Option Investor

Daily Newsletter, Tuesday, 7/12/2011

Table of Contents

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

Market Wrap

Another Domino Falls

by Jim Brown

Click here to email Jim Brown
Pushing the market lower was news that Moody's cut Ireland's debt to junk but providing an intraday bounce was news the Fed was considering QE3. Whatever happened to trading stocks on fundamentals?

Market Statistics

The equity markets seem to be depending less on stock fundamentals and more on economic and geopolitical news than ever before. Even the Fed is facing the same dilemma. In the FOMC minutes released today we see they were worried that the debt crisis in Europe could continue to grow and bleed over into the global markets and weaken the U.S. economy. Today Moody's cut Ireland's debt to junk to join Portugal and Greece in the junkyard. Ireland had an Aaa rating just two years ago but their recent economic slide and surge in debt forced them to seek a 85 billion euro bailout in November.

The biggest problem facing Europe today is the potential for another round of bailouts after the first group ends and the bailout fund will be depleted. Greece is expected to need another 110 billion euro and Ireland 45 billion. Add in Portugal, Italy a Spain and you are going to need a bigger bailout fund than what the euro nations have already agreed.

Ireland has the second highest debt behind Greece at 118% of GDP. That is up from only 25% in 2007. The EU has already pledged 70 billion euros of the 85 billion requested but that is not going to be enough.

Global stock markets plunged on Tuesday to stretch the three-day decline to the biggest drop since March. U.S. treasury yields fell to the lows for 2011 as the euro weakened overnight to a four month low.

The European debt crisis is far from over and investors are starting to get the feeling this could end badly. The EU finance ministers appear to now be open to a selective default by Greece to reduce the amount of debt they have to repay. This is a bad precedent since it opens the door for similar defaults from the other weak countries and the insolvency of many European banks. This weighed on the global markets and kept the U.S. market from recovering today.

The FOMC minutes produced a minor spike after investors realized the Fed was openly debating whether to begin a QE3 program if the economy remained weak. Some members were open to the idea while others were opposed. All realized the inflation pressure had risen but most believed they were transitory. Those few members who believed inflation was possibly not temporary were the same ones who felt removing the current accommodative monetary policy should begin soon.

The Fed did lay out their plan for removing the current policy once situations warranted it. The first step would be to stop the current reinvestment of principal as existing assets matured. The second step would be to modify the guidance in the FOMC post meeting statements. Third would be to begin raising the Fed Funds target rate and lastly begin selling treasuries currently in the Fed portfolio. That last step would not occur until after the first rate increase. They also expected the sales process to take 3-5 years before the Fed's portfolio returned to normal.

With the FOMC split about future action it is pretty clear that there will be no change in rates until at least the second quarter and most analysts are focused on the June meeting as the first rate hike if the economy recovers as the Fed expects.

Several members were concerned the recovery might proceed slowly and unemployment would continue to be unacceptably high and require some form of Fed intervention. However, after discussing the various options in the FOMC toolkit they expressed concern that the Fed may not be able to stimulate hiring with the current tools. The Fed is trapped in its current position. They can't apply more stimulus in the form of rates because Fed rates are zero. They can't do a QE3 because of political constraints and the potential to increase inflation in commodities. They can't tighten because employment is too low. The bottom line is the Fed will remain on hold unless the economy either worsens appreciably or improves significantly.

It was a good news, bad news report for traders. Good news because the Fed was open to a QE3 program if needed. Bad news there were several hawks on the committee that would require a seriously weakened economy before a QE3 could happen. The announcement spike was quickly sold.

A new program was also announced. The Fed members now have a formal blackout period starting on Tuesday the week before the meeting and ending Friday after the meeting. They will have to refrain from talking about the economy and meeting agenda and refrain from discussing the meeting other than what is specifically in the minutes of the meeting. They also agreed to avoid political partisanship. That last one is interesting since the actions of the Fed reflect on the administration. I suspect the Ron Paul influence in the House is starting to weigh on Fed nerves. Paul is strongly anti Federal Reserve and he is running for president after 12 terms in the House. He first was elected in 1976. After stepping down after four terms he defeated an incumbent in 1996 to take back the seat. He has little or no chance of winning the election but his views about the Fed will be national news fodder in the months ahead.

In the economic news the Job Openings and Labor Turnover Survey (JOLTS) showed a weakening labor market in May. This is no surprise since the nonfarm payrolls for May and June were both weak. The survey period for the JOLTS report covers the last half of May and the first half of June so there is no direct correlation with the nonfarm payrolls. This is a lagging report and was mostly ignored.

