Option Investor
Newsletter

Daily Newsletter, Thursday, 5/26/2016

Table of Contents

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

Market Wrap

Rally Fizzles

by Thomas Hughes

Click here to email Thomas Hughes

Introduction

The rally began to show weakness today, even as new data supports strength in the economy. Jobless claims, pending home sales and durable good orders were all better than expected, reveal strength in the economy and point to an increased chance for a June rate hike. Adding to concerns were statements from at least 2 Fed officials; Bullard and Powell. According to them the market continues to mis-judge the FOMC and that a hike is warranted "very soon". Even so, the CME's Fed Watch Tool shows only a 30% chance of a hike at the June meeting.

International markets were fairly quiet today. Asian indices posted gains but they were minimal, led by a 0.27% gain in the Shang Hai Composite. Trading in the region was impacted by a strengthening yen and uncertainty of expected central bank actions in Japan and the US. European indices fared a little better, posting gains of roughly 0.5% as WTI and Brent crude both topped the $50 level for the first time since late last year.

Market Statistics

Futures trading indicated a flat to positive open for the US market. Trading ticked higher following the jobless claims and durable goods data but not substantially. At the open the indices moved higher, about 4 points for the SPX, and then proceeded to trend sideways in a very tight the rest of the morning. By 11AM most indices were showing a small loss for the day and were not able to regain positive territory until late afternoon. Even so, gains were small, less than a quarter percent, and within the early range.

Economic Calendar

The Economy

Today's data was pretty good and suggests the economic boom I've predicted for the 2nd half of the year may not be too far off. Initial jobless claims fell -10,000 to 268,000 from last week's unchanged data. The 4 week moving average of claims rose however, due to the recent spike in claims, but remains consistent with labor market health. Speaking of the recent spike in claims, I learned today that NY allowed certain public school employees to file for unemployment during the spring break holiday which accounts for the massive increase in claims we saw at the end of April. This week NY reported a -15,881 decline in new claims. On a not adjusted basis initial claims fell -1.6% versus an expected gain of 2.0% and have fallen back below last years levels by -3.7%.


Continuing claims rose this week, by 10,000, on top of an upward revision of 1,000 to last week's figure. Continuing claims totaled 2.163 million in this week's report and very near the 43 year low. The 4 week moving average also rose, by 8,500, to hit 2.151 million but remains very low and consistent with labor market health.

The total number of Americans filing for unemployment benefits fell once again, consistent with historical trends, to hit 2.055 million and a new 6 month low. Total claims are down -3.4% from last years levels and remain consistent with ongoing labor market health and declining unemployment levels. Based on the historical trends we can expect another 3 weeks of declinhes with a target below the 2 million mark, at which time we may see a month or two of increases before making another sustained move lower going into the fall and holiday season.


Durable Goods data was released at 8:30AM and came in above expectations. New orders for durable goods rose 3.4% versus an expected gain of only 0.6%. Transportation and aircraft led the increase, durables ex-transportation rising only 0.4%. Ex-defense orders rose by 3.7%. Shipments increased 0.6%, as did unfilled orders, while inventories declined by -0.2%. Capital goods, non-defense, rose by 7.8%. The weak spot was new orders for heavy machinery, down -0.7%.

Pending home sales data was also much better than expected and helps confirm strength in the broader housing market. Pending sales rose by 5.1%, analysts had expected only 0.6%, the third month of increases and set a new 10 year high. The index is now reading 116.3 and is up 4.6% versus last April. March was also revised higher.

The Dollar Index

The Dollar Index fell today, contrary to what I would've expected due to the strong data we received this morning. The index fell about -0.25% intraday, closing with a loss closer to -0.15%, confirming resistance at the 61.8% retracement level. Resistance is likely due to uncertainty over the FOMC decision due out in 3 weeks. Today the Fed's Bullard and Powell both made comments to the effect that the market was misjudging the FOMC intent and that a normalization of policy was warranted "soon" but both also hedged their comments. Powell says it doesn't feel like an economy with inflation about to break out.

The dollar has risen in value over the past few weeks because of hawkish sounding Fed talk, if they do not raise rates it is likely to fall back and test for support. However, even without a rate hike if the data continues to show signs of strength the dollar is likely to continue rising longer term. First target for support is along the short term moving average near $94.65, next target is just below that along the 78.6% retracement line, near $94.20.


