Option Investor

Daily Newsletter, Tuesday, 12/22/2009

Table of Contents

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

Market Wrap

Santa Claus Rally Comes Early

by Jim Brown

Click here to email Jim Brown

Santa came early this year with the S&P and Nasdaq closing at new highs for the year. The good economic news was spreading holiday spirit and rewarding the bulls for their faithfulness.

Market Stats Table

The economic calendar favored the bulls today with strong existing home sales a major plus. Existing home sales rose +7.4% in November. That was on top of a +10.1% increase in October. Sales came in at an annualized rate of 6.54 million homes. That is a +44% increase over the sales rate one year ago and the strongest pace since early 2007. It is well over the 5 million unit average over the last 12 months. Home inventories fell to 6.5 months of supply and that is a major drop from the 11.2 months of supply in November 2008. Sales have now gained on a year ago basis for four consecutive months and the longest string of such gains since the end of 2005.

November was the last month for the initial homebuyer tax credit and sales in November were obviously influenced by this event. The homebuyer credit was eventually extended and enhanced with an additional credit for existing home owners as well as new buyers. This will help sales in the spring but probably not in December. I would expect this hot pace of sales to slow in December but pick up sharply in February and March.

Analysts believe the housing market will not really begin to improve until late in 2010 and the overhang of two million foreclosures is expected to wane. Prices overall are still expected to continue declining through the third quarter of 2010 and bottom at a -37% decline. Obviously some areas have already bottomed but several states are still seeing persistent declines. The chart below is very positive with the pace of sales well off the bottom and moving nearly vertically thanks to the buyer tax credit.

Existing Home Sales Chart

Weekly chain store sales rose +0.6% compared to +0.4% in the prior week. This is actually a very small increase for the last week before Christmas. The winter storm in the northeast impacted sales and there may be a carry over into this week. Still consumers are just not buying as they have in years past but with over 15 million out of work that is to be expected.

The last revision of the Q3 GDP came in lower than expected at +2.2% gain compared to the consensus for +2.9% gain. The prior reading was a +2.78% gain and the initial reading was a gain of +3.53%. The drop came from downward revisions in business investment, inventories and consumer spending. Corporate profits rose +$132 billion from Q2 levels.

The slow decline through all the revisions suggests the strength of the rebound was a lot weaker than previously thought. The recession may be over thanks to the stimulus and the record intervention by the Fed and Treasury but the economy has not yet found any real traction. Employment is still very weak and not expected to really improve until Q2/Q3 of 2010.

The Richmond Fed Manufacturing survey fell to a -4 in December from +1 in November and a high of 14 back in Aug/Sep. The backlog of orders fell to -12 and shipments fell -12 points to -6 and the lowest level since March. However the six-month outlook rose to +29 from +24 and the employment index rose +7 points to -2. This manufacturing report was negative as far as the outlook for economic activity growth but it was exactly what the market needed today.

Richmond Fed Survey Chart

The Richmond Fed Survey, GDP and weak chain store sales were all market positive because it means the Fed will not be raising rates any time soon. It is a weak recovery with a weak job market and the Fed should be vindicated for their current "extended period" stance on rates.

Add to that the jump in home sales even if it was motivated by tax credit stimulus and you have signs of a recovery but clearly signs of a weak recovery. If this kind of mixed improvement continues we could see the Fed on hold until the middle of 2010. That will keep the dollar weak assuming we don't have any sovereign defaults overseas. This was a good day for economics and that seems strange to say but it was exactly what the market wanted to see.

Adding to the positive spin was a drop in the mass layoffs for November. The number of layoff events impacting 50 or more workers fell to 1,797 in November from 2,127 in the prior month. The number of workers impacted in November fell to 165,346, down from 217,182 in October. This was the third straight monthly decline. Manufacturing still accounted for 28% of all layoffs but down from 39% in November 2008. Compared to the same period in 2008 the number of mass layoffs has been cut nearly in half. This was another market positive report.

Reports due out tomorrow include Mortgage Applications, Personal Income, Consumer Sentiment, New Home Sales and Oil Inventories. Short of a nuclear event in one of those reports they will be ignored. The markets are already shutting down for the holidays. Volume on Tuesday was only 6.4 billion shares and there are two days left in the week. Volume on Wednesday should be less than 6 billion and Thursday could be under 3 billion. Christmas Eve in 2008 only have 2.3 billion shares across all markets.

