Option Investor
Newsletter

Daily Newsletter, Monday, 10/24/2011

Table of Contents

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

Market Wrap

Merger Monday, Earnings, Europe Ignite The Rally

by Todd Shriber

Click here to email Todd Shriber
Having one catalyst to move the market higher is always helpful. Two is even. And three, well that is just icing on the sundae. That is exactly what Mr. Market had working in his favor today as a slew of mergers and acquisitions news, some decent earnings reports and news that was viewed as positive out of Europe helped send the S&P 500 to a gain of 1.3%. The Dow Jones Industrial Average notched another triple-digit gain while the Nasdaq soared almost 2.1%.

Market Stats

In a clear sign that the risk on trade is on, at least for now, West Texas Intermediate Crude futures jumped 4.4% to their highest closing price in three months. In fact, it is more expensive to buy oil now than it is to buy longer-dated contracts, the condition known as ''backwardation.'' Some decent economic data points out of China and Japan, the world's second- and third-largest oil consumers behind the U.S., buoyed crude's fortunes today.

For those that prefer to play the oil patch with equities, the earnings slate this week is littered with oil companies as XOM, CVX, COP and OXY, the four largest U.S. oil companies, all deliver third-quarter results. Those numbers probably will not be great because of the week macroeconomic environment and that is expected at this point, so Wall Street might be looking more at production and new project outlooks for the current quarter and 2012.

Oil Chart

In a day chock full of mergers and acquisitions news, one of the headline deals came courtesy of the health insurance sector where Cigna (CI) said it will acquire rival HealthSpring (HS) for $3.8 billion in an effort to gain more exposure to the rapidly growing Medicare Advantage market. News of the deal sent HealthSpring soaring by 33.7% on volume that was nearly 26 times the daily average.

Tennessee-based HealthSpring has about 340,000 Medicare Advantage customers in 11 states and a Medicare prescription drug business with more than 800,000 customers, according to the Associated Press. Cigna has less than 50,000 Medicare Advantage customers and that might be the motivation behind the 37% premium Cigna is paying for HealthSpring. Connecticut-based Cigna raised its 2011 profit forecast to $5.05 -$5.30 a share from $4.95-$5.25. Analysts were expecting $5.29 a share. Cigna's estimate excludes any estimate from the HealthSpring transaction.

HealthSpring Chart

Enterprise software giant Oracle (ORCL) is acquiring closely held Endeca Technologies in a deal that was inked last week though disclosed today. While Oracle did not disclose how much it paid for Massachusetts-based Endeca, the Boston Globe reported the price tag could be close to $1.08 billion. Endeca counts Bessemer Venture Partners, Venrock, Intel (INTC) and SAP Ventures among its backers, according to the San Jose Business Journal.

As anyone that follows the tech sector knows, Oracle is one of the most acquisitive companies around. Sometimes, there will even be news of multiple Oracle deals in the same day as was the case today. Looking to boost its exposure to the booming cloud-computing space, Oracle said it will buy RightNow Technologies (RNOW) for $1.5 billion. The news sent shares of RightNow up 19.4% on volume that was roughly 32 times the daily average.

Oracle may be getting RigthtNow on the cheap. As the Financial Times reported, after recent $85 million funding round, folks close to RightNow valued the company at $2 billion. Montana-based RightNow was profitable in the second quarter and the deal means Oracle can butt heads even more with rival Salesforce.com (CRM).

RightNow Chart

Of course, no Merger Monday would be truly complete without a juicy rumor to get the market buzzing. This one is familiar target with a different potential suitor this time around. The Wall Street Journal reported over the weekend Google (GOOG) has held talks with unidentified private firms about procuring financing to acquire downtrodden rival Yahoo (YHOO). The news sent Yahoo shares up by 3.7%. For several years now, Yahoo has been the subject of takeover speculation with Microsoft usually being the company viewed as the most likely suitor.

Google has deep pockets of its own and a penchant for overpaying on acquisitions. Remember the premium on Motorola Mobility (MMI)? Obviously, neither Google nor Yahoo commented on the rumor. It should be noted that to this point, only China's Alibaba, in which Yahoo owns a stake, has publicly expressed its interest in Yahoo. Private equity firms KKR, Blackstone and Silver Lake have been mentioned as possible Yahoo suitors in various press reports though no confirmation has been made public.

Before getting too excited about Google acquiring Yahoo, keep this in mind: Google has often had rocky relationships with governments, be they in Beijing or Washington, D.C. I found it doubtful the Justice Department will just let Google acquire Yahoo without making some stern anti-competition inquiries.

