Option Investor

Daily Newsletter, Saturday, 9/17/2016

Table of Contents

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

Market Wrap

All Quiet

by Jim Brown

Click here to email Jim Brown

Quadruple witching Friday was quiet but ships can still sink in a calm sea.

Weekly Statistics

Friday Statistics

The markets gapped lower at the open and the Dow declined -140 at the lows. However, once those morning lows were reached, the markets moved quietly sideways the rest of the day. The last hour saw a sharp increase in volume as option positions were settled, the S&P rebalanced and a new S&P sector created for REITs. These events caused volume to spike from 6.7 billion shares on Thursday to 9.6 billion shares on Friday. Internals were 3:1 decliners over advancers but the indexes other than the Dow, remained relatively flat.

The Biotech Index was the exception with a -2.3% decline when the rest of the indexes were only down an average -0.35%. Pushing the sector lower was disappointing news from Novavax (NVAX) on a phase 3 trial. The company said the 3 Resolve trial on an experimental RSV F vaccine "did not demonstrate vaccine efficacy" in the prevention of a lower respiratory tract disease. The trial covered 11,850 patients. In the earlier trials, the RSV vaccine had shown a significant decrease in respiratory illness. In the 3 Resolve trial, the patients receiving the vaccine instead of a placebo actually had a higher incidence of infection.

Shares of NVAX crashed -85% because the drug was expected to generate $6 to $8 billion. Now those hopes have been crushed.

On the economic front, the Consumer Price Index (CPI) rose +0.2% in August and that lifted the chance of a Fed rate hike next week from 12% to 15%. Rising inflation towards the Fed's target of 2.0% is a key metric. The consensus was for a gain of +0.1% after a zero gain in July. The core CPI, excluding food and energy, rose +0.3%.

The headline CPI is now up +1.1% year over year and the core CPI is now up +2.3% and the Fed will be taking notice. This will be a heavily discussed topic at next week's Fed meeting.

Helping to push the headline CPI higher was a +2.9% rise in utility bills. Food prices were unchanged overall but food prices at home declined. Meats, poultry and eggs fell -0.4%, nonalcoholic beverages declined -0.1% and "other" food fell -0.2%. Food away from home rose +0.2%.

One major problem area was medical costs. Medical care costs rose +1.0% and the largest monthly gain since 1982. Medical care services rose +0.9% after a +0.5% rise in July. Hospital services rose +1.7% after a +0.4% increase in July. Physician services rose +0.7% for the second consecutive month and medical care commodity prices rose +1.1% after a +0.4% rise in July. The Affordable Care Act has proven not to be affordable.

The futures probability for a rate hike next week rose from 12% on Thursday back to 15% on Friday. That means there is an 85% chance they will not hike rates. If they did hike with probability that high, the market would decline significantly. The market has almost completely priced out the potential for a rate hike. Meanwhile the odds of a December rate hike have risen to 56.5%

Consumer sentiment for September was unchanged at 89.8 and only -0.2 below the July reading. That means sentiment has been practically unchanged for three months after a high of 94.7 in May. However, the internal components shifted dramatically. The present conditions component declined from 107.0 to 103.5 and the lowest level since October while the expectations component rose from 78.7 to 81.1. Fewer people said it was a good time to buy a car or other major household item.

I believe this is the impact of the political contest. With the mudslinging in high gear and the candidates talking about how bad things are, the consumer is starting to believe them.

The calendar for next week is of course headlined by the Fed announcement and the Yellen press conference. While the Fed is not expected to raise rates, Yellen may point directly at the December meeting as a likely target. If she begins preparing the markets this far in advance, the impact should be minimal.

Of almost equal importance this week is the Japanese monetary policy update at 1:AM on Wednesday. The BoJ is expected to take some kind of policy action. Analysts speculate they will cut interest rates again and push rates farther into negative territory. They are also expected to adjust the asset purchase program, possibly adding more stock and ETF purchases. They are also likely to change their bond purchases by adjusting the duration of securities it will purchase. Some analysts believe they will stop buying long dated bonds, therefore allowing long rates to rise while short-term rates continue to be negative.

The BoJ promised a major report on the direction of monetary policy at this meeting and analysts have been speculating for weeks what that could reveal. Like the ECB the BoJ is running out of bonds to buy. They have already acquired the majority of securities in the market.

The ECB said it was going to maintain the status quo and not increase its QE program. If the BoJ announces the same watch and wait strategy, it will enforce the idea that central banks have run out of ammunition and ideas and it could be market negative.

If the overseas central banks have reached the end of their policy cycle while the Fed is prepared to begin hiking rates, it could upset the risk parity trade, where investors have allocated so much money for equities and so much for bonds with the idea they will balance each other out. If bonds begin selling off in volume, it could upset those ratios and upset the equity market.

The following week we will get the last revision to the Q2 GDP, which was at +1.1% growth in the August revision. The Q2 number is not expected to post a material change. However, the Q3 GDP estimates are suddenly falling sharply after a couple weeks of negative economic data.

In early August, the Atlanta Fed real time GDPNow was predicting +3.8% growth for Q3. That has fallen to +3.0% but the rate of decline is accelerating. This is another reason the Fed would have trouble hiking rates in September. They need to see if this trend is going to continue. The Fed has never hiked rates, until last December, with the GDP below 3.5% growth. With our current growth at +1.1% the data demands no rate hike or the Fed would lose what little credibility it currently has.

UnitedHealth (UNH) shares spiked nearly $3 after the Obama administration told insurers they would not be reimbursed for the billions in 2015 losses. This was expected. However, the Dept of Health and Human Services (HHS) invited insurers to join in lawsuits against the government in order to win future financial settlements over the failure to pay. That is the first time I can remember that one department of government recommended suing another in hopes of financial gain.

The HHS memo confirmed that any funds collected by the government would first be used to shrink the $2.5 billion insurance shortfall from 2014 and no funds would be available for repayment of 2015 losses. The "risk corridor" program was designed to transfer funds from insurers that made money from Obamacare to insurers that lost money under the program. Any "excess profits" of more than 3% of premiums paid were to be paid in to the government to be distributed to other insurers with "excessive losses" of more than 3%. This is the third and final year of the risk corridor program and that is why the majority of insurers have dropped out of the Obamacare program.

The insurance program is a failure because the younger, healthier consumers failed to sign up, and older, sicker consumers signed up but could not pay and the insurers ended up with much higher costs. For 2014, the excess profits paid into the government were just $362 million while the excess losses were more than $2.9 billion. It is widely known that losses were even higher in 2015 but the government has not released the numbers because it would be a further admittance the program was failing. The 2016 calendar year is expected to be even worse. With no excess profits to compensate for excess losses, the insurers are fleeing the program like rats from a sinking ship.

