Option Investor
Newsletter

Daily Newsletter, Tuesday, 5/18/2010

Table of Contents

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

Market Wrap

Familiar Themes Send Stocks Lower

by Todd Shriber

Click here to email Todd Shriber
Tuesday's trade was somewhat of a reversal of what we saw yesterday. On Monday, the major U.S. indexes started the day off in negative territory and languished there until an afternoon rally saved the day. On Tuesday, it looked like stocks were poised to book some decent gains, but a late-day meltdown scuttled any plans the bulls had for a positive close. The Dow Jones Industrial Average shed almost 115 points to close at 10,510.95 while the S&P 500 lost 16 points to finish the day at 1120.80. Tech continues the weak as the Nasdaq slid 37 points to 2317.26 and small-caps may be getting to rollover after an almost 2% decline for the Russell 2000. All four indexes were down by at least 1%.

Stats Table

Two of biggest U.S. retailers and Dow components at that reported first-quarter results before the bell. Decent news from Home Depot (HD) and Wal-Mart (WMT) should have been enough to encourage some positive trade. Then again, this earnings season has shown investors that the positive expectations were already baked into the share prices of many stocks and the ensuing reaction to even the best reports has been nothing if not disappointing. Expecting Home Depot and Wal-Mart to set the world on fire today was probably asking for too much given the current environment.

Atlanta-based Home Depot's profit update, and more importantly, its guidance, were superior to what rival Lowe's (LOW) offered up yesterday. Home Depot said it earned $725 million, or 43 cents a share, compared to $514 million, or 30 cents a share, a year earlier. Excluding one-time items, the largest U.S. home improvement retailer earned 45 cents a share on sales of $16.86 billion. Analysts were expecting a profit of 40 cents a share on sales of $16.37 billion.

While the guidance offered by Lowe's yesterday was disappointing, Home Depot said it will slightly beat the consensus estimate for its full-year earnings. The company raised its 2010 guidance to $1.88 a share up from a previous estimate of $1.79. Analysts had been expecting $1.87 a share. Home Depot added that it expects sales to rise by 3.5% this year. The company's previous estimate called for a 2.5%.

Sales at stores open at least a year jumped 3.3% during the quarter, the first quarterly increase for that metric in almost five years and individual transactions increased by 4.2%, also the biggest increase in almost five years. The shares were still down 2.4% on the day.

Home Depot Chart

Wal-Mart, the world's largest retailer, said its first-quarter profit surged 10% to $3.32 billion, or 88 cents a share, from $3.02 billion, or 77 cents a share, a year earlier. Same-store sales fell by 1.4%, marking the fourth consecutive quarter Wal-Mart has reported a decline in that metric. That decline is especially disappointing given that those four quarters cover a recession and only the nascent stages of a recovery. What I mean is if Wal-Mart cannot lure shoppers in during a recession, that may not bode well for the stock going forward.

Wal-Mart has the feeling a ''Dog of the Dow'' or to be more candid, dead money. The shares have been significantly outpaced by a variety of retailers, both high-end and not-so-high-end, over the past year. Dollar General (DG), Family Dollar (FDO), Nordstrom (JWN) and Tiffany (TIF) all outperformed Wal-Mart by at least four-fold in the past year.

The company said it expects to earn 93 cents to 98 cents a share in the current, but that is not very exciting given that analysts were already expecting 98 cents. Showing what a fickle beast the stock market is, it would have been logical to expect that Wal-Mart would trade lower today, but the stock was the only one of the 30 Dow stocks to finish the day in positive territory, gaining almost 2% to close at $53.71.

Wal-Mart Chart

As I mentioned in the headline for this wrap, in the absence of ample headlines to explain the day's declines, it was the same old songs sending the bulls running for cover, namely declining commodities prices and Europe-related fears. I am not sure if the commodities/materials/energy trade is taking a break or if it is broken beyond repair (at least for the near- to medium-term), but is obvious that these names that helped lead the market higher pre-financial crisis only to be among the biggest losers in 2008 and early 2009, may be repeating that pattern.

Materials names were among the leaders off the March 2009 lows and they are again contributing some of the biggest declines. Oil looked like it was starting to firm a bit in overnight trading, but that rally was short-lived and NYMEX-traded crude for June delivery, closed at $69.41 a barrel, after falling as low as $68.91. That is good for the lowest closing price since Sept. 29, 2009, according to the Wall Street Journal. Crude has declined in 10 of the past 11 trading sessions, the longest skid since October 2003, the Journal reported.

