Option Investor

Daily Newsletter, Thursday, 1/27/2011

Table of Contents

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

Market Wrap

Amazon Hammered After Disappointing Earnings

by Jim Brown

Click here to email Jim Brown
Business may be good at Amazon but it was not good enough to prevent a -$16 drop in afterhours trading.

Market Statistics

The story for Thursday was one of winners and sinners with some stocks exploding higher on good earnings and the sinners imploding on weaker than expected results. It was a typical earnings day with the exception of the additional volatility caused by the markets straining to extend their gains over critical resistance levels. Investors have no confidence in the market rally and the slightest weakness in any earnings report is met with heavy selling. This is a symptom of many traders expecting a correction and maintaining a hair trigger on the sell button.

It was also a busy day for economics and the morning started off in the hole after the weekly jobless claims spiked unexpectedly by 50,000 to 454,000. This was the largest weekly jump since September 2005. Analysts were quick to blame the back-to-back snowstorms but claims have now risen in three of the last four weeks. This is a quick reminder and confirmation of what the Fed said on Wednesday about the weak job market and not yet self-sustaining recovery. Continuing claims rose by a larger +94,000 to 3.991 million. There are millions more who have already run out of benefits and are no longer carried on the government roles. The four-week moving average rose to 428,750 and the highest level since November.

The Mass Layoff report showed a continuing decline in layoff events but this is a lagging report for the December period. New layoffs fell from 148,800 in November to 137,992 in December. Manufacturing continues to be a drag with 22% of all layoffs and 26% of initial claims.

Pending home sales actually rose in December with the index at 93.7% compared to 92.2% in November. The pace of buying is increasing but rising very slowly. Since this period on the calendar is normally stagnant this is increasing optimism for the coming spring sales season. Sales have now increased in five of the last six months. Tight credit continues to plague the sector. With rates starting to inch back up we should see a strong surge in the spring as the remaining buyers try to beat the rate hikes.

The Chicago Fed National Activity Index broke into positive territory at +0.03 for December after being in negative territory for the prior four months. The housing sector continued to be a drag on the index. Despite the drag the indexes rebounded from -0.40 to +0.03. I know these small decimal numbers don't attract much interest but that was a big jump in the index.

On the flip side the Kansas Fed Manufacturing Survey headline number for January declined to 11 from 21 in December. The new orders component dropped from 16 to zero for the second consecutive monthly decline. Backorders declined from 9 to 2 and the average workweek fell from 10 to 6. This was not a good report. January slowdowns are common but this one was pretty steep.

The calendar for Friday is pretty skinny but the Q4 GDP report will be the highlight. Estimates are for +3.6% growth. A significant miss on those estimates could provide some significant market volatility since the rally is built on improving expectations.

Economic Calendar

The big news for the day was of course the barrage of earnings reports. The biggest news came after the close when Amazon failed to inspire allegiance from investors and the stock was crushed. Amazon reported earnings of 91-cents and that beat estimates of 88-cents. The problem came in the revenue at $12.95 billion compared to estimates of $13.01 billion. Remember, this was the holiday quarter when Amazon posts its best numbers. Missing estimates for that quarter when they normally greatly exceed the goals is a serious miss. That miss may not be much in terms of dollars but it is damaging to sentiment. Amazon provided guidance of $12.0-$13.3 billion in October. Their actual revenue was well inline with their forecasts but investors were still unhappy.

Amazon had a very small gross margin of 3.8% so changes in revenue are critical. Analysts were expecting margins of 4%. Unfortunately for Q1 they are only projecting operating income of $260-$350 million, which implies a margin range of 2.9% to 3.9%. Analysts were expecting a 5% margin for Q1.

Amazon has been spending on building out its distribution system and that lowers profits. They announced last year they were building 13 new distribution centers plus they acquired Diapers.com and Quidsi.com. To physically be able to ship millions of packages per day during the holiday season they have to build these monster distribution centers. You have to pay before you can pay. Obviously having these cents in operation in the future will be good for profits long term. The short term results in lower profits. Amazon has never shied away from investing for the future and long-term investors should be prepared to buy the dip. At least one analyst believes the stock could decline to $150 before it moves higher again.

