Option Investor

Daily Newsletter, Monday, 4/12/2010

Table of Contents

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

Market Wrap

Greece News Helps Stocks To Small Gains

by Todd Shriber

Click here to email Todd Shriber
News of a massive $61 billion loan package from European Union members and the International Monetary Fund (IMF) to Greece bolstered the Euro and in turn, led to small gains for the major U.S. indexes. The gains were looking far better earlier in the session, but another one of those sell programs kicked in during the afternoon and that left the Dow Jones Industrial Average with a gain of just 8.62 points for a close at 11005.97. The S&P 500 continued to inch toward 1200, gaining 2.11 points to settle at 1196.48 and the Nasdaq gained almost four points to close at 2457.87.

Stats Table

I mentioned last week that the spreads on Greek bonds over German bunds had blown-out to historical highs and the cost of insuring Greek debt via credit default swaps had also soared to record levels, but on news of the aforementioned loan package, those credit default swaps fell 62 basis points to 364 basis points. Spreads between Greek bonds and German bunds narrowed today by 49 basis points. That news helped the Euro appreciate against the 16 major currencies. The currency had been down almost 5% this year against the dollar. The bulls can only hope that this is the final chapter in the Greek saga that has been a real issue for equity markets.

Euro/Dollar Chart

Stocks also got a lift from a healthy dose of mergers and acquisitions news. Electric utilities Mirant (MIR) and RRI Energy (RRI) rose by 18% and almost 15%, respectively, on news that the two companies would combine through a stock-swap merger valued at over $3 billion. The combined company will be called GenOn Energy and have a market value of $3.1 billion and 24,700 megawatts of generating capacity, according to MarketWatch.

Under the terms of the deal, which was announced on Sunday night, Mirant shareholders will receive 2.835 RRI shares for each Mirant share they own. Mirant will own 54% of the new company and RRI will own the remaining 46%. GenOn will be based in Houston and the new board will have five directors from each company. The transaction is expected to close later this year.

Sure, M&A activity of this magnitude is a good sign for the broader market, but as it pertains to Mirant and RRI, one might argue that this is an example of two wrongs coming together with the hopes of forming a right. As you can tell from the chart below, Mirant has not been a stellar performer recently. Neither has RRI. Both stocks are down about 30% this year.

Mirant Chart

Moving over to the oil patch, Apache (APA), the second-largest U.S. independent oil and gas producer, said it will acquire Devon Energy's (DVN) shallow-water operations in the Gulf of Mexico for $1.05 billion. That is far higher than the $750 million Dow Jones reported Apache would pay Devon when news of the deal broke late last week.

The deal comes as part of Devon's plans to divest its international and offshore assets to focus on the North American natural gas market. After taxes, the sale to Apache should net Devon about $840 million in proceeds. Combine that with the $7 billion asset sale to BP (BP), Europe's largest oil company, that Devon announced last month, and Devon is going to be close to raising $7.5 billion, the high end of the range the company estimated for its asset sales.

In addition, Devon still has some assets in China that it wants to sell. The Gulf properties acquired by Apache are projected to produce 9,500 barrels of liquid hydrocarbons and 55 million cubic feet of natural gas per day, Reuters reported. The deal is expected to close in June.

Devon Energy Chart

Staying in the oil sector, ConocoPhillips (COP), the third-largest U.S. oil company, said it will sell its 9% stake in the Syncrude project in the Canadian oil sands to China's Sinopec, the largest oil refiner in Asia, for $4.65 billion. The deal is one of the largest to date by an Asian energy producer in North America. Canadian regulators are not expected to oppose the transaction.

Conoco's plans to divest $10 billion in assets to shore up its balance sheet have been well-known for at least several months. The company's leveraged balance sheet has hampered profits and led to a debt burden that is far greater than rivals Exxon Mobil (XOM) and Chevron (CVX), the two largest U.S. oil companies, both of which are much bigger than Conoco in terms of market value.

To be fair to Conoco, analysts were saying that the sale of Syncrude may have been worth only $4 billion, so the company got a better price for its stake than was originally expected and that helped the shares gain over 1% to touch a new 52-week high at $56.17 before closing at $55.96. If anything, this deal highlights the fact that China's demand for oil remains strong and if the country's oil companies need to overpay a bit to acquire new assets, they will do so. The deal is expected to close in the third quarter.