The Oil Index

Oil prices flirted with the $50 level today. Both WTI and Brent moved above this level for the first time since late last year, both also fell back below $50 before the end of the session. On the one had we have increasing evidence of supply/demand rebalancing, on the other is a market that is still out of balance. Rebalancing is a future expectation, imbalance is a present reality and with prices reaching new highs is likely to continue. The higher prices get the more incentive shale producers, OPEC and non-OPEC countries will have to produce and sell more. Prices may continue to rise but there is reason to suspect a correction is coming.

The Oil Index persists in diverging from oil prices. The index opened with gains but is still well below the most recent peak, and far below a 7 month high. Today's action suggests resistance is building along the 1,140 level, also indicated by the short term moving averages inability to break above the 61.8% retracement level. The indicators are mixed, they suggest a shift in momentum to the upside is about to happen but without a break above 1,140 this may be temporary. Even if the index moves above 1,140, next target for resistance is just a few points higher, near 1,175.


The Gold Index

Gold prices were up in the early hours of the day, only to fall into the red following the release of economic data. Spot price fell about -0.25% to trade near $1220 and a two month low. Prices are being pressure lower by a stronger dollar and FOMC outlook and could move down to $1200 over the next couple of weeks if the data remains strong.

The gold miners are also in decline. Today the miners ETF GDX opened with a small gain, just below the short term moving average, and then fell from that level. The sector appears to be in reversal, today's action confirming a double top, with indicators in support of that move. The MACD momentum is bearish, strong and on the rise while stochastic is trending lower. If gold prices don't recover in the next few days the ETF will likely fall with targets near $21.80 and $21.20.


In The News, Story Stocks and Earnings

Dollar General and Dollar Tree both reported earnings before the bell, and both beat expectations. Dollar General beat EPS projections by nearly 10% although revenue fell a bit short. Even so sales rose by 7%. Dollar Tree did even better, aide by the purchase of Family Dollar, the opening of new stores and a 2.3% increase in comp store sales. Sales are up 133%, earnings up 105%, and guidance has been raised to a range above consensus estimates. Shares of both stocks were up today's session, but Dollar Tree is the real winner, gaining nearly 13% to trade at a new all time high. Dollar General gained only 5% but is also trading at a new all time high.


The retail sector was able to move higher on the DG and DLTR news but had a hard time holding on to the gains. The Retail Sector SPDR XRT gapped up at the open and then fell back to close the gap later in the day. Even so the ETF was able to post a gain near 0.5% and appears set to move higher. The indicators have rolled into a bullish signal, indicating higher prices, with the short term moving average as a first target. A break above the average would be bullish and could carry the ETF up to the $45-$46 level.


The housing sector did not move higher today despite the strong pending sales data. The XHB Housing Sector SPDR opened with a small gain only to give it up and more by the end of the session. Today's candle is black and may indicate a retreat to test support along the $33.50 level and the short term moving average. The indicators are bullish following the new home sales inspired break above the short term moving average so today's action appears to be consolidation rather than sign of reversal. First upside target is near $35, a break above this level would be bullish for the sector and could carry the ETF up to $37.50.


The Indices

Today's action was indecisive to say the least. Trading ranges were tight, moves small and without direction. The data shows a strengthening economy yet earnings outlook for the next quarter remains weak. While the data suggests that earnings and revenue will grow, it also suggests the FOMC will be raising interest rates. Raising interest rates is scary for the market, it could derail the growth, but it is also a sign the economy is strengthening.

The day's biggest mover was the Dow Jones Transportation Average with a loss of -0.27%. The transports made a very small spinning top style doji, just below resistance. Resistance is the short term moving average, just below the 7,750 level. The indicators have rolled into a bullish signal, confirmed by MACD's zero line cross yesterday, so more upside is very possible, but requires a break above the moving average. If so a move to next resistance, near 8,100, is very likely. If not a move back support at 7,500 become likely.


The next largest move, to the downside, was made by the Dow Jones Industrial Average. The blue chips fell -0.14% and created a small spinnning top candle with small upper and lower shadows. The move occurred close to neither support nor resistance, and appears to be consolidation before another move higher. The indicators have rolled into a bullish signal, confirmed today with a zero line crossover in the MACD, with upside target only 175 points above today's close, 18,000. This level is likely to provide resistance and may cap gains in the near term, a break above would be bullish and likely lead to a test of the all time high.


The S&P 500 made the smallest move of all the indices today, -0.02%. The broad market created a very small spinning top type doji not close to support or resistance. Today's move appears to be a pause within a near term rally, not surprising following two days of gains, and is supported by bullish indicators. Both MACD and stochastic are on the rise, confirming Tuesday's break above the short term moving average, and point to higher prices. First upside target is near 2,110 with a possible move to my resistance line at 2,120. A break above this level would be bullish and likely carry the index up to test resistance at the all time high near 2,130.


