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Daily Newsletter, Saturday, 8/27/2016

Table of Contents

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

Market Wrap

Good Dove, Bad Hawk

by Jim Brown

Click here to email Jim Brown

Janet Yellen and Stanley Fischer played good cop, bad cop on Friday but it translated into good dove and bad hawk.

Weekly Statistics

Friday Statistics

Janet Yellen caved in to the pressure and spoke about the chance for a rate hike in 2016 but there were so many qualifiers that nobody believed her. The market rallied on the seemingly dovish comments. The most hawkish comment Yellen made was "In light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months." That is hardly a warning to prepare for a September to remember. Stocks rallied after she qualified that with several more sentences about data dependent conditions would have to be met. The lack of specificity on a timetable suggested a hike would happen later rather than sooner.

Two hours later Vice Chairman Stanley Fischer warned that September was not only a live meeting but potentially the first of two hikes over the next four months. When Fischer was asked in a live interview if the market should prepare for a rate hike in September and maybe again in December, he replied "Yes, if the data cooperates." He warned that the country was at full employment and a strong jobs report next Friday would have to be taken into account at the September meeting. He also tried to correct the lack of focus in Yellen's comments saying, "Her comments were consistent with a September hike and possibly two hikes this year, but the Fed will not know the course of policy until it sees the data." He warned that inflation was nearing the Fed's 2% target and the Fed should be preemptive rather than reactive meaning it should hike in advance rather than waiting for all conditions to be fulfilled before acting.

Fischer's demeanor was compared to somebody that wanted to make sure there was at least one hike in 2016 so he was trying to ratchet up expectations for two just to guarantee at least one hike. If you constantly prepare everyone for two hikes then only one hike becomes the middle ground where everyone can agree.

The Dow spiked +122 points to 18,572 on Yellen's comments, fell -237 to 18,335 on Fischer's comments and then rebounded +63 points into the close. Volatility returned for several hours on Friday.


St Louis Fed President James Bullard said Friday he favors raising rates in September and then doing nothing for the next two years. Bullard recently converted to a dovish stance and is now the most dovish of all the voting members. He believes the economy is strong enough to move rates away from nearly zero but is not expected to be strong enough for further hikes for a long time. He pointed to the anemic GDP growth projected to be only 2% through 2018 as a reason the Fed should not move aggressively. He believes bad rate guidance has hurt the Fed's credibility.

Atlanta Fed President Dennis Lockhart said "I can see two rate hikes as possible with three more Fed meetings in 2016."

The chance of a September rate hike rose to 36% from the 18% chance I posted last weekend. The odds of a December hike jumped from 53% to 64% over the last week. Rate hikes are coming and the market is now pricing in at least one before the end of 2016.



The first revision of the Q2 GDP edged down slightly from 1.2% to 1.1% growth. That compares to 0.83% in Q1 and 0.87% in Q4. Needless to say the growth is very anemic and Yellen could easily wait until 2017 to hike rates because of the slow growth economy.

Consumption added 2.94% to the GDP while fixed investments removed -0.42%, inventories -1.26% and government -0.27%. Exports were the only other positive component with a 0.10% gain. Corporate profits declined -1.19%.

There are worries the current economic cycle is coming to an end. The current economic expansion has lasted 7 years and is the third longest ever. However, the Q3 outlook is still positive at 3.4% according to the latest Atlanta Fed real time GDPNow forecast. Using Stanley Fischer's preemptive model, September would be the right month to hike but what if the forecast was wrong? That is why Yellen's "wait for the data" stance is probably the one that will win.



The final revision in Consumer Sentiment for August declined minutely from 90.4 to 89.8. That is the lowest level since the 89.0 in April and the second lowest since the 87.2 last September. Sentiment is still fading from the 11-year high in January 2015 at 98.1 and the outlook is bearish. The present conditions component fell from 109 to 107 and the expectations component rose slightly from 77.8 to 78.7.

The next several months in an election year typically see a decline in consumer sentiment. In the period from July-Jan in 2012, the average was 75.3 with a low of 72.3 suggesting we have farther to fall. Politicians are telling consumers how bad things are and how they are going to fix it. Unfortunately, the promises never come true and consumers are left with the low outlook until the next spring.

On the positive side, the low mortgage rates and falling gasoline prices are helping to support sentiment.


We have a full calendar next week with the employment reports and the national ISM Manufacturing Index. Any of those events can move the market but the big one to watch is the Nonfarm Payrolls on Friday. The expectations are for a reading of 160,000 but there are whisper numbers at 180,000. Any number over 200,000 is almost a guarantee of a rate hike at the meeting on September 20th. That means the market will be very cautious on the lead up to Friday if the ADP report on Wednesday is strong. Currently the forecast is for a gain of +165,000 jobs.

The ISM Manufacturing Index is struggling to hold over 50 after a reading of 52.6 for July. The manufacturing sector has shown spotty results in the various regional reports with the Philly Fed Manufacturing survey barely posting a gain with +2.0 last week. The Richmond Fed Manufacturing Survey fell from +10 to -11 last Tuesday. Factory orders have been in negative territory for several months. This makes the ISM important for the Fed's rate hike outlook.


The Herbalife (HLF) war heated up again on Friday. Bill Ackman, who has a $1 billion short on HLF in his Pershing Square hedge fund, said he was contacted by Jefferies to see if he was interested in buying Carl Icahn's 17 million share stake. They contacted him in case he was interested in buying some shares to cover his existing short. The story made headlines all day with Ackman hyping the sale attempt saying Icahn was selling the shares because "Herbalife is toast" under the new marketing plan demanded by the government. Icahn was contacted during the day but had no comment. The story started with an article in the Wall Street Journal.

After the bell, Icahn announced he bought another 2.3 million shares. After being down as much as $4 intraday to $57, the stock rallied to trade over $64 in after hours. Icahn has permission from Herbalife to acquire up to 35% of the company. After Friday's acquisition, his stake has risen to 20.8%.

As the smoke cleared late in the day, Icahn said he never gave Jefferies permission to shop his position, worth more than $1 billion. Jefferies then said it never received a sell order from Icahn or anyone at his firm. Both of those claims could be "technically" correct but factually untrue. Icahn and Jefferies could have been testing the water after shares have declined for three weeks. If a willing buyer was found, Jefferies could have communicated the price back to Icahn and then a decision could have been made. Unloading $1 billion in stock in a questionable company would be a challenge. Icahn could not wake up one morning and just put in a sell order and have it executed. There are 93 million shares outstanding and Icahn now owns roughly 20 million. Average daily volume is 1.9 million. It would decimate the price to have 20% of the stock suddenly available for sale. Until Friday's purchase, Icahn's average price was in the $32 range. He may have a huge paper profit but until those shares are sold, there is no actual profit.

