Option Investor

Daily Newsletter, Thursday, 7/7/2011

Table of Contents

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

Market Wrap

Nasdaq Eight In A Row

by Jim Brown

Click here to email Jim Brown
A better than expected jobs number from ADP caused yet another gap higher and the markets ended very close to new highs. The bulls are back with the Nasdaq posting an impressive string of eight consecutive gains.

Market Statistics

The economic report powering the market to another big gain was the ADP Employment report for June. The ADP report was expected to show a gain of 60,000 jobs after posting a +38,000 job gain in May. The ADP number for June came in showing a very surprising gain of 157,000 new jobs. This suggests the Non-Farm Payrolls could be substantially higher. The ADP estimates have been consistently lower than non-farm estimates for months by an average of 40,000 jobs a month. This suggests the non-farm numbers on Friday could be as high as 200,000 jobs. That would be a very surprising turn of events for those who were expecting a possible decline to less than 50,000 jobs.

The sudden improvement in the ADP report does NOT mean the non-farm payrolls are going to automatically be significantly higher. After the ADP news the analysts were quick to upgrade estimates from the official consensus of +88,000 to the 110,000-125,000 range. Deutsche Bank raised their estimate to 175,000 jobs. Hopefully this won't end up being a head fake and the non-farm number being a real disappointment. Remember, the non-farm number includes government workers and those have been declining rapidly as stimulus programs end.

One clue for me that the non-farm data could be disappointing is the weekly Jobless Claims. The claims declined to a seven week low at 418,000 but last week's numbers were revised higher from 428,000 to 432,000 and an eight week high. So which is the real trend? The difference between the high and low over the last seven weeks has been 14,000 claims and that would pretty well indicate there is no improvement in hiring and we employment has flat lined. However, those on extended benefits or whose benefits expired could be taking jobs and that would not show up in the weekly numbers.

Jobless Claims Chart

Another factor producing bullish market sentiment was the spike in retail sales for June. Sales rose +6.9% compared to a +5.4% rate in May. If you remove fuel sales the number was still a strong +5.5% increase. After removing the seasonal factors like the late Easter this was the best June since 1999. What happened to our soft patch?

Total chain store sales increased +8.8% including both new and existing stores. This is a phenomenal spike in sales and most of it came before the sharp drop in gasoline prices after the IEA announcement. With gas prices still declining and the stock market in rally mode it should cause consumer sentiment to improve even further. Hot weather in June was also a positive input because it caused consumers to shop for seasonal items. Retailers were also discounting heavily after the soft patch dip in May. Discount stores were especially strong with Costco sales rising +14% overall.

S&P Retail Index Chart

The economic calendar for Friday is headlined by the Non-Farm Payrolls, Wholesale Trade and Consumer Credit.

Economic Calendar

The positive ADP report also helped push crude prices through the roof. Growth in jobs equals growth in oil demand. It helped to have Goldman, Barclay's and Morgan Stanley all reiterating their views for much higher prices later this year and in 2012. Goldman said, "In our view, it is only a matter of time before inventories and OPEC spare capacity become effectively exhausted, requiring higher oil prices to restrain demand, keeping it in line with available supply." Brent crude, the actual price of crude on the world markets spiked +4.83 to $118.45 and punching through resistance at $115. U.S. WTI crude rallied less with only a +1.84 gain due to the technical problems with an abundance of crude inside the USA.

Also pushing the prices higher was a realization the IEA was not actually releasing much oil in Europe and instead only reducing the inventory requirements of member countries. Secondly much of the oil scheduled for release in Europe was actually refined products and not oil and those products are plentiful. Investors need to realize this was a political move not necessarily a needed move.

All three banks believe the global economy will accelerate in the second half and demand will spike accordingly. Goldman expects the S&P GSCI Commodity Index to rally +20% over the next twelve months. Goldman expects Brent crude to average $130 a barrel over the next twelve months. Morgan Stanley believes it will average $120 for the last half of 2011 and then rise to $130 in 2012.

Brent Crude Oil Chart

U.S. WTI Crude Oil Chart

Helped by a drop in the dollar and rate hikes in Europe and China the precious metals were also in rally mode. The rate hike in Europe and China and the potential for more in the future highlighted the rising inflation in those countries. As the global economy accelerates later this year that inflation could also rise making precious metals desirable as inflation hedges. Economic acceleration will also increase demand for the metals for use in technology products. Barclay's reiterated their bullish outlook and said they anticipate a retest of the $1558 highs.