Yes, the crude charts look crude these days (pun intended), but copper futures did see some relief after several weeks of intense selling pressure. Copper for July delivery gained 9.9 cents to close at $3.031 per pound after the Commerce Department said housing starts rose by 672,000 in April. That was copper's biggest gain in seven weeks, according to Bloomberg News.

Copper Chart

Of course Europe is still manufacturing headlines that send the bulls running for cover. Today, it was Germany's turn to roil equity markets by announcing a ban on naked short-selling. Germany's financial regulator BaFin said the ban starts at midnight tonight in Germany and applies to equities as well as naked credit default swaps on Eurozone government bonds. The ban will also apply to Germany's 10 largest banks and insurance providers and will last until March 31, 2011.

You may remember that the SEC's short sale ban in 2009 proved futile and it served to spook investors about how bad things really were at the time. While bans on short-selling are well intended, particularly if the bans target naked shorts, a far more devious group than regular bears, the bans can be avoided by astute traders. Just because there was a ban on short selling in the U.S. in 2009 did not mean that proprietary trading desks and hedge funds could not short U.S.-listed stocks and the same will be true of Germany's ban. It may hamper shorting of Franfurt-listed stocks, but many of Germany's biggest names trade on other major exchanges, including a few here in the States, so this action is likely to see muted success.

The unintended consequence of Germany's plan to enact tighter control on naked shorts is that the plan has many a pundit speculating that Europe's largest economy may be hiding something. Look at the impact problems in Greece and Portugal have had on global equity markets. Now imagine if Germany, a larger and more important player on the global economic stage, says that its economic house is not in order.

I am not saying that is going to happen, but if Germany continues to spook investors, the fallout will certainly be ugly. All of this is a roundabout way of saying that the iShares MSCI Germany Index (EWG) is worth watching as a potential short. The ETF was down almost 1.5% today on almost six times the average daily volume.

After the bell, Dow component Hewlett-Packard (HPQ), the world's largest personal computer and printer maker, said it earned $2.2 billion, or 91 cents a share in its fiscal second quarter, compared with $1.7 billion, or 71 cents a share, a year earlier. Excluding items, HP earned $1.09 a share, beating the consensus estimate of $1.05. Sales jumped 13% to $30.8 billion, beating the consensus estimate of $29.8 billion.

Weakness among large-cap tech names has been lamented in this space for several weeks, so I would not expect the HP report to lift the sector at large, but is should be noted that the company did offer some bullish full-year guidance. HP said it expects to earn $4.45-$4.50 a share, up from previous guidance of $4.37-$4.44.

The company said it is seeing an uptick in orders from small businesses and financial services firms, but that a true recovery in PC demand from large corporate customers will not be seen until the second half of this year. After losing 1.54% during the regular trading session, HP shares were up 2.44% to $47.93 in after-hours trading.

HP Chart

Taking a look at the charts, last night I mentioned 10,350 as the next support area for the Dow and with today's close just above 10,500, we could be seeing just how strong support at 10,350 is before the end of the week. From there, the 200-day moving average at 10,248 would be the next area to watch on the downside. The HP news on its own is not enough to counter falling oil prices and a tumbling Euro.

Dow Chart

The Germany naked short ban was not good news for financials, regardless of home domicile, and that news pressured the S&P 500 Seventy eight of the index's 79 financial names traded lower on Tuesday and as is the case with the Dow, we could be seeing how strong the next critical support level is for the S&P 500. By that I mean 1100 or 1101.58 if we are splitting hairs about the 200-day line. Either way, if the aforementioned negative catalysts persist and there is little reason to believe they will not, 1100 could be seen in short order.

S&P 500 Chart

The Nasdaq is offering no shelter from the storm. On Tuesday, only seven of the Nasdaq 100 stocks finished the day in positive territory and not one of them was a marquee name like Apple (AAPL), Amazon (AMZN) or Google (GOOG). If Wednesday does not bring some positive trade, the Nasdaq could be testing support at 2300 tomorrow.

Nasdaq Chart

I mentioned last night that I found the strength in small-caps to be suspicious, but Tuesday's trade highlighted some dents in the armor with the Russell 2000 absorbing the biggest percentage loss of the major U.S. indexes. The close at 682.75 puts the Russell 2000 well below its 50-day moving average of 698.64. That is still a good bit above support at 650, but the other side of that coin is that small-caps merely have more selling ahead of them.

