Option Investor
Newsletter

Daily Newsletter, Thursday, 9/28/2017

Table of Contents

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

Market Wrap

Market Holding Up Into End-of-Week/Month/Quarter

by Keene Little

Click here to email Keene Little
We've had a choppy pattern for this week's rally/bounce, which has the appearance of an attempt to hold the market up this week. But the larger price pattern supports new highs and it's still a good time to stick with the trend until the market tells us otherwise.

Today's Market Stats

The RUT has had a strong week but the others have not been able to put in the same performance. The energy and banking stocks have helped lift the small caps and there's probably been an effort to swing some money into these more volatile stocks this week to help improve the "performance" of funds as they get ready to close the books on September and the 3rd quarter. We'll have to see if there will be any unwinding of this effort next week. But even we get a decent pullback next week it's not looking like the market has seen its highs yet. Bears need to stay in their caves for at least a little longer.

This morning the market started with a gap down but that was just another dip-buying opportunity for all the dipsters out there. Between those who just looking for any dip to buy and those fund managers wanting to prevent any kind of selling this week, the bears have had nothing to do all month. The modest pullback (-3% for SPX) in August and the -1.4% pullback on September 5th are all the bears have had to play with. The rest of the time it's been better to simply stay long and add to positions with every pullback, as small as they have been. At some point that will stop working but ride it while you can.

As I'll get into with the charts, there is the possibility for a brief spike down early next week but it should be another good buying opportunity but perhaps only for one more leg up to complete the rally. Calling tops in this market has been an exercise in frustration (not that that will stop me, wink) and I'm not about to call one here. However, I'm seeing enough signs to tell me not to get complacent about the upside while not shorting it either. Building up a cash position is a good idea as we head into October. I believe this October, like previous ones in years ending in 7, will be a bull killer and not the bear killer that is October's reputation. There are no bears to kill here.

When trying to decipher the market, the king of all indicators is of course price. All else doesn't matter but it doesn't mean we shouldn't be looking for signs that prices are stretched. One indication of the strength of a market's move is market breadth, for which there are many components.

One market breadth indicator that has worked out well in the past, as far as indicating when the bulls should start to worry, is the cumulative advance-decline line. When it starts to show negative divergence with price (the a-d line makes a lower high while price makes a higher high) we should start to worry about the rally being on its last legs and to button up stops. At the moment there is no negative divergence and this has kept up the chatter about why bulls don't need to worry about this rally.

The cumulative a-d line for SPX has been shown before and shows a tight correlation with SPX over the past 5 years. As I noted on the chart, it's practically a 1:1 correlation and as correlations go, it doesn't get much better than this. But it's looking more like a coincident indicator and that's not terribly helpful. As I'll show further below, there are some things that tell us we might need to look elsewhere for clues now that some fundamental things have changed in the market.

Correlation between SPX Cumulative Advance-Decline line and SPX

Trading volume is one indicator of the strength behind a market move. We've often heard volume can be supportive of a move, up or down, and when volume is waning it means the move is losing its support. It's common for tops to be formed simply because most buyers are already in the pool and waiting for others to continue the buying so that prices keep heading higher.

Many look for a catalyst to start the selling but oftentimes it occurs simply because sellers start to overwhelm buyers (and it's the reason many market tops are rounding affairs, as opposed to v-bottoms). As I'll point out later on the SPX weekly chart, we're seeing bearish divergence at the new price highs since March and we're seeing a similar divergence in volume, which has been slowing since the rally off the February 2016 low began, as can be seen on the NYSE chart below.

In last week's market wrap I had shown a chart of corporate buybacks vs. SPX and pointed out the slowdown in buybacks since mid-2016 and this slowdown could be part of reason for the overall slowdown in volume. But whatever the reason, the declining volume is an indication the rally could run out of gas soon.

At the moment the slowing volume is just another indication that the rally is long in the tooth but not necessarily ending. However, the slowing volume in a rising wedge pattern is a reason to be cautious about the upside (rising wedges break down fast when they break).

NYSE and its trading volume

There's another problem with the current market, which could be related to the declining volume seen above. The chart below compares the equal weighted SPX index with the "normal" cap-weighted SPX index that we normally watch. Currently there's a large divergence between the two, which is larger than anything seen in the past decade. This tells us the rally has been on the backs of the large caps while the smaller stocks are participating less.

This is more evidence of the shift to passive investing (buying ETFs like SPY) vs. active investing and the consequence is that when the selling starts in the ETFs there is going to be a much larger decline in the indexes than might otherwise have occurred. The ETFs will simply go begging for buyers and selling the ETFs will mean selling all the stocks in those ETFs, regardless of the quality of some individual stocks. It's the reverse of what's happening now with a lack of price discovery. All stocks in the ETF, regardless of whether or not they're worth buying, get bought together. When the selling starts we'll see the baby getting thrown out with the bath water.

