Option Investor

Daily Newsletter, Monday, 11/7/2016

Table of Contents

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

Market Wrap

The FBI Bounce

by Thomas Hughes

Click here to email Thomas Hughes


FBI Director Comey says no new evidence and the market cheers. The news came late Sunday afternoon, in time for global markets to rally, but doesn't seem to have moved the needle very much in terms of the polls. The only thing I can say to that is that the pollsters said England wouldn't Brexit up to and until the polls closed. Today's action was extreme to say the least, a knee jerk reaction to non-news news, and on such tepid volume all of today's gains could be reversed with ease. Aside from that, news was centered on the election in general, the debate of which candidate is really better for the economy and to some extend earnings and economic data expected out later this week.

International were very moved by Comey's ringing endorsement of Secretary Clinton and rallied just about across the board. Asian markets were up in the range of 0.5% to 1.5% give or take, European markets were more vigorous and rallied in the range of 1.5% to 2.5%.

Market Statistics

Futures indicated a substantial rally at open, nearly 1.5% for the S&P 500, all morning and nothing in the early hours of the day dampened the mood. There was little in the way of earnings, only 31 S&P 500 companies are expected to report this week, and no economic data to speak of. The indices gapped up at the open and then proceeded to climb throughout the morning, although as I said volume was no better than average. The rally continued all day, more likely due to a lack of sellers than a hoard of buyers, and left the indices at the top of the day's range with gains in the range of +2%.

Economic Calendar

The Economy

No economic data today and very little this week, about 10 reports including oil and natural gas inventories. What we do have is fairly inconsequential; JOLTs tomorrow, wholesale inventory on Wednesday, jobless claims Thursday and Michigan Sentiment Friday. Next week is a different story; CPI, PPI, housing data, manufacturing indexes, Fed surveys, the works.

Moody's Survey Of Business Sentiment made a whopping jump of 1.4% last week despite the email curve-ball thrown to us. The index is now reading 31.8%, the highest level since early May. Mr. Zandi says that global business sentiment is holding up well and is steadfast. The US leads, South America lags, but all in all the global economy is expanding at a pace on par with expectations.

A little more than 85% of the S&P 500 has reported earnings so far this cycle and the results are better than expected. The caveat is that forward outlook continues to decline, although it remains positive and showing earnings growth into the end of next year. Of those that have reported 71% have beaten EPS estimates, above average, while only 54% have beaten revenue estimates, a little below average. The blended rate of earnings growth for the quarter is now 2.7%, up more than 1% from last week. At this rate we could easily see the final rate of earnings growth come in above 3%.

Looking forward growth is expected to continue in the fourth quarter but those expectations have fallen by -0.7% in the last week to 3.9%. Full year 2016 estimates remain firm at 0.2% and will likely rise before the end of the 4th quarter cycle. Full year 2017 estimates have also fallen, another -0.4%, with all index growth projected to be 11.6%.

The Dollar Index

The Dollar Index jumped 0.75% in the biggest move since late June. Today's action, if in line with longer term dollar outlook, was driven entirely by the FBI revelation and market relief, however misplaced. Long term outlook remains dollar positive, the FOMC is on track to possibly raise rates in December while other central banks remain locked into QE programs. The Fed Watch Tool shows a 76.5% chance of hike at the December meeting First upside target is the $98.56 level, a break above that could go as high as $100.50.

The Oil Index

Oil rebound somewhat today on remarks from OPEC that it was really going to cut production levels at the next meeting. The news helped to lift prices by nearly 2% but failed to carry WTI above the $45 mark. The OPEC news is bullish but met with skepticism, what have they been able to do so far?, so it's impact on prices is likely limited in the face of high supply, high production and tepid demand. The $45 is one possible level for resistance, $46 and $48 look more likely targets for pullbacks should bullish sentiment persist into the end of the week.

The oil sector remains trapped within recent ranges with little hope of breaking out, to the upside, while oil prices remain below $45. The Oil Index itself remains range bound within the upper half of the 7+ month trading range and shows no signs of imminent exit, in either direction. The indicators remain firmly weak and consistent with range bound trading, trending near/around the mid-points of their respective ranges. Oil prices may continue to rebound, the index may follow, but resistance at the upper boundary near 1,180 is likely to hold.

