Option Investor
Newsletter

Daily Newsletter, Wednesday, 5/26/2010

Table of Contents

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

Market Wrap

Was that the bottom?

by John Gray

Click here to email John Gray
Yesterday's strong rally after a gap down move to support at 1040 (SPX) was impressive. It's unclear to me whether it was short covering or genuine buyers who perceived a rare buying opportunity. In reality, it was probably a little of both. At any rate, it was welcome relief for embattled bulls who have been bludgeoned unmercifully by the manic selling and high volatility over the past three weeks.

Futures continued to trudge higher overnight and opened positively this morning along with bourses around the globe. Sentiment was helped this morning at 8:30 AM when the U.S. Census Bureau reported that Durable Goods sales in April surged $5.6 billion (2.9%) to $193.9 billion, the fourth increase in the last five months. March was revised to no change. The surge was led by Transportation.

Later in the morning the Commerce Department reported that New Home Sales rose 14.8% in April to their highest level since May, 2008. New homes sales are up 47.8% compared with a year ago. This number needs to be taken with a grain of salt because much of the surge could be credited to the government's tax credit which has now expired. Toll Brothers shares jumped by 3% after reporting a narrower than expected loss and the company saying that new orders have increased by 41%.


Toll Brothers

All eyes will be focused on the Gulf of Mexico over the next two days as BP begins the so-called "Top Kill" procedure in an attempt to stop the flow of oil from the ruptured well. In a memo released to Congress BP admitted that there were a "series of underlying failures" and that there were "indications of very large anomalies". It is not clear who was responsible for failure to act on these warnings. Everybody is pointing their fingers at the other guy. The Obama Administration is catching an enormous amount of flak from both the left and the right. The White has vowed to keep "a boot on the neck of BP". Suffice it to say that BP shareholders are not enjoying this fiasco.


BP PLC

Mark Hulbert, who writes a newsletter that tracks the sentiment of market-timers (among other things), has noticed an interesting phenomenon. In the short span of 13 trading days the market-timers' that he tracks have gone from full-blown bullish to full-blown bearish. Prior to May 6th, most were recommending an 80% exposure to equities (the highest level since 2000). Now, they are recommending a MINUS 45% exposure to equities. In other words, they are recommending that their clients remain in short positions. What makes this so unusual is that in previous market tops most advisory services continued to remain stubbornly bullish well past the time that it was obvious that they were wrong. In a strange, contrarian sort of way, this could actually be interpreted as bullish since these guys are rarely right at the top or the bottom.

The European Union proposed today that member states should establish "bank resolution funds" which would be used to pay for the orderly wind down of any future failed banks. This would be paid for by a levy on the banks. The proposal was a little short on details i.e. how it was to be collected or how big the fund needed to be. This comes on the heels of the US Senate's recently-passed financial reform legislation which contains similar language. Its purpose, of course, is to avert the type of meltdown Lehman's bankruptcy caused.

While we are on the subject of the financial reform legislation, one of the provisions contained therein is a ban on so-called "proprietary trading" by banks. This, of course, refers to banks speculating and trading with their own funds as opposed to trading their client's funds. This is aimed at about five or six of our largest banks that are heavily involved in this practice. Probably the largest "offender" is Goldman Sachs.


GS

In a May 26, 2010 article in the Huffington Post staff writer Shahien Nasiripour reported the following: "Of the 63 trading days in the three-month period ending in March, Goldman Sachs generated revenue of at least $25 million on EVERY SINGLE DAY, according to its latest quarterly filing with the Securities and Exchange Commission. On three of every five days, Wall Street's most profitable firm, generated revenues exceeding $100 million trading stocks and bonds, and creating and entering into derivatives contracts". How about you? Did you do that well? When you combine Goldman's assets with those of the other behemoths, is it any wonder that they can control the market? Do you see why these guys drive Keene and me into a state of apoplexy?


Trading Revenue

Just because we have not had another crisis du jour out of Europe(that seems to roil the markets on a daily basis), does not necessarily mean that all is calm on our eastern flank. Reports out of Europe indicate that the French and the Brits are furious with Germany about the ban on "naked" short sales. First, they are annoyed that Germany took the action unilaterally without consulting them and, secondly, they don't believe the move will accomplish anything (and I agree). In fact, the Brits have let it be known that if anybody wants to short German bonds they are welcome to do it on the British Exchanges. This is not exactly what I would call Continental unity.