S&P 500 Equal-Weighted index vs. S&P 500 Cap-Weighted index

Getting back to the cumulative advance-decline line (the 2nd chart above), it is probably not as useful a breadth indicator that it once was. Many are calling for the market to continue rallying and that we shouldn't worry about a top because the a-d line is so strong. As Bill Fleckenstein mentioned recently, we are in a different kind of trading environment, which he described with the following formula and statement: "QE + ETFs + algos = new era, until it isn't. Then chaos."

Backing up Fleckenstein's formula, Doug Kass, a big name in hedge fund management, recently said "Be alert, consider the contrary and think about sitting out some of the market's dances, perhaps before your legs are chopped off." His concern about the market comes from the fact that he thinks too many are looking at the market the same way, or as he calls it, "group stink." As he says, "Group stink is a powerful force in the markets, especially when the machines and algorithms and the ever-constant inflows into popular passive funds and ETFs dominate the investment backdrop."

In Kass's opinion there is too much group stink right now and there's a near-universal view that stocks will just keep heading higher from here and that any dip is just another opportunity to buy more. We all know what happens in group stink situations where everyone runs over to one side of the boat.

Don't be caught with the crowd too long

OK, warnings out of the way, I [group] stink we'll see higher prices in the coming week(s) but I also believe this market is dangerously close to a major high. I say dangerous because part of the group stink is that we should all sit tight and not let a market decline shake us out of our positions. But by the time these same people recognize there's a problem you will have already lost at least 20% of your portfolio value and you're not going to get it back for a long time. Why live through a large decline when you can get into cash and be a buyer at lower prices? Hence the reason to raise cash levels. IMHO, the upside potential is dwarfed by downside risk.


S&P 500, SPX, Weekly chart

SPX, like the NYSE shown above (with the volume discussion), is wedging up tighter into the tip of its rising wedge for the rally from January 2016. At the same time it's showing bearish divergence on the momo oscillators since March, which fits well with the 5th wave of the rally. Yesterday's high near 2512 is only 4 points away from the 2516 projection for the 5th wave (the rally from January 2016), where it would equal the 1st wave of the rally.

If the rally can make it a little higher than 2516 it would run into the top of its rising wedge and the midline of the up-channel for the rally from 2010-2011, both near 2550 in another two weeks. It takes a drop below the August 21st low near 2417 to tell us a top is in place but an early warning would be a drop below the uptrend line from February 2016, currently near 2473.


S&P 500, SPX, Daily chart

If SPX stair-steps higher in the coming week, as depicted in bold green on the daily chart, we could see the rally finish near 2525, which is where it would run into the trend line along the highs from March-May. The shorter-term pattern, which is shown more clearly on the 30-min chart further below, suggests we could see a sharp pullback into early next week and then the resumption of the rally. Only a sharp break below the uptrend line from February-November 2016 (the bottom of the rising wedge on the weekly chart) would convince me that we've seen the top. So the bears need to see SPX below 2480 before turning aggressive.

Key Levels for SPX:
- bullish above 2516
- bearish below 2480


S&P 500, SPX, 30-min chart

Because the pattern for this week's bounce off Monday's low is so choppy it's either an ending pattern to the upside or part of what will become a larger 3-wave pullback from September 20th. A sharp pullback that stays above the uptrend line from February-November 2016 would be a buying opportunity since it should lead to another (and final) high in October. Regardless of how this rally finishes (stair-step higher like that shown on the daily chart above or a sharp decline and then back up), it's looking like we could be setting up once again for an October surprise in the year ending in 7.


Dow Industrials, INDU, Daily chart

Since Monday, when the Dow dropped back below its uptrend line from November 2016 - May 2017, it has been banging its head on the trend line with its bounce attempts but it hasn't been able to climb back above the line, which will be near 22420 on Friday. Like SPX, I show the potential for the Dow to stair-step higher into next week to complete its rally. But because of the choppy bounce pattern this week we could instead get a sharp pullback into Monday/Tuesday and then another rally leg. In either case it's looking like we should expect higher prices before a top looks more likely.

Key Levels for DOW:
- stay bullish above 22,179
- bearish below 22,038


Nasdaq-100, NDX, Daily chart

The techs have been weaker than the other indexes, largely thanks to the FAANG stocks. These few stocks led the tech indexes higher when they were rallying but now they've been a drag as they lose their momentum to the upside. As an example, last week I showed the H&S topping pattern for AMZN. Its neckline is near 938.60 and it was tested on Monday and Tuesday. It predictably bounced off that neckline support but any further decline below Tuesday's low at 931.75 would suggest the H&S pattern will play out (which points down to 785 for an objective).

