Option Investor

Daily Newsletter, Wednesday, 10/13/2010

Table of Contents

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

Market Wrap

Another Day, Another Rally

by James Brown

Click here to email James Brown

Market Stats

Bulls continue to stampede the market higher with the S&P 500 posting its fourth gain in a row. The rally was fueled by strong earnings results from Intel (INTC) and J.P.Morgan Chase (JPM) yet these big caps failed to advance individually following their reports. Railroad giant CSX added strength to the transports with a bullish earnings report and a +4.2% rally on Wednesday. The mood was bullish overseas too as stocks reacted to the FOMC minutes released yesterday, which reassured the market that the Fed was planning another round of quantitative easing (QE for short). Some are even calling this market rally a little QE euphoria (i.e. exaggerated feelings of elation and well being). After a +13% rally off the August lows you could say the S&P 500's move it looking a little exaggerated.

Weakness in the U.S. dollar continues to power strength in commodities. It's the same story we've been reporting on for weeks now. The dollar sank toward its eight-month lows and metals rallied toward new highs. Gold appears to be steamrolling higher toward the $1,400 level as gold futures gained $23.80 (+1.8%) to close at $1,370.50 an ounce. Gold hit an intraday high of $1,375. Silver added +3.6% to close at $23.98, a new 30-year high. Copper prices rose +0.8% at another new 27-month high. Meanwhile crude oil bounced with a +1.6% gain to close at $82.99 a barrel. News that China's crude oil imports hit a new record high in September helped fuel the gain. Plus the IEA and the U.S. Energy Department both raised their forecast for oil due to rising demand. The Energy Department now expects oil will rise, on average, by $1.00 to $83 a barrel in 2011. After the closing bell tonight the API oil inventory report came out and the results were bullish. The American Petroleum Institute said U.S. inventories fell by four million barrels when they were actually expecting a buildup of 1.5 million barrels. The API report tends to vary significantly from the EIA report, which is due out tomorrow morning.

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

Chart of the GLD gold ETF:

Chart of the SLV silver ETF:

Sooner or later this trend in the dollar and commodities will reverse, or at least correct, and the profit taking in commodities could be very ugly. However, with the future facing a significant QE program from the Fed the long-term weakness in the dollar should promote a long-term bullish trend for commodities.

Bonds were weaker this morning after setting new relative highs just a couple of days ago. Investors bought the dip in bonds midday and the bond market pared its losses thanks to news that the Fed was going to spend $32 billion over the next month buying bonds as it continues to reinvest any sales from their mortgage-backed debt portfolio. Speaking of mortgages the Mortgage Bankers Association reported that their index of mortgage applications rose for the first time in six weeks after mortgage rates fell to another new record low. Total applications for a mortgage rose +15% led by a +21% jump in refinancing applications.

The rally in stocks was very widespread with gains in both Asia and Europe. News that business confidence in China improved helped fuel investor sentiment. China also said that automakers shipped +19% more passenger cars to dealers in September than a year ago (no wonder their oil consumption is surging). The Chinese Shanghai index rose +0.7% while the Hong Kong Hang Seng rallied +1.45% to close at a new 28-month high. In Japan the NIKKEI index bounced following Tuesday's sharp -2.1% decline. Early morning gains in Japan were fading as investors worry about the impact of a strong yen, near 15-year highs against the dollar, will have on corporate earnings. On a more positive note Japan saw core machinery orders rise +10.1% in August. The NIKKEI index rose +0.16% on Wednesday. Elsewhere in the region Australia said consumer confidence improved. Meanwhile India's stock market surged +2.4% toward its recent 52-week highs.

Gains were a lot stronger in Europe as investors reacted to the FOMC minutes from yesterday, which suggested the Fed is pretty close to enacting another round of QE soon. The rally was led by commodity-related stocks thanks again to dollar weakness. The German DAX index gained +2% to close at new two-year highs. The French CAC-40 rose +2.1% and the English FTSE rallied +1.5%.

