Option Investor
Newsletter

Daily Newsletter, Saturday, 6/12/2010

Table of Contents

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

Market Wrap

Paradigm Shift

by Jim Brown

Click here to email Jim Brown

Last week saw a major paradigm shift in investor sentiment due to the sudden burst of good economic news from around the world. Maybe we are not headed off the cliff as analysts thought.

Market Statistics

The economic reports on Friday provided a mixed picture once again. The retail sales for May fell -1.2% after posting a +0.6% increase in April. Sales fell sharply at building materials stores (-9.3%) motor vehicles and parts (-1.7%) and gasoline stations (-3.3%). The furniture sector was the only real gainer at +1.0%. This was the first decline in total sales since September. The decline in the headline number was driven by that big decline in building materials. The decline in building materials was due to the April 30th deadline for the homebuyer tax credit.

The decline in all sectors pretty much confirms a lower forecast for the next couple months. Sales in early Q2 were very strong heading into that tax deadline and there is nothing on the horizon to boost sales again until the back to school surge. Until job losses begin to decline we are not likely to see sales rise.

Weekly jobless claims refuse to decline with 456,000 last week. Claims have hit a plateau at 450,000 per week with spikes to 475,000. This is not a sign of a strong economy. We need to see those claims decline to about 300,000 per week for job gains to stick.

Strangely, despite the high jobless claims the first reading of Consumer Sentiment for June rose to 75.5 and the highest level since January 2008. The present conditions and expectations components both rose +1.9 points. Consumers continue to complain they are depressed but sentiment is slowly creeping higher although it is still at normal recessionary levels. Survey respondents actually lowered their estimates for future inflation from 3.2% to 2.7%. On the positive side gasoline prices are not going up as they normally do this time of year.

Consumer Sentiment Chart

I pointed out a week or so ago that the Weekly Leading Index had collapsed. The predicted annualized growth rate is now -3.5% and this was the first week in negative territory since June 2009. This was the fifth weekly decline in the index and the growth rate and nine of the last ten weeks were declines. Continued weakness in the WLI suggests the recovery is in trouble.

Inventory replenishment was responsible for more than half of the GDP gains in prior quarters and that replenishment cycle has completed its initial rebound and should slow to a more normal trend. The main drag on the WLI and the economy will remain jobs. We are already getting estimates for the June jobs report and the numbers are coming in around a loss of 200,000 jobs.

Weekly Leading Index Chart

There are several major reports on the economic calendar for next week. The NAHB Housing Market Index on Monday should give us an idea how badly the housing market plunged when the tax credit expired. Nevada Senator Harry Reid is facing a tough reelection campaign and he said on Friday he will introduce a bill next week to extend the tax credit through September. This is aimed at people who are having trouble getting closed because banks are dragging their feet on short sales. It is unknown what criteria he will put on the bill and if he will reopen it for new purchases. You can bet other senators will want some of the vote getting fame that would come with another revision to the homebuyer tax credit.

The Producer Price Index and Consumer Price Index will be released and the Fed will be looking for signs of inflation OR deflation in the reports. The CPI is expected to decline another -0.2% and be right on the verge of deflationary. The producer price index is expected to decline by -0.5%.

These reports are a primary reason Bernanke and his ECB counterpart Jean Claude Trichet have pretty much confirmed interest rates are going to remain near zero for a long time. They would rather fight inflation than deflation and with Europe and the U.S. weakening there is no reason to raise rates.

The Philly Fed Manufacturing Survey is on Thursday and it has been rising slowly. Analysts will be looking to see if that trend can continue.

Economic Calendar

The FDIC closed Washington First International Bank in Seattle on Friday bringing the total of banks closed in 2010 to 82. Last year 140 banks were closed compared to 25 in 2008 and three in 2007. However, the FDIC said they expected the number of failing banks to top out in the third quarter.

