Option Investor

Daily Newsletter, Tuesday, 7/27/2010

Table of Contents

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

Market Wrap

Economics Trump Earnings

by Jim Brown

Click here to email Jim Brown

Positive earnings from companies like Dupont failed to boost the market after economic reports tick lower.

Market Stats Table

Dupont (DD) posted earnings that nearly tripled and raised their guidance due to growing sales and higher prices. Dupont posted earnings of $1.26 per share compared to analyst estimates of only 93-cents. Revenue grew 26% and exceeded estimates by $500 million. Unfortunately a +4% spike in the stock of this Dow component failed to overcome negative economics.

The July Consumer Confidence report dropped to 50.4 and the lowest level since February. This was a -4 point drop from June and a -12.3 point decline since May's 62.7 level. The present conditions component fell only -0.7 to 26.1 but the expectations component fell -6 points to 66.6. Job expectations declined as did home buying intentions. However, people planning on buying cars and appliances picked up slightly. The percentage of respondents expecting the equity markets to decline over the next six months rose to more than 75%.

Consumer Confidence Chart

The Richmond Fed Survey fell sharply by -7 points to 16.0 from June's 23.0 reading. This is down from the recent high of 30 back in April. The new orders component was cut in half from 25.0 to 13.0, down from 41.0 in April. Backorders fell to 1.0 from their high of 16.0 in May. Capital expenditure plans fell from 25.0 to 17.0. Supplier delivery time plummeted from 17.0 to 4.0 indicating the backlog for components has declined sharply. The shipment component dropped from 22.0 to 9.0.

On the positive side the employment component rose to 15.0 from 9.0 and the average workweek rose slightly. Manufacturers appear to be staffing up for the holiday merchandise manufacturing cycle.

Richmond Fed Chart

The drop in the Richmond Fed Survey followed a sharp decline in the Texas Manufacturing Survey on Monday. The Texas Survey declined to -21.0 in July from -4.0 in June. The recent high was +21.1 in April. The pace of decline is very sharp. Numbers below zero are considered economic contraction. As you can see in the table below the decline in activity has been rather dramatic since the April highs.

Texas Manufacturing Survey Chart

Texas Manufacturing Survey Table

The Case Shiller Home Price Indexes showed existing home prices rose faster than previously thought in the three months ending in May. The 20-city index rose +4.6% compared to the same period in 2009. However, this is more than likely a residual effect from the homebuyer tax credit that expired at the end of April. On a month ago basis the cities with the largest appreciation were Boston +1.6%, Chicago +1.2%, Los Angeles +1.7%, San Diego +1.1%, San Francisco +1.7% and Washington +1.5%. The only decliner in the top ten index was Las Vegas at -0.5% MTM and -6.5% YOY.

The major reports due out on Wednesday are the Durable Goods, Fed Beige Book and Oil Inventories.

Also depressing the equity markets was earnings results from US Steel. The company posted earnings of 45-cents before currency issues and that missed analyst estimates of 63-cents. The CEO was asked about the shape of the recovery using the normal V, U or W shaped descriptions. He said, "you can use any alphabet letter you want but the recovery is going to be choppy and take a long time." Also, "We are still not prepared to say there is a turn or that we are getting optimistic again but it feels like there is a little bit more traction in the spot markets in Europe than there is so far in North America." The less than inspiring guidance knocked -6% off the companies share price and caused a panic sell off in all the commodities.

US Steel Chart

AK Steel (AKS) posted results that beat the street by 7-cents on revenues that almost doubled. Shipments doubled to 1.4 million tons on a 9% increase in prices. AKS reported the highest steel shipments since 2008. However, raw materials costs boosted operating costs by 78%. Like US Steel, AKS said there was significant uncertainty in the global markets that will translate into lower selling prices in Q3.

Thanks to the steel companies economic guidance and the drop in consumer confidence the price of gold fell -23 to a new three month low at $1160. The dollar started off the morning at a new three month low but recovered slightly before day's end.

Gold Chart

Crude prices declined -1.63 to close at $77.35 after spending three days hugging the $79 level. Crude prices have been solidly over $75 for most of July on hopes of an economic rebound and worries over potential shutdowns in the gulf. Over 28% of crude output from the gulf was shutdown over the weekend on worries that Bonnie would strengthen and cause more damage.

