Option Investor
Newsletter

Daily Newsletter, Thursday, 11/3/2016

Table of Contents

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

Market Wrap

Three Days To Go

by Thomas Hughes

Click here to email Thomas Hughes

Introduction

The market has weathered a busy three weeks rather well; with only three days left until the election volatility is on the rise as investors seek shelter from a growing storm. Earnings growth has returned to the market, economic data continues to trend positively and the FOMC stood pat on interest rates, the only thing left to rattle the market is the election and the chances it will rattle the market are only getting stronger. Tomorrow's NFP report will no doubt be an important one but the big market move, I suspect, won't come until next Wednesday.

Election jitters, the FOMC and falling oil prices weighed on Asian markets in the overnight session. The Nikkei led with a drop near -1.75%, followed by the Heng Seng's decline of -0.56%. European indices fared no better and were further depressed by a new ruling from British courts regarding the Brexit. Apparently, even though the referendum passed, the new PM must wait on a vote from parliament before beginning the Brexiting process. The ruling has raised questions about when or even if the Brexit will actually happen, meanwhile the Bank of England held rates steady and says that the vote has had no apparent impact on the British economy. They upped their GDP target for 2016 to 2.2%, with that moderating to 1.4% in 2017. European indices held flat for most of the day but sold off in late day trading, led by the FTSE.

Market Statistics

Futures trading indicated a flat to positive open for the US indices all morning, a raft of economic data and earnings reports having little impact on the trade. The open was quiet, fallout from the FOMC meeting was minimal, and the market was able to hold just above break even for the first half of the day. Just after lunch bearish sentiment prevailed and sent the indices down to an intraday low, about -0.25% for the S&P 500. This low held for a bit, sideways trading ensued, only to have a new low set in the early afternoon and then another shortly before the close of the session.

Economic Calendar

The Economy

Lots of data today, first up on the list is the Challenger, Gray&Christmas report on planned layoffs. This reports is released at 7:30AM and is for October. The number of layoffs planned in October fell by -31% month over month and -39% year over year to the second lowest level this year and the lowest October reading since 1999. The year to date total is now -14% below last year's YTD total with the energy and computer sector leading with the highest number of layoffs. Energy alone is up 15% YOY on a YTD basis. Despite continued weakness in the energy sector and ongoing restructuring with the computer sector job losses are trending lower in the near and long term, consistent with labor market improvements.


Initial claims for unemployment jumped by 7,000 from a not-revised figure to hit 265,000 in the past week. The four week moving average of claims gained 4,750 to hit 257,750. This is the 87th week for claims to trend below 300,000, the longest streak since 1970. On a not adjusted basis claims increased by 3.7% versus an expected increase of only 1.0% and are down -5.1% over this same week last year. My home state of NC leads gainers with an increase of 2,389 new initial claims, Kentucky leads decliners with a drop in claims of -4,073.


Continuing claims fell -14,000 to hit 2.046 million and a new low dating back to June, 2000. The four week moving average of continuing claims also fell, shedding -9,000, to hit 2.040 million and a new low dating back to July, 2000. The continuing claims figures has resumed its long term down trend, is making new lows on a week to week basis and consistent with improvement in the labor market.

The total number of Americans claiming unemployment rose for the first time in nearly 3 months, gaining 36,000 to reach 1.780 million. This increase is not unexpected (seasonal trends) although I thought there may have been one more week of decline before bottoming. Regardless, we can now expect to see the total number trend higher into the end of the year as staffing levels are cut in efforts to meet year-end budget targets and seasonal workers are laid off.


Third quarter productivity and labor cost data was also released at 8:30AM, both much better than expected. Productivity jumped 3.10% versus an expected gain of 1.80% and much better than the Q2 decline or -0.2%. Within the data there was a 3.4% increase in hourly wages, positive for the consumer, and a 3.4% increase in output, positive for the producers. Total unit labor costs only increased by 0.3% versus an expected jump of 1.2% and the much better than the 3.90% reported for the 2nd quarter.

New Orders for factory goods was released at 10AM and came in a tenth hotter than expected. September factory orders came in at 0.3%, up a tenth from expectations but down a tenth from the previous month. The dark cloud in the data is a sharp downturn in new orders, led by a -1.1% decline in transportation equipment. Surprisingly though, automobile production jumped to a level not seen since July of last year, suggesting the recent down tick in auto sales may be a short lived thing.

