Option Investor
Newsletter

Daily Newsletter, Tuesday, 12/20/2011

Table of Contents

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

Market Wrap

Thank Shorts for the Rally

by Jim Brown

Click here to email Jim Brown
A sudden turn of events in Spain and strong economics in the U.S. and Germany caused a major short squeeze and pushed the Dow back over 12,000.

Market Statistics

For a change it was Europe that helped propel our markets higher rather than lower. Germany's IFO business sentiment index for December rose unexpectedly to 107.2 from 106.6 in November. Analysts had been expecting a decline to 106.0 or lower. That was the second monthly increase. The IFO chief said Germany appears to be successfully defying the downturn in Western Europe and the worries over the debt crisis. Stabilization tendencies are beginning to emerge. Companies are more positive about their outlook for the next six months and the opportunities for export are also looking better."

In Spain the Treasury reported sales of euro 5.6 billion in 3-month debt. That was well above the expected target of 4.5 billion and the yield fell to 1.74% from 5.1% in the prior auction on Nov 22nd. The yield on the 6-month bills fell to 2.44% from 5.22%. This remarkable change in yields and increase in bids is likely the result of the ECB offering banks 3-year loans at 1% and accepting almost any collateral for those loans. Banks can now borrow money from the ECB and buy this short term sovereign debt. That gives them a fat spread on the yields and the ECB gave them the money to buy the debt.

I discussed this ECB "long term liquidity" option last week as a potential way out of the debt mess at least temporarily. It solves two problems. It lowers the rates countries will have to pay for their debt service and provides revenue for the banks with little or no risk to aid them with their liquidity problems. Banks improve, sovereign debt costs improve and the pressure is off for an immediate solution to the debt crisis.

The debt crisis is actually improving. Portugal's finance minister said the budget deficit would likely fall below 5% in 2011 from 9.8% in 2010. Greece reported it was making good progress on the "bond swap" with private investors and it could be completed next month. That is the 50% haircut for those investors.

Any good news out of Europe is a cause for celebration and the market definitely cheered. At least those long stocks and commodities cheered but the shorts were definitely in pain. The U.S. economics helped to keep the opening rally moving and provided shorts zero relief.

In the U.S. the new residential construction for November exploded higher with starts rising to 685,000 from 628,000 on an annualized basis. That was a +9.3% gain over October. Single family starts increased +2.3% to 447,000. Permits rose +5.7% over the prior month and a year over year gain of +20.7%. Starts in the Northeast rose +53.8% and the West increased +22.6%. Housing completions declined -5.6% to 542,000 due to weather delays. The biggest contributor to the headline number was a +25.3% increase in multi-family starts. So many people can no longer qualify for a mortgage the rental rates are soaring along with the demand for rental units.

Chain store sales also surged higher last week by +3.4% and the largest weekly gain since 2000. Year over year growth rose to +4.6% and the biggest gain since early July. Customer traffic was strong across all segments with apparel and departments stores leading the increase. The ICSC said consumers are behind in their holiday shopping with only 70% completed compared to normal 74% for this time of year. The prior two weeks of sales had been running below normal. Apparently they are now racing to catch up. Gasoline prices fell -6 cents last week and -21 cents over the last five weeks. This is bullish for consumer sentiment. I bought gas in the Denver area for $2.95 a gallon over the weekend. That was encouraging even though I know it won't last.

Despite this being a holiday week the economic calendar remains busy for the rest of the week. The headliners will be the Chicago Fed Activity Index and Consumer Sentiment. The GDP revision is not expected to change much so not likely a market mover unless there is a major surprise.

Economic Calendar

The dollar declined -0.5% because of the stronger economic news from Europe and the rise in the euro. He drop in the dollar plus the optimism in Germany and the U.S. helped push commodities higher.

Dollar Index Chart

Crude rallied more than $3 on the optimism but there was also support from concerns over North Korea and lingering worries over a future disruption over Iran's nuclear ambitions. The OPEC meeting is fading in our rear view mirror and depleted global inventories are coming back into focus.

