Option Investor
Newsletter

Daily Newsletter, Tuesday, 1/24/2017

Table of Contents

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

Market Wrap

Animal Spirits Return

by Jim Brown

Click here to email Jim Brown

The markets finally posted a decent day where every index participated and the Nasdaq was roaring.

Market Statistics

Today's rally was remarkable for one major reason. Five Dow components reported earnings. Those were MMM, DD, JNJ, TRV and VZ. Of those five companies, four of them were the biggest losers for the day. Those four stocks knocked more than 56 points off the Dow and that would have normally been enough to turn the direction negative for the day. Instead, IBM and DD combined to add more than 55 points to the Dow and completely erase the earnings negativity. This was a rare day indeed. Note that it only took a combined gain of 16.48 actual points to lift the Dow +112.86 points. That is the crazy part about a price-weighted index.


There was a flood of positive economic information this morning that helped lift the markets.

The Existing Home Sales for December came in slightly lighter than expected at 5.49 million with analysts expecting 5.50 million. The November headline number was 5.61 million on an annualized basis. This was still a good number for a winter month. The minor drag came from a slowdown in condo sales. Single-family home sales were 4.88 million, a decline of only 9,000 units. Condo and co-op sales were 610,000, down -70,000 from November. The homes on the market declined sharply to only 3.6 months of inventory at the current rate of sales. That was 4.7 months of supply back in July. The median home price declined from $234,400 to $232,200 but with the rapidly declining inventories, that price is sure to rise.


The Richmond Fed Manufacturing Survey continued to improve with the headline number rising from 8 to 12. The internals components, especially the new orders and employment added significantly to the headline number. The backorders declined but the inventory to order gap moved sharply higher suggesting more activity will be seen in the coming weeks.

That headline number was higher than all but one month in 2016. It is also the first time since July 2015 that the index has posted three consecutive months of gains.

In the separate services survey the headline number jumped from 4 to 15. That is the highest reading since October 2015.



The North American Semiconductor Industry (SEMI) Book-to-Bill ratio for December rose from 0.96 to 1.06. That means $106 in orders were received for every $100 of product shipped. In December, companies received $1.987 billion in orders compared to $1.865 billion in shipments. This is the last time SEMI will produce this report. They said a change in the way some companies report/track orders and billings was responsible.


The calendar for the rest of the week is uneventful except for the GDP on Friday. Traders will be focusing on the Fed meeting next week and the rate decision on Wednesday.


Dow component DuPont (DD) reported earnings of 51 cents that easily beat estimates for 42 cents. However, revenue of $5.211 billion missed estimates for $5.246 billion. They guided for Q1 earnings to decline roughly 18% year over year but that includes a 15-cent charge for the costs associated with the Dow Chemical merger. Their adjusted earnings should rise 8%. The company pushed back the anticipated date for closing the merger to the end of June and three months later than expected. The company needs the extra time to address concerns by regulators that the merger will restrict new pesticide discoveries. The EU granted them an extension until March 14th to provide additional data for review. DuPont shares soared 4.5% on the news.


Dow component Verizon (VZ) reported earnings of 86 cents that missed estimates for 89 cents. Revenue of $32.3 billion narrowly beat estimates for $32.1 billion. Wireless revenues declined -1.5% to $32.4 billion. Wireless Ebitda margins of 36.9% missed expectations for 40.2% by a wide margin. The company did not provide any update on the Yahoo acquisition other than to say they were pushing the date out another three months while they assess the impact of the multiple data breaches. The CFO said they have not reached any final conclusions yet. Shares fell -4.4% on the report.


Dow component Travelers (TRV) reported earnings of $3.20 that easily beat estimates for $2.80. Revenue of $7.19 billion also beat estimates for $6.07 billion. The earnings beat was driven by a settlement of a reinsurance dispute and higher returns from investments. Shares declined -1% on the news.


Dow component Johnson & Johnson (JNJ) reported earnings of $1.58 that beat estimates for $1.56 per share. Revenue of $18.11 billion barely missed estimates for $18.12 billion. They guided for 2017 to earnings in the range of $6.93 to $7.08 and analysts were expecting $7.11 per share. Revenue guidance was $74.1 to $74.8 billion with analysts expecting $75.1 billion. The company said the strong dollar was going to be a problem in 2017. Shares fell -2% on the news.