The API inventory report after the close showed that crude inventories rose +3.08 million barrels when analysts were expecting a decline of -2.3 million. The API report is not closely followed by traders but should this carry over into the EIA report on Wednesday we could see another drop in oil prices.

Oil Chart

Oil companies are so skittish about a potential disaster befalling their operations and costing them billions that they are shutting down operations at the first sign of trouble. This will likely continue for years until the collective mental scars have healed. There are only a very few companies that could afford the kind of disaster that hit BP. Everyone else would be put out of business with a loss of that magnitude. Diamond Offshore and Ensco said in the last week that there were a lot of deepwater rigs for sale by the smaller companies who see the BP disaster as what could happen to them and they are no longer willing to take the risk. Diamond said they might try to raise some money in order to take advantage of the discounted rig prices.

BP's disaster was a wake-up call for the entire industry and it is going to be an expensive lesson. BP reported earnings today that included $32 billion in charges related to the oil spill and said it planned to sell $30 billion in assets over the next 18 months. Despite claims by analysts and brokerages like Goldman Sachs that the total bill could be as much as $150 billion, the markets were stressed that BP reported a $32 billion charge this early in the process. Wall Street expected a big number but not that big. Unfortunately the numbers will get bigger. BP is facing as much as $18 billion in fines plus so many lawsuits that a conference for lawyers was scheduled for this weekend to determine how best to proceed. Even the SEC has started a probe on how BP handled disclosure to shareholders. I would not want to get out of bed in the morning if I was CEO of BP.

Tony Hayward stepped down as CEO on Tuesday and Robert Dudley will take over as the CEO. I wrote an article on Hayward and the 100-year history of BP and the coming name change last night. You can read it here.

Chart of BP

Earnings for today were fairly lackluster with few high profile results. Buffalo Wild Wings (BWLD) beat the street by 8-cents and gained about $3 in after hours trading. Lower prices for chicken parts and an aggressive store-opening program were credited with the gains. Same store sales were also up +7%. This should be a clear indication that drug companies and hospitals are going to do well in the future since hot wings are just about the most unhealthy food you can eat.

Broadcom (BRCM) reported profits that rose well over 1000% from the comparison quarter. Broadcom reported profits of 52-cents compared to only 3-cents in the comparison quarter. Revenue beat street estimates but only slightly. The CEO said strong product demand and market share gains would drive strong revenue growth in Q3 as well. Broadcom raised its guidance to $1.7-$1.8 billion and analysts were expecting $1.67 billion. BRCM shares did not respond and gained only about 30-cents in afterhours trading.

Earnings for the rest of the week include the rest of the major oil companies as well as Boeing, Amgen, Symantec and Visa to highlight a few. The earnings cycle has peaked and finding big reports to hold up the market is going to become more difficult.

Earnings Calendar

The weak consumer confidence numbers created worry about consumer spending and that caused a decline in Dow components AXP, MCD, HD, WMT and INTC. The increasing worry about a weak consumer and possibly a double dip recession is overshadowing strong earnings from companies like Dupont. Weak guidance from some high profile names like US Steel made it increasingly harder for the major indexes to move over resistance.

The Dow closed barely positive with the S&P and Nasdaq closing barely negative. The Dow Transports posted the biggest decline at -1.3% after KSU and NSC both beat the street but saw their shares fall sharply after the reports. KSU declined by -6% and NSC -2%.

That appears to be the predominate pattern. Report earnings, beat the street and watch your stock price get crushed. This does not bode well for the rest of the week and for the market in August. I have mentioned several times that I expect the markets to show weakness before the end of July. I am running out of days for that prediction to come true but so far that key resistance on the S&P is still holding.

We saw the S&P move over 1100 on Monday but come to a dead stop at the 200-day average at 1113.95. The Dupont news spiked the indexes over that level this morning but the selling was immediate and the S&P retreated to hug the 1113 level the rest of the day.

The 200-day at 1113.95 and the 50% retracement level at 1116 should remain strong resistance. SPX 1115.10 also happens to be where the S&P closed 2009 so a move over 1116 puts the SPX positive for the year.

Volume remains light and that favors the sellers. Volume is a weapon of the bulls and it appears that after three triple digit days on the Dow they have run out of ammo.

I have to admit I was encouraged by the nice upward move on the S&P over the last six days but until it moves over resistance I am not along for the ride. I scanned a lot of charts today and quite a few that were looking bullish last week are showing signs of stress.