The Services Sector ISM index was also released at 10AM and shows a slowing of expansion in the services sector. The headline reading of 54.8 is expansionary but slower than the previous months 57.1 and below expectations. Within the report activity and new orders are both strong at 57.7 while employment levels show a more modest expansion at 53.3. Regardless the slowdown services are expanding.

The Dollar Index

The Dollar Index extended its correction in today's session. The Fed's decision to hold rates steady set the stage for near term weakness in the index that is being compounded by election fears and a surge in pound value driven by today's BOE/Brexit news. I say near term weakness because the longer term outlook continues to support higher rates, expanding US economy and a stronger dollar. Today's action carried the index down by -0.25% to test support at the 61.8% retracement level. The indicators are bearish and pointing lower so support is likely to be tested further. Tomorrow's NFP report could help provide support, or not, with next Wednesday a likely target for a much bigger move. Support is at today's closing level, just above $97. A move lower could go as low as $96.20 before meeting support, a move higher could go as high as $98.65 before hitting resistance. Longer term I am still anticipating a retest of highs near $100.50.


The Oil Index

The oil market continues to slide on rising fear, or acceptance I should say, of a market glut. Yesterday's record breaking injection of US crude supplies was followed up today by an above expectations injection of natural gas supplies and the realization that OPEC just isn't doing anything substantial to actually support the market. An attack on Nigerian oil infrastructure helped to support prices in early trading but that faded throughout the day, leaving prices for WTI down more than -1.4% on the day. WTI has now broken below the $45 support target and could easily head to $40.

The Oil Index is treading water within a trading range, today's action another day of sideways drift within that range. Price action created a small doji like candle, below the short term moving average, just about dead in the center of 7+ month trading range. The long term outlook is bullish, the sector is expected to see earnings growth next year, while the nearer terms are dominated by oil prices and volatility in the oil pits. The indicators are consistent with a test of support near 1,120 or possibly as low as the bottom of the range near 1,100. A break below support does seem likely at this time, not unless there is a serious deterioration in oil prices and/or earnings outlook.


The Gold Index

Gold held steady in a day of choppy trading. The metal is trading hovering around $1,300, driven by an election fear driven flight to safety, compounded by the dollar correction. It looks like $1,300 is providing resistance at this time and may hold, the longer term outlook is for dollar strength so any upside at this time is likely to be limited. A break above $1,300 may find next resistance at $1,320. A fall from $1,300 may find support in the $1,275 range.

The Gold Miners ETF moved up over the past few days, in tandem with the rise in gold prices, but have also hit a potentially strong resistance level coincident with the gap that opened during the first week of October. Today's action was positive, the ETF gained a little more than 1.75%, but was capped by resistance below yesterday's high and within the aforementioned gap. The indicators are rolling over, consistent with resistance levels, and firing an early/weak sell signal in line with the 3 month down trend. Support is currently at the short term moving average, just below today's opening price, a fall from this level could go as low as $22.50. A move up will require a break of resistance to move more than a nominal amount.


In The News, Story Stocks and Earnings

Today may have been the single biggest day of the earnings this cycle, I'm not exactly sure, there are a lot on the list. Despite this the news of the day was not earnings but politics, the election and the future of the economy, the stock market and the country. The amount of concern that, whatever the outcome, the election will result in a major market slide is growing. The VIX has risen for the last 8 days straight and today added more than 16% to hit a new 4 month high. The indicators look strong, the index is moving up with conviction, so this move could easily continue into the election and beyond. Next upside target is near $25, another 10% and more above today's close.


Another shock wave, completely unrelated to the election but not politics, that hit the market today was the announcement of a congressional inquest into the generic drug market and price fixing with the possibility of charges being filed. The news hit the sector hard with names like Mylan and Teva plunging -8% to -10%.


After hours action was busy, quite a few heavily traded names reported earnings and not all delivered what the market wanted to hear. To start it off, Starbucks reported EPS of $0.56, a penny above consensus, on revenue also above consensus. Results were driven by a 4% increase in global comp sales, 6% in China, and led the board to approve a 25% increase to the dividend. Shares gained more than 6% on the news.

CBS also beat top and bottom line consensus estimates, adjusted earnings beat by 17%. CEO Moonves says that "political spending is ramping up nicely" so we can expect to see that impact on the current quarter's results. This stock gained more than 2% in after hours trading.