Here is an interesting article from the Silver Institue on the future is industrial demand. It makes a good case why silver is going back to $50 and beyond. Silver Demand

Here is another article from Standard Charter Bank on why gold is going to $5,000 an ounce by 2015. In Gold We Trust

Gold Chart

Silver Chart

This was a quiet day for stock news but Lumber Liquidators (LL) shareholders were screaming in pain. LL was apparently selling into a completely different consumer marketplace in Q2 than those chains I reported on earlier. LL said an unexpected softening of demand hurt Q2 earnings and forced it to lower full year guidance and revenue forecasts. Same store sales declined -8%. The company said, "Value conscious consumers became more price sensitive and cautious in their discretionary spending." The company is now expecting earnings of 18-20 cents compared to analyst estimates of 32-cents. The company operates 250 stores in North America and plans to open up to 44 in 2011. LL shares dropped -29%.

Lumber Liquidators Chart

News Corp (NWS) was in the news about every 15 minutes after the company said it was shutting down its tabloid "News of the World" publication due to the increased revelations related to the hacking attacks several years ago. News Corp announced it was closing the publication due to the obviously illegal activities to gather news details that had been condoned in the past. James Murdoch issued the death notice saying, "The News of the World is in the business of holding others to account but it failed when it came to itself." Sunday's edition will be the last one and will not have any advertising. People working for the publication either hacked into voicemails or contracted with others to hack the numbers and supply the information. Reportedly five people are going to be arrested this weekend for their role in the pattern of illegal activity that has existed for years.

News Corp Chart

The market has been on an amazing buying binge for the last two weeks and to say it was over extended would be an understatement. Take the IBM chart below. Wells Fargo downgraded IBM today to a hold (market perform) saying near term upside is limited. IBM only gave back a dollar but the downgrade could be the start of a new trend.

IBM Chart

Amazon Chart

We have seen such big gains from the major stocks that further downgrades are pretty much guaranteed. For instance since June 17th BIDU is up +24%, FFIV +22%, WYNN +22%, NFLX +20%, BBBY +16%, WFMI +16%, etc. What are the odds of those stocks receiving downgrades in the next couple weeks especially when the earnings cycle may not be exciting. With negative guidance running 2.5 to 1 over positive guidance the recent gains may be at risk.

The 10-day moving average of the Advance/Decline line is at the high end of its historical range. S&P tells us more than 75% of the S&P is over its 50-day average. The market is definitely over extended.

However, the Dow Transports set a new record high on expectations the long awaited recovery will accelerate in the second half.

Dow Transport Chart

I am afraid the rally is built on hope for a rally rather than any real fundamentals. The speed at which markets can go from very oversold to overbought is always surprising. The ability of overbought markets to continue going higher is also a constant source of surprise or should I say dismay.

The first 2-3 days are sharp reversals and while everyone is pleased to see them they rarely want to buy into them. The shorts continue to launch new positions only to be forced to cover almost immediately. The funds chase the markets higher because they can't afford to miss a move. Meanwhile the retail investor is waiting on the sideline with increasing impatience for a pullback so they can join the party. For many that pullback never comes and they eventually capitulate and buy the top only to find out they were the last buyers.

I fear that is where we are today except these markets are right on the verge of breaking out to new multi year highs. Nothing makes traders throw caution to the wind more than new highs. That is why buying breakouts is such a popular strategy. Everyone believes everyone else knows something they don't and they don't want to miss out on the next leg higher. Many times that leg arrives and many times the investor optimism that got us to this level evaporates at the first sign of trouble.

I am not sure the Non-Farm Payrolls on Friday could have a bad number. If it is good the reluctant buyers on the sidelines will throw in the towel and jump on the bus. If the number is bad those same traders may rationalize it as a lagging number where a good dose of ugly has already been priced in.

When you look at the S&P chart the actual level achieved is bullish and it is rapidly closing on the May highs. However, the speed of the rebound that started on the 27th is very unnerving. The minor pause this week ahead of the ADP numbers was barely a pause and more like a stutter step. It was definitely not profit taking.

