Option Investor
Newsletter

Daily Newsletter, Thursday, 12/29/2016

Table of Contents

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

Market Wrap

The Market Waits

by Thomas Hughes

Click here to email Thomas Hughes

Introduction

The markets continue to consolidate within near term trading ranges, waiting on the start of the New Year. What will the New Year bring? By all accounts growth in earnings and the economy, how much growth is the question weighing on everyone's mind. Next week's raft of monthly macro-data may help answer important questions. Regardless, GDP and earnings growth expectations for next year are positive, expansionary and bullish for equities.

Trading action was light around the world as post-holiday trading volumes persist. Asian indices were mixed following the US sell-off, led by the Nikkei and a loss of -1.30%. European indices did not fare much better, closing with minimal losses and basically flat for the day.

The news of the day turned out to be political in nature. President Obama evicted more than 2 dozen Russian diplomats and shut down 2 of their compounds in retaliation for the election tampering and hacking attacks. Russia has responded saying the move is illegal and will be countered. For those of us who can remember the Cold War years, here we go again.

Market Statistics

Futures trading was light in the early electronic session, indicating a flat to mildly positive open all morning. There was little in the way of economic data and nothing in the way of earnings or business news to move the market. The open was calm, the indices began the day in positive territory, just above the bottoms of near term trading ranges, and were able to make some gains within the first half hour of trading. Gains were small, about 0.15% for the SPX, and did not last. By 11AM most indices had fallen into negative territory where they remained for the better part of the day.

Economic Calendar

The Economy

Jobless claims data was as expected, consistent with seasonal trends and long term labor market health. Initial claims came in at 265,000, up 10,000 from last week's not revised data, while the 4 week moving average of claims fell -750 to 263,000. This is the 95th week of claims under 300,000, the longest streak since 1970. On a not adjusted basis claims rose 7.9 versus an expected gain of 12% and are down -1.8% year over year. There has been some volatility in the numbers lately but based on the historical data remain consistent with seasonal trends. Increases in initial claims should peak out in early January and then fall off into the spring and summer. The state with the largest increase in claims is Ohio with +2,625, the state with the largest decrease in claims is Pennsylvania with -1,521.


Continuing claims increased by 63,000, on top of a +3,000 revision to last week's data, to hit 2.102 million. The 4 week moving average of continuing claims rose 4,500 to hit 2.042 million. This is the highest level of continuing claims in 4 months but within seasonal expectations and still near the long term low. Despite the gains over the past few weeks continuing claims remain consistent with labor market health. Continuing claims should peak in the next few weeks and then subside going into the spring and summer.

The total number of Americans claiming unemployment benefits jumped 102,430, in line with expectations, to hit 2.140 million. The jump in claims is well within seasonal expectations and remains consistent with long term labor market improvements. We can expect to see total claims hit its peak in the next 2 to 3 weeks, near 2.75 million, and then fall off into the spring and summer. Next week we'll get the latest round of ADP, Challenger and NFP. The only thing on tap tomorrow, economically, is the Chicago PMI.


The Dollar Index

The Dollar Index fell in today's action. The index lost a little more than -0.5% on an absence of news but remains within the near term trading range. Despite today's loss the dollar remains within a near term consolidation range just below long term highs. It is supported by economic trends, FOMC outlook and expected economic strength that has put upward pressure on FOMC expectations. In the near term the indicators are consistent with a test of support within an uptrend but are also showing divergences that indicate a deeper correction is possible. Near term support is just below today's closing price at the $102.50 level, a break below that level would be bearish and could take the index down to the short term moving average, near $102.00, or to the next target at the recently broken previous long term high near $100.50. A move higher, in line with the prevailing trend, may find resistance at the $103 level, a break above this would be bullish.


The Oil Index

Oil prices wavered near the recently set high as US crude stockpiles unexpectedly build. The build, +600,000 barrels, comes in the face of the expected OPEC production cuts that has WTI and Brent trading near 18 month highs. If, and it is a big if, OPEC actually follows through on production cuts, enough to actually affect the supply/demand imbalance, prices could continue higher. The risk is that bullish outlook relies on OPEC, it's members (who don't like each other) and the non-members who have also agreed to cuts. If, and I think this is a more likely scenario, production does not decline noticeably in January oil prices could see a big correction.


