Option Investor

Daily Newsletter, Wednesday, 9/22/2010

Table of Contents

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

Market Wrap

Dollar Drops, Gold Gleams, Stocks Stall

by James Brown

Click here to email James Brown

Market Stats

The rally in stocks stalled on Wednesday following yesterday's less than inspiring release from the Federal Reserve. If the FOMC believes the U.S. economy needs help then growth must be slowing down even faster than expected. The banking sector was a big drag on the market with a -1.9% decline. Recent strength in the technology sector vanished following an earnings warning from PMC-Sierra Inc. (PMCS) and Adobe's (ADBE) disappointing earnings guidance last night. Shares of PMCS lost -6% while ADBE plunged -19% for the day.

The Fed's comments yesterday were not bullish for the dollar and the U.S. dollar fell to new five-month lows on Wednesday. Treasuries rallied again pushing the yield on the 10-year bond down to 2.54%. Precious metals soared as investors worried about the next round of quantitative easing and the effect on our currency. Gold hit a new all-time high for the fifth day in a row. The intraday high was $1,298 an ounce before settling with a +1.4% gain at $1,292.10. Gold is poised to mark its tenth annual gain in a row. Copper futures rose to new five-month highs and platinum rallied to four-month highs. Silver was a big winner too with a +2.4% gain to $21.05 an ounce. This was the first time silver has closed over $21 since March 2008. It was a different story for oil futures. Oil slipped 26 cents to $74.71 a barrel following a bearish increase in inventories. The Energy Department said crude supplies jumped 970K barrels to 358.3 million when economists were expecting a -1.75 million draw down.

Chart of the U.S.dollar ETF (UUP):

Chart of the Gold ETF (GLD):

It was a down day for stocks around the world. Most of the major indices closed in negative territory. The Hong Kong Hang Seng was an exception with a +0.2% gain but the Chinese Shanghai market was closed for holiday as was the Korean and Taiwan markets. The Hong Kong market will close for holiday tomorrow. In Japan the NIKKEI index recovered from its morning losses but failed to hold any midday gains and closed in negative territory with a -0.37% drop on light volume. Traders are still very much focused on the yen/dollar relationship after last week's currency intervention by Japan. There is a lot less worry about the yen strengthening since it is widely expected that Japan will step in again and sell more yen to weaken their currency (currently trading near 85 yen to the dollar).

European markets were struggling with bearish economic data. The 16-nation euro zone industrials orders showed a -2.4% drop in July following a +2.4% rise in June. Economists were only expecting a -1.4% decline. Naturally worries are growing that manufacturers will slow down production and hiring if demand continues to wane. The EU zone also saw its consumer confidence stumble. Analysts were expecting an improvement from -11.4 in August to -10 but today's report only showed an improvement to -11.2. Slowing growth and drastic budget cuts by several regional governments is taking its toll on the population's attitudes (do you recall all of the recent strikes?). Currently economists are projecting the EU to see +0.5% GDP growth in the third quarter, down from +1.0% growth in the second quarter.

News on the residential real estate market here in the U.S. continues to sour. The Federal Housing Finance Agency (FHFA) issued their report on home prices with mortgages backed by Freddie Mac and Fannie Mae. According to their report housing prices slipped -0.5% in July and they revised June's decline from -0.3% to -1.2%. Economists were only expecting a -0.2% drop for July, which was the eighth monthly decline in a row and marks a -3.3% plunge from a year ago. Based on these numbers home values have fallen to September 2004 levels. The market is suffocating under a tidal wave of foreclosures. A few days ago RealtyTrac reported August was the worst month on record with over 95,000 homes repossessed. The National Association of Realtors is due to release their August sales figures on existing home sales tomorrow. The July report was terrible with a -27% drop in home sales so the bar is set pretty low for August.