The NASDAQ Composite was able to post a gain for today's session, but a small gain, only 0.14%. The tech heavy index created a very small candle, doji, and indicated higher. Resistance is about 1% above today's close and is first target should the index continue higher. A break above this level would be bullish and could carry it up to the 5,050 level or higher. First target for support is near 4,795 and the short term moving average.


The market took a breather today, not unusual following 2 days of gains. Whether or not it continues to move higher is yet to be seen. Tomorrow there are two things to be aware of, either of which could move the market; a speech from Janet Yellen and the 2nd estimate for 1st quarter GDP. Yellen will be watched for FOMC clues, the GDP for signs of strength in the economy. Expectations are for GDP to be revised higher to 0.9%, a strong number will be bullish but also raise the chances for a sooner-rather-than-later rate hike.

I am still concerned about 2nd quarter earnings outlook, negative earnings growth is not good and could easily cause the market to correct, but the signs are good for a boom in activity that could carry us through the summer. Labor data remains strong, housing data is much better than expected, and the two combined could drive profits in the 2nd half. I'm not quite ready to give up my bearish stance for the near term, but am increasingly convinced the 2nd half of the year is going to be good for business, the economy and the market. Believe it or not the next earnings cycle begins in only 6 weeks, better than expected with rising forward expectations will go a long way to helping the market move higher.

Until then, remember the trend!

Thomas Hughes


New Plays

Internet of Things

by Jim Brown

Click here to email Jim Brown
Editor's Note

Sierra Wireless intends to capture a decent share of the IoT market and given their current revenue projections of $630-$670 million for 2016, even a small share would be a big boost.


NEW BULLISH Plays

SWIR - Sierra Wireless - Company Profile

Sierra Wireless engages in building the Internet of Things with intelligent wireless solutions. They operate in three segments, Original Equipment Manafacturer, Enterprise Solutions, and Cloud Connectivity Services. They offer cellular embedded modules, software and tools to integrate wireless connectivity into various products and solutions.

In their recent earnings they reported an adjusted profit of 8 cents. Revenue declined -5.1% because of previously reported softness in orders from several existing automotive customers. For Q2 they expect earnings in the range of 9-17 cents on revenue of $150-$160 million. For the full year they guided to earnings of 60-90 cents on revenue of $630-$670 million. They bought back 549,583 shares in the quarter.

The revenue in the OEM solutions segment declined -9.1% due to softness in auto production in Q1. Enterprise solutions revenue rose 9% and cloud and connectivity systems revenue rose 92%. They began upgrading their global LTE core network to provide additional connectivity for wholesale operators.

In their guidance, they said business should improve significantly because of more than 40 new customer programs moving into production on new IoT products. They manufacture to customer specifications when the customer adds a new product.

Earnings Aug 4th.

To go from an 8 cent profit in Q1 to 60-90 cents for the full year is a major gain in profitability. Shares have been rising since the earnings report and showing no weakness when the market was down.

With a SWIR trade at $20.30

Buy SWIR shares, currently $19.90, initial stop loss $18.45.
No options recommended due to wide spreads.



NEW BEARISH Plays

No New Bearish Plays



In Play Updates and Reviews

Sleepy Friday Ahead

by Jim Brown

Click here to email Jim Brown

Editors Note:

Friday marks the beginning of the summer doldrums and volume should be very light. This will continue on Tuesday as everyone returns from the holiday and tries to decide how they are going to invest or not invest for the summer months. Some will probably decide that the market is within 2% of its recent highs and they may try to go long. Depending on Friday's market action and Yellen's comments, they may decide to remain flat until after the Fed meeting. Whatever they decide, Tuesday's volume will be very light.

The fact the S&P has held at 2,090 at the close is somewhat bullish. However, the highs on both of the last two days was 2,095 and that is strong resistance. The bullish part of that scenario is that the index did not recoil significantly from that level. This means it is still in play.

The Dow failed at the same 17,890 level the last two days and closed about 60 point lower. The real resistance is 17,925 so the early failure suggests traders are trying to jump in early with new shorts.

That could be the fact that pushes us higher. If shorts are loading up at 17,890 and 2,095 and the low volume allows institutional traders to push the market around we could get another short squeeze that takes us higher.




Current Portfolio





Current Position Changes


SCTY - Solarcity

The long position remains unopened until a trade at $24.75.


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


OMED - OncoMed Pharmaceuticals -
Company Profile

Comments:

No specific news. Minor decline in a weak market after shares closed at a new four-month high on Wednesday.

Original Trade Description: May 21st.