Las Vegas sands also beat top and bottom estimates, as did Weight Watchers. GoPro however, did not meet expectations. Their results were so bad that the stock was halted before the release and did not reopen for trading until 30 minutes later. Due to declining demand for its ever more expensive, which have turned out to be a kind of novelty item and not the must have they once were, products the company reported a net loss of -$0.74, a little more than double what the market was expecting. Along with this comes weak guidance for the current quarter and CEO Nick Woodman's assurance that demand for the new line is strong and that the company will return to double digit earnings growth next year. The stock dropped nearly -30% on the news.


The Indices

Today's action was largely to the downside but there was one notable exception. The Dow Jones Transportation Average closed with a gain of 0.34% after trading much higher during the session. Today's action was bullish but weak and capped at the top of the recent trading range. The indicators remain consistent with range bound trading and do not show strength. At best this index looks like it will continue to move sideways, trending below the 8,100 level. At worst it may in for a correction to trend, target near 7,750.


The tech heavy NASDAQ Composite posted the largest decline, weighed down by Facebook which lost nearly -6% due to poor forward growth outlook, just over -0.92%. The index created a medium sized black candle, the third one in a row, and appears headed down to test support in the 5,000 to 5,050 range. The indicators are bearish and moving lower, consistent with lower prices, but not yet showing strength so a deeper move may not be forthcoming.


The S&P 500 made the next largest decline in today's session, just shy of -0.50%. The broad market index created a small-to-medium sized black candle, moving down from broken support, and appears like it is moving down to the next support target, possibly 2,050. The indicators are pointing lower, consistent with a test of support, but not showing any kind of strength at this time.


The Dow Jones Industrial Average posted the smallest decline in today's session, only -0.16%. The blue chips had the wildest ride in today's session, opening with a nice upward gap only to sell off hard throughout the day to close at the low. Today's action is the second day to close below the bottom of the September/October trading range and a sign that lower prices may be on the way. The indicators are still consistent with range bound trading but pointing lower so further testing of support at current levels is likely in the least. A move down from here, near 17,930, could go as low as 17,500 before finding next support.


It looks like the market is going to pull back to a stronger support level before the election. The growing chance that a possible criminal or egomaniac will get elected is becoming more of a certainty. What happens after the election is less of a certainty. On the one hand Hillary supports the establishment, so the status quo is likely to be maintained, if you can believe her. On the other hand Trump is threatening to do all kinds of things that are scaring lots of folks, but just might be the tough love America and the world needs. What I know for certain is that market will survive whatever happens; if we go into next week with our positions secure and some cash on hand we will be able to weather the storm, and maybe even make some money. I'm cautious, wary, and still see the makings of a long and sustained bull market rally that could begin, if not before the end of this year then really soon thereafter.

PS, don't forget what happened with the Brexit. All that pent up fear gave us a buying op that delivered an 8.6% rally in the SPX over the course of only a few weeks.

Until then, remember the trend!

Thomas Hughes


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New Option Plays

Risk Management

by Jim Brown

Click here to email Jim Brown

Editors Note:

The S&P has been down for 8 consecutive days with only 3 trading days left until the election. The election uncertainty is growing and there is a very strong potential for high volatility over the next three days. Friday could be the worst. Monday and Tuesday could see some bargain hunting. I am recommending we continue to wait patiently at least until Friday passes. Anything we could add on Friday could be stopped out before the day is over. We should never trade unless there is a reasonable assumption of market direction and today there is no way to judge that. We are very oversold and there could be a monster short squeeze. OR, the payroll report on Friday could be weak like the ADP report and see the market decline even faster on economic worries. There is simply no reason to put money at risk on Friday.



NEW DIRECTIONAL CALL PLAYS

No New Bullish Plays


NEW DIRECTIONAL PUT PLAYS

No New Bearish Plays



In Play Updates and Reviews

Small Caps Still Leading

by Jim Brown

Click here to email Jim Brown

Editors Note:

The Russell 2000 made a new 4-month low and is closing in on 1,150 while the S&P is racing to catch up. The S&P has now posted a loss for 8 consecutive days. That is a streak that has not been seen since 2008. The election uncertainty is growing by the day.

With only three more trading days until the election is over, there is little time to raise cash and escape from potentially catastrophic positions. The biotech sector was down another -2.5% on worries Clinton could pull off a win.

I believe we need to remain on the sidelines until this volatility event is over.



Current Portfolio


Stop Loss Updates

Check the graphic below for any new stop losses in bright yellow. We need to always be prepared for an unexpected decline.


