Option Investor
Newsletter

Daily Newsletter, Thursday, 11/10/2016

Table of Contents

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

Market Wrap

Market Rally Defies the Experts

by Keene Little

Click here to email Keene Little
The stock market rally that followed a Trump election victory has defied the opinions of most market analysts. It was another example of how the market will embarrass the majority who are in agreement on something. Now we have to wonder if it's just a knee-jerk response (short covering) or something more bullish.

Today's Market Stats

Heading into the election I saw a poll of market analysts about what they believed would happen if Trump or Clinton won the election. The majority, like 93% of them, believed the stock market would sell off if Trump won. When I saw that number, plus a chart setup that supported the bulls (which admittedly had me wondering if Clinton would win), I thought they're probably going to be proven wrong. Paradoxically that then had me wondering if Trump would win the election so that we would get the rally.

This is the challenge we face when trying to figure out how the market will react to the news, not what the news might be. At any rate, the 93% were proven wrong with a market rally after a Trump win, proving once again that when the majority agree on something about the market it's often best to fade them. It was another important lesson in using contrarian opinion when thinking about market direction.

In today's market we had a large spread between indexes with the INDU and RUT up strong (+1.2% and +1.6%, resp.), NDX down hard (-1.6%) and SPX up marginally (+0.2%). The Dow was helped by a few heavyweights, such as a couple of the big banks, Pfizer (PFE), CAT and IBM. NDX was hurt by the FANG stocks (FB, AAPL and AMZN, NFLX and GOOG), which were seriously defanged today. Much of the rotation between sectors is based on what investors think the Trump administration policies might be and where his promised infrastructure spending will go.

Like yesterday, today's trading volume was very heavy, about twice what we've typically seen lately. But the day saw a lot of rotation between sectors and the result was up volume only nudged out down volume but advancing issues were less than declining issues. As will be shown on the charts, the risk for bulls is that all this churning is happening up against some strong resistance levels and it's incumbent upon the bulls to keep up the buying pressure, or at least not allow any serious selling pressure to take hold. A rally or a day of consolidation on Friday is what the bulls need to see. But any sharp decline back down could leave the charts looking vulnerable to stronger selling.

Equity futures had chopped sideways/up last night and this morning opened with a gap up. That was followed by about 15 minutes of buying before the sellers smacked the market back down with selling that lasted about 45 minutes. Following that was a recovery effort that lasted most of the day. Other than the Dow and RUT, which did make it up to new intraday highs, the other indexes struggled to regain their morning losses. I think the next day or two is going to provide some important clues about what the rest of the month might be like.

SPX was the "neutral" index today so I'll start off with a review of it with a look at the weekly, daily and 60-min charts.


S&P 500, SPX, Weekly chart

This week's rally now has SPX back-testing its broken uptrend line from February-June, near 2180 (today's high was 2182). From just a chart perspective, this is a classic back-test of broken support and is a shorting opportunity. The stop should be kept fairly tight and not much above today's high. A continuation of the rally could see it head much higher over the next few weeks, with an upside target zone of 2250-2300. One potential target, especially if we see SPX nuzzle up underneath its broken uptrend line for a couple more weeks, is near 2223, which is the 127% extension of its previous decline (May 2015 - February 2016). This extension is a common target/reversal level. But if the market rolls back over from here we could see SPX drop down to price-level support at 1992 in the next few weeks.


S&P 500, SPX, Daily chart

Today finished with a long-legged doji as SPX finished in the middle of a large-range day. It broke through its downtrend line from August, currently near 2168, tagged its broken uptrend line from February and closed below both. With the long-legged doji at its broken uptrend line and with the VIX climbing today it has me wondering if the doji is a reversal-in-the-making and signaling a coming strong decline, which would mean this week's rally is setting a bull trap. I like the setup for a short play but it has to be on a short leash considering the upside potential if the rally continues.

Key Levels for SPX:
- bullish above 2183
- bearish below 2125


S&P 500, SPX, 60-min chart

The 60-min chart shows a closer view of the price action around the broken uptrend line from February-June and the broken downtrend line from August-September. The rally off last Friday's low is currently just a 3-wave move and as such it could be just a sharp a-b-c bounce correction that will now be followed by a resumption of the decline. Today's double back-test of the broken uptrend line looks like a stronger sell signal since the intraday break of the downtrend line was not able to hold into the close. Based on the bearish setup here it looks like a good opportunity to short SPX against today's high. If we get just a choppy consolidation on Friday it would be a signal for bears to step aside since a consolidation following a rally should lead to another rally. You don't want to hold short if SPX rallies above 2183 since the upside potential is significant (2250-2300).