The Gold Index

Gold prices tanked today on a rising dollar and risk on appetite. The price of spot gold fell -1.75%, nearly $23.00, to trade just above $1,280. Today's action confirms resistance at the $1,300 level and could take the metal down to longer term support levels near $1,250.

The Gold Miners ETF GDX fell -3.5% in today's action, falling from the short term moving average and below the 38.2% retracement level. This move reconfirms resistance at the moving average and the gap formed October 4th, if not a continuation of the short term down trend. The indicators are confirming resistance and indicating a buy in line with the prevailing short term down trend so a move lower to retest for support looks likely. The $23.50 level is a possibility but $22.50 looks like a firmer target to me. A drop below support would be bearish and could lead the ETF down to $19.75.

In The News, Story Stocks and Earnings

The VIX fell sharply in response to today's rally, shedding just over -17.25%. The so called fear index in retreat from a short term high but not necessarily heading back down to previous low levels. First target for possible support is near $17.50 with additional targets just below that near the short term moving average. Considering the earnings environment, a still spotty economic recovery, Fed uncertainty and tomorrow's election results it is very possibly we could be entering a period of increased, prolonged, volatility regardless of the ultimate direction of the equity market.

Sysco, the nations largest purveyor of restaurant supplies, reported earnings before the bell and delivered a positive surprise. The company reported adjusted earnings of $0.63 per share, better than expected and excluding the addition of a recent acquisition. On a not adjusted basis sales grew 11.2% over the comparable quarter with a 20% increase in gross profit and a 146 increase in margins. Shares of the stock rose nearly 10% to trade near the recently set all time high.

Priceline reported after the bell beating on the top and bottom line. The bad news is that total revenue fell roughly 50% from the year ago quarter and forward guidance is on the weak side. Despite the mixed news shares of the stock rallied in after hours trading, extending today's gains to nearly 10% and setting a new all time high.

The Indices

The indices moved up and up and up today, closing at the highs of the day. The move was led by the Dow Jones Transportation Average which gained more than 3% and broke out to a new 1 year high. Despite the break out the index remains below potential resistance and well below the all time high. Resistance is at 8,350, a resistance zone set at the end of last year, and may be strong. The indicators are bullish and pointing higher so a test of resistance at this new level is likely. A break beyond this could be quite bullish and lead the entire market higher.

The next biggest gainer in today's action was the NASDAQ Composite. The tech heavy index gained nearly 2.4% and created a small white candle after gapping up more than 1.5% at the open. Today's action is bullish and looks like a bounce in line with the long term up trend. The indicators are a bit spotty, bullish in the near term but not showing strength or even really confirming support at this level, so I am not fully convinced the bounce is for real. First target for resistance is at the 5,200 level and the short term moving average, a break above that more bullish but still in need of breaking resistance near 5,350. If the index falls back in tomorrow's session support is near the 5,000 level.

The next biggest move was made by the S&P 500. The broad market gained a little more than 2.25% in a move that regained the upper side of 2,120 but fell short of the short term moving average. The move looks like a bounce from a long term trend line but is yet to be confirmed by the indicators. The indicators remain mixed and on the weak side so I would not be at all surprised to see another test for support, possibly as low as 2,100 or just below.

The Dow Jones Industrial Average brings up the rear in today's session with a gain of only 1.87%. The blue chips created a long white candle that appears to be confirming support at and bouncing up from the long term up trend line. The caveat is that today's action is really just a volatile swing within the 2 month trading range, and one driven by an extreme swing of sentiment (Comey releases email news and market falls, Comey says emails are no big deal and market surges). If the index breaks out of the range to the upside we could see a test of the all time high.

The market made a nice swing today but I'm afraid that is all it might be, a swing. The move was driven by a wild shift in sentiment that could easily swing the other way tomorrow. Aside from the transports the indices remain trapped within recent ranges and waiting for the election results with little indication of which direction they will go once the results are in. I still see the signs of a long term rally in the making, there may be a correction post-election but in my view it will most likely be a buy-on-the-dip opportunity for long term positions.

Until then, remember the trend!

Thomas Hughes

New Option Plays

Deadbeat Renter

by Jim Brown

Click here to email Jim Brown

Editors Note:

Seritage Growth Properties was spun off from Sears Holdings in July 2015 in an effort to raise cash. It was a good plan for Sears but bad for Seritage.


No New Bullish Plays

The markets rallied more than 2% in a monster short squeeze and making new long entries at this level without knowing who won the election would be very risky. The results on Tuesday will be pivotal for the markets. I will add long plays once we know the market direction.


