Option Investor

Daily Newsletter, Wednesday, 7/28/2010

Table of Contents

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

Market Wrap

Durable Goods Disappoints. Beige Book is Lukewarm

by James Brown

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Market Stats:

The stock market's rally appears to have stalled as the S&P 500 index struggles with technical resistance near the simple 200-dma. The major U.S. indices posted their second decline in a row but the S&P 500 is still up over +8% from its closing July lows. According to Reuters, about 50% of the S&P 500 component companies have reported their Q2 earnings results and 77% of them have beat analysts' expectations. There was a huge wave of earnings results released last night and this morning and while the trend of better results continue the news failed to impress traders.

The markets were focused on economic data, which proved to be disappointing. The durable goods report showed an unexpected decline. The Fed's Beige Book report was lukewarm. The U.S. dollar spent the day drifting sideways, which left commodities to trade on their own. Agricultural-related commodities like coffee, corn, oats, sugar, and wheat all performed well. Gold futures managed a minor bounce (+0.4%) following yesterday's sell-off. Crude oil futures slipped -0.8% and closed under $77 a barrel following the weekly inventory report. The EIA said oil inventories increased +7.31 million barrels but economists were expecting a decline of -1.73 million barrels. This was the biggest jump in inventories since March 19th. It is possible that last week's tropical storm disrupted deliveries to refineries, which would account for part of the unexpected jump in inventories. Yet U.S. refiners were still operating at 90.6% of capacity, compared to 91.5% the week before.

In other news the bond market rallied, pushing the yield on the 10-year treasury down to 3.0%. Investors were digesting a $37 billion auction of 5-year bonds. The bid to cover ratio was strong at almost 3.1. Money has continued to flow into the bond market, which suggests investors are cautious and looking for safe havens, not riskier assets like stocks.

Foreign markets were a mixed bag on Wednesday. Asian stocks rallied. The Japanese NIKKEI index led the way with a +2.7% gain to a new two-week high thanks to strong earnings results and a weaker yen. A weaker yen makes Japanese exports cheaper. Camera maker Canon was a standout as its stock surged +5.7% following a strong earnings report this morning. The Chinese market continues to rally as well. The Shanghai index gained +2.2% and the Hong Kong Hang Seng index extended its gains to seven days in a row with a +0.5% gain. In Europe the trend was mostly lower as investors reacted to the disappointing economic data in the U.S. this morning. The German DAX index fell -0.4% and the English FTSE slipped -0.8%.

The trend of waning momentum in U.S. economic data continues. Before the opening bell the U.S. Census Bureau announced that durable goods orders, for goods meant to last at least three years, fell -1.0%. Wall Street was expecting a gain of +1.0%. Manufactured durable goods in June fell $2.0 billion to $190.5 billion. This was the second monthly decline in a row. To make matters worse they revised May's numbers lower. The transportation segment declined -2.4% and is now down four out of the last five months. However, transports can be a volatile component of the durable goods numbers. Minus the transports durable goods orders will still down -0.6% compared to estimates of +0.6%.

The Federal Reserve's Beige Book report also confirmed that growth in the U.S. economy is losing steam. The Beige book provides an in depth look at the 12 regional districts of the country. Eight of the 12 districts said growth was "modest". Only the Cleveland and Kansas City areas said growth remained "steady". The Atlanta and Chicago regions said growth had declined. Retailers said sales were okay but they remain cautious as consumers seem to be focusing on the essentials. The Beige book report also showed that both commercial and residential real estate was slowing down. On a side note the Mortgage Bankers Association said their applications index fell -4.4% last week.

There has been a large amount of earnings reports in the last 24 hours. I'm going to try and hit some of the highlights (and lowlights). If you're not interested you may want to skip the new few paragraphs. This morning we had two heavy weights in the healthcare industry report earnings. Both Aetna (AET) and WellPoint (WLP) beat analysts' estimates and raised their guidance but it wasn't enough for investors. AET delivered a profit of $1.05 a share, which was 31 cents ahead of expectations and revenues came in at $8.55 billion versus the $8.49 billion estimate. WLP managed to beat estimates by 12 cents with a profit of $1.67 a share. WLP's revenues fell 6.8% to $14.22 billion and that was below estimates of $14.66 billion. Shares of AET lost 2.8% while shares of WLP fell 3.7% for the day.

Investors were not impressed with results from industrial companies like Boeing (BA) and General Dynamic (GD). BA was one of the worst performers in the Dow Jones Industrials with a -1.9% decline as investors sold the news. BA beat estimates by 5 cents with a profit of $1.06 a share but revenues missed estimates at $15.57 billion versus $16.13 billion. BA's management reaffirmed their prior 2010 guidance but this was below Wall Street's estimates. The sell-off in BA is not too surprising since the stock had rallied +10% in the last few days. Meanwhile shares of GD failed to move much on its earnings beat. The company delivered a profit of $1.68 a share compared to analysts' estimates of $1.61. Revenues were flat at $8.1 billion but GD's management raised their 2010 earnings guidance.

