Option Investor
Newsletter

Daily Newsletter, Monday, 1/9/2017

Table of Contents

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

Market Wrap

Treading Water, Waiting

by Thomas Hughes

Click here to email Thomas Hughes

Introduction

The indices tread water, once again, just below current all time highs waiting on earnings, the economy, the FOMC and Trump's inauguration. Outlook is mixed, depending on who's opinion you are reading, I still see expanding earnings growth and expanding economic growth leading the market. This week's action may be a little muted due to a light economic calendar and the Friday kickoff to earnings season. FYI, Alcoa no longer starts off the "official" season, its release date has been pushed back 2 weeks due to the recent split into two publicly traded companies.

International markets were mixed, hovering near the flat line with most closing with gains/losses in the range of 0.25% to 0.5%. In Asia, trading was affected by 3 things. First, Japanese markets were closed for holiday. Second, a lower forecast for iron ore. Third, evolving Trump/China rhetoric and in particular the battle over the One China policy playing out in social media and tabloid venues. European indices were sent skittering in the wake of comments from British PM May to the affect that the UK was in fact going to leave the EU.

Market Statistics

Futures trading indicated a flat to slightly negative open all morning. Trading was quiet, there was little in the way of real news, economic data or even market moving headlines to generate activity. The open was calm, the indices opened with losses in the range of -0.1% and moved sideways from there with choppy action. Tepid sideways trading persisted the entire day.

Economic Calendar

The Economy

No economic data today and very little this week. The reports that we do get will be dominated by Friday's lineup which includes retail sales for December, Michigan Sentiment, Empire Manufacturing and PPI. Tomorrow we'll get the JOLTs report; within that look for the number of job openings month to month and year to year along with the quits rate. The number of job openings is important, but more important is the state of employee confidence as displayed by the quits. Quits have been running steady at/near long term highs, a sign that workers are confident of finding new and/or better work.

The Moody's Survey of Business Confidence has spiked in the past 3 weeks, gaining another 0.3% in the last week to bring the 3 week total to +3.9. This is an 8 month high and a sign of rebounding confidence among global businesses. Mr. Zandi says that business has started 2017 off strong, led by improvements in assessment of current and future conditions.


Earnings season is about to get started in earnest. So far about 4% of the S&P 500 has reported, bringing the blended rate for 4th quarter earnings growth down another tenth to 3.0%. Of those who have reported 73% have beaten on the earnings end, consistent with the averages, but only 36% have beaten revenue estimates. The average is closer to 55%, the decline could be a sign of a number of thing during the period, some good some bad, but it is still too early to tell. On a positive note, full year 2016 earnings growth estimates have risen by a tenth to 0.2%.


Looking forward the outlook remains positive although estimates continue to fall in revisions. First quarter 2017 estimates for earnings growth have fallen to 11%, second quarter to 10.5%, but both are still strong. Full year 2017 is also strong, and steady, at 11.5%. Based on recent trends I would expect to see these numbers fall a bit before the end of the but there are changes at had. The FOMC is raising interests or one, for another Trumponomics. Both of these may induce some volatility in the numbers, possibly the beginning of a cycle of upward revisions. Now that we've exit the earnings recession and are looking forward toward growth upward revisions to earnings are the next bull market trigger I am looking for in this data.


The Dollar Index

The Dollar Index closed the day with some small losses following a mixed session. The index was first up a bit on last week's NFP report but then later fell to profit taking amid FOMC speculation to close with a loss near -0.20%. The index created a small black candle squeezed between resistance and the rising support of the short term 30 day moving average. The moving average has provided support three times in the last few months and is the established trend at this time. Both MACD and stochastic are bearish, if weakly so, and suggest that support will continue to be tested in the near term. A break below the moving average could be bearish but I'd be cautious about that until the FOMC meeting. Support is currently at/near today's close around the $102 level. A break below here could go as low as $100.49.

The trend is driven by strengthening economic data, the FOMC and Trumponomic outlook, all of which are highly questionable. It is these questions that have caused the current pull back from support, their answers will drive the market going forward. This week is light on all three, next week not so much. The economic calendar heats up for one thing, there is an ECB meeting for another and Trump is inaugurated to top it all off. Then, two weeks later, the FOMC meeting. At this time there is only a 2% chance of February rate hike. The ECB, they are not expected to do anything either, a change to their recently stated stated policy of tapering could roil the market further.


The Gold Index

The gold rebound continues. Spot gold jumped another 1% to trade at $1185 and a 6 week high. The rebound is driven by dollar weakness, an uncertain rate hike time line and a change in economic conditions and so may continue until we get firmer data, some action from Trump or the FOMC. Resistance is likely at $1200, a break above that could indicate a shift in sentiment toward gold.

The Gold Miners ETF GDX gained 1.25% but created a black bodied candle with visible lower shadow, the second day of listless action following the break above the 50% retracement line. Price action is consolidating above the 50% retracement line and the short term down trend line and may indicate a break in trend. The indicators are both bullish but there are some signs the rebound has, or is near to, running its course, namely a peak in the MACD and early signs of resistance in the %K. The ETF is currently sitting on support, near $22.50, with a possible move up to $24.50. If support is broken it would indicate a return to trend with downside target near $18.50.


