Option Investor
Newsletter

Daily Newsletter, Saturday, 11/19/2016

Table of Contents

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

Market Wrap

Calm Before the Storm?

by Jim Brown

Click here to email Jim Brown

The major indexes all posted gains for the week but those gains were muted after the post election bounce.

Weekly Statistics

Friday Statistics

The Dow only managed a 20-point gain for the week as the big cap stocks started to fade. The small cap Russell 2000 continued to surge with its 11th consecutive daily gain and another new high. The small caps are definitely leading the market but the large caps are beginning to weaken.

I believe this is the consolidation period from the monster post election gains. Traders were locking in profits ahead of the weekend event risk. It never hurts to take some gains off the table and reposition into different stocks.

With Thanksgiving week typically bullish it will be interesting to see if the historical trend holds or will the profit taking increase. I believe we will see continued but possibly muted gains.

The Russell is extremely overextended and due for a rest with resistance at 1,325. On Monday, more than 25% of the Russell components made new 52-week highs. That was a record.


On the economic front, the Kansas Fed Manufacturing Survey for November posted a decline from 6 to 1 and right on the verge of going negative again. That is only the 4th positive number over the last 12 months with a low of -12 in February. Nearly all the components weakened with prices paid the big gainer. Weak activity in nondurable goods, specifically food products and plastic items were blamed. Producers were still optimistic despite the weakness.



The state and regional employment reports showed employment increased in only 11 states in October, down from 14 in September. Employment fell in 5 states and was unchanged in 34 states. Washington added 10,600 jobs, Michigan 18,900 and California 31,200 for the biggest gainers. Connecticut lost 7,200, South Carolina -9,900 and Minnesota lost 12,500 to top the losers list. The report was ignored.

The economic calendar for Thanksgiving week is relatively bland with the existing home sales and Richmond Fed surveys on Tuesday the only material reports. The FOMC minutes are already assumed to point to a December rate hike so there is no mystery there.

The CME odds of a rate hike are now over 95% so there the hike is already priced into the market. The only surprise would be a hike of more than a quarter point but I doubt the market would care.



There was very little stock news on Friday as everyone is already going dark for the holidays. Foot Locker (FL) reported earnings of $1.13 compared to estimates for $1.11. Revenue of $1.89 billion matched estimates. Same store sales rose 4.7% and in line with estimates. The company opened 21 new stores in the quarter but closed 28 nonperforming stores. Shares were up fractionally on the news.

However, the earnings had a negative impact on Under Armour (UA). Foot Locker said the Steph Curry 2.0 and 2.5 shoes "performed well" during Q3 but the Curry 3.0 shoe which came out on October 27th, "started off a bit slower than the two previous models" but it was still early. Shares of UA fell -4% on the comment.



Hibbett Sports (HIBB) reported a 21% decline in earnings to 66 cents that badly missed estimates for 74 cents. Revenue of $237 million was only fractionally shy of the $237.8 million estimate. They guided for full year earnings of $2.82-$2.88 per share. They blamed the soft quarter on weak apparel sales because of the unseasonably warm weather. Shares fell 11% on the news.


Abercrombie & Fitch (ANF), a serial disappointer, reported earnings of 2 cents compared to estimates for 21 cents and earnings of 48 cents in the year ago quarter. Revenue of $821.7 million missed estimates for $830.6 million. A year ago, they posted $878.57 million in revenue. This was the 15th consecutive quarter of declining sales. Same store sales fell -6% compared to estimates for a -3.9% decline. The company said it expected "challenging" comps for Q4 but slightly better than Q3. Analysts are expecting earnings of $1.07 on revenue of $1.07 billion. Shares fell -14% on the news.


The Buckle (BKE) reported earnings of 48 cents that missed estimates for 51 cents. Revenue of $239.2 million matched estimates. Same store sales imploded with a -15.3% decline. Online sales fell -8.5%. Year to date sales are down -11.8%. It was a miserable report but shares rose 2% for no apparent reason. This looks like a short candidate along with ANF.


