Option Investor
Newsletter

Daily Newsletter, Monday, 10/3/2011

Table of Contents

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

Market Wrap

Ugly Start To Q4

by Todd Shriber

Click here to email Todd Shriber
It was noted across dozens of outlets over the weekend that the third quarter of 2011 was the worst for U.S. stocks since the fourth quarter of 2008. Well, the fourth quarter of 2011 is off to a savage start as the Dow Jones Industrial Average looked on Monday with 2.4% loss. That is good by comparison to the loss of nearly 3% for the S&P 500 and the loss of more than 3% for the Nasdaq. The Russell 2000 plunged 5.4%.

Stats Table #1

A combination of recession and Greek default fears gripped the market today, but there were actually a couple of decent economic reports out here in the U.S. The Commerce Department said construction spending climbed 1.4% in August following a 1.4% drop in July. Private construction increased 0.4% in August while residential building jumped 0.7%.

The banner report, sort of, was the September reading on the Institute for Supply Management's factory index, rose to 51.6 last month from 50.6 in August. Economists expected a September reading of 50.5. New orders were flat, but employment inched higher, so this was arguably a good news/bad news report. Still, readings above 50 signal expansion, but stocks acted as if the ISM number was zero.

ISM Table

About the only thing that worked from the long side today was gold. Silver followed suit as well. Gold futures climbed for a second straight session as Greece's woes once again spurred demand. September was the worst month for gold since October 2008, but if any asset class can be counted on to bounce higher from an oversold condition these days, it would be gold.

On Sept. 30, holdings in gold-backed exchange-traded products rose 0.2 percent, the first increase in a week, to 2,213.6 metric tons, according to data compiled by Bloomberg. That is a relevant anecdote, but what should accompany that is the fact that ETFs backed by physical gold saw little in the way of outflows during the yellow metal's September correction. Translation: It was hedge funds and other speculators selling gold futures contracts to cover bad bets elsewhere that drove gold prices, not a fundamental change in the gold story. Gold Chart

Talk about not flying the friendly skies. Shares of AMR Corp. (AMR), the parent company of American Airlines, the third-largest U.S. carrier, plunged 33.1% on volume that was more than six times the daily average on speculation the company is burning through cash at alarming rate and may need to seek bankruptcy protection. AMR expected to end the third quarter with a cash and short-term investment balance of about $4.7 billion, including $475 million in restricted cash, Bloomberg News reported, citing an AMR filing.

The decline in AMR shares is made even more stunning by the fact that the stock was already down 62% for the year before the opening bell today. This is also the lowest the stock has been since May 2003 when it touched $2.10, the post-Sept. 11th low. American's stock is the worst-performer among the major U.S. airlines this year, not surprising given the company lost $286 million in the second quarter while most airlines were profitable.

Much is made of fuel costs as they pertain to airlines and there is no getting around the fact that fuel is number one operating cost for any airline. Logically, airlines benefit when oil prices fall, which they have been doing recently. This scenario underscores some major problems in American's business model because the U.S. Oil Fund (USO) was down 20% in the past three months before the start of trading today. Over the same time, AMR shares were down 45%.

Labor is still a major problem for airlines and as Barron's reported, American pilots are departing quickly because they want to lock in their pensions, which would be vulnerable in the event of a bankruptcy. The reality is compensation is another 800-pound gorilla for American and if the U.S. really is a free market economy, Uncle Sam would do well to stay out of this mess and let AMR rise or fall on its own merits.

AMR Chart

For one day at least, shares of Internet search provider Yahoo (YHOO) looked better compared to the broader market after Jack Ma, founder and CEO of Chinese e-commerce giant Alibaba, said his company would be interested in buying Yahoo. All of Yahoo, Ma said, not just the 40% stake in Alibaba currently owns.

Yahoo and Alibaba have a relationship that goes back to 2005, but what was normally a cordial affair became strained under former Yahoo CEO Carol Bartz. Bartz refused to oblige Ma when he wanted to repurchase some of the Alibaba shares owned by Yahoo. Bartz is no long a problem for Ma and the latter may be smelling blood in the water. Still, Yahoo founder Jerry Yang reportedly said last month the company is not for sale. After Yang blew the deal with Microsoft (MSFT) several years ago, he may not have the luxury or the board's support in eschewing another takeover offer.

Yahoo Chart

Not surprisingly, Monday's action was a bloodbath for commodities as recession fears sent crude oil tumbling to its lowest closing price in a year. Coal is another commodity that has not been immune to the ''risk off'' trade. In fact, coal, which I admit I was bullish on a few months ago, has been infected with a commodities flu.

Last Friday after the close, Arch Coal (ACI) sneaked in a profit warning that did not go unnoticed today. The company said it will post a full-year adjusted profit of no more than $1.40 a share. That is well below the $1.75 the company previously forecast and the $2.01 Wall Street was expecting.