Speaking of home sales the pace of mortgage applications is not painting a very healthy picture. Mortgage rates are still near record lows at 4.44% for a 30-year fixed rate mortgage. Yet applications are down. The Mortgage Bankers Association said their index of applications fell -1.4% last week. This is the third weekly decline in a row. Applications for new purchases dropped -3.3% and refinancing fell -0.9%. A Reuters article calculated that at current rates your monthly payment is only $503 per $100,000 financed. FYI: NAR estimates the median price of a home in this country at $183,000.

Corporate news was generally discouraging today. Adobe (ADBE) made the biggest splash following its earnings report last night. The company beat estimates by 5 cents a share but the market was unhappy with its guidance. The stock garnered several downgrades and gapped open lower to eventually settle with a -19% decline near its 2010 lows. Tech giant Microsoft (MSFT) had much better news but traders were already in a mood to sell. MSFT announced they were raising their quarterly cash dividend by 23% from 13 cents to 16 cents. It is their first dividend increase in two years but investors were expecting more. The stock gapped open lower and closed with a -2.1% loss on the session.

Normally a dividend raise is a sign of confidence by management that the environment is improving so it's safe to return money to shareholders. Today's increase in dividend bumps MSFT's yield to 2.5% a year, giving it the 12th highest yield in the NASDAQ 100. The company is poised to pay out $5.5 billion a year in dividends thanks to its 8.65 billion shares outstanding. MSFT is also taking advantage of the market's demand for high-quality corporate paper. Yesterday the board approved up to $6 billion in new debt and today MSFT sold $4.75 billion in debt, some of it at the lowest level in U.S. history. The company has over $37 billion in cash but a lot of this is overseas and it is cheaper for MSFT to raise money here by selling bonds at extremely low rates than repatriating their cash and paying taxes on it.

In less happy news the Wall Street Journal reported that Blockbuster Inc. is on the verge of filing for Chapter 11 bankruptcy protection. The company has been withering under competition from Netflix (NFLX), Amazon.com's download service, and Red Box. Blockbuster is struggling with $900 million in debt and hundreds of big brick and mortar stores. Smaller rival Movie Gallery Inc. filed for bankruptcy over six months ago and instead of reorganizing they decided to liquidate the company. There is plenty of speculation if Blockbuster will be able to emerge from bankruptcy or not. This could be the final credits for Blockbuster.

Online auction giant Ebay (EBAY) is another example of traders being in a mood to sell. EBAY guided its third quarter earnings toward the top of its previous range (35-37 cents a share) and yet investors sold the news anyway. The stock fell -5.5% midday but pared its losses to just -1.6% before the closing bell. EBAY is still up over 26% from its July 2010 lows.

There were exceptions. General Mills Inc. (GIS) reported earnings this morning of 64 cents a share. That was one cent better than expected. Revenues missed estimates at $3.53 billion versus $3.57 billion. GIS claimed that globally the sales environment is still tough but their core food business remains strong. Management reaffirmed their 2011 guidance and the stock shot higher to post a +2.69% gain.

In after hours action the earnings data continues to trickle in. Bed Bath and Beyond (BBBY) and Red Hat (RHT) released their results. BBBY delivered a profit of 70 cents a share, which was 7 cents better than expected. Q2 revenues rose +11.6% to $2.14 billion, beating estimates of $2.1 billion. Same store sales jumped +7.4% compared to a decline of -0.6% a year ago. BBBY management raised their 2011 guidance and the stock was up over +4% after hours. Meanwhile software firm Red Hat (RHT) reported earnings of 19 cents a share, which was one cent ahead of expectations. Revenues climbed almost +20% to $219.8 million, which was better than the estimate. The company issued upside earnings and revenue guidance going forward. After a -4.3% decline during the regular session shares were trading higher this evening.

It's not rocket science to see that the market's short-term trend is up. However, stocks are very overbought. The S&P 500 is up about +9% from its late August lows. The S&P 500's rally just failed at prior resistance near 1150. This is not a spot to be loading up on bullish positions. Broken resistance near 1130 should offer some short-term support but I would prefer to look for a dip near the 200-dma or better yet a dip near the 1100 area before considering new bullish positions. This appears to be a "buy the dip" market right now but we need to look for a decline toward support. The best place to look for support is prior resistance.

