Option Investor

Daily Newsletter, Tuesday, 9/7/2010

Table of Contents

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

Market Wrap

Labor Day Hangover

by James Brown

Click here to email James Brown

Market Stats

Stocks faced a Labor Day weekend hangover as the major U.S. averages lost just over 1%. Investors were yet again facing concerns over the strength of Europe's banking system and renewed worries over a potential default. Strikes in France and London only intensified the focus on Europe. The U.S. dollar strengthened against the euro and money rushed back into the U.S. bond market after last week's sell-off. The yield on the 10-year note dropped to 2.6%. Gold gapped open higher and closed near all-time highs at $1,259 an ounce. Crude oil slipped -0.6% to $74 a barrel. It was a bullish day for some of the agriculture commodities with coffee futures up +2.8%, oats +2.7%, and sugar up +4.1%.

Asian markets were mixed. Investors were reacting to news that both the Bank of Japan (BoJ) and the Central bank of Australia both decided to leave rates unchanged (versus raising them) due to fears of a second half slow down. Both countries pointed to weakness in the U.S. as a concern. Australia was also causing a stir after Prime Minister Julia Gillard was re-elected for a second term and promised to raise taxes on companies with mining operations in Australia. Mining stocks naturally turned lower on the news.

Politics were also fueling uncertainty in Japan as the markets wait for the Democratic Party's leadership election on September 14th. The Japanese NIKKEI index snapped a four-day winning streak with a -0.8% decline. The Hong Kong Hang Seng index gained +0.22% while the Chinese Shanghai index closed virtually unchanged at +0.08%.

Profit taking was worse in Europe. Germany reported that factory orders declined -2.2% in July from an upwardly revised +3.6% gain in June. Economists were expecting a +0.5% rise. While this is the biggest one-month drop in over a year keep in mind that Germany just had its best quarterly growth in 20 years. Orders were still up +18% compared to a year ago. The German DAX index closed down -0.6%.

Millions of workers went on strike in France today protesting various austerity measures and a government proposal to raise the retirement age from 60 to 62. France's Interior Ministry put the number of demonstrators at 1.1 million while the CFDT union said it was closer to 2.5 million. French leaders argued that it could be worse with several neighboring countries thinking about raising the retirement age to 67 or 68 years old. Meanwhile in London most of the subway system was shutdown as workers launched a 24-hour strike over job cuts. It was a busy day for the bus system. Unfortunately for Europe there are more strikes to come. This Wednesday there will be a strike by transportation workers in Greece. On September 21st there is a protest planned in the Czech Republic over a 10% pay cut for government employees. On September 29th Spain is expecting another labor strike. In spite of the strikes the biggest story on Wall Street was concern over the European banks but more on that in a moment. At the end of the day the English FTSE lost -0.58%. The French CAC-40 fell -1.1%, both ending a multi-day winning streak.

The big story today was concern for the European banking system as word surfaced that the highly questionable stress tests over the summer masked how much risk the banks actually had to toxic sovereign debt. You may recall that the European stress tests this past summer were big on hype and low on details. They were widely panned as being too lenient. Of the 90 banks reviewed only 7 of them failed the test.

Now it seems the largest banks may need to raise another 134 billion euros worth of capital to cover potential losses from their risky sovereign assets (mostly Greek, Portuguese, and Spanish bonds). Over the summer there was rising concern as European banks were unwilling to lend to each other. If the banks don't trust each other why should investors? Investors are once again voting with their money. The yield on a 10-year Greek bond has surged to more than 11.2%, which is a clear indication that investors are demanding more reward for the substantial risk that Greece may eventually default. Yields on Greek bonds haven't been this high since just before the EU and IMF agreed on a bailout for Greece.

Doubts are also rising for Ireland with yields on Irish bonds surging. The spread between Irish bonds and German bonds has hit 20-year highs. There is growing concern that a single default by one country (whether that's Greece, Portugal, Spain, Ireland, or Italy) will create a domino effect that will wipe out the banks and spark additional sovereign defaults. Unfortunately the IMF claims European banks continue to look weaker than their U.S. rivals since Europe's banks have only written down about 3% of their troubled assets versus 7% for U.S. banks.

Back at home in the U.S. the markets were digesting President Obama's Labor Day speech at a rally in Milwaukee. Obama is proposing a $50 billion, six-year plan to overhaul the U.S. transportation system. Eventually the overhaul would cost more than $50 billion but it would rebuild 150,000 miles of roadway, build or repair 4,000 miles of railroad, build or renew 150 miles of airport runways and provide better air-traffic control systems. The plan also wants to develop a high-speed train system. The President claims this new transportation plan will create jobs and will not increase our deficit but he failed to outline how many jobs it would create or how we could pay for it.

