Option Investor
Newsletter

Daily Newsletter, Tuesday, 10/23/2012

Table of Contents

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

Market Wrap

And Down We Go...

by Thomas Hughes

Click here to email Thomas Hughes
The markets were down sharply after a string of earnings misses. Today was all about revenue, earnings and guidance. Yesterday good news from Yahoo! helped the major indexes to snap back from early morning weakness and regain last weeks close. Today, poor reports have sent the markets back down, breaking an important support line and raising the question of just how far down are we going to go?

Market Stats

Introduction

Futures were down sharply this morning following high profile revenue misses from Dupont, Xerox and 3M. The S&P futures trade was down as much as -16 points for most of the morning with the Dow and Nasdaq posting similar declines.

We have been expecting earnings to be bad for some time. Estimates have been ratcheting down for the last two quarters as the world slowdown reached what many believe now to be a short term bottom. Now we're here and it's not the current earnings and it's not the revenue short-falls that are hurting us, its the guidance. Major world players have been lowering their full-year and fourth quarter guidance and that is what is depressing stock prices. Investors are worrying over the outlook for fourth quarter profits, but is the worry misplaced?

Year-to-date the major indexes are up. The S&P is (or was two days ago) up over 15% with the Dow and Nasdaq close behind. The Dow was up close to 10% before Friday's open; more than half of the Dow stocks were up more than 10%. The three day sell off which started on Friday has brought the S&P down to about a 10% gain on the year, 6% for the Dow. Compared to last year's markets gains even this still looks good. It's no surprise that many investors and portfolio managers are choosing to take profits.

One trend I have noticed amongst earnings reports this quarter is this: Revenues are falling short but profits are in-line or above expectations, basically this means that margins are improving for one reason or another. If this trend of increased profit on lower revenue continues into the fourth quarter, and we get the fourth quarter rise in US and world GDP then corporate profits should also improve and possibly surpass the current guidance. Lowered guidance and the chances of increased profits is a recipe for upside surprises and market rallies. However, the strength of the bounce, if any, will be heavily dependent on economic data.

Today also starts FedWatch as the FOMC begins their October meeting. The committee is not expected to make any changes to policy but the statements will be very important. Every word of the statement will be carefully scrutinized for what it says now and what any changes may mean. The Fed could easily spark buying or selling, depending on their outlook.

This quarter the economic conditions are showing signs of improving; housing has apparently turned a corner and unemployment is down at the lowest levels since the start of the crisis. The signs are pointing to a stronger third quarter than expected despite the revenue shortfalls we keep running into. The economic data, which supports earlier predictions of a fourth quarter economic uptick, has caused many to speculate that the 3rd quarter is actually an earnings trough and that the 4th quarter will show an improvement. If this is the case then the fear could be misplaced. Tomorrow look to the Fed for confirmation or denial of my theory.

Europe and Asia

The European markets closed down more than 1% today. Earnings worries here and in the Eurozone are weighing heavily on share prices. Adding to the turmoil is yet another development in the Spanish bail-out-or-not drama. The country, or at least parts of it, were downgraded by Moody's based on budgetary short falls and liquidity issues. These problems won't be helped by a downgrade, which will likely spook some Spanish bond holders. I have said in past recaps that the appearance of EU and Spanish leaders working on the problem may be enough to keep confidence up but at some point enough has to be enough.

Asian shares ended the day mixed. Earnings caution helped to keep prices in check while investors sift through the data. Some headline stories out of the east today include Taiwan's inflation is up, Japan is contemplating more QE, China real estate lending rebounded in the third quarter and South Korea is expected to have grown at the rate of 1.8% for 2012.

Gold and Oil

Gold traded lower today, extending its decline to near a two month low. The price of gold doesn't care about corporate earnings, it cares about the economy and the price of money. With economic data supporting stabilization in the short term there is little hope for more QE. Without the hope of additional money in the system and a growing fear of weakening global demand (due to lower corporate guidance and business outlook) the price of gold should continue to fall toward support. The FOMC statement tomorrow could impact trading and add some volatility in the short term.