ConocoPhillips Chart

In smaller scale M&A news, California Pizza Kitchen (CPKI) gained almost 1.6% on news that the company was holding talks with private equity firms about a possible sale of the company. The stock popped to $22.92, a new 52-week high, in the morning before steadily selling-off for the rest of the day. Specific buyers were not mentioned in press reports and the CEO of Domino's Pizza (DPZ) said in a CNBC interview after the market closed that his company would not be interested in California Pizza Kitchen.

Just a few weeks ago, it appeared that smart phone maker Palm (PALM) was headed for zero. After all, it is hard to argue that the Pixi has been a legitimate competitor to Apple's (AAPL) iPhone or Research In Motion's (RIMM) BlackBerry. Yet it has been hard to be short Palm recently as takeover news, perhaps the only reason to be long this name, has propped the stock up.

That was the case on Monday as Palm shares gained more than 17% on news that the company hired Goldman Sachs (GS) and Qatalyst Partners to perhaps find a buyer. Monday's headlines follow rumors that swirled last week China's Lenovo and Taiwan's HTC may be interested in Palm. You may remember Lenovo as the company that acquired IBM's (IBM) personal computer business a few years ago.

Palm Chart

I cannot forget to mention that earnings season starts in earnest this week and Alcoa (AA), the Dow component and largest U.S. aluminum producer, got the ball rolling after the market closed today with its first-quarter earnings report. Maybe it is because Alcoa is a commodities producer, a Dow member or because it is always the first marquee name to report earnings, but this report is always closely followed.

The company said it lost $201 million, or 20 cents a share, compared with $497 million, or 61 cents a share, a year earlier. Excluding one-time charges, Alcoa earned 10 cents a share, which was inline with analyst estimates. Revenue surged almost 20% to $4.9 billion.

Outlook is normally the thing to look at when evaluating Alcoa's earnings report and the company had some positive things to say as it is forecasting sales growth in the automotive, heavy truck and trailer markets this year. The company said it is seeing improving demand for aluminum, which hit an 18-month high Monday.

The company said 2010 ''will clearly be better than 2009,'' but that is expectation for nearly every company in every sector and it should be noted that analysts had substantially reduced their estimates for Alcoa, so meeting estimates that had been revised lower is no big feat. Either way, it pays to remember that the Dow is a price-weighted index, meaning that the stocks with the highest price tags account for bigger percentages of the index than the lower-priced members. Alcoa has the lowest price tag of the 30 Dow stocks and is the worst performer in the index thus far in 2010.

Alcoa Chart

Looking at the charts, sure, the Dow closed above 11,000 at a fresh 18-month high, but Monday's trade was not exactly awe-inspiring. The 11,000 figure, as I noted last week, is nothing more than round-number resistance, but a real hurdle can be found around 11,125. With earnings season upon us, the catalysts are there to keep moving the Dow higher or to finally drag it back to Earth.

Tomorrow afternoon is big in terms of earnings reports. I would not underestimate the importance of CSX's (CSX) report because rail carriers offer a good glimpse as to how the broader economy is performing. CSX is not a Dow member, but it is a member of the transports average. The big kahuna will be Intel (INTC). The biggest semiconductor maker in the world and Dow component reports after the close tomorrow. JPMorgan Chase (JPM) chimes on Wednesday morning and Bank of America (BAC) and General Electric (GE) report on Friday morning, so yeah, this is an important week for the Dow.

Dow Chart

Of course, all of those stocks are also members of the S&P 500 which is trying to break real resistance at 1200. As Jim mentioned over the weekend, 1200-1250 was the year-end target offered by many analysts and for those brave enough to boost their targets beyond 1250, earnings and full-year guidance had better be strong to help the S&P 500 toward 1300.

S&P 500 Chart

The Nasdaq continues to hover just above resistance at 2450 and another long-term resistance point at 2465 is not that far off. A near-term move to 2500, while possible, is not probable, but this is an important week for the Nasdaq as well. The Intel report is followed by Google (GOOG) on Thursday and if those reports feature upside surprises and bullish guidance, the Nasdaq may able to traverse 2465, or at least challenge that level, this week.

