Option Investor

Daily Newsletter, Sunday, 2/21/2016

Table of Contents

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

Leaps Trader Commentary

Fingers Crossed

by Jim Brown

Click here to email Jim Brown
After the strongest three day gain for the S&P since October 2011 the markets failed to sell off on Thr/Fri. In theory, that suggests the big selling is over and a continued rally is possible. Paraphrasing Yogi Berra, "theory rarely works in practice."

There are two keys for next week. The first is Dow resistance at 16,500. The Dow came to a dead stop at that level on Wednesday and then faded into the weekend. The Dow must break through that level for a continued market rally to have a chance. The second key is the 1,950 level on the S&P-500. The S&P failed to reach that strong resistance last week and failed at the weaker resistance at 1,927 before fading to 1,917 at Friday's close.

However, the S&P only lost a nickel on Friday. After gaining more than 1% for three consecutive days for the first time since 2011 the failure to really take profits on Thr/Fri suggests the major sellers are done. Anyone still interested in dumping a lot of stock would have jumped right on that failure at 1,927 and driven the market lower again. That did not happen.

The Russell 2000 also posted a 5 point gain on Friday +4% for the week. The Semiconductor Index ($SOX) posted a 5% gain for the week. The Dow Transports gained +3.4% to extend their gains from the prior week. Bullishness or in this case short covering is breaking out all over.

Helping lift the market was a nearly 11% gain in oil prices. With the correlation between oil and the S&P at roughly 80% the rise in crude allowed the S&P to move higher. Many of the energy stocks saw decent gains despite negative headlines about potential dividend cuts and bankruptcies.

The Dow Transports have rallied +13.7% since the low at 6,403 on January 20th. With oil prices low and the headlines over the Zika virus fading the airlines are soaring. Delta has rebounded +16.7% since the February 8th low. A positive transport sector is always positive for the Dow industrials.

The biotech sector rebounded +11.4% from the 2,575 low on the Biotech Index ($BTK). This lifted the Nasdaq and the Russell.

The market rebound was broad based across all sectors and the volume was strong for the first four days. The volume was weak on Thr/Fri when the market was weak. Friday was option expiration and we only traded 7.5 billion shares. When determining market direction follow the volume. The direction with the heaviest volume is the direction the move will likely continue.

We were knocked out of more than half of our positions and I am recommending we reload Nike and General Electric. The declines were purely market related when the S&P dipped to 1,810 and a two-year low.

The S&P futures are up as I type this on Sunday night and the Asian indexes opened higher. It is still early and there is a lot of darkness before the dawn. It appears we are going higher on Monday but we will not know is the opening bounce will be sold until we get there.

I apologize for not getting the newsletter out last Monday evening as expected. I did not get back in town from my son's wedding until late and I was not mentally up to the task.

Jim Brown

Send Jim an email


Will They Stick?

by Jim Brown

Click here to email Jim Brown
The market posted the best week of the year with the Nasdaq gaining nearly 4% and the S&P 3.5%. This is in sharp contrast to the prior week when the S&P set new two-year lows. Will this rebound stick?

Current Portfolio

Current Position Changes

M, GE, NKE, BAC, JPM were stopped out.

GE and NKE will be reopened on Monday.

Stop Loss Updates

Check the portfolio graphic for any new stop losses in bright yellow. We need to always be prepared for an unexpected decline.

New Plays

Time to Buy Oil?

by Jim Brown

Click here to email Jim Brown
With daily headlines out of the Middle East about a limit on production it makes the early June OPEC meeting even more important. If they can limit production in the coming weeks that could provide a common ground to cut production in June.

CVX - Chevron Corp - Company Profile

Chevron Corp explores, produces and refines oil and gas on a global scale. The upstream division explores and produces oil and gas. The downstream division refines the oil, produces petrochemicals and liquefies and distributes LNG around the world. Chevron is the real deal with operations in every facet of oil and gas production and distribution.

Despite the low oil prices Chevron continues to announce the completion of multiple projects to significantly enhance ongoing production. Currently Chevron produces about 2.54 million Boepd globally. They have a global refining capacity of 1.9 mbpd where profits offset the decline in crude prices. In Q3 Chevron had net income of about $2 billion. They generated cash from operations of $5.4 billion and paid out $2 billion in dividends.

