Option Investor

Daily Newsletter, Sunday, 10/26/2014

Table of Contents

  1. Leaps Trader Commentary
  2. Portfolio
  3. New Plays
  4. Play Updates
  5. Watch

Leaps Trader Commentary

Market Bounce Turns Into Best Week Of The Year

by James Brown

Click here to email James Brown

Over two years ago European Central Bank President Mario Draghi promised to do whatever it takes to protect the EU from the region's financial crisis. Now that the crisis is flaring up again amidst a significant economic slowdown there were rumors the ECB might starting buying corporate bonds as part of their own QE program. The central bank denied the rumors but the story still helped fuel a rally in equities. The combination of oversold conditions in stocks, the ECB story above, and slightly better economic data out of China, Japan, and Europe helped produce the S&P 500's best weekly performance of the year.

The U.S. market's sell-off from the September high to the October low destroyed about $2 trillion worth of stock valuations. In the last seven trading days the market has recovered a significant portion of those losses. The S&P 500 is up +8% from its October 15th low near 1,820. The rebound last week was impressive. The Dow Industrials rallied +2.59%. The small cap Russell 2000 gained +3.3%. The S&P 500 soared +4.1%. The NASDAQ composite added +5.29%. Banks were up +3.8%. The transportation stocks climbed +5.1%. Semiconductor stocks delivered an electrifying +6.38% gain and the biotechs outperformed them all with a +7.5% surge last week.

Economic Data

It was a quiet week for U.S. economic data. Mortgage rates hit their lowest levels in a year and that fueled a +23.3% rise in refinance applications. Yet applications for new mortgages actually dropped -4.8%. Existing home sales hit their highest levels since September 2013 with a rise from an annual pace of 5.05 million homes to 5.17 million. The sale of new homes hit a six-year high with the annual pace hitting 467,000 in September. The August number was revised lower from 504K to 466K. Given such a sharp revision we might want to eye the September reading with skepticism. The average price on a new home dropped -4.0% year over yet. That was the first price decline in months.

Overseas Economic Data

Earlier I mentioned that better than expected economic data overseas helped fuel the rally. That's true but only because investors focused on the latest PMI data and not all of the economic headlines. The Eurozone reported their manufacturing PMI numbers came in at 50.7. That's up from 50.3 and better than the expected drop below 50. Germany also saw improvement with rise in its manufacturing PMI data from 49.9 to 51.8. France went the opposite direction with a drop from 48.8 to 47.3, which was worse than expected. Numbers above 50.0 suggest economic growth and below 50.0 means economic contraction.

Europe remains in serious trouble. A little uptick in their PMI numbers doesn't mean their issues are over. The EU is headed for its third recession in six years and much of the region is poised to see deflation. That's disturbing when you consider Europe accounts for almost 20% of the global economic activity. Spain did see some improvement with its unemployment with a drop 23.7%, the lowest level since 2011. Yet France said their unemployment hit a new record high.

We're going to hear a lot more about Europe on Monday as the market digests the ECB's stress tests. After a year-long test the central bank is unveiling which of the largest 130 European banks failed their stress test. There was a leak on Friday and Bloomberg disclosed that 25 of the banks will fail the test. Yet this negative headline was softened by news that ten of these banks have already raised new capital and ten more were in the process of shoring up their finances.

Looking toward Asia there was some improvement in Japan with their manufacturing PMI hitting a seven-month high at 52.8, which was better than expected. China also saw its manufacturing PMI rise from 50.2 to 50.4, also ahead of estimates. Unfortunately China unveiled that their economy is growing at its slowest pace in five years. Their Q3 GDP number showed growth slipping from a +7.5% pace to +7.3%. China also saw its average home price fall for the fifth month in a row. The slowdown in real estate seems to be picking up speed with all 70 cities survey showing declines and the average drop has grown from -0.5% to -1.3% year over yet.

