Option Investor
Newsletter

Daily Newsletter, Wednesday, 9/22/2010

Table of Contents

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

Market Wrap

Dollar Drops, Gold Gleams, Stocks Stall

by James Brown

Click here to email James Brown

Market Stats

The rally in stocks stalled on Wednesday following yesterday's less than inspiring release from the Federal Reserve. If the FOMC believes the U.S. economy needs help then growth must be slowing down even faster than expected. The banking sector was a big drag on the market with a -1.9% decline. Recent strength in the technology sector vanished following an earnings warning from PMC-Sierra Inc. (PMCS) and Adobe's (ADBE) disappointing earnings guidance last night. Shares of PMCS lost -6% while ADBE plunged -19% for the day.

The Fed's comments yesterday were not bullish for the dollar and the U.S. dollar fell to new five-month lows on Wednesday. Treasuries rallied again pushing the yield on the 10-year bond down to 2.54%. Precious metals soared as investors worried about the next round of quantitative easing and the effect on our currency. Gold hit a new all-time high for the fifth day in a row. The intraday high was $1,298 an ounce before settling with a +1.4% gain at $1,292.10. Gold is poised to mark its tenth annual gain in a row. Copper futures rose to new five-month highs and platinum rallied to four-month highs. Silver was a big winner too with a +2.4% gain to $21.05 an ounce. This was the first time silver has closed over $21 since March 2008. It was a different story for oil futures. Oil slipped 26 cents to $74.71 a barrel following a bearish increase in inventories. The Energy Department said crude supplies jumped 970K barrels to 358.3 million when economists were expecting a -1.75 million draw down.

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

Chart of the Gold ETF (GLD):

It was a down day for stocks around the world. Most of the major indices closed in negative territory. The Hong Kong Hang Seng was an exception with a +0.2% gain but the Chinese Shanghai market was closed for holiday as was the Korean and Taiwan markets. The Hong Kong market will close for holiday tomorrow. In Japan the NIKKEI index recovered from its morning losses but failed to hold any midday gains and closed in negative territory with a -0.37% drop on light volume. Traders are still very much focused on the yen/dollar relationship after last week's currency intervention by Japan. There is a lot less worry about the yen strengthening since it is widely expected that Japan will step in again and sell more yen to weaken their currency (currently trading near 85 yen to the dollar).

European markets were struggling with bearish economic data. The 16-nation euro zone industrials orders showed a -2.4% drop in July following a +2.4% rise in June. Economists were only expecting a -1.4% decline. Naturally worries are growing that manufacturers will slow down production and hiring if demand continues to wane. The EU zone also saw its consumer confidence stumble. Analysts were expecting an improvement from -11.4 in August to -10 but today's report only showed an improvement to -11.2. Slowing growth and drastic budget cuts by several regional governments is taking its toll on the population's attitudes (do you recall all of the recent strikes?). Currently economists are projecting the EU to see +0.5% GDP growth in the third quarter, down from +1.0% growth in the second quarter.

News on the residential real estate market here in the U.S. continues to sour. The Federal Housing Finance Agency (FHFA) issued their report on home prices with mortgages backed by Freddie Mac and Fannie Mae. According to their report housing prices slipped -0.5% in July and they revised June's decline from -0.3% to -1.2%. Economists were only expecting a -0.2% drop for July, which was the eighth monthly decline in a row and marks a -3.3% plunge from a year ago. Based on these numbers home values have fallen to September 2004 levels. The market is suffocating under a tidal wave of foreclosures. A few days ago RealtyTrac reported August was the worst month on record with over 95,000 homes repossessed. The National Association of Realtors is due to release their August sales figures on existing home sales tomorrow. The July report was terrible with a -27% drop in home sales so the bar is set pretty low for August.

Speaking of home sales the pace of mortgage applications is not painting a very healthy picture. Mortgage rates are still near record lows at 4.44% for a 30-year fixed rate mortgage. Yet applications are down. The Mortgage Bankers Association said their index of applications fell -1.4% last week. This is the third weekly decline in a row. Applications for new purchases dropped -3.3% and refinancing fell -0.9%. A Reuters article calculated that at current rates your monthly payment is only $503 per $100,000 financed. FYI: NAR estimates the median price of a home in this country at $183,000.