The Oil Index continues to consolidate within the near term trading range, just below recently set long term highs. The index has been supported on the recent rise in oil prices and, more importantly, the forward earnings growth outlook for 2017. The energy sector, in aggregate, is expected to post year over year earnings growth of 343%, reversing this years earnings decline of -75%. This, regardless of oil prices (provided they don't tank), is the likely driver of the sector in the near to short term. The index gained about 0.05% today but price action has been nearly flat over the past 9 trading sessions. The indicators are consistent with a consolidation/test of support within an uptrend and setting up for another leg higher. The current MACD peak is convergent with the latest high suggesting strength in the market and more new highs on the way. Resistance is at 1,300, a break above this level would be bullish.


The Gold Index

Gold rebound in today's session, up nearly 1.5%, to close above $1,150 for the first time in two weeks. The gains were driven by today's dollar weakness and did not snap the short term down trend in gold. Long term outlook for the dollar is bullish, today's action has not altered that, and that is bearish for gold plain and simple. Today's move in gold barely retraces the 6 month bear market and faces tough resistance at the $1,200 level, if it is able to sustain the move above $1,150. Next weeks data is a big risk for the dollar and gold; strong data and signs of inflation could put pressure on the Fed to hike more often, or more aggressively, than the market now expects and that could send the dollar higher and gold lower.

The gold miners got a lift from gold prices but not enough to break the short term down trend. The Gold Miners ETF GDX gained nearly 7.5% in a move that appears to have strength but likely to be short lived. The ETF is moving up toward resistance and a retest of the 50% retracement level at a point that coincides with the short term down trend line, near $22.00, and resistance is likely to be strong. This will be the 4th time this trend line has been tested since the August market reversal/September confirmation and a likely point of entry for bearish positions. The indicators are bullish in the near term, moving higher, but remain consistent with bear market conditions in the short to long term. Upside target for resistance is $22.00 in the very near term with a possible retest of recent lows near $18.50 in the near to short term. Longer term, provided the dollar continues to rise, a full retracement to $12.25 remains a possibility.


In The News, Story Stocks and Earnings

Disney. Star Wars Rogue 1. I saw it and I liked it and what I noticed, aside from how much richer the Star Wars universe is, is that the theater was still full even weeks after the opening. My point is that this movie is a winner, far beyond expectations, and has firmly cemented the future of Star Wars and Disney. All they need to do now is fix ESPN and avoid new pitfalls. Shares of the stock held steady in today's session, just above yesterday's close, and within a recent consolidation range. Prices are holding just below the one year high of $106.75 which is the current resistance target. A break above this level would be bullish


Amazon was awarded a patent today for a flying warehouse. That's right. A Jetson's-like flying fulfillment center that would hover in high altitude, be serviced by shuttle flights for crews and product, and send drones out on delivery as order come in. The design included with the patent application use a blimp to support a large warehouse structure, so far no news about plans to build it. Other innovations Mr. Bezos has in store for us are drone delivery, the first was completed this month, and personally tailored shopping experiences powered by AI. Shares of the stock fell -1.20% in today's session but are flat over the past 3 weeks, near the middle of the post-earnings trading range.


The Indices

Trading was basically flat for the day. The indices opened with small gains, gave them up and in exchange for small losses, held those most of the day and then climbed back to near break-even by the close. No move was large, the day's top loser shedding only -0.12% at the close. The tech heavy NASDAQ Composite created a small spinning top doji and set a new two week low. Despite the new low today's close is above the previous all time high, a critical support target that is confirmed at this time by the short term moving average. The indicators are consistent with a test so support, near 5,400, within an up trend and do yet indicate more. A break below 5,400 would be bearish in the near term, a bounce from this level bullish and trend following.


The Dow Jones Industrial Average posted the next largest decline, -0.07%, and created a similar doji spinning top. This candle is at the bottom of a near term consolidation range, a range that has formed following a strong rally and may indicate continuation. The indicators are consistent with a test of support within an up trend with targets at 19,800 and 19,500. A break below 19,800 would be bearish in the near term only, a break below 19,500 could be more serious.


