Option Investor
Newsletter

Daily Newsletter, Wednesday, 6/2/2010

Table of Contents

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

Market Wrap

Home Sales & Analyst Upgrades Fuel Market Bounce

by James Brown

Click here to email James Brown

The markets looks pretty ugly on Tuesday afternoon as stocks appeared headed for their late May lows. Thankfully trader sentiment seemed to change early this morning. Better than expected pending home sales, strong auto sales numbers, positive analyst comments on some oil service stocks, and expectations for this Friday's jobs report all played their part in Wednesday's very widespread market rebound. Not one major sector index closed in negative territory. The S&P 500 index surged 2.5% back toward short-term resistance near the 1100 level. The NASDAQ gained 2.6% with a bounce from its 200-dma. The Dow Jones Industrial Average rallied 2.2% with a move up toward its 200-dma. The small cap Russell 2000 index outperformed with a 3.0% gain.

Chart of the S&P 500 index:

Chart of the NASDAQ index:

Chart of the Russell 2000 index:

The rally got started early this morning overseas in Asia. News that Japan's Prime Minister Hatoyama would resign after eight months on the job briefly sent the Japanese NIKKEI index shooting higher. The Japanese yen declined on this news with a big drop against the dollar. Hatoyama is the fourth Japanese PM to resign after being in the office for less than a year. The NIKKEI's rally didn't last and the index eventually lost 1.1%. The Hong Kong Hang Seng gained +0.17% and the Chinese Shanghai inched up +0.12%.

Traders in Europe remain cautious. All eyes are on the euro currency, which rebounded from yesterday's four-year low against the dollar at $1.211. Spain's consumer confidence numbers saw their biggest decline on record with a drop from 78.2 in April to 65.1 in May. Big budget cuts by the government combined with a 20% drop in the stock market over the last several weeks was too much for consumers that are already facing a real estate depression and 20% unemployment. Spain's Ibex index fell 0.3%. The English FTSE dropped 0.23%, The French CAC-40 slipped 0.05% and the German DAX index closed virtually unchanged.

The U.S. dollar index was virtually unchanged in spite of the movement in the euro and yen. Commodities managed to inch higher anyway. Crude oil futures rose 1.1% to $73.40 a barrel. Copper prices opened lower this morning but closed up 0.6% by day's end. Gold traded sideways and closed at $1,225.10 an ounce. The individual commodities may not have moved that much but the commodity-related stocks certainly did. Oil and oil service stocks were big movers with the OIX oil index up 3.3% and the OSX oil services index soaring 5.5%. Even shares of BP rebounded 3.1% while their emergency efforts to plug the leak hit another snag. The spinning diamond-tipped saw blade to cut through the main pipe was snagged this morning. Fueling the move in oil services were bullish analyst comments on shallow-water drillers since the administration has put a hold on new deep-water drilling.

OIX Oil Index chart:

OSX Oil Services Index chart:

Steel stocks were big performers with the SLX steel ETF up 7.1%. I'd like to blame the big May sales numbers released by automakers this morning but I doubt it. Short covering across the commodity names is a more realistic explanation. The SLX certainly looks like it has hit a short-term bottom. On the subject of auto sales, this morning's numbers were pretty impressive. Domestic auto manufacturers and most of the Asian producers saw double-digit sales gains in May. Government Motors, err excuse me, General Motors saw a 17% rise in sales. Chrysler reported a 33% jump in sales making May 2010 the first month in over two years the company sold more than 100,000 vehicles (source: Reuters). Ford announce a 22% increase in sales and said they would up production since inventory had fallen to a 48-day supply. A normal supply is 60-days. Ford also made big news today when the company announced it would retire the 71-year old Mercury brand at the end of this year. Honda said sales grew +19%, Hyundai +33%, Nissan +25%, Subaru +35%, Kia Motors +21%. The laggard was Toyota Motor Co. with a +7% gain.

SLX - Steel ETF chart:

If vehicle sales were this strong in May then expectations for retail sales may have just jumped. Several of the major chain store will report their May same-store sales figures tomorrow morning. It should be a really easy month to beat since same-store sales fell more than 4% back in May 2009 thus year-over-year comparisons should be a cinch. U.S. consumer confidence numbers are near two-year highs. Yet the month of May was the worst May in decades and volatile stock markets tend to put consumers on the defensive. Tomorrow will actually bring multiple economic reports. We'll see the weekly jobless claims data (likely ignored), monthly factory orders but this will be overshadowed by the ISM Services index and the ADP Employment report. The ADP numbers do not count government hiring but economists are still expecting a big improvement.

