Option Investor
Newsletter

Daily Newsletter, Saturday, 5/22/2010

Table of Contents

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

Market Wrap

One-Day Rebound Or Reversal Of Downward Trend?

by Todd Shriber

Click here to email Todd Shriber
U.S. stocks rebounded from Thursday's down draft, the biggest losing day in a year, on news that Germany approved its share of the $1 trillion European bailout package and investor sentiment that indicated recent selling was a bit overdone.

After losing 376 points on Thursday and seeing all 30 of its constituents finish that day lower, the Dow Jones Industrial Average gained 125 points on Friday to close at 10,193.39. The only Dow components to finish the day lower were AT&T (T) and Microsoft (MSFT). The S&P 500 gained 16.1 points to settle just below 1088 and the Nasdaq finally showed some signs of life, adding 25 points to close at 2229.04. All around, a good one-day performance, but not enough to keep the Dow and S&P 500 from losing more than 4% on the week. The Nasdaq was down more than 5% for the week.

Stats Table

As I have been saying all week, riskier assets have not been in favor, but for one day at least, they seemed to be back in vogue. The Euro rose the most in eight months against the U.S. Dollar as forex traders unwound bearish positions on the pair. The Euro had been hovering near four-year lows against its American counterpart for most of the weak and plenty of pundits were calling for a technical bounce.

Short-covering was another catalyst to boost the Euro on Friday. It is hard to be short any security that can be considered ''high beta'' heading into the weekend these days. After all, you never know what kind of news is going to emerge from the Eurozone. That said, short-covering and a technical bounce do not represent changes to the Euro's fundamentals. In other words, the common currency is far from out of the woods and it could be just stabilizing or consolidating before another leg lower starts to form.

There are other interesting goings on among other major currencies as well. Both the Australian Dollar and Swiss Franc saw substantial declines this week, prompting speculation that the central banks in those countries intentionally intervened in the currency market. The difference being the Reserve Bank of Australia would do so to prop up its currency while the Swiss National Bank would move to weaken the Franc against the Euro.

Euro/Dollar Chart

Speaking of riskier assets, the one-day respite from fretting over Europe and the strength of the global economic recovery helped select commodities enjoy some bullish trade on Friday. In the case of crude oil, the trading was just less bad (and only moderately so) than it had been over the past several days. The July contract made its debut on Friday, falling 76 cents, or 1.07%, to $70.04 per barrel. For those bullish on oil, seeing crude futures continue to tumble on day when stocks moved higher is not an encouraging sign.

Decoupling of equities and oil is problematic for oil bulls because the two asset classes share an intimate correlation with each other, at least a fair amount of the time. Remember oil prices plunged along with stocks in late 2008 and early 2009 only to rebound with equities off the March 2009 lows. More recently, the S&P 500 and crude prices moved in tandem about 90% of the time in the past month, according to Bloomberg News.

That is below the 94% correlation level seen in mid-March, but you get the picture. Actually, this is really a case of what comes first, the chicken or the egg? Energy stocks account for about 11% of the S&P 500's sector weight and the index is cap-weighted, meaning the companies with the biggest market caps account for the biggest percentages of the index. That means Exxon Mobil (XOM) is the most prominent member of the index.

Bottom line: Do not expect a lot of days of stocks moving higher while oil moves lower and vice versa.

Oil/Stocks Correlation

Copper prices did catch a bid on Friday, rising the most in three months on news that China will continue its voracious appetite for the red metal. The world's largest country imported almost 310,000 tons of copper last month, but copper prices had been hammered as risk appetite waned due to the European debt crisis.

Copper for July delivery gained 11.65 cents, or 4%, to close at $3.061 on Friday, but copper futures are still down almost 9% this year, due in large part to declines in China's equity markets.

Copper Chart

There was plenty of positive trade to go around in the materials sector on Friday, a welcomed change for a group that has suffered mightily at the hands of Europe's debt contagion. In the past month, the iShares Dow Jones US Basic Materials ETF (IYM) and the Materials Select SPDR (XLB) are down about 12% while the Market Vectors Coal ETF has been thrashed to the tune of 20%. All three were up at least 2.46% on Friday.