AAPL's weekly chart showed the start of a break of its uptrend line from November 2016 (the bottom of its up-channel), currently near 159, and it indeed broke with last week's close at 151.89. It could bounce back up for a back-test of the bottom of the up-channel but at the moment it's looking like it could simply continue lower from here. This is not a stock I'd be looking to buy until it reaches its 50-week MA, currently near 138. That should be good for a bounce but with the longer-term pattern looking like a major top is in place I think there will be better places to invest. AAPL is done (imho).

FB is bouncing back up to its broken 50-dma, which it broke on Monday, currently near 169.55 (today's high was 169.07) and we'll have to see if it can recover. Otherwise a back-test followed by a bearish kiss goodbye would suggest the top for FB is in place.

Last week NFLX tested its July high and Monday's strong decline leaves a double top with bearish divergence. GOOGL looks like it could press higher. So 4 out of 5 of the FAANG stocks look like they're in trouble (not confirmed yet but looking like a failure waiting to happen). The tech indexes are strongly dependent on these 5 stocks so they bear watching closely.

As for NDX, it looks like it could be in the final leg of a shallow rising wedge. The choppy pattern and the Fib projections for the legs of the wedge fit and the expectation from this pattern is that NDX will finish near 6025 next week. If the bulls can rally NDX above 6050 it would point higher to the trend line along the highs from November 2014, near 6150 in the 2nd week of October. In this case I would expect to see a strong recovery in the FAANG stocks. With the choppy price structure it's hard to tell what kind of larger pattern is playing out but what I've depicted on the NDX chart (a little more upside and then a selloff) is my best guess at the moment. I reserve the right to change my mind when the market tells me to. ;-)

Key Levels for NDX:
- bullish above 6050
- bearish below 5839


Russell-2000, RUT, Daily chart

The RUT has had a strong rally from its August 18th low and it got a strong pop once it cleared resistance at its trend line along the highs from 2007-2015. Today it added marginally to the rally but short term it's looking ready for a pullback. At this point I'm looking only for a pullback before heading higher again. I show strong upside potential to about 1525 by October opex 9the 20th). That is of course just speculation at the moment but I think it's important to see the upside potential so that you know what kind of risk:reward you have when evaluating a trade. Only after a pullback (assuming we'll get one, unless they've been outlawed) will we start to get some upside targets for the final leg (5th wave) of the rally.

Key Levels for RUT:
- bullish above 1458, cautious below 1452
- bearish below 1414


10-year Yield, TNX, Weekly chart

With what looks like a bull flag pattern for the pullback from December, TNX could soon break out if it makes it a little higher. Today's high at 2.34 was a test of the top of the down-channel and if it breaks above July 2016 high near 2.4 it would be a bullish move. There's still the downtrend line from 1988-2007 it would have to deal with later, near 2.47, but breaking out of the bull flag pattern would likely be an indication we'll get another leg up at least equal to the July-December 2016 rally, which points to 3.32%. Otherwise a turn back down from here and a drop below the September 7th low near 2.03 would likely lead to a strong decline.


U.S. Dollar contract, DX, Daily chart

The US$ has broken out of its down-channel from May and is now back above its 20- and 50-dma's. It's looking like smooth sailing to higher prices, maybe. The dollar is currently back-testing both price-level S/R, near 93.30, and the bottom of its previous down-channel from January (from which it broke down in July), currently near 93.15. It's possible that's all we'll see for this bounce and now down to the $90 area before setting up a stronger rally. But if the dollar rallies a little further and breaks above 94 it would strengthen the dollar bull's case that it's ready now for a stronger rally.


Gold continuous contract, GC, Daily chart

Gold lost price-level support this week at 1300, as well as dropping back below its 50-dma, currently climbing up toward the 1300 level. Gold bulls would look to be in better shape back above 1300 and especially if it can get back above Tuesday's bounce high at 1317. Otherwise it's looking like gold should head lower and the next downside target would be a test of its broken downtrend line from 2011-2016, near 1267.


Oil continuous contract, CL, Daily chart

Oil tried to climb above its downtrend line from 2015-2017 and its broken uptrend line from 2016, both of which crossed on Wednesday near 51.90. If that was the top, which is the setup here (but not confirmed), we'll see oil head back down and drop below its June low at 42.05. The first thing oil bears need to do is get oil back below the September 6th high at 49.42 to leave a confirmed 3-wave bounce up from the August 31st low. If the oil bulls prevail here we should see at least a test of the January-February highs near 55.


