Option Investor

Daily Newsletter, Tuesday, 11/13/2012

Table of Contents

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

Market Wrap

Cisco Rally?

by Jim Brown

Click here to email Jim Brown

Cisco beat the street after the bell and shot up +8%. Will that be enough to rally the markets on Wednesday?

Market Statistics

Cisco (CSCO) reported earnings of 48 cents that beat the street estimate of 46 cents. That was a year over year gain of +18%. Revenue of $11.9 billion was slightly higher than estimates of $11.77 billion. Revenue rose +6% over the comparison quarter. Gross margins were 62.7% and the company has $45 billion in cash. Cisco shares spiked +8% in afterhours trading not because the results were so strong but simply because traders were expecting Cisco to miss estimates and warn due to weakness in Europe.

CEO John Chambers gave cautious but firm guidance for the current quarter and that helped fuel the short covering in afterhours trading. Chambers said global macroeconomic uncertainty continued but Europe "will get worse before it gets better." CFO Frank Calderoni projected revenue growth of 3.5% to 5.5% in the current quarter. The street is looking for 4.5% so guidance was right in line.

The market may see a short squeeze in the tech sector on Wednesday but that may not trigger a broad market rally.

Cisco Chart

We saw a rally early Tuesday after Home Depot (HD) posted a strong earnings beat. The Dow rallied +149 points from the morning lows to touch +83 intraday. That intraday rally faded in the afternoon and the Dow closed down -58 points and almost the lows of the day.

Home Depot shares rallied to a +3.6% gain despite the Dow decline late in the afternoon. HD reported earnings of 74 cents compared to estimates of 70 cents. Revenue rose +4% to $18.13 billion compared to estimates of $17.92 billion. HD raised full year guidance to $3.03 per share from the prior $2.95. Revenues are expected to rise about +5.2%.

HD expects to see a $360 million in sales from the Hurricane Sandy damage. They are using the number from Hurricane Irene and Sandy was stronger with more flooding so the actual sales could be higher. The CEO said Q3 results were better than expected as a result of the improvement in the housing market. Customer transactions over $900, which account for about 20% of sales, rose +4.3% during the quarter driven by purchases of appliances, flooring and kitchen equipment.

The company took a charge for closing its stores in China. The DIY (Do it yourself) model never caught on in China where the mindset is DIFM. (Do it for me) China is also a monster referral network where business is done through referrals rather than advertising.

Home Depot Chart

Dow component Microsoft (MSFT) knocked the Dow lower at the open after they announced the surprise departure of Steve Sinofsky. He was the head of the Windows unit and widely expected to replace Steve Ballmer when Steve retires. Sinofsky rescued Microsoft from the Windows Vista failure with a strong Windows 7 release and just two weeks ago released a major upgrade in Windows 8. The 23 year veteran Sinofsky ruled the Windows kingdom with an iron fist and abrasive management style and that may have been a reason for Ballmer to make the change. Ballmer appointed two relative unknowns to replace Sinofsky.

Microsoft shares fell to a 10 month low on the news.

Microsoft Chart

Casino stocks declined after Las Vegas Sands and Genting Singapore reported the lowest gaming revenue in more than 18 months. Slower economic growth and tighter rules are restricting spending by gamblers. The newness of the gambling opportunity may be wearing off and the pain of losing is settling in on the gamblers. Anyone who has been exposed to gambling for any length of time eventually realizes that the house always wins in the end.

Singapore's economy is also slowing with only a +1.5% rise in GDP in 2012 compared to 4.9% in 2011. The industry regulator is also squeezing business by charging local residents $82 every time they enter a casino. That pretty well restricts the walk in traffic. Genting was fined $600,000 in September for reimbursing entry fees through promotions including free tickets to concerts. Las Vegas Sands said gaming revenue declined -28% to $470.8 million. Genting said revenue fell -20% to S$528.4 million. Despite the decline in gaming revenue the Marina Bay Sands recorded a 12% increase in hotel revenue and had a 99.8% occupancy rate for the 2,560 room resort with an average daily rate of $361.

