Option Investor

Daily Newsletter, Tuesday, 7/6/2010

Table of Contents

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

Market Wrap

Jinx Broken?

by Jim Brown

Click here to email Jim Brown

The Dow erased a +170 point gain to traded in negative territory but eventually closed positive to end the string of losses at seven days.

Market Stats Table

It was a low volume, low news market in a holiday week. There was limited economic news and not much for traders and investors to cling to for moral support. When the Dow erased its +170 point gain to trade in negative territory 30 minutes before the close I though for sure we were going down hard before the day was out. Thankfully some bargain hunting and short covering provided just enough lift to turn the indexes green.

The only material economic report for the day was the ISM nonmanufacturing report for June. The headline came in at 53.8 and a decline from the 55.4 in May. Anything over 50 represents growth. The index stalled out at 55.4 for three months from March through May before weakening in June.

New orders fell -2.7 points to 54.4 and exports fell by 5.5 points to 48 and into contraction territory. Employment fell back into contraction territory at 49.7. The prices paid component fell by 6.8 points to 53.8 and the lowest level since October 2008 when the country was in the great recession. This is a further warning that the country is at risk of a depressionary phase.

The ISM survey has significant representation by real estate and construction firms so the decline in activity after the expiration of the tax credit could have been the major drag on the results. Also, the survey is reactive to the equity markets and the decline of the last three weeks could have soured respondent sentiment.

ISM Nonmanufacturing Chart

Global semiconductor sales rose +4.5% in May over April and 47.6% over May 2009. Sales reached a new record high of $24.65 billion, which was a $1.07 billion increase since April. The Americas saw month-to-month sales rise +8.2% and +5% in the Asia Pacific region. Year over year sales saw the Americas rise +52.9%, Asia Pacific +50.9%, Europe +43.8% and Japan posted the slowest growth at 43.8%.

Unfortunately analysts believe this could be the top in the chip market. Semiconductor markets for PCs and cell phones represent nearly 60% of global semiconductor consumption. Analysts believe this sector could come under pressure as the austerity moves in Europe reduce spending. Secondly, China's ISM has declined for two months and is resting just over 50 and threatening to slip into contraction territory. Analysts worry that this slowdown will carry over into the broad manufacturing sector and reduce demand for chips.

The semiconductor index ($SOX) rallied to 340 on the initial news but then gave back more than -10 points on the analyst worries. The decline in semiconductors was a major reason the Nasdaq traded so negatively near the close. RBC Capital downgraded MXIM, ISIL and ZRAN because of the decline in consumer sales. "Checks over the last few weeks have indicated slowing demand, particularly in consumer-driven segments."

Semiconductor Index Chart

The only economic reports due out for Wednesday are the Mortgage Applications and the weekly Chain Store Sales snapshot. There are no economic reports of note for the rest of the week. Jobless Claims on Thursday would probably be of the most interest with Retail Sales for June also a possibility.

Tesla (TSLA) shorted out today with a -16% drop to close under $16 and a new post IPO low. Tesla priced at $17 and rallied to just over $30 the day after the IPO. Since that high it has been a sharp decline. Tesla has had its share of problems. Tesla survived a plane crash that killed three high level Tesla employees back in February. Tesla barely avoided bankruptcy several months ago but was rescued by a private investor. It has sold only 1086 of its $100,000 electric roadsters but plans to sell 20,000 of a more modestly priced $50,000 sedan. Unfortunately when pressed the company said it "had not completed the design, component sourcing or manufacturing process for the sedan so it is difficult to forecast the eventual cost, manufacturability or quality." I think it may also be difficult to project the value of TSLA stock given their lack of profits and lack of a real product.

Tesla Chart

Picture of a $100K Tesla roadster that was being driven by an employee giving a potential customer a test drive. The car left the road at more than 100 KPH and flipped, immediately ejecting both occupants. The worst injury was a broken hand and a lot of bruises and scratches.