In terms of individual materials names, Bucyrus (BUCY) was up almost 6% while Cliffs Natural Resources (CLF) and Joy Global (JOYG) gained almost 7%. The materials sector was so strong that even embattled Massey Energy (MEE), whose executives were on Capitol Hill earlier this week attempting to atone for the Upper Big Branch mine tragedy, gained almost 4%. Not to be outdone was one of my old favorites, Freeport McMoRan (NYSE: FCX). Freeport gained 5.3% on Friday, but that does not hide the fact that the stock was flirting with $90 in early April. The shares closed at $67.01 on Friday now reside almost exactly in the middle of their 52-week range.

Freeport McMoRan

Financials were another sector seeing some relief on Friday. The Senate passed its version of the financial reform bill on Thursday night, putting Congress on the doorstep of passing the most substantive reforms for this industry in seven decades. The House and Senate must reconcile their bills and press reports are saying Democrats hope to have the bill on President Obama's desk by early July.

Financials' move higher on Friday was a case of markets liking clarity mixed in with some buying in yet another sector that may qualify as oversold. Bank of America (BAC), JPMorgan Chase (JPM) and Goldman Sachs all traded higher by at least 3.3% on Friday despite the fact that this bill does propose a host of tighter controls on the banking industry.

At the least industry now knows reform is imminent and the market can price that into these stocks if it has not done so already. The House version of the bill seeks to collect $150 billion in fees from banks for use in liquidating a failed financial version, but at their core, both the House and Senate versions are attempting to make sure if another Lehman Brothers scenario occurs, the failed institution will not roil markets the way Lehman's collapse did.

The Senate bill does place tighter restrictions on proprietary trading, a major source of revenue firms like Goldman and JPMorgan, and other speculative activity and instruments like credit default swaps, so it may have been surprising to see that financials were the biggest gainers among the S&P 500's 10 industry groups on Friday. At the end of the day, the banks know what they have to deal with and that was apparently worth something on Friday. Shares of Mastercard (MA) were even upgraded by Oppenheimer to ''buy'' from hold'' following the news and that helped the stock gain 4.1% on the day.

XLF Chart

Adding to the Friday cheer was some mergers and acquisitions news. I guess the companies involved could not wait a few more days to announce the news on Merger Monday, but that is their pregogative and by Friday, the market could have used good news in any form. Sanford C. Bernstein published a research note at the end of 2009 indicating that global M&A activity would pick up by about 35% this year and while I am not sure exactly what the pace is on a percentage basis thus far in 2010, M&A activity has been brisk and is rebounding from a recession-induced decline.

M&A Activity

On Friday, Abbott Laboratories (ABT) said it would acquire India's Piramal Healthcare, a generic drug producer, for $3.7 billion. Abbott will pay $2.12 billion to start then $400 million a year for four years. Acquiring Piramal makes Abbott the top pharmaceutical firm in India, Asia's second-fastest growing economy and the second-largest country in the world by population, with a 7% market share. The company expects $8 billion in sales from India this year and for that total to double by 2015.

Abbott will use some of its free cash to fund the purchase and the company said it did not expect the transaction to affect earnings estimates. This is Abbott's second major international purchase this year after acquiring Belgium's Solvay Pharmaceuticals for $6.2 billion in February, another purchase aimed bolstering Abbott's presence in emerging markets. Emerging markets now account for about 20% of Abbott's sales.

Most of the major European and North American pharma companies are pushing their way into emerging markets these days. A smart and necessary move given increased competition from generic pharmaceuticals firms, weak new product pipelines and the long list of expiring patents big pharma companies have to contend with.

Abbott Chart

In other M&A news, auto parts maker Johnson Controls (JCI) offered $1.25 billion for rival Visteon (VSTNQ). Notice the ''Q'' in the ticker there. That means Visteon is currently in Chapter 11 bankruptcy. Johnson Controls said the deal, if an accord is ever reached, would help it boost its presence in China.

Visteon is apparently leery of the offer, saying information on critical details is lacking and it could just be a way for Johonson Controls to drag a vulnerable rival out of bankruptcy. Visteon call the offer ''highly conditional and vaguely defined.''

Visteon said it has had ''difficult'' dealings with Johnson Controls in the past and that it is possible that the latter is trying to muck up the former's bankruptcy proceedings, which according to Visteon are at a critical point. I never thought of the auto parts sector as one with a flair for the dramatic, but that may be changing.