The debt limit ceiling is now taking center stage. The Non-Farm Payrolls will be the last economic number this week and the debt limit will be the only news next week. When the president is doing impromptu press conferences every 48 hours and opposing congressional leaders are trading daily points in the press there is no way to avoid the event taking control of our future.

A Merrill Lynch analyst said today a deal on the debt limit was worth 100 points on the S&P and those expectations are currently being factored into the gains. No deal and apparent battle right up to the August 2nd date could take us down -100 points. I don't believe we could drop 100 points but that was his expectation. I personally don't believe they will go to the drop dead date based on the increasing urgency to get it done. The point here is the market pricing in a strong jobs number and a debt limit deal. There could be a monster sell the news event if the conditions for the deal are ugly.

The S&P broke over resistance at 1340 to close at 1353. The high close in May was 1363 so the S&P is only 10 points away from a new multiyear closing high. As long as the bad news bulls remain in control and shorts are still trying to short the market we are likely to move higher. Support is well below at 1320 so plenty of room for profit taking.

S&P Chart

The Dow is a carbon copy of the S&P with a close less than 100 points from the May high close at 12,810. That remains the target regardless of what happens on Friday.

When the indexes get this close to prior highs those old highs become a self-fulfilling target. Bears tend to ease up on the shorts until those old resistance highs are hit so they can load up again. Unless the Non-Farm numbers are really bad I can't imagine we won't take at least an intraday run at the highs. There is a sell the news event in our future but until it happens we won't know which event it is.

Dow Chart

The Nasdaq traded at a new 10-year high intraday but could not close there. The high close from May was 2873.54 and the Nasdaq traded up to 2879 before losing traction at the close. With the payrolls due out before the market opens any reasonable trader would have been taking profits at the close. The Nasdaq is up 265 points (10.1%) since June 27th and it has shown no weakness with eight consecutive days of gains. Obviously there will be some profit taking in our near future. Just how near is what keeps the shorts up at night.

Nasdaq Chart

There is nothing to really summarize tonight. The targets are locked in and without a really crummy jobs report they should be tested on Friday. If the report is very good we could easily make new highs. This is the kind of market I thoroughly dislike. We can spend days waiting for a dip to buy that never appears and once we capitulate and jump in that is the signal for the beginning of a new correction. Let your conscience be your guide.

I apologize for the lateness of the newsletter tonight. We had some really bad weather in Denver this evening that knocked out power and flooded much of the city. Tough to write without power. Sometimes we are reminded we are at the mercy of the elements.

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Jim Brown

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New Option Plays

Will It Be An Excuse?

by James Brown

Click here to email James Brown

Editor's Note:

The U.S. stock market is up big time in the last two weeks. Will the June non-farm payroll data (jobs report) become an excuse to sell and take profits or will it add fuel to the fire and lift the market even higher?

Today's ADP report showed a gain of +157,000 jobs versus estimates for +70,000. Tomorrow economists are expecting the government's job data to show +105,000 in June versus +54,000 in May with the unemployment rate unchanged at 9.1%. This month it seems that estimates for the job report tomorrow are all over the map so it's hard to tell how investors might react.

I am not adding any new candidates tonight. Stocks are short-term overbought and need to correct but we all know the market can always grow more overbought. We'll wait and see how the market reacts to the economic data tomorrow and then add new candidates this weekend.

- James

In Play Updates and Reviews

TIF Hits Our Target

by James Brown

Click here to email James Brown

Editor's Note:

Nearly two dozen retailers reported June same-store sales and most of them were better than expected. The sector strength lifted TIF to our final exit target.


Current Portfolio:

CALL Play Updates

Caterpillar - CAT - close: 111.63 change: +1.55

Stop Loss: 102.25
Target(s): 112.00
Current Option Gain/Loss: Unopened
Time Frame: Until the earnings report
New Positions: Yes, see trigger

07/07 update: Cyclical stocks were popular targets for the bulls today. CAT actually gapped open higher and rallied to $112.65 intraday. Shares settled with a +1.4% gain. The stock is now up +17.5% from its mid June low near $95.00. We really don't want to chase a move like that. However, we might want to adjust our buy-the-dip trigger soon. At the moment I am leaving our trigger at $105.50. After we see how the market reacts to the jobs data tomorrow we'll re-evaluate our trigger placement.

