Option Investor
Newsletter

Daily Newsletter, Thursday, 8/18/2011

Table of Contents

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

Market Wrap

Double Ugly

by Jim Brown

Click here to email Jim Brown
The markets were hammered again but this time on two fronts. Worries over European banks started the decline overnight and U.S. economics was the secondary blow.

Market Statistics

The morning started off grim after the Wall Street Journal said the Federal Reserve was questioning European banks with operations in the U.S. about their cash levels required to operate in the USA. Reportedly some European banks have been withdrawing cash from U.S. operations and moving it to Europe as the banking crisis heats up overseas. However, a Fed report last week claimed U.S. branches of European banks became net borrowers of dollars from their overseas affiliates for the first time in a decade. Obviously the rumor mill is very active because you can't have it both ways.

There was also news that an unnamed European bank was forced to borrow $500 million from the ECB's emergency liquidity fund on Wednesday night. That was the first time since Feb 23rd a bank was forced to borrow from the ECB.

Analysts and investors alike are afraid European banks are seeing a run on assets as Europeans continue to withdraw their money into paper euros. There has been a "stealth run" on the banks by consumers for the last couple months but it has been accelerating as worries increase.

In response to the WSJ article New York Fed President William Dudley said the Fed was "always scrutinizing banks" and that it treated U.S. and European banks "exactly the same." Of course that does not mean the Fed did not question the European banks as part of their normal scrutiny.

Most European banks are still carrying loans from 2008 and sovereign debt on countries like Greece, Ireland and Portugal at par value. They have not written down the value of those loans because it would force them to raise significant amounts of new capital. Eventually the loans will default and the damage will occur suddenly rather than an orderly markdown over time.

The $2.5 trillion money market industry has been pulling deposits out of European banks for the last several months on concerns the debt crisis is spiraling out of control. Interbank lending has also dried up much like we saw in the U.S. during the Lehman and Bear Stearns crash. Nobody was confident in what assets a bank really had so they quit doing counter party transactions and that sucked the liquidity out of the system. The Fed is worried this outflow of cash from the European side, plus the halt to interbank lending, could cause the crisis to spiral out of control. Societe Generale shares fell more than 12% because its dollar exposure was around 23% of its balance sheet.

French banks have been hit especially hard because they are more reliant on U.S. money market deposits for liquidity. There was also a rumor Goldman Sachs told a French bank they no longer wanted to do counter party transactions.

Other banks with U.S. branches hard hit were Barclays (BCS) -11%, Deutsche Bank (DB) -7% and Lloyds (LYG) -9%.

When global investors don't know the truth about the safety of European banks there is only one place to put their money and that is the U.S. treasury market. The yield on the ten-year Treasury note fell to 1.978% and a new low. The 30-year declined to a two-year low but still above the 2008 levels. However, 30-year mortgage rates declined to an historic low.

Ten-Year Note Yields Chart

Thirty-Year Bond Yield Chart

Helping to push money into the bond market was a really ugly economic report in the Philly Fed Manufacturing Survey. The headline number declined 33 points to -30.7 in August and well into contraction territory. Typically numbers lower than -25 indicate a recession. That has been true in all but one instance back in 1995.

The internal components were very negative. In May/June we saw a sharp deterioration from the conditions in April but that eased slightly in July with only two components in negative territory. However, in August the downward acceleration was brutal. The headline number has fallen -74.1 points since the +43.3 reading in March.

We should have known there was trouble ahead when the back orders failed to recover in July. With the Philly Fed severely negative it is a very bad omen for the broader economy. This is only a regional report but it has strong correlations with the broader ISM Manufacturing Survey due out in two weeks.

A drop of this magnitude in the Philly Survey would normally equate to a loss of 500,000 to 700,000 jobs in the Nonfarm Payrolls in two weeks. However, we have not seen a material increase in the weekly jobless claims so I strongly doubt the payroll report will be significantly negative.