As I opined last week, the solution to Europe's sovereign debt problem is not to just keep moving debt from one balance sheet to another. As painful as it may be, debt destruction is the only answer and that may, indeed, involve a period of deflation. Todd Harrison (Minyanville) had this to say on the subject: "There are two alternative forward paths: On the one side, debt destruction, asset class deflation and an outside-in globalization once the dust settles. On the other, we continue to give the global drunk another drink with hopes that he does not sober up. The sad truth is that one day he will, and our children will be forced to pick up the bar tab if we do not change our ways soon". Of course, he includes the United States in this (as well he should).

Gold continues to climb today and it looks like it wants to retest its high on May 12th and May 14th at 1250. A strong dollar is not deterring its advance.


Gold

Let's have a look at the charts and see if they give us any clues about what lies ahead. First, let's examine the SPX chart. We got a big gap up opening that peaked at 1090.75 about 10:40 AM. It retreated from that level and traded sideways for most of the day. I would anticipate that SPX will encounter stronger resistance at 1104 (200 DMA) and again at 1107 (50% retracement). If the bulls can successfully breach those levels I would look for more resistance to appear at 1115 (January's opening print) and 1122 (62% retracement). And lastly, the 50 DMA is at 1165. It dropped below this average on the "Flash Crash" on May 6th. It tested it from underneath the following Monday and promptly fell away. If the bulls can overcome all these obstacles, it would clear the way for new highs. It is a pretty daunting task in my opinion.


SPX

The Russell 2000 (RUT) has been something of a curiosity to me. Fund managers keep buying these small caps in the face of these uncertain times. Usually one would expect the funds to be rotating into the more liquid large caps. Either they know something I don't know, or they are not very bright. Unlike the others, the RUT has not dropped below its 200 DMA (yet). Today it gapped up (with the rest) and hit a high of 657.95 when the markets peaked just before 11:00 AM. I would expect stronger resistance at 667 (50% retracement) and even stronger resistance at the 678-685 area. The one thing I'm fairly certain of is that if the rest of the markets take dump RUT will not be far behind.


Russell 2000

And finally, the granddaddy of them all - the DOW. It jumped up today and hit 10,178.88 before retreating. Above at 10,283 lies its 200 DMA. If it does not stub its toe there, it will surely encounter some strong head winds at 10,357 (50%). Above 10,500 the DOW must contend with the previously broken 20 DMA (10,591) and its 50 DMA (10,830). I'm not saying the bulls can't do it, but it's a steep hill to climb.


DOW

Yesterday's strong rally off the lows, and today's continuation of the rally did not surprise me. The markets have gone from obscenely overbought in late April to grossly oversold (now). An oversold bounce (aided by short covering) is to be expected. However, I think it would be unwise to heed the advice that the cheerleaders in news media offer so freely. I am of the opinion that we had a major trend change in early May. A more likely strategy for profits going forward will be shorting the rallies - not buying the dips. Having said that, I would also caution that bear markets (if that's what we have entered) are not easy to trade either. They are characterized by sharp (sometimes vicious) rallies so you must remain ever-vigilant. Unless you are Goldman Sachs you can't make money every day of your life. The only thing us mortals can do is try to win more than we lose.

Remember, the markets are closed on Monday in observance of Memorial Day. Have a good long weekend.


New Plays

Long and Short Candidates

by Scott Hawes

Click here to email Scott Hawes


NEW BULLISH Plays

Rino International - RINO - close 12.38 change +0.84 stop 10.50

Company Description:
RINO International Corporation is engaged in the business of designing, manufacturing, installing and servicing wastewater treatment and flue gas desulphurization equipment for use in China's iron and steel industry, and anti-oxidation products and equipment designed for use in the manufacture of hot rolled steel plate products. The Company has three principal products and product lines: the Lamella Inclined Tube Settler Waste Water Treatment System, the Circulating, Fluidized Bed, Flue Gas Desulphurization System and the High Temperature Anti-Oxidation System for Hot Rolled Steel. The Company's sole business activities are acting as a holding company of its direct and indirect subsidiaries, Innomind Group Limited, RINO Investment (Dalian) Co., Ltd. (RINO Investment), Dalian RINO Heavy Industries Co., Ltd. (RINO Heavy Industries) and Dalian Innomind Environment Engineering Co., Ltd. (Dalian Innomind).

Target(s): 14.50, 15.95, 16.90
Key Support Areas: 11.75, 11.50, 11.20
Key Resistance Areas: 12.75, 13.75
Time Frame: Several weeks

Why We Like It:
RINO has taken out to the woodshed recently and I believe it due for a turnaround. The appears to have found support in the $10.75 area which dates back to prior support in August 2009 and prior resistance in June of 2008. The stock bounced nicely off of this yesterday and followed through nicely today gaining +7.28% In addition, the stock trades at a ridiculously low PE ratio of about 5. I think there is a lot of room to for this stock to run and I suggest readers take advantage of the building momentum. I'm going to place an initial wide stop at $10.50 which is below the key support level, but it will be adjusted as the trade develops. I think we can make $2 in this trade but there could be some volatility so please use proper position to manage risk.