Russell 2000 Chart

I said last night that I saw no reason to be bullish about stocks right now and my tune has not changed in 24 hours. Germany announced its naked short selling ban after European markets closed, so I would expect markets there to open lower tomorrow, putting pressure on U.S. index futures. Minutes from the Fed's latest meeting will be released at 2PM Eastern time tomorrow, so Wednesday may be an ideal day to take a breather and stay on the sidelines.


New Plays

Long Candidate

by Scott Hawes

Click here to email Scott Hawes

General Electric - GE - close 17.23 change -0.33 stop 16.19

Company Description:
General Electric Company (GE) is a diversified technology, media and financial services company. The Company’s products and services include aircraft engines, power generation, water processing, security technology, medical imaging, business and consumer financing, media content and industrial products. The Company serves customers in more than 100 countries. The Company operates through five segments: Energy Infrastructure, Technology Infrastructure, NBC Universal (NBCU), Capital Finance and Consumer & Industrial. (source: company press release or website)

Target(s): 18.25
Key Support Areas: 17.00, 16.50
Key Resistance Areas: 17.85
Time Frame: Several weeks

Why We Like It:
GE has pulled back to a key support level of $17.00 dating back to September 2008 and I suggest readers take advantage of an ensuing bounce. GE also has support all the way down to $16.50. The stock is converging with an upward trend line from Novembers 2009 and the aforementioned support levels. These areas give us a good reference to place a stop to limit risk. There is no doubt GE's chart looks terrible but most stock charts do, and I'm viewing the pullback as opportunity to enter a quality name that may catch a bid as investors flee from more speculative names. Shares are lower in the after hours and futures are also weak. I'm eyeing two areas as a potential entry: $17.00 or $16.50 depending on the price action on Wednesday. Our time frame is a couple of weeks and our stop $16.19 which is below the support levels listed above.

Suggested Position: Long GE Stock at current levels.

Annotated Chart:

Entry on May xx
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 88 million
Listed on 5/18/10, 2010


In Play Updates and Reviews

SINA and TIE Closed

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:

Good evening. We closed SINA today for a loss and TIE for a gain. The loss in SINA and the gain in TIE essentially offset each other. I suggest readers consider closing short positions on weakness tomorrow. S&P futures are down almost -10 points as I write this but this is creating an oversold market and we must be smart in taking profits when the opportunity presents itself. That time could be tomorrow morning. There is inevitably going to be a relief rally and we have long positions to take advantage of the bounce. If there is a hard sell-off we'll just need to honor our stops if they are hit and get out of the way, but we have room below on our long positions to give them time to work. I'm still focused on an S&P range in the 1,115 to 1,155 area (lowered from 1,170 after today's sharp reversal). However, I also continue to believe there is much more downside risk than upside opportunity so staying nimble is paramount. This environment remains difficult to manage swing trades but the important thing is we are booking more profits than losses in our model portfolio. Please email me with any questions.

Current Portfolio:


BULLISH Play Updates

AMR Corp. - AMR - close 7.09 change -0.22 stop 6.60

Target(s): 7.95, 8.25, 8.65
Key Support Areas: 7.00, 6.85, 6.75
Key Resistance Areas: 7.64, 8.00, 8.30, 8.70
Current Gain/Loss: -1.80% Time Frame: Several weeks
New Positions: Yes with a tight stop

Comments:
AMR gapped higher at the open but then immediately sold off which enabled us to initiate long positions at $7.22. It appeared as if AMR found support and was headed higher but the overall market weakness was simply too much. AMR has good support at the levels mentioned above. I am expecting these levels to hold but if they don't we'll step aside if our stop is hit. I'll leave my comments from last the play release as they are still valid. Prices of AMR stock are coiling from a period of higher lows and lower highs dating back to October 2008. The stock is sitting on an upward trend line dating back to March 2009 and appears to be headed up to the longer term downtrend line which is near $9.00. The stock also just broke out above a shorter term downtrend line that started with the highs on April 26th and has turned down to retest the backside of that trend line. AMR also made a double bottom at about $7.00 from 5/12 and 5/17 and bounced nicely. There is also strong support $6.85 which provides a great reference point to place a stop just below at $6.60. I am looking for AMR to rally up to $7.95 which is our first target and about +9% from current levels. Our second and third targets are $8.25 and $8.65 respectively.