OncoMed Pharmaceuticals is a clinical-stage company focused on discovering and developing novel anti-cancer stem cell and immuno-oncology therapeutics. OncoMed has seven anti-cancer therapeutic candidates in clinical development, where each target key cancer stem cell signaling pathways including Notch, Wnt and R-spondin LGR. OncoMed is advancing its wholly owned GITRL-Fc candidate and an undisclosed immuno-oncology candidate (IO#2) toward clinical trials in the 2016-2017 timeframe. OncoMed has formed strategic alliances with Celgene Corporation, Bayer Pharma AG and GlaxoSmithKline (GSK).

OncoMed is making six presentations at ASCO related to six oncology drug candidates, including robust preclinical anti-tumor activity data for its wholly owned GITRL-Fc candidate and from clinical trials of vantictumab, ipafricept, demcizumab and tarextumab.

All of that is Greek to me but this is a cancer conference and OncoMed is an up and coming cancer drug company. They should be right at home and the notes I have read suggest several of their drugs are very promising. They have milestone payments coming from GSK, Bayer and Celgene coming in 2016-2017 of more than $270 million.

Shares have risen steadily since the earnings miss on May 5th. As a preclinical company they do not have retail revenues and depend on funding from their partners. They will have operating losses until their drugs are in the marketplace.

Shares spiked on the 28th after AbbVie said they were buying cancer drug company Stemcentrx for $10.2 billion. That company is in the same stem cell research sector as OMED.

Earnings August 4th.

With the ASCO meeting still 10 days away we could benefit from some of the building excitement and hopefully the company's presentations at the meeting will increase the interest in the stock.

Position 5/23/16:

Long OMED shares @ $12.80, see portfolio graphic for stop loss.

No options recommended because of wide spreads.



SCTY - Solarcity - Company Profile

Comments:

No specific news. Shares were mildly negative in a flat market.

This position remains unopened until a trade at $24.75.

Original Trade Description: May 25th.

SolarCity Corporation designs, manufactures, installs, monitors, maintains, leases, and sells solar energy systems to government, residential, and commercial customers in the United States. The company provides solar energy systems; solar lease and solar power purchase agreements; MyPower loan agreements; grid control/energy storage systems; zep solar mounting systems and proprietary software. It also sells electricity generated by solar energy systems to customers.

Q1 was a bad quarter for the solar stocks. Multiple companies have missed earnings and lowered guidance. Solar City was no exception. The company lost -$2.52 compared to estimates for -$2.32. However, revenue of $122.6 million easily beat estimates for $110 million. They guided for the current quarter for a loss of $2.70-$2.80 and analysts were expecting $2.13. The company cut estimates for full year installations to 1,000 to 1,100 megawatts compared to analyst estimates for 1,250 megawatts. Shares dropped -21% on the news to support at $16.50. Shares are down -65% in 2016.

The company said they were expanding into new states in the second half and that would increase sales. Also, sales are normally up in the summer months because roofs are not covered with snow.

They blamed the weak first quarter on regulatory challenges and increased prices that slowed sales. Nevada regulators said they were increasing fees to connect your solar installation to the grid and they were reducing the price the utility companies were going to pay for your power when it reaches the grid. That slowed installations in Nevada. I would think utility companies would like the extra power because they do not have to pay to generate it.

There was also some uncertainty about the extension of the investment tax credits for solar installations. The government did not extend the credits until last December.

Solar City actually installed much more wattage than expected. The company had forecasted it would install 180 megawatts in the quarter. They actually installed 214 megawatts, up 40% from year ago levels. The problem came from the bookings. They only booked 160 megawatts to add to the order backlogs. That meant their backlogs shrank for the quarter. However, the CEO said bookings were up +25% in March/April.

This play recommendation is a bet on Elon Musk as much as it is a bet that Solar City will continue to improve its sales and reduce expenses. There have been rumors that Musk was thinking about taking Solar City private for multiple reasons. Whether that happens or not is of course unknown. However, I do not expect Musk to let Solar City fail or continue to post negative results. He will direct the company and if the current CEO cannot post solid improvements, I am sure Musk can find somebody that will.

Earnings Aug 8th.

With a SCTY trade at $24.75

Buy SCTY shares, initial stop loss $22.25.

Optional:

Buy July $28 call, currently $1.07, initial stop loss $22.25.



SQ - Square - Company Profile

Comments:

No specific news, no gain.

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 Jun $11 call @ 55 cents. See portfolio graphic for stop loss.

Previously closed 5/17/16: Long May $10 put @ 60 cents. Exit $1.00, +.40 gain.




