Option Investor

Daily Newsletter, Tuesday, 1/3/2017

Table of Contents

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

Market Wrap

Direction Change?

by Jim Brown

Click here to email Jim Brown

After a week of declines, the Santa Rally returned to lift the Dow by +175 points at the open.

Market Statistics

The Dow gave back all but 4 points of its gains intraday but a new wave of buying at the close squeezed the shorts once again to power the index to a +119 point gain. There was $1.4 billion in market on close buy orders. Before everyone begins to believe we are headed significantly higher, there were some mitigating headlines.

Chinese economic numbers came in better than expected to power a strong rally in the Chinese markets overnight. That pushed the S&P futures to a strong gain and caused significant short covering at the open. I warned about this possibility last week.

Oil prices surged to $55.25 on the Chinese economics and that added to the short covering in energy equities. U.S. economic reports were also positive and that added fuel to the fire. Midday, oil prices crashed back to $52.11 and that weighed on equities.

This is also the period where yearend retirement contributions hit fund desks and they put that money to work immediately. The last five trading days of December and first two days of January are considered the Santa Rally because of the impact of those retirement funds and the investment of holiday bonuses. The first week of trading in any year is normally very volatile with spikes and swings in both directions.

There is a saying, "As goes the first week, so goes January. As the S&P goes in January, so goes the rest of the year." This adage has an 87.9% accuracy rate with only 8 major deviations in the last 66 years. The first week is important but one day does not make a week.

The ISM Manufacturing Index rose from 53.2 to 54.7 and the highest level since December 2014. Analysts expected only a minor rise to 53.5. New orders rose from 53.0 to 60.2 and new export orders rose from 52.0 to 56.0. However, backorders were flat at 49. Production rose from 56.0 to 60.3 to continue eating away at the order backlogs. Twelve industries reported gains and four industries reported declines. The biggest declines were in furniture and printing.

This was a good report but many of the internal components still need to improve significantly.

Construction spending for November rose from +0.6% to +0.9%. Analysts were expecting +0.6% and this was the strongest gain in five months. Private spending rose +1.0% and public spending +0.8%. Total construction spending for November was $1.13 trillion. That was up 4.5% from November 2015. Private spending accounted for $843.1 billion, up +5.7% from 2015.

The CoreLogic Home Price Index for November rose 7.1%, up from 6.7% in October. This was the 23rd consecutive month of increases. Prices reached new highs in 14 states. Only Connecticut saw prices decline with a -0.5% drop. With mortgage rates rising and housing inventories falling the race is on to make a purchase while the interest rates are still relatively cheap.

Moody's Chart

The headline event for Wednesday is the FOMC minutes. Nobody is expecting a surprise but you can never tell from the post meeting statements exactly what happened in the meeting. Analysts will be looking for clues on whether we are more likely to have 2 or 3 rate hikes in 2017.

The ADP Employment report on Thursday is expected to post slower job growth of 172,500 jobs compared to 217,000 in November. A weak retail sector could be the culprit. The Nonfarm Payrolls on Friday are expected to decline only slightly from 178,000 to 175,000.

Stock news was still light with many analysts and reporters still absent for the holiday. Dow component Disney (DIS) received an upgrade from hold to buy from Evercore ISI. The analyst made Disney a top pick for 2017. The analyst said the ESPN risks were well-understood and short term growth challenges were already priced into the stock. HULU, which Disney owns 30%, is expected to launch a cable like service this year that features Disney programming. They announced last week an agreement with Disney to stream more than 50 classic Disney titles. They are expecting a slightly smaller box office for Disney in 2017 since they had 6 of the top ten movies in 2016. They are off to a good start with Rogue One already over $850 million globally.

Xerox (XRX) shares rallied 20% on a combination of factors. They completed the spinoff of services company Conduent (CNDT) and the shares were adjusted down to a closing price of $5.75 as of Friday to compensate for the $15 share price of Conduent. However, Credit Suisse upgraded them to outperform from neutral, citing a more focused print business and a bigger than expected cost savings. He said Xerox would be moving towards Managed Print Services (MPS) and graphics processing. Their price target is $8. JP Morgan also upgraded from neutral to overweight.

Abercrombie & Fitch (ANF) was downgraded by Oppenheimer from perform to underperform and Jefferies cut them from buy to hold. Analysts said their turnaround had stalled with same store sales down -6% in Q3. The actual Abercrombie brand saw sales fall -14% while the Hollister brand was flat. The last 8 ratings changes were all downgrades. Shares actually posted a minor gain after an early morning drop.