The initial reaction to the six-year overhaul seemed doubtful that Obama could get this plan passed through Congress. However, Wall Street was naturally more optimistic about his proposed tax cuts. The President will speak tomorrow in Cleveland where he will outline new rules that enhance a business' ability to depreciate equipment. Obama is also set to propose a permanent extension to the research tax credit.

The most sensational headline today was news that technology giant Hewlett-Packard (HPQ) is filing a lawsuit against its previous president Mark Hurd. A few weeks ago Hurd resigned from HPQ over sexual harassment accusations. Yesterday Oracle (ORCL) announced it was hiring Mark Hurd as president of the company to report only to Larry Ellison and the Board of Directors. HPQ immediately filed a lawsuit to prevent Hurd from accepting this job. Hewlett claims that as the previous president of HPQ and as the new president of ORCL it would be impossible for Hurd to not "utilize" or "disclose" sensitive trade secrets he knows from working at HPQ. Thanks to Hurd's leadership HPQ has grown from a major hardware producer to include data-center technology and other enterprise solutions - two areas that bring it head to head with ORCL. Shares of HPQ were down -1% while shares of ORCL rallied +5.8%.

After hours shares of ZymoGenetics (ZGEN) almost doubled with a rally to $9.80 a share on news that BristolMeyers Squibb Co (BMY) was buying the company for $9.75 a share (about $885 million). Shares of BMY are not moving on the news but look poised to breakout over resistance near $26.75. In other news Altera (ALTR) is showing some after hours strength after the company raised its third-quarter revenue guidance from +4%-8% to +10%-14%. Shirt-maker Phillips-Van Heusen (PVH) reported better than expected earnings after the closing bell. Wall Street was looking for a profit of 54 cents. PVH delivered 72 cents a share on revenues of $1.1 billion. PVH also raised their EPS guidance to $3.70-3.80 for 2011 versus consensus estimates of $3.62. The stock is not seeing much of a move in after hours.

Technically the market was looking a little short-term overbought with a rally from 1040 to 1105 (+6.2%) in the S&P 500 in the previous four days. Giving back a -1.1% decline isn't that bad but it does look like the S&P 500 is failing at its simple 100-dma. If you're market outlook is bullish then watch for support near 1080. Not only is the 1080 level previous support and resistance but it is also a 38.2% Fibonacci retracement of the S&P 500's early September rally. If the 1080 level fails then look for support near 1065.

Intraday Chart of the S&P 500 index:

Daily Chart of the S&P 500 index:

The NASDAQ's rally has failed near the bottom of its early August gap down. The 2200 level should offer some short-term support and if that fails then the 2150 and 2100 levels. Technicals on the NASDAQ are mixed. I would keep an eye on the SOX semiconductor index as a leading indicator. The SOX has been trying to find a bottom the last couple of weeks but it looks like the oversold bounce is failing near prior support (now new resistance).

Chart of the NASDAQ index:

Chart of the SOX semiconductor index:

The small cap Russell 2000 index, which saw a rally from 590 to 643 (+8.9%) was one of the worst performers with a -2.1% decline on Tuesday. A traditional pull back toward the 38.2% Fibonacci retracement would suggest a dip to 622 while a 50% correction would bring the $RUT back to 616. Personally, since the $RUT tends to be more volatile than the rest, I would look for a pull back toward 616 or 610.

Chart of the Russell 2000 index:

Tomorrow afternoon the market could move on the Federal Reserve's Beige Book report. The report is only published eight times a year and provides anecdotal evidence of business activity for each Fed district. The last report said economic activity has continued to increase but gains were "modest". Here's a link to the last report from July 28th, 2010.
Most Recent Fed Beige Book Report

Markets will also be focused on Thursday's weekly initial jobless claims. Economists are expecting 470,000 new claims compared to 472,000 the prior week.

Overall it looks like stocks were due for a little pull back after last week's impressive bounce. The question is will traders buy the next dip? After a frustrating summer the better question might be, are fund managers in a mood to buy stocks or clear their books (sell) and wait for the next entry point? This will depend on economic data and the elections. If economic data improves and the threat of a double-dip recession recedes then stocks will likely climb. If economic data disappoints then investors will struggle for a reason to buy. Yes, it's true that on a valuation basis the S&P 500 is cheap at 12 times earnings but that doesn't mean it can't get cheaper. Given the trend of analysts lower their second half 2010 and full year 2011 estimates I think odds are pretty good we might see another decline ahead of the November elections. Then again stocks might be range bounce until the mid-term elections. The stock market hates uncertainty and until the votes are counted there will be an incentive to sit on the sidelines. After the elections, assuming economic data isn't unraveling, the market should have a bullish bias.