Wednesday turned out to be a relatively light news day. Earnings from Intel yesterday and JPM this morning topped headlines. There were a lot of expectations for JPM, the country's second-biggest bank by assets, and investors were hoping for some insight into the banking sector that has been lagging the market's widespread rally. Wall Street was expecting a profit of 89 cents a share (most estimates were in the 88-90 range) on revenues of $24.64 billion. JPM delivered a profit of $1.01 on revenues of $24.34 billion. The net profit improvement appeared to be fueled by a release of loan loss reserves. Jamie Dimon, JPM's CEO, said home equity charge-offs remain high but they were slowly improving. The company's credit card charge-offs were also improving. It appears that JPM is expecting an increase in litigation as the company set aside an additional $1.3 billion in litigation reserves. Mr. Dimon was generally upbeat that the environment was improving but warned that if economic conditions worsen it will naturally have a negative impact on their mortgage portfolio. Shares of JPM gapped open this morning but the rally failed at its descending 200-dma and shares ended the session off -1.3% to close just under $40 a share.

After hours tonight the big earnings headline was educator Apollo Group (APOL). The company delivered a profit of $1.31 a share on revenues of $1.26 billion. This was a penny better than expected with revenues matching estimates. Unfortunately enrollments last quarter were lower than expected. Management warned that the drop in enrollments would likely continue and the company withdrew their prior fiscal year 2011 guidance due to growing concerns over regulatory changes in their industry. The stock has put in a bearish double top with failed rallies under the $54 level a few weeks ago. Shares closed the normal session down -0.9% at $49.50 but they're now trading near $42.20 in after hours.

Apple Inc. (AAPL) was making headlines again. The stock rallied to new all-time highs and closed over $300 a share. The stock is up +275% from its early 2009 lows near $80. The company said they will hold a "Mac Event" next Wednesday to unveil their new Mac operating system. Better than expected iPad sales also helped buoy the stock. The Wall Street Journal helped fuel expectations that AAPL would soon launch an iPhone model designed for Verizon's network. Thus far the iPhone has been exclusively on the AT&T network here in the U.S. The thought process is that every person who buys an iPhone or an iPad is much more likely to buy one of AAPL's higher-margin Mac computers. One of these days AAPL is going to announce another stock split. The company last split its stock 2-for-1 in February 2005 when shares were trading near $90. AAPL is due to report earnings on October 18th.

The world's largest retailer was making headlines as Wal-Mart (WMT) held an investor conference today. The company's CEO Mike Duke offered an optimistic outlook for their Q4 U.S. sales without offering any specifics. Sales have actually been declining for WMT as consumers cut back. Of course WMT faces pretty easy comparisons to last year where the company saw -2% same store sales growth in the fourth quarter. The company doesn't report earnings until mid November.

Another stock making headlines this morning was St. Joe Co.'s (JOE), which saw its share price plummet -10% on volume 19 times the norm. The sell-off was sparked by negative comments from hedge-fund manager David Einhorn, who is famous for his bearish calls on Lehman Brothers ahead of the meltdown in 2008. Einhorn believes that JOE will be unable to recover from the collapse in Florida's real estate market and the one-two punch caused by the Gulf of Mexico oil spill. It is worth noting that prior to today's decline the most recent data listed short interest in JOE at more than 41% of the 92-million share float.

Looking ahead the market is going to be moving on earnings news and economic data. Google (GOOG) will top the earnings headlines for Thursday while General Electric (GE) will be the major earnings report on Friday. Traders will also digest several economic reports. On Thursday we'll see the Producer Price Index (PPI), the U.S. trade balance numbers, and the initial and continuing jobless claims. Friday will bring the Consumer Price Index (CPI), the New York Empire State manufacturing survey, the latest retail sales numbers, and consumer sentiment.