Wells Fargo (WFC) was cut to a sell at BMO Capital Markets. They believe the rally after the scandal has been too extreme and they issued a $47 price target with the stock at $53. After the bell, Wells Fargo declared cash dividends on their various preferred shares from $18.75 to as much as $414.06 per share depending on the preferred series. Also after the bell, bank regulators revoked WFC's right to be exempted from some executive compensation rules and said it might attempt to claw back some pay from executives. The bank also has to apply for permission before appointing any new officers. In the period after the scandal, new account openings declined 44% year over year and -27% from September to October. Account closures rose 3%. Based on all the bad news I agree with the BMO call. WFC looks over extended here.


Citigroup (C) was cut to neutral by Macquarie with a $57 price target. The stock closed at $55.45.

Gap Inc (GPS) was cut to sell by Citigroup with a $25 price target, about $6 under the Thursday close at $30.71. The reason was the weak outlook in Thursday's earnings. The stock immediately crashed to $25.50 on the combination of the headlines.


The earnings cycle is coming to a close and there are very few companies reporting next week. Jack in the Box (JACK) on Monday will be a highlight along with Hewlett Packard Enterprise (HPE) on Tuesday. Hewlett was raised to outperform at Raymond James ahead of the earnings. Deere & Co (DE) will report on Wednesday and this could be an interesting event. The stock is very extended given the weak global demand for tractors.


According to Factset, more than 95% of S&P-500 companies have reported earnings for Q3. More than 72% beat their earnings estimates and 55% beat their revenue estimates. The blended earnings growth for Q3 is +3.0% and the first quarter of growth since Q1-2015. At the beginning of the quarter, the consensus was for a -2.2% decline. Companies posted 2.7% revenue growth and that was the first quarter with growth since Q4-2014.

For Q4, 68 companies have issued negative guidance and 32 companies have issued positive guidance. The forward S&P-500 PE is 16.7. Another 13 S&P companies will report earnings this week.

Q4 earnings growth is now expected to be 3.4% with 4.9% revenue growth. For all of 2017 analysts are projecting 11.4% earnings growth and 5.9% revenue growth. This will change significantly from quarter to quarter. For instance, Q1 earnings growth is expected to be 13.4% alone but the strong dollar is likely to knock that back considerably.

The dollar has surged to a 14-year high at $101.21 on the dollar index, which values the dollar against a basket of currencies. This is going to be very damaging to companies that export and sell products overseas. The rising dollar is going to negatively impact commodities and that will eventually be a drag on equities.


The rising dollar along with the Brexit issues in Europe have pushed the Euro to within .02 of a ten-year low. The Euro could reach parity with the dollar in a short period of time if the current trends continue.


Gold prices have collapsed back to $1,200 on the surging dollar and the outlook for a stronger economy. The gotcha in this decline is that Trumps policies could fuel inflation and make gold a good investment in the future.


The yield on the ten-year treasury has spiked nearly 65 basis points over the last three weeks. That is a 35% increase in yield in a very short period of time. This is causing havoc in the mortgage market with 30-year rates now in the 4.25% range. Borrowers are now being rejected because they no longer qualify at the higher rates. Obviously, 4.25% is not high on a relative basis but it is high compared to the 3.25% advertised rate just a month ago.


The equity rally may be ending its run in the short term. As I reported above the analyst downgrades are starting to flow because so many stocks, especially financials, have risen significantly. While reducing a rating on one or two banks is not likely to subdue sentiment, having a dozen analysts reduce ratings on the leaders will have an impact.

Temporarily, the big banks are holding their gains but this is not likely to last. There will be profit taking. I would look at the December 14th Fed announcement as a sell the news event if we have not already seen some significant profit taking before that event.


OPEC has still not made up their collective minds about a potential production agreement and the meeting is the following Wednesday. Crude prices have traded between $43-$46 for the last two weeks with the exception of the one-day dip to $42. U.S. inventories are building again with the addition of 22.1 million barrels over just the last three weeks. I expect volatility to pick up slightly as we get closer to the meeting and the headlines begin to flow.