We are only eight days away from the Non Farm Payroll report for July and the weekly jobless claims continue to be stubbornly strong. The early estimate for jobs lost is in the range of -250,000. That would be a major drag on the markets and this is already weighing on market sentiment.

If the S&P does weaken the two support levels to watch are 1085 and 1060. A breakout over current resistance targets 1150 but I am not holding my breath. I would be a reluctant long over 1116.

S&P-500 Chart

The Dow managed to move over resistance at 10,500 on Monday and hold those gains today thanks to Dupont. After three triple digit gains the Dow is over extended again and running out of news generators to power it higher. Boeing will be one of those remaining news points when it reports on Wednesday.

We saw a similar surge over resistance in June and the Dow tried to move over the 10,500 level for three consecutive days with no success at holding the gains. If Boeing surprises to the upside and provides an upside kick to the Dow then maybe there is a chance for the rally to continue but I remain skeptical. Should weakness appear the support levels to watch are 10,300 and 10,065.

Dow Chart

Apple (+4.80) and Google (+3.66) were not able to power the Nasdaq to a gain. There were only 25 Nasdaq stocks that gained more than a buck and there were plenty that did not gain at all. Over 1400 Nasdaq stocks lost ground. Tech stocks are not normally high flyers in the late summer. After the Q2 earnings cycle there is little excitement over tech stocks until the fourth quarter. Despite some good news from chip stocks the excitement already appears to be fading.

The Nasdaq has yet to test critical resistance at 2325 and without any big tech earnings to power the index higher I fear it will not reach that level. That is the June resistance highs and the 100-day average. A move over that level would be bullish. Earnings scheduled for Wednesday include SYMC, CTXS, LRCX, TQNT and AKAM. Those are not exactly market moving tech reports. Support is currently 2225 and 2175.

Nasdaq Chart

In summary, I remain skeptical of the rally and still expect the markets to show weakness soon. The Q2 earnings cycle is nearly over and the news events that can power the market higher are dwindling. I will be very surprised if we don't trade lower over the next 2-3 weeks but I would be a reluctant buyer over S&P 1116. We could see some month end money come into the market but the big flows are quarter end not month end.

Jim Brown

New Option Plays

Short ETF Play

by Scott Hawes

Click here to email Scott Hawes


Semiconductor HOLDRS Trust - SMH - close 28.56 change -0.11 stop 29.66

Company Description:
The Semiconductor HOLDRS Trust issues depositary receipts called Semiconductor HOLDRS, representing an undivided beneficial ownership in the United States-traded common stock of companies that develop, manufacture and market integrated circuitry and other products known as semiconductors, which allow for speed and functionality in components used in computers and other electronic devices. The Bank of New York is the trustee. The 20 issuers of underlying securities represented by a Semiconductor HOLDR, as of August 1, 2005, were Analog Devices, Inc., Altera Corporation, Applied Materials Inc, Advanced Micro Devices, Inc., Amkor Technology Inc, Atmel Corp, Broadcom Corp, Intel Corporation, KLA-Tencor Corporation, Linear Technology Corporation, LSI Logic Corporation, Micron Technology Inc., Maxim Integrated Products Inc, National Semiconductor Corporation, Novellus Systems Inc, SanDisk Corporation, Teradyne, Inc., Texas Instruments Incorporated, Vitesse Semiconductor Corp and Xilinx Inc.

Target(s): 27.50, 27.15
Key Support/Resistance Areas: 29.00, 28.20, 27.40, 27.00
Time Frame: 1 to 2 weeks

Why We Like It:
I'm sticking with ETF's for now to filter out some of the earnings noise. SMH finds itself at the top of a trading range between $26.00 and $29.00 for the past three months. Today's candle on the ETF is a dark cloud cover pattern which is considered a reversal signal. The candle opened above yesterday's high and then pierced half of the prior day's candle. This is considered an exhaustion gap and I believe SMH, along with the broader market, will retrace some of the recent gains. SMH has also formed a bearish wedge over the past couple of weeks and it should break to the downside for a price correction, especially considering the overbought conditions. We'll place an initial stop at $29.66 to give this some room and will adjust it once we are in the position.

