Option Investor
Newsletter

Daily Newsletter, Monday, 8/2/2010

Table of Contents

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

Market Wrap

August Starts With A Bang

by Todd Shriber

Click here to email Todd Shriber
Stocks ended July in sluggish fashion, but that was forgotten on Monday as European bank earnings and renewed economic optimism lifted the S&P 500 to to gain of 24 points, or 2.2%, helping the index extend an almost 7% gain notched in July. The close at 1125.86 is the best for the index since May 17. The Dow Jones Industrial Average surged 208 points, or almost 2%, to settle at 10.674 and the Nasdaq added almost 41 points to close at 2295. Small-caps enjoyed a decent day as well with the Russell 2000 gaining nearly 11 points to close at 661.86.

Stats Table

The economic data points released were a big contributor to the rally enjoyed by equities. Construction spending surprisingly rose by 0.1% in June, according to data released by the Commerce Department. Economists had been expecting a decline of 0.5%. For 2010, total construction spending is basically flat, but some noteworthy gains have been seen on the residential side and that might be a sign that things are not as bad as some worry warts would like to believe.

Construction Spending

The Institute for Supply Management released its manufacturing reading for July and that number fell to 55.5 from 56.2 in June, beating the median forecast of 54.5. Despite the fact that the ISM booking metric, viewed as one of the more important indicators, fell to a one-year a low, investors seemed more impressed with the fact that the July number came in above 50, which is considered a bullish reading. New orders slumped to 53.5 in July from 58.5 in June and inventories rose, neither being good signs, but for one day at least, the ISM report was viewed as positive.

ISM Chart

Speculation that the global economic recovery is for real is big news for copper as the red metal continues on a torrid pace. Copper for September delivery traded on the New York Mercantile Exchange rose 7.8 cents, or 2.36%, to $3.3895 per pound after earlier touching $3.3965, good for the highest closing price since April 28. Keep in mind that copper put in this rally just two days after China said manufacturing contracted in July. That is the first time China has seen a manufacturing contraction since March 2009.

Analysts believe copper caught a bid from, believe it or not, western economies. The ISM number certainly helped today as did news that the Eurozone manufacturing purchasing managers index rose to 56.7 in July from 55.6 June. Not surprisingly, Germany was a big reason, but Italy also factored into that equation.

There are more reasons to like copper. The London Mercantile Exchange said inventories fell by 425 tons today to 413,075 tons. In the U.S., COMEX copper stocks lost 102 short tons to 100,727 tons as of last Friday and the Commodity Futures Trading Commission is reporting that speculators doubled their net long exposure to copper for the week ending July 27.

Copper Chart

Spurred by the jovial economic news and the Dollar finding its way to a three-month low, crude oil found its way to a close above $80 a barrel, the first time that has happened since May. Some analysts maintain the view that oil needs to move above $82.50 a barrel to finally leave the $70-$80 range in the dust, but Monday's trade is a step in the right direction for oil bulls.

Oil Chart

Speaking of oil, a combination of news that BP (BP) is preparing to start its latest attempt to plug the Macondo well, a $498 million asset sale and overall bullish sentiment sent Anadarko Petroleum (APC) to a gain of $4.11, or 8.36%, for a close at $53.27. Anadarko, the second-largest U.S. independent oil and gas exploration firm, said it will sell $498 million in Colorado assets to Texas-based Western Gas (WES), a master limited partnership.

Anadarko and Western Gas apparently have a cordial relationship as this is the third deal between the two companies in the past year. In February, Anadarko sold $254.4 million in assets to Western and that transaction was preceded by a $107 million deal in July 2009. In the essence of full disclosure, count me among those that was not happy to see Anadarko soaring today. I am short a straddle that involves the August 57.50 calls and with Anadarko reporting second-quarter earnings tomorrow after the close, I expect to be quite nervous over the next couple of days.

Anadarko Chart

Finding losers among the energy and materials sectors was difficult to do today and of course on a day when copper was so strong, I would be remiss if I did not mention Freeport McMoRan (FCX). A lot of companies have soundly beat earnings estimates and gone on to stay flat or even trade lower following those reports, reducing the number of post-earnings trades from the long side.

Freeport McMoRan flies in the face of that logic. Just days before its July 22 second-quarter update, Freeport was trading below $60. The bulls ran into the stock in a big way from July 19 through July 22, sending it over $66. The shares traded over $75 today before closing at $74.80, just below the 200-day moving average. Dwindling copper stockpiles and rising prices are a sweet recipe for Freeport shares, that is a given.

If market sentiment stays positive and copper inventories keep falling, Freeport could challenge it's April peak just below $90 in the near-term. I have included the Freeport chart below, but will recommend another equity-based copper play for readers that choose not to be involved with copper futures or thinly-traded copper ETNs: The iShares MSCI Chile Investable Market Index Fund (ECH). ECH is the lone country-specific ETF for Chile and Chile is the largest copper exporter in the world. ECH hit a new 52-week high today on more than twice the average daily volume.