BP can't get a break. The administration is ramping up its grandstanding attack on BP and trying to force BP to defer its pending dividend. The talk over a potential bankruptcy is increasing daily. Louisiana is already preparing a post BP bankruptcy plan to deal with the remaining cleanup. However, there are rumors that the Gulf States are going to pursue criminal claims if BP did file bankruptcy because criminal acts can't be limited in a bankruptcy.

President Obama talked with British Prime Minister David Cameron at 11:AM on Saturday to try to cool U.S.- U.K. tensions. The talk reportedly lasted 30 minutes and went well according to reports. Both leaders issued press releases that attempted to tone down the animosity. Obama reiterated that BP will be responsible for the cleanup and for compensating the tens of thousands of people who have lost money due to the spill.

The BP board is scheduled to meet on Monday to discuss whether or not to defer the 84-cent dividend. Millions of Britons depend on the BP dividend for income. It is the most widely held dividend paying stock in Britain.

The median estimate for the current oil flowing from the well is now 30,000 bpd. That would equate to a $130 million government fine PER DAY until the well is capped. Goldman Sachs is now claiming that the worst-case cost to BP for the cleanup could be in the range of $70 billion.

BP claims it will be able to capture up to 25,000 bpd sometime next week and up to 40,000 bpd by July. By all estimates this is a phenomenal well and it is a real shame BP will not get to produce it. The relief wells will kill it and BP claims they won't drill it again because it has run unchecked for too long and has probably ruined the long-term flow rate. However, I would not doubt that someone else will eventually acquire the lease from BP and eventually produce oil from this formation. There could be a huge bankruptcy sale in BP's future.

BP's CEO, Tony Hayward, is meeting with the president for a butt kicking session on Wednesday and testifying before Congress on Thursday. You can bet he is not looking forward to next week. This is going to be a media circus. The president will be making speeches about his meeting and lawmakers will be fighting for face time interrogating Hayward like starving mongrels over a piece of meat. The Hayward testimony will be the equivalent of a public flogging.

BP Chart - Weekly

The big news last week was the surge in business around the world. China reported a 50% surge in exports for May compared to May 2009. Imports surged +48%. Most analysts now believe China is growing somewhere around a 12% rate and even if they successfully slow the economy it may only drop back to 9%. If China's exports are surging so strongly then business much be good in the countries receiving those goods.

Brazil said its Q1 GDP roared at +9% and the highest GDP growth rate since the IBGE started tracking the GDP figures in 1995. It also was the fourth consecutive quarter of growth. Brazil's planning minister said the estimates for full year GDP growth had risen to 6%. Latin America is also on a growth spurt but somewhat less than Brazil's.

The BRIC countries plus Latin America account for more than 50% of the global GDP and India, China, Brazil and Latin America are all streaking ahead of the OECD countries like the U.S. and Europe.

The U.S. is still expected to grow by 3% for all of 2010 according to Bernanke last week. Europe is mixed but it still expected to break even or possibly show some growth despite the austerity measures in the weaker countries.

If more than half the global economy is surging at two to three times the rate of the OECD then the other half should not be able to retard the overall growth. This fact was echoed numerous times last week as various analysts repositioned their forecasts for the next year.

It was announced late Friday that port traffic in California is exploding. The Long Beach port reported incoming container traffic jumped +25% in May and empty containers heading back to Asia jumped by 35%. That is a positive sign because it suggests there is higher demand for empty containers in Asia. The Los Angeles port saw a 20% jump in import traffic and a 58% jump in empty outgoing containers. Exports jumped by 15%. More than 40% of all U.S. imported products come through the LA port.

These numbers are very positive indicators of U.S. consumption and goods trafficking. You may remember back in 2008 I reported that the U.S. railroads had sidelined thousands of container cars for lack of traffic. New Mexico and Arizona looked like a railroad parking lot with every siding full of parked container cars being stored until business returned.