Tesla Roadster

Another IPO hitting the market today was the Agricultural Bank of China. This should be the biggest IPO ever at $19.2 billion. Shares priced in the middle of the range at HK$3.20. They are selling 22.2 billion shares. This is the fourth largest bank in China and it is doing the IPO to raise capital because of heavy losses from bad lending practices. The bank received $139 billion in bailouts in 2008. At least it has customers, 320 million of them and 23,624 branch outlets. The bank made more than one trillion yuan of new loans in 2009. That is more than the GDP of New Zealand. Their nonperforming loan ratio is 2.91% and the highest of any China lender. Numerous sovereign wealth funds are lining up for $500 million or more in shares with Qatar Investment Authority planning to invest $2.8 billion and the Kuwait Investment Authority $800 million.

In the U.S. a Canadian company, Smart Technologies, is set to price 35.3 million shares tonight at $16-$18 with the midpoint around $600 million. That would be the largest U.S. IPO for the year. Smart Technologies makes things like interactive digital white boards that allow users to place shared files on the board where everyone in the meeting can mark them up. Intel owns 26% and Apax Partners 51.4%. Over 75% of the stock being sold is coming from insiders.

JP Morgan upgraded Goldman Sachs to overweight saying their risk management was best in class. Deutsche Bank was cut to neutral based on its capital deficit. Goldman said it has placed a moratorium on campaign contributions to politicians running for national office. According to people at the firm the move is designed to insulate Goldman from charges they might be looking to influence lawmakers in reference to financial reform. They said the ban would be lifted once President Obama signed into law the financial reform package currently being discussed. Reportedly CEO Lloyd Blankfien and JPM CEO Jamie Dimon are livid that politicians who had accepted large donations from Wall Street in the past had engaged in "banker bashing" over the past year to score points with voters and failed to fight provisions in the financial reform legislation. Come on guys, they are politicians. What did you expect?

Goldman upgraded Caterpillar (CAT) on expectations North American demand is expected to rise over the next few months. They maintained a neutral rating but raised the price target to $70. Citigroup upgraded Progressive (PGR) from hold to buy saying the recent weakness had created a buying opportunity. Barclays upgraded Halliburton (HAL) to overweight from neutral saying stronger pricing should push earnings higher.

Richard Bove was pounding the table again on Citigroup saying the stock should hit $8.50 within three years. He said once the government finished selling their shares, probably by the end of the summer but at least by the end of the year, the stock should begin to move higher. Bove believes Citigroup will successfully shed its commercial credit division and other non-core assets and see rapid growth in its consumer banking business. Hitting $8.50 would be better than a 100% return but considering the 28.4 billion shares outstanding as a result of the bailout it is going to be VERY tough to move higher. Earnings per share are going to be fractional. I expect a monster reverse split over the next year.

The earnings reporting cycle does not really begin until next week and economic reports are scarce. This means the markets are left to trade on sentiment and overseas news. The overseas markets were volatile last night with big declines at the open followed by decent rebounds. However, the Singapore market closed at a new 52-week low. The European markets performed better after news broke that the majority of the banks would likely pass the stress test. This improved European sentiment and that carried over into our markets.

Early last night our S&P futures traded down to 1002.75 or -9 points. As Europe recovered the S&P futures rallied almost vertically to 1038 at 10:AM. That was a +36 point rebound although the afternoon selling took them back down to 1013. The strongly positive futures caused a strong bout of short covering at the open but the sellers were waiting for the bounce to fade and they were soon rewarded. The +172 point Dow gain was completely erased although short covering at the close pushed the indexes back into positive territory.

The S&P appears to have found support at 1020 but one day of gains is not a rally. I was hoping for a washout sell off today to clear the margin sellers and give the funds a dip to buy. Unfortunately it did not happen. After the sell off back to slightly negative territory and then a barely positive close I am not sure how to interpret that for tomorrow. I could easily construct a scenario where the lack of another strongly negative day emboldens the bulls into imagining a bottom at 1020 and we rally into the first two weeks of earnings. That would be my most likely scenario tonight. The second option would be for one more attempt to break the bank and push the S&P lower to retest 1000. If it came on enough volume that could qualify as temporary capitulation event and we could rebound from there into earnings. The bottom line is that I think we will rally over the next couple weeks and then traders will take another look at the board and decide whether to hold them or fold them. A break under 1000 cancels both scenarios.