Profit Targets

Check the graphic below for any profit stops in green. We need to always be prepared for a profit exit at resistance.




Current Position Changes


YUM - Yum Brands

The long put position was opened at $58.89.

XBI - Biotech ETF

The long call recommendation remains unopened until $50 or $58.



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BULLISH Play Updates


HON - Honeywell - Company Profile

Comments:

No specific news. Honeywell is holding up very nicely in a weak market. So far, it is holding over support.

Original Trade Description: October 15th.

Honeywell International Inc. operates as a diversified technology and manufacturing company worldwide. Its Aerospace segment offers aircraft engines, integrated avionics, systems and service solutions, and related products and services for aircraft manufacturers and operators, airlines, military services, and defense and space contractors, as well as spare parts, and repair and maintenance services for the aftermarket. This segment also provides auxiliary power units; propulsion engines; environmental control, connectivity, electric power, flight safety, communication, navigation, radar, surveillance, and thermal systems; engine controls; aircraft lighting products, as well as wheels and brakes; advanced systems and instruments; and turbochargers, as well as management, technical, logistics, repair, and overhaul services to original equipment manufacturers in the air transport, regional, business, and general aviation aircraft; and automotive and truck manufacturers. The company's Home and Building Technologies segment offers environmental and energy, security and fire, and building solutions. Its Safety and Productivity Solutions segment provides sensing and productivity Solutions, and industrial safety products. Its Performance Materials and Technologies segment provides catalysts and adsorbents; equipment and consulting services for the petroleum refining, gas processing, petrochemical, and other industries; and automation control, instrumentation, software, and services for the oil and gas, refining, pulp and paper, industrial power generation, chemicals and petrochemicals, biofuels, life sciences, metals, minerals, and mining industries. Company description from FinViz.com.

On Oct 7th, Honeywell shares collapsed from $116 to $105 after the CEO warned that profits would be below guidance and they lowered guidance for the rest of 2016. The CFO said on the conference call, "In the third quarter, we continued to see slow growth across much of our portfolio." Declines in the emerging markets and the oil industry have crimped demand for business aircraft and helicopters, hurting Honeywell's unit that sells jet engines, cockpit controls and aerospace parts.

The company preannounced earnings of $1.60 compared to prior guidance of $1.67-$1.72. For the full year they lowered their forecast by 6 cents to $6.64 per share. The company is in the middle of a reorganization process that will increase profits in the future.

After the stock was crushed by the warning, the CEO appeared on CNBC and said the warning was not received in the way he thought it would be. "I gave credit for people understanding what our long-term profile was. I was wrong. I could have done a significantly better job of communicating this story. We tried to do it in the context of 2017 is going to be good, but it seemed to get totally lost" in the headlines.

The CEO went on to explain that the hiccup in Q3 was minor in the bigger picture given the businesses they just sold in September and the organizational restructuring currently in progress. They only cut full year earnings by 6 cents and will still produce earnings of $6.64 or better. Also the changes in progress will allow Honeywell to grow earnings by 10% or more in 2017. That adds another 66 cents or more to an already robust earnings picture.

He said he was "astounded by the reaction" to the minor cut in earnings. He went on to say that while the business jet business was lagging, the aerospace business was still doing well and should not have been lumped into the warning. He also said the energy business had bottomed in Q3 and would be improving in Q4.

Basically the CEO took a giant step by going on CNBC and saying he was wrong in how the lowered earnings estimates were portrayed and he did a good job of explaining that the weakness was much narrower than presented and the outlook for 2017 was outstanding.

Shares spiked on the news but faded slightly into the close as the market faded. Their formal earnings will be on Oct 21st and I am sure they will take great pains to present a rosy picture.

I am recommending a December call to get us through what is normally the best six weeks in the market. We will hold over those Oct 21st earnings.

Update 10/21/16: Honeywell reported earnings of $1.67 that beat estimates for $1.60. Revenue of $9.8 billion also beat estimates for $9.77 billion. They guided for the current quarter to earnings in the range of $1.74-$1.78 and analysts were expecting $1.75.

Position 10/17/16:

Long Dec $110 call @ $2.51, see portfolio graphic for stop loss.


TREE - Lending Tree - Company Profile

Comments:

No specific news. Shares opened higher but faded with the market.

Original Trade Description: October 31st.

