Option Investor

Daily Newsletter, Saturday, 7/29/2017

Table of Contents

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

Market Wrap

Sentiment Damaged?

by Jim Brown

Click here to email Jim Brown

The sudden 143-point Nasdaq decline on Thursday may have damaged market sentiment.

Weekly Statistics

Friday Statistics

With multiple highly regarded market analysts warning of an impending sell off and the sudden 143-point Nasdaq decline on Thursday, we could be nearing a point where investor sentiment is going to sour. The Nasdaq crash like we saw on Thursday, tends to knock a bunch of people out of the market as their stop losses are hit. Investors understand when a stock declines for a reason like an earnings miss but when the top 20 stocks decline 4% to 5% in just a few minutes without any news, that is a shock to sentiment.

The Nasdaq dipped to support again on Friday but rebounded slightly to end with only a 7 point loss despite the Amazon earnings miss. That suggests any sentiment damage was light and there are still investors buying the dip. However, do you remember August of 2015?

Starting on August 18th, 2015, the S&P declined from 2,101 to 1,867 in ONLY five trading days. That was a drop of -235 points. The Nasdaq dropped -800 points in those same 5 days. The VIX shot up from 14 to 53 in 3 days. So what caused this? The decline began on Tuesday of option expiration week and was fed by a market drop in China to six-month lows, Grecian Prime Minister Alex Tsipras said he would resign after losing parliamentary majority and some bland FOMC minutes that suggested the economy was doing fine and the Fed could begin hiking rates over the coming quarters. Who knew a relatively benign series of events could knock 11% off the S&P in five days? (FYI, if you are researching past market events, did you know you can go back to ANY daily market commentary on OptionInvestor.com all the way back to 1998? That really comes in handy when trying to learn why the market moved on any particular day.)

Prior to the decline, the market decline the S&P had been moving sideways in a 75-point range for more than five months. Suddenly one morning somebody kicked off a sell program that triggered a cascade event where sell stops were hit causing volume to increase and volatility to explode. Liquidity evaporated because the dip buyers were overrun on the first drop below 2,050. There is not an unlimited supply. Once they are blown out, the market can free fall until sellers run out of stock.

S&P August 2015

The Volatility index had been idling along for an extended period of "abnormally low volatility" just like we are seeing today. I wrote in the Option Writer newsletter on Wednesday, "When volatility returns it seldom arrives slowly. It tends to arrive suddenly and violently." The 2015 market crash was a prime example. The headlines were not expected and individually they were not that bad. The market does not need a reason to decline. It declines when investors large and small suddenly decide in the same week that maybe it is time to take some chips off the table.

I recommend all readers reevaluate the amount of capital they have at risk as we head into the normally volatile Aug/Sep period. Unexpected events do happen with some regularity.

VIX August 2015

The lead economic report on Friday was the GDP for Q2. The headline number rose from 1.24% growth in Q1 to 2.57% in Q2. Consumption contributed 1.93%, fixed investment 0.36%, exports 0.18% and government 0.12%. Inventories removed 0.2%.

Real disposable income rose 3.2%, up from 2.8% in Q1. The personal savings rate declined from 3.9% to 3.8%. The PCE inflation indicator showed a 0.3% rate of inflation, down from 2.2% in Q1. The core rate, excluding food and energy, declined from 1.8% in Q1 to 0.9%.

Despite the fluctuations from quarter to quarter, the economy continues to muddle through the post crisis expansion period at almost exactly a 2% growth rate. The economic expansion is now 8 years old and the third longest in history. In reality, the economy is remarkably stable given the almost full employment and the lack of any material inflation.

The final reading on July consumer sentiment improved slightly to 93.4 from the initial 93.1 reading. This was the lowest reading since October and the second month of 2 point declines. The present conditions component improved from 112.5 to 113.4 and the expectations component declined from 83.9 to 80.5.

We have a busy calendar for next week with home sales, ISM and employment data. The jobs will be the most important with the ADP Employment number expected to rise from 158,000 to 186,000 jobs for July. The ADP numbers have missed expectations to the downside the last several months. The Nonfarm Payroll numbers on Friday are expected to decline from 222,000 to 182,000. The nonfarm numbers have greatly exceeded expectations the last several months. Regardless of the numbers, the Fed is likely on hold until December, according to most analysts and quite a few do not expect any further rate changes until 2018.

The rest of the economic reports have been relatively stable with the occasional dip or gain but remaining near the recent trend.

Stock news was very light on Friday with volume light at 5.99 billion shares. It was a summer Friday and volume was actually a little higher than normal with only three weekends left before kids begin returning to school. If traders are going to squeeze in another vacation, time is running out.

Advancers of 3,504 narrowly beat decliners of an even 3,500. I do not recall seeing them that close in several years. Trading interest was definitely lacking.