After the bell, Tesla reported deliveries for Q4 and all of 2016. For Q4 they delivered 22,200 cars compared to estimates for 26,000. The company said there was a production slowdown in October when they switched to new parts for some autopilot components. Production accelerated again late in the quarter once the glitch was resolved. They delivered 76,230 cars for all of 2016 compared to estimates for 80,000. Tesla said they do not count the cars until they are delivered and there were 2,750 vehicles that were delayed in transit or the customer was unable to take the delivery. At the end of December there was a total of 6,450 cars in transit that will be counted as Q1 deliveries. Shares fell -$4 in afterhours.

Shares of Regeneron (REGN) fell $9 in afterhours when a federal judge refused to throw out a court verdict upholding two Amgen patents for a cholesterol drug. Amgen filed the suit in an attempt to stop Regeneron and Sanofi from selling the drug Praluent, which lowers bad cholesterol.

Mattel (MAT) announced a competitor to Amazon's Echo device that is being called a virtual assistant for babies. The device is called Aristotle and has an artificial intelligence that responds to voice commands. Mothers can reorder diapers, formula, etc, have it play music for the baby, soothe infants back to sleep, read bedtime stories, play games and teach toddlers different words. It has an HD camera for observation from another room. This device will cost $300 and will begin selling this summer. This is actually a very good move for Mattel, whose sales have been declining. Announcement

Every company wishes the market would reward them for a downgrade. McKesson (MCK) was downgraded by Mizuho from buy to neutral. Shares rallied $7 on Tuesday. However, there was other news. The company said it completed the $2.1 billion acquisition of Rexall Health from privately held Katz Group. That gives the company 470 pharmacies in Canada.

AmerisourceBergen (ABC) was also downgraded by Mizuho from buy to neutral and there was no other news. Shares spiked 6%. That has to be frustrating to the analysts that issue the downgrades in hopes of profiting from their shorts.

The brain drain at Twitter (TWTR) is continuing. Kathy Chen, hired only 7 months ago to be managing director of Greater China, announced her resignation. Twitter has lost 11 top-level executives in 2016 as the outlook for the company dims. Adam Messinger, chief technology officer, resigned in December. Analysts believe these resignations may be part of a targeted 9% reduction in force that some believe is necessary before Twitter can sell itself.

Crude oil crashed on the rising dollar and some technical issues after trading at a high for 2016. The $55 level was seen as psychological resistance and it hung at that level for about 60 minutes before falling off the cliff. Traders with long positions probably tightened their stops when that $55 level was reached and once the decline began, it was dramatic.

Coupled with that the dollar traded at a new 14-year high and that caused a decline in all the commodities.

Natural gas was also a big loser for the day. After touching $4 last week on the return of the polar vortex, the new weather report calling for a warm spell, sent prices crashing. Apparently, they were not talking about Colorado with 6-12 inches of snow expected on Wednesday and zero degree lows the rest of the week in Denver.


The first week of the year is normally volatile. The first day of trading for 2017 saw 7.43 billion shares exchange hands. That is high given the volume over the last couple weeks but it is still lower than the 8.4 billion shares on the first day of trading in 2016. The difference is that the Dow lost 277 points on the first day of 2016.

One day does not make a trend. We cannot tell anything about market direction for January after only one day of trading. That is especially true given the 175-point intraday range on the Dow. Sellers were definitely waiting and resistance was not broken.

Tonight the Asian markets are in rally mode with the Nikkei up more than 2% as I type this. That has caused the S&P futures to rebound from negative territory to slightly positive at +2 points.

My analysis and expectations for January have not changed. I still believe we will see some downside volatility over the next three weeks. Until the indexes break through overhead resistance, I am going to cling to those beliefs.

The S&P rebounded back over prior support at 2,250 and closed at 2,257. Strong resistance remains at 2,275. It would take a decent move from here to break through that resistance.

The Dow rebound was mostly a short squeeze prompted by the strong S&P futures overnight. The +175 at the open only held about an hour and the selling was dramatic. The rebound at the close is troubling. This appeared to be a major buy program and another short squeeze given the speed and timing of the move.

The Dow chart is inconclusive but this appears to be a normal post decline rebound that is destined to fail. We will not know for sure until the end of this week.

The Nasdaq posted a decent rebound but closed well off its highs and right on prior support at 5,425. Were it not for the 20-point rebound right at the close, the chart would look a lot different. The index is at risk for repeating its Friday decline back under 5,400. It would take two good days of gains to return to the resistance highs at 5,490.