Las Vegas Sands Chart

Gilead Sciences (GILD) held its gains from yesterday after announcing a cure for Hepatitis C. A study in human patients eliminated the virus in 100% of patients tested. The study showed that when added to the standard Hep C medicines it cleared the virus in all 25 patients tested. The one pill, once daily dosage with a 100% success rate is going to be a blockbuster drug for Gilead worth an estimated $5 billion yearly. Abbot Labs also released the results of a study where 87% of 79 patients tested were cured. Bristol Meyers reported results of their test where 94% of patients were cured with their drug. Normally those would be outstanding results but Gilead's 100% success will be hard to beat. Also, the Gilead drug works in four weeks while Abbots takes 12 weeks. Hep C affects more than 170 million people worldwide. If the Gilead drug proves as successful in the field as in trials it could make Hep C the seventh disease to be eradicated like small pox and polio. I would buy any dip on GILD.

Gilead Chart

AMD reported late Tuesday it had hired JP Morgan to explore options, which could include a sale, as the demand for its chips declines. The industry is moving to mobile and away from traditional PCs. Intel is stretching its lead on server chips and AMD is left with products that are obsolete almost as soon as they are released. The only reason AMD exists is to keep Intel from being considered a monopoly. Intel has supported AMD with grants and loans in the past to keep them afloat because it was cheaper than fighting court battles over being a monopoly.

Sources told Reuters the outright sale of the company was not a priority, (as if anyone would actually buy them), but of more importance was the sale of their patent portfolio. AMD later sent an email to Reuters saying AMD was not pursuing a sale of the company at this time. AMD is laying off workers because their cash burn rate is reaching critical levels. Some analysts believe a technology company might buy AMD to gain full control of the chip process for their own products rather than rely on outside vendors, long lead times and questionable quality control.

AMD Chart

There was nothing material to the market on the economic calendar today. The weekly chain store sales rose +0.7% but that report is just noise. The Treasury Budget for October shot up to a shortfall of -$120.0 billion from the +$75 billion in September. The average over the last eight months is a shortfall of about -$70 billion a month. October is the first month in the fiscal year so we are off to a good start on the next deficit. Interest payments accounted for $25 billion of the shortfall. That number will continue rising.

The national debt is roughly $16.4 trillion and should grow to more than $20 trillion over the next four years regardless of what kind of debt/spending deal gets done in relation to the fiscal cliff. That pretty much assures us of further ratings downgrades and higher interest rates once the Fed quits buying all the treasuries. Any "grand bargain" will likely be in the neighborhood of $2 trillion in reduced spending over ten years. That is $200 billion a year and we are running a deficit of -$1.2 trillion a year. That means the deficit will decline to only $1.0 trillion a year. That is a step in the right direction but nowhere close to what is needed to fix the problem. We are headed for financial disaster and nobody in Washington has the guts or the votes to fix it.

For Wednesday the highlight is the FOMC minutes at 2:PM. I don't expect any surprised but you never know.

Economic Calendar

I will try to make this topic as painless as possible. Fiscal cliff. Still there. No progress. Talk is cheap.

Natural gas futures rallied to $3.78 and close to the high for the year on expectations for the first inventory decline of the winter demand cycle when inventories are reported on Thursday. This is much ado about nothing since natural gas inventories are currently at an all time high of 3.929 TCF. There was only a 21 Bcf injection last week and the weather has been cold across much of the country. However, the lack of electricity in much of the Northeast as a result of Sandy could have reduced demand. Gas prices have risen more than 25 cents in the last two days. That is an amazing spike.

Natural Gas Chart

Crude oil declined to $85.27 and remains just over critical support at $85. The headline about the U.S. becoming the largest producer of oil in the world by 2020 has gotten a lot of attention despite its mathematical improbability. The decline today was due to a lowering of demand estimates by the IEA in their monthly update.

Crude prices should be nearing the point where they begin their summer rally but the broader market and the worries over the fiscal cliff could delay the start of that seasonal rally. Should support at $85 break we could easily see a retest of $80 but I seriously doubt there will be any further declines from that level.

We could see some volatility in oil prices later this week because both WTI and Brent futures expire this weekend.

Crude Oil Chart

I warned in the weekend letter the market was likely to weaken as worries over the fiscal cliff and most importantly changes in the capital gains and dividend taxes are discussed. On Monday the markets fought to a draw. Today I was surprised to see them significantly higher intraday but reality returned as we neared the close.