Several times over the last three weeks I tried to come up with a long-term put option trade that would work but the premiums were sky high and the bid/ask spreads too wide. Nearly everyone believes the long-term outlook under the new government mandated marketing plan, is going to mean a lot smaller profit and a very small sales force. The new plan says the majority of commissions must come from selling the product to retail customers rather than signing up new distributors. That is going to dramatically slow sales because the distributor workforce is going to evaporate.


Tesla (TSLA) won antitrust approval from the FTC to acquire SolarCity (SCTY). While nobody expected any objection, the early approval from the FTC means the waiting period has expired. Elon Musk will still have to receive approval from SolarCity shareholders. Those investors holding SCTY shares would receive 0.11 shares of Tesla per share of SCTY. Today that is worth $24.20 and Musk initially offered $26.50-$28.50 per share. Shares were trading over $27 when the final agreement was announced. Since Musk and his cousins are majority shareholders in SCTY and they have agreed not to vote their shares it will be interesting to see of the remaining shareholders actually vote for the take-under.



Shares of Pure Storage (PSTG) erased a 13% gain to close negative after reporting earnings. The company had a Q2 loss of 16 cents that was better than the 23-cent loss analysts expected. Revenue surged 93% to $163.2 million and beat estimates for $155.2 million. They guided for Q3 revenue in the range of $187-$195 million and analysts were expecting $191 million. Volume was 8 times normal and shares spiked to $13.50 at the open after a prior close at $11.82. Almost immediately, sellers appeared and shares fell back to $11 intraday and closed at $11.38. JMP Securities blamed it on the weakness in the storage sector. Nimble (NMBL) Storage did the same thing early in the week. This is related to the warnings from Seagate that demand from cloud companies is slowing.


I think the key here is the rapidly growing size of disk capacity. With 8 terabyte drives now common and 10 terabyte drives coming, it takes a lot fewer drives to hold the rapidly growing cloud data. Three years ago, a 2 terabyte drive was the new hot commodity.

Three years ago, a "high capacity" server had the capacity to hold 16 drives. SuperMicro (SMCI) recently announced a 90-drive server. The amount of data that one server can now hold is off the scale of human comprehension, at least for this human. A terabyte is 1,000 gigabytes or in round numbers 1 trillion bytes. Using the new 10 terabyte drives and the 90-drive server there would be more than 900 terabytes of data on one server. You lose some in the formatting process and some in your RAID configuration, but that is still a lot of data.

To put it into perspective, the Library of Congress claims to have about 600 terabytes of data in its files. Ancestry.com has 600 terabytes of data that contain all the census data on every individual from 1790 to 1930. Yahoo has about 100 terabytes in its historical website files since inception. Pictures are big but the Hubble Telescope has only collected 45 terabytes of pictures in its 20-year history. To backup one terabyte of data requires more than 220 DVDs.

The bottom line is that it takes far fewer drives today to hold much more data and storage companies have discovered the law of diminishing returns.

SuperMicro Servers

Ulta Salon (ULTA) finally stumbled. The company reported earnings of $1.43 compared to estimates for $1.39. Revenue was $1.07 billion compared to estimates for $1.06 billion. Same store sales rose 14.4% compared to 12.9% analysts expected. However, the retailer said it expected earnings of $1.25-$1.30 for Q3 and analysts were expecting $1.30. That one sentence caused the spectacular gains for the last six months to come to an end. This is definitely a buy the dip stock but wait until a rebound begins.


Autodesk (ADSK) reported a loss of 5 cents compared to estimates for 13 cents. Revenue of $550.7 million declined -10% but still beat estimates for $512 million. Autodesk is moving from a purchase model to a cloud subscription model and that always decreases revenue in the short term but increases it in the long term. Total subscriptions rose by 109,000 to 2.82 million.


This is the final week for stragglers reporting Q2 earnings. Palo Alto networks, Salesforce.com, Broadcom, Ciena, and Ambarella are the highlights for the week. There are still some retailers reporting with HAIN, ANF, DSW, FRED, GIII, ISLE, NCTY, CHS, FIVE, SCVL, BEBE, LE and LULU closing out the sector earnings.


More than 98% of the companies in the S&P already reported earnings for Q2 and the final results are available. Some 71% have beaten on earnings and 53% beat on revenue. Earnings declined -3.2% for the quarter making it the fifth consecutive quarterly decline. Revenue declined -0.2% and the sixth consecutive quarterly decline. For Q3, 77 companies have issued negative guidance and 33 have issued positive guidance.

Q3 earnings are expected to decline -2.2% and Q4 should see a +5.5% rebound in earnings growth. Revenue is expected to rise 2.2% in Q3 and 4.9% in Q4.

Apple CEO Tim Cook vested in his five-year anniversary bonus and it was a whopper. On Friday, Cook converted 1.26 million restricted stock units to common shares worth $135 million. He sold 990,117 shares to net $35.8 million after taxes. Cook now owns 1.3 million Apple shares and 3.5 million unvested stock units. Shares declined slightly on Friday but it was likely market related rather than Cook's share sale.


Amazon (AMZN) said it was going to build three new brick and mortar book stores in Chicago, San Diego and Portland. The company already has a large store in Seattle that it used to prove the concept. Amazon has many square miles of merchandise in inventory and they view these stores as a showroom for their hot items we well as books. Devices including the Kindles, Fire TV and Echo sell well when people can touch them and learn about their features. Amazon can also use the stores as test centers to see how customers react to new devices or new features.

Amazon's electronic devices are the top sellers on their website but they are just scratching the surface in the consumer market. Multiple analysts were saying Amazon should have bought Best Buy a couple years ago to get a jump start on showrooming their own products nationwide.

Amazon also announced Amazon Vehicles, an online platform for users to research cars, auto parts and accessories. The platform will include specifications, images and reviews for a large number of car models. Users will be able to compare prices and features. Analysts believe this is a prelude to selling cars on Amazon at some point in the future.


Amazon claimed another victim on Friday. Rackspace (RAX) said it was going to be acquired by Apollo Global for $32 a share or $4.3 billion. Amazon and Rackspace were fierce competitors in the cloud space but in the end, you cannot compete and win against Amazon. Rackspace pioneered a cloud operating system called OpenStack. A company could install its own datacenter and then choose OpenStack cloud services to move files, apps and services around to multiple cloud locations. That means the company would never be locked into one location and maintained complete flexibility. The product was very successful but Amazon Web Services (AWS) continued to take customers away from Rackspace. Eventually Rackspace partnered with Microsoft to sell and support the Azure cloud. RAX even tried to partner with AWS and sell a higher priced version of AWS that included a strong customer service component. Amazon has a bad reputation for customer service for AWS. You are pretty much on your own once you contract for cloud space.