Dow component 3M (MMM) reported earnings of $1.88 compared to estimates for $1.87 per share. Revenue of $7.33 billion missed estimates for $7.37 billion. They guided for full year earnings $8.45 to $8.80 per share. Analysts were expecting $8.64 per share. The company beat on earnings thanks to some aggressive cost controls rather than rising sales. Revenue only rose from $7.298 billion to $7.329 billion. The strong dollar reduced sales by 0.8% and they expect the pressure to continue. Shares fell -2.50 on the news.


Lockheed Martin (LMT) reported earnings of $3.25 that beat estimates for $3.05 per share. Revenue of $13.75 billion also beat estimates for $13.03 billion. For all of 2017 the company expects earnings of $12.25 to $12.55 and that is below estimates for $12.88. Revenue guidance for $49.4 to $50.6 billion was above estimates for $49.5 billion. Shares fell -4.57 on the news.


Alibaba (BABA) reported adjusted earnings of $1.30 compared to analyst expectations for $1.15 per share. Revenue of $7.67 billion rose 54% and beat estimates for $7.48 billion. Part of the revenue surge came from a record breaking Singles Day in November. Shoppers spent $17.4 billion and Alibaba said at one point it was processing 175,000 orders per second. Alibaba does not report revenue on items sold by third parties but only on the commission received from those sales. The company is projecting 53% sales growth in 2017. That is up from the prior forecast for 43% growth. They reported 443 million annual active buyers last quarter. The monthly active "users" rose from 393 million to 493 million. Cloud computing revenue rose +115% to $254 million. Digital media and entertainment revenue spiked +273% to $585 million. Shares rallied 3% on the news. I wonder if Jeff Bezos and team are always grouped together in a conference room waiting for the BABA earnings so they can pour through them looking for strengths and weaknesses?


On the topic of Amazon, Consumer Intelligence Research Partners (CIRP) said the company sold 3.1 million Echo devices in Q4 and 8.2 million in 2016. They would have sold more but they ran out of inventory in the first week of December. For comparison, Google Home has sold about 500,000 units. With more than 3,000 branded skills for the Echo, Amazon has a big head start in monetizing the product. A skill would be something like "Alexa, schedule me an Uber ride to the airport at 10:AM on Thursday." Another example would be "ask CNBC for the latest headlines" or a "stock quote on IBM." In the future, these will not be free for the brands. Amazon earnings are Feb-2nd.


After the bell, Seagate (STX) reported earnings of $1.38 compared to estimates for $1.07. Revenue of $2.89 billion beat estimates for $2.82 billion. That was up from 82 cents in the year ago quarter. The company also announced a 63-cent dividend payable April 5th to holders on March 22nd. Analysts are going to have to come up with some new price targets. The consensus target was $39.73 and shares spiked to close at $42 in afterhours. The company guided for current quarter revenue of $2.7 billion compared to forecasts for $2.61 billion. They guided for full year earnings of $4.50 per share.


Cree Inc (CREE) reported earnings of 30 cents compared to analysts expectations for 8 cents. Revenue of $347 million also beat estimates for $325 million. However, for the current quarter they guided for revenue of $285 to $315 million and earnings of 9 cents. Analysts were expecting $315 million and 8 cents per share. Shares spiked to $30.50 on the earnings but collapsed back to $28 on the guidance.


Only two Dow components report earnings on Wednesday with three on Thursday. The Thursday calendar is strongly tech weighted and that means Friday's market open could be volatile.


Bob Evans Farms (BOBE) said they were selling their restaurants to PE firm Golden Gate Capital for $565 million. The company would then be free to focus on its refrigerated foods grocery business. They will use a portion of the proceeds to pay a special onetime dividend of $7.50. The sale is the result of a long running fight since 2013 with activist investor Sandell Asset Management to separate the BEF Foods. Separately the company is buying Pineland Farms Potato Co for $115 million. Both transactions are expected to close by the end of April.


Barclay's downgraded Apple (AAPL) from overweight (buy) to equal weight (neutral) saying there is no growth potential for Apple. The analyst said Apple would be weighed down by sluggish smartphone sales in general, not just slowing iPhone sales. Barclay's reduced the price target from $119 to $117 saying the company's sticky ecosystem and large cash holdings could continue to support the stock price near term. Currently there are 35 buy ratings, one hold rating and one sell rating on Apple shares. I expect better things out of Apple later this year when they release the 10th anniversary iPhone. I expect those sales to be strong. Apple's current challenge is resistance at $120.


Crude prices rose only fractionally thanks to a minor decline in the dollar on Monday. Today's market action was neutral. WTI declined -27 cents in afterhours to $52.91. There is no future in trading crude for the next several weeks. All the movements will be headline related and they are likely to contradict from headline to headline.



