Option Investor

Daily Newsletter, Tuesday, 8/3/2010

Table of Contents

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

Market Wrap

Bullish Pause

by Jim Brown

Click here to email Jim Brown

The minor profit taking today was bullish because there was a real chance we could have given back all of Monday's short squeeze gains.

Market Stats Table

The short squeeze on Monday pushed the indexes to levels that were above recent resistance and there was a good possibility that we would see a significant decline back to those levels on Tuesday. Despite the mixed economics the selling was lackluster and the indexes managed to hold onto most of Monday's gains.

Pressuring the market at the open was the Personal Income report for June. Income and spending slowed dramatically from the early 2010 rate. Personal incomes were flat with the headline number at zero for June. Spending rose only 0.1% and the lowest level since September. The PCE deflator, a measure of inflation at the consumer level, fell -0.1% to only 1.4% for the year. The Core PCE was flat at zero and the first time it did not rise since March 2009. This is just one more data point that confirms the economic slowdown that began in June.

Personal Income Chart (Moody's)

Factory Orders for June declined by -1.2% compared to a decline of -1.4% in the prior month. This is the second monthly decline and the first time in negative territory since August 2009. This is a lagging report and was inline with analyst estimates. This was not a market mover but another data point in the wall of worry for the bulls.

Factory Orders June (Moody's)

The Pending Home Sales for June fell to 75.7 from 77.6 in May. The consensus was for a gain to 79.0 and that did not happen. At 75.7 the index is at its lowest point on record and a dismal picture of the housing sector. This is strictly a result of the expiration of the homebuyer tax credit and the lack of motivated buyers as we moved into summer. The index declined -30% in May and another -2.6% in June. The decline puts the index -10.6% below the June 2009 level when we were just coming out of the recession. Future gains in housing will depend entirely on a pickup in employment. Until jobs become available again the demand for housing will remain low.

On the positive side the vehicle sales for July rose to 11.8 million on an annualized basis from 11.1 million in June. This was inline with analyst estimates. This pace was the highest level for the entire year but still well below the 16.5 million plus level before the recession. Losing the economic impact of producing an additional five million cars a year is significant. Note the cash for clunkers spike in the chart below.

Vehicle Sales Chart

Economic reports due out on Wednesday include the Challenger Employment report and ISM non-manufacturing. The two major economic events in our future are the Non-Farm Payrolls on Friday and the FOMC meeting next Tuesday.

Research in Motion (RIMM) finally announced its iPhone competitor today called the BlackBerry Torch. The phone has a touch screen and a slide out keyboard. This is not a product that will blow away the competition but it is an upgrade for Blackberry users. The Torch will sell for $199, same as the iPhone and it will run on the AT&T network. In fact AT&T claims it spent thousands of hours working with RIMM in developing this phone, which suggests AT&T will be vigorously marketing their new product. AT&T said this was the best Blackberry phone ever and AT&T said there would be as big an advertising campaign as you have seen in some time.

The Torch also has an on screed keyboard and a new operating system called Blackberry 6. The phone is much closer to the iPhone and the Android with features and applications. RIMM lost $1.45 in today's market but much of that was continuing backlash from the decision by several nations in the Middle East to restrict the Blackberry because the messages are encrypted and not available to governments spying on its citizens. Saudi Arabia and the UAE were the most recent countries to make the threat.

Anadarko Petroleum (APC) reported earnings after the close of 49-cents compared to analyst estimates of 35-cents. Anadarko raised its production guidance for the second time this year to be in the range of 232 to 236 million BOE. That is a 5% to 7% increase over 2009. Despite having to shutdown drilling activity in the gulf the company said its land based programs in the Marcellus, Eagleford and Haynesville shale plays helped boost production by +6%.

The big hickey hanging over Anadarko is the potential bill for 25% of the cleanup costs in the gulf. Anadarko is a 25% "non-operating" owner of the Macondo well. Anadarko has taken a strong stance that "based on publicly available information, testimonies and investigations to date, this tragedy was preventable and likely the result of the operators (BP) gross negligence and/or willful misconduct." Anadarko has pledged to aggressively fight any attempt by BP to bill APC for cleanup expenses.