Freeport McMoRan Chart

A world away from the commodities realm, health insurance provider Humana (HUM) was another one of Monday's juggernauts, jumping $1.71, or 3.64%, to $48.73 on volume that was about 50% higher than the daily average. The company said its second-quarter profit rose 21% to $340.1 million, or $2 a share, form $281.8 million, or $1.67 a share, a year earlier. Revenue surged 9.5% to $8.65 billion from $7.9 billion. Analysts had been expecting a profit of $1.67 a share on revenue of $8.61 billion.

Better yet, Humana raised its full-year guidance to $5.65 to $5.75 a share from previous guidance of $5.55 to $5.65 a share. Analysts had been forecasting a full-year profit of $5.71 a share.

Humana Chart

Taking a look at the charts, the S&P 500 closed right at support at 1100 last Friday, but blasted higher from there on Monday and was able to move above resistance at 1115. The close above 1125 is another encouraging sign as it puts the index within earshot of 1130, an area that if taken out on a strong volume, could induce plenty of sideline dwellers to get into the game. There are plenty of big-names reporting earnings this week, but the economic calendar will probably play a bigger roll in the S&P 500's weekly result. The ISM services report is due out on Wednesday and this Friday is the first Friday of the month, meaning non-farm payrolls are due out before the market opens.

S&P 500 Chart

A 200-point move for the Dow is usually an impressive feat, particularly on a day with no earnings news and that is just what the Dow delivered on Monday. Trading just below 10,675, the blue chip index barreled through resistance at 10,500. Support is still the 200-day moving average at 10,415. Most Dow members have already delivered earnings report, but Pfizer (PFE) and Procter & Gamble (PG) report on Tuesday.

Not to be trite, but I do not expect the Pfizer report to do much for the Dow, especially on the upside. It takes an act of God to move this stock and since Procter & Gamble has already raised its dividend, I would not be depending on that name to spark the Dow higher by a substantial margin either. Kraft (KFT) and Walt Disney (DIS) report on Thursday.

Dow Chart

The Nasdaq flirted with resistance at 2300 today before settling just below that number at 2295, but it has to be noted that the Nasdaq's strength has been impressive in the wake of several downgrades of the semiconductor sector. There is other news to watch with the Nasdaq this week that does not involve earnings (the Nasdaq earnings calendar is pretty light this week).

I would be keeping an eye on Research In Motion (RIMM) as it locks horns with Saudi Arabia and the United Arab Emirates on Blackberry service in those two countries. Beyond that, biotech will be in play as news crossed the wires on Monday evening that French pharma giant Sanofi-Aventis (SNY) has made a $69 per share to acquire Genzyme (GENZ). Genzyme is the biggest maker of drugs to treat rare genetic disorders and given the complex formulas the company uses to make those treatments, it is not overly vulnerable to generic competition, making Genzyme particularly appealing to a traditional pharma suitor.

Support on the Nasdaq is 2225.

Nasdaq Chart

Sure, the Russell 2000 was higher today, but the index could not make its way above resistance at 668, so I maintain my stance that only a move above 675 would be truly exciting for small-caps. Support looks firm at 640.

Russell 2000 Chart

After Monday's move, the S&P 500 is close to being overbought and that is not unreasonable to expect after July's 6.9% run. A move above 1130, which could happen as soon as tomorrow, would only bolster the bulls further. As I said last week, my gut tells me economic data points, not earnings, are going to drive stocks for the next few weeks and that puts a lot of emphasis on Friday's job report. A positive number that includes some signs of private sector job growth could lead to a strong August. A disappointing number will have the opposite impact.


New Plays

Short Candidate

by Scott Hawes

Click here to email Scott Hawes
Editor's Note:
Good evening. Today's huge rally has created overbought conditions and we are entering levels where short positions look more attractive. There is still some earnings noise that the market is working through but the focus is starting to shift towards Friday's employment report which will probably set the tone in trading for the remainder of August. I expect trading to be choppy and there is bound to be large swings in both directions. I've chosen a short play on the DJIA (via DIA) for tonight. This will balance our model portfolio and enable us to take advantage of an ensuing pullback. Please email me with any questions.


NEW BEARISH Plays

SPDR DJIA ETF - DIA - close 106.73 change +2.03 stop 108.75

Company Description:
The investment seeks to provide investment results that, before expenses, generally correspond to the price and yield performance of the Dow Jones Industrial Average (DJIA). The fund holds the Portfolio and cash, and is not actively "managed" by traditional methods. To maintain the correspondence between the composition and weightings of stocks held by the Trust and component stocks of the DJIA, the Trustee adjusts the portfolio from time to time to conform to periodic changes in the identity and/or relative weightings of index securities, typically within three business days before or after the day on which such changes are scheduled to take effect.

