Option Investor
Newsletter

Daily Newsletter, Wednesday, 6/9/2010

Table of Contents

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

Market Wrap

Oversold Bounce Has Reversed

by James Brown

Click here to email James Brown

Market Stats for 06/09/10:

Wednesday turned out to be rather disappointing for investors. Stocks initially rallied on strong economic data out of China, generally positive comments from Fed chairman Ben Bernanke, and another round of improvement in the Beige book report. The U.S. markets were up 1% midday, the Dow Industrials traded back above the 10,000 mark, and the energy sector helped lead the way with a 2% rally. Unfortunately the oversold bounce ran out of steam. The euro's early strength failed near resistance. Geopolitical risks remain high. Shares of oil giant BP sank on fears of potential bankruptcy. Energy stocks reversed to close down over 1%.

Foreign markets were mostly higher by day's end. A government official in China disclosed that the country's exports for May 2010 were up +50% from last year's levels and the number new loans were significantly higher than expected. Economists were looking for a +32% jump in exports. This better than expected export number eased fears that the global economy was stalling, especially given the low-growth environment in Europe. The sharp rise in new loans alleviated some concern that China's actions to slow down their economy had not gone too far. The Chinese Shanghai index rallied 2.7% after hitting new one-year lows yesterday. The Shanghai is still off 18.4% from its April highs. The Hong Kong Hang Seng index gained +0.69% for the session and remains more than 11% off its 2010 highs. The Japanese NIKKEI index underperformed to close at six-month lows.

Stock market gains were widespread in Europe. Yesterday the British market was hammered after credit rating agency Fitch issued cautious comments about Britain's debt burden and budget deficits. This was not new information and England's FTSE index recovered with a 1.1% gain on Wednesday. Banks were showing leadership after a Citigroup analyst issued positive comments for European banks and suggested that bank dividends in Europe are poised to rise significantly. France's second largest bank Societe Generale SA also made headlines after the company said recent rumors about their derivative losses in the second quarter are unfounded. They are not expecting any "bad surprises" this quarter. The French CAC-40 rallied 1.96% for the day. Germany's DAX index managed a 1.98% gain for the session. The DAX has shown the most relative strength amongst its peers over the last several weeks with the German market only down -5.4% versus -12.7% for the FTSE. Yet movement in the DAX has been very volatile with huge whipsaws up and down since April. I suspect today is more of an oversold bounce and short-covering move. European stocks have been down three days in a row so today's move looks like a reaction to strength in banks and the Chinese export news. Traders remain on the defensive against new regulations with both French President Nicolas Sarkozy and German Chancellor Angela Merkel trying to convince European Commission President Barroso to impose an EU-wide ban on naked short-selling of stocks and bonds.

The euro currency remains the proxy for investor sentiment regarding Europe's chances to solve their debt problems. Unfortunately the early morning strength in the euro faded with a failed rally near the $1.20 level against the U.S. dollar. Naturally the dollar moved the opposite direction with a sharp move lower this morning only to rebound from prior resistance (now new support). Commodities like copper gapped open higher, presumably on the China news, but faded lower throughout the day on the dollar's intraday strength. Gold hit some profit taking with a $10 drop to $1,235.00 an ounce after hitting a new high on Tuesday. Crude oil bucked the trend in the dollar and managed a 2.7% gain to $73.91 a barrel. Ben Bernanke issued comments that EU's problems wouldn't have a big impact on the U.S. Now combine this with the China's strong exports and suddenly investors were more optimistic about demand for oil. Plus, it didn't hurt that oil supplies fell more than expected. The Energy Department reported their weekly oil inventory data this morning. Economists were expecting a drop of 1.3 million barrels but the report showed a decline of 1.8 million barrels.

Chart of the U.S. dollar ETF (UUP):

Chart of the Euro ETF (FXE):

There were multiple economic releases today. The biggest one was the Federal Reserve's monthly Beige Book report, named for the color of its cover. This morning's report showed improving economic activity across all 12 Federal districts, which is an improvement. Last month (April) the St. Louis district did not show any growth. The pace of growth in May was considered moderate and the Fed made note that negative headlines from Europe has raised the level of uncertainty for our own economy. The report also showed that inflation remained under control, which should allow the Fed to keep interest rates low for the foreseeable future. Meanwhile Federal Reserve Chairman Ben Bernanke spoke before the House Budget Committee today. His comments that EU's challenges would not have much impact on the U.S. economy helped fuel the rally this morning. I do want to point out that Bernanke stated an economic "double dip" in the U.S. could not be "ruled out".