Crude Oil Chart

Gold rallied on the dollar but there were also anecdotal stories of central banks starting to make purchases after the strong discount of the last two weeks. Commodity fund managers in Europe reported customers placing large orders for long term accounts. The $1600 level is key as a psychological level and $1618 is key as the 200-day average. If we continue over $1618 it could trigger some technical buying. However, analysts believe the next rebound in gold may not be until January. Institutions want to go into year-end with cash after having taken profits in gold. They will begin new positions in January.

Gold Chart

In stock news General Mills (GIS) reported a -28% decline in Q2 earnings to 67-cents compared to 92-cents in the year ago quarter. Excluding acquisition charges for Yoplait and other items earnings were 76-cents per share. In the guidance they see costs rising 10-11% for the year but they have raised prices to offset those additional costs. For the full year GIS expects earnings of $2.59 to $2.61 and analysts were looking for $2.61. Shares declined slightly on the news.

Red Hat (RHT) declined -9% after reporting earnings Monday after the close that beat the street by 2-cents but guidance was only in line with estimates. For the current quarter they expect 26-27 cents per share and analysts were looking for 26-cents. Revenue grew +23% and several analysts said the weakness was a buying opportunity.

Red Hat Chart

Oracle (ORCL) reported earnings after the close and missed on both earnings and revenue. Earnings were 54-cents compared to estimates of 57-cents. Revenue was $8.8 billion compared to estimates of $9.23 billion. Oracle guided for 55-58 cents in the current quarter compared to analyst estimates of 59-cents.

Sales of new software licenses rose only +2% compared to double digit estimates by some analysts. Oracle itself had predicted a 6% to 16% increase. Oracle said orders from Europe were weak. Other companies had put off signing contracts late in the quarter on worries over events in Europe and Asia. Japan was also weak as they continue to recover from the earthquake.

This earnings miss and lowered guidance could be a negative for the markets on Wednesday but that assumes somebody is paying attention. With the weak volume today it may only impact Oracle stock.

Oracle Chart

Nike (NKE) posted earnings of $1.00 compared to estimates of 97-cents. Revenue increased +18% to $5.73 billion. This was a decent earnings report and they were pretty positive on expectations for 2012. They nearly always post decent sales gains in a summer Olympics year. With basketball restarting they should get a boost from that exposure as well. Nike also said it planned to raise prices to offset higher costs and they expect margins to decline slightly until those increases occur. Shares rose +2% after the close.

Jefferies (JEF) rocketed 22.9% higher today after reporting earnings that declined -23%. While that sounds like a confusing pair of statistics it was actually good news. Expectations were for a more significant decline. Jefferies was punished for the MF Global woes. When MF started crashing everyone looked at Jefferies as another potential problem. The company went to extremes to assure the market they did not have similar problems and also deleveraged in a hurry to prove that point. They slashed their balance sheet by about 25% to $35 billion in assets while reducing its leverage at the same time. Current leverage is only 10:1.

Even with all the slashing and trashing the company's investment banking revenue declined only -10% and less than some of their competitors who were not undergoing the same stresses. Goldman's IB revenue fell -33%. When the initial concerns broke Jefferies slashed its exposure to Greek, Irish, Italian, Portuguese and Spanish debt by 50%, twice, in only a few hours of trading. They cut euro zone bond exposure from $2.4 billion on Nov-1st to $375 million by Nov 30th. They went public and did what no other similar firm has ever done and disclosed their positions to show they had no material risk.

Posted earnings were 21-cents compared to JPM estimates of 11-cents and Goldman estimates of 15-cents. Shares of JEF rallied +23% to $14.50 and a two month high.

Jefferies Chart

After the bell the Federal Reserve released a long awaited and much stronger set of banking regulations designed to implement some of the Dodd-Frank rules and prevent another 2008 catastrophe. They released a 173 page document outlining new capital requirements, leverage limitations, annual stress tests and rules to limit credit exposure. Basically banks with more than $50 billion in assets will be required to maintain 5% capital. That increases +1% to +2.5% depending on the size of the bank in order to meet the Basel rules. They must keep 30 days of cash on hand during high stress periods. They cannot have more than 25% of their capital at risk to any one company. If that company has assets over $500 billion that limit declines to a 10% capital restriction. This is meant to limit exposure to a problem like Lehman, Bear Stearns or AIG. S&P futures did not blink after the surprise announcement so apparently the stronger rules were expected.