Chart of the S&P 500 index:

Even with the decline yesterday and today the NASDAQ composite is still up about +11% from its August lows. The move has been virtually non-stop. The breakout to new relative highs is very positive but we just don't want to chase it here. Previous resistance near 2300 could be new support for the NASDAQ but I would prefer to look for a dip near 2260. Consider the volatile move higher readers may want to wait for a pull back to 2250 instead before looking for new bullish positions.

Chart of the NASDAQ index:

As expected the small cap Russell 2000 index rallied to resistance near 670 and stalled. The move looks like a clearly defined failed rally and I would expected a deeper correction. The 640 and 630 levels are a good spot to watch for potential support on the $RUT index.

Chart of the Russell 2000 index:

Tomorrow morning investors will be reacting to the weekly initial jobless claims. Economists are expecting 450,000 new claims, which would match last week's number. We'll also see the leading indicators from August. The bigger report will be the NAR's existing home sales data for August. Analysts are estimating a small improvement to an annual pace of 4.1 million homes. Friday's market moving event is probably the durable goods orders number. Also out Friday is the new home sales figures for August.

In summary, the trend is up but stocks are overbought and way overdue for a correction. We want to buy a dip but look for a decline near support


New Option Plays

Online Broker Play

by Scott Hawes

Click here to email Scott Hawes


Charles Schwab - SCHW - close 13.63 change -0.29 stop 14.42

Company Description:
The Charles Schwab Corporation (CSC) is a financial holding company. Through its subsidiaries, the Company engages in securities brokerage, banking and related financial services. As of December 31, 2009, CSC provided financial services to individuals and institutional clients through two segments: Investor Services and Institutional Services. As of December 31, 2009, the Company had $1.42 trillion in client assets, 7.7 million active brokerage accounts, 1.5 million corporate retirement plan participants and 722,000 banking accounts.

Target(s): 13.10, 12.85, 12.55
Key Support/Resistance Areas: 14.10, 13.35, 13.05, 12.65
Time Frame: 1 to 3 weeks

Why We Like It:
We are going with a cheapie in the financial services sector tonight, which looks terrible across all industries, from banks, to lenders, to broker dealers. A study released today said that the 85% of Americans do not trust the financial markets and have therefore reconsidered their investment activities. Retail trading volumes are way down which will hurt firms like Chuck (SCHW). Technically, the stock has run right up into prior support (now resistance) from July and has turned lower. The stock has also been making lower highs and lower lows and I see no reason for this pattern to stop if the broader market cooperates. It would be nice to see some retracement of today's losses but a breakdown is also a good set-up. I suggest readers initiate short positions with one of two triggers. If SCHW trades up to $13.70 or down to $13.55. If triggered at $13.70 we are playing for an 85 cent pullback which is our 2nd target and a gap fill. If this target is reached the estimated gain on the position is +60%. If we are wrong we won't get hurt too bad as the option is cheap.

NOTE: November strikes were just recently released in SCHW so the open interest not as great as other months. The spreads are reasonable and I am not worried about liquidity as trading will begin to pick up.

Suggested Position: Buy November $13.00 PUT, current ask $0.50, estimated ask at entry $0.45 (try to enter at no more than 45 cents)

Annotated chart:

Entry on September xx
Earnings: 10/14/2010 (unconfirmed)
Average Daily Volume: 11 million
Listed on September 22, 2010

In Play Updates and Reviews

Lots of Movement

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:
Good evening. We had lots of movement today in our positions. NVDA and XLNX were closed for big gains, while FCX was closed for a smaller loss. I am looking to take profits on SWC tomorrow. Feel free to email me with any questions or comments. I owe a couple of readers responses and will reply tomorrow morning as I had difficulties accessing those emails this afternoon. Have a great evening!