Last week was a good week for the drilling sector. Despite oil prices hitting $42 the week before, the active rig count rose by +20 to 588. Oil rigs added 19 and gas rigs added 1. The offshore count increased by 2 to 23. Producers have been mixed in their comments about the odds for an OPEC agreement but they are putting rigs to work as though they expect it to happen.


 


 

Markets

There have been multiple studies done covering trading patterns surrounding Thanksgiving week. Each reached a similar conclusion but different reasoning for the pattern. Without going into a lot of detail, it is sufficient to say that the market is typically bullish in Thanksgiving week. Black Friday is normally bullish and it is blamed on the positive consumer sentiment because of the holiday and the fact a lot of investors are not working on Friday so they tend to be on the computer rather than out wandering the malls.

The week after Thanksgiving is random and some blame the direction on the results of the Black Friday-weekend sales. If the retail reports are bullish then it is seen as a positive event for a strong holiday season. If the post weekend reports are negative then sentiment turns negative. There are analysts that are recommending selling retailers on Black Friday in a sell the news trade.

The Stock Trader's Almanac first noted the positive Thanksgiving trend in 1987. For the 35 years prior, the Wednesday before Thanksgiving and the Friday after were up 33 of 35 years. Unfortunately, that trend changed as soon as it was discovered. In the 29 years since 1987, there have been 13 declines and 16 advances. However, since 1987 the Dow has posted gains from the Black Friday close until year-end 22 of 28 times.

The big question is whether post election bounce has pulled all the buying forward and left us with another confused market until 2017.

The S&P had a strong chance of making a new high last week but missed it by a few cents. The record closing high from August is 2,190.15. The opening high on Friday was 2,189.89. That missed the old high by .26 points.

I speculated last week that a retest of that high could either produce a breakout where those shorts still in denial suddenly raced to cover OR it could turn into a double top followed by a decline.

So far, neither has happened but the selling was immediate when the S&P spiked to that Friday high. Fortunately, the decline was minimal and the S&P only lost 5 points.

The setup for next week is bullish. If the S&P could break through that 2,190 level in a normally bullish week, we might get some follow through. Nothing attracts new investors faster than new highs.

Support levels are now 2175, 2165 and 2150.


The Dow ran into resistance from November 2015 at the 18,900 level on Monday and never progressed any further for the rest of the week. With all the Dow earnings behind us, there is only post earnings depression ahead and profit taking from the post election bounce. I would like to think that the dead stop for a week at 18,900 was that consolidation and the trend higher will resume. However, what I wish and what really happens seldom comes to pass.

I am very encouraged that while the Dow failed to move over 18,900 it also failed to decline for the entire week with a progression of higher lows, even though the lows were only microscopically higher. The Dow traded in roughly a 100-point range from around 18,813 to 18,913. Given the +959 point gain the prior week, this tight range with no material profit taking was remarkable. That also gives us the support and resistance levels to watch for next week.



The Nasdaq closed only 6 points below a new high on Thursday at 5,333. Friday's intraday high at 5,346 was a new intraday high by 3 points but it could not hold the gains. Like the S&P, it flirted with the high but was not able to push through.

This tells us there are sellers waiting in both cases. However, like the Dow, the Nasdaq did not decline materially with only a 12 point loss on Friday ahead of weekend event risk. The indexes are poised to move higher but it will require a new sentiment spark to make it happen.



The Nasdaq 100 is still lagging but it did recover somewhat from the post election volatility. The biggest drag on Friday was GOOG and GOOGL with a combined 20-point decline. The sector rotation is still taking its toll but once the profit taking begins in the financials the techs should improve.


I have mixed emotions about next week. It is typically bullish and the indexes did not pull back significantly from resistance. That suggests underlying strength that is more than just a trading bounce. However, we are very overextended and due for a dip.