Anadarko Chart

Baker Hughes (BHI) is not exposed to the Macondo well but the company is exposed to the moratorium in the gulf. BHI reported earnings today of 41-cents that were 2-cents below estimates due to the drop in services income in the gulf. BHI said the impact was 3-cents in Q2 and could rise to between 8-11 cents in both Q3 and Q4 if the moratorium was not lifted soon. Revenue rose +44% to $3.37 billion. BHI was crushed on the earnings news and lost -6.57 for the day.

BHI Chart

In a different sector Priceline shareholders will be celebrating when the market opens on Wednesday. The company reported earnings after the close that blew away estimates and the stock spiked +$37 in after hours trading. Earnings of $3.09 beat street estimates of $2.65. Bookings were up +43% to $3.4 billion led by international travel and hotel reservations. International bookings were up +63%. The company said it expects bookings to rise another 33% to 38% in Q3. Expedia (EXPE) also reported stronger sales and profits last week. Shorts expecting an earnings miss in PCLN were severely disappointed.

Priceline Chart

Whole Foods Market (WFMI) reported earnings inline with estimates but an +88% improvement over the comparison quarter. Same store sales rose +8.8% and the company raised its full year outlook to $1.38 per share. Unfortunately that was inline with analyst estimates and was joined by lowered sales expectations for Q4. This caused the shares to decline -$2 in after hours.

Electronic Arts (ERTS) reported better than expected earnings after the bell and reaffirmed guidance for the full year. Investors were not excited but the stock price rose slightly in after hours. ERTS is finding it harder to market its older titles like the Madden football and the Sims.

DR Horton (DHI) reported earnings that were inline with estimates and lower than historical norms because of the severe drop in sales after the tax credit ended. However, DHI said sales improved modestly in June and July. The DHI CEO said 2011 would be a tough year for builders after the pull forward of buyers into the tax credit period. DHI shares fell -6% on the gloomy forecast.

Dean Foods (DF) lost -10% after reporting earnings that were inline with estimates at 25-cents on revenue of $2.95 billion. That revenue was light and the CEO complained that consumers are not making enough money and are facing tight budgets when they shop. He said the highly promotional environment for private label brands and especially milk was what hurt results. Pricing for store branded milk is below historic levels and the gap between it and the major brands is growing. That keeps shoppers buying the less expensive options. Income fell -28% in the unit that markets milk, creamer and dairy products. However, sales at the organic segment including plant based beverages like soy, rose +18%. S&P analyst Tom Graves reiterated his "strong sell" on the stock saying continued competition will hurt profits. Earnings reports have not been kind to Dean Foods recently.

Dean Foods Chart

Dow component Procter & Gamble shares lost -3.5% after it reported earnings that disappointed the street. PG reported earnings of 71-cents that missed the street estimates by 2-cents but the worst part was the lowered guidance. PG said earnings for the next four quarters could fall below analyst estimates because of low spending by consumers and higher advertising requirements to maintain market share. The CEO said sales in the developed countries (US and Europe) were very slow. PG lost a little more than $2 but because of it's weighting in the Dow this equated to -18 Dow points.

Other consumer products companies have also warned of weak spending. Clorox met expectations but said promotional spending would be higher for the next six months. The company predicted earnings of $4.50 to $4.65 per share and analysts were expecting $4.58 per share. Clorox said sales would be at the low end of its prior growth forecast.

Colgate (CL) also reported weaker than expected sales and higher costs from advertising spending. Kimberly Clark (KMB) reported an increase in profits but said higher material costs and promotions would weigh on future earnings.

Office Max (OMX) reported higher than expected profits but warned the slowing economy would weigh on future profits and predicted revenue declines in Q3 and the full year. Shares fell -13% on the dismal outlook. The CFO said the economic outlook was keeping businesses and consumers from spending money. He said the back to school shopping season was shaping up to be a "very tough environment."