The Dow Jones Transportation lost only -0.04%, reclaiming nearly all of the intraday losses before the closing bell. The index created a small doji candle after trading in a range of only 1%. The candle is sitting on short term support at the 30 day moving average with bearish indicators. The index has corrected after a strong rally and is now at a critical juncture. If the rally is to continue in the near to short term support at the moving average needs to hold. Based on the MACD peaks and specifically the strong peak associated with the onset of the Trump Rally, market participation was fairly strong leading up to these levels and suggests support will hold and a retest of the recent high is likely.


The S&P 500 brings up the rear in today's lineup with a loss of -0.03%. The broad market index created a small doji spinning top and set a new 3 week low. Despite setting a new low the index remains above support and near the all time high. Divergences in the indicators suggested a pull back to support could happen, now that it is it does not appear to be very strong, at least not yet. First target for support is just below today's close at an up trend line that is confirmed by the short term moving average. The indicators are consistent with a test of support within an up trend and so far reveal one that is very weak. Should support fail, near 2,230, a move down to the previous all time high near 2,200 is likely.


The markets have been consolidating near all time highs with indications of potential correction. Now it looks like that correction is happening and it doesn't look like it is very strong. The thing to remember is that this is the holiday week, the final week of the year, volumes are low, market participation is thin and anything that happens now is just as like to be a whipsaw as a real move. Next week is when the rubber hits the road in terms of the the Trump Rally. There may be selling at the start of the year, I can understand if folks want to start the year with profits, and it may lead to more than just a dip despite an expected quarter of positive earnings growth.

If near term support fails we could see as much as a 3 to 5% correction before strong support along long term up trend lines and moving averages are reached. Short to long term however, the outlook remains bullish; earnings growth is back and expanding with positive forward outlook. Risk at this time lay in next weeks data bundle. Too hot and the market could get bent on FOMC expectations, too cold expectations for the 1st and 2nd quarter could take a hit. This makes me a bull long term, hoping for the big dip, cautious in the near term waiting to see what happens next.

Until then, remember the trend!

Thomas Hughes


 

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New Plays

Last Minute Positioning

by Jim Brown

Click here to email Jim Brown
Editor's Note

Time has run out for those investors trying to position their portfolio for year-end. Volume will be extremely light on Friday except for the pension fund rebalancing at the close. That could cause a significant volume spike with the market moving sharply lower.

Traders will be looking forward to the holiday weekend but dreading the potential volatility at the close.

There is no reason to add more positions because we are already heavily weighted to the downside. Take it easy and enjoy the weekend. Next week could be a roller coaster.



NEW BULLISH Plays

No New Bullish Plays


NEW BEARISH Plays

No New Bearish Plays



In Play Updates and Reviews

Window Dressing?

by Jim Brown

Click here to email Jim Brown

Editors Note:

After Wednesday's market decline, today's minor move was probably support from window dressing. That is not likely to help much on Friday if the pension fund rebalance occurs as expected. The markets are just passing time until the calendar rolls over. We cannot derive much information from today's lack of a material move other than volume was very light and there was no conviction on either side.

There is no reason to try and enter new long positions in this market. We should avoid additional risk and limit our exposure until the market picks a direction in January.





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


VXX - VIX Futures ETF
The short position remains unopened until a trade at $29.50.



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BULLISH Play Updates

No Current Bullish Plays



BEARISH Play Updates

AKS - AK Steel - Company Profile

Comments:

No specific news on AKS. Testing support.

Original Trade Description: December 17th.