Economic reports

This morning's reports were not market movers, especially since there were no surprises. The 3rd estimate for GDP came in at the expected 3%. Friday morning's reports include personal income and spending, with a slight drop expected for both. We'll also get PCE prices, watched closely by the Fed, and they're expected to show a little higher inflation than we've been seeing. Chicago PMI and Michigan Sentiment after the open should not be market movers.


Conclusion

There are enough differences between the price patterns of the major indexes to keep us guessing who's in charge. Clearly the RUT is in charge to the upside since its August 18th low but it's a volatile index and who knows how long this will last. There was a lot of wringing of hands and gnashing of teeth when the RUT was in its strong decline into the August low. Now everyone has turned bullish with the small caps rallying hard. If oil turns back down and takes the oil stocks with it we could see a rapid reversal in the RUT. But right now the RUT is our leader to the upside.

The techs have been hurt recently by the selling in the FAANG stocks and as discussed above, 4 out of the 5 FAANG stocks look vulnerable to stronger selling. A strong RUT and weak tech indexes leaves us guessing which way the wind will blow next. In the middle we have the blue chips and the choppy move up this week does not look bullish. If they continue to chop their way higher it will be a sign of an ending pattern to the upside. But a top does not look to be in place yet and if we get a sharp pullback into early next week I think it will lead to another, and likely final, leg up to a new high. The same can be said for the RUT.

As it looks now, which is obviously subject to change as the price pattern dictates, we should see the market make final highs in October. I think we're looking at a strong possibility for this October to be a bull killer, opposite to its normal bear-killer status. Octobers in years ending in 7, for whatever reason, have been times for bulls to lay in their stops and get out of the way of a coming decline. Otherwise there will be much more pain than most are thinking likely right now. Don't be a complacent bull. And if you're a bear I think you'll need to stay in your cave a little longer until the coast is clear.

Good luck and I'll be back with you next Wednesday.

Keene H. Little, CMT


New Plays

Hurricane Shopping

by Jim Brown

Click here to email Jim Brown
Editor's Note

Conn's expects sales to decline in the short term but rally in the months ahead as consumers replace all their household goods.



NEW BULLISH Plays

CONN - Conn's - Company Profile

Conn's, Inc. operates as a specialty retailer of durable consumer goods and related services in the United States. It operates through two segments, Retail and Credit. The company's stores provide furniture and mattress, including furniture and related accessories for the living room, dining room, and bedroom, as well as traditional and specialty mattresses; home appliances comprising refrigerators, freezers, washers, dryers, dishwashers, and ranges; and home office products consisting of computers, printers, and accessories. Its stores also offer consumer electronics, such as LED, OLED, Ultra HD, and Internet-ready televisions; and Blu-ray players, and home theater and portable audio equipment. The company also provides short- and medium-term financing to its retail customers, as well as offers product support services, such as product repair services, repair service agreements, and various credit insurance products. As of January 31, 2017, it operated 113 retail locations in Alabama, Arizona, Colorado, Georgia, Louisiana, Mississippi, Nevada, New Mexico, North Carolina, Oklahoma, South Carolina, Tennessee, and Texas. Conn's, Inc. was founded in 1890 and is based in The Woodlands, Texas. Company description from FinViz.com.

Conn's reported earnings of 26 cents and analysts were expecting a loss of 2 cents. Revenue of $366.6 million missed estimates for $371.9 million. They are located outside of Houston and were forced to close 23 stores, distribution and service centers in Beaumont and Houston. They lost 100 selling days as a result of the storm.

The company said collections from customer financings would be impacted and sales were slow after the stores reopened. However, once utilities and transportation systems were restored, the business saw a large uptick in activity. People who were flooded out have to replace all of their furniture and electronics. Because the company is located in and has a heavy presence in Houston, they will benefit from the surge in replacing household items for months into the future. Shares are rebounding on this outlook.

Earnings Dec 7th.

Shares broke out to a new high on Wednesday and added to those gains on Thursday. The stock is in breakout mode and investors are buying the story.

Options are somewhat expensive because of the breakout to new highs.

Buy CONN shares, currently $25.65, initial stop loss $23.65.
Alternate position: Buy Nov $28 call, currently $1.15, initial stop loss $21.50.



NEW BEARISH Plays

No New Bearish Plays


Entry disclaimer: To avoid an unfavorable entry point, we will not launch a new play if the stock gaps more than $1.00 at the market open.



In Play Updates and Reviews

Continued Gains

by Jim Brown

Click here to email Jim Brown

Editors Note:

There is definitely rotation in progress as the Russell added to its gains. With big cap tech stocks weak and the Nasdaq gaining only 0.14 of a point, portfolio managers are clearly rotating out of the big cap stocks and into small caps ahead of the Q3 earnings and the best six months of the year, which starts on November 1st.