In stock news Micron (MU) blew through analyst estimate and posted earnings of 23 cents per share. Analysts were expecting only a 7-cent profit. Revenue rose +24% and Micron was positive on the conference call. Reaction in the stock during the after hours session was muted because nobody was around to hear the news.

One stock that did have interested investors was RedHat (RHT). RedHat posted earnings of 17-cents and beat the street by a penny. Normally a penny beat is not a market mover. They also raised guidance slightly but the real boost for the stock came from comments from the CEO that he was seeing strength "across the board" in North America and Europe but growth was picking up more strongly in the United States. He said customers were starting new projects again. "Our pipeline remains quite strong. We are optimistic about the business going forward." RHT rose from $29.86 to $31.80 in after hours.

RedHat Chart

Google (GOOG) moved over $600 again to close at a new 52-week high and the target prices are starting to rise again. The google chart is a perfect picture of a bullish chart and the 30-day average as been support since March. Most analysts are starting to wake up to the fact that Google has a PE that is roughly half of the 78 PE carried by Amazon. The online retailers margins are a fraction of Google's margin and they have a lot more overhead and consumer risk. Despite the $600 stock price analysts are saying again that Google is cheap. A 10:1 stock split announcement would give the stock a major boost.

Google Chart

The positive housing news produced winners in the homebuilders and the building supply stores. Home Depot closed at a new 52-week high and attracted a new round of positive comments from analysts. Home builders are expected to double over the next 12 months as they restart their building cycles. I have noticed dormant fields here in the Denver area that were graded and plotted a couple years ago but then abandoned are being revived and graders are back to groom them for housing starts in the next couple months. KB Home (KBH) and Ryland (RYL) were getting lots of press today but the chart on DR Horton looks the most appealing to me with a nice rounded bottom.

Chart of DR Horton

OPEC met in Angola and as expected they didn't change a thing. They are already cheating to the tune of about 2 million barrels per day above their "official" quotas and the price of oil is holding over $70 so according to them this is a perfect world. Saudi Oil Minister al-Naimi actually said "the price is perfect." The price rallied on the news to close at $74.30 as the new February front month contract tries to find equilibrium in market place since it is no longer tied to the January contract that expired on Monday.

Crude Oil Chart

The airlines are thriving despite the price of oil being over $70. The price of jet fuel is low because of extra refining capacity and excess crude inventories. The XAL Airline index closed at a new 52-week high. I continually scratch my head since the papers were full of stories over the last week about airline ticket prices being slashed by up to 78% for holiday travel. Airlines were canceling their requirements for booking travel two weeks in advance and basically saying, "come on down and fly today" with discount rates. The problem is a -4% drop in travel over the same period in 2008 and plenty of vacant seats for holiday travel. Think about that for a minute. We know how bad travel was in Q4 of 2008. It was Armageddon in the financial sector with major financial institutions failing every week. Consumers were boarding up their windows for the coming depression rather than boarding airplanes for holiday travel. Now in December 2009 holiday travel is down another 4%? So why are the airlines at 52-week highs?

Airline Index Chart

I think the obvious reason that airline stocks, housing stocks, tech stocks and others are rising is the bursting of the bubble. Got you there, you are thinking I mistyped that last sentence. The bubble that is bursting is the pessimism bubble. Optimism is breaking out all over and the economic bears don't know what to do. I have not gone off the deep end and I still expect a short dip in January but I believe things are looking up long term and the market will reflect this in 2010. I keep hearing about analyst upgrades for earnings estimates for Q4 and now all of 2010 and the bulls are starting to be more prevalent on the airwaves than gloomy sound bites from Nouriel Roubini.

According to TrimTabs.com this is shaping up to be the best year in the markets since 2003. The S&P is up +23% for the year, +55% since March and earnings estimates are rising. This strong market performance has come despite record outflows from stock funds, record inflows into bond funds, record new offerings, record lows for insider buying and stock buybacks. This was a monster wall of worry for the bulls to overcome and it will still be the best year since 2003. Somebody pinch me, this must be a dream. I am looking forward to a buying opportunity in January and I hope everyone else is as well.