LendingTree, Inc., operates an online loan marketplace for consumers seeking loans and other credit-based offerings in the United States. The company offers tools and resources, including free credit scores that facilitate comparison shopping for these loans and other credit-based offerings. Its mortgage products comprise purchase and refinance products. The company also provides information, tools, and access to various conditional loan offers for non-mortgage products, including auto loans, credit cards, home equity loans, personal loans, reverse mortgages, small business loans, and student loans. In addition, it offers information, tools, and access to other products, including credit repair, through which consumers obtain assistance improving their credit profiles; debt relief services, through which consumers obtain assistance negotiating existing loans; home improvement services, through which consumers have the opportunity to research and find home improvement professional services; personal credit data, through which consumers gain insights into how prospective lenders and other third parties view their credit profiles; real estate brokerage services, through which consumers are matched with local realtors who assist them in their home purchase or sale efforts; and various consumer insurance products, including home and automobile, through which consumers are matched with insurance lead aggregators to obtain insurance offers. Company description from FinViz.com.

Lending Tree reported revenues that rose 35.5% to $94.6 million but missed estimates for $96.9 million. Earnings of 80 cents were in line with analyst estimates. The company lowered its revenue guidance for the full year from $380-$390 million to $370-$375 million. The stock was knocked for a $16 loss to $75.

Yes, they reported a 35.5% increase in revenue but missed estimates by $2 million and the stock was crushed. That is hardly worth a major decline.

That is not the entire story. Mortgage product revenues rose 21%. Total loan requests rose 68%. Small business lending has risen more than 200% from the year ago quarter. The MyLendingTree.com customer portal product now has more than 3.7 million members.

The CEO was not apologetic. He said in a quarter where mortgage rates were near a record low we optimized the business to expand margins and grow profits.

Earnings Jan 26th.

I see nothing wrong with Lending Tree. While they did miss revenue fractionally and guided fractionally lower for the full year, the business is booming. We should see a swift rebound because there are very few companies of any type growing this fast.

Position 11/1/16:

Long Dec $85 call @ $4.00, see portfolio graphic for stop loss.


XBI - Biotech ETF ETF Profile

Comments:

The XBI lost -4% on Thursday to close at $53.51. I am going to add an entry if the ETF touches $50. I am also changing the strikes from December to January. If Clinton loses the election there will be a monster rebound.

This position remains unopened until a trade at $50 or $58.

Original Trade Description: October 29th.

The SPDR S&P Biotech ETF seeks to provide investment results that, before fees and expenses, correspond generally to the total return performance of the S&P Biotechnology Select Industry Index.

The XBI traded up to $69 in late September and has since crashed back to support at $56 as various biotech stocks released data on drug trials that were not successful, were involved in drug pricing schemes or simply issued a profit warning as was the case with Illumina.

The three weeks of headlines over the EpiPen pricing disaster pushed all the drugs stocks lower on worries of drug price controls.

Comments from Clinton, Warren and Sanders about drug pricing concerns also caused investors to flee the biotech sector.

The biotechs may have ended their decline in fear of Hillary Clinton. After the news on Friday about the FBI reopening the criminal investigation on her emails, that should make it really tough to win the election. That means the biotech sector could begin to rebound even before the vote if the polls tighten even further or move into Trump's favor.

On Friday 10/28, the healthcare sector imploded on earnings and warnings from several companies including McKesson, AmerisourceBergen, Cardinal Health and others. The XBI failed to decline after hitting support at $56.

With the XBI now -18% off its September high, all of those factors above are baked into the market. This may be time to place a bet on a biotech rebound.

The ETF has support at $56 and the 200-day at $56.55. The dip on Friday penetrated to $55.80 but then rebounded $1 in a weak market.

I am recommending we buy a cheap December call ahead of the polls that will be out next week. If Clinton does win, we will exit on any weakness.

With a XBI trade at $58

Buy Jan $60 call, currently $1.51, no initial stop loss.

With a XBI trade at $50.50

Buy Jan $55 call, currently $3.25, no initial stop loss.



BEARISH Play Updates (Alpha by Symbol)

BIG - Big Lots - Company Profile

Comments:

No specific news. Down with the market.

Original Trade Description: October 26th.