Dow Industrials, INDU, Daily chart

The Dow rallied much stronger than SPX this week but it too managed only a back-test of its broken uptrend line from February-June. It broke it intraday but pulled back and closed marginally below the line. Today's high stopped just shy of a trend line along the highs from November 2015 - August 2016, near 18905. RSI quickly made it up into oversold territory and while it could easily remain there with an extended rally it is a warning sign that a reversal back down is possible at any time.

Key Levels for DOW:
- bullish above 18,925
- bearish below 18,250


Nasdaq-100, NDX, Daily chart

The bulldog named FANG had some dentist work done today and the dog was defanged today. Collectively FB, AMZN, AAPL, NFLX and GOOG finished down more than -3% today and that was an improvement from earlier in the day. NDX finished down -1.6% and it had been down -2.9% earlier in the day. This was while the Dow was up more than +2% and the RUT was up more than the +1.6% where it finished. That's a split that you don't often see. The daily candle for NDX is a bearish engulfing candlestick, which is an outside down day and usually a good reversal indication. With the candle following a back-test of the bottom of its broken rising wedge pattern off the September low it has "SELL!" written all over it. It was able to hold price-level support at 4740 for the close so it remains possible we'll see at least a bounce correction but I'd short a bounce against today's high near 4856. This morning's gap up and quick morning high looks like a bull trap.

Key Levels for NDX:
- bullish above 4860
- bearish below 4656


Russell-2000, RUT, Daily chart

As mentioned previously, the RUT was up relatively strong today, as it was yesterday, and since it's been a leader for the stock market (up and down) it's worth watching closely here. Today it broke above its downtrend line from September, near 1235, and made it up to a downtrend line from June 2015 - September 2016, which at 1259 is a little shy of its September high near 1263. Now we wait to see if resistance is broken, which would be confirmed with a rally above 1264 (and holds above), or if today's breakout turns into a failed breakout with a drop back below 1235.

Key Levels for RUT:
- bullish above 1264
- bearish below 1188


10-year Treasury Note emini futures, ZN, Weekly chart

Treasuries have made a big move this week, much larger than normal, and it appears the bond market is more convinced the Fed will raise rates in December. There's been strong selling, as can be seen on the weekly chart of the 10-year Note (emini futures), and that has driven rates higher. But bonds bear watching here since ZN has dropped down to a long-term uptrend line from the low in June 2008 and as can be seen, this uptrend line acted as support twice in 2015. If the line is broken it will be a strong signal that more selling could be coming. But if it holds as support it's possible a reversal back up would be supported by selling in the stock market (rotating from stocks into Treasuries).


High Yield Corporate bond ETF, HYG, Weekly chart

The other bond fund to watch carefully is HYG. I've recently been showing its weekly chart to point out the fact that it recently broke down from its rising wedge pattern off the February low and that was an early-warning sign for the stock market. This week it has sold off while the stock market rallied and it sold off strongly again today. It has made it down to its broken downtrend line from June 2014, at 84.25, so it could get a bounce but any further selling would be that much more of a negative message for the stock market. If traders are taking off risk by getting out of HYG it means buying in the riskier stocks, such as the small caps, could be a bad move.


KBW Bank index, BKX, Weekly chart

The banks have been on fire this week, especially yesterday and today (+3.8%). At last week's high BKX was starting to look a little weak, with bearish divergence, on its daily chart, and much of the rally the past two days could be short covering once it broke above last week's high (yesterday). Or perhaps it's a stronger belief that the Fed will now feel free to raise rates since the election is over (higher rates help the banks make more money). Whatever the reason, this week's rally has BKX up more than +13% from last Friday's low. Too much, too fast? It could be and it has achieved a price projection at 82.19 (with today's high at 82.60) for two equal legs up from February. It has also achieved a 62% retracement of the 2007-2009 decline, at 81.65, which was almost tagged at its July 2015 high. A failure here would leave a big double top against the 2015 high but there is still more upside potential if the bulls can keep up the buying pressure. The trend line along the highs from April 2010 - July 2015 will be near 86.60 by the end of the month.


U.S. Dollar contract, DX, Daily chart

The US$ got a boost this week and after some volatility around the election results it has rallied back up to the October 25th high at 99.09 with today's high at 99.08. It could pull back again within its up-channel from May, the bottom of which was tested with a quick spike down to 95.90 Tuesday night (just above its 200-dma at 95.86), but the upside target for the move up from May continues to be a little over 100 before heading back down for the last leg of its consolidation pattern since March 2015.