The rally today was clearly a short squeeze. The S&P gained +30 points at the open and never looked back. The succession of news stories never gave the shorts an opportunity to escape and there was no fade at the close in order to reload.

S&P Chart - 5 min

Volume was low at only 7.03 billion shares and it will decrease every day this week. This was probably the highest volume day of the week since Monday only managed 6.2 billion shares as option expiration settlements were handled calmly.

The news from Europe was positive but it was far from an all clear signal. There is still plenty of pain ahead. We will find out this week how much money European banks are going to request from the ECB in that three year liquidity program. Some analysts believe it could be as much as $500 billion. Who knows how investors will handle that kind of number. They could be relieved the ECB is resolving the liquidity crisis or they could be concerned because the crisis is so big.

The key for the rest of the week will be the lack of interest. Most institutional traders, hedge funds, etc have shutdown for the week if not the year. There will be far few traders at work as each day passes. Very low volume increases volatility but at least we should not see any major buy/sell programs. They don't want to launch programs in a thin market because of the resulting volatility.

The short squeeze saw the S&P rebound from 1205 and danger of falling below the psychological 1200 level, to close at 1240 and well over the resistance at 1225. The futures are showing no signs of a decline late this evening and after a gain of +337 points you would normally expect profit taking. I consider this bullish. However, we need to see how Europe and Asia respond to our rally and there is a lot of darkness before morning.

Support should not be 1225 and resistance 1260-1265. I sure didn't think on Sunday I would be quoting the 1265 number again this week.

S&P Chart

The Dow rebounded back over the 200-day and the resistance at 12,000 to close at 12,100. That is only about 100 points from the December high. One more good day and this market will make a serious change in sentiment. Any push over 12,200-12,230 would bring out the bulls in a race to year end. No self respecting money manager would want to be in cash at year end with the Dow at a five month high.

Dow Chart

The Nasdaq rallied back over the 100-day average at 2562 and even closed slightly over 2600 and prior support. The key here will be whether Oracle will sour sentiment and nip the rally in the bud. The semiconductor index rebounded +4.5% but remains well below any meaningful resistance. It will take more than a one day wonder to turn the semiconductor bears bullish.

Apple rebounded +14 after hovering at support at $380 for four days. The close at $396 was one dollar over resistance and any further move higher should trigger some additional buying.

The next meaningful resistance is the 200-day at 2660.

Nasdaq Chart

Semiconductor Chart

Russell Chart

The short squeeze was good for plenty of press coverage and the majority of investors will have pleasant thoughts when they see the headlines on the 10:00 news. However, it did not change market sentiment materially. It was a short squeeze and they happen routinely in bear markets.

Most rallies begin with a major short squeeze although they don't normally continue higher without a pause. Strong rallies are made over the objections of the bears and normally continue without any material reason for the sudden change in sentiment. Analysts will tell you the points producing the initial squeeze are not sufficient to push the market higher but sometimes the rally continues.

What analysts can't see in their daily dissection of the data is the frustration of investors and the hopes that better times are ahead. Maybe we will see that this week since this is historically a bullish week because of the holidays and year end retirement contributions.

The point here is that nothing changed in Europe other than the lower bond yields for Spain. Depending on the news from the ECB over the next several days we could see some improvement in investor sentiment. However, as we heard from Oracle tonight there are concerns in the business community that Europe could continue to be a problem. If you are long, enjoy the ride. Just don't get married to your positions because divorce is always painful.

If you have to be in the market take small positions and exit early.

 

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Send Jim an email


New Plays

Computer Hosting & Discount Retailers

by James Brown

Click here to email James Brown


NEW BULLISH Plays

Rackspace Hosting - RAX - close: 45.16 change: +0.95

Stop Loss: 43.45
Target(s): 49.75
Current Gain/Loss: unopened
Time Frame: 4 to 8 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
RAX is in the hosting and cloud computing industry. Shares have been slowly working their way higher. Now it's challenging a key trendline of resistance. A breakout here could provoke some short covering, especially since the most recent data listed short interest at almost 14% of the 105.7 million share float.

