Option Investor
Newsletter

Daily Newsletter, Wednesday, 6/16/2010

Table of Contents

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

Market Wrap

Traders Indecisive on Economic Data & Corporate News

by James Brown

Click here to email James Brown

Market Stats:

Stocks were off to a poor start this morning as investors digested disappointing Fedex earnings and shockingly low housing starts. News that BP chose to cut its dividend and fund a $20 billion escrow account helped remove some uncertainty over the embattled oil giant and the market rebounded. Unfortunately the gains were short-lived and stocks closed virtually flat on the session following Tuesday's big rally. The market also sifted through the industrial output numbers, PPI report, and news that WPO triggered the new circuit breakers and Fannie Mae and Freddie Mac would be delisted from the NYSE.

Intraday Chart of the S&P 500 (5-minute):

Foreign markets were mostly higher with Japan leading the way in Asia. The Japanese NIKKEI index surged 1.8% to a one-month high on what looks like short covering. The Chinese Shanghai index closed up 0.29% and the Hong Kong Hang Seng rose just 0.05%. Gains were more even across Europe but stocks struggled on the disappointing housing start numbers in the U.S. Mobile phone maker Nokia (NOK) also disappointed the market with an earnings warning and shares of NOK plunged almost 9%. The economic data in the U.K. was mixed with consumer confidence falling to its lowest levels in almost a year. At the same time the number of initial jobless claims fell in May to a new one-year low. The England FTSE managed to keep the winning streak alive with its sixth gain in a row, up +0.39% for the session. The French CAC-40 gained +0.39% and the German DAX rose +0.26%.

After yesterday's big moves in the currency market the euro and the dollar both drifted sideways on Wednesday. The lack of action in currencies left commodities to trade on their own. The results were mixed. Gold futures slipped almost $4 to $1,230.50 an ounce. Copper prices hit some profit taking with a 1.3% drop following a six-day rebound. Crude oil futures ignored the bearish weekly oil inventory report in the U.S. and rose 0.9% to $77.67 a barrel. This is somewhat surprising and could be a reaction to the BP news or hope that global economic activity won't slow down too much. The inventory numbers this morning were certainly a surprise. Analysts were expecting a drop of 1.75 million barrels of oil and an increase of 640,000 barrels of gasoline. Instead the Energy Information Administration said oil inventories rose 1.7 million barrels and gasoline supplies sank by 600,000 barrels. U.S. refineries operations fell 1.2% to 87.9% of capacity.

The economic data flow for the U.S. economy continues to be mixed. The housing starts number was the biggest surprise. The Commerce Department said housing starts fell 10% in May to an annual pace of 593,000 from 659,000 in April. This was the biggest drop since March 2009. The single-family home starts component plunged 17%, which was the largest decline since 1991. The number of building permits also saw an decline to a new one-year low. Home builders have a right to be cautious. Unemployment remains high and the qualification window for the homebuyer tax credit expired on April 30th. Odds are good the sale of existing home and new homes will continue to underperform. More than one market pundit is expecting residential real estate to see another 10% to 20% decline before home prices finally hit bottom.

On a brighter note the industrial production numbers were good. Output for U.S. factories, mines, and utilities rose 1.2% in May. This was the largest improvement since August 2009 and followed a 0.7% gain in April. Economists were only expecting +0.9% growth in output. Thus far U.S. output is up 10 out of the last 11 months but we're still down 7.8% from the high in December 2007.

The big drop in energy prices in May (gasoline -7%) helped push the headline PPI number lower. The Producer Price Index helps measure inflation at the wholesale level. This morning the Labor Department reported that prices paid to farmers and factories fell 0.3%. The core-PPI, which excludes more volatile energy and food prices, rose +0.2%. Economists were looking for a -0.5% drop in the headline number and a +0.1% gain for the core number.

One of the biggest headlines today was the deal between oil giant BP and the White House. BP announced they would set up a $20 billion fund to help compensate victims of the Gulf oil spill. BP's management announced they would stop the upcoming June 21st quarterly dividend payment (about $2.6 billion) and all further quarterly dividends for the rest of the year. By ending their dividend payments, cutting back on spending, and selling some assets BP plans to put $10 billion into the fund by this time next year. President Obama pointed out that this $20 billion victim's compensation fund was not a limit on BP's potential exposure and it has no impact on what the final clean up cost totals might be. I found it interesting that BP plans a separate $100 million fund to help out of work oil rig workers following President Obama's moratorium on deep-water drilling.