Gold continuous contract, GC, Daily chart

Gold's pattern has been choppy (corrective) and therefore short-term projections are very difficult. But based on its back-test of support-turned-resistance at 1308 last week and again on Monday that's been followed by a drop back down it looks like a bearish kiss goodbye that should lead to lower prices. A break below its October 7th low near 1243 should usher in more selling. The next price-level support is down near 1182, or maybe the May 31st low at 1199, before we could see a bigger bounce correction. But another rally above price-level resistance near 1308 would likely see a larger rally and potentially up to the 1400 area.


Oil continuous contract, CL, Daily chart

Last week's decline for oil had it dropping back below its broken downtrend line from June-August, which created a failed breakout attempt. That rally attempt left behind a double top with the June high. With the drop back below the broken downtrend line last week it also broke below its uptrend line from August so it was a double breakdown signal. This week's bounce was back up to its downtrend line and today's selling leaves a small back-test and bearish kiss goodbye. If the sellers drive oil below its 200-dma, currently at 43.50, we should see oil drop down to its August low at 39.19 and potentially much lower.


Economic reports

There were no market-moving economic reports this morning and only one report Friday morning -- Michigan Sentiment will be reported at 10:00. No big change is expected and I doubt the market will pay much attention to it.


Conclusion

The election results fooled the majority of the political "experts" and then the stock market fooled the majority of the financial "experts." It's been a wild week and today's stock market simply added to the confusion with the mixed messages from the different indexes. But even with the large differences between the main indexes I see similar setups where they've rallied up to potentially strong resistance and either sold off from there, such as NDX, or are potentially ready to sell off.

The bulls need to at least hold the market up on Friday to maintain the potential for a higher rally. A choppy pullback/consolidation would keep things looking bullish. But a sharp (impulsive) decline would suggest this week's rally might have set some bull traps and it would be a message to traders to not hold onto long positions since a stronger selloff could occur from here (and then prove the experts correct). We should have a much clearer picture in the next day or two and in the meantime stay nimble in your trades.

Good luck and I'll be back with you next Wednesday.

Keene H. Little, CMT

In the end everything works out and if it doesn't work out, it is not the end. Old Indian Saying


New Plays

Consolidation Time

by Jim Brown

Click here to email Jim Brown

Editors Note:

Markets sometimes move in sprints but eventually they have to pause to rest. The Dow has gained 1,389 points in four days and closed well into new high territory today. Meanwhile the Nasdaq 100 dropped back below 4,700 intraday as it lost 78 points. This was a clear sign of sector rotation as investors move into areas that should do good under a Trump presidency.

The Dow is on fire because it is the large cap industrials, energy and banks. The tech portion of the Dow was under pressure as was the dividend stocks like PG and JNJ. Strangely, IBM was an exception. The gains in the Dow stocks have been off the scale. For instance caterpillar (CAT) is up 17% over the last five days and Goldman Sachs +14%. I am loving it but these gains cannot continue.

We are likely to see some profit taking on Friday. Given the recent gains, it could be severe. Once we do consolidate, I believe we will continue higher. We just need to wait for that consolidation.



NEW BULLISH Plays

No New Bullish Plays


NEW BEARISH Plays

No New Bearish Plays



In Play Updates and Reviews

Never Ending Story

by Jim Brown

Click here to email Jim Brown

Editors Note:

The market continued to rise but there were pockets of problems like big cap tech stocks. The Dow rose sharply again but the Nasdaq 100 crashed with a -78 point decline. You may remember when we were headed into the end of October fiscal year end that big caps techs were bought because portfolio managers did not know who was going to win the election and therefore what sectors to buy. They bought tech stocks instead.

Now that the president has been chosen they are bailing on those tech stocks and buying healthcare, banks, biotechs, energy, etc. This is why the Dow at +218 and the Nasdaq 100 at -78 were at opposite ends of the spectrum today.

The market is due for a rest. This mixture of gains and losses is a prelude to real profit taking and Friday could be the day. There is not a never-ending story in the market. Streaks always end.





Current Portfolio


Stop Loss Updates

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


Profit Targets

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





Current Position Changes


RCII - Rent-A-Center
The long stock position was opened at $11.25.

EBAY - Ebay Inc
The short stock position was stopped out at $28.75.



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Short term Calls and Puts on equities = Option Investor Newsletter

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BULLISH Play Updates

MENT - Mentor Graphics - Company Profile

Comments:

No specific news. Nice gain in a positive market. New closing high.