The Gold Index has continued to trade sideways; the potential bull triangle has failed. Today the index traded down in tandem with the underlying metal as lower prices impacted future profit expectations. The index dropped down below its short term moving average and is now approaching its long term support level of 200. This level has been an important pivot point over the last 5 years, if the index falls below this level new down sides targets of 275 and 250 will come into play. Barrick Gold, one barometer of the gold industry, is scheduled to report earnings November 1st. The report should give us insight into supply/demand and price expectations for the fourth quarter and into 2013.

The Gold Index, daily

Weak corporate guidance and revenues are also impacting the price of oil. The reductions in guidance are causing speculators to lower expectations for demand and subsequently prices. The good news is that the lower prices are good for the economy and corporations and could help with the fourth quarter up tick I have been talking about. The price of oil fell today by another -2.6% on global slowdown worries, continuing its slide below $90.

The Oil Index gapped down today, dropping below the 30 day EMA, the 150 day EMA and long term support. The index has been moving down from the top of a range and is looking like it will keep moving down in the near term. Downside targets for the index are 1150 and an intersection with the up trend line around 1100.

The Oil Index, daily

Bonds

Bond rates fell today on the ten year treasury. The rates are still above the long term support and the short term moving average. The ten year also seems to be catching the added boost of longer term bearish traders. The rate has climbed above the 150 day EMA and could be getting ready to make a move higher. This makes me ask the question “If bond rates are falling and investors are leaving the safe haven of US backed debt where are they going...into equities?'

Ten Year Treasury Yield, daily

Earnings, Earnings, Earnings

Dupont spooked the markets this morning when it reported an 11% drop in revenue for the fiscal third quarter. The company also announced that it would be cutting 1,500 jobs in a restructuring effort and that it is lowering its full year outlook for 2012 by nearly a dollar per share. Previous guidance had full year earnings in a range around $4.20, now Dupont is expecting to earn a mere $3.30 per share. The stock dropped close to 9% today on high volume to a long term support level.

Dupont, daily

Xerox also fell by nearly 9% today. The company reported adjusted earnings in-line with estimates on lower revenues. It was the lower revenues that investors focused on. The thing for us to take note of though is that Xerox is one more business to improve margins over the last year. This is a trend that is echoing throughout the business world and will help stocks increase profits and beat estimates at some point in the future. Xerox fell on heavy volume to a one year low but was halted at the long term support line. MACD and Stochastic indicators both support the possibility of a bottom at this level but it will take a little more time to confirm that hypothesis.

Xerox, daily

3M Corporation could be the poster child for the current market. The company increased earnings on slightly lower revenue and guided the full year to just below the previous range. The new guidance is in line with analysts estimates and according to the press release “reflects the current economic realities”. In a nutshell they said that they sold a little less due to the economic slowness, earned a little more profits due to better margins and that the future was more or less OK but recent global weakness still gives them reason for concern. The stock dropped on the news, losing close to 4% on only average volume. The fall took the stock below a long term support level and the 150 day EMA.

3M, daily

One of few bright spots in the market today was Harley Davidson. The company reported earnings in line with its expectations, reiterated its previous guidance and announced that it expects to spend less than anticipated on restructuring this year. Investors met the news with enthusiasm and sent the stock up by more than 7%. The move took share price above the short and long term moving averages and a short term resistance level.

Harley Davidson, daily

Coach was another surprising earnings beat on a day dominated by earnings fears. The company beat on the top and bottom lines and is standing by its full year guidance. The company increased earnings and revenue over the same time last year by more than 5% each and says it is well positioned going into the holiday season. The stock, which has been trading near a 12 month low popped on the news, gaining 8% on increased volume. The stock is currently trapped between the long and short term EMA's. A break above the 150 day EMA is necessary for me to take a bullish technical outlook.

Coach, daily

Facebook reported after the bell. The highly anticipated report was expected to show a reversal of last quarters -$0.08 loss. The social media behemoth surprised investors and even beat the streets estimates. Facebook posted earnings of $0.12 per share versus the estimated $0.11 and the stock gained close to 10%.

Facebook, daily

The Indexes

The markets opened broadly lower this morning, all three posting double digit declines in the opening minutes of trading. The S&P started the day with a -9 point move that quickly slid to -12, -15 and lower before reaching today's bottom around 1408. This move has taken the S&P into the very important support zone that we all have been watching for the last few months. The index must hold this level to remain bullish into the near term. A drop below this could spark technical selling and bring us down to next support at 1380 and then 1350.

