Option Investor

Daily Newsletter, Monday, 8/30/2010

Table of Contents

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

Market Wrap

Back To Reality

by Todd Shriber

Click here to email Todd Shriber
Stocks came crashing back to Earth following last Friday's rally, which was obviously temporary in nature. That is not surprising given that Friday's cheery trade was led by less bad economic news, not truly good news. Monday's result was another triple-digit loss for the Dow Jones Industrial Average, which has the index teetering on the brink of dropping below 10,000 again, and losses of at least 1.39% for all three major U.S. indexes.

Stats Table

Today's culprit from the world of weak economic news was the Commerce Department's report that showed disposable income fell in July. That is the first monthly decline since January. That number is adjusted for inflation, so the Bureau of Economic Analysis shows us that disposable personal income and personal consumption expenditures actually moved higher in July by 0.2% and 0.4%, respectively. The numbers were flat in June, so it might be reasonable to wonder why the market was down today if these numbers were supposedly better than the previous month's results.

The devil is in the details, of course. The chart below shows consumers spent more than they saved in July. If that trend holds going forward, that will be good news for GDP since the consumer accounts for roughly 70% of U.S. GDP, but there is truly a double-edged sword. A lack of thriftiness on the part of the American consumer is undoubtedly one reason why the economy is in the situation it is in today. Spending more than is earned is not a sustainable practice and leads to an eventual decline in expenditures.

Income/Consumption Chart

If Monday's trade is any indication, and I think it is, this is going to be a tough week to be long stocks. As Jim noted in the weekend, the weekly calendar is chocked full of economic news releases that could really weigh on the bulls. I am going to jump straight to the marquee report: Friday's August unemployment release. Anything is possible, but I would not be betting on a strong number. The U.S. is still dealing with a bleak unemployment scenario as evidenced by the employment to population ratio, which now lingers near levels not seen since 1983, according to the Angry Bear blog.

Employment/Population Ratio

Making matters worse is that post-recession jobs growth following the most recent downturn has been anemic when measured against previous recessions. The Bear says we want to see an employment to population ratio of 100% or higher. Unfortunately, we are not quite there yet.

Post-Recession Employment/Population Ratio

Once again, weak economic data overshadowed another day of robust news flow on the mergers and acquisitions front. Spotting stocks large-cap stocks that finished in the green today was pretty easy: Most were involved in M&A. However, the performance of stocks on the back of better-than-average M&A activity, not only recently, but for the entire year, can only considered disappointed.

For the year, there has been $1.34 trillion in announced global mergers and acquisitions, 25% higher than the comparable period a year ago, according to Bloomberg News. The tech sector has been especially active on the M&A front. In theory that should be good news not only for the Nasdaq, but also for the S&P 500 because tech is one of the two largest industry components to the latter index, but both indexes are down 5% year-to-date.

Intel (INTC) shed more than 2% today on news that it would pay $1.4 billion for Infineon's wireless unit. In less than two weeks, Intel has announced more than $9 billion in acquisitions and all of that has the stock trading 15 cents away from a 52-week low.

One of the day's big winners was a company that sure does not get a lot of press was Cogent (COGT), a maker of security systems that read finger and palm prints, surged 24.4% after Dow component 3M (MMM) said it would buy the company for $943 million. Nearly 19.5 million Cogent shares changed hands today compared to average daily volume of 665,000 shares. The deal values Cogent $10.50 a share, an 18% premium to where the shares closed on Friday.

Cogent Chart

As I said, winners were hard to come by today and that is why a stock that gained just over 3% on the day is somewhat noteworthy. I am talking about biotech firm Genzyme (GENZ), which was up by almost 3.4% after French pharmaceuticals giant Sanofi Aventis (SNY) finally made its acquisition offer for Genzyme public. Rumors of this deal have been flying around for months, but Sanofi appears to be growing frustrated and has now told the world about its $18.5 billion for Genzyme.