Original Trade Description: October 13th.

Mentor Graphics Corporation provides electronic design automation software and hardware solutions to design, analyze, and test electro-mechanical systems, electronic hardware, and embedded systems software worldwide. It offers printed circuit boards; Mentor Graphics Scalable Verification tools; Questa platform to verify systems and integrated circuits (ICs); FastSPICE, Eldo, and ADVance MS analog/mixed signal simulation tools; and Veloce hardware emulation system. Further, the company provides software, tools, and professional engineering services; and methodology development, enterprise integration, and deployment services. It sells and licenses its products through direct sales force, distributors, and sales representatives to the communications, computer, consumer electronics, semiconductor, networking, multimedia, military and aerospace, and transportation industries. Company description from FinViz.com.

Billionaire Paul Singer, head of Elliott Management, announced on Sept 29th his firm was taking an active 8.1% stake in Mentor Graphics. In the SEC filing Elliott said there are "strategic opportunities" available at MENT and he is going to force a sale. Singer is no stranger to activist investing. Since 1994 he has launched 114 campaigns and 14 proxy fights when companies do not take his advice and get the M&A ball rolling. Elliott has $27 billion under management and Mentor only has a $3 billion market cap. If the board does not take action quickly, Elliott could launch a proxy fight to get enough people on the board that will take action. As a relatively small company, Mentor is in the crosshairs and there is very little chance for escape.

Shares spiked in the middle of the day on Thursday after TheStreet posted an article explaining Elliott' s game plan. The close at $27.92 was a 15-year high. Since Elliott announced his position at $24.69 the shares have risen about $3.50 with $2 of that the first day. Elliott is in for the long term and they will not be bailing on a $3 gain. They have a much larger goal in mind.

Earnings Nov 17th.

A lot of investors follow these activist funds and I would expect the stock to continue to rise as the headlines appear. More than 7,000 Jan $30 calls were bought today against an open interest of only 3,944.

Because of the afternoon spike I was going to put an entry trigger on the position just over the afternoon high. However, the S&P futures are down hard again tonight and maybe we will get an opportunity to buy the stock lower so I did not add the trigger. Support is $26.

Position 10/14/16:

Long Jan $30 call @ $1.35, see portfolio graphic for stop loss.

Previously Closed 11/1/16: Long MENT shares @ $28.54, exit $28.25, -.29 loss



RCII - Rent a Center - Company Profile

Comments:

No specific news. New 4-week high.

Original Trade Description: November 9th.

Rent-A-Center, Inc., leases household durable goods to customers on a rent-to-own basis. The company operates through four segments: Core U.S., Acceptance Now, Mexico, and Franchising. It offers durable products, such as consumer electronics; appliances; computers, including tablets; smartphones; and furniture, including accessories under rental purchase agreements. The company also provides merchandise on an installment sales basis; and offers the rent-to-own transaction to consumers who do not qualify for financing from the traditional retailer through kiosks within retailer's locations. It operates retail installment sales stores under the Get It Now and Home Choice names; and rent-to-own and franchised rent-to-own stores under the Rent-A-Centre, ColorTyme, and RimTyme names. As of December 31, 2015, the company owned and operated approximately 2,672 stores in the United States, Canada, and Puerto Rico, including 45 retail installment sales stores; 1,444 Acceptance Now kiosk locations in 40 states and Puerto Rico; 532 Acceptance Now direct locations; and 143 stores in Mexico, as well as franchised 227 rent-to-own stores in 31 states under the Rent-A-Center, ColorTyme, and RimTyme names. Company description from FinViz.com.

For Q3, the company posted earnings of 11 cents compared to estimates for 9 cents. Revenue of $693.9 million missed estimates for $698.4 million. Same store sales fell -8.4% but that was actually better than the 9.8% estimates. For the full year they guided to earnings of $1.05-$1.15 and revenue of $2.07 to $2.10 billion.

On the surface those results were terrible. The CEO said the "Q3 earnings were negatively impacted by unexpected capacity-related system outages following the full implementation of our new store information management system within our core U.S. stores" and he was "terribly disappointed." Fortunately, the problem is now behind them and Q4 is normally a strong quarter.

Earnings Jan 25th.

Shares crashed from $13 to $8 on the earnings and have now rebounded over the last four weeks to $11. The trend over the last month has been steady and there is no reason to expect that to change over the next month. If the market is going to be positive now that the election uncertainty has passed, then the stock should do well.