AK Steel Holding Corporation, through its subsidiary, AK Steel Corporation, produces flat-rolled carbon, stainless and electrical steel, and tubular products in the United States and internationally. It produces flat-rolled value-added carbon steels, including coated, cold-rolled, and hot-rolled carbon steel products; and specialty stainless and electrical steels in sheet and strip forms. The company also produces carbon and stainless steel that is finished into welded steel tubing, which is used in the automotive, large truck, industrial, and construction markets; buys and sells steel and steel products, and other materials; and produces metallurgical coal from reserves in Pennsylvania. It sells its flat-rolled carbon steel products primarily to automotive manufacturers and to customers in the infrastructure and manufacturing markets, including electrical transmission, heating, ventilation and air conditioning equipment, and appliances; and coated, cold-rolled, and hot-rolled carbon steel products to distributors, service centers, and converters. The company sells its stainless steel products to manufacturers and their suppliers in the automotive industry; manufacturers of food handling, chemical processing, pollution control, and medical and health equipment; and distributors and service centers. It also sells electrical steel products to manufacturers of power transmission and distribution transformers, as well as for use in the manufacture of electrical motors and generators. Company description from FinViz.com.

The steel sector rallied on expectations for Trump to place additional tariffs on imported steel and make American steel more competitive. While I am all for fair trade changes, that is likely to take many months if not a year or more to implement any changes what will help the U.S. steel companies. It will be months or quarters after that before the changes actually begin to show up in the earnings of these companies.

Earnings January 24th.

AKS rallied from $4.93 before the election to $11.39 for a +131% gain. Shares faded somewhat last week but still closed at $10.38 on Friday. When the post election balloon bursts, this stock could decline significantly. I would expect that to happen in the first week in January. I definitely do not expect the stock to be making higher highs.

Position 12/19/16:

Short AKS shares @ $10.17. See portfolio graphic for stop loss.

Optional:

Long Jan $10 put @ .69 cents. No initial stop loss.



IWM - Russell 2000 ETF - ETF Profile

Comments:

The Russell 2000 actually posted a minor gain in a weak market. There are still some small cap buyers. This could be one last bit of window dressing.

Original Trade Description: December 10th

The IWM ETF seeks to track the investment results of the Russell 2000 Small cap Index.

The Russell is up +232 points or 20.1% in the last 22 trading days. It is grossly over extended and many small cap Russell stocks are up 30% to 40%. I understand the bullish sentiment that believes the economy will be better in 2017 but it will not be because of President Trump. His proposals will take months to get through the House and Senate and there is likely to be some major battles. Obamacare will not go away until 2018 or longer because it takes a long time to plan and execute a change that big. Lower taxes will not happen until 2018 because it will take months for both houses to vote on an acceptable tax bill. I seriously doubt they will change rates in the middle of the year. Any change will not occur until 2018.

I could go on but you get the picture. Typically, there is a honeymoon phase after a new president is elected. This phase has run its course. There are 14 trading days left in 2016 and any new highs are likely to be made before Christmas. After Christmas, investors may begin to worry and once into January and a new tax year, the selling could be dramatic. Do you remember January 2016? The market was not nearly as overextended as it is today and the Dow fell -2,150 points in just two weeks. Entering into a new tax year allows traders to capture profits and invest that money for another year before paying taxes.

Dow - January 2016

We also have the potential for a really messy inauguration or even a terrorist attack at the event. That potential will give cautious investors another reason to take profits in January.

I am recommending a long put on the Russell ETF. There is no stock vehicle we can use other than the VXX to capitalize on a market sell off. The VXX is flawed and while it may go up, it may not go up enough to make it worthwhile and it is volatile from day to day. I chose the Russell ETF because the premiums are cheap and the volatility should work in our favor. If you cannot use options then I suggest you buy the VXX shares at the first sign of market weakness after Christmas.

There is also another trigger factor to consider. The Dow is approaching 20,000 and that could be a massive sell the news event given the big gains. Since the Dow could hit that level this week I am recommending we initiate our long put position in advance.

Because the market could still rise, I want to follow the IWM higher and enter the position only when the ETF rolls over.

The ETF has short-term support at 137.75 and again at $137.25. I am recommending we enter the position with a dip to $137. If the Russell continues higher, I will continue raising the entry point as needed.

Position 12/12/16 with an IWM trade at $137.00

Long Feb $134 put @ $3.38, see portfolio graphic for stop loss.



SHLD - Sears Holdings - Company Profile

Comments:

Sears announced a standby letter of credit backed by CEO Eddie Lampert to keep the company afloat for a few more months. Since they lost $748 million in Q3 alone, this is only a band-aid. However, it did produce a short covering bounce of 10%.

