Option Investor
Newsletter

Daily Newsletter, Wednesday, 9/1/2010

Table of Contents

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

Market Wrap

Stocks Surge on ISM and China PMI News

by James Brown

Click here to email James Brown

Market Stats

Better than expected manufacturing data from the Chinese PMI released last night and the ISM report this morning sparked a short-covering rally in stocks. The U.S. market surged from oversold levels to the best gain in months following the worst August in nine years, which saw the S&P 500 lose -4.7%. The better than expected reports overshadowed a drop in construction spending and dismal August car sales. Meanwhile tech giant Apple (AAPL) made headlines with several improvements on some of the company's the best selling items.

Asian markets were mixed. The big event overseas was the Chinese PMI data coming in stronger than expected. Economists were looking for the August purchasing managers' index to rise from 51.2 in July to 51.5. The manufacturing index rose to 51.7, but this may have been influenced by seasonal changes as factories gear up again following mid-summer maintenance. Australia had a positive influence on the Asian markets today. Sydney's Bureau of Statistics said Q2 GDP growth was fueled by better than expected consumer spending. The country saw GDP grow +1.2%, better than the +0.9% estimate. Meanwhile Japan's NIKKEI index rallied +1.1% thanks to a bounce in the dollar against the yen. The NIKKEI dipped under the 8800 level this morning, hitting a 16-month low before bouncing back into positive territory. The Chinese Shanghai lost -0.6%. The Hong Kong Hang Seng gained +0.43%.

In Europe the various stock markets completely ignored news that Germany's retail sales slipped for the second month in a row. July's retail sales dropped -0.3% when analysts were expecting +0.5% gain. The stronger manufacturing data from China and U.S. fueled big gains across the region. England's market saw an extra boost from M&A talk. The English FTSE rallied +2.8%. The German DAX gained +2.68%. The French CAC-40 soared +3.8%.

The manufacturing data this morning temporarily relieved fears that the global economy was slowing down too fast. Now add in a weak U.S. dollar and it was a strong day for commodities. Copper is a key element in manufacturing and copper prices rallied +3.15%. Crude oil futures, after a -9% drop in August, soared +2.9% on Wednesday, ignoring the bearish inventory data this morning. The EIA reported that inventories rose +3.4 million barrels, which is above the +1.9 million estimate. Some of the agriculture commodities performed well with coffee prices up +2.1%, sugar up +3.75%, and wheat rising +3.3%. Gold futures edged lower with a -$3.40 decline to $1,246.90/oz.

The stock market rally sucked money out of the bond market and yields rallied as a result. The 10-year U.S. bond yield climbed from 2.47% yesterday to 2.58% today. Speaking of the bond market a Bank of America analyst expects that yields will drop to an all-time low of 2% in less than a year. The Federal Reserve's decision to start buying treasuries again will lift the bond market and drag yields to new lows.

Naturally the major headline today was the ISM data. Economists were expecting the national ISM to show a drop from 55.5 in July to 52.8. Yet the Institute for Supply Management reported that their manufacturing activity index rose to 56.3 in August. Readings over 50.0 indicate growth and expansion and August was the 13th month in a row this report has been positive. There is some hope that stronger data from the manufacturing sector will translate into a positive influence on the jobs market. However, readers should keep in mind that the manufacturing sector is only 11% of the U.S. economy.

The better than expected ISM data overshadowed news on construction spending, mortgage applications, and auto sales. The Commerce Department said construction spending fell -1.0% in July to the lowest level in ten years. June's previously estimated gain was revised lower to a -0.8% drop. On a more positive note the Mortgage Bankers Association said their mortgage applications index rose +2.7% last week. Both refinance applications and new purchases improved and together they marked the fifth weekly rise in a row for applications thanks to record-low mortgage rates. The average interest rate on a 30-year fixed mortgage is 4.43%.

Auto sales were not so encouraging. Nervous consumers are not buying new cars with unemployment hovering near 10%. August is normally a strong month for auto sales but this year sales vanished marking the worst August in almost 30 years. Month to month sales were bad but year over year they were terrible since summer 2009 was driven by the government's "cash for clunkers" rebate program. General Motors said August sales dropped -7% from July but -25% from a year ago. Ford (F) said sales dropped -5% from July and -11% from August 2009. Toyota saw a -12% drop from July and -34% from a year ago. Nissan's sales dropped -7% from July and -27% from August 2009. Honda Motor Co. said August sales slowed -3% but fell -33% from a year ago.