Exxon Mobil (XOM) hit a 52-week low intraday after missing estimates. The company reported earnings of 78 cents ($4.3 billion) compared to estimates for 83 cents. Revenue of $62.88 billion did beat estimates for $61.16 billion. Production averaged 3.922 million Boepd and flat with the year ago quarter. Liquids production fell 3% to 2.269 million bpd due to field depletion. Natural gas production rose 2% to 9.92 Bcf per day thanks to gains in Australia. The refining division reported profits of $1.4 billion, up $560 million from Q2-2016. Exxon refined an average of 4.4 million bpd, a 5% increase. Capex declined -24% to $3.9 billion.

The company said they made the final investment decision for the Liza field, offshore Guyana. They are now projecting gross recoverable resources for the Stabroek block at 2.25 billion to 2.75 billion oil-equivalent barrels. That block includes the Liza field and discoveries at Payara and Snoek. They announced results and progress on multiple other discoveries. The company has a lot of future production coming online in the next 3-5 years.

On the flip side, Chevron (CVX) reported earnings of 91 cents compared to estimates for 89 cents. Revenue of $34.48 billion greatly exceeded estimated for $31.18 billion. Overall production rose an impressive 10% to 2.78 million Boepd. Production was boosted by multiple long-term projects coming online. Those include the Gorgon LNG facility, which is now 100% operational and the Wheatstone LNG facility where Train 1 is complete. They also started production at the Angola LNG project, Jack/St Malo in the Gulf, and the Alder project. They did not complete any asset sales in Q2 but they expect to complete another $5 billion by the end of 2017. They are currently producing 175,000 bpd in the Permian with production rising. Overall operating expenses were down 10% and capex spending declined 25% because most of the major projects are now complete. Shares rose $2 on the news and added 14 Dow points.

Dow component Merck (MRK) reported earnings of $1.01 compared to estimates for 87 cents. Revenue of $9.93 billion beat estimates for $9.79 billion. They guided for the full year for earnings of $3.76-$3.88 with revenue of $39.4-$40.4 billion. Revenue for the drug Keytruda nearly tripled to $881 million but their top selling drugs, Januvia and Janumet saw sales decline -8% to $1.51 billion. That missed estimates for $1.62 billion. Shares rose fractionally on the news.

Drug maker AbbVie (ABBV) reported earnings of $1.42 that beat estimates for $1.40. Revenue of $6.94 billion just barely edged by estimates for $6.93 billion. Sales of Humira rose 13.7% to $4.72 billion. Analysts were expecting $4.64 billion. U.S. sales rose 18%. The drug has a list price of $4,441 for a two-pen pack and is used to treat autoimmune disorders. Sales of their Hep-C treatment, Viekira Pak, were $225 million and missed estimates for $2.57 million.

AbbVie has the best drug pipeline in the market with multiple drugs nearing adoption that could generate sales over $1 billion a year each. However, shares declined slightly after earnings.

American Air Lines (AAL) reported earnings of $1.92 that rose 8% and beat estimates for $1.97. Revenue of $11.105 billion rose 7.2% but barely beat estimates or $11.087 billion. They plan on spending $4.1 billion on new aircraft this year as they renew the fleet. They spent $1.1 billion in Q2 for 16 mainline aircraft and 4 regional planes. These are replacing existing planes rather than simply making additions. They repurchased 10 million shares for $450 million and they have $1 billion left on their existing buyback authorization. Shares posted a fractional gain.

Rockwell Collins (COL) reported earnings of $1.64 compared to estimates for $1.58. Revenue of $2.09 billion rose 57% and beat estimates for $2.03 billion. They guided for the full year to earnings of $5.95-$6.15 with revenue of $6.8 billion. They ended the quarter with $578 million in cash. Shares spiked $4.71 on the news. All of the defense contractors have been reporting strong earnings and guidance.

Lithia Motors (LAD) reported earnings of $2.28 that rose 16% and beat estimates for $2.22. Revenue was $2.47 billion. They guided for the full year for earnings of $8.35-$8.50 with revenue from $9.6 to $9.9 billion. Same store sales rose 3%, used vehicle sales rose 4%, service, body and parts sales rose 7%. They announced a dividend of 27 cents payable August 25th to holders on August 11th. Shares rose $7 on the news.

As of Friday, 289 S&P companies have reported earnings and 73% beat expectations. This is above the long-term average of 64% and the short-term average of 71%. Of those 289 companies, 70.9% beat on revenue, also above the 59% and 56% averages. The current forecast for final Q2 earnings is 10.8% growth. There have been 83 instances of negative guidance and 45 companies issued positive guidance. The current 12 month forward PE is 17.9 for the S&P. Next week only one Dow component reports earnings, Apple, with 134 S&P companies reporting. After this week, 423 S&P companies will have reported and the majority of the Q2 earnings cycle will be over.

In addition to Apple earnings on Tuesday evening, Tesla reports on Wednesday, Activision Blizzard and YUM Brands report on Thursday.