The Russell 2000 is the broadest index we track daily. The 8-point rebound was lackluster and it closed well off the highs and just above support. The Russell is typically our market sentiment indicator and it is the weakest of the four charts.

The simple answer is that the market is due for a rest. However, like an unruly 3 yr old, it is fighting naptime. This is the second longest bull market ever and the third strongest post war bull. However, earnings could be challenging because of the strong dollar. Valuations are high and once earnings begin to appear, we could have another reason for some profit taking to add to the other handful of reasons I have been writing about for the last two weeks.

Sam Stovall of S&P said today's trading was mechanical (robots, algos, program trades) and not human based. He also expects weakness in mid January.

I am sticking to my outlook for a decent bout of volatility between now and the inauguration. Once this week is over, I will restudy that outlook and put the update in my weekend commentary. I would definitely refrain from adding a bunch of long positions based on Tuesday's gains. There is no compelling need to be long the market. There is always another buying opportunity in the future.



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New Option Plays

Not a Trend

by Jim Brown

Click here to email Jim Brown

Editors Note:

One day does not make a trend. One day of market gains does not mean the potential January decline has been cancelled. The first two days of January are part of the Santa Rally period because of the end of year retirement fund inflows. We need to wait for a couple days to see if this is just a fund flow event or something that can continue. There is no compelling need to be long the market. There is always another buying opportunity in the future.


No New Bullish Plays


No New Bearish Plays

In Play Updates and Reviews

Santa Finally Appears

by Jim Brown

Click here to email Jim Brown

Editors Note:

The Santa rally found some traction this morning but the sleigh was sliding backwards intraday. The Dow spiked +176 points at the open after a big rally in Asia carried over into the S&P futures. The Dow spiked to 19,938 at the open but fell back to 19,775 intraday.

The Santa rally is the last five days of the year plus the first two days of January. This is when the end of year retirement funds hit and fund managers put that money to work. A one day rebound is not a trend.

The rest of the week will be key for market direction.

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

No Changes

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

No Current Bullish Plays

BEARISH Play Updates (Alpha by Symbol)

CAT - Caterpillar - Company Profile


No specific news. Big spike with the Dow but sellers appeared instantly.

Original Trade Description: December 17th

Caterpillar Inc. manufactures and sells construction and mining equipment, diesel and natural gas engines, industrial gas turbines, and diesel-electric locomotives worldwide. The company's Construction Industries segment offers backhoe, small wheel, skid steer, multi-terrain, compact track, medium and compact wheel, and track-type loaders; mini, wheel, and track excavators; track-type tractors; and select work tools, motor graders, telehandlers, soil compactors, and pipelayers, as well as its related parts for the heavy and general construction, rental, mining and quarry, and aggregates markets. Its Resource Industries segment provides electric rope and hydraulic shovels; draglines; drills; highwall and longwall miners; hard rock vehicles; articulated, large mining, and off-highway trucks; large wheel loaders; wheel tractor scrapers; wheel dozers; machinery components; hard rock continuous mining systems; electronics and control systems; and select work tools for use in mining and quarry applications. The company's Energy & Transportation segment offers reciprocating engines, generator sets, marine propulsion systems, gas turbines and turbine-related services, diesel-electric locomotives, and other rail-related products and services. Its Financial Products segment provides retail and wholesale financing for Caterpillar equipment, machinery, and engines; offers property, casualty, life, accident, and health insurance; insurance brokerage services; and purchases short-term trade receivables. The company's All Other segments remanufactures Cat engines and components, and provides remanufacturing services for other companies; offers business strategy, and development, management, manufacturing, marketing, and support primarily for paving, forestry, industrial, waste, and Cat products. Company description from FinViz.com.

Caterpillar's business has been in decline for several years as the energy sector went into hibernation and Asia's economic growth appeared to slow. For some reason, the stock bottomed on January at $58 and rallied to almost $100 despite a weak outlook in every earnings cycle. The $18 post election bounce was just another example of irrational exuberance. The election did not sell more tractors overnight and a pickup in their business could be several quarters away.

The best thing Caterpillar has in its favor is OPEC's decision to cut production. That means a year from now oil prices may have recovered slightly and energy companies may begin to buy more tractors. That is a long time off for an $18 spike.