Johnson Controls Chart

Another sector benefiting from the ''it may finally be time to do some buying'' theme was the oil services group. Diamond Offshore (DO) was another name that Oppenheimer upgraded on Friday, helping the shares gain almost 4%. Oppenheimer said the recent tumble by oil services names ''could represent a buying opportunity.'' That helped the Oil Services HOLDRs ETF (OIH) jump $2.70, or 2.68%, to $103.52. The ETF has lost more than 20% since the April 20 explosion at the Deepwater Horizon rig in the Gulf of Mexico.

OIH Chart

In earnings news, semiconductor maker Marvell Technology (MRVL) added $1.48, or 8.3%, to settle at $19.32 after the company reported firs-quarter results that handily beat Wall Street estimates. The maker of circuits used in the BlackBerry mobile device also surprised investors by forecasting second-quarter revenue of $900 million to $930 million, well above the Street estimate of $864.8 million. Marvell said new products from BlackBerry maker Research In Motion (RIMM) are helping drive second-quarter growth.

Marvell Chart

Looking at the charts, it looks like the lows brought about by the May 6 flash crash acted as support on Friday because the major U.S. indexes did open lower and it looked like Friday was going to be another bloody day. In fact, the Dow was down by triple digits early in the session before reversing course. Friday's gain was still not enough to get the Dow back above its 200-day moving average at 10,262, which is likely the next resistance point.

From there, previous support levels that we previously discussed are likely to turn into new resistance. I am talking about 10,350, 10,500, 10,750, etc. Of course that assumes that the bulls are ready to take control again. If the Dow does not hold above 10,000, I would still be looking at 9850-9875 as I mentioned on Thursday.

Dow Chart

Similar comments can be made about the S&P 500. The 1100 area faltered as support, but the index was able to move above 1085 yesterday. Assuming that old support area turned into new resistance, it was a positive sign to see the index move back above that level. Now 1100 needs to be dealt with again. The S&P 500 had some problems just over 1100 in January, but took out that resistance relatively easily in March, but I am not betting on an easy road back to 1200 this time around.

The best thing that can be said about the index's behavior on Friday is that a bounce of 1065 was seen and 1050 was never in question.

S&P 500 Chart

At least the Nasdaq was able to reclaim its 200-day line on Friday, though it is probably little compensation for tech bulls that have been punished mightily in recent weeks. I am very apprehensive about suddenly turning bullish on tech just because of one decent day and even if the Nasdaq can find its way back above 2250, the index is going to face formidable resistance at various points if it hopes to add another 100 points from there. Overall, if the market weakens against next week, I still think 2185 is going to come into play.

Nasdaq Chart

As for small-caps, I noted on Thursday that the Russell 2000 needed to find support at its 200-day line or risk being punished even more. Well, the index did bounce off that area, around 628, and closed just below 650, which could prove to be a new resistance point. I would be very cautious around the 650 area on the Russell 2000. No matter how you slice it, the index gained just over 1% on Friday after shedding more than 5% on Thursday and that is not a bullish two-day trend.

Russell 2000 Chart
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We all know the old expression that stocks do not move up in a straight line and they do not always fall without some faint attempts by the bulls to stop the declines. The selling was probably a tad overdone heading into Friday and there were some headlines for stocks to benefit from, along with an options expiration day. I am going to wait for confirmation that a real rally is starting again before changing my tone. As I said earlier, unless oil starts to firm up, any move higher for equities could be short-lived.


New Plays

Long and Short Candidates

by Scott Hawes

Click here to email Scott Hawes


NEW BULLISH Plays

MetroPCS Communications - PCS - close 8.39 change -0.15 stop 7.80

Company Description:
MetroPCS Communications, Inc. (MetroPCS) is a wireless telecommunications provider. The Company offers wireless broadband mobile services under the MetroPCS brand in selected metropolitan areas in the United States over its own licensed networks or networks of entities, in which the Company holds a substantial non-controlling ownership interest. The Company provides a variety of wireless communications services to its subscribers on a no long-term contract, paid-in-advance, flat-rate, unlimited usage basis. As of January 2010, it offers service plans on a flat-rate basis inclusive of applicable taxes and regulatory fees. As of December 31, 2009, the Company had over 6.6 million subscribers. (source: company press release or website)