SRG - Seritage Growth Properties - Company Profile

Seritage Growth Properties (Seritage) is a self-administered and self-managed real estate investment trust (REIT). The Company is engaged in the acquisition, ownership, development, redevelopment, and management and leasing of diversified retail real estate across the United States. The Company's assets are held by and its operations are primarily conducted through directly or indirectly, by Seritage Growth Properties, L.P. Its portfolio include approximately 42.4 million square feet of gross leasable area (GLA), which consists of approximately 230 owned properties totaling over 37.0 million square feet of GLA across approximately 49 states and Puerto Rico and interests in approximately 30 joint venture properties totaling over 5.4 million square feet of GLA across approximately 17 states. Its portfolio includes over 3,000 acres of land, or approximately 10 acres per site for its owned properties. The Company's portfolio include approximately 42.4 million square feet of gross leasable area (GLA), which consists of approximately 230 owned properties totaling over 37.0 million square feet of GLA across approximately 49 states and Puerto Rico and interests in approximately 30 joint venture properties totaling over 5.4 million square feet of GLA across approximately 17 states. Company description from Reuters.com.

When Seritage was spun off from Sears it held about 230 properties with either a Sears store or a Kmart as the anchor tenant. Almost immediately, Sears began serving notice of intent to terminate leases. In September, Sears notified Seritage it was terminating 17 more properties. These properties are normally older malls with Sears of Kmart as the anchor tenant. Once Sears or Kmart leaves, the malls have a good chance of dying.

Seritage is rapidly remodeling and trying to release these malls and strip centers. However, in their recent earnings they disclosed the average rent before Sears/Kmart terminated was $19.25 per square foot. The average rent they are receiving after those anchor stores leave is now $13.75 per square foot.

There are two big challenges. The first is the death of the mall. Average rents are going to deteriorate until the mall finally closes. Numerous malls have already been shutdown and bulldozed to make way for office buildings of some type. That is not bad for Seritage since each center they own averages about 10 acres. However, they cannot just terminate all the leases just because Sears terminates. They will try to replace the anchor tenant and continue to operate as a mall as long as possible but income will continue to decline.

The second challenge is the current weakness in the Sears/Kmart business. There is a constant stream of rumors that Kmart will file bankruptcy after the holidays. Some distributors are no longer shipping them product for fear of not being paid.

Since the majority of Seritage properties are occupied by Sears/Kmart they are at extreme risk for further declines in those retail businesses.

Earnings Feb 2nd.

Monday's market rally lifted Seritage from a 7-month low but shares only managed to gain 26 cents. If the prior decline continues it should return to the lows and test $40 in the weeks ahead. I am recommending an April option to get us past any January closing announcements by Sears.

Buy April $40 put, currently $2.00, no initial stop loss.

In Play Updates and Reviews

Tick Tock, Tick Tock

by Jim Brown

Click here to email Jim Brown

Editors Note:

The FBI news on Clinton caused a monster short squeeze. Unfortunately, this reminds me a lot of the market rally before the Brexit vote when the polls showed a 5% lead for the remain camp. When the vote was actually taken and the leave camp won, there was a monster -125 point decline in the S&P over the next two days. I know all the polls give Clinton a 2% to 4% lead but it is not over until it is over. Wednesday could be really exciting. Tick Tock.

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

IWM - Russell 2000 ETF

The long call position was entered at the open at $118.00.

XBI - Biotech ETF

The long call recommendation remains unopened until $50 or $58.

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

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Long and short equity trades = Premier Investor

BULLISH Play Updates

HON - Honeywell - Company Profile


No specific news. $3 spike in the market short squeeze.

Original Trade Description: October 15th.