We have a clean "death cross" of the 50 through the 200-day average. In theory that should be a strong sell signal.

S&P-500 Chart - Daily

S&P-500 Chart - Death Cross

The Dow is transitioning into the death cross and the +57 point rebound today was so small that it barely showed up on the chart given the recent declines. A +57 point gain would normally be decent but not when you consider the -172 point decline from the morning's highs. The Dow has a clear pattern of lower lows and Friday's close was a new 9-month low. We were severely oversold after losing -8% in the last two weeks. We were due for a bounce to equalize the pressures. I am not bullish on the Dow chart and prefer to focus on the S&P and the Russell.

Dow Chart

The Nasdaq chart shows the index flirting with the 50% Fib retracement level at 2063. The negativity in the chip stocks today made it impossible for the Nasdaq to do much but tread water. Apple helped with a minor +1.69 gain but there was nobody following the general higher. I don't think the Nasdaq is giving us a trading signal.

Nasdaq Chart

In stark contrast to the positive close on the other indexes the Russell 2000 closed decidedly negative with a -1.5% drop. This was due to structural issues rather than fund managers suddenly deciding to sell small caps. The Russell is still suffering from rebalance hangover. Fund managers are still cleaning up problems with their portfolios caused by the rebalance of the Russell indexes.

Berkshire Hathaway was such a big addition to the Russell 1000 it caused a ripple down effect where fund managers had to sell every one of the Russell 3000 (RUT 1000 + RUT 2000) stocks with a smaller market cap than Berkshire. That was obviously about 2,993 of them. Many fund managers take their role as index tracking manager seriously and swap stocks exactly on the day the rebalance occurs. Other managers game their changes with additions and deletions in the weeks before and after the rebalance. You may remember there was 11.5 billion shares traded on the rebalance day with 104 million of those shares the Berkshire B shares.

Even with high tech computer modeling programs the ripple down effect of selling those 2,993 Russell stocks is still impacting the markets. This will be resolved by the end of this week as the trailing edge managers catch up with reality. Until then the Russell is not really giving us a sell signal as it appears on the chart (unless it breaks below 590) but a positive turn will give us a buy signal. A positive turn means the rebalance impact is over and managers not indexed to the Russell and waiting for the smoke to clear will be free to buy small caps again.

Russell Chart

To summarize, I laid out my two scenarios in the S&P discussion above. Both of them have us rising into earnings either from the current 1020 support or after one last dip to retest S&P 1000. I believe this rally will just be a trade and will eventually fail after the first two weeks of earnings. Once the big caps report and the guidance is sifted I think investors will move to the sidelines to watch for a double dip with plans to move back into the market in October.

Jim Brown

New Option Plays

Long Candidate in Pharmaceuticals

by Scott Hawes

Click here to email Scott Hawes


Allergan, Inc. - AGN - close 61.82 change -0.47 stop 59.38

Company Description:
Allergan, Inc.is a multi-specialty health care company focused on developing and commercializing pharmaceuticals, biologics and medical devices. It discovers, develops and commercializes pharmaceutical, medical device and over-the-counter products for the ophthalmic, neurological, medical aesthetics, medical dermatology, breast aesthetics, obesity intervention, urological and other specialty markets.It has two reportable segments: specialty pharmaceuticals and medical devices. The specialty pharmaceuticals segment produces a range of products, including ophthalmic products for chronic dry eye, glaucoma therapy, ocular inflammation,allergy and retinal diseases. The medical devices segment produces a range of medical devices, including breast implants, the Lap-Band System and the Orbera Intragastric Balloon System and facial aesthetics products.As of February 26, 2010, the Company acquired Serica Technologies, Inc.

Target(s): 63.75, 64.45, 65.25
Key Support/Resistance Areas: 65.50, 64.50, 63.80, 61.80, 59.50
Time Frame: 1 week

Why We Like It:
AGN closed above a downtrend line that began on 4/1 on Friday and has now retraced some of those gains and tested the backside of it. The stock is also above a key support level at $61.80 and all of its major SMA's, which should provide additional support if there is a pullback. I'm expecting the stock to bounce with the overall market and possibly retest its YTD highs. However, I suggest being quick to tighten stops if AGN moves higher. If AGN hits our first target we should be able to make 30% to 40% on the call position. Option activity has also been picking up mainly in the July strike prices. Our stop will be $59.38 which is below the opening gap up on Friday and all of the SMA's.