The survey period ran from August 8th to August 16th and the stock market was setting its correction lows on the 10-11th and that could have had a material impact on orders and sentiment.

Philly Fed Components

Philly Fed Chart

Helping to calm some jittery nerves over the Philly Survey was a tame report on weekly Jobless Claims. The weekly number of new claims rose slightly to 408,000 from 399,000 the prior week. (revised from 395,000) The consensus estimate was for a rise to 400,000. An increase of this amount is just the normal weekly noise. There was nothing negative to be derived from the jobless claims and certainly not a major increase in layoffs as would normally be indicated by the Philly Fed. This suggests the Philly Fed was impacted by the political and economic events in the news and not by actual events in the manufacturing process.

Note the slow decline in claims over the last eight weeks. There is no indication of a significant change in economic activity. Only Florida, Texas and North Carolina reported an increase in claims of more than 1,000. Definitely not a recession.

Jobless Claims Chart

Another report causing slight concern was the Consumer Price Index. The headline number rose +0.5% in July and the fastest level since March. No sign of any recession here. The decline in June of -0.2% was erased. The core rate, ex food and energy, was lower at +0.2% slightly lower than readings for the prior two months. Core inflation over the last 12-months is now +1.8% and well within the Fed's target range. However, food is up +4.2% and energy +19.0% year over year. The Fed can fool itself with the low core reading but the prices you and I pay are significantly higher.

Consumer Price Index Chart

Existing Home Sales for July fell to 4.67 million (annualized) from 4.77 M in June. That was a -3.5% drop and is indicative of the stress being felt by the consumer. Having the stock market plummet -2100 points in a matter of days and credit requirements getting stronger instead of weaker and the outlook for home buyers is worsening. Prices are still expected to fall and buyers are electing to wait for potentially lower prices ahead. With mortgage rates plunging it will probably stimulate some people to consider a purchase but sales are not really expected to pickup until next spring. Distress sales are declining but only slightly as banks work through their backlog of foreclosures.

The Conference Board Leading Indicators for July ROSE by +0.5% and that is another indication the country is not falling back into recession. Six of the ten components rose and that was the same as in June. Those components declining slightly were consumer expectations, building permits, average workweek and the pace of deliveries.

After the close the SEMI Book to Bill numbers were released for July. The BTB ratio of orders to shipments fell to .86 from .94. That means only $86 in orders were received for every $100 in shipments. Equipment orders fell -15.7% nd shipments fell -7.6%. That is the largest decline in orders since January 2009 when orders fell more than 60%. The .86 BTB ratio is a six-month low and only a point above the .85 two year low set in January. This was not a positive report and would seem to indicate manufacturers are not investing in new product inventory over conservative levels.

Economic reports due out on Friday are the Regional Employment and Risk of Recession.

On Wednesday evening Morgan Stanley started the sell off ball rolling around the world when the brokerage company slashed its global economic outlook. Morgan Stanley cut global growth rates to +3.9% from +4.2% but that included a cut on developed economies including the U.S. to 1.5% growth. Morgan said the U.S. and Europe are "dangerously close to recession" due to "recent policy errors, especially Europe's slow and insufficient response to the sovereign crisis and the drama around lifting the U.S. debt ceiling, which have weighed on financial markets and eroded business and consumer confidence."

The cut was not surprising and they were not the first to do it but it was the straw that broke the market's back overnight on Wednesday. Other market declines included the FTSE -4.5%, DAX -6%, CAC 40 -5.5%, FTSE MIB -6%, Swiss IDX -4%, STOXX -5% and IBEX 35 -4.7%. Today's market decline was very broad based and touching all overseas markets as well as the USA.

Banks were especially hard hit because the market rumors about halts to counter party transactions and liquidity. The $500 million overnight ECB loan to an undisclosed bank helped to increase fears of a liquidity event similar to Lehman. Despite capital levels at U.S. banks much higher today than pre Lehman there is still a concern over exactly what kind of exposure U.S. banks have to Europe. Bank America and Citigroup fell -6% with JPM -4% and WFC -5%.