Major Indices:

The S&P 500 has gone from oversold to overbought with an seven-day, +8% bounce. Now the rebound is nearing potential resistance at its simple 50-dma. On the weekly chart you can also see the S&P 500 is nearing what could be resistance at the bottom of its broken bullish channel. Year to date the S&P 500 is up +6.3%.

chart of the S&P 500 index:

Weekly chart of the S&P 500 index

The NASDAQ composite's rebound is equally impressive with a 367-point bounce from its October 15th low. The 4500 level should be round-number resistance but so far momentum favors the bulls. If the rally continues the 2014 highs near 4600 will be the next significant challenge. The big bounce has left the NASDAQ with a +7.4% 2014 gain.

chart of the NASDAQ Composite index:

Intraday chart of the NASDAQ Composite index

The small cap Russell 2000 index ($RUT) is up about +7.5% from its October low. Year to date the $RUT still has a -3.8% loss. The 1120-1150 zone could be tough resistance to rally through. I'm still worried the small caps could be an anchor slowing down the rest of the market.

chart of the Russell 2000 index

Weekly chart of the Russell 2000 index

Economic Data & Event Calendar

The pace of economic data picks up this week. We will get two looks on consumer confidence and sentiment. There will be two regional Federal reserve surveys. Thursday will bring the U.S. Q3 GDP estimate. Yet the big event for the week is probably the two-day FOMC meeting. The meeting ends on Wednesday and the Fed should officially put the nails in the coffin for its QE program. The focus will be on the Fed's statement.

Meanwhile Q3 earnings season continues. It will be another busy week of corporate results. We saw a lot of high-profile earnings misses last week with the likes of IBM, KO, MCD, and AMZN. Yet for every miss there was another beat. Of the 300+ S&P 500 components who have reported about 65% have beaten estimates. That's a little bit below average but earnings growth is coming in at +5.1%, which is better than the expected +4.1%. Less than half the companies reporting are beating Wall Street's revenue estimates, which is a potential warning signal.

Economic and Event Calendar

- Monday, October 27 -
Pending Home Sales
Texas regional manufacturing survey

- Tuesday, October 28 -
Durable Goods
Richmond Fed manufacturing survey
Case-Shiller 20 city home price index
Consumer Confidence
FOMC meeting begins

- Wednesday, October 29 -
FOMC interest rate decision

- Thursday, October 30 -
Weekly Initial Jobless Claims
U.S. Q3 GDP estimate

- Friday, October 31 -
Personal Income & Spending
Employment Cost Index
Chicago PMI
University of Michigan Consumer Sentiment survey

Additional Events to be aware of:

November 7: Nonfarm payrolls (jobs) report
December 17: FOMC meeting

Looking Ahead:

Looking ahead investors should remain encouraged by the weakness in crude oil. We've touched on it before. The huge drop in crude oil prices has fueled a significant decline in gasoline. AAA reports that the average price of a gallon of gas in this country is now $3.05. That's down from the April high of $3.70. Globally the drop in fuel prices could equal more than one trillion dollars worth of economic stimulus as money normally spent on fuel can now be spent somewhere else. Jeffrey Gundlach, considered by some the new bond investor king, is predicting that the drop in crude oil isn't over yet. Gundlach expects another $10 drop toward $70 a barrel.

Lower fuel prices should be bullish for the upcoming holiday shopping season. The National Retail Federation is forecasting a +4.1% increase in spending this year. That's up from +3.1% a year ago and better than the +2.9% 10-year average. I would not be surprised to see spending actually surpass the 4% estimate. The real winners this year will probably be online shopping. December 1st will be Cyber Monday, which is the first Monday after Black Friday. It will make plenty of headlines as the growth is online shopping is expected to soar.

If you are a Game of Thrones fan then you know that "Winter is Coming." The situation in Eastern Europe could get a lot more intense as winter approaches. Russia has proven itself to be a bully and it knows that most of Europe relies on Russian natural gas to heat their homes. If Russia decides to use its natural gas supplies as leverage again it could get ugly. This could be another thorn in the market's paw over the next few months.

