Option Investor

Daily Newsletter, Monday, 7/26/2010

Table of Contents

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

Market Wrap

Monday Belongs To The Bulls

by Todd Shriber

Click here to email Todd Shriber
Stocks built on last week's gains today, buoyed by some positive new home sales data and a guidance boost from FedEx (FDX). The news sent the Dow Jones Industrial Average to another triple-digit gain with the blue chip index adding almost 101 points to close just below its intraday high at 10,525. The S&P 500 gained more than 12 points to finish at 1115, just above the 200-day moving average while the Nasdaq added 27 points to close right at its high of the day at 2296.43. Small-caps were not left behind as the Russell 2000 surged 14.57 points, or 2.24%, to settle at 665.22.

Stats Table

Sales of new homes jumped 23.6% in June from a record low in May, according to the Commerce Department. New homes were purchased at a seasonally adjusted rate of 330,000, well above the May's revised total of 267,000 units. Sales moved higher in three of four regions with the Northeast sporting the biggest gain at 46.4%. Sales jumped 33.1% in the South and 20.5% in the Midwest. The West continues to be a problem as sales in that region slumped 6.6% in June.

Despite the drop in the West, the home sales news was decidedly bullish and an unexpected surprise given that the government's tax credit for home buyers expired in April. The Commerce Department said the number of new homes for sale has dropped to its lowest level since late 1968. Obviously, some job growth will be needed to continue driving demand for new homes and if that does not happen, June's positive report may be nothing more than a one-off event.

The homes sales news was a positive for equities, but it was also felt in the commodities pits as copper surged to a 10-week on the report. NYMEX-traded copper for September delivery gained 3.8 cents to settle at 3.223 per pound, the highest close for the red metal since May 13. Copper has rebounded in a big way after plummeting in June as fears of a double-dip recession have abated and investors have gotten used to the idea that China's ''slower'' GDP growth is still pretty darn impressive.

Analysts seem reluctant to say that copper will enter a new bull market before the end of the year, but expectations are in place for higher price ranges in the second half with that trend continuing into 2011. There are other fundamental catalysts behind the move in copper. Copper stockpiles as tracked by the London Mercantile Exchange have dropped 7.7% in July, the biggest monthly drop since June 2009 according to Bloomberg News. Yes, that means more copper is being purchased. Copper Chart

As I mentioned earlier, FedEx, the second-largest package shipping firm in the world, charmed investors with another sign that the global economic recovery has some steam left in it by saying it expects to earn between $1.05 a share and $1.25 a share for its first fiscal quarter, which ends on August 31. The company earned 58 cents a share in the comparable period in 2009. FedEx previously said it expected to earn 85 cents to $1.05 a share for the quarter and analysts had been expecting $1.01 a share. The first-quarter results will be delivered on September 16.

FedEx also said it expects a profit of $4.60 to $5.20 a share for its full fiscal year, well above previous full-year guidance of $4.40 to $5 a share. Analysts were expecting a full-year profit of $4.98 a share. FedEx cited a pick-up in demand for international priority shipping services, which are expected to surge 20% this quarter, as one reason for the bullish guidance. Priority shipping services cost more and the increased demand is a good sign for the global economy because it shows customers will ante up a few more dollars to get their packages faster.

Tennessee-based FedEx is feeling strongly enough about its business prospects going forward that it decided to reinstate its company match for 401(k) plans for its U.S. workers. The company suspended the match last year when business was slack and the cost of the 401(k) reinstatement is included in its new earnings forecast, according to the Associated Press.

FedEx Chart

The bullish news from FedEx follows some positive comments from rival UPS (UPS), which said last week that will be able to tame the impact of slower economic growth in the U.S. with robust demand in international markets. UPS has raised its earnings guidance twice this year and the shares were up almost 2% while FedEx jumped 5.6%. All of that is good news for the Dow Jones Transportation Index Fund (IYT), the ETF that tracks the transportation sector. IYT popped 2.7% today as the index the ETF tracks touched its highest level in more than two months. Looking at IYT's chart, the ETF is trading comfortably its 50- and 200-day moving averages and looks poised to take out its April peak with the help of more positive catalysts.