The daily charts look a little ominous. Today's selling has completed a bear move that is nearly identical to the bullish continuation signal we got only a few weeks ago. The selling, though severe in comparison to the last few months, is a natural part of market cycles and has not broken the longer term trends. The S&P has been making gains all year in the face of slowing corporate earnings and economic growth, a pause is natural and good for the rally's health. The markets could take a breather and blow off some more earnings steam over the next week to ten days as the next round of economic data comes out.

SPX, daily

Looking at the short term charts, 30 minutes bars, we can see that the selling began last week as the S&P approached the four year closing highs. In fact, over the last 5 weeks the index has done the same thing three times, making successively lower highs each time. This suggests the bears are getting more aggressive; they're willing to sell at a lower price each time the S&P reaches a peak. The momentum on this most recent down streak reached an extreme on Friday and then diverged from price yesterday and today. The difference is that yesterday we got a good report from Yahoo which helped to drive the price back up above support. If the S&P does not regain this support level over the next day or two more selling could ensue.

SPX, 30 minute bars

The VIX finally made a spike up from the long term lows. The spike took the VIX above the short term moving average but failed to cross the critical 20 level into the “fearful” zone. The index is still well within the safe range of 15-20 and looks like it will stay there. Today's candle and upper wick suggest that options traders were selling as prices were rising. This could mean that some of the options protection is coming out of the markets as investors and traders sell protective puts and buy-back short calls. If this is the case it will reduce resistance in the S&P going forward. Until the VIX actually crosses into the +20 range I have to remain neutral to bullish on the markets in the near to short terms.

The VIX, daily

Earnings will continue to add volatility to the markets. This week is one of the busiest for the earnings season with over 500 companies reporting. Competing for attention will be the FOMC statements and new economic data. I believe it will be the data that drives direction and not 3rd quarter earnings. The data supports a stabilization from the the 3rd quarter lows and an increasing possibility for corporate earnings to improve in the fourth. The S&P could trend sideways for the next 4-6 weeks as we wait for more data to point the way or it could drop down to the long term trend before making up its mind about which way to go.

We are definitely in a time of uncertainty. The third quarter was poor, revenue is down, profits are up, data is stabilizing and guidance is being reduced. With so much conflicting information it is easy to understand why the markets are trying to sell off. I expect more volatility overnight as the world markets react to a new round of Flash PMI reports. Later in the day statements from the FOMC could help us understand where the economy is going and on Friday the GDP advance numbers will help us understand where we have been.


Stay vigilant, be conservative and remember the trend.

Thomas Hughes


New Plays

Showing Relative Strength

by James Brown

Click here to email James Brown


NEW BULLISH Plays

Trex Co. - TREX - close: 34.69 change: +0.52

Stop Loss: 33.70
Target(s): 38.50
Current Gain/Loss: unopened

Entry on October xx at $ xx.xx
Listed on October 23, 2012
Time Frame: exit prior to the Nov. 1st earnings report
Average Daily Volume = 229 thousand
New Positions: Yes, see below

Company Description

Why We Like It:
TREX manufacturers building materials, especially decking materials. Shares held up very well today during the market's sell-off. Traders bought the dip at the stock's rising 30-dma and TREX outperformed with a +1.5% gain. Now TREX is on the verge of breaking out past resistance.

Shares have resistance near $35.00. I am suggesting a trigger to open bullish positions at $35.15. We'll start with a stop under today's low. Our target is $38.50 but if shares don't move fast enough then we will plan on exiting prior to the November 1st earnings report.

Trigger @ 35.15

Suggested Position: buy TREX stock @ (trigger)

Annotated chart:




In Play Updates and Reviews

Widespread Declines for Everything

by James Brown

Click here to email James Brown

Editor's Note:
Almost everything turned lower today. Stocks, bonds, commodities, even the U.S. dollar posted declines. Looks like investors were in a mood to sell and it didn't matter what.

AIG, AOL, TOL were stopped out. TIE was closed this morning as planned.