The suggestion by DHS that insurers sue the government for their losses caused stocks in the sector to spike on Friday.

This is the text of that specific section of the memo from HHS.

We know that a number of issuers have sued in federal court seeking to obtain the risk corridors amounts that have not been paid to date. As in any lawsuit, the Department of Justice is vigorously defending those claims on behalf of the United States. However, as in all cases where there is litigation risk, we are open to discussing resolution of those claims. We are willing to begin such discussions at any time." In other words, sue us, then we will settle with you out of a different bank account called the Government Judgment Fund. And, "HHS recognizes that the Affordable Care Act requires the Secretary to make full payments to issuers. HHS will record risk corridors payments due as an obligation of the United States Government for which full payment is required." The key here is that Congress must authorize the funding and it has been specifically cut off since it was a side deal the president made with insurers after Obamacare was passed and signed into law.

Twitter (TWTR) shares rallied 4.4% after their first NFL live-stream broadcast on Thursday night. There was an average of 243,000 Twitter viewers throughout the broadcast and that was only a fraction of the 15.7 million people that watched on TV. Some 2.3 million Twitter viewers clicked in for a few seconds, probably to see what the fuss was about, but many left almost immediately. The average Twitter viewing time was 22 minutes.

The actual reviews were actually good but most said it was unlikely they would ever watch more than a few minutes on Twitter because of the screen size on the mobile phone and the lag time, which some said was 30 seconds or more. There were many complaints about the pause to "buffer" before the transmission could continue. These are all growing pains for the Twitter effort to become more relevant.

The problem for Twitter is that the 2.3 million unique viewers is now a benchmark that future NFL streams will be weighed against. If over the next several weeks that number declines on a weekly basis, the positive hype surrounding the effort will quickly turn into a death knell as analysts predict the end of streaming.

Deutsche Bank (DB) was hammered after the U.S. Justice Dept asked the bank to pay $14 billion in fines over the subprime mortgage disaster in 2008. The bank was expecting a fine of $2.0 to $3.0 billion. The bank already paid $1.9 billion in 2013 to settle similar claims. They said they "have no intent to settle these potential civil claims anywhere near the number cited." DB said the negotiations have just begun and they are sure the eventual settlement will be more in the range of settlements with other banks.

Unfortunately, for DB there have been some whopper settlements. With the EU taxing authority asking for $14 billion in back taxes from Apple, there may have been a little payback in the number requested from DB.

Aug 2014, $16.6 billion, Bank of America
Nov 2013, $13.0 billion, JP Morgan
Jul 2014, $7.0 billion, Citigroup
Apr 2016, $5.1 billion, Goldman Sachs
Feb 2016, $2.6 billion, Morgan Stanley
Feb 2016, $1.2 billion, Wells Fargo

Dow component Intel (INTC) raised its Q3 revenue guidance to $15.6 billion give or take $300 million. That compares to the prior guidance of $14.9 billion give or take $500 million. The company said they underestimated PC demand. Gross margin is expected to be 62%, up 2% from the prior estimate. R&D is expected to rise $100 million to $5.2 billion and the Q3 tax rate at 22%. They made the announcement on Friday because their quiet period before Q3 earnings on Oct 18th began at the close on Friday. Shares spiked 3% on the news.

Citigroup (C) shares were down slightly after Goldman Sachs cut the bank from buy to neutral and removed it from the focus list. Goldman said Citi's earnings failed to materialize and the 7.7% return on equity was well below management's 10% target. "We do not see a path to meaningful inflection without an improvement in the macro environment." Goldman said Citi's capital returns may be prohibited under the 2017 stress test rules.

The market would be in a different place this weekend were it not for Apple (AAPL). Monday's low was $102.53 and shares hit $116.13 on Thursday. That was worth approximately +108 Dow points and it is the largest weighting in the Nasdaq 100 at 14.6% and responsible for 41 points of the +172 point rebound from Monday's lows.

Not only did Apple rock the indexes but the stocks in the Apple food chain were also up strongly. AVGO, SWKS, QRVO, NXPI, QCOM and CRUS were all up on expectations for higher sales. That powered a strong rebound in the Semiconductor Index to a new high at Friday's open.

Without the gains from Apple and its suppliers, the markets would probably have closed significantly lower for the week. Instead the Dow closed with a minor +0.2% gain for the week while the Nasdaq 100 gained a whopping +2.9% along with a +2.3% gain in the Nasdaq Composite.

Amazon (AMZN) garnered some upgrades on Friday. Evercore raised their price target to $1,015 and the highest on the street but RBC Capital Markets was right behind them at $1,000. RBC said an independent survey found that Amazon likely had 60 million Prime accounts. They also said Amazon had sold more than 7 million Echo devices powered by their Alexa Voice Service. In their survey, many homes with an Echo had more than one. Even with that market penetration, they have only scratched the surface. Recently in a discussion with hedge fund managers, the common assumption was a double in Amazon's share price over the next three years.

Another new product Amazon is pushing is the "Dash Button." This is a WiFi enabled button you can get for almost any product you can buy at Amazon. In the example graphic below, there is a Dash button for Tide laundry detergent. You place the button on or around the washing machine using the self-adhesive backing. When you are about to run out of Tide you push the button. The button communicates with Amazon over WiFi and two days later Tide arrives on your doorstep courtesy of Amazon Prime free shipping. The button is programmed when you receive it through an Android or Apple smartphone. You tell it which product/quantity you want whenever the button is pushed and then place it in an appropriate location. I am amazed at the gimmicks Amazon comes up with to further hook you as a permanent Prime customer. The button costs $4.99 to buy but the first time you use it you will receive a $4.99 credit so basically it is free.

This will be so handy that millions of Amazon customers will order buttons for things they would normally buy at the local grocery store. Having a button means no shopping list, fewer bags to carry in from the store and probably fewer trips to the store. Need more coffee, toilet paper, Red Bull, trash bags, kitty litter? Push the button. Amazon Page

I have no doubt Amazon shares will reach $1,000. It is only a matter of time.

Tesla shares may have found a new bottom at $195 after Elon Musk said a new version of the Autopilot will be available next Wednesday. The new software will rely more on radar than on cameras in order to help the software "see" what is going on around the car and better avoid collisions. Radar was added to the cars in 2014 but it was initially supposed to supplement the cameras. There will also be a driver penalty for failing to obey the commands to take control of the wheel. If a driver repeatedly ignores those commands, the car will park itself and the driver will have to restart it in order to engage the "Autosteer" mode again. Musk said, while the update will make the autopilot much safer it does not mean "perfect safety." "Perfect safety is really an impossible goal."