This deal may not have the melodrama of the BHP Billiton (BHP)/Potash (POT) showdown, but it is getting close. Genzyme has rejected the Sanofi offer, which values Genzyme at $69 a share, a tad below where the stock closed today. Analysts are saying Sanofi may need to raise the offer to $75 or $80 a share to get the deal done. I do not want to speculate on whether Sanofi will raise its offer because I simply do not if that is going to happen, but what is clear is that Genzyme makes for an attractive target.

The Massachusetts-based company makes complex genetic treatments that, for lack of a better way of putting it, are really hard for other companies (read: Generic producers) to copy. Traditional pharma firms, American, French or otherwise, are struggling with stagnant pipelines and expiring patents for blockbuster drugs in the coming years, so acquiring a company like Genzyme makes a lot of sense. The disclaimer being if the price is right. Major Sanofi shareholders, including French oil giant Total (TOT) have already expressed concern about the potential of overpaying for Genzyme.

For its part, Genzyme should be careful and not be too greedy because there is not much in the way of substantive rumors that mention another possible bidder for the company. This is the same dangerous game Potash is playing when two of the most likely suitors beyond BHP, Rio Tinto (RTP) and Vale (VALE) have already said they are not interested.

Genzyme Chart

Speaking of M&A soap operas, the Dell (DELL) vs. Hewlett-Packard (HPQ) for 3Par (PAR) saga continues to drag on as HP has once again trumped its smaller rival by offering $2 billion, or $30 a share, for 3Par, the data storage and cloud computing firm. The ball is back in Dell's court to counter after its last offer of $27 a share looked good for a minute, but now looks not good enough.

Oddly enough, of the three stocks, only 3Par was down today. Dell may have traded higher because the market is starting to realize the company is not going to win this battle and the bright side of that is Dell will not be overpaying for 3Par. HP was the only member of the Dow to finish higher today because the company announced a $10 billion share buyback. Given HP's acquisitive ways, I am willing to bet that many of those shares will not stay in the company treasury for very long.

HP Chart

Looking at the charts, the S&P 500 honored resistance in the 1060-1065 area by dutifully retreating from Friday's close at 1064. Monday's close at 1048 brings us back to sniffing distance of support at 1040 and I get the feeling the that the 1040-1060 range will continue to be what we see heading into Friday's job number. Support at 1040 has held a couple of times, but if it finally does break, target 1010-1015 as the next stopping point.

S&P 500 Chart

Things were looking good for the Dow after making a strong move above resistance at 10,100 last Friday, but all those gains were undone today and the blue chip index is back close to psychological support at 10,000. So resistance at 10,100 is back in place and even if the Dow can move back above that level, it would have to deal with more resistance at 10,300. After 10,000 first support is 9900 then 9800.

Dow Chart

It sure would be nice to be able to say something positive about the Nasdaq for a change, but tech just will not oblige. Resistance around 2150 held firm and the almost 34-point tumble today puts the index almost 20 points away from support at 2100. This is another area that has held a couple of times and because volume is weak these days, it may take another day or two before 2100 is threatened again. Still, it is troublesome that with all the tech M&A activity that the Nasdaq is not performing better. And yes, Genzyme is a Nasdaq 100 stock.

Nasdaq Chart

The Russell 2000 was the worst performer of the indexes mentioned here, losing 2.44% today, but at least closed above 600. I am still concerned that further flirtations with support 590 spell trouble and that a break of that support is coming sooner rather than later.

Russell 2000 Chart

In the essence of simplicity, this much is clear at this point: Stocks are beholden to economic data and that data continues to be ugly, so why be involved from the long side this week. All of the important economic reports that come out before Friday's jobs number have some jobs component to them, which could prove to be an invitation to stay short or stay out.