New Option Plays

Long Candidate

by Scott Hawes

Click here to email Scott Hawes

iShares Russell 2000 - IWM - close 63.11 change -1.22 stop 59.80

Company Description:
iShares Russell 2000 Index Fund (the Fund) seeks investment results that correspond generally to the price and yield performance of the Russell 2000 Index (the Index). The Index measures the performance of the small-capitalization sector of the United States equity market. The Index is a float-adjusted capitalization-weighted index of equity securities issued by the approximately 2,000 smallest issuers in the Russell 3000 Index.

Target(s): 66.50, 67.75
Key Support/Resistance Areas: To Follow
Time Frame: 2 to 4 weeks

Why We Like It:
I believe any further weakness in the Russell 2000 and broader market present buying opportunities for an early fall rally and into the mid-term elections, of which will probably result in gridlock in Washington which is generally good for equities. Fund managers will begin reallocating their portfolios and cash on the sidelines should be put to work. Let's use a trigger of $62.50 to initiate long positions in IWM which is near the 38.2% retracement from the lows on 8/24 to the highs on 9/3. Our initial stop will be $59.80. Our targets are near the June and July highs.

Suggested Position: Buy November $57.50 CALL, current ask $2.37, estimated ask at entry $2.10

Annotated daily chart:

Entry on September xx
Earnings N/A (unconfirmed)
Average Daily Volume: 60 million
Listed on September 7, 2010

In Play Updates and Reviews

Stocks Retrace

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:

CALL Play Updates


ConocoPhillips - COP - close 53.66 change -1.39 stop 52.30 *NEW

Target(s): 56.65, 57.50, 58.25
Key Support/Resistance Areas: 58.50, 57.00, 53.00 to 53.50
Current Gain/Loss: -18%
Time Frame: 1 to 3 weeks
New Positions: Yes

9/7: We are long November COP calls as the stock hit our trigger in early trading. Oil sold off today on the back of a better than +1% rally in the US Dollar. We are going to be right or right out of this trade. COP is sitting on its 50-day SMA and also has solid support down to $53.00. If this support is broken we'll step aside. New positions can be opened with a tight stops below. Our official stop has been lowered just underneath the 200-day SMA.

9/4: Whether you believe the economy is improving or not, Oil companies should do well with the slimmest prospects of economic growth. Even if that growth is at a slower pace at least it is not a contracting scenario we've been dealing with throughout August. Technically, COP has made a series of higher lows and is now above all of its moving averages. I would like to see some retracement of last weeks gains which I think will be bought. I suggest readers initiate long positions on weakness in the stock, using a trigger of $54.70 which is near Friday's lows and above the 20-day SMA. More nimble traders could consider buying a breakout over Friday's highs or wait for a larger retracement to the $54.00 area. But I'm not so sure we are going to get it prior to the stock advancing higher. I am looking for a $2 to $3 move higher and if triggered our profit projection for the first two targets is +55% and +80%. Our stop is $52.85.

Suggested Position: Buy November $57.50 CALL, entry was at $1.05

Entry on September xx
Earnings 10/28/2010 (unconfirmed)
Average Daily Volume: 8.9 million
Listed on September 4, 2010

Int'l Business Machines - IBM - close 125.95 change -1.63 stop 121.90

Target(s): 127.75, 129.90
Key Support/Resistance Areas: 132.00, 128.00, 127,00, 123.00
Current Gain/Loss: +0%
Time Frame: 1 to 2 weeks
New Positions: Yes

9/7: IBM closed near Friday's lows which was a gap higher from Thursday. If the stock does not bounce here it could be headed to $124.60 area. New positions can be considered now or on any further weakness.

9/4: Today's gain in IBM takes some of the sting out of our loss in AAPL. IBM is approaching our first target of $127.75 but we my experience a pullback early this week. Any pullback to the $126.50 to $126.25 area could be considered for new positions. However, if IBM goes higher first I suggest being quick to take profits.

9/2: We are long IBM calls as our $125.25 entry was triggered. IBM traded within yesterday's range so there is not much report. Tomorrow's employment has the potential to hurt or help us. If the report is bad and the market sells off readers may want to consider placing a tighter stop in the $123.80 area.

