Option Investor
Newsletter

Daily Newsletter, Tuesday, 6/12/2012

Table of Contents

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

Market Wrap

Bipolar Market

by Jim Brown

Click here to email Jim Brown
Multiple triple digit Dow moves in alternating directions are typically a sign of market tops and bottoms. Which is it?

Market Statistics

Investors can't seem to make up their mind whether they are bullish or bearish on the headlines from Europe. The enthusiasm from the announced bailout of the Spanish banks faded faster than it arrived and the markets crashed on Monday. There were multiple reasons analysts were using on Monday on why the bank bailout will not work and the preponderance of the evidence is pretty strong.

When the EU bails somebody out the money comes from the EU members. Each member has to kick in their share based on their economic size. For instance Germany has to contribute 27%, France 20%, Italy 18%, Spain 12%, etc. For the EU to loan 100 billion euros to Spain at 3% interest that poses a problem. Italy is almost as bad off as Spain and has no excess cash lying around. That means Italy will have to sell 18 billion euros of debt in the open market at their current rate of 6.15% yield in order to loan that to Spain at 3%. That is a losing proposition. Secondly Spain is 12% and Spain has no money and no way to raise money with their debt yields rising to a record of 6.84% on Tuesday. Since they have admitted they are basically broke nobody is going to lend them new money for any reasonable rate. Spain can't contribute its 12 billion euros and that means everyone else has to contribute more.

Greece is 3% of the euro and it does not have three billion euros and no way to raise it. I could go on down the list but you get the idea. As more countries line up for bailouts that reduces the number of countries remaining that are able to contribute.

The amount of the bailout is still in question. The EU said they would loan up to 100 billion euros but Spain refuses to disclose a number until an independent audit is completed on June 21st. There are significant worries that the amount needed will be well over 100 billion.

Spanish banks are in trouble because of a busted real estate bubble. Prices have fallen off a cliff over the last three years and some analysts believe as many as 50% of the loans are underwater. Even worse the Spanish government expects prices to decline another -35%, which will make the nonperforming loan outlook even worse. Almost any bank bailout today will prove to be insufficient in 2013.

Lastly with the situation in southern Europe continuing to decline and the possibility of further bailouts of multiple countries in the hundreds of billions of euros there is a growing concern or maybe I should say acceptance that the euro zone in its present form will disintegrate. Southern Europe could begin an orderly exit and northern Europe would form a stronger fiscal union and actually come out much better off. Germany and France would no longer have to pay for the sins of the weaker countries. The euro currency would strengthen significantly and the resulting euro zone would become a power block.

Unfortunately the term "orderly exit" is fraught with challenges. After 20 years in the great euro experiment the interrelationships are immense. Banks have massive balance sheets full of sovereign debt from other EU countries. That debt would have to be dumped before any breakup because any country leaving the euro would see its new currency plunge in value by as much as 50%.

Without the EU backing them up with constant bailouts there would be defaults with some quite large. Debt worth trillions would be lost or severely written down. It would NOT be orderly no matter how hard they tried.

Banks are already confronting deposit flight to other countries. That has prompted the EU finance ministers to produce plans to halt capital flight if Greece exits or any other country becomes insolvent. These plans include limiting ATM withdrawals, Cash withdrawals and wire transfers. It also includes ending the current ability to travel between EU countries without a visa. Basically they can then prevent Greek, Spain or Italian citizens from traveling to France or Germany or other countries in an effort to keep them at home with their money. This is a major point in the planning process and shows how worried the EU is about a future breakup.

With bailout debt taking a first position on the list of country creditors there is little incentive for institutions and investors from ever wanting to own that country's debt in the near future. If you know in advance that there are hundreds of billions in debt ahead of you in priority and the country is already taking bailouts because they can't pay existing debts then you will shop somewhere else for bonds. A bailout country is basically cut off from private investors. Institutions buy sovereign debt for capital preservation and guaranteed return. Buying subordinated debt in a bailed out country supplies neither condition.

Applying for a new credit card and using it to make the payments on your existing cards has never worked. Creating new debt to make payments on old debt is always a loser. By bailing out these countries over and over the rest of the euro zone is simply throwing good money after bad because they already have so much effort committed to keeping the zone together. Multiple countries appear to be coming to the point where they believe it is no longer worth it.