The S&P posted a minor gain of 3 points but did close above prior resistance of 2,508. The Dow Transports rallied to close at a new high and confirm the moves in the Dow industrials. The Russell 3000 also closed at a new high with a 2 point gain.





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


FDC - First Data
The short stock position was entered at the open.



If you are looking for a different type of trading strategy, try these newsletters:

Short term Calls and Puts on equities = Option Investor Newsletter

Credit spreads and naked puts = OptionWriter

Long term option investments = LEAPS Investor

3-6 month Option Trades = Ultimate Investor

Iron Condors = Couch Potato Trader



BULLISH Play Updates

AMD - Advanced Micro Devices - Company Profile

Comments:

No specific news. No gain. Waiting for the next headline.

Original Trade Description: Sept 23rd

Advanced Micro Devices, Inc. operates as a semiconductor company worldwide. Its primarily offers x86 microprocessors as an accelerated processing unit (APU), chipsets, discrete graphics processing units (GPUs), and professional graphics; and server and embedded processors, and semi-custom System-on-Chip (SoC) products and technology for game consoles. The company provides x86 microprocessors for desktop PCs under the AMD A-Series, AMD E-Series, AMD FX CPU, AMD Athlon CPU and APU, AMD Sempron APU and CPU, and AMD Pro A-Series APU brands; and microprocessors for notebook and 2-in-1s under the AMD A-Series, AMD E-Series, AMD C-Series, AMD Z-Series, AMD FX APU, AMD Phenom, AMD Athlon CPU and APU, AMD Turion, and AMD Sempron APU and CPU brand names. It also offers chipsets with and without integrated graphics features for desktop, notebook PCs, and servers, as well as controller hub-based chipsets for its APUs under the AMD brand; and AMD PRO mobile and desktop PC solutions. In addition, the company provides discrete GPUs for desktop and notebook PCs under the AMD Radeon brand; professional graphics products under the AMD FirePro brand name; and customer-specific solutions based on AMD's CPU, GPU, and multi-media technologies. Further, it offers microprocessors for server platforms under the AMD Opteron; embedded processor solutions for interactive digital signage, casino gaming, and medical imaging under the AMD Opteron, AMD Athlon, AMD Sempron, AMD Geode, AMD R-Series, and G-Series brand names; and semi-custom SoC products that power the Sony Playstation 4, Microsoft Xbox One, and Xbox One S game consoles. Company description from FinViz.com.

Expected earnings Oct 24th.

Nvidia (NVDA) shares were rocked last week after news broke that Tesla was looking at moving to AMD and away from Nvidia for the chips to power the autonomous driving functions. The initial headline saw AMD spike and Nvidia decline. The actual story is that AMD and Nvidia are partnering on creating a chip solution for Tesla. It is no surprise that AMD is in the mix because Tesla hired Jim Keller to lead development of Autopilot. Keller previously worked at AMD and led the development of the Zen architecture and the new Ryzen processors.

It appears that Nvidia and AMD have a team of about 50 engineers working to develop a comprehensive solution for Tesla. Here is where it gets interesting. I would not be surprised to see Tesla make an acquisition bid for AMD. The company only has a $13 billion market cap compared to $110 billion for Nvidia. AMD has a lot of products that are different from the Nvidia product line even though they both make GPUs. AMD has only existed for years as a foil for Intel. The bigger company could not be considered a monopoly as long as AMD existed. Now with Qualcomm getting into the processor market and AMD and Nvidia in a high tech partnership, it would make sense for Nvidia to acquire AMD. Since GPUs are a small part of AMD's product line, there may not be that much regulatory concern. Is it a long shot? Absolutely, but definitely in the realm of possibilities.

Even if there is never an acquisition bid, just the combination of AMD and Nvidia in a partnership validates the technical capabilities of AMD and lifts them into the big league. Where AMD has always been a low cost alternative to Intel and always 1-2 generations behind in technical expertise, they have dramatically improved their game in the last 12-18 months. Instead of being road kill on the Intel superhighway to state of the art processors, they have surged to be a real competitor. Partnering with Nvidia is a real step up for the company.

The chart is ugly with no apparent trend but there is decent support at $12. They could easily catch fire as investors begin to understand the ramifications of the partnership and we could see another leg higher like the one that started the prior May. There are no guarantees but I do not believe anyone sees AMD's future as anything but positive given recent events.

Update 9/25/17: AMD and Nvidia declined after Intel announced the next generation in the Core CPU line for desktops. This 8th generation Core-i7-8700K is the bet gaming processor ever with an internal clock frequency of 4.7 Ghz and Intel's fastest ever. They will also support 4K video. This is a challenge for AMD but the company is still ahead of Intel in the GPU race.

Position 9/25/17:

Long AMD shares @ $13.25, see portfolio graphic for stop loss.
Alternate position: Long Jan $14 call @ $1.25, see portfolio graphic for stop loss.



