Option Investor

Daily Newsletter, Wednesday, 6/23/2010

Table of Contents

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

Market Wrap

New Home Sales Plunge to Worst on Record

by James Brown

Click here to email James Brown

Stocks continue to slide marking their third loss in a row for the U.S. markets. The major indices did manage to pare their losses and a few sector indices did close in positive territory but the tone was bearish. The U.S. dollar declined, oil fell sharply, gold closed negative but off its worst levels of the session. Trading was dominated by two big events, new home sales and the FOMC meeting. New home sales plunged to their worst level on record. The Federal Reserve left rates unchanged, near zero, for the 18th month in a row. The Fed's statement took a more cautious tone and money continues to move into safe haven securities. The bond market rose again with the yield on the 10-year note closing near 3.11%, the lowest close since May 2009.

A quick look at the foreign markets reveals that stocks struggled around the globe on Wednesday. Excitement over China's decision to let the yuan appreciate has begun to fade. Concerns over Europe were to blame for Asia's poor performance. The Chinese Shanghai index lost 0.7%, which leaves it essentially unchanged from a week ago. It's rival the Hong Kong Hang Seng has been outperforming with an 800-point gain from last Wednesday to 20,856. The Hang Seng inched up +0.18% today. Meanwhile the Japanese NIKKEI was a big underperformer with a 1.8% sell-off to 9,923. The breakdown under the psychological 10,000 level is not a good sign and volume was extremely bearish with 8 declining stocks for every 1 advancing stock. The next level of support for the NIKKEI is the 9800 level.

European markets experienced widespread declines, which isn't too surprising since concerns over Europe have returned to the forefront. The Bank of England made headlines when minutes from their last interest rate meeting showed a division. The last vote was 7-1. That one vote to raise rates was the first one since August 2008. Investors were also reacting to news that Europe's services and manufacturing slowed down in June but not as bad as expected. Economists were expecting the regional composite index to fall from 56.4 in May to 55.8. The index came in at 56.0. Readings over 50 are interpreted as growth.

We can't talk about Europe without talking about Greece. Investors are growing more cautious again with the yields on bonds for Greece and Spain rising. High yields on government bonds are a sign of fear the countries could default. One country that is still holding on is Germany, Europe's largest economy. A German based market research firm expects that consumer confidence will remain steady compared to expectations for a decline in June. One of Germany's high-profile exporters said they have sold out one of their main products. I'm talking about Bayerische Motoren Werke AG (a.k.a. BMW). There was an industry conference in Spain today and BMW's sales chief said they have sold out of their revamped 5-series sedan and there is a three-month wait for deliveries.

European markets opened lower, tried to rally midday but reversed sharply lower on the U.S. new home sales data. At the end of the day the German DAX index fell -1.0%. The English FTSE index lost 1.3% and the French CAC-40 gave up -1.7%.

The new home sales data had a similar affect here in the U.S. with stocks immediately turning south. Everyone knew that sales would worsen following the tax-credit expiration. We just didn't know how badly. Economists were expecting a 19% drop from 504,000 in April to 420,000 in May. This morning the U.S. Commerce Department announced that new home sales plunged -32.7% to an annual pace of 300,000 units. This is the worst reading on record dating back to 1963. April's numbers were also revised lower from 504K to 446K.

The median price of a new home stumbled -9.6% from a year ago to $200,900. This is the lowest median price since December 2003. The rate of sales fell across all regions of the country led by a -53% crash in the West. Homebuilders have good reason to be scared the real estate market could see another dip and they are keeping inventories light. The report this morning showed inventories fell to 213,000, which is the lowest level since 1970. You can bet that sliding prices for new homes does not bode well for prices on existing homes.

The FOMC meeting was a bit anticlimactic. No one expected the Federal Reserve to raise rates and they didn't. The market already knew that the U.S. recovery was shaping up to be an uneven one and the Fed's comments only confirmed that. Officially the Fed left the overnight interbank lending rate in their target zone of 0.00%-to-0.25%, which is where it has been since December 2008. The media was quick to point out that the Fed did not mention Europe specifically but certainly hinted that the drama overseas has had an effect. Here are a few excerpts from the FOMC's statement this afternoon:

"Information received since the Federal Open Market Committee met in April suggests that the economic recovery is proceeding and that the labor market is improving gradually. Household spending is increasing but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit.

...employers remain reluctant to add to payrolls. Housing starts remain at a depressed level. Financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad.

...Nonetheless, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be moderate for a time."