Nasdaq Chart

While the earnings schedule is decent for this week and it is an options expiration week, I think small gains will continue to be the order of the day, unless the earnings reports I mentioned are really disappointing. I will go back to something that I have mentioned several times in the past and that is if JPM and BAC beat to the upside AND can offer clarity (by that I mean a specific date) on dividend increases, that could be the news the market needs to notch some solid gains this week.

New Option Plays

SPY Puts is our Order of the Day

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:

This bearish play on the S&P 500 play will even out our portfolio and act as a hedge against our long positions.


SPDR S&P 500 Index - SPY - close: 119.74 change: +0.19 stop: 123.05

Company Description:
SPDR S&P 500 ETF (the Trust), formerly SPDR Trust, Series 1, generally corresponds to the price and yield performance of the S&P 500 Index. The S&P 500 Index consists of 500 selected stocks, all of which are listed on the exchange, the NYSE or NASDAQ, and spans over 24 separate industry groups. (source: company press release or website)

Why We Like It:
The S&P 500, along with all of the major indices, looks vulnerable here and I believe it is overdue for a pullback. The ETF appears ready to finally break its steep uptrend line from the February lows. The financials make up a large part of this index and they are right at their November 2008 highs which we anticipate will act as resistance and start the selling in SPY. SPY is also approaching its 200-week SMA and prior support from July/August 2008 which should also provide good resistance. I am suggesting May puts at current levels. Our target is on this trade is $115.50 and we have a time frame of a couple of weeks. However, if the selling picks up steam our target could be hit relatively quickly. We will use an initial stop of $123.05 but expect to lower the stop if the trade is moving our direction.

Suggested Position: Buy PUT MAY $119.00, current ask $2.00

Annotated Chart:

Entry on April xxth at $ xx.xx
Earnings Date Not Applicable
Average Daily Volume = 164 million
Listed on April 12th, 2010

In Play Updates and Reviews

Time to Get Defensive

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:

I believe our positions are in the right sectors but its time to get defensive. We have moved up our stop on PRE, lowered several of our targets, and are also adding a bearish play on SPY to act as a hedge on our long leaning portfolio.

Current Portfolio:

CALL Play Updates

F5 Networks - FFIV - close: 63.99 change: -0.77 stop: 61.40

FFIV closed in the lower quarter of its trading range on Monday. On the intraday charts the $63.50 to $64.00 level has been a key support/resistance area over the last several weeks. The stock is also forming a symmetrical triangle that began on April 1 on its intraday charts. FFIV remains stuck below $65.50. We need it to break-out above this level for our target of $69.75 to be hit. However, I continue to be cautious about a broader market sell-off which would probably take FFIV down. As such, I am looking to close the position this week (or at least move up stops), especially if the stock makes a new high. Our stop remains a $61.40 for now. I am not suggesting any new positions at this time. I want to remind readers again that this is an aggressive, higher-risk trade and we want to keep our position size small.

Current Position: CALL MAY $65.00 (FFIV 10E65.00) @ $3.00

Entry on April 6th at $ 65.26
Earnings Date 04/21/10
Average Daily Volume = 1.0 million
Listed on April 5th, 2010

Coca-Cola - KO - close: 54.59 change: +0.83 stop: 52.95

KO continued its bounce off of its 200-day SMA which has produced a +2.50% rally off the lows from Thursday. My technical analysis comments from the weekend remain the same. KO appears to be forming a higher low on the daily chart. Another positive sign for KO is that it closed above its 20-day and 50-day SMA's. KO is entering a congestion/resistance area just overhead at the $55 to $56 level. KO still looks oversold and if it can break through this level the stock should see $57.00. Our options are doing better and we still have plenty of time until May options expire but KO is a slow mover and I don't want to get stuck in a losing position. KO tends to be a defensive play so it could rally if the overall market is weak. I am moving our target to exit the position from $59.00 to $57.00 but will consider closing the position prior to this level if KO starts to struggle. Conservative traders should consider exiting their positions if KO rallies into the aforementioned congestion zone, with $55.25 as a potential target.