Current Position: Long AMR stock at $7.22

Entry on May 18, 2010
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 19 million
Listed on 5/15/10, 2010


Broadridge Financial Solutions - BR - close 21.06 change -0.26 stop 20.36

Target(s): 22.40, 22.75
Key Support Areas: 21.00, 20.50
Key Resistance Areas: 22.00, 22.45, 23.00
Current Gain/Loss: -0.89%
Time Frame: Several weeks
New Positions: Yes

Comments:
BR broke through the upward trend line from October 2, 2009 today as the overall market was under pressure. Now BR finds itself sitting on an upward trend line that began on October 30, 2009 as well as horizontal support at $21.00. All of these levels are good set-ups to initiate long positions but if the overall market continues to be weak the levels don't really matter. I am cautiously positioning for a relief bounce here and my thesis for initiating BR. The stock has support here and at $20.50. If that level is broken we'll step aside. My comments from the play release remain valid. I believe the stock is poised to bounce from here. The stock also has strong horizontal support just above $21.00 and again at $20.75 and $20.50. Our stop will be below these levels at $20.36. From a fundamental perspective BR trades at a low 13.3 PE ratio and I believe this stock would benefit from financial reform due to the record keeping and technology services they specialize in. I believe the overall market could bounce from here as well which will help long positions. Our time frame several weeks and our target $22.40.

Current Position: Long BR Stock at $21.25.

Entry on May xx
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 1.2 million
Listed on 5/15/10, 2010


Dr. Pepper Snapple Group - DPS - close 38.12 change +0.12 stop 32.49

Target(s): 36.80, 38.80
Key Support Areas: 35.75, 34.75, 32.70
Key Resistance Areas: 36.80, 37.45
Current Gain/Loss: N/A
Time Frame: Several weeks
New Positions: Waiting for trigger

Comments:
DPS just won't quit. Rumors were flying today that they are a takeover candidate and the stock peaked its head out to a new 52 week high. DPS may have formed a double top though and if it follows through to the downside we may still get triggered. From a contrarian point of view the double top could even be a good short trade but you must be quick for it to work. I won't step in front if it but would welcome a long position if DPS pulls back to its 20/50-day SMA, which it has to at some point. For this reason I would like to leave this position open for a few more days to see if selling kicks in. So we will wait patiently for the pullback to our trigger near $35.00. If there is significant weakness in the market DPS should make it down here and I want to be ready to take advantage of it. If triggered our stop is $32.49. Please keep your position size small since the market has been so volatile.

Suggested Position: Long DPS stock if it trades near $35.00

Entry on: May xx
Earnings Date: More than 2 months (unconfirmed)
Average Daily Volume: 1.9 million
Listed on: May 8, 2010


Quicksilver Resources, Inc. - KWK - close 12.47 change -0.12 stop 11.75

Target(s): 14.25
Key Support Areas: 12.35, 12.00
Key Resistance Areas: 13.25, 14.00
Current Gain/Loss: -1.81%
Time Frame: Several weeks
New Positions: Yes

Comments:
KWK held up fairly well today all things considered. The stock traded over $13 in early trading before closing -0.95% lower. The stock remains near the bottom of its 9-month sideways channel which was our basis for taking the trade. In addition, natural gas has built a nice base over the last two months and I believe the commodity and natural gas stocks are due for a rally. KWK has exhibited great overall strength during the past week as the overall market has been under pressure. The stock has very strong support at $12.00 which was a prior resistance level dating back to October 2008. We are looking for a move up to the $14.25. But I also encourage readers to take profits if KWK gets legs and pushes up over today's highs. The stock broke an upward trend line from November 2009 a couple of weeks ago and I am looking for it to turn back higher and retest the back side of that trend line which is right where our target. This price is about +11% higher than today's price. KWK made a double bottom from 11/2009 2 weeks ago and has responded nicely.

Current Position: Long KWK Stock at $12.70.

Entry on May 17, 2010
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 3.0 million
Listed on 5/15/10, 2010


BEARISH Play Updates

Baidu, Inc. ADR - BIDU - close 71.57 change -1.61 stop 79.10

Target(s): 71.50 (hit), 65.10
Key Support Areas: 71.40, 68.50, 65.00
Key Resistance Areas: 75.64, 78.50, 82.25
Current Gain/Loss: +3.61%
Time Frame: Several Weeks
New Positions: Yes

Comments:
BIDU hit our first target of $71.50 today. Conservative traders may want to exit positions at current levels or on any further weakness to protect profits. BIDU looks vulnerable from here but if there is a bounce in the overall market we may endure a little pain before it heads back down. We need BIDU to break and close below $71.50 to get moving towards our final target of $65.10. From a fundamental perspective BIDU trades at a PE ratio of about 100 which makes no sense when compared to its American counterpart GOOG which trades at a PE of about 23. Our stop is $79.10 which is above last Wednesday's high. This stock can be volatile and is prone to gaps so please be smart when considering position size.