I have to cut this short tonight. My mother (90) went into the hospital last week and the doctors called me in for a conference this afternoon and I lost two hours of writing time.

The Dow closed at 10464 and the chart below has not changed from then I drew it two weeks ago. The trading range on the Dow is still rock solid with resistance at 10500. However, based on the performance of the Nasdaq, S&P and Russell I view this shortfall on the Dow as a positive. Money is no longer being spent only on blue chips. There is a clear move to small caps and techs and that is a positive indicator for the overall markets.

The Dow has had two nice days and despite the volatility this afternoon still posted a gain of 50 points. We still have about five days before year-end and the trend is actually becoming more bullish. I could easily see a move over 10500 before the January dip.

Dow Chart

The S&P picked up some speed and managed to close at 1118 and over resistance of 1115 despite a strong dollar hitting a new three-month high. The S&P closed at a new high for the year and could be poised to really gain some ground in a low volume market if the shorts are forced to begin covering. Resistance at 1115 has been an easy short for nearly two months and a break in that trend could produce some serious short covering. Resistance over 1115 is well above at around 1175.

SPX Chart

The Nasdaq is in breakout mode and considering it broke out of a bearish wedge this could continue to be strong once over 2252. You may remember my Nasdaq charts from the last couple weeks with the 61% fib retracement resistance at 2252. This is the 61% rebound point for the bear market drop. It should be at least minimal resistance and guess where the Nasdaq stopped today? Yes, 2252. I would expect this to be a challenge but based on some of the short covering I saw on some individual tech stock charts we could move past this quickly. This is a bullish breakout and it could be accentuated by the thin market over the next two days.

Nasdaq Chart

The Russell has not yet broken over October resistance but sprinted out of congestion to challenge that resistance on Tuesday. I can't emphasize how critically important this level is to the markets. If fund managers are shifting enough buying out of blue chips and into small caps to push the Russell over 623 then we may be in for a major change in market sentiment. This would be very bullish and depending on the strength could even negate or reduce the potential for an early January dip.

Russell Chart

The problem traders face tonight is knowing whether the two day rally is just a pull forward from the normal post Christmas rally, window dressing or new buying and a change in trend from the last two months. If this is a new push higher that triggers short covering in a thin market on Wed/Thr then we could be off to the races. If this is just window dressing then we should stall at today's closing levels and go sideways until next week. I would like to think we are facing a new paradigm and the bulls are starting to get aggressive again. Time will tell.

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Jim Brown

New Option Plays

Metals Looking Stronger

by James Brown

Click here to email James Brown


NUCOR Corp. - NUE - close: 45.34 change: +0.72 stop: 41.75

Why We Like It:
Some of the metal stocks have been showing relative strength. NUE has managed to breakout over resistance at $44.00, at $45.00, at its 100-dma and at its exponential 200-dma. Shares do look a little bit overbought here. I would open call positions now but keep your positions small. Only 1/2 or 1/4 your normal size. Then if we see NUE correct back toward $44.00 we can choose to double down and increase our position on a dip or a bounce. Our multi-week target is $49.50.

Suggested Options:
We will plan to exit ahead of the late January earnings report. I'm suggesting the February calls. My preference is the $45 strike.

BUY CALL FEB 45.00 NUE-BI open interest=448  current ask $2.35

Annotated Chart:

Entry  on  December 22 at $ 45.34 (1/2 position or less)
Change since picked:       + 0.00
Earnings Date            01/28/10 (unconfirmed)
Average Daily Volume =        4.5 million  
Listed on  December 22, 2009         

In Play Updates and Reviews

Bulls Charge Toward Christmas

by James Brown

Click here to email James Brown

We had one of our bullish plays hit our target and another hit our entry point to buy calls.

CALL Play Updates

EQUINIX Inc. - EQIX - close: 107.06 change: -0.25 stop: 99.75

Tuesday ended with a quiet and disappointing session for EQIX. Shares did rebound from the intraday low but still closed in the red while most of the market closed higher. The general trend, which is up, remains unchanged. Our first target is $109.50. Our second target is $113.50. The plan was to use small position sizes to limit risk.