The company has announced a decrease in capital expenditures from $42 billion in 2013 to $25 billion in 2016 and as low as $20 billion in 2017 depending on the market. This was helped by most of the work being completed on their two LNG facilities in Australia at a cost of nearly $60 billion. These facilities are preparing for first LNG and will be a source of a huge production increase for Chevron over the next three years.

On January 27th Chevron announced a $1.07 dividend for Q1 and they are confident cash flow will cover dividends through 2017. The CEO said maintaining the dividend will be their top priority in a period of low oil prices. Their current yield is about 5.1%.

The company announced on January 26th, first gas at the Chuandongbei Project in Southwest China. The project covers more than 800 square kilometers and is thought to contain more than 3 trillion cubic feet of gas. The LNG project consists of three trains that can process 258 million cubic feet of gas per day. The first train is now in operation and the other two trains are under construction and nearing completion. Chevron owns 49% of the project and China National Petroleum owns 51%.

In December they announced first oil from the Moho Bilondo development offshore the Republic of Congo. The project is 50 miles offshore in 4,000 feet of water. The initial project has 11 wells that are expected to produce 40,000 bpd. In November they announced first oil from the Lianzi Development Project also offshore the Republic of Congo. This project is 65 miles offshore in 3,000 feet of water and is also expected to produce 40,000 bpd.

Chevron has such strong financials that along with Exxon they were the only two companies not included in the recent Moody's warning of ratings downgrades. The rating agency said they were going to downgrade 120 oil and gas companies and 55 mining companies. Chevron and Exxon were exempted.

In the last earnings cycle for Q3 Chevron beat estimates by 37.9% and has posted an average beat of 15.11% for the last four quarters. Their refining and chemicals businesses have offset the losses from the lower oil prices. Chevron is set to announce earnings on Friday. I would not normally recommend a long position ahead of earnings but Chevron has a lot to brag about and production increased significantly in Q4. Conservative investors may want to wait until next week to enter the position.

Chevron shares have shown relative strength to the market because of their balance sheet, high production, new projects coming online and the dividend. That means we should be somewhat insulated from a price crash. Once oil prices do begin to rise for whatever reason we should see Chevron shares outpace the sector because of their relative strength.

Chevron probably has more new production in the pipeline than any other U.S. company. Most of that production is gas with two monster projects in Australia. The Gorgon project is a multibillion dollar LNG facility with the export capability of 15.6 million tons per annum (MTPA)(2.184 Bcf/d) of LNG to Asian markets. Demand for gas to Asia is expected to double by 2025. The fields feeding this LNG plant have more than 40 Tcf of gas with new discoveries every month. The first train of the three-train project is under construction and should be operational in 2015.

The $29 billion Wheatstone project will consist of two LNG trains with a combined capacity of 8.9 MTPA (1.25 Bcf/d) with the option to expand to 25 MTPA (3.5 Bcf/d). The first LNG output will be in 2016. More than 80% of the gas supplied to Wheatstone will come from Chevron fields. Another 20% will come from an Apache find in the same region. Chevron has made 21 major discoveries of gas in the region since 2009. The initial discovery was 9 Tcf of gas but more is being added every month.

There have been some worries recently about a surplus of LNG with numerous projects getting close to commencing operations. Chevron was one of the first to sanction the major projects in Australia and they presold the vast majority of their production for the next 20 years. If LNG prices do decline, Chevron will be protected. The Australian projects are close to Asia so shipping is less of an expense making their gas more desirable. With the projected startup later this year and full production by the end of 2016 this will be a monster boost to Chevron's global production.

Gorgon is the world's largest LNG project since 2010 and Australia's largest LNG project. Chevron owns 47% and Exxon and Shell own 25% each. Chevron spent $4.5 billion in 2014 and is expected to spend $3 billion in 2015 on Gorgon. Just beginning operations turns this project from a money pit into a moneymaker with revenue net to Chevron of $2.1-$2.9 billion a year.

