Option Investor

Daily Newsletter, Tuesday, 5/18/2010

Table of Contents

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

Market Wrap

Familiar Themes Send Stocks Lower

by Todd Shriber

Click here to email Todd Shriber
Tuesday's trade was somewhat of a reversal of what we saw yesterday. On Monday, the major U.S. indexes started the day off in negative territory and languished there until an afternoon rally saved the day. On Tuesday, it looked like stocks were poised to book some decent gains, but a late-day meltdown scuttled any plans the bulls had for a positive close. The Dow Jones Industrial Average shed almost 115 points to close at 10,510.95 while the S&P 500 lost 16 points to finish the day at 1120.80. Tech continues the weak as the Nasdaq slid 37 points to 2317.26 and small-caps may be getting to rollover after an almost 2% decline for the Russell 2000. All four indexes were down by at least 1%.

Stats Table

Two of biggest U.S. retailers and Dow components at that reported first-quarter results before the bell. Decent news from Home Depot (HD) and Wal-Mart (WMT) should have been enough to encourage some positive trade. Then again, this earnings season has shown investors that the positive expectations were already baked into the share prices of many stocks and the ensuing reaction to even the best reports has been nothing if not disappointing. Expecting Home Depot and Wal-Mart to set the world on fire today was probably asking for too much given the current environment.

Atlanta-based Home Depot's profit update, and more importantly, its guidance, were superior to what rival Lowe's (LOW) offered up yesterday. Home Depot said it earned $725 million, or 43 cents a share, compared to $514 million, or 30 cents a share, a year earlier. Excluding one-time items, the largest U.S. home improvement retailer earned 45 cents a share on sales of $16.86 billion. Analysts were expecting a profit of 40 cents a share on sales of $16.37 billion.

While the guidance offered by Lowe's yesterday was disappointing, Home Depot said it will slightly beat the consensus estimate for its full-year earnings. The company raised its 2010 guidance to $1.88 a share up from a previous estimate of $1.79. Analysts had been expecting $1.87 a share. Home Depot added that it expects sales to rise by 3.5% this year. The company's previous estimate called for a 2.5%.

Sales at stores open at least a year jumped 3.3% during the quarter, the first quarterly increase for that metric in almost five years and individual transactions increased by 4.2%, also the biggest increase in almost five years. The shares were still down 2.4% on the day.

Home Depot Chart

Wal-Mart, the world's largest retailer, said its first-quarter profit surged 10% to $3.32 billion, or 88 cents a share, from $3.02 billion, or 77 cents a share, a year earlier. Same-store sales fell by 1.4%, marking the fourth consecutive quarter Wal-Mart has reported a decline in that metric. That decline is especially disappointing given that those four quarters cover a recession and only the nascent stages of a recovery. What I mean is if Wal-Mart cannot lure shoppers in during a recession, that may not bode well for the stock going forward.

Wal-Mart has the feeling a ''Dog of the Dow'' or to be more candid, dead money. The shares have been significantly outpaced by a variety of retailers, both high-end and not-so-high-end, over the past year. Dollar General (DG), Family Dollar (FDO), Nordstrom (JWN) and Tiffany (TIF) all outperformed Wal-Mart by at least four-fold in the past year.

The company said it expects to earn 93 cents to 98 cents a share in the current, but that is not very exciting given that analysts were already expecting 98 cents. Showing what a fickle beast the stock market is, it would have been logical to expect that Wal-Mart would trade lower today, but the stock was the only one of the 30 Dow stocks to finish the day in positive territory, gaining almost 2% to close at $53.71.

Wal-Mart Chart

As I mentioned in the headline for this wrap, in the absence of ample headlines to explain the day's declines, it was the same old songs sending the bulls running for cover, namely declining commodities prices and Europe-related fears. I am not sure if the commodities/materials/energy trade is taking a break or if it is broken beyond repair (at least for the near- to medium-term), but is obvious that these names that helped lead the market higher pre-financial crisis only to be among the biggest losers in 2008 and early 2009, may be repeating that pattern.

Materials names were among the leaders off the March 2009 lows and they are again contributing some of the biggest declines. Oil looked like it was starting to firm a bit in overnight trading, but that rally was short-lived and NYMEX-traded crude for June delivery, closed at $69.41 a barrel, after falling as low as $68.91. That is good for the lowest closing price since Sept. 29, 2009, according to the Wall Street Journal. Crude has declined in 10 of the past 11 trading sessions, the longest skid since October 2003, the Journal reported.

