Option Investor

Daily Newsletter, Thursday, 10/6/2011

Table of Contents

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

Market Wrap

Are We Done Yet?

by Jim Brown

Click here to email Jim Brown
After a new bear market low on Tuesday followed by a rebound covering three days is the market about done going up?

Market Statistics

Europe finally woke up to the fact their banks needed help. The ECB said it would reintroduce year-long loans, giving banks access to unlimited cash through January 2013. The ECB also said it would resume purchases of bonds to encourage lending. That is the ECB version of quantitative easing. At the same time the European Commission is pushing for a coordinated injection of capital into banks. German Chancellor Angela Merkel said policy makers "shouldn't hesitate" if it turns out financial institutions are undercapitalized. What Merkel says matters since Germany is 27% of the EU.

Events came to a head this week with the second rescue of Dexia and an earnings warning from Deutsche Bank and a cut of 500 jobs related to write downs on sovereign debt. Overnight bank deposits at the ECB soared early this week to highs not seen in over a year. This is due to banks afraid to loan money to other banks or do counter party transactions. It was a wakeup call for the ECB.

The Bank of England surprised everyone by raising the ceiling for their own quantitative easing program to 275 billion pounds ($421 billion). Only 11 of the 32 economists in a Bloomberg survey expected that action. The chief analyst at Societe Generale had predicted an increase and still believes the BOE will add to the new program. Citigroup expects as much as 225 billion more by year end. The BOE will buy bonds (Gilts) across a range of maturities at three weekly auctions with an initial size of 1.7 billion pounds. The bank said it was keeping its benchmark rate at a record low of 0.5%. That was predicted by all 53 analysts surveyed. The move by the BOE showed the bank was more worried about growth than inflation since the inflation rate in the U.K. is 4.5% and already more than twice the target rate of 2%. The ECB had earlier disappointed analysts by leaving its base rate at 1.5%.

What does this all really mean? First, it removes the worry over bank failures in Europe. The bank runs should stop and the banks should not have any funding worries for the next year or more. Secondly, they are making preparations for a soft landing for the banks when Greece defaults in November. By shoring up the banks ahead of the event it removes the risk of the actual event.

While the problem in Europe is far from over the outcome appears clear. The EU is going to backstop the banks and Greece debt will be restructured by at least 50% or more. That will remove the pressure from Greece and allow them to rebuild their economy. The banks will take a hit on the bonds but the EU is going to prop them up. The worst in Europe appears to be almost over.

Without the weight of Europe on the equity markets investors were forced to turn to economics and earnings and the news was not that bad. Chain store sales for September spiked +5.5% on top of a +4.8% gain in August. Excluding fuel and international sales the growth rose by 4.6% from 3.9%. There is no recession in retail. Growth at luxury stores (+10.4%) and wholesale clubs (+12.0%) led the sector. The ICSC is now predicting 5% growth for October.

Remember, there was a hurricane in early September that depressed sales for a week so that makes these numbers even stronger. There was also a stock market crash in August and September that would have normally depressed retail sales. Same store sales at 23 retailers averaged a growth of +5.1%. Target, Nordstrom and Macy's all beat strong same store sales estimates. Note the trend on the chart is growing steadily.

Retail Sales Chart

The weekly Jobless Claims rose to 401,000 and the prior week's questionable number was revised up from 391,000 to 395,000. The prior week's decline was the result of a seasonal adjustment. Coming in this week at just barely over 400,000 is encouraging. When claims move under 400,000 and begin easing lower the expectations for job growth will begin to rise. At just over 400K the job growth is normally anemic. While the pace of layoffs may have declined it does not mean the pace of hiring has increased. Watching the jobless claims for meaningful jobs direction is like watching grass grow. Weeks of miniscule changes appear lackluster as the slow process of rebuilding begins. If we suddenly saw claims fall under 375,000 and continue to improve I am sure analysts would be falling all over themselves to upgrade the economy. Until then we wait.