Rackspace finally raised the white flag and gave up competing with the 800-lb gorilla. It will be interesting to see what Apollo will do with the company since RAX has tried multiple product offerings and been crowded out by Amazon at every turn. Analysts believe Amazon will eventually push even Google to the sidelines. AWS has already won the market share war and now they are just picking up the stragglers as they increase that share.


Oil prices faded late in the week after the Saudi oil minister Al-Falih said an oil output freeze would be "positive" if it happened but ruled out a production cut. "We will be willing to listen to our colleagues, what they have to offer in that area. I do not believe an intervention of significance is required." These comments were seen as evidence Saudi Arabia may not be totally on board with the concept.

"There is the freeze that is official, and there is the freeze that is practical," Al-Falih said. "Today, when you think about it practically, many countries today are at their capacity. Their room for an increase are limited, certainly for the short or medium term."

I wrote about this last week. With most OPEC countries already at maximum production, announcing a freeze would just be putting a new name on maximum production. However, Libya is slowly coming back online as well as Nigeria and neither of those countries are going to agree to a production freeze at their current output levels. Iran and Iraq are also increasing production so their participation is questionable.

The rebound in prices stalled at $48.50 and once past Labor Day we should see inventories build faster and prices decline.


Active onshore rigs declined -2 to 489 but oil rigs were flat at 406. Gas rigs fell -2 and offshore rigs declined -1. It will be interesting to see if that 8 week rebound in rigs can be sustained, decline or increase further. I suspect it would take $50 oil or higher to really get a lot of rigs off the sidelines.


 


 

Markets

The markets continue to tease investors with the potential for a move in either direction. Bulls see the repeated tests of the recent highs as evidence the market wants to go higher. Bears see the repeated failure at those highs as evidence the market wants to go lower. In this market, there is something for everyone but neither side is having any luck finding winning trades.

The S&P has moved sideways in a 40-point range since July 14th. That is the longest stretch of low volatility since before the financial crisis. Eventually this compressed market will break out of the consolidation trend and it could be explosive and it could move in either direction. The S&P has not made a 1% move in 35 sessions.

What happens over the next five weeks will likely set the stage for a longer-term move. With earnings expected to rise 5.5% in Q4 the most likely direction is higher once the volatility have passed. We are now one week into the six weeks of the year with the highest volatility with five to go. I seriously doubt we will continue sideways for five more weeks.

The S&P traded in a 27-point range on Friday and the widest range since this new high consolidation began in mid July. Despite the 27-point range, the index only lost -3 points to close at 2,169. The intraday low at 2,160 was a three week low. This could be the start of the volatility but it was also due to the conflicting comments from the Fed heads. There is still five days before the holiday weekend and volume should continue to be very low. After Labor Day is when the market should go directional. However, given the increased outlook for a September rate hike there could be a cloud over the market next week as well.

Support at 2150-2160 is the critical level to watch as well as the 2,193 double top intraday highs from the last two weeks. A break below 2,150 should retest 2,100.


The converging resistance on the Dow at 18,625 is still intact and the index lost -157 points for the week to test initial support at 18,350. The next test could be 18,250 and then 18,000. The Dow stocks are all in the post earnings depression phase and there are no catalysts to push the Dow higher.

The banks spiked slightly higher on Friday then faded into the close. The energy stocks are fading along with the price of oil. The drug stocks were weak on the drug pricing scandal surrounding Mylan. Retailers were slipping on poor sector performance and outlook. Every sector seemed to have some new headline that was weighing on prices.

On the positive side, there were no big losers. There were plenty of chances for Dow stocks to crater but the declines were only minimal. This suggests there are still plenty of dip buyers for the big caps.

If the 18,250 level breaks we could be in for a larger than normal decline ahead of the equity fund portfolio restructuring in September. Conversely, if a rally suddenly breaks out from here that takes the index well over 18,625 it could trigger significant short covering and price chasing by funds afraid the market is running away from them.



The Nasdaq managed to buck the trend on Friday thanks to a 1% gain in the biotech sector. The 62-point trading range ended with only a 6-point gain, but still a gain to lift the index a little farther above that critical support.

The biotechs have been the curse of the Nasdaq over the last several weeks. The biotech sector has seen big gains and losses and they are dragging the Nasdaq higher and lower depending on the day. The BTK closed at a five week low and slightly below support at 3,300. The sector could go either way next week but the Mylan price hikes are now old news. If I had to bet on a direction, it would be higher. That would benefit the Nasdaq and help prevent a meltdown under 5,200.




The Russell 2000 small caps are still in a positive trend. This is the most bullish index but it does have risk to the bottom of the channel at 1,225. As long as fund managers are nibbling at the small caps, the market is not in danger. When that changes, it could spell a change in direction for the big cap indexes first.


I am neutral on direction for next week. The Russell 2000 seems to be saying we will go higher but the Dow and S&P are at three-week lows. The big caps led us to new highs but have lost traction. The small caps were laggards on the early rally but are now the strongest section of the market.

This will be week two of the six most volatile weeks of the year and volume will be extremely light. That may be the saving grace because most institutional traders will be out of the office. It is the week after Labor Day that could set the tone for September.

I would continue to caution not to be overly long this week. Keep some cash available and a shopping list of stocks you would like to buy on a dip. We are long overdue for at least a minor bout of profit taking and it could appear at any time.

If you like the market commentary you have been receiving and you are on a free trial then now is the time to subscribe. Do not wait until you miss a newsletter to decide you want to take the plunge.

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Random Thoughts


Bullish sentiment reversed sharply with a -6.1% drop to 29.4%. Considering this survey ends on Wednesday that was before the anguish over the Yellen speech. Neutral sentiment rose +2.9% and bearish sentiment +3.3%. Bullish sentiment is about 10% under the normal average and neutral sentiment is 10% above average. Bearish sentiment is almost exactly at the 30.5% long-term average. Something scared the bulls early last week and that could carry over into next week.



Yellen warned because average job gains of 190,000 over the last three months and expectations for inflation to rise to 2% over the next "several" years and expected growth in the GDP, we should expect the Fed to raise interest rates gradually over time. That was about as neutral as you can get. Yes, we are going to raise rates but it will be data dependent and could take years to return to normal. It was hardly a hawkish speech but Fischer handled the bad news for her.

In Yellen's speech, she laid out several scenarios for dealing with the next recession. After seven years of expansion, the next recession cannot be that far away but that distance is measured in years not weeks. The most common forecast is for a recession to appear around 12-18 months from now.