It must have been too warm in San Francisco today. Steve Jobs ditched his trademark black mock turtleneck while presenting the latest round of gadgets from Apple Inc. (AAPL). The company unveiled improvements for their Apple TV system, iPod touch, iPod nano, and iPod shuffle. The newest iPod touch will have a camera and video-chat features similar to the iPhone. The latest iPod nano will have a touch screen. The new Apple TV system is smaller and cheaper (at $99) and lets consumers download movies and high-definition TV shows from the Internet. Most of the buzz centered on the Apple TV system, which will allow users to download TV shows for 99 cents and movies the same day they hit rental stores for $4.99. Netflix subscribers will also be able to download movies to their TVs via the new Apple system. Shares of AAPL ended the day up +2.9% at $250 a share. NFLX soared +7.4% to $135 a share.

One of the best performers today was Burger King (BKC). The stock spiked higher and settled with a +14.6% gain near $18.85 a share following news the company was in talks to go private with 3G Capital. The 56-year old company went public back in May 2006 at $17 and the last couple of years have been rough for shareholders. The stock has been consistently underperforming its rival McDonald's (MCD) the last few months.

Technically the market is bouncing from oversold conditions near significant support levels. The rally today could have been exacerbated by beginning of the month inflows to mutual funds. We could easily see this bounce continue for a few more days but that depends on how the market chooses to interpret the jobs data this Friday. The S&P 500 has been bouncing from support near the 1040 level and after failing to breakdown over the past few days traders decided to cover on the stronger manufacturing news. What worries me is the lack of volume behind this move but that doesn't mean the rally can't continue.

Currently the S&P 500 index is testing resistance near 1080 and its simple 50-dma. Should the rally continue we can expect resistance at 1100 and then in the 1130 region (early August highs). There is also potential technical resistance with the 100-dma near 1108 and the 200-dma near 1115. If you're feeling optimistic then the S&P 500 could still be working on an inverse (bullish version) head-and-shoulders pattern. A strong close over the 1130 level would suggest a bullish target of 1,240 but I suspect the 1220 level remains very significant resistance. Let's pretend for a moment that the jobs number disappoints and stocks reverse lower again. The S&P will probably break support near 1040 but the 1010-1000 zone could be decent support. A drop under 1,000 could portend a longer decline toward the 950 area.

Chart of the S&P 500 index:

2nd Chart of the S&P 500 index:

The NASDAQ Composite delivered a very strong move with a gap open higher and a +2.9% gain. The tech-heavy index has broken out of the 2100-2150 trading range. It certainly looks like the NASDAQ is poised to rally further but watch for resistance near 2200, 2250, and the 2300 area. The index could also see trouble at the 50-dma and 200-dma. Broken resistance near 2150 should offer some short-term support.

Chart of the NASDAQ index:

Aggressive traders may want to pay more attention to the small cap Russell 2000 index. Not only did the $RUT outperform its large-cap peers with a +3.8% gain today but the $RUT appears to be building on a bullish double bottom pattern. The 50-dma might offer some resistance but I wouldn't be surprised to see this rally hit the 640 area.

Chart of the Russell 2000 index:

I would also keep an eye on the Dow Jones Transportation index, which just rallied past resistance near its 50 and 200-dma. Broken resistance near 4200 should offer some short-term support for the transports. Keep an eye on the SOX semiconductor index. The trend is down but the semiconductors are very oversold and poised for a rebound. Look for resistance in the 325-330 zone. I would also keep an eye on the banking indices. These were poor performers in August with both the BIX and BKX sinking to new relative lows. On a very short-term basis this group looks ready to bounce further but I would expect the rebound to run out of steam.

Looking ahead we have the pending home sales, Kansas Fed manufacturing survey, retail same-store sales figures and the weekly initial jobless claims data all coming out tomorrow (Thursday). The pending home sales data will likely be bad and the retail data could disappoint since early reports on back to school shopping were not very encouraging. The Kansas Fed could go either way. Sadly the jobless numbers have been getting worse as the four-week moving average starts to march closer toward 500,000 new jobless a week. Today's ADP employment report was another disturbing look at the job market. ADP only counts job growth at private companies and their August employment report was a disappointment with -10,000 jobs instead of the +15,000 analysts were expecting. Together, the rising trend in weekly jobless claims and the ADP number today does not bode well for Friday's non-farm payroll number. Economists are expecting the jobs data to show a drop of -120,000 jobs in August but that number will be tainted by the last round of terminations for temporary census workers. The real number to watch is the private sector employment. Wall Street expects a drop of private sector jobs from +71,000 in July to +41,000 in August. Anything worse than that could spell serious trouble for the stock market.