The other economic reports today was the wholesale inventories data and the MBA mortgage applications report. Wholesale inventories rose +0.4% in April, which continues the trend for March (+0.7%) and February (+0.6%). Sales continue to outpace inventory growth as April sales rose +0.7%. The stock to sales ratio slipped -0.1% to an all-time low of 1.13. The MBA purchase applications index is another clear indicator that the real estate market is slowing down now that the tax credit has expired. Mortgage purchase applications fell -5.7% from a week ago, which pushes the four-week change to -35%. Refinancing applications plunged -14.3% in spite of 30-year fixed rate mortgage rates hovering under 5%.

Fueling the market decline this afternoon was weakness in the financials and the energy sector. Investors have a wait-and-see attitude on the banks as we wait for the latest version of the financial reform bill. The White House, Senate and the congressional leaders are all trying to shape the biggest reform for the banking industry since the 1930s. Former Federal Reserve chairman and current White House advisor Paul Volcker made headlines this morning with his comments that the next version of the bill will probably have the "Volcker rule". This rule limits proprietary trading at big banks, limits their sponsorship of hedge funds, and limits their growth to avoid a too-big-to-fail scenario.

Oil stocks were probably a bigger drag on the market and the strength in crude oil provided no help today. One analyst suggested that BP might be forced into bankruptcy as soon as a month from now over costs and liabilities associated with the oil spill in the Gulf of Mexico. The markets are also concerned that BP may have to cut or eliminate their cash dividend to pay for the spill. Today's 15% plunge in shares of BP pushed the stock under the $30.00 mark. Shares are down 21% this week and down 50% from their highs near $60 when the leak occurred. Anadarko Petroleum (APC) only has a 25% stake in the leaking well but shares fell more than 18% today. APC was trading near $75 prior to the leak and closed under $35 today. The political rhetoric against BP has risen to hurricane levels, which only adds to the selling pressure on the stock. Average volume on BP is normally about 47 million shares a day. Today BP traded over 241 million shares. Combine today's oil sector weakness with Goldman Sachs' downgrade of the oil drillers yesterday and you can see it hasn't been a good week for energy stocks.

Chart of BP:

Technicals on the market don't look so good. It's easy to argue that stocks are oversold but just because they're oversold is not a reason to buy. The S&P 500 is down -13.3% from its closing 2010 highs. When we get into the -15% to -20 levels investors start to worry that stocks have moved into a bear market. If you are feeling optimistic then today's bounce near 1040 in the S&P 500 could be a possible bullish double bottom or at least a bounce from a new 1040-1100 trading range. Unfortunately, the oversold bounce failed under 1080 near the descending 10-dma. Bears could argue that the S&P 500 is coiling for a breakdown and a new move lower. If the 1040 level breaks then we are looking at drop toward the 1,000 level or even 950, which should be strong support. The 1,000 level would line up closely with the 38.2% Fibonacci retracement of the bounce from early 2009 and the 940-950 area is close to a 50% retracement.

Weekly Chart of the S&P 500:

Daily Chart of the S&P 500:

The Dow Jones Industrial Average has a similar pattern with a bounce on Tuesday near the May lows and the same bearish reversal near the simple 10-dma this afternoon. If the DJIA breaks down under support near 9750 I think we're headed for the 9400 area. Today's decline leaves the DJIA about 11.6% off its 2010 highs.

Chart of the Dow Jones Industrials:

The tech-heavy NASDAQ has underperformed both the S&P 500 and the DJIA with a 14.7% correction from its 2010 highs. Yesterday's bounce from the 2140 level has reversed and the index looks poised to hit new relative lows soon. The next level of support is the 2100 level, which was the low back in February.

Chart of the NASDAQ Composite:

The small cap Russell 2000 index has gone from outperformance during the spring rally to underperformance during the sell-off. The $RUT is off -16.7% from its 2010 highs and we're getting close to bear-market territory, which is traditionally -20% or more. The intraday rally reversed at technical resistance near the simple 200-dma. If the downtrend continues we're probably looking at the next level of support near 580 and the February low.