The key language today, at least the line that grabbed most of the headlines was, "Financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad." Overall the tone of their statement was more cautious than a month ago. In April the Fed said the economy had continued to strengthen. Today they said the recovery was "proceeding", which is probably another way to say the rate of growth has not improved. In April the Fed said unemployment was beginning to improve. Today the term was "improving gradually", which is a very nice way to comment on the disastrous jobs report earlier this month that only showed +41,000 in non-government jobs.

I'll try and sum up the Fed's decision today. Inflation is nearly nonexistent and we're facing potential signs of deflation. Unemployment remains near a 26-year high with little signs of improvement. Consumer credit remains tight and consumers are still nervous, which keeps their spending "constrained". The residential housing market is sliding backward and could be a drag on the economy for years. Meanwhile the sovereign debt crisis in Europe and the lack of growth in Europe could have a negative impact on our own recovery. Yet overall the Fed remains optimistic our recovery will continue. If we are going to recover then why does the market believe the Fed will not raise rates until mid 2011 or possibly 2012?

Checking the headlines it seems that BP is having another bad day. An underwater robot bumped into the venting system and BP had to remove one of the containment caps on the gushing oil well. According to a Reuters article this cap had helped siphon 700,000 gallons of oil in the previous 24 hours. With the cap removed the spill was leaking at an extremely high rate. There are some estimates out there estimating the leakage at 2.5 million gallons a day. Oil markets were also reacting to the weekly oil inventory report. Once again analysts were looking for inventories to fall but the EIA reported that crude inventories rose two million barrels. The combination of rising inventories coupled with expectations for slacking demand pushed oil to a -2.7% loss today.

After the closing bell tonight there were a couple of earnings reports. Bed Bath and Beyond (BBBY) reported earnings that were 4 cents better than Wall Street's estimates at 48 cents a share. Revenues came in better than expected at $1.92 billion versus the $1.89 billion estimate. Same store sales for the quarter rose more than 8%. It sounds like a good quarter but shares of BBBY will probably trade lower tomorrow because management issued an earnings warning for the current quarter. BBBY now expects a profit of 59-63 cents compared to analysts' estimates of 64 cents.

Footwear, sport apparel and equipment giant Nike (NKE) reported earnings after the close. Results were inline with analysts' estimate of $1.06 a share. Revenues climbed 8.5% but came in slightly under expectations of $5.15 billion for the quarter. It will be interesting to see if NKE holds its long-term trendline (see chart).

Weekly Chart of Nike (NKE):

Apple Inc. (AAPL) will be back in the headlines tomorrow. The company is supposed to launch its fourth generation iPhone across the nation on June 24th. Yet demand has been so strong, with more than 600,000 already sold, the company has encountered some supply problems. AT&T said that they will not have any of the new iPhones until Monday. There are reports that consumers might be able to find a few of the new iPhones at Apple's stores, Best Buy, RadioShack, and Wal-mart tomorrow. In an effort to steal some of AAPL's thunder, rivals Google (GOOG) and Verizon (VZ) have just unveiled another new smartphone competitor running the Google Android software. The new phone is called the Droid X. It's made by Motorola and sports a 4.3 inch display.

The IPO market has not been very strong this year, at least not in the U.S., but one IPO guaranteed to grab headlines is General Motors. There was a story out today that GM is planning an IPO for this fall. Unnamed sources suggest GM's plan is to sell at least 20% of the government's stake in the company reducing the Treasury Department's ownership from 61% to less than 50% making them a minority shareholder. It's estimated the IPO would raise between $10 and $15 billion. If GM can file the appropriate paperwork by August they could schedule the IPO for early November, just in time for the 2010 elections.

Technically the market doesn't look so great. Most of the major indices produced a clearly defined bearish reversal pattern on Monday and Tuesday's sharp decline only confirmed it. The S&P 500 has reversed under its 50 and 100-dma and the close under 1100 and its 200-dma is certainly bearish. The S&P 500 is back inside its previous trading range of 1,110 and 1040. The index might bounce at 1080 or 1060 but the only real support is 1040. If the 1040 level breaks we're looking at a significant decline toward the 1,000 level and probably toward the 950 area. There has been some chatter about the S&P 500 testing and failing at the top of its Bollinger band oscillator. Either the index is just pulling back to rebound from the center line (red) or it could portend a drop back toward the bottom of its band (see the chart below).

Weekly chart of the S&P 500 index:

Daily chart of the S&P 500 index:

Bollinger Band chart of the S&P 500 index:

The Dow Jones Industrials has failed at its 50-dma and closed back under its 200-dma, both are negative developments. If the decline continues we can look for a possible bounce near 10,000 or the 9800 level. The NASDAQ produced a different kind of bearish reversal. The index saw a bearish engulfing (reversal) pattern and Tuesday's decline confirmed the move. Bulls are trying to defend the NASDAQ near 2250 and its 200-dma but I wouldn't bet on this level holding. The NASDAQ's next level of support is the 2200 area and the 2140 mark. It is worth noting that the NASDAQ has also failed at the top of its Bollinger bands, the move looks almost identical to the S&P 500's.

