Option Investor
Newsletter

Daily Newsletter, Wednesday, 8/1/2012

Table of Contents

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

Market Wrap

FOMC Drives Markets

by Thomas Hughes

Click here to email Thomas Hughes
As mentioned by my colleagues in previous wraps, today's market was driven by the FOMC. The economic data, which continues to show declines, was ignored in hopes of further policy easing and stimulus.



The weak data will help to increase the chances for policy easing in the future but most analysts, economists and traders agreed that the there would be little in the way easing with this meeting and they weren't wrong. The Fed left the rate unchanged and announced no new policy changes. They cited a number of negative and/or declining metrics in their statement and downgraded their view of the economy. The wording in the statement was changed from “expanding moderately” to “decellerated somewhat” in the first half of the year. What was surprising was a the lack of extension of their low-rate pledge, which should stand until 2014. The statement also said that additional action would be taken if it was deemed necessary. This is almost exactly what Bernanke has said before in statements to congress and the press.

The decision by the FOMC to hold off on further stimulus could turn out to be very wise. There are expectations for the global economy to turn up in the second of half of this year already, without stimulus. Several estimates, including one from Kiplinger's and one from the Conference Board, have second half GDP growth accelerating to near 2%. If that is the case, then the upturn is happening now, without the easing and perhaps we should wait and see how it unfolds.

The day started as the futures markets considered the overnight data out of Asia. Basically, it was set aside in favor of the FOMC meeting. However, it should not be ignored. The China official PMI came in lower than the expected 50.3 at 50.1. This gauge is still showing expansion, but just barely. India also reported that its manufacturing sector had reached a new 9 month low. South Korean manufacturing is also declining and their exports have reached a 3 year low, dropping 8.8% this month. Some economist are speculating that the Asian manufacturing sector will be rebounding in the current quarter but so far there is no evidence of this.

Asian markets traded near the flat line today. Internationally, eyes are on the FOMC and the ECB to determine economic and market direction. The Hang Seng gained 0.12%, the Nikkei lost -0.61% and the Shang Hai index added 0.94%.

The ADP employment data came in much weaker than expected. The estimates were for a gain in employment much larger than what was delivered. ADP reported that its gauge of non-farm private pay rolls increased by 163,000 in July, below the consensus estimate. Analysts had been predicting a much larger gain of 179,000 just last week. ADP also revised its June number down to 172,000 from 176,000.

The US non-farm payroll data is due out at the end of the week and is not expected to be much better than the ADP report. US non-farm payrolls are only expected to grow by about 80,000, much weaker than the economy needs. Within today's ADP number the services sector led with a gain of 148,000 new jobs. Construction employment also picked up for the second month adding 5,000 new jobs. The report cited that this was the 30th month of employment gains and the job market had picked up since the spring downturn. Overall, total unemployment remains at high levels and has made at least a short term bottom from its downtrend earlier this year.



Mortgage Applications rose last week. The gains were made on demand for refinancing of current loans. The number of applications for new home purchases fell, not a good sign for the struggling home market.

The ISM gauge of manufacturing fell to 49.8. Below the median 50 mark, showing a slight contraction in the sector. Analysts had been expecting the number to remain above 50 at 50.4.

Europe was quiet today, awaiting action from the ECB. The ECB meeting tomorrow comes with the same expectations as today's FOMC meeting, a dovish outlook and the possibility of stimulus to come soon. The FOMC made no hints of what or when future stimulus would be, perhaps the ECB will be a little more forthcoming. Today the European markets traded mixed, the FTSE 100 gained 1.38% followed by the Xetra Dax and the Spanish Ibex index at -0.27%.

Earnings are still rolling in, and like the economic data, were mostly ignored in favor of the FOMC and ECB meetings. Time Warner reported lower revenue this quarter but the stock gained over 1% in early trading anyway. The media giant reported a 33% drop in net earnings based on weak magazine sales and CNN's poor ratings. The earnings of $0.44 per share beat the estimates and that is why the stock is up. Time Warner also reported that ad sales were softening and that they expected the revenue from ads to remains flat over the current quarter. The stock traded up to a an all time high but has weak momentum and volume.

Time Warner, daily

Comcast also beat the street's estimates, posting $0.50 per share, vs the expected $0.47. Revenue for the quarter was up and in line with the expectations. The cable operator, like Time Warner, made some gains in internet and phone services but was held back by the operation of NBC. The stock is also trading near multi-year highs with weak momentum.