The common question for the Fed is what to do when a new recession appears if interest rates are too low for the Fed to react with rate cuts. She theorized that rates in the 3% range would be sufficient for a future rate cut cycle along with $2 trillion of QE in order to stabilize the economy, unless the recession was unusually long or severe. If a dramatic recession were to appear, she suggested the Fed might delve into other asset classes for QE to be effective. Those would be stocks, ETFs and corporate bonds. Japan is already in this mode and now that the door has been cracked open, the Fed would like to have that ability as well.

She kept referring to "future policy makers" suggesting she does not plan on being around a long time. Given that the Fed has never unwound a stimulus program without causing a market crash and recession and the current stimulus program is the largest on record, she may be planning an exit before that unwinding occurs so she does not have to face the political heat.

Full Yellen Speech


The University of Chicago broke with a current trend when it sent a letter to new students telling them what to expect when they begin their intellectual journey.

Once here you will discover that one of the University of Chicago's defining characteristics is our commitment to freedom of inquiry and expression. Members of our community are encouraged to speak, write, listen, challenge, and learn, without fear of censorship.

Civility and mutual respect are vital to all of us, and freedom of expression does not mean the freedom to harass or threaten others. You will find that we expect members of our community to be engaged in rigorous debate, discussion, and even disagreement. At times this may challenge you and even cause discomfort.

Our commitment to academic freedom means that we do not support so-called "trigger warnings," we do not cancel invited speakers because their topics might prove controversial, and we do not condone the creation of intellectual "safe spaces" where individuals can retreat from ideas and perspectives at odds with their own.

Fostering the free exchange of ideas reinforces a related University priority - building a campus that welcomes people of all backgrounds. Diversity of opinion and background is a fundamental strength of our community. The members of our community must have the freedom to espouse and explore a wide range of ideas.

While I applaud their stance, many others did not. There was an immediate Twitter war between those that want to coddle students and treat them like grade schoolers and those who were cheering the university's stance. Some donors polled their pledges saying they were not going to support the uncaring stance, saying individual feelings should be protected rather than be exposed to harsh opinions of others.

I believe the university made the right choice. They are the first college to challenge "safe spaces" in an acceptance letter. There are no safe spaces and trigger warnings in life. The sooner these pampered children understand that the better off they will be in the world. Just my two cents.


Burning Man celebrates its 30th anniversary this year. The event starts on Sunday and runs through September 5th. If you do not already have tickets, it is too late to consider going. The general admission tickets at $340 plus an $80 parking ticket, sold out long ago and the ticket resale sites have been getting 2-3 times the face value but those have now evaporated. The event has changed from a bonfire on the beach outside San Francisco to a weeklong event with 70,000 attendees participating in sex, drugs and rock and roll. It is called a combination of Woodstock, Circus du Soleil and Alice in Wonderland all taking place on the planet Tatooine. The event is capped by the ritual burning of the wooden man, which is more than 100 feet tall.

Everything is free with nothing for sale except coffee and ice. Costumes are worn all the time along with those wearing nothing at all. The event attracts all kinds of celebrities including Katy Perry, Jim Belushi, John Stamos, Susan Sarandon, Will Smith and dozens of other actors just blending into the crowd. Mark Zuckerberg helicoptered in last year and handed out hundreds of grilled cheese sandwiches before getting lost in the crowd. Celebrities assume new names for the week so they can fit in with the regular crowd. Elon Musk and his cousin Lyndon Rive came up with the idea of starting SolarCity while they were camped out at the event. Put it on your bucket list if you are a free spirit under 40. Burning Man


 

Enter passively and exit aggressively!

Jim Brown

Send Jim an email

 

"If you don't read the newspaper you are uninformed. If you do read the newspaper you are misinformed."

Mark Twain



Index Wrap

Decision Time

by Jim Brown

Click here to email Jim Brown
The major indexes have traded sideways since July 14th. It is time for a directional decision.

The S&P has traded in a very narrow 40-point range since July 14th. That is the lowest prolonged volatility since the financial crisis. The Volatility Index ($VIX) has been trading in the 11-12 range for nearly two months. Volatility spiked slightly last week as the various Fed speakers voiced their opinions on rate hikes. Despite the bounce, volatility is still low on a historical basis.


The weekly S&P chart is showing weakness developing and the momentum indicators worsening. The index has support at 2,160, 2,160 and 2,100. On the daily chart the indicators are in full decline. The very narrow trading range since July 14th is destined for a breakout in the days ahead. Only the direction is unknown. The S&P nearly traveled the entire range on Friday.




The Russell 2000 is the only index still rising and it has yet to reach its prior highs. As long as the Russell continues to make gains the broader market will not collapse. The day it appears the Russell is rolling over will be the day the big cap indexes die.

The Russell gains have been steady and other than the first three weeks of the rebound they have been minor. Those are the type of gains that stick. Slow and steady wins the race.


The S&P-600 small cap index made a new high last week after a string of new highs. The 600 is much narrower and weighted differently. It is an invitation only index so the low quality stocks are not represented. The Russell 2000 is simply the 1,000 smallest stocks in the Russell 3,000. There is no quality methodology on the Russell 2000.

The S&P 600 suggests the market is going higher. However, the trend is your friend until it ends and it is really overextended.


The S&P-400 Midcap index is also at new highs but with far less conviction than the S&P-600. The midcap stocks appear to be weaker than the small caps and we already know the big cap S&P-500 is even weaker. There is a clear pattern here and that enforces the focus on the small cap indexes.


The relationship between the semiconductor index and the Nasdaq has peaked. The various semiconductor stocks appear to have begun to fade and the Nasdaq and $SOX are on the verge of rolling over.


I have talked a lot lately about the Nasdaq getting support from the biotech sector. The correlation is not nearly as equal as the semiconductor stocks but the dollar value of the biotech stocks are significantly higher than the semiconductor stocks. Even a distant correlation has a significant impact on the Nasdaq.

Put the semiconductors and biotechs together moving in the same direction and the Nasdaq has no chance.


The Russell 3000 is the widest index covering the top 3,000 stocks by market cap. The R3K stalled at uptrend resistance and has failed to make a new high for two weeks. A failure at 1,272, which was the prior high from early 2015, could be catastrophic with a potential decline to 1,200. While I do not expect that to happen, we are in the six most volatile weeks of the year.


The volume should be very light next week and that can emphasize volatility because a normal buy/sell program can look like a fat finger trade and move the markets. Fund managers have to be careful trading in an extremely thin market and they "should" put off any major restructuring until after Labor Day.