The trading action in the market is still very bullish as most of the major averages just powered past another level of resistance. Looking at these charts it is easy to see the QE euphoria. We could be witnessing scared fund managers chasing stocks higher ahead of their fiscal yearend on October 31st. The S&P 500 just broke out over potential resistance near 1173 and its mid-May highs. This index is very overbought with a +13% rally in the last several weeks. In a "normal" market I would look for a pull back to the 38.2% Fibonacci retracement, which at this point has risen toward the 1130 level. Yet we may not be in a normal market until we get past the elections. Broken resistance near 1150 should now be new support. The next level of significant resistance is the 1200-1220 zone. I would hesitate to launch new positions with the index this overbought.

Do you remember all the hype about the "death cross" back in June when it looked like the S&P 500's simple 50-dma was going to cross under the simple 200-dma. We did see the "death cross" and it is normally considered to be a very bearish event suggesting a longer-term decline. In just a few days the S&P 500 should create a "golden cross" when the 50-dma crosses up and over its 200-dma. The golden cross is the opposite of the death cross and should forecast a longer-term bullish trend. We'll have to wait and see. This sort of technical signal can offer some great insight into the market's general trend but like all signals they don't work 100% of the time.

Chart of the S&P 500 index:

The NASDAQ composite leaped higher this morning and confirmed the breakout over resistance near 2400. However, this index appears to have resistance about every 50 points and the rally stalled at 2450. Currently the NASDAQ is up more than +16% from its late August lows and way overdue for some profit taking. If you like to watch the Fibonacci levels then a normal pull back to the 38.2% Fib retracement level would be 2320 but odds are pretty good that the NASDAQ will find some support near 2350 on any significant dip. What I find more interesting is the NASDAQ-100 index (NDX). The NDX is the top 100 companies in the NASDAQ and these big caps have been screaming higher. Yet it's worth noting that the NDX just tested major resistance near 2050-2060. A breakout here would be very bullish but I would expect some sort of sideways consolidation or pull back first.

Chart of the NASDAQ index:

Chart of the NASDAQ-100 (NDX) index:

The small cap Russell 2000 index (RUT) continues its march higher and closed over potential round-number resistance at the 700 level today. The RUT is up nearly +20% from its late August lows. The rally has been pretty consistent save for a couple of two or three days pullbacks. My opinion is the same. The trend is up and the relative strength in the small caps is very encouraging but I wouldn't want to chase it here. On a short-term basis I would be looking for support in the 680-670 zone. The next level of overhead resistance is 720.

Chart of the Russell 2000 index:

Once we get past this week the headlines will be overflowing with earnings news. We're facing a virtual flood of announcements next week. Currently analysts are estimating that the S&P 500 will see +23-to-24% earnings growth compared to a year ago but revenues will only improve +7%. According to Bloomberg the S&P 500 has consistently seen more than 70% of its components beat estimates for the past five quarters in a row, which happens to be a 17-year record. Normally, given the big gains already built into the market, I would expect profit taking on any sort of earnings news. Yet the mood of the market seems to be ignoring any bearish headlines. Thus the overall trend is up but individual stocks will still suffer if they warn (e.g. like APOL tonight).

I don't know about you but I'm getting a feeling of deja vu with the current market action and the rally from February to April last spring. Eventually this rally will correct. Unless you are a very nimble trader, I would wait for a better entry point than chasing stocks higher.


New Option Plays

Lumber Plays

by Scott Hawes

Click here to email Scott Hawes
Editor's Note:
We do not have new plays to release tonight but have provided some ideas below. James will be filling in for me the remainder of the week and weekend.

Trade Idea:
Take a look at stocks in the lumber industry. After a pullback in recent weeks, lumber futures have been exploding over the past few days and the lumber stocks are starting to break out. Companies in the sector include PCL, LPX, WY, RYN, PCH, and DEL to name a few.