Missouri-based Arch lost 9.3% on volume that was better than double the daily average. The glum news from Arch sent the Market Vectors Coal ETF (KOL) down 5.5% on above average turnover. In the past couple of weeks, Alpha Natural Resources (ANR), Walter Energy (WLT) and Arch have issued production or profit warnings. Those three stocks stocks combine for roughly 14% of KOL's weight. No wonder the chart is so ugly.

Coal ETF Chart

Looking at the charts, I am afraid I do not have good news. The S&P 500 failed to hold support at 1120 and round number support at 1100 was also violated. The close below 1100 sets the S&P 500 up for a return to the 1050-1060 area. From there, 1025 is the next off ramp. Should that area not hold, and perish the thought, but a return to 860 is not out of the question.

S&P 500 Chart

Selling pressure was intense on the Dow today with 29 of 30 components finishing the day in the red. Wal-Mart was the lone Dow stock to close high. Support at 10,600 was not tested today, though this seems to be a formality. XOM and CVX were a mess today while CAT lost nearly 4.5% and Bank of America (BAC) shed nearly 10%. Assuming 10,600 does not hold, and I do not think it will, the Dow is probably headed back to 10,000.

Dow Chart

Things are not much better concerning the Nasdaq. After Friday's big loss, 2340 should have been next support, but the next closed about five points below there today. More closes below 2340 probably send the Nasdaq to 2210 and then to 2100. And yes, I say that knowing that the fourth quarter is supposed to be good for tech stocks. AAPL, AMZN and BIDU were all down a tad less than 2% today while GOOG was whacked to the tune of nearly 5%.

Nasdaq Chart

The decline on the Russell 2000 was breathtaking today. With a plunge of almost 5.4%, the small-cap index seems destined to retest critical support at 590. I want to say that an ETF like the ProShares UltraShort Russell 2000 (SRTY) makes sense here, but this decline has been so hard and fast that I am a little worried about messing with an ETF as volatile as this one. With the Russell 2000 just 19 points from critical support, SRTY offers $3-$4 of upside assuming the declines stop at 590.


This is clearly a fear-driven market as evidenced by the fact that we are sitting at the lows for the year. Economic numbers have not been bad over the past few days and it would appear that the U.S. and China will dodge another significant recession next year, but until the jobs number, which comes up Friday, starts showing real signs of life, buyers have plenty of reasons to stay on the sidelines. Earnings season is fast-approaching, but I would not be betting on enough positive surprises there to get the S&P 500 back to 1350 before year-end. At this point, even 1300 looks very tricky.

Todd Shriber


New Plays

Holding Company

by James Brown

Click here to email James Brown


NEW BEARISH Plays

Loews Corp. - L - close: 33.50 change: -1.05

Stop Loss: 35.15
Target(s): 30.50
Current Gain/Loss: +0.0%
Time Frame: 3 to 6 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
Loews Corporation (L) is a massive holding company. They have significant ownership stakes in CNA Financial (CNA), Diamond Offshore (DO), Boardwalk Pipeline Partners (BWP), and they own 100% of HighMount Exploration and 100% of Loews Hotels.

The stock looks very bearish with a breakdown to new 52-week lows today. Shares have formed a bear-flag pattern that points toward $30, which coincides with its 2010 lows. I am suggesting bearish positions now. We'll use a stop loss above the 10-dma at $35.15. Our target is $30.50. More aggressive traders could aim a little lower. The Point & Figure chart for L is bearish with a $23 target.

NOTE: Don't go overboard on the Oct. $30 puts just because they look cheap.

Suggested Position: short L stock @ the open

- or -

buy the OCT $30 PUT (L1122V30) current ask $0.50

Annotated chart:

Entry on October 04 at $ xx.xx
Earnings Date 10/31/11 (unconfirmed)
Average Daily Volume = 2.1 million
Listed on October 03, 2011



In Play Updates and Reviews

Technology Stocks Underperform

by James Brown

Click here to email James Brown

Editor's Note:
The tech-heavy NASDAQ fell -3.2% versus a -2.8% drop in the S&P 500. Our bullish trade on RHT was stopped out. Plus the USO trade was stopped out.

-James

Current Portfolio:


BULLISH Play Updates

Bristol-Myers Squibb - BMY - close: 31.49 change: +0.11

Stop Loss: 29.90
Target(s): 33.50
Current Gain/Loss: +1.0%
Time Frame: 6 to 8 weeks
New Positions: see below

Comments:
10/03 update: BMY continues to show relative strength. Yet I would hesitate to launch new positions, especially with the market's major indices hitting new 52-week lows.

current Position: Long BMY stock @ $31.15

- or -

Long 2012 Jan. $30 call (BMY1221A30) Entry $2.26

09/27 new stop loss @ 29.90
09/26 trade opened

Entry on September 26 at $31.15
Earnings Date 10/26/11 (unconfirmed)
Average Daily Volume = 13.6 million
Listed on September 22, 2011


PowerShares Gold Double Long - DGP - close: 54.44 change: +1.92

Stop Loss: 49.40
Target(s): 59.00, 64.00
Current Gain/Loss: -1.4%
Time Frame: 8 to 10 weeks
New Positions: see below

Comments:
10/03 update: It seems that gold has regained its "safe haven" status as investors buy the precious metal on today's stock market sell-off. The DGP gapped open higher at $54.53 and closed with a +3.6% gain.