Part of that reality was a further decline by the S&P 500 that took it significantly below the 200-day average at 1381. The 1375 close is a clear break and it suggests we are about to start a new leg down. However, the Cisco earnings could produce a short squeeze at the open. The Nasdaq 100 futures are up +12.50 but the Russell 2000 futures are down -3.50 so we could have a mixed market at the open but the outlook is still for a move lower.

The S&P has broken all the uptrend support and the 200-day average. The next material support is 1265 but there are some stepping stones along the way so buyers could step in at any time if there is any progress on the fiscal cliff discussions.

S&P Chart - Daily

The Dow has clearly broken down and the failure of the 149 point rebound intraday was a very bad omen. Surely there was some worry over the Cisco earnings but the longer term selling trend was still in place. The next material support is 12,500 and the odds are very good it will be tested this week.

Dow Chart - Daily

The Nasdaq failed at soft support at 2900 and should be targeting 2800. The Cisco earnings will probably provide a short squeeze at the open but like the Dow rally today it will likely be sold. There are just too many challenges for the market to mount a material rally. (Famous last words)

I would simply follow the trend rather than try to fight it. I think it is too early to be looking for a buying opportunity.

Nasdaq Chart

The Russell 2000 is also in breakdown mode and significantly under the 200-day average. The next pause point could be 783 but the most likely target is 765. With the Russell futures down -3.50 after the Cisco earnings it suggests there will be selling on Wednesday.

Russell 2000 Chart

I have been telling you I expect the markets to move lower. However, there are a number of analysts making comments after today's close saying we are close to a bottom. They are saying a further drop to S&P 1355 or 1335 would be a launch point for a year-end rally. Personally I believe it is too early to be thinking year-end rally when the fiscal cliff battles have yet to be fought. Politicians are just now getting around to establishing their positions and are weeks away from a potential resolution. I suppose it could happen sooner but it would be the equivalent of Moses parting the Red Sea. You can't get 600 senators and representatives and a victorious president to come together for a tent revival on the White House lawn just because the market has lost a few hundred points. Positions, guidelines and talking points established in the coming weeks will be the battle lines for the next four years. It is not going to happen overnight.

I would be cautious of any rebounds until there is something concrete to celebrate.

Until then, enter passively, exit aggressively!

Jim Brown

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New Option Plays

REITs and Casinos

by James Brown

Click here to email James Brown


Avalonbay Communities - AVB - close: 130.32 change: -0.84

Stop Loss: 132.05
Target(s): 121.50
Current Option Gain/Loss: Unopened
Time Frame: 4 to 6 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
High dividend stocks could see continued selling pressure as investors choose to exit positions now in 2012 before taxes go up in 2013. Combine that with the market's general downward trend and AVB could be in trouble. Shares are testing support at the $130 level.

I am suggesting a trigger to buy puts at $129.75 with a stop loss at $132.05. Our target is $121.50. I will point out that the lows back in February 2012 were in the $129.60-129.25 range. Readers may want to wait for a drop below $129.25 as an alternative entry point.

Trigger @ 129.75

- Suggested Positions -

buy the DEC $125 PUT (AVB1222x125) current ask $1.40

Annotated Chart:

Entry on November xx at $ xx.xx
Average Daily Volume = 593 thousand
Listed on November 13, 2012

Las Vegas Sands - LVS - close: 42.51 change: -0.95

Stop Loss: 44.05
Target(s): 36.50
Current Option Gain/Loss: Unopened
Time Frame: 4 to 8 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
Asian properties have been the main source of new revenues for many of the casino companies in recent years. Locations like Macau and Singapore have been driving growth. There was a Bloomberg article out recently that said Singapore casinos appear to be slowing down as the country's economy contracts. LVS said their Singapore property just reported their lowest levels of gambling revenues in 18 months.

Shares of LVS looks poised for more declines now that the oversold bounce from Friday has failed. Friday's low was $42.35. I am suggesting a trigger to buy puts at $42.25. Our target is $36.50 but more conservative traders may want to exit in the $38.50-38.00 area.