According to John Challenger, the CEO of Challenger, Gray & Christmas, planned firings inched up 1.3% in May to 38,810 from a multi-year low of 38,326 in April. Essentially planned firings for corporate America have fallen to "pre-recession" levels. A year ago the number of planned layoffs was 111,182. All of the clues appear to be pointing to a pretty strong jobs report this Friday. Expectations have been inching higher. Two weeks ago economists were looking for +480,000 new jobs in May. A week ago it was +503K. Now it's up to +513,000 and they expect the unemployment rate to fall from 9.9% to 9.8%.

The real question is going to be how many of these jobs are temporary census jobs and how many are private sector jobs. This morning the U.S. Census said they had 573,779 workers on their payroll but we don't know how many of these are going to be counted for May's jobs report. Analysts are focusing on private-sector jobs and the number to look for is +150,000 or better. There is a big possibility that the afternoon surge higher in the stock market on Wednesday was due to short covering ahead of the jobs report. We can thank Vice President Biden for that. It seems like the White House has already got a look at the May non-farm payrolls number since Biden let slip this afternoon that Friday's report would be "well beyond" the last report. If this is the case, and traders are covering shorts ahead of the jobs number because the number has been leaked, then the market could actually see a "sell-the-news" reaction on Friday morning unless it really surprises to the upside.

I'm a little surprised that traders didn't "sell-the-news" on the pending home sales report this morning. Economists were looking for +5% rise in sales. The National Association of Realtors said April's numbers came in at +6%. Everyone knows that buyers were rushing to get under contract on a house before the end of April to qualify for the expiring homebuyer tax credit. This is a temporary, artificial spike in sales. The trend in sales is going to reverse with April likely to be the peak.

Traders may want to take a look at the financial sector. Energy and financials are two of the biggest chunks of the market and both saw very strong gains today. The banks (+3% on Wednesday) got a boost thanks to positive comments out of BAC and word that JPM had been upgraded to a "buy". Bank of America's (BAC) CEO Brian Moynihan was optimistic about the economy. He felt that charge-offs may have peaked and there was improvement for loan demand. Brian also reiterated that BAC does not have any significant exposure to Europe. Shares of BAC gained 2.98% and look ready to challenge resistance at its 200-dma. JPM gained 2.6% on the session. Both the BKX and BIX banking indices are trying to find a bottom near prior resistance and what should be support. I think this sector is worth a look for a short-term trade.

Chart of the BIX banking index:

The problems in Europe remain but the market sell-off that began in late April appears to be a little exhausted. There are several economic releases tomorrow but unless the numbers are truly horrible the focus will remain on Friday's non-farm payrolls (jobs) report. The S&P 500 looks like it has a good chance of breaking out past the 1100 level on Thursday and that should spark even more short covering ahead of the jobs report. Friday morning could be volatile but I'm going to stick my neck out and suggest the major indices are poised for a multi-day advance. The fact that stocks seem to be holding above their February 2010 lows is a positive sign. One trader suggested we're in the "eye of the storm" for the next two to three weeks. June is the end of the quarter. After a punishing May, mutual fund managers are going to want to dress up their portfolio for the quarter end. Thus we could see some significant window dressing over the next couple of weeks. If the S&P 500 can close 1100 and its 200-dma then the next level of significant resistance is probably the 1130 level and then the 1150 level.


New Plays

Oil and Technology

by Scott Hawes

Click here to email Scott Hawes


NEW BULLISH Plays

ProShares Ultra Crude Oil - UCO - close 9.62 change +0.36 stop 8.90

Company Description:
ProShares Ultra DJ-UBS Crude Oil seeks daily investment results that correspond to twice (200%) the daily performance of the Dow Jones—UBS Crude Oil Sub-Index (the Index). The Index, a sub-index of DJ—UBS Commodity Index, is intended to reflect the crude oil segment of the commodities market. The Index consists of futures contracts on crude oil only. The Index is valued using the settlement prices for the underlying futures contracts.