Current Position: Long October $130.00 CALL, entry was $1.50

Entry on September 1, 2010
Earnings 10/18/2010 (unconfirmed)
Average Daily Volume: 5.5 million
Listed on August 28, 2010

NVIDIA Corp. - NVDA - close 9.99 change +0.09 stop 9.15

Target(s): 10.75, 11.35, 11.80
Key Support/Resistance Areas: 11.85, 11.45, 11.00, 10.25, 9.45
Time Frame: 1 to 2 weeks

9/7: We are waiting to be triggered in NVDA. The stock closed above its 50-day SMA for the first time since 4/15. If the market rebounds tomorrow we will most likely get triggered on the breakout.

9/4: In my opinion the odds of the broader market going higher are greater than it going lower, although there will probably be a pullback so the bulls can regain their energy. As such, I think NVDA can be bought and I suggest readers initiate long positions using a trigger of $9.72 (just above the 20-day SMA and today's low) or a breakout at $10.30 (above the 8/23 high). Ideally, it would be nice to get the lower price as I have been advocating in recent updates but either has the potential to produce a nice winning trade. Our new stop will be $9.15 initially. I've updated the targets and the play release from 8/28.

9/1 & 9/2: More nimble traders may want to consider bullish positions in NVDA now as the stock is almost 7% below our plan to buy it on a breakout. Officially we will wait for the breakout but if that doesn't happen in soon the play will most likely be dropped.

Suggested Position: Buy October $10.00 CALL with a trigger of $9.72 or $10.30, current ask $0.54

Entry on August xx
Earnings 11/4/2010 (unconfirmed)
Average Daily Volume: 23.5 million
Listed on August 28, 2010

Rackspace Hosting, Inc - RAX - close 20.07 change -0.72 stop 17.95

Target(s): 20.75(hit), 21.30, 23.00
Key Support/Resistance Areas: 23.50, 21.40, 20.00, 19.50, 19.00, 18.00
Current Gain/Loss: +7%
Time Frame: 3 to 5 weeks
New Positions: Yes

9/7: RAX drifted lower all day and broke an intraday trend line. However, RAX closed above the pivotal $20.00 support level and also has all of its major moving averages below. New positions can be considered now, especially on any further weakness. The next level of support below $20.00 is near $19.50.

9/4: RAX consolidated gains today and finished relatively flat after selling off early in the session. New positions can be considered on pullbacks. I've added a $21.95 target and I think this will get hit later this week after a possible dip early.

9/2: This marks the second time our first target has been hit. My comments from remain the same. Also, if tomorrow's employment report is bad readers should consider closing positions.

Current Position: Buy December $21.00 CALL, entry was at $1.40

Entry on August 25, 2010
Earnings 11/9/2010 (unconfirmed)
Average Daily Volume: 1.75 million
Listed on August 25, 2010

Stillwater Mining - SWC - close 14.73 change -0.55 stop 13.55 *NEW*

Target(s): 16.30, 16.95, 17.65
Key Support/Resistance Areas: 14.40 to 14.70
Current Gain/Loss: -16%
Time Frame: 1 to 3 weeks
New Positions: Yes

9/7: SWC sold off and closed its gap higher from Thursday to Friday. The stock closed above its key support level of $14.40 to $14.70 and is maintaining an upward trend line since 8/25. New positions can be considered at current levels. I've moved the stop to just below the 20-day SMA.

9/4: We are long SWC as of today's open. The stock opened at our trigger and we are looking for a continued move higher. Readers may want to consider opening new positions on pullbacks, perhaps around $14.75. This would fill the gap higher today. Considering the impressive run in SWC over the past 4 days a pullback should be expected.

9/2: Industrial metals such as silver and palladium that SWC mines are in demand and prices are increasing. SWC has broken out and closed above a key pivot level in the $14.50 area. I suggest readers buy SWC calls if the stock trades to $15.05 which is above today's high of $14.98. If the broader market rallies on good a employment report tomorrow SWC should eventually trade up towards its 52 week highs. If the broader market sells off on a bad employment report we may consider entering at a lower price next week. There is a lot of support below. If triggered our initial stop will be $13.95.

Current Position: Long October $15.00 CALL, entry was at $1.20

Entry on September 3, 2010
Earnings 11/4/2010 (unconfirmed)
Average Daily Volume: 1.62 million
Listed on September 2, 2010

PUT Play Updates

Abercrombie & Fitch - ANF - close 34.57 change -1.12 stop 36.20 *NEW*

Target(s): 35.05 (hit), 34.60 (hit), 34.05, 33.25
Key Support/Resistance Areas: 38.20, 37.25, 32.75, 34.00, 30.50
Current Gain/Loss: -13%
Time Frame: Several weeks
New Positions: No

9/7: I've lowered the stop in ANF to $36.20 and added a target of $33.25. I suggest readers continue to use weakness to close positions or tighten stops. 9/4: My comments from below remain valid. Sellers stepped in again when ANF tried to move higher and the stock closed near its lows. The chart looks terrible but ANF should benefit from a strong broader market so I urge readers to be cautious. We don't want to be swimming against the current. I'm expecting some market weakness early this week and suggest readers use it to tighten stops or close positions to protect capital. I've narrowed the targets significantly.