The big question both short-term traders and long-term investors are asking a lot these days is whether or not BP is a buy at these levels (currently trading around $32). Shares did seem to find some support after falling 50% from the $60 level and it wouldn't surprise me to see BP produce a significant oversold bounce. The stock saw a 1.4% bounce today on hopes that the $20 billion victim fund helped, in a small way, define some of BP's risk. Yet long-term no one knows what BP's exposure to victim compensation, clean up costs, and penalties might be. This could end up being a black cloud over BP's stock price for a very long time. As long as you have a clearly defined stop loss to limit your risk you could always consider a speculative position on BP but it remains a very high-risk bet in my book.

Chart of BP:

Shares of FedEx (FDX) had an effect on the market today. The stock is a component in the Dow Jones Industrials, Dow Transportation average, S&P 100, and S&P 500 indices. Today shares were hammered for a 5.9% loss, completely erasing the last four days of gains. Prior to the opening bell FDX reported its Q4 earnings, which came in at $1.33 a share and a penny above estimates. Revenues soared +20% and came in better than expectations at $9.43 billion for the quarter. Management seemed to have good things to say. Internal volumes were at multi-year highs. International shipments roared with a +23% improvement thanks to strength in Asia, Latin America, India, China and Brazil. Yet investors were disappointed with the company's guidance when FDX offered 2011 guidance in the $4.40-5.00 range compared to Wall Street's estimates at $5.05. Many consider FDX to be a key bellwether company for the U.S. and global economy. Let's hope this isn't a sign of things to come for the second quarter earnings season that begins in July.

Chart of FDX:

Shares of Apple Inc. (AAPL) managed to outperform the market with a 2.9% gain to $267.25 a share. You may recall that after the company unveiled the new fourth generation iPhone this month there was a huge burst of sales for its rival, Google's Android phones. It almost seemed like the iPhone had lost its mojo and consumers were flocking to competing products. It seems that would have been a poor assumption. Yesterday AAPL and AT&T announced that the 4th generation iPhone set a record-breaking sales pace of more than 600,000 units - the highest ever for a single day of preorders. This was on top of an online ordering hiccup that prevented some consumers from actually getting their orders processed. The new iPhone is expected to hit stores on June 24th.

Washington Post made headlines on Wall Street today as the first stock to trigger the new SEC single-stock circuit breakers. The Security and Exchange Commission's new trading curbs began on June 11th and they're supposed to kick in whenever a stock rises or falls by more than 10% in less than five minutes. This afternoon shares of WPO jumped from $462 to $919-929, nearly doubling the stock price. There were three trades for a total of 766 shares, which were all cancelled.

Elsewhere in corporate news it was announced that shares of Fannie Mae (FNM) and Freddie Mac (FRE) would be delisted from the NYSE. These government-sponsored entities (GSEs) were bailed out by the U.S. government during the subprime crisis. The government now owns about 80% of these two companies. Shares of FRE fell 38% to $0.75 while FNM dropped 39% to 0.56 a share on this news. The move follows a directive by the Federal Housing Finance Agency telling both firms to delist their shares. The move from the NYSE to the pink sheets (OTC Bulletin Board) is expected to happen in the first half of July.

Technically the market looks a lot more bullish, at least on a short-term basis. The S&P 500 managed to hold Tuesday's close above the simple 200-dma in addition to short-term resistance near the 1,110 area. This certainly lends strength to the argument that the lows near 1,040 looks like a bullish double bottom. I would remain cautious since the S&P 500 has significant resistance near the 1,150 area. I also anticipate the 50-dma crossing under the 200-dma in the next two or three weeks, which is normally a very bearish development.

Chart of the S&P 500 index (daily):

The NASDAQ Composite failed under its simple 100-dma this afternoon and is hovering near the 2300 level, which was the top of its range for the last three weeks. While the NASDAQ also has a possible bullish double bottom the index looks a little short-term overbought, you could probably say the S&P 500 looks a little bit overbought with a six-day bounce from the June 8th lows.

Chart of the NASDAQ Composite:

The small cap Russell 2000 index ($RUT) has seen a very nice bounce off its June lows but the rally has stalled at resistance near the 670 level. The index may need to retrace a few steps and build up some steam before actually breaking out.