Tobacco companies were hammered on Friday after the FDA said it was proposing a cut in nicotine to "non addictive" levels. The FDA chief, Scott Gottlieb, directed the staff to develop new regulations on nicotine. Most non-smokers are always amazed that cigarettes are even legal. Cigarette smoking is responsible for 480,000 deaths annually. If any other product caused even 100,000 deaths, it would have been banned long ago. The FDA said studies have found that reducing nicotine levels by 90%, leads smokers to be "less dependent."

There are concerns that a reduction in nicotine could lead to more smoking and even more harmful effects from the bad chemicals in cigarettes. However, studies have shown that reducing by 90% leads to less smoking because the dependency fades. With the availability of e-cigarettes there is no need to continue inhaling harmful smoke and the FDA is going to force that evolution. The FDA is also going to consider new regulations on cigars. Altria (MO) fell 15% intraday but rebounded to only a 7% loss. You can bet this decline is not over.

Snap Inc (SNAP) continues to decline but we could be nearing a turning point. With a 37% short interest of 69 million shares out of a float of 188 million, investors are betting the lockup expiration is going to be a disaster. More than 85% of the authorized shares will see their lockup expire in August. On Monday, 400 million shares are free to trade. On August 14th another 782 million shares are released. On August 30th another 20 million shares expire. Reportedly, officers and directors hold 60% of the shares to be released so we do not know what they are planning to do. Shares hit $29.44 on the second day of trading and have declined to $13.81 at Friday's close.

Investors have been betting that the lockup expiration will be a disaster given the decline in the stock price. People have seen the value of their holdings decline sharply as Facebook and others have cloned most of SnapChat's features and user growth has slowed dramatically. They may be tempted to jump ship and take whatever they can get today rather than wait for shares to rebound. Many expirations in the past have had the opposite results where very few holders sold and the stock rebounded when shorts were forced to cover. At the same time, there have been disasters so we will not know which occurs until it actually happens.

The Dow Transports crashed last week with a 244-point decline. In theory, the falling transports will be a drag on the Dow industrials but it did not happen with the Dow setting new highs nearly every day. The rising oil prices may be a drag on the transports but I suspect there are other forces in play. Railroads guided for a weak Q3 and shares declined. It was not that there was a shortage of freight but Q3 2016 had a strong uptick in freight so the comps for this quarter will be high. Airlines are packing people in as tight as possible so they are not reporting any serious traffic problems. Trucking companies are running ads for drivers on nearly every Sirius radio station with $5,000 sign on bonuses and guaranteed earnings and future bonuses. They are not hurting for business. This may just be profit taking from the big rebound to new highs but any further declines could be Dow negative.

Crude prices rallied strongly after Saudi Arabia said they would export one million barrels less per day starting in August and U.S. inventories declined sharply. The U.S. rig counts are starting to plateau according to Halliburton and some companies have talked about slowing their production efforts to let prices stabilize. All of those things are positive but one of them is fake news.

Saudi Arabia burns up to one million barrels of oil per day more than normal in August because they use oil to generate electricity for cooling and August temperatures are unbearable in Saudi Arabia. They have played this game many times in the past with promised cutbacks because they know the general public does not know about the extra demand. They cannot export that oil because they need it. Secondly, they said they would export 1.0 mmbpd less not "produce" 1.0 mmbpd less. That is the key fact. If they continue to export less after the August heat passes, it just means they will store the oil for future sale when nobody is watching.

Personally, I am glad Saudi Arabia captured trader's attention with the export ploy because that lifted crude prices, which supports the equity market. Unfortunately, there will come a day later this year when the export numbers rebound. Since the U.S. driving season ends with the Labor Day weekend, that export bump will be in a low demand cycle. Prices will be pressured again.


The market may have suffered some significant damage to sentiment on Thursday. The S&P suffered an outside reversal day meaning there was a higher high and lower low followed by a lower close on the following day. This is also called a bearish engulfing pattern in candlestick charting. The key here is the word bearish. While there is never a guarantee of future direction, the pattern typically indicates a change in trend. The chart may not look bearish and it may not work out that way but chartists all over the country are looking at those candles this weekend and trying to decide if they should buy the dip or sell the next bounce.

The key point is there is nothing wrong with earnings, the economy or the Fed. There is no specific reason why the market should decline. We know it does not need a specific reason but it normally takes a reason to push investors into action. With earnings expected to be over 10%, congress moving towards tax reform and the Fed on hold for months to come, the decision should be to buy the dip. Washington gridlock is positive for markets because nothing negative can be passed. However, the sudden outbreak of market warnings could be changing the way investors are looking at the market. Add in the fact that August and September are the two weakest months of the year and they may decide to take some chips off the table.

With liquidity shrinking as more and more investors move to passive funds and ETFs, any sudden changes in direction could trigger a significant move. The August correction in 2015 would be a prime example.

Initial support is now 2,465 with 2,483 as solid resistance. If we were to break through that level, the large round number psychological resistance at 2,500 could be a real challenge in a typically weak August.