The report showed there were three million job openings on the last day of May. This is consistent with what the CEO of Kelly Services said last week. These openings are unfilled because there are not enough qualified people available.

The U.S. International Trade deficit rose to -$50.2 billion in May. That was an increase from the -$43.6 billion in April. That is the highest level since October 2008. Two thirds of the increase came from the rising prices for oil and oil products. Petroleum imports rose +10.3% in value in May. The average price of imported oil in May was $108.70 and the highest since August 2008.

The economic calendar for the rest of the week is very busy but the highlight will be the Bernanke testimony. Now that lawmakers have the FOMC minutes to browse for topics to use in the questioning the attack on Bernanke will be even more aggressive. That makes it even more of a danger to the market. At this point there is little Bernanke can say positive about the economy since his last press conference he said he did not know why the economy was not growing. He has no clue or at least one he will not acknowledge publicly. Always being forced to remain politically correct does have its drawbacks.

Economic Calendar

The potential for another FOMC stimulus program may not be very likely today but the anticipation of the FOMC minutes pushed the dollar lower intraday. When the minutes were released and QE3 was mentioned the fate of the dollar was called into question.

Gold and Oil promptly rocketed higher with gold prices gaining about $24 to close at $1567 today. The intraday high was $1574 and only -$3 from the all time high of $1577.40 set back in April. That represents an $83 gain since the low at $1480 on July 1st. Inflation fears in the U.S., fears the Fed could implement a QE3 and push the dollar lower and fears over a meltdown in Europe have given the gold bugs something to live for.

Gold Chart

Crude prices in the U.S. rallied to $97.50 intraday but the real price of oil as represented by Brent closed at $116.85 and a slight decline from yesterday. Brent is facing declining supply from the North Sea and a temporary shutdown in deliveries from Britain's Buzzard field.

On the positive side Gaddafi appears to be ready to leave Libya. The French reported he is seeking a deal to leave the country as a negotiated end to the crisis. French Prime Minister Francois Fillon said "a political solution is more indispensable than ever and is beginning to take shape. Emissaries are telling us Gaddafi is ready to go. The question is no longer whether he goes but when and how." With Nato launching over 100 sorties on Monday the heat is rising in Gaddafi's kitchen. The U.S Stat Dept expressed doubts about the "emissaries" saying a lot of people claim to speak for Gaddafi but their claims are contradictory. Numerous "deals" have been promised over the last several months but none have ever come to pass. It is obvious the oil trading community did not believe it or prices might have declined.

Brent Crude Oil Chart

Alcoa (AA) reported earnings on Monday night that were inline with reduced estimates and the stock declined slightly today after seeing some increased volatility Monday night. It was a lackluster earnings report for a sector that was supposed to post some stellar gains. Alcoa said higher costs for raw materials and higher transportation costs were the problem.

Fastenal (FAST) reported earnings that grew +36% on improving sales. FAST earned +32 cents compared to analyst estimates of 30-cents. Revenue rose +23%. Same store sales rose +19%. The company opened 75 stores in the first six months of 2011.

Fastenal Chart

Infosys (INFY) posted earnings of 67-cents that were less than the 71-cents analysts expected. Revenue rose +23% to $1.67 billion but missed estimates of $1.768 billion. The company hired 9,922 workers in the quarter to raise their total to 133,560 employees. Shares of INFY declined -6%.

Infosys Chart

Wolverine World Wide (WWW), a competitor to Sketchers, Deckers and Timberland, posted its smallest quarterly beat in six quarters due to rising costs and lower margins. WWW earned 48-cents compared to analyst estimates of 46-cents. WWW reiterated full year guidance of $2.40-$2.50 but analysts were expecting $2.48 and the higher end of the range. WWW said the increase in prices for raw materials resulted in a margin decline. Shares of WWW fell -7%.

Wolverine Chart

Granted those companies listed above are not your IBM or Caterpillar but did you notice the common thread in each report. Lower margins and sharply declining stock price after the earnings report. This is what analysts have feared for Q2. Earnings estimates have been slipping although they still are expected to be more than 12.5%. The lackluster performance is indicative of the problems faced in Q2 when consumers pulled back from shopping as gasoline prices rose and companies faced higher input costs from commodities and fuel prices.