Corporate news was generally discouraging today. Adobe (ADBE) made the biggest splash following its earnings report last night. The company beat estimates by 5 cents a share but the market was unhappy with its guidance. The stock garnered several downgrades and gapped open lower to eventually settle with a -19% decline near its 2010 lows. Tech giant Microsoft (MSFT) had much better news but traders were already in a mood to sell. MSFT announced they were raising their quarterly cash dividend by 23% from 13 cents to 16 cents. It is their first dividend increase in two years but investors were expecting more. The stock gapped open lower and closed with a -2.1% loss on the session.

Normally a dividend raise is a sign of confidence by management that the environment is improving so it's safe to return money to shareholders. Today's increase in dividend bumps MSFT's yield to 2.5% a year, giving it the 12th highest yield in the NASDAQ 100. The company is poised to pay out $5.5 billion a year in dividends thanks to its 8.65 billion shares outstanding. MSFT is also taking advantage of the market's demand for high-quality corporate paper. Yesterday the board approved up to $6 billion in new debt and today MSFT sold $4.75 billion in debt, some of it at the lowest level in U.S. history. The company has over $37 billion in cash but a lot of this is overseas and it is cheaper for MSFT to raise money here by selling bonds at extremely low rates than repatriating their cash and paying taxes on it.

In less happy news the Wall Street Journal reported that Blockbuster Inc. is on the verge of filing for Chapter 11 bankruptcy protection. The company has been withering under competition from Netflix (NFLX), Amazon.com's download service, and Red Box. Blockbuster is struggling with $900 million in debt and hundreds of big brick and mortar stores. Smaller rival Movie Gallery Inc. filed for bankruptcy over six months ago and instead of reorganizing they decided to liquidate the company. There is plenty of speculation if Blockbuster will be able to emerge from bankruptcy or not. This could be the final credits for Blockbuster.

Online auction giant Ebay (EBAY) is another example of traders being in a mood to sell. EBAY guided its third quarter earnings toward the top of its previous range (35-37 cents a share) and yet investors sold the news anyway. The stock fell -5.5% midday but pared its losses to just -1.6% before the closing bell. EBAY is still up over 26% from its July 2010 lows.

There were exceptions. General Mills Inc. (GIS) reported earnings this morning of 64 cents a share. That was one cent better than expected. Revenues missed estimates at $3.53 billion versus $3.57 billion. GIS claimed that globally the sales environment is still tough but their core food business remains strong. Management reaffirmed their 2011 guidance and the stock shot higher to post a +2.69% gain.

In after hours action the earnings data continues to trickle in. Bed Bath and Beyond (BBBY) and Red Hat (RHT) released their results. BBBY delivered a profit of 70 cents a share, which was 7 cents better than expected. Q2 revenues rose +11.6% to $2.14 billion, beating estimates of $2.1 billion. Same store sales jumped +7.4% compared to a decline of -0.6% a year ago. BBBY management raised their 2011 guidance and the stock was up over +4% after hours. Meanwhile software firm Red Hat (RHT) reported earnings of 19 cents a share, which was one cent ahead of expectations. Revenues climbed almost +20% to $219.8 million, which was better than the estimate. The company issued upside earnings and revenue guidance going forward. After a -4.3% decline during the regular session shares were trading higher this evening.

It's not rocket science to see that the market's short-term trend is up. However, stocks are very overbought. The S&P 500 is up about +9% from its late August lows. The S&P 500's rally just failed at prior resistance near 1150. This is not a spot to be loading up on bullish positions. Broken resistance near 1130 should offer some short-term support but I would prefer to look for a dip near the 200-dma or better yet a dip near the 1100 area before considering new bullish positions. This appears to be a "buy the dip" market right now but we need to look for a decline toward support. The best place to look for support is prior resistance.