DVAX - Dynavax - Company Profile

Comments:

No specific news. Nice gain and a close above the consolidation pattern.

Original Trade Description: Sept 20th

Dynavax Technologies Corporation, a clinical-stage immunotherapy company, focuses on leveraging the power of the body's innate and adaptive immune responses through toll-like receptor (TLR) stimulation. Its product candidates are being investigated for use in multiple cancer indications, as a vaccine for the prevention of hepatitis B and as a disease modifying therapy for asthma. The company's lead product candidates include HEPLISAV-B, an investigational adult hepatitis B vaccine, which is in Phase III clinical trials; and SD-101, an investigational cancer immunotherapeutic that is in Phase I/II studies. Its product candidates also comprise AZD1419, which is in Phase II clinical trial for the treatment of asthma; DV230F that is in preclinical stage for the treatment of liver tumors; and DV1001, a TLR 7&8 agonist, which is in preclinical stage for the treatment of for multiple malignancies, as well as DV281 for the treatment of non-small cell lung cancer. It has collaboration and license agreements with AstraZeneca AB to develop AZD1419 for the treatment of asthma; and Merck & Co. to develop SD-101 for varios immuno-oncology therapies. Company description from FinViz.com.

Dynavax has a vaccine for Hepatitis B. Shares crashed on August 10th when the FDA asked for more information despite a 12-1 vote to approve it. The results of the request for info will be released no later than November 10th according to the company. They are confident the drug will be approved and they are already targeting an early 2018 release date.

Cathy Reese of Empire Asset Management said investors should use the current volatility to buy the stock and she has a $38 price target.

Earnings Nov 1st.

Shares have rebounded from the early August dip as investors become more confident the vaccine will be approved. Shares peaked a $21.85 on September 11th and then faded for a week as profit taking appeared. Wednesday's close was a 7-day high.

I am not planning on holding this position into the announcement. I would like to exit by the end of October to avoid any unplanned declines.

Options are very expensive because of the big expectations. This will be a stock only position.

Postion 9/21/17:

Long DVAX shares @ $21.10, see portfolio graphic for stop loss.



KTOS - Kratos Defense - Company Profile

Comments:

Kratos received a $6.2 million contract for specialized products in support of national security.

Original Trade Description: August 14th.

Kratos Defense & Security Solutions, Inc. provides mission critical products, solutions, and services in the United States. The company operates through three segments: Kratos Government Solutions, Unmanned Systems, and Public Safety & Security. The Kratos Government Solutions segment offers microwave electronic products; satellite communications; technical and training solutions; modular systems; and defense and rocket support services. The Unmanned Systems segment provides unmanned aerial, ground, and seaborne, as well as command, control, and communications systems. The Public Safety & Security segment designs, engineers, deploys, operates, integrates, maintains, and operates security and surveillance solutions for homeland security, public safety, critical infrastructure, government, and commercial customers. The company serves national security related agencies, the department of defense, intelligence agencies, and classified agencies, as well as international government agencies and domestic and international commercial customers; and critical infrastructure, power generation, power transport, nuclear energy, financial, IT, healthcare, education, transportation, and petro-chemical industries, as well as government and military customers. Kratos Defense & Security Solutions, Inc. was founded in 1994 and is headquartered in San Diego, California. Company description from FinViz.com.

Kratos builds drones for target practice for the U.S. military. They are also building drones for combat for air to air and air to land. They also provide communication systems for missiles, satellites and various other platforms.

China and Russia are rapidly militarizing space and Kratos is working with the U.S. military to improve satellite communication to defend against attacks. The DoD is currently spending a lot of money to prepare for war in space. Kratos owns and operates a global satellite demonitoring business with revenues rising 61% in Q1.

Kratos has so many new programs in operation it would be impossible to list them here and several of them are secret programs for unnamed clients.

Kratos guided for a return to profitability in Q2 and sharply rising revenue for the full year. Shares spiked 30% in the four weeks after Q1 earnings. Their next report is August 3rd. I am recommending we buy an option and hold over the report. If the earnings are as positive as they teased in the Q1 report we could see another sharp reaction. This company is in all the right places for the increase in defense department spending.

Kratos unveiled its newest high performance class of military unmanned aerial system technology at the Paris Air Show. The XQ-222 Valkyrie and UTAP-22 Mako drones provide fighter like performance and are designed to function as wingmen to manned aircraft in contested airspace. The Valkyrie can carry various weapons and intelligence systems and has a range of 3,000 miles. The Mako is designed to carry sensors and stealthily infiltrate hostile airspace to gather intelligence. Both are designed to operate with or without manned flights. The Air Force recently pitched the functions of the Valkyrie saying a F-35 with a group of fighter/bomber drones could maximize control of airspace and ground attack operations. The F-35 can select targets and pass information to specific drones while maintaining situational awareness from a stealthy and relatively safe position.

Just over the last couple weeks Kratos announced a $2.9 million order for an airborne communications system, a $10 million order for a ballistic missile defense system, $23 million for a military radar system and $8 million for a GPS Satellite protection system. Analysts are expecting a record $800 million in revenue for 2018. They expect to do $150 million in unmanned revenues in 2018.

Kratos posted earnings of 1 cent and a $10.4% increase in revenue to $186 million. They guided to be free cash flow positive by $25 million in 2017.

Expected earnings Oct 26th.

With the daily new contract awards shares have risen $1.50 in the last week and closed at a 5-week high on Monday. They are very close to breaking out to a new high.

Update 9/5/17: New high in a weak market. Unfortunately, after the close they announced a secondary offering of 12.5 million shares that will increase the float by 14%. If I recommended we sell at the open on Wednesday, we are going to get hit with the normal "sell the news" decline. If we retain the position, stocks normally rise after a secondary is completed. We can either take a loss on Wednesday or hang on for a bigger gain later. I am recommending we hold the position. I am removing the stop loss to avoid being knocked out of the position for a loss. Shares declined to $12.80 in afterhours, a drop of $1. If that is all the decline we get, I would be very happy.

Update 9/6/17: KTOS announced a $46 million contract with the Saudi Royal Navy to assist in increasing military communications and preparedness. They also announced the QWK Integrated Solutions LLC, a partnership of multiple defense firms had won a $3.038 billion five year contract. The partnership will provide for rapid development and integration of space, missile defense, cyber, directed energy and related technologies to support SMDC/ARSTRAT and the warfighter.

Update 9/11/17: The company announced it had successfully completed a required number of missions with their jet powered unmanned drone system. The missions are part of the performance demonstrations prior to delivery of ten drones over the next six months. The customer was not announced for security reasons. However, a program they announced with the Navy several months ago called for delivery of 10 drones in 2017 with the potential for multiple follow on orders in 2018. This could be part of that project.

Update 9/18/17: Kratos deployed the first fully autonomous vehicle in Colorado with the Colorado Dept of Transportation. The robot vehicle replaces the trailing vehicle in a work construction crew. It follows the crew throughout the day and acts as a mobile crash barrier. Previously, a CDOT employee had to drive a specially built truck mounted with impact absorbing rear bumpers. Basically, this protects the work crew on the road by giving erratic drivers something to hit other than the work crew. There is still the problem of the driver in this truck when a car, truck or semi plows into the truck at 70 mph. In Colorado these bumper trucks were hit an average of 7 times per year, sometimes with injury to the CDOT drivers. The Kratos robotic crash guard truck has no driver so nobody is injured with an errant civilian vehicle crashes into it. The robot vehicle monitors the work crew and maintains a safe distance behind them with enough lane coverage to keep them from getting hit.

Update 9/21/17: KTOS successfully completed the third test of AN/SPY-6(V) Air and Missile Radar (AMDR) against a live ballistic missile target. The new radar is slated to begin service on the Navy's next generation Arleigh Burke Class Guided Missile Destroyer currently under development. This is a big step for Kratos.

Position 8/15/17:

Long KTOS shares @ $12.78, see portfolio graphic for stop loss.
Alternate position: Long Nov $15 call @ 65 cents, see portfolio graphic for stop loss.

With shares just crossing the $12.50 strike price, we had to reach out to $15 and a distant month.



MRVL - Marvel Technology - Company Profile

Comments:

No specific news.

Original Trade Description: August 30th.

Marvell Technology Group Ltd. designs, develops, and markets analog, mixed-signal, digital signal processing, and embedded and standalone integrated circuits. It offers a range of storage products, such as hard disk drive (HDD) and solid-state drive controllers, as well as HDD components, such as HDD preamps components; and develops software enabled silicon solutions consisting of serial advanced technology attachment port multipliers, bridges, serial attached SCSI, and non-volatile memory express redundant array of independent disks controllers and converged storage processors for enterprise, data centers, and cloud computing businesses. The company also provides networking products comprising Ethernet solutions comprising Ethernet switches, Ethernet physical-layer transceivers, and single-chip network interface devices; and embedded communication processors. In addition, it offers a portfolio of connectivity solutions, including Wi-Fi, and Wi-Fi/Bluetooth integrated system-on-a-chip products, which are integrated into a variety of end devices, such as enterprise access points, home gateways, multimedia devices, gaming products, printers, automotive infotainment and telematics units, and smart industrial devices. Further, the company provides printer-specific standard products, as well as full-custom application-specific integrated circuits; and communications and applications processors. Company description from FinViz.com.