Original Trade Description: December 15th

Sears Holdings Corporation operates as a retailer in the United States. It operates in two segments, Kmart and Sears Domestic. The Kmart segment operates retail stores that offer a range of products, including consumer electronics, seasonal merchandise, outdoor living, toys, lawn and garden equipment, food and consumables, and apparel; and in-store pharmacies. It provides merchandise under the Jaclyn Smith, Joe Boxer, and Alphaline labels; Sears brand products, such as Kenmore, Craftsman, and DieHard; and Kenmore-branded products. As of October 31, 2015, this segment operated approximately 952 Kmart stores. The Sears Domestic segment operates stores that provide appliances, consumer electronics/connected solutions, tools, sporting goods, outdoor living, lawn and garden equipment, apparel, footwear, jewelry, and accessories, as well as automotive services and products, such as tires, batteries, and home fashion products. It also offers appliances and services to commercial customers in the single-family residential construction/remodel, property management, multi-family new construction, and government/military sectors; appliance and plumbing fixtures to architects, designers, and new construction or remodeling customers; parts and repair services for appliances, lawn and garden equipment, consumer electronics, floor care products, and heating and cooling systems; and home improvement services, as well as protection agreements and product installation services. This segment provides merchandise under the Kenmore, Craftsman, DieHard, Covington, Canyon River Blues, Metaphor, Outdoor Life, Structure, and Apostrophe brands, as well as under the Roadhandler, Ty Pennington Style, and Alphaline brands. As of October 31, 2015, this segment operated 735 Sears stores. Company description from FinViz.com.

We played Sears as a short before and excitement about the coming holiday shopping helped lift shares in early November. Now that the holiday numbers are starting to come in, the results are very dismal. Sears is closer to bankruptcy today than they have ever been.

Last week they posted a GAAP loss of $748 million and an adjusted loss of $333 million. Gross margins fell to 19.2% compared to JC Penny at 37.2%. Sears is forced to severely discount items to attract what few shoppers they have. Same store sales at Kmart fell -4.4% and -10% at Sears. Revenue fell -12.5% to $5.0 billion.

Earnings March 9th.

Fitch warned Sears will burn through $1.5-$1.8 billion in cash this year and even selling off the Craftsman brand as planned will only gain them an additional 12 months of life.

Sears closed at a new 14-year low on Thursday and the outlook is growing increasingly dim. Suppliers fear a bankruptcy in January once the holiday shopping is over. Several suppliers have halted shipments to Sears on fears they will not be paid.

Update 12/19/16: Sears is desperate. They are offering a 20% discount on Sears.com this week if you pick up the merchandise at a store. The offer applies to apparel, jewelry, luggage, furniture, bed & bath, home decor and air mattresses.

Starting 12/21 coats are 60% off, up to 60% off women's boots, up to 75% off jewelry.

Starting 12/23 sleepwear is 60% off, watches 30%, Craftsman's tool sets 50% off.

Position 12/16/16:

Short SHLD shares @ $10.17, see portfolio graphic for stop loss.

No options recommended because of price.



VXX - Volatility Index Futures - ETF Description

Comments:

The VXX rose on a minimally weak day. If we get a couple of sharp declines it could hit our entry target relatively quickly.

Original Trade Description: December 28th

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 began.

We exited the last short at $26.65 for a $7 gain back on December 13th. I am expecting the January volatility to lift the VXX back to $30. That will give us a great entry for the expected market rally in Feb/Jan where the VXX will crash again.

Unfortunately, put options are expensive with a volatility instrument at this price level. The only recommendation is to short the ETF and forget it. 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. We may have to rotate in and out a couple times but it will eventually go to $10. Once we are in the position and profitable I will put a trailing stop loss on it. If the stop is hit 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.

I am putting an entry trigger on the position at $29.50, a level we saw on December 1st. I would expect this to be hit in early January. The VXX could rise well over $30 if the market really corrects so I am not putting a stop loss on the position until the correction is over.

With a VXX trade at $29.50

Short VXX shares, currently $24.62, no initial stop loss.

No options recommended because of price.





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