Option Investor
Newsletter

Daily Newsletter, Tuesday, 5/10/2016

Table of Contents

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

Market Wrap

Oil and Yen

by Jim Brown

Click here to email Jim Brown

Japan's finance minister warned the country would intervene in the currency market if the yen continued to rise. S&P futures spiked 10 points.

Market Statistics

The yen dropped sharply and a short squeeze was born. Crude prices shook off a drop to $43 and rebounded to close at $44.69 on worries over production outages in multiple countries. This caused energy stocks to soar as shorts covered and many rose more than 5%. Never short a dull market because you never know what headline will cause a short covering panic.

The surge in the overnight futures caused a massive short squeeze at the open that carried through until the close. After two weeks of declines a large number of short positions had been created ahead of the Sell in May cycle. Many of those positions were blown out this morning.

If you need further proof other than the Dow chart look at the Goldman chart below. Goldman had declined $10 in the prior six sessions and spiked $4 today on no news. The shorts that were built up during that decline were squeezed out on the spike.



Traders ignored a 7.6% intraday decline in steel in China and iron ore fell -6%. That does not sound like a growing economy. However, the Chinese consumer price index rose +2.3% for the third consecutive month led by food prices. The producer price index fell -3.4% and slightly less than the 4.3% decline in March. China is going to come back and haunt us but it was ignored on Tuesday.

On the U.S. economic front the NFIB Small Business survey rose for the first time in 2016. The headline number rose from the 2016 low of 92.6 to 93.6 and the highest level since December. However, the internal components were basically unchanged. The three categories that rose were plans to increase employment from 9 to 11, job openings from 25 to 29 and earnings trends from -22 to -19. Expectations for the economy to improve declined from -17 to -18, plans to raise prices fell from 17 to 16 and plans to raise compensation from 16 to 15. I thought it was interesting that respondents expect the economy to worsen but they are increasing employment.

The Job Openings and Labor Turnover Survey (JOLTS) showed the number of job openings rose from 3.7% in February to 3.9% in March. Job openings rose to 5.757 million but new hires declined from 5.5 million to 5.3 million. Separations declined from 5.16 to 5.06 million suggesting workers are content to stay in their current jobs. The JOLTS report is a lagging report for the March period and it was ignored.

Wholesale trade rose +0.1% for March after a -0.5% decline in February. This was the first gain since September. This was the first time in months that inventories did not decline and that suggests the inventory cycle has run its course and the manufacturing sector could rebound. Durable goods inventories declined -0.1% with nondurables rising +0.5%. Sales rose +0.7% with durables down -0.2% and nondurables up +1.6%. That is the first time sales have been up since October.

There is nothing material on the schedule for Wednesday with the April Retail Sales report on Friday the next big event. With the retailers all reporting earnings or lack thereof this week, that sales report could give us an earnings direction for Q2.


The Nikkei 225 rose +2.15% on the comments from the Japanese finance minister. Those were the strongest comments from an official since the BoJ failed to add additional stimulus several weeks ago and the yen has been rocketing higher. The drop in the yen on his comments helped lift the dollar to its fifth day of gains.




After the close on Monday The Gap (GPS) warned of slowing sales and guided lower on earnings. Shares fell -11% today and weighed on all the retailers. The Gap said same store sales fell -10 at Old Navy, -7% at Banana Republic, -4% at The Gap and -7% globally. With the majority of retailers reporting earnings later this week, it was not a good sign. Gap said earnings would be in the range of 31-32 cents compared to estimates for 44 cents.


L Brands warned on Thursday and shares are still falling. Several analysts have come out in favor of buying L Brands here but I would definitely wait until we see a bottom form and that may not happen until the other retailers report.


Allergan (AGN) shares spiked $11 after the company said it would buy back up to $10 billion in stock thanks to high drug sales. The company reported earnings of $3.04 that beat estimates for $2.99. Revenue rose 48% to $3.8 billion but missed estimates for $3.95 billion. That statistic drives me nuts. Revenue rose 48% but still missed analyst estimates. What are analysts thinking and why should a company be penalized for missing outrageous estimates? Fortunately, the stock buyback news helped push the stock higher.