Offsetting the decline the Dow caused by PG was a nice gain by Pfizer. Pfizer reported a +9% gain in profits helped by a +58% gain in revenue. Much of that gain was due to the acquisition of Wyeth last October. Net income was $4.96 billion or 62-cents per share. This beat estimates by a dime. Pfizer is facing some stiff generic competition for its $13 billion a year drug Lipitor and eight other high margin drugs when protection expires in 2015. In planning for this revenue drop Pfizer has cut 17,500 employees from a targeted 19,500 by 2012.

Pfizer Chart

To date over 370 of the S&P-500 companies have reported earnings and the earnings growth for Q2 is now +42% and well above prior estimates. It should settle in the high 30% range after everyone reports. The financial sector has posted growth of +37% and almost double what was expected only a month ago. This helped push the sector to a new three-month high in Monday's short squeeze.

August and September are historically the two worst months of the year for the markets. Traders and funds alike were already setting up for an August decline as we ended last week. The better than expected PMI news from China and the better than expected U.S. ISM report provided ample fuel for a giant short squeeze that pushed the indexes well over current resistance.

In theory the squeeze rally should have been quickly sold today and that did not happen. The S&P built a two-day base at 1100 last week and used that base for the Monday rocket launch to 1127. That came within four points of the resistance high in June at 1131. For reference the 100-day average is 1127 and while the 100-day is not normally a reactive indicator for the S&P I am sure there were some traders thinking that was a good place to sell.

The lack of any material selling today even in the face of a multitude of less than exciting earnings reports is bullish. While that bullish reluctance may not survive the week it was noteworthy.

Volume was very low at only 7.1 billion shares and the A/D line was 2:1 negative. There was little selling pressure but it was broad based. Volume should continue to slow and that could increase volatility.

S&P-500 Chart

The Dow managed to spike well over the June highs thanks to the short squeeze and it was able to hold its gains today. This is bullish but two days does not make a trend. The odds are still strong that we will see a decline into August. The guidance from companies like PG, CL, KMB, OMX was partially offset by news from PCLN and EXPE but the key to their earnings was "international travel." Most consumer companies still claim the U.S. is not growing. Traders will have to decide if the global growth is going to trump U.S. growth and produce higher profits for U.S. companies. Most of the Dow components are large multinationals that will benefit from the global growth.

I am neutral on the Dow over the 10600 level. This is a breakout and the lack of selling was bullish. However, it we see it start to roll over the pace of the decline could accelerate. Support is well back at 10400 and that gives the index a wide range to explore without damaging the trend.

Dow Chart

The Nasdaq is the troublesome chart today. The Monday squeeze failed to exceed the prior week's highs and was not even close to the 2341 high set back in June. There is significant resistance at 2300 and again at 2320. The Nasdaq big caps are weak. Intel broke below its 200-day average on Friday and closed fractionally below it again today after Monday's spike higher. The Semiconductor Index is on the verge of breaking below the 200-day and several chip stocks released poor guidance.

The Nasdaq and the Russell 2000 are the weak links heading into August. Until the Nasdaq can move over 2320 I doubt any rally in the Dow and S&P will last. Note in the chart that the downtrend line in blue was exactly where the Monday rally failed.

Nasdaq Chart

In summary I think the lack of any material selling in the face of negative guidance from multiple companies was bullish. However, tech stocks are going to be the indicator to watch as we move through the week. If techs continue to weaken then it is only a matter of time before traders will start to pile on the shorts.

We have the Non-Farm Payrolls on Friday and a potential pothole in the road and the FOMC meeting next Tuesday. That is also a potential negative because the Fed's economic outlook is deteriorating. There are rumors the Fed could implement some more stimulus next Tuesday and that could cause traders to worry that conditions are declining faster than they thought. Time will tell but those two events could seriously damage or improve market sentiment depending on how they transpire. Who knows, maybe we actually added jobs in July. Stranger things have happened before.