There are plenty of economic headlines on the calendar so there is the risk of a headline triggering some unwarranted Fed hysteria. That is very likely late in the week as we approach the employment report on Friday.

However, the next five weeks are "normally" the most volatile of the year with second half lows made in September and October. Normal seasonal patterns have been absent this year so we cannot simply move to the sidelines and wait for a September decline. I continue to recommend refraining from being overly long and suggest we keep some cash in case a buying opportunity arrives.

Enter passively and exit aggressively!

Jim Brown

Send Jim an email


New Option Plays

Acquisition Complete

by Jim Brown

Click here to email Jim Brown

Editors Note:

Cavium completed an acquisition of QLogic and the cost savings will be huge. This should benefit the combined company in the months ahead.



NEW DIRECTIONAL CALL PLAYS

CAVM - Cavium Inc - Company Profile

Cavium, Inc. designs, develops, and markets semiconductor processors for intelligent and secure networks. It offers integrated semiconductor processors for wired and wireless networking, communications, storage, cloud, wireless, security, video, and connected home and office applications. The company's products also include a suite of embedded security protocols that enable unified threat management, secure connectivity, network perimeter protection, and deep packet inspection. In addition, it provides commercial grade embedded Linux operating systems, development tools, application software stacks, and support and services.

On August 17th, Cavium completes the $1.36 billion acquisition of QLogic. The acquired company has been around a long time and is a leading name in the Ethernet market. As of 2015, QLogic had a double digit market share lead over its peers. Pacific Crest believes Cavium will be able to reduce QLogic's manufacturing costs by 50% and this would help capture further market share gains on cost while expanding into congerged NIC and onboard LAN markets. That could produce another $1 billion in revenue.

Analysts raised estimates for Cavium revenue from $526 million to $957 million and earnings rose from $1.87 to $2.60.

Earnings Oct 26th.

Shares have been moving up since late June when the acquisition was announced. They plateaued at $55 over the last week but could be poised to move higher with resistance at $64.

With a CAVM trade at $56.40

Buy Nov $60 call, currently $3.20. Initial stop loss $52.85.

Optional: sell Nov $70 call, currently 75 cents. Initial stop loss $52.85.

Net debit $2.45


NEW DIRECTIONAL PUT PLAYS

No New Bearish Plays



In Play Updates and Reviews

Conflicting Views

by Jim Brown

Click here to email Jim Brown

Editors Note:

The market rallied on Yellen's comments and crashed on Fischer's comments. Yellen said the case for a rate increase had strengthened but then qualified it with several other comments that suggested there was no rush. Fischer was interviewed and asked if the market should prepare for a September rate hike and possibly a December hike as well. He said, yes if the data cooperates. While that is not cast in concrete the rest of his comments suggested the market should start planning for a new rate hike.

The Dow spiked +122 points on Yellen's dovish remarks and then fell -235 points on Fischer's remarks to bottom at 18,335. The dip buyers arrived on schedule and the Dow recovered to 18,400 and a loss of -53 points. The volatility returned in a big way and could carry over into next week.

The dip buyers are alive and well but the sellers came out in force on the Stanley Fischer comments about the potential for two rate hikes over the next four months. The bulls rescued the indexes at the close but it was a volatile session.

I did not add plays on Thursday night for exactly this reason. We knew there would be volatility but did not know the direction. On Friday, we saw it in both directions so watching from the sidelines was the right call.



Current Portfolio


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BULLISH Play Updates


AKAM - Akamai Technologies - Company Profile

Comments:

No specific news. The buyout of Rackspace Hosting by Apollo for $4.3 billion kicked Akamai into the spotlight as the next potential acquisition target as the private equity crowd bulks up on cloud companies. Shares spiked on the news.

Original Trade Description: August 13th.

Akamai Technologies, Inc. provides cloud services for delivering, optimizing, and securing content and business applications over the Internet in the United States and internationally. The company offers performance and security solutions designed to help Websites and business applications operate while offering protection against security threats. It also provides media content delivery solutions that are designed to deliver movies, television shows, live events, games, social media, software downloads, and other content on the Internet in fixed line and mobile networks; adaptive delivery solutions for streaming video content; and download delivery solution that offers accelerated distribution for large file downloads, including games, progressive media files, documents, and other file-based content.

If you have a large amount of content on the web that is routinely downloaded by thousands or even millions of people around the world, Akamai has the solution. Assume you are a streaming media company with 20,000 downloadable movies. If all those downloads were streamed out of one location to thousands of customers around the world, the bandwidth and server horsepower required at the host location would be enormous. Delays would result when everyone started downloading movies after dinner in the evening.

Akamai solves this problem by cloning your download library and spreading copies around in multiple locations around the world. When a customer clicks on a movie to download, that movie is sent from the location closest to him. In the Internet world, distance is time. The farther you are from the website location the longer the downloads will take because they have to pass through dozens of "pipes" and "routers" as they make their way to your. By putting heavily used content in major geographic locations, Akamai shortens the distance for those in that area. Akamai also provides security and redundancy for the companies providing the source data.

In the Q2 report Akamai reported earnings of 64 cents on a 6% rise in revenue of $572 million. Analysts were expecting 64 cents and $575 million. The cloud security solutions unit saw revenue rise +42% to an annualized rate of $360 million. International revenue rose 25% to $177 million.

The problem came from the USA where revenue declined -1%. Two of the company's largest customers, Facebook and Amazon, began remotely hosting more of their own content and that reduced revenue. Those two companies were previously 12% of Akami revenue and they declined to 5%. The company guided for Q3 earnings of 59-62 cents on revenue of $566-$578 million. Analysts were expecting 66 cents on revenue of $590 million.

The key point here is that overall revenues rose 6% despite the sharp decline in revenue from Facebook and Amazon. The second point is that now they are only 5% of total revenue and they cannot decline much farther. Akamai said those two customers were building their own "content distribution network" or CDN, which is a very expensive undertaking and the vast majority of Akamai customers could not afford to do that. Obviously Amazon has AWS with massive datacenters all around the world so it only makes sense for them to clone their own content into multiple locations. That is the same with Facebook. They have hundreds of thousands of servers in secure locations all around the world and no longer need Akamai to handle the bulk of their data delivery.

With Akamai continuing to grow even when 7% of their prior revenue base went away, it shows how strong the business really is today. The rapidly growing cloud security solutions business and the international growth will continue to accelerate.

Akamai shares fell from $58 to $48 on the lowered guidance. After trading sideways for two weeks with no further declines, Wells Fargo upgraded them from neutral to buy on Thursday. I believe they will recover their pre earnings level of $58, which just happened to be an eight month high.

Earnings are October 25th.