I mentioned last week that analysts tend to always be looking for the "end" of the trend rather than the extension of the trend. That happens in both bullish and bearish markets when a strong reversal appears. I can remember years ago expecting the end of a sudden bullish reversal every week for months and every week it failed to occur. Because of that memory, I hesitate to predict an end to this rally. The investing paradigm has changed. Bonds are being sold and money is pouring into equities, Since the election more than $35 billion has flowed into equity funds and $10 billion has flowed out of bond funds. Bank of America's Michael Hartnett, said it was the largest equity inflows in two years and the largest bond fund outflows in 3.5 years. He also said it was the largest weekly disparity ever. It is entirely possible we are seeing the long awaited Great Rotation out of bonds and into equities. If that is the case, equities have a long way to go.

On Friday, Tom Lee of Fundstrat was still predicting 2,325 for the year end S&P. He also believes the paradigm has changed. He said more than 21,000 new regulations have been created over the last 8 years that can be wiped out with the stroke of a pen. This will free businesses from hundreds of billions in regulatory costs. He said Washington's regulatory staff has increased by more than 25% at a cost of $108 billion a year to enforce these regulations.

With multiple big name analysts now predicting a continued boom it would be tough for portfolio managers to bet against the trend. Of course, the last 8 days does not make a trend. It would be a good start but we need the S&P and Nasdaq to follow the Dow and Russell to new highs before we can actually call it a trend.

 

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Random Thoughts


The surge in bullish sentiment continues and with good reason. Bullish sentiment has risen more than 23% over the last two weeks. Bearish sentiment declined -7.8% over two weeks and neutral sentiment has declined -15.3%. This survey ended on Wednesday before the Nasdaq made the new intraday high.

Last week results

Prior week results


 

Enter passively and exit aggressively!

Jim Brown

Send Jim an email

 

"Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas."

Paul Samuelson


 


New Plays

Techs Recovering

by Jim Brown

Click here to email Jim Brown
Editor's Note

The broader market was in rally mode after the election but tech stocks were seeing some profit taking as investors raised cash to put into banks and industrials. Over the last week, the big caps in the Dow began moving sideways but the tech stocks were starting to find buyers. Many are now breaking out to new highs.



NEW BULLISH Plays

OCLR - Oclaro Inc - Company Profile

Oclaro, Inc. designs, manufactures, and markets lasers and optical components, modules, and subsystems for the optical communications, industrial, and consumer laser markets worldwide. The company's products generate, detect, combine, and separate light signals in optical communications networks. It offers client side transceivers, including pluggable transceivers; line side transceivers; tunable laser transmitters, such as discrete lasers and co-packaged laser modulators; lithium niobate modulators to manipulate the phase or the amplitude of an optical signal; transponder modules for transmitter and receiver functions; and discrete lasers and receivers for metro and long-haul applications. Company description from FinViz.com.

Oclaro posted strong earnings of 14 cents compared to estimates for 10 cents. Revenue of $136 million also beat estimates for $132 million. The company raised guidance for Q4 to revenue in the $146-$154 million range.

Piper Jaffray said Oclaro will be the only company shipping products in volume in the next two quarters. They cited a lack of price competition today that will appear in mid 2017 as new competitors enter the market in volume. The industry is currently under capacity constraints. PJ also said there was strong demand from China and traction in the U.S. was accelerating due to the surge in IoT devices and video streaming.

Earnings Jan 31st.

Shares surged after earnings then faded the prior week in the Nasdaq uncertainty. Last week the stock broke over resistance at $9.25 and is now breaking out to five-year highs. I believe the rally will continue now that it is in breakout mode.

Buy OCLR shares, currently $9.84, initial stop loss $8.35

No options recommended because of price and spreads.



NEW BEARISH Plays

No New Bearish Plays



In Play Updates and Reviews

I Think I Can

by Jim Brown

Click here to email Jim Brown

Editors Note:

The little index that thought it could is continuing to make new highs. The Russell 2000 gained another 6 points to close at a new record high and this was the 11th consecutive daily gain. The Russell just keeps ticking higher as small cap financials and industrials add to their gains.