You can't draw a conclusion for the quarter based on the earnings so far this week but traders are probably starting to become a little more cautious in the size and quantity of their positions. This is an expiration week and the geopolitical problems, earnings problems and debt battle in Washington are simply adding too much risk for the markets to remain in rally mode without a serious uptick in earnings results soon.

Google has earnings on Thursday with JP Morgan and those will be the earnings traders will seize upon for trading direction. For Wednesday we have Marriott, Yum Brands, ASML and Adtran. They are not expected to move the market like the JPM/GOOG reports have been known to do.

Cisco CEO John Chambers spoke at a conference today but he avoided talking about layoffs. However, sources close to Cisco claim the company is laying off 7,000 workers and offered early retirement packages to another 3,000 who have accepted the offers. Cisco is expected to take charges of up to $1.1 billion for the layoffs. Cisco shares rallied slightly on the news.

Microchip Technology (MCHP) fell -12% after the company cut its guidance and received several downgrades. MCHP said it took a hit from the Japan earthquake that was larger than previously expected. UBS cut its rating from buy to neutral and JP Morgan kept their rating at neutral but cut the price target to $29 from $36. The MCHP CEO cited "broad based weakness" in Q2 in addition to the auto supply problems. MCHP shares declined -12%. The drop in MCHP helped push the Semiconductor Index to a loss of -3%.

MCHP Chart

The markets tried to hold the line today but the late day downgrade of Ireland was the kiss of death. The S&P had held on support at 1320 until the spike after the minutes but the debt downgrade immediately killed the spike and pushed the S&P to close at the low of the day at 1313. This break of support could be critical for Wednesday's market. Granted this was a knee jerk reaction to a late day news event but the decline below the 100-day at 1316 is a sell signal. Unless there is a sudden improvement overseas and overnight the odds are increasing we could see a retest of the 200-day at 1275.

S&P Chart

The Dow broke support at 12,500 and closed at the low for the week. The next support target could eb 12,400 but without a decent improvement in some of the factors weighing on the markets I am not optimistic. The European mess is worsening and earnings in the U.S. have yet to show any positive trend. On the positive side the profit taking from last week's rally has retraced about 35% of the gains so we are due for some bargain hunting soon.

Dow Chart

The Nasdaq was the biggest percentage loser of the major indexes and that was due mostly to the decline in chip stocks thanks to MCHP. The close was exactly on the 38% Fib retracement of the recent gains but still well above the next support level at 2860.

The Nasdaq decline came despite a $10 rally in Google. When GOOG reports earnings on Thursday there is normally a monster knee jerk reaction so traders will probably be skittish of holding their positions in Nasdaq stocks over the Google earnings.

Nasdaq Chart

On Sunday I said I was cautiously bullish going into earnings but that sliver of bullishness was crushed by the daily geopolitical events from Europe and Washington. Add in the so far lackluster earnings and there is no reason to own stocks today. I considered buying the dip all day until the Ireland debt downgrade after 2:PM. After watching the indexes decline on the news to the lows of the day I am glad I waited.

I am now cautiously bearish until after Thursday's earnings. That should be a pivotal point for the week. We had two weeks of amazing gains and now it is time to pay the piper. I suggest waiting patiently on the sidelines for a trend to emerge. Futures are positive as I post this commentary so there is always the possibility of good news breaking out somewhere. Maybe the Ireland drop was just reactionary and cooler heads will prevail.

Jim Brown

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New Option Plays

1300 Here We Come

by James Brown

Click here to email James Brown

Editor's Note:

Stocks are correcting thanks to growing worries over the EU periphery. Tomorrow Fed Chairman Bernanke speaks before congress. Stocks may not move much as they wait for any market-moving comments. Meanwhile the next major earnings release is not until Thursday.

Considering the current correction in stocks and today's breakdown below support in the S&P 500 it looks like this index is headed for round-number, psychological support near 1300.

I haven't given up on buy-the-dip bullish strategies but we need to be patient. Here are a list of stocks I am watching for potential buy-the-dip trades (FCX, CLB, SIAL, ORLY, MCD, IBM, and V). Plus, a couple of stocks that might be bearish trades are GMCR and GS. GMCR seems to be sinking on worries it will lose market share to growing competition in the K-cup business. GS has been stuck in a down trend for months and looks poised to once again break support near $130. The GMCR trade would be very high risk since shares have a habit of crushing the shorts.

No new candidates tonight.