Position 8/15/16:

Long Nov $55 Call @ $2.46, see portfolio graphic for stop loss.


ETN - Eaton Corporation - Company Profile

Comments:

No specific news. Shares still holding over support.

Original Trade Description: August 22nd.

Eaton Corporation operates as a power management company worldwide. The Electrical Sector is a global leader in power distribution, power quality, industrial automation and power control products and services. Products include circuit breakers, switchgear, UPS systems, power distribution units, panelboards, loadcenters, motor controls, meters, sensors, relays and inverters. The principal markets for the Electrical Americas and Electrical Rest of World segments are industrial, institutional, government, utility, commercial, residential, information technology and original equipment manufacturer customers. In California's aerospace industry, the Eaton Corporation manufactures and markets a line of systems and components for hydraulic, fuel, motion control, pneumatic systems and engine solutions. Eaton is a manufacturer of systems and components for use in mobile and industrial applications. Markets include agriculture, construction, mining, forestry, utility, material handling, machine tools, molding, power generation, primary metals, and oil and gas. The Hydraulics group also includes Eaton's Filtration, Golf Grip and Airflex industrial clutch and brake businesses. The Vehicle Group comprises the company's truck and automotive segments. The truck segment is involved in the design, manufacture and marketing of powertrain systems and other components for commercial vehicle markets. Key products include manual and automated transmissions, clutches and hybrid power. Eaton’s automotive segment produces products such as superchargers, engine valves, valve train components, cylinder heads, locking and limited-slip differentials, fuel, emissions, and safety controls, transmission and engine controls, spoilers, exterior moldings, plastic components, and fluid connectors. The company was founded in 1916.

For Q2 the company reported earnings of $1.07 that beat estimates for $1.05. Revenues of $4.08 billion beat estimates for $4.05 billion. Revenues were down -5.4% due to lower sales to the automotive sector and a decline in sales to the oil and gas sector. Currency issues also removed -1% from revenue. The company narrowed its full year guidance from $4.15-$4.45 to $4.20-$4.40 per share. They still expect revenues to decline 2% to 4% for the full year because of the drop in oil and gas sales and the weak global economy and a currency impact of $225 million.

Next earnings Nov 1st.

Argus said the company was doing well in a tough environment and they expect the oil and gas sector to rebound in 2017. They said Eaton was selling at a discount to its peers and raised their rating from hold to buy. Eaton has been restructuring since 2013 and Argus expects that to bear fruit in the year ahead with earnings rising appropriately.

Eaton shares rallied for two weeks after the August 2nd earnings and then went sideways with the market over the last week. Shares closed on Monday at a 52-week high at $67.72. Resistance is $73.50.

If the market rallies as expected after Labor Day, I would expect Eaton to move higher to test that resistance. This is a quality company with low volatility and they pay a $2.28 dividend for a 3.37% yield.

Position 8/23/16 with a ETN trade at $68.05

Long Oct $70 call @ $.99, no initial stop loss.


ITW - Illinois Tool Works - Company Profile

Comments:

No specific news. Shares closed at a new high on Tuesday.

Original Trade Description: August 17th.

Illinois Tool Works Inc. manufactures and sells industrial products and equipment worldwide. It operates through seven segments: Automotive OEM; Test & Measurement and Electronics; Food Equipment; Polymers & Fluids; Welding; Construction Products; and Specialty Products. The company distributes its products directly to industrial manufacturers, as well as through independent distributors. Illinois Tool Works Inc. was founded in 1912.

In late July, ITW reported earnings of $1.46 that rose 12.3% and beat estimates for $1.40. Revenue of $3.43 billion beat estimates for $3.40 billion. ITW guided for Q3 earnings of $1.42-$1.52 compared to analyst estimates for $1.46. The company raised full year guidance for earnings by 10 cents to the $5.50-$5.70 range. Analysts were expecting $5.51 per share.

The stock jumped from $111 to $115 on the news and then traded sideways for two weeks on post earnings consolidation. In early August the shares started a slow climb to hit $119 and a new high. Every day I thought about recommending ITW but I kept waiting for a pullback. We saw a minor decline on Tuesday to $118 and a positive gain on Wednesday. This may be our chance to buy a dip, even as small as it was.

Earnings Oct 19th.

Position 8/19/16 with an ITW trade at $119.25

Long Dec $125 call @ $2.05. No initial stop loss.


MKC - McCormick & Co - Company Profile

Comments:

No specific news. Minor decline in a weak market.

Original Trade Description: August 20th.

McCormick & Company manufactures, markets, and distributes spices, seasoning mixes, condiments, and other flavorful products to the food industry. It operates through two segments, Consumer and Industrial. The consumer segment offers spices, herbs, seasonings, and dessert items. It provides its products under the McCormick, Lawry's, Stubb's, and Club House brands in the Americas; Ducros, Schwartz, Kamis, and Drogheria & Alimentari brands, as well as Vahine brand in Europe, the Middle East, and Africa; McCormick and DaQiao brands in China; McCormick and Aeroplane brands in Australia; and Kohinoor brand in India, as well as through regional and ethnic brands, such as Zatarain's, Thai Kitchen, and Simply Asia. This also supplies its products under the private labels. This segment serves retailers, including grocery, mass merchandise, warehouse clubs, discount and drug stores, and e-commerce retailers directly and indirectly through distributors or wholesalers. The Industrial segment offers seasoning blends, spices and herbs, condiments, coating systems, and compound and other flavors to multinational food manufacturers and foodservice customers.

They reported Q2 earnings of 75 cents that beat by a penny. Revenue rose 3.8% to $1.06 billion and matched estimates. Consumer sales rose 7% to $641.8 million while industrial sales declined -0.7% to $421.5 million. For the full year they guided for earnings on a constant currency basis of $3.68 to $3.75 and analysts were expecting $3.74. Revenues are expected to be $4.34 to $4.43 billion but that was on the low side of estimates for $4.41 billion. They expect sales growth of 5% and EPS growth of 10%. They said they had more confidence they would come in at the high end of their revenue and sales guidance. However, that only matched expectations on earnings and was still light on revenue.

Earnings Sept 29th.

They have several challenges. The quit selling a low cost economy product in India and that reduced revenue. Indians have a very low standard of living and try to find the lowest cost products. The company also warned on currency issues. Total sales growth in Q2 was 3.8% but adjusted for constant currency that would rise to 6%.

They also had an issue with private label customers lowering prices for their products. That means a $2 box of private label pepper is competing with a $2.50 box of McCormick pepper. The company is actually fine with that and encourages private label distributors to adjust prices to whatever price point generates the most sales. Apparently, McCormick is perfectly happy growing market share at a reduced revenue rate. They are still making money on private label products and those products are capturing market share.