Honeywell International Inc. operates as a diversified technology and manufacturing company worldwide. Its Aerospace segment offers aircraft engines, integrated avionics, systems and service solutions, and related products and services for aircraft manufacturers and operators, airlines, military services, and defense and space contractors, as well as spare parts, and repair and maintenance services for the aftermarket. This segment also provides auxiliary power units; propulsion engines; environmental control, connectivity, electric power, flight safety, communication, navigation, radar, surveillance, and thermal systems; engine controls; aircraft lighting products, as well as wheels and brakes; advanced systems and instruments; and turbochargers, as well as management, technical, logistics, repair, and overhaul services to original equipment manufacturers in the air transport, regional, business, and general aviation aircraft; and automotive and truck manufacturers. The company's Home and Building Technologies segment offers environmental and energy, security and fire, and building solutions. Its Safety and Productivity Solutions segment provides sensing and productivity Solutions, and industrial safety products. Its Performance Materials and Technologies segment provides catalysts and adsorbents; equipment and consulting services for the petroleum refining, gas processing, petrochemical, and other industries; and automation control, instrumentation, software, and services for the oil and gas, refining, pulp and paper, industrial power generation, chemicals and petrochemicals, biofuels, life sciences, metals, minerals, and mining industries. Company description from FinViz.com.

On Oct 7th, Honeywell shares collapsed from $116 to $105 after the CEO warned that profits would be below guidance and they lowered guidance for the rest of 2016. The CFO said on the conference call, "In the third quarter, we continued to see slow growth across much of our portfolio." Declines in the emerging markets and the oil industry have crimped demand for business aircraft and helicopters, hurting Honeywell's unit that sells jet engines, cockpit controls and aerospace parts.

The company preannounced earnings of $1.60 compared to prior guidance of $1.67-$1.72. For the full year they lowered their forecast by 6 cents to $6.64 per share. The company is in the middle of a reorganization process that will increase profits in the future.

After the stock was crushed by the warning, the CEO appeared on CNBC and said the warning was not received in the way he thought it would be. "I gave credit for people understanding what our long-term profile was. I was wrong. I could have done a significantly better job of communicating this story. We tried to do it in the context of 2017 is going to be good, but it seemed to get totally lost" in the headlines.

The CEO went on to explain that the hiccup in Q3 was minor in the bigger picture given the businesses they just sold in September and the organizational restructuring currently in progress. They only cut full year earnings by 6 cents and will still produce earnings of $6.64 or better. Also the changes in progress will allow Honeywell to grow earnings by 10% or more in 2017. That adds another 66 cents or more to an already robust earnings picture.

He said he was "astounded by the reaction" to the minor cut in earnings. He went on to say that while the business jet business was lagging, the aerospace business was still doing well and should not have been lumped into the warning. He also said the energy business had bottomed in Q3 and would be improving in Q4.

Basically the CEO took a giant step by going on CNBC and saying he was wrong in how the lowered earnings estimates were portrayed and he did a good job of explaining that the weakness was much narrower than presented and the outlook for 2017 was outstanding.

Shares spiked on the news but faded slightly into the close as the market faded. Their formal earnings will be on Oct 21st and I am sure they will take great pains to present a rosy picture.

I am recommending a December call to get us through what is normally the best six weeks in the market. We will hold over those Oct 21st earnings.

Update 10/21/16: Honeywell reported earnings of $1.67 that beat estimates for $1.60. Revenue of $9.8 billion also beat estimates for $9.77 billion. They guided for the current quarter to earnings in the range of $1.74-$1.78 and analysts were expecting $1.75.

Position 10/17/16:

Long Dec $110 call @ $2.51, see portfolio graphic for stop loss.

IWM - Russell 2000 ETF - ETF Profile


The FBI headlines caused a massive short squeeze and we entered this position at the open with the gap higher to $118. That is not how I would have wanted to enter the position and now we need the Clinton bounce to hold.

The morning gap higher took the IWM right to resistance at $119 and it failed to penetrate.

The dip entry recommendation has been cancelled.

Original Trade Description: November 5th.

The IWM currently holds 1,975 stocks and attempts to replicate the performance of the Russell 2000 Small Cap Index.

The S&P has now declined for nine consecutive days and the longest streak in 36 years. That is the equivalent to red coming up on the roulette table nine times in a row. The index is short-term oversold after a 4.8% decline. I believe the sell off over election uncertainty is nearly over. Investors and funds have had a week since the end of the October fiscal year end to make changes to their portfolios and raise cash for their post election purchases.

We all know there are several sectors that will not do well under a Clinton presidency and some that will prosper. Under a Trump presidency there are more profitable sectors but there is a greater fear of the unknown. He is a take no prisoners type of person and he has a lot of ideas about how to make American great again. Unfortunately, it may start off with a larger market sell off on that uncertainty.

Clinton is still ahead in the polls with two days to go and she is pulling out all the stops. The electoral map favors Clinton because there are more democrats than republicans. The heavily populated coastal states with a high number of electoral votes are liberal democrat while most of the flyover states are conservative republican.