Amazon shares rose +9.40 in regular trading before it was slammed for a -$16 drop in afterhours.

Amazon Chart

On the flipside NetFlix spiked +28 on earnings and news it surpassed 20 million subscribers. NetFlix reported a +52% rise in Q4 earnings on Wednesday. Earnings were 87-cents compared to estimates of 71-cents. As more people subscribe the company said it was becoming easier to obtain rights from Hollywood studios and add online content to reduce the cost of mailing DVDs. The company said it expected to end Q1 with more than 22 million subscribers and end 2011 with more than 27 million. NetFlix said it added 3.8 million subscribers in Q4 alone. NetFlix projected Q1 earnings from 90-cents to $1.13 per share compared to analyst estimates of 87-cents. Many analysts had been expecting NetFlix to begin losing subscribers and profits as more competitors emerge. Evidently there are no serious competitors large enough to dent the gains from the market leader. Shorts were crushed by the strong earnings leading to a +28 gain.

Netflix Chart

Caterpillar (CAT) reported earnings of $1.47 per share compared to estimates of $1.27. The 20-cents beat was enough to overcome some market weakness and push the stock up about a buck but nowhere near the moves of NetFlix. There was some concern because the margins shrank but analysts expect business to remain strong because miners are getting more for their ores and they can afford to spend on equipment. CAT said it was spending money on new capacity and new product development as well as considering some strategic acquisitions. Revenue for 2011 is expected to exceed $50 billion and potentially break the record set in 2008.

Microsoft earnings were released at 2:50 PM when a data-mining firm found a rough draft on the Internet and started tweeting the details. Microsoft apologized for the error and promised it would not happen again. The software giant posted earnings of 77-cents and barely over the 74-cents this time last year. The drag came from the Windows division where Windows Seven has begun to fade as a top revenue generator. The earnings were a strong beat of estimates at 68-cents and revenue also beat. The year ago quarter had a one time contribution of $2 billion in revenue from advance sales of Windows Seven. Microsoft has sold over 300 million copies of Seven and 20% of Internet connected PCs now use that operating system.

Microsoft said it had already sold 8 million units of the Kinect motion-sensor videogame device that connects to the Xbox console. That boosted revenue in the Entertainment and Devices group by 55%. Microsoft said revenue in that division would continue to grow at a 50% clip. Sales of Office 2010 are 50% ahead of Office 2007 at the same point in the launch cycle. Office 2010 is the most successful consumer version they have ever shipped. This is surprising since Sun Micro (now Apple) and Google both offer competing versions of Office type products.

Shares of Microsoft spiked when the news broke during market hours but returned to the flat line almost immediately and continued flat after hours.

Microsoft Chart

Motorola (MMI) posted gains in revenue and earnings in Q4 but the company predicted a net loss of $26 to $62 million in Q1. The company warned that Verizon's competitive actions in Q1 surrounding the iPhone launch could have a negative impact on Android phones. "We are already seeing a slowdown in sales." Apparently the impending availability of the iPhone at Verizon will take away the competitive edge the Android had with the carrier. However, AT&T in retaliation for losing their exclusivity with Apple said they would be heavily marketing the Android phones in Q1 to make up for the lost business from the iPhone. Shares of MMI dropped -12% on the news.

Motorola Chart

Murphy Oil (MUR) was the worst performing S&P stock during the regular session after the company reported earnings of 90-cents that missed the 92-cent analyst estimate. Some estimates were as high as 97-cents. The company said production fell due to lower volumes at an offshore Malaysian field where maintenance issues and bad weather slowed installation of drilling equipment. Overall production fell -15.3% year over year and that is what killed Murphy's share price. The lower production drew multiple analyst downgrades. Shares declined $7.50 or -10% on the news.