Jobless Claims Chart

The economic calendar for Friday is headlined by the Nonfarm Payrolls. The consensus expectations are for a gain of 60,000 jobs compared to zero jobs gained in August. However, the ADP Employment report on Wednesday predicted a gain of 91,000 private sector jobs on Friday. The ADP does not have a good track record of predictions but they keep trying and I am pretty sure some of the week's rally is based on that prediction. The ADP report is private sector only and does not count government jobs. The Nonfarm Payroll report does include government workers and those jobs have been declining all year.

Friday's market will depend entirely on the payroll report. This could be a pivotal point for the current rally. A better than expected number could energize those buyers hoping for an end to the bear market and a worse than expected number could energize the sellers. Either way the +8% S&P rebound from Tuesday's low is grossly over extended and the potential for a sell the news event is very strong. A lot of the rally today was probably anticipation of a good jobs number.

The Federal Reserve made its first Treasury sale today by offering $8.8 billion in two-year Treasuries. There were more than $242 billion in bids for those treasuries. That was the most oversubscribed treasury auction I have ever heard of and that was on a day when equities were up strongly once again. It makes you wonder why bidders were so hot to get a 0.27% yield.

At the same time the 30-year mortgage rate fell below 4% for the first time in history. The rate declined to 3.94% from 4.01% the prior week. The average rate on a 15-year loan declined to 3.25%. The prior 30-year lows were 4.08% back in the 1950s but the favorite term back then was 20-25 years. This should prompt a massive refinance boom and another surge in home buying for those with jobs and credit.

Unless you live in a cave you know Steve Jobs died on Wednesday from his long term illness. This was not unexpected given the disturbing pictures of a frail Jobs entering and exiting his doctors office. His family said he died peacefully at home with his family.

Steve was an amazing individual and through his imagination and force of will he has given the world some wonderful electronics and I am sure Apple will continue to produce products for years to come that were designed in some way by Steve Jobs. Not all of his products were hits (Lisa, the Cube, Apple TV, etc) but the ones that did exceed expectations did so in grand style. He created and or resurrected multiple companies into multibillion dollar empires. Apple, NeXT, and Lucasfilm, which became Pixar. Jobs dropped out of college after only one semester to return home and take a job at computer game maker Atari with Steve Wozniak. A year later he went on retreat to India and came back a Buddhist with a shaved head and traditional Indian clothing. He and Wozniak sold everything they had in 1976 and started Apple in his parent's garage. The rest is history.

Forbes claims he had 5.426 million Apple shares and 138 million Disney shares and estimated his net worth at $8.3 billion making him the 42nd wealthiest American. He transferred his various real estate holdings in to different trusts in 2009 just after he exited Apple on his medical leave. It is unknown how his stock holdings had been split up.

Apple shares did not react negatively to his death as they might have in years past. Jobs had nurtured Tim Cook to take over as CEO and his partner in the design aspects was Jonathan Ive. Ive took charge of the design team in 1996 and they have been responsible for the look, feel and function of the products so famous today. That is not expected to change. Apple shares ended the day flat on a volume of 29 million. Two years ago an unexpected obituary would have knocked $100 of the stock.

Several brokers reiterated their ratings post Jobs. Ticonderoga Securities has a buy rating with a price target of $666. Sterne Agee also has a buy rating with a $500 target. Piper Jaffray says overweight with a target of $600.

Apple Chart

Yahoo closed down slightly although well off the lows of the day. Multiple reports appeared suggesting Yahoo is planning on selling its Japanese assets. Yahoo owns those assets in conjunction with Softbank. If it is successful in unloading those assets it would make it easier to sell the remaining company to someone in the USA. Microsoft continues to be mentioned as a potential suitor. Yahoo has a 35% stake in the Japan business, which has a total value of roughly $19 billion. Softbank has about a 40% interest. It is clear the company is in transition and the odds of the remaining Yahoo business remaining independent are close to zero. Various analysts have predicted a total takeout value on Yahoo between $19 and $31 per share.