The order cycle is several months long. Retailers have been placing orders for several months for goods that will be sold during the 2010 holiday season. A spokesman for the port of Los Angeles said the ships coming in now are larger than in the past and they are arriving full. The May numbers were the second best ever and eclipsed only by May 2006 at the height of the global economic boom. The LA port processed 502,792 containers in May. Year to date the port has processed 2.9 million containers with 2.3 million going through Long Beach. Those numbers alone stagger the imagination and the biggest volume period is still ahead.

I was impressed that the market held its ground all day on Friday and even recovered from the opening dip. The indexes traded mixed to negative most of the day until the minor short covering spike at the close. After the big short squeeze on Thursday I expected at least a little give back on Friday. Instead of a retracement the Dow used 10,120 as support and after the opening dip it never varied.

However, the volume was the lightest day since April 5th. Only slightly more than seven billion shares changed hands. The Thursday short squeeze just barely ticked over nine billion shares. The extraordinarily low volume on the rally days is a non-confirmation of the moves. The heavier volume on the down days is a confirmation of that trend. Tuesday's decline came on 11.3 billion shares. However, overall the volume in general has been declining the last couple weeks as summer vacations take traders away from the market.

Next Friday is a quadruple witching expiration and much of the volatility last week could have been related to position squaring after a month in a down market. Normally the volatility is in the week before expiration but there could still be plenty left for next week.

I went into this commentary with a change in heart. I was shedding my bearish fur and contemplating a switch to a bullish bias. However, as I warned last week, any rebound off the lows that failed to more over SPX 1105 was just another range bound week. We need a break above that resistance before we can start turning bullish.

I do want to emphasize that the news from China, Brazil, Latin America and the California ports is bullish. Offsetting that bullish uptick in news is the summer doldrums, low volume and the lack of a compelling reason to be long. I do believe that we are approaching the point where conditions will change. Earnings are expected to be good although the comparisons are going to start getting a lot harder. We have not had that many warnings but we are just moving into that part of the cycle.

The U.S. economy is experiencing signs of stress but not yet in full retreat unless of course you look at the Weekly Leading Indicators. To put it bluntly the U.S. recovery is struggling but the patient is expected to survive.

I sat down at noon on Friday to write this with an improved bias. By midnight I had received several dozen emails from my normal subscription list and from readers and other editors. Every single one was bearish. One from Mark Steele, BMO Capital Markets head of quantitative and technical research was headed "Go To Cash." He advocated exiting any equity positions and going to cash. His rationale was based on the worsening of the global credit markets and the sovereign debt crisis being far from over.

The SocGen head of global strategy, Albert Edwards, called for the resumption of the structural bear market. He pointed to the decline in the Weekly Leading Indicators as evidence of a big economic decline ahead. Glad to see I am not the only one to use that report.

Richard Russell, editor of the Dow Theory Letters was adamant that readers get out of stocks. Woody Dorsey's proprietary sentiment indicators have fallen to a measly 1% compared to the 100% reading in April.

Now we can take all this bearishness as a sign the market is about to decline significantly to at least a 20% dip around 975 on the S&P or we can take it as a sign that maximum bearishness is the sign of a market bottom.

Unfortunately there is a third option. The excitement over the Q2 earnings may not be strong enough to rescue us from the summer doldrums but may be just enough to trick a few investors back into the market. That plus the relatively bullish global news could break us out of our recent range but fall short of producing a real rally.

I realize this creates an investing conundrum. How do we manage our plays when the outlook is so mixed? In this environment we have to fall back to the simple technical indicators because the fundamentals are skewed by the politics of the financial reform bill, debt crisis and politics. Jobs in July are going to be ugly but will be explained way as census terminations and the regular summer slump.

To escape this whirlpool of conflicts we simply need to watch the S&P 500. If it moves over the 200-day average at 1107 we enter long plays. If the S&P moves back below 1100 we enter short plays. It sounds absurdly simple and the devil is always in the details.