The global equity crash and financial insecurity pushed gold to a new record high at $1832 and silver to almost $41. Also helping the gold rush was news Hugo Chavez was nationalizing Venezuela's gold production and bringing back more than $11 billion in gold currently on deposit around the world. It looks like his piggy bank has run dry. A Russian company operates Venezuela's biggest gold mine so I wonder how that is going to play out with his new Russian buddies who are selling him all those military weapons?

Gold Chart

Unfortunately the nearly -5% decline in the U.S. markets caused another rout in the oil markets as traders raced to exit futures positions to cover margin calls in equities. The Dow declined -500 points at the open and everyone who had levered up long positions in equities and commodities thinking the bad news was behind us was crushed at the open. It became a scramble to raise margin money again and crude futures were hit hard. Selling crude futures to raise money was a valid idea since Morgan Stanley's downgrade of global growth and the Philly Fed dropping back to recession levels both suggested a period of weak demand ahead for oil products.

The plunge in oil prices knocked WTI back to $81 when it was trading at $89 just yesterday. The rapid plunge in prices triggered stop losses and the rest as they say is history. Another buying opportunity for those with a long-term perspective. Marvin Schwartz, managing director at Neuberger Berman, was advocating long term buy of energy equities on CNBC today. He gently explained the "demand is about to exceed production" scenario and reiterated this was a buying opportunity. For those of us already in the sector we may have a different name for it but it is still a buying opportunity.

Crude Oil Chart

Hewlett Packard (HPQ) was supposed to report earnings after the close today. Unfortunately for them some of the news was leaked and they were forced to put out a press release at 3:PM and the stock was halted for trading. The news was not good. Hewlett reported better than expected earnings at $1.10 that beat estimates by a penny. Revenue was inline with estimates. That was the extent of the good news.

HPQ lowered guidance for the current quarter to $1.12 to $1.16 compared to estimates for $1.32. Revenue guidance was lowered to $32.3 billion compared to estimates at $34 billion. HPQ is going to take a one time charge of $1 billion related to the shutdown of its WebOS business. The CEO said Hewlett struck out on the WebOS push but maybe somebody else would like to buy the skeleton and try to make it work. The WebOS operating system is used in the TouchPad and WebOS phones. That does not bode well for their TouchPad sales and Hewlett indicated they were going to abandon that effort and close the division. The CEO said they could be successful in the consumer device business but it would require the investment of a lot of time and capital and they have elected to put that capital to work elsewhere. HPQ just bought Palm last year for $1.8 billion and now it is getting out of the business. Canceling the smartphone and TouchPad products is a major change in direction. That is also evidence of multiple major mistakes by management. Maybe it is time to dump management along with the TouchPad.

Hewlett also said it was considering spinning off its personal PC division the Personal Systems Group. That would be the final break from the Carly Fiorina era and the acquisition of Compaq. The CEO said he wanted to position the company more like IBM in software and services and move away from consumer products.

Hewlett also confirmed it was in talks to acquire Autonomy Corporation for $11.7 billion. Autonomy is the UK's largest software company and the board recommended shareholders accept the Hewlett offer and 79% premium.

You may remember on Tuesday night I warned about the problems with the TouchPad and the potential for HPQ to take a major plunge after the earnings. I recommended a short term combination play to capture whatever move appeared. The $30 call, $29 put (Aug) were both trading for about 48-cents each about 30 min before the close with HPQ at $29.50. With HPQ down to $26.50 overnight that would have been a winning trade. Without the TouchPad in their product line they could go a lot lower.

Hewlett Packard Chart

The S&P crashed at the open to 1134 and that level was only briefly penetrated to 1131 just before the close. However, the end of day dip was bought and the S&P closed at 1140. Despite the -53 point decline there was no technical damage. The rally had stalled for the prior two days and the market was looking for direction. The S&P stalled at 1205 just like I discussed on Tuesday so aggressive traders were already loading up on Wednesday's close.