Abbott Labs (ABT) shares rallied 2% after the company said Johnson & Johnson (JNJ) was buying its medical optics unit for $4.325 billion in cash. That unit was responsible for just over 5% of Abbott's revenues in 2015. This will include ophthalmic products in the company's cataract surgery, laser refractive surgery and consumer eye health segments.

Gilead Sciences (GILD) may finally be ready to go on a shopping spree. They are selling $5 billion in debt that will close on the 20th. Jefferies pointed out that unlike prior debt deals the prospectus added the words "future acquisitions" to the phrase regarding the use of the funds. The "general corporate purposes" language was enhanced. In prior debt deals, there was no reference to acquisitions. After the debt sale is concluded next week, the company will have $29.5 billion in cash on hand and its outstanding debt will rise from $22 billion to $27 billion. Analysts are now suggesting Gilead may not do just one acquisition but potentially several acquisitions to really beef up their future drug portfolio. Gilead is scheduled to announce the results from nine clinical trials over the next three months. Companies mentioned as potential Gilead targets include CLVS TSO VRTX and KITE. Clovis would be my bet.

Real estate is now the 11th S&P sector. REITS and real estate companies have been removed from their prior home in the Financial Sector and given a home of their own. For the Global Industry Classification Standard (GICS) this is the biggest event in 15 years. The flurry of new REITS over the last several years has been strong enough to warrant their own classification and it will be a dividend producing beauty. The stocks in the sector will hold trillions of dollars in real estate and their market cap is in excess of $900 billion. The last GICS change in 2001 allowed REITs to be included in the S&P indexes. The S&P indexes now include more than 90 REITs with 26 included in the S&P-500. Analysts believe the sector could see new investments of as much as $30 to $100 billion because of the new focus. A quick review of several REIT charts found that nearly all had been in sharp decline over the last week. I am using Digital Realty (DLR) in the chart below.

Netflix (NFLX) was sued by Twenty-First Century Fox (FOXA) for illegally hiring two of its employees while they were still under contract with Fox. The two employees were a former drama-programming executive and a film promotion executive. A Netflix spokesman released this comment. "We intend to defend this lawsuit vigorously. We do not believe Fox's use of fixed term employment contracts in this manner are enforceable. We believe in employment mobility and will fight for the right to hire great colleagues no matter where they work." Netflix shares were up $2 on Friday but the news did not break until just before the closing bell.

Oil prices declined on Friday as OPEC production increased. Exports from Nigeria and Libya are increasing now that internal problems in those countries are fading. Libya lifted the force majeure from its main port after the military seized the port from rebel control. In Nigeria, Exxon is preparing to export Qua Lboe crude for the first time in months with the first cargo to load next week.

Earlier in the week, the IEA reduced its forecast for demand growth by -100,000 bpd for 2016 and -200,000 bpd in 2017. The agency said a supply glut could continue through the first half of 2017.

The Algerian energy conference will be Mon-Wed starting on the 26th and some OPEC countries have agreed to meet unofficially on the sidelines to discuss a production freeze. The result of this meeting will provide for direction to Russia and Saudi Arabia when they meet at the end of October. The official OPEC production meeting is not until Nov 5th.

Analysts are starting to talk about oil in the $30s again but it is just speculation at this point.

Baker Hughes pointed out that more than 100 active rigs have been reactivated since May. While that is encouraging the total today is only 506. We would have to reactivate more than 1,425 additional rigs to return to the 1,931 peak from August 2014. Everything is relative.




The Dow did not make a 1% move on Friday but it came close when it was down -140 points at the lows. The Dow and S&P are exhibiting extreme volatility with the last six days of dramatic movement. The S&P is now stuck under resistance at 2,150, which was support for the prior 8 weeks. The 2,120 level is now support and a breakdown there should find additional support at 2,100.

The Dow and S&P both have lower high patterns but until they make a lower low, it is just consolidation. Typically, the market is positive on the day before a Fed announcement. However, the last two months have been anything but typical. With the chances for a rate hike at only 15% the market "should" ignore the risk and continue the historical trend. However, investors are very nervous about the market. The number of high profile hedge fund managers coming out with market warnings in recent could keep retail investors on the sidelines.

The market is approaching an inflection point. Next week is the fifth week of the most volatile six-week period in the year. If negative volatility does not appear next week, it probably will not appear the week after either.

Fund managers are looking for a serious dip to buy stocks for their October 31st fiscal year end window dressing. They typically do that in the middle of October. If a decline does not appear this week, they may accelerate those buys and the normal end of October rally could start early.

As long as the S&P remains above 2,100 next week, that could be a signal there will be no further selling and the funds could begin buying stocks.

The Dow has a similar level of new support at 18,000. Despite the big gains by Apple last week the Dow only managed to gain 38 points for the week but the highlight is that 18,000 did not break. As long as we can say that same thing next weekend, we should begin to see positive moves.

There is not likely to be any headlines moving Dow stocks next week but anything is always possible. We were not expecting the guidance upgrade from Intel but it appeared.

The Nasdaq 100 big cap index ($NDX) is only 13 points from a new closing high over 4,831 thanks to Apple and the chip stocks. Any continued gains by the Apple gang could push the index to a breakout and that would be positive for market sentiment. At this point, it would be a good bet that any October rally will be led by tech stocks because funds will be adding those stocks that have performed the best in order to dress up their portfolios.

The Nasdaq Composite Index is 39 points below its closing high at 5,283. The composite index is dragging a lot of dead wood along with it but it could still make a new high if the Apple gang continues to post gains.

The biotech sector was a major drag with a -2.3% decline on Friday. However, the sector was up +1.3% for the week in spite of Friday's loss. Biotechs are probably the main reason the composite index did not keep up with the Nasdaq 100.

The Nasdaq has been rising all week so it does not have the clear support line that we see on the Dow and S&P. With the index back over 5,200 it does bring that prior support back into play.

On the Russell 2000, the strong pattern of gains over the last two months finally broke but the support at 1,205 held on the initial dip and the index did not retest the August lows at 1,200. This is strong for sentiment and we need that 1200-1205 range to continue to hold until the broader market turns positive. This may be the only dip fund managers are going to get so any light weakness next week could be bought.

This is important. All the major indexes closed down on Friday with the Dow down -140 at the lows. However, the Volatility Index ($VIX) declined -6% suggesting nobody was worried about a further market drop. The VIX is calculated on the price for puts on the S&P. Put prices rise when there is a lot of demand and decline when demand drops. A declining VIX means limited demand for puts and is bullish for market sentiment.

With time expiring on the worst six week period of the year and the markets failing to extend the losses from the prior Friday, I am borderline bullish for the next two weeks. We still have to cross over the Fed announcement pothole on Wednesday and then hang on for another week or so but the lack of a material decline during this period is market positive.