So why did the market rally today? Initially there was a small rebound simply because Monday's decline was overdone. On top of that minor rebound Chicago Fed president, Charles Evans, said he supported immediate Fed action to produce faster job growth. That action included having the Fed commit to super low interest rates until unemployment fell significantly. That would mean changing the Fed statement from "until 2014" until "unemployment declines to 5%" or something similar. That could be 2015 or later. The Fed meets next week and at least four of the Fed members have said in the last couple weeks that they support further Fed action. The comments by Evans were responsible for igniting the fire under the market. Unfortunately Evans is not currently a voting member.

There were no economic reports of note today. Weekly chain store sales declined -0.7%. Import and Export prices declined by -1.0% for May. The Treasury budget increased to -$124.6 billion from -$122.5 billion for May.

The calendar for Wednesday includes the Producer Price Index and Retail Sales for May. Of most interest will be the Jamie Dimon testimony on the JP Morgan trading loss. That will be the main topic of the day and headlines on every news page.

Economic Calendar

One of the best economic reports out today was not an economic report as all. It was the Michael Kors (KORS) earnings report. The high end retailer reported earnings that more than doubled from 10-cents to 22-cents. Analysts were expecting 16-cents. Revenue rose +58%.

KORS forecast Q2 earnings of 18-20 cents compared to analyst estimates of 17 cents. They also raised guidance for the full year to revenue of $1.7-$1.8 billion with a profit of $1.08 to $1.12 per share. Analysts were looking for 98-cents. Same store sales are expected to rise +35%.

Michael Kors is one of the judges on Project Runway, a TV fashion show. The luxury retailer opened 71 new stored in 2011 to close the year with 231. KORS shares rallied +8% on the news. However, it was the sentiment aspect that helped the market. Luxury spending is accelerating again and that suggests the economy may not be as weak as some had expected.

KORS Chart

After the bell Dell Inc (DELL) announced the initiation of an 8-cent quarterly dividend starting in Q3. That will give it a yield of about 2.7%. Shares rose 30 cents on the news. Shares had been under serious pressure after declining from $18 to a close of $11.98 today on weaker earnings and slowing sales. Dell has been buying back shares like crazy at the low prices and they have reduced their outstanding share count by 14% over the last several years. There are still 1.75 billion outstanding. Dell has been struggling with the iPad stealing share

Dell Chart

Crude oil continued to decline ahead of the OPEC meeting. Growing economic weakness in Europe and rising inventories ahead of the Iranian oil embargo is pushing prices lower. Brent crude, the benchmark price for Saudi Arabia and the Persian Gulf nations, closed at $97 today. The contract does expire on Friday so there could be some expiration pressures as well.

Brent at $97 is a critical level for Saudi Arabia and the OPEC meeting later this week. Saudi Arabia needs prices in the $98 range to cover its budget and pay for social programs that are keeping the Arab Spring at bay in the kingdom. Since Saudi is the biggest OPEC producer at 10.1 mbpd and the biggest excess producer they can single handedly control prices by altering production. The OPEC meeting is going to be stressful with multiple countries lobbying for a production cut to support prices. Saudi is likely to continue producing at the current level because they don't want a nuclear Iran almost more than Israel.

Brent Crude Chart

I know this sounds like a broken record but the rally today was mostly short covering. Monday's sharp reversal from a +100 point open to an -143 point close was the ideal entry point for shorts. The gap over initial resistance and sharp decline in the first hour back below that resistance was a flashing signal for shorts to jump on the down elevator. When the elevator refused to decline any further at Tuesday's open there was a rush for the exit that added +14 points to the S&P in about 40 minutes. It was clearly a short squeeze with a possible buy program thrown in.

The S&P moved sideways for the next four hours with a small spike at the close as the remaining shorts threw in the towel.

Resistance on the S&P is 1325 and we close at 1324. That level has been strong since May 22nd and even though there have been penetrations above that level they did not last. Every spike over 1325 has been immediately sold.

Fortunately that gives us a clear line on the chart to make decisions. A move over 1325 that holds its gains would be bullish while another failure there would be bearish. A failure that pushed the S&P back below support from the prior four days at 1307 would be increasingly bearish. A lower low below the 1266 we saw on June 4th would put us back into correction mode and restart a new leg down.