9/2: There is obviously a big seller of ANF which makes me think the sell-off could continue in the stock. However, tomorrow is a wild card so I urge readers to be cautious with positions if the broader market rally continues. I've tightened the stop and adjusted the targets.

Current Position: Long October $34.00 PUT, entry was at $2.10

Entry on August 25, 2010
Earnings: 11/11/10 (unconfirmed)
Average Daily Volume: 3.5 million
Listed on August 24, 2010

United Technologies - UTX - close 67.98 change -0.28 stop 69.11

Target(s): 67.65, 67.05, 66.40
Key Support/Resistance Areas: 69.00, 68.50 67.50, 66.50, 64.75,
Current Gain/Loss: -29% Time Frame: 1 to 2 weeks
New Positions: No

9/7: UTX came within 2 cents of our immediate target in early trading. My comments from below remain the same. I'm suggesting we use weakness to close positions or tighten stops to protect capital.

9/4: UTX closed just below its 20-day and 50-day SMA's. I'm expecting the stock to turn back lower here but I don't think the selling will last long so I suggest readers begin to look for a exit. We have to respect this week's turnaround in the market and use weakness to close positions, even if that means a loss. I've provided three near term targets readers should use to consider closing positions or tightening stops as they approach.

9/1: We got filled at the higher trigger in UTX so we are now long October $65 puts for $1.60. Considering the turnaround in equities today I suggest readers use caution in this position. I've narrowed the targets to account for the higher fill and suggest readers consider taking profits or tightening stops to protect them at these levels.

8/31: A strengthening US dollar is bad for multinational companies who derive income from abroad. After a sell-off in the dollar over the past couple of months it looks poised to break out higher and UTX looks poised to break down lower. The plan is to short UTX if it breaks down to $64.50 but I would also suggest shorting UTX if it trades up to close the gap from 8/24 at $67.00. If we get filled at the higher price our stop will be $69.11. If we get filled at the lower price our stop will $67.61.

Current Position: Long October $65.00 PUT, entry was at $1.60

Entry on September 1, 2010
Earnings: 10/20/10 (unconfirmed)
Average Daily Volume: 4.4 million
Listed on August 31, 2010


NUCOR Corp. - NUE - close 39.38 change +0.70 stop 39.25

Target(s): 38.35, 38.10, 37.60, 36.05 (hit),
Key Support/Resistance Areas: 43.00, 40.30, 37.00, 35.00
Option Current Gain/Loss: -53.1%
Time Frame: 4 to 6 weeks
New Positions: No

9/7: Steel stocks surged higher today on takeover speculation for US Steel. Many steel stocks benefited from the news and NUE hit our stop in early trading after coming within 7 cents of our immediate exit target. We are flat the position for a loss. Implied volatility increased so our option premium didn't suffer as much I thought it would. My comments below remain valid for readers who may still have positions.

9/4: It is time to look for an exit in NUE. After the stock hit our first target of $36.05 on 8/25 it has surged +8%. We have to respect this move and step aside if our stop is hit. More aggressive traders may want to consider a looser stop up near $41 but if NUE marches higher before a pullback your option premium will get crushed. Our official stop is above the 50-day SMA which is where NUE closed on Friday. In addition, NUE has broken and closed above a trend line from May (see dashed line) and is sitting just underneath a secondary trend line from 6/14. This is natural spot for NUE to retrace some of the recent gains which is when I suggest looking for an exit. I have provided three near term targets to consider. Be ready to protect capital on pullback because it could come quick.

9/2: My comments below remain the same. I've adjusted the immediate target and tightened the stop, which is above the 50-day and downtrend line. This is the place for pullback but if we don't get it NUE could breakout higher so I suggest getting out of the way and protecting capital.

9/1: I've added a $37.40 as a target and suggest readers begin to look for an exit in NUE. The stock's 20-day, 50-day, and downtrend line are all just overhead which should provide a pullback and exit point, even it is a loss.

Closed Position: Long October $35.00 PUT at $0.45, entry was at $0.96

Annotated Chart:

Entry on August 20, 2010
Earnings Date 10/21/10
Average Daily Volume 2.9 million
Listed on August 19, 2010