Big Lots, Inc., operates as a non-traditional, discount retailer in the United States. The company offers products under various merchandising categories, such as food category that includes beverage and grocery, candy and snacks, and specialty foods departments; consumables category, which comprises health and beauty, plastics, paper, chemical, and pet departments; soft home category that consists of home decor, frames, fashion bedding, utility bedding, bath, window, decorative textile, and area rugs departments; hard home category, including small appliances, table top, food preparation, stationery, greeting cards, and home maintenance departments; and furniture category consisting of upholstery, mattress, ready-to-assemble, and case goods departments. It also provides merchandise under the seasonal category that includes lawn and garden, summer, Christmas, toys, and other holiday departments; and electronics and accessories category, including electronics, jewelry, hosiery, and infant accessories departments. The company operates 1,449 stores in 47 states. Company description from FinViz.com.

For Q2, the company reported earnings of 52 cents compared to estimates for 45 cents. Revenue of $1.2 billion missed estimates for $1.22 billion. For the current quarter they guided for a profit of 1 cent to a loss of 4 cents. That is not exactly a stellar performance.

Revenue growth in Q2 slowed from the 3% in Q1 quarter to a -0.5% decline in Q2. Same store sales only rose +0.3%. Big Lots warned Q4 comps would be "flattish" and leaving the door open for a decline. They revised down full year revenue guidance to only 1-2% growth. The admitted online sales were only about 4% of the total and there was limited inventory online. That is not what investors wanted to hear.

Earnings Dec 2nd.

Shares collapsed to plateau about $47 in September. In October that plateau declined to $44.50 and this week that level has now broken. With the market weakening there is less tolerance for companies that are not performing. Shares are near a 9-month low.

Position 10/27/16:

Long December $42.50 put @ $2.10, see portfolio graphic for stop loss.


VXX - VIX Futures ETF - Company Profile

Comments:

Resistance at $36 finally broke. When a positive market returns the VXX will drop faster than it rallied.

This is a long-term position and I will not be commenting on it on a daily basis. There is no news on the VXX since it is not a company.

Original Trade Description: September 21st.

The VXX is a short-term volatility product based on the VIX futures. As a futures product it has the rollover curse. Every time they roll to a new futures contract they have to pay a premium and that lowers the price of the ETF. It is a flawed product with a perpetual decline built in from the monthly roll over in the futures contracts.

As evidence of this flaw, they have now down four 1:4 reverse stock splits. The last four reverse splits occurred at $13.11 (11/2010), $8.77 (10/2012), $12.84 (11/2013), $9.52 (8/8/16). The prospectus says it can reverse split anytime it trades under $25 for a prolonged period and the splits will always be 1:4.

After the August split the ETF moved sideways for four weeks at $36. The volatility event on Sept 9th with the Dow falling -2.5% spiked the VXX from $33 to $42 in three days. That bounce has faded and it is almost back at $33. You are probably thinking, the $40 level would have been a good entry point and you are right in hindsight. However, with the market in danger of breaking down if the Fed had hiked rates, it was better to wait. Now there is nothing on the horizon to cause a spike other than normal market movement.

This is going to be a long-term position. I am not putting a stop loss on the position because long term the VXX always goes down. If we get another volatility spike we will buy another position at a higher level and then ride them both back down.

The market typically rises in late October and into the Thanksgiving weekend. A rising market reduces volatility.

I thought about using a spread to reduce the out of pocket costs. However, that means the strikes have to be relatively close together for the short strike to have any premium. Since the VXX could decline 10 points or more before December, that would limit our potential return to 3-4 points in a spread. However, if we do get a big decline we can spread out at much lower level to further increase our gains.

Position 9/22/16:

Long Dec $33 Put @ $4.20. No stop loss.


YHOO - Yahoo - Company Profile

Comments:

No specific news. New 3-month low.

Original Trade Description: October 15th.

Yahoo! Inc., provides search and display advertising services on Yahoo properties and affiliate sites worldwide. The company offers Yahoo Search that serves as a guide for users to discover information on the Internet; Yahoo Mail, which connects users to the people and content; and Yahoo Messenger, an instant messaging service, which enables users to connect, communicate, and share experiences in real-time. It also provides digital content products, including Yahoo News, which gives users to discover, consume, and engage around the news, content, and video; Yahoo Sports, which serves audiences of sports enthusiasts; Yahoo Finance that offers a range of financial data, information, and tools; Yahoo Lifestyle to engage users passionate about style and fashion; and Tumblr, which provides a Web platform and mobile applications on iOS and android to create, share, and curate content, as well as Tumblr messaging that enables users to engage with other users that share their same interests and passions. Company description from FinViz.com.