We know there needs to be some profit taking soon. It will be interesting to see how small or big the dip will be given the massive profits that have accumulated in the small cap stocks. In the S&P-600 more than 50 stocks have gained more than 25% since the election. That cannot continue.

I am being cautious in adding new positions because this streak will eventually fail and there could be a sharp downdraft before it recovers.




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


HUN - Huntsman
The long call position was closed at the open.



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BULLISH Play Updates

FTK - Flotek - Company Profile

Comments:

No specific news. Shares declined only slightly with oil prices volatile.

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.



GNC - GNC Holdings - Company Profile

Comments:

No specific news. Only a fractional decline.

Original Trade Description: November 15th.

GNC Holdings, Inc., operates as a specialty retailer of health, wellness, and performance products. The company operates through three segments: Retail, Franchise, and Manufacturing/Wholesale. Its products include vitamins, minerals, and herbal supplement products; and sports nutrition products, diet products, and other wellness products. The company sells its products under the GNC proprietary brands, including Mega Men, Ultra Mega, Total Lean, Pro Performance, Pro Performance AMP, Beyond Raw, GNC Puredge, GNC GenetixHD, and Herbal Plus, as well as under third-party brands. It operates a network of approximately 9,000 locations under the GNC brand worldwide. The company sells its products through company-owned retail stores; Websites, including GNC.com and LuckyVitamin.com, as well as Drugstore.com; domestic and international franchise activities; third-party contract manufacturing; and e-commerce and corporate partnerships. Company description from FinViz.com.

Just over a month ago there was a contingent of Chinese buyers circling GNC when it had a market cap of about $4 billion. When they reported earnings and lowered guidance that market cap fell to about $1 billion. Shares fell from $22 to $13 making the company even more attractive for the Chinese buyers.

The key here is not the U.S. or European business. The key point in a Chinese acquisition is the health conscious Chinese consumer. In China there are plenty of health products but most are scams or poorly processed with large amounts of unknown fillers. The health food and vitamin market is not well managed and all sorts of scary products exist.

GNC as a global brand is the answer. Chinese consumers would feel comfortable buying the brand and knowing there were no harmful ingredients.

Over the last several days, GNC shares have started ticking up again. GNC has hired Goldman Sachs to find a buyer and it is only a matter of time before that happens. The uptick in the shares could be due to rumors leaking out about a potential transaction. Option prices have also escalated suggesting something in progress.

Earnings Jan 26th.

Position 11/16/16:

Long GNC shares @ $14.75, see portfolio graphic for stop loss.

No options recommended because of price.



HUN - Huntsman Corp - Company Profile

Comments:

The remaining long cal position on HUN was closed at the open to avoid expiration.

We were stopped out of the long position on HUN shares on Sept 8th. We had a left over November $19 call.

Original Trade Description: August 23rd.

Huntsman Corporation manufactures and sells differentiated organic and inorganic chemical products worldwide. The company operates in five segments: Polyurethanes, Performance Products, Advanced Materials, Textile Effects, and Pigments and Additives. The company's products are used in various applications, including adhesives, aerospace, automotive, construction products, personal care and hygiene, durable and non-durable consumer products, electronics, medical, packaging, paints and coatings, power generation, refining, synthetic fiber, textile chemicals, and dye industries. Huntsman Corporation was founded in 1970.

They reported Q2 earnings of 53 cents that beat estimates for 52 cents. Revenue of $2.54 billion matched estimates. They generated more than $350 million in free cash flow and made an early repayment of $100 million in debt. They also announced they were selling some of its European facilities and would use the proceeds to repay debt. They sold a manufacturing facility to Innospec Inc for $225 million and the transaction is expected to close in Q4. Huntsman will remain a raw materials supplier to the facilities once the transaction is completed.