Target(s): 9.00, 9.25
Key Support Areas: 8.18, 8.05, 7.85
Key Resistance Areas: 8.62, 8.90
Time Frame: 1 to 2 weeks

Why We Like It:
PCS has shown relative strength while the overall market has declined in recent weeks. There was major volatility during the flash crash in this stock which appears to have shaken out the weak hands. The stock has responded nicely since and bounced off of its 20-day SMA on Friday. I'm playing for a bounce in PCS along with the overall market and I suggest readers initiate long positions if PCS retests its lows from Friday near $8.20. If the market bounces from here I think PCS is poised to retest its recent highs, which are near our targets of $9.00 and $9.25. We'll use tight a stop at $7.80, which is below a gap fill from 5/10 to 5/11. I also like the 2:1 risk/reward set-up of this trade: we are risking 40 cents to make 80 cents, and possibly $1.05.

Suggested Position: Long PCS stock at if it trades down near $8.20

Annotated Chart:

Entry on May xx
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 9.6 million
Listed on 5/22/10, 2010


NEW BEARISH Plays

Royal Caribbean - RCL - close 28.34 change +0.58 stop 31.50

Company Description:
Royal Caribbean Cruises Ltd. (Royal Caribbean) is a cruise company. As of December 31, 2009, it operated 38 ships in the cruise vacation industry with approximately 84,050 berths. The Company owns five cruise brands, Royal Caribbean International, Celebrity Cruises, Pullmantur, Azamara Club Cruises, and CDF Croisieres de France. In addition, Royal Caribbean has a 50% investment in a joint venture with TUI AG, which operates the brand TUI Cruises. Its cruise brands primarily serve the contemporary, premium and up-market segments of the cruise vacation industry. The Company’s ships operate worldwide in approximately 400 destinations. Royal Caribbean has offices in the United Kingdom, Germany, Norway, Italy, Spain, Singapore, China, Brazil and Australia.

Target(s): 25.05, 24.05
Key Support Areas: 27.40, 25.00
Key Resistance Areas: 28.85, 29.80
Time Frame: Several Weeks

Why We Like It:
RCL has been pummeled over the last couple of weeks and I believe there is more downside in the stock's future. The stock has broken an upward trend line that started on 7/8/09 and is ever so close to breaking its longer term upward trend line that started on 3/3/09. I suggest readers take advantage of the weakness and initiate short positions on any bounces or if the stock trades down to $27.35 first. Ideally I would like to see RCL rally to close the gap down from 5/19 to 5/20 near $29.70. This would provide an ideal entry point for a short position which is near its recent down trend line and would also constitute a back test of the broken upward trend line previously mentioned. A slightly lower entry point could also be $28.85 which is near the highs of the past 2 days. If RCL breaks below $27.38 (Friday's low) I believe the stock should see $25.05 in short order which is our first target. Our second more aggressive target is $24.05. Our initial stop will be $31.50 and our time frame is several weeks.

Suggested Position: Short RCL stock if it trades up near $29.70, or if it trades to $27.35 - whichever occurs first.

Option Traders:
Suggested Position: Buy JUNE $28.00 PUT, current ask $2.10

Annotated chart:

Entry on May xx
Earnings More than 2 months (unconfirmed)
Average Daily Volume: 4.5 million
Listed on May 22, 2010


In Play Updates and Reviews

Patience Pays Off for DPS Entry

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:

Good evening. Last week was extremely volatile which forced us to close most positions in our portfolio due to targets and stops being hit. The volatility is making things extremely difficult to manage and also making our time in the trades quicker than we anticipated. But the volatility also brings opportunity with it. We are biased more to the long side, at least early this week, as I am anticipating a relief rally in the markets. I am in the camp that we will be in a trading range for several weeks if not months and that we are currently in the bottom of that range. In the S&P 500 I think 1,050 to 1,115 or slightly higher is the shorter term range to focus on. Please feel free to email me with any questions.