Nearly every day last week the Dow benefitted from strong earnings related gains in several stocks. Boeing gained 29 points for the week and added 198.5 Dow points. The Dow only gained 250 points for the week so Boeing accounted for 79% of that gain. The odds of that happening again next week are zero. Apple is the only Dow reporter this week and I would be shocked if they posted a significant gain.

Thanks to Boeing and several others, the Dow has broken out to a new high and well over prior resistance. The next hurdle will be the round number resistance at 22,000. Coming in the month of August that could be a significant hurdle. Without a handful of Dow stocks posting large gains, I doubt the index is going to easily exceed that level.

Starting next week, the Dow should begin experiencing post earnings depression. That means traders will begin taking profits in those big earnings gainers and moving on to something else.

On Thursday, the Nasdaq hit 6,461 intraday for a new high then plunged -143 points to 6,318 intraday. The entire move took only about 90 minutes and traders bought the dip. However, the velocity of the rebound was lackluster and recovered only 52 of those points. That was followed by another dip at Friday's open, thanks to Amazon's earnings miss, and the index could not return to positive territory.

Friday's rebound was powered by the big caps with Google recovering some if its losses for the week. Apple remains unstable ahead of its earnings with every forecast imaginable making the rounds. Some have Apple surprising to the upside on the strength of everything but the iPhone and some have it disappointing because people held off on purchases in anticipation of the iPhone Pro/8. Many analysts believe Apple will have to guide lower because of the slippage in production of the new phone. Most analysts are not expecting deliveries until November. The good news is that any slippage will be made up in a much larger Q1. Translation, buy any material post earnings dip.

Over the last three months, we have had three similar declines in the Nasdaq. Only one of them rebounded immediately. The other two had some volatility issues for several days before a rebound occurred. That is entirely possible this time as well. However, since earnings are fading there is less incentive for traders to buy the dip in tech stocks. There has been such a flurry of dire warnings about an impending correction, they may want to cling to cash in hopes that comes true in Aug/Sep.

Support is well below at 6,100 but there could be some stutter steps at multiple levels on the way down. Once a real decline appears, traders will be eagerly awaiting a pause point to begin buying. That should limit any real decline.

The Russell had a decent rally going until Wednesday. The three-day decline knocked it back to support at 1,425 and that is a critical level. A breakdown there should target 1,400 and it would be damaging to market sentiment.

There was a $900 million buy program on the NYSE at the close on Friday. This overcame any decline caused by traders exiting positions ahead of the weekend. It would be nice if we knew who was buying but that information is not available. If it were a well-known hedge fund it would be bullish. If it were a sovereign wealth fund, it would not be particularly bullish because they do not normally time buys to capitalize on dips or opportunities. It is mechanical rather than opportunistic.

The main point to stress this weekend is that the majority of the big cap, high profile earnings are over. Post earnings depression should appear soon. Whether positive earnings expectations for Q3 can overcome that depression is of course unknown. Volume is going to be weak over the next month as vacations wind down and kids go back to school. Money will be leaving the market to pay tuition. I continue to recommend not being overly long in the weeks ahead. Respect the historical trend for weakness in Aug/Sep whether it comes true this year or not.

If you like the market commentary you have been receiving and you are on a free trial then now is the time to subscribe. Do not wait until you miss a newsletter to decide you want to take the plunge.

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Random Thoughts

With the markets closing at new highs on Wednesday, the day this survey closes, I would have expected a significant boost in bullish sentiment. Instead, there was a minor decline. Investors were moving to neutral and away from bearish but not quite bullish. Slightly more than 65% still believe the market is not going higher.

A mystery trader, not the recently unmasked "50 Cent" that works for Ruffer LLP, has acquired 262,000 VIX October $15 calls. To fund it he sold 262,000 VIX $12 puts expiring in October. He used those proceeds to buy a 1x2 call spread, which involves buying 262,000 $15 calls and selling 524,000 $25 calls. If the VIX spikes but does not exceed $25 in October, he could make up to $262 million. If the VIX exceeds $32.50, he would begin to lose money. The October expiration covers two Fed meetings, the Congressional budget battle and the debt ceiling battle at the end of September.

North Korea is nearing the point of military action. On Friday they launched an ICBM that flew 2,299 miles into space, roughly 10 times the height of the International Space Station and then returned to earth about 621 miles from NK to land in Japanese waters. Scientists have calculated the rocket could reach Denver, Chicago or Dallas and any city west of those locations. Kim Jong Un then announced they now have the capability to hit any U.S. city with a nuclear weapon. That remains to be seen since shooting an empty rocket straight up into space is a lot easier than accurately shooting a loaded one horizontally for 7,500 miles. However, U.S. Marine General Joseph Dunford, Chairman of the Joint Chiefs of Staff, contacted his South Korean military counterpart, General Lee Sun Jin, to discuss "military options."

In a new assessment, U.S. officials warned North Korea will be able to launch a nuclear capable ICBM as early as next year. President Trump said he was weighing "some pretty severe things" in response. North Korea already has two satellites that cross over the U.S. twice a day. I really hope they do not have EMP weapons Kim can use in the event North Korea is attacked.