S&P Chart

The Dow chart is an exact duplicate of the S&P with the Dow returning to strong resistance at 12575 at the close. Another failure here would not gain any traction unless it moved below initial support at 12,400. However, a breakout on decent volume could trigger a rush of follow on buyers. Monday's spike did not last long enough to gain any support. Sellers were clearly waiting and I suspect they are still waiting.

Dow Chart

The Nasdaq turned in a decent performance with a +1.2% gain of +33 points but it failed to return to the same resistance levels as seen in the Dow and S&P. The 2860 level was untouched with a close at 2842. Apple gained slightly on news from the developer's conference but Google lost ground and closed at a six month low. Support remains 2800.

Nasdaq Point Gainers

Nasdaq Chart

Russell Chart

I believe we are in the Twilight Zone or maybe I should say the Neutral Zone in Star Trek terminology. We remain hostage to the headlines and despite the big moves on Mon/Tue the volume was terrible at just slightly over 6.0 billion shares. There was no conviction in a very thin market. All the big players are waiting on the sidelines for the headline fog to fade.

Launching a big bet with the number of major events just ahead could be suicide for an institutional investor. If the "wrong" party wins in Greece we could see additional months of market instability as the indecision over exit/no exit grows. Meanwhile the U.S. economics are weak and there is a Fed meeting next week where anything can happen. You probably don't want to be short ahead of the Fed but you don't want to be long ahead of Sunday's Greek election. That means all your trades are measured in hours instead of weeks and that produces a volatile market.

If I had to pick a directional bet it would probably be short into the weekend reversing to a long on Monday depending on the outcome in Greece. Both bets would be extremely volatile and carry a high level of risk.

I am writing again on Thursday and it will be interesting to see if the outlook has changed in 48 hours.

Enter passively, exit aggressively!

Jim Brown

Send Jim an email


New Plays

Technology & Home Improvement

by James Brown

Click here to email James Brown


NEW BULLISH Plays

Allot Communications - ALLT - close: 27.01 change: +0.86

Stop Loss: 25.99
Target(s): 29.90
Current Gain/Loss: unopened
Time Frame: 6 to 8 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
According to their website this Israeli technology company is a "leading provider of intelligent IP service optimization solutions for fixed and mobile broadband operators and large enterprises." Investors seem to be taking a bullish view on the stock with shares closing at all-time, record highs today.

I'd like to see a little more follow through since the $27.00 level is apparently resistance from early May. We'll use a trigger at $27.25 to launch small bullish positions with a stop loss at $25.99. Our upside target is $29.90.

Trigger @ 27.25

Suggested Position: buy ALLT stock @ (trigger)

- or -

buy the Jul 30 call (ALLT1221G30) current ask $0.95

Annotated chart:

Entry on June xx at $ xx.xx
Earnings Date 07/31/12 (unconfirmed)
Average Daily Volume = 584 thousand
Listed on June 12, 2011


Home Depot, Inc. - HD - close: 52.24 change: +0.89

Stop Loss: 51.35
Target(s): 58.50
Current Gain/Loss: unopened
Time Frame: 6 to 9 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
Shares of this home improvement giant are challenging resistance at multi-year highs. The lack of follow through on yesterday's bearish reversal is encouraging but I would not buy it yet. The $53.00 level seems to be the challenge.

I am suggesting a trigger to open bullish positions at $53.05 with a stop loss at $51.35 (just under today's low). Our multi-week target is $58.50.
FYI: The Point & Figure chart for HD is bullish with a long-term $95 target.

Trigger @ 53.05

Suggested Position: buy HD stock @ (trigger)

- or -

buy the Aug $55 call (HD1218H55) current ask $1.03

Annotated chart:

Entry on June xx at $ xx.xx
Earnings Date 08/14/12 (unconfirmed)
Average Daily Volume = 14.3 million
Listed on June 12, 2011



In Play Updates and Reviews

Bounce Off the Morning Lows

by James Brown

Click here to email James Brown

Editor's Note:
The U.S. market's rebounded off their morning lows and erased most of yesterday's losses. Unfortunately that did not stop IDIX from hitting our stop loss this morning.