BEARISH Play Updates

ENDP - Endo Intl Plc - Company Description

Comments:

No specific news. Dead flat for a week. Waiting on ASCO to start next week.

Resistance is 15.85 to 16.15 and I recommend we stay with it until we see if that resistance will hold. The current stop loss of $16.45.

Original Trade Description: May 11th.

Endo develops, manufactures and distributes pharmaceutical products and devices worldwide. The market well known brands including Percocet, Lidoderm, Voltaren and a wide range of pain medications and testosterone replacement therapies.

Shares have declined from $26 last week to $14 today. The company slashed full year guidance by -11% on revenue and -23% on earnings. The acceleration of the decline over the last several weeks has been in reaction to some generic competitors expected to receive approvals from the FDA soon.

The company also disclosed they were being investigated by the U.S. Attorney's Office for its relationship with pharmacy benefit managers or PBMs. In light of the improper relationship between Valeant and Philidor the USAO is investigating to see if the same problems exist at Endo. In November, Novartis had to pay a $390 million fine to settle charges it paid specialty pharmacies for illegal kickbacks in exchange for inducing patients to refill certain medications.

Endo is also under pressure as a result of the Valeant Pharmaceutical disaster and the overall decline in the biotech sector.

Earnings are August 4th.

Even though shares are down significantly from the May 6th news, I believe they will continue falling and could go into single digits. The similarities to Valeant's pharmacy problems and the impact to Valeant's stock are too close and should weigh on Endo.

Position 5/12/16:

Short ENDP shares @ $13.81, see portfolio graphic for stop loss.

Optional

Long June $12.50 put @ $1.05, see portfolio graphic for stop loss.



FDC - First Data - Company Profile

Comments:

No specific news.

While we were stopped out on the short on 5/23 there was no stop loss on the option and that position remains open. At the current 10-cent price that is a lottery ticket that the headlines will fade and the original direction will return.

Original Trade Description: May 16th.

First Data provides electronic ecommerce solutions for merchants, financial institutions and card issuers worldwide. The operate in three segments including global business solutions, global financial solutions and network & security solutions. This includes retail point of sale solutions, mobile ecommerce solutions and webstore solutions.

In their Q1 earnings, they grew revenue 3% and operating income rose from $185 to $220 million. Earnings of 24 cents were slightly above expectations for 21 cents. Revenue of $1.69 billion was below estimates for $1.71 billion. Unfortunately, FDC has $19 billion in debt compared to its $3 billion market cap. Interest expense in the first quarter was $263 million or more than $1 billion a year.

Global business solutions revenue declined in the quarter while financial solutions and security solutions showed only marginal growth.

Earnings July 21st.

While the company tried to put a positive face on the future by projecting revenue growth, it appears investors were not impressed. Shares have fallen from $13.50 to $10.50 over the last three weeks since earnings. FDC does not provide guidance and that is troubling to some investors.

I am anticipating a retest of the post IPO low at $8.50 or even worse, depending on the market.

Position 5/17/16:

Long July $10 put @ $.60, no stop loss.

Previously closed 5/23/16: Short FDC shares @ $10.69, exit $11.55, -.86 loss.



LOCO - El Pollo Loco - Company Profile

Comments:

No specific news. Moving very slowly on no news.

Original Trade Description: May 18th.

El Pollo Loco develops, franchises, licenses and operates quick service restaurants in the USA. The company offers individual and family sized chicken meals, Mexican inspired entrees and sides. They currently have 430 company owned and franchised restaurants. They are planning opening 16-20 additional stores in 2016.

The big spike on the IPO came on name recognition, a successful roadshow and a small number of shares initially offered. They later waived the lockup period and allowed insiders to sell their shares on November 19th, 2014, two months earlier than stated in the IPO documents. Shares crashed from $33 on the news and have never recovered that level.

The reported earnings on May 5th of 17 cents that missed estimates for 18 cents. Revenue of $94.4 million also missed estimates for $96.9 million. They guided for full year earnings of 70-74 cents, which was almost zero growth from the Q1 numbers. That suggests the competition is fierce and they are having trouble gaining market share. Earnings in 2015 were 71 cents.

Net income declined -19.8% in Q1. Same store sales declined -0.6% for company operated restaurants. That is not a good track record to use when selling new franchises.

Next earnings August 4th.

I think the crazy chicken is dying. Their moment in the sun is fading along with their stock price. Shares are rapidly approaching their post IPO low of $9.58 and once you break under that $10 level it is very hard to recover.

Position 5/19/16

Short LOCO shares @ $10.61, see portfolio graphic for stop loss.
No options recommended.





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