Botox sales surged from $84 million to $637 million after the FDA approved it not only for wrinkles but for muscle spasms and bladder control. Allergan shares hit a two-year low on Thursday.


Stamps.com (STMP) ruined a string of impressive post earnings gains despite some really good numbers. The company reported earnings of $1.72 compared to estimates for 25 cents. The company raised full year guidance from $5.00-$5.50 to $6.00-$6.50. Shares spiked 17% in afterhours trading BUT gave it all back today. STMP has a habit of monster post earnings spikes but the gains from Monday after the close evaporated almost immediately this morning and ended the day with a $5 loss. There was no specific news that related to this decline. Once a trend is established traders will eventually bet against it. The options on STMP are extremely overpriced and it is next to impossible to trade them ahead of earnings.


Lumber Liquidators (LL) posted a loss of 29 cents compared to estimates for 28 cents. Revenue fell -10.2% to $233.5 million, which also missed estimates. Same store sales fell -13.9%. The CDC said in February that people buying laminate flooring from China were three times more likely to get cancer than it had calculated earlier. They originally said chemical levels in the flooring could cause as many as 9 deaths per 100,000 people. That estimate was updated to as many as 30 deaths per 100,000. Shares fell 8% on the earnings news.


Nokia (NOK) reported an 8% decline in network sales to $5.9 billion. Analysts were expecting $6.27 billion. Nokia said customers were holding off on purchases while the company digests the Alcatel-Lucent acquisition. The company bought Franco-American Alcatel-Lucent for $17.8 billion so it can compete with other network providers. Shares fell to a new low.


After the bell Dow component Disney reported earnings of $1.36 compared to estimates for $1.40. Revenue of $12.97 billion missed estimates for $13.19 billion. This was the first quarterly miss for Disney in five years. The company saw a slower than expected 4.5% increase in revenues from overseas theme parks after the terrorist attacks in Paris and Belgium. The revenue they did receive was reduced by the impact of the strong dollar.

Media network revenue of $5.793 billion missed estimates for $5.9 billion. The company said a calendar shift caused the majority of the weakness. In Q1 they only had one college football game compared to seven games in the year ago quarter.

Studio revenue was very strong with a 22% increase to $2.1 billion thanks to multiple blockbusters over the last six months and they have more to come.

Disney said it was dropping the Infinity game console business and would take a $147 million charge and lay off 300 workers. CEO Bob Iger said he had no plans to work past his previously announced retirement date in 2018. Analysts believe he would stay until a replacement is found if the board asks him to remain as CEO.

Disney shares declined from $106.60 to $100.92 in afterhours. As a Dow component that equates to about a 45 point headwind for the Dow on Wednesday.


Electronic Arts (EA) reported earnings of 50 cents that beat estimates for 42 cents. Revenue of $924 million beat estimates for $89 million. The company said the profits were driven by the Star Wars Battlefront game that has sold more than 14 million units. EA released multiple new games in the quarter including "Plants vs Zombies: Garden Warfare 2," "Unravel" and "EA Sports UFC 2." Shares spiked $5 in afterhours. Guidance for the current quarter was weak but the full year guidance was stronger.


The pox on retailers continued with Fossil (FOSL) reporting earnings of 20 cents that beat estimates for 14 cents. Revenue of $660 million fell -9% and missed estimates for $667 million. However, they warned that Q2 earnings would be 15 cents and full year earnings would now be $1.80-$2.80 compared to prior guidance for $2.80-$3.60. Analysts were expecting $3.03 and 58 cents in Q2. They blamed the fitness band craze and Apple Watch for increasing competition in the space. Shares fell -25% in afterhours.


Earnings for Wednesday are light with Jack in the Box and Macy's the most watched of the list. Thursday is retail day with Dillards, Nordstrom and Kohls with JC Penny on Friday.