Chart of the small cap Russell 2000 index:

In summary the path of least resistance is still down. Stocks appear to be coiling for a breakdown into a new leg lower. Tomorrow's economic data with the trade balance report and the weekly initial jobless claims will probably not offer any market support. Investors remain very concerned over Europe's inability to solve its debt problems. A recent Bloomberg poll showed that 73% of investors expect Greece to default on its debt in spite of all the aid it has received. Until stocks quit reacting to negative news out of Europe we're going to have trouble sustaining any stock market gains.

Traders should remain concerned about the geopolitical risks simmering around the world. The United Nations Security Council just voted 12-to-2 in favor of imposing new sanctions against Iran. The countries of Turkey and Brazil voted against the measure with Lebanon choosing to abstain from the vote. A Bloomberg article said this is the fourth round of sanctions against Iran since 2006 and today's sanctions are designed to "restrict financial transactions" and further tighten the arms embargo including seizure of any cargo related to Iran's missile or nuclear technology.

There is still a chance the market could bounce on window dressing as we near the quarter end on June 30th but I wouldn't bet on it. I don't see any significant reasons for investors to buy stocks. The disappointing jobs data a few days ago reinforced the idea that the U.S. could roll over into a double-dip recession. We may not get any clarity on how corporate America is doing until second quarter earnings season begins in July.

- James


New Plays

Short Index Play

by Scott Hawes

Click here to email Scott Hawes


NEW BEARISH Plays

iShares Russell 2000 - IWM - close 63.75 change +0.04 stop 49.15

Company Description:
iShares Russell 2000 Index Fund (the Fund) seeks investment results that correspond generally to the price and yield performance of the Russell 2000 Index (the Index). The Index measures the performances of the small-capitalization sector of the United States equity market. The Index is a float-adjusted capitalization-weighted index of equity securities issued by the approximately 2,000 smallest issuers in the Russell 3000 Index.

Target(s): 60.75, 59.50, 58.75
Key Support/Resistance Areas: 63.30, 62.60, 61.50, 60.70, 58.00
Time Frame: 1 to 2 weeks

Why We Like It:
IWM is ready for a move lower to at least test recent lows but I think it could go all the way down to the $58.00 area which is below our 3rd target for this trade. The stock is barely hanging on to its lowest closing price since February. It also printed a reversal bar at the 200-day SMA today which give us a good reference point to place a tight protective stop just above at $63.75. I would like to see IWM retrace some of this afternoon's decline and will use $62.30 as an ideal entry point. If IWM is weak at the open traders may also consider entering positions, especially if the index can not trade above its opening range. This trade could be quick so I urge readers to protect profits if IWM is moving in our direction.

Suggested Position: Short IWM stock

Option Traders:
Suggested Position: Buy July $61.00 PUT, current ask $2.93

Annotated chart:

Entry on June xx
Earnings N/A (unconfirmed)
Average Daily Volume: 101 million
Listed on June 9, 2010


In Play Updates and Reviews

PXD Closed For Nice Gain

by Scott Hawes

Click here to email Scott Hawes

Editor's Note: Good Evening. PXD hit all of our targets in early trading today so we are flat the position for a +8% gain. Stocks look vulnerable here. Tomorrow's open is going to be interesting. If we break down I urge traders to exit long positions quick as the selling could easily intensify. I also suggest traders be smart with short positions and protect profits as things can reverse quickly. If I am wrong and the markets surge higher all of this needs to be considered in reverse. Stay nimble and please email me with any questions.

Current Portfolio:


BULLISH Play Updates

Direct TV - DTV - close 37.70 change +0.09 stop 35.70

Target(s): 38.20, 38.50, 39.50, 41.50
Key Support/Resistance Areas: 38.60, 37.00, 36.30
Current Gain/Loss: N/A
Time Frame: Several weeks
New Positions: Waiting to be triggered

Comments:
My comments from last night remain the same. I am going to shift gears on this trade and lower our trigger to enter long positions to the rising 50-day SMA near $36.50. It feels like DTV wants to trade down there so lets limit our risk in the trade and pounce on the stock if it gets there. The 50-day SMA is currently $36.40 but is rising.

