Option Investor
Newsletter

Daily Newsletter, Monday, 11/14/2016

Table of Contents

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

Market Wrap

A Change In Paradigm

by Thomas Hughes

Click here to email Thomas Hughes

Introduction

Global indices continue to cheer in the wake of the Trump victory, the market at least seems to accept the new paradigm. Two notable moves in today's action occurred in the Dollar Index and Dow Jones Transportation Index which both surged to new long term highs. Other markets held their ground, at or near last week's highs, while investors consolidate positions and prepare for a period of lower taxes, deregulation, infrastructure spending and rising inflation.

Asian markets were a bit mixed but most indices closed with gains. The Japanese Nikkei led with gains near 1.75%, trading there was boosted by better than expected GDP numbers. Consensus estimate of 0.9% was blown out of the water by actual results of 2.2% and the first strong evidence that Abenomics and negative interest rates are working to spur economic activity. Europe closed the day with most indices in the green although gains were small, in the range of 0.25% to 0.50%.

Market Statistics

Futures trading indicated a flat to mildly positive open all morning. There was no economic data or noteworthy earnings releases before the bell to impact trading so action was pretty dull. At the open trading was to the upside but very choppy, just above break even levels, and did little more than hold gains posted last week. Most of the major indices, except the transports as noted above, spent the day drifting sideways within ranges set in the early part of the day and were not able to break them. Sideways trading continued into the end of the day leaving the indices near the middle of their respective ranges, and the blue chips at a new all time high.

Economic Calendar

The Economy

No economic data today but lots this week including retail sales, PPI, CPI, housing data and much more. The most important may be the CPI and PPI but Wednesday's release of FOMC Minutes could easily steal the spotlight. Taken together we will get an X-ray look at the FOMC along with important reads on consumer and producer level inflation, the housing sector, the consumer and a couple of regional manufacturing releases that could add momentum to the Trump Trade.

Moody's Survey Of Business Confidence gained another 0.8% to hit 32.6 and a new 6 month high. This is the 5th week of gains and the 1st week post-Trump; Mr. Zandi says that the "shocking presidential results" have had no noticeable impact on global sentiment. Based on the market rally I'd say that there had been a positive impact on sentiment but who am I to judge? Regardless, according to his summary sentiment remains steadfast around the world; the US is strongest, the EU has shrugged off the Brexit and poor sentiment in South America appears to have at least bottomed.


Just over 91% of the S& 500 has reported earnings so far this season. Of those that have reported 71% have beaten EPS estimates and 55% have beaten revenue estimates, both basically in line with trends over the past few quarters. All 11 sub sectors of the S&P 500 have beaten earnings expectations.The blended rate for earnings growth is now 2.9% and looks like it will remain at or near this level into the end of the season; the earnings recession has come to an end.


Looking forward earnings growth remains positive and on the upswing, although outlook continues to dim. Fourth quarter growth fell -0.3% to3.6% and a new low; based on 4 year trends this is likely to rise to 7.5% to 8% by the end of the 4th quarter cycle. Full year 2016 outlook held steady at 0.2% for the third week, full year 2017 outlook fell -0.2% to 11.2% and is also a new low.


Diminishing earnings growth outlook is a concern but what I would call a brick-in-the-wall-of-worry. Outlook for earnings growth is positive and expands into the end of next year regardless of the fact that the amount of expected growth is declining. Add in the chance that earnings will run 4% better than expected, on average, for each quarter of the year and 2017 growth could be as high as 16%. Add in the Trump effect from tax relief alone and those expectations could easily top 20%.

The Dollar Index

The Dollar Index surged more than 1% to hit a new 1 year high, break above the 100 level and approach the all time high. The index is supported by expectations of increased inflation expansion driven by the Trump economy, hopes for the Trump economy and the need for FOMC interest rates hikes due to current economic conditions reinforced by expectations for the Trump Economy. Today's move is strong, looks decisive and is confirmed by bullish signals in the indicators. There may be consolidation of pull back following today's move but a test of the all time high near 100.50 and probably a new all time high look fairly certain.