Shares sold off from $107 to $100 in the month following the earnings report. After putting in a double bottom at $100 the stock is moving higher and a break over $102 could see the gains accelerate. This is a good stable company paying a $1.72 annual dividend without a lot of drama along the way. I expect it to return to the highs, market willing.

position 8/22/16 with a MKC trade at $102.15

Long Dec $105 call @ $2.40. See portfolio graphic for stop loss.


OC - Owens Corning - Company Profile

Comments:

No specific news. Minor loss in a weak market.

Original Trade Description: August 24th.

Owens Corning produces and sells glass fiber reinforcements and other materials for composites; and residential and commercial building materials worldwide. It operates in three segments: Composites, Insulation, and Roofing. The Composites segment manufactures, fabricates, and sells glass reinforcements in the form of fiber; and manufactures and sells glass fiber products in the form of fabric and other specialized products. Its products are used in pipe, roofing shingles, sporting goods, consumer electronics, telecommunications cables, boats, aviation, defense, automotive, industrial containers, and wind-energy applications in the building and construction, transportation, consumer, industrial, and power and energy markets. The Insulation segment manufactures and sells fiberglass insulation into residential, commercial, industrial, and other markets for thermal and acoustical applications; and manufactures and sells glass fiber pipe insulation, flexible duct media, bonded and granulated mineral fiber insulation, and foam insulation used in above- and below-grade construction applications. The Roofing segment manufactures and sells residential roofing shingles, oxidized asphalt materials, and roofing accessories used in residential and commercial construction, and specialty applications.

For Q2 they reported earnings of $1.29 that beat estimates for 85 cents. Revenue of $1.55 billion also beat estimates for $1.47 billion. They repurchased one million shares in the quarter with 2.8 million left on the current authorization. They projected second half shipments of roofing to be flat after a 20% surge in the first six months of 2016. This is a seasonal business. Hail storms that cause roof replacements are heaviest in April-July.

Earnings Oct 26th.

Shares were very volatile after the earnings with a range of $50.88 to $58.69. After the volatility passed the stock found support at $53 and moved sideways for four weeks. This week shares have started to climb out of the consolidation and the stock closed at $54.81 on Wednesday and actually posted a gain in a weak market. That was a four-week high.

This is a low volatility stock and could be a safe location to wait out any market volatility over the next six weeks.

Position 8/25/16

Long Nov $55 call @ $2.35, see portfolio graphic for stop loss.


PAG - Penske Automotive Group - Company Profile

Comments:

No specific news. Shares posted a minor gain in the weak market.

Original Trade Description: August 10th.

Penske Automotive Group, Inc. operates as a transportation services company. The company operates through three segments: Retail Automotive, Retail Commercial Truck, and Other. It operates retail automotive and commercial vehicle dealerships principally in the United States and Western Europe; and distributes commercial vehicles, diesel engines, gas engines, power systems, and related parts and services primarily in Australia and New Zealand. The company engages in the sale of new and used motor vehicles; and related products and services, such as vehicle service and collision repair services, as well as placement of finance and lease contracts, third-party insurance products, and other aftermarket products. The company also operates 14 dealerships locations of heavy and medium duty trucks primarily under Freightliner and Western Star brand names, as well as offers a range of used trucks, and service and parts. Further, the company distributes commercial vehicles and parts to a network of more than 70 dealership locations, including 3 company-owned retail commercial vehicle dealerships. At the end of 2015 they operated 355 automotive retail franchises with 181 in the USA, and 174 outside the US, primarily in the UK.

For Q2 they reported earnings of $1.11 and beat estimates for $1.08. Revenue rose 6.8% to $5.3 billion and also beating estimates for $5.1 billion. On a constant currency basis revenue rose 9.2%. They sold 115,106 vehicles in Q2. Gross profits rose 5.5% to $771.3 million. Cash on hand rose from $62 million to $97 million.

On July 27th Penske Automotive acquired an additional 14.4% interest in Penske Truck Leasing from GE Capital for $498.7 million. That raised their ownership to 23.4%. They expect this to add 25 cents to earnings on annual basis. In April a Penske subsidiary, Premier Truck Group acquired Harper Truck Centers, a commercial truck dealership in Ontario Canada. The acquisition will add $130 million in annual revenue.

On August 2nd Chairman and CEO, Roger Penske, acquired 710,121 shares for an averge price of $39.10 for a total value of $27,765,730. Since 2010 Roger had sold 501,326 shares in three transactions. That makes his recent buy even more important because if marks a change in sentiment.

Update: On August 10th CEO Roger Penske bought another 151,412 shares for $6 million. Roger Penske acquired another 50,000 shares on August 11th at an average price of $41.40. He is on a buying binge with new positions every 2-3 days. Just in August he has purchased nearly one million shares for roughly $40 million. That brings his total ownership to 31,066,574 shares. There are only 85 million outstanding. It looks like he may be taking the company private, one bite at a time.

Update: On August 22nd, Roger Penske bought another 300,000 shares at $42.55 for $12.8 million. No other news and the stock spiked 4%. That raises his holdings to roughly 31.5 million shares and there are only 85 million outstanding. His ownership is now over 37%. He has purchased more than 1.5 million shares in the last month.

Earnings Oct 27th.

PAG shares are about to break over long-term resistance at $40. Shares closed at $40.20 and that complicates the trade. If we buy the $45 call, which is only $1, the stock has to move $5 to really make a difference in the option price. If we buy the ITM call at $40, which is $2.95 we are paying an ATM premium that will decline as it moves farther into the money. However, for every $1 the stock raises the option will appreciate significantly. Currently the $35 call is $6.30. That is what we could expect the $40 call to be worth if the stock rises to $45. At the same time, the $45 call would rise from the current $1 to $2.95. Do we invest $3 to make $3 or do we invest $1 to make $2? I am going to recommend the $45 call because of the lower cost, lower risk and higher percentage return if PAG rises to $45. The risk is that it stalls somewhere between $40 and $45 and we never reach the ITM premium level before the Oct earnings. I believe this chart is worth the risk. I am going to put a $41 trigger on it to make sure it breaks through that resistance.

Position 8/11/16 with a PAG trade at $41.00

Long Nov $45 call @ $1.35, no initial stop loss.


SWKS - Skyworks Solutions - Company Profile

Comments:

No specific news and another gain to a 4-month high in a weak market.

Original Trade Description: August 18th.