Jim Brown

New Option Plays

Long Trade Set-up

by Scott Hawes

Click here to email Scott Hawes
Editor's Note:
Good evening. Equities are consolidating and have paused right at major resistance areas on all of the major indexes and most sectors. Many stocks making moves are doing so in the wake of earnings reports and we have chosen to stay away from them due to the inherent risk involved. I have scanned hundreds, if not thousands of charts, this week and I simply have not found many set-ups that are worth placing directional trades in that do not have upcoming earnings, or that have already made their move after earnings. If the broader market breaks out to the upside I would rather initiate long positions on a retracement of the breakout rather than anticipate it. Placing trades based on breakouts (up or down) has also proven to be difficult in recent months. Cash is a position and I suggest trading lightly until have a better sense of direction which should be resolved in the coming days. We currently have a short position in the DJIA (short DIA) hedged with a short position in treasuries (long TBT) and we were stopped out of two long positions today. I have listed one long trade set-up below in Morgan Stanley that I like for those interested and we will be releasing new plays in the coming days. Please email me with any questions.

Long MS - MS gapped higher on 7/21 after a stellar earnings report and has been consolidating in a bull flag for a couple of weeks. The stock has broken out of the bull flag to the upside and looks poised to test its 200-day SMA which is about +5% from current levels. If the broader market fails at these levels MS will also likely fail so a tight is suggested.

In Play Updates and Reviews

Two Positions Closed

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:

CALL Play Updates

ProShares UltraShort 20 YR Treasury - TBT - close 36.39 change -0.35 stop 35.55

Target(s): 36.90, 37.50 (hit), 38.00, 39.25, 40.50
Key Support/Resistance Areas: 42.00, 41,00, 39.70, 38.25, 37.55, 34.65
Current Gain/Loss: -7.3%
Time Frame: Several Weeks
New Positions: Yes

8/3: After a brief dip in early trading TBT recovered nicely. Prices are coiling on its intraday chart and a breakout should happen tomorrow or Thursday. If TBT breaks above today's highs it should easily trade to our first two targets which are both below the 50-day SMA. I suggest tightening stops at these levels to see if we can get more out of the trade. A break above the 50-day SMA should easily send TBT towards our more aggressive targets.

8/2: It appears Friday's sell-off in TBT was short lived as I suspected. However, the price action in bonds and equities still seems somewhat disconnected. TBT looks like it is forming a higher low and has 20 more cents to go before closing the gap down on Friday. This will likely act as intraday resistance but I expect TBT to eventually break it and trade back up to our $37.50 target and possibly our more aggressive targets. I suggest readers begin to trail stops higher to see if we can catch a larger move. For now, I've moved the stop up to $35.55 which is below Friday's lows and the upward trend line on the daily chart.

Current Position: Long 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

PUT Play Updates

SPDR DJIA ETF - DIA - close 106.39 change -0.34 stop 108.75

Target(s): 105.15, 104.30, 103.65
Key Support/Resistance Areas: 108.00, 107.00, 105.90, 104.75, 104.20, 103.50
Current Gain/Loss: +0.00%
Time Frame: 1 week
New Positions:

8/3: It was an inside day for DIA in that it traded within yesterday's high/low price range. DIA closed just about where it opened so we are currently breakeven on the position. I've raised the first target to $105.15 so that it is just above Friday's high as opposed to its closing price. A trip down to this level could happen fast and it is a good place to consider tightening stops or taking profits. For options traders this level should produce a +20% gain. Our next target is $104.30 which just above the 200-day SMA.

8/2: The DJIA has rallied right into prior resistance from its January highs and is forming a bearish rising wedge pattern. This pattern calls for a sharp decline but may bounce around current levels or push a little higher first. In addition, today's +2% gain in equities has created overbought conditions and I believe DIA will turn back to at least fill the gap higher from today. We'll use a tight stop of $108.75 and I have offered three very realistic near term targets, along with a more aggressive target should things get moving to the downside in earnest. The stop is above a gap down from 5/15 so if DIA closes the gap we have some room. If DIA makes it up to close this gap (5/13 close was $108.10) I would be very surprised to see it go any higher before heading towards our targets. I suggest readers be quick to tighten stops as targets approach because the drop could come quick.

