Option Investor

Daily Newsletter, Tuesday, 1/26/2010

Table of Contents

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

Market Wrap

Preview of Things to Come

by Jim Brown

Click here to email Jim Brown

Tuesday's rally failure could be a preview of things to come based on less than exciting earnings, weaker housing numbers, fear of the Fed and the Speech on Wednesday.

Market Stats Table

The market weakness was led by further news out of China about higher reserve requirements for banks in another move to slow down their rebounding economy. In the first three weeks of 2010 banks have already loaned more than the entire fourth quarter of 2009. Last week six banks were told to stop lending completely and three more have stopped this week. The reserve requirements announced today put the brakes on those still able to lend.

Helping to sour sentiment was a bigger than expected earnings loss by Regions Financial (RF) of 51-cents. Analysts were only expecting a loss of 34 cents. The loss came from higher than expected loan charge offs and a higher loan loss reserve of $1.18 billion for the quarter. Non-performing loans rose to $4.41 billion from $1.72 billion in 2008. Charge offs for the quarter were $692 million.

The continued worry over loan losses in both consumer loans and commercial real estate is weighing on the financial sector and the markets. Current estimates for pending foreclosures are for 4.5 million homes to be foreclosed in 2010. Some of those may be saved by loan modification programs but more than 50% of recently modified loans have gone delinquent again within six months.

The vast amount of foreclosure inventory headed for the market in the spring is depressing home prices again. The Case Shiller Home Price released today improved only slightly to a decline of -5.3% in November compared to the October decline of -7.3%. Some areas actually showed positive gains but there is clearly a slowing in the price rebound as banks begin dealing with problem loans again. Most banks deferred foreclosures in November/December/January in order to keep people in their homes with the heat on rather than be faced with vacant homes and frozen pipes causing extensive damage. Now banks are ramping up foreclosures in order to have the houses vacant in time for the spring shopping season before the homebuyer tax credit expires.

Case Shiller Indexes

In other economic news the weekly chain store sales for last week declined by -2.5% suggesting consumers are tapped out and are no longer spending. There were no weather problems keeping consumers from shopping.

Consumer Confidence for January improved slightly in January to 55.9, up from 53.6 in December. This is still a very low level and less than half the levels seen in 2007 over 110. Contrary to other consumer indicators the present conditions component provided most of the gain with a jump from 20.2 to 25. The 20.2 reading for December was the lowest level for this cycle and even lower than during the financial meltdown in late 2008, early 2009. It is not surprising that we saw a significant bounce now that the frustration of a holiday season with limited funds has passed. The internal components relating to employment both improved slightly.

Those consumers planning to buy a car spiked from 3.9% to 5.1% suggesting that confidence in the future is improving. Consumer don't ramp up plans to purchase autos if they think employment is going to be a problem. Those expecting their income to decline over the next six months fell to 16.2% and the lowest level since September 2008. The improvement in confidence was only present in consumers over 35. The confidence of respondents under 35 dropped sharply.

Consumer Confidence Chart

The first of the regional Fed reports showed that manufacturing in the Richmond Fed district declined for the second consecutive month into negative territory with a -2 headline reading. This was slightly better than the -5 in December but this is two months now in contraction territory after seven months in an expansion phase as high as +14. The backlog of orders component fell to -13. The employment component fell to -5 and marked three months in negative territory. While the consumer confidence numbers are firming this has not translated into a surge in consumer spending and a new inventory replenishment cycle for manufacturers.

On the calendar for Wednesday are the New Home Sales, Mass Layoffs and Oil Inventory reports. Most importantly the Fed will release their January meeting announcement at 2:15 ET. Nobody expects any change in rates but the statement will be very important especially considering the Bernanke confirmation is running out of time. Will Bernanke play it safe and release a benign summary or will he try to shake things up by pointing out areas of weakness in the economy that will require further management by an active Fed chairman. I am betting on a benign announcement with a continuation of the "extended period" comments.

After the bell today Yahoo reported earnings that met street estimates of 11-cents. The stock rose +50 cents in after hours after Yahoo noted that demand for premium display advertising had improved significantly. Yahoo said revenue would rise to $1.575 billion to $1.675 billion compared to $1.58 billion in 2009-Q1. CEO Carol Bartz said Yahoo has positive momentum and prospects were good heading into 2010. However, Yahoo's revenue fell by -12% and declined for the fifth consecutive quarter. This is the sharpest decline in eight years. Their expectations for +3% revenue growth was encouraging for the economy that advertising was improving but at the same time disappointing for Yahoo when compared to Google's strong performance.