Suggested Position: Long DTV stock if it trades down near its 50-day SMA, currently near $36.50

Option Traders:
Suggested Position: Buy July $37.00 CALL, current ask $1.91, estimated ask at entry $1.40

Entry on June xx
Earnings Date 8/5/10 (unconfirmed)
Average Daily Volume: 12.3 million
Listed on 6/5/10


Petroleo Brasileiro SA - PBR - close 37.56 change +0.46 stop 35.90 *NEW*

Target(s): 38.50, 39.25, 39.95
Key Support/Resistance Areas: 37.45, 36.25
Current Gain/Loss: -0.24%
Time Frame: 1 week
New Positions:

Comments:
PBR gapped up just above our entry target at $37.52 and then pulled back into the $37.65 range which is where we initiated long positions. The stock proceeded to gain over $1 and our position was up +2.6% but PBR proceeded to give it all back late in the day. The candlestick pattern formed has me concerned and is considered a reversal pattern. I suggest conservative traders sell positions or use a tight stop to limit risk. However, if you believe the selling in oil stocks is overdone PBR gives you a great chance to capitalize on some gains. This is why. PBR remains above the ascending triangle resistance in the $37.25 to $37.50 area that should now act as support. In addition, the stock gained +1.24% on the day while the remainder of the market, including oil stocks, experienced losses. PBR has also been one of the best performers of the integrated oil companies recently. With all of this said we still must be prudent and capital so I would like to raise the stop a bit to $35.90 which will give us some leeway if there is a further pullback. I'm also listing a target to just below today's highs at $38.50 which is a good place to tighten stops. PBR could even trade back up to this level by the end of the week. Nonetheless tomorrow will be interesting.

Current Position: Long PBR stock at $37.65

Option Traders:
Suggested Position: Buy July $37.00 CALL

Entry on June xx
Earnings Date 8/13/10 (unconfirmed)
Average Daily Volume: 19.6 million
Listed on 6/8/10


Quest Software - QSFT - close 18.58 change -0.20 stop 18.10

Target(s): 19.60, 20.00, 20.50, 21.00
Key Support/Resistance Areas: 18.40, 18.60, 19.36, 20-day SMA, 50-day SMA
Current Gain/Loss: -2.21%
Time Frame: Several weeks
New Positions: Yes

Comments:
QSFT is not cooperating and has all of a sudden become an underperformer and technology stocks in general seem to have shifted gears. QSFT gapped up higher today and quickly sold off the remainder of the day. For options traders we chose out of the money calls to limit capital at risk for this very reason. We still have some time to see if QSFT turns around so let's stick with the set-up and see if the stock can get some legs here. The stock closed below the recent breakout of resistance at $18.70 which are highs from April, January, and October that I thought would act as support. I urge readers to be sellers into any strength as the week comes to an end by trailing and tightening stops if the QSFT rallies. Our stop remains at $18.10 which is just below its 50-day SMA. This may be a little to close to the 50-day SMA so the overall market strength or weakness should be considered if QSFT is trading down at this level. If there is a bar that closes below $18.10 I would suggest placing the stop below the low of that bar to see if the stock can reverse.

Current Position: Long QSFT stock at $19.00

Option Traders:
Suggested Position: Buy July $20.00 CALL

Entry on June 7, 2010
Earnings Date 8/10/10 (unconfirmed)
Average Daily Volume: 1.9 million
Listed on 6/2/10


BEARISH Play Updates

Aeropostale, Inc. - ARO - close 28.75 change +0.81 stop 29.55

Target(s): 27.30, 27.00, 26.35, 25.25
Key Support/Resistance Areas: 29.35, 28.50, 27.50, 27.00, 26.30, 25,00
Current Gain/Loss: -1.95%
Time Frame: 1 to 2 weeks
New Positions: Yes

Comments:
Retailers were strong today but that will change in a hurry if the market is weak tomorrow. Technically ARO retraced 61.8% of the down move from its highs on 6/3 to its lows on 6/8 and then reversed. It also has printed a reversal bar with a topping tail off of its 50-day SMA. All of this bodes well for our position and I am expecting ARO to test its 200-day SMA in the coming days, which is near our $26.35 target. I've also listed a target at $27.30 which is just above yesterday's lows as a possible target to exit positions or tighten stops. If we go lower from here we will have a nice profit so please protect profits if ARO melts down. Our stop is $29.55 which is above the recent congestion area and above the 50-day SMA.