The key point here is that Clinton is favored to win despite all her problems. If that turns out to be the case the market is expected to rally 3% to 5% very quickly.

There is always the possibility of a Trump upset and a temporary market dip but that would be the "Brexit dip" that should be bought. This is a headline event rather than a sudden change in the government. It would take many months or even years to get his changes passed into laws, and some would never be passed. The key point is that a Trump victory could be a sell the news event followed by a Brexit type rebound.

I am recommending a call position on the Russell 2000 ETF because the Russell is the most oversold. It is also cheaper for a speculative position.

I am going to recommend two entries. One for a positive move higher and one for a dip buy. It is entirely possible we could end up with both positions. If the dip entry is triggered first, cancel the rebound entry.

This is a SPECULATIVE position. Do not invest money you cannot afford to lose.

Rebound entry:

Position 11/7/16: With an IWM trade at $117.25
Long Dec $119 call @ $2.47, no initial stop loss.

Dip entry: CANCELLED

With an IWM trade at $112.05
Buy Dec $115 call, estimated @ $2.25, no initial stop loss.

TREE - Lending Tree - Company Profile


No specific news. $2 gain in the market short squeeze.

Original Trade Description: October 31st.

LendingTree, Inc., operates an online loan marketplace for consumers seeking loans and other credit-based offerings in the United States. The company offers tools and resources, including free credit scores that facilitate comparison shopping for these loans and other credit-based offerings. Its mortgage products comprise purchase and refinance products. The company also provides information, tools, and access to various conditional loan offers for non-mortgage products, including auto loans, credit cards, home equity loans, personal loans, reverse mortgages, small business loans, and student loans. In addition, it offers information, tools, and access to other products, including credit repair, through which consumers obtain assistance improving their credit profiles; debt relief services, through which consumers obtain assistance negotiating existing loans; home improvement services, through which consumers have the opportunity to research and find home improvement professional services; personal credit data, through which consumers gain insights into how prospective lenders and other third parties view their credit profiles; real estate brokerage services, through which consumers are matched with local realtors who assist them in their home purchase or sale efforts; and various consumer insurance products, including home and automobile, through which consumers are matched with insurance lead aggregators to obtain insurance offers. Company description from FinViz.com.

Lending Tree reported revenues that rose 35.5% to $94.6 million but missed estimates for $96.9 million. Earnings of 80 cents were in line with analyst estimates. The company lowered its revenue guidance for the full year from $380-$390 million to $370-$375 million. The stock was knocked for a $16 loss to $75.

Yes, they reported a 35.5% increase in revenue but missed estimates by $2 million and the stock was crushed. That is hardly worth a major decline.

That is not the entire story. Mortgage product revenues rose 21%. Total loan requests rose 68%. Small business lending has risen more than 200% from the year ago quarter. The MyLendingTree.com customer portal product now has more than 3.7 million members.

The CEO was not apologetic. He said in a quarter where mortgage rates were near a record low we optimized the business to expand margins and grow profits.

Earnings Jan 26th.

I see nothing wrong with Lending Tree. While they did miss revenue fractionally and guided fractionally lower for the full year, the business is booming. We should see a swift rebound because there are very few companies of any type growing this fast.

Position 11/1/16:

Long Dec $85 call @ $4.00, see portfolio graphic for stop loss.

XBI - Biotech ETF ETF Profile


The XBI rallied 4.5% even though the market spike was a Clinton rally. This is the power of a broad market rally. Even though biotechs and drug companies would be under pressure with a Clinton presidency, those shorts were squeezed just as hard or maybe harder than anything else.

This position remains unopened until a trade at $50 or $58.

Original Trade Description: October 29th.

The SPDR S&P Biotech ETF seeks to provide investment results that, before fees and expenses, correspond generally to the total return performance of the S&P Biotechnology Select Industry Index.

The XBI traded up to $69 in late September and has since crashed back to support at $56 as various biotech stocks released data on drug trials that were not successful, were involved in drug pricing schemes or simply issued a profit warning as was the case with Illumina.

The three weeks of headlines over the EpiPen pricing disaster pushed all the drugs stocks lower on worries of drug price controls.

Comments from Clinton, Warren and Sanders about drug pricing concerns also caused investors to flee the biotech sector.