These are just two of the dozens of projects Chevron has in progress. In the last ten years, Chevron has added 10.2 billion barrels of oil equivalent to its reserves.

The biggest factor in Chevron's favor is the pending start of the Australian LNG operations. This will significantly increase global production, reduce capex and increase cash flow. The earnings reports in 2016 will show significant improvements.

I am recommending an optional short put to offset some of the premium for the expensive LEAP calls.

Buy 2017 $90 LEAP Call, currently $7.55, no initial stop loss.


Sell short Jan $70 LEAP Put, currently $4.20, no initial stop loss

Net debit $3.35.

Play Updates

February Nightmare Continues

by Jim Brown

Click here to email Jim Brown
Editors Note:

The market decline to open February continued with the S&P setting a new two-year low. We were stopped out of the majority of our positions only to see those stocks rebound strongly after the dip. I am reloading the GE and NKE positions but the banking sector continues to be weak and I am dropping BAC and JPM. The recent earnings warnings in the retail sector suggest we should avoid Macy's as well.

Because of the market volatility, I am not putting stop losses on any new plays. This is dangerous because not all declines are bought. Some go on to become bear markets. However, these are long term positions on quality companies that have already seen significant declines. When the market weakness eventually fades the leadership companies will be the first out of the bottom. If a company dips low enough we will sell a lower LEAP against the open position to turn the position into a spread and reduce our losses.

There is no easy answer to market corrections. They occur and we must deal with them. If we simply wait on the sidelines for the all clear signal, we could miss some good entry points. If we buy the dip the dip may continue. This is all part of investing.

The key is to own quality companies that will have good relative strength and survive the correction with the least amount of losses.

Original Play Recommendations (Alpha by Symbol)

BAC - Bank of America - Company Profile


Bank of America dropped to a three-year low with the market dip to 1,810 on the 11th. There is nothing wrong with the bank but the banking sector is fearful of negative rates, a China meltdown and the banking crisis in Europe. We were stopped out on the decline and I am dropping BAC as a position. Fortunately the option was cheap and we only lost 41 cents.

Original Trade Description: January 31st:

It has been a rough few years but finally the worst is over for this sector and stock. You cannot ignore a company that earns $15 billion a year.

Bank of America has been ignored since late December and their earnings report in early January did not generate a lot of excitement. The bank said it earned 28 cents that beat estimates for 27 cents. That equates to a profit of $3.3 billion. They ended the full year with a $15.9 billion profit. From where I am sitting that is outstanding since it was up from only $3.38 billion in 2014.

The bank did not get a bounce from earnings because the CFO said increasing revenue was difficult in this market because the bank is more heavily exposed to low interest rates because it has a large retail banking business and very little profit centers like stock and bond trading that support Goldman and JP Morgan. The earned their profits the old-fashioned way one retail customer at a time and by slashing costs wherever possible. They eliminated 10,000 of its 223,715 employees and closed 129 branches. That leaves them with 4,726 locations.

BAC has $21.3 billion in energy loans and had $75 million in energy charge-offs in the quarter. The bank had $19.53 billion in revenue for the quarter and ended the year with $1.2 trillion in deposits. Once interest rates begin to rise the profits are going to explode higher.

BAC returned $4.5 billion to shareholders in 2015, $1.3 billion in Q4, through stock buybacks and dividends.

The last nine analyst ratings changes have been upgrades. On Friday, Credit Agricole upgraded them from sell to buy and skipping the hold level in the middle. Sandler ONeil, Wells fargo, Nomura, Bernstein and Robert W Baird have all upgraded BAC to buy.

Multiple analysts published notes last week recommending Bank of America at the current three-year low. Their legal troubles are about over with the vast majority of the financial crisis problems behind them. They are well away from any level that could be worrisome in the Fed's stress test scenarios. They are making money and staying out of trouble and they are paying nearly a 2% dividend.

To summarize, I believe the worst is over for the large banks and Bank America is in the sweet spot for when interest rates do rise.

Note: This same position was recommended in the Premier Investor Newsletter as a long stock play. I thought the timing was perfect to make it a LEAP play as well.