The Oil Index

Oil prices fell nearly -4% today as concerns the OPEC deal isn't enough washed through the market. WTI fell more than -$2.00 to trade below $52 and set a 3 week low. Today's fear is driven by rising US output and Iranian exports which threaten to undo all that the OPEC deal hoped to achieve. I still favor the bear argument, supply and production are outpacing demand, so am expecting prices to remain volatile in the near term.

The Oil Index fell -1.21% to trade just above the short term moving average. The moving average is now support, just above 1,250, and may add lift to the index in the coming days and weeks. The indicators are bearish and suggest that support may be tested in the near term but are not strong enough to suggest that it will be broken. In the near term, oil prices are likely to drive volatility and possibly a test of support. Longer term, earnings growth outlook is supporting the sector and likely to drive it higher.


In The News, Story Stocks and Earnings

The earnings cycle will kick off on Friday with releases from JP Morgan, Wells Fargo and Bank of American which, as a sector, are expected to post the 2nd highest rate of growth this quarter, +13.8%. As a group these stocks also looked poised to rise as much as 15% to 25% in the near to short term, provided of course outlook does not change. The Financial sector SPDR XLF lost about a half percent in today's action but the losses are moot, it has been in a tight consolidation range for the past month of trading days. This range follows a strong up trend that is supported by earnings and economic outlook and could indicate continuation of that trend into the short term. The indicators are mixed but generally consistent with consolidation within an up trend, stochastic in particular having reversed and formed a weak bullish crossover and trend following entry. Support is near $23.25, upside targets are near $25 and $27 in the near to short term.


McDonald's announced that it was selling 80% of its China operations to a group of US and China based investors. The deal values the business at over $2 billion and is expected to close this summer. Benefits to McDonald's include lower costs while retaining ownership of the brand and a share of the profits. Shares of MCD fell -0.25% but held steady near last week's close and the short term moving average.


The Acuity Brands, maker of top lighting brands like Lithonia and Peerless, announced record first quarter results but fell well short of consensus. The good news is that sales, income, profits and diluted earnings all grew by double digits. The bad news is that margins declined due to weak sales volume and only modest activity in the quarter. The execs went on to say that they expect weak sales trends to linger into the first half of the year and may affect full year outlook, not good for investor confidence. Shares of the stock were hit hard by the news, falling more than -15% on high volume.


The Indices

Today's action was more sideways drift, more consolidation more waiting for earnings season, economic data, Trump and the FOMC. One however was able to drift up, and to set a new all time high while doing so. The NASDAQ Composite closed with a gain of 0.19% at 5531.82, a new all time closing high. The tech heavy index created a small spinning top candle while doing so and looks like it could test resistance again. Resistance is the all time intraday high set Friday, just a few points above today's close. The indicators are still mixed but appear to be rolling over into trend following entry signals; MACD is crossing the 0 line from below with today's action, a sign of shifting momentum, and stochastic is forming a weak bullish crossover while flattening out. If these signals confirm we can expect to see a continuation of the rally with upside target near 5,750.


The day's biggest loser was the Dow Jones Transportation Average which lost -0.89%. Despite the loss the transports did little more than bob along the 9,000 level for the 8th day in a row. This tight congestion band is the bottom of a one month consolidation range which has formed just below recently set all time highs. This consolidation has resulted in a retreat to support that is confirmed by the indicators. MACD remains bullish so support may be tested further, stochastic however is more bullish. Stochastic has already formed a weak bullish crossover and the first of two crossover signals that make up a strong trend following entry. When confirmed, if, we can expect to see the transports retest the recent highs and probably set new ones. If not, a break below current support would be bearish in the near term with downside target near 8,500.


The Dow Jones Industrial Average made the second largest decline today, -0.38%. The blue chips created a small spinning top candle within the one month consolidation range and does not look like it is going anywhere soon. The indicators are consistent with a test of support and consolidation within an up trend, stochastic showing overbought conditions have been relieved and set up for another rally. Resistance is 20,000, a break above this level would be bullish indeed, upside target 20,500 in the near term, 21,000 in the short. If resistance holds, or the break above 20K turns out to be whipsaw, downside targets for support are 19,500 and 19,000 in the near term.


The S&P 500 made the smallest decline, -0.35%, and created a small black bodied spinning top candle. Today's action is more sideways drift within the recent trading range, a range that does not look to be broken tomorrow or even this week. The indicators are mixed but generally consistent with consolidation within an uptrend. MACD remains bearish which suggest that support may still be tested, stochastic is showing a weak bullish crossover and early trend following signal which suggests that any test of support that may come is the next entry point for bullish trend following positions. Near term support target is the short term moving average and short term up trend line, a break below this would be bearish. A bounce would be bullish and trend following with upside target near 2,300 near term and 2,500 short term.


The indices continue to consolidate. The market continues to wait. Earnings, economic data, soon to be President Trump and the FOMC are all on the minds of traders. Will growth be as good as we expect, will the data continue to show recovery, will the new President do all the good things for the economy he has said and when will the FOMC raise rates again. The good news is that the indices have been able to hold at or near recently set highs while they consolidate. The market has been allowed to calm down after the post-election rally, overbought conditions have been alleviated and a base has been built. All we need now are confirmations of our expectations and the market should break out to the upside. I remain cautiously bullish.

