Option Investor

Daily Newsletter, Wednesday, 7/21/2010

Table of Contents

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

Market Wrap

Unusually Uncertain

by James Brown

Click here to email James Brown

Volatility continues in the market as investors react to another round of earnings results and comments from Federal Reserve Chairman Ben Bernanke. The afterglow of Apple's (AAPL) positive earnings report from last night overshadowed disappointing numbers and guidance from Yahoo (YHOO), which helped the NASDAQ composite index gap open at 2,236 this morning. Investors responded positively to earnings results from financial giants Wells Fargo (WFC) and Morgan Stanley (MS) and that helped the S&P 500 gap open at 1,086. Unfortunately the strength was short-lived. The open proved to be the high of the day with the rally failing at the 50-dma for both the S&P 500 and the NASDAQ.

Ben Bernanke's testimony before Congress proved to be the big event for the session. Traders were unhappy with Ben's lack of confidence in the economy. At the end of the day money was moving back into the perceived safety of U.S. bonds and the U.S. dollar. The yield on the 10-year note closed under 2.9%, which hasn't happened since April 2009. The yield on the 2-year note fell to a new low of 0.58% (it has fallen to 0.55% after hours). The euro slipped as investors moved money out of riskier assets. This powered a bounce in the dollar. Commodities reacted with a decline. Gold futures fell over $7 to $1,184.40 an ounce. Crude oil futures slipped 1.5% to $76.40 a barrel but this was compounded by an unexpected build up in oil inventories. The EIA said inventories jumped +360,000 barrels when economists were expecting a drop of -1.4 million barrels. Copper prices outperformed with a +1.6% gain and appear to have broken out above a two-month trendline of resistance.

Chart of Copper ETN (JJC)

Overseas markets were generally positive following yesterday's bounce in the U.S. Commodity-related securities, specifically oil and mining stocks, were some of the best performers in both Asia and Europe. The Chinese Shanghai index rose +0.26% and the Hong Kong Hang Seng index rallied +1.1%. The Shanghai managed to hit a new three-week high and lift its gains for the week to almost +5%. Investors are speculating that the Chinese government will ease its policies in the second half of this year since the government has been successful in slowing down the economy. Meanwhile the Japanese NIKKEI index underperformed with a -0.2% decline.

The major European markets were higher across the board. Positive earnings results and some M&A activity helped boost stocks higher. Banks were some of the best performers averaging about +2% thanks in part to Morgan Stanley's strong performance here in the U.S. Investors are still speculating that the stress tests for European banks will yield positive news. The results for the stress tests are due to be released this Friday. At the end of the day the major averages faded from their opening rally to close at their lows for the session. The English FTSE rose +1.4%. The French CAC-40 gained +0.75%. The German DAX added +0.38%.

Last week the minutes to the June 22-23 FOMC meeting made headlines when it was revealed that the Federal Reserve had downgraded their economic forecast for the U.S. Fed officials now expect the unemployment rate to end this year in the 8.3% to 8.7% range, which is up from 8.1%-8.5%. Currently the unemployment stands at 9.5%. Regulators also expect U.S. GDP for 2011 to grow in the +3.5% to +4.2% range, down from +3.4%-4.5%. The market was hoping that Fed Chairman Ben Bernanke might shed more light on this downgrade and offer some hope for the second half of 2010.

Experienced traders know that the one thing the market hates the most is uncertainty. Thus Ben's comments that the Fed's "economic outlook remains unusually uncertain" did not inspire any confidence. Bernanke's testimony moved the market as stocks immediately turned south on his uncertain outlook. A Republican Senator asked Bernanke if the Fed was "out of bullets" should the economy roll over into another recession. Ben suggested they still had tools available, including lowering interest rates paid to banks. That was a surprise since rates have been stuck in the 0.0% to 0.25% range since December 2008. Officially the Federal Reserve does not expect the economy to slip back into a double-dip recession but the skeptic in me naturally wonders, "what else would Ben say in front of Congress?"

When asked about his view of the future, Bernanke stated that the Federal Reserve members "expect continued moderate growth, a gradual decline in the unemployment rate, and subdued inflation over the next several years." Yes, you read that right. He said, "next several years." If the economy doesn't see a double dip we are probably looking at a long, slow grind higher. Ben reiterated that the fragile economy and the lack of inflation would allow the Fed to keep rates low for an "extended period". Ben also repeated his concerns over Europe's debt crisis and how it might affect the global recovery.

