Option Investor
Newsletter

Daily Newsletter, Thursday, 1/31/2019

Table of Contents

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

Market Wrap

Two Down, One To Go

by Thomas Hughes

Click here to email Thomas Hughes

Introduction

The market moved higher on strong earnings and confirmation the FOMC is close to ending quantitative tightening. Today's move wasn't strong but it was nice to see following Wednesday's FOMC driven rally.


The FOMC has confirmed what the market was already coming to believe; the pace and trajectory of future interest rate hikes will be much slower and lower, interest rates will stay low for a prolonged period of time, and the end of quantitative tightening. Quantitative tightening, otherwise known as the Fed's Balance Sheet Run-Off, has been sapping liquidity from the US economy and one of three hurdles for the bulls the market has now overcome.

Market Statistics

Another hurdle, fear of economic/earnings recession, has also been swept away. The fears, driven in large part by the FOMC tightening cycle and trade woe, were overblown in most cases. The earnings reports we've seen so far haven't been great compared to 2018 but they are much better than expected (on balance) and the outlook for 2019 isn't as bad as the sell-side analysts led us all to believe. With the FOMC off the tightening cycle, it is possible economic growth could begin to re-accelerate.

The final hurdle blocking the path to new all-time highs for the broad US equities market is the China/US trade impasse and even that seems to be gaining positive momentum. The trade-talks between Chinese Vice Premier Liu He and Trump's top aides have progressed to the point a meeting between Trump and Xi is in the works. There are still some sticking points to be hammered out, and the meeting would take place in late February after the next Trump summit with Kim Jong Un, but it's still big news for markets to latch on to.

Economic Calendar

The Economy

Initial jobless claims surged unexpectedly over the last week but maybe showing impact from the government shutdown. The report doesn't make special note of the shutdown and only tracks civilian government employees but the number of those has been steadily rising over the last few weeks. The number of initial claims jumped 53,000 to hit 253,000 and the highest level since September 2017 (that high was driven by storm-related outages).

The four week moving average of claims rose 5,000 to hit 220,500. The surge in claims is troubling and needs to be watched to see how long it lingers. Based on all other labor-based data points and the end to the shutdown I do not expect this figure to linger long at these elevated levels.


Continuing claims rose 69,000 to hit 1.782 million. This is the largest number of continuing claims since 4/28/17 and another red flag linked, at least in part, to the government shutdown.

The total number of jobless claims fell -66,958 to hit 2.148 million. This decline is in line with expectations and helps confirm the peak in claims reached last week, with one caveat. This data lags the initial claims data by two weeks and could easily see another spike as the impact of government shutdown works its way through the system. On a year over year basis claims are down 7.2% and consistent with long-term labor market trends.


The Challenger, Gray & Christmas report on planned layoffs shows the number of planned job cuts rose 20.7% in the last month to 52,988. This is 18.7% above the same month last year and evidence employers are downsizing their workforces post-holidays. The retail sector led the job cuts but cuts were fairly broad, looking at it relative to all January's this month's cuts are below average but skewed to the high-end of the range. More importantly, while job cuts linger in some sectors others are still hiring. The number of planned hires topped 74,000, oddly enough led by the retail sector, which suggests labor-market weakness in the retail sector is very isolated.


The fourth quarter employment cost data was a bit better than expected. The Employment Cost Index rose only 0.70% versus the 1.0% expected. The gains were driven by a 0.60% increase in wages and a 0.7% increase in incentives. On a year-over-year basis, civilian labor costs have risen 2.9% while private business labor costs have risen by 3.0%.

The Chicago Business Barometer (PMI) fell -7.1 points to 56.7. This is the weakest level in two years but still a solid read and well above 50. Four of the five sub-indices were lower in the last month led by new orders and production. Despite the decline, this is the 24 month of readings above 50 and evidence economic expansion is still underway. The risk is that PMI will continue to slacken until activity begins to contract but that has been mitigated in large part by the FOMC, earnings outlook, and labor data.