A UK driver had a very bad day on Friday. The driver had just purchased a Ferrari 430 Scuderia, one of only 499 made and worth about $200,000. The car can go 0-60 in 3.3 seconds with a top speed of 198 mph. Within an hour of picking up the supercar, he totaled it when the car went airborne and crashed. The driver escaped with minor cuts and bruises but the car was completely destroyed. When complaining about your bad day, just remember, things could be worse.


Enter passively and exit aggressively!

Jim Brown

Send Jim an email


"Much of the social history of the Western world, over the last three decades, has been a history of replacing what worked with what sounded good."

Thomas Sowell


Index Wrap

Will History Repeat?

by Jim Brown

Click here to email Jim Brown
August and September are normally the two weakest months of the year.

Will history repeat itself or should we expect a late summer rally? The correct answer to that question would be worth a lot of money. However, historically, the average S&P decline for each month is only about 1.2% to 1.5%. That is hardly worth getting excited about. Unfortunately, averages have a way of distorting the facts. There are some years where the markets dipped 15% over that period and others where they gained sharply. If you average anything over 30 to 50 years, it is hard to see the potential damage.

If this August turns into a repeat of 2015, it would be very painful. There is no reason to expect that kind of decline but there was no reason to expect it then either.

October is called the "bear killer" month because more bear markets end in October than any other month. Those bearish markets typically decline in Aug/Sep to reach a low in early October. That has happened so much in the past that investors became accustomed to buying the October lows in advance of the best six months of the year strategy that starts on November 1st.

This year we have no specific reason for a sell off other than just being long term overbought. The forward PE on the S&P is 17.9 and 16 is considered a reasonable PE. The number is higher for high growth stocks but that is the average. The 17.9 is not high but it is elevated.

The analysts and fund gurus warning about a correction sometimes mention the Cyclically Adjusted PE or CAPE, which is currently 30.23 and the second highest in history. This was made famous by Robert Shiller and is also called the Shiller PE. The CAPE is the price to earnings ratio based on average inflation-adjusted earnings from the prior 10 years. That takes into account multiple market cycles over a trailing 10-year period.

Using the CAPE as a measuring stick, stocks are very overvalued. However, we know from experience there is no maximum number. Stocks can remain overvalued for sometime but there will eventually be a rapid devaluation.

There is no tape across the finish line for the market and no guarantee of an immediate decline once that line is crossed. Think of it as long distance race. Some runners cross the finish line and collapse while others slow down gradually to cool off. How the market reacts depends on the sentiment at the time and any headlines that trigger the peak.

I apologize for the small chart but we have a width restriction in email. For the larger chart click here

As I wrote in the Option Investor commentary this weekend, there are no specific reasons for an immediate decline. Earnings are strong, the Fed is on hold, the economy is healthy and Washington is gridlocked. We could go months or even a year before a material decline appears, BUT, that is not likely. The S&P is up 36.5% or 661 points since the last material sell off that ended in February 2016 at 1,810. That is a long time without a material decline and a lot of uncaptured profits are at risk.

On a shorter-term basis, the S&P punched through uptrend resistance over the last two weeks but could not hold the gains. There was a lot of choppy movement at the top. Thursday's decline was an outside day and the addition of Friday's decline makes it a bearish engulfing candle, which typically signifies a change in direction.

Despite that bearish comment, the S&P chart is still overall bullish. The MACD is about to turn negative again but a positive day on Monday could reverse that indicator.

The most bullish chart for the last several weeks was the advance/decline line for S&P stocks. That sharp uptrend stalled last week and we could be seeing the first signs of market weakness.

The correlation between the High Yield ETF and the S&P remains very high at 94%. Yield junkies are still sucking up high yield debt at almost the same rate as equities in the S&P. There is no market weakness in this chart.

The Dow had a great week with a gain of 250 points but note the A/D line also stalled. The Dow gains were only due to a small number of stocks that posted outsized gains. Boeing was up 29 points and added 198 points to the Dow. That is only one stock out of 30 so it is hard to call it a Dow rally. It was a Boeing rally. Note the MACD on the A/D chart is on the verge of a negative cross despite the strong gains.

The Dow chart is strongly bullish on the surface but suffers from the same lack of breadth impacting the A/D chart. The Dow soared through uptrend resistance but it was only driven by 5-6 stocks. The potential for 5-6 stocks to make the same enormous gains again this week is close to zero.

The Nasdaq has been the market leader over the last 20 days with a monster rebound from the early July lows. This looks very similar to the rebound out of the April lows and we would be very fortunate if the pattern repeated. The Nasdaq did suffer some extended profit taking from early June through early July. Despite the gains over the last 20 days, the index is not that overbought. It still needs to rest again in order to give traders the confidence to buy the dip. Nobody likes to buy new highs, especially after the volatility event we had on Thursday.