- James

In Play Updates and Reviews

Stocks Struggle, S&P Breaks 1320

by James Brown

Click here to email James Brown

Editor's Note:

Europe continues to plague the market. This time it was a downgrade of Ireland's debt to junk status. The S&P 500 has broken support near 1320 and 1315 in addition to breaking down under its 50-dma and 100-dma. The next stop looks like support near 1300.

Traders should be defensive here. You may want to exit early any questionable bullish positions.


Current Portfolio:

CALL Play Updates

Agrium Inc. - AGU - close: 87.23 change: +0.15

Stop Loss: 85.90
Target(s): 94.00, 98.00
Current Option Gain/Loss: -14.8% & - 4.2%
Time Frame: 4 to 5 weeks
New Positions: see below

07/12 update: AGU saw an initial surge higher this morning but the rally failed near yesterday's highs. That's a little concerning. AGU was fading lower with the market into the closing bell. I am starting to grow a little concerned here. Readers may want to hesitate on launching new positions. Our exit targets are $94.00 and $98.00. FYI: The Point & Figure chart for AGU is bullish with a $104 target.

- Suggested Positions -

Long AUG $90 call (AGU1120H90) Entry @ $2.70

- or -

Long AUG $95 call (AGU1120H95) Entry @ $0.94

Entry on July 11 at $88.54
Earnings Date 08/03/11 (unconfirmed)
Average Daily Volume = 1.7 million
Listed on July 9, 2011

Caterpillar - CAT - close: 106.93 change: -1.23

Stop Loss: 105.95
Target(s): 114.00
Current Option Gain/Loss: -10.4%
Time Frame: Until the earnings report
New Positions: see below

07/12 update: It was a bumpy session for CAT with shares churning sideways in the $106.70-108.50 range. The close under $107 and its 10-dma is short-term bearish. It looks like CAT wants to drop toward support near $105 but the problem is we have a stop at $105.95. Aggressive traders willing to handle the risk may want to lower their stop under the $105 level. I am not suggesting new bullish positions today.

Don't forget that we do not want to hold over the July 22nd earnings report.

- Suggested Positions -

Long Aug. $110 call (CAT11H110) entry @ 3.15

07/11 Triggered @ 107.50.
07/09 adjusted trigger to $107.50, stop to $105.95, target to $114.00

Entry on July 11 at $107.50
Earnings Date 07/22/11 (confirmed)
Average Daily Volume = 8.4 million
Listed on July 2, 2011

Cerner Corp. - CERN - close: 62.29 change: -0.54

Stop Loss: 61.45
Target(s): 64.75
Current Option Gain/Loss: +34.3%
Time Frame: 3 to 6 weeks
New Positions: see below

07/12 update: CERN spent the day dancing back and forth across the $62.60 level. Shares eventually sank to their 10-dma. As discussed previously CERN looks headed for the $62 area. More conservative traders may want to exit early. We have a stop loss at $61.45. I would be tempted to buy calls again if we saw a bounce from support near $60 and its 50-dma.

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

- Suggested (small) Positions -

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

07/09 new stop loss @ 61.45
07/08 Planned exit. July calls @ +125.0%
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

Diamond Foods Inc. - DMND - close: 76.62 change: +0.29

Stop Loss: 73.25
Target(s): 79.50
Current Option Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see trigger

07/12 update: DMND saw a brief dip toward $75.00 and then a rebound. Shares managed to close in positive territory. The low today was only $75.19 so we're still waiting for a decline to $75.00 as our entry point. More conservative traders could wait for a dip closer to the 30-dma as their entry point instead.

If triggered our first target is $79.50. FYI: The Point & Figure chart for DMND is bullish with a $90 target.

Trigger @ $75.00

- Suggested Positions -

buy the AUG $75 call (DMND1120H75) -small positions-

Entry on July xx at $ xx.xx
Earnings Date 10/05/11 (unconfirmed)
Average Daily Volume = 237 thousand
Listed on July 11, 2011

Joy Global - JOYG - close: 93.78 change: -0.69

Stop Loss: 91.40
Target(s): 102.00
Current Option Gain/Loss: Unopened
Time Frame: 3 to 6 weeks
New Positions: Yes, see trigger

07/12 update: JOYG spent most of Tuesday ricocheting between the $94 and $96 levels but eventually closed near its lows under $94. Currently our new plan is to buy calls on a dip at $93.00 with a stop at $91.40. More aggressive traders could place their stop under support at $90.00 instead. Our upside target is $102.00. I would keep positions small.

