Option Investor

Daily Newsletter, Wednesday, 8/4/2010

Table of Contents

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

Market Wrap

Better Than Expected

by James Brown

Click here to email James Brown

Market Stats

After a choppy start to trading this morning the up trend remains and the U.S. market continued to drift higher. Better than expected results from the private-sector ADP employment report and the ISM Services data helped shake off concerns over a housing slow down in China. Meanwhile another wave of strong earnings results buoyed the markets. The U.S. dollar managed a bounce against most of its rivals. The move was exceptionally strong against the Japanese yen.

The dollar strength failed to have much of an effect on commodities. Gold futures gained over $9 to $1,196 an ounce. Copper rose +1.1%. Natural gas futures rallied more than 2%. Crude oil prices consolidated sideways as investors digested the weekly inventory data. Oil supplies fell 2.78 million barrels to 358 million, following last week's surge of 7.31 million barrels. Analysts were only expecting a drop of 1.65 million this past week. Gasoline supplies in the U.S. hit their highest levels since 1990.

Trading was relatively quiet in Europe. The large number of earnings reports in Europe failed to have much impact. What did have an impact was bearish comments from one of England's largest retailers, which said the first half decline in sales would probably get worse in the second half of 2010. Overall European indices managed to rebound from their morning lows. The French CAC-40 gained +0.2%. The German DAX rallied +0.37%. While the British FTSE lost -0.19%.

It was a mixed day for Asian markets. The Japanese NIKKEI really under performed with a -2.1% as investors reacted to a surge in the yen against the dollar. A stronger yen makes Japanese exports more expensive in the U.S. and the dollar sank toward a 15-year low against the yen yesterday. It was a different story in China. The rally in Chinese stocks continues but investors are growing concerned about the real estate market. Some of the trepidation this morning in U.S. stocks was due to a report that Chinese banking regulators are instructing the banks to repeat their stress tests but this time pretend the Chinese real estate market falls -60%. Worries have been growing for months that the red-hot Chinese real estate market would eventually burst and derail the economy's growth. The government has been trying to slow things down with restrictions on lending but it may not be enough. Last year Chinese banks loaned out a record-breaking $1.4 trillion worth of mortgages as real estate prices surged more than 60%.

The last stress test performed on Chinese banks assumed a -30% drop in property values and a +1.08% rise in interest rates. The demand for a new test sparks from data in May and June that saw property values tick lower two months in a row. This time regulators want to see banks run the test with a scenario that shows a 50% to 60% drop in property values for cities that saw the biggest boom. Currently no one is predicting a -60% plunge in housing values but there are estimates that the Chinese market could see a -20% decline over the next 18 months. At the end of the day the Hong Kong Hang Seng rose +0.43% and the Shanghai index rose +0.44%.

Today's market moving economic news was the ISM Services index and the ADP employment report. The service sector employs about 80% of the U.S. workforce and economists were expecting the ISM services (a.k.a. non-manufacturing) index to tick down from 53.8 in June to 53.0. Investors were surprised to hear the Institute for Supply Management announce that their services index rose to 54.3 in July. Readings above 50 indicate expansion and growth and July was the seventh month in a row the ISM services index has shown growth.

The new orders component in the ISM services index rose from 54.4 to 56.7. The real surprise was the employment gauge, which jumped to 50.9. This was the second time since December 2007 that the ISM services employment component hit positive territory (above 50). There is speculation that this increase in the ISM services employment gauge should forecast a +100,000 increase in new jobs last month. Investors got another look at jobs today with the ADP employment report, a private-sector look at the labor market. Wall Street was expecting the ADP report to show a gain of +25,000-30,000 jobs. Before the opening bell ADP said businesses added +42,000 in July, compared to last month's +19,000.

Currently economists are expecting Friday's non-farm payrolls (jobs) report to show a headline number of -70,000 jobs but an increase of +90,000 private sector jobs. The overall decline represents a loss of -160,000 temporary census jobs. The market is also expecting the unemployment rate to tick higher from 9.5% to 9.6%. Together the better than expected ISM services data and the ADP number both suggest we could see a stronger jobs number on Friday. Unfortunately the market's whisper number for Friday probably just jumped. If we don't see strong enough private-sector job growth you can expect the market to sell-off on Friday morning. Don't forget that we'll also get the weekly initial jobless claims data tomorrow. Analysts are expecting 455,000 new claims, which is about average these days.