The month of October is known for its volatility and this year October has delivered on that seasonal trend in spades. Looking at the week ahead I suspect that we will see stocks consolidate sideways the next three days as investors wait to hear from the Federal Reserve on Wednesday afternoon. Once the FOMC decision is published we will probably see a spike in volatility on Wednesday afternoon. Thursday and Friday could be driven by earnings news or the Q3 GDP report.



Portfolio Update

by James Brown

Click here to email James Brown

Current Portfolio

Portfolio Comments:

The stock market's oversold bounce really picked up speed last week. The U.S. market delivered its best weekly performance of the year.

FDX and HUM graduated from our watch list to our play list last week.

Disclaimer: At any given time the author may have positions in any or all of any companies mentioned in the Leaps Newsletter.

--Position Summary Table--
Table lists Directional CALL or PUT/LEAPS only.
Insurance puts, if applicable, are not shown.

Red symbol/name represents a play or option position exited or closed this week.

New Plays

Big Relative Strength

by James Brown

Click here to email James Brown

- New Trades -

Checkpoint Software Tech. - CHKP - close: 72.70

10/26/14: CHKP has been on our LEAPS Trader watch list for over a month. After bouncing near support the rebound in CHKP accelerated sharply. This stock soared $6.43 or +9.7% to end last week at a multi-year closing higher. Our plan was to buy calls if shares closed above $72.50. Friday's close at $72.70 meets that requirement. Officially our trade opens on Monday morning but I am suggesting investors may want to wait for a pullback. After a 10% gain in five days you might be better off buying a dip. The $70.00-70.50 area should be short-term support.

CHKP's earnings report last week helped fuel the rally. Wall Street was expecting a profit of $0.91 a share on revenues of $367 million. The company reported a profit of 93 cents with revenues up +7.6% to $370.4 million. Multiple analysts raised their price target on CHKP following the earnings report.

NOTE: Keep in mind the 2015 January calls only have about three months left. You may want to buy the 2016s.

Earlier Comments: September 14, 2014:
CHKP is another technology stock and it is similar to AKAM in that both have beaten earnings estimates every quarter this year and both are trading near 14-year highs. While AKAM facilitates Internet traffic, CHKP seeks to guard its clients against Internet hazards.

The company describes itself as, "the worldwide leader in securing the Internet, provides customers with uncompromised protection against all types of threats, reduces security complexity and lowers total cost of ownership. Check Point first pioneered the industry with FireWall-1 and its patented stateful inspection technology."

"Today, Check Point continues to develop new innovations based on the Software Blade Architecture, providing customers with flexible and simple solutions that can be fully customized to meet the exact security needs of any organization. Check Point is the only vendor to go beyond technology and define security as a business process. Check Point 3D Security uniquely combines policy, people and enforcement for greater protection of information assets and helps organizations implement a blueprint for security that aligns with business needs. Customers include tens of thousands of organizations of all sizes, including all Fortune and Global 100 companies. Check Point's award-winning ZoneAlarm solutions protect millions of consumers from hackers, spyware and identity theft."

It feels like a week doesn't go by that we don't hear about another major hacking scandal in the business world. It's not going away and corporations have to constantly update their cyber defense. CHKP has been working cyber security since 1993.

Shares of CHKP spent much of this year consolidating gains from 2013. However, the last week of August produced a crucial breakout past resistance near $70.00. Tonight I am suggesting a trigger to buy calls if CHKP can close above $72.50. We'll start with a stop at $69.45. The point & figure chart is bullish and currently forecasting an $89.00 target. We'll start with a long-term target in the $95-100 zone (our target to exit the 2015 calls will be lower).