Crude prices rebounded $1.21 in the regular session to $44.65 on worries the production cuts in Canada and elsewhere would actually eliminate the prior production surplus. Estimates for production cuts from Canada range from 280,000 bpd to 1.5 mbpd. Nigerian production is at a multiyear low at 1.7 mbpd because of attacks by MEND rebels. Columbian production is down -200,000 bpd and Libyan production is down to 300,000 bpd. Venezuelan production is falling because they cannot pay for workers or well services. While these concerns were lifting prices, traders were ignoring the new production coming online from Saudi Arabia at 350,000 bpd, Kuwait 250,000 bpd, etc. Iranian exports have risen to 2.8 mbpd from 700,000 under the sanctions. They are targeting 3.8 mbpd and the pre-sanction levels. Traders seem to fixate on one headline per day and today it was Canada and rising summer demand. May is the lowest demand month of the year and August is the highest. Demand will rise by 2.0 mbpd through August as Saudi Arabia burns an extra 1.0 mbpd to generate electricity during the summer months.

After the bell, the API inventory report for last week showed an inventory gain of 3.45 million barrels compared to estimates for a gain of 714,000. WTI turned slightly negative on the headline but it is the EIA number at 10:30 tomorrow morning that will drive prices on Wednesday. The CFTC said open interest on long futures contracts was at record highs. Nobody is left to buy oil.


Markets

The S&P exploded higher at the open on short covering. The index stalled at 2,080 for a couple hours before another surge of capitulation at the close pushed it above the light resistance from the prior Monday at 2,082.


The S&P has major resistance from 2,100 to 2,116 and it will take more than short covering to power the index through those levels at this point on the calendar. The current high close at 2,130 was made on May 21st last year after the index spent a week banging on the 2,130 level. The decline was not straight down but mostly sideways until the bottom fell out in August. This year there are far more events cluttering the headlines and the high close at 2,102 on April 21st could be the high for several more months. It will be interesting to see if there is any follow through to today's short squeeze. I am sure there are still some shorts in denial and expecting this rebound to fail. If we move higher that could produce some more short covering.

Key support remains 2,040 and key resistance 2,116.


The Dow came to a dead stop at key resistance at 17,925 but it did exceed that level in April to touch 18,167 and the top of the next resistance range. Key support is 17,500 and I doubt that will be seen this week. The 45-point Disney headwind is not really impacting the Dow futures overnight with only a -24 point decline. However, a lot of those gains in Dow components today are surely going to see some profit taking over the next couple of days. The $4 squeeze in Goldman Sachs on no news is just begging shorts to sell the rip. Same with IBM, Boeing and United Technologies.



The Nasdaq moved sharply higher with a 60 point gain to 4,809 and well over support at 4,750. However, the Nasdaq has a long way to go to retest the resistance from April at 4,960 and even farther to attempt a breakout over resistance at 5,160. The Nasdaq did not get any support today from the biotech sector with the index only slightly positive. That was the motive power for the Monday gain with the index rising 3%. Today it was up only .5% compared to 1.25% on the rest of the indexes.

This looks an awful lot like a normal oversold bounce and I will be very surprised if it continues significantly higher.



The Biotech Index rebounded only to the next resistance level over 3,000. This looks a lot like an ordinary oversold bounce and we could still retest 2,750.


The Russell 2000 rallied 10 points but it was only .94% compared to 1.25% on the big cap indexes. The underperformance suggests the short covering in the small caps was less pronounced and could easily fade. The bounce off 1,100 came from the right level but it needs to exceed 1,150 before it will garner any respect.


Historically a big short squeeze like we saw today, will fail over the next 48 hours. However, on rare occasions a big short squeeze is actually the start of a major rally that can run for weeks. While I do not expect that this week, it is always possible. The volume today was anemic at 6.6 billion shares and actually less than Monday's 6.8 billion. The recent down days like we saw last week came on 7.7 to 8.9 billion shares. Follow the volume. The days with the highest volume represent the correct direction.

Enter passively, exit aggressively!

Jim Brown

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New Plays

No Need to Rush

by Jim Brown

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Editor's Note

The market is directionally challenged and lacks conviction. After multiple days of chopping around just above support a headline generated short squeeze appeared.

The big short squeeze lost traction at critical resistance. The S&P is facing strong resistance at 2,100 and the Dow at 17,925 to 18,165. Both indexes have failed here recently. The short squeeze was an oversold bounce and it came on low volume of 6.6 billion shares. Today was the lowest volume since April 26th.