They are also planning to close their titanium dioxide manufacturing (TiO2) facility in South Africa in addition to spinning off their remaining TiO2 business in early 2017. The closure/spinoff will save $200 million.

Update 10/28/16: Huntsman reported earnings of 38 cents that beat estimates for 35 cents. Revenue of $2.36 billion missed estimates for $2.49 billion. Free cash flow was $300 million after an early repayment of $100 million in debt. The announced the filing of a Form 10 registration statement for a spinoff og the Pigments, Additives and Textile Effects businesses expected to occur in the first half of 2017.

The earnings, restructuring and debt repayment plans have given the stock a positive bias. Shares broke over resistance on Tuesday to trade at a 52-week high. The next material resistance is $23.

Earnings Oct 26th.

Position 8/30/16 with a HUN trade at $17.65

Closed 11/18/16: Long Nov $19 call @ 54 cents. Exit .25, -.29 loss.

Previously Closed 9/8/16: Long HUN shares @ $17.65, exit $16.65, -$1.00 loss.



IDTI - Integrated Device Technology - Company Profile

Comments:

No specific news. Nice continued gain after the breakout over resistance.

Original Trade Description: November 14th.

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.

Position 11/15/16:

Long IDTI shares @ $23.69, see portfolio graphic for stop loss.

No options recommended because of price.



XLF - Financial SPDR ETF - ETF Profile

Comments:

The XLD was flat for the day as traders took profits elsewhere.

Original Trade Description: November 16th.

The Financial Select Sector SPDR Fund seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the Financial Select Sector Index.

The ETF is comprised of 44% banks, 20% capital markets, 19% insurance, 11% diversified financial services and 6% consumer finance.

All of those sectors will do better as rates rise. As of today the CME FedWatch Tool shows a 91% chance of a rate hike in December as well as a 91% chance for the February meeting and 92% for March. If they do hike in December the odds will decline for February but depending on their commentary the March meeting will still be on the table. Multiple Fedwatchers have speculated there could be 3-4 rate hikes in 2017 if the economy continues to improve.

The Fed has to hike rates in 2017 in order to have some room to maneuver if the business cycle rolls over and a recession appears. We are in the third longest expansion in history and we are due for another recession soon.

The banks rallied on the rise in treasury yields and the expectations for the December rate hike as well as the potential for decreased regulation. President elect Trump has said he would kill regulations harming the banking industry. There is even talk of modifying Dodd-Frank.

Banks have rallied significantly and I would not suggest buying the actual ETF after the big gain. However, I do not believe the gains are over. The gains last week spiked the ETF to a 7-year high but the 2007 highs were over $30.

On Tuesday, somebody bought 300,000 contracts of the March $23 call at an average of 55 cents. That was $16.5 million in option premiums. That takes some serious conviction. I am recommending we follow them and buy the same call option. That way our risk is limited to $50 per contract. I am willing to bet $50 that the ETF will be over $23 by March. This is a long term position and there will not be a stop loss.

Position 11/17/16:

Long March $23 call @ 29 cents. No stop loss.




BEARISH Play Updates

VXX - Volatility Index Futures - ETF Description

Comments:

New historic low.

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 done 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.




Left Over Lottery Tickets

These positions were left over from prior plays where we had an optional option with no stop after the stock position was closed. Rather than close these for a few cents they are left open as a "Lottery Ticket" play. With months before expiration, anything is possible. A strong move in a single stock can be well worth the additional patience.

These positions are only updated on the weekend.


HOV - Hovnanian Enterprises - Company Profile

Comments:

No specific news. HOV had a good week. Our Feb $2 call only cost 20 cents so we can afford to wait for a recovery.

Original Trade Description: July 27th.

Hovnanian Enterprises, Inc. is a builder of residential homes. The Company designs, constructs, markets and sells single-family detached homes, attached townhomes and condominiums, urban infill, and active lifestyle homes in planned residential developments. It markets and builds homes for first-time buyers, first-time and second-time move-up buyers, luxury buyers, active adult buyers and empty nesters. The Company has two distinct operations: homebuilding and financial services. The Company, excluding unconsolidated joint ventures, is offering homes for sale in 196 communities in 34 markets in 16 states throughout the United States. The Company's financial services operations provide mortgage loans and title services to the customers of its homebuilding operations.