The markets are oversold even after the Thursday short squeeze. Sentiment is extremely negative. If we were to see some event push the S&P over 1107 the short squeeze would be much stronger and could last for several days.

I am not looking for a long-term rally but a move over 1107 could last for several days to several weeks depending on the news events. The S&P tested support at 1050 three times in 2010. The last test on Tuesday produced a decent bounce that overcame additional selling on Wednesday. This is the cheese in the trap. Millions of traders are eyeing that cheese and wishing they had the guts to have bought that Tuesday dip but they didn't. When/If the S&P moves over 1107 they will remember a week of wishing they had bought the dip and then jump on the breakout to avoid a second missed opportunity. At least that is my theory and I am sticking with it.

Should that happen we would probably stall somewhere under 1150 and then chop around for the rest of the summer. Personally I am not worried about the rest of the summer but just getting past the next couple of weeks. That makes our task easy. We buy the breakout over 1107 and short a failure at 1100. Let the high paid analysts bet their jobs on the market direction. We will just trade what it gives us.

S&P-500 Chart - 90 Min

S&P-500 Chart - Daily

The Dow also has a clearly defined resistance battle ahead at 10,220-10,260. The 200-day is slightly higher at 10,310 and the 50% retracement level of the March lows at 10340. The first problem is what I will call the 10250 wall. Rather than discussing the 220-260 level repeatedly I am going to call it 250 and forget it. With only 30 stocks in the Dow the potential for random spikes and dips prevents being very specific on support and resistance levels.

If the Dow moves over the 10,250 barrier it may stumble at the 200-day but the Dow is not normally moving average reactive. There may be some hesitancy when it crosses averages but the spikes in the individual stocks is much more a factor so don't get frustrated watching moving averages on the Dow.

If the Dow moves over 10,250 we could see some short covering. The Caterpillar CEO was on CNBC on Friday and saying positive things about the global economy but negative things about U.S. politics and its impact on business. He believes the global economy will prevail and sees a strong recovery in progress.

On the support side we have 10,120 from Friday and 9800 from last week's lows.

Dow Chart

The Nasdaq has been lagging the broader market but the pattern was the same last week. Tech traders seem to be focusing on only a handful of stocks and ignoring the rest. Support at 2140 was tested twice and a couple upgrades on the chip stocks helped prevent a meltdown. Apple's post announcement slide was erased by the Thursday short covering and the short squeeze in the last 15 minutes of trading on Friday.

I am not bullish on the Nasdaq today. Resistance is 2275-2300 and several tech stocks have warned on earnings. I suspect techs are going to lag any breakout by the S&P.

Nasdaq Chart

The Russell lagged the other indexes last week and that is not a bullish sign. We saw some sharp drops when the markets were weak and the RUT appeared to be headed for 600 but never made it. Resistance at 650 tends to get lost in the shuffle with the real resistance at 670. Support is 620 but that was broken twice last week.

Russell 2000 Chart

In summary I started out this commentary with a slightly more bullish mindset and without the dozens of bearish emails I probably would have kept that view. The global economy is improving without us and should eventually drag us kicking and screaming into a full-blown recovery by late 2011. That may not help our markets next week since that view is long term and the market is struggling to get by day to day.

We could have enough momentum to manage a breakout over S&P 1107 but I did not see it in the volume. Gains on two-month lows in volume tend to be lipstick on a pig rather than the real pinup girl.

I recommend putting on the blinders and ignoring the news and focusing on the charts. If we move over 1107 I would go long for a trade. If we fail at 1100 I would think about going short. That keeps our life simple and carefree and does not keep you up at night trying to sort through all the global economics and geopolitical mess.