Murphy Oil Chart

The commodity sector is getting pummeled after weeks of solid gains. The price of oil declined to just over $85 after inventories began rebuilding over the last two weeks and Saudi Arabia started talking about higher oil production. Add in the sharply higher jobless claims and support began dissolving. Oil prices are in free fall now and should find support in the $83.50 range. The dollar is expected to improve over the next four weeks and that will keep pressure on crude prices.

Chart of Crude Oil

Gold suffered its biggest one-day loss in three weeks with a -2% drop to 1310. Investors feel less insecure about the situation in Europe and about the U.S. recovery so they are moving into higher risk investments like equities. The S&P traded at 1300 today for the first time since September 2008. That is drawing money off the sidelines and forcing former gold bulls to take profits. Comex gold futures traded 370,000 contracts and about 65% more than normal. Open interest in gold futures has declined -17% in the last week. Several analysts have echoed my thoughts from last week that support should be in the $1280-1282. Gartman is looking for support in the $1307 range.

Chart of Gold

The S&P is drawn to the 1300 level like a moth to a flame but we all know what happens when the moth actually meets the flame. The S&P 1300, Dow 12000 levels have been drawing investors interest for a couple weeks now and both traded over those levels today for a very short period. At the risk of sounding like a bear I would be really concerned if we did not trade over those levels on Friday. Traders can only stand just so much foreplay before they grow worried and abandon the attempt.

Earnings like Amazon's could weigh on sentiment now that the earnings cycle is about to wind down. Most of the big companies have now reported and we are heading into the second and third tier companies where earnings quality will not be as strong. Next week is normally where the post earnings depression appears.

If the S&P is successful in pushing through 1300 the next resistance level is 1310 and the 71% Fib retracement of the 2009 dip. The S&P has not had a decent bout of profit taking since early November.

S&P-500 Chart

The Dow is having the same problem with 12,000 as the S&P is having with 1300. Twice it has punched through only to be dragged back below that level before the close. The bears are doing their best to keep the pressure on. This is psychological resistance more than technical but it is still resistance. Initial support has risen to 11975 and does not leave much room for the Dow to maneuver. That means there are a lot of stop losses waiting very close to the current price. However, EVERY dip has been bought for weeks so traders will expect the next dip to be bought as well. That plan works until suddenly it doesn't.

Dow Chart

The Nasdaq, unlike the Dow and S&P, actually had a decent bout of profit taking last week. There is nothing to keep traders from buying techs except for monster single stock declines like Amazon that destroy sentiment. Futures are negative overnight as you would expect. The Nasdaq has managed to claw its way back to resistance over 2760 and buying interest is pretty strong thanks to last week's dip. I am not going to forecast a direction for the Nasdaq on Friday because it all depends on how long term investors react to the Amazon earnings and plans for the future.

Nasdaq Chart

In summary I believe the market is struggling. Yes, it is making new highs but only barely. It is over extended and needs to rest. However, we all know it can remain irrational and over extended far longer than the bears can remain solvent if that is what it wants to do. I think Friday will be a coin toss but if pressed for a direction I would expect a minor decline. The bulls are still in charge but they are facing mounting pressure from the bears that have taken up residence at 12000/1300. If we can push through those levels they will again be forced to cover and the battle will begin anew at a higher level. Eventually the remaining bears are going to be forced to capitulate and go long and that is when we need to start seriously worrying about a decline.

Jim Brown

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New Option Plays

Blame the Snow

by James Brown

Click here to email James Brown


Compass Minerals - CMP - close: 92.21 change: +2.21

Stop Loss: 87.75
Target(s): 94.75, 99.00
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: See below

Company Description
Based in the Kansas City metropolitan area, Compass Minerals is a leading producer of minerals, including salt, sulfate of potash specialty fertilizer and magnesium chloride. The company provides highway deicing salt to customers in North America and the United Kingdom and specialty fertilizer to growers worldwide. Compass Minerals also produces consumer deicing and water conditioning products, ingredients used in consumer and commercial foods, and other mineral-based products for consumer, agricultural and industrial applications. Compass Minerals also provides records management services to businesses throughout the U.K. (source: company press release or website)

Why We Like It:
Yesterday I listed CMP in my editor's note as a watch list candidate. The rally continues with shares up four days in a row. Today is significant because shares have broken out through the top of its trading range and resistance near the $90.00 level. We can probably blame the huge snow storms in the northeast for the move higher since CMP owns a highway deicing salt business.