Target(s): 10.00, 10.50, 10.95
Key Support/Resistance Areas: 9.00, 9.25, 9.70, 10.05, 10.30, 10.80
Time Frame: 1 week

Why We Like It:
UCO (and Crude Oil Futures) made a double bottom with yesterday's and today's lows. It also appears oil is making a higher low on the daily chart and I believe the commodity is poised to move higher from here. I would like to use $9.50 as an ideal entry point and have listed multiple targets above that can be used to exit positions. The 20-day SMA will most likely provide some resistance and is near our 1st target of $10.00. Ultimately I think UCO has a lot more room to run but we will take profits when the opportunity presents itself and look for better entries. Our initial stop will be $8.90 which is below the gap from 5/26 to 5/27. *NOTE: UCO is leveraged fund and with it comes volatility. Using a small position size to limit risk is recommended. I also view this as an aggressive and quick trade that may only last a few days.

Suggested Position: Long UCO at current levels or if it trades down near $9.50.

Annotated Chart:

Entry on June xx
Earnings Date 7/22/10 (unconfirmed)
Average Daily Volume: 7.8 million
Listed on 6/2/10


Quest Software - QSFT - close 19.26 change +0.58 stop 18.40

Company Description:
Quest Software, Inc. (Quest) designs, develops, markets, distributes and supports enterprise systems management software products. The Company’s primary portfolio of software products includes software solutions grouped into four categories: Application Management, Database Management, Windows Management and Virtualization Management. In addition to perpetual software licenses, it sells time-based software licenses wherein customers pay a single fee for the right to use the software and receive maintenance for a defined period of time. It also provides support, maintenance and implementation services for these products. Its segments include Licenses and Services. The Licenses segment develops, and markets and sells licenses to use, software products. The Services segment provides post-sale support for software products and fee-based training and consulting services related to its software products. In December 2009, the Company acquired PacketTrap Networks, Inc.

Target(s): $19.60, 20.50, 21.00
Key Support/Resistance Areas: 18.60, 19.36
Time Frame: Several weeks

Why We Like It:
QSFT is relative strength play that is involved in virtualization software and cloud computing, among other things. These stocks have done extremely well as the market has been under pressure over the past month. QSFT has recently broken out of a resistance level near $18.60 which has acted as support the last couple of days. The stock made new all time highs on 5/19 and if the market can continue its bounce from today I expect QSFT to make new highs again. I have also noticed unusual option activity picking up in the July strike prices and above average volume, both bullish signals. I would like to see QSFT pullback near the $19.00 level which we will use as a trigger to enter long positions. With all of that said I want to keep a tight leash on the trade with a stop at $18.60 to protect capital if things reverse lower. I am also choosing a $20.00 out of the money call option to limit capital at risk.

Suggested Position: Long QSFT stock if it trades down near $19.00

Option Traders:
Suggested Position: Buy July $20.00 CALL, current ask $1.10, estimated ask at entry $1.00

Annotated Chart:

Entry on June xx
Earnings Date 8/10/10 (unconfirmed)
Average Daily Volume: 1.9 million
Listed on 6/2/10


In Play Updates and Reviews

Back on Track

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:

Good evening. Our positions moved in the right direction today, but now we need follow through to the upside. We are positioned for a continued bounce possibly into next week. And I plan to have more short candidates soon. I am also listing several targets and support/resistance levels in our trades to help readers better manage positions. My goal is to help readers protect profits at critical levels which is essential considering the current market volatility.

Current Portfolio:


BULLISH Play Updates

Cypress Semiconductor - CY - close 11.43 change +0.32 stop 10.85 *NEW*

Target(s): 11.70, 11.95, 12.25, 12.95
Key Support/Resistance Areas: 12.40, 12.00, 11.75, 11.40, 11.00, 10.75
Current Gain/Loss: +2.05% Time Frame: 1 to 2 weeks
New Positions: Yes

Comments:
CY double bottomed with yesterday's lows and then surged higher. The stock also broke its intraday downtrend line and then back tested it. All of thiws is bullish and I am expecting follow through from here. I've raised our stop to $10.85 which is just below CY's 200-day SMA. This will protect our capital in case there is a reversal. I've also listed another target at $11.70 which is just below a resistance area listed above. This is a prudent place to consider tightening stops or taking profits.