Short-term traders can try and take advantage of the market's swings, especially when the indices are trading so closely off obvious support and resistance levels. However, I am suggesting readers stay cautious. Bank of America's New York office came out with some discouraging figures on U.S. growth. The firm now expects U.S. GDP growth for the rest of 2010 to fall toward +1.65% and they're projecting 2011 growth to decline to +1.8%. I suspect we will see more and more analysts lowering their growth expectations for the U.S. soon. The stock market could choose to interpret today's numbers in two ways. You could argue that +1.6% is a whole lot better than a double-dip recession and investors could focus on the fact we're still growing, albeit slowly. Or there is the risk that investors choose to react negatively to growth estimate downgrades and argue that stocks may be priced too high for these lowered expectations.

Lastly, readers on the east coast better grab their rain jackets. Category four Hurricane Earl, the biggest storm in U.S. waters this year, is not expected to make landfall on U.S. soil but it will pass close enough that residents from South Carolina to Massachusetts will feel the storm's influence. The weather service has already recorded 50 foot waves out in the Atlantic and there is a chance that the storm path veers closer to the coast than expected. If Hurricane Earl misses us it will soon be followed up by Tropical Storm Fiona.

-James


New Plays

Relative Strength

by Scott Hawes

Click here to email Scott Hawes


NEW BULLISH Plays

Dr. Pepper Snapple Group - DPS - close 37.71 change +0.89 stop 35.93

Company Description:
Dr Pepper Snapple Group, Inc. (DPS) is an integrated brand owner, manufacturer and distributor of non-alcoholic beverages in the United States, Canada and Mexico with a varied portfolio of flavored (non-cola) carbonated soft drinks (CSD) and non-carbonated beverages (NCB), including ready-to-drink teas, juices, juice drinks and mixers. The Company's brand portfolio includes CSD brands, such as Dr Pepper, Sunkist soda, 7UP, A&W, Canada Dry, Crush, Squirt, Penafiel, Schweppes and Venom Energy, and NCB brands, such as Snapple, Mott’s, Hawaiian Punch, Clamato, Rose’s and Mr & Mrs T mixers.

Target(s): 38.85, 39.95
Key Support/Resistance Areas: To Follow
Time Frame: 1 to 2 weeks

Why We Like It:
DPS has been a relative strong performer throughout the recent market sell-offs and has also been the subject of takeover chatter in recent months. Technically, the stock has formed rounded bottom over the past month which signals a shift from sellers to buyers. The stock is on the verge of breaking out higher and I suggest readers initiate long positions in the stock on any weakness using $37.30 as a trigger. Our targets are +4% and +7% higher. Our stop is below the recent swing low at $35.93.

Suggested Position: Long DPS stock if it trades to $37.30

Annotated daily chart:

Entry on September XX
Earnings 11/4/10 (unconfirmed)
Average Daily Volume: 2.6 million
Listed on August 31, 2010


In Play Updates and Reviews

Tighten Stops On Shorts

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:
Good evening. Our short positions took a beating today. I have narrowed targets on shorts and suggest readers begin to look for exits on weakness or tighten stops to protect capital. Please email me with any questions.

Current Portfolio:


BULLISH Play Updates

The Andersons, Inc - ANDE - close 36.56 change +0.68 stop 34.45

Target(s): 38.90, 40.50, 41.50
Key Support/Resistance Areas: 41.50, 40.50, 39.20, 38.00, 35.50
Current Gain/Loss: -1.24%
Time Frame: 1 to 3 weeks
New Positions: Yes

Comments:
9/1: ANDE remains in a high tight bull flag. If the broader market strength continues the stock should break higher and head towards our targets. All of my comments below remain the same.

8/31: ANDE closed relatively flat on the day. The stock remains above the key support level in the $35.00 to $35.50 area which is the logical area for a bounce back higher. This area is not a bad place to consider new bullish positions.

8/28: ANDE is hanging tough and maintaining its upward trend line with the 20-day SMA acting as support. I'm looking for the stock to break out higher and move up towards our targets.

Current Position: Long ANDE stock, entry was at $37.02

Options Traders: Buy December $40.00 Calls, current ask $2.10

Entry on August 19, 2010
Earnings 10/28/2010 (unconfirmed)
Average Daily Volume: 180,000
Listed on August 18, 2010


Ultrashort MSCI Europe - EPV - close 19.54 change -1.78 stop 17.78

Target(s): 20.00, 20.50, 21.00, 22.00
Key Support/Resistance Areas: To Follow
Time Frame: 1 to 2 weeks

Comments:
NOTE: This is an double inverse ETF and a bearish play on European equities. Expect volatility and use small position size to manage risk.