There will be more margin selling on Friday and probably some more volatility thanks to option expiration and a follow on effect from what is sure to be an Asian decline overnight.

Most analysts were expecting a retest of the lows so the decline was not unexpected. This was not a monster selling event but more of a buyer boycott. Volume did increase from the 7.1 billion shares on Wednesday to 11.5 billion today. That was still significantly lower than the 15-16 billion share days we saw during the correction last week. It was a 90% day with 10.7 billion shares in declining volume compared to 764 million shares of advancing volume.

This did not feel like a capitulation day. I believe there are plenty of traders waiting for the retest so there was no urgency to exit or to pile onto the decline with new shorts. If you were not short at the open there was no play.

Support is 1115-1120 so that would be the target for any dip on Friday. I seriously doubt we will see a major rebound on Friday but I have been surprised before. With Europe the major problem there is event risk to being long over the weekend. A decline below 1115 could trigger additional selling with a target of 1100.

S&P-500 Chart

The Dow is a carbon copy of the S&P with a solid failure at 11,500 on Wednesday and a close below 11,000 today. With any margin selling at all on Friday we could see the Dow sink even lower. The next material target for a retest of the lows would be 10,700.

Dow Chart

The Nasdaq was hit very hard with more than a -5% decline. The low at 2362 was very close to a valid retest of the lows at 2350 and close enough this could be seen as a valid retest under normal conditions.

However, tech stocks are performing so badly that I am concerned we could see a lower low. With Google (-28) and Apple (-14) imploding we could see some follow on selling when those margin calls hit overnight.

Nasdaq Chart

The Dow Transportation Index closed at a 52-week low and this is a serious blow to market sentiment. This suggests investors are concerned the second half growth scenario is now firmly broken and they are heading for the exits. The transportation index is seen as a sentiment index and sentiment is definitely tanking.

Dow Transports Chart

I remain neutral on the market. I would buy a retest of the lows but only if there was a bounce in progress. The sentiment indicators are very negative but I believe the Philly Fed Survey was an anomaly. Nothing else we have seen recently has been even close to that kind of decline in activity. Remember, that is a sentiment survey where respondents are asked how they "feel" about business conditions. Nobody is actually adding up orders and shipments to produce hard numbers. With the market in the tank it appears business sentiment was also in the tank. I believe future reports will not show that level of negativity. However, the market may not care and simply head south because that is the path of least resistance.

Jim Brown

Send Jim an email


New Plays

Convenience Stores

by James Brown

Click here to email James Brown


NEW BULLISH Plays

Susser Holdings - SUSS - close: 18.84 change: +0.38

Stop Loss: 17.30
Target(s): 21.75
Current Gain/Loss: unopened
Time Frame: 4 to 8 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
SUSS runs a regional chain of convenience stores and fuel stops. The stock has a very, very small float of only 7.75 million shares and the average daily volume is less than 90 thousand a day. That alone makes me a little nervous trading the stock. Yet SUSS has been showing impressive relative strength.

Thursday saw SUSS bounced from the $18.00 level and rally to a +2.0% gain on volume nearly twice the norm. That's normally a bullish signal. I am suggesting very small bullish if and only if both SUSS and the S&P500 index both open positive tomorrow morning. If triggered we'll use a stop loss at $17.30, which is a little wide and another reason why we want to keep our position size small.

FYI: The Point & Figure chart for SUSS is bullish with a $28.50 target.

If SUSS and S&P500 both open positive tomorrow morning, then open positions.

Suggested Position: buy SUSS stock @ open

Annotated chart:

Entry on August xx at $ xx.xx
Earnings Date 11/09/11 (unconfirmed)
Average Daily Volume = 88.5 thousand
Listed on August 18, 2011



In Play Updates and Reviews

Better Than the Market

by James Brown

Click here to email James Brown

Editor's Note:
Most of our bullish candidates held up reasonably well and suffered smaller declines than the market's major indices.

HON was stopped out.

I am removing our entry point on PCAR until the weekend.