Breakout trigger: Wait for a close above $72.50
Then buy calls the next morning with a stop at $69.45

BUY the 2015 Jan $75 call (CHKP150117C75) current ask $1.40

- or -

BUY the 2016 Jan $80 call (CHKP160115c80) current ask $4.80

10/27/14 trade begins.
10/24/14 CHKP meets our entry point requirement with a close at $72.70. Trigger was a close above $72.50
10/05/14 Friday's move might signal the end of the pullback.
Option Format: symbol-year-month-day-call-strike


Weekly Chart

Current Target: CHKP @ 95.00-100.00 zone
Current Stop loss: 69.45
Play Entered on: 10/27/14
Originally listed on the Watch List: 09/14/14

Play Updates

Rebuilding Our Active Plays

by James Brown

Click here to email James Brown

Editor's Note:

We had two watch list candidates (FDX and HUM) graduated to our active play list below.

Closed Plays

None. No closed plays this week.

Play Updates

DaVita Healthcare Partners - DVA - close: 76.73

10/26/14: The stock market's big rally last week lifted shares of DVA to new all-time highs. The breakout past resistance in the $75-76 zone is good news.

I would be tempted to buy calls again if we saw DVA retest $75.00 and bounce.

DVA is scheduled to report earnings on November 6th.

Earlier Comments: June 1, 2014:
DVA is in the healthcare sector. The company provides kidney dialysis services and related lab services. The most recent earnings report was lackluster but DVA did report revenue growth above Wall Street estimates. Management has been buying up smaller domestic rivals and expanding overseas into countries like China, Columbia, Germany, India, Malaysia, Portugal, Saudi Arabia, and Taiwan. In the U.S. DVA has about 35% of the outpatient dialysis market.

Bears on this stock would argue the company is at risk for pricing pressures from Medicare. About 90% of its total U.S. dialysis patients are on some form of government-assisted program. Nearly 80% of are part of Medicare. The latest rules from Medicare said there would be no price changes in 2014 and 2015 but there could be reimbursement reductions in 2016 and 2017.

This pressure from Medicare has not stopped Warren Buffet's Berkshire Hathaway from raising its stake in DVA. Berkshire started investing in DVA back in Q4 2011. They have been slowly building a position and this past quarter (Q1 2014) Berkshire added another 1.1 million shares. Their total position is now 37.6 million shares worth about $2.6 billion. Berkshire tends to be a long-term investors, longer than our timeframe but it is still a vote of confidence for DVA.

- Suggested Positions -
(Closed on October 16, 2014)
JUN 04, 2014 - entry price on DVA @ 71.44, option @ 2.65*
symbol: DVA150117C75 2015 JAN $75 call - exit $1.65** (-37.7%)

- or -

JUN 04, 2014 - entry price on DVA @ 71.44, option @ 4.70*
symbol: DVA160115C80 2016 JAN $80 call - current bid/ask $4.60/5.90

10/16/14 DVA hit our stop at $71.75 to close our 2015 calls.
**option exit price is an estimate since the option did not trade at the time our play was closed.
10/12/14 adjusting stop loss strategy:
Use a stop at $71.75 for the 2015 calls.
Use a stop at $69.85 for the 2016 calls.
08/24/14 new stop at $69.85
07/31/14 DVA reports better than expected bottom and top line results
07/20/14 new stop @ 69.00
06/04/14 trade begins. DVA opens at $71.44
*option entry price is an estimate since the option did not trade at the time our play was opened.
06/03/14 DVA closed at $71.47, above our trigger of $71.25
Option Format: symbol-year-month-day-call-strike

Current Target: DVA @ 85.00
Current Stop loss: 69.85 for the 2016 calls, $71.75 for the 2015s
Play Entered on: 06/04/14
Originally listed on the Watch List: 06/01/14

FedEx Corp. - FDX - close: 163.88

10/26/14: FDX has graduated from our watch list to our active play list. The plan was to buy calls if shares closed above $158.00. Our trade began on October 22nd.

Transports helped lead the rally higher. FDX gained almost $8.00 and now shares are testing resistance near their highs from late September and early October. After such a big bounce I would expect a pullback soon.

I am not suggesting new positions at this time.

Earlier Comments: October 19, 2014:
FDX is one of the largest package delivery companies in the world. The company's most recent earnings report showed improvement. FDX beat Wall Street's estimates on both the top and bottom line. Profits were up +24% from a year ago and it was the second quarter in a row that FDX beat estimates.