We are in the middle of the busiest week of Q2 earnings. Naturally earnings results continue to influence the market (editor's note: the next nine paragraphs cover earnings results). This morning there were several high-profile announcements in the banking industry. Wells Fargo (WFC) announced a profit of 55 cents a share, which was 7 cents better than expected. Revenues fell about 4.9% to $21.39 billion, just fractionally under expectations for $21.4 billion. A year ago WFC earned 57 cents. Management offered some positive comments that credit losses were improving. However, WFC's nonaccrual loans, those loans that the bank deems are in trouble and might eventually get charged off, actually rose 2% to $27.81 billion. Shares of WFC gapped open higher at $27.53 but gave back most of its gains to close up 15 cents at $26.06.

Another major bank reporting this morning was U.S. Bancorp (USB). The company beat Wall Street's estimates by 12 cents with a profit of $0.50 a share. Revenues soared almost +115% to $4.52 billion versus estimates of $4.35 billion. These results were overshadowed by strong earnings from Morgan Stanley (MS). Morgan Stanley delivered a profit of $0.80 a share, which was 34 cents better than analysts expected. Revenues jumped +53% to $7.95 billion versus the $7.93 billion estimate. Trading revenues for a lot of the big banks has been suffering. Goldman Sachs, JPM, Bank of America all saw their total trading revenues fall by more than -30%. Yet MS' company-wide trading revenues only fell -12%. Stock-trading revenues at MS actually surged +82%. Shares of MS gapped open and spiked to $27.89 before settling at $26.80 (+6.2%).

Chart of Morgan Stanley (MS)

Mining giant Freeport McMoran (FCX) also reported earnings before the market open today. The company beat Wall Street's estimates by 12 cents with a profit of $1.40 a share. Revenues came in at $3.68 billion, slightly ahead of estimates of $3.66 billion. Profits were fueled by much higher metal prices. The average price of copper was $3.06 per pound this past quarter compared to $2.22 a year ago. The average price of gold was $1,234 an ounce versus $932 a year ago. Shares of FCX broke out above its simple 50-dma and closed with a 2.7% gain but pared back most of its morning advance.

The flood of earnings continued after the closing bell. Some of the highlights were EBAY, QCOM, SBUX, WDC, NFLX, and BIDU. Online auction giant EBAY managed to beat analysts' estimates by 2 cents with a profit of $0.40 a share. Revenues rose +5.6% to $2.21 billion, which was better than the $2.16 billion estimate. Unfortunately, EBAY does a lot of overseas business and the drop in the euro has had a negative impact on the company. Management guided both its Q3 earnings and revenues estimates lower.

Qualcomm Inc. (QCOM), a huge player in mobile phone chips, managed to beat Wall Street's estimates. QCOM reported a profit of 57 cents a share compared to estimates of 54 cents. Revenues fell -1.7% to $2.71 billion but that was still better than the $2.63 billion estimate. QCOM offered guidance that was in-line with previous estimates but suggested the average selling price for products using their CDMA chips would see a slight improvement. The stock rallied more than 3% in after hours toward $37 a share.

The world's largest coffee chain, Starbucks Corp. (SBUX), reported earnings of 29 cents a share. This was in-line with estimates. Revenues jumped +8.7% to $2.61 billion, better than the $2.55 billion estimate. Management said the improvement was fueled by a healthy growth in their same-store sales and their new Via instant coffee product. SBUX also reported a +30% increase in their quarterly cash dividend from 10 cents to 13 cents a share. Unfortunately the company also reported rising commodity costs and shares were trading lower in after hours.

Another consumer-related company was Netflix (NFLX). The movie-rental giant announced they added more than one million new subscribers last quarter. Earnings results came in at 80 cents a share, which was 9 cents better than expected. Revenues rose +27.2% to $519.8 million, but this missed analysts' estimates of $524.4 million. The company said the number of consumers using their online streaming content rose from 55% in Q1 to 61% in Q2. NFLX raised their full-year estimates and forecasted subscriber growth to hit the 17.7-to-18.5 million range. In spite of the strong results traders are selling the news after hours with shares of NFLX down about $12 to $108. I'm not too surprised to see a sell-the-news reaction with shares of NFLX up over 60% in the second quarter.

