings spike tomorrow. Unfortunately the stock delivered a disappointing earnings report tonight and shares are trading down near $179.50 in after hours.

I am removing IBM as a candidate.

Trade will not be opened.

Chart:

Entry on October xx at $ xx.xx
Earnings Date 10/17/11 (confirmed)
Average Daily Volume = 6.6 million
Listed on October 15, 2011