Current Portfolio:

CALL Play Updates

Stillwater Mining - SWC - close 16.21 change +0.86 stop 15.77 *NEW*

Target(s): 15.45 (hit), 15.90 (hit), 16.30, 16.60
Key Support/Resistance Areas: 14.40 to 14.70, 15.00
Current Gain/Loss: +35%
Time Frame: 1 to 3 weeks
New Positions: Yes, only on pullbacks

9/22: Material stocks like SWC are benefiting from the money printing promises of the Fed. SWC surged +5.6% today and closed on its high. I am looking to take profits on this trade. If SWC gets a pullback tomorrow intraday support begins at $16.00 down to $15.90. Let's raise the stop to $15.77 and I suggest we take profits at the close tomorrow if our remaining targets of $16.30 and $16.60 (lowered) are not reached tomorrow. $16.60 will fill a gap from 5/13. Traders may want to consider a 15 or 20 cent trailing stop to see how much more we can get out of the trade.

9/21: SWC sold off hard this morning and had a nice recovery this afternoon. I suggest readers use caution and consider exiting positions, especially on strength. All of the above targets remain valid. My comments from below remain the same.

9/20: SWC recouped some of its losses from Friday, closing +2.10% on the day. The stock's rally seems to be getting a little long in the tooth and is probably going to experience a correction. Readers may want to consider closing positions or using a tighter stop in the $14.85 area. If SWC heads back up towards our targets prior to correcting be prepared to take profits or tighten stops to protect them.

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

Transocean Ltd - RIG - close 59.89 change +0.22 stop 53.40

Target(s): 62.95, 64.50, 66.50
Key Support/Resistance Areas: 55.50, 58.25, 63.90, 64.90
Current Gain/Loss: -30%
Time Frame: 2 to 4 weeks
New Positions: Yes

9/22: Nothing has changed and volume continues to be light as RIG is consolidating. Today the stock printed a bottoming tail hammer but I am still concerned of a broader market pullback. My comments below remain the same.

9/21 RIG broke out to a new a high today but it was quickly sold into. I continue to like the volume patterns in this stock and today's volume on the pullback was on the one of the lightest days since RIG broke higher on 9/10. However, it appears the broader may get a pullback here so we may need to exhibit some patience. New positions can be considered at current levels or on a pullback to $58.35 where there is solid support.

Current Position: Long November $65.00 CALL, entry was at $2.25

Entry on September 13, 2010
Earnings 11/3/10 (unconfirmed)
Average Daily Volume: 8 million
Listed on September 11, 2010

iPath S&P 500 VIX ST Futures - VXX - close 17.06 change +0.27 stop

Target(s): 18.45, 19.25, 20.40
Key Support/Resistance Areas: 17.50, 19.75, 20.60
Current Gain/Loss: +4%
Time Frame: 1 to 2 weeks
New positions: Yes

NOTE: I view this as an aggressive trade so small position size is recommended. Long VXX is a bearish play on equities, however, it is listed as long play because we are long the underlying instrument.

9/21: We are long VXX at the open today. I am looking for a spike higher in the coming days which means we need to experience some broader market weakness. My comments from the play release are below.

9/20: The market remains overbought and is need of a healthy pullback to regain its energy. Traders are getting complacent as evidenced by VXX printing new 52-week lows multiple times in the past week. I suggest we play for a spike in volatility in the coming days and initiate long positions in VXX at current levels. Our first two targets are +10% and +14% higher from current levels which could happen in a matter of a day or two correction if it is strong enough. If reached, these targets should produce approximately +60% to +80% gains on options positions. I am releasing this play without an initial stop, but will implement one in the next day or two.