Yahoo Chart

U. S. Steel (X) was a weight on the market after they warned of a wider than expected loss in 2010 and a Q4 loss of $1.86 per share. Analysts were looking for a loss of -1.44 per share. Investors had been betting on the sector in December and early January and the sudden dampening of expectations caused a serious sell off today. Shares of U.S. Steel fell -12% or -6.62 to $49.56. There was a flurry of downgrades and S&P cut the price target to $35 while maintaining a sell rating. Just a year ago US Steel earned $2.50 per share on revenue of $4.5 billion.

U.S. Steel Chart

U.S. Steel competitor Nucor (NUE) reported a small profit of 18 cents and beating estimates of 7-cents. However, Nucor also predicted a tough 2010 and earnings pressure from falling prices on their current inventory. Earnings from these two companies put a cloud over the outlook for not only the U.S. recovery but the global recovery as well.

In the chip sector ST Microelectronics (STM) posted better than expected sales but warned that demand was slowing in 2010. STM posted revenue of $2.58 billion and a gross margin of 37% and both beat estimates. However, STM posted a per share loss of -4 cents compared to estimates for a profit of 2.2 cents. STM said it expected Q1 revenues to decline 7% to 13%.

So far this cycle 118 S&P companies have reported earnings. Of those 80% have beaten earnings per share estimates and 16% have missed estimates. According to Thomson only 65% have beaten revenue estimates with 35% coming in below analyst's expectations. Banks and financial institutions had been expected to lead the earnings parade with strong results but a closer examination shows otherwise. 51% of financial companies have missed EPS estimates and revenues are averaging 10% below consensus. Meanwhile tech stocks are averaging a 19% estimate beat with revenues 6% over estimates.

Overall S&P companies have reported EPS growth of +196% compared to expectations for +184%. However, if you take out financials that EPS growth falls to only +11% compared to expectations of 8%. Revenues for all companies have seen +6% growth compared to estimates for +7% growth. If you remove financials that revenue growth falls to only +1% and inline with expectations. Basically non-financial companies are flat lining on revenue with their earnings per share gains still coming mostly from cost cutting and not sales.

Those numbers I just reported are putting pressure on stock prices because investors were expecting a blowout quarter. Instead we are getting a lot of continued cost cutting gains and weak guidance. It is going to be very difficult to maintain a rally on these earnings numbers over the next couple months.

Apple Inc traded flat after Monday's record earnings as investors wait for the big tablet announcement on Wednesday. This is being hyped as the biggest new product since the iPhone and everyone is expecting Steve Jobs to go to great lengths to make it appear even more important. We found out today that the iPad or iTablet or whatever it is going to be called is going to use the same operating system as the iPhone. That suggests it will have the same screen manipulation options for dragging, expanding, swiping, etc. It also suggests that applications written for the iPhone could also work on the iPad. It is probably going to be a computer, an E-reader, a video player and maybe even a phone.

Unfortunately the hype has been so strong that it will be practically impossible to meet expectations. About the only thing it is not expected to do is cure swine flu or turn back time for Port-au-Prince. I would not be surprised to see Apple decline after the announcement as the air begins to bleed out of the expectation balloon.

Chart of Apple

S&P confirmed today that Berkshire Hathaway would replace BNI in the S&P indexes after Berkshire shareholders vote on the BNI acquisition on Feb-11th. Warren Buffett said index funds would have to buy 6% of the outstanding stock to add Berkshire to their holdings. Berkshire class B shares split 50:1 last Wednesday and closed today at $68. Berkshire B shares do have options if you want to play that S&P addition sometime after Feb-11th. The stock is going through some post split depression this week after spiking to $3500 from $3200 in the days before the split. Once it returns to support around $65 I would look to add some calls for about three months in the future assuming the market cooperates.

Berkshire B Chart

Problems the market is facing for the rest of the week include the FOMC announcement, President Obama's State of the Union speech on Wednesday and the vote to confirm Bernanke on Thursday. The FOMC should not be a problem but the market is always cautious ahead of the event. Analysts will want to see the extended period statement and hopefully some positive comments about the economy.

The State of the Union speech in past years has been something that preempted normal programming and had you channel surfing to find something of interest. This speech is expected to be chock full of new programs, new rules and populist politics. It is almost inconceivable that there won't be something to rile the market so everyone will be paying rapt attention.