Yahoo Chart

Monsanto (MON) reported earnings Wednesday and continued its three day spike with a +8% gain today. The company said seed sales were brisk and farmers were opting for the higher priced seeds rather than trying to save money. They are looking to move up in quality and derive more bushels per acre. Monsanto posted a loss of 21-cents but better than the 27-cent loss analysts had expected.

Monsanto Chart

Other than the news from Europe and the death of Steve Jobs there was not very much news today. Traders are in strong denial over the rebound but volume has been very strong. Unlike most big market moves that start with a high volume reversal and then follow on with low volume days as traders wait for the rebound to reverse.

Volume on Tuesday's new low was nearly 13 billion shares. Wednesday traded 9.4 billion and Thursday 9.0 billion. Even more impressive was the 10:1 up volume over declining volume today. It appears the rebound was actually gaining speed rather than slowing at resistance. This has caused some serious confusion for the bears.

The S&P has rallied +8.3% since the 1075 low on Tuesday. We can go entire years without an 8% gain. We have gone from significantly oversold to overbought in only three days and there is an major economic event at Friday's open. The market is priced to perfection for a decent payroll number.

However, does that number really matter? With a sudden flurry of good news out of Europe have we reached the point where the biggest worry is fading? If Europe is really going to shore up their banks and make a Greek default a nonevent then investors may be ready to come back to the market. The volume imbalance today could be a clue.

The next resistance levels on the S&P will be 1195 and 1220.

S&P-500 Chart

The Dow rallied over 11,000 just after the open and then held over that level the rest of the day. A closing spurt of buying at the close pushed it over 11,100. Next resistance would be 11,350-11,400 with support at 11,000.

IBM was the biggest winner at +4.84 followed by CAT +2.83, MMM +2.12 with the financials providing strong support. Less fear of exposure to Europe coupled with a reversal of the shorts funds were using to hedge against European defaults were the reasons for the financial rebound.

Dow Chart

The Nasdaq managed a very nice gain when you realize that Apple closed negative and provided zero support. Google helped with a $10 gain, WYNN +12, BIDU +10 and PCLN +24. Apparently the worries over China stocks have faded.

The Nasdaq managed to close over 2500 after bouncing off 2300 just two days ago. That +200 point rebound is still short of the -300 point decline that began four days earlier. This is extreme volatility but it appears traders are embracing it. Overhead resistance is now 2600.

Nasdaq Chart

The Russell also powered to a strong gain but remains below the two levels of downtrend resistance. The Russell has rallied +12% off the lows at 602 but it was also the weakest index on the way down. A +12% gain is strong but there is a lot of overhead resistance still to overcome.

Russell Chart

The markets closed at the highs for three consecutive days. That is a dramatic change from the prior week when closing on the lows was a daily occurrence. Much of our rebound has been short covering from the significantly shorted decline. Eventually those shorts are going to disappear and it will be up to investors to overcome resistance and push the market higher.

"IF" Europe is really going to be resolved soon, and the events of this week would suggest that, then a major weight will be removed from the market. Financials will be able to trade on their value not by how many funds are shorting them to hedge Europe. Economics are slightly better than expected and almost nobody in the business community is claiming we are in a recession. It may take some time for the realization to strike Wall Street and Friday's jobs and next week's start of the earnings cycle will be key.

I am neutral for Friday just because of the distance the rally has traveled in three days. I am bullish for the next week as long as nothing new pops up on the threat monitor. Unless something changes I am in buy the dip mode.

Jim Brown

Send Jim an email

New Option Plays

Shorts Are Nervous

by James Brown

Click here to email James Brown

Editor's Note:

In addition to tonight's new trade, readers may want to put these stocks on their watch list for an entry point:


Please note that I am concerned for the rally. Stocks are up big off their Tuesday lows. We could see equities spike higher on Friday and then sell-off into the weekend. Investors will want to consider keeping their position size small to limit risk.