Suggested Position: Long RINO stock at current levels

Option Traders:
Suggested Position: Buy July $12.50 CALL, current ask $1.45

Annotated Weekly Chart:

Entry on May xx
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 926,000
Listed on 5/25/10, 2010


NEW BEARISH Plays

Perrigo Company - PRGO - close 58.10 change +2.06 stop 62.55

Company Description:
Perrigo Company is a global healthcare supplier that develops, manufactures and distributes over-the-counter and prescription pharmaceuticals, nutritional products, active pharmaceutical ingredients, and pharmaceutical and medical diagnostic products. The Company operates in three segments: Consumer Healthcare, Rx Pharmaceuticals and API. The Company has other category that consists of the Israel Pharmaceutical and Diagnostic Products. The Company operates through wholly owned subsidiaries. In the United States, its operations are conducted through L. Perrigo Company, Perrigo Company of South Carolina, Inc., Perrigo New York, Inc., Perrigo Holland, Inc. and Perrigo Florida, Inc. Outside the United States, its operations are conducted through Perrigo Israel Pharmaceuticals Ltd., Chemagis Ltd., Quimica y Farmacia S.A. de C.V., Laboratorios Diba, S.A., Wrafton Laboratories Limited, Brunel Pharma Limited and Galpharm Healthcare Ltd.

Target(s): 54.30, 53.10, 51.80
Key Support Areas: 56.80, 56.00, 54.25
Key Resistance Areas: 59.50, 60.50
Time Frame: 1 to 2 weeks

Why We Like It:
There is no doubt PRGO has been a strong performer as of late but I think the stock has seen its best days, at least for the time being. PRGO printed a reversal bar today which was near its 50-day SMA from below. It also appears the stock may be trying to put in a lower high. PRGO is below its 20 and 50-day SMA which should act as good resistance. I am looking for PRGO to retest its recent lows near $54.30 about -6.50% lower from it current price levels. I suggest we take advantage of the volatility in this stock and initiate short positions.

Suggested Position: Short PRGO stock at current levels or if it trades up to $58.90.

Annotated chart:

Entry on May xx
Earnings More than 2 months (unconfirmed)
Average Daily Volume: 1.3 million
Listed on May 22, 2010


In Play Updates and Reviews

Big Gains Booked Today

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:

Good evening. We closed 4 long positions today on strength in the market. The net gain on those closed positions was +16.75%. Our big winner was PCS which gave us a +9.75% gain. As a result, our model portfolio has narrowed significantly. In this volatile environment we are releasing trades for quick profits and picking precise entry and exit points. Cash is also a position and protecting capital is not a bad idea. I've released a new long and short candidate that I think have potential, again for quick trades.

Current Portfolio:


BULLISH Play Updates

Console Energy - CNX - close 35.06 change +0.25 stop 32.95

Target(s): 37.50, 38.80
Key Support Areas: 33.90
Key Resistance Areas: 35.75, 37.55
Time Frame: 1 to 2 weeks

Comments:
CNX gapped open higher but then sold off with the market in the afternoon. We are waiting patiently for our entry near $34.05. My comments remain the same from the play release. I believe the sell off in coal stocks was overdone and they appear to be building momentum for a move higher. CNX double bottomed with lows on Friday and Monday and has responded nicely. The stock also has longer term support dating back to resistance in late 2008 (see weekly chart below). I would like to see some retracement in the recent gains and use $34.05 as a trigger to enter long positions. Our initial stop will be $32.50 which is just below 5/20 and 5/24 lows (pull up a daily chart). Our targets of $37.50 and $38.80 are both below the stock's 20 and 50-day SMA's and also below the recent downtrend line. This is a countertrend trade that has potential but I also view it as aggressive and quick so please use small position size to manage risk.

Suggested Position: Long CNX stock if it trades down near $34.05

Option Traders:
Suggested Position: Buy July $35.00 CALL, current ask $3.20, estimated ask at entry $2.80

Entry on May xx
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 7.0 million
Listed on 5/25/10, 2010


BEARISH Play Updates

Royal Caribbean - RCL - close 27.96 change +0.22 stop 31.50

Target(s): 27.80
Key Support Areas: 27.38, 25.00
Key Resistance Areas: 28.00, 28.85, 29.80
Current Gain/Loss: +3.68%
Time Frame: 1 or 2 days
New Positions: No

Comments:
RCL traded down to its 200-day SMA today and bounced nicely today. Although the stock closed only -0.61% on the day, it closed +6.2% off of its lows. I'm sure short covering had something to do with this but how things can change so drastically in a matter of hours is beyond me, so we must deal with the circumstances. I suggest readers be cautious and prevent this trade from turning into a loser. My fear at this point is that RCL may rally all the way up to fill the gap down between 5/19 and 5/20. I suggest we place a tight stop at $28.45 and just get out of the way for a small profit if this is hit. I also want to list a lower target at $27.80 which is just above today's close.