Chart of the S&P 500 index:

Even with the decline yesterday and today the NASDAQ composite is still up about +11% from its August lows. The move has been virtually non-stop. The breakout to new relative highs is very positive but we just don't want to chase it here. Previous resistance near 2300 could be new support for the NASDAQ but I would prefer to look for a dip near 2260. Consider the volatile move higher readers may want to wait for a pull back to 2250 instead before looking for new bullish positions.

Chart of the NASDAQ index:

As expected the small cap Russell 2000 index rallied to resistance near 670 and stalled. The move looks like a clearly defined failed rally and I would expected a deeper correction. The 640 and 630 levels are a good spot to watch for potential support on the $RUT index.

Chart of the Russell 2000 index:

Tomorrow morning investors will be reacting to the weekly initial jobless claims. Economists are expecting 450,000 new claims, which would match last week's number. We'll also see the leading indicators from August. The bigger report will be the NAR's existing home sales data for August. Analysts are estimating a small improvement to an annual pace of 4.1 million homes. Friday's market moving event is probably the durable goods orders number. Also out Friday is the new home sales figures for August.

In summary, the trend is up but stocks are overbought and way overdue for a correction. We want to buy a dip but look for a decline near support

-James


New Plays

Short Broker Dealer

by Scott Hawes

Click here to email Scott Hawes


NEW BEARISH Plays

Stifel Financial Corp - SF - close 47.95 change -1.59 stop 50.10

Company Description:
Stifel Financial Corp is a financial services holding company. It provides securities related financial services to approximately 1.0 million client accounts of customers throughout the United States and Europe. The Company operates in three segments: Global Wealth Management, Capital Markets and Other. Its subsidiaries include Stifel, Nicolaus & Company, Incorporated (Stifel Nicolaus), a full service retail and institutional brokerage and investment banking firm; Century Securities Associates, Inc. (CSA), an independent contractor broker-dealer firm; Stifel Nicolaus Limited (SN Ltd), and Stifel Bank & Trust (Stifel Bank).

Target(s): 46.05, 45.05, 44.05
Key Support/Resistance Areas: 50.00, 48.00, 45.75, 45.00, 43.50
Time Frame: 1 to 2 weeks

Why We Like It:
The financial services sector looks terrible across all industries, from banks, to lenders, to broker dealers. A study released today said that the 85% of Americans do not trust the financial markets and have therefore reconsidered their investment activities. Retail trading volumes are way down which will hurt firms like SF. I suggest readers initiate short positions in SF using one of two triggers. Let's use a trigger to short SF if it trades up to $48.45 or if breaks down to $47.52. The stock may find support at some of its moving averages but ultimately SF should head down to test its recent lows if the broader market cooperates. If triggered at $48.45 our targets range from -4.5% to -9% lower. Our stop is above Tuesday's high.

Suggested Position: Short SF stock if it trades to $48.45 or $47.52

Options Traders: Buy November $45.00 PUT, current ask $1.50

Annotated chart:

Entry on September xx
Earnings: 11/09/2010 (unconfirmed)
Average Daily Volume: 250,000
Listed on September 22, 2010


In Play Updates and Reviews

Big Gains In Our Takeover Target

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:


BULLISH Play Updates

Brocade Communications - BRCD - close 6.26 change +0.61 stop 6.05 *NEW*

Target(s): 5.95 (hit), 6.20 (hit), 6.37, 6.50
Key Support/Resistance Areas: 6.60, 6.20, 6.00, 5.75, 5.40, 5.00
Current Gain/Loss: +8.87%
Time Frame: 1 to 3 weeks
New Positions: No

Comments:
9/22: Wow! The takeover chatter has regained steam in BRCD and the stock exploded +10.80% higher today. This is one of the reasons I released the trade and it is time to protect profits, or at least take some of them off the table. The chatter today came from IBM as an interested party at $7.50 per share, however, I have nothing to confirm this other than news sources I use. We can not count on this so I suggest we move the stop up to $6.05 and begin to trail it up if BRCD continues to break out. I've added a target of $6.37 which is near today's highs and a place where traders may consider a double top play. I highly suggest taking half or more of your position off the table and see how much more you can get out of the remaining position.

9/21: BRCD traded relatively quiet today. My comments below remain the same.