In the tech sector the hard-disk drive maker Western Digital Corp. (WDC) reported earnings of $1.13 a share. This may not be comparable to analysts' estimates of $1.38 a share. Revenues at WDC jumped +23.5% to $2.38 billion but that was still below the consensus at $2.45 billion. WDC's disappointing results follow results from rival Seagate Tech (STX), who missed analysts' estimates yesterday. Shares of WDC lost -5.2% on the session and were down another -3.3% in after hours, trading under the $30.00 level.

Google's biggest competition in China is Bidu.com (BIDU). BIDU reported earnings after the close and beat analysts' estimates by 4 cents with a profit of 35 cents a share. Revenues jumped +74.4% to $282.3 million, which was better than Wall Street expected at $276.7 million. BIDU issued positive, upside guidance for the third quarter and shares were trading higher after hours near $75.

Technically I don't see a lot of change in the market's posture. The major indices are still building a pattern of lower highs. The last several days has seen overhead resistance at the simple 50-dma, which proved resilient again this morning. If the market wants to go down it will find a reason to do so. Thus far, while we have seen some individual winners, investors are still concerned about a slowdown in corporate revenues. On a short-term basis if the S&P 500 continues to sink, I would look for support near 1040. If 1040 breaks then we'll probably see a quick drop toward the July lows near 1020 or the 1,000 mark.

Chart of the S&P 500 index:

The tech-heavy NASDAQ composite has the same pattern with the index producing a failed rally at the simple 50-dma this morning. The trend of lower highs and lower lows doesn't bode well and neither does the death cross technical pattern with the 50-dma crossing under the 200-dma. On a short-term basis the NASDAQ might see some support near 2140 but I suspect this index will be testing its July lows before the month is out.

Chart of the NASDAQ index:

In other news President Obama signed the financial reform bill into law today. At the televised signing ceremony Obama said the new law will prevent any future taxpayer-funded bailouts for the banking industry. The 390,000-word bill will also set up a new consumer-protection agency. While we're on the subject of legislation there was an ABC news article out today discussing a new tax found in the healthcare reform bill passed earlier this year. In an attempt to help pay for the new healthcare law there is a new tax on gold coin and bullion sales. Every time a consumer sells more than $600 worth of gold to a dealer it has to be reported on a 1099 form. With gold at more than $1,200 an ounce it won't take much to trigger this tax. This new tax is expected to raise $17 billion over the next ten years. The Industry Council for Tangible Assets (ICTA) is furious over this new tax hidden in the healthcare bill and they're already trying to get it repealed.

Tomorrow will bring a handful of economic reports and another full day of earnings news. Investors will be watching the weekly initial jobless claims, which is expected to come in at 445,000. We'll also hear the latest reading on continuing unemployment claims. The Existing Home Sales report is supposed to show an annual sales pace of 5.09 million units. The Leading Indicators from June are expected to drop -0.4%.

On the earnings front there will be dozens and dozens of companies reporting. Some of the high-profile names are: Bristal-Meyers Squibb (BMY), American Express (AXP), Amazon.com (AMZN), SanDisk Corp. (SNDK), Baxter International (BAX), United Parcel Service (UPS), The Hershey Co. (HSY), 3M Co. (MMM), AT&T (T), Capital One Financial Corp. (COF), Caterpillar (CAT), Diamond Offshore Drilling (DO), Eli Lilly (LLY), Nokia (NOK), and Microsoft (MSFT).

The existing home sales number might be a market mover but I suspect the market has already priced in a disappointment. Earnings news will be the main driver tomorrow. Unfortunately, the market's trend is down and traders seem poised to sell the news. Trade carefully!


New Option Plays

Short Candidate That Has A Gap To Fill

by Scott Hawes

Click here to email Scott Hawes


Eaton Corp - ETN - close 73.14 change +4.08 stop 74.90

Company Description:
Eaton Corporation (Eaton) is a diversified power management company. The Company is engaged in the manufacturing of electrical components and systems for power quality, distribution and control; hydraulics components, systems and services for industrial and mobile equipment; aerospace fuel, hydraulics and pneumatic systems for commercial and military use, and truck and automotive drive train and power train systems for performance, fuel economy and safety.