Earnings in 2014 were $6.38, 2015 $4.64, 2016 they are estimated to be $3.26 and for 2018 analysts expect $3.15. However, CAT said last week that the estimates were overly optimistic. While Asian sales may have quit declining there is no material rebound at present.

Earnings Jan 24th.

This is a play on the retracement of that $18 bounce. When the company says analyst expectations are overly optimistic you can bet analysts will begin to lower their numbers. That should produce an extra weight on the stock in addition to any normal decline with the Dow in January.

The earnings are Jan 24th and the February options are expensive. Since this is a short-term position, I am recommending the January options. I believe any material decline will happen in the first two weeks of January.

Position 12/19/16:

Long Jan $90 put @ $1.89, see portfolio graphic for stop loss.

DIA Dow ETF - ETF Profile


No material news. Big rally overseas spiked the U.S. futures to trigger short covering at the open. This should be temporary.

Original Trade Description: December 7th

The SPDR Dow Jones® Industrial Average ETF Trust seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the Dow Jones Industrial Average.

Remember Dow 10,000? Traders talked about it for weeks. When it was finally hit, they were passing out Dow 10,000 hats on the floor of the NYSE for a week. That was December 11th 2003. It was a big milestone for the market.

Now 13 years later we are about to double that with Dow 20,000. Given the place on the calendar, the massive post election rally and the potential for normal profit taking in January, the Dow 20,000 touch could be a massive sell on the news event.

However, we are only 386 points way and it could happen as soon as next week. The Fed rate announcement on Wednesday could either cripple that potential or accelerate it if the Fed maintains a dovish posture on future rate hikes. I believe we will hit Dow 20K before the end of December. When that happens I want to be short the DIA ETF and plan on holding it through January.

I am choosing the Dow because it is the most overbought and could produce the biggest percentage move. Just look at Goldman's chart and the profit that needs to be removed there.

Because there will be plenty of other traders thinking along the same lines I want to enter the put position at 19,900 or $199 on the DIA ETF. I know I am jumping in front of a speeding train to enter a short position on a runaway market but the potential is very high for a good trade.

Position 12/12/16:

12/12 - 1/2 position: Long Feb $195 put @ $3.40, no initial stop loss.

12/13 - 1/2 position: Long Feb $195 put @ $3.15, no initial stop loss.

DRI - Darden Restaurants - Company Profile


No specific news. Nice decline in a bullish market.

Original Trade Description: December 20th

Darden Restaurants, Inc., through its subsidiaries, owns and operates full-service restaurants in the United States and Canada. As of May 29, 2016, it owned and operated 1,536 restaurants, which included 843 Olive Garden, 481 LongHorn Steakhouse, 54 The Capital Grille, 65 Yard House, 40 Seasons 52, 37 Bahama Breeze, and 16 Eddie V's restaurants. Company description from FinViz.com.

Darden Restaurants (DRI) reported earnings on Tuesday of 64 cents that beat estimates by a penny. Revenue of $1.64 billion missed estimates for $1.65 billion. They guided for the full year 2017 to earnings of $3.87-$3.97 per share. Same store sales growth was choppy. Olive Garden saw +2.6%, Longhorn Steakhouse +0.1%, Capital Grille+1.2%, Eddie V's +2.7%, Yard House +0.7%, Seasons 52 -0.3% and Bahama Breeze +2.6%. Shares spiked $2 on the news but faded in the afternoon to close negative. Darden had rallied 23% since the election.

The idea behind the rally was the end of the push for a $15 per hour minimum wage. When Clinton lost, that effort turned into wishful thinking because republicans have held the view that a lower wage offers entry level workers an opportunity and they can move up in the organization if they are qualified and work hard. Was that worth a 23% rally in Darden shares? I find it hard to believe.

Now that Darden earnings are over, we should expect a couple weeks of post earnigns depression and given the recent rally and the chance for a market decline in early January, the Darden drop could be significant.

Position 12/21/16:

Long Feb $72.50 put @ $1.55, see portfolio graphic for stop loss.

GATX - GATX Corporation - Company Profile


No specific news. Shares closed at a two-week low after a minor rebound from support.