We are suggesting a trigger to open bullish positions at $45.55 with a stop at $43.45. More conservative traders may want to wait for RAX to close over $46.0 instead since the spring 2011 highs may still be resistance.
FYI: The Point & Figure chart for RAX is bullish with a $65 target.

Trigger @ 45.55

Suggested Position: buy RAX stock @ 45.55

- or -

buy the Jan $45 call (RAX1221A45) ask $2.00

Annotated chart:

Entry on December xx at $ xx.xx
Earnings Date 02/09/12 (unconfirmed)
Average Daily Volume = 1.5 million
Listed on December 20, 2011


Ross Stores Inc. - ROST - close: 47.86 change: +1.61

Stop Loss: 45.75
Target(s): 52.50
Current Gain/Loss: unopened
Time Frame: 4 to 6 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
ROST continues to show strength. The stock rallied +3.4% to close at all-time highs near $48.00. The stock recently had a 2-for-1 split on December 15th. Nimble traders might want to try and buy a dip near $46.00, which has been support for two weeks. I am suggesting we open bullish positions when ROST trades at $48.05.

Trigger @ 48.05

Suggested Position: buy ROST stock @ 48.05

- or -

buy the 2012Jan $50 call (ROST1221A50) ask $0.45

Annotated chart:

Entry on December xx at $ xx.xx
Earnings Date 03/19/12 (unconfirmed)
Average Daily Volume = 1.1 million
Listed on December 20, 2011



In Play Updates and Reviews

Bears Get Bruised

by James Brown

Click here to email James Brown

Editor's Note:
A market-wide bounce of close to +3% for the major indices put bearish traders on the defensive.

-James

Current Portfolio:


BULLISH Play Updates

Oxford Industries Inc. - OXM - close: 43.44 change: +1.40

Stop Loss: 40.65
Target(s): 44.90
Current Gain/Loss: + 2.6%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
12/20 update: OXM soared to new multi-year highs with today's +3.3% gain. I don't see any changes from my prior comments. Nimble traders can buy dips near the rising 10-dma (currently $41.65).

Earlier Comments:
If our trade is opened we'll use a tight stop loss at $40.65 and we want to keep positions small to limit our risk. Our target is $44.90. FYI: The Point & Figure chart for OXM is bullish with a $62 target.

(small positions)

current Position: long OXM stock @ $42.32

- or -

Long Jan $45 call (OXM1221A45) entry $0.85

Entry on December 19 at $42.32
Earnings Date 03/29/12 (unconfirmed)
Average Daily Volume = 220 thousand
Listed on December 17, 2011


United Continental Holdings - UAL - close: 20.67 change: +0.37

Stop Loss: 20.35
Target(s): 24.75
Current Gain/Loss: unopened
Time Frame: 4 to 8 weeks
New Positions: see below

Comments:
12/20 update: Hmm... today's performance in UAL was not very inspiring. Shares gained +1.8% versus a +2.9% rally in the S&P 500. UAL's bounce failed to breakout past its 200-dma. We'll give it a couple more days. If UAL doesn't improve soon then we'll drop it as a candidate.

Currently our plan is to open small bullish positions when UAL trades at $21.55.

Earlier Comments:
I see potential resistance near $21.50 so the newsletter is suggesting a trigger to open small bullish positions at $21.55. We'll use a stop loss at $20.35. We'll set our exit target at $24.75.
FYI: The Point & Figure chart for UAL is bullish with a $31.50 target.

Trigger @ $21.55 (small positions)

Suggested Position: buy UAL stock @ 21.55

- or -

buy the 2012Jan $22.50 call (1221A22.5)

Entry on December xx at $ xx.xx
Earnings Date 01/25/12 (unconfirmed)
Average Daily Volume = 7.1 million
Listed on December 17, 2011


BEARISH Play Updates

Broadcom Corp. - BRCM - close: 29.05 change: +1.31

Stop Loss: 30.25
Target(s): 26.00
Current Gain/Loss: + 4.8%
Time Frame: 6 to 8 weeks
New Positions: see below

Comments:
12/20 update: After sinking to new 52-week lows yesterday BRCM took a big chunk out of our gains with a +4.7% oversold bounce today. BRCM should find resistance near the $30 level. I am not suggesting new positions at this time.