Current Portfolio:


BULLISH Play Updates

Bank of America - BAC - close: 9.36 change: -0.19

Stop Loss: 9.25
Target(s): 10.45
Current Gain/Loss: unopened

Entry on October xx at $ xx.xx
Listed on October 18, 2012
Time Frame: 6 to 8 weeks
Average Daily Volume = 141 million
New Positions: Yes, see below

Comments:
10/23/12: BAC looked so ready to breakout higher yesterday. Yet the broad-based weakness today pushed the stock to a -1.9% decline. We are still waiting for a breakout from its sideways consolidation.

I am suggesting a trigger to launch bullish positions at $9.65 with a stop loss at $9.25. Our multi-week target is $10.45.

Trigger @ 9.65

Suggested Position: buy BAC stock @ (trigger)

- (or for more adventurous traders, try this option) -

buy the 2013 Jan $10 call (BAC1319a10)



Ctrip.com Intl. - CTRP - close: 19.67 change: -0.18

Stop Loss: 19.25
Target(s): 24.75
Current Gain/Loss: unopened

Entry on October xx at $ xx.xx
Listed on October 22, 2012
Time Frame: Exit prior to the Nov. 5th earnings report
Average Daily Volume = 2.9 million
New Positions: Yes, see below

Comments:
10/23/12: CTRP delivered a relatively quiet session. The stock gapped open lower and then churned sideways in a narrow range. I don't see any changes from my prior comments.

A breakout past this resistance could lead to more short covering. I am suggesting a trigger to launch small bullish positions at $20.55 with an initial stop loss at $19.25. Our target is $24.75 but we will plan to exit ahead of the November 5th earnings report if CTRP doesn't hit our target by then.

Keep positions small to limit risk. CTRP can be a little volatile.

Trigger @ 20.55 *Small Positions*

Suggested Position: buy CTRP stock @ (trigger)

- (or for more adventurous traders, try this option) -

buy the NOV $21 call (CTRP1217k21)



DreamWorks Animation - DWA - close: 20.61 change: -0.22

Stop Loss: 19.95
Target(s): 22.00
Current Gain/Loss: +0.0%

Entry on October 18 at $20.60
Listed on October 17, 2012
Time Frame: exit prior to the Oct. 30th earnings report
Average Daily Volume = 902 thousand
New Positions: see below

Comments:
10/23/12: DWA followed the market lower this morning. Shares spiked down toward round-number support at $20.00 and bounced. Traders could use this bounce as a new entry point but I would be super cautious about launching new bullish positions here. Please note our new stop loss at $19.95.

Our exit target is $22.00 but more aggressive traders could aim higher.

Earlier Comments:
The stock could see a short squeeze. The most recent data listed short interest at 43% of the 63 million share float. We do not want to hold over the October 30th earnings report.

current Position: Long DWA stock @ $20.60

- (or for more adventurous traders, try this option) -

Long NOV $20 call (DWA1217k20) Entry $1.45

10/23/12 new stop loss @ 19.95
10/18/12 triggered @ 20.60



ICICI Bank - IBN - close: 39.89 change: -0.71

Stop Loss: 39.15
Target(s): 44.85
Current Gain/Loss: unopened

Entry on October xx at $ xx.xx
Listed on October 22, 2012
Time Frame: 3 to 6 weeks
Average Daily Volume = 1.4 million
New Positions: Yes, see below

Comments:
10/23/12: It wasn't just the U.S. trading lower today. Global markets around the world were seeing weakness. Shares of IBN gapped open lower and then drifted sideways in a narrow range.

Use a trigger to open bullish positions at $40.85. If triggered our target is $44.85. Keep our position size small to limit risk.

Trigger @ 40.85 *Small Positions*

Suggested Position: buy IBN stock @ (trigger)



Mattress Firm - MFRM - close: 32.70 change: +0.24

Stop Loss: 32.40
Target(s): 39.50
Current Gain/Loss: unopened

Entry on October xx at $ xx.xx
Listed on October 20, 2012
Time Frame: 6 to 8 weeks
Average Daily Volume = 405 thousand
New Positions: Yes, see below

Comments:
10/23/12: MFRM managed to outperform most of the market by closing in positive territory. Traders bought the dip this morning and MFRM came roaring back. Aggressive traders could buy this bounce with a stop under today's low. I am suggesting we stick to our plan and wait for a breakout.