Target(s): 104.85, 104.25, 103.65
Key Support/Resistance Areas: 108.00, 107.00, 105.90, 104.75, 104.20, 103.50
Time Frame: 1 week

Comments:
The DJIA has rallied right into prior resistance from its January highs and is forming a bearish rising wedge pattern. This pattern calls for a sharp decline but may bounce around a little near current levels first. In addition, today's +2% gain in equities has created overbought conditions and I believe DIA will turn back to at least fill the gap higher from today. We'll use a tight stop of $108.75 and I have offered three very realistic near term targets, along with a more aggressive target should things get moving to the downside in earnest. The stop is above a gap down from 5/15 so if DIA closes the gap we have a some room. If DIA makes it up to close this gap (5/13 close was $108.10) I would be very surprised to see it go any higher before heading towards our targets. I suggest readers be quick to tighten stops as targets approach because the drop could come quick.

Suggested Position: Short DIA stock at current levels

Options Traders: Buy September $106.00 PUTS, current ask $2.60

Annotated chart:

Entry on August xx
Earnings: N/A (unconfirmed)
Average Daily Volume: 14 million
Listed on August 2, 2010


In Play Updates and Reviews

Long Positions Post Strong Gains

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:


BULLISH Play Updates

Bally Technologies - BYI - close 33.37 change +1.07 stop 32.70 *NEW*

Target(s): 32.95 (hit), 33.95, 34.95, 35.70
Key Support/Resistance Areas: 37.50, 36.75, 35.75, 34.00, 32.50
Current Gain/Loss: -2.71%
Time Frame: Several Weeks
New Positions: No

Comments:
8/2: BYI rebounded today and closed +3.31% higher. Let's tighten the stop to $32.70 and see how much more we can get out of this position. I suggest readers consider closing positions if our target of $33.95 is hit. This level is just below a key resistance area from the past month and at a minimum stops should be tightened.

7/31: BYI opened at our stop of $31.84 so we must let the opening range resolve itself prior to executing the stop. This is a stop rule we have utilized in the past and I suggest all readers use. Essentially, when a stock gaps open near or below a predetermined stop let the first 15 or 30 minute opening range close. Then place the protective stop below the range for long positions. For short positions place the stop above the range. This provides a better measure of the true strength or weakness in the stock and often times will keep you in the position looking for a better exit. Considering the current volatile conditions this rule is a must have. It worked perfectly in BYI today and keeps us fighting another day. BYI recovered nicely and our targets should come into play prior to our new stop of $31.72 getting hit, which is below today's low. I've also adjusted the targets slightly. If BYI can find its footing here and equities are strong next week the stock should find its way up to the $34.00 level.

Current Position: Long BYI stock, entry was at $34.30

Options Traders: Long September $35.00 CALL

Entry on July 28, 2010
Earnings 8/12/10 (unconfirmed)
Average Daily Volume: 1.38 million
Listed on July 26, 2010


Teck Resources Ltd - TCK - close 36.92 change +1.67 stop 32.65

Target(s): 36.00, 36.90, 37.70
Key Support/Resistance Areas: 37.00, 36.00, 34.75, 34.00, 33.00, 32.25
Current Gain/Loss: N/A
Time Frame: 1 to 2 weeks
New Positions: Yes

Comments:
8/2: TCK gapped higher at the open and ran away from us. The stock closed +4.74% on the day and has already hit our first two targets. TCK has resistance at current levels and should retrace some of today's gains. I suggest we be patient and see if TCK heads toward closing today's gap higher before initiating long positions. Let's adjust our trigger up to $35.55 which is just below today's low and 30 cents above the gap. The 20-day and 50-day SMA's are now rising and should provide support if TCK goes any lower that this. TCK is also trading in an upward channel and if the broader market remains strong the stock should trade to new highs. Let's take advantage of any weakness.

7/31: TCK has broken out of its primary downtrend that began on 4/7 and surged higher this past week up to its 200-day SMA before turning down. Material stocks are gaining momentum and I think the recent pullback has allowed them to regain energy for a continued move higher. The stock is maintaining an upward trend line that began on 7/1 and is also above its 20-day and 50-day SMA's. I suggest we us a trigger $34.85 to initiate long positions. Our stop will be $31.80 which is below the 20-day and 50-day SMA's and the recent upward trend line. The stop will be adjusted once we are in the position.