Jim Brown


New Plays

Long Oil Play

by Scott Hawes

Click here to email Scott Hawes

Northern Oil & Gas - NOG - close 14.40 change +0.25 stop 13.10

Company Description:
Northern Oil & Gas, Inc., is an independent energy company engaged in the acquisition, exploration, exploitation and development of oil and natural gas properties. It is focused on the activities primarily on projects based in the Rocky Mountain Region of the United States, specifically the Bakken and Three Forks/Sanish formations within the Williston Basin. As of March 1, 2010, the Company owned working interests in 188 successful discoveries, consisting of 185 targeting the Bakken/Three Forks formation and three targeting a Red River structure. As of December 31, 2009, the Company completed drilling on approximately 10% of the Bakken prospective acreage inventory assuming 640-acre spacing units. As of December 31, 2009, the Company’s principal assets included approximately 104,000 net acres located in the Williston Basin region of the northern United States and approximately 10,000 net acres located in Yates County, New York.

Target(s): 14.95
Key Support/Resistance Areas: 15.00, 13.60, 13.15
Time Frame: 1 to 2 weeks

Why We Like It:
NOG has broken a recent downtrend line and looks like it is trying to form a higher low that would be confirmed if the stock trades above its recent highs. The stock also has solid support at $13.60 which is a prior resistance area from early 2010. NOG has also taken back its 20-day SMA and I believe a trip up to 50-day SMA will follow in short order. I would like to see a retracement of some the gains late last week and use a trigger to enter bullish positions if NOG trades down near $13.80 which is just above Friday's low. I expect NOG to at least retest its June 3rd high which is above our target of $14.95 and below the 50-day SMA. If the trade plays out how we expect the gain will be +8%. We are risking 75 cents to make $1.15. NOTE: I consider this a volatile stock and industry so please use proper position size to limit risk.

Suggested Position: Long NOG stock if it trades down near $13.80

Option Traders:
Suggested Position: Buy July $12.50 CALL, current ask $2.45, estimated ask at entry $2.00

Annotated Chart:

Entry on June xx
Earnings Date 7/29/2010(unconfirmed)
Average Daily Volume: 700,000
Listed on 6/8/10


In Play Updates and Reviews

PBR & ALTR Closed, IWM Opened

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:


BULLISH Play Updates

Direct TV - DTV - close 38.47 change -0.08 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:
I am keeping the set-up on this trade the same and waiting for the stock to trade near its 50-day SMA prior to entering. It has to trade down there and we will be ready to pounce on the stock when it does. The 50-day SMA is currently $36.70 and it is rising but placing an order slightly above this is suggested.

Suggested Position: Long DTV stock if it trades down near $36.80 which is just above its 50-day SMA

Option Traders:
Suggested Position: Buy July $37.00 CALL, current ask $2.24, estimated ask at entry $1.40

Annotated chart:

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


Quest Software - QSFT - close 19.35 change +0.59 stop 18.58

Target(s): 19.50, 20.00, 20.50, 21.00
Key Support/Resistance Areas: 18.40, 18.70, 19.36, 20-day SMA, 50-day SMA
Current Gain/Loss: +1.84%
Time Frame: Several weeks
New Positions: Yes

Comments:
QSFT is gaining momentum and I expect it to hit our target(s) this week. I have adjusted our first target to $19.50. I can't figure out why the July $20 call option has lost money when the stock has gained in value. The delta is .41 which means that for every price move in the underlying stock the price of the option should move at a rate of 41% of the move. So if QSFT gained 50 cents the price of the option would increase by about 20 cents, or about +24% of our entry price. I suspect the volatility has been sucked out of the premium we paid. I doubt it has to do with time decay because there are still 5 weeks left until July expiry. In any event, if the volatility is decreasing in the stock it should bode well for another push higher this week. I suggest selling into further strength this week or tighten stops to protect any profits. A tighter stop could be placed $18.90.