Prior to the financial crisis HOV was an active buyer of land and had extensive holdings when the crash appeared. The decline in home buying and the change in the mortgage business caused them to be very over extended as a result of the crash. Since 2009 they have liquidated a lot of land holdings, built out and sold a lot of properties and have consolidated their efforts and reduced costs significantly.

For Q2 they reported a loss of 6 cents, which was less than half the 13-cent loss in the year ago quarter. Revenues rose 39.6% to $654.7 million. For the first 6-months of the fiscal year revenues rose 34.5% to $1.23 billion. The $7.9 million loss was well below the $25.2 million loss in the year ago quarter. The number of active contracts rose +0.9% to 1,812 homes with the value of the contracts rising 16% to $1.4 billion. The number of contracts in the first six months of fiscal 2016 rose 7.3% to 3,343. The total contract backlog at the end of the quarter was $1.58 billion, up 27.8% from the $1.23 billion at the end of fiscal Q2 2015. As of April 30th, they controlled 34,997 lots.

They paid off $233.5 million in debt over the prior two quarters and ended the period with $125.6 million in liquidity. Since the end of the quarter liquidity has risen $75.1 million due to closings and joint venture funds received. They also paid off another $86.5 million in debt that matured in May.

CEO Ara Hovnanian said, "While our revenue grew 40% and Adjusted EBITDA increased over 220%, as we said last quarter, we remain focused on deleveraging our balance sheet and maximizing our profitability rather than on additional growth. Since October 15, 2015, we have paid off $320 million of debt. More importantly, we continue to believe that we will have the liquidity to pay off the remaining debt maturities through the end of 2017. We are certain that we are taking the correct steps that will best position our company for future success. While it is discouraging to report a loss for the first half of fiscal 2016, it is nevertheless a significantly reduced loss, and we anticipate our profitability in the second half of the year will more than offset this loss."

With the low mortgage rates and the rising number of home sales, I do expect HOV to return to profitability by the end of the year. It has been a long 7 years but they are finally getting rid of the accumulated debt and are riding the wave of new home buyers.

Stocks typically begin to rise about 6-months before widely predicted events. If HOV expects to post profits in Q3/Q4 now is the time to buy the stock. At $1.87 per share I look at it as a LEAP option that does not expire. This is not going to be a rocket stock. This is a buy it and forget it position until year end. Once we are in the position I will track it in the Lottery Play portfolio each weekend. Shares traded at $7 in 2013-2014 and could easily return to that level once they post those profits.

Update 9/9/16: HOV reported Q2 earnings of zero compared to estimates for 6 cents. Revenue rose +32.6% to $716.9 million. For the full year the company guided to revenue of $2.7 to $2.9 billion and analysts were expecting $2.75 billion. The sold or joint ventured 21 communities to reduce their active selling communities from 214 to 193. This impacted revenue as the older communities were culled from the active business. They sold 1,467 homes in Q2 and slightly less than the 1,658 in the same period in 2015, also the result of selling some communities. Their order backlog rose 7.7% to $1.48 billion. There are 3,232 homes currently contracted to be built. They delivered 1,574 homes in the quarter, a +11.8% rise. After paying off $320 million in debt their cash position was $187.7 million. They acquired about 900 lots in the quarter in 20 different communities. They guided for a solid profit in the current quarter of $32-$42 million before some expenses including land acquisitions.

Do not back up the truck on this position just because the stock is cheap. Unexpected events do happen. Just buy a few hundred shares and we will shoot for a return to $6 or a 400% gain.

Position 7/28/16

Long February $2 call @ 20 cents. No stop loss.

Previously Closed 10/17/16: Long HOV shares @ $1.86, closed $1.61, -.25 loss.





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