Keeping an eye on IYT tomorrow might be a good idea as Kansas City Southern (KSU) reports earnings before the bell and Norfolk Southern (NSC) chimes in after the market closes.

IYT Chart

No shock here: BP (BP) was in the news again after weekend press reports fueled speculation that embattled CEO Tony Hayward would be forced out has head of the Europe's largest oil company by production volume. There is some cold war humor in the news that the verbally challenged Hayward will step down in October because he will take a post with TNK-BP, the British company's Russian joint venture. I will let you make your own ''left out in the cold'' and Russia in the winter time jokes at Hayward's expense.

Managing Director Robert Dudley will take the reins from Hayward. Dudley, a native of the Gulf coast region and 30-year oil industry veteran, took over the day-to-day management of the spill cleanup efforts from Hayward in June, prompting speculation he would eventually succeed Hayward as CEO. Dudley will be the first American CEO in BP's history. Wall Street apparently liked the news as BP shares gained $1.79, or 4.86%, to close at $38.65. Volume was light by BP's standards at about 33.6 million shares compared with average daily trade of 65.3 million.

BP will deliver second-quarter earnings tomorrow before the bell with analysts forecasting a profit of $1.39 a share on revenue of $72.6 billion. Tuesday's earnings schedule is light in terms of pre-market reports from marquee names (DuPont (DD) might be the only other truly noteworthy report to watch before the bell) so I think it's fair to say that a lot of ears and eyes will be focused on the BP report and what the company has to say about asset sales and spill costs.

BP Chart

Tuesday could be a continuation of the current bull move or a hurdle for the bulls to clear with the consumer confidence report due out at 10AM Eastern time. The consensus estimate is for a reading of 51, down from the previous reading of 52.9. Case-Shiller home prices are due out before the market opens.

In the wake of the positive results of the European bank stress tests, earnings reports from Deutsche Bank (DB) and UBS (UBS) could be worth monitoring as well to see just how much investors are committed to the idea of renewing risk appetite.

Looking at the charts, I would say it is positive that the S&P 500 eked out a close above its 200-day moving average on Monday, but the index now has to contend with June high of 1131 and it might take moving past the 1130 area to encourage some new buyers to get off the sidelines. There are still a bunch of noteworthy names left to report earnings, but the story is not likely to change much.

The market is pricing in top and bottom line beats as well as pared third- and fourth-quarter estimates. What I am saying is that since the earnings story is well-documented and not all that thrilling at this point, it is going to take some more positive economic news to keep the bulls interested through August.

S&P 500 Chart

The Dow was able to move past June resistance with Monday's close at 10,525 and support looks firm at 10,000. A retreat to that level probably is not in the cards for this week, but making a move to 10,750 or beyond might be challenging. DuPont is the only Dow member reporting tomorrow and Boeing (BA) steps up on Wednesday. Even if Exxon Mobil (XOM) and Chevron (CVX) knock the cover off the ball later this week, asking for more than 100-150 points from here might be a tad on the greedy side.

Dow Chart

The Nasdaq closed at a four-week high on Friday and built on those gains today, moving above the 200-day moving average, but tech is still a sector to be leery of, as these stocks did a whole lot of nothing even when the earnings reports were strong. I might be inclined to change my posture if the Nasdaq can clear its June peak of 2341.

Nasdaq Chart

Small-caps have rallied hard and fast with the Russell 2000 surging over 60 points in less than two weeks. Depending on your indicator of choice, the Russell 2000 is now overbought are close to getting there, so I would be careful after this big move higher and look at a break of 675 as the next potential buy signal.

Russell 2000 Chart

While it is undeniable that stocks have performed well over the past week, denying the existence of a downtrend that started in April could be a foolish bet. Much has been made of the major indexes reclaiming this moving average or that moving average, but we have been down this road before and stocks could not hold their gains the last time around. Investors are going to need to be motivated to deploy cash over the next five or six weeks and that motivation needs to come improving economic indicators.

I want to personally apologize for the late hour at which you received today's wrap. I was on wedding duty this weekend and my flight home was delayed so much that I did not arrive back in California until 4PM local time.