Position 11/10/16 with a RCII trade at $11.25

Long RCII shares @ $11.25, see portfolio graphic for stop loss.

Optional:
Long Dec $12.50 call @ 20 cents, no stop loss.




BEARISH Play Updates

EBAY - Ebay Inc - Company Profile

Comments:

No specific news. Big spike at the open to hit our stop loss at $28.75 exactly to the penny. The long put option is still open with no stop loss.

Original Trade Description: October 31st.

eBay Inc. operates e-commerce platforms that connect various buyers and sellers worldwide. Its platforms enable sellers to organize and offer inventory for sale; and buyers to find and buy it virtually anytime and anywhere. The company's Marketplace platforms include its online marketplace at ebay.com and the eBay mobile apps; and StubHub platforms comprise its online ticket platform at stubhub.com and the StubHub mobile apps, which enable fans to purchase tickets to the games, concerts, and theater shows. Its Classifieds platforms include a collection of brands, such as Mobile.de, Kijiji, Gumtree, Marktplaats, eBay Classifieds, and others that offer online classifieds and help people find whatever they are looking for in their local communities. The company platforms enable users to find, buy, sell, and pay for items through various online, mobile, and offline channels, which include retailers, distributors, liquidators, import and export companies, auctioneers, catalog and mail-order companies, classifieds, directories, search engines, commerce participants, shopping channels, and networks. Company description from FinViz.com.

For more than a decade Ebay has been the primary sales hub on the web but as Amazon and others grew, Ebay fell out of favor. There are very few new items left for sale on Ebay because you can buy they cheaper from Walmart, Target or Amazon. That left Ebay to struggle to increase sales on mostly used items.

In Q3 Ebay earnings fell from $545 million and 45 cents to $418 million and 36 cents. For Q4 they expect revenue of $2.36-$2.41 billion and earnings of 52-54 cents. Analysts were expecting $2.4 billion and 54 cents. For the full year, they are now guiding for $1.85-$1.90 and $8.95 to $9.0 billion. Analysts were expecting $1.89 and $8.95. For both Q3 and the full year analysts were expecting more than the Ebay guidance.

Shares fell 18% on the news to $28.61 then rebounded two days later to $29.71. That rebound has faded and EBAY closed at $28.51 on Monday with support well below at $24.

There is just no excitement surrounding EBAY today. Since they spun off PayPal they have been struggling to grow the business. I believe shares will retest the $24 level unless we get a runaway tech rally after the election. I am not holding my breath.

Position 11/1/16:

Closed 11/10/16: Short EBAY shares @ $28.51, exit $28.75, -.24 loss.

Still open:

Long Dec $28 put @ .72, see portfolio graphic for stop loss.



VXX - Volatility Index Futures - ETF Description

Comments:

The VXX rallied on the crash in the big cap tech stocks. This should be temporary but the market is due for a rest.

Since this is a long-term play, I am not going to comment on it every day. Just forget it is in your portfolio and hope for a strong market rally in Q4.

Original Trade Description: September 6th.

The VXX is a short term volatility product based on the VIX futures. As a futures product it has the rollover curse. Every time they roll to a new futures contract they have to pay a premium and that lowers the price of the ETF. It is a flawed product with a perpetual decline built in from the monthly roll over in the futures contracts.

As evidence of this flaw, they have now down four 1:4 reverse stock splits. The last four reverse splits occurred at $13.11 (11/2010), $8.77 (10/2012), $12.84 (11/2013), $9.52 (8/8/16). The prospectus says it can reverse split anytime it trades under $25 for a prolonged period and the splits will always be 1:4.

After the August split the ETF moved sideways for four weeks at $36. I think everyone was waiting for the typical August volatility. When it did not show up and the market rallied on Friday that support broke. And the decline has begun.

Because there may be some September volatility, anyone in this position must understand that it may move higher before it moves lower BUT it will always move lower. We just have to wait it out. Volatility never lasts forever.

Unfortunately, put options are expensive with a volatility instrument at this price level. The only recommendation is to short the ETF and forget it. If we do get a prolonged rally as some are expecting we could see strong gains in the next 2-3 months. This will be a long-term position. This is not a 2-3 week play. I can guarantee you, if history holds, we can play this until it splits 1:4 again at $10. Once we are in the position and profitable I will put a trailing stop loss on it. We will take profits and then look for a bounce to get back in. We could keep this play in the portfolio on a trading basis permanently.

Position 9/7/16:

Short VXX shares @ $33.88, no initial stop loss.

No options recommended because of price.





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