The biotechs may have ended their decline in fear of Hillary Clinton. After the news on Friday about the FBI reopening the criminal investigation on her emails, that should make it really tough to win the election. That means the biotech sector could begin to rebound even before the vote if the polls tighten even further or move into Trump's favor.

On Friday 10/28, the healthcare sector imploded on earnings and warnings from several companies including McKesson, AmerisourceBergen, Cardinal Health and others. The XBI failed to decline after hitting support at $56.

With the XBI now -18% off its September high, all of those factors above are baked into the market. This may be time to place a bet on a biotech rebound.

The ETF has support at $56 and the 200-day at $56.55. The dip on Friday penetrated to $55.80 but then rebounded $1 in a weak market.

I am recommending we buy a cheap December call ahead of the polls that will be out next week. If Clinton does win, we will exit on any weakness.

With a XBI trade at $58

Buy Jan $60 call, currently $1.51, no initial stop loss.

With a XBI trade at $50.50

Buy Jan $55 call, currently $3.25, no initial stop loss.

BEARISH Play Updates (Alpha by Symbol)

VXX - VIX Futures ETF - Company Profile


Monster 12% decline after a week of gains.

This is a long-term position and I will not be commenting on it on a daily basis. There is no news on the VXX since it is not a company.

Original Trade Description: September 21st.

The VXX is a short-term volatility product based on the VIX futures. As a futures product it has the rollover curse. Every time they roll to a new futures contract they have to pay a premium and that lowers the price of the ETF. It is a flawed product with a perpetual decline built in from the monthly roll over in the futures contracts.

As evidence of this flaw, they have now down four 1:4 reverse stock splits. The last four reverse splits occurred at $13.11 (11/2010), $8.77 (10/2012), $12.84 (11/2013), $9.52 (8/8/16). The prospectus says it can reverse split anytime it trades under $25 for a prolonged period and the splits will always be 1:4.

After the August split the ETF moved sideways for four weeks at $36. The volatility event on Sept 9th with the Dow falling -2.5% spiked the VXX from $33 to $42 in three days. That bounce has faded and it is almost back at $33. You are probably thinking, the $40 level would have been a good entry point and you are right in hindsight. However, with the market in danger of breaking down if the Fed had hiked rates, it was better to wait. Now there is nothing on the horizon to cause a spike other than normal market movement.

This is going to be a long-term position. I am not putting a stop loss on the position because long term the VXX always goes down. If we get another volatility spike we will buy another position at a higher level and then ride them both back down.

The market typically rises in late October and into the Thanksgiving weekend. A rising market reduces volatility.

I thought about using a spread to reduce the out of pocket costs. However, that means the strikes have to be relatively close together for the short strike to have any premium. Since the VXX could decline 10 points or more before December, that would limit our potential return to 3-4 points in a spread. However, if we do get a big decline we can spread out at much lower level to further increase our gains.

Position 9/22/16:

Long Dec $33 Put @ $4.20. No stop loss.

YHOO - Yahoo - Company Profile


No specific news. A 2% rebound with the market. Actually, that was a weak rebound given the spike in the market and it stopped right at resistance.

Original Trade Description: October 15th.

Yahoo! Inc., provides search and display advertising services on Yahoo properties and affiliate sites worldwide. The company offers Yahoo Search that serves as a guide for users to discover information on the Internet; Yahoo Mail, which connects users to the people and content; and Yahoo Messenger, an instant messaging service, which enables users to connect, communicate, and share experiences in real-time. It also provides digital content products, including Yahoo News, which gives users to discover, consume, and engage around the news, content, and video; Yahoo Sports, which serves audiences of sports enthusiasts; Yahoo Finance that offers a range of financial data, information, and tools; Yahoo Lifestyle to engage users passionate about style and fashion; and Tumblr, which provides a Web platform and mobile applications on iOS and android to create, share, and curate content, as well as Tumblr messaging that enables users to engage with other users that share their same interests and passions. Company description from FinViz.com.

After a lengthy process Yahoo agreed to be bought by Verizon for $4.8 billion. However, after the deal was done, Yahoo announced it had a serious cyberattack with data from over 500 million users stolen. This was not told to the potential buyers during the bidding process. The bidders were told there had been various attacks over the years but it was presented as a routine event that all online websites have to fight.