- James


Sears Holding - SHLD - close: 63.51 change: +1.62

Stop Loss: 59.90
Target(s): 68.50
Current Option Gain/Loss: Unopened
Time Frame: 2 to 4 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
Sears is a heavily shorted stock and when the market reversed higher on Tuesday this stock shot higher through resistance at $60.00 and its 50-dma. Now it looks like SHLD is turning around after weeks of consolidating sideways. This should make shorts very nervous. There potential resistance at the 100-dma and the $66 level but I expect that if the market continues to rally then SHLD will soar toward its exponential 200-dma or $70.00.

The problem I have with this trade is that the jobs report is due out tomorrow morning. If the jobs number is good then the stock market (and SHLD) will probably gap open higher. More conservative traders may want to avoid this trade if SHLD gaps open too high (how high is too high? that's up to you). I am setting our exit target at $68.50, which is just under the 200-ema and its trendline of lower highs.

Please note that we do NOT want to buy calls unless both SHLD and the S&P500 index both open positive tomorrow.

It's worth noting that the Point & Figure chart on SHLD has reversed higher and is now pointing to an $83 target.

FYI: The most recent data listed short interest at 47% of the float.

*See Entry Point Details Above*

- Suggested Positions -

buy the OCT $65 call (SHLD1122J65) current ask $2.47

- or -

buy the NOV $67.50 call (SHLD1119K67.5) current ask $3.35

Annotated Chart:

Weekly Chart:

Entry on October xx at $ xx.xx
Earnings Date 11/17/11 (unconfirmed)
Average Daily Volume = 644 thousand
Listed on October 06, 2011

In Play Updates and Reviews

Third Day of Gains

by James Brown

Click here to email James Brown

Editor's Note:

Stocks extend the oversold bounce to three days in a row. Shorts continue to cover with the market's major indices bouncing back toward resistance. We had both our PNRA and WLT put plays get stopped out.


Current Portfolio:

CALL Play Updates

Alexion Pharmaceuticals - ALXN - close: 65.64 change: +0.93

Stop Loss: 59.90
Target(s): 67.90
Current Option Gain/Loss: +32.5%
Time Frame: 3 to 4 weeks
New Positions: see below

10/06 update: Volume on ALXN dropped but shares extended their gains to three in a row. The stock's close above potential resistance at $65.00 is short-term bullish. I am not suggesting new positions at this time.

More conservative traders might want to raise their stop loss.

- Suggested Positions -

Long OCT $65 call (ALXN1122J65) Entry $2.00

Entry on October 05 at $63.16
Earnings Date 10/20/11 (unconfirmed)
Average Daily Volume = 1.8 million
Listed on October 04, 2011

Check Point Software - CHKP - close: 56.45 change: +2.39

Stop Loss: 53.45
Target(s): 55.75 , 57.75
Current Option Gain/Loss: +52.7%
Time Frame: 3 to 4 weeks
New Positions: see below

10/06 update: Target achieved. It was a big day for CHKP with the stock's +4.4% gain outperforming the major indices. The breakout past $55.00 and its 100-dma is bullish but CHKP does look short-term overbought now. The top of the gap down near $56.50 could be resistance. Our first target was hit at $55.75. The bid on the October $55 call was near $2.30 (+27.7%). Our final target is $57.75. Please note our new stop loss at $53.45.

- Suggested Positions -

Long OCT $55 call (CHKP1122J55) Entry $1.80

10/06 new stop loss @ 53.45
10/06 1st target hit at $55.75
bid on Oct. $55 call @ 2.30 (+27.7%)
10/03 testing support near $51.00, consider an early exit
10/01 readers may want to consider an early exit now.
09/26 trade opened.