Until then, remember the trend!

Thomas Hughes


 

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New Plays

Going Back In

by Jim Brown

Click here to email Jim Brown
Editor's Note

After just exiting a successful short on Sears the recent events suggest we should reload.



NEW BULLISH Plays

No New Bullish Plays


NEW BEARISH Plays

SHLD - Sears Holdings - Company Profile

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 several times before. We were stopped out on Dec-30th when the CEO arranged a bridge loan to get them out of trouble temporarily. Now that the holiday numbers are starting to come in, the results are very dismal. Sears is eventually expected to file bankruptcy.

In November, 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 will only gain them an additional 12 months of life.

Sears closed at a new 14-year low on Dec-28th and the outlook is growing increasingly dim. Suppliers fear a bankruptcy in 2017 once the holiday shopping is over. Several suppliers have halted shipments to Sears on fears they will not be paid.

In early January they announced they were closing 150 stores. There are 109 Kmarts and 41 Sears stores. Last week they announced the sale of the Craftsman brand to Stanley Black & Decker for $900 million but they get less than half of that in cash. The rest is paid out over the next 3-5 years. That shows how desperate they are for cash since they originally expected to raise $1.5 to $2.0 billion on the sale. Now they are looking to sell the Kenmore and Diehard brands.

With the Craftsman sale and the loan from the CEO and a new $500 million loan secured by real estate, they have developed about $1.5 billion in Liquidity. Fitch warned Sears will burn through $1.5-$1.8 billion in cash this year and even selling off the Craftsman brand will only gain them an additional 12 months of life.

When they announced the Craftsman sale at less than expected terms, the stock fell back from the early January gains. The outlook is grim despite the short-term cash inflows.

Short SHLD shares, currently $9.11, initial stop loss $11.10.

No options recommended because of price.



In Play Updates and Reviews

Small Caps Leading Again

by Jim Brown

Click here to email Jim Brown

Editors Note:

Small cap stocks always lead the market up and down and the Russell 2000 is at critical support. You have read my comments on the Russell leading and it has been negative for the last three days. It closed just over 1,350 which would be a critical support break if the decline continues.

Many of the stocks that rallied after the election have begun to roll over in the last several days. The expected January dip may appear after all.





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

HZNP - Horizon Pharma - Company Profile

Comments:

No specific news. Minor gain.

Original Trade Description: January 7th.

Horizon Pharma plc, a biopharmaceutical company, engages in identifying, developing, acquiring, and commercializing medicines for the treatment of arthritis, pain, inflammatory, and/or orphan diseases in the United States and internationally. The company's marketed medicine portfolio consists of ACTIMMUNE for the treatment of chronic granulomatous disease and osteopetrosis; RAVICTI and BUPHENYL/AMMONAPS to treat urea cycle disorders; DUEXIS and VIMOVO for the treatment of signs and symptoms of osteoarthritis, rheumatoid arthritis, and ankylosing spondylitis; and PENNSAID for the treatment of pain of osteoarthritis of the knees. Its products also include MIGERGOT to treat vascular headache; RAYOS/LODOTRA for the treatment of rheumatoid arthritis, polymyalgia rheumatic, systemic lupus erythematosus and multiple other indications; and KRYSTEXXA to treat chronic refractory gout. The company has a collaboration agreement with Fox Chase Cancer Center to study ACTIMMUNE in combination with PD-1/PD-L1 inhibitors for use in the treatment of various forms of cancer. Company description from FinViz.com.

Horizon recently received approval to sell the drug Quinsair in Canada. It was already approved in the EU. This is a drug for the management of chronic pulmonary infections in adults with cystic fibrosis. Only about 75,000 people around the world are candidates for the drug and 4,500 in Canada. They acquired the drug when they bought Raptor Pharmaceutical Corp in October.

The company also announced they had received a Notice of Allowance from the U.S. Patent office on the drug Ravicti. This will result in a patent being issued to Horizon that is good to 2030. Horizon has seven patented drugs and 11 drugs currently available for sale.

Shares of Horizon declined in early December after a late stage trial on another drug failed to achieve the desired result. Shares have been moving up steadily since that December drop. Friday's close was a 4-week high.

Horizon will present next week on the 10th at the JPM Healthcare Conference.

Earnings Feb 6th.

I am putting an entry trigger on the position just in case the market decides to roll over on Monday.

Position 1/9/17 with a HZNP trade at $17.75

Long HZNP shares @ $17.75, see portfolio graphic for stop loss.

No options recommended because of wide spreads.



BEARISH Play Updates

AKS - AK Steel - Company Profile

Comments:

No specific news. Stocks that ran up after the election are finally rolling over.

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 appears ready to break support with the IWM close under $135. The bulls are leaving the building.

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.



VXX - Volatility Index Futures - ETF Description

Comments:

The VXX decline has stalled and should the market continue to drop, you can bet the VXX will be shooting higher soon.

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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