Trigger @ 42.25

- Suggested Positions -

buy the DEC $40 PUT (LVS1222x40) current ask $0.94

- or -

buy the 2013 Jan $40 PUT (LVS1319m40) current ask $1.52

Annotated Chart:

Entry on November xx at $ xx.xx
Average Daily Volume = 6.4 million
Listed on November 13, 2012

In Play Updates and Reviews

The Midday Bounce Fails

by James Brown

Click here to email James Brown

Editor's Note:

The U.S. market's midday bounce has failed with stocks rolling over this afternoon and closing near their lows.

Our MELI trade has been triggered. We are adjusting our strategy on MOS based on the company's bearish guidance tonight.

Current Portfolio:

CALL Play Updates

American Tower Corp. - AMT - close: 74.23 change: -0.51

Stop Loss: 73.95
Target(s): 79.85
Current Option Gain/Loss: Unopened
Time Frame: 3 to 6 weeks
New Positions: Yes, see below

11/13/12: The sideways churn in AMT continues. If we see AMT close under $74 I am likely to drop it as a candidate.

Earlier Comments:
The early October high was $76.22. I am suggesting a trigger to buy calls at $76.25. Our target is $79.85. More aggressive traders could aim higher.

Trigger @ 76.25

- Suggested Positions -

buy the DEC $77.50 call (AMT1222L77.5)

Entry on November xx at $ xx.xx
Average Daily Volume = 2.3 million
Listed on November 7, 2012

Nu Skin Enterprises. - NUS - close: 46.11 change: -0.97

Stop Loss: 45.45
Target(s): 54.00
Current Option Gain/Loss: Unopened
Time Frame: 3 to 6 weeks
New Positions: Yes, see below

11/13/12: NUS came close but did not hit our trigger today. The late morning rally reversed at the $47.50 level. Shares actually underperformed the market with a -2.0% drop for the day.

Earlier Comments:
If the stock continues to climb it could spark another short squeeze. The most recent data listed short interest at 20% of the 50.7 million share float. Due to NUS' volatility I am suggesting we keep our position size small to limit our risk. We do not know what sort of headlines might emerge from NUS' annual investor day on November 14th (this Wednesday). I am suggesting a trigger to buy calls at $47.60. FYI: The Point & Figure chart for NUS is bullish with a $65 target.

Trigger @ 47.60 *Small Positions*

- Suggested Positions -

buy the DEC $50 call (NUS1222L50)

Entry on November xx at $ xx.xx
Average Daily Volume = 1.2 million
Listed on November 12, 2012

PUT Play Updates

Carpenter Tech. - CRS - close: 47.62 change: -0.91

Stop Loss: 50.05
Target(s): 42.50
Current Option Gain/Loss: - 4.3%
Time Frame: 3 to 6 weeks
New Positions: see below

11/13/12: CRS gave back a good chunk of yesterday's gains. The intraday bounce attempt rolled over underneath the simple 10-dma.

Earlier Comments:
Our multi-week target is $42.50. CRS can be somewhat volatile so readers may want to limit their position size to reduce risk.

- Suggested Positions -

Long Dec $45 PUT (CRS1222x45) Entry $1.15

Entry on November 12 at $48.23
Average Daily Volume = 460 thousand
Listed on November 10, 2012

Dow Jones Industrial Average (ETF) - DIA - close: 127.53 change: -0.51

Stop Loss: 130.15
Target(s): 125.25
Current Option Gain/Loss: + 6.7%
Time Frame: 3 to 4 weeks
New Positions: see below

11/13/12: The DIA's intraday bounce failed and shares look poised to hit new relative lows soon. I am lowering our stop loss to $130.15.

- Suggested Positions -

long DEC $125 PUT (DIA1222x125) entry $1.79

11/13/12 new stop loss @ 130.15
11/08/12 new stop loss @ 130.60

Entry on November 08 at $129.18
Average Daily Volume = 5.3 million
Listed on November 7, 2012

iShares Russell 2000 ETF - IWM - close: 78.70 change: -0.45

Stop Loss: 81.05
Target(s): 75.50
Current Option Gain/Loss: + 5.2%
Time Frame: 4 to 6 weeks
New Positions: see below

11/13/12: We see a similar performance here in IWM. The market's morning rally reversed and the IWM closed near its lows for the session. I am lowering our stop loss to $81.05.