Position 2/1/16, Stopped 2/11/16: Closed: Long 2017 $15 LEAP @ $1.22, exit .81, -.41 loss.

GE - General Electric - Company Info


GE dipped below support at $28 last week to stop us out for a fractional gain. The rebound took it back to a two month high. The market weakness brought it back down to $29 and only $1 above our last entry.

I am recommending we reload this position. However, rather than replace it with the 2017 LEAPS I am going to recommend we spend about 70 cents more and go out to 2018. This will take us past any future volatility and past the election process. GE has so many good things in process that I believe they will be significantly higher by January 2018. Having that long a time frame takes out the worry about the short term fluctuations.

Original Trade Description: December 20, 2015:

GE has been slowly drifting higher since the 2009 market lows. Most of 2014 and 2015 the stock was stuck churning sideways. The situation changed in early October this year after a big activist investor got more involved. It's making a difference. The S&P 500 is down -2.6% year to date. Yet GE is up +20% in 2015 and should continue to outperform in 2016.

GE is in the industrial goods sector. According to the company, "GE is the world's Digital Industrial Company, transforming industry with software-defined machines and solutions that are connected, responsive and predictive. GE is organized around a global exchange of knowledge, the 'GE Store,' through which each business shares and accesses the same technology, markets, structure and intellect. Each invention further fuels innovation and application across our industrial sectors. With people, services, technology and scale, GE delivers better outcomes for customers by speaking the language of industry. www.ge.com"

One of the biggest changes at GE has been the company's long-term transformation to get rid of its financial assets that have been an albatross around its neck for so long. Management is focusing on the company's roots, which is industrial products and innovation.

The company recently held their annual meeting with analysts. The year ahead brings a lot of challenges. The global market is still struggling. The U.S. economy is limping along at +2% growth. Plus the strong dollar hurts sales outside the U.S. In spite of these headwinds GE's CEO Jeffery Immelt is bullish on 2016.

Management is forecasting 2016 earnings to rise +15% on revenue growth of +2% to +4%. That is impressive for such a massive company like GE who does so much business overseas. They also foresee paying investors $8 billion in dividends and spending $18 billion on stock buybacks in 2016. GE provided a long-term 2018 earnings forecast of more than $2.00 per share compared to $1.30-1.20 a share in 2015. They expect to return $55 billion to shareholders in dividends and buybacks between now and 2018. That sort of investor-friendly action could help GE weather any market volatility in 2016.

The stock has been showing relative strength the last few months. The stock held up pretty last week too during the market's volatile moves. GE tagged multi-year highs on Wednesday. The point & figure chart is bearish and forecasting a long-term target at $53.00.

The action in GE's stock over the last few weeks is either a new top or it is a new base. We are betting it is the latter.

Position 1/20/16, stopped 2/11/16:

Closed: Long Jan 2017 $30 call, entry $1.30, exit $1.40, +.10 gain

Buy 2018 $30 LEAP call, currently $2.59, no stop loss.

JPM - JP Morgan - Company Info


JPM gapped down to $52.50 on Thursday the 11th to stop us out of the position for a 40-cent loss. The meltdown in the European banks was the reason and although JPM shares have recovered, the sector is still weak. I am not recommending we reload this position.

Original Trade Description: January 31st

JP Morgan is the largest U.S. bank with assets in excess of $2.3 trillion. It calls itself a financial services firm that operates in four segments. Those are consumer & community banking, corporate & investment banking, commercial banking and asset management. The bank earned $22.41 billion in 2015 on revenue of $89.72 billion.

For Q4 the bank reported earnings of $1.32 that beat estimates for $1.30. Revenues were $22.89 billion. Earnings were held back because of a 21% decline in profits in commercial banking because of energy loans. The CFO said we are ready to increase loan loss reserves as needed if the energy sector remains weak for a long period.

Legal expenses declined from $1.1 billion to $606 million in Q4 as they wind down all the remaining problems left over from the financial crisis. JP Morgan would have been rock solid but they were pressured by the Fed into taking over Bear Stearns and Washington Mutual at the height of the financial crisis. Most of their legal settlements over the last five years came from loans sold by those two firms and JP Morgan inherited those problems when they agreed to acquire them.