The breakout higher is bullish and traders may want to buy calls right now. However, I'm hoping for a dip back to the $91.00 level. The newsletter is setting a trigger to buy calls at $91.00. Stop loss at $87.75. Our targets are $94.75 and $99.00.

Trigger @ 91.00

- Suggested Positions -

Buy the 2011 February $95.00 calls (CMP1119B95) current ask $1.60

- or -

Buy the 2011 March $95 calls (CMP1119C95) current ask $2.40

Annotated Chart:

Entry on January xxth at $ xx.xx
Earnings Date 02/08/11 (confirmed)
Average Daily Volume = 210 thousand
Listed on January 27th, 2010

In Play Updates and Reviews

Target Achieved

by James Brown

Click here to email James Brown

Editor's Note:

FDS hit our first target to take profits. I've updated our stop loss on FDS. Meanwhile DECK hit our trigger to buy puts.


Current Portfolio:

CALL Play Updates

Deere & Co. - DE - close: 90.99 change: +1.60

Stop Loss: 87.99
Target(s): 94.75, 99.50
Current Option Gain/Loss: Unopened
Time Frame: 2 to 3 weeks
New Positions: Yes, see trigger

01/27 update: Rival CAT issued strong earnings numbers and guidance this morning yet shares of CAT only gained +0.9%. Shares of DE fared even worse, not even testing resistance near $92.00. There is no change from my prior comments. We have a trigger to buy calls at $92.10. Keep your position size small to limit your risk! Our secondary target is $99.50 should DE manage a breakout. We do not want to hold over the mid February earnings report.
The Point & Figure chart for DE is bullish with a $100 target.

Trigger @ 92.10

- Suggested Positions -

Buy the 2011 February $95 calls (DE1119B95) current ask $0.96

Entry on January xxth at $ xx.xx
Earnings Date 02/16/11 (confirmed)
Average Daily Volume = 3.3 million
Listed on January 26th, 2010

FactSet Research Systems - FDS - close: 99.78 change: +1.29

Stop Loss: 95.75
Target(s): 99.90, 103.50
Current Option Gain/Loss: +27.5%, and +50.0%
Time Frame: 2 to 3 weeks
New Positions: see below

01/27 update: Target achieved. The rally continues for FDS and shares hit round-number, psychological resistance at the $100 level today. We had a target to take profits at $99.90. Please note I'm raising our stop loss to $95.75. I would not be surprised to see FDS hit some profit taking here. The stock should have short-term support at $98 and $96. No new positions at this time. Our final target is $103.50.

Small Positions

Long the 2011 February $95 call (FDS1119B95) Entry @ $2.90

- or -

Long the 2011 February $100 call (FDS1119B100) Entry @ $0.70

01/27 New stop loss @ 95.75
01/27 1st Target Hit @ 99.90. Feb. $95 call @ $4.25 (+46.5%)
01/27 1st Target Hit @ 99.90. Feb. $100 call @ $1.45 (+107%)


Entry on January 25th at $96.64
Earnings Date 03/16/11 (unconfirmed)
Average Daily Volume = 181 thousand
Listed on January 24th, 2010

FedEx Corp. - FDX - close: 94.36 change: +0.05

Stop Loss: 91.75
Target(s): 99.90, 104.75
Current Option Gain/Loss: -42.9%
Time Frame: 4 to 6 weeks
New Positions: see below

01/27 update: More of the same from FDX. Shares are stuck churning sideways. There is no change from my prior comments. Eventually this stock is going to move and shares are nearing the trendline of higher lows. So a rally or a breakdown should be imminent. I would be reluctant to launch new positions.