The Oil Index

Oil prices remain under pressure as faith in OPEC evaporates like water in the desert. The cartel is calling for production caps and cuts that, at face value, should help oil supply/demand imbalances to stabilize but when compared to actual production levels and production level increases do very little to address the situation. As of last week's report OPEC is pumping oil at a new monthly record that would leave production well above the levels seen the last two times they talked the market up on hopes of stabilizing prices. Conspiracy or not they are adding serious volatility to the market. WTI fell more than -1.5% in early trading to hit $42.75 but managed to regain most of that loss before the close. Next downside target is $40, a break below here could spell trouble for the oil industry and next years earnings outlook.

My new theory for oil is that low prices could help spur the economy in this time of change and lead to increased demand. How low they go in the near term is hard to say but I wouldn't be surprised to see demand outlook begin to improve in the next few months and a true stabilization of oil prices.

The Oil Index remains range bound. The index fell to test support near the middle of the 7+ month range and managed to rally from there but still closed with a loss for the day. Price action created a small white bodied candle, just above support, with indicators consistent with range bound trading. Current bias is to the downside, support at 1,120 could be tested or broken, if broken a move to the bottom of the range near 1,090 is likely.


The Gold Index

Gold prices are tanking. The surge in the dollar is overcoming any kind of physical support that exists and pushing gold prices down to long term lows. Today's action saw spot prices dip another -0.5% to touch a new 5 month low just above $1,200. Momentum is to the downside, next target for support is $1,200 and likely to be reached in the short if not nearer term. If prices were to rebound for some reason first target for resistance is $1,250.


In The News, Story Stocks and Earnings

Fall out from the election is plaguing some big names. Facebook is one. The social media giant is coming under fire for how it handles posts, particularly political and fake news posts, and the reliability of the information contained within. Some are saying that Facebook helped to influence the election by allowing the rampant spread of completely false propaganda, an allegation Zuckerberg denies. A twist in the story is the apparent existence of software designed to prevent such abuses that was not used for fear of its affect on, among other things, the election. Shares of the stock fell -3% to hit a new 6 month low, extending losses incurred following the release of earnings.


Apple is feeling the sting of a possible trade war with China. China's government issued a statement through a state backed newpaper saying they would retaliate with tariffs and restrictions of their own, and cited Apple's iPhone as a specific target. The statements went on to say that the government of China does not believe it will come to a trade war calling the threats campaign rhetoric and citing laws limiting the Presidents power to impose such tariffs. Shares of Apple fell -2.5% to hit $105 and 2 month low where there is potential for support. If so, this could be the Trump Entry for Apple. A cooling of rhetoric or, best case scenario, a warming of relations between China and Trump could send this one back up to test recent highs.


Boeing was also named in the Chinese news report as a target of retaliatory trade practices if a trade war were to be engaged. The paper says that a number of orders for Boeing planes would be replaced for Airbus aircraft instead, the news however did not have material impact on the company's stock prices. Shares actually rose in today's session, gaining nearly 1%, to tickle a one year high and were further supported by late day reports Warren Buffet was buying airlines.


The Indices

Today's market action was largely without significant move, at least in terms of the major indices. The one stand out is the Dow Jones Transportation Average which gained nearly 2.20%. The transports have come late to the party but are making up for lost time, gaining nearly 10% in the last 8 days to break above resistance levels and set a new 18 month high. The index looks poised to continue this move and eventually retest all time highs set almost exactly 2 years ago. The indicators confirm and support this move, both showing strength and suggestive of higher prices. Next upside target is near 9,000 and a consolidation range just beneath the current all time high.