New Homes Sales was not originally scheduled for today, it is the first of the shutdown-delayed data to be released. The data is good but lagging by two months so take it with a grain of salt. The number of New Homes sold in November jumped 16.9% to 657,000. The increase was driven by fear of rising rates and helped to spur the homebuilders higher in today's action. On a year over year basis, sales are still trending lower by 7.7%, based on some recent mortgage app data that may change this year.


The Dollar Index

The Dollar was able to regain some of Wednesday's losses and may be confirming the bottom of a trading range. Today's action was driven by the data and trade news as one point to modest US economic growth and the other could open the doors to economic expansion. The FOMC's policy statement weakened the dollar but was as-expected so largely discounted by the market. Additionally, yesterday's ultimatum from the EU to the UK weakened the EUR and the GBP. The EU says there is to be no renegotiation on Brexit, the UK can take it or leave it, and puts the UK in a tight spot; take it or leave it. Support for the DXY is still at $95.50 and a reversal at this level looks possible.


The Gold Index

Gold prices were able to hold steady in today's session. The metal tried to move higher but fell back to break even by the end of the session. The candle is small and doji-like so may mean nothing but for now, there is a potential for resistance at the $1,320 level. If resistance holds at this level a retracement to support may follow. A consolidation and move above $1,320 would likely continue to $1,340.


The Gold Miners ETF has extended its break of the $22.50 level and looks like it could go higher. The near-term rally in gold stocks seems to be gaining momentum and likely to continue to gain momentum while gold prices are on the rise. The indicators are both bullish and rising so higher prices are expected. My next target for resistance is $23.00 and then $24.00.


The Oil Index

Oil prices moved up strongly on word the Saudi's were cutting exports to the US. The cuts are part of the OPEC deal to curb production and more than the Saudi's quota. The news helped push WTI above $55 for the first time in nearly 3 months but the outlook for US production and concerns for global demand capped the gains. By the end of the session, WTI had given up all the days gains to close beneath resistance and within the near-term consolidation range.


The Oil Index moved up to close with a new near-term high but the candle is small and continuation is questionable. The index may be ready to move higher but, based on the expectation for earnings decline in 2019, I am not to optimistic about it. A move up is likely to find resistance at the 1,300 level and then the long-term moving average if it does materialize. If not, support may be found at 1,275 or1,250.


In The News, Story Stocks and Earnings

GE saw strong gains in today's session after it beat earnings expectations. The company produced a 60% decline in profits over the last year but revenue grew and some other positive factors were announced. The number one is that GE has settled its DOJ investigation of accounting practices for $1.5 billion dollars. CEO Larry Culp says the company's turnaround is progressing nicely and the worst is nearly over.

The company's cash flow is going to be hurt by restructuring charges and efforts to deleverage the balance sheet, investments in the healthcare business, and some other one-time items but those costs will pay off over the long-term. Shares of the stock jumped 10% at the open and moved higher from there. The only negative I see is that some shareholders took this opportunity to get out of GE and that sentiment may cap gains in the near to short-term.


Shares of Amazon were flat in the after-hours session after reporting blowout earnings. The company says revenue grew 20% led by a 46% increase in AWS revenue and EPS is $6.04. The EPS beat is substantial, nearly $0.40, but EPS is hit-or-miss with this company depending on how much they spend and where. Guidance for the next quarter is strong but on the low side of consensus which is likely what shares held steady after the report.


Shares of Yum China were up more than 6% in after-hours trading after it reported earnings. The company says sales have not been hurt by the US/China trade situation but growth is mixed at the segment level. Total same-store sales increased by 2.0% led by 3% increase at KFC and lagged by a 4% decrease at Pizza Hut. Operating margins narrowed slightly but operating profits are up 77% so investors didn't care.