- Small Positions -

current Position: long the DGP @ $55.26

09/27 trade opened
09/26 reload this trade. Buy the open tomorrow, new stop 49.40
09/26 Trade opened on gap down at $51.96.
Trade stopped out at $51.45 (-0.9% loss)

Entry on September 27 at $55.26
Earnings Date --/--/--

1st Attempt:

Entry on September 26 at $51.96
Exit on September 26 at $51.45 (-0.9%)


Average Daily Volume = 1.3 million
Listed on September 24, 2011


BEARISH Play Updates

Avon Products Inc. - AVP - close: 18.97 change: -0.63

Stop Loss: 20.25
Target(s): 17.75, 15.50
Current Gain/Loss: +4.9%
Time Frame: 4 to 8 weeks
New Positions: see below

Comments:
10/03 update: AVP sank to a new two-year low and closed down -3.2% for the session. I am not suggesting new positions at this time. Cautious traders may want to take profits early on the put option (currently +58%).

Earlier Comments:
Our targets are $17.75 and $15.50. Readers may want to consider the November puts instead of Octobers. FYI: The Point & Figure chart for AVP is bearish with a $7.00 target.

Current Position: short the stock @ $19.96

- or -

Long OCT $20 PUT (AVP1122V20) Entry $0.79

10/01 new stop loss @ 20.25

Entry on September 29 at $19.96
Earnings Date 10/27/11 (unconfirmed)
Average Daily Volume = 3.9 million
Listed on September 28, 2011


CSX Corp. - CSX - close: 18.39 change: -0.28

Stop Loss: 20.26
Target(s): 18.10, 16.25
Current Gain/Loss: + 6.4%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
10/03 update: I am a little surprised that CSX did not see bigger declines today. The Dow Jones Transportation index fell -3.5%. CSX only fell -1.5%. I'm sure the plunge in airlines ($XAL -9.8%) probably accounted for most of the weakness in transports today, thanks to the AMR bankruptcy rumors.

The trend for CSX is still down. I would not open new positions at the moment. Readers may want to lower their stop loss a bit. Cautious traders may want to take profits on the put option now (currently +63%).

Earlier Comments:
Our first target is $18.10. Our second, much more aggressive target is $16.25, which could take a few weeks to get there.

Current Position: short CSX stock @ $19.65

- or -

Long OCT $20 PUT (CSX1122V20) Entry $1.20

Entry on September 28 at $19.65
Earnings Date 10/18/11 (confirmed)
Average Daily Volume = 12.4 million
Listed on September 27, 2011


Phillip Morris Intl. - PM - close: 61.76 change: -0.62

Stop Loss: 64.25
Target(s): 60.25, 57.50
Current Gain/Loss: +3.8%
Time Frame: 6 to 8 weeks
New Positions: see below

Comments:
10/03 update: Positive analyst comments on PM today may have helped slow its descent. Shares only fell -0.9% versus -2.8% for the S&P500 index. Readers will want to note that PM is nearing potential support at the mid March lows near $61.35. You may want to hesitate on launching new positions.

Current Position: short PM stock @ 64.21

- or -

Long NOV $60 PUT (PM1119W60) Entry $1.60

10/01 new stop loss at $64.25

Entry on September 29 at $64.21
Earnings Date 10/20/11 (unconfirmed)
Average Daily Volume = 10.9 million
Listed on September 28, 2011


Research In Motion - RIMM - close: 20.50 change: +0.20

Stop Loss: 22.65
Target(s): 18.25, 16.25
Current Gain/Loss: - 1.3%
Time Frame: 6 to 8 weeks
New Positions: see below

Comments:
10/03 update: Hmm... I need to urge caution here. A bounce in RIMM was not what we expected today. It's not too surprising since the $20.00 level could be psychological support but with the widespread market declines I was expecting RIMM to break down. If the NASDAQ can punch through its August lows then I would expect RIMM to follow it lower. At the moment there is a chance the NASDAQ sees an oversold bounce tomorrow and I'm worried that RIMM could bounce with it.

Therefore, no new positions on RIMM at the moment. We'll wait and see how shares perform tomorrow. Nimble traders could try and time a failed rally near $22 as a potential entry point. Fundamentally, I would argue that RIMM still has a lot of problems. Bulls on the stock would argue those problems are already baked into the share price. I'm not convinced that's true.