Daily chart of the NASDAQ Composite index:

The small cap Russell 2000 index produced a move similar to the NASDAQ's with a bearish engulfing reversal pattern and a drop back toward its rising 200-dma. If you are tempted to bet on a bounce I'd wait for one near the 620 area. As of today I have to chalk this week up as another win for the Stock Trader's Almanac, which said the week after June option expiration has been negative several years in a row. Light volume will remain a consistent problem throughout the rest of summer. I am still concerned by the rally in treasuries. If fund managers are moving money into the safety of bonds what does that say about their view for the stock market?

The U.S. Federal Reserve still expects +3% growth this year and even stronger growth in 2011. Yet the double-dip recession camp is getting stronger again. The sovereign debt problems in Europe combined with stricter austerity measures across the EU will squash growth and have Europe leading us into the double-dip recession. Bulls could argue the U.S. might be able to avoid a recession since the U.S. has only spent about half of the original stimulus package. My biggest concerns are unemployment and housing. The housing market is not going to improve for months, maybe years to come. That will keep unemployment too high for consumers to feel confident in spending again. Right now estimates range from 3-to-5 million to 6-to-10 million foreclosures over the next three years. It's my hope that with the Fed keeping interest rates near zero, all the adjustable rate mortgages will actually adjust down instead of higher and help keep people in their homes.

Later this week the market will digest the weekly initial jobless claims, which have been hovering around 450,000. Thursday will also bring the Durable Goods Orders, which will shed some light on manufacturing. Friday we'll get the latest estimate on GDP plus the University of Michigan consumer sentiment numbers (final revision for June). I doubt any of these will have too much affect on the market. Given this week's failed rally on Monday the path of least resistance might be down but there is a good chance the market is stuck in a sideways pattern. Investors might choose to sit on the sidelines until we get a better look at corporate profits once Q2 earnings season begins in a couple of weeks.


P.S. Congratulations to the U.S. team in the FIFA 2010 World Cup. If you're a soccer fan then you already know the U.S. team managed to beat Algeria 1-0 and advance to round 16 of the 2010 World Cup. Their next game will be against Germany, Ghana or Serbia, who play later today.

New Option Plays

Short Candidate

by Scott Hawes

Click here to email Scott Hawes


Whirlpool Corp - WHR - close 97.71 change -0.23 stop 105.50

Company Description:
Whirlpool Corporation (Whirlpool) manufactures and markets a range of appliances and related products, primarily for home use. The Company's principal products are laundry appliances, refrigerators, cooking appliances, dishwashers, mixers and other small household appliances. It also produces hermetic compressors for refrigeration systems. Whirlpool manufactures products in 12 countries under 13 principal brand names and markets products worldwide. Whirlpool’s geographic segments consist of North America, Europe, Latin America and Asia.

Target(s): 95.10, 91.50, 86.05
Key Support/Resistance Areas: To Follow
Time Frame: 1 to 2 weeks

WHR has been making lower highs and has broken many trend lines. The stock has one more trend line providing support from the July lows to the February lows. However, I think it only a matter of time before this is broken and the stock retests or breaks its recent lows near $91.50. WHR is also below its 20-day and 50-day SMA's and I think there is enough overhead resistance to enter short positions $98.80 which is below today's highs and the 20-day SMA. I am going to place a wide initial stop at $105.50 to account for volatility and will adjust it once we are in the position.

Suggested Position: Buy August $95.00 PUTS current ask $6.40, estimated ask at entry $5.90

Annotated chart:

Entry on June xx
Earnings 7/21/2010 (unconfirmed)
Average Daily Volume: 2 million
Listed on June 23, 2010

In Play Updates and Reviews

Big Winner Closed

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:

CALL Play Updates

Cisco Systems - CSCO - close 22.86 change -0.11 stop 22.20

Target(s): 23.65, 23.90, 24.20
Key Support/Resistance Areas: 23.65, 22.55
Current Gain/Loss: -1.2%
Time Frame: 1 to 2 weeks
New Positions: Yes

CSCO hit our target to enter long positions at $22.85. We are playing for a bounce in the stock within the base it has built over the past month. This could be a quick trade and I suggest readers take profits if CSCO bounces as I anticipate. I've also listed another higher target at $23.90 which is near Monday's highs. If CSCO hits our target we should make about 60 cents on the option position for a +35% gain. If CSCO breaks out of the base it could rally to fill a gap which is up near our more aggressive 3rd target of $24.20 and below the stock's 200-day SMA. NOTE: I view this trade as potentially being quick once it is opened.