The Nasdaq could see additional weakness if the semiconductor sector continues to decline. If Apple disappoints and/or warns about production delays on the iPhone Pro/8, we could see chip stocks take another dip and that would lead the Nasdaq lower.

The Russell 2000 is now the weakest index. After a nice rally and new high, the index failed at 1,452 on three out of four days and then rolled over to retest support at 1,425. If that level breaks, the next target would be 1,400 and that would be negative for market sentiment. The MACD turned bearish on Friday.

While there is no specific reason for a market decline in August other than the historical trend, the market does not need a reason to rest. A sudden decline can come at any time. Because of the historical trend, I would suggest not being overly long over the next few weeks. Keep your stop losses in place and I would not buy any initial dips. Look for a rebound first and then pick an entry point. There is always another day to trade if you have money in your account.

Enter passively and exit aggressively!

Jim Brown

Send Jim an email

New Option Plays

Chronic Underperformer

by Jim Brown

Click here to email Jim Brown

Editors Note:

Some companies always succeed while some have evolved into chronic underperformance. IBM has evolved to a company that has seen revenue decline quarterly for years.


No New Bullish Plays


IBM - International Business Machines - ETF Profile

International Business Machines Corporation provides information technology (IT) products and services worldwide. Its Cognitive Solutions segment includes Watson, a cognitive computing platform that interacts in natural language, processes big data, and learns from interactions with people and computers. The company's Cognitive Solutions segment also offers data and analytics solutions, including analytics and data management platforms, cloud data services, enterprise social software, talent management solutions, and solutions tailored by industry; and transaction processing software that runs mission-critical systems in banking, airlines, and retail industries. The company's Global Business Services segment offers business consulting services; delivers system integration, application management, maintenance, and support services for packaged software applications; and business process outsourcing services. Its Technology Services & Cloud Platforms segment provides cloud, project-based, outsourcing, and other managed services for enterprise IT infrastructure environments. This segment also offers technical support, and software and solution support; and integration software solutions. The company's Systems segment offers servers for businesses, cloud service providers, and scientific computing organizations; data storage products and solutions; and z/OS, an enterprise operating system for z systems. It has a strategic collaboration with ABB Ltd to develop industrial artificial intelligence solutions. The company was formerly known as Computing-Tabulating-Recording Co. and changed its name to International Business Machines Corporation in 1924. Company description from FinViz.com.

Expected earnings October 17th.

IBM reported revenue of $19.29 billion, down -5% annually and the 21st consecutive quarterly decline. Analysts were expecting $19.49 billion and that was already on the low side. Earnings were $2.97 and beat estimates for $2.74 thanks to a lower tax rate of 9.2%. Full year guidance was reiterated for "at least" $13.80. Several years ago, they made a big deal out of forecasting $20 a year in earnings. That is not likely to happen in this decade. All five of IBM's reporting segments posted revenue declines.

The problem with IBM is the lack of a light at the end of the tunnel. There is no way out of this problem without major changes which could include splitting the company up or going on an acquisition spree. Shares hit $182.50 in February but hopes have now been dashed twice with Q1 and Q2 earnings. The outlook is dim.

If the market were to roll over and the Dow decline materially, IBM would be a leader in that decline. It has been losing ground even when the Dow is setting new highs.

With earnings Oct 17th we can use the Oct options which expire on the 20th. They should hold their premium well.

Buy Oct $140 put, currently $3.10, initial stop loss $148.50.

In Play Updates and Reviews

Rough Week for Techs

by Jim Brown

Click here to email Jim Brown

Editors Note:

The Nasdaq declined again thanks to a sharp decline in Amazon and Starbucks. The damage would have been worse but there was a $900 million buy program just before the close. The Dow manages to add another 33 points and pull within 170 points of 22,000.

End of month retirement cash flows should support the indexes for a several more days with the normal August volatility not expected until the second week of August. The Nasdaq crash on Thursday cleaned out the portfolio but most were August options and we would have exited those over the next week or two anyway. The forced exits caused us to lose some of our gains. That is normal for the market.

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

The long put position was entered at the open.

THO - Thor Industries
The long call position was stopped at $104.85.

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

COST - Costco - Company Profile


WR Baird reiterated an outperform rating with a $200 price target. They see the 15% decline a major buying opportunity and expect revenue to grow 4% to 5% in the current quarter. They see Costco as the leader in the retail sector.

Original Trade Description: July 26th.

Costco Wholesale Corporation, together with its subsidiaries, operates membership warehouses. It offers branded and private-label products in a range of merchandise categories. The company provides dry and packaged foods, and groceries; snack foods, candies, alcoholic and nonalcoholic beverages, and cleaning supplies; appliances, electronics, health and beauty aids, hardware, and garden and patio; meat, bakery, deli, and produces; and apparel and small appliances. It also operates gas stations, pharmacies, optical dispensing centers, food courts, and hearing-aid centers; and engages in the travel businesses. In addition, the company provides gold star individual and business membership services. As of August 28, 2016, it operated 715 warehouses, including 501 warehouses in the United States, Washington, District of Columbia, and Puerto Rico; 91 in Canada; 36 in Mexico; 28 in the United Kingdom; 25 in Japan; 12 in Korea; 12 in Taiwan; 8 in Australia; and 2 in Spain. Further, the company sells its products through online. Company description from FinViz.com.