The bank is so strong they were able to digest more than $6 billion in losses caused by a rogue trader nicknamed the London Whale. That turned out to be just a blip in their financials where it could have caused serious harm to a lesser firm. They still produced record profits in that year despite the loss.

On January 26th the bank entered into an agreement with Ambac Financial Group to pay $995 million to resolve the last of their claims from the financial crisis. With this agreement, Ambac will drop objections to the $4.5 billion agreement between Blackrock and Pimco for faulty home loans in 2008.

JP Morgan continues to confound the experts and grow despite the long list of legal problems they inherited in 2008. Now that those problems are mostly behind them the bank is free to concentrate on increasing profitability. As interest rates rise their massive loan and deposit base will make them even more profitable.

JPM has an investor day on February 23rd. Earnings are April 13th.

JPM shares found support in the January sell off around $56 although they dipped to $54 on the January 25th market crash. The influx of acquisition cash on the 29th caused a +$2.22 gain to $59. I expect that gain to fade and give us a better price on the LEAP call when we are finally triggered. I am putting an entry point over $60 just to make sure we do not get trapped in any post Friday decline. My ideal entry target would be a dip back to $58.

I am recommending a breakout trigger and a buy the dip trigger. Use the one that is hit first but not both.

Position 2/2/16 stopped 2/11/16

Closed: Long Jan $62.50 call @ $3.15, exit $2.75, -.40 loss.

KMB - Kimberly Clark - Company Info


KMB is showing great relative strength and holding at the recent highs. The dip to $125 on the Thursday crash avoided the prior stop loss. I raised the stop to $126.65 for this week to lock in a profit if the market is volatile again.

Original Trade Description: December 6, 2015:

There are not many public companies that have been around as long as KMB. The company has a history going back more than 140 years. It looks like investors are still bullish on it with KMB trading near all-time highs.

KMB is in the consumer goods sector. According to the company, "Kimberly-Clark (KMB) and its well-known global brands are an indispensable part of life for people in more than 175 countries. Every day, nearly a quarter of the world's population trust K-C's brands and the solutions they provide to enhance their health, hygiene and well-being. With brands such as Kleenex, Scott, Huggies, Pull-Ups, Kotex and Depend, Kimberly-Clark holds No. 1 or No. 2 share positions in 80 countries."

The company has beaten Wall Street's earnings estimates the last three quarters in a row. A stronger labor market in the U.S. combined with lower gasoline prices should be a tailwind for consumer spending in the globe's biggest economy. Meanwhile KMB is pursuing high-growth opportunities in emerging markets.

Technically the stock has been trading sideways in the $117.00-123.00 zone the last seven weeks. The recent bounce near the bottom of its trading range might suggest a bullish breakout soon. The point & figure chart is bullish and forecasting at $163 target. Tonight I am suggesting investors wait for KMB to close above $123.00 and then buy calls the next morning with an initial stop loss at $116.95.

Position 12/16/15:

Long Jan 2017 $130 Call, entry $7.50, see portfolio graphic for stop loss.

01/31/16 new stop @ 121.65
12/27/15 new stop @ 119.40
12/16/15 Trade begins. KMB opens at $124.75
12/15/15 Triggered with KMB @ $124.44, above our $123.00 trigger

M - Macy's - Company Info


Macy's crashed back to $37.50 and a four week low on the Thursday market crash. We were stopped out for a 50 cents loss at $38.85. With the weakness in recent retail earnings I am not recommending we reload this position.

Original Trade Description: January 17th, 2016:

Leading up to the 2008 financial crisis shares of Macy's (M) were already in decline. The stock fell nearly -90% from its 2007 highs and by late 2008 M traded near $5.00 a share. The market didn't bottom until early 2009. At that time M was trading about $6.25. The stock rallied the next six years in a row. It looked like 2015 would make it seven years in a row. Then momentum suddenly reversed in July 2015. The stock surged to all-time highs near $73.00 on rumors of an activist investors getting involved. That proved to be the peak. Macy's collapsed from about $73.00 in July to $34.50 in December - a 52% plunge. Recent action suggest Macy's has bottomed and all the bad news is priced in.