Earlier Comments:
MFRM could see a short squeeze. The most recent data listed short interest at 30% of the very, very small 9.0 million share float. MFRM is currently consolidating under resistance at $34.00.

I am suggesting a trigger to open bullish positions at $34.10. Our target is $39.50.

Trigger @ 34.10

Suggested Position: buy MFRM stock @ (trigger)



Plum Creek Timber - PCL - close: 43.94 change: -0.29

Stop Loss: 42.95
Target(s): 44.75
Current Gain/Loss: + 1.8%

Entry on October 15 at $43.15
Listed on October 13, 2012
Time Frame: exit prior to earnings on Oct. 29th (not yet confirmed)
Average Daily Volume = 1.1 million
New Positions: see below

Comments:
10/23/12: PCL produced an "inside day" with today's range inside Monday's range. This is a show of indecision by traders. I don't see any changes from my prior comments. More conservative traders could raise their stops toward $43.25. I am not suggesting new positions.

current Position: Long PCL stock @ $43.15

10/18/12 new stop loss @ 42.95, adjust target to $44.75
10/16/12 new stop loss @ 42.40
10/15/12 triggered at $43.15



BEARISH Play Updates

Navistar Intl. - NAV - close: 19.49 change: -0.36

Stop Loss: 20.55
Target(s): 16.00
Current Gain/Loss: + 1.3%

Entry on October 19 at $19.75
Listed on October 16, 2012
Time Frame: 3 to 6 weeks
Average Daily Volume = 1.6 million
New Positions: see below

Comments:
10/23/12: NAV bounced to resistance near $20.00 and reversed. This move can be used as a new bearish entry point. More conservative traders could tighten their stops.

Earlier Comments:
The 2008 lows were near $15.50 so we're going to target a drop to $16.00. FYI: There is already a growing amount of bearish pressure on the stock with the most recent data listing short interest at 15% of the 47.4 million share float.

current Position: short NAV stock @ $19.75

- (or for more adventurous traders, try this option) -

Long NOV $20 PUT (NAV1217w20) entry $1.55

10/20/12 new stop loss @ 20.55
10/19/12 triggered @ 19.75



Sohu.com - SOHU - close: 38.40 change: +0.32

Stop Loss: 40.05
Target(s): 36.00
Current Gain/Loss: + 2.9%

Entry on October 10 at $39.55
Listed on October 9, 2012
Time Frame: Exit prior to the Nov. 5th earnings report
Average Daily Volume = 472 thousand
New Positions: see below

Comments:
10/23/12: Hmmmm... today's action in SOHU could be a warning signal for bears. The stock market produced a very broad-based decline and yet SOHU bounced back from its morning lows to close positive. We don't want to see that kind of relative strength in our bearish candidates. Furthermore today's move is technically a bullish engulfing candlestick reversal pattern but this needs to see confirmation.

I am lowering our stop loss to $40.05. More conservative traders may want to exit early. I am not suggesting new positions at this time.

Earlier Comments:
I have to warn you that SOHU can be a volatile stock so we need to limit our position size to reduce our risk or consider trading the options. Our target is $36.00. More aggressive traders could aim for the $34.00 area.

*Small Positions*

current Position: short SOHU stock @ $39.55

- (or for more adventurous traders, try this option) -

Long Nov $37.50 PUT (SOHU1211w37.5) entry $1.85

10/23/12 new stop loss @ 40.05
10/20/12 new stop loss @ 40.55
10/18/12 new stop loss @ 41.01



Trimble Navigation - TRMB - close: 46.54 change: +0.31

Stop Loss: 48.05
Target(s): 42.50
Current Gain/Loss: + 0.6%

Entry on October 19 at $46.50
Listed on October 10, 2012
Time Frame: exit prior to earnings on Nov. 1st
Average Daily Volume = 697 thousand
New Positions: see below

Comments:
10/23/12: I want to caution traders about our TRMB play. The stock spiked down this morning and pierced its 300-dma. Yet the stock reversed higher after falling to $45.16. The fact that TRMB closed up in positive territory is a potential warning signal. You could argue this is a one-day bullish reversal, especially considering the market's widespread weakness today.