Current Position: Long CY stock at $11.20

Option Traders:
Suggested Position: Buy July $11.00 CALL

Entry on 6/1/2010
Earnings Date 7/22/10 (unconfirmed)
Average Daily Volume: 4.7 million
Listed on 5/29/10


Diana Shipping, Inc - DSX - close 13.66 change +0.35 stop 12.90

Target(s): 14.00, 14.35, 14.75
Key Support/Resistance Areas: 15.00, 14.40, 14.15, 13.50, 13.25, 13.00
Current Gain/Loss: +1.19%
Time Frame: 1 to 2 weeks
New Positions: Yes

Comments:
DSX closed right on its 20-day SMA today and if it can break through I expect this trade to produce nice returns. Ultimately, $14.35 is our original target which is just below the stock's 50, 100, and 200-day SMA's. This is the area I will be looking to take profits. The stock also has resistance at $14.15 which is why I have also listed $14.00 as a lower target. I would expect some resistance here and is also a good place to tighten stops.

Current Position: Long DSX stock at $13.50

Option Traders:
Suggested Position: Buy July $12.50 CALL

Entry on 5/28/10
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 1.4 million
Listed on 5/27/10, 2010


K12 Inc - LRN - close 25.15 change +0.12 stop 23.65 *NEW*

Target(s): $27.35, 28.25
Key Support/Resistance Areas: 25.35, 24.40, 24.00
Time Frame: 1 to 2 weeks

Comments:
LRN remains strong and we are patiently waiting to be triggered. My comments from last night remain the same. We moved up the lower trigger to enter to $24.70 and move up the stop to $23.65 to protect capital. The new lower trigger is 1 penny above Tuesday's lows. LRN is a relative strength play that continues to make higher lows despite the recent weakness in the market. I am looking for LRN to break out above its recent highs and then test its prior highs from 2007 and 2008, which are near our targets of $27.25 and $28.25. The stock's volume has been increasing in recent weeks as the price has been increasing which signals accumulation and may indicate institutional money is being put to work in LRN. This is normally a bullish indicator. We'll use one of two triggers to enter long positions. If LRN trades down near $24.70 or if it trades up to $25.50 which would be the highest print of the past 52 weeks. Our stop will be $23.65 which is below the LRN's 20 and 50-day SMA's. *NOTE: LRN's average volume is about 200,000 shares. Therefore I consider this an aggressive trade so please use proper position size to manage risk.*

Suggested Position: Long LRN stock if it trades down near $24.70 or up to $25.50, whichever occurs first.

Entry on June xx
Earnings Date 9/9/10 (unconfirmed)
Average Daily Volume: 200,000
Listed on 5/29/10


Rino International - RINO - close 12.61 change +0.69 stop 11.70

Target(s): 13.25, 13.65, 14.00, 14.50, 15.95, 16.90
Key Support/Resistance Areas: 15.00, 14.50, 13.75, 12.75, 11.75
Current Gain/Loss: -0.71%
Time Frame: Several weeks
New Positions: Yes, with a tight stop

Comments:
RINO seems to have found its footing and I expect the stock to follow through higher from here. There are several targets listed above readers can use as a guide to exit positions or tighten stops. I'm eyeing $13.65 as a potential stall point for RINO but if the broader market continues higher we could see a nice rally in RINO. $13.65 is a logical place to at least tighten stops or take some profits off of the table. Fundamentally, RINO trades at a low PE ratio of about 5 and I think there is a lot of room to for this stock to run.

Current Position: Long RINO stock at $12.70

Option Traders:
Suggested Position: July $12.50 CALL

Entry on May 27, 2010
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 926,000
Listed on 5/25/10, 2010


BEARISH Play Updates

NONE. PRGO CLOSED ON TUESDAY, SII CLOSED TODAY (see below).


CLOSED BEARISH PLAYS

Smith International, Inc - SII - close 37.70 change +3.25 stop 35.75

Target(s): 34.55 (hit), 33.60, 32.15
Key Support/Resistance Areas: 42.00, 40.90, 39.00, 37.00, 34.00
Current Gain/Loss: -0.70%
Time Frame: 1 to 2 weeks
New Positions: Closed

Comments:
No harm no foul is about all I can say about this trade. A lesson to be learned is to honor our targets and stops. After hitting our first target yesterday afternoon SII reversed hard this morning. We kept the trade open trying to squeeze more out of it, but it wasn't meant to be. It was very apparent in early trading this morning that honoring our stop and stepping aside was the right thing to do. So we are out of the trade for small loss. *NOTE: I view this trade as aggressive so please use proper position size to manage risk.

Closed Position: Short SII stock at $35.95, entry was $35.70; For options traders: Long July $37.00 PUT at $3.35, entry at $3.30

Annotated Chart:

Entry on 6/1/2010
Earnings 7/28/10 (unconfirmed)
Average Daily Volume: 7.6 million
Listed on May 29, 2010