Volume dictates direction and a big move like we saw today on low volume shows no conviction. It suggests we will fail at resistance. I do not want to add new long plays only to have them roll over with the market if that failure occurs. I do not want to add new short plays just in case that short squeeze ignited a potential rally. We are already weighted with more bearish plays that will work if the markets fail at resistance. There is no need to add more today. We should only trade when we have a reasonable chance of success. There is no reason to rush into new positions just because the market is open.



NEW BULLISH Plays

No New Bullish Plays


NEW BEARISH Plays

No New Bearish Plays



In Play Updates and Reviews

Total Confusion

by Jim Brown

Click here to email Jim Brown

Editors Note:

Last night the S&P futures were down -5 in afterhours. They rebounded to +12 overnight to trigger a major short squeeze. Last night I said, "The S&P futures are down -5 in the afterhours session but that could change by morning. The futures give you the market sentiment right now but there could be a dramatic move in either direction before morning based on headlines from Europe, Asia, the Middle East and from events here in the USA." The dramatic move appeared and the shorts ran for the exits with their hair on fire.

It is impossible to predict market movements overnight because there are so many factors that can influence the open. With markets in dozens of countries, currencies in even more and economic events every hour on the hour somewhere, picking a direction is a coin toss.

Take tonight for instance. Dow component Disney is down -$7 after missing earnings. That equates to about 50 Dow points so the index will be under pressure at the open. Fossil self destructed on very negative guidance and fell -25%. However, the S&P futures are flat, Nasdaq futures are +2 and Dow futures are -25. If I had to pick a direction I would say positive but we have that long period of darkness before the open so anything is still possible.

The S&P pushed over resistance at 2,075 to close at 2,084 and still under strong resistance at 2,100 and 2,110. In theory, the S&P should fail at these levels and continue moving lower into the summer. Yogi Berra said theory never works in practice.




Current Portfolio





Current Position Changes


GPRO - GoPro

The short position was opened with a trade at $9.65.


BLMN - Bloomin Brands

The long position was opened at $19.71.


NTAP - NetApp

The short position was stopped at $23.25.


Profit Targets

Check the graphic above for any profit stops in green. We need to always be prepared for a profit exit at resistance.


Stop Loss Updates

Check the graphic above for any new stop losses in bright yellow. We need to always be prepared for an unexpected decline.



BULLISH Play Updates


BLMN - Bloomin Brands -
Company Profile

Comments:

No specific news. Minor gain to stretch its breakout over resistance.

Original Trade Description: May 9th.

Bloomin Brands owns and operates casual, upscale casual and fine dining restaurants primarily in the USA. Their brands include Outback Steakhouse, Carrabbas Italian Grill, Bonefish Grill and Flemings Prime Steakhouse & Wine Bar. They operate over 1,500 locations in 48 states and 22 countries.

They reported operating earnings of 47 cents that missed estimates for 50 cents. Revenue of $1.16 billion missed estimates for $1.17 billion. Same store sales in the U.S. declined -1.5%. Shares surged 9% despite the miss.

Despite the weak quarter the company reaffirmed full year estimates for earnings growth of at least 10%. The company blamed restructuring costs on the weak quarter and said that would not be a problem in future quarters. They had previously projected a strong second half of 2016. They also pointed to sales in the Brazilian Outback Steakhouse that rose 8.8%. During the quarter they also bought back $75 million in stock. Strong dollar currency translation issues also reduced earnings. The company also declared a dividend of 7 cents payable on May 19th to holders on May 6th. They entered into a sale leaseback transaction where they sold 41 restaurants for $141.4 million and used $87 million to pay down debt.

Shares spiked 9% after the earnings and continued moving higher over the last two weeks. They closed today at a 7-month high.

Position 5/10/16:

Long BLMN shares @ $19.71, initial stop loss $18.25.

No option recommendation due to wide spreads.



TRN - Trinity Industries - Company Profile

Comments:

No specific news. Back over support. Let's hope it stays there.

We have time to wait for a rally.