- Suggested Positions -

Long 2013 Jan $75 PUT (IWM1319m75) entry $1.53

11/13/12 new stop loss @ 81.05

Entry on November 08 at $79.85
Average Daily Volume = 36 million
Listed on November 7, 2012

Lufkin Industries - LUFK - close: 50.19 change: +0.64

Stop Loss: 51.85
Target(s): 45.15
Current Option Gain/Loss: -43.3%
Time Frame: 3 to 4 weeks
New Positions: see below

11/13/12: I do not see any news to account for LUFK's relative strength today. Shares outperformed the market with a +1.2% gain. Bears can argue that the rally failed near its descending 10-dma. Bulls can argue that today has created a bullish engulfing candlestick reversal pattern. The larger pattern remains bearish but I am not suggesting new positions at this time.

- Suggested Positions -

Long DEC $45 PUT (LUFK1222x45) entry $1.50

Entry on November 09 at $48.95
Average Daily Volume = 467 thousand
Listed on November 8, 2012

Mercadolibre - MELI - close: 73.91 change: -1.15

Stop Loss: 77.75
Target(s): 70.25
Current Option Gain/Loss: + 3.6%
Time Frame: 3 to 6 weeks
New Positions: see below

11/13/12: MELI gapped open lower at $74.56 this morning. That was below our trigger at $74.75 and immediately triggered our play. Shares bounced back this afternoon but started to roll over under what should be new resistance at the $75.00 mark.

Earlier Comments:
I do consider this a higher-risk trade. MELI can be volatile and is arguably already oversold with a four-week decline. Of course stocks can always get more oversold.

Trigger @ 74.75

- Suggested *Small* Positions -

Long DEC $72.50 PUT (MELI1222x72.5) entry $2.75

11/13/12 play triggered on gap down at $74.56. suggested trigger was $74.75

Entry on November 13 at $74.56
Average Daily Volume = 603 thousand
Listed on November 12, 2012

The Mosaic Co. - MOS - close: 50.75 change: -0.38

Stop Loss: 52.75
Target(s): 49.00
Current Option Gain/Loss: +61.5%
Time Frame: 3 to 6 weeks
New Positions: see below

11/13/12: Good news! MOS continues to weaken and shares are nearing our target. Plus, there is even better news if you're holding puts. Tonight after the closing bell MOS has lowered its Q2 production guidance due to weaker international demand. The stock was trading lower after hours near $48.50. Shares of MOS are likely to gap open lower tomorrow morning.

Previously I suggested we exit at $50.25. Based on tonight's headlines I am moving our exit target down to $49.00. We'll adjust the stop loss down to $52.75. Keep in mind if something happens and MOS does not hit our target we need to exit before November options expire after Friday.

- Suggested Positions -

Long NOV $55 PUT (MOS1217w55) entry $2.60

11/13/12 MOS has lowered guidance, adjust exit target to $49.00 and stop loss to $52.75
11/12/12 adjust target to $50.25
10/27/12 new stop loss @ 54.25
10/23/12 triggered @ 53.45

Entry on October 23 at $53.45
Average Daily Volume = 3.9 million
Listed on October 20, 2012

Vornado Realty - VNO - close: 75.54 change: -0.55

Stop Loss: 80.15
Target(s): 72.50
Current Option Gain/Loss: Dec75p: + 7.1% & 2013Jan$75p: + 7.8%
Time Frame: 3 to 6 weeks
New Positions: see below

11/13/12: VNO continues to sink and shares are now down five days in a row. I want to warn readers that VNO is short-term oversold and will likely see a bit of a bounce off the $75.00 level. Broken support at $78, $79 and $80 should all offer some overhead resistance. I am not suggesting new positions at this time.

- Suggested Positions -

Long DEC $75 PUT (VNO1222x75) entry $1.40*

- or -

Long 2013 Jan $75 PUT (VNO1319m75) entry $1.90*

11/12/12 trade opened on gap down at $76.89
*option entry price is an estimate since the option did not trade at the time our play was opened.

Entry on November 12 at $76.89
Average Daily Volume = 1.1 million
Listed on November 10, 2012