The next biggest gain in today's session was set by the Dow Jones Industrial Average, a mere 0.11%, and enough to set another new all time high. The blue chips are moving up on expectations of infrastructure spending, expanding US economic growth and the spill-over effect of expanding global economic growth. The index created a small doji candle that could be a shooting star but is most likely a spinning top, we'll see. A consolidation at this level should be expected now that the index is trading above previous all-time-high-resistance. In the near term, provide we get some follow through in the market, upside target is roughly 850 points above today's close. Longer term, Dow 20,000 does not look unlikely.


The S&P 500 made the smallest loss in today's session, -0.01%. Price action looks like consolidation beneath current all time high levels and gearing up to make a run to test resistance. The indicators are bullish and confirm the move, a reconfirmation in the indicators and break to new highs would be very bullish in my opinion and could easily lead the index up to 2,400 in the near to short term. For now, upside target is near 2,200 and the current all time high with support rising along with the short term moving average near 2,140.


The NASDAQ Composite made the biggest loss in today's session but only -0.36%. The move appears to be part of consolidation along support levels consistent with the short term moving average and could lead to further upside. The indicators have confirmed the bounce and suggest prices will continue to rise in the near term. First upside target is just above today's close, near the current all time high, and may not be broken unless the market follows through on the Trump Rally. A break to new all time highs would be bullish and could lead the index up to 5,500 in the near term.


Today's action was a consolidation of last week's Presidential Rally and the indices look poised to extend that move into the near, short and long term. Supporting this outlook is ongoing economic recovery, positive and expanding earnings growth outlook, low oil prices and a general acceptance that the Trump presidency will bring a period of unfettered growth for the US economy. Unless something completely unexpected hits the market I just don't see any reason to expect the onset of bear market conditions. As for the FOMC, they and their rate hike don't seem that important anymore. Important yes, but not as important as they were even a week ago. Not to discount them but it seems assured that rates are going to begin rising very very soon. On the market, I'm still cautious, but cautiously bullish, looking to buy on the dips and preparing for what could be a long ride upward.

Until then, remember the trend!

Thomas Hughes


New Plays

Lagging the Market

by Jim Brown

Click here to email Jim Brown
Editor's Note

In this environment, we have to find the underperformers because everyone else is already overbought. Not to beat a dead horse here but out of my universe of 400+ small cap stocks it was very difficult to find one that had not rallied 10% or more over the last week. Anyone that had not rallied, we do not want to buy. In this market we are looking for the Goldilocks stocks, not too hot and not too cold.



NEW BULLISH Plays

IDTI - Integrated Device Technology - Company Profile

Integrated Device Technology, Inc. designs, develops, manufactures, and markets a range of semiconductor solutions for the communications, computing, consumer, automotive, and industrial end-markets worldwide. It operates in two segments, Communications; and Computing, Consumer, and Industrial. The Communications segment offers communication timing products, such as clocks and timing solutions; flow-control management devices comprising Serial RapidIO switching solutions; multi-port products; telecommunications products; static random access memory products; first in and first out memories; digital logic products; radio frequency products; and frequency control solutions. The Computing, Consumer, and Industrial segment provides clock generation and distribution products, programmable timing devices, computing timing solutions, high-performance server memory interfaces, PCI Express switching solutions, power management solutions, and signal integrity products, as well as sensing products for mobile, automotive, and industrial solutions. Company description from FinViz.com.

IDTI reported earnings of 34 cents that beat estimates for 33 cents. Revenue of $184.1 million barely edged ahead of estimates for $184.0 million. Revenue rose 8% making the 12th consecutive quarter of revenue growth.

They announced multiple new products for the quarter including a new 5G product in corporation with IBM for the connected car. They also obtained certification for their second production facility for automotive capabilities.

Earnings Jan 30th.

Shares spiked from $21 to $24 on the earnings then settled in for two weeks of post earnings depression. Over the last two days shares has ticked higher again and closed at $23.60 on Monday. This has been resistance from early October and from back in June. With the positive earnings and a positive market I expect the stock to breakout this time.