Current Position: Short ARO stock, entry was at $28.20.

Option Traders:
Suggested Position: Buy July $27.00 PUT

Entry on June 8, 2010
Earnings 8/19/2010 (unconfirmed)
Average Daily Volume: 3.3 million
Listed on June 7, 2010


Bank of Nova Scotia Halifax - BNS - close 46.77 change +0.07 stop 49.15

Target(s): 46.30, 45.15, 44.05, 42.50
Key Support/Resistance Areas: 49.00, 48.30, 48.00, 47.50, 46.30, 45.00
Current Gain/Loss: +1.74%
Time Frame: 1 to 2 weeks
New Positions: Yes, but only on bounces

Comments:
BNS gapped up above our trigger to enter short positions so we waited for the stock to break below the opening range and then initiated short positions. This is the same gap rule we've using recently when stocks gap up or down or near stops and entries. That was the confirmation that showed the stock was weak. After BNS broke down that was all she wrote. The stock proceeded to lose about dollar and I expect more downside from here. One thing to keep an eye on is that BNS may be forming an inverse head and shoulders pattern on its hourly chart with the right shoulder at $46.30. This is also near its 200-day SMA and the stock could get a bounce near this level. I do expect more downside but I also urge readers to protect profits. I've adjusted our targets slightly and also listed a raised target which is near the stock's recent closing prices. These are the areas where stops need to be tightened to protect against a reversal. I'll leave my comments from the play release as they remain valid. BNS is in a downtrend and I am looking for the stock to rally up near its 20-day SMA in the coming days and make another lower high. The stock is finding buyers near the $45.00 area but this will should eventually wane after the market bounces. The stock has barely been hanging on to its 200-day SMA and I expect BNS to eventually break it and trade down to new lows. I would like to use a trigger to enter short positions if BNS trades up near $47.40. This is near a prior support/resistance area dating back to December that I think will hold. Our stop is $49.15 which is above the highest closing price since May 17th. Readers may also consider initiating short positions at current levels or if the stock trades below $46.00 but this is a decision to be made intraday depending on market conditions.

Current Position: Short BNS stock at $47.60

Option Traders:
Suggested Position: Buy July $45.00 PUT

Entry on June 9, 2010
Earnings 8/26/2010 (unconfirmed)
Average Daily Volume: 685,000
Listed on June 8, 2010


CLOSED BULLISH PLAYS

Pioneer Natural Resources - PXD - close 63.95 change +1.65 stop 61.48 *NEW*

Target(s): 64.50 (hit), 64.90 (hit), 66.00 (hit), 66.80 (hit)
Key Support/Resistance Areas: 61.50, 60.00, 59.00
Current Gain/Loss: +8.09%
Time Frame: 1 to 2 weeks
New Positions: Closed

Comments:
PXD was extremely bullish this morning and traded right through all of targets so we are out for a nice gain of +8.09%. I hope readers took profits on this trade as my comments from last night were fairly accurate. If not, the position still has a +4.47% gain as of yesterday's close so please protect profits. I'll leave my comments from last night. I'm expecting PXD to follow through with the bounce tomorrow but I urge readers to protect profits as the bounce may be short lived if the broader market begins to roll over. I would keep a keen eye on the first 15 minute trading range and trail stops up if PXD trades higher. If the stock trades lower I would be quick to book a profit. The above targets are still valid as exit areas and I have also listed $64.90 which is just below today's high. For readers who will not be able to monitor the position I suggest placing a stop at $61.48 which will protect against a hard reversal if things go lower tomorrow. This will limit your losses to about 32 cents if our targets our not hit tomorrow.

Closed Position: Long PXD stock at $66.80, entry was at $61.80

Annotated chart:

Entry on June 8, 2010
Earnings Date 7/28/2010 (unconfirmed)
Average Daily Volume: 6.4 million
Listed on 6/5/10