Yes, the crude charts look crude these days (pun intended), but copper futures did see some relief after several weeks of intense selling pressure. Copper for July delivery gained 9.9 cents to close at $3.031 per pound after the Commerce Department said housing starts rose by 672,000 in April. That was copper's biggest gain in seven weeks, according to Bloomberg News.

Copper Chart

Of course Europe is still manufacturing headlines that send the bulls running for cover. Today, it was Germany's turn to roil equity markets by announcing a ban on naked short-selling. Germany's financial regulator BaFin said the ban starts at midnight tonight in Germany and applies to equities as well as naked credit default swaps on Eurozone government bonds. The ban will also apply to Germany's 10 largest banks and insurance providers and will last until March 31, 2011.

You may remember that the SEC's short sale ban in 2009 proved futile and it served to spook investors about how bad things really were at the time. While bans on short-selling are well intended, particularly if the bans target naked shorts, a far more devious group than regular bears, the bans can be avoided by astute traders. Just because there was a ban on short selling in the U.S. in 2009 did not mean that proprietary trading desks and hedge funds could not short U.S.-listed stocks and the same will be true of Germany's ban. It may hamper shorting of Franfurt-listed stocks, but many of Germany's biggest names trade on other major exchanges, including a few here in the States, so this action is likely to see muted success.

The unintended consequence of Germany's plan to enact tighter control on naked shorts is that the plan has many a pundit speculating that Europe's largest economy may be hiding something. Look at the impact problems in Greece and Portugal have had on global equity markets. Now imagine if Germany, a larger and more important player on the global economic stage, says that its economic house is not in order.

I am not saying that is going to happen, but if Germany continues to spook investors, the fallout will certainly be ugly. All of this is a roundabout way of saying that the iShares MSCI Germany Index (EWG) is worth watching as a potential short. The ETF was down almost 1.5% today on almost six times the average daily volume.

After the bell, Dow component Hewlett-Packard (HPQ), the world's largest personal computer and printer maker, said it earned $2.2 billion, or 91 cents a share in its fiscal second quarter, compared with $1.7 billion, or 71 cents a share, a year earlier. Excluding items, HP earned $1.09 a share, beating the consensus estimate of $1.05. Sales jumped 13% to $30.8 billion, beating the consensus estimate of $29.8 billion.

Weakness among large-cap tech names has been lamented in this space for several weeks, so I would not expect the HP report to lift the sector at large, but is should be noted that the company did offer some bullish full-year guidance. HP said it expects to earn $4.45-$4.50 a share, up from previous guidance of $4.37-$4.44.

The company said it is seeing an uptick in orders from small businesses and financial services firms, but that a true recovery in PC demand from large corporate customers will not be seen until the second half of this year. After losing 1.54% during the regular trading session, HP shares were up 2.44% to $47.93 in after-hours trading.

HP Chart

Taking a look at the charts, last night I mentioned 10,350 as the next support area for the Dow and with today's close just above 10,500, we could be seeing just how strong support at 10,350 is before the end of the week. From there, the 200-day moving average at 10,248 would be the next area to watch on the downside. The HP news on its own is not enough to counter falling oil prices and a tumbling Euro.

Dow Chart

The Germany naked short ban was not good news for financials, regardless of home domicile, and that news pressured the S&P 500 Seventy eight of the index's 79 financial names traded lower on Tuesday and as is the case with the Dow, we could be seeing how strong the next critical support level is for the S&P 500. By that I mean 1100 or 1101.58 if we are splitting hairs about the 200-day line. Either way, if the aforementioned negative catalysts persist and there is little reason to believe they will not, 1100 could be seen in short order.

S&P 500 Chart

The Nasdaq is offering no shelter from the storm. On Tuesday, only seven of the Nasdaq 100 stocks finished the day in positive territory and not one of them was a marquee name like Apple (AAPL), Amazon (AMZN) or Google (GOOG). If Wednesday does not bring some positive trade, the Nasdaq could be testing support at 2300 tomorrow.