Senator Harry Reid has scheduled the vote to confirm Bernanke on Thursday. Reportedly there are now enough votes to insure confirmation. Wall Street and the market acted so badly last week when several democratic senators tried to flush the confirmation that president Obama was forced to call in favors and lean on some senators to make sure a negative vote was one problem he would not have to face in the future. It was amazing how quickly he came to Bernanke's aid after the market imploded on the news.

We are rapidly approaching the WB point. That is not the WB network but the "Why Buy" period for stocks. Once earnings are pretty much over as they will be after Microsoft reports on Thursday there is little incentive to buy stocks. Earnings have been weaker than expected with almost no revenue growth and every day we get another list of warnings. The economy is not rebounding as fast as investors had hoped and the markets are up +65% or more since last March.

With bears becoming more bold as each day passes and bulls running out of stories to buy and the indexes either at or falling below critical support the outlook is becoming increasingly dim. The markets gave back solid gains today to finish in the red and that is never a good sign after a big sell off. It means traders who bought the dip could not hold the gains and lacked the confidence and the strength to maintain the rebound. The markets will need a story or a major event to create a short squeeze soon or the path of least resistance is down.

The Dow has closed below critical support at 10300 for two consecutive days and interim support at 10200 appears to be weakening. Odds are increasing for a move back below 10000. Resistance has fallen to 10260 and afternoon sell programs have returned.

Dow Chart

The S&P-500 is still holding above three-month support at 1085 but a break there targets 1035 or lower. The S&P is being held up by the large tech stocks and a sell the news event on Apple on Wednesday could be ugly. Strong earnings from tech stocks like INTC, IBM, GOOG and TXN were not enough to hold their gains and all are trading sharply lower from their earnings release dates. If this trend continues with Microsoft that could be the last straw that starts the decline. S&P 1085 is the critical support level to be watched and a break there should be the start of another leg down.

S&P-500 Chart

The Nasdaq continues to hold at critical support at 2200 and the future of the index depends on reaction to Apple's announcement on Wednesday and the Microsoft earnings on Friday. As I showed you earlier the tech sector has the strongest earnings for a non-financial sector but we are already trading -125 points off the highs and we are running out of major tech events to keep us in rally mode. If support at 2200 fails I believe we will see 2040.

Nasdaq Chart

In summary the markets have several potholes ahead in the FOMC, SOTU speech, Bernanke vote, Apple announcement and Microsoft earnings. If we survive all those events there is nothing the following week to provide additional support and we face the January non-farm payrolls with the potential for a sharp increase in jobs lost plus a major revision to prior numbers.

I believe the path of least resistance is down but that does not mean there won't be a couple of short squeezes in our immediate future. I would use any rebounds to resistance as entry points for bearish plays.

Jim Brown

New Option Plays

Big Banks, Big Electronics

by James Brown

Click here to email James Brown

Editor's Note:

The stock market could end up churning sideways on Wednesday as investors wait for the FOMC decision Wednesday afternoon. After the announcement stocks can get a little wild with big swings and sharp reversals but investors may choose to sit tight and wait to hear President Obama's state of the union address Wednesday night.


JPMorgan Chase - JPM - close: 38.44 change: -0.77 stop: 41.55

Why We Like It:
You could easily argue that JPM is already short-term oversold and due for a bounce. However the stock is acting very bearish. Investors must be very concerned about the Obama administration actually passing significant reforms that will change the current banking system and how some of these large banks make money. Shares of JPM broke key support near $40.00 and its 200-dma. It has bounced around for a couple of days and now broken down to new lows.

I'm suggesting small bearish positions now. Our first target to take profits is at $35.25. Our second target is $32.00.

Suggested Options:
I am suggesting the February $38 or the March $35 puts.

BUY PUT FEB 38.00 open interest=11,923 current ask $1.34
(CBOE format: JPM1020N38)
BUY PUT MAR 35.00 open interest=11,307 current ask $1.07
(CBOE format: JPM1020O35)

Annotated Chart:

Entry  on   January 26 at $ 38.44 
Change since picked:       + 0.00
Earnings Date            04/15/10 (unconfirmed)
Average Daily Volume =         46 million  
Listed on   January 26, 2010         

SIEMENS - SI - close: 93.60 change: +4.29 stop: 98.30

Why We Like It:
SI reported earnings this morning before the bell. Fourth quarter profits came in at 1.48 billion euros on revenues of 17.4 billion euros. Analysts were only expecting a profit of 950 million euros with revenues closer to 17.9 billion. SI beat the earnings estimates thanks to cost cutting. The company reaffirmed its full year guidance even though SI has been struggling with global demand for its services (engineering) and products (electronics).