There was a crowd of companies reporting earnings last night. Some of the companies making headlines are CBS, ERTS, PCLN, TIE, WFMI, and APC. Media giant CBS reported earnings that were 4 cents better than expected with a profit of $0.25 a share. Revenues were a lot better than expected at $3.33 billion for the quarter. Shares of CBS rallied to a new two-month high with today's 4.1% gain. Electronic Arts (ERTS) was the world's largest video game maker until it was eclipsed by the merger of Activision and Blizzard (now Activision Blizzard Inc.). Shares of ERTS surged +7.4% and broke out over its simple 200-dma after reporting a profit of 24 cents, which was 11 cents higher than expected. Revenues fell almost 34% to $539 million but that was still better than Wall Street expected. ERTS issued relatively bearish comments for the current quarter and only reaffirmed their estimates for 2011.

Priceline.com (PCLN) was a HUGE winner today. The stock gapped open higher and closed with a +21% gain at new all-time highs following last night's report. Analysts were expecting a profit of $2.65 a share on revenues of $733 million. PCLN delivered a profit of $3.09 with a 27% rise in revenues to $767.4 million. PCLN's management significantly raised their earnings and revenue guidance going forward. This is very good news for PCLN has sheds a positive light on consumer and business spending for travel. The earnings results garnered two analyst upgrades this morning.

Chart of Priceline.com (PCLN):

Unfortunately for shareholders of Titanium Metals Corp. (TIE) the stock was moving the opposite direction. Shares had been trading near one-year highs the past couple of weeks but TIE lost more than 11% following last night's earnings report. Profits came in at 11 cents a share but that was only 1 cent better than expected. Revenues were $212 million, which missed expectations of $225.1 million. The disappointing report garnered a downgrade from "buy" to "neutral". Another disappointment was Whole Foods (WFMI). Shares of WFMI fell more than 8.4% following its earnings report last night. Management delivered a profit of 38 cents a share, which was in-line with estimates. The company issued guidance that was relatively in-line with estimates for the current quarter and they raised estimates for their fiscal year 2011 but it wasn't enough for investors.

Oil company Anadarko Petroleum (APC) also reported earnings last night. Wall Street was expecting a profit of 35 cents a share on revenues of $2.75 billion. APC delivered a profit of 49 cents but revenues were only $2.6 billion. Shares rallied on the news (+2.2%) to close at new two-month highs. The stock was probably getting an additional boost from news that BP's attempt to stop the leaking Macondo well in the Gulf of Mexico appears to be having some success. Engineers began a "static kill" operation to inject drilling mud into the well and alleviate the pressure at the well head but we're still a few days away from the relief wells finally plugging the hole. There was also a story out today suggesting that 74% of all the oil that has leaked from the well (currently estimated at 4.9 million barrels) has been removed or dispersed from the Gulf waters. Scientists believe 25% of the oil naturally evaporated or dissolved in the water. Another 20% was either captured at the source or skimmed from the water. Another 8% was broken up with chemicals. The math in the article didn't really add up and there are certainly critics that find the report hard to believe. BP has taken responsibility for the leak but APC owns a minority stake in the well while Transocean (RIG) owned the rig BP was leasing to drill it. Shares of all three have been rising this week.

In other news Intel (INTC), Barnes & Noble, and Goldman Sachs were making headlines. Intel made headlines when it reached a $1.25 billion settlement agreement with the FTC. The government argued that INTC prevented the price of its chips from falling as fast as the market would have naturally allowed and that INTC exerted too much control over its rivals by strong arming computer makers into not using competitors' chips. Shares of INTC were flat on the session. Bricks and mortar bookseller Barnes & Noble (BKS) has decided to put itself up for sale. It is believed that activist investor Ron Burkle had a hand in this decision. There is speculation that the company's founder Leonard Riggio might lead an investor group to take the company private. BKS has been struggling with slowing sales as Amazon.com (AMZN) steals market share with its growing electronic book market thanks to the Kindle. Shares of BKS gapped open higher and eventually settled with a +19% gain.

Wall Street powerhouse Goldman Sachs (GS) made headlines intraday when CNBC broke the story that the firm was thinking about spinning off its extremely profitable proprietary trading unit. The recent financial reform bill included a version of the "Volcker Rule", named after former Federal Reserve Chairman Paul Volcker. The rule places limits on a bank's ability and exposure to prop trading and hedge fund investments. This is noteworthy because GS is famous for having the best prop trading businesses on Wall Street. The Volcker rule doesn't come into affect for years but GS is taking a very proactive view and positioning themselves to be the first firm ready for the new rules. There was some disagreement on how this move would affect the company's profitability, especially since the details of how this move will occur are still unknown. Shares of GS rallied +3.2% to a new three-month high on the story.