Nasdaq Chart

I mentioned last night that I found the strength in small-caps to be suspicious, but Tuesday's trade highlighted some dents in the armor with the Russell 2000 absorbing the biggest percentage loss of the major U.S. indexes. The close at 682.75 puts the Russell 2000 well below its 50-day moving average of 698.64. That is still a good bit above support at 650, but the other side of that coin is that small-caps merely have more selling ahead of them.

Russell 2000 Chart

I said last night that I saw no reason to be bullish about stocks right now and my tune has not changed in 24 hours. Germany announced its naked short selling ban after European markets closed, so I would expect markets there to open lower tomorrow, putting pressure on U.S. index futures. Minutes from the Fed's latest meeting will be released at 2PM Eastern time tomorrow, so Wednesday may be an ideal day to take a breather and stay on the sidelines.

New Option Plays

This Company has Support Now

by Scott Hawes

Click here to email Scott Hawes

Hewlett Packard Co - HPQ - close 46.79 change -0.73 stop 44.90

Company Description:
Hewlett-Packard Company is a global provider of products, technologies, software, solutions and services to individual consumers, small- and medium-sized businesses (SMBs) and large enterprises, including customers in the government, health and education sectors. The Company’s offerings span multi-vendor customer services, including infrastructure technology and business process outsourcing, technology support and maintenance, application development and support services, and consulting and integration services; enterprise information technology infrastructure, including enterprise storage and server technology, networking products and resources, and software that optimizes business technology investments; personal computing and other access devices, and imaging and printing-related products and services. In April 2010, the Company completed its acquisition of 3Com Corporation. (source: company press release or website)

Target(s): 49.70
Key Support Areas: 46.50, 45.50
Key Resistance Areas: 48.25, 50.00
Time Frame: Several weeks

Why We Like It:
HPQ reported earnings after the bell that beat estimates and the company raised its guidance for the remainder of the year to $4.45 to $4.50 per share. This means that HPQ is now trading at less than 11 times forward earnings. The stock also has support at $46.50 and $45.50 which gives us a good reference to place a stop to limit risk. There is no doubt HPQ's chart looks terrible but most stock charts do, and I'm viewing the pullback as opportunity to enter a quality name that may catch a bid as investors flee from more speculative names. Shares are higher in the after hours but futures are weak. I'm eyeing two areas as a potential entry: $47.10 or $46.10 depending on price action on Wednesday. Our time frame is a couple of weeks and our stop $44.90 which is below the low on October 2, 2009.

Suggested Position: JUNE $47.50 CALL if HPQ trades down near $47.00 or $46.00, current ask $1.54.

Annotated chart:

Entry on May xx
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 16 million
Listed on May 18, 2010

In Play Updates and Reviews

The Volatility is Tough to Manage

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:

Good evening. We closed SINA today for a loss and RRC for a gain. I suggest readers consider closing short positions on weakness tomorrow. S&P futures are down almost -10 points as I write this but this is creating an oversold market and we must be smart in taking profits when the opportunity presents itself. That time could be tomorrow morning. There is inevitably going to be a relief rally and we have good quality longs to take advantage of the bounce. I'm still focused on an S&P range in the 1,115 to 1,155 area (lowered from 1,170 after today's sharp reversal). However, I also continue to believe there is much more downside risk than upside opportunity so staying nimble is paramount. This environment remains difficult to manage swing trades but the important thing is we are booking more profits than losses in our model portfolio. Please email me with any questions.

Current Portfolio:

CALL Play Updates

Becton Dickinson & Co. - BDX - close 74.30 change +0.52 stop 72.20

Target(s): 77.50
Key Support Areas: 74.00, 72.50
Key Resistance Areas: 75.65, 76.70
Current Gain/Loss: +0.00%
Time Frame: Several weeks
New Positions: Yes

BDX gapped higher this morning and then sold off right into $74.25 which was the maximum price we wanted to enter CALL positions. As such, we are now long June $75 CALLS at $1.55. The stock hung in fairly well considering the overall market's descent. Our position is breakeven. I'll leave my technical comments from the play release as they have not changed. BDX got some publicity after hours on Monday as news came out that Berkshire Hathaway initiated a large stake in the company last quarter. I like the stock at these levels and believe it will trade up to the $77.50 area which is our target and near the 50-day SMA. BDX's prices have been coiling and it is sitting near an upward trend line that started on 5/5/09. The stock has a ways to go to get up to the downtrend line which sits near $79.00. I also believe this is a good defensive play that will do well if there is a relief rally in the broader market or a sideways consolidation. The stock is near a key pivot level at $74.00 dating back to early 2008 which should act as support if BDX can push up through. I suggest readers initiate long positions at no more than $74.25. BDX traded at $75.00 in the after market so be patient and wait for the pullback near $74.00. Our stop is $72.20 and our time frame is several weeks.