Yahoo Chart

In earnings news and in another positive sign for the risk on crowd, Dow component Caterpillar (CAT), the world's largest maker of construction and mining equipment, jumped 5% on volume that was 33% above average after the company posted a 44% surge in third-quarter profits. Illinois-based Caterpillar earned $1.14 billion, or $1.71 per share, compared with $792 million, or $1.22 per share, a year earlier.

Well, that is the previous quarter and what is done is done. Caterpillar's guidance was excellent. The company forecast full-year revenue of $58 billion up from a previous forecast of $56 billion to $58 billion. Caterpillar expects a profit of $6.75 a share, up from previous guidance of $6.25-$6.75. Factor in the benefit of acquiring Bucyrus and Caterpillar expects to earn $7.25 a share this year.

CAT Chart

Not everyone can deliver earnings reports like that. Netflix (NFLX) used to be able to, but this company has really lost its way. The company reported third-quarter results after the bell, but what is really important here is not the previous quarters profit or revenue. What is important is the loss of 810,000 subscribers between the second and third quarters and total U.S. subscribers of 23.79 million at the end of the third quarter, that is below the expected 24 million.

Making matters worse, Netflix forecast a fourth-quarter profit of 36-70 cents a share on revenue of $841-$875 million. Analysts were expecting $1.08 a share on revenue of $920 million. Customer cancellations rose to 6.3% in third quarter from 4.8% in the second quarter. And all this explains why Netflix shares are down almost 28% in the after-hours session, flirting with $87. The stock has not traded below $90 since April 2010.

Netflix Chart

In other after-hours news, Texas Instruments (TXN), the second-largest U.S. semiconductor maker, delivered decent third-quarter results, but the shares were trading lower after TI forecast fourth-quarter revenue of $3.26 billion to $3.54 billion. That is below the estimate of several analysts. The consensus view is for revenue of $3.43 billion, but at least one analyst was expecting $3.57 billion.

Texas Instruments Chart

Looking at the charts, the S&P 500 took out resistance at 1225 on Friday, reclaiming its 100-day moving average in the process. The index's bullish ways continued to today as the S&P 500 closed just 21 points below its 200-day moving average, which is likely the next critical resistance area. From there, round number resistance at 1300 looms, but there is pretty clear sailing back to the 1340-1350 area.

S&P 500 Chart

The Dow's chart is showing similar breakout characteristics to the S&P 500 and on an intraday basis, the blue-chip index was able to jump over resistance at 11, 925, but finished just below that mark. Earnings reports from DD and MMM on Tuesday could help the Dow not only clear that resistance, but maybe also get back to its 200-day line at 11,965. After Tuesday, five more Dow components deliver third-quarter results this week.

Dow Chart

The Nasdaq blew past resistance at 2665 today to trade just over resistance at 2700 for a little while before closing at 2699. Maybe the Nasdaq is due for a breather and NFLX and TXN, even though it is not a Nasdaq stock, provide ideal excuses. The other side of the coin is NFLX has been in the tank for a while now and Amazon (AMZN) reports tomorrow after the close and those headlines are far more important to the Nasdaq's near-term fortunes than NFLX.

Nasdaq Chart

As I mentioned earlier, the market benefited from having three positive catalysts on Monday and it is rare that we get a troika of good news on the same day. Oddly enough, there was not really anything substantive to emerge out of Europe over the weekend, but riskier assets reacted positively anyway. European policymakers meet again on Wednesday and if nothing bad comes of that meeting, it will be another excuse to rally. Imagine if they really made progress on the sovereign debt issue? I think we would love to see how stocks would react to that news.

Todd Shriber


New Option Plays

Retail & China

by James Brown

Click here to email James Brown


NEW DIRECTIONAL CALL PLAYS

Abercrombie & Fitch - ANF - close: 73.00 change: +3.34

Stop Loss: 67.90
Target(s): 77.25
Current Option Gain/Loss: Unopened
Time Frame: 2 to 3 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
Many of the retail names were showing strength today. ANF broke out from a two-week consolidation and resistance near $72.00. Today's move looks like a new entry point for a run at the 52-week highs near $77.50.

I am labeling this as an aggressive trade. ANF can be a volatile stock and we have a wide stop loss. I would launch small bullish positions tomorrow but only if both ANF and the S&P 500 index both open positive. Please note we do not want to hold over the mid November earnings report. Our exit target is $77.25.