Suggested Position: Buy August $65.00 CALLS, current ask $3.10

Annotated Chart:

Entry on July xx
Earnings Date 8/8/10 (unconfirmed)
Average Daily Volume: 2.58 million
Listed on 7/6/10

In Play Updates and Reviews

Triggered on Short Play

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:

PUT Play Updates

Children's Place - PLCE - close 42.41 change -1.16 stop 48.10

Target(s): 43.40, 41.70, 40.70, 40.05
Key Support/Resistance Areas: 46.40, 47.00, 46.00, 44.50, 43.40, 41.50
Current Gain/Loss: +2.5%
Time Frame: 1 to 2 weeks
New Positions: No

7/6: PLCE gapped higher this morning and sold off the remainder of the day. I'm concerned that this stock may bounce higher along with the market from here so I am suggesting we close this position at the open tomorrow. We didn't get the entry that I hoped for and I do not want this position to turn into a loser. We will either have a small loss or small gain depending on how the market opens tomorrow.

7/3: PLCE printed a bearish engulfing candlestick on its daily chart. However, there is also a bullish inverse head and shoulders pattern forming on the intraday charts. This could be good for a bounce early next week but I believe there is enough overhead resistance to keep any bounces under control. If PLCE breaks down first without bouncing I suggest readers be quick to take profits at $41.70. Otherwise we'll monitor any bounces and adjust as things develop. I'm going to keep a wide stop for now due to the volatility.

7/1: The follow through to the downside in PLCE just didn't happen today. In hindsight I should not have listed our lower trigger to enter, especially with the oversold market conditions. My thought process was PLCE would hit our $41.70 target relatively quick on a breakdown, but things reversed. And I didn't think we would snap right back up after breaking down. The good news is PLCE is testing the backside of its broken downtrend line and remains below its declining 20-day and 50-day SMA's. There is a lot of congestion overhead which I think will keep bounces under control. A tighter stop could be placed at $47.05 which is above both of the aforementioned SMA's. We may need to exhibit some patience with this trade but I think the sellers will show up.

Current Position: August $45.00 PUTS, entry was at $4.00

Entry on July 1, 2010
Earnings 8/19/2010 (unconfirmed)
Average Daily Volume: 700,000
Listed on June 30, 2010

Deere & Co. - DE - close 54.63 change +0.13 stop 60.05

Target(s): 53.25, 51.75, 50.25, 49.05
Key Support/Resistance Areas: 60.00, 57.50, 56.50, 56.00, 54.00, 52.70, 51.50
Current Gain/Loss: +15%
Time Frame: 1 to 2 weeks
New Positions: Yes, on bounces

7/6: DE traded up to $56.06 this morning which triggered our entry to buy August $45.00 PUTS. The stock sold off the remainder the day and has peeked its head below the 200-day SMA for three consecutive sessions but has yet to close below it. If it does we should hit our first target of $53.25 relatively quick. If DE breaks down prior to bouncing I suggest readers be quick to take profits at the first target or tighten stops to protect against a hard reversal.

7/3: Last week DE broke below its 20-day, 50-day, and 100-day SMA's and a trend line that began in August of 2009. The stock traded all the way down to its 200-day SMA on Thursday and Friday where I expect it bounce. I suggest readers enter short positions on strength in the stock. I've chosen $55.75 as an entry trigger. Depending on the strength of any bounces readers may also consider waiting until the $56.50 to $57.50 area prior to initiating short positions (see rectangle on chart). This area is below the 20-day and 50-day SMA's which should be the extent of any bounces in the stock. I'm just not sure DE will bounce that high which is why I have chosen $55.75. We'll use a wide stop at $60.05 and will adjust it after we are in the position. Our primary target is $51.75 but I have offered several other targets readers can us as a guide to tighten stops or simply take profits if things move in our direction.