Current Position: JUNE $75.00 CALL, entry at $1.55.

Entry on May 18, 2010
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 1.6 million
Listed on May 17, 2010

Celgene Corp. - CELG - close 58.00 change -1.76 stop 56.90

Target(s): 62.95
Key Support Areas: 58.00, 57.00
Key Resistance Areas: 60.00, 61.25
Current Gain/Loss: -28%
Time Frame: Several weeks
New Positions: Yes

CELG has been oscillating between $58 and $60 since last Monday. As soon as CELG hit $60 early this morning the trap door swung open and the stock immediately traded down to $58 which is where it closed, down -2.95%. Buyers stepped in but the bounce was quickly sold into. CELG now finds itself sitting at horizontal support and an upward trend line from its February lows. The support looks solid at this level but it needs to bounce from here and get back above its 20-day SMA or our position could be in jeopardy. If the support breaks and things fall apart our stop is in place, which is $56.90 and below the April 22 low.

Current Position: JUNE $60.00 CALL, entry at $2.58.

Entry on May 17, 2010
Earnings Date: More than 2 months (unconfirmed)
Average Daily Volume: 4.3 million
Listed on May 15, 2010

Steel Dynamics - STLD - close 14.50 change -0.36 stop 14.15

Target(s): 16.25, 16.80
Key Support Areas: 14.50, 14.25
Key Resistance Areas: 15.50, 15.85
Current Gain/Loss: -18% Time Frame: About 2 weeks
New Positions: Yes

STLD gapped higher at the open and quickly sold off with the remainder of the market. This gave readers a chance to initiate CALL positions once the gap was filled at about 85 cents. If you were patient and did not enter call positions due to the overall market weakness I think now is good time to consider it with a tight stop. My technical comments from the play release remain the same. STLD finds itself right at the its long term support area at $14.50. $14.25 is also a support level. STLD has been trading in a sideways channel between $14.50 and $18.00 for the past 9 months and finds itself at the bottom of the channel (see dashed lines on chart in the new play release). There have been times when the stock has peaked its head above and below the channel but these are key pivot levels that have been fairly reliable. In addition, the $14.50 price level is converging with an upward trend line that started on 7/8/2009 and we have a good reference point to place a stop just below these levels. I am looking for a relief bounce in this stock and the overall market and I suggest readers initiate call positions at current levels. Our first target is $16.25 which is about +9% higher than current levels. Our time frame is about 2 weeks. I also like the 2:1 risk reward ratio of this trade: we are risking about 70 cents to make $1.40.

current Position: JUNE $15.00 CALL, entry at $0.85.

Entry on May xx at $xx
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 6.7 million
Listed on May 17, 2010

PUT Play Updates

Baidu, Inc. ADR - BIDU - close 71.57 change -1.61 stop 79.10

Target(s): 71.50 (hit), 65.10
Key Support Areas: 71.40, 68.50, 65.00
Key Resistance Areas: 75.64, 78.50, 82.25
Current Gain/Loss: +16%
Time Frame: Several Weeks
New Positions: Yes

BIDU hit our first target of $71.50 today. Conservative traders may want to exit positions at current levels or on any further weakness to protect profits. BIDU looks vulnerable from here but if there is a bounce in the overall market we may endure a little pain before it heads back down. We need BIDU to break and close below $71.50 to get moving towards our final target of $65.10. From a fundamental perspective BIDU trades at a PE ratio of about 100 which makes no sense when compared to its American counterpart GOOG which trades at a PE of about 23. Our stop is $79.10 which is above last Wednesday's high. This stock can be volatile and is prone to gaps so please be smart when considering position size.