Current Portfolio:


BULLISH Play Updates

JetBlue Airways - JBLU - close: 5.07 change: -0.15

Stop Loss: 4.99
Target(s): 6.00
Current Gain/Loss: - 4.3%
Time Frame: 6 to 8 weeks
New Positions: see below

Comments:
06/12/12 update: Something doesn't make sense with JBLU's performance today. The XAL airline index didn't see any big moves. The price of oil didn't see any big moves. The market was moving higher this afternoon. Yet JBLU started sinking. It appears the culprit might be JBLU's afternoon announcement that its May 2012 traffic numbers rose +7.4%. That should be good news not bad news!

The stock dipped to support near $5.00. If there is any follow through on this sell-off tomorrow then JBLU will hit our stop loss at $4.99.

Earlier Comments:
If a breakout does occur JBLU could see a short squeeze. The most recent data listed short interest at 20% of the 233 million-share float.

Trigger @ 5.30

Suggested Position: buy JBLU stock @ $5.30

- or -

Long Jul $5.00 call (JBLU1221G5) Entry $0.55

06/11/12 triggered @ 5.30

Entry on June 11 at $5.30
Earnings Date 07/24/12 (unconfirmed)
Average Daily Volume = 5.7 million
Listed on June 09, 2011


BEARISH Play Updates

Abercrombie & Fitch - ANF - close: 31.36 change: +0.29

Stop Loss: 33.85
Target(s): 30.50
Current Gain/Loss: + 7.6%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
06/12/12 update: ANF tagged a new two-year low at $30.64 intraday and then bounced to a +0.9% gain.

Readers may want to go ahead and take profits now. I am not suggesting new positions at this time.

current Position: short ANF stock @ $33.93

- or -

(exited on June 5th)
Jul $30 PUT (ANF1221S30) Entry $1.05 exit $1.56 (+48.5%)

06/05/12 exited July $30 puts at the open (bid) $1.56 (+48.5%)
06/04/12 new stop loss @ 33.85
prepare to exit our July $30 puts at the open tomorrow.
06/02/12 new stop loss @ 34.55, adjust exit to $30.50

Entry on May 31 at $33.93
Earnings Date 08/15/12 (unconfirmed)
Average Daily Volume = 3.9 million
Listed on May 30, 2011


Allegheny Technologies - ATI - close: 28.91 change: +0.34

Stop Loss: 31.01
Target(s): 25.25
Current Gain/Loss: - 0.6%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
06/12/12 update: The stock market did not see much follow through on yesterday's declines. The same goes for the steel and metal industry. ATI did slip to a new relative low at $28.23 but reversed to close up +1.1%, which is in-line with the market's rebound today.

The larger pattern for ATI remains bearish. Readers may want to wait for a bounce or a failed rally near $30.00 before initiating positions.

* Small Positions *

current Position: short ATI stock @ $28.74

- or -

Long Jul $27.50 put (ATI1221S27.5) Entry $1.35

Entry on June 12 at $28.74
Earnings Date 07/25/12 (unconfirmed)
Average Daily Volume = 1.98 million
Listed on June 11, 2011


Baker Hughes Inc. - BHI - close: 39.27 change: +0.65

Stop Loss: 40.15
Target(s): 35.25
Current Gain/Loss: - 1.1%
Time Frame: 6 to 8 weeks
New Positions: see below

Comments:
06/12/12 update: After four down days in a row BHI finally produced a bounce. Shares added +1.6%. We can look for overhead resistance at the $40.00 level. A failed rally there can be used as a new bearish entry point.

Suggested Position: short BHI stock @ $38.85

- or -

Long Jul $37 PUT (BHI1221S37) Entry $1.50

06/11/12 triggered @ 38.85

Entry on June 11 at $38.85
Earnings Date 07/20/12 (unconfirmed)
Average Daily Volume = 6.8 million
Listed on June 09, 2011


Heritage-Crystal Clean - HCCI - close: 17.50 change: +0.09

Stop Loss: 18.25
Target(s): 14.50
Current Gain/Loss: - 1.7%
Time Frame: 6 to 8 weeks
New Positions: see below

Comments:
06/12/12 update: HCCI spent the session in a very narrow range. I am still expecting this bounce to fail under $18 or its simple 10-dma (currently 17.82). Wait for the reversal lower before initiating positions.

Earlier Comments:
I want to warn you that this is an aggressive trade. The average volume of 55,000 is very, very light, which can lead to sharp intraday spikes. Plus, the most recent data listed short interest at 14% of the very, very small 8.4 million share float. That raises the risk of a short squeeze. FYI: The Point & Figure chart for HCCI is bearish with a $14.00 target.