In Play Updates and Reviews

Big Winner Closed

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:
Good evening. I have brief updates for you tonight which are listed below the updated model portfolio snapshot below. All of my comments remain valid from yesterday so please refer to those updates for more details.

We used the strength in V today to close the position for a +98% gain. All of our short positions suffered setbacks (except PNC) and I would use the strength as opportunities to consider opening new positions. Our stops are just overhead if there happens to not be a correction.

Today's breakout higher has exhaustion written all over it. I caution readers to keep bullish positions on a tight leash, while still remaining nimble on bearish positions. Trailing stops on both side of the market is probably the right move as I expect volatility to really pick up steam in the coming days/weeks. Finally, James will be filling in for me the remainder of the week and weekend. I look forward to catching up with you all on Monday.

Current Portfolio:

CALL Play Updates

GNK - The stock is consolidating near multi-week highs. I anticipate dips getting bought.

TC - The stock gapped higher but drifted lower the entire day. TC could head lower to fill today's gap prior to moving higher.

PUT Play Updates

ATK - The stock remains below its 200-day SMA while the bearish head and shoulders formation still remains. Now we need follow through lower.

ISLN - What can I say? ISLN is defying gravity and gained more than +3% today. We chose deep out of the money puts to limit losses for this very reason. If a correction gets going in earnest I think our targets will be reached which should limit the damages.

NTAP - We are long puts at $1.90 as of today's open. This play was released based on the overbought market conditions and a bearish head and shoulders pattern on its daily and hourly chart. I still like new positions and would consider them at current levels.

PNC - The stock continues to trade terrible and lost 3 cents today while the broader market surged higher. If we get a correction in the coming days our targets should easily be reached. I suggest using those to exit positions or tighten stops to protect profits/capital. $50.35 and $49.50 are the primary targets.

WFMI - I obviously didn't think WFMI would retrace this much of its losses but a reversal from here is easily in the cards. The stock is near its primary downtrend line and volume was much lower than recent distribution days. If we get a correction WFMI should fall hard. Considering today's rip our puts have only lost 22% so trying new positions at these levels makes a lot of sense to me.


Visa, Inc. - V - close 74.25 change -0.04 stop 67.40

Target(s): 74.90 (hit), 76.90 (hit), 79.40
Key Support/Resistance Areas: 79.80, 77.50, 75.00, 72.50, 70.50, 68.00
Final Gain/Loss: +97.9%
Time Frame: 3 to 5 weeks
New Positions: Yes

10/13: V surged higher with the market today and we used the opportunity to exit positions into the strength, per last night's updates. Our target of $76.90 was hit and we have booked a much needed +98% gain. I suggest readers protect profits up here, especially considering the overbought conditions.

10/12: I was somewhat disappointed in V's performance today as the stock closed flat on the day, while other financial stocks fared better. V is consolidating above its 100-day SMA. The stock has support at $72.50 which is also near its rising 20-day SMA. A move to our first target should produce a +30% to +40% gain, while a move to our 2nd target should produce a +80% to +90% gain. These are the primary targets and I suggest using moves into these areas as opportunities to exit positions or tighten stops.

10/9: V traded right down to our entry Friday morning and bounced. We are long November $75 calls at $1.92. I do not see V trading much lower than its rising 20-day SMA which is currently $71.55 and increasing about 30 cents per day. This puts the 20-day SMA in the $72.50 to $73.00 range later this week. Any pullback to this area will provide another good entry point. The stock also has support at $72.50 if there is bigger pullback earlier in the week. I like V to go higher as they have worked through the issues that caused the stock to sell-off over the past few months. Even a small move up to out 1st target should produce a +40% gain, while a move to our 2nd target should produce a +85% gain. I plan to tighten the stop in the coming days.

Closed Position: Long November $75.00 CALL at $3.80, entry was at $1.92

Annotated Chart:

Entry on October 7, 2010
Earnings 10/27/2010 (unconfirmed)
Average Daily Volume: 6.8 million
Listed on October 4, 2010