FYI: Traders will want to take note of the fact that the most recent data listed short interest at 8% of the 85.8 million share float. Plus, the Point & Figure chart for ANF is bullish with a $98 target.

*See Entry Point Details Above*

- Suggested Positions -

buy the NOV $75 call (ANF1119K75) current ask $2.84

Annotated Chart:

Entry on October xx at $ xx.xx
Earnings Date 11/16/11 (unconfirmed)
Average Daily Volume = 2.1 million
Listed on October 24, 2011


iShares China 25 index ETF - FXI - close: 35.28 change: +1.82

Stop Loss: 32.95
Target(s): 39.50
Current Option Gain/Loss: Unopened
Time Frame: 3 to 6 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
One of the big (and positive) headlines today was a bullish reading on the early (Flash) PMI data in China. Readings over 50 normally indicate expansion and growth and this reading came in positive last night at 51.1, ending a three-month losing streak. Shares of the FXI gapped open higher and surged to a +5.4% gain and broke through resistance at the 50-dma and the $35.00 level.

Normally, I would avoid chasing a move this big but Chinese stocks have been very oversold for months. Granted the big bounce from the October lows means they are less oversold now but there is still room to move higher. Looking at the FXI it appears to have been forming a bull-flag pattern and today's move is a breakout.

I am suggesting bullish positions now but only if both the FXI and the S&P 500 index both open positive tomorrow. More nimble traders may want to wait for a dip back toward the $34-33 area before considering new bullish positions. Our multi-week target is $39.50.

If the FXI can trade over $36.00 it would reverse its Point & Figure chart into a new buy signal.

FYI: The top five components in the FXI are China Mobil, China Construction Bank, Industry and Commercial Bank of China, CNOOC (oil company), and PetroChina Co (another oil company). You view percentage of the ETF here:
http://us.ishares.com/product_info/fund/overview/FXI.htm

*See Entry Point Details Above*

- Suggested Positions -

buy the NOV $35 call (FXI1119K35) current ask $1.57

Annotated Chart:

Entry on October xx at $ xx.xx
Earnings Date --/--/--
Average Daily Volume = 30 million
Listed on October 24, 2011



In Play Updates and Reviews

Market Rallies into a New Week

by James Brown

Click here to email James Brown

Editor's Note:

The U.S. stock market surged on Monday with widespread gains. The NASDAQ delivered a strong +2.3% gain but the small cap Russell 2000 rallied +3.3%.

Most of our trades look good except for COST, which underperformed the market today. Our COST trade is not open yet.

-James

Current Portfolio:


CALL Play Updates

Bed Bath & Beyond Inc. - BBBY - close: 62.23 change: +0.42

Stop Loss: 58.90
Target(s): 64.75
Current Option Gain/Loss: +10.6%
Time Frame: 2 to 4 weeks
New Positions: see below

Comments:
10/24 update: Hmm... BBBY underperformed the market on Monday with a +0.6% gain versus +1.2% in the S&P 500. The stock spent the session hovering sideways above $62.00. The overall trend still looks bullish but today makes me a little cautious.

*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


Costco Wholesale - COST - close: 84.48 change: -0.82

Stop Loss: 83.75
Target(s): 97.50
Current Option Gain/Loss: Unopened
Time Frame: 4 to 8 weeks
New Positions: Yes, see below

Comments:
10/24 update: COST did not participate in the market's widespread rally on Monday. That is worrisome. Shares merely consolidated sideways in the $84-85 zone. I don't see any changes from my weekend comments. Right now our plan is to buy calls at $86.50. Nimble traders may want to consider buying calls on a dip near $82.50-82.00 instead.

Earlier Comments:
If triggered we'll use a stop loss at $83.75. Our multi-week exit target is $97.50. Cautious traders will want to consider an exit near $90 or $94 instead. Keep positions small.

Trigger @ $86.50 (small positions)

- Suggested Positions -

buy the NOV $85 call (COST1119K85)

- or -

buy the 2012 Jan $90 call (COST1221A90)

Entry on October xx at $ xx.xx
Earnings Date 12/07/11 (unconfirmed)
Average Daily Volume = 2.9 million
Listed on October 22, 2011


Goldman Sachs - GS - close: 103.98 change: +1.89

Stop Loss: 97.95
Target(s): 114.00
Current Option Gain/Loss: - 3.8%
Time Frame: 4 to 6 weeks
New Positions: see below

Comments:
10/24 update: Our new trade on GS is open. The stock gapped higher at $102.65 and almost $105 intraday before setting with a +1.8% gain. I would still consider new positions now or you could wait for a breakout past resistance at $105.00 instead.