Current Position: Long November $18.00 CALL, entry was at $1.25

Entry on September 22, 2010
Earnings N/A (unconfirmed)
Average Daily Volume: 21 million
Listed on September 21, 2010

PUT Play Updates

Archer Daniels Midland - ADM - close 33.39 change +0.54 stop 33.76

Target(s): 32.20, 31.25, 30.85
Key Support/Resistance Areas: 33.50, 31.00, 29.80
Current Gain/Loss: -40%
Time Frame: 1 to 2 weeks
New Positions: Yes

9/22: My thesis (fundamentally & technically) for entering this position is on the verge of failing and we could get stopped out tomorrow if the strength continues. I've changed the immediate target to $32.20 which is just above the 20-day SMA. $31.25 is still in the cards but ADM need to turn lower now. The broader market strength or weakness will likely determine our fate. I suggest getting out of the way and taking the loss if our stop is hit.

9/20 & 9/21: We are short ADM and playing for a pullback. New positions can be considered at current levels. The play release is below and my comments remain valid.

9/18: Cautious comments from analysts about rising agricultural commodity prices is likely to affect ADM's business. The stock is overbought and is due for correction after an incredible run higher off of the July lows. ADM has also formed a bearish dark cloud cover technical pattern that suggests the decline is imminent. I suggest we open positions at current levels and play for a $1 to $2 move lower. The primary targets are $31.25 and $30.85 and if reached they should produce a +40% to +60% winner. Our stop is above the 52-week high set on Friday.

Current Position: Long October $32.00 PUT, entry was at $0.82

Entry on September 20, 2010
Earnings: 11/2/2010 (unconfirmed)
Average Daily Volume: 6 million
Listed on September 18, 2010

SPDR S&P 500 ETF - SPY - close 113.42 change -0.56 stop 116.25

Target(s): 112.10, 111.50, 110.65
Key Support/Resistance Areas: 115.00, 113.00, 110.60, 50-day, 20-day
Current Gain/Loss: -40%
Time Frame: 1 week
New Positions: Yes, if playing for a quick pullback

9/21 & 9/22: The bulls have made an impressive run but it appears they are getting exhausted. If the selling starts, which will most likely come fast, I think traders will run for the exits to lock in profits. This is when we want to exit this position or tighten stops to protect capital. I tweaked the middle target above due to a calculation error.

9/20: My comments from below have not changed. SPY broke out today but I do believe it will get sold into which sets things up for a much need healthy pullback in the broader market. I suggest using this pullback as an opportunity to close positions or tighten stops, even if we have to take a loss. I've adjusted our targets. The first target is just above the 200-day SMA while the final target is a gap fill which is just above the rising 20 and 50-day SMA's.

9/18: I believe any breakouts in the broader market will be sold into and dips will be bought. I'm looking for a retracement in SPY over the next week or so to fill some gaps and retest its converging 100-day, 50-day, and 20-day SMA's from above. This is when we will close the position and consider a new long entry. $110.65 is the primary target at this point which give us a +35% to +40% gain.

Current Position: Long October $109.00 PUT, entry was at $1.56

Entry on September 14, 2010
Earnings: N/A (unconfirmed)
Average Daily Volume: 198 million
Listed on September 13, 2010


NVIDIA Corp. - NVDA - close 11.39 change +0.10 stop 11.08

Target(s): 10.75 (hit), 11.05 (hit), 11.45 (hit), 11.80
Key Support/Resistance Areas: 11.85, 11.45, 11.00, 10.25, 10.00 9.45
Current Gain/Loss: +108.3%
Time Frame: 1 to 2 weeks
New Positions: Closed

9/22: We are flat NVDA for a +108% gain. The stock continues to look bullish but we need to lock in gains with October options. Pullbacks in this stock can probably be bought, perhaps to the $10.75 area.

9/21: NVDA broke out today on a weak tape gaining +5.4% on the day. Our options have gained +93% and it is time to fiercely protect capital. Let's move the stop all the way up to $11.08 which will guarantee a nice profit. I also suggest we exit positions at the close tomorrow if our stop or remaining targets are not reached. I've added a target of $11.45 which is near today's highs and the 7/14 highs. Traders may want to consider a 10 or 15 cent trailing stop to see how much more we can get out of the trade.