Original Trade Description: March 18th

Trinity Industries manufacturers rail cars, highway guard rails and steel beams for infrastructure projects, structural towers for wind turbines and electrical distribution grids, oil and chemical storage tanks, barges to transport grain, coal, aggregates, tank barges to transport oil, chemicals and petroleum products. The company was founded in 1933.

Shares crashed in mid February after they reported earnings that beat the street but guidance that disappointed. Earnings of $1.30 easily beat estimates for $1.07 but revenue of $1.55 billion missed estimates for $1.61 billion. They had full year earnings of $5.08 per share.

They guided for 2016 to earnings of $2.00 to $2.40 per share. The challenge is the slowdown in orders for railroad tank cars and barges to transport oil. With oil prices crashing the producers and refiners are cutting back on capex spending until prices recover. Trinity said revenue in 2016 could decline -32%. Shares declined -35% over two days on the news.

The key here is that Trinity is now trading at a PE of 3. Yes 3.74 to be exact. With earnings in the middle of their range at $2.20 and a PE of 10 that would equate to a $22 stock price.

Here is the good news. The company has $2.12 billion in cash and undrawn credit. They are not in financial trouble. They authorized a $250 million share buyback starting January 1st. They have an order backlog of $5.4 billion in orders for 48,885 railcars. They received orders for 2,455 cars in Q4 and their backlog stretches out to 2020. The barge division received orders for $190.1 million in Q4 and had a backlog of $416 million as of December 31st. The structural tower segment has $371.3 million in order backlogs.

They recognize that tankcar and barge orders are going to remain slow until oil prices recover, which should happen later this year.

This stock was extremely oversold but began recovering in early March. Trinity produces a lot of railcars for carrying all types of products other than oil. That demand is not going to disappear and they already have order backlogs stretching into 2020.

At their current valuation they could also be an acquisition candidate. This is a great business that has been overly punished by the oil crash.

Earnings April 21st.

Position 3/21/16:

Long July $20 call @ $1.50, no stop loss.

Previously Closed 4/5/16: Long TRN shares @ $19.15, exit $17.50, -1.65 loss.



WIN - Windstream Holdings - Company Profile

Comments:

No specific news.

Original Trade Description: March 11th

Windstream provided network communications and technology solutions for consumers, businesses and enterprise organizations. They provide high-speed internet access, hosted web services and cable TV to a combined total of 1.6 million residential and business customers. They have more than 125,000 miles of high-speed fiber optic cable with speeds up to 500 gbps along their main corridors. They have 11 major data centers providing web hosting, cloud services, etc.

In the Q4 earnings, WIN reported adjusted earnings of $1.41 that crushed estimates for a loss of 48 cents. Revenue of $1.427 billion missed estimates slightly for $1.433 billion. The major earnings beat came from a spinoff of some of its telecom assets into a REIT. The cash received from the spinoff will allow some major network improvements in the months ahead.

The company declared a 15-cent quarterly dividend payable April 15th to holders on March 31st. That equates to a 7.3% annual yield.

WIN shares have been moving higher since they reported earnings on February 25th. Shares are at resistance at $8.25 and could breakout this week. The next resistance would be $11.85.

While we are not playing the stock for a takeover there is always the chance that somebody like Verizon or even Google could decide the $750 million market cap was chump change for 125,000 miles of high-speed fiber, cable TV and data center business.

I am going way out on the option to August because it is cheap and it will make a good lottery play even if we close the stock position early.

Update 5/5/16: Windstream reported a much smaller loss than expected. The company reported an adjusted loss of 23 cents compared to estimates for 54 cents. Revenues declined slightly to $1,373.4 million and missed estimates for $1,378.8 million. However, product revenues rose 11% to $32.4 million. WIN bought back $75 million in shares in Q1. The company ended the quarter with 1,430,700 household subscribers.

Position 3/11/16

Long August $9.00 call @ .38 cents.(Adjusted) NO STOP LOSS

Previously closed 3/29/16: Long WIN shares @ $8.22, exit $7.10, -1.12 loss.




BEARISH Play Updates


GPRO - GoPro - Company Profile

Comments:

No specific news. The position was entered with a trade at $9.65.

Original Trade Description: May 5th.