There is one more hurdle we have to cross and that is the first presidential debate on the following Monday. That is a wildcard for the markets and you never know what will be said and how the market will react. That is especially true this election season.

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Random Thoughts

Bearish sentiment spiked a whopping +7.4% with a lot of neutral investors suddenly turning bearish. The bulls are shrinking as heightened volatility tends to turn people cautious.

At the Delivering Alpha hedge fund conference last week there was an abundance of negativity and most of it revolved around negative rates and the end of the debt cycle. Hedge heads were unanimous that negative rates were a serious danger and without a return to normal soon, there would be a monster bubble that could destroy the global markets.

Former Treasury Secretary Tim Geithner called the market "dangerous" and "scary." "I think the scarier things are really about politics, the scary erosion of the pragmatic center in politics, the diminished capacity to make sensible economic choices, something governments really have to do."

Carl Icahn said, "You look at the environment, and I think it's very dangerous. You're walking on a ledge and you might make it to the end, but you fall of that ledge and you're really going to see trouble."

Ray Dalio said he saw a "dangerous situation" in the debt markets. "There's only so much you can squeeze out of the debt cycle, and we're there globally. You can't lower interest rates more."

Paul Singer said, "I think it's a very dangerous time in the global economy and global financial markets."

Goldman Sachs Peter Oppenheimer warned that staying invested in stocks and bonds is an "unacceptable risk." He recommended selling bonds, the S&P-500 and Europe's Stoxx 600 "due to elevated valuations across assets and the risk of shocks."

"We see strong positioning, headwinds from the resumption of the Fed rate hike cycle and a strong dollar, and increasing political uncertainty into the U.S. elections."

Given the many bad market calls from Goldman Sachs over the last two years, this could be a contrarian indicator leading to a market rise.

Will the last employee out please turn off the lights. On Friday, Sears Holdings, which owns Kmart as well, informed employees in 13 states their stores would be closed in December. They will begin liquidation sales on September 22nd. One newspaper said a total of 60 stores would be closed.

Separately, Seritage Growth Properties, a REIT that owns 235 Sears and Kmart stores, revealed in a SEC filing that Sears had given notice of termination for leases on 17 Kmart stores.

Sears previously announced the decision to close 80 stores starting in July. Kmart operates about 870 stores today, down from 1,300 in 2012.

Moody's warned earlier in the week that Sears and Kmart do not have enough cash to stay in business. Moody's said the company was bleeding cash and would have to continue relying on real estate sales, sales of assets or outside funding to sustain operations. Moody's estimated their cash burn was $1.5 billion a year. In August, Sears reported cash on hand of only $276 million and not near enough to buy inventory for the holiday shopping season.

In Q2, sales fell -8.8% to $5.7 billion. Same store sales for Sears fell -7% and -3.3% for Kmart.

In 2000, Sears had sales of $41 billion a year. That declined to $15 billion in 2015. Over the same period Kmart sales have fallen from $37 billion to $10 billion. Sears has funded debt of $3.5 billion and unfunded pension liabilities of $2.1 billion. The company's minimum pension contributions for 2016-2017 are $596 million and nearly twice the cash on hand.

Shoppers claim when they do go to a Sears store they have to beg them to take their money. Many report wandering around the floor for a long time just trying to find a sales person to handle their sales. Other say they have quit going back because the shelves are bare and the merchandise they do have has been picked over so much there is nothing left but scraps.

Shoppers at Kmarts claim the store has been using sheets and shower curtains to hide empty shelves and closed departments.

Empty Sears store in Richmond Virginia. Center shelves have been removed instead of sitting empty.

A 58-year-old warehouse worker in Scotland took a picture that is believed to be a new photo of the Loch Ness Monster. The Loch has been searched repeatedly using every technology known to man but no signs of a monster creature have ever been found. Still, these pictures continue to surface periodically and at least this one is clear and in focus.


Enter passively and exit aggressively!

Jim Brown

Send Jim an email


"The greatness of a man is not how much wealth he acquires, but in his integrity and his ability to affect those around him positively."

Bob Marley

Index Wrap

Counting Down the Days

by Jim Brown

Click here to email Jim Brown
Traders are counting down the days until the worst six weeks are over.

Monday will be the start of the fifth week of the most volatile six-week period of the year. Everyone is holding their breath either hoping there is a bigger drop that provides a buying opportunity or hoping there is no drop and their current long positions are safe.

With the Fed announcement and the BoJ announcement next Wednesday that is likely to be a major hurdle for investors. Once past Wednesday there are only 7 trading sessions left in the volatile six-week period.

Obviously, that is not a hard and fast date and the volatility could end at any time or continue through the election. For fund managers that latter option would be scarier than the Exorcist. They want the dip to occur next week and then they want clear sailing until their fiscal year end on October 31st. Unfortunately, we rarely get what we want. I want to win Power Ball but that is hard to do without buying a ticket.

The market is behaving rather well. Other than the Dow, S&P and Russell 3000 the rest of the indexes are maintaining their upward bias. The broad market Russell 3000 has an identical chart to the Dow. The big drop on the 9th followed by five days of strong volatility. The R3K should be viewed as "the market" rather than the Dow but that would be hard to convince most investors. This is the 3,000 largest stocks in the market and any stock not in the R3K is miniscule and not relative to the overall market.

The fact the R3K has not broken below support at 1,250 is bullish. This suggests the market is not going lower in the limited time we have left in the normally volatile period. Obviously, a major drop can still occur just like it did last week but after a week of trying to push stocks lower the bears may have run out of conviction.

On a shorter term scale the Dow remains in a downtrend with a series of lower highs. However, the support at 18,000 is solid. One more good test next week, that produces another strong +200 point rebound, would be the ideal portfolio manager buy signal. Conversely, a break below 18,000 would be very negative and could suggest a much lower low.

The small cap S&P-600 had been leading the market higher. The pattern on this short term chart is a textbook picture of a lackluster rebound from strong support after a sharp decline. In theory, these patterns break to the downside after the dip buyers begin to fade when the rebound slows. However, the index was down only slightly on Friday and there is the possibility that multiple test of support across five days was sufficient to bring buyers back into the market. Time will tell.

Another successful dip to support followed by a rebound back to 740 would be the perfect picture of a conviction retest and would suggest a continued rally.

We did see a correlation tumble last week when bonds and treasuries sold off. The High Yield ETF rolled over and that weakened the market momentum. If the HYG continues to decline it could drag the market with it. The correlation is normally very strong with the HYG as the leader.

The cumulative advance-decline line on the S&P has begun to weaken. The MACD rolled over in late July after the initial market spike to the 2,100 level on the S&P. Since then it has been a fight to hold that level. If the AD line drops below the 3475 level from last week, we could see some institutional investors begin to head for the sidelines.