Markets

Tuesday was a very interesting day. With a couple Dow stocks outweighing four major post earnings decliners we saw a strong short squeeze in the morning hours. The S&P and Nasdaq rallied to new highs but the Russell and Dow, despite their gains, remain below resistance.

Wednesday could be even more interesting. With the S&P slightly above 2,280 we could see some more short covering. It that is strong enough it could trigger the start of a new leg higher for the S&P. Volume was strong at 7.0 billion shares and advancers were 5,266 to 1,863 decliners. New highs totaled 588 and the strongest day since December 13th, when the Dow pushed through 19,950 intraday for the first time. We have been moving sideways ever since.

The close above 2,280 was just enough to claim the statistic but not enough to really trigger any further buying. The intraday high was 2,284.63 and that was not enough to punch through that new high resistance. We need to see the S&P trade over 2,285 and hold it to convince the shorts it is time to cover and switch to longs. The S&P futures are only fractionally positive and there is no sign of buying overnight despite the Asian markets being up strongly.


The Dow finally rebounded back into its recent range but the 19,912 close is still about 88 points below the 20,000 level and as we have seen in the past, there is a lot of resistance between here and 20K. The more Dow components that report earnings, the weaker the Dow should become. The week or two of post earnings depression that follows each report is going to be a drag on the index. That is especially true if those companies continue to miss on earning, revenues and guidance.

The critical levels for the rest of the week are 20,000 and 19,800.


The Nasdaq closed with a major gain of 48 points and a real breakout to a new high at 5,600. That is a big round number so it will be interesting to see if the gains continue. The rally was a combination of chips, biotechs and the FANG stocks. Note that Apple is not in the list.

There is nothing negative about the Nasdaq chart. It was a clean breakout and is now well above that 5,530 support I wrote about for the last two weeks.



The Russell 2000 posted a strong 21 point gain but that was only enough to get it back over support but not enough to even touch that resistance at 1,375 that held all last week. The small caps appear to have relinquished their leadership role to the Nasdaq for the time being.


I wrote all last week that the Nasdaq and S&P appeared to be preparing for a breakout. Now that it has happened, we need a couple more days of gains to pull the Dow through 20,000 and help the Russell move to a new high as well. The sentiment in the market is improving on a daily basis. It appears the Trump honeymoon may have been revived. He is turning into the energizer bunny with nonstop meetings and pro growth comments. If he can keep that up for the first 100 days, we could be a lot higher by summer.

JP Morgan CEO, Jamie Dimon, not originally a fan of Trump during the primaries has turned into a convert. Almost daily, he points out the multiple positives that will push the market higher. He said something this week to the effect of "investors have not seen anything yet if Trump can actually get some of this stuff accomplished." Add to that the rebound in the global economies and Dimon expects solid 3% to 4% GDP growth ahead. That is the kind of talk that can push investors off the sidelines and back into the market.

Enter passively, exit aggressively!

Jim Brown

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New Plays

No Rush

by Jim Brown

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Editor's Note

We are still in that post inauguration phase where market direction could be volatile. The S&P futures are only up fractionally tonight after a big day in the market. The morning short squeeze lost traction about 1:30 and the indexes were moving down at the close. We are not out of the post inauguration week yet and although the internals are turning bullish there is no reason to rush into the market. Let's see if the rally sticks.



NEW BULLISH Plays

No New Bullish Plays


NEW BEARISH Plays

No New Bearish Plays



In Play Updates and Reviews

Short Squeeze!

by Jim Brown

Click here to email Jim Brown

Editors Note:

All the major indexes moved significantly higher in morning trading but lost traction in the afternoon. The S&P and Nasdaq closed at new highs while the Dow and Russell 2000 rebounded strongly but remain under strong resistance. One day does not make a trend and there were plenty of shorts in the market. However, we may be seeing the market finally choosing a direction and that could be up.

Today was remarkable since four of the five Dow components reporting earnings actually closed lower. The Dow ramp was on stocks that did not report today and they overcame the earnings negativity.





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


FRED - Fred's Inc
The short stock position was entered at the open.

VXX - VIX Futures ETF
The short recommendation has been cancelled.



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Short term Calls and Puts on equities = Option Investor Newsletter

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BULLISH Play Updates

BOX - Box Inc - Company Profile

Comments:

No specific news. Minor gain and holding at the recent highs. No retracement!

Original Trade Description: January 21st.