New Option Plays

Short Index Play

by Scott Hawes

Click here to email Scott Hawes


SPDR S&P 500 ETF - SPY - close 111.56 change +1.15 stop 113.55

Company Description:
SPDR S&P 500 ETF (the Trust), formerly SPDR Trust, Series 1, generally corresponds to the price and yield performance of the S&P 500 Index. The S&P 500 Index consists of 500 selected stocks, all of which are listed on the exchange, the NYSE or NASDAQ, and spans over 24 separate industry groups.

Target(s): 109.50, 108.60, 107.75
Key Support/Resistance Areas: 113.20, 111.65, 110.00, 109.50, 108.55
Time Frame: 1 to 2 weeks

Why We Like It:
SPY has rallied right into resistance and its 200-day SMA from below. This is a logical place for SPY to turn back lower towards its 50-day SMA. We are playing for a retracement which I think SPY will do prior to moving much higher. The bottom line is that SPY is need of healthy pullback before it can move much higher. I've chosen a stop of $113.55 which is above the June highs and the 100-day SMA.

Suggested Position: September $110.00 PUTS, current ask $3.25

Annotated chart:

Entry on July xx
Earnings: N/A (unconfirmed)
Average Daily Volume: 236 million
Listed on July 26, 2010

In Play Updates and Reviews

Looking for Broader Market Pullback

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:

CALL Play Updates

Human Genome Sciences - HGSI - close 26.36 change +0.54 stop 23.95

Target(s): 26.60, 27.05, 27.55
Key Support/Resistance Areas: 28.00, 27.10, 26.60, 25.00, 24.25
Time Frame: 1 to 2 weeks

7/26: HGSI came within 7 cents of hitting our trigger to enter long positions. We are having trouble getting into positions as the stock's are nearly missing our triggers. HGSI has an upward tend line from its 7/1 lows and I think the stock will turn back to touch it in the comings days. I'm keeping the set-up and trigger the same.

7/24: HGSI broke and closed above its primary down trend line that began on 4/13. The stock has made a higher low and has convincingly broken above its 20-day and 50-day SMA's. I suggest we initiate long positions on weakness in the stock. I expect a pullback somewhere between $25.50 and $25.10. Officially, we'll use $25.50 as a trigger with a stop at $23.95 which is below the upward trend line and the 50-day SMA. I believe HGSI should trade up to its 200-day SMA near our second target of $27.05. Our first target is $26.60 which can be used an area to begin tightening stops.

Suggested Position: September $26.00 CALL, current ask $2.25, estimated ask at entry $2.08

Entry on July xx
Earnings Date 10/25/10 (unconfirmed)
Average Daily Volume: 4.2 million
Listed on 7/24/10

ProShares UltraShort 20 YR Treasury - TBT - close 36.52 change +0.10 stop 34.25

Target(s): 37.50, 39.40, 40.50, 41.95
Key Support/Resistance Areas: 42.00, 41,00, 39.70, 38.25, 37.55, 34.65
Current Gain/Loss: -4%
Time Frame: Several Weeks
New Positions: Yes

7/26: TBT was initiated at the open. The ETF is finding some resistance at its secondary downtrend line but it appears it is only a matter of time before this is broken and TBT breaks to the upside. My comments from the play release remain the same.

7/24: I think bonds are way overvalued and are due for a correction. TBT is an leveraged inversely correlated instrument. Typically bond prices move opposite of stock prices, i.e. as the stock prices decline prices of bonds generally move higher and bond yields move lower, and vice-versa. So a long play in TBT is a bet that bond prices will decline and bond yields will rise which means that money will be flowing out of the bond market and probably into the stock market. In general, bonds are slow movers so TBT gives you more bang for your buck and is highly liquid with average daily volume of about 8 million shares. TBT mad a double bottom on 7/1 and 7/21 and I believe it is poised to move higher. The ETF closed above its 20-day SMA and a prior resistance level at $36.30. TBT has a downtrend line to deal with but I am not expecting it to experience too much trouble here. Our immediate target is $37.50 which near a prior resistance level and just under the ETF's 50-day SMA. TBT will probably find resistance there and when it finds its footing and moves higher we will have a reference point to trail the stop higher. My intention is that this trade could last several weeks and I think TBT could make a run up to its October 2009 lows which is near $42.00. Interest rates are at all time lows and I just don't see them going any lower which will bode well for a long position in TBT. Our stop is $34.25 which is below the YTD lows. NOTE: If there is weakness in equities early this week TBT will probably pullback so patience is most likely needed. A lower entry could be considered in the $36.00 area but I'm not certain we will get it.