9/1: Wow, EPV gapped nearly -6% lower at the open which was below our stop so this position was not opened, i.e. we would have been simultaneously stopped out. European equities rallied on the heels of economic data just like here in the US. The question remains whether this is a one day event or the start of something bigger. We probably won't know that until Friday's employment numbers but I suspect we may get some follow through to today's rally. EPV looks like it wants to fill the gap higher on 8/11 which would be a pullback to the $18.90 area. If we can get filled at this price I suggest initiating a small long position in EPV (bearish position in European equities) and play for a bounce in the ETF. I've adjusted our targets and stops.

8/31: EPV has broken out of its long term downward trend line and has made a series of higher highs and higher lows throughout the month of August. I believe there will be a correction in European stocks and this one way to play it. I suggest we initiate positions if EPV trades to down to $21.10 and we'll use a tight stop of $20.21 to keep losses small if we are wrong. Our first two targets are +6% and +10% higher respectively.

Suggested Position: Long EPV stock if it trades to $21.10

Entry on August xx
Earnings N/A
Average Daily Volume: 259,000
Listed on August 31, 2010


Rackspace Hosting, Inc - RAX - close 20.12 change +0.43 stop 17.95

Target(s): 20.75(hit), 21.30, 23.00
Key Support/Resistance Areas: 23.50, 21.40, 20.00, 19.00, 18.00
Current Gain/Loss: +2.39%
Time Frame: 3 to 5 weeks
New Positions: Yes, preferably on a pullback

Comments:
9/1: We are looking good here as RAX is above the key $20.00 support level and the ascending triangle that has been forming since June. Now we need follow through. If RAX spikes back up to our first target protect profits or consider taking a portion of your position off of the table.

8/31: RAX experienced a set-back today when Benchmark Co. cut its rating to hold from buy. The firm reiterated their price target of $22. RAX closed at $19.69 and if it goes to $22.00 we will be happy campers. Once this selling subsides RAX should turn back up. The stock is maintaining its primary upward trend line and is still above all of its major moving averages. For options traders we have December strikes so time is on our side for now. Readers may want to consider this pullback as an entry point.

8/28: Wow! RAX surged nearly +8% higher on Friday and is approaching our 2nd target. I think this stock has the potential of reaching its 52-week highs near our final target of $23.00. RAX is also being talked about as a potential takeover target in the cloud computing space which is why I have suggested the December options, i.e. to give this time to work. Readers may want to consider taking some profits off of the table and keeping the remainder of your position open to see if RAX rewards us.

Current Position: Long RAX stock, entry was at $19.65

Options Traders: Long December $21.00 CALL

Entry on August 25, 2010
Earnings 11/9/2010 (unconfirmed)
Average Daily Volume: 1.75 million
Listed on August 25, 2010


BEARISH Play Updates

Automatic Data Processing - ADP - close: 39.37 change: +0.76 stop: 40.75 *NEW*

Target(s): 38.85 (hit), 38.05, 37.25, 36.50
Key Support/Resistance Areas: 41.00, 39.00, 37.30
Current Gain/Loss: -1.60%
Time Frame: Several weeks
New Positions: Yes

Comments:
9/1: ADP double topped with the high on 8/23 before pulling back. My comments from below remain valid in regard to exercising caution with this trade. Our stop is above the 30-day and 50-day SMA so we need this bounce to be short lived if our targets are going to be met.

8/31: ADP is moving slow and I am concerned of a broader market bounce in equities. We have a small gain in this trade and I suggest readers use caution. I've added a target of $38.05 and have lowered the stop to $40.75.

8/28: ADP looks ready to bounce along side the broader market. The stock closed right on a steep downtrend line but I think it's only a matter of time before it's broken. Readers may want to consider using a tighter stop or simply exiting positions. Our official stop is above the 20 and 50-day SMA's but a tighter stop of $40.10 could be used. I've also listed a target near breakeven ($38.85) on the trade. ADP could show some weakness early in the week and this could be used a logical exit point as it is an intraday support level.