- Suggested Positions (only small positions so far) -

Buy the 2011 April $100 call (FDX1116D100) Entry @ $2.96

01/22: January options have expired (-100%)
01/13: New targets for the April calls (99.90 and 104.75)
01/12: New stop loss @ 91.75
01/08: New exit strategy for January calls. Try to exit at 40 cents or more.
12/17: FDX opens at $94.23 - our entry point.
12/16: Adjusted Entry - initiate small positions now (@ Friday's open)

Entry on December 17th at $94.23
Earnings Date 12/16/10 (confirmed)
Average Daily Volume = 2.1 million
Listed on November 29th, 2010

Research In Motion - RIMM - close: 61.98 change: -0.02

Stop Loss: 59.90
Target(s): 64.75, 67.50
Current Option Gain/Loss: -37.6%, and -27.2%
Time Frame: 4 to 6 weeks
New Positions: see below

01/27 update: Hmm... should we be concerned for RIMM? The NASDAQ outperforms today but RIMM barely moves. Volume was light for the stock today. Shares are consolidating sideways above its 50-dma. I am reluctant to open new positions here. Our final target remains $67.50.

- Suggested Positions -

Long the 2011 February $62.50 calls (RIMM1119B62.5) Entry @ $2.47

- or -

Long the 2011 March $65.00 calls (RIMM1119C65) Entry @ $2.35

01/13: New stop @ 59.90
01/13: 1st Target Hit @ 64.75. Feb. call @ $4.00 (+61.9%) Mar. call @ $3.75 (+59.5%)
01/12: New stop loss @ 58.45

Entry on January 6th at $61.00
Earnings Date 03/31/11 (unconfirmed)
Average Daily Volume = 9.9 million
Listed on January 5th, 2010

CBOE Market Volatility Index - VIX - close: 16.15 change: -0.49

Stop Loss: N/A
Target(s): 24.00, 28.00
Current Option Gain/Loss: -25.0%
Time Frame: 4 to 6 weeks
New Positions: see below

01/27 update: The market's strength is not helping our VIX trade. There is no change from my prior comments. I would still consider new positions here. You could wait for a dip closer to the 16.00-15.50 zone before launching positions.

Officially we're listing this play without a stop loss but more conservative traders may want to consider a stop loss under the recent lows near $15.30. We have two targets to take profits at 24.00 and at 28.00.

- Suggested Positions -

Long the 2011 March $22.50 calls (VIX1116C22.5) Entry @ $1.60

Entry on January 26th at $17.00
Earnings Date --/--/--
Average Daily Volume =
Listed on January 25th, 2010

PUT Play Updates

Cognizant Technology Solutions - CTSH - close: 73.17 change: -0.05

Stop Loss: 75.25
Target(s): 70.25, 68.00
Current Option Gain/Loss: -11.5%
Time Frame: exit ahead of earnings
New Positions: see below

01/27 update: I am somewhat encouraged by the lack of action in CTSH today. Tech stocks and the NASDAQ were pushing higher but CTSH just sat there and drifted sideways along the $73 level. Readers may want to wait for another failed rally in the $74-75 zone before launching new positions. Our first target is $70.25. Our secondary target is $68.00. We still want to avoid holding over earnings. That only gives us a few trading days (earnings are Feb. 7th).

- Suggested Positions (very small positions only!) -

Long the 2011 February $70.00 PUT (CTSH1119N70) Entry @ $1.30

01/24 CTSH opened at $73.13. Put option opened at $1.30 01/22 Moved from call candidate to put play.

Entry on January 24th at $73.13
Earnings Date 02/07/11 (confirmed)
Average Daily Volume = 1.8 million
Listed as a PUT on January 22nd, 2010

Decker's Outdoor Corp. - DECK - close: 76.62 change: +0.88

Stop Loss: 80.25
Target(s): 70.50, 65.50
Current Option Gain/Loss: -11.3%, and - 8.3%
Time Frame: 3 to 4 weeks
New Positions: see below

01/27 update: Our put play on DECK is now open. As expected shares bounced toward the $77 level. Shares actually hit $77.10. Our trigger to buy puts was at the $77.00 mark. DECK should have resistance at the 50-dma and the $78-80 zone.