Box, Inc. provides cloud-based mobile optimized enterprise content collaboration platform that enables organizations of various sizes to manage their enterprise content from anywhere. The company's platform enables users to collaborate on content internally and with external parties, automate content-driven business processes, develop custom applications, and implement data protection, security, and compliance features. Box, Inc. offers its solution in 22 languages. It serves healthcare and life sciences, financial services, legal services, media and entertainment, retail, education, energy, and government industries. Company description from FinViz.com.

Box is rapidly growing its customer for document management for companies with a global workforce. They are competing with other companies for cloud collaboration and access. More than 69,000 companies worldwide now use Box. They have broken into the media sector and now many production companies use Box for storing and distributing their production content. This has given Box a new niche in the market. Box has partnered with Salesforce.com, IBM and Microsoft in the cloud space. Their goal is to partner and grow with them rather than compete with those giants.

The company reported a smaller than expected loss for Q3 and expect to post an even narrower loss for Q4. Their guidance for Q4 is a loss of 13 cents on revenue of $109 million. That is better than the 26 cents loss in Q4-2015.

Earnings March 1st.

Shares broke out to a new 52-week high on January 12th before pulling back slightly with the market. They closed 5 cents below a new 52-week high on Friday.

Position 1/23/17 with a BOX trade at $17.10

Long BOX shares @ $17.10, see portfolio graphic for stop loss.




BEARISH Play Updates

ENDP - Endo International - Company Profile

Comments:

No specific news. New 14-year closing low.

Original Trade Description: January 14th

Endo International plc develops, manufactures, and distributes pharmaceutical products and devices worldwide. Its U.S. Branded Pharmaceuticals segment offers chronic pain management products, such as BELBUCA, OPANA ER, and Percocet; Lidoderm for opioid analgesics; and Voltaren gel for osteoarthritis pain, as well as XIAFLEX for treating Peyronie's and Dupuytren's contracture diseases. This segment also provides Supprelin LA for central precocious puberty treatment; testosterone replacement therapies, such as Aveed and TESTOPEL, as well as Fortesta and Testim gels; Frova and Sumavel DosePro for migraine headaches; Valstar, a sterile solution for intravesical instillation of valrubicin; and Vantas for the palliative treatment of prostate cancer. The company's U.S. Generic Pharmaceuticals segment provides tablets, capsules, powders, injectables, liquids, nasal sprays, ophthalmics, and transdermal patches for pain management, urology, central nervous system disorders, immunosuppression, oncology, women's health, and cardiovascular disease markets. Its International Pharmaceuticals segment offers specialty pharmaceutical products in various therapeutic areas, including attention deficit hyperactivity disorder, pain, women's health, and oncology; generic, branded generic, and over-the-counter products in the areas of dermatology and anti-infectives; injectables for the treatment of pain, anti-infectives, cardiovascular, and other therapeutics areas; and healthcare services, products, and solutions to hospitals, pharmacies, and practitioners, as well as for government healthcare programs. The company also provides Monarc subfascial hammock to treat female stress urinary incontinence; and Elevate transvaginal pelvic floor repair system for the treatment of pelvic organ prolapse. It sells its branded pharmaceuticals and generics directly, as well as through wholesale drug distributors. Company description from FinViz.com.

Endo is a small $3 billion market cap company but they have been around since 1920. They are headquartered in Dublin Ireland and could easily be impacted by an import tax. They do have some common products and they do have earnings.

Endo has been benefitting from raising drug prices and a study underway to determine how much companies have raised prices over the last ten years is bound to highlight Endo as a serial hiker. The company already warned that the pricing environment was going to remain challenging in 2017 with 30% year over year declines in generics. If the new replacement for Obamacare does require bidding for generic drugs as Trump has mentioned, Endo could be under a lot of pressure. Add in the import taxes and it could be ugly. Investors are anticipating these events and the stock is falling.

On Thursday somebody bought 4,000 February $12.50 put for 70 cents. That is a $280,000 bet they are going lower. If Trump repeats his desire for lower drug prices in the inauguration speech, the drugs companies are going to collapse again.

Earnings February 7th.

Position 1/17/17:

Short ENDP shares @ $13.22, see portfolio graphic for stop loss.

No options recommended because of price and spreads.



FRED - Freds Inc - Company Profile

Comments:

No specific news. However, FRED did file an amended SEC notice that changed the debt levels it had raised prior to the acquisition of the 865 WBA/RAD stores. There was no date referenced but by restating the debt terms slightly, investors may had felt that the deal was closer to completion. That is far from the truth but it did allow FRED shares to gain 14 cents in a bullish market. I believe this is temporary.