After a lengthy process Yahoo agreed to be bought by Verizon for $4.8 billion. However, after the deal was done, Yahoo announced it had a serious cyberattack with data from over 500 million users stolen. This was not told to the potential buyers during the bidding process. The bidders were told there had been various attacks over the years but it was presented as a routine event that all online websites have to fight.

When it was disclosed a couple months ago that the attack happened in 2014 and involved more than 500 million accounts, that caused Verizon to take a second look and they are currently trying to decide on whether to back out of the deal or offer something significantly less. There are multiple class action suits against Yahoo for not guarding customer information. With 500 million accounts, even a $20 per account fine or settlement would cost them $10 billion and more than twice what Verizon agreed to pay. The announcement of the attack constitutes a material adverse change or MAC that allows Verizon to walk with no penalty.

On Friday, Yahoo announced they were not going to hold a conference call or the normal webcast of the earnings after the close on Tuesday because of the intense discussions with Verizon.

I view the odds of a Verizon backing out of the deal as very high. They were already paying about $1 billion more than the next highest offer. Now they are faced with potentially inheriting a $10 billion problem if they conclude the deal. Even if it was only $5 billion or even $2 billion, it makes the deal very uneconomical.

If Verizon walks, Yahoo shares will return to $30 or lower very quickly because nobody else is going to step up and assume that liability either. It would mean Yahoo will have to go it alone and the stock could be trashed.

Update 10/18/16: Yahoo reported revenue that fell -14% to $857 million. This is the fourth consecutive quarter that revenue has fallen more than 10%. They beat on earnings with 17 cents compared to estimates for 11 cents but did it on major cost cutting with the termination of 2,200 employees or one-fifth of its workforce. Verizon signaled last week it was reconsidering the acquisition because of the damage from the cyber attack. The decision to complete the deal or back out should be made over the next 2-3 weeks. Yahoo did not hold a conference call in order to avoid having to answer questions that might stir up more objections by Verizon.

Update 10/26/126: Verizon executive, Marni Walden, said Verizon was taking an in-depth look at how the Yahoo cyber attack occurred and what risk Verizon would have from continuing the acquisition. They would have an answer within 60 days. She said the deal still makes sense strategically BUT we have to be careful about what we do not know. The deal was tentatively still on track but the impact of the breach was "material" and still a big unknown. Use of the word material refers to a possible "material adverse change" or MAC clause in the contract that would allow Verizon to walk from the deal. With 500 million accounts hacked, a $20 fine on each account would be $10 billion and more than twice the $4.8 billion sales price.

This is a speculative position. We do not know what is going to happen or in what time frame. Do not enter this position with money you cannot afford to lose.

Position 10/17/16:

Long Jan $40 put @ $1.90. See portfolio graphic for stop loss.


YUM - YUM Brands - Company Profile

Comments:

No specific news. Shares rebounded slightly after three days of declines.

Original Trade Description: November 2nd.

YUM! Brands, Inc., operates quick service restaurants. It operates in three segments: the KFC Division, the Pizza Hut Division, and the Taco Bell Division. The company develops, operates, franchises, and licenses a system of restaurants, which prepare, package, and sell various food items. As of April 21, 2016, it operated approximately 36,000 restaurants in approximately 130 countries and territories primarily under the KFC, Pizza Hut, and Taco Bell brands, which specialize in chicken, pizza, and Mexican-style food categories. Company description from FinViz.com.

Yum China had 7,300 stores and adding 1,500 since 2012. Currently they are on a path to add 600 stores a year with a growth target of 20,000 stores. This was the growth engine for Yum Brands.

Now the parent company is going to focus on a dividend model and returning cash to shareholders. Yum is planning on reducing its owned store count in the U.S. from 3,200 to 1,000. In the U.S. the pace of new restaurants has slowed significantly and Yum will concentrate on generating and retaining cash of its existing portfolio.

While Yum may generate a great dividend in the years to come, the excitement has evaporated from the stock. There will be little growth and earnings are going to flat line.

Earnings Jan 4th.

Shares are at $60 and I think they have risk to $55 or even $45. There is support at $57.50 but the company has changed. I would not be surprised to see shares cut through that support very quickly.

The YUMC shares began trading on Tuesday and YUM shares have declined sharply on Tue/Wed. The option is cheap and we will have little risk.

Position 11/3/16:

Long Dec $57.50 put @ $1.10, see portfolio graphic for stop loss.




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