The same AD chart for the Dow shows a two-month low last week and a decided lack of momentum. The Dow appears ready to roll over and break below the 18,000 level if you measure its strength by the AD ratio. You need more advancers than decliners to maintain a bullish market and that ratio is slipping.

The percentage of S&P stocks over their 200-day average fell to 71.8% but that is still bullish as long as the decline does not accelerate. Of greater concern is the dramatic decline for stocks over their 50-day average. The percentage fell from 87.4% in late July to 29.8% at the low last week. This is a short-term representation of the direction of the market. The shorter-term average overshot the price and many stocks are now generating sell signals as they cross below that average.

We talk a lot about the health of the global economy. The global equity market is also a concern. The Dow Global Index had broken above resistance in late July but fell back to that level last week. A decline below Friday's close would be negative.

The biotech sector is struggling. The prior week it was drug-pricing headlines. Last week it was failing drug trials. The Novavax trial news on Friday threw a wet blanket over all the drug research companies. I thought the $BTK was going to break out on Thursday when it closed over 3,400. Friday was a setback but it could be short lived with the Gilead Sciences news and expectations for them to go on a shopping binge. If the BTK can rebound to close well over 3,400 again, it could breakout and help lift the Nasdaq to a new high and that would be very positive for market sentiment.

The Nasdaq was hit the prior week by negativity ahead of Apple's iPhone announcement. The chip stocks that supply Apple were leading the $SOX lower and that was dragging the Nasdaq lower. The instant turnaround from the news of the iPhone sales was dramatic. The correlation remains intact and both indexes closed just under new highs.

I am neutral on the market for Monday. The Tuesday before a Fed announcement is normally positive. The day of the announcement is mixed with higher volatility. The day after the announcement is normally when the market picks a direction. Of course, all of those "normal trends" can be erased in a heartbeat by a flurry of negative headlines.

The New York bombing that injured 29 people late Saturday could be a factor that moves the markets on Monday. Details are still sketchy and anything is possible. If it turns into a terror event the market will likely move lower. One random bomb is bad. Multiple random bombs over the next several weeks is a disaster. Eventually the terrorists are going to realize they do not need to commit suicide with their attacks and they can be a lot more productive with multiple minor attacks that cause minimal damage physically but major psychological damage to consumers as a whole. A dozen random bombs over a span of several weeks before the holiday shopping season could cause serious economic harm even if they never killed anyone.

Keep your eyes on the headlines and your finger on the exit trigger while the markets are open.

Enter passively and exit aggressively!

Jim Brown

Send Jim an email

New Option Plays

Virtual Leader

by Jim Brown

Click here to email Jim Brown

Editors Note:

Nvidia is the top chip stock and with monthly new product announcements they are going to be there a long time. Shares refuse to sell off from the recent highs despite the volatile market.


NVDA - Nvidia Corp - Company Profile

NVIDIA Corporation operates as a visual computing company worldwide. It operates in two segments, GPU and Tegra Processor. The GPU segment offers processors, which include GeForce for PC gaming; Quadro for design professionals working in computer-aided design, video editing, special effects, and other creative applications; Tesla for deep learning, accelerated computing, and general purpose computing; and GRID for cloud-based streaming on gaming devices. The Tegra Processor segment provides processors that integrate a computer onto a single chip under the Tegra brand name; DRIVE automotive computers, which offer supercomputing capabilities; and tablet and portable devices for mobile gaming under the SHIELD name. The company's products are used in gaming, professional visualization, datacenter, and automotive markets. It sells its products primarily to original equipment manufacturers, original design manufacturers, system builders, motherboard manufacturers, add-in board manufacturers, and retailers/distributors. Company description from FinViz.com.

Q2 earnings rose 800% to 40 cents and beat estimates for 37 cents. Revenue of $1.43 billion beat their own guidance of $1.35 billion they gave in Q1. Earnings in the year ago quarter were 5 cents and $1.15 billion. They hiked full year revenue guidance as well as the current quarter. They guided for Q3 revenue of $1.68 billion and analysts were only expecting $1.45 billion. During the first six months of 2016, they bought back $509 million in shares and paid $124 million in dividends. The company had $4.88 billion in cash at the end of Q2.

Earnings Nov 10th.

They recently released several new graphics cards that are twice as fast and 40% cheaper than the cards they are replacing.

Nvidia's Graphics Processing Units or GPUs have become more than just video chips. They have become supercomputing processors and can be packaged in large groups to parallel process monster datasets and computations that would have taken weeks with conventional chips. They are truly revolutionizing the processor industry.

The focus on Artificial Intelligence or AI, a lot of companies like Google and Amazon are turning to GPUs to handle the monster amounts of data they collect every day. Facebook already uses Nvidia M40 GPU accelerators to power its Big Sur machine learning computers. Those NVIDIA GPUs were specifically designes to train deep neural networks for enterprise data centers, and the company says they are 10-20 times faster than other network computers. Nvidia said their GPD powered machine learning computers can help train networks new things in just a few hours that would take days or weeks with less powerful systems.

The new P100 GPU is 12 times faster than the prior version and can provide more performance than "several hundred computer nodes" and up to eight P100s can be interconnected to provide previously unheard of computing power. The chips in the GPUs contain more than 15.3 billion transistors each and the largest chip ever built at 16 nanometer technology. That is twice as many as on Intel's biggest chips. The P100 delivers more than 10 teraflops of performance. One teraflop can process one trillion floating-point instructions per second and the P100 can do 10 teraflops or 10 trillion calculations per second.

The COSMOS weather forecasting application runs faster on the P100 than the 27 servers, running twin multicore processors each that were previously tasked with the project. Intel makes commodity processors for the millions of PCs and servers in the world. Nvidia is light years ahead of Intel in technology. Nvidia's data center revenue increased 63% in Q1.

Nvidia shares have been stair-stepping higher since January. That means they post solid gains for a month or so and then pause to consolidate with a minor retracement. They set a new high at $63.38 on August 12th, the day after their Q2 earnings beat. Shares have moved sideways for a month. Last week, when the extreme market volatility hit on the 9th, shares dropped from $63 to $57. Within 4 days the stock was back at $63. I believe it it now poised to breakout now that the weak holders have been eliminated.

Buy Nov $65 call, currently $3.45, no initial stop loss.


No New Bearish Plays

In Play Updates and Reviews

Not Quite 1%

by Jim Brown

Click here to email Jim Brown

Editors Note:

The volatility continued with the Dow with a -0.7% drop but the support level changed. The Dow decline stopped at 18,100 instead of 18,000 so that could be a sign the dip buyers no longer believe 18,000 is going to break. However, this was a quadruple witching Friday with an S&P rebalance and the creation of a new S&P sector so there was plenty of other things going on that could have softened the selling.