9/20: I am looking for NVDA to break out above the $10.80 level which should catapult the stock up towards its 100-day SMA (currently at $11.19 but declining). I want to lower the next target to $11.05 to account for the declining 100-day SMA and suggest readers take profits at this level or tighten stops to protect them.

Closed Position: Long October $10.00 CALL at $1.50, entry was at $0.72

Annotated chart:

Entry on September 8, 2010
Earnings 11/4/2010 (unconfirmed)
Average Daily Volume: 23.5 million
Listed on August 28, 2010


Freeport-McMoRan - FCX - close 84.51 change +1.52 stop 84.55

Target(s): 80.20, 79.40, 78.00
Key Support/Resistance Areas: 84.25, 76.50, 75.00
Final Gain/Loss: -64%
Time Frame: 1 week
New Positions: Closed

9/22: We were taken out of FCX today for a disappointing and bad loss. The money printing promises by the Fed sparked commodities and materials stocks yesterday afternoon and it continued today. FCX has broken through an uptrend line and prior resistance from last fall. The stock will correct at some point but I was simply too early. Hopefully, readers were on board with our other winners which takes some of the sting out of this loss.

9/21: What a day, FCX gave up all of yesterday's big advance and then some by the time noon rolled around. However, after the FOMC announcement the stock rallied hard into the close. All told, FCX traded in a 3% range today and closed down 36 cents. Traders holding long positions in FCX had a scare today and if selling picks up again we could see a sharp move lower. This is when we should consider exiting positions or tightening stops as our targets approach.

9/20: A Goldman Sachs upgrade on FCX to buy from neutral sent the stock +2% higher today. As a result, our position suffered greatly and now we need to look for an exit. This move higher in FCX can not continue but it appears any dips will most likely get bought. I've added an immediate target of $80.20, while $79.40 will fill a gap higher. FCX should make it down to these levels on a pullback and is where I suggest readers close positions or tighten stops to protect capital. This could all come at once on one big down day.

Closed Position: Long October $75.00 PUT $0.63, entry was at $1.75

Annotated Chart:

Entry on September 15, 2010
Earnings: 10/20/2010 (unconfirmed)
Average Daily Volume: 10 million
Listed on September 14, 2010

Xilinx, Inc - XLNX - close 26.02 change -0.15 stop 27.20

Target(s): 25.40, 25.00
Key Support/Resistance Areas: 26.75, 25.60, 25.20, 24.00
Final Gain/Loss: +88.2%
Time Frame: 1 to 2 weeks
New Positions: Closed

9/22: The breakdown in XLNX happened a faster than I anticipated but the stock hit our final target of $25.00 in early trading this morning. As such, the position has been closed and we'll take the +88% gain. Looking at an intraday chart for readers who still have positions, resistance begins at $25.75 but that is going to take away most of the current gains as of today's close (+60%). It appears XLNX wants to still head lower but broader market weakness needs to continue.

9/21: We are short XLNX as of the open this morning. My comments below haven't changed.

9/20: Semiconductor stocks have experienced a slew of recent downgrades and they keep coming as RBC cut its rating on XLNX to Sector Perform from Outperform. The semi's have been the worst performing sector over the past month and a broader market pullback should send the stocks in the sector back to retest their recent lows. If it weren't for the strong market today XLNX would probably have closed near our targets, but the intraday recovery is providing a second chance to enter short positions. I suggest readers initiate short positions at current levels and play for quick pullback of $0.80 to $1.20. If our targets are reached the estimated gain on the position is +50% to +75%.

Closed Position: Long October $26.00 PUT at $1.28, entry was at $0.68

Annotated Chart:

Entry on September 21, 2010
Earnings: 10/20/2010 (unconfirmed)
Average Daily Volume: 7 million
Listed on September 20, 2010