Earlier Comments:
Our downside targets are $18.25 and $16.25. I would keep our position size small. RIMM is likely to see some volatility.

- Small Positions -

current Position: short RIMM stock @ $20.22

- or -

Long OCT $20 PUT (RIMM1122V20) Entry $0.65

Entry on October 03 at $20.22
Earnings Date 12/15/11 (unconfirmed)
Average Daily Volume = 27.7 million
Listed on October 01, 2011


Vulcan Materials Co. - VMC - close: 26.19 change: -1.37

Stop Loss: 30.25
Target(s): 25.25, 23.00
Current Gain/Loss: +5.0%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
10/03 update: Our VMC trade is off to a good start. Shares opened at $27.58 and plunged to a -4.9% drop. I would not chase it here. Wait for a failed rally near $28 or the 10-dma before launching new positions.

Earlier Comments:
FYI: Investors should note that the most recent data did list short interest at 19% of the 128 million share float. That is pretty high interest and raises the risk of a short squeeze if the market bounces.

- small positions -

current Position: Short VMC stock @ $27.58

- or -

Long OCT $26 PUT (VMC1122V26) Entry $1.50

Entry on October 03 at $27.58
Earnings Date 10/31/11 (unconfirmed)
Average Daily Volume = 2.0 million
Listed on October 01, 2011


Xilinx Inc. - XLNX - close: 27.06 change: -0.38

Stop Loss: 29.55
Target(s): 25.20, 23.00
Current Gain/Loss: +0.5%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
10/03 update: I am a little surprised that XLNX did not see bigger declines today. The SOX semiconductor index fell -3.6% with a drop toward its August lows. XLNX opened at $27.22 and dipped to $26.77 intraday before paring its losses to just -1.3%. The overall trend is still down but I'm a little concerned that the SOX might bounce from its August lows and that could fuel a bounce in XLNX. Readers may want to wait for a new failed rally near $28.00-28.50 or a bounce near the 10-dma in XLNX before initiating new positions.

Earlier Comments:
FYI: The Point & Figure chart for XLNX is bearish with a $20 target. The bear-flag pattern on the daily chart would suggest a downside target near $23.

current Position: short XLNX stock @ $27.22

- or -

Long OCT $27 PUT (XLNX1122V27) Entry $0.94

Entry on October 03 at $27.22
Earnings Date 10/19/11 (confirmed)
Average Daily Volume = 5.1 million
Listed on October 01, 2011


CLOSED BULLISH PLAYS

Red Hat Inc. - RHT - close: 40.46 change: -1.80

Stop Loss: 41.75
Target(s): 46.50, 48.00
Current Gain/Loss: -2.2%
Time Frame: 6 to 8 weeks
New Positions: see below

Comments:
10/03 update: It was an ugly day for RHT. The stock underperformed the market with a -4.2% drop. Shares have broken down under possible short-term support at $42.00, at its 100-dma, its 10-dma, 20-dma, and its exponential 200-dma. I warned readers over the weekend that last week's action looked like a bearish reversal. Shares of RHT hit our stop loss at $41.75 pretty early this morning.

closed Position: Long RHT stock @ $42.72, exit 41.75 (-2.2%)

- or -

OCT $45 call (RHT1122J45) Entry $1.15, exit 0.75 (-34.7%)

10/03 stopped out at $41.75
09/29 new stop loss @ 41.75
09/27 new stop loss @ 41.40

chart:

Entry on September 26 at $42.72
Earnings Date 12/21/11 (unconfirmed)
Average Daily Volume = 2.7 million
Listed on September 24, 2011


U.S. Oil ETF - USO - close: 29.74 change: -0.75

Stop Loss: 30.45
Target(s): 34.50
Current Gain/Loss: -2.2%
Time Frame: 6 to 8 weeks
New Positions: see below

Comments:
10/03 update: The weekend brought no relief for oil. Investors are still concerned of a global slowdown. While the ISM data in the U.S. was better than expected it was worse than expected overseas. Oil prices tumbled helped in part by a rising U.S. dollar. The USO oil ETF gapped open lower at $30.01, which was below our stop loss at $30.45. The trade was closed immediately.

closed Position: Long the USO @ $30.71, exit 30.01 (-2.2%)

- or -

NOV $32 call (USO1119K32) Entry $1.81 exit $1.28 (-29.2%)

10/03 stopped out on gap down at $30.01
09/28 Cautious traders may want to exit early now
09/27 new stop loss @ 30.45
09/26 trade opened at $30.71
09/24 removed conditional entry, adjusted stop to $29.75.

chart:

Entry on September 26 at $30.71
Earnings Date --/--/--
Average Daily Volume = 10.7 million
Listed on September 22, 2011