Current Position: August $22.00 CALL, entry was at $1.65

Entry on June xx
Earnings Date 8/5/10 (unconfirmed)
Average Daily Volume: 69 million
Listed on 6/16/10

Hanson Natural Corp - HANS - close 39.20 change -0.26 stop 38.25

Target(s): 40.20, 40.70, 42.40, 43.25
Key Support/Resistance Areas: 42.50, 41.00, 40.25, 39.30, 38.50
Current Gain/Loss: -6.8% Time Frame: 1 to 2 weeks
New Positions: Yes

We are long HANS as of the open this morning. The stock sold off early but drifted higher the remainder of the day. HANS remains above it 20-day and 200-day SMA and is providing support for the stock. I've adjusted the targets slightly and have provided another target at $40.20 which is near the stock's 50-day SMA and $1 higher than the today's closing price. This will produce a winning trade and I suggest readers at least tighten stops at this level in case HANS can't break out of the ascending triangle. The overall strength of the bounce in the market will likely determine the fate of the break out. I'll leave my comments from the play release. HANS got hit hard during the flash crash but has since held up well, making a series of higher lows. The stock is forming an ascending triangle on the daily chart and has an unfilled gap from the flash crash all the way up near $42.40. In addition, the stock is above its 20-day and 200-day SMA but has recently pulled back from its 50-day SMA. I suggest readers play for a bounce here with the building momentum of the ascending triangle. I also believe the S&P 500 will bounce as it is approaching the its 20-day SMA which should help stronger stocks that have performed. We have a good reference point to place a tight protective stop just below the 200-day SMA at $38.25, which also below the primary upward trend line. Our primary targets are $40.70 and $42.40.

Current Position: August $40.00 CALLS, entry was at $2.20

Entry on June 23, 2010
Earnings Date 8/5/10 (unconfirmed)
Average Daily Volume: 1.1 million
Listed on 6/22/10

PUT Play Updates

Dollar Thrifty Auto Group - DTG - close 43.71 change +0.14 stop 45.90 *NEW*

Target(s): 43.15 (hit), 42.70, 41.65, 40.05, 39.35
Key Support/Resistance Areas: 45.50, 44.15, 43.50, 41.50, 39.00,
Current Gain/Loss: +6%
Time Frame: 1 week
New Positions: Yes

Our first target $43.15 was hit today. Our options at the time were worth $2.25 which was almost a +40% gain on the position. The stock proceeded to bounce higher in the afternoon and evaporated all of those gains. Once our target was hit a protective stop could have been placed at $43.40 which was above the 10:30 30-minute bar (or the 10:45 15 minute bar). Placing a stop at this level would have stopped you out with a +21% gain, which was hit on the 12:00 bar (the option was worth $2.00). This is simply an example of protecting profits as positions move in the right direction. DTG hit a road block late in the day at $44.15 which is broken support from last week. I'm looking for the stock to move lower form here as it ever so close to breaking support and its trend line. The stock also remains below its 50-day and 20-day SMA's and DTG could bounce all the way up to these levels, where it would probably fail. However, if DTG breaks lower prior to bouncing I suggest readers begin to tighten stops and protect profits. $43.15 and $42.70 are still valid targets. $42.70 would fill a gap from 4/27 to 4/28.

Current Position: July $45.00 PUTS, entry was at $1.65

Entry on June 22, 2010
Earnings 8/19/2010 (unconfirmed)
Average Daily Volume: 9.1 million
Listed on June 19, 2010


NetApp, Inc. - NTAP - close 40.10 change +0.33 stop 41.05 *NEW*

Target(s): 39.70, 39.05, 37.00, 35.25
Key Support/Resistance Areas: 41.84, 40.00, 39.00, 36.50, 35.00
Current Gain/Loss: +69.23%
Time Frame: 1 week
New Positions: Closed

We are flat NTAP per last nights updates for a +69.23% gain. This was a good countertrend trade from a double top formation on the 5 year weekly chart. This stock could have more downside but I urge readers who may still have positions to not let this turn into loser. The market is at a critical reflection point right now and if there is any meaningful bounce NTAP could print new highs. NOTE: I view this trade as potentially being quick.

Closed Position: July $41.00 PUTS at $2.20, entry was at $1.30

Annotated Chart:

Entry on June 21, 2010
Earnings 8/19/2010 (unconfirmed)
Average Daily Volume: 9.1 million
Listed on June 19, 2010