The stock rallied on the earnings news but the rebound faltered midday. I suspect this is a knee jerk reaction to the earnings beat and investors will sell into the report to lock in gains. Thus I'm suggesting we take advantage of today's pop to buy puts. We'll use a stop loss above the recent resistance. Our first target is $87.55. Our second target is $81.00. Our time frame is three to four weeks.

Suggested Options:
I am suggesting the March $90 puts.

BUY PUT MAR 90.00 open interest= 79  current ask $3.20
(CBOE format: SI1020O90)

Annotated Chart:

Entry  on   January 26 at $ 93.60 
Change since picked:       + 0.00
Earnings Date            01/26/10 (confirmed)
Average Daily Volume =        368 thousand 
Listed on   January 26, 2010         

In Play Updates and Reviews

The Bounce Rolls Over

by James Brown

Click here to email James Brown

CALL Play Updates

*Currently we do not have any call play updates*

PUT Play Updates

FEDEX Corp. - FDX - close: 80.76 change: +0.07 stop: 82.55

FDX struggled all day to rally toward yesterday's highs and then began to roll over with the market late in the session. There is no real change from my prior comments. If FDX bounces look for resistance near $82.00-82.50 and buy puts on a failed rally. If FDX sinks I'd look for a dip under $79.75 or $79.50 as a new entry point. Our first target is $75.25.

Entry  on   January 25 at $ 79.45 
Change since picked:       + 1.31
Earnings Date            03/18/10 (unconfirmed)
Average Daily Volume =        3.0 million  
Listed on   January 23, 2010         

Gymboree - GYMB - close: 39.04 change: -0.73 stop: 42.75

Some of the retail stocks got a bounce out of the better than expected consumer confidence numbers this morning. GYMB was not one of them. The stock failed at $40.00 again this morning and sank to a new relative low. Our first target is $35.50. Our second, longer-term target is $32.00. We are going to use a slightly wider, more aggressive stop loss in case GYMB sees an oversold bounce. Consider using small positions to limit your risk. Over the weekend I suggested the February $40 puts (GQU-NH).

Entry  on   January 23 at $ 39.74 
Change since picked:       - 0.70
Earnings Date            03/04/10 (unconfirmed)
Average Daily Volume =        513 thousand 
Listed on   January 23, 2010         

Infosys Tech. - INFY - close: 54.06 change: -0.44 stop: 56.25

The early morning bounce attempt in INFY failed near $55.00 and shares settled right at support at the 50-dma. INFY looks fragile here and poised for a breakdown in spite of being short-term oversold. There is no change from my prior comments. I am suggesting we use a trigger at $53.40 to open small put positions. If triggered our first target is $50.15. Our second target is $46.50.

Entry  on   January xx at $ xx.xx <-- TRIGGER @ 53.40
Change since picked:       + 0.00
Earnings Date            04/15/10 (unconfirmed)
Average Daily Volume =        1.5 million  
Listed on   January 25, 2010         

Mettler Toledo Intl. - MTD - close: 98.97 change: -0.12 stop: 102.25

Today's session produced another entry point to buy puts. Traders bought the early morning dip near $98.00 but the bounce failed at the $100.00 level. Our first target is $95.25. Our second target is $90.50. Our time frame is a couple of weeks. We do not want to hold over the early February earnings report.

Entry  on   January 22 at $ 99.40
Change since picked:       - 0.43
Earnings Date            02/04/10 (unconfirmed)
Average Daily Volume =        134 thousand 
Listed on   January 21, 2010         

Retail Holders - RTH - close: 91.96 change: +0.46 stop: 95.05

Better than expected consumer confidence numbers from the Conference Board this morning gave stocks and the retailers a boost. Unfortunately for the bulls the rally ran out of steam. I remain bearish on the RTH and would still consider new positions here at current levels. If you think the market needs to bounce first before continuing lower then wait for a failed rally in the $93-94 zone as your entry point. Our first target is the $87.00 level. The 200-dma will probably be support. The RTH moves kind of slow.

Entry  on   January 23 at $ 91.42 
Change since picked:       + 0.54
Earnings Date            --/--/--
Average Daily Volume =        1.7 million  
Listed on   January 23, 2010