Technically the market's short-term trend is still up. The S&P 500's bullish breakout and close above its simple 200-dma earlier this week is certainly positive. However, the S&P 500 is still trading under technical resistance at its 100-dma and the June highs near 1130. If the index can get past the 1130 level there is significant resistance near 1150 and the January highs.

Chart of the S&P 500 index:

The NASDAQ composite has a similar pattern with overhead resistance at its 100-dma and then at its June highs. The bounce off the July lows has been impressive but there is still a pattern of lower highs. Hampering the NASDAQ's rally is weakness in the semiconductor sector. The SOX semiconductor index has been range bound the last few weeks and not even close to breaking out higher any time soon. Traditionally the semiconductor (chip) stocks lead the NASDAQ one way or the other.

Chart of the NASDAQ index:

Chart of the SOX Semiconductor index:

The small cap Russell 2000 index ($RUT) is still bouncing higher. I am encouraged that the $RUT rallied this week because last week looked like a potential top, especially on the weekly chart (not shown). There is still clear resistance near the 100-dma and the June highs and a close over the 670-680 zone would look pretty bullish. I am suggesting that readers also keep an eye on the transports. The Dow Jones Transportation index has been showing strength and looks poised to breakout past resistance near the 4500 level at any moment. This could set up for a rally toward the 2010 highs, which would inspire investor confidence for the rest of the market.

Chart of the small cap Russell 2000 index:

Chart of the Dow Jones Transportation index:

Looking ahead I expect stocks to drift sideways until the jobs report on Friday morning. Thursday will bring the weekly initial jobless claims, continuing claims, and the chain store (same-store) sales figures for July. It is certainly possible that the same-store retail sales numbers could move the market but I suspect any move will be muted as traders wait for Friday. Let's hope that the bearish comments by British retailers are not echoed here in the states. Given the improvement in the ISM services and ADP numbers today, the jobs report needs to surprise to the upside for it to have much effect on the stock market. Otherwise traders may choose to sell the news!


New Option Plays

Playing Defense

by Scott Hawes

Click here to email Scott Hawes
Editor's Note:
Good evening. Other than a knee jerk sell reaction to news this morning today was rather quiet with nothing resolved. This suggests to me that traders may be nervous and we could get an intense down day which we will use to our advantage if it happens. Getting lubed up to the long side at these levels is not the right move. I am keeping things light for now and have reprinted the long Morgan Stanley trade set-up below for those interested.

NOTE: James will be taking over for me the remainder of the week. We have some new plays to release so stay tuned and I look forward to catching up with you next week.

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

Quiet Day

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:
NOTE: There is no model porfolio snapshot tonight due to technical difficulties.

CALL Play Updates

ProShares UltraShort 20 YR Treasury - TBT - close 36.90 change +0.51 stop 35.55

Target(s): 36.90(hit), 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: +9.7%
Time Frame: Several Weeks
New Positions: Yes

8/4: TBT is showing signs of life and I expect it move higher from here. This ETF (short bonds) is a good hedge against our short DIA position. After the big sell-off in TBT on Friday we offered a lowered target of $36.90 which was hit today. Options positions are now up nearly +10% and I am looking for TBT to trade to at least $37.50 andpossibly higher which is below the 50-day SMA and still a valid target. 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. We plan to tighten the stop in the coming days when we have a better reference point.

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.

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 106.96 change +0.57 stop 108.75

Target(s): 106.25, 105.25, 104.30, 103.65
Key Support/Resistance Areas: 108.00, 107.00, 105.90, 104.75, 104.20, 103.50
Current Gain/Loss: -8%
Time Frame: 1 week
New Positions:

8/4: The markets melted higher again today despite an early attempt to sell-off. Our main goal with this trade is to fill the gap higher from Monday which is near 105.25. This is the area where readers should tighten stops, or use a trailing stop, to see if the selling intensifies or if buyers step in. We are at resistance points so this is a logical place for the DJIA to turn lower to regain some energy before possibly moving higher. The drop could happen fast so simply taking profits is also a smart move. A drop to this area will produce a winning trade and for options traders it should be a +20% gain. For readers looking for a quicker exit $106.25 could be considered which is near this week’s lows as the DJIA is stubbornly hanging onto the gap.

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.

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