Target(s): 71.55, 70.80, 69.85
Key Support/Resistance Areas: 74.00, 71.50, 70.00, 68.50
Time Frame: 1 to 2 weeks

Why We Like It:
ETN reported earnings this morning that beat estimates and the stock closed +5.9% on the day with most of that coming in the form of a gap higher. The company also guided higher but the stock is still expensive trading around a 20 PE ratio. ETN has gained over +10% in just two days and has rallied right into a downtrend line from its April to June highs. I expect there to be a significant retracement and we could see ETN begin to close the gap higher from today. At a minimum we should see ETN turn back towards today's lows and its 50-day SMA. Our stop will be above today's highs at $74.90. NOTE: the September strikes were recently released so the open interest isn't as high as other months.

Suggested Position: September $70.00 PUTS, current ask $2.40 (try to enter no higher than $2.30)

Annotated chart:

Entry on July xx
Earnings: More than 2 months (unconfirmed)
Average Daily Volume: 1.7 million
Listed on July 21, 2010

In Play Updates and Reviews

Big Winner Closed

by Scott Hawes

Click here to email Scott Hawes

PUT Play Updates

Costco Wholesale - COST - close 53.61 change -1.48 stop 57.25

Target(s): 53.80, 53.00, 52.25
Key Support/Resistance Areas: 56.80, 55.60, 54.25, 53.40, 51.50
Time Frame: 1 week

7/21: COST tanked -2.69% today has already hit our first target. It's probably wishful thinking that the stock will rally up to our target of $55.80, but if we are patient we might get one of those rally days so I suggest we see how the rest of the week plays out. I will lower the trigger to $55.50 which is near the 20-day SMA and $55.60 resistance area which is where I expect COST to hit a brick wall.

7/20: COST has broken through key support/resistance areas at $56.80 and $55.60 and is below all of its major moving averages which are declining. The stock is rallying to test these areas from below and I suggest readers using a trigger of $55.80 to enter short positions on any further strength COST exhibits in the coming days. This area is near the most recent downtrend line. We'll use a tight stop at $57.25 which is just above the 50-day and 20-day SMA's, the recent downtrend line, and the congestion area overhead. COST has a large gap to be filled down near the $52 level which is near our most aggressive target and could happen if weakness reappears in the broader market. NOTE: September options were just recently released so the open interest is less than other months.

Suggested Position: September $55.00 PUTS, current ask $2.66, estimated ask at entry $1.45

Entry on July xx
Earnings 10/7/10 (unconfirmed)
Average Daily Volume: 3.76 million
Listed on July 20, 2010

PowerShares QQQQ Trust - QQQQ - close 44.64 change -0.62 stop 45.10 *NEW*

Target(s): $45.05 (hit), 44.60 (hit), 44.40 (hit 7/17, 7/20), 44.15, 43.90
Key Support/Resistance Areas: 46.77, 45.25, 44.46, 43.50, 42.50, 41.00
Current gain/loss: -25.00%
Time Frame: 1 week
New Positions: Yes, but expect a quick exit

7/21: QQQQ gapped higher and essentially sold off the remainder of the day. The stock hit our first target of $45.05 and drifted higher to the $45.40 area which is where the real selling began. For intraday traders I've provided an intraday chart to illustrate where protective stops could have been placed to protect against a reversal and to get the most of the price action that was happening (see red lines on the chart). The initial stop could have been placed near the $45.50 level which was above the initial swing high (see small oval). QQQQ then proceeded to sell off hard hitting our targets of $44.85 and then finally $44.60 at the end of the day. Once these targets were hit the stops could have been moved down to the $45.10 area which was above prior intraday support areas of the past few days (which should now act as resistance). This is the ideal way to deal with the current volatility upon us. So now we are ready to lower the stop to $45.10 going into tomorrow. $44.10 is still a valid target just above the 20-day SMA that has been previously hit. This is the area where I suggest tightening stops to see if we can get even more out of the position. If things continue to the downside the immediate next targets are $44.15 and $43.90 with the most aggressive target at $43.40. I know managing a trade like this is difficult for traders who do not trade intraday. A possible solution would be to initiate a trailing stop which will protect you from a hard reversal back to the upside. In this case the trailing stop would be about 45 cents. My goal is to exit this positions this week.