Comcast, daily

Green Mountain Coffee Roasters released their earnings after the bell. The company reported slowing sales growth and lowered its 2012 outlook for the second time this year. The stock was volatile in after hours trading, first dropping 6% then swinging back into positive territory. Green Mountain is being hit by weakening demand stemming from its k-cup delivery system emerging from patent protection.

Green Mountain Coffee Roasters, daily

Harley Davidson should be in hog heaven after increasing revenue by 14%. The huge gain, based on strong US sales, fell short of the consensus estimates. Harley says it will be impacted negatively in the future by currency exchange rates from over seas operations and slowing sales growth. The stock dropped significantly in early trading, losing more than 3% and falling below a support line.

Harley Davidson, daily

Avon opened lower today, trading on top of a long term support line, after announcing a 70% decline in earnings on a 9% drop in revenue. US sales were particularly weak and were blamed on a declining sales force. Avon also reported profit losses based on currency exchange and the strengthening dollar.

Avon, daily

Master Card increased its profit by 15% but revenue fell short of estimates. The credit provider reported that transactions and payments volume had both increased but total revenue fell short because of customer rebates. The company executives are “uncertain” about economic growth in the second half but see signs of strength in their business. The stock dropped below its short term moving average in early trading and failed to regain the level before close.

Master Card, daily

Owens Corning, maker of building materials, reported that its profit fell by nearly 50% in the quarter. The biggest declines in the business were seen in the Composites section, which accounts for about 1/3 of all business. The stock surged up from a support zone on the news but was held back by the 30 day moving average. Owens is being squeezed by long term support and a down trending moving average.

Owens Corning, daily

The price of oil traded up over 1% today but settled back toward the 0.8% range following the FOMC rate decision announcement and statement. The price was further supported by an unexpectedly large draw on oil supply. Oil gained $0.69, or .78%, at today's close.

Gold dropped sharply today ahead of the FOMC announcement, falling below $1600 for the first time in over two weeks. The price of all metals fell today following the string of weak economic reports from around the world. Silver and Copper both lost around 2% during the days trading.

The Gold Index fell today but was held up by its short term moving average. The index has now made a higher low and appears to be confirming long term support set in 2010. There is still downside risk in gold, if the economy begins to show signs of improving and the Fed does not need to act at the next meeting gold could resume it's fall.

The Gold Index,daily

Today's FOMC meeting was not the market mover that traders were anticipating. The week remains full, so be watchful, this week could still prove to be important for the equities markets. Tomorrow eyes will be on the ECB but there will also be important employment data that will need to be considered. Tomorrow Challenger reports its expected job cuts numbers and unemployment claims are on the list. The data continues on Friday with the US non-farm payrolls numbers.

Economic Calendar

Last week the S&P entered the resistance zone between 1380 and 1420 I have described in past recaps and has since eased lower in anticipation of today's announcement. Ahead of the release the S&P traded in a tight range, just over and under the bottom number of the range and the 78.8% retracement of the 2008 bear market. Immediately following the announcement the S&P turned negative but quickly recovered from the selling pressure. During the afternoon the major market flirted with yesterday's closing level but failed to regain positive territory.

S&P 500, one day

Today the S&P 500 closed beneath the resistance zone after trading in a very tight range. The MACD and stochastic indicators are both weak on the one day charts and divergent from the two month up trend. The FOMC decision did very little in the way of helping bullish momentum and I am expecting the same from the ECB decision. The employment numbers tomorrow and especially on Friday will likely have more impact on near term direction.

S&P 500, daily

The Vix made a higher low this week and moved above its short term moving average. The VIX is still in the calm zone, between 15 and 20 but heading up toward the top end of the range. While not alleviating current fears, the FOMC did not cause any new ones and that is what I expect tomorrow from the ECB as well.

VIX, daily

The Dow treaded water at the 13,000 mark today but fell to near 12975 just before closing. Now that the FOMC is out of the picture, at least for the next few weeks, earnings and the economy will take over again. There is currently no reason to expect an improvement in corporate earning in the next quarter and that is what will likely drive stock prices now.

Dow, daily

Keep on the lookout for signs of economic strength and beware of unexpected weakness. The ECB is likely to follow the lead of the FOMC and maintain its dovish stance while doing nothing at this time. The ECB is likely to move before the FOMC but when is still in question. The world's attention, the trading world's attention anyway, will be on Mario Draghi and what the ECB says it's going to do to spur the European economy.