Suggested Position: short BRCM stock @ $30.53

- or -

Long 2012Jan $28 PUT (BRCM1221M28) Entry $0.88

12/14/11 new stop loss @ 30.25
12/13/11 new stop loss @ 30.55
12/12/11 new stop loss @ 31.20
12/05/11 BRCM gapped open higher at $30.53.

Entry on December 05 at $ 30.53
Earnings Date --/--/-- (unconfirmed)
Average Daily Volume = 8.2 million
Listed on December 03, 2011


Cash America Intl. - CSH - close: 46.34 change: +0.52

Stop Loss: 47.25
Target(s): 40.25
Current Gain/Loss: unopened
Time Frame: 3 to 6 weeks
New Positions: Yes, see below

Comments:
12/20 update: CSH underperformed the market today with a +1.1% gain. The stock essentially drifted sideways near $46.00. The newsletter is still waiting for a breakdown under support. We have a trigger at $44.75. Our target is $40.25.
FYI: The Point & Figure chart for CSH is bearish with a $33 target.

Trigger @ 44.75

Suggested Position: short CSH stock @ 44.75

- or -

buy the Jan $45 put (CSH1221M45)

Entry on December xx at $ xx.xx
Earnings Date 01/26/12 (unconfirmed)
Average Daily Volume = 331 thousand
Listed on December 14, 2011


Ctrip.com Intl. - CTRP - close: 23.44 change: +0.91

Stop Loss: 24.25
Target(s): 20.25
Current Gain/Loss: - 1.9%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
12/20 update: The market's big bounce today fueled some short covering in CTRP and the stock gained +4.0%. I am not suggesting new positions at this time but nimble traders could be ready for a failed rally near $24.00.

Earlier Comments:
I do consider this an aggressive trade. FYI: The Point & Figure chart for CTRP is bearish with a $9.00 target. Note: We want to keep our position size small to limit our risk. CTRP can be a volatile stock and short interest is nearing 10% of the float.

*Small Positions*

current Position: short CTRP stock @ 23.00

- or -

Long 2012Jan $22.50 PUT (CTRP1221M22.5) entry $1.40

12/19/11 new stop loss @ 24.25
12/13/11 readers may want to exit early. CTRP is not cooperating.
12/12/11 CTRP gapped open lower @ 23.00

Entry on December 12 at $23.00
Earnings Date 02/13/12 (unconfirmed)
Average Daily Volume = 5.2 million
Listed on December 10, 2011


Electronic Arts - EA - close: 20.57 change: +0.73
(symbol changed from ERTS)

Stop Loss: 22.05
Target(s): 18.05
Current Gain/Loss: + 0.3%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
12/20 update: Shares of EA (previously ERTS) gained +3.6% on Tuesday. Look for resistance near $21 and its 10-dma. I am not suggesting new positions at this time.

Earlier Comments:
Our multi-week target is $18.05. I would expect possible support at $20.00 and $19.00. This trade is going to take some patience. Let's keep our position size small.

(small positions)

current Position: short ERTS stock @ 20.65

- or -

Long 2012Jan $20 PUT (ERTS1221M20) entry $1.05

12/19/11 ERTS will start trading as EA starting on the 20th

Entry on December 14 at $20.65
Earnings Date 02/01/12 (unconfirmed)
Average Daily Volume = 5.7 million
Listed on December 13, 2011


PACCAR Inc. - PCAR - close: 37.29 change: +1.81

Stop Loss: 38.25
Target(s): 32.50
Current Gain/Loss: + 4.6%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
12/20 update: After a sharp two-week sell-off PCAR is seeing a big bounce with a +5.1% gain today. Look for resistance near $38.00. I am not suggesting new positions at this time. More conservative traders may want to exit early now.