Entry  on  December 09 at $103.02
Change since picked:       + 4.04 
Earnings Date            02/10/10 (unconfirmed)
Average Daily Volume =        501 thousand 
Listed on  December 09, 2009         

Infosys Tech. - INFY - close: 54.45 change: +0.37 stop: 49.90

INFY is still churning sideways in the $53-55 zone. There is no change from my prior comments. Our first target to take profits is at $55.75. Our second and final target is $59.50. We will plan to exit ahead of the January 12th earnings report.

Entry  on  December 05 at $ 51.88 /gap down entry point
                           /originally listed at $52.46
Change since picked:       + 2.57
Earnings Date            01/12/10 (confirmed)
Average Daily Volume =        1.4 million  
Listed on  December 05, 2009         

General Dynamics - GD - close: 68.20 change: -0.39 stop: 67.45

I would seriously consider an early exit in GD right now. The stock has been under performing the last few days. Shares are still hovering near support but this relative weakness is worrisome. More cautious traders might want to abandon ship. I'm not suggesting new positions at this time.

Our first target to take profits in GD is $74.95. FYI: The Point & Figure chart is bullish with a $105 target.

Entry  on  December 14 at $ 70.66 (half position)
Change since picked:       - 2.46
Earnings Date            01/27/10 (unconfirmed)
Average Daily Volume =        1.6 million  
Listed on  December 14, 2009         

Mettler Toledo - MTD - close: 106.02 change: +2.25 stop: 99.45

MTD displayed relative strength with a 2.1% gain and a new 2009 high. Our first target is $109.00.

Entry  on  December 19 at $102.66 (small positions) /gap down entry
Change since picked:       + 3.36
Earnings Date            02/04/10 (unconfirmed)
Average Daily Volume =        106 thousand
Listed on  December 19, 2009         

Blue Nile Inc. - NILE - close: 62.40 change: +2.01 stop: 57.40

Our new call play on NILE is off to a strong start. Shares rallied 3.3% with decent volume. Our first target is $64.90.

Entry  on  December 21 at $ 60.39
Change since picked:       + 2.01
Earnings Date            02/18/10 (unconfirmed)
Average Daily Volume =        144 thousand 
Listed on  December 21, 2009         

Norfolk Southern - NSC - close: 53.01 change: -0.07 stop: 49.75

The railroad stocks are still stuck in their trading range and NSC is hovering at the top of its trading range near $53.00. Our first target is now $56.50. Our second and final target is $59.50. Our time frame is several weeks. FYI: The Point & Figure chart is bullish with a $65 target.

Picked on  November 21 at $ 51.84 (small positions)/gap higher entry
Change since picked:       + 1.17
Earnings Date            01/27/10 (unconfirmed)
Average Daily Volume =        5.4 million  
Listed on  November 21, 2009         

Precision Castparts - PCP - close: 114.83 change: +1.01 stop: 107.25

The rally continues in PCP with the stock up three days in a row. Shares closed at another new 2009 high and hit $115.60 intraday. PCP has already hit our first target at $112.45. Our second target is $118.75. The Point & Figure chart is bullish with a $131 target.

Picked on  December 01 at $107.35
Change since picked:       + 7.48
                            /1st target hit $112.45 (+4.7%)
Earnings Date            01/20/10 (unconfirmed)
Average Daily Volume =        817 thousand 
Listed on  November 28, 2009         

Stifel Financial - SF - close: 58.20 change: +0.53 stop: 54.95

Our call play on SF has been opened. The stock broke out to new highs after trading sideways for months. Our plan was to buy calls at $58.05. The stock hit $58.25 intraday. Our first target is $64.50. Our time frame is January expiration. The P&F chart is bullish and points to a $70 target.


Entry  on  December 22 at $ 58.05
Change since picked:       + 0.15
Earnings Date            02/11/10 (unconfirmed)
Average Daily Volume =        207 thousand 
Listed on  December 16, 2009         

UnitedHealth Group - UNH - close: 32.32 change: +0.15 stop: 27.99

UNH continues to inch higher and set a new closing high for the year. At this time I'd consider buying new call positions on a dip or bounce near $30.50-30.00. Our first target is $34.00. Our longer-term target is $36.00. Our time frame is several weeks. If you buy March calls you might want to think about holding over the late January earnings report.