Our targets are $70.50 and $65.50. The Point & Figure chart for DECK is bearish with a $65 target.

- Suggested Positions -

Long the 2011 February $75.00 PUTS (DECK1119N75) Entry @ $2.65

- or -

Long the 2011 March $75.00 PUTS (DECK1119O75) Entry @ $4.80

01/27 DECK hit our trigger to buy puts at $77.00


Entry on January 27th at $77.00
Earnings Date 02/24/11 (unconfirmed)
Average Daily Volume = 1.5 million
Listed on January 20th, 2010

Google Inc. - GOOG - close: 616.79 change: + 0.29

Stop Loss: n/a
Target(s): n/a
Current Option Gain/Loss: see below
Time Frame: 1 month
New Positions: No

THIS IS A STRANGLE TRADE (not a simple put play)

01/27 update: Thursday was a very quiet day for GOOG. This lack of movement is killing our aggressive bet on GOOG. There is no change from my prior comments.

We're not interested in the day to day churn in GOOG. What we want to see is this stock pick a direction and run with it. Right now GOOG news to either breakout past $640 or breakdown under $600. I'm not suggesting new strangle positions at this time.

We will keep the February strangle position for a few more days and re-evaluate our exit strategy.

STRANGLE TRADE: Buy an out of the money CALL and PUT

STRANGLE #2 (February) initial cost $15.10, currently: $2.50 (-83.4%)

2011 February $680 call (GOOG1119B680) Entry @ $6.20

- AND -

2011 February $580 put (GOOG1122N580) Entry @ $8.90

01/22: Exit the January strangle at the open.

Entry on January 20th at $626.77
Earnings Date 01/20/11 (unconfirmed)
Average Daily Volume = 3.4 million
Listed on January 19th, 2010

iShares Russell 2000 Index - IWM - close: 79.35 change: +0.23

Stop Loss: 80.80
Target(s): 75.00
Current Option Gain/Loss: -47.8%
Time Frame: 1 to 2 weeks
New Positions: see below

01/27 update: The IWM is still bouncing. The recent action has been bullish but there should still be resistance at the $80.00 level. Readers may want to wait for the IWM to fail near $80 before initiating new bearish positions.

Small Position only

Long the 2011 February $77 puts (IWM1119N77) Entry @ $1.65

Entry on January 20th at $78.14
Earnings Date --/--/--
Average Daily Volume = 38 million
Listed on January 19th, 2010

Monsanto Co. - MON - close: 73.68 change: +0.14

Stop Loss: 75.51
Target(s): 69.00, 66.00
Current Option Gain/Loss: -24.0%, and -10.2%
Time Frame: 3 to 4 weeks
New Positions: see below

01/27 update: MON saw a couple of spikes toward the $74.50 level but it looks like the bounce could be losing momentum. I would still consider new bearish positions here with our stop loss at $75.51. Our targets are $69.00 and $66.00.

- Suggested Positions -

Long the 2011 February $70 PUT (FDS1119N70) Entry @ $1.00

- or -

Long the 2011 March $70 PUT (FDS1119O70) Entry @ $1.85

Entry on January 26th at $73.00
Earnings Date 03/31/11 (unconfirmed)
Average Daily Volume = 6.2 million
Listed on January 24th, 2010

Panera Bread Co. - PNRA - close: 97.14 change: +1.04

Stop Loss: 100.55
Target(s): 95.15, 91.00
Current Option Gain/Loss: + 5.2%
Time Frame: 3 weeks
New Positions: see below

01/27 update: PNRA is trying to bounce from support at the 100-dma but the rally failed under the $98 level today. I am not suggesting new positions at this time. Our first target to take profits is at $95.15. Our second target is $91.00.

- Suggested Positions - (small positions)

Long the 2011 February $95 PUTS (PNRA1119N95) Entry @ $2.85

01/26 New stop loss @ 100.55, target adjusted from 95.50 to 95.15

Entry on January 24th at $97.96
Earnings Date 02/10/11 (unconfirmed)
Average Daily Volume = 364 thousand
Listed on January 22nd, 2010