Trigger @ 105.50

- Suggested Positions -

Buy the Aug. $110 call (CAT11H110)

Entry on July xx at $ xx.xx
Earnings Date 07/22/11 (unconfirmed)
Average Daily Volume = 8.4 million
Listed on July 2, 2011

Cerner Corp. - CERN - close: 64.29 change: +0.63

Stop Loss: 60.90
Target(s): 64.75
Current Option Gain/Loss: +150.0% & +87.5%
Time Frame: 3 to 6 weeks
New Positions: see below

07/07 update: CERN has almost hit our target. Shares added another +0.9% with its eighth gain in a row. Our risk right now is that the jobs report really disappoints and the market sinks and CERN gaps open lower tomorrow. Cautious traders may want to plan on an early exit at the open on Friday no matter what the news is.

Currently our exit target is $64.75. However, we will exit our July calls tomorrow (Friday) at the closing bell assuming shares have not yet hit target. If you have August options you can hang on and aim higher but CERN is overbought and due for a correction.

Please note our new stop loss at $60.90.

Earlier Comments:
We do not want to hold over the late July earnings report.

- Suggested (small) Positions -

Long July $60 call (CERN1116G60) Entry @ $1.60

- or -

Long Aug. $62.50 call (CERN1120H62.5) Entry @ $1.60

07/07 new stop loss @ 60.90
07/07 plan on exiting July calls on Friday at the close.
07/02 New stop loss @ 58.75
07/02 Cautious traders may want to exit the July calls now for a gain

Entry on June 29 at $60.76
Earnings Date 07/28/11 (unconfirmed)
Average Daily Volume = 624 thousand
Listed on June 28, 2011

Joy Global - JOYG - close: 98.91 change: +2.19

Stop Loss: 89.90
Target(s): 99.50
Current Option Gain/Loss: Unopened
Time Frame: 3 to 6 weeks
New Positions: Yes, see trigger

07/07 update: Cyclical and resource names were strong performers on Thursday. JOYG rallied +2.2%. JOYG is now up almost +20% from its lows just three weeks ago. We do not want to chase this move especially with JOYG nearing resistance at $100. I am leaving our buy-the-dip trigger unchanged at $92.75 but we'll reconsider adjusting after we see the market reaction to the jobs report tomorrow.

Trigger @ $92.75 (Small Positions)

- Suggested Positions - Buy the Aug $95 call (JOYG1120H95)

Entry on June xx at $ xx.xx
Earnings Date 08/31/11 (unconfirmed)
Average Daily Volume = 1.9 million
Listed on June 30, 2011

Norfolk Southern - NSC - close: 76.99 change: +0.56

Stop Loss: 71.75
Target(s): 79.75
Current Option Gain/Loss: Unopened
Time Frame: up until its earnings report.
New Positions: Yes, see trigger

07/07 update: The Dow Jones Transportation index rallied to another new all-time high. Railroad stocks did not contribute much today. NSC managed a +0.7% gain. Currently we have a buy-the-dip trigger at $74.50 with a stop at $71.75. Our target is $79.75 but we do not want to hold over the late July earnings report.

Trigger @ $74.50

- Suggested Positions -

Buy the Aug. $75 call (NSC11H75)

07/06 adjusted entry trigger to $74.50 and stop to 71.75

Entry on July xx at $ xx.xx
Earnings Date 07/27/11 (unconfirmed)
Average Daily Volume = 2.3 million
Listed on July 2, 2011

Sociedad Quimica Minera de Chile - SQM - close: 65.80 change: -0.17

Stop Loss: 59.75
Target(s): 67.25, 69.75
Current Option Gain/Loss: Unopened
Time Frame: 4 to 6 weeks
New Positions: Yes, see Trigger

07/07 update: It looks like the rally in SQM could be running out of steam. The early morning spike reversed. We are expecting a pull back to jump on board the larger up trend.

We want to launch bullish positions on a dip at $63.00 with a stop loss at $59.75. If triggered our upside targets are $67.25 and $69.75. Traders could certainly aim higher but we don't want to hold over the late August earnings.

NOTE: There is always a little extra risk trading a foreign company's stock since the stock will tend to jump around based on trading back in its home country. Readers may want to keep their position size small.