Costco shares were knocked for a $32 loss on the news that Amazon was buying Whole Foods. There was panic that Amazon was getting into the grocery business and would decimate the sector. Nothing could be further from the truth. Even if it was it would cause the most trouble for chains like Kroger, Safeway, Sprouts Farmers Market, etc.

If the acquisition goes through, and there is growing doubt, I do not foresee Whole Foods selling big screen TVs, winter parkas, cameras, caskets, cruises or ketchup and toilet paper by the case. The two stores are not compatible.

Furthermore, 45% of Costco members are already Amazon Prime members we as well based on a Morgan Stanley survey. Members of both services are looking for deals.

Costco makes the majority of its money from memberships (75%) and very little margin on its products. Amazon and Whole Foods are not going to undercut Costco on prices. Costco had 48.3 million members at the end of last quarter, up from 47.9 million. There were 37.4 Gold Star members and 18.3 million executive memberships. Total cardholders rose from 88.1 million to 88.9 million. Whole Foods has 350 stores and only about 12 million estimated repeat shoppers.

Did you know that Costco sells its products on Amazon. Costco's private label brand, "Kirkland" makes up about 20% of Costco's sales in the stores and those same products are available on Amazon. Actually, sales of the Kirkland products on Amazon are higher than in the stores.

Earnings August 24th.

Costco shares are starting to recover from the decline. Shares appear to have bottomed at support at $1.50. I expect them to rise as we get closer to earnings. Any remaining shorts will not want to hold over an earnings report that is likely to be strong. It the market decides to weaken in August, Costco is insurance since it has already sold off. Investors will be looking to buy the beaten down stocks as a safety play.

Position 7/27/17:

Long Sept $155 Call @ $2.40, see portfolio graphic for stop loss.

THO - Thor Industries - Company Profile


No specific news. The choppy market finally took its toll and stopped us out of Thor.

Original Trade Description: July 15th.

Thor Industries, Inc., through its subsidiaries, designs, manufactures, and sells recreational vehicles, and related parts and accessories primarily in the United States and Canada. It operates through Towable Recreational Vehicles and Motorized Recreational Vehicles segments. The company offers travel trailers under the Airstream International, Classic Limited, Sport, Flying Cloud, Land Yacht, and Eddie Bauer trade names, as well as Interstate and Autobahn Class B motorhomes; gasoline and diesel Class A and Class C motorhomes under the Four Winds, Hurricane, Chateau, Challenger, Tuscany, Axis, Vegas, Palazzo, Synergy, Quantum, Compass, Gemini, A.C.E, Alante, Precept, Greyhawk, and Redhawk trade names; and fifth wheels under the Redwood and DRV Mobile Suites trade names. It also provides conventional travel trailers and fifth wheels under the Montana, Springdale, Hideout, Sprinter, Outback, Laredo, Alpine, Bullet, Fuzion, Raptor, Passport, Cougar, Coleman, Kodiak, Aspen Trail, Voltage, Cameo, Cruiser, ReZerve, Sunset Trail, Zinger, Landmark, Bighorn, Sundance, Elkridge, Trail Runner, North Trail, Cyclone, Torque, Prowler, Wilderness, Shadow Cruiser, Fun Finder, Stryker, Sportsmen, Spree, Venom, Durango, SportTrek, Connect, Sportster, Sonic, Jay Flight, Jay Feather, Eagle, Pinnacle, Seismic, AR-One, Launch, Autumn Ridge, Travel Star, Highlander, Roamer, and Open Range trade names. In addition, the company offers equestrian recreational vehicle products with living quarters under the Premiere, Silverado, Ranger, Laredo, Trail Boss, and Trail Hand trade names; lightweight travel trailers and specialty products under the Camplite and Quicksilver trade names; and Class A motorhomes under the Insignia, Aspire, Anthem, and Cornerstone trade names, as well as provides aluminum extrusions and specialized component products. Company description from FinViz.com

In a weak economy, Thor is kicking butt. The company reported earnings of $2.11 which rose 41.6% compared to estimates for $1.87. Revenue of $2.02 billion rose 57% beat estimates for $1.96 billion. Operating cash flow rose 26.2% and gross profits rose 45.5%.

Sales of towable travel trailers rose 52.6% and sales of motorized RVs rose 78.7%. There was no bad news in the Thor report.

Estimated earnings date September 4th.

With the company posting record earnings the stock spiked from $94 to $104 on June 6th. When the market dipped, shares only pulled back to $102. In late June they rebounded to $110. During the market volatility over the last three weeks they dipped back to $102 and found support there once again. Now that the market has turned positive shares are rebounding.