(SMALL positions to limit risk)

current Position: short HCCI stock @ $17.20

Entry on June 07 at $17.20
Earnings Date 07/23/12 (unconfirmed)
Average Daily Volume = 55 thousand
Listed on June 06, 2011


InterDigital, Inc. - IDCC - close: 23.13 change: +0.08

Stop Loss: 24.75
Target(s): 21.50
Current Gain/Loss: + 4.2%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
06/12/12 update: IDCC's lack of participation in the market's rally today is a small victory for the bears. Shares are hovering near the $23.00 level. I am not suggesting new positions at this time. Please note our new stop loss at $24.75.

current Position: short IDCC stock @ 424.15

- or -

Long Jul $22.50 PUT (IDCC1221S22.5) Entry $1.15

06/12/12 new stop loss @ 24.75
06/08/12 traded opened with IDCC gapping down at $24.15

Entry on June 08 at $24.15
Earnings Date 07/25/12 (unconfirmed)
Average Daily Volume = 648 thousand
Listed on June 07, 2011


Polypore Intl. - PPO - close: 36.02 change: +1.06

Stop Loss: 36.85
Target(s): 30.25
Current Gain/Loss: - 4.0%
Time Frame: 3 to 6 weeks
New Positions: see below

Comments:
06/12/12 update: PPO is not cooperating with a +3.0% gain today. Although it's worth noting that the rally did reverse under resistance at its 50-dma today. Technically this churning between $37 and $34 is just noise. More aggressive traders may want to put their stop above the 50-dma, currently at $36.93 (maybe 37.05?). I am not suggesting new positions at this time.

Earlier Comments:
We want to keep our position size small because a lot of investors are already short this stock. The most recent data listed short interest at 33% of the 46.3 million share float. If something happens and PPO starts to suddenly show strength it could spark some short covering. Considering buying put options to limit your risk.

(SMALL Positions)

current Position: short PPO stock @ $34.82

- or -

Long Jul $32.50 PUT (PPO1221S32.5) Entry $1.95

Entry on June 08 at $34.82
Earnings Date 08/01/12 (unconfirmed)
Average Daily Volume = 1.2 million
Listed on June 07, 2011


Schnitzer Steel - SCHN - close: 24.03 change: +0.93

Stop Loss: 26.75
Target(s): 21.50
Current Gain/Loss: + 5.6%
Time Frame: exit prior to earnings on June 28th,
New Positions: see below

Comments:
06/12/12 update: After underperforming the market yesterday some of the steel stocks saw a strong bounce today. SCHN gained +4.0%. The $24.50-25.00 should be resistance. More conservative traders may want to start ratcheting down their stop loss now. I am not suggesting new positions at this time.

We want to keep our position size small.

(small positions)

current Position: short SCHN stock @ $25.45

- or -

Long Jul $25 PUT (SCHN1221S25) Entry $2.10*

06/04/12 new stop loss @ 26.75
*06/01/12 entry price on the option is an estimate. Option failed to trade on Friday.

Entry on June 01 at $25.45
Earnings Date 06/28/12 (unconfirmed)
Average Daily Volume = 474 thousand
Listed on May 31, 2011


CLOSED BULLISH PLAYS

Idenix Pharmaceuticals - IDIX - close: 8.80 change: +0.16

Stop Loss: 8.49
Target(s): 11.50
Current Gain/Loss: - 8.2%
Time Frame: 4 to 8 weeks
New Positions: see below

Comments:
06/12/12 update: IDIX managed to outperform the market with a +1.85% gain today. Unfortunately that doesn't tell the whole story. This morning IDIX violated support at its exponential 200-dma, its simple 200-dma and the $8.50 level. Our stop loss was hit at $8.49.

closed Position: Long IDIX stock @ $9.25 exit $8.49 (-8.2%)

- or -

Jul $10 call (IDIX1221G10) Entry $1.10, exit $0.55 (-50.0%)

06/12/12 stopped out at $8.49
06/07/12 triggered at $9.25

chart:

Entry on June 07 at $ 9.25
Earnings Date 05/02/12
Average Daily Volume = 1.5 million
Listed on June 01, 2011