I am not suggesting new positions and we will lower our stop loss to $48.05.

(Small Positions)

current Position: short TRMB stock @ $46.50

- (or for more adventurous traders, try this option) -

Long Nov $45 PUT (TRMB1211w45) Entry $1.40

10/23/12 new stop loss @ 48.05, warning, today could be a bullish reversal in TRMB
10/19/12 triggered @ 46.50



CLOSED BULLISH PLAYS

American Intl. Group - AIG - close: 34.75 change: -0.80

Stop Loss: 34.85
Target(s): 39.75
Current Gain/Loss: - 3.2%

Entry on October 9 at $36.00
Listed on October 8, 2012
Time Frame: exit prior to earnings on Nov. 1st
Average Daily Volume = 44 million
New Positions: see below

Comments:
10/23/12: The market's widespread decline today hit the financials pretty good and AIG gapped open lower at $35.03. Shares quickly fell under support at $35.00 and hit our stop at $34.85.

closed Position: Long AIG stock @ $36.00 exit $34.85 (-3.2%)

- (or for more adventurous traders, try this option) -

Nov $37 call (AIG1211k37) entry $0.76 exit $0.30 (-60.5%)

10/23/12 stopped out at $34.85
10/22/12 today's bounce of $35.00 looks like a new entry point.
10/18/12 new stop loss @ 34.85
10/15/12 new stop loss @ 34.45

chart:



AOL Inc. - AOL - close: 35.50 change: -0.28

Stop Loss: 35.49
Target(s): 39.90
Current Gain/Loss: -4.7%

Entry on October 16 at $37.23
Listed on October 15, 2012
Time Frame: exit prior to the NOV 6th earnings report
Average Daily Volume = 1.6 million
New Positions: see below

Comments:
10/23/12: I warned readers yesterday that AOL would probably hit our stop loss today. Sure enough, the stock hit our stop midday. Readers may want to keep an eye on AOL to see if it bounces from its 50-dma.

closed Position: buy AOL stock @ $37.23 exit $35.49 (-4.7%)

- (or for more adventurous traders, try this option) -

NOV $38 call (AOL1217k38) entry $1.10 exit $0.55 (-50.0%)

10/23/12 stopped out at $35.49
10/22/12 AOL looks poised to hit our stop tomorrow
10/20/12 readers may want to raise their stops toward Friday's low (35.73)

chart:



Toll Brothers - TOL - close: 34.55 change: -0.41

Stop Loss: 34.30
Target(s): 38.50
Current Gain/Loss: - 3.7%

Entry on October 22 at $35.60
Listed on October 20, 2012
Time Frame: 6 to 8 weeks
Average Daily Volume = 3.2 million
New Positions: see below

Comments:
10/23/12: We had a relatively tight stop loss on our TOL trade. I still think TOL has potential as a bullish candidate so keep it on your radar. Today's market decline was strong enough to push TOL to our stop loss at $34.30.

closed Position: Long TOL stock @ $35.60 exit $34.30 (-3.7%)

- (or for more adventurous traders, try this option) -

2013 Jan $38 call (TOL1319a38) Entry $1.35* exit $0.95 (-29.6%)

10/23/12 stopped out @ 34.30
10/22/12 TOL hit our entry point at $35.60 today. *option entry price is an estimate since the option did not trade at the time our play was opened.

chart:



CLOSED BEARISH PLAYS

Titanium Metals - TIE - close: 12.23 change: -0.12

Stop Loss: 12.65
Target(s): 11.00
Current Gain/Loss: + 2.3%

Entry on October 4 at $12.41
Listed on October 3, 2012
Time Frame: 6 to 8 weeks
Average Daily Volume = 1.5 million
New Positions: see below

Comments:
10/23/12: I was concerned that TIE may have bottomed. Last night we adjusted our plans to exit this morning at the open. TIE gapped down at $12.12 before bouncing off the $12.00 mark.

*Small Positions*

closed Position: short TIE stock @ $12.41 exit $12.12 (+2.3%)

10/23/12 closed early this morning
10/22/12 prepare to exit at the open tomorrow
10/13/12 new stop loss @ 12.65

chart: