Option Investor

Daily Newsletter, Wednesday, 7/29/2009

Table of Contents

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

Market Wrap

The Rally Takes a Breather

by Judy Alster

Click here to email Judy Alster
The S&P 500 has gained some 10% in the last two weeks, fueled by decent results -- so far -- this earnings season. Are investors hurrying to buy genuine future earnings? Or are they just running to get on the merry-go-round before it starts turning too fast? They will keep doing that, won't they. At least superficially there are contradictory reports; chipmakers seem chipper, for example (see below), but Microsoft says computer demand is still soft. Many companies are pointing to cost-cutting measures to account for their estimate-beating results, but of course that can't go on forever for as an old boss of mine used to scream, "That doesn't help us sell more pizza pies." (We sold advertising space, but we got his point.)

No company ever shrank to greatness, so until sales both new and organic start rising, maybe we should keep the good champagne on ice.

Since the economy seems to be slooooowly coming out of a recession, we're probably in a market "news equilibrium" where optimistic and pessimistic reports will cancel each other out for a while until the good news begins to prevail. Although here's a report to make investors smile: Midway through earnings announcements, companies are beating expectations by about five percentage points, with a year-over-year profit decline of 30.5% compared to a 35.5% decline in the first quarter and a queasy-making 67% plummet in last year's fourth quarter. Equally cheering is that three-quarters of companies are beating estimates and that there are improvements in virtually every industry.

However, today's market results were -- I think the clinical term is blah:

Index Wrapup

Energy prices took the steam out of the stock market today with stocks closing lower across the board. Depressed by a 2.5% drop in energy stocks as oil prices fell, the S&P 500 closed down four points, or 0.5%, at 975, with eight of 10 industry groups closing lower.

S&P 500 Index

The final hour did recover some losses. For those who like an intraday chart, here's the S&P for today; the Dow and the Nasdaq for today looked similar:

S&P 500 Intraday

The Dow Jones Industrial Average lost 26 points, or 0.3%, to 9,071, led by losses in Caterpillar (CAT), General Electric (GE) and Alcoa (A) and setting the stage for some profit taking after a roughly 11% rise in the S&P 500 since July 10.

Dow Jones Industrial Average

Nasdaq Composite

It was a big day for economic reports but let's start off with some stock news. After more than a year of negotiations, Microsoft (MSFT) and Yahoo (YHOO) finally agreed to team up in the Internet-search business, in an effort to better compete against industry leader Google. Under the 10-year agreement that came this morning, Microsoft will become the engine for Yahoo's Internet-search tool, while Yahoo will handle all sales relationships with advertisers. The deal includes a revenue sharing agreement that Yahoo boldly says will generate a half-billion dollars operating income and $275 million in operating cash flow annually; the company also says the deal will save it at least $200 million in capital expenditures. Yahoo lost $2.08 or about12% after rising for several weeks, perhaps on the rumor; Microsoft has risen 58% since March and was down about 1.4% today.



With communication companies in the earnings spotlight, Sprint Nextel (S) posted a wider-than-expected loss as its coveted wireless postpaid monthly bill paying customers continued to hang up on it, 991,000 in the second quarter, sending its shares down. The company recently launched an unlimited prepaid calling plan which has already garnered nearly 780,000 customers and yesterday, having decided that if you can't beat 'em, buy 'em, announced its acquisition of Virgin Mobile USA (VM), who has 5.25 million retail customers. Sprint lost 54 cents today or 11.8%.

Sprint Nextel

Qwest's (Q) revenue slid but profit was up 18% on a one-time tax savings. Here too, customers are abandoning land lines, pushing revenue down 9% to $3.09 billion. The stock lost 8 cents or 2% to close at $3.98. In a mirror image, American Tower Corp. (AMT), who owns wireless communications towers, saw its second-quarter profit drop 65 percent, hurt by a higher tax rate even as sales climbed. The company earned $56.3 million or 14 cents a share, compared with $158.8 million or 38 cents last year. Sales climbed 8% to $423.4 million. The company reaffirmed its 2009 guidance for adjusted earnings of $1.16B to $1.19B. The stock, trading in a range all year, lost 24 cents or less than 1% to $33.29.

Alvarion Ltd. (ALVR), who supplies WIMAX solutions, saw its quarterly loss widen to $4 million or 6 cents a share from $812,000 or 1 cent a year ago, and sales shrink 16% to $58.7 million. The company has big broadband contracts in the U.S. and Italy but nevertheless expects a third-quarter loss. Its stock fell 78 cents or 16.46%.


In related news, Asian and European semiconductor manufacturers seemed optimistic Wednesday as they predicted demand and prices picking up in the second half of the year. Europe's top chipmaker STMicroelectronics and even Germany's struggling Infineon all forecast that this quarter's sales would beat last quarter's. Makers of the chips used in the world's computers, mobile phones and other gadgets are starting to see a recovery as the new academic year approaches, helped by China's massive stimulus package.

Earlier this month, the world's biggest chipmaker, Intel (INTC), said computer markets were strengthening, and Texas Instruments (TXN) seemed upbeat, stopping short of saying the worst was over. The Semiconductor Industry Association said earlier this month that global semiconductor sales in May rose 5.4% from April to $16.5 billion, though they were still 23% lower than in May 2008. Chips have usually been a pretty good indicator of future activity. Let's accentuate the positive with a chart of Texas Instruments; Intel's looks similarly optimistic:

Texas Instruments

And in banking, Spain's Banco Santander SA (STD), up 174% since March, said its second-quarter net profit fell a smaller-than-expected 4%, as sharply higher lending income offset higher loan-loss provisions. Spain's largest bank by assets expects earnings in the second half to be in line with the first half and reiterated its full-year target of repeating last year's net profit of €8.88 billion ($12.58 billion) in 2009. The stock took a 2.9% breather on the news.

Banco Santander

Among the day's important economic news, crude oil futures tumbled over $3.88 or over 5.5% to $63.35, the biggest decline in three months, after the American Petroleum Institute and Energy Information Administration reported larger-than-expected stockpile builds. Crude stocks rose 5.2 million barrels in the July 24 week to 347.8 million, a very large build (the biggest weekly build since April) that was only partly offset by a 2.3 million barrel draw in gasoline stocks. Interestingly, the "draw" in gasoline reflects lower output, not higher demand, with refineries operating at a casual 84.6% of capacity. Distillate stocks also rose even though distillate output declined. This growing weakness in gasoline demand is big news, at minus 1.1% year-on-year after a still-weak plus 0.7% in the prior week.

As for oil prices, they were up nearly 50% this year so this drop is hardly a surprise. Oil looked overpriced in the $70s and some think it will continue to weaken for several months, since it's become clear that the recent rally was based mainly on speculation triggered by government stimulus rather than increased usage.

The Philadelphia Oil Service Sector index fell 3.3%; ConocoPhillips (COP), who reported earnings of $1.3 billion or 87 cents, off 76% year over year, had a big gap down, losing 4.5%.

Philadelphia Oil Services Index

Conoco Phillips

Also not helping was China. The late session sell-off in the Chinese market helped keep Wall Street in the red. China's industrials and commodities led the slide, while its two biggest state-owned commercial banks, Industrial and Commercial Bank of China and China Construction Bank have kept a tight reined on their 2009 lending targets. After a stunning, practically uninterrupted 62% runup since March, the Shanghai Composite Index lost over 5%. Shanghai Petroleum (SHI) fell back today as well, after three big leaps this month:

Shanghai Petroleum

Today's Treasury auction of 5-year notes was anemic, even weaker than Tuesday's 2-year sale. It was a record amount of notes, some $39 billion. Coverage, or the number of bids submitted divided by the number accepted, was low at 1.92, indicating low interest, and the still-high yield of 2.689% was 5.5 basis points above expectations (buyers in the secondary market can expect slightly less).) Indirect bidding was very weak this auction at 37% compared to 63% in June. So dealers are left sitting on some supply here. It will be interesting to watch Thursday's Treasury auction of $28 billion in 7-year notes.

Five Year Treasury Note Yield

And the Federal Reserve released its July Beige Book today. For each Beige Book, a different Fed district bank compiles anecdotal evidence on economic conditions from each of the 12 Federal Reserve districts. The book is produced roughly two weeks before the monetary policy meetings of the Federal Open Market Committee.

According to the latest book, prepared for the August 11-12 meeting, the recession is gradually nearing an end. (You heard it here.) The book stated that the economy continued to be weak going into the summer, but most Districts indicated that the pace of decline has moderated. For the critical consumer sector, most Districts reported retail activity as "sluggish," with labor markets described as "soft." A look at the chart below shows a sharp rise in consumer activity in recent weeks, however. Some Districts noted improvement in housing markets. However, commercial real estate, a relatively new locus of concern, has weakened further in recent months.

Consumer Staples

Reports on the manufacturing sector were slightly more positive than in the previous Beige Book, although Districts attributed some of the recent increases in production to replenishment of low finished-goods or customer inventories. Credit markets are still a concern. Overall lending activity was stable, but low or weakening further for most loan categories. Banks are still tightening lending standards in many Districts. Mortgage lending was down and commercial and industrial loans fell or remained weak.

Why is the Beige Book a big deal? Since it's released two weeks before each FOMC meeting, investors can see at least one of the many indicators which Fed officials will use to determine interest rate policy, and can position their portfolios accordingly. Obviously, if the Beige Book reflects any inflationary pressures, the Fed may well raise interest rates to tamp things down; if it shows gloomy conditions, the Fed may lower interest rates in order to stimulate activity. Many investors wait for the Beige Book while conjecturing busily about the possibility of an interest rate change. If the outcome differs from expectations, the effect on the markets can be dramatic.

With no real surprises, the Beige Book report pretty much conformed to market expectations. The Fed forecasts very demure positive growth in the second half, and as things stand now they're probably right. Interest rates should be low for some time to come. Once again, we're told that recovery will be slow. Knowing Americans, however, I would bet that the recovery will indeed take some time to get started but that once it's off the mark it will rapidly gain speed. The next Beige Book is released on September 9.

New factory orders for durable goods in June dropped sharply, largely on a plunge in civilian aircraft orders. Durable goods orders fell 2.5% in June, following a jump of 1.3% the month before. The decline was worse than the consensus forecast of a 0.5% fall, but if you want to ignore the transportation component, new durables orders actually advanced a monthly 1.1%. Year-over-year, overall new orders for durable goods in June slipped to minus-26.8% from minus-23.9% the previous month. Without transportation, they edged down to minus 24.1% from minus 23.0%. Transportation fell a considerable 12.8%. In that group, nondefense aircraft fell 38.5% while defense aircraft jumped 30.1% and motor vehicles slipped 1.0%.

The chart below shows the June transportation slide, but note that so far, July shows a net gain.

Nasdaq Transportation Index

Another hefty decline was communications equipment, down 10.8%. Weak also were fabricated metals and computers & electronics. The gainers were primary metals (iron, steel, copper, aluminum, lead, titanium, zinc) up 8.9%; machinery, up 4.4% and electrical equipment, up 0.9%. There's a whole school of stock forecasters who say the prices of primary metals are a very hot leading indicator of economic and stock market activity, and I am not about to call them wrong. Note the two-month rise in primary metals:

Industrial Metals Index

One positive for future production was another drop in durables inventories, which declined almost 1% in June after a prior month drop of 1.1%. Not a bad sign. Low inventories are a hopeful indicator because they mean that at some point manufacturers will have to increase production. Of course, the real champagne news will be strong increases in orders rather than just a need to restock the shelves.

The Mortgage Bankers' Association releases its weekly new-mortgage report on Wednesdays and today's was more of the same. The mortgage-purchase applications index was unchanged for the week ending last Friday, the 24th, at 262.0. The index has held steady at mostly depressed levels most of the year. The refinance index has been very volatile, though, reacting to changes in mortgage rates. The refinance index fell 11% to 1,862.1 as most mortgage rates rose in the week. Thirty-year fixed mortgages rose five basis points to an average 5.36% .

At the same time, new home sales grew 11% in June, as the Commerce Department told us the other day, sending shares of home builders aloft. New home sales hit a seasonally adjusted rate of 384,000 units, up from 346,000 units in May, beating analysts' forecast of 360,000 and the strongest pace since November 2008. Sale prices still remained weak as the median price (not the average, but the price directly in the middle of all price points) dropped 12% year over year to $206,200. Put it in the good-news folder in the belief that the housing market is at last turning. Note the hopeful recent upturn in the housing charts below:

Housing Starts Through June

Single Family Home Sales Through June

After hours, Visa Inc. (V) said its fiscal third-quarter profit jumped nearly 73% as cost-cutting helped offset declining payment processing volume. The company reported net income of $507 million or 67 cents a share, up from $422 million or 51 cents a year ago, hitting analysts' expectations. Revenue rose 2% to nearly $1.65 billion, slightly above analysts' forecast. The stock gained 48 cents to $66.78.


Tomorrow brings earnings from Apache Corp., Alaska Communications, AstraZeneca, Cigna, Colgate-Palmolive, Expedia, Las Vegas Sands, Monster Worldwide, Sony, Tyco, Walt Disney and Waste Management, to name a mere few. We also get jobless claims, the natural gas report, three Treasury auctions and the money supply, gaining in importance since the Fed funds rate has been essentially at zero.

On the subject of the Fed, Chairman Ben Bernanke took part in a town hall-format interview last Sunday in Kansas City, Missouri. The focus was heavily on how Bernanke viewed the financial crisis, the recession, and the role of the Fed. The interview was broadcast in three segments this week and is available on the PBS web site. Let's take a look at it and see whether it tells us anything we haven't guessed.

New Option Plays

Editor's Note

by James Brown

Click here to email James Brown
Editor's Note:

Sometimes the best trade is no trade at all. Markets remain very overbought but they continue to resist any selling attempts. It seems like investors are waiting for something and it could be the GDP report due out on Friday (or even the jobs report due out August 7th). I still think the 1,000 level is acting like a magnet on the S&P 500 but it could also be tough resistance to break. Our bias is bullish but I'm suggesting readers wait for a pull back toward the 950 region, which as broken resistance should offer new support for the market.

Chart of the S&P 500 index:

In Play Updates and Reviews

Waiting for the GDP

by James Brown

Click here to email James Brown

Editor's Note:

Boring! Stocks have been churning sideways in a narrow range all week long. Bulls can applaud the market's resilience in holding on to its gains from the prior two weeks yet equities remain overbought and due for a correction. It's possible that the market continues to slide sideways until the GDP report announced on Friday morning.

CALL Play Updates

Fluor Corp. - FLR - close: 53.65 change: -1.32 stop: 47.45

FLR under performed the market on Wednesday with a 3.7% decline. Shares actually dipped to a low of $50.64. That was almost enough to hit our trigger but not quiet. What's odd is that I couldn't find any specific news for the sell-off. It could have been a reaction to earnings from JEC last night but JEC only lost 1.7%. If FLR is going to show this much relative weakness with the market moving sideways I'm moving our trigger point lower from $50.25 to $48.50. This is more inline with the rising trend of higher lows and definitely limits our risk more.

If triggered our first target is $54.80. Our second target is $59.00 but we may not have time. FLR is due to report earnings in less than three weeks. We do not want to hold over the announcement.

Picked on     July xx at $ xx.xx <-- TRIGGER @ 48.50
Change since picked:      + 0.00
Earnings Date           08/10/09 (unconfirmed)
Average Daily Volume =       2.4 million  
Listed on  July 25, 2009         

Euro Currency ETF - FXE - close: 140.33 chg: -1.37 stop: 139.40

The U.S. dollar produced a pretty big bounce today. This has pushed the FXE toward "support" near $140 and its 50-dma. Given our stop loss at $139.40 I would use this pull back as a new entry point. I would buy the September calls. Our first target is $144.50. Our second target is $148.50. The P&F chart is bullish with a $168 target.

Picked on     June 23 at $140.76
Change since picked:      + 0.43
Earnings Date           00/00/00
Average Daily Volume =       461 thousand    
Listed on  June 23, 2009         

Gold Miner ETF - GDX - close: 37.18 change: -1.17 stop: 36.49

The same move in the dollar that pushed the FXE lower also pushed gold prices lower and that showed up in the GDX. I'm not suggesting new bullish positions in the GDX at this time. GDX has already exceeded our first target. Our second target is $42.40.

Picked on     July 13 at $ 36.49 /gap higher entry
                               /originally listed at $35.93
Change since picked:      + 0.69
            gap higher exit   /1st target hit @ 39.95 (+9.4%)
Earnings Date           00/00/00
Average Daily Volume =       6.8 million  
Listed on  July 13, 2009         

IDEXX Labs - IDXX - close: 49.80 change: +0.61 stop: 44.95

Traders bought the dip in IDXX at $48.57 today. Nothing has changed for us. We're still patiently waiting for a dip toward what should be support.

The plan is to buy calls on a dip at $47.50. If triggered our first target is $52.00. Our second target is $54.90. Our time frame is four to eight weeks.

Picked on     July xx at $ xx.xx <-- see TRIGGER
Change since picked:      + 0.00
Earnings Date           07/24/09 (confirmed)
Average Daily Volume =       383 thousand 
Listed on  July 25, 2009         

Legg Mason - LM - close: 27.59 change: +0.20 stop: 23.75

The brokerage stocks showed some relative strength today but overall LM is just churning sideways like the major market averages. The plan is to buy calls on the stock at $25.25 but we can really use the 25.25-24.00 zone as an entry point. If triggered our first target is $29.50. Our second target is $33.40. My time frame is four to eight weeks.

Picked on     July xx at $ xx.xx <-- see TRIGGER
Change since picked:      + 0.00
Earnings Date           07/20/09 (confirmed)
Average Daily Volume =       3.4 million  
Listed on  July 25, 2009         

S&P 100 index - OEX - close: 455.18 change: -1.20 stop: 451.90

The sideways consolidation is narrowing just a bit, which might suggest a breakout soon. It's possible the breakout (either direction) may not happen until the Friday morning GDP report.

I'm suggesting a trigger to buy OEX calls at 458.10. If triggered our target to exit is 469.00. More aggressive traders may want to aim for the 480 region.

FYI: I listed a few alternatives to trading the OEX in the original play description from Tuesday night.

Picked on     July xx at $ xx.xx <-- see TRIGGER @ 458.10
Change since picked:      + 0.00
Earnings Date           00/00/00 
Average Daily Volume =        xx 
Listed on  July 28, 2009         

Polaris - PII - close: 36.93 change: +0.02 stop: 31.45

There is no change from my prior comments on PII. We might want to raise our trigger to buy calls toward the $34.00 level but for now I am suggesting readers wait for a dip in the $33.00-32.00 zone with a tight stop at $31.45. Our first target is $37.25. Our second target is $39.50.

Picked on     July xx at $ xx.xx <-- see TRIGGER
Change since picked:      + 0.00
Earnings Date           07/16/09 (confirmed)
Average Daily Volume =       436 thousand 
Listed on  July 18, 2009         

PUT Play Updates

Alliant Techsystems - ATK - close: 78.36 change: -0.38 stop: 81.15

The defense sector indices displayed a little relative strength today but ATK did not. Shares lost 0.48% and are testing technical support at their 100-dma. It is worth noting that volume was pretty strong today at 934K shares.

Our first target is $75.25. Our second target is $72.00 but we may not have time for ATK to reach $72.00. Earnings are due out on August 6th and we don't want to hold over the announcement. I'm suggesting a stop loss at $81.15. FYI: The Point & Figure chart is bearish with a $62 target.

Picked on     July 27 at $ 78.88
Change since picked:      - 0.52
Earnings Date           08/06/09 (confirmed)
Average Daily Volume =       443 thousand 
Listed on  July 27, 2009         

LEAP Wireless - LEAP - close: 25.34 change: -1.42 stop: 29.45

Shares of LEAP lost 5.3% as they traded down in association with larger rival Sprint Nextel (S), which lost almost 12% following a bearish earnings report.

Our first target for LEAP is $22.65. Our second target is $20.25. The $22.50 level could be strong support so I suggest readers take off most of their position there. FYI: The P&F chart is bearish with a $19.00 target.

Picked on     July 17 at $ 26.80 *triggered    
Change since picked:      - 1.46
Earnings Date           08/06/09 (confirmed)
Average Daily Volume =       2.2 million  
Listed on  July 16, 2009         

United Technologies - UTX - close: 53.20 change: +0.76 stop: 55.05

UTX displayed some relative strength with a 1.4% gain. I'm not suggesting new positions at this time but watch for a failed rally under $54.00. Our first target to take profits is at $50.15.

Picked on     July 22 at $ 53.12
Change since picked:      + 0.08
Earnings Date           07/21/09 (confirmed)
Average Daily Volume =       5.9 million  
Listed on  July 22, 2009         

Strangle & Spread Play Updates

(What is a strangle? It's when a trader buys an out-of-the-money (OTM) call and an OTM put on the same stock. The strategy is neutral. You do not care what direction the stock moves as long as the move is big enough to make your investment profitable.)

McDonald's - MCD - close: 56.41 change: -0.06 stop: n/a

The action in MCD looks bearish with a failed rally pattern under the $57.00 level and near its 200-dma. We're not suggesting new strangle positions at this time.

I suggested the August $60 calls (MCD-HL) and the August $55 puts (MCD-TK). Our estimated cost is $1.25 (0.70 + 0.55). We want to sell if either option hits $2.75 or higher. This may take a few weeks to succeed.

Picked on     July 18 at $ 57.84
Change since picked:      - 1.43
Earnings Date           07/23/09 (unconfirmed)
Average Daily Volume =       7.8 million  
Listed on  July 18, 2009         


Nike - NKE - close: 54.37 change: +1.46 stop: 53.51

There is no reason for NKE to be showing so much strength. The consumer is cutting back. Consumer confidence is falling. Analysts are worried about the back-to-school sales season. Yet shares have out performed the market these last few days and today saw NKE break through resistance near $53.50 and its 50-dma. We could blame a better than expected earnings report from Under Armour (UA) but UA is a relatively new contestant in the sports apparel and shoe business compared to a giant in the industry like NKE. Our put play has been closed.


Picked on     July 23 at $ 51.14
Change since picked:      + 2.37<-- stopped @ 53.51 (+4.6%)
Earnings Date           09/23/09 (unconfirmed)
Average Daily Volume =       3.8 million  
Listed on  July 23, 2009