Original Trade Description: December 15th

GATX Corporation leases, operates, manages, and remarkets assets in the rail and marine markets in North America and internationally. The company operates in four segments: Rail North America, Rail International, American Steamship Company (ASC), and Portfolio Management. The Rail North America segment primarily leases railcars and locomotive, as well as other ancillary services. This segment also offers repair, maintenance, modification, and regulatory compliance services on the railcar fleet. The Rail International segment leases railcars, as well as offers repair, regulatory compliance, and modernization work for railcars. The ASC segment operates a fleet of vessels that provide waterborne transportation of dry bulk commodities, such as iron ore, coal, limestone aggregates, and metallurgical limestone for steel makers, automobile manufacturing, electricity generation, and non-residential construction markets. The Portfolio Management segment is involved in leasing, asset remarketing, and marine operations, as well as manages portfolios of assets for third parties. As of December 31, 2015, it operated a fleet of 17 vessels; a fleet of approximately 106,100 cars; a fleet of 18,400 boxcars; and a fleet of 611 older four-axle and 26 six-axle locomotives. Company description from FinViz.com.

There has been no news since the company announced a 40 cent dividend on Oct 28th. The dividend is payable on Dec 31st to holders on Dec 15th. That is today. That means nobody else is going to be buying the shares to get the dividend.

Earnings Jan 19th.

GATX has rallied 69% since the election. I can only assume it was because of the rally in the Dow Transports in anticipation of a better economy in 2017. There is no current fundamental reason for a 69% rally and odds are good once the stock begins to roll over with the market it could fall very hard. Apparently other investors believe the same way since the only put strike with any volume is the January 60 puts. There is more volume in that one strike than all the other strikes combined.

Position 12/16/15:

Long Jan $60 put @ $2.35, no initial stop loss to avoid any volatility spikes.

MAT - Mattel - Company Profile


Mattel spiked on the announcement of a smart baby monitor named Aristotle. It is similar to Amazon's Echo/Alexa. Mothers can reorder diapers, formula, etc, have it play music for the baby, soothe infants back to sleep, read bedtime stories, play games and teach toddlers different words. It has an HD camera for observation from another room. This device will cost $300 and will begin selling this summer. This is actually a very good move for Mattel and the stock decline could be over. Announcement

Original Trade Description: December 28th

Mattel, Inc. designs, manufactures, and markets a range of toy products worldwide. The company operates in three segments: North America, International, and American Girl. It offers dolls and accessories, vehicles and play sets, and games and puzzles under the Mattel Girls & Boys brands, including Barbie, Monster High, Disney Classics, Ever After High, Little Mommy, Polly Pocket, Hot Wheels, Matchbox, CARS, Disney Planes, BOOMco, Radica, Toy Story, Max Steel, WWE Wrestling, and DC Comics. The company also provides its products under the Fisher-Price brands, such as Fisher-Price, Little People, BabyGear, Laugh & Learn, Imaginext, Thomas & Friends, Dora the Explorer, Mickey Mouse Clubhouse, Disney Jake, the Never Land Pirates, and Power Wheels. In addition, it offers its products under the American Girl brands comprising Truly Me, BeForever, and Bitty Baby; and construction, and arts and crafts brands, such as MEGA BLOKS, RoseArt, and Board Dudes, as well as publishes the American Girl magazine. Mattel, Inc. sells its products directly to consumers via its catalog, Website, and proprietary retail stores, as well as directly to retailers, including discount and free-standing toy stores, chain stores, department stores, and other retail outlets; to wholesalers; and through agents and distributors. Company description from FinViz.com.

Retail surveys showed a 9% decline in toy sales over the holiday shopping season. Several of the high profile toys that did sell, suffered serious glitches that have buyers burning up the phone lines wanting refunds and/or replacements.

Zacks downgraded Mattel to a sell saying earnings growth at Mattel, even before the holiday disaster, was only 3.1% compared to the industry average of 21.2%. For the current year Mattel is only expecting 1.2% growth and that was before the holiday news. The company has already projected sales for 2016 to decline -1.9% and that forecast is sure to be revised lower. Analyst earnings estimates were already moving lower and the holiday sales news should accelerate that trend.

Toymakers are facing something called "age compression." Previously the age range for Barbie toys was 3 to 9 years. Now that has compressed to 3 to 6 years. Electronic games are making kids smarter and taking up a large percentage of their playtime. Toys are being left in the toy box. This is good news for companies like ATVI and EA but bad news for Mattel.

The company is also vulnerable to the strong dollar because of sales overseas. The dollar is at 14 year highs and Q4 earnings are going to be impacted.

Earnings January 18th.

This is going to be a short play. With earnings on the 18th, we are going to use a February option and we will exit before the earnings report. The expected market decline in early January should accelerate any drop in Mattel shares.

Position 12/29/16:

Long Feb $27 put @ $1.30, see portfolio graphic for stop loss.

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