Current Position: JUNE $73.00 PUT, entry at $4.65

Entry on May 14, 2010
Earnings July 15, 2010 (unconfirmed)
Average Daily Volume: 68 million
Listed on May 13, 2010

Leggett & Platt, Inc. - LEG - close 23.83 change -0.35 stop 25.35

Target(s): 23.00, 22.25
Key Support Areas: 23.75, 23.42, 23.00
Key Resistance Areas: 24.75, 25.15
Current Gain/Loss: +13%
Time Frame: Several Weeks
New Positions: Yes

LEG gapped higher this morning near our key resistance level of $24.75 and then sold off the remainder of the day. On the intraday charts LEG may be forming a bullish inverse head and shoulders pattern. If the market is strong tomorrow this is probably going to bode well for LEG. If not, the pattern will probably fail. Our position is up +13% right now but we may have to live through a bounce for LEG to ultimately reach our target. From a bearish perspective LEG is piercing the bottom wick of yesterday's price bar and also closed below its 20-day SMA. And LEG is still below its downward trend line which started on April 30. However, we need LEG to break through $23.75 and yesterday's low of $23.42 to keep things moving in the right direction. I am going to list a new first target of $23.00 which is just above the stock's 50-day SMA and the low on May 10. If LEG breaks $23.42 support we should see the 50-day SMA in short order but I wouldn't try to squeeze out the remainder of the gap between $23.00 and the 50-day SMA. Rather, I suggest readers take profits or tighten stops to protect profits. Our CALL position should be worth about $2.40 if LEG trades down here which would garner a +50% gain. I suggest taking profits here and not holding through any bounce.

Current Position: June $25.00 PUT, entry at $1.60

Entry on May 17, 2010
Earnings More than 2 months (unconfirmed)
Average Daily Volume: 2 million
Listed on May 15, 2010


Range Resources Corp - RRC - close 46.57 change -1.40 stop 50.75

Target(s): $46.00 (hit), 45.00, 44.00, 42.50
Key Support Areas: 46.00, 45.00, 43.30
Key Resistance Areas: 47.25, 48.40, 49.00, 50.00
Current Gain/Loss: +32%
Time Frame: A couple of days
New Positions: Closed

After gapping higher at open RRC sold off with the remainder of the market and ultimately hit our target of $46.00 for the second time. When RRC could not close a 15 minute bar over the first bar the stock sold off hard the remainder of the day. We are flat the position for a decent gain of +32% and are ready to move on to other opportunities. This position tested my patience and I am glad to exit. For readers who may still have positions you may get lucky tomorrow as the after market is currently under pressure. I suggest not getting too greedy though and take profits on any further weakness. I'll leave my comments from last night as they are still valid. RRC still remains below a bunch of congestion near $49.00 that I don't think it can overcome, but I can't endure another trip back up to these levels which is why I think readers should take profits here. In addition, oil is definitely oversold and if oil gets some legs and the overall market bounces from here I don't want to be involved in the stock. If RRC is weak at the open we'll trail our stop down and if it is strong we'll exit early. A tight stop could be placed at $47.25 if readers want to give this some room to play out. *NOTE: We chose further out of the money options than usual to reduce risk in the trade. Please use small positions due to the volatility in this stock and the recent sell off in oil looks oversold.

Current Position: JUNE $42.50 PUT at $1.25, entry was at $0.95

Annotated Chart:

Entry on 5/11/2010
Earnings Date 7/22/2010 (unconfirmed)
Average Daily Volume: 3.1 million
Listed on 5/8/2010

Sina Corporation - SINA - close 37.57 change +2.72 stop $37.05

Target(s): 33.25 (hit), $33.50, 32.50, 30.50
Key Support Areas: $33.40 32.50, 30.50
Key Resistance Areas: 35.40, 36.00, 36.80
Current Gain/Loss: -50%
Time Frame: 1 week
New Positions: Closed

Ouch! I broke my rules and paid for it with SINA. SINA reported earnings after the bell that were better than expected but their Q2 revenue forecast was lower than consensus estimates. The forecast didn't seem to matter as investors piled into the stock. I am frustrated with the way I managed this trade. Essentially I let a winner turn into a loser, did not take profits when we hit our target of $33.25, and decided to hold the position over earnings. All mistakes that I typically avoid and it reinforces the importance of following rules. But its not the end of the world and the recent winners we have booked eases some of the pain. In any event, we'll pick ourselves up, note the mistakes, and look for better opportunities. Every trade can't be a winner.

Closed Position: JUNE $35.00 PUT at $1.10, entry at $2.20

Annotated Chart:

Entry on May 4th at $2.20
Earnings Date May 17, 2010 (unconfirmed)
Average Daily Volume: 1.1 million
Listed on May 1, 2010