I am using the September strike because of the September earnings date. We will exit well before then but that date will keep the premiums inflated.

Position 7/17/17:

Closed 7/28: Long Sept $110 call @ $3.00, exit $1.86, -1.14 loss.

VIX - Volatility Index - Index Profile


The VIX rebounded again at the open but faded as the Dow moved farther into positive territory. Next week could be really interesting.

Original Trade Description: July 12th.

The CBOE Volatility Index (VIX Index) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Since its introduction in 1993, the VIX Index has been considered by many to be the world's premier barometer of investor sentiment and market volatility. Several investors expressed interest in trading instruments related to the market's expectation of future volatility, and so VX futures were introduced in 2004, and VIX options were introduced in 2006.

The VIX closed at a 24-year low on July 14th at 9.51. The index has been spending a lot of time under 10 over the last three months and this is highly abnormal. The VIX typically trades up to 20 or more three times a year or more. That has not happen since the days before the election. This period of abnormal volatility WILL eventually end.

With the Trump administration getting more desperate to achieve some legislative goals there is always the risk they will go to extremes to get them accomplished. Add in the unknown but rapidly expanding Russian probes and anything is possible. We saw the Dow fall triple digits intraday on just the release of 5 emails from Trump Jr. If the probe actually uncovered something material, it could cause a major market meltdown.

The debt ceiling and the budget expire on Sept 31st. If Congress cannot get a budget passed and raise the debt ceiling, the government would shut down on October 1st. We have seen this before. The last time it happened the U.S. lost its AAA credit rating and the market declined sharply for more than a week.

What about North Korea? Military force could be used at any time but North Korea seems dead set on testing another nuke and expanding its ICBM tests. If fighting breaks out between the U.S. and North Korea it would cause a significant market decline because of the geopolitical concerns and the potential loss of life in Seoul, South Korea.

Even if none of those events occurred, there is always the risk of a 10% market decline just because we have not had one in a very long time. With August and September the worst months of the year for the market, the potential for a correction this year could be higher than normal. The Nasdaq is already up 18% and the Dow 9% for the year. The FAANG stocks are at record highs, which many say are unsupported by fundamentals.

There are so many potential opportunities for a market disaster. It only makes sense to take out some protection while the volatility is at record lows. I am recommending a November call to get us past the Aug/Sep period and the potential for a debt ceiling event in early October.

Position 7/20/17:

Long Nov $15 call @ $1.85, no stop loss. Target $22 to exit.

BEARISH Play Updates (Alpha by Symbol)

DIA - Dow ETF - ETF Profile


The Dow posted another positive close thanks to the spike in oil prices and Chevron. Goldman and UnitedHealth were also lifting the index. Next week could be really interesting.

Original Trade Description: July 27th.

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 (the "Index"). The Dow Jones Industrial Average (DJIA) is composed of 30 "blue-chip" U.S. stocks. The DJIA is the oldest continuous barometer of the U.S. stock market, and the most widely quoted indicator of U.S. stock market activity. The DJIA is a price-weighted index of 30 component common stocks.

The Dow closed at a new high in an ugly market solely because of big gains in Boeing, Disney and Verizon. If the rest of the market continues lower, the Dow will eventually crater as well. I am recommending we enter a put position on the Dow ETF at the current high.

Position 7/28/17:

Long Oct $215 put @ $3.33, see portfolio graphic for stop loss.
Short Oct $205 put @ $1.29, see portfolio graphic for stop loss.
Net debit $2.04.

SPY - S&P-500 ETF - ETF Profile


End of month retirement cash inflows kept the indexes from any material declines but next week could be interesting as earnings begin to fade.

Original Trade Description: July 24th.

• The SPDR S&P 500 ETF Trust seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the S&P 500 Index (the "Index") The S&P 500 Index is a diversified large cap U.S. index that holds companies across all eleven GICS sectors.

The S&P is marching slowly towards a date with destiny and 2,500. Since the median estimate by the top 16 analysts was a 2,450 yearend price target on the S&P, the arrival at 2,500 could be a tripwire that triggers an August correction. We have not had a 5% drop in a year and it has been 9 months since a 3.5% decline. With earnings rapidly playing out and most of the high profile companies will finish reporting by next Wednesday, I am going to recommend a bearish position for August/September.

I am going to set an entry trigger for a SPY put with the S&P at 2,495. Since aggressive traders normally want to anticipate a particular number, I want to enter the position just before we reach that level.

Update 7/26/17: The Dow was up +100 points, Nasdaq +10, Nasdaq 100 +20 and the S&P only gained 70 cents. The Russell 2000 lost -6 and the S&P-400 lost -15. We may not get to that 2,495 level. I am going to add another trigger/strike in case we get a failure from this level.

The upside entry trigger has been cancelled.

Position 7/27/17 with a S&P trade at 2,465:

Long Oct $243 put @ $3.65, see portfolio graphic for stop loss.

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