Suggested Position: September $28.00 PUTS, current ask $1.07

Annotated chart:

Entry on July xx
Earnings: N/A (unconfirmed)
Average Daily Volume: 15 million
Listed on July 26, 2010

In Play Updates and Reviews

Two New Plays Opened

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:

CALL Play Updates

Human Genome Sciences - HGSI - close 25.70 change -0.66 stop 23.95

Target(s): 26.50, 27.00, 27.55
Key Support/Resistance Areas: 28.00, 27.10, 26.60, 24.70, 24.25
Current Gain/Loss: +1.6%
Time Frame: 1 to 2 weeks
New Positions: Yes

7/27: HGSI traded to our $25.50 trigger to enter long positions and then bounced into the close. HGSI has solid support down to $24.70 which is near the 50-day SMA and recent upward trend line. We may have to exhibit a little patience to allow HGSI to gather its footing but I expect the stock to maintain its upward trend line. I made some minor adjustments to the above targets.

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.

Current Position: September $26.00 CALL, entry was at $1.82

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 37.22 change +0.70 stop 34.25

Target(s): 37.50, 38.00, 39.25, 40.50, 41.95
Key Support/Resistance Areas: 42.00, 41,00, 39.70, 38.25, 37.55, 34.65
Current Gain/Loss: +30.9%
Time Frame: Several Weeks
New Positions: Yes

7/27: TBT broke above its most recent downtrend line and closed +1.92% higher on the day. The next level of resistance is $37.50 to $38.00 which is just below its 50-day SMA. TBT will most likely find resistance in this area. Our first target is $37.50 which is not a bad place to consider taking profits or tightening stops. For options traders our current gain is +30.9% and at $37.50 it should be about +42%. Ultimately I expect TBT to trade up to the $39.00 to $41.00 level which is near our more aggressive targets. However, it will not do this in a straight line. So taking some profits off of the table or tightening stops is a good strategy. I plan to officially tighten the stop when there is a better reference point but be aware that there should be a pullback in the $37.50 to $38.00 level.

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 27, 2010
Earnings N/A (unconfirmed)
Average Daily Volume: 3.8 million
Listed on July 24, 2010

ProShares Ultra Basic Materials - UYM - close 30.44 change -0.71 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 week

7/27: UYM printed a bearish engulfing candlestick today which should get the ETF moving towards our $29.10 long entry trigger in earnest. This is a key prior support/resistance level dating back to the fall of 2009 and is a good place to consider a long position. I believe the pullback should happen this week. I'm expecting UYM and the broader market to pullback but it should be a healthy pullback to some energy before pushing higher. NOTE: This is a leveraged ETF so please use proper position size to limit risk.

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 $2.95, estimated ask at entry $2.15 (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

SPDR S&P 500 ETF - SPY - close 111.55 change -0.01 stop 113.55

Target(s): 110.30, 109.50, 108.60, 107.75
Key Support/Resistance Areas: 113.20, 111.65, 110.00, 109.50, 108.55
Current Gain/Loss: +8.6%
Time Frame: 1 to 2 weeks
New Positions: Yes

7/27: The gap higher in the S&P 500 today allowed us to enter short positions in SPY at a better price. SPY drifted lower most of the day and I am expecting more downside, at least in the near term. I am going to offer a higher first target at $110.30 which is just above the mid-July highs. SPY will probably bounce at this level and it is a good place to protect against reversal. A tighter stop could be placed at $112.55 which is just above today's highs.

7/26: 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.

Current Position: September $110.00 PUTS, entry was at $2.90

Entry on July 27, 2010
Earnings: N/A (unconfirmed)
Average Daily Volume: 236 million
Listed on July 26, 2010


Costco Wholesale - COST - close 57.21 change +1.50 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: -39.8%
Time Frame: 1 week
New Positions: No

7/27: In the pre-market Stifel raised COST to a buy from a hold which started the buying and short covering and determined our fate in this trade. COST gapped +1.4% higher at the open and our stop was hit this afternoon. The stock rallied right through its 50-day SMA with little resistance. The stop was placed at $57.25 because it was above the 50-day SMA and the most recent lower high. In hindsight it probably should have been a little higher. For readers who may still have positions I would place a stop above today's highs and the primary downtrend line. COST should retrace some of today's gains especially if the broader market is weak. I do not know how much further COST can go but it has entered a congestion area dating back to September of 2009 which should keep things in check. At a minimum the stock should close the gap higher today before moving much higher.

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.

Closed Position: September $55.00 PUTS at $0.89, entry was at $1.48

Annotated chart:

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