Thomas Hughes


New Option Plays

Two Down, Two to Go

by Jim Brown

Click here to email Jim Brown
Two critical economic events are now behind us but there are still two critical events in our future.

Editor's Note:

The market held its recent gains and failed to self destruct after the Fed failed to announce any new stimulus programs. They did dangle a carrot saying they "are prepared to take further action" and some analysts believe that could be as early as next week if the ECB and Nonfarm Payrolls disappoint.

The ADP Employment report estimated there were +163,000 new jobs added to the economy in July. That compares to estimates for the Nonfarm Payroll report on Friday at +100,000.

I was impressed that the market did not sell off on the Fed news despite the widespread belief that the ECB will also disappoint on Thursday. For that reason I am adding a lon recommendation tonight. I want to keep a very slim portfolio until next week simply because there is no way to tell what the remaining headlines are going to do to the market.

James is on vacation this week.


NEW DIRECTIONAL CALL PLAYS

Mosaic - MOS - close: 57.97 change: -.14

Stop Loss: 57.50
Target(s): 67.00
Time Frame: 4-6 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
Mosaic is a fertilizer stock and its products are in high demand in normal growing seasons. This year we are experiencing a major drought that could impact crop yields dramatically and farmers are already plowing under corn fields and soybeans.

According to Citibank analyst PJ Juvekar the last two times in recent history when we had severe droughts (1983, 1988) the demand for fertilizer actually rose by +8% for phosphate and +2% for potash. Not being a farmer I can't tell you why but those are the facts.

Juvekar said Citi now prefers Mosaic to Potash (POT) over the next 12 months and sees a near term target of $66. MOS closed at $58 on Wednesday. The company has $3.8 billion in cash that could be used for share buybacks.

I have been watching MOS for a breakout to play it in another publication. There is strong resistance at $59.75 but I believe a positive market such as we might see from new ECB action will send buyers into Mosaic stock.

Shares have not declined since their earnings in mid July. Despite the bad market last week they held their gains. This underlying bullishness suggests a positive market could break through that resistance.

All the reasoning I have given above supports a longer term play than is normally suggested in these pages. However, I believe investors are looking at longer term fundamentals as they shop for stocks that can rebound in the next market move higher. Secondly I believe they will see the underlying strength in Mosaic as a position of safety in an unstable market. Mosaic just declared a 25 cent dividend and that attracts longer term buyers.

Trigger: Enter only with an MOS trade at $60.25

- Suggested Positions -

Position: Long Sept $62.50 Call (MOS1222I62.5), currently $1.62
Mosaic Chart

Entry on UNOPENED xx at $ xx.xx
Average Daily Volume = 3.0 million
Listed on Aug 1, 2012


NEW DIRECTIONAL PUT PLAYS

No new bearish plays today


In Play Updates and Reviews

Confused?

by Jim Brown

Click here to email Jim Brown
The Fed did exactly as I expected with no new stimulus but the market held its gains.

Editor's Note:

The Fed pulled the switcheroo in their statements to increase expectations for future stimulus.

In the June statement the Fed said:

The Committee will closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.

In today's statement they said:

The Committee is prepared to take further action as appropriate to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.

While those statements may look the same they took out the "closely monitor" statement and changed the text to "committee is prepared" to take further action.

For the average person that context change would be meaningless. For analysts that make a living deciphering Fed statements they believe the Fed is preparing to take immediate action, possibly as soon as Friday.

I know, that sounds like a stretch of the imagination but look at it this way. The ECB "may" pull out the big guns when they meet on Thursday. The Fed did not want to waste one of its remaining bullets if the ECB is about to use a cannon. Secondly, if the Nonfarm Payroll report on Friday shows a strong uptick in jobs then the Fed would have acted too soon and wasted that bullet.

By waiting until Friday, or more likely Monday, they get to see the ECB moves and market reaction. They also get to see the payroll report and market reaction. Then they can deliberate over the weekend, decide if action is needed and announce something on Monday when it is unexpected by most traders.

Obviously this is just analyst speculation but it was enough to keep the market from selling off after the announcement today.

I updated the stop losses on three plays and highlighted the new stops in yellow in the portfolio graphic.