The Dow and S&P only gave back slightly less than half of their Thursday gains. However, both are still showing a lower high pattern until the S&P closes over 2,165 and it closed at 2,139 today.

The pre-Fed rally should appear on Tuesday, assuming nothing changes, but Monday is a tossup. With only two weeks left in the "worst 6-weeks" period of volatility, we should be nearing the point where fund managers give up looking for a decline and start window dressing for their fiscal year end on Oct 31st. The last two weeks in October are normally bullish but we still have to get through the next two weeks before we can bet on the October rebound.

Current Portfolio

Stop Loss Updates

Check the graphic below for any new stop losses in bright yellow. We need to always be prepared for an unexpected decline.

Profit Targets

Check the graphic below for any profit stops in green. We need to always be prepared for a profit exit at resistance.

Current Position Changes

RGR - Sturm Ruger

The long put position remains unopened until a trade at $54.85.

If you are looking for a different type of option strategy, try these newsletters:

Credit spreads and naked puts = OptionWriter

Long term option investments = LEAPS Investor

3-6 month Option Trades = Ultimate Investor

Iron Condors = Couch Potato Trader

Long and short equity trades = Premier Investor

BULLISH Play Updates

ALXN - Alexion Pharmaceuticals - Company Profile


No specific news. Excellent $1.76 move on Alexion to surge over resistance at $130.

Original Trade Description: September 14th.

Alexion Pharmaceuticals, Inc., a biopharmaceutical company, develops and commercializes life-transforming therapeutic products. The company offers Soliris (eculizumab), a monoclonal antibody for the treatment of paroxysmal nocturnal hemoglobinuria (PNH), a genetic blood disorder; and atypical hemolytic uremic syndrome (aHUS), a genetic disease. It provides Strensiq (asfotase alfa), a targeted enzyme replacement therapy for patients with hypophosphatasia (HPP); and Kanuma (sebelipase alfa) for the treatment of patients with lysosomal acid lipase deficiency. The company also conducts Phase IV clinical trials on Soliris for the treatment of PNH registry; Phase III clinical trials for the treatment of myasthenia gravis, neuromyelitis optica spectrum disorder, and delayed kidney transplant graft function; and Phase II clinical trials for antibody mediated rejection in presensitized renal transplant patients. It develops cPMP (ALXN 1101) that is in Phase II/III trial for treating metabolic disorders; and ALXN 1007, a novel humanized antibody in Phase II clinical trial for the treatment of anti-phospholipid syndrome and graft versus host disease. Company description from FinViz.com.

The Uncommon Strength campaign supports building global communities for patients with rare diseases, which include atypical hemolytic uremic syndrome (aHUS), hypophosphatasia (HPP), lysosomal acid lipase deficiency (LAL-D) and paroxysmal nocturnal hemoglobinuria (PNH). While the platform aims to provide key information about the diseases to educate the patients and their families, it also offers interactive connection through social media components to unite the global community.

Last week Alexion was awarded orphan drug status by the EU on the ALXN1007 drug for the treatment of graft-versus-host disease (GVHD). This is an anti-inflammatory monoclonal antibody targeting complement protein C5a, currently in a phase II study in patients with newly diagnosed acute GVHD of the lower gastrointestinal tract (GI-GVHD). This disease has a 30-40% mortality rate. The orphan drug status provides certain incentives for the company to proceed with marketing including a longer period of market exclusivity. They have several other drugs similar to ALXN1007.

In Q2 they reported adjusted earnings of $1.25 compared to estimates for $1.17. Revenue of $753.1 million also beat estimates for $742.5 million.

Earnings Oct 27th.

Shares dipped in late August and traded sideways for two weeks. They have been trying to rebound despite the volatile market. Options are expensive so I am recommending a November call spread to reduce the expense.

Position 9/15/16 with a ALXN trade at $130.50

Long Nov $135 call @ $6.00, see portfolio graphic for stop loss.
Short Nov $145 call @ $1.90, see portfolio graphic for stop loss.
Net debit $4.10.

CLVS - Clovis Oncology - Company Profile


No specific news. Excellent 6% gain and a new 10-month high. There are rumors Clovis could be a potential acquisition target by Gilead.

Original Trade Description: September 13th.

Clovis Oncology, Inc., a biopharmaceutical company, focuses on acquiring, developing, and commercializing anti-cancer agents in the United States, Europe, and internationally. It is developing three product candidates, which include Rociletinib, an oral epidermal growth factor receptor and mutant-selective covalent inhibitor that is under review with the U.S. and E.U. regulatory authorities for the treatment of non-small cell lung cancer; Rucaparib, an oral inhibitor of poly polymerase, which is in advanced clinical development for the treatment of ovarian cancer; and Lucitanib, an oral inhibitor of the tyrosine kinase that is in Phase II development for the treatment of breast cancers. Company description from FinViz.com.

Clovis has been rising on the prospects for the drug Rucaparib. They reported last week the FDA was not planning on holding an advisory committee meeting to discuss the new NDA application. The FDA has accepted the company's NDA for accelerated approval and granted it a priority review. The FDA response is expected to be positive and is expected by Feb 23rd.

Clovis has several anti cancer drugs in final stages and the outlook is very positive. Just seeing that CLVS shares have not declined in the recent market drops is a very strong indication that portfolio managers are buying and holding.

Earnings Nov 3rd.

We have to use a January call spread because October is the only other series available and with Friday the expiration for September, the October premiums will collapse next week. The net cost is the same but with the January options, we have more flexibility in the weeks ahead.

Position 9/14/16

Long JAN $30 call @ $6.00, see portfolio graphic for stop loss.
Short JAN $40 call @ $3.31, see portfolio graphic for stop loss.
Net debit $2.69

IDCC - Interdigital - Company Profile


No specific news. Shares faded slightly in a bad market but still holding 50 cents from its highs.

Original Trade Description: September 7th.

InterDigital, Inc. designs and develops technologies that enable and enhance wireless communications in the United States and internationally. It offers technology solutions for use in digital cellular and wireless products and networks, such as 2G, 3G, 4G, and IEEE 802-related products and networks. The company develops cellular technologies comprising technologies related to CDMA, TDMA, OFDM/OFDMA, and MIMO for use in 2G, 3G, and 4G wireless networks and mobile terminal devices; and other wireless technologies related to Wi-Fi, WLAN, WMAN, and WRAN. Its patented technologies are used in various products, including mobile devices, such as cellular phones, tablets, notebook computers, and wireless personal digital assistants; wireless infrastructure equipment comprising base stations; and components, dongles, and modules for wireless devices. As of December 31, 2015, it had a portfolio of approximately 20,400 patents and patent applications related to the fundamental technologies that enable wireless communications. Company description from FinViz.com.