M is part of the services sector. They are in the department story industry. According to the company, "Macy's, Inc., with corporate offices in Cincinnati and New York, is one of the nation's premier retailers, with fiscal 2014 sales of $28.015 billion. The company operates about 900 stores in 45 states, the District of Columbia, Guam and Puerto Rico under the names of Macy's, Bloomingdale's, Bloomingdale's Outlet, Macy's Backstage and Bluemercury, as well as the macys.com, bloomingdales.com and bluemercury.com websites. Bloomingdale's in Dubai is operated by Al Tayer Group LLC under a license agreement."

U.S. retail sales were very disappointing last year. All of 2015 saw retail sales rise +2.1%. That's down from the five-year average of +5.1%. All year long analysts were expecting consumers to spend more because they were saving more money at the gasoline pump due to falling oil prices. That extra spending never showed up. This lack of spending weighed on several retailers and M's stock continued to sink. Macy's management took advantage of their falling stock price and bought back over 30 million shares last year.

Of course stock buybacks will also do so much. On January 6th Macy's slashed their full-year guidance due to weak sales during the holiday shopping season. Cold weather apparel and goods were not selling due to an unusually warm winter. Macy's said their comparable-store sales dropped -4.7% during the November-December time frame. The company reduced their full-year outlook from $4.20-4.30 a share down to $3.85-3.90 a share. Wall Street was expecting $4.24. That same night Macy's announced a major restructuring program. They will close 36 stores this spring. Plus they will reduce staff and cut costs in an effort to save $400 million a year. Shares rallied the next day.

If a company can cut its earnings guidance and rally then all the bad news is probably priced in. If you haven't noticed lately the stock market is plunging. The S&P 500 is already down -8.0% in the first ten trading days of 2016. Shares of Macy's are moving the opposite direction and the stock is up +8.2% year to date. The recent lows near $34.00 look like a bottom. However, we would like to see M breakout past technical resistance at its 50-dma and past its recent highs.

Position 1/25/16, closed 2/11/16:

Closed: Long 2017 Jan $45 call @ $3.40, exit $2.90, -.50 loss

NFLX - Netflix - Company Info


I am still a believer in Netflix. Shares rebounded from the drop to $80 two weeks ago and did NOT put in a lower bottom on the Thursday market drop like all the other stocks did. Netflix has rebounded from that $80 low to $89 and traded as high as $94.77 on Wednesday. I am not ready to buy a new call just yet.

The market still has the potential to decline further and I prefer to wait until NFLX either moves over $97 or retests the lows at $80.

Once it appears Netflix has stopped going down we will replace our stopped call with a new strike. We still have $9.45 in net premium received from selling the put after subtracting the $5.59 loss in the call. That will cover much of the price of a new call once a bottom is reached.

Original Trade Description: January 24th.

Netflix has a plan for total domination of streaming video. On December 31st they were active in 60 countries. In early January they announced they had expanded into 130 additional countries a full year ahead of schedule. The original plan was to complete the expansion by the end of 2016. This gives them a huge additional base of prospective users of more than 450 million broadband accounts. Everyone around the world knows of Netflix. Many have been waiting for them to open in their country. Netflix could gain more than 25 million new users in 2016 alone. They currently have just under 75 million. The 190 countries does not include China. They are working on getting into China but the government has put numerous censorship roadblocks in their path that need to be overcome. They expect to be in China in 2017. They added 4.04 million international subscribers in Q4 and that was just from the existing 60 countries.

Netflix said it was targeting young, outward-looking, affluent consumers with international credit cards and would spread out from that base.

Last year Netflix raised prices for new subscribers by $1 to $10 a month for unlimited high definition streaming. Existing subscribers were left at the $8 level. Now the company is saying those grandfathered under the $8 plan will see their exemption expire in May. They can continue paying $8 a month for standard definition but the rate will rise to $10 for HD shows and movies. Premium subscribers getting 4K UHD videos will be paying $12 a month. With 75 million subscribers this represents a cash windfall with the $8 rate rising 50% to the $12 level if you want UHD. Netflix said they were already seeing very fast adoption of the $12 plan by existing users. Plus, premium subscribers can stream to 4 devices simultaneously rather than just 2.