Original Trade Description: January 23rd.

Fred's, Inc., together with its subsidiaries, sells general merchandise through its retail discount stores and full service pharmacies. The company, through its stores, offers household cleaning supplies, health and beauty aids, disposable diapers, pet foods, paper products, various food and beverage products, and pharmaceuticals to low, middle, and fixed income families in small- to medium- sized towns. It also sells general merchandise to franchised Fred's stores. As of January 30, 2016, the company operated 641 company-owned stores, which included 60 express stores in 15 states and 18 franchised stores under the Fred's name, as well as 372 pharmacies and 3 specialty pharmacy facilities primarily in the southeastern United States. It also operates 18 franchised stores under the Fred's name. Company description from FinViz.com.

Freds has been in retail trouble for over a year. Their same store sales continue to decline since every grocery store, Walmart and Target in America has added a pharmacy. Shares had been in decline until Walgreens/Rite Aid agreed to sell Fred's 865 Rite Aid stores in an effort to get FTC approval for the WBA/RAD merger. That would make Fred's the third largest drugstore chain in the U.S. and shares doubled on the news.

A funny thing happened on the way to the merger. The FTC said last week they did not believe that was enough of a consideration to approve the merger. Walgreens has 8,200 stores and Rite Aid has 5,000 stores. Selling Fred's 865 Rite Aid stores was not enough. The combined WBA/RAD would have more than 12,500 stores to Fred's 1,500. CVS would become number two at 9,655 stores. The FTC believes the post merger environment would create two heavyweights that would dominate their respective areas.

Shares of Fred's have been in decline for a week on the worry the FTC will either block the merger OR they will be forced to sell a much larger block of WBA/RAD stores to Fred's and the company will not be able to complete the transaction or they will become too big too fast and begin losing money like crazy as they try to ramp up distribution and management to handle the suddenly increased store count.

Fred's announced a secondary offering on Friday to raise money for the acquisition. If the deal changes that causes additional problems. If the deal were to triple in size, Fred's would have to do another secondary to raise the additional cash and it could be a whopper of an offering.

Earnings March 9th.

I believe Fred's will continue to give back those monster gains from the December headline. If the WAG/RAD merger approval gets extended that creates more indecision for Fred's.

Position 1/24/17:

Short FRED shares @ $14.97, see portfolio graphic for stop loss.



IWM - Russell 2000 ETF - ETF Profile

Comments:

The Russell 2000 saw a major rebound of +21 points but the index is still at the low side of its recent range. We may be nearing a change in market direction and we should know over the next couple days.

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:

No specific news. Costar said the current trend in retail closures could impact as much as 1 billion square feet of retail space. More than 5,000 stores have closed in the last 18 months representing 50 million square feet. Add to that the recently announced closures for Sears, Kmart, Macy's, The Limited, etc and that represents another 28 million square feet.

Original Trade Description: January 9th

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.

Update 1/11/17: In an OP-ED piece Forbes said the sale of Craftsman signaled the opening of the final chapter for Sears. They said the Craftsman sale and the potential sale of the Kenmore and Diehard brands represented a "going out of business" sale.

Update 1/19/17: Sears announced it was ending its decades old employee discount program. They are going to allow employees to earn points on purchases that will be good for future discounts. Currently they get a discount on items at the time of purchase. By scrapping that plan, the company gets the money up front and maybe the employee will use their points on future purchases. The point values differ on different types of merchandise. If Sears eventually files bankruptcy, the points would disappear. This is another sign the company is in trouble.

Update 1/21/17: Moody's downgraded Sears credit rating from Caa1 to Caa2. Moody's said Sears is running out of stuff it can sell for cash. They only have 211 properties that are unencumbered and worth about $2.5 billion. With the company burning cash at the rate of $1.5 billion they are rapidly approaching the end of the line. Moody's said they could raise cash with the sale of the Kenmore and Diehard brands but after that they are done. There is nothing left to sell that will produce a large inflow of cash.

Position 1/10/17:

Short SHLD shares @ $8.97, see portfolio graphic for stop loss.

No options recommended because of price.


VXX - Volatility Index Futures - ETF Description

Comments:

The VXX imploded and lost nearly $1 on the spike in the market. While I want to be short this ETF, I am not willing to just short it today given the recent declines. There will be some volatility in our future. When it occurs we will jump on this ETF again. I am cancelling the recommendation for now.

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.

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