Option Investor

Daily Newsletter, Monday, 4/26/2010

Table of Contents

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

Market Wrap

What Should Have Been...

by Todd Shriber

Click here to email Todd Shriber
If you were reading the headlines before the market opened Monday morning, you probably would have thought that stocks were poised to enjoy a solid day and that was the case for a part of the trading session, but by the time the closing bell rang, the S&P 500 had dropped 5.23 points to settle at 1212.05 and the Nasdaq lost 7.2 points to close at 2522.95. Only the Dow Jones Industrial Average closed higher on the day, gaining three-quarters of a point to finish the day at 11,205. I suppose that still qualifies as a ''gain'' and no matter how small it was, the Dow was able to extend its winning streak to six consecutive days.

Stats Table

There was plenty of mergers and acquisitions news to feast on before the market opened today and while none of the deals could be labeled as ''mega,'' an uptick in M&A activity is a good sign, particularly after the plunge in acquisitions during the financial crisis. Stifel Financial (SF) said it will acquire Thomas Weisel Partners (TWPG) for $318 million in stock. Oddly enough, Stifel is doing this deal to bolster its presence in M&A advisory services for the technology sector, a specialty of Thomas Weisel.

In other M&A news, car rental giant Hertz Global Holdings (HTZ) said it will acquire smaller rival Dollar Thrifty Group (DTG) for $1.2 billion in a transaction that will form the second-largest U.S. care rental firm. Shares of both companies were up sharply on the news and the deal fueled speculation that more consolidation in the car rental sector could be on the way as the industry is just starting show signs of bouncing back from the recession.

Another billion dollar deal on Monday came from Charles River Laboratories (CRL), which agreed to acquire China's WuXi Pharmaceuticals (WX) for $1.6 billion in cash and stock. The deal will help Massachusetts-based Charles River expand its clinical research and development operations on an international level and the company said WuXi would help Charles River bolster its toxicology business. Even when combining all of these deals, the price tag is not very large, but that is not the point. The point is an uptick in a M&A activity will probably be interpreted to be a good sign and that could help this rally along even more.

M&A Activity

Even with the economy improving, it seems companies in the travel and leisure business think consolidation is the way to go to streamline their operations and cut costs. Of course, the airline sector loves some good M&A talk , though talks between United (UAUA) and Continental Airlines (CAL) may have reached an impasse due to the proposed exchange ratio in the stock-for-stock transaction.

The New York Times reported both companies agreed to an ''at-market'' deal, but Continental wants to exchange shares based on United's price before news broke that the two companies were in talks. United wants to use a later share price, which would be more beneficial to its shareholders. The outcome for United here is interesting because it broke off talks with US Airways (LCC) as discussions with Continental progressed, but if no marriage with Continental materializes, United may have to find another partner to dance with.

United Chart

In addition to those deals, there was some good earnings news before the bell from a pair of companies that are considered bellwethers. Caterpillar (CAT), the world's largest maker of construction and mining equipment and a Dow component, not only reported strong first-quarter results, but offered a solid outlook as well. The Illinois-based company earned $233 million, or 36 cents a share, in the first quarter compared with a loss of $112 million, or 19 cents a share, a year earlier. Excluding a charge related to the health care reform legislation, Caterpillar would have earned 50 cents a share. Analysts were expecting a profit of 39 cents.

Revenue did fall 11% to $8.2 billion during the quarter, but investors seemed to digest that news easily because Caterpillar reported some stout international growth. Sales in Asia surged 20% during the quarter. And if you are among those investors that do consider Caterpillar a bellwether, comments from the company's management team bode well not only for shareholders, but perhaps the economy at large.

Chief Financial Officer Dave Burritt said ''we're in a revival'' and that emerging markets are undoubtedly driving growth for the company. Caterpillar has rehired about 2,000 workers after laying-off 19,000 full-time and 18,000 part-time and contract employees last year, according to the Associated Press. The shares touched a new 52-week high of $72.83 on Monday before closing up $2.87, or 4.2% to $71.65.

Caterpillar Chart

Another company that is, shall I say economically sensitive, that reported stellar first-quarter results on Monday was Whirlpool (WHR), the world's largest appliance maker. The maker of Maytag, KitchenAid and its namesake brand turned a profit of $164 million, or $2.13 a share, more than double the $68 million, or 91 cents a share, the company earned a year earlier. Revenue jumped 20% to $4.27 billion. Analysts had been expecting a profit of $1.33 a share on sales of $3.79 billion.