One of the better performers today was C.H.Robinson Worldwide Inc., a transportation stock that surged more than +6% to a new one year high near $65 a share. Last night CHRW reported earnings of 59 cents a share. That was 4 cents better than expected. Revenues rose +27% to $2.45 billion versus the $2.32 billion estimate. The results prompted an analyst upgrade this morning from "hold" to a "buy" with a $73 price target.

It was a rough day for the homebuilders. The DJUSHB home construction index plunged -3.3% following a disappointing earnings report from Meritage Homes Corp. (MTH). Before the bell this morning MTH delivered a profit of 13 cents a share, which was better than the 12 cents analysts were expecting. MTH's revenues surged +31.5% to $291.4 million compared to the $255.7 million estimate. Yet investors sold the news when they saw that MTH's new orders plunged -22% as a result of the expiring homebuyer tax credit. After the closing bell we heard similar numbers from Ryland Group (RYL), the nation's seven-largest homebuilder. A year ago RYL lost $1.70 a share. For the second quarter RYL lost 49 cents a share. It was an improvement but Wall Street was only expecting a loss of 25 cents a share. Revenues improved +37% to $373.3 million, which was much better than the estimate ($302 million). Yet the real story here is probably RYL's orders, which fell off a cliff with a -44% decline following the tax credit expiration.

Credit and debit card processor Visa (V) was a headliner this evening. Processed transactions rose +14% to 11.7 billion for the quarter. Cross-border volumes climbed +17% as the trend from cash and checks to plastic continues. Visa reported a profit of 97 cents a share on revenues of $2.03 billion, which beat Wall Street's estimates of 93 cents a share on revenues of $1.97 billion. Visa's CEO said the company might struggle to keep up this performance next year since it is too early to tell how the new debit-card regulations will affect their results. Fortunately, the switch from cash and checks to cards is a long-term bullish trend for the company. Visa's main rival, Mastercard (MA), reports earnings on August 3rd.

In non-earnings news Amazon.com (AMZN) was making headlines as speculation grows the company is poised to announce a new Kindle model. The online retailer has had a huge success with its ebook reader the Kindle and recently reduced the price on it to $189. Yet today AMZN's website put a "temporarily out of stock" notice for the Kindle product, which only heightens expectations that AMZN will announce an upgraded model soon.

Market technicals are mixed. Short-term the trend for the S&P 500 is still up but momentum has stalled as the index tests technical resistance at its 200-dma. If we just look at the month of July you could argue that the S&P 500 is in the second half of its bull flag pattern, which would suggest an up move toward the 1140 level. Yet I'm not convinced the index will get that high with additional resistance near 1130 (June's high of 1131) and the simple 100-dma near 1128. If the current two-day dip continues we can probably look for some short-term support near 1100 and the 1080 levels.

Chart of the S&P 500 index:

If you step back and look at the last few months you can almost picture the S&P 500 forming an inverse head-and-shoulders pattern. It still needs to form the right shoulder with another dip and rebound near the 1140 area. If this scenario were to play out then we are looking at a potential rally toward the April 2010 highs near 1215. Personally, I'm not that optimistic on the market but it is a possibility. Longer-term I am still concerned that the S&P 500 will correct down toward the 950 area.

2nd Chart of the S&P 500 index:

Weekly Chart of the S&P 500 index:

Earnings season continues but investors will turn their focus toward economic data. Next week the big event will be July's non-farm payroll (jobs) report. We still have a couple of key reports this week. Tomorrow the market will be digesting the weekly initial jobless claims and the continuing unemployment claims. Analysts expect initial claims to come in at 464,000. On Friday we'll hear the Chicago PMI report, the final July Michigan (consumer) sentiment numbers. Plus, we'll see the advance Q2 GDP numbers. Economists are estimating the U.S. economy grew at +2.5% in the second quarter.

I want to caution traders about this market bounce. The short-term trend is up and nimble traders can still play the trend. However, I want to warn you that the trend of waning momentum in the economic data is a true concern. Bulls will argue it is just a slow down as the economy slowly improves. Bears will suggest we're starting to slip toward the double-dip recession. No one has a lot of certainty either way right now. The disappointing consumer confidence numbers this week are a warning flag. Hopefully the back-to-school shopping season that starts soon will show that consumers are not as nervous as they appear.

It is worth noting that a couple of UBS analysts published a research note yesterday that warns investors to sell now and take profits. They are concerned that the market will roll over and the S&P 500 will retest the 944 area. That is awfully close to the 950-942 level of support I have been drawing on the weekly S&P 500 chart. For me the takeaway here is that traders should not get too married to your positions or your bias. Stay nimble and keep your trades small.