Annotated Chart:
7/20: QQQQ gapped lower and traded to within 11 cents of our $43.75 target. The market looked ugly and after an early bounce and the Q's even retreated to retest its lows. For intraday traders a stop should have place above the first 30 minute high of $44.12 which would have protected small profits in this position. After this level was broken the Q's proceeded to bounce and never looked back, surging +3% from its lows. Will there be follow though? It appears there will be some with AAPL's earnings report which is boosting the NASDAQ 100 futures +0.50% in the aftermarket. This equates to about 23 cents in QQQQ which is below our stop and last week's highs. It is amazing how things changed on a whim this morning which we have seen a lot of lately, and it has helped and hurt our positions. This time it is painful but we have a plan and we need to stay nimble to find a proper exit. So I have listed additional immediate targets above which are intraday support/resistance areas. QQQQ should retrace some of these gains and these are areas where the ETF may find support. They are good areas to tighten stops or exit positions. It wouldn't surprise me to see QQQQ retrace a good portion today's gains and retest its declining 20-day SMA (currently $44.51 and declining). The Q's are also below two downtrend lines and its 200-day and 50-day SMA's. It will be interesting to see how it plays out.

Current Position: August $45.00 PUTS, entry was at $1.85

Entry on July 8, 2010
Earnings N/A (unconfirmed)
Average Daily Volume: 100 million
Listed on July 7, 2010

Wynn Resorts - WYNN - close 81.96 change -1.96 stop 85.10 *NEW*

Target(s): 81.55, 80.50, 79.50, 78.25
Key Support/Resistance Areas: 85.00, 84.00, 76.50, 72.00
Current Gain/Loss: -34%
Time Frame: 1 week
New Positions: Yes

7/21: WYNN came within 2 cents of hitting our revised first target this afternoon so I have raised this 5 cents. The stock prices of WYNN are coiling and it is due for a trip lower. When that happens I suggest readers use the above targets to tighten stops to see how much more we can get out the position. I think WYNN's early strength was more about a prior unfilled gap than true strength. I think we will see $80.50 and probably $79.50 prior to going much higher. I'm going to lower the stop to $85.10 which is above today's high. If WYNN trades up to this level its probably headed towards $88.00 but I like it go lower first.

7/20: Once again WYNN was down -$2 at the open and pulled a complete reversal. Conservative traders may want to consider exiting this position and preserving capital as we have already lost -$1.50 in the option premium. After WYNN broke below key support levels and its 20-day, 50-day and 100-day SMA's the stock has catapulted higher with the broader market. It's time to salvage what we can so I have listed 4 targets above and I suggest readers begin too tighten stops or exit positions at these levels.

NOTE: I view this trade as being aggressive and potentially quick.

Current Position: August $75.00 PUTS, entry was at $3.50

Entry on July xx
Earnings 7/29/10 (unconfirmed)
Average Daily Volume: 2.92 million
Listed on July 17, 2010


United States Steel - X - close 44.79 change +0.50 stop 43.15

Target(s): 43.25 (hit), 45.25(hit), 46.20 (hit)
Key Support/Resistance Areas: 48.70, 46.25, 50-day SMA, 43.50, 40.80, $40.00
Final Gain/Loss: +89.8%
Time Frame: 1 week
New Positions: Closed

7/21: X gapped open higher, hitting and oscillating around our final target of $46.20 the entire morning. As such, we are flat the position for a much needed +89% gain. The stock gave back most of the morning gains when the broader market selling set in this afternoon. X can probably be bought again but I would like to see it come down to the $43.60 which was its recent break out level. $44.43 is the 50-day SMA so a break below there may bring in more selling. For readers who may still have positions I urge you to protect profits.

7/20: X made a huge turn around today and our position has now gained +26% after looking terrible yesterday. I've adjusted the targets and moved up the stop to $43.15. I suggest readers be smart about protecting profits here but also try to let the position run as far as possible. Our next target of $44.40 should be hit in the morning. This is near today's highs and the 50-day SMA and readers should consider tightening stops or simply taking profits at this level, especially if you can not trade intraday. Our next targets are $45.25 and $46.20 which are at the bottom and top of a congestion area from mid June. There is good a chance X pulls back from its 50-day SMA so caution is urged.

Closed Position: August $46.00 CALLS at $2.62, entry was at $1.38

Annotated Chart:

Entry on July 15, 2010
Earnings Date 7/27/10 (unconfirmed)
Average Daily Volume: 13.5 million
Listed on July 14, 2010