9/18 & 9/20: I am concerned about BRCD per my 9/15 comments. However, the stock has held its ground and remains in a bull flag. It could just as easily break higher or lower. If a breakout occurs before a pullback I suggest readers begin to look for an exit or tighten stops to protect profits. $5.95 and $6.20 are the primary targets.

Current Position: Long BRCD stock, entry was at $5.75

Options Traders: Long October $6 CALL

Entry on September 10, 2010
Earnings 11/23/10 (unconfirmed)
Average Daily Volume: 12.7 million
Listed on September 4, 2010


Noble Corp - NE - close 35.09 change -0.17 stop 32.25

Target(s): 35.90, 36.80, 38.30
Key Support/Resistance Areas: 36.95, 38.50, 33.50
Current Gain/Loss: +1.42%
Time Frame: 1 to 3 weeks
New Positions: Yes, on pullbacks

Comments:
9/21 & 9/22: NE continues to look strong but I am concerned about the overbought conditions in the broader market. A dip could come but I think it will be bought and may give readers another chance to enter. My comments below remain valid.

9/18: NE made a nice recovery today closing +1.7% on the day. The stock remains in a bull flag on its daily chart. If we break higher prior to a pullback I suggest readers look for an exit or tighten stops to lock in profits. I've added $35.90 as a target which is approximately +4% from our entry, while $36.80 is +6%. I'll be looking to take profits or tighten stops as these levels approach.

9/15: NE traded down to $34.36 and bounced hard into the close. Our first target is just under the 200-day SMA and near the 8/4 highs. Our stop is below the converging 20, 50, and 100 day moving averages. My comments from the play release remain the same.

Current Position: Long NE stock, entry was at $34.60

Options Traders: Long October $36.00 CALL

Entry on September 15, 2010
Earnings 10/20/10 (unconfirmed)
Average Daily Volume: 3.7 million
Listed on September 11, 2010


iPath S&P 500 VIX ST Futures - VXX - close 17.06 change +0.27 stop NONE

Target(s): 18.45, 19.25, 20.40
Key Support/Resistance Areas: 17.50, 18.50, 19.75, 20.60
Current Gain/Loss: -3.62%
Time Frame: 1 week
New Positions: Yes

Comments:
NOTE: I view this as an aggressive trade so small position size is recommended. Long VXX is a bearish play on equities, however, it is listed as long play because we are long the underlying instrument.

9/21 & 9/22: I suggest we stick with no stop here and play for a broader market pullback. The bulls look tired and the pullback could come quick as traders will run for the exits to lock in profits. This is when we want to be selling positions and tightening stops. For readers who do not have positions I view the depressed levels in VXX as an opportunity for nice quick trade. Just remember to plan your exit and stick with it. $18.45 and $19.25 are the primary targets.

9/20: I want to temporarily remove the stop in VXX as it is too close to current levels. We will get a spike in volatility in the coming days which is when we will close VXX for a profit, or tighten stops. This is risky move and a judgment call based on the current overbought conditions and low volatility levels. My comments below remain valid.

9/18: My guess is that a breakout prior to a pullback will most likely stop us out in VXX. But I like volatility here as the market is in much need of a healthy pullback. A pullback will likely be fast and furious and VXX should spike 5% to 10% which will give us an opportunity to close this position for a profit. I've added a target of $18.50. Be ready to take profits or tighten stops to protect them as our targets approach. My comments from below have not changed.

Current Position: Long VXX stock, entry was at 17.70

Options Traders: Long October $19.00 CALL

Entry on September 14, 2010
Earnings N/A (unconfirmed)
Average Daily Volume: 21 million
Listed on September 13, 2010


BEARISH Play Updates

Alleghany Technologies - ATI - close 44.15 change -0.00 stop 46.82

Target(s): 42.05, 41.00, 40.10
Key Support/Resistance Areas: 46.25, 43.80, 42.00, 40.00
Current Gain/Loss: +1.12%
Time Frame: 1 to 2 weeks
New Positions: Yes, on strength or a breakdown

Comments:
9/22: ATI tried to make a run higher today but the move was stopped dead in its tracks and ATI immediately headed lower and consolidated near those lows the entire day. The stock is hanging onto its 20-day SMA and if it breaks below our targets should be reached relatively quick. I am looking for broader market weakness in the coming days and for ATI to trade down near $42.00 fairly quick.

9/21: Steel producers have been getting downgraded and the sector remains in a downtrend. I suggest we take advantage of an impending correction in the broader market and initiate short positions in ATI, which should send ATI back towards its recent lows. Let's use one of two triggers. If ATI trades up to $44.65 or a break down to $43.78. If triggered at $44.65 our first two targets are -4.5% and -7% lower. Our stop is above a recent downtrend line that began in late July.

Suggested Position: Short ATI stock, entry was at $44.65

Entry on September 22, 2010
Earnings: 10/20/2010 (unconfirmed)
Average Daily Volume: 1.7 million
Listed on September 20, 2010


Deckers Outdoor Corp - DECK - close 46.52 change -1.53 stop 47.10 *NEW*

Target(s): 47.40, 46.15, 45.25
Key Support/Resistance Areas: 50.25, 45.00, 43.50
Current Gain/Loss: +5.66% Time Frame: 1 to 2 weeks
New Positions: No

Comments:
9/22: The sell-off in DECK continued today as the stock lost -3%. We came within 2 pennies of our $46.10 target so this has been raised 5 cents. If DECK trades down to $46.15 take profits or tighten stops to protect them as this could be construed as a double bottom set-up by some traders. I've also added another target of $45.25 which could get hit if the broader market weakness picks up. Regardless, we need to protect profits so I've lowered the stop all the way down to $47.10 which guarantees up a nice profit.

9/21: We are short DECK as of the today's open. The stock proceeded to sell-off -2.50% today and looks headed towards our targets just below. My comments from the play release below remain the same.

9/20: The retail sector has experienced an impressive string of consecutive advances and is due for pullback with the broader market. DECK has overhead resistance and is sitting just below a downtrend line that began with its 52-week highs in June. I suggest readers initiate short positions at current levels and play for -4% to -6.5% pullback. Our stop will be above the downtrend line and it will be adjusted after we are in the trade.

Current Position: Short DECK stock, entry was at $49.31

Entry on September 21, 2010
Earnings: 10/21/2010 (unconfirmed)
Average Daily Volume: 859,000
Listed on September 20, 2010


CLOSED BEARISH PLAYS

Freeport-McMoRan - FCX - close 84.51 change +1.52 stop 84.55

Target(s): 80.20, 79.40, 78.00
Key Support/Resistance Areas: 84.25, 76.50, 75.00
Final Gain/Loss: -4.45%
Time Frame: 1 week
New Positions: Closed

Comments:
9/22: We were taken out of FCX today for a disappointing and bad loss. The money printing promises by the Fed sparked commodities and materials stocks yesterday afternoon and it continued today. FCX has broken through an uptrend line and prior resistance from last fall. The stock will correct at some point but I was simply too early. Hopefully, readers are on board with some of our other winners which takes some of the sting out of this loss.

9/21: What a day, FCX gave up all of yesterday's big advance and then some by the time noon rolled around. However, after the FOMC announcement the stock rallied hard into the close. All told, FCX traded in a 3% range today and closed down 36 cents. Traders holding long positions in FCX had a scare today and if selling picks up again we could see a sharp move lower. This is when we should consider exiting positions or tightening stops as our targets approach.

9/20: A Goldman Sachs upgrade on FCX to buy from neutral sent the stock +2% higher today. As a result, our position suffered greatly and now we need to look for an exit. This move higher in FCX can not continue but it appears any dips will most likely get bought. I've added an immediate target of $80.20, while $79.40 will fill a gap higher. FCX should make it down to these levels on a pullback and is where I suggest readers close positions or tighten stops to protect capital. This could all come at once on one big down day.

Current Position: Short FCX stock, entry was at $80.95

Options Traders: Long October $75.00 PUT

Annotated chart:

Entry on September 15, 2008
Earnings: 10/20/2010 (unconfirmed)
Average Daily Volume: 10 million
Listed on September 14, 2010