When it was disclosed a couple months ago that the attack happened in 2014 and involved more than 500 million accounts, that caused Verizon to take a second look and they are currently trying to decide on whether to back out of the deal or offer something significantly less. There are multiple class action suits against Yahoo for not guarding customer information. With 500 million accounts, even a $20 per account fine or settlement would cost them $10 billion and more than twice what Verizon agreed to pay. The announcement of the attack constitutes a material adverse change or MAC that allows Verizon to walk with no penalty.

On Friday, Yahoo announced they were not going to hold a conference call or the normal webcast of the earnings after the close on Tuesday because of the intense discussions with Verizon.

I view the odds of a Verizon backing out of the deal as very high. They were already paying about $1 billion more than the next highest offer. Now they are faced with potentially inheriting a $10 billion problem if they conclude the deal. Even if it was only $5 billion or even $2 billion, it makes the deal very uneconomical.

If Verizon walks, Yahoo shares will return to $30 or lower very quickly because nobody else is going to step up and assume that liability either. It would mean Yahoo will have to go it alone and the stock could be trashed.

Update 10/18/16: Yahoo reported revenue that fell -14% to $857 million. This is the fourth consecutive quarter that revenue has fallen more than 10%. They beat on earnings with 17 cents compared to estimates for 11 cents but did it on major cost cutting with the termination of 2,200 employees or one-fifth of its workforce. Verizon signaled last week it was reconsidering the acquisition because of the damage from the cyber attack. The decision to complete the deal or back out should be made over the next 2-3 weeks. Yahoo did not hold a conference call in order to avoid having to answer questions that might stir up more objections by Verizon.

Update 10/26/126: Verizon executive, Marni Walden, said Verizon was taking an in-depth look at how the Yahoo cyber attack occurred and what risk Verizon would have from continuing the acquisition. They would have an answer within 60 days. She said the deal still makes sense strategically BUT we have to be careful about what we do not know. The deal was tentatively still on track but the impact of the breach was "material" and still a big unknown. Use of the word material refers to a possible "material adverse change" or MAC clause in the contract that would allow Verizon to walk from the deal. With 500 million accounts hacked, a $20 fine on each account would be $10 billion and more than twice the $4.8 billion sales price.

This is a speculative position. We do not know what is going to happen or in what time frame. Do not enter this position with money you cannot afford to lose.

Position 10/17/16:

Long Jan $40 put @ $1.90. See portfolio graphic for stop loss.

YUM - YUM Brands - Company Profile


No specific news. Up $2 with the market.

Original Trade Description: November 2nd.

YUM! Brands, Inc., operates quick service restaurants. It operates in three segments: the KFC Division, the Pizza Hut Division, and the Taco Bell Division. The company develops, operates, franchises, and licenses a system of restaurants, which prepare, package, and sell various food items. As of April 21, 2016, it operated approximately 36,000 restaurants in approximately 130 countries and territories primarily under the KFC, Pizza Hut, and Taco Bell brands, which specialize in chicken, pizza, and Mexican-style food categories. Company description from FinViz.com.

Yum China had 7,300 stores and adding 1,500 since 2012. Currently they are on a path to add 600 stores a year with a growth target of 20,000 stores. This was the growth engine for Yum Brands.

Now the parent company is going to focus on a dividend model and returning cash to shareholders. Yum is planning on reducing its owned store count in the U.S. from 3,200 to 1,000. In the U.S. the pace of new restaurants has slowed significantly and Yum will concentrate on generating and retaining cash of its existing portfolio.

While Yum may generate a great dividend in the years to come, the excitement has evaporated from the stock. There will be little growth and earnings are going to flat line.

Update 11/4/16: Yum announced a giant expansion plan for Taco Bell. They are going to add 2,600 stores by the end of 2022 to bring their total to 9,000 US locations. That will increase employment by 100,000 from the current 210,000. Shares declined on the news.

Apparently I was wrong about Yum Brands lack of expansion. They are taking their most popular store and spending the money they are getting from yum China to expand it. While this will have no impact on YUM in the near future, it would be beneficial five years from now and raise earnings and dividends.

Earnings Jan 4th.

Shares are at $60 and I think they have risk to $55 or even $45. There is support at $57.50 but the company has changed. I would not be surprised to see shares cut through that support very quickly.

The YUMC shares began trading on Tuesday and YUM shares have declined sharply on Tue/Wed. The option is cheap and we will have little risk.

Position 11/3/16:

Long Dec $57.50 put @ $1.10, see portfolio graphic for stop loss.

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