Trigger @ $93.00 (Small Positions)

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

07/11 relist this play with a trigger at $93.00 and stop @ 91.40

07/11 JOYG hit our trigger at $96.00 (actually $95.97) and then hit our stop at $94.75. The option opened at $2.32 (ask) and we were stopped out at $2.20 (bid) for a loss of -5.1% We were fortune this loss was not larger!

07/09 Adjusted trigger to $96.00, stop to $94.75, target to $102.00, and option strike to Aug. $100 call.

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: 73.92 change: -0.75

Stop Loss: 73.40
Target(s): 79.75
Current Option Gain/Loss: -15.3%
Time Frame: up until its earnings report.
New Positions: see below

07/12 update: Uh-oh! Our NSC trade is in trouble. Shares lost another -1% and closed under what should have been support at $74.00. More conservative traders may want to exit immediately. We have a stop loss at $73.40. I am not suggesting new positions at this time.

- Suggested (SMALL) Positions -

Long Aug. $75 call (NSC11H75) Entry @ $1.95

07/12 NSC has broken support at $74. Readers may want to exit early
07/11 triggered @ 74.50
07/09 new stop loss @ 73.40. Small positions!
07/06 adjusted entry trigger to $74.50 and stop to 71.75

Entry on July 11 at $74.50
Earnings Date 07/27/11 (unconfirmed)
Average Daily Volume = 2.3 million
Listed on July 2, 2011

Panera Bread Co. - PNRA - close: 130.21 change: +0.09

Stop Loss: 128.35
Target(s): 138.50, 144.00
Current Option Gain/Loss: -16.1%
Time Frame: 3 to 4 weeks
New Positions: see below

07/12 update: Shares of PNRA remain buoyant. You could argue that this lack of profit taking is a show of relative strength. The stock is hovering near support at $130. Please note that I am raising our stop loss to $128.35. If we get stopped out we might try again on a dip or bounce near the $125-123 area.

While PNRA is holding up readers may want to hesitate on launching new positions right now. We do not want to hold over the late July earnings report.

Don't forget that PNRA has significant short interest and could see a short squeeze higher. FYI: The most recent data listed short interest at 8.6% of the small 28.2 million-share float.

- Suggested Positions -

Long AUG $135 call (PNRA1120H135) Entry @ $3.40

07/12 new stop loss @ 128.35

Entry on July 11 at $130.61
Earnings Date 07/26/11 (unconfirmed)
Average Daily Volume = 337 thousand
Listed on July 9, 2011

Starbucks Corp. - SBUX - close: 39.57 change: -0.17

Stop Loss: 37.75
Target(s): 44.00
Current Option Gain/Loss: unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see below

07/12 update: The early morning bounce in SBUX failed. Shares look more and more like they want to correct toward support near $38.00. I am lowering our buy-the-dip entry point from $38.75 to $38.50. We do not want to hold positions over the late July earnings report.

Trigger @ $38.50

- Suggested (Small) Positions -

buy the AUG $40.00 call (SBUX1120H40)

07/12 adjust trigger to $38.50
07/11 Our first attempt at a call play on SBUX did not pan out. Shares opened lower at $39.98 and then hit our relatively tight stop loss at $39.45. The option opened at $1.49 (ask) and we were stopped out at $1.22 (bid)for an -18% loss.
We are reloading this trade with a buy-the-dip trigger at $38.75.

Entry on July xx at $ xx.xx
Earnings Date 07/28/11 (unconfirmed)
Average Daily Volume = 6.8 million
Listed on July 9, 2011

VMware, Inc. - VMW - close: 100.40 change: -1.73

Stop Loss: 99.75
Target(s): 109.75, 114.00
Current Option Gain/Loss: -11.2%
Time Frame: seven trading days
New Positions: see below

07/12 update: Two down days in a row has put our VMW trade in jeopardy. The stock dipped to support near $100 and hit $99.80 intraday. We have a stop loss at $99.75. More aggressive traders may want to adjust their stop loss lower and give VMW more room to maneuver.

Technically the $100 level is still support so I would consider buying calls here. However, given the market's weakness this week readers may want to wait on initiating new positions.

We only have a few trading days. VMW is due to report earnings on July 19th and we do not want to hold over the announcement. I would keep positions small. VMW can be a little volatile.

- Suggested Positions -

Long AUG $110 call (VMW1120H110) Entry @ $3.10

Entry on July 11 at $103.19
Earnings Date 07/19/11 (confirmed)
Average Daily Volume = 1.9 million
Listed on July 9, 2011