GoPro develops hardware and software associated with capturing, managing, sharing and enjoying engaging content. They offer cameras and all the accessories associated with affixing those cameras to any object in order to capture action videos.

GoPro soared onto the scene in late 2014 and shares ramped up to nearly $100 until the execution problems began to appear. After owning the action camera sector for several years they are now facing a growing onslaught of competitors with far deeper pockets and bigger teams of software engineers. GoPro cameras remain some of the higher priced in the sector because of their history but that is quickly changing.

They reported earnings on Thursday after the bell. They posted a loss of 63 cents missing estimates for a loss of 60 cents. However, revenue of $183.54 million beat estimates for $171 million BUT it was a -49.5% decline over the year ago quarter of $363 million and a profit. They shipped 701,000 cameras but that was a -47.8% decline from last year. They affirmed guidance for revenue of $1.35 to $1.50 billion for the full year BUT they are delaying one of their biggest revenue drivers for the year.

The Karma drone was supposed to be released in the first half of 2016 and was expected to provide a revenue boost for the company. In the earnings conference call, they said the release of the drone would be pushed out into the holiday season. How they are going to meet their prior revenue estimates after losing six month of drone sales is a mystery. When asked about it on the conference call the CEO basically said, "trust us." This is especially troubling when SZ DJI Technology is rapidly monopolizing the drone market. DJI has been called the Apple of the drone industry. They sold and estimated 70% of the consumer drones sold in 2015. Now they will have another six months to flood the market with multiple drone models before the GoPro Karma even gets off the ground.

Shares fell slightly in afterhours but I expect them to make a new low in the weeks ahead. They closed the afterhours session at $10.16 and the historic low is $9.01. The afterhours low was $9.57.

Position 5/10/16 with a GPRO trade at $9.65

Short GPRO shares @ $9.65. See portfolio graphic for stop loss.



INSY - Insys Therapeutics - Company Profile

Comments:

The Biotech sector was flat despite the heavy short covering in the rest of the market. No specific news.

Original Trade Description: May 4th.

Insys is a specialty pharmaceutical company that develops and commercializes supportive care products. Their main drug (Subsys) is a sublingual fentanyl spray for cancer pain in opioid-tolerant patients.

They warned before earnings that Q1 sales of Subsys would only be in the range of $61-$62 million after Q4 sales were in the $91 million range, up +38%. In the year ago quarter Subsys sales were $70.5 million.

The problem is what the FDA said was improper off-label marketing that expanded the use of the drug last year. With that practice halted analysts believe the drug's best days are over.

Compounding the revenue problem was a decision by the FDA to move an approval date for Syndros from April 1st to July 1st. Syndros is a reformulation of the marijuana based drug marinol. Insys believes this could be a big seller in the hundreds of millions of dollars.

While that may be good for Insys in the future the trader community is leaving the stock until we get closer to the approval date.

Insys reported earnings of 11 cents that beat estimates for 8 cents. Revenue from Subsys was $62 million. Shares have been declining since the earnings report because of the revenue warning.

Earnings July 28th.

Position 5/5/16 with an INSY trade at $13.60

Short INSY shares @ $13.60, initial stop loss $14.60



NTAP - NetApp - Company Profile

Comments:

No specific news. Shares rebounded on short covering and stopped us out at $23.25. For the prior two days the stock came within a nickel of hitting the stop so this was not unexpected.

Original Trade Description: April 25th.

NetApp provides software, systems and services to manage and store computer data worldwide. Data ONTAP storage operating system that delivers integrated data protection, comprehensive data management, and built-in software for virtualized, shared infrastructures, cloud computing, and mixed workload business applications; E-Series storage systems for storage area network workloads (SAN); all-flash arrays that deliver input/output operations per second and ultralow latency to drive speed, responsiveness, and value from the applications that control key business operations; and hybrid arrays for mainstream business applications.

About two weeks ago the stock trend turned negative and has started accelerating downward after Sterne Agee and Macquarie both downgraded from neutral to sell. Sterne Agee said the downgrade came after the Q1 IT survey. The survey showed weakness in end-user budgeting for storage systems and upgrades. Spending had declined 10% year-over-year and was negatively weighted towards incumbent vendors. Agee said they did not expect revenue from ONTAP8 and SolidFire to offset enough share loss potential over the next year. The analyst said valuation appears compressed and the stock should underperform its peers.