Shares of Symantec were also sharply higher in the after-hours session. The company beat on the top and bottom lines and provided better than expected forward guidance on strength in both consumer and enterprise segments. Symantec also increased its buyback program to $1.3 billion which will provide a lot of support in the future. Shares were up more than 6% on the news.

The Indices

Today's index action was mixed in terms of result but generally bullish relative to the market. The day's leader is the NASDAQ Composite with a gain of 1.37%. The tech-heavy index created a small green bodied candle moving up to break the long-term moving average and extend the bounce from the short-term moving average. The indicators are confirming this move with a strong bullish crossover so higher prices are expected over the next few weeks. A move up from here may find resistance at 7,500, a move above there could go as high as 8,000.


The S&P 500 closed with a gain of 0.85% and above its long-term moving average. The index is extending the bounce from the short-term moving average support zone and is indicated higher. The indicators both show bullish activity that suggests a move to 2,775 is possible. The caveat is that the signal is still weak so tight stops are recommended for bullish positions and profits should be taken on short-term positions if resistance targets are reached.


The Dow Jones Industrial Average closed with a loss of -0.06 but it created a green candle in the process. The index opened with a slight loss and then moved up for most of the day as traders scooped up discount stock. The index is consolidating above the long-term moving average and supported by the indicators so another push higher is expected. The next targets for resistance are 25,250 and 25,750, a move above there would be bullish.


The Dow Jones Transportation Average closed with the largest loss, -0.19%, and created a red candle but the action is still more bullish than not. The index opened with a gain that would have been a new closing high and then moved lower to test support near yesterday's close. The candle shows that there is some support present and the indicators concur so a move higher is expected. Both indicators are bullish but momentum is weakening so resistance at the long-term moving average may cap gains. A move above the 150-day EMA would be bullish.


The market is slowly coming back to its senses. The fears that drove stocks to a 20% correction are dissipating. We're not out of the woods yet but earnings aren't as bad as the analysts thought they would be, the FOMC has taken its foot off the economic brakes, and trade tensions on are on the mend so I think it is safe to say the risk is to the upside. Economic activity could easily re-accelerate in 2019, analysts outlook could brighten, and earnings could beat expectations so there is a solid chance we could see a sustained bull market rally this year. I am firmly bullish for the long-term but still only cautiously bullish for the near-term. Better safe than sorry.

Until then, remember the trend!

Thomas Hughes


New Option Plays

Negative Bias

by Jim Brown

Click here to email Jim Brown

Editors Note:

Amazon's earnings disappointment knocked 82 points off the shares in afterhours. The Nasdaq futures are down -33 points and this bias is likely to carry over into Friday's trading. Add to that the big gains in some of the big cap tech stocks for the week and there is a good chance we will see some profit taking before the weekend. There is no guarantee, but I doubt many investors are going to be racing to buy Facebook after a $16 spike on Thursday. Apple was up $15 over the last two days at its intraday high on Thursday. These are profits at risk until the positions are closed.

 

New positions are only added on Wednesday and Saturday except in special circumstances.


NEW DIRECTIONAL CALL PLAYS

No New Bullish Plays


NEW DIRECTIONAL PUT PLAYS

No New Bearish Plays



In Play Updates and Reviews

Critical Resistance

by Jim Brown

Click here to email Jim Brown

Editors Note:

The Nasdaq has led the rally over the last couple of days and is now at critical resistance. It has been a great couple of days for the tech sector but the Nasdaq stopped right at the 100-day and downtrend resistance. We have run out of week and there will be little in the way of headlines on Friday. The Amazon earnings have pushed the Nasdaq futures down -33 tonight and that is likely to carry over into Friday as investors begin to worry about weekend event risk.



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


QCOM - Qualcomm
The short position was stopped at the open.


Full updates on all plays on Wednesday and Saturday. Only closed plays are updated on other days.


BULLISH Play Updates

No Updates to Current Positions


BEARISH Play Updates

QCOM - Qualcomm - Company Profile

Comments:

QCOM gapped open to $51.28 and 3 cents over our stop loss. We exited the put position for a minor gain.