NOTE: Our 2012Jan $36 puts are now $35.30 puts thanks to the recent dividend.

Earlier Comments:
More aggressive traders could place their stop above $41.30 instead. There is possible support near $36.75, near its November low, but we're aiming for $32.50.

(Small Positions)

current Position: short PCAR stock @ $39.11

- or -

Long 2012Jan $35.30 PUT (PCAR1221M35.3) Entry $0.80

12/19/11 new stop loss @ 38.25
12/17/11 new stop loss @ 39.05
12/15/11 thanks to a 70-cent dividend our 2012Jan $36 puts are now 35.30 puts.

Entry on December 09 at $39.11
Earnings Date 02/01/12 (unconfirmed)
Average Daily Volume = 2.7 million
Listed on December 08, 2011


SunTrust Banks, Inc. - STI - close: 16.87 change: +1.07

Stop Loss: 17.15
Target(s): 11.00
Current Gain/Loss: - 4.6%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
12/20 update: Now that's perfect timing! STI breaks down to new two-year lows on Monday and then gaps higher and surges +6.7% today. The stock is nearing resistance at the $17.00 level. Wait for this bounce to stall or reverse before considering new positions.

current Position: short STI stock @ $16.12

- or -

Long 2012Jan $15 PUT (STI1221M15) entry $0.41

Entry on December 20 at $16.12
Earnings Date 01/20/12 (unconfirmed)
Average Daily Volume = 7.6 million
Listed on December 19, 2011


AT&T Inc. - T - close: 29.12 change: +0.38

Stop Loss: 29.55
Target(s): 24.25 or 22.75
Current Gain/Loss: + 0.9%
Time Frame: 6 to 9 weeks or more
New Positions: see below

Comments:
12/20 update: I am very surprised that shares of AT&T were not weaker today. Last night the company gave up on plans to acquire T-Mobile and will pay its parent company a $4 billion break up fee. Yet shares of AT&T bounced off this morning's low and rallied +1.3% by the closing bell.

I am not suggesting new positions at this time. We will inch our stop loss down to $29.55.

current Position: short T stock @ 29.40

- or -

Long 2012Jan $27.50 PUT (T1221M27.5) Entry $0.31

- or -

Long Mar $26 PUT (T1217O26) Entry $0.42

12/20/11 new stop loss @ 29.55
12/19/11 after hours, T announces it will give up on plans to acquire T-Mobile, will pay $4 billion break up fee
12/17/11 new stop loss @ 29.65

Entry on December 07 at $29.40
Earnings Date 01/26/12 (unconfirmed)
Average Daily Volume = 23.4 million
Listed on November 26, 2011


Vera Bradley, Inc. - VRA - close: 30.50 change: -0.32

Stop Loss: 35.25
Target(s): 27.50
Current Gain/Loss: + 8.0%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
12/20 update: VRA continues to show relative weakness. Today would have been the perfect day for shorts to panic and send VRA up +10% on short covering. Yet that didn't happen. The morning bounce failed and shares slipped toward round-number support at $30.00.

Readers may want to go ahead and take profits now with VRA down -8% from our entry point. I am not suggesting new positions at this time. Officially our exit target is $27.50.

Earlier Comments:
Traders need to keep in mind this is an aggressive, higher-risk trade. We want to keep our position size very small to limit risk. The most recent data listed short interest at almost 80% of VRA's very small 19.7 million share float. If there is some sort of unexpected rally in this stock it could spark a short squeeze and stops may not work very well in a fast market environment. I would suggest using put options in a situation like this to limit your risk but the spreads on the January puts are too wide. Our target is $27.50 although readers may want to take profits near $30.00 since it could prove to be round-number support. FYI: The Point & Figure chart for VRA is bearish with a $26 target.

(very small positions only!)

current Position: short VRA stock @ $33.17

12/19/11 new stop loss @ 35.25
12/15/11 this is an aggressive, higher-risk trade.

Entry on December 16 at $33.17
Earnings Date 12/07/11
Average Daily Volume = 796 thousand
Listed on December 15, 2011