New Option Plays

Another Short Retail Candidate

by Scott Hawes

Click here to email Scott Hawes


Limited Brands Inc - LTD - close 24.14 change -0.82 stop 25.65

Company Description:
Limited Brands, Inc. is a specialty retailer of womens intimate and other apparel, beauty and personal care products and accessories under various trade names. The Company sells its merchandise primarily through its retail stores in the United States and Canada and through its Websites and catalogues. The Company operates in two segments: Victoria's Secret and Bath & Body Works. It sells its products at more than 1,000 Victoria's Secret stores and more than 1,600 Bath & Body Works stores nationwide, via the Victoria's Secret Catalogue and online at www.VictoriasSecret.com and www.BathandBodyWorks.com. It also sells upscale accessory products through its Henri Bendel flagship and 10 accessory stores, as well as online at www.HenriBendel.com. Target(s): 23.30, 22.70, 22.05
Key Support/Resistance Areas: 25.40, 23.85, 22.60, 22.00
Time Frame: Several weeks

We are sticking with a consumer name in the retail space. Retailers are weak and LTD looks ready for a drop if the broader market cooperates. Technically LTD looks like it wants to retest its recent swing lows. There was also a big buyer of the September $25 puts with over 2,200 contracts purchased and I like the volume flow. I suggest we initiate short positions now or on any strength in the stock. $24.50 is just below the 50-day SMA which can be used to time an entry. Our stop is $25.65. Our first target of $23.30 which is about -5% lower from current levels. NOTE: The October strikes were just recently released for trading so the open interest isn't as high as surrounding months.

Suggested Position: Buy October $24.00 PUT, current ask $1.40

Annotated chart:

Entry on August xx
Earnings: 11/17/10 (unconfirmed)
Average Daily Volume: 4.4 million
Listed on August 30, 2010

In Play Updates and Reviews

Equities Are Near Support

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:
Good evening. I had major technical difficulties with my trading software today so I am only able to provide you with brief comments on current open positions. Most of my comments from the weekend remain valid so please refer to Saturday's newsletter for more details unless otherwise noted below. I was able to restore my software and will be back on track tomorrow. Thanks for your patience.

Today's lack of follow through higher in the broader market was certainly a disappointment to the bulls. Whether the one day event was Friday's rally or today's sell-off will soon be determined. In reality, trading could be very choppy the remainder of the week as summer winds down and we head into the long holiday weekend on light volume. Regardless of which way the market may break we should have some opportunities to book profits. Feel free to email me with any questions.

Current Portfolio:

CALL Play Updates

CAM - My comments from the weekend remain the same. I am looking for follow through higher to exit positions on strength.

FTI - I was a little surprised with the weakness in FTI today. The chart remains bullish but we'll need some broader market strength to get things moving higher. My comments from the weekend remain the same.

PNRA - We were triggered in PNRA today and the stock reversed rather quickly. We are long October $80 CALLS at $3.30.

RAX - After a +8% rip on Friday RAX gave a little back today closing down -2.25%. A retracement was expected and now I am looking for RAX to regain its footing and move higher in the comings days/weeks.

NVDA - The stock has not broken out so the position is unopened. More nimble traders could open positions now with a tight stop to take advantage of today's weakness. Please refer to the new play in Saturday's newsletter for more details of our set-up.

PUT Play Updates

ANF - Lost -2.64% and looks headed towards our targets. I suggest taking profits or tightening stops to protect them on further weakness.

AAPL - After being relative underperformer recently, AAPL showed relative strength today by out performing the broader market, gaining +0.36%. The stock double topped with Thursday's highs at $245.75 which is where the sellers stepped in. I want raise our first target on this position to just above Friday's low at $236. If AAPL trades down there we will have a winning position and I suggest consider taking profits or tightening stops to protect them.

NUE - NUE lost -1.5% today and nothing has changed with our targets. $36.05 was reached last week and NUE should trade back down to retest its lows from 8/29 at $35.71. We have a gain in the position and suggest readers use weakness to take profits or tighten stops.

OXY - OXY gave back -2.18% of the gains from Friday. We are near breakeven on the trade and suggest readers use weakness to consider closing positions. $72.25, $71.60, and $70.25 are the immediate targets. $72.25 is near last week's lows which is where OXY found support.