Current Position: Short RCL stock at $28.80

Option Traders:
Suggested Position: Buy JUNE $28.00 PUT

Entry on May 24
Earnings More than 2 months (unconfirmed)
Average Daily Volume: 4.5 million
Listed on May 22, 2010


CLOSED BULLISH PLAYS

Dr. Pepper Snapple Group - DPS - close 37.29 change +0.18 stop 35.95

Target(s): 36.80 (hit), 37.00 (hit), 37.50 (hit), 37.95
Key Support Areas: 37.15, 36.90, 36.50, 35.75, 34.40, 32.70
Key Resistance Areas: 37.70
Final Gain/Loss: +5.63%
Time Frame: 1 to 2 weeks
New Positions: Closed

Comments:
DPS has hit our first 3 targets and I do not want to push our luck any further. The stock almost traded up to our final target today but reversed 11 cents shy of it. But we still have a nice +5.63% gain and are flat at $37.50. DPS traded above this level most of the day giving ample opportunity to exit. For readers who still have positions please protect profits and do not let this reverse on you. I have listed multiple support levels above that can be used to place tight stops.

Closed Position: Long DPS stock at $37.50, entry was at $35.50

Annotated Chart:

Entry on: May 21
Earnings Date: More than 2 months (unconfirmed)
Average Daily Volume: 1.9 million
Listed on: May 8, 2010


General Electric - GE - close 16.01 change +0.06 stop 15.94

Target(s): 16.25 (hit), 17.00, 17.45, 18.25
Key Support Areas: 16.00, 15.65
Key Resistance Areas: 16.25, 16.80, 17.20, 17.80, 18.00
Final Gain/Loss: -3.82% Time Frame: Closed
New Positions: No

Comments:
GE gapped open at $16.35 which was above our lowered target so we are now flat on the position for a loss of -3.82%. The trade simply didn't work and I consider it good riddance. We'll move on to better opportunities. Our winners today more than compensated for this loss. I do not see much support immediately below here so I urge readers who may still have positions to be careful. $16.00 and $15.65 are two levels to keep an eye on.

Closed 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


Kinross Gold Corp - KGC - close 16.90 change +0.06 stop 16.06

Target(s): 17.25 (hit), 17.75
Key Support Areas: 16.90, 16.45, 16.25
Key Resistance Areas: 17.25, 17.95
Final Gain/Loss: +5.18% Time Frame: 1 to 2 weeks
New Positions: Closed

Comments:
KGC gapped higher today and hit our first target of $17.25 so we are flat the position for a nice +5.18% gain. The stock traded up to $17.35 and spent the first 2 hours of trading oscillating above and below $17.25. When the stock could not close bars above previous bars it was a clue to get out. Also, the gold miners ETF GDX started to unravel so we honored the target and booked our profit. This may be setting up for another long entry if KGC trades back down near our original entry price. For readers who still have positions the above support levels can be used as tighter stops to protect profits.

Closed Position: Long KGC stock at $17.25, entry was at $16.40

Option Traders:
Suggested Position: Buy JUNE $16.00 CALL

Annotated Chart:

Entry on May 25, 2010
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 7.2 million
Listed on 5/22/10, 2010


MetroPCS Communications - PCS - close 8.77 change +0.33 stop 7.80

Target(s): 9.00 (hit), 9.25
Key Support Areas: 8.65, 8.45, 8.18, 8.05, 7.85
Key Resistance Areas: 8.62, 8.90
Final Gain/Loss: +9.76% Time Frame: 1 to 2 weeks
New Positions: No

Comments:
Wow, what a day for PCS! Yesterday the stock traded in a tight range for 3 hours at our entry price of $8.20 before breaking out in the afternoon. Today, the stock gapped higher and catapulted up to hit our target of $9.00, not once but twice. After the double top was made the stock sold off but still closed +3.91% on the day. I mentioned last night that taking profits when you have a chance is a must. And making almost 10% on this play provided the perfect opportunity for us to take profits. For readers who still have positions PCS has intraday support at $8.65 and $8.45. I suggest tightening stops to protect profits.

Closed Position: Long PCS stock at $9.00, entry was at $8.20

Annotated Chart:

Entry on May 25
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 9.6 million
Listed on 5/22/10, 2010