IDCC does not make the equipment that uses its designs and patents. They lease those patents to other companies for annual royalty payments based on the volume of devices sold. This is a very lucrative business because they do not have the cost of production or the risk any specific product will not sell in the marketplace.

For Q2 they reported earnings of 48 cents that beat estimates for 26 cents. Revenue of $75.9 million was $300,000 short of estimates. They received an arbitration award of roughly $150 million from Huawei in the quarter that will be reported as income in Q3. They also announced a new multi-year patent agreement with Huawei for 3G and 4G units. They ended Q2 with $814 million in cash.

Update 9/8/16: The company issued revenue guidance for Q3 of $220-$225 million. This compares to Q2 revenue of $75.9 million. Quarterly revenues are volatile because they receive royalties on new products when shipped. For instance, a royalty on the iPhone 7 would show a monster jump in Q4 compared to minimal revenue in Q3.

Earnings Oct 27th.

IDCC is a member of the S&P-400 MidCap index.

IDCC shares are moving slowly higher with very little volatility. They closed at a new high on Wednesday. I know the daily chart looks scary but the 90-min chart below shows the three weeks of consolidation after their Q2 earnings jump. That consolidation is breaking to the upside and given their guidance, I believe it has room to run. I am using an inexpensive option in case disaster strikes.

Position 9/8/16 with a IDCC trade at $73.25

Long Oct $75 call @ $1.60. See portfolio graphic for stop loss.

ITW - Illinois Tool Works - Company Profile


No specific news. Shares faded with the market but remain over support at $115.

Original Trade Description: September 12th.

Illinois Tool Works Inc. manufactures and sells industrial products and equipment worldwide. It operates through seven segments: Automotive OEM; Test & Measurement and Electronics; Food Equipment; Polymers & Fluids; Welding; Construction Products; and Specialty Products. The company distributes its products directly to industrial manufacturers, as well as through independent distributors. Illinois Tool Works Inc. was founded in 1912. Company description from FinViz.com.

In late July, ITW reported earnings of $1.46 that rose 12.3% and beat estimates for $1.40. Revenue of $3.43 billion beat estimates for $3.40 billion. ITW guided for Q3 earnings of $1.42-$1.52 compared to analyst estimates for $1.46. The company raised full year guidance for earnings by 10 cents to the $5.50-$5.70 range. Analysts were expecting $5.51 per share.

Earnings Oct 19th.

The stock jumped from $111 to $115 on the news and then traded sideways for two weeks on post earnings consolidation. In early August, the shares started a slow climb to hit $119 and a new high. Every day I thought about recommending ITW but I kept waiting for a pullback.

On Sept 2nd shares spiked to $123.50 on no news. That spike was erased and shares drifted back down to the prior consolidation range of $119 and held there for two days. The 9/9 crash knocked us out of our prior position and shares dipped to $114.91 on Monday the 12th. Real support is $114.50. I am going to recommend this position for a reentry on a dip to $115.50 on any further market weakness.

Position 9/13/16 with an ITW trade at $115.50

Long Dec $120 call @ $2.50. See portfolio graphic for stop loss.

LITE - Lumentum Holdings - Company Profile


No specific news. Minor gain but another new high.

Original Trade Description: September 12th.

Lumentum Holdings Inc. manufactures and sells optical and photonic products for optical networking and commercial laser customers worldwide. It operates in two segments, Optical Communications and Commercial Lasers. The Optical Communications segment offers components, modules, and subsystems that enable the transmission and transport of video, audio, and text data over high-capacity fiber optic cables. It offers optical communication products, including optical transceivers, optical transponders, and supporting components, such as modulators and source lasers; modules or sub-systems containing optical amplifiers, reconfigurable optical add/drop multiplexers or wavelength selective switches, optical channel monitors, and supporting components; and products for 3-D sensing applications, including a light source product. This segment serves customers in telecom and datacom markets. The Commercial Lasers segment offers diode, direct-diode, diode-pumped solid-state, fiber, and gas lasers; and photonic power products, such as fiber optic-based systems for delivering and measuring electrical power. This segment serves customers in markets and applications, such as manufacturing, biotechnology, graphics and imaging, remote sensing, and precision machining such as drilling in printed circuit boards, wafer singulation, and solar cell scribing. Company description from FinViz.com.

In Q2 LITE reported adjusted earnings of 41 cents compared to estimates for 35 cents. Revenue of $241.7 million beat estimates for $238.4 million. The company guided to earnings of 40-46 in Q3 and revenue in the range of $245-$255 million. Both were slightly ahead of analyst estimates.

Raymond James upgraded the stock saying strong demand from new datacenter build outs and from China was pushing sales higher. The company only has two competitors, Finsar and Nistica, and they only compete in certain products. Raymond James believes LITE can increase sales in that category by 50% by year-end. Verizon's network upgrades are expected to supply $900 million to LITE over the next several years. Zacks also joined the upgrade club with a strong buy.

The stock is also getting a boost from the strong performance of Acacia (ACIA), which sells some similar products. The winning is rubbing off on LITE.

Shares made a new high at $37.82 on Friday morning and then dipped to $35.37 this morning before rebounding to close just under the prior high.

Position 9/13/16 with a LITE trade at $37.75

Long DEC $40 call @ $2.65, see portfolio graphic for stop loss.

BEARISH Play Updates (Alpha by Symbol)

DIA - Dow Jones ETF - ETF Profile


Support moved slightly higher from 18,000 to 18,100 and held despite several attempts to push down. We are locked in a volatility range from 18,000 to 18,300 and eventually one side will break. If that 18,100 level holds again on Monday it would suggest the market is going higher next week.

I would like to see the play be successful but a breakdown would damage all the long plays that we currently hold. I look at this as a hedge against a market decline.

The six weeks after August option expiration are the most volatile of the entire year.

Original Trade Description: August 1st.

The Dow posted another lower low as it fades from the 18,622 intraday high set back on July 20th. The last three days the Dow has traded under support at 18,400 only to rebound back over that level at the close. The 18,350 level is secondary support and today's low was 18,355.

All but six Dow components have reported earnings and there are only two reporting this week. Those are PG and PFE on Tuesday. The Dow is experiencing post earnings depression. After a stock reports earnings there is typically a period where it declines as traders leave that stock in search of something else to trade that has not yet reported.

PG 8/2
PFE 8/2
DIS 8/9
HD 8/16
CSCO 8/17
WMT 8/18

The Dow is very over extended, suffering post earnings depression and heading into the two weakest months of the year, which are seasonal decliners.

Bank of America expects a 10-15% decline over the next two months.

Goldman Sachs said this morning they expect a 5-10% decline. Goldman said, rising uncertainty in the U.S. and globally, negative earnings revisions, decelerating buybacks and overly dovish Fed expectations would send the market lower over the next several months.