Entry on September 26 at $53.00
Earnings Date 10/20/11 (unconfirmed)
Average Daily Volume = 1.6 million
Listed on September 20, 2011

Hewlett Packard - HPQ - close: 25.05 change: +1.19

Stop Loss: 21.45
Target(s): 29.50
Current Option Gain/Loss: +58.8%
Time Frame: 8 to 12 weeks
New Positions: see below

10/06 update: HPQ rallied to new two-week highs with today's +4.9% gain. The rally did stall at round-number, psychological resistance and the mid September high near $25.00. It is worth noting that HPQ is up +14.6% from its Tuesday low. This would be a good spot for the stock to see some profit taking.

I am not suggesting new positions at this time. More conservative traders may want to take a little money off the table. The next level of resistance for HPQ is the $26.25-26.50 zone.

- Suggested Positions -

Long 2012 Jan. $24 call (HPQ1221A24) Entry $2.14

09/27 new stop loss @ 21.45

Entry on September 23 at $22.52
Earnings Date 11/21/11 (unconfirmed)
Average Daily Volume = 26.6 million
Listed on September 22, 2011

United Technologies - UTX - close: 70.98 change: +1.37

Stop Loss: 66.80
Target(s): 74.50
Current Option Gain/Loss: +23.6%
Time Frame: 3 to 4 weeks
New Positions: see below

10/06 update: Yesterday I was worried that UTX was not participating in the rally. Today shares managed to outperform its peers by a small amount with a +1.9% gain. I want to remind you that conservative traders may want to exit early at technical resistance at the 50-dma (currently 72.70). I am not suggesting new positions in UTX at this time.

NOTE: We do not want to hold over UTX's earnings report on Oct. 19th.

- Suggested Positions -

Long OCT $70 call (UTX1122J70) Entry $2.24

Entry on October 05 at $69.61
Earnings Date 10/19/11 (confirmed)
Average Daily Volume = 6.3 million
Listed on October 04, 2011

PUT Play Updates

None. Currently we do not have any active put plays.


Panera Bread Co. - PNRA - close: 106.80 change: +0.73

Stop Loss: 107.25
Target(s): 98.00, 92.50
Current Option Gain/Loss: Oct$100: -62.8% & NOV$95: -40.2%
Time Frame: 3 to 4 weeks
New Positions: see below

10/06 update: PNRA underperformed the market today with a +0.6% gain versus +1.8% for the NASDAQ composite. Yet shares still managed to hit an intraday high of $107.86. Our stop loss was hit at $107.25. PNRA still has a lot of overhead resistance in the $110--115 zone.

Earlier Comments:
FYI: I do need to caution readers that the most recent data listed short interest at about 10% of PNRA's small float of approximately 28 million shares. That's above average short interest and a widespread market bounce could spark some short covering.

- Suggested Positions -

OCT $100 PUT (PNRA1122V100) Entry $3.50 exit $1.30* (-62.8%)

- or -

NOV $95 PUT (PNRA1119W95) Entry $4.60, exit $2.75* (-40.2%)

10/06 stopped out at $107.25
*options did not trade when PNRA hit our stop loss. 10/04 new stop loss @ 107.25.


Entry on October 03 at $103.01
Earnings Date 10/25/11 (unconfirmed)
Average Daily Volume = 574 thousand
Listed on October 01, 2011

Walter Energy Inc. - WLT - close: 63.06 change: +1.76

Stop Loss: 62.05
Target(s): 50.50
Current Option Gain/Loss: -61.0%
Time Frame: 3 to 4 weeks
New Positions: see below

10/06 update: WLT opened at $61.86 this morning and very quickly hit our stop loss at $62.05. Shares managed to close above their simple 10-dma, which is short-term bullish. Overall, I am not convinced that this week is a bottom for WLT.

*Small Positions* - Suggested Positions -

OCT $50 PUT (WLT1122V50) Entry $2.95, exit $1.15 (-61.0%)

10/06 stopped out at $62.05


Entry on October 04 at $55.72
Earnings Date 10/26/11 (unconfirmed)
Average Daily Volume = 4.2 million
Listed on October 03, 2011