Earlier Comments:
We want to keep our position size small to limit our risk. Our target is $114.00. More conservative traders may want to exit near $110 instead.

(Small Positions) - Suggested Positions -

Long NOV $110 call (GS1119K110) Entry $1.84

Entry on October 24 at $102.65
Earnings Date 10/18/11 (confirmed)
Average Daily Volume = 8.2 million
Listed on October 22, 2011


iShares Transportation ETF - IYT - close: 87.68 change: +1.46

Stop Loss: 82.45
Target(s): 90.00
Current Option Gain/Loss: +39.5%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
10/24 update: The IYT continues to rally although shares of the transport ETF spent most of Monday churning sideways in the $87.50-88.00 zone. The close over its 100-dma and exponential 200-dma today is bullish.

Earlier Comments:
Readers will want to keep our position size small since the transports are short-term overbought given the huge bounce from its October lows.

(small positions)

- Suggested Positions -

Long NOV $87 call (IYT1119K87) Entry $2.15

10/22 new stop loss @ 82.45
10/21 Gap higher entry @ 85.33

Entry on October 21 at $85.33
Earnings Date --/--/--
Average Daily Volume = 662 thousand
Listed on October 18, 2011


Rockwell Automation - ROK - close: 68.40 change: +1.86

Stop Loss: 61.90
Target(s): 71.75
Current Option Gain/Loss: +36.3%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
10/24 update: Our new trade on ROK is open. The stock and the S&P 500 opened higher. Shares rallied to their 100-dma and closed up +2.79%. I would not chase it here. The $66-65 levels should be short-term support. FYI: We were fortunate the Nov. $70 call opened lower at $1.65.

Earlier Comments:
Let's keep our position size small. Our exit target is $71.75. FYI: The Point & Figure chart for ROK is bullish with a $91 target.

(Small Positions)- Suggested Positions -

Long NOV $70 call (ROK1119K70) Entry $1.65

Entry on October 24 at $66.62
Earnings Date 11/08/11 (confirmed)
Average Daily Volume = 1.7 million
Listed on October 22, 2011


SPX Corp. - SPW - close: 55.42 change: +2.63

Stop Loss: 51.75
Target(s): 57.75
Current Option Gain/Loss: +63.8%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
10/24 update: It was a big day for SPW. The stock finally broke through recent resistance in the $53-54 area and surged to a +4.9% gain today. I would not chase it here. If you're looking for an entry point consider waiting for a dip near $53.50ish.

NOTE: New stop loss at $51.75.

Earlier Comments:
This is an aggressive trade so we want to keep our position size small. FYI: The Point & Figure chart for SPW is bullish with a $78 target.

(Small Positions)- Suggested Positions -

Long NOV $55 call (SPW1119K55) Entry $1.80

10/24 new stop loss @ 51.75
10/20 trade opened at $51.80
10/19 Trade still not open. Try again.
10/18 New entry point on this bounce. See entry details above
10/17 Trade not open. Remove entry point for 24 hours, then re-evaluate.

Entry on October 20 at $51.80
Earnings Date 11/02/11 (confirmed)
Average Daily Volume = 701 thousand
Listed on October 15, 2011


PUT Play Updates

Currently we do not have any active put trades.


Market Neutral Play Updates

iShares Russell 2000 ETF - IWM - close: 73.42 change: +2.29

Stop Loss: n/a
Target(s): To Be Determined
Current Option Gain/Loss: + 3.9%
Time Frame: 3 to 4 weeks
New Positions: see below

Comments:
10/24 update: Small caps were big performers today. The IWM rallied +3.2%, outpacing its big cap peers. The IWM is nearing potential resistance at its late August highs in the $73.60-73.90 zone and its 100-dma and exponential 200-dma. Don't be surprised to see a little pull back.

We are not suggesting new positions at this time.

FYI: A strangle involves buying both an out of the money call (OTM call) and an out of the money put (OTM put). The expectation is that the underlying equity (IWM in this case) will move enough to make one side profitable and cover the entire position and then some.

- Strangle Position cost: 4.55 current value: 4.73 (+3.9%)

Out-of-the-Money Call option:
Long NOV $72 call (IWM1119K72) Entry $2.30, current bid $3.48

- and -

Out-of-the-Money Put option:
Long NOV $68 put (IWM1119W68) Entry $2.25, current bid $1.25

Entry on October 21 at $ xx.xx
Earnings Date --/--/--
Average Daily Volume = 89 million
Listed on October 20, 2011