Jeffrey Gundlach of DoubleLine with $100 billion under management, said "sell everything" most asset classes are "frothy and nothing here looks good." "Stock investors have entered a world of uber complacency." "Investors seem to have been hypnotized that nothing can go wrong." He expects the next big money to be made on the short side.

Peter Boockcar, chief market analyst at the Lindsey Group, said, "Take off the beer goggles, the markets are dangerous. To me, the U.S. stock market is the most expensive in the world."

According to Bespoke, over the last 20 years the Dow has performed the worst in August of any other month.

However, just because some big names and big banks turn negative on the market, it does not mean it is guaranteed to move lower. Markets tend to move in the direction that will confound the most people at any given time.

I believe we should accept the risk and launch another index short using the Dow ETF (DIA) since it is the weakest in August. The Dow has risk to 18,000 and a breakdown there could take it back to 17,400.

I am going to recommend an October put spread so we can capitalize on any decline that lasts into September. Typically market bottoms are in October. If you do not want to use a spread, I would buy the September $182 puts, currently $2.55. Just remember, once we are into September the premiums will decline sharply.

Position 8/2/16:

Long Oct $182 put @ $3.98, see portfolio graphic for stop loss.
Short Oct $172 put @ $1.73, see portfolio graphic for stop loss.
Net debit $2.25

HSY - Hershey Co - Company Profile


No specific news. New 2-month closing low.

Original Trade Description: September 3rd.

The Hershey Company manufactures, imports, markets, distributes, and sells confectionery products. It offers chocolate and non-chocolate confectionery products; gum and mint refreshment products comprising chewing gums and bubble gums; pantry items, such as baking ingredients, toppings, beverages, and sundae syrups; and snack items, including spreads, meat snacks, bars and snack bites, and mixes. The company provides its products primarily under the Hershey's, Reese's, Kisses, Jolly Rancher, Almond Joy, Brookside, Cadbury, Good & Plenty, Heath, Kit Kat, Lancaster, Payday, Rolo, Twizzlers, Whoppers, York, Scharffen Berger, Dagoba, Ice Breakers, Breathsavers, and Bubble Yum brands, as well as under the Golden Monkey, Pelon Pelo Rico, IO-IO, Nutrine, Maha Lacto, Jumpin, and Sofit brands. It markets and sells its products to wholesale distributors, chain grocery stores, mass merchandisers, chain drug stores, vending companies, wholesale clubs, convenience stores, dollar stores, concessionaires, and department stores. The Hershey Company was founded in 1894 and is headquartered in Hershey, Pennsylvania. Company description from FinViz.com.

Mondelez offered $107 per share for Hershey in June. Shares spiked to $110-$115 in anticipation of an upgraded offer. After two months of discussions they finally got around to price. The Hershey board said it would need a lot higher price to get the deal approved. Mondelez thought about it and came back saying "maybe they could go to $115" if some conditions were met. Hershey replied that was not high enough and it would take at least $125 to continue the discussion. Mondelez immediately broke off negotiations saying there was no "actionable path" to a conclusion.

Hershey is struggling. Sales have been slowing as new competition slowly erodes market share. The Hershey Trust owns 80% of the voting stock so even if the Hershey board decided to consider an offer the trust would have to approve it along with the Pennsylvania Attorney General, which has power over the trust. There will not be another deal and the trust board is being reconstituted in 2017 as demanded by the AG so no major actions will be approved.

Hershey is going to have to deal with its own market share losses and slowing sales. This means the outlook for Hershey shares is negative. Last week Bank America reiterated an underperform rating with a price target of $100 and shares closed the week at $99. The outlook is underwhelming and the stock should decline back to the $90 range where it was stuck before the Mondelez offer.

Earnings Nov 1st.

Position 9/8/16 with a HSY trade at $98.75

Long Nov $95 put @ $1.60. See portfolio graphic for stop loss.

RGR - Sturm Ruger & Company - Company Profile


No specific news. Shares dipped to within 3 cents of our entry trigger at $54.85.

The position remains unopened until a trade at $54.85.

Original Trade Description: September 15th.

Sturm, Ruger & Company, Inc. designs, manufactures, and sells firearms under the Ruger trademark in the United States. It operates in two segments, Firearms and Castings. The company offers single-shot, autoloading, bolt-action, and sporting rifles; rimfire and centerfire autoloading pistols; single-action and double-action revolvers; and firearms accessories and replacement parts, as well as manufactures and sells steel investment castings and metal injection molding (MIM) parts. It sells its firearm products through independent wholesale distributors to commercial sporting market; and castings and MIM parts directly or through manufacturers' representatives. The company also exports its firearm products through a network of commercial distributors and directly to foreign customers comprising primarily of law enforcement agencies and foreign governments. Company description from FinViz.com.

In Q2, RGR reported earnings of $1.22 that beat estimates for $1.19. Revenue rose +19% to $167.9 million. The company said the new AR-15 clone, the AR-556 was responsible for one-third of all sales.

However, the pace of sales growth declined from the 26% rate in Q1. Ruger also surprised investors with a new CEO succession plan. The highly regarded Michael Fifer will retire in May and be replaced by the COO Christopher Killoy. The company had not mentioned a possible succession plan at the last shareholder meeting. Killoy is a good choice because he graduated from West Point and worked at both GE and competitor Smith & Wesson before joining Ruger as head of sales in 2003. He will only be the fourth CEO in Ruger's history.

The slowdown in sales growth was accompanied by a decline in background checks. FBI background checks slowed in August to only a 6% rise compared to 37% growth in July and 39% in June. The actual number of checks fell from 2.19 million in July to 1.85 million in August.

The gun makers have been posting some outstanding earnings thanks to rapidly rising gun sales only those sales are slowing now that Trump has pulled even or slightly ahead of Clinton. Trump is pro gun and Clinton is anti gun. As long as his numbers are improving, gun sales are likely to slow. However, should Clinton surge into the lead again, the numbers will rocket higher. Consumers are not going to spend hundreds of dollars to buy another gun if they think their gun rights will be safe for another 4 years. If Clinton surges into the lead again, they will be out in force buying those "extra" guns. The biggest surge will occur if Clinton wins the election on Nov 8th. At that point we want to be long every gun manufacturer and ammunition maker.

Earnings Nov 1st.

Ruger shares closed at an 8-month low on Wednesday. The rebound on Thursday was lackluster in a market were the Dow was up +200 points. With sales growth slowing and investors thinking the "bun boom" is over we could see Ruger retest the November lows at $48.

With a RGR trade at $54.85

Buy a Jan $52.50 put, currently $3.50, initial stop loss $57.25
Sell short Jan $45 put, currently $1.05, initial stop loss $57.25
Net debit $2.45

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