Skyworks Solutions, Inc., designs, develops, manufactures, and markets proprietary semiconductor products, including intellectual property worldwide. Its product portfolio includes amplifiers, attenuators, battery chargers, circulators, DC/DC converters, demodulators, detectors, diodes, directional couplers, diversity receive modules, filters, front-end modules, hybrids, LED drivers, low noise amplifiers, mixers, modulators, optocouplers/optoisolators, phase shifters, phase locked loops, power dividers/combiners, receivers, switches, synthesizers, technical ceramics, VCOS/synthesizers, and voltage regulators. The company provides its products for automotive, broadband, cellular infrastructure, connected home, industrial, medical, military, smartphone, tablet, and wearable applications.

In other words, Skyworks chips are in quite a few devices in the Internet of Things (IoT). The stock has been punished by investors because of the decline in expectations for Apple iPhone sales. That is a big business for Skyworks but fare from their only business. They also produce chips for phones like the Samsun Galaxy that is taking market share away from Apple. They are losing share for one customer and gaining share at another plus they sell chips for hundreds of other products not related to smartphones.

They reported earnings of $1.24 compared to estimates for $1.21. Revenue of $751.7 million also beat estimates for $750.1 million. They guided for revenue in the range of $831 million for the current quarter and earnings of $1.43.

Earnings Nov 3rd.

CLSA upgraded the stock from underperform to outperform saying the bad news on worried about Apple's sales is already priced in and the CEO gave conservative guidance that should be easy to beat. The company said its flagship smartphone chipset sales were expected to grow 20% in 2016. The analyst raised the target price to $77.

Shares were up strongly on Thursday despite the weak market. They are poised to break over resistance at $72 and retest the $79 level. Because of the gain the option premiums are inflated so I am recommending a call spread. The October strikes will not be available until next week so we have to go with November.

Position 8/19/16 with a SWKS trade at $72.05

Long Nov $75 call @ $3.70, no initial stop loss.
Short Nov $82.50 call @ $1.66, no initial stop loss.
Net debit $2.30.



BEARISH Play Updates (Alpha by Symbol)

DIA - Dow Jones ETF - ETF Profile

Comments:

Plenty of volatility surrounding Yellen and Fischer but the dip was bought. The six weeks after August option expiration are the most volatile of the entire year.

Original Trade Description: August 1st.

The Dow posted another lower low as it fades from the 18,622 intraday high set back on July 20th. The last three days the Dow has traded under support at 18,400 only to rebound back over that level at the close. The 18,350 level is secondary support and today's low was 18,355.

All but six Dow components have reported earnings and there are only two reporting this week. Those are PG and PFE on Tuesday. The Dow is experiencing post earnings depression. After a stock reports earnings there is typically a period where it declines as traders leave that stock in search of something else to trade that has not yet reported.

PG 8/2
PFE 8/2
DIS 8/9
HD 8/16
CSCO 8/17
WMT 8/18

The Dow is very over extended, suffering post earnings depression and heading into the two weakest months of the year, which are seasonal decliners.

Bank of America expects a 10-15% decline over the next two months.

Goldman Sachs said this morning they expect a 5-10% decline. Goldman said, rising uncertainty in the U.S. and globally, negative earnings revisions, decelerating buybacks and overly dovish Fed expectations would send the market lower over the next several months.

Jeffrey Gundlach of DoubleLine with $100 billion under management, said "sell everything" most asset classes are "frothy and nothing here looks good." "Stock investors have entered a world of uber complacency." "Investors seem to have been hypnotized that nothing can go wrong." He expects the next big money to be made on the short side.

Peter Boockcar, chief market analyst at the Lindsey Group, said, "Take off the beer goggles, the markets are dangerous. To me, the U.S. stock market is the most expensive in the world."

According to Bespoke, over the last 20 years the Dow has performed the worst in August of any other month.

However, just because some big names and big banks turn negative on the market, it does not mean it is guaranteed to move lower. Markets tend to move in the direction that will confound the most people at any given time.

I believe we should accept the risk and launch another index short using the Dow ETF (DIA) since it is the weakest in August. The Dow has risk to 18,000 and a breakdown there could take it back to 17,400.

I am going to recommend an October put spread so we can capitalize on any decline that lasts into September. Typically market bottoms are in October. If you do not want to use a spread, I would buy the September $182 puts, currently $2.55. Just remember, once we are into September the premiums will decline sharply.

Position 8/2/16:

Long Oct $182 put @ $3.98, no initial stop loss.
Short Oct $172 put @ $1.73, no initial stop loss.
Net debit $2.25


IBM - IBM Corporation - Company Profile

Comments:

IBM declined again but only slightly. The dip buyers are alive and well.

Original Trade Description: Aug 23rd.

International Business Machines Corporation provides information technology (IT) products and services worldwide. The company's Global Technology Services segment provides IT infrastructure services, such as IT outsourcing, integrated technology, cloud, and technology support services. Its Global Business Services segment offers consulting and systems integration services for strategy and transformation, application innovation services, enterprise applications, and analytics; application management, maintenance, and support services; and processing platforms and business process outsourcing services. The company's Software segment provides middleware and operating systems software, including WebSphere software to integrate and manage business processes; information management software that enables clients to integrate, manage, and analyze data from various sources. The business was started in 1924.

This is not a bearish recommendation on IBM's business. This is a trading recommendation based on its chart pattern and the impact on the Dow. IBM has posted revenue declines for 17 consecutive quarters. The business format is changing and IBM is adapting. However, turning IBM around is like turning a VLCC tanker around. They carry 2 million barrels of oil and it takes miles to slow and turn because of their momentum.

IBM is making the turn and their cloud business is growing rapidly but it could take years before the restructuring is complete.

The problem for the market is that IBM is an expensive Dow component. At $160 per share it carries a lot of weight. After they reported earnings showing a big jump in cloud revenue and a major investment from Warren Buffett, the stock rallied to $163 where it stalled for the last two months. At Tuesday's close it was resting on support at $160 and as the Dow dropped to close at the low for the day.

The problem as I see it is this. There is no reason to buy IBM shares. They will post another revenue decline this quarter. That makes it a sell candidate for portfolio managers trying to raise cash for their end of year buys. It is also a high dollar stock so they get a lot of cash back when they sell it compared to selling a GE or a Pfizer. When you need to raise cash you sell the biggest stock with the least promising outlook.

The Dow is the weakest of the major indexes. If the market ever decides to correct over the next six weeks, you can bet the Dow will be the leader to the downside. That means IBM will likely be the leader inside the Dow because there is no real reason to own it when there are so many better stocks in rally mode.

I am recommending we buy the Oct $155 put with an IBM trade at $159. That will be below the support at $160 and potentially the start of a decline that could dip to $150 depending on the market.

Position 8/24/16 with an IBM trade at $159

Long Oct $155 put @ $3.25, see portfolio graphic for stop loss.




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