Whirlpool also said emerging markets are contributing to its growth, namely Brazil and Asia. More importantly, the company raised its full-year guidance in a big way, saying it now expects to earn $8 to $8.50 a share, up from previous guidance of $6.50 to $7 a share. So what can be extrapolated from the Whirpool news and outlook? Perhaps that home sales are going to pick up in latter half of this year. New home buyers buy new appliances and buyers of existing homes often like to replace the appliances that came with the house they just purchased.

Appliances are considered durable goods and durable goods orders are an important economic data point. So it might be fair to say that strong guidance from a company like Whirlpool indicates consumers are getting stronger. Yet it should be noted that trade in Whirlpool's shares was somewhat deceiving on Monday. Yes, the stock finished the day higher by $10.20, or almost 10%, and rallied to a new 52-week high of $118.44 on volume that was more than six times the daily average, but the stock opened at $112.28 and closed at $112.42.

Whirpool Chart

I frequently voice my personal frustration over how an economy with the stature (or lack thereof) of Greece can weigh on U.S. stocks and I think a similar scenario was at play on Monday. What I mean is it was financials that derailed what should have been a nice day for stocks on Monday. Financials were the worst performing industry group within the S&P 500 as the usual post-earnings retreat was seen in shares of the big retail banks. That hurt shares of JPMorgan Chase (JPM) and Bank of America (BAC). Citigroup (C) retreated on news of the Treasury Department's plan to sell its massive stake in the bank.

Of course, I cannot forget to mention Goldman Sachs (GS), which shed $5.37, or 3.41%, to close at $152.03 on Monday. Goldman's CEO Lloyd Blankfein and other key executives will be testifying on Capitol Hill regarding allegations that the bank misled investors in convoluted mortgage securities and by misled, I mean whether or not Goldman was shorting securities it was recommending to clients on the long side. Blankfein maintains Goldman did not have ''a massive short'' against the mortgage market nor was the firm betting against its clients.

Goldman Sachs Chart

I would agree that these big banks are ''important'' companies in the U.S. corporate lexicon, but to echo the sentiments of several politicians, these firms do not produce anything. Companies like Caterpillar and Whirlpool do and the longer doubt remains about the health of the U.S. financial system, we could see at least few more disappointing trading days like we saw today.

Fortunately or unfortunately, depending on your perspective, the now infamous financial reform bill the Senate wants to consider will have to wait another day as Republicans mustered enough votes to block cloture on the bill. The vote was 57-41 with Sen. Bill Nelson (D-Neb.) the lone Democrat voting with the Republicans. Sixty votes are need for cloture.

It may seem like good news for financial stocks that an up-or-down vote on the bill was delayed, but the longer this issue lingers, financials cold remain under pressure, so it might be best for the markets to get this vote over and done with.

Looking at the charts, the Dow still resides right around uptrend resistance in 11,200 neighborhood. On the upside 11,245 would be the next hurdle and support can be found at 11,000. There are still some earnings reports that could be meaningful for the index, namely 3M (MMM) and DuPont (DD) both of which report before the open tomorrow. Outlook on chemical shipments is the news to watch regarding DuPont.

Dow Chart

The S&P 500 cleared resistance at 1214 last week, but Monday's drop has the index a couple of days worth of average gains away from resistance at 1222. The FOMC meeting starts tomorrow as do the Goldman hearings on the Hill and the combination of those events could be enough to generate another day of selling, but not to a large extent. If 1200 is broken on the downside, 1190 should act as support.

S&P 500 Chart

Considering the Nasdaq's recent bullish ways, Monday's decline is hardly enough to represent a reversal of the current trend. Netflix (NFLX) continues its parabolic ascent, gaining more than 8% on Monday and Amazon (AMZN) turned in a nice day as well, but Google (GOOG) got whacked and Apple (AAPL) and Baidu (BIDU) both traded lower as well. Either way, the Nasdaq has broken out and a move above 2540 may stoke some fresh buying.

Nasdaq Chart

I agree with Jim's sentiments from the weekend that stocks are certainly due for a breather, but betting against the obvious trend would likely prove foolhardy. If not for the decline in financials I would likely be telling you about Dow 12,260, S&P 500 1220 and Nasdaq 2535.