Marvel reported earnings of 30 cents that beat estimates for 28 cents. Revenue of $605 million beat estimates for $601 million. Free cash flow more than doubled from $38 million to $89 million. Core revenues rose 6%, storage controller revenues rose 13%. SSD chips rose from 20% to 25% or revenue. The new SSD products are rapidly gaining market share and remain a high profit item. Gross margin was 60.4%. They guided for Q3 for revenue of $595-$625 million with earnings of 30-34 cents per share.

Expected earnings Nov 23rd.

The company is in the midst of a restructuring process while they are changing their product mix for the better. Apparently it is working.

Shares spiked from $15.75 to $17.25 after earnings then pulled back slightly on post earnings depression. They rebounded today to a new 2-month high and very close to a new high.

Position 8/31:

Long MRVL shares @ $17.79, see portfolio graphic for stop loss.
Alternate position: Long Oct $18 call @ 64 cents, see portfolio graphic for stop loss.




BEARISH Play Updates

FDC - First Data - Company Profile

Comments:

FDC announced a new service called Disburse-to-Debit to allow companies that hire temporary workers or "gig" workers to pay them instantly upon completion of a task by sending the money to their debit cards. This works for people like Uber drivers, part time workers at special events or even insuranve companies paying claims. An agent can upload the user data and the debit card payment arrives instantly. This is a smart service and FDC shares rallied 33 cents on the news.

Original Trade Description: September 16th.

First Data is a global leader in commerce-enabling technology, serving approximately six million business locations and 4,000 financial institutions in more than 100 countries around the world. The company's 24,000 owner-associates are dedicated to helping companies, from start-ups to the world's largest corporations, conduct commerce every day by securing and processing more than 2,800 transactions per second and $2.2 trillion per year. Company description from FDC.

First Data earnings will be impacted by the three hurricanes because retail activity was slowed significantly over the weeks following the hurricane impacts. FDC said retail activity declined 72% in the first three days and was not expected to resume significantly for weeks. Stores need to recover from the floodwaters and flooding. They need electricity restored in order to run registers and POS terminals.

Expected earnings Nov 6th.

FDC also had the unfortunate luck of filing for a secondary offering of 85 million shares with an overallotment allowance of another 12.75 million on September 11th, just after the twin storms. The shares were sold by New Omaha Holdings, a major shareholder in FDC. With only about 300 million shares actively traded that is close to a 25% increase in the float. The shares were priced on Sept 18th at $17.75 each.

Selling nearly 100 million shares when your shares are already depressed would be expected to depress them even further. Shares closed at $17.55 on Wednesday and the 4-month low close is $17.47. Any further decline could put them into free fall to major support at $15.

There is always the potential for an earnings warning over the next several weeks.

Position 9/28:

Short FDC shares @ $17.56, see portfolio graphic for stop loss.
Alternate position: Long Jan $17 put @ 70 cents, see portfolio graphic for stop loss.



VXX - Volatility Index Futures - ETF Description

Comments:

No specific news. Since this is a long-term position, there will not be daily commentary.

Original Trade Description: September 18th.

The VXX is a short-term volatility ETF 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 five reverse splits occurred at $13.11 (11/2010), $8.77 (10/2012), $12.84 (11/2013), $9.52 (8/8/16), $12.77 (8/22/17). The prospectus says it can reverse split anytime it trades under $25 for a prolonged period and the splits will always be 1:4.

We know from experience that the VXX always declines. The last two times we shorted this ETF we had a $7.23 and $5.98 gain.

Unfortunately, put options are expensive with a volatility instrument at this price level. The only recommendation is to short the ETF and forget it. If we do get a prolonged rally into year-end we could see a sharp decline in the VXX over the next 2-3 months. This will be a long-term position. This is not a 2-3 week play. I can guarantee you, if history holds, we can play this until it splits 1:4 again at $10. Once we are in the position and profitable I will put a trailing stop loss on it. We will take profits and then look for a bounce to get back in.

The VXX is hard to short. Shortsqueeze.com says there are 19.9 million shares short out of 26.7 million shares outstanding. The shares are out there and being traded because the volume on Monday was 29.6 million. You have to tell your broker you really want to short it and make them find the shares. Sometimes it takes days or even a week before your broker will find you the shares. Trust me, be persistent and it will be worth the effort.

I had held off after the 1:4 reverse split because the options were expensive and I was expecting volatility in September from the budget battle and debt ceiling hurdle. With those issues pushed out into December, the volatility is dropping like the proverbial rock. Several readers have already emailed me asking when I was going to put this position back in the portfolio.

Position 9/19/17:

Short VXX shares @ $40.95, see portfolio graphic for stop loss.





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