-James

Current Portfolio:


BULLISH Play Updates

Alexion Pharmaceuticals - ALXN - close: 50.31 change: -1.43

Stop Loss: 47.90
Target(s): 54.00, 57.00
Current Gain/Loss: - 0.7%
Time Frame: 2 to 5 weeks
New Positions: see below

Comments:
08/18 update: ALXN is holding up reasonably well. The NASDAQ lost -5.2% while ALXN only gave up -2.7%. Shares were holding near support at the $50.00 level most of the session. If the market's major indices open positive tomorrow then we can use this dip in ALXN as a new entry point. Otherwise I would wait for the S&P500 and NASDAQ to retest their lows from last week before considering new positions here.

Our plan was to keep our position size small to limit our risk.

Current Position: ALXN stock @ $50.67

- or -

Long SEP $55 call (ALXN1117I55) Entry $1.40

08/15 new stop loss @ 47.90
08/12 trade is open.
08/11 open positions if ALXN and S&P500 are positive Friday morning
08/09 new entry point strategy, new stop loss, new targets.

Entry on August 12 at $50.67
Earnings Date 10/20/11 (unconfirmed)
Average Daily Volume = 1.7 million
Listed on August 8, 2011


Apollo Group Inc. - APOL - close: 45.31 change: -1.47

Stop Loss: 44.70
Target(s): 53.00
Current Gain/Loss: - 3.6%
Time Frame: 4 to 8 weeks
New Positions: see below

Comments:
08/18 update: APOL was not immune to the market sell-off today but shares only lost -3.1% versus -5.2% in the NASDAQ. Traders were buying dips in APOL near the $45.00 level all day long. If the market's major indices open positive tomorrow then we can use this dip in APOL as a new entry point. Otherwise I would wait for the S&P500 and NASDAQ to retest their lows from last week before considering new positions here.

Don't forget we did raise the stop loss to $44.70 yesterday.

Suggested Position: Long APOL stock @ $47.00

- or -

Long SEP $50 call (APOL1117I50) Entry $1.32

08/17 new stop loss @ 44.70

Entry on August 17 at $47.00
Earnings Date 10/12/11 (unconfirmed)
Average Daily Volume = 2.6 million
Listed on August 16, 2011


Avon Products Inc. - AVP - close: 20.96 change: -0.78

Stop Loss: 20.20
Target(s): 23.50, 24.40
Current Gain/Loss: - 4.3%
Time Frame: 6 to 8 weeks
New Positions: see below

Comments:
08/18 update: AVP gapped open lower at $21.16 and eventually closed with a -3.5% decline. Selling slowed after the first hour and shares spent most of the day consolidating sideways. Last week's lows were in the $20.30 region. I would use a dip near $20.30 as a new entry point to buy AVP or calls on the stock.

- small bullish positions -

Suggested Position: Long AVP stock @ $21.91

- or -

Long SEP $23 call (AVP1117I23) entry $0.50

Entry on August 17 at $21.91
Earnings Date 10/27/11 (unconfirmed)
Average Daily Volume = 5.1 million
Listed on August 15, 2011


Carpenter Technology - CRS - close: 44.32 change: -3.21

Stop Loss: 43.45 (stock only)
Target(s): 51.50, 56.50
Current Gain/Loss: - 3.6%
Time Frame: 1 to 3 weeks
New Positions: see below

Comments:
08/18 update: Ouch! Today's -6.75% decline took our CRS trade from a gain to a loss. The stock gapped open lower near $46 and then dropped toward last week's lows near 444.00. The intraday low this afternoon was $43.81. This should be support and we have a stop loss at $43.45. If the S&P500 opens positive tomorrow I would use today's dip in CRS as a new entry point to start bullish positions. Any further declines will likely stop us out.

Earlier Comments:
We do want to keep our position size small to limit our risk.

Current Position: Long CRS stock @ $46.01

08/15 exit Aug. $50 call now, bid $0.75 (+15.3%)
08/13 consider an early exit on the Aug. call
08/11 *entry is an estimate. option did not trade today.