Original Trade Description: Dec 31st

QUALCOMM Incorporated designs, develops, manufactures, and markets digital communication products worldwide. It operates through three segments: Qualcomm CDMA Technologies (QCT); Qualcomm Technology Licensing (QTL); and Qualcomm Strategic Initiatives (QSI). The QCT segment develops and supplies integrated circuits and system software based on code division multiple access (CDMA), orthogonal frequency division multiple access, and other technologies for use in wireless voice and data communications, networking, application processing, multimedia, and global positioning system products. The QTL segment grants licenses or provides rights to use portions of its intellectual property portfolio, which include various patent rights useful in the manufacture and sale of wireless products comprising products implementing CDMA2000, wideband CDMA, CDMA time division duplex, and/or long term evolution standards and their derivatives. The QSI segment invests in early-stage companies in various industries, including automotive, Internet of things, mobile, data center, and healthcare for supporting the design and introduction of new products and services for voice and data communications, and new industry segments. The company also provides products and services for mobile health; products designed for the implementation of small cells; development, and other services and related products to the United States government agencies and their contractors; and software products, and content and push-to-talk enablement services to wireless operators. In addition, it licenses chipset technology, and products and services for use in data centers. QUALCOMM Incorporated was founded in 1985 and is headquartered in San Diego, California. Company description from FinViz.com.

The last 12 months have been turbulent for Qualcomm. First they tried to acquire NXP Semiconductor (NXPI). They received approvals from 7 of the 8 countries that needed to approve the transaction. While they were waiting on China's approval, Broadcom (AVGO) made a hostile offer to acquire Qualcomm for $121 billion. Qualcomm would be forced to drop the bid for NXPI if they accepted the Broadcom bid. Qualcomm fought Broadcom and finally got the government to veto the deal under a national security rationale.

Broadcom quickly made a big show of becoming a U.S. company by changing its domicile to the U.S. That was not enough to convince CFIUS they were not a threat. Eventually Broadcom dropped its bid.

Qualcomm tried to continue its acquisition of NXPI but China refused to approve the acquisition and Qualcomm was forced to abandon the acquisition attempt and pay a $2 billion breakup fee.

While Qualcomm and NXPI would have been stronger together, Qualcomm is not sitting still. They are rapidly moving forward on 5G communications, automotive chips, internet connectivity, Internet of Things, network processing, etc.

The company just announced a $30 billion stock buyback. That is one-third of the company using the funds they had set aside for the NXPI acquisition.

The next challenge for Qualcomm is settling the patent dispute with Apple. The phone company has protested the way Qualcomm collects royalties on its products. Instead of only charging a royalty on the specific parts in the phone, Qualcomm has always charged a royalty on the entire cost of the phone. In the beginning, companies did not balk because without Qualcomm's parts the phone would not have been possible. After paying royalties to Qualcomm for years, Apple decided they were paying too much money to Qualcomm and sued them to change the patent. Since Apple and every other phone manufacturer had been paying Qualcomm under this structure for years, Apple does not have a very good chance of winning. They do have a lot of money and the best lawyers in the world but the law is the law and signed agreements are tough to fight.

This suit is expected to be settled soon. Qualcomm has been successful in getting some models of iPhones blocked from sale and with each court action they are making it more likely there will be a settlement soon. The CEO said he thought it would be in Q4 but it has not happened yet.

With a 4% dividend and buying back 33% of the stock, there is no reason for Qualcomm shares not to rise in the coming months. The stock should also be somewhat immune to market movement over the coming weeks thanks to the monster buyback.

Qualcomm reported earnings of 90 cents that beat estimates for 83 cents. Revenue of $5.80 billion also beat estimates for $5.52 billion. However, the company guided for Q4 revenue of $4.5-$5.3 billion and earnings of $1.05-$1.15. Analysts were expecting $5.57 billion and 95 cents. The decline was due to a lack of Apple sales. Apple normally buys 35-50 million chips in Q4 but they have dropped Qualcomm as a supplier until the royalty fight is concluded in court. Shares lost $7 post earnings.