Current Position: August $55.00 PUTS, entry was at $3.00

Entry on July 6, 2010
Earnings 8/18/2010 (unconfirmed)
Average Daily Volume: 5.4 million
Listed on July 3, 2010

Lululemon Athletica Inc. - LULU - close 36.05 change -0.27 stop 43.10

Target(s): 35.25, 34.05, 33.00
Key Support/Resistance Areas: 42.25, 39.75, 37.00, 35.16, 32.75
Time Frame: 1 week

7/6: LULU came within 15 cents of hitting our trigger to enter short positions today, and then reversed down. The stock has faced a barrage of selling recently and is coming into a prior support/resistance area near our first target of $35.25. If the stock keeps testing this area the support should eventually break. I only wish LULU and the market were not so oversold. I am expecting this stock to bounce, maybe even up to its 50-day SMA which is near $40.00. Considering the conditions I would like to raise our entry back to $39.25 (below the 50-day SMA). If we are patient and get a good short entry it should pay off.

7/3: This is an example of a stock not letting shorts in for swing trade. It may be wishful thinking to expect LULU to bounce all the way up to $39.25 after the selling pressure on Friday. It would be ideal to see LULU make a run up towards its declining 50-day SMA which would be the first time testing it from below since it was broken on 6/28. But I doubt that will happen so I suggest we lower our trigger to enter to $38.40 which is just below Thursday's high. In the end, I think LULU trades down to its 200-day SMA but if it keeps declining prior to bouncing we may lose our chance. For readers who trade intraday LULU provides some good opportunities and if things are moving fast (up or down) this is a good stock to consider trading.

7/1: LULU has been whipsawing in a wide $10 range for past 3 months and I think it is ready to let go to the downside. When it happens it should let go fast. LULU is maintaining one last trend line from its 7/09 lows to its 2/10 lows. But I'm not too concerned about this trend line holding in today's market conditions. The retail sector is weak and LULU trades at a high P/E. The stock is below its declining 20-day and 50-day SMA's and there is a lot of congestion to keep any bounces under control. I suggest initiating short positions into strength. $39.25 provides an ideal entry point which we will use a trigger to enter short positions. I will also add that more conservative traders may want to wait until LULU tests its 50-day SMA from below which also corresponds with the back side of its most recent trend line that broken this week. We'll place an initial wide stop at $43.10 to account for volatility and will adjust it once we are in the position.

Suggested Position: Buy August $35.00 PUTS if LULU trades to $39.25, current ask $2.80, estimated ask at entry 1.60

Entry on July xx
Earnings 8/19/2010 (unconfirmed)
Average Daily Volume: 700,000
Listed on July 1, 2010

Starbucks Corp. - SBUX - close 23.61 change -0.73 stop 26.31

Target(s): 23.70, 22.55, 21.30
Key Support/Resistance Areas: 26.50, 26.00, 25.25, 24.80, 24.00, 23.60, 22.50
Time Frame: 1 to 2 weeks

Why We Like It:
7/6: SBUX came within 6 cents of our trigger to enter short positions and then proceeded to close down -3.04%. I'm expecting SBUX to bounce with the broader market so I suggest being patient and ready to short the stock if it trades to our trigger of $24.75.

7/3: Last week SBUX broke below a trend line that began in October 2009 and collapsed below it 20-day, 50-day, and 100-day SMA's. These SMA's (in particular the 100-day SMA) have been key areas where the stock has bounced during its rally over the past year. And now that the stock is below them it has probably seen its best days, at least for awhile. I would like to use a trigger of $24.75 to enter short positions which is below the stock's 100-day SMA, the underside of the broken trend line, and the recent steep downtrend line, all of which are converging (see oval on chart). The $25.00 area could also be considered an entry point but I chosen $24.75 because it is near Friday's highs which could possibly form a double top on the intraday charts. Our primary target is $22.55 but I have also listed $23.70 as area to consider tightening stops. It is above the 200-day SMA which SBUX has not touched in over a year.

Suggested Position: August $25.00 PUTS, current ask $2.20, estimated ask at entry $1.50

Entry on June xx
Earnings 7/21/2010 (unconfirmed)
Average Daily Volume: 10 million
Listed on July 3, 2010