Current Position: Short BIDU stock at $74.25.

Option Traders:
Suggested Position: Buy JUNE $73.00 PUT

Entry on May 14, 2010
Earnings July 15, 2010 (unconfirmed)
Average Daily Volume: 68 million
Listed on May 13, 2010


Leggett & Platt, Inc. - LEG - close 23.83 change -0.35 stop 25.35

Target(s): 23.00, 22.25
Key Support Areas: 23.75, 23.42, 23.00
Key Resistance Areas: 24.75, 25.15
Current Gain/Loss: +1.04%
Time Frame: Several Weeks
New Positions: Yes

Comments:
LEG gapped higher this morning near our key resistance level of $24.75 and then sold off the remainder of the day. On the intraday charts LEG may be forming a bullish inverse head and shoulders pattern. If the market is strong tomorrow this is probably going to bode well for LEG. If not, the pattern will probably fail. Our position is up +1% right now but we may have to live through a bounce for LEG to ultimately reach our target. From a bearish perspective LEG is piercing the bottom wick of yesterday's price bar and also closed below its 20-day SMA. And LEG is still below its downward trend line which started on April 30. However, we need LEG to break through $23.75 and yesterday's low of $23.42 to keep things moving in the right direction. I am going to list a new first target of $23.00 which is just above the stock's 50-day SMA and the low on May 10th. If LEG breaks $23.42 support we should see the 50-day SMA in short order but I wouldn't try to squeeze out the remainder of the gap between $23.00 and the 50-day SMA. Rather, I suggest readers take profits or tighten stops to protect profits. We would gain +4.50% if LEG trades down here which and I suggest taking profits and not holding through any bounce.

Current Position: Short LEG stock at $24.00

Option Traders:
Suggested Position: Buy JUNE $25.00 PUT

Entry on May 17, 2010
Earnings More than 2 months (unconfirmed)
Average Daily Volume: 2 million
Listed on May 15, 2010


CLOSED BULLISH PLAYS

Titanium Metals - TIE - close 16.65 change -0.57 stop 14.70

Target(s): 17.30, 18.00
Key Support Areas: 16.00, 15.50, 15.00
Key Resistance Areas: 16.00, 16.70, 17.25
Current Gain/Loss: +6.46%
Time Frame: Several weeks
New Positions: Yes

Comments:
Our TIE trade has worked out very nice in such a short amount of time. TIE gapped open higher today and traded all the way up to $17.58. The stock proceeded to sell-off rather quickly but found legs again and traded up to $17.44. Our target of $17.30 was hit twice so we are flat on the position for a +6.46% gain. With the overall market weakness here I'm happy with the gain and will take the profit. For readers who still have positions please protect profits and don't let this turn into a losing position. Intraday support is tough to determine but in reality there isn't much until $16.00. $16.40 may provide some sort of bounce.

Closed Position: Long TIE Stock at $17.30, entry was at $16.25

Annotated chart:

Entry on May 17, 2010
Earnings Date 8/4/2010 (unconfirmed)
Average Daily Volume: 3.8 million
Listed on 5/10/10, 2010


CLOSED BEARISH PLAYS

Sina Corporation - SINA - close 37.57 change +2.72 stop $37.05

Target(s): 33.25 (hit), $33.50, 32.50, 30.50
Key Support Areas: $33.40 32.50, 30.50
Key Resistance Areas: 35.40, 36.00, 36.80
Current Gain/Loss: -6.01%
Time Frame: 1 week
New Positions: Closed

Comments:
Ouch! I broke my rules and paid for it with SINA. SINA reported earnings after the bell that were better than expected but their Q2 revenue forecast was lower than consensus estimates. The forecast didn't seem to matter as investors piled into the stock. I am frustrated with the way I managed this trade. Essentially I let a winner turn into a loser, did not take profits when we hit our target of $33.25, and decided to hold the position over earnings. All mistakes that I typically avoid and it reinforces the importance of following rules. But its not the end of the world and the recent winners we have booked eases some of the pain. In any event, we'll pick ourselves up, note the mistakes, and look for better opportunities. Every trade can't be a winner.

Closed Position: Short SINA stock at $37.05, entry was at $34.95

Annotated chart:

Entry on May 4,2010 at $34.95
Earnings Date May 17, 2010 (unconfirmed)
Average Daily Volume: 1.1 million
Listed on May 1, 2010