Buy IDTI shares, currently $23.60, initial stop loss $22.60

No options recommended because of price.



NEW BEARISH Plays

No New Bearish Plays



In Play Updates and Reviews

New Russell High

by Jim Brown

Click here to email Jim Brown

Editors Note:

The Russell 2000 gained another 16 points to close at 1,298 and a new high. The chart below is scary. Those kinds of gains are not sustainable. We need to see 2-3 days of decent profit taking that would allow the indexes to build a new base for another leg higher.

The Dow and Nasdaq are going through that process now. The Nasdaq is really getting hit from the sector rotation out of big cap tech stocks. The Russell is benefitting from the continued rally in the biotechs but that did not keep the Nasdaq positive today.

The Mentor Graphics play finally concluded. Siemens is goig to buy them for $37.25 a share and I am recommending we close the position.




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


FTK - Flotek
Long stock position entered at the open.

MENT - Mentor Graphics
Siemens announced a buyout. Close the position.



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BULLISH Play Updates

FTK - Flotek - Company Profile

Comments:

No specific news. Shares posted a minor gain despite a drop in oil prices.

Original Trade Description: November 12th.

Flotek Industries, Inc. develops and supplies oilfield products, services, and equipment to the oil, gas, and mining industries in the United States and internationally. The company's Energy Chemistry Technologies segment designs, develops, manufactures, packages, and markets chemistries under the Complex nano-Fluid brand for use in oil and gas well drilling, cementing, completion, stimulation, and production activities, as well as for use in enhanced and improved oil recovery markets. This segment also constructs and manages automated material handling facilities; and manages loading facilities and blending operations for oilfield services companies. The company's Drilling Technologies segment inspects, manufactures, sells, markets, and rents down-hole drilling equipment that are used in energy, mining, and industrial drilling activities through direct and agent-based sales. Company description from FinViz.com.

In the Q3 cycle they reported a loss of 5 cents on revenue of $73.7 million. That was slightly more than the estimates for a 3-cent loss. Revenue estimates were for $79.5 million. The company explained their 16.2% decline in revenue saying there was a 43.2% reduction in the active rig count in Q3 compared to Q3-2015. In other words, their available business was cut nearly in half but they only recorded a 16% decline in revenue. That was actually a 1.0% increase sequentially from Q2.

Flotek services oil wells and especially new wells with their down hole products including their patented Complex nano-Fluid (CnF) technology that is used in fracking wells. Unlike fracking chemicals used by others, the Flotek CnF chemicals are completely non-toxic and have been proven to provide a slippery surface in the reservoir so that oil flows freely. This nontoxic chemical mix made from citrus oils is seen as a plus for producers constantly under fire for potential ground water contamination.

With rigs going back to work and drilled but uncompleted wells being brought online, the company said they were seeing signs of recovery in the sector. The drop in crude prices to $43 last week failed to depress the stock.

FTK has put in a bottom at $11 and could be ready to move towards the September highs at $16.

If OPEC actually announces some kind of production agreement on Nov 30th, the sector could respond aggressively.

Earnings Feb 1st.

Position 11/14/16:

Long FTK shares @ $11.72, see portfolio graphic for stop loss.

No options recommended because of price.



MENT - Mentor Graphics - Company Profile

Comments:

Siemens has agreed to buy Mentor Graphics for $37.25 per share or $4.5 billion. Part of the reason for entering the position was the activist shareholder position with Paul Singer recommending they explore strategic alternatives. There was heavy call option activity as well suggesting there was a deal brewing. We were rewarded for our patience.

CLOSE THE POSITION

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. Shares lost -2.6% in a mixed market. Maybe they are finally going to head lower.

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:

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

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



VXX - Volatility Index Futures - ETF Description

Comments:

The VXX edged down despite the mixed market but it was only a minor decline.

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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