Current Position: September $37.00 CALL, entry was at $1.23

Entry on July xx
Earnings N/A (unconfirmed)
Average Daily Volume: 3.8 million
Listed on July 24, 2010

ProShares Ultra Basic Materials - UYM - close 31.15 change +0.45 stop 27.20

Target(s): 30.35, 31.20,
Key Support/Resistance Areas: 31.30, 30.50, 29.00, 28.00, 27.25
Time Frame: 1 weeks

7/26: My comments from 7/24 have not changed. We are looking for UYM to retrace some of its recent gains prior to entering long positions with a trigger of $29.10.

7/24: UYM came within 30 cents of our trigger to enter long positions. This market has a knack for not letting traders into positions and UYM continued motoring higher on Friday. The ETF is near a support/resistance area at $30.50 and I believe it will turn back towards the $29.00 level to gain steam before eventually breaking above Friday's highs. The fact of the matter is that there are probably a lot of people still "holding the bag" from the mid June swing highs (or before) and that overhead supply needs to be worked off before UYM continues higher. This is why it is higher risk to chase it at these levels unless you are trading intraday and using a very tight stop. So the question is how far will it pullback and what is the ideal entry point? UYM has intraday support at $29.30 down to $28.80. If these levels break the next level of support is down at $28.00 which is also near the 50-day SMA. These are three entry levels I suggest readers use as a guide to enter positions. Officially, we are going stick with $29.10 as our trigger. This will be a throwback to the middle of the developing upward channel and is also just above a key pivot level for UYM dating back November 2009. UYM may even push up to its 200-day SMA before turning down but in the end I think patience will pay off. I've adjusted the strike price to September $30.00 calls.

Suggested Position: September $30.00 CALL, current ask $3.30, estimated ask at entry $2.20 (I suggest entering this position with a limit order between the bid/ask spread. Try to enter at no more than 5 to 10 cents above the middle of the bid/ask spread)

Entry on July xx
Earnings Date N/A (unconfirmed)
Average Daily Volume: 1.9 million
Listed on 7/22/10

PUT Play Updates

Costco Wholesale - COST - close 55.71 change -0.24 stop 57.25

Target(s): 55.40, 54.80, 54.30
Key Support/Resistance Areas: 56.80, 55.60, 54.25, 53.40, 51.50
Current Gain/Loss: -5.4%
Time Frame: 1 week
New Positions: No

7/26: My comments from 7/24 have not changed. COST drifted lower the entire day and traded to within 5 cents of our first target above before bouncing. We are looking for a pullback in the broader market and COST should easily trade towards our revised targets giving us the chance to exit a winning position.

7/24: COST traded to $55.50 which triggered our entry for short positions. There is intraday resistance right at this level plus a downtrend line from 6/15 so this is a logical spot for COST to retrace some of the gains from the past two days. COST has now had two powerful rallies since 7/7 off of the $53.50 support level (i.e. double bottom). There is obviously a lot of support at this level and I just don't see it revisiting those lows for awhile. As such, we need to adjust so I suggest we stay nimble on this trade and begin looking for an exit. I have adjusted our targets above to use as a guide to tighten stops or simply take profits. I am looking for a small gain on this trade, nothing more. At a minimum COST should turn back to test its 20-day SMA near $55.40. Our next targets are $54.80 and $54.30. I expect the broader market to be weak early this week which should get COST moving towards these targets.

Current Position: September $55.00 PUTS, entry was at $1.48

Entry on July 23,2010
Earnings 10/7/10 (unconfirmed)
Average Daily Volume: 3.76 million
Listed on July 20, 2010