Noteworthy is a report from Bloomberg News that says despite the huge rally enjoyed by stocks over the past 13 months, U.S. equities still look as cheap as they have looked at any point over the past 20 years. The report says that the S&P 500 is trading at 14.1 times earnings forecasts, its lowest level since 1990, excluding period immediately following the Lehman Brothers debacle. Headlines like that may be one catalyst to jolt retail investors who are feeling they have missed the rally off the sidelines.

New Option Plays

Countertrend Play on Homebuilders

by Scott Hawes

Click here to email Scott Hawes


Toll Brothers - TOL - close 22.79 change -0.21 stop 15.90

Company Description:
Toll Brothers, Inc. designs, builds, markets and arranges financing for single-family detached and attached homes in luxury residential communities. The Company is also involved, directly and through joint ventures, in projects where it is building, or converting rental apartment buildings into high, mid, and low-rise luxury homes. The Company caters to move-up, empty-nester, active-adult, age-qualified and second-home buyers in 21 states of the United States. As of October 31, 2009 the Company delivered 32,189 homes from 604 communities. The Company operates its own land development, architectural, engineering, mortgage, title, landscaping, lumber distribution, house component assembly, and manufacturing operations. It also develops, owns and operates golf courses and country clubs. (source: company press release or website)

Why We Like It:
TOL surged higher last week along with the other homebuilders, setting new 52-week highs. The surge was credited to a sharp increase in new home sales which many feel was a result of the homebuyer tax credit expiring this week. This probably created pent-up demand and the builders could suffer from it in the future. In addition, TOL is a builder of luxury homes and the tax credit phases out for married persons making more than $225K per year. So TOL may not have benefitted like the other builders. I believe the rally in TOL may have been "dragged along for the ride" and I am expecting a pullback. From a technical standpoint TOL has reached resistance from August 2009 which I think will hold and give us the pullback we are looking for to make a quick profit. I would like to buy puts on TOL at current levels. We'll use a stop of $24.25 which is above the recent highs. Our target is $21.50 and our time frame is a couple of days to about two weeks, depending on price action.

Suggested Position: JUNE $23.00 PUT, current ask $1.40

Annotated Chart:

Entry on April xx at $ xx.xx
Earnings Date Over 2 months
Average Daily Volume = 3.2 million
Listed on April 26, 2010

In Play Updates and Reviews

BCR PUTS are Performing Well

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:

Good evening traders. The markets made more 52-week highs today before retreating at the end of the day. I expect to see some weakness in the markets heading into Wednesday's FOMC announcement but the dips are probably going to be short lived as they have been for the past 3 months. Although, the democratic version of the financial reform bill was voted down tonight so that may give a boost to the financials tomorrow. It will be interesting to see what the Fed says on Wednesday. If their language changes it could spark some serious selling so please stay nimble with any long positions. We are looking to exit BCR for a nice profit and SPY for loss in the next day or two. We are still waiting entry for triggeres on HANS and WFT, and plan initiate PUTS in TOL tomorrow (new play).

Current Portfolio:

CALL Play Updates

Hanson Natural Corp. - HANS - close 43.04 change -0.04 stop 39.25

We are still waiting to be triggered on HANS at $42.30. The stock traded in a very tight range today and found support at $42.83. If there is a selloff in the next few days I want to be ready to purchase calls on HANS as outlined below. I'll leave my comments from Saturday for those readers who may not have read them. Our trigger was almost hit on Thursday (it traded down to $40.82) which would have been beautiful because the stock closed +4.26% higher on Friday. When I released this play I thought about setting the trigger at $41.05 and in hindsight that was probably an error on my part. With that being said, this stock looks very bullish to me. My only concern is a broader market pullback, but that doesn't seem to be happening either. So I ponder whether or not this trade can still work, and I think it can. Here is what I want to do. If HANS retraces about half of Friday's gain to $42.30 I suggest readers initiate call positions as outlined below. From a technical standpoint HANS almost touched its upward trend line and a recent support/resistance level at about $40.75 before bouncing hard. In addition, the stock is forming a longer term ascending triangle and is currently in the middle of an upward channel that has been intact since mid 2009. I believe the stock is poised to breakout higher or at least trade to $43.75 which is our first target. Our second target is $44.95. The company reports earnings on May 6 so we will be out of this trade prior to the report. Although there was unusual call buying late last week so traders may be expecting a good earnings report, but this is just speculation. Let's use a stop of $39.25. Our time frame is 1 to 2 weeks.