Current Position: CALL May $55.00 (KO 10E55.00) at $1.62

Entry on March 24th at $ 55.22
Earnings Date 04/21/10
Average Daily Volume = 14.6 million
Listed on March 23rd, 2010

L-3 Communications - LLL - close: 94.39 change: +0.48 stop: N/A

We initially viewed this trade as a highly speculative trade and our April 100 calls purchased for $0.30 are now essentially worthless. At this point we will need some sort of a catalyst or news event on LLL to make any money. If LLL happens to spike and the options become worth something we will sell them immediately. I am not suggesting any new positions in LLL at this time.

We chose the out of the money $100 calls to keep our capital investment very small and our position size limited.

Current Position: CALL APRIL 100.00 (LLL 10D100.00) @ $0.30

Entry on March 18th at $ 93.88
Earnings Date 04/22/10
Average Daily Volume = 908 thousand
Listed on March 17th, 2010

Occidental Petrol. - OXY - close: 86.79 change: +0.23 stop: 83.45

OXY was up marginally today +0.27% and is inching higher. OXY has strong support in the $84.50 to $85.00 level and are I am expecting this support to hold if there is any weakness in OXY this week. OXY appears poised to rally from here to new 52-week highs. But we will need crude oil and overall market strength to be in our favor. Our calls in OXY have now gained about $0.70 and we are up +21%. Conservative readers should consider selling their positions or placing a defensive stop to protect profits. On Saturday I moved our first target down $1.00 to $88.75 which is just below last weeks highs. I am looking for OXY to rally to this level in the next week and if it does it will ensure a nice profit on our position. We'll use a longer-term target at $94.00 but this could take several weeks to achieve.

Current Position: BUY CALL MAY $85.00 (OXY 10E85.00) at $3.25

Entry on April 7th at $85.50
Earnings Date 04/29/10 (unconfirmed)
Average Daily Volume = 5.5 million
Listed on April 6th, 2010

PartnerRe Ltd. - PRE - close: 79.79 change: -0.91 stop: $78.75 *NEW*

PRE reversed hard on us today and formed a bearish engulfing candlestick on the daily charts and closing near its lows of the session. I am suggesting readers be cautious here and should consider tightening up stops to limit losses if the selling in PRE continues. My fear is that PRE may have seen its highs for the time being, although there are two key technical levels that may support PRE in the coming days. The stock is very close to its 20-day SMA and an ascending trend line that started March 10, which are both at $79.64. The stock could trade down to the $79.00 level before bouncing so a logical level to place to move up stops would be at $78.75. If PRE can break-out above $81.05 it should test its October 2009 highs of $81.70 which we are going make our new first target. If PRE follows through and breaks out above $81.70 we have a good chance to reach our new second target of $83.90 (just below the late 2007 highs). Conservative traders should consider lightening up positions or taking profits if PRE rallies into the $81.00 level, which should also produce a winning trade.

Current Position: CALL MAY $80.00 (PRE 10E80.00) $ $2.40

Annotated Daily Chart:

Entry on April 6th at $ 80.55
Earnings Date 04/27/10
Average Daily Volume = 989 thousand
Listed on March 20th, 2010

Silicon Laboratories – SLAB – close: 50.47 change: -0.42 stop: 47.95

We are waiting for a pullback in SLAB prior to initiating positions. My comment from Saturday's new plays remains the same. SLAB broke out of resistance in the $49 area on Monday (4/5). The stock closed the week almost $2 higher at $50.89. SLAB is in the semiconductor sector which has been showing overall relative strength recently. The SOX index and SLAB have been holding their uptrend line, and upward channel, since February. I am expecting a quick retracement of SLAB down to its prior resistance line (which is now support) at around $49.25 which we will use as a trigger to buy calls. Our first target is $51.95 and our second more aggressive target is $53.95. Both of these levels are near highs from 2006 and 2003. We'll place our initial stop at $47.95.

Trigger to open bullish positions at $49.25

Suggested Position: CALL MAY $50.00, current ask $2.50, estimated ask at trigger price $1.30

Entry on April xxth at $ xx.xx
Earnings Date 4/28/10
Average Daily Volume = 762,000
Listed on April 10th, 2010