Netflix plans to stream more than 600 hours of original content in 2016 compared to 450 hours in 2015. There will be 31 new and returning original series, up from 16 in 2015. There will be two dozen original feature films and documentaries, 30 children's series and a variety of comedy specials.

Analysts believe Netflix earnings are going to soar in 2017 as the adoption of streaming in those 130 new countries begins to accelerate. That is good news because Netflix shares are highly overvalued according to normal metrics. Revenues have been rising 25% annually and streaming content obligations rose by 15% in 2015. They are paying a lot for content but they are essentially taking it off the market to prevent anyone else from competing. They can now use that content in 190 countries so they are leveraging their assets to expand future revenue. Their current PE of 346 is less than half of Amazon's 851 PE. They are operating on the same business model as Amazon. If you build it subscribers will come. When they finish their expansion phase, which is limiting earnings today, they will be highly profitable with more than 200 million subscribers by 2020. That equates to $2 billion a month in revenue. That is a month, not a year.

Buying Netflix requires a leap of faith that investors will return to it as a momentum growth stock. After the earnings report shares have been weak as traders looking for an earnings bounce move on to other stocks in hopes of repeating the process. Shares closed at $100 on Friday after a low of $97 during Wednesday's market crash.

I am suggesting we target that $97 level for a long entry. However, the LEAPS are so expensive we have to use a combination play to make it work.

One option would be to buy the stock and sell a January $110 LEAP covered call, currently $17.50. if we buy the stock at the $97 target we are protected against a decline to $80 by the premium we receive. If Netflix does not drop significantly and rebounds to more than $110 then we make roughly 20% or $20 over the next year. We cannot complain about a 20% gain in this market. If Netflix shares did decline significantly so $90 or so, the option premiums will shrink significantly and we could buy back the $110 LEAP for a profit and then buy a LEAP at a lower level for less money.

Another option would be to use a combination position where we buy the LEAP and then sell a put spread or a naked put to offset the cost of the LEAP call. One example would be to buy the $110 call for $17 and sell the $90 put for $14.25 giving you a net debit of $2.95 to be long Netflix for the next year. If shares declined under $90 you "may" be obligated to buy the stock at $90 "if" it was put to you. With the volume of puts on Netflix that potential is minimal but it does exist. If you were put I would sell a covered LEAP call to cover any losses and you still have your $110 long call for when the stock rebounds.

The option I am recommending is the combination play. If Netflix trades at $97.25 we enter the following trade. I am using the even dollar strikes in case there is another stock split in 2016.

Position 1/26/16 when NFLX traded at $97.25

Closed 2/3/16: Long January 2017 $110 LEAP call @ $15.00, exit $9.41, -5.59 loss
The call position will be replaced once the market volatility eases.

Still short January 2017 $90 LEAP put @ $14.95, no stop loss.
Net debit 5 cents. If we are put the stock our cost will be $74.95 and a bargain.

NKE - Nike - Company Info


We were stopped out of the prior position on Feb 8th when Nike shares declined to $54. The rebound was almost immediate but rocky. It appears that weakness has faded and shares closed at a two week high on Friday.

I am recommending we reload the Nike position using the same Jan $65 call, currently $3.90.

Original Trade Description: January 24th

Nike split 2:1 on December 23rd at $132 and the stock went straight down from there. When a stock is a major fund holding and it splits, there is a rush to the exits by some funds. They can sell the new shares nearly tax-free when it is classed as a stock dividend and they still have the same number of shares in the original position. Some funds have restrictions on the number of shares they can hold in any single position. A stock split doubles the number of shares and sometimes puts them over the limit and they sell the extras. These factors cause what is called "post split depression." Nike shares have now experienced that depression.

Shares declined from the $66 level the day of the split to $56 last week on fears the holiday retail selling may have been weak. Given Nike's predominant position in athletic leisure apparel they will always be the dominant seller compared to Under Armour and LuluLemon.