Trigger to buy calls if HANS trades to $42.30

Suggested Position: Buy MAY $43.00 CALL, current ask $1.75, estimated ask at entry $1.40

Entry on April xx at $ xx.xx
Earnings Date 5/06/10
Average Daily Volume = 854,000
Listed on April 21, 2010

Weatherford International - WFT - close 18.29 change +0.56 stop 15.90

WFT kept on going today and has run away from our trigger. I do not suggest chasing the stock, rather be patient and wait for WFT to retrace. I am optimistic WFT will eventually trade down to our trigger at $17.55. Aggressive traders could consider raising their trigger up to $17.85 which is near a recent swing high. Depending on the price action we may initiate positions at this level. But ideally I would like to wait until $17.55. Overall market direction and volume is what I will be looking at to make the call. I'll leave my comments from Saturday for readers who may not have read them. On the intraday charts WFT double bottomed last week on April 19 and 22 and has since exploded. This was probably due to data released late last week regarding oil rig count activity which is through the roof. Rig counts are near all time highs in many parts of the United States. We are talking about 25%+ sequential quarterly growth in both oil and gas. This should bode well for WFT and their sector. And I would like to participate in this momentum on the first WFT pullback. I suggest traders buy June calls if WFT trades to $17.55. There is some resistance at $17.80 but I think it's only a matter of time before it busts through this level. I am going to place a wide stop on this trade at $15.90. I think this trade has some potential but we may need to give it some time and room to work which is why I want to buy June calls.

Trigger to buy June Calls if WFT trades to $17.55, or a more aggressive entry at $17.85

Suggested Position: JUNE $17.00 CALL, current ask $1.83, estimated ask at entry $1.40

Entry on April xxth at $ xx.xx
Earnings Date Over 2 months
Average Daily Volume = 14.9 million
Listed on April 24 2010

PUT Play Updates

Bard (CR), Inc – BCR – close 84.87 change -1.07 stop 90.10

BCR almost hit our target today to exit the trade at $84.60. The stock traded down to $84.63 so we are still long puts. I'm looking for BCR to remain under pressure in the coming days and plan to exit the position. I continue to believe healthcare related companies will struggle and be volatile as more details surface about the healthcare reform bill, but the downside momentum may be waning as the sector is approaching key longer term support levels. If good news surfaces it could spark a rally and turn a winning position into a losing one. From a technical standpoint, BCR is forming a bearish wedge pattern on its daily chart and looks vulnerable. The stock closed well below its 20-day SMA today and has broken an upward trend line that started on February 5. I initially thought this trade was going to last about 2 weeks but I am now looking for a quick exit and suggest readers take profits when they have the chance. Our $1.45 puts are now worth about $2.30, representing a +58% unrealized gain. I will gladly take profits if BCR is under pressure again tomorrow. I am keeping our stop on the position at $90.10 (above Friday's high) due to its recent volatility. Our time frame is 1 to 2 days.

Current Position: JUNE $85.00 PUT, entry at $1.45

Entry on April 23 at $ 1.45
Earnings Date Greater than 1 month
Average Daily Volume = 1.5 million
Listed on April 22

SPDR S&P 500 Index - SPY - close: 121.81 change: +0.79 stop: 123.05

SPY made another 52-week high today before retreating at the end of the day. I expect to see some weakness in the markets heading into Wednesday's FOMC announcement but the dips are probably going to be short lived as they have been for the past 3 months. My comments from Saturday remain the same on how to exit this position. I expect the volatility to continue this week and at some point SPY should have a significant intraday correction before getting bought. When that happens I will be looking to exit the position. I have two targets: the first is $120.05 which is just above the lows on Wednesday and Thursday, and the second is just above SPY's 20-day SMA (now at $119.55), which SPY bounced off of twice last week. I will tighten stops if these levels are reached with the assumption that I will be taken out. I also suggest traders tighten stops prior to these levels if the market starts to reverse on weakness. $120.75 is a level of interest to tighten stops as well. If SPY trades down to $120.75 our put should be worth about $1.30, at $120.00 our put should be worth about $1.60, and at $119.35 it should be worth about $1.80. If volatility surges it could be worth more. Our stop remains $123.05 which is just above SPY's 200-week SMA. Our time frame is 1 to 4 days.

Current Position: SPY PUT MAY $119.00, entry at $2.05

Entry on April 13th at $ 2.05
Earnings Date Not Applicable
Average Daily Volume = 164 million
Listed on April 12th, 2010