Chart of the Russell 2000 index:

On a short-term basis I am encouraged by the market's recent strength. There is still a chance we could see some volatility surrounding option expiration this Friday but normally summer Fridays are pretty boring, low-volume affairs. After Friday odds have improved that the market could see some end of quarter window dressing. However, I would not get seduced by any market rebound. You can trade it but I would hesitate to make any long-term bets. I'm concerned that we might be in the "eye of the storm". The economic data from the U.S. continues to be mixed. I am still in the double-dip camp. Although I will note that the American Bankers Association reported that their economic advisory committee believes the U.S. will avoid a double-dip. Instead the ABA believes the U.S. will grow by 3.2% in 2010 and 3.0% in 2011 but only half of the jobs lost during the recession will return.

Longer-term Europe remains a problem. Their debt challenges are still here and will remain an extremely heavy burden for years to come. You may not like him but George Soros shared his opinion that a double-dip recession in Europe is "inevitable". I happen to agree. The strict austerity measures being enforced in Europe will severely hamper growth but they have no choice since they have to deal with their debt problems. Mr. Soros went on to say that flaws in the euro would prevent the EU from being able to solve their problems and has the potential to "destroy" the EU. The region would probably see years of stagnation and there is a real risk of rampant civil unrest.

- James


New Plays

Long and Short Candidates

by Scott Hawes

Click here to email Scott Hawes


NEW BULLISH Plays

Cisco Systems - CSCO - close 23.29 change -0.04 stop 22.20

Company Description:
Cisco Systems, Inc. designs, manufactures and sells Internet protocol (IP)-based networking and other products related to the communications and information technology (IT) industry, and provides services associated with these products and their use. The Company provides a line of products for transporting data, voice, and video within buildings, across campuses, and around the world. Its products are designed to transform how people connect, communicate and collaborate. The Company’s products are installed at enterprise businesses, public institutions, telecommunications companies, commercial businesses and personal residences. It has five segments: United States and Canada, European Markets, Emerging Markets, Asia Pacific, and Japan. The Emerging Markets theater consists of Eastern Europe, Latin America, the Middle East and Africa and Russia and the Commonwealth of Independent States. In December 2009, the Company completed its acquisition of Starent Networks..

Target(s): 23.55, 24.20
Key Support/Resistance Areas: 23.65, 22.55
Time Frame: Several weeks

Why We Like It:
CSCO has been building a nice base for the past 3 to 4 weeks and is trading in a $1 range (4.5%) between $22.55 and $23.55. $22.50 is key pivot level for the stock dating back to 2006. It appears the stock may want to break out of this base, but we don't necessarily need that to happen for a profitable trade. CSCO looks stable here with a lot of support and I suggest we take advantage of the reliable price pattern that is being built. I would like to use $22.85 as a trigger to enter long positions. If triggered options traders should be able to purchase July $22.00 calls for about $1.30 (current ask is $1.64). If CSCO then proceeds to rally to the top of its base at $23.55 we should make about 55 cents on the position for a +40% gain. If CSCO breaks out it could rally to fill the a gap which is up near our more aggressive 2nd target of $24.40 and below the stock's 200-day SMA. Another entry could be considered at $23.05. Our Stop will be $22.20. NOTE: I view this trade as potentially being quick.

Suggested Position: Long CSCO stock if it trades down near $22.85

Option Traders:
Suggested Position: Buy July $22.00 CALL, current ask $1.64, estimated ask at entry $1.30

Annotated Chart:

Entry on June xx
Earnings Date 8/5/10 (unconfirmed)
Average Daily Volume: 69 million
Listed on 6/16/10

<-- NEW SHORT PLAYS -->


NEW BEARISH Plays

Mohawk Industries - MHK - close 53.27 change -0.81 stop 24.25

Company Description:
Mohawk Industries, Inc. is a producer of floor covering products for residential and commercial applications in the United States and residential applications in Europe. The Company is a carpet and rug manufacturer, and manufactures, markets and distributes ceramic tile, natural stone and hardwood flooring in the United States, as well as a producer of laminate flooring in the United States and Europe. The Company operates in three segments: the Mohawk segment, the Dal-Tile segment and the Unilin segment.