Management said their 2015 fiscal year was off to a great start. The company has enough demand they have recently raised prices on some services.

The plunge in crude oil and fuel prices is a huge tailwind for FDX. As a transportation company the cost of fuel is a major expense. With oil at four-year lows it should be a boost to FDX margins.

FDX should also benefit from the growth in online shopping. Last year there was a huge last minute surge in Christmas sales that needed to be delivered quickly by companies like UPS and FDX. This year online shopping is expected to grow +17%. That's another bonus for FDX.

The stock has been volatile thanks to the market's big swings but FDX is still respecting its long-term bullish trend of higher lows.

Tonight I am suggesting we wait for a close above $158.00 and buy calls the next morning with a stop loss at $148.50.

- Suggested Positions -
OCT 22, 2014 - entry price on FDX @ 160.74, option @ 12.65*
symbol: FDX160115C170 2016 JAN $170 call - current bid/ask $13.80/14.25

10/22/14 trade begins. FDX opens at $160.74
*option entry price is an estimate since the option did not trade at the time our play was opened.
10/21/14 triggered with a close at $159.88, above our trigger of $158.00
Option Format: symbol-year-month-day-call-strike

Chart of FDX:

Current Target: FDX @ TBD
Current Stop loss: 148.50
Play Entered on: 10/22/14
Originally listed on the Watch List: 10/19/14

Humana Inc. - HUM - close: 133.11

10/26/14: HUM is another watch list candidate that has graduated to our active play list. The plan was to wait for shares to close above $130.25 and then buy calls the next morning. Our trade opened on October 22nd.

If you're looking for an entry point now I'd consider waiting for a dip near $130 and then buy a bounce. Otherwise consider waiting for a close above $136.00.

Earlier Comments: October 19, 2014:
HUM is in the healthcare sector. The company offer health insurance. Right now that's a good spot to be as the system irons out the kinks in the Affordable Care Act (a.k.a. Obamacare). Thus far Obamacare has been a boon to insurers as more and more Americans sign up for health insurance.

Shares of HUM did see a pullback from its recent highs near $136 down to $121 (a -11% correction) but now HUM is on the rebound. Even with the pullback HUM still has a long-term bullish trend of higher lows. The point & figure chart is bullish and suggesting a long-term target of $173.00.

Tonight I am suggesting we wait for HUM to close above $130.25 and then buy calls the next morning with a stop loss at $119.75. I do want to warn you that HUM is scheduled to report earnings on November 7th but several of its peers (AET, CI, and WLP) will report earnings in the next two weeks (before the end of October). Their quarterly results and guidance (good or bad) could influence shares of HUM.

- Suggested Positions -
OCT 22, 2014 - entry price on HUM @ 133.75, option @ 13.25*
symbol: HUM160115C140 2016 JAN $140 call - current bid/ask $10.30/14.20

10/22/14 trade begins. HUM opens at $133.75
*option entry price is an estimate since the option did not trade at the time our play was opened.
10/21/14 triggered. HUM closed @ 133.27, above our suggested entry above $130.25
Option Format: symbol-year-month-day-call-strike

Chart of HUM:

Current Target: HUM @ TBD
Current Stop loss: 119.75
Play Entered on: 10/22/14
Originally listed on the Watch List: 10/19/14


Financial Giant

by James Brown

Click here to email James Brown

New Watch List Entries

GS - Goldman Sachs

Active Watch List Candidates

LLY - Eli Lilly & Co

Dropped Watch List Entries

FDX and HUM have graduated to our active play list.

CHKP has been moved to our new plays tonight.

New Watch List Candidates:

Tonight we are only adding one new watch list candidate. I want to add more but the volatility over the last three weeks has been crazy and it might be wiser to wait for the market to settle a bit.

I looked at hundreds and hundreds of stocks this weekend. The market's recent strength is encouraging but we've gone from oversold to overbought in about seven days. We are also in the middle of earnings season, which can produce new entry points but it can also crater a stock on an earnings miss. You don't want to jump in too early and see your stock collapse on a disappointing result or guidance.