Suggested Position: Long TCK stock if it trades down to $35.55

Options Traders: September $36.00 CALL, current ask $2.89, estimated ask at entry $2.15

Entry on August xx
Earnings More than 2 months (unconfirmed)
Average Daily Volume: 6.4 million
Listed on July 31, 2010


Oil Service HOLDRS - OIH - close 109.53 change +4.39 stop 107.90 *NEW*

Target(s): 108.50 (hit), 110.25, 111.20
Key Support/Resistance Areas: 110.50, 108.60, 107.00, 104.75, 102.80
Current Gain/Loss: +1.89%
Time Frame: 1 to 2 weeks
New Positions: No

Comments:
8/2: OIH gapped higher this morning and broke through the $107.00 resistance level of the ascending triangle mentioned in the play release. The sector never looked back and OIH posted +4.18% gains on the day. Call positions were initiated at the open and have already gained +27%. Our target of $108.50 was hit and OIH came within 2 cents of our reaching our $110.30 target before closing about 80 cents below its high of the day. I've adjusted the $110.30 target down 5 cents and have also added $111.20 which is below the 100-day SMA. If OIH breaks over today's high of $110.28 I recommend readers tighten stops to protect against a reversal. There is nothing wrong with booking gains at current levels as well. I've adjusted the stop up to $107.90 to protect capital but a tighter stop could be placed at $108.45.

7/31: I'm sticking with an ETF here to eliminate some of the earnings noise and mitigate risk in individual names. Oil service stocks have been beaten down and are now showing signs of life. OIH is forming an ascending triangle on its daily chart and has made a series of higher lows since it bottomed on 6/1. The ETF is above its 20-day and 50-day SMA's which is providing further support. I'm comfortable with positions at current levels with tight a stop of $102.30 which is below the low from 7/23. We will either be right or right out of this trade. We are playing for a breakout above $107.00 into the $108.50 to $110.00 area which is near our two targets. $108.50 was a prior support level in the fall of 2009 so OIH could see some resistance there. As OIH approaches our targets I suggest readers be quick to take profits or tighten stops.

Current Position: Long OIH stock, entry was at $107.50

Options Traders: Long September $110.00 CALL

Entry on August 2, 2010
Earnings N/A (unconfirmed)
Average Daily Volume: 8 million
Listed on July 31, 2010


ProShares UltraShort 20 YR Treasury - TBT - close 36.74 change +0.89 stop 35.55 *NEW*

Target(s): 36.90, 37.50 (hit), 38.00, 39.25, 40.50
Key Support/Resistance Areas: 42.00, 41,00, 39.70, 38.25, 37.55, 34.65
Current Gain/Loss: +0.63%
Time Frame: Several Weeks
New Positions: Yes

Comments:
8/2: It appears Friday's sell-off in TBT was short lived as I suspected. However, the price action in bonds and equities still seems somewhat disconnected. TBT looks like it is forming a higher low and has 20 more cents to go before closing the gap down on Friday. This will likely act as intraday resistance but I expect TBT to eventually break it and trade back up to our $37.50 target and possibly our more aggressive targets. I suggest readers begin to trail stops higher to see if we can catch a larger move. For now, I've moved the stop up to $35.55 which is below Friday's lows and the upward trend line on the daily chart.

7/31: The price action in bonds on Friday has me scratching my head in amazement. Bond yields tanked and bond prices surged (i.e. money was flowing into the bond market as traders were snatching up bonds at ridiculously low yields) which caused TBT to gap lower and close -2.98% on the day. This was an uncharacteristic huge move and is not normal. What's more interesting is that bonds never gave anything back throughout the day as equities surged higher on Friday morning after their gap lower. One of the two following scenarios has got to give here and the tone should be set in trading on Monday. Either money will flow out of stocks and into bonds creating a big sell off in equities (bad for TBT) or money will flow out of bonds and into equities creating a rally in equities (good for TBT). Medium to longer term I am bearish on equities but in the short term I think the latter is going to happen and we will see stocks rally, or at least hold up, with money flowing out of bonds. This will get our position in TBT moving back in the right direction. I really like new positions in TBT at these levels as well. Looking at a longer term weekly chart of bond prices (i.e. /ZN or TLT) one might think bonds have room to run to their fall 2008/spring 2009 highs. But this was the financial crises and money markets were failing and there is simply no crises like that right now. The other side of that argument is that maybe we are on the verge of a crises and we should listen to what the bond market is telling us. While I believe another crises is bound to happen I'm just not buying that argument quite yet. I believe there can be a sell-off in equities without a surge higher in bond prices or drop in yields. Nonetheless, we have to manage the trade and $36.90 is a level readers may want to consider exiting TBT. This would close the gap lower from today while also booking a winning trade. In the end, I think today's sell-off in TBT was an anomaly that will either be corrected early next week or we are on the verge of a bigger sell-off in equities. Unfortunately, today provided us very few clues as to what will happen. The above targets can be used as guide to tighten stops or simply take profits.

Current Position: Long TBT stock, entry was at $36.51

Options Traders: Long September $37.00 CALL

Entry on July 27, 2010
Earnings N/A (unconfirmed)
Average Daily Volume: 3.8 million
Listed on July 24, 2010