Target(s): 52.05, 50.40, 49.10
Key Support/Resistance Areas: 55.00, 52.00, 50.00
Time Frame: 1 to 2 weeks

Why We Like It:
MHK has rallied +14% from its 6/8 lows and finds itself in a resistance and congestion area between $53.00 and $55.00. The stock has also hit its 100-day and 20-day SMA's and has turned back. I believe it is time for the stock to turn back down from here and fill the gap higher between 6/11 and 6/14. MHK is a residential and commercial manufacturer of floor products in the US and Europe. The construction industry is struggling on both continents and consumer spending is weak. Any bad news about the industry or lowered guidance warnings could send the stock tumbling. Fundamentally, the company trades at about 28 times trailing earnings which I think is too high. I am going to place a wide stop above the 50-day SMA at $58.05 to account for volatility, but a tighter stop could be placed at $56.60 which is above the congestion zone and should give enough room for the trade to work. Our primary target is $50.40 but the stock may find support at $52.02. If it breaks this level it should see $50.40 in fairly quick. NOTE: This stock is volatile so please use proper position size to limit risk.

Suggested Position: Short MHK stock at current levels

Option Traders:
Suggested Position: Buy August $50.00 PUT, current ask $3.20

Annotated chart:

Entry on June xx
Earnings 7/20/2010 (unconfirmed)
Average Daily Volume: 975,000
Listed on July 29, 2010


In Play Updates and Reviews

Energy Play Opened

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:


BULLISH Play Updates

Direct TV - DTV - close 39.33 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:
We are patiently waiting for DTV to come to us. If it doesn't cooperate soon I will be removing the trade from the portfolio. My comments from last night remain the same. DTV has ran away from us a bit here as we have waited 8 trading days and still haven't gotten filled. $37.20 is a key support area and the 50-day SMA is rising towards this level everyday. Let's use this as our trigger to enter positions. Essentially we are playing for a bounce near the stock's 50-day SMA which it has not touched since the flash crash. The stock also has two trend lines underneath our entry which should provide further support if we get filled. The 50-day SMA is currently $36.87 and it is rising but placing an order slightly above this is suggested.

Suggested Position: Long DTV stock if it trades down near $37.20, which is just above its 50-day SMA

Option Traders:
Suggested Position: Buy July $37.00 CALL, current ask $2.78, 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


Northern Oil & Gas - NOG - close 14.21 change +0.08 stop 13.05

Target(s): 14.75, 14.90
Key Support/Resistance Areas: 15.00, 13.60, 13.15
Time Frame: 1 to 2 weeks

Comments:
NOG traded down to $13.92 and we almost got triggered today. I would like to move up the trigger to $13.95 which is just above today's highs. The stock's 20-day SMA (currently $13.66) is starting turning up and I expect this to hold if we get filled. $13.95 is an area that is also near the upward trend line that has formed with the lows from 5/25 and 6/8. Our trigger to enter could get hit early tomorrow but if the stock gaps close to or below our entry I suggest waiting to enter the position until the opening range is broken to the upside. This will ensure the position is moving in the right direction prior to going long. My comments from the play release remain mostly the same. 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 and is also near the 20-day SMA. NOG has 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 $13.95 which is just above Friday's low. I expect NOG to at least retest its June 3rd high which is above our targets of $14.75 and $14.90 (adjusted) and below the 50-day SMA. If the trade plays out how we expect the gain will be about 6% to 7%. 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 $13.95

Option Traders:
Suggested Position: Buy July $12.50 CALL, current ask $2.25, estimated ask at entry $2.05

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


Ormat Technologies - ORA - close 29.79 change +0.13 stop 27.25

Target(s): 30.45, 31.80
Key Support/Resistance Areas: 32.00, 30.60, 29.00, 27.50
Current Gain/Loss: +1.85%
Time Frame: Several weeks
New Positions: Yes

Comments:
ORA traded down to our entry at $29.25 late this morning so we long the stock. The stock closed above its 50-day SMA and made new daily highs. All of this is good but there is some resistance overhead so there could be a pullback. The broader market strength or weakness is sure to influence the direction of the stock. Our initial target is $30.45 with our more aggressive 2nd target at $31.80. I'll leave my comments from the play release. ORA has broken through a long term primary downtrend line and a short term secondary downtrend line. The stock broke through and closed above a resistance area near $29.00. ORA is essentially a utility that is involved in the alternative energy business (i.e. geothermal) and may be in the right place at the right time with a push from the White House in this sector. I would like to see a retracement of some of today's gains and use $29.25 as an ideal entry point to initiate long positions. The stock closed near its 50-day SMA so I expect a pullback before a larger move to the upside. Our stop will be $27.25 which will give this trade some room to work.

Current Position: Long ORA stock at $29.25

Option Traders:
Suggested Position: Buy July $30.00 CALL

Entry on June 16, 2010
Earnings Date 8/4/10 (unconfirmed)
Average Daily Volume: 345,000
Listed on 6/15/10