Current Positions: Short ADP stock, entry was at $38.75

Option Traders: Long November $37.00 puts

Entry on August 24, 2010
Earnings Date 10/28/10 (unconfirmed)
Average Daily Volume: 3.2 million
Listed on August 19, 2010


Chesapeake Energy - CHK - close 21.24 change +0.56 stop 21.60

Target(s): 20.60, 20.20, 19.70 (hit), 19.10
Key Support/Resistance Areas: 22.50, 21.60, 20.30, 19.65, 18.75, 18.00
Current Gain/Loss: -2.07% Time Frame: 1 to 2 weeks
New Positions: Yes

Comments:
9/1: After having a +5% gain during the breakdown on 8/25 we now have a -2% loss and are vicariously close to getting stopped out in CHK. The stock closed below the 50-day SMA and the backside of the its recent broken downtrend line. But any further broader market strength is probably going to stop us out. I believe the stop is in the right place and suggest readers step aside if it is hit. I've added two targets just below which are good places to consider closing positions or tightening stops to protect capital.

8/31: CHK has printed two topping tail candlesticks off of the 20-day SMA from below and a downward trend line. This is a bearish signal but we will most likely need more weakness in the market for CHK to move lower.

8/28: My comments from below about CHK violating the prior days candlesticks is not a good sign for this short position. Our stop is $21.60 so we won't get hurt too bad if we are taken out but readers should be aware that Friday's pattern can be considered a reversal pattern. In hindsight, we should have taken the +5% gain we had from the breakdown on 8/25. Nice job to readers that did.

Current Position: Short CHK stock, entry was at $20.81

Options Traders: Long October $20.00 PUTS

Entry on August 16, 2010
Earnings: 11/2/2010 (unconfirmed)
Average Daily Volume: 10 million
Listed on August 14, 2010


Starbucks Corp. - SBUX - close: 23.68 change: +0.70 stop: 25.05

Target(s): 22.70, 22.20, 21.30
Key Support/Resistance Areas: 25.00, 23.50, 22.00, 21.00, 20.00
Current Gain/Loss: -1.63%
Time Frame: Several weeks
New Positions: Yes

Comments:
9/1: Readers may want to consider a tighter stop in the $25.50 area which is above the stock's primary downtrend line and the 200 & 20-day SMA's. However, this stop would be just below the 50-day SMA. The primary downtrend line and 20-day SMA are in the $24.00 area and SBUX has filled a gap down. All of these factors should keep bounces in check but broader market strength will most likely still lift the stock if it continues.

8/31: SBUX shed almost -2% today. Volume was much higher than in recent days when the stock was drifting higher. If there is broader market weakness in the coming days SBUX could quickly trade down to our targets. Otherwise, there is a bunch overhead congestion which should keep bounces in check.

8/28: My best guess is that SBUX has some unhappy shareholders at higher prices which should keep bounces in the stock in check. There is a lot of congestion overhead but we may need to exhibit some patience through a bounce.

Current Position: Short SBUX stock, entry was at $23.30

Options Traders: Long October $23.00 puts

Entry on August 24, 2010
Earnings Date 11/04/10 (unconfirmed)
Average Daily Volume: 8.0 million
Listed on August 19, 2010


CLOSED BULLISH PLAYS

HNSI, Inc - HNSI - close 26.29 change +.11 stop 28.11

Target(s): 25.80 (hit), 25.40, 25.05, 23.75
Key Support/Resistance Areas: 28.90, 27.25, 25.80, 200-SMA, 23.50, 22.00
Final Gain/Loss: -3.35%
Time Frame: 1 to 2 weeks
New Positions: Closed

Comments:
9/1: HSNI hit our first target yesterday at $25.80 and has rallied +8% off of its lows. We had a +5% gain and were stopped out to the tick this afternoon for -3.35% loss. The lesson learned is that we have to protect profits or simply take them when given the chance. I tightened the stop to $28.11 yesterday because it was above all of its moving averages and recent swing highs. In hindsight, the stop may have been too tight but it may have also been the right call if HNSI continues higher. Time will only tell.

8/31: HSNI hit our $25.80 target this afternoon before bouncing and closing in positive territory. I want to tighten the stop to $28.11 to protect against a more meaningful bounce. I've added $25.40 as a target with $25.05 as the next target which is just above the stock's 200-day SMA. I would be taking profits or tightening stops to protect them as these levels approach. $25.80 is still a valid target and could be construed as a double bottom play by some traders so readers should still consider taking profits here as well.

8/28: HSNI may bounce with the broader market but I will be surprised if it takes out the downtrend line from its April highs. I have tightened the targets significantly and suggest readers take a small gain or tighten stops to protect the gains should HSNI reach them.

Closed Position: Short HSNI stock at $28.11, entry was at $27.20

Annotated chart:

Entry on August 25, 2010
Earnings: 11/11/2010 (unconfirmed)
Average Daily Volume: 495,000
Listed on August 24, 2010