Cowen recently reiterated a buy rating and $73 target. Canaccord Genuity reiterated a buy and $75 target. Bank of America reiterates a neutral and $67 target.

Earnings Feb 6th.

Apple is trying to push out a software update to force phones to remove patent liabilities in China. Qualcomm is pressing the court to force an immediate halt to sales. Apple said late in the day that the China sales ban would force them to settle the patent suit with Qualcomm. Obviously that is exactly what Qualcomm has been trying to accomplish. Apple said being forced to settle with Qualcomm would force all other manufacturers to pay higher royalties as well. Everyone has been hoping Apple would be victorious and they would benefit from the same lower royalties if Apple won. Apple is trying to claim that Qualcomm's royalty agreements, which they signed and paid royalties on for years, is no longer valid because the price of the phone has risen so high. The agreement calls for a set percentage of the sales price as the royalty amount. When phones sold for $400 it was a smaller amount but now with $1,000-$1,500 phones that same percentage is a lot bigger number.

Apple is also playing politics in their court filings warning that China will lose millions of dollars in taxes and revenue if the ban is enforced. Of course, they could just pay Qualcomm what they owe and there would be no ban.

Qualcomm also won an injunction in Germany to force Apple to halt sales of iPhones.

Starting on January 4th, Qualcomm will participate in a 10-day non-jury trial against the FTC. This trial is the key to the settlement of Apple's suits around the world. Qualcomm will argue for its current patent and licensing model and fee schedules. The outcome of the trial will either boost Qualcomm's $5.2 billion a year royalty stream or crash it to a fraction of that amount. LINK

Nobody disagrees that Qualcomm's engineering and designs are the best in the business. They are simply whining that Qualcomm charges too much to license those technologies.

The outcome of this trial could move the stock $10 or more in either direction. I am proposing we buy a call and a put and hang on for the ride. One of them could been deep in the money and the other will expire worthless.

Update 1/5: Qualcomm acted to enforce the ban on iPhones in Germany and Apple was forced to pull the specific models from stores. Germany's biggest retailer, Gravis, said it still had all Apple products on sale but that is likely to end quickly. Qualcomm posted a bond of 1.34 billion euros in order to put the enforcement into effect. According to the court order, Apple had to stop the sale, offer for sale and importation for sale of all infringing iPhones in Germany. The court also ordered Apple to recall the affected iPhones from third-party resellers in Germany.

The 10-day non-jury trial with the FTC over patent procedures began on Friday.

Update 1/23/19: Noted short seller Sahm Adrangi and his Kerrisdale Capital hedge fund took aim at Qualcomm saying a loss to the FTC in the current trial would cut the stock price in half. If the company loses they would be forced to "license core patents to competitors and to renegotiate all of its existing licenses on fair terms." Kerrisdale argued that Judge Lucy Koh, currently presiding over the case, has already ruled against the company on several maters and may be inclined to rule in favor of the FTC.

Update 1/30: QCOM reported earnings after the close and should their afterhours gains hold, we will be stopped out at the open on Thursday. The company reported earnings of $1.20 that beat estimates for $1.09. Revenue of $4.84 billion missed estimates for $4.90 billion because of Apple's continued refusal to pay their royalties and license fees. They guided for Q1 earnings of 65-75 cents and revenue of $4.4-$5.2 billion. Analysts were expecting 69 cents and $4.83 billion. Shares rose to $51.40 in afterhours.

They did not mention the current FTC case in their earnings release. They did mention the billions owed by Apple and Huawei that will be paid if the various court cases end in Qualcomm's favor.

Position 12/31/18:
Closed 1/31: Long Feb $52.50 put @ $1.39, exit $2.98, +1.59 gain.

Previously closed: 1/22: Long Mar $60 Call @ $2.06, exit .60, -1.46 loss.