Trigger @ 63.00

- Suggested Positions - These will obviously be cheaper when SQM dips to $63.

buy the Aug. $65 call (SQM1120H65)

- or -

buy the Oct. $70 call (SQM1122J70)

Entry on July xx at $ xx.xx
Earnings Date 08/30/11 (unconfirmed)
Average Daily Volume = 558 thousand
Listed on July 6, 2011

Teradata Corp. - TDC - close: 62.33 change: +0.70

Stop Loss: 54.90
Target(s): 62.00, 64.50
Current Option Gain/Loss: Unopened
Time Frame: 4 to 6 weeks
New Positions: Yes, see trigger

07/07 update: TDC is up four weeks in a row. The stock looks very over extended here. We'll reconsider adjusting our entry point after we see the market's performance following the jobs data. I am suggesting bullish positions on a dip to $58.50.

Trigger @ $58.50

- Suggested Positions -

buy the Aug. $60 call (TDC1120H60)

07/05 new trigger @ 58.50, new targets 62.00 and 64.50
07/02 New trigger @ 57.55, new stop @ 54.90, new targets @ 61.00 & 64.00

Entry on June xx at $ xx.xx
Earnings Date 08/04/11 (unconfirmed)
Average Daily Volume = 1.8 million
Listed on June 25, 2011

Toyota Motor Corp. - TM - close: 84.64 change: +0.37

Stop Loss: 79.40
Target(s): 85.75, 89.50
Current Option Gain/Loss: Unopened
Time Frame: 4 to 6 weeks
New Positions: Yes, see Trigger

07/07 update: TM continues to rally and just posted its seventh gain in a row. I don't see any changes from my prior comments.

We don't want to launch new positions right here. I am suggesting we buy calls on a dip at $82.00 with a stop loss at $79.40, under the simple 200-dma. Our target is $85.75 and $89.50. We'll plan on exiting ahead of the early August earnings report.

NOTE: Shares of TM traded here in the U.S. gap open (up or down) every day as the stock adjusts for trading back home in Japan. This can be a frustrating experience with the gaps every day. We may not get triggered at $82.00. The play could be opened on a gap down below this level.

Trigger @ $82.00

- Suggested Positions -

buy the Aug. $82.50 call (TM1120H82.5) current ask $3.05

- or -

buy the Aug. $85 call (TM1120H85) current ask $1.75

Entry on July xx at $ xx.xx
Earnings Date 08/01/11 (unconfirmed)
Average Daily Volume = 539 thousand
Listed on July 05, 2011

PUT Play Updates

Scotts Miracle Gro Co. - SMG - close: 51.77 change: +1.21

Stop Loss: 52.51
Target(s): 47.50, 45.50
Current Option Gain/Loss: -38.8%
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

07/07 update: Traders may want to abandon ship! SMG rallied +2.3% on no news. It could be bears trying to cover ahead of the jobs report tomorrow morning. Our risk now is SMG could gap open higher if the economic data tomorrow is bullish. We have a stop loss at $52.51. I am not suggesting new bearish positions at this time.

- Suggested (small) Positions -

Long Aug. $50 PUT (SMG1120T50) Entry @ $1.80

Entry on July 6 at $50.20
Earnings Date 08/02/11 (confirmed)
Average Daily Volume = 991 thousand
Listed on July 5, 2011


Tiffany & Co. - TIF - close: 83.05 change: +1.62

Stop Loss: 74.85
Target(s): 79.75, 84.00
Current Option Gain/Loss: -------- +119.2%
Time Frame: 3 to 6 weeks
New Positions: see below

07/07 update: TIF has hit our final target at $84.00. Two dozens retailers reported their June same-store sales today. TIF was not one of them but most of the results were better than expected giving the retail sector a big boost. The RLX retail index ended the day up +2.3%.

Shares of TIF surged to $84.49 intraday, a +3.75% move. Our exit target was hit at $84.00.

- Suggested (SMALL) Positions -

Aug. $80 call (TIF1120H80) entry @ $2.44, exit $5.35 (+119.2%)

07/07 Final Target Hit @ 84.00, Aug. calls @ +119.2%
07/05 Target hit @ 79.75, Exit July calls @ 2.80 (+47.3%), Sell half of our August $80 calls @ 2.50 (+2.4%)
07/02 new stop loss @ 74.85
07/02 Cautious traders may want to exit the July calls now with the bid at $2.57 (+35%)


Entry on June 28 at $76.80
Earnings Date 08/26/11 (unconfirmed)
Average Daily Volume = 1.8 million
Listed on June 27, 2011