Radar Screen:
Here is a list of stocks on my radar screen. These have potential to be LEAPS trades down the road if the right entry point presents itself. In no particular order:


Some of these I would like to see a pullback before we consider bullish positions (AAPL, TRV, CELG, CCI).

A few of these have earnings coming up and I'd rather wait to see how the market reacts to their earnings report before we consider long-term bullish positions (CAH, ESRX, ALL).

The Goldman Sachs Group, Inc. - GS - close: $183.35

Company Info

Goldman is in the financial sector. They are considered part of the national investment brokerage industry. Goldman was founded in the year 1869 and is headquartered in New York. The company provides investment banking and management services to corporations, other financial institutions, governments and high-net-worth individuals. The lion share of their business is institutional client services where GS makes markets in fixed income, equities, currencies, and commodities.

The company's recent earnings report was strong. GS announced its Q3 results on October 16th. As of the first nine months of 2014 their revenues were up $1.4 billion above the same period a year ago. Management has managed to boost profits by reducing costs. A strong mergers and acquisitions market in 2014 has helped drive GS' results as the company is gaining market share.

Looking at their recent results Wall Street expected a profit of $3.21 per share on revenues of $7.8 billion for the quarter. GS delivered $4.57 per shares, a +59% increase from a year ago. Revenues soared +25% to $8.4 billion. GS saw $20 billion in net inflows bumping client assets to $1.15 trillion.

The company does have a habit of crushing analysts' earnings estimates so the market wasn't that surprised. The stock actually sank on these results but the initial weakness is over and GS is rebounding.

The stock experienced a -10% correction from its early October high to the mid October low. The recent breakout past resistance near $180 and all of its key moving averages is encouraging. I would be tempted to buy calls right now. However, I suspect the market might see some mild profit taking after last week's big rally.

Tonight I am suggesting a buy-the-dip entry point at $180.50 with a stop loss at $174.50. Our long-term target is the $220-230 zone.

Buy-a-dip at $180.50 with a stop at $174.50

BUY the 2016 Jan $200 call (GS160115c200) current ask $9.60

Option Format: symbol-year-month-day-call-strike

Chart of GS:

Originally listed on the Watch List: 10/26/14

Active Watch List Candidates:

Eli Lilly & Co - LLY - close: 66.05

10/26/14: LLY has seen some really big moves in the last eight trading days. The stock is normally not that volatile, which is one of the reasons we added to the watch list. While the short-term rally is encouraging the stock is now looking a bit overbought.

Tonight I am adjusting our entry point strategy. Instead of waiting for a close above $66.25 we will now wait for a close above $67.00 and then buy calls the next morning.

Earlier Comments: October 5, 2014:
You may have noticed that stocks have turned a bit more volatile recently. That could be a new trend after as investors try to look ahead into 2015 and ponder a market environment without a QE program by the Federal Reserve. That's why tonight we're looking at a stock like LLY, which is traditionally considered a more safe haven trade.

LLY has been building on its longer-term trend of higher lows. Plus the company has seen some good news. The U.S. FDA recently approved LLY's new once-a-week injectable diabetes drug for adults with type 2 diabetes. This new treatment, Trulicity, helps improve the patients' blood sugar levels. There are an estimated 26 million Americans who suffer with type 2 diabetes. LLY is also teaming up with AstraZeneca to work on a Alzheimer's treatment.

The two-week pullback in shares of LLY was pretty mild and investors are already buying the dip. We want to hop on board if this rebound continues. Tonight we are suggesting investors wait for LLY to close above $66.25 and then buy calls the next morning with a stop loss at $61.90.

trigger: Wait for LLY to close above $67.00
Then buy calls the next morning with a stop at $61.90

BUY the 2016 $70 call (LLY160115c70)

10/26/14 adjust entry point strategy. Move trigger from $66.25 to a close above $67.00. Option Format: symbol-year-month-day-call-strike

Originally listed on the Watch List: 10/05/14