Current Position: Long QSFT stock at $19.00

Option Traders:
Suggested Position: Buy July $20.00 CALL

Annotated chart:

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

Bank of Nova Scotia Halifax - BNS - close 48.39 change +0.22 stop 49.55

Target(s): 46.30, 45.15, 44.05, 42.50
Key Support/Resistance Areas: 49.00, 48.30, 48.00, 47.40, 46.30, 45.00
Current Gain/Loss: -1.66%
Time Frame: 1 to 2 weeks
New Positions: Yes, with a tight stop

Comments:
BNS closed right on its downtrend line that I think will hold as resistance. It is now above a key support/resistance level at $47.40 which is concerning. The overall strength or weakness is most likely going to determine the fate of this trade. I am looking for BNS to at least trade back down to its 200-day SMA which is near our first target of $46.30. I have adjusted our stop to $49.55 which is above the 50-day SMA and a recent gap so if BNS decides to fill the gap we should be protected.

Current Position: Short BNS stock at $47.60

Option Traders:
Suggested Position: Buy July $45.00 PUT

Annotated chart:

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


iShares Russell 2000 - IWM - close 63.75 change +0.04 stop 66.60

Target(s): 62.10, 60.75, 59.50, 58.75
Key Support/Resistance Areas: 64.50, 63.30, 62.60, 61.50, 60.70, 58.00
Current Gain/Loss: Time Frame: 1 to 2 weeks

Comments:
We are short IWM at $64.25. IWM closed right on its downtrend line and is just below its declining 20-day SMA. This is a lot for the index to overcome and I believe it will reverse to at least retest its closing lows near $62.10. Our new stop will $65.75. This trade could be quick so I urge readers to protect profits if IWM is moving in our direction.

Current Position: Short IWM stock at $64.25

Option Traders:
Suggested Position: Buy July $63.00 PUT, current ask $2.80

Annotated chart:

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



CLOSED BULLISH PLAYS

Petroleo Brasileiro SA - PBR - close 38.32 change -0.25 stop 37.65

Target(s): 38.50 (HIT), 39.25, 39.95
Key Support/Resistance Areas: 37.45, 36.25
Final Gain/Loss: +2.26%
Time Frame: 1 week
New Positions: Closed

Comments:
We closed PBR at our target of $38.50 which was also hit on Thursday. We are flat the position for a +23.4% gain. For readers who still have positions the above targets, stop, and support/resistance areas can be used as a guide to protect profits. PBR may have some room to run here but I would rather take the profit than be surprised with a gap down in the market that could wipe out profits.

Closed Position: Long PBR stock at $38.50, entry was at $37.65

Entry on June 9, 2010
Earnings Date 8/13/10 (unconfirmed)
Average Daily Volume: 19.6 million
Listed on 6/8/10



CLOSED BEARISH PLAYS

Altera Corp - ALTR - close 24.38 change +0.81 stop 24.25

Target(s): 23.15, 22.60
Key Support/Resistance Areas: 24.15, 23.80, 23.15
Final Gain/Loss: -1.89% Time Frame: 1 to 2 weeks

Comments:
The head and shoulders pattern on ALTR failed and the stock ran right up through our stop. So we are right out of the trade as instructed in the play release. Considering the immense strength in ALTR on Friday morning positions really should not have been opened. It was apparent the pattern was going to fail in the first 30 minutes of trading. For any readers who have positions I suggest placing a stop above the opening range on Monday and see if ALTR reverses. There is resistance right where the stock closed and it could be forming a double top with the highs from 6/3 and 6/4 and is also approaching its 50-day SMA from below. I actually like the short set-up here with a tight stop at $23.75 which is above the 50-day SMA. In hindsight we probably should have waited for ALTR to reach its 50-day SMA and then entered a short position but I saw the head shoulders pattern and was anticipating a move lower off of the right shoulder. I've provided an hourly chart for illustration.

Closed Position: Short ALTR stock at $24.25, entry was at $23.80

Annotated chart:

Entry on June 11, 2010
Earnings 7/20/2010 (unconfirmed)
Average Daily Volume: 9.7 million
Listed on June 10, 2010