Entry  on  December 10 at $ 30.31 
Change since picked:       + 2.01
Earnings Date            01/21/10 (unconfirmed)
Average Daily Volume =        819 thousand 
Listed on  December 10, 2009         

United Tech. - UTX - close: 69.35 change: -0.01 stop: 67.45

UTX delivered another disappointing session. The stock remains stuck in the $69.00-70.00 zone. I'm suggesting readers wait for a new rise over $70.25 to launch positions. More conservative traders may want to use a tighter stop loss. Our first target is $74.75. The Point & Figure chart is bullish with a $95.00 target.

Entry  on  December 15 at $ 70.25
Change since picked:       - 0.90
Earnings Date            01/21/10 (unconfirmed)
Average Daily Volume =        4.0 million  
Listed on  December 12, 2009         

Valmont Industries - VMI - close: 81.72 change: -0.48 stop: 78.45

VMI hit new relative highs this morning but couldn't hold them. Shares under performed the market with a 0.5% decline. Our first target to take profits is at $84.90. Our second target is $88.75. FYI: The most recent data list short interest at 9% of the very small 20.1 million-share float.

Entry  on  December 10 at $ 81.00
Change since picked:       + 0.72
Earnings Date            02/10/10 (unconfirmed)
Average Daily Volume =        238 thousand 
Listed on  December 05, 2009         

Vertex Pharma - VRTX - close: 42.90 change: +0.75 stop: 39.75

VRTX is extending its gains with another 1.7% rally. Our target to exit is at $44.25. My time frame is several weeks.

Entry  on  December 03 at $ 40.25
Change since picked:       + 2.65
Earnings Date            02/09/10 (unconfirmed)
Average Daily Volume =        3.2 million  
Listed on  November 23, 2009         

Whirlpool - WHR - close: 83.65 change: +0.10 stop: 74.99

Target achieved. WHR spiked to $85.01 this morning. Our first target to take profits was at $84.75. The stock eventually pared its gains and the move looks like a short-term top. I would expect a minor correction back toward $81-80. Our second target is $89.00. FYI: The Point & Figure chart is bullish with a $103 target.


Entry  on  December 19 at $ 80.76 /gap higher entry
Change since picked:       + 2.89
                             /1st target hit $84.75 (+4.9%)
Earnings Date            02/08/10 (unconfirmed)
Average Daily Volume =        1.6 million  
Listed on  December 19, 2009         

PUT Play Updates

Freeport McMoran - FCX - close: 78.45 change: +0.49 stop: 80.55

FCX is still trying to bounce and it's inching closer to resistance near $80.00 again. Wait for the rally to fail before launching new put positions.

Remember, we should consider this an aggressive, higher-risk trade because the dollar, commodities, and shares of FCX can be somewhat volatile. The plan was to use very small positions to limit risk. Our first target is $72.50. I'm adding a second target at $68.50.

Entry  on  December 12 at $ 76.81 
Change since picked:       + 1.64
Earnings Date            01/26/10 (unconfirmed)
Average Daily Volume =       12.6 million  
Listed on  December 12, 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.)

Apple Inc. - AAPL - close: 200.36 change: +2.13 stop: n/a

AAPL is above round-number resistance at the $200 level and above its 50-dma. This is definitely short-term bullish. I am not suggesting new strangle positions at this time.

The options in the January strangle were January $220 calls (AJL-LV) and the January $180 puts (APV-XR). Our estimated cost is $5.60. We want to sell if either option hits $10.00 or more.

Picked on  November 30 at $199.91
Change since picked:       + 0.45
Earnings Date            01/21/10 (unconfirmed)
Average Daily Volume =       15.1 million  
Listed on  November 30, 2009         

United Parcel Service - UPS - close: 58.58 change: -0.04 stop: n/a

There is not much change in shares of UPS nor do I see any changes for our trade. I'm not suggesting new strangle positions.

January Strangle
The options suggested for the January strangle were the January $60.00 calls (UPS-AL) and the January $55.00 puts (UPS-MK). Our estimated cost was $1.35. I would plan to sell if either option hit $3.50 or more.

Picked on  November 21 at $ 57.99 /gap open entry
Change since picked:       + 0.59 
Earnings Date            02/02/10 (unconfirmed)
Average Daily Volume =        4.7 million  
Listed on  November 21, 2009