New Option Plays

Treading Lightly Heading Into GDP Report

by Scott Hawes

Click here to email Scott Hawes
Editor's Note: Good evening. I suggest we tread lightly heading and protect capital into Friday's GDP report. This is sure to be a market mover and may give us a better sense of whether this market will breakout higher or head lower. In the mean time we have open positions on both sides of the market to take advantage of short term spikes higher or lower. I may have a new play to release tomorrow and will definitely have two or three more to release in the weekend newsletter. I have listed a bearish set-up below that may make it into the model portfolio.

Short XLU (Utilities ETF): XLU is approaching its December 2009 highs which will present a double top set-up. Utilities tend to oscillate in fairly reliable channels once they are established and this will present a good countertrend set-up after a strong +10% gain in the sector over the past month. I like entries anywhere from $31.20 to $31.75 with a stop over the December highs of $32.08.

In Play Updates and Reviews

New Short Play Opened

by Scott Hawes

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CALL Play Updates

Human Genome Sciences - HGSI - close 25.27 change -0.43 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: -13%
Time Frame: 1 to 2 weeks
New Positions: Yes

7/28: HGSI pulled back to its upward trend line and 50-day SMA as mentioned in last night's updates. The stock remains in its upward channel and above its 50-day and 20-day SMA's. I am looking for HGSI to bounce from here and believe this is a good entry point with a tight stop.

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.

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

Entry on July 27, 2010
Earnings Date 10/25/10 (unconfirmed)
Average Daily Volume: 4.2 million
Listed on 7/24/10

ProShares UltraShort 20 YR Treasury - TBT - close 36.97 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: +9%
Time Frame: Several Weeks
New Positions: Yes

7/28: TBT found resistance right at $37.50 as mentioned in last night's updates and this proved to be a good spot to take a portion of your profits off the table. TBT has intraday support at current levels and all the way down to its 20-day SMA which also corresponds to the backside of the broken downtrend line $36.25. The ETF could pullback down to this area and still be considered bullish. I'm comfortable giving this some room to work and am looking for a better reference point to tighten the stop.

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.

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

Entry on July 26, 2010
Earnings N/A (unconfirmed)
Average Daily Volume: 3.8 million
Listed on July 24, 2010

ProShares Ultra Basic Materials - UYM - close 30.13 change -0.31 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

7/28: Our trigger to enter long positions at $29.10 is getting close. $29.00 is a key support/resistance area dating back to the fall of 2009 which is why I am sticking with the $29.10 entry price. However, I will also add that the 38.2% retracement from the 7/20 lows to the 7/27 highs is $29.28, the 50% retracement is $28.54, and the 61.8% retracement is $27.78. And the 50-day SMA is near $28.00. All of these areas can be considered as good long entry points but it is a decision that needs to be made as market conditions develop. Conservative traders may want to consider lowering their entry to the $28.55 area but I'm just not certain UYM will make it down there. The broader market strength or weakness will determine how far UYM pulls back.

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 gain some energy before pushing higher. NOTE: This is a leveraged ETF so please use proper position size to limit risk.

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

Semiconductor HOLDRS Trust - SMH - close 28.08 change -0.45 stop 29.66

Target(s): 27.55, 27.15
Key Support/Resistance Areas: 29.00, 28.20, 27.40, 27.00
Current Gain/Loss: +17.7%
Time Frame: 1 week
New Positions: Yes

7/28: Short positions were initiated in SMH this morning and the ETF proceeded to break down and out of the ascending wedge and dark cloud cover mentioned in yesterday's play release. SMH has intraday support at current levels but if it breaks we should hit our first target of $27.55 (raised 5 cents) relatively quick. This is near the 20-day SMA and a good place to tighten stops to protect profits. SMH will probably bounce there and it may happen fast so please protect profits.

7/27: 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, entry was at $1.07

Entry on July 28, 2010
Earnings: N/A (unconfirmed)
Average Daily Volume: 15 million
Listed on July 27, 2010

SPDR S&P 500 ETF - SPY - close 110.83 change -0.72 stop 113.55

Target(s): 110.30, 109.55, 108.60, 107.75
Key Support/Resistance Areas: 113.20, 111.65, 110.00, 109.50, 108.55
Current Gain/Loss: +21.7%
Time Frame: 1 to 2 weeks
New Positions: Yes

7/28: SPY drifted lower the entire day and came within 16 cents of hitting our $110.30 target. I believe SPY is destined to touch its upward trend line from the 7/1 lows which is near our 2nd target of $109.50, however, protecting profits against a reversal is highly suggested. A trip down to this area could happen fast so I suggest placing an order and be ready to take profits if we get there. SPY may also bounce in the $110 area which is the mid-July highs and just below our first target. I'm not quite ready to tighten the stop yet.

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