Current Portfolio:


BULLISH Play Updates

EMC Corp. - EMC - close 17.96 change +0.28 stop 16.95

Target(s): 18.20, 20-day SMA, 18.70
Key Support Areas: 17.65, 17.55, 17.45, 17.10
Key Resistance Areas: 17.80, 18.00, 18.50, 18.85
Current Gain/Loss: +1.18%
Time Frame: 1 to 2 weeks
New Positions: Yes, on weakness with a tight stop

Comments:
EMC gapped down with the rest of the market on Friday but immediately rebounded and closed near its highs of the day, +1.58% higher. The stock is now battling its long term pivot level dating back to June of 2007 at $18.00. EMC is finding support on a trend line that began with the 9/3/09 lows to 2/5/10 lows, and finally the flash crash lows on 5/6/10. But the stock still faces overhead congestion like many others. If EMC can get over $18.00 we should hit our first target at $18.20. Our more aggressive second target has been lowered to $18.70 which is just below the stock's 50-day and 20-day SMA's. I've also listed the 20-day SMA as a target and urge readers to exit positions or tighten stops if the stock trades anywhere near this level to protect capital and protect against a reversal. EMC could trade up to its 50-day SMA if the bounce in the overall market can continue this week. With the extreme up and down volatility and oversold conditions we could easily see a continued short covering rally creating a sharp move higher and if that happens we need to be taking profits.

Current Position: Long EMC Stock, entry at $17.75.

Annotated chart:

Entry on May 20, 2010
Earnings Date: More than 2 months (unconfirmed)
Average Daily Volume: 25 million
Listed on 5/19/10


Dr. Pepper Snapple Group - DPS - close 36.27 change -1.80 stop 32.49

Target(s): 36.80 (hit), 37.95
Key Support Areas: 35.75, 34.40, 32.70
Key Resistance Areas: 36.93, 37.45
Current Gain/Loss: +3.44%
Time Frame: 1 to 2 weeks
New Positions: Only on a pullback

Comments:
Our patience paid off as DPS gapped lower at the open right at our trigger of $35.5. This is right where we wanted to enter near the 20/50-day SMA's. We are now long the stock. DPS immediately reversed and actually traded through our first target of $36.80. For readers who have positions I encourage you to use tight stops on this trade and be a seller into strength to protect against a reversal and to protect profits. The stock has good support with its 20-day and 50-day SMA's below. Our second and final target is $37.95. Our time frame is 1 to 2 weeks and our stop remains at $32.49. This is an overall relative strength play which should do well if the bounce on Friday continues in the overall market. But I still view this as an aggressive trade so please keep your position size small since the market has been so volatile.

Current Position: Long DPS stock at $35.50.

Annotated chart:

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


General Electric - GE - close 16.42 change +0.16 stop 15.94

Target(s): 17.00, 17.45, 18.25
Key Support Areas: 16.25, 16.00
Key Resistance Areas: 16.80, 17.20, 17.80, 18.00
Current Gain/Loss: -3.41%
Time Frame: Several weeks
New Positions: Yes, on weakness with a tight stop

Comments:
GE gapped opened significantly lower on Friday and below our stop. When this happens I have a rule for exiting positions if the stock has an opening gap up or down through, or very close to stops. For long positions here is my rule of thumb: If a stock gaps down below the stop that has been established, wait for the first 15 minutes of trading before doing anything. Then place a new protective stop just under the low of that first 15 minutes of trading. Reverse the entire scenario for shorts. The reason I do this is because I want to measure the real strength or weakness in the stock. I don’t want a Good Til Cancelled (GTC) stop to be unnecessarily triggered at the open because often times stocks gap and reverse immediately, which keeps us in the position and looking for a better exit. In GE’s case this worked perfectly on Friday and kept us in the position. GE closed above its 200-day SMA but still looks vulnerable here. The stock is now going to have to battle the key pivot level of $17.00 dating back to September 2008. We're hanging on by a thread here and it is do or die time for GE and the market in general. I'm looking for the bounce off of Friday's lows to continue and I urge readers to be careful. I suggest selling into strength or tightening stops if GE gets up to the $17.00 level. This is our first target which is breakeven on the trade. Our nest target is $17.45 which is near highs from September 2009. We'll keep our stop at $15.94.

Current Position: Long GE Stock at $17.00.

Annotated chart:

Entry on May 19, 2010
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 88 million
Listed on 5/18/10, 2010


BEARISH Play Updates

NONE. ALL SHORT POSITIONS CLOSED DURING THURSDAY's MARKET WEAKNESS.