Another analyst said deteriorating net income would keep the stock depressed.

Earnings May 25th.

Based on the chart shares may not find support until $21. The last two days shares have stalled the decline at just over $24. I am recommending we short NTAP with a trade at $23.95 and target $21 for an exit.

Position 4/29/16 with a NTAP trade at $23.95

Closed 5/10/16: Short NTAP shares @ $23.95, exit $23.25, +.70 gain

Optional

Closed 5/10/16: Long June $24 put @ $1.17, exit $1.54, +.37 gain.



SQ - Square - Company Profile

Comments:

Square traded in a very tight range and only gained 15 cents. Given the huge number of shorts the lack of a rebound is encouraging.

Original Trade Description: May 7th.

Square develops and provides payment processing, point-of-sale, financial and marketing services worldwide. It provides Square Register, a point-of-sale software application for iOS and Android, which enables sellers to process credit cards for multiple items through their smart device.

The company was knocked for a 22% loss after reporting a Q1 loss of 14 cents compared to estimates for 9 cents. Revenue rose +51% to $379.2 million and beat estimates for $343.6 million. However, operating expenses rose +72% to $207 million. G&A costs rose from $28 million to $96 million because of a $50 million charge for a lawsuit against Robert Morley, who claims to be the creator of the Square card reader.

Square also has a share lockup expiration on Square on May 17th. About 64 million shares will be unlocked and the float will increase nearly three times. A lot of early investors including Visa, Starbucks, Sequoia Capital (5%) and Khosla Ventures (17%) will be able to sell their shares. Given the reduced guidance and rapid decline there may be a race to the exits.

According to the Wall Street Journal, a whopping 69.48% of the shares (14.6 million) are short as of March 15th. Currently the public float is only 21.01 million shares. Source

I was going to recommend shorting the stock into the lockup expiration but the short interest is too high. The cost to borrow the shares would be prohibitive and with that much short interest it could be explosive. Also, I have seen many lockup expirations that have turned into the bottom for the stock. Expectations are so bearish that the stock declines to a ridiculous price before the actual expiration and then there is no selling. Anyone with shares in the lockup could have already shorted the stock to protect those declining shares. When the lockup expires they use their unlocked shares to cover their shorts.

I am proposing we use a combination strategy. I am recommending we buy a May $10 put, which expires three days after the lockup expiration. At the same time I am recommending we buy a June $11 call in expectation for a sharp post lockup rebound. Remember, revenue increased 51% in Q1 and they raised guidance.

If the stock declines, we sell our put for a profit before expiration and that reduces the cost in the call.

Position 5/9/16:

Long May $10 put @ 1.10. No stop loss.
Long Jun $11 call @ 55 cents. No stop loss.



XLF - Financial ETF - ETF Profile

Comments:

The ETF spiked on a $4 gain by Goldman Sachs and this probably killed our chances of recovering anything from the long put. The May option will expire on the 20th.

Original Trade Description: April 11th.

The XLF is commonly referred to as the banking ETF. However, it is actually a Financial Sector ETF. Banks account for 33% of the holdings with WFC, JPM, BAC, C, USB and GS six of the top ten holdings. Insurance, brokers, diversified financial services and REITs make up the rest of the ETF.

We are playing it to capitalize on the movements in those six top banks as they report earnings. The ETF normally moves slowly and I would not recommend it as a stock holding ahead of those earnings simply because we do not know which way it will move.

I am recommending a short-term option strategy called a strangle using very inexpensive options. We only care about catching the post earnings move in what could be a rocky quarter. Since estimates are already very low there is the potential for an upside surprise and that could cause some short squeezes with the banks.

I looked at playing the weekly puts but the premiums were in some cases higher than the May premiums so we will buy the time even though we will not use it.

Position 4/12/16

Closed 4/29/16: Long May $23 call @ 19 cents, exit .58, +.39 gain.
Long May $22 put @ 47 cents, no stop loss.
Net debit 66 cents.





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