Entry on August 11 at $46.01
Earnings Date 10/26/11 (unconfirmed)
Average Daily Volume = 622 thousand
Listed on August 9, 2011


Giant Interactive Group Inc. - GA - close: 7.80 change: -0.17

Stop Loss: 7.20
Target(s): 9.30
Current Gain/Loss: - 7.8%
Time Frame: 4 to 8 weeks
New Positions: see below

Comments:
08/18 update: It was a relatively quiet day for GA. Shares gapped open lower at $7.86. The intraday rally failed midday and shares closed with a loss of -2.1% compared to -5.2% in the NASDAQ or -4.4% in the S&P500.

If the market's major indices open positive tomorrow then we can use this dip in GA as a new entry point. Otherwise I would wait for the S&P500 and NASDAQ to retest their lows from last week before considering new positions here.

More conservative traders may want to consider a higher stop loss!

Earlier Comments:
Readers should consider this a higher-risk, more aggressive trade. We want to keep our position size small to limit our risk.

Current Position: Long GA stock @ $8.46

- or -

Long SEP $7.50 call (GA1117I7.5) Entry $0.95

Entry on August 15 at $ 8.46
Earnings Date 11/16/11 (unconfirmed)
Average Daily Volume = 1.3 million
Listed on August 13, 2011


PACCAR Inc. - PCAR - close: 34.88 change: -2.38

Stop Loss: 35.85
Target(s): 39.90, 43.00
Current Gain/Loss: unopened
Time Frame: 6 to 8 weeks
New Positions: see below

Comments:
08/18 update: Our new trade in PCAR is not open yet. Both the S&P500 and PCAR opened lower today. Shares have fallen toward last week's lows and what "should" be support near $35.00. Aggressive traders could use this dip as a new entry point and just adjust your stop (maybe in the $34.40 area).

I am suggest we temporarily remove our entry point on PCAR. Odds just shot up significantly that the major indices will retest their lows from last week. If that happens and PCAR is already at last week's lows then we could see PCAR breakdown further. I would watch for the next level of support near the January 2010 lows around $33.50.

In summary, we'll remove our entry point strategy on PCAR for tomorrow and re-evaluate on Friday night.

Entry Point Removed. Just Wait and Watch Tomorrow.

Entry on August xx at $ xx.xx
Earnings Date 10/25/11 (unconfirmed)
Average Daily Volume = 5.6 million
Listed on August 17, 2011


BEARISH Play Updates

None. No bearish plays currently.


CLOSED BULLISH PLAYS

Honeywell Intl. - HON - close: 42.76 change: -3.23

Stop Loss: 44.40 (stock only)
Target(s): 49.75, 53.50
Current Gain/Loss: - 5.7%
Time Frame: 2 to 6 weeks
New Positions: see below

Comments:
08/18 update: Thursday proved to be an ugly, ugly day for HON. If the widespread market weakness was not bad enough shares of HON were downgraded this morning. The stock gapped open lower at $44.45 and quickly plunged to its low of the day at $42.13. Our stop loss was hit at $44.40 (-5.7%).

We did not have a stop on the option position but I'm suggesting an early exit there as well. More aggressive traders may want to hang on to their September options since we have four weeks before they expire and HON could easily rebound. My biggest concern is the stock's breakdown to new relative lows on huge volume! That's not a good signal.

Earlier Comments:
We want to keep our position size pretty small to limit our risk. We're not using a stop loss on our option positions.

closed Position: Long HON stock @ $47.10, exit 44.40 (-5.7%)

- or -

SEP $50 call (HON1117I50) Entry $0.95, exit $0.20 (-78.9%)

08/18 stock position stopped out @ 44.40
08/18 option, suggested an early exit. bid @ 0.20

chart:

Entry on August 15 at $47.10
Earnings Date 10/21/11 (unconfirmed)
Average Daily Volume = 7.8 million
Listed on August 13, 2011