Current Position: Long September $106.00 PUTS, entry was at $2.70

Entry on August 3, 2010
Earnings: N/A (unconfirmed)
Average Daily Volume: 14 million
Listed on August 2, 2010


Netflix, Inc. - NFLX - close 104.41 change +2.53 stop 100.80

Target(s): 106.25, 108.50, 111.35
Key Support/Resistance Areas: 114.00, 112.00, 108.50, 105.50, 103.00, 102.00,
Final Gain/Loss: -24%
Time Frame: 1 week
New Positions: Closed

8/3: NFLX quickly sold of this morning during the first 30 minutes of trading before rebounding over $5 the remainder of the day. This hit our stop so we are out of the position for a loss. I wanted to keep a tight stop on this trade and this morning's weakness shook us out. Stock's are at precarious levels right now and could go either way, including NFLX. Readers who still have positions should have gains so I suggest protecting them and use a tight stop to protect against a reversal. The stock needs to break above yesterday's highs of $105.00 which may produce quick pop to the upside, which is where I would be a seller or use a trailing stop.

8/2: NFLX gapped higher at the open this morning and quickly sold off to fill the gap. This isn't the price action I was expecting on such a strong tape as traders quickly took profits from gains on Thursday and Friday. I believe the stock can still bounce from here as it closed above its intraday downtrend line and the downtrend line that started on 7/22. In addition, the stock has built quite a base in the $101 to $102 area where it is currently finding solid support. However, if the broader market can not break higher from here NFLX will likely hit our stop. I have tightened the targets and suggest readers be quick to close positions or tighten stops as these areas approach.

Current Position: Long September $105.00 CALL at $4.75, entry was at $6.25.

Annotated chart:

Entry on August 2, 2010
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 3.5 million
Listed on 7/31/10

Oil Service HOLDRS - OIH - close 107.73 change -1.80 stop 107.90

Target(s): 108.50 (hit), 110.25, 111.20
Key Support/Resistance Areas: 110.50, 108.60, 107.00, 104.75, 102.80
Final Gain/Loss: +5.7%
Time Frame: 1 to 2 weeks
New Positions: Closed

8/3: After yesterday's impressive gains and trading to within 2 cents of our final target, OIH gapped lower and hit our stop this morning. Baker Hughes, which is a large holding in OIH, lost -13% after their earnings report and was responsible for big portion of the ETF's losses. So we are flat the trade for a small gain. I tightened the stop yesterday to protect capital and prevent a hard reversal. Things looked ugly this morning and even looked like OIH may try to fill yesterday's gap higher, but it rebounded nicely and is now forming an ascending triangle on today's intraday chart. If OIH breaks above $108.15 it should pop higher where I would be a seller into strength or be using a trailing stop to protect profits.

8/2: OIH gapped higher this morning and broke through the $107.00 resistance level of the ascending triangle mentioned in the play release. The sector never looked back and OIH posted +4.18% gains on the day. Call positions were initiated at the open and have already gained +27%. Our target of $108.50 was hit and OIH came within 2 cents of our reaching our $110.30 target before closing about 80 cents below its high of the day. I've adjusted the $110.30 target down 5 cents and have also added $111.20 which is below the 100-day SMA. If OIH breaks over today's high of $110.28 I recommend readers tighten stops to protect against a reversal. There is nothing wrong with booking gains at current levels as well. I've adjusted the stop up to $107.90 to protect capital but a tighter stop could be placed at $108.45.

Closed Position: Long September $110.00 CALL at $3.85, entry was at $3.65

Annotated chart:

Entry on August 2, 2010
Earnings N/A (unconfirmed)
Average Daily Volume: 8 million
Listed on July 31, 2010