Current Portfolio:


CALL Play Updates

Health Care REIT - HCN - close: 61.67 change: -0.31

Stop Loss: 61.20 (new)
Target(s): 64.75
Time Frame: exit prior to the Aug 6th earnings
New Positions: see below

Comments:
08/01/12 update: The weak market translated into a minor decline on HCN and I am going to take that as a warning and raise the stop loss to $61.20. If the ECB disappoints and the markets begin an August decline that higher stop will take us out without much damage.

FYI: The Point & Figure chart for HCN is bullish with a $70 target.

- Suggested Positions -

Long Aug $60 call (HCN1218H60) entry $1.55

Entry on July 24 at $61.15
Earnings Date 08/06/12 (confirmed)
Average Daily Volume = 1.5 million
Listed on July 23, 2012


Hess Corp. - HES - close: 47.81 change: +.64

Stop Loss: 45.35
Target(s): 49.85
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
08/01/12 update: Hess rose with crude prices as expected. We need to see a move over 48.50 to trigger new buying.

- Suggested Positions -

Long AUG $47.50 call (HES1218H47.5) Entry $1.05

- or -

Long SEP $47.50 call (HES1222I47.5) Entry $2.02

07/26/12 triggered on gap open higher at $46.65

Entry on July 26 at $46.65
Earnings Date 07/25/12
Average Daily Volume = 4.3 million
Listed on July 25, 2012


PUT Play Updates

United Rentals, Inc. - URI - close: 27.77 change: -1.13

Stop Loss: 30.55 (new)
Target(s): 23.00
Time Frame: 3 to 6 weeks
New Positions: Yes, see below

Company Description
Comments:
08/01/12 update: We got a nice decline today as that initial support at 28.85 broke. The next challenge will be support at $27.00.

I lowered the stop loss to $30.55 and just over prior resistance.

FYI: The Point & Figure chart for URI is bearish with a long-term $17 target.

Trigger: None

Positions

Long Sep $26 PUT (URI1222U26) @ $1.25

Entry on July 30 at $ 29.70
Earnings Date 07/17/12
Average Daily Volume = 4.4 million
Listed on July 26, 2012


iShares Russell 2000 ETF - IWM - close: 78.41 change: -0.70

Stop Loss: 79.50 (new)
Target(s): 75.75
Time Frame: 2-4 weeks
New Positions: Yes, see below

Company Description
Comments:
08/01/12 update: Excellent decline as the IWM went into free fall at the close. If the ECB disappoints we could see our $75 target very quickly. Our put is now in the money.

The target is a decline to the June support at $75.

Trigger: IWM at $78.85, hit at 11:40 AM on July 39th

Positions

Long Oct $78 PUT (IWM1220V78) @ $3.26, Stop $81.25 on IWM

Entry on July 30 at $ 78.85
Average Daily Volume = 60.0 million
Listed on July 28, 2012


Akamai Technologies - AKAM - close: 35.14 change: -.05

Stop Loss: 36.75
Target(s): 32.00
Time Frame: 2-4 weeks
New Positions: Yes, see below

Company Description
Comments:
08/01/12 update: Akamai has not yet been opened. The entry trigger is a trade at $34.85. AKAM closed within 29 cents of that trigger so we are poised perfectly for a down market.

Why We Like It:
Akamai reported earnings of 43 cents last week that beat the street and raised guidance. The stock soared +25% on the news. That was on Thursday. Friday's market short squeeze failed to add any material gains to that spike BUT Monday's lackluster market also failed to produce a material decline in AKAM.

After a 25% spike well above the consolidation range of the last three months you would expect the spike to fade and profit taking appear. The raised guidance is probably what is holding shares up. However, if the Nasdaq begins to roll over on less than expected help from the ECB/Fed then profit taking could begin with a vengeance.

This is a high risk play. If we do get a dip to trigger our put entry and the market turns around the dip in AKAM could be seen as a buying opportunity.

I am looking for AKAM to retrace about half of its gains from last week if profit taking appears.

I am recommending we buy the Sept $34 put in anticipation of a possible decline to the June support at $32.

Trigger: Enter only with an AKAM trade at $34.85

- Suggested Positions -

Position: Long Sept $34 PUT (AKAM1222U34), currently $1.19

Entry on UNOPENED xx at $ xx.xx
Average Daily Volume = 3.3 million
Listed on July 30, 2012


CLOSED BULLISH PLAYS

No Closed Calls


CLOSED BEARISH PLAYS

No closed puts