The reported earnings in late December of 90 cents, that rose +22% and beat estimates for 85 cents. Revenue rose +4% to $7.686 billion but missed estimates for $7.808 billion because of the strong dollar. Excluding the dollar impact revenues rose +12% and well over $8 billion.

The company guided for earnings growth in the "mid teens percentages" and said there was no weakness in China. They announced a $12 billion stock buyback program in November and raised their dividend by +14%.

Nike is targeting $50 billion in annual revenue by 2020 with online direct ecommerce sales of $7 billion, up from $1 billion in 2015. Online sales rose +51% in 2015.

Competitor Under Armour is targeting total sales of $8 billion by 2018 to put that aggressive Nike target into perspective.

Nike plans to begin selling in Mexico, Chile and Turkey in 2016. Nike began e-commerce sales to Canada, Switzerland and Norway in the last quarter.Sales in China rose +28% despite the economic downturn. North American sales rose +10% with futures orders up +14%.

Earnings are March 22nd.

I am recommending we buy the $65 LEAP with a Nike trade at $62.25 to confirm the rebound from the lows last week.

Position 2/1/16, stopped 2/8/16

Closed: Long January 2017 $65 LEAP Call @ $5.00, exit $2.59, -2.41 loss

Buy January 2017 $65 LEAP Call, currently $3.90, NO STOP LOSS.

SBUX - Starbucks - Company Info


We reloaded the Starbucks position at the open on the 8th after being stopped out the prior week. The dip to $53 on the 8th gave us a great entry point on the option. I think Starbucks will turn out to be a big winner for us. Nomura initiated coverage on Friday with a buy rating and $70 price target.

Original Trade Description: January 24th.

We were stopped out of the Starbucks position by a penny on the January 20th market crash. The company reported great earnings and failed to decline. The only hiccup was a temporary decline in sales growth in Europe because of the terrorist attacks. CEO Howard Schultz said they were headed for a record quarter in Europe until the Paris attack and then everything came to a screeching halt. He also said buying and traffic patterns were returning to normal and 2016 should be a good year. They reported 9% same store sales increases in the U.S. and 6% elsewhere other than Europe. Earnings growth is expected to be 15% annually for the next five years. They are opening 500 stores a year in China for the next 5 years and Schultz expects China's revenue to exceed the U.S. in the years to come. Schultz said at the current low stock price they were "backing up the truck" to buy as many shares as possible.

The world seems to have an insatiable appetite for coffee. Starbucks is more than happy to help fill that need. The first Starbucks opened in Seattle back in 1971. Today they are a global brand with locations in 66 countries. SBUX operates more than 21,000 retail stores with more than 300,000 workers.

A few years ago Business Insider published some facts on SBUX. The average SBUX customer stops by six times a month. The really loyal, top 20% of customers, come in 16 times a month. There are nearly 90,000 potential drink combinations at your local Starbucks. The company spends more money on healthcare for its employees than it does on coffee beans.

The company's earnings results were only mediocre most of 2014 year. You can see the results in SBUX's long-term chart below. After incredible gains in 2013 SBUX has essentially consolidated sideways in 2014. SBUX broke out of that sideways funk after it reported earnings in January 2015.

Five-Year Plan

In late 2014 SBUX announced their five-year plan to increase profitability. Here's an excerpt from a company press release:

"The seismic shift in consumer behavior underway presents tremendous opportunity for businesses the world over that are prepared and positioned to seize it," Schultz said (Howard Schultz is the Founder, Chairman, President, and CEO of Starbucks). "Over the next five years, Starbucks will continue to lean into this new era by innovating in transformational ways across coffee, tea and retail, elevating our customer and partner experiences, continuing to extend our leadership position in digital and mobile technologies, and unlocking new markets, channels and formats around the world. Investing in our coffee, our people and the communities we serve will remain at our core as we continue to redefine the role and responsibility of a public company in today's disruptive global consumer, economic and retail environments."

"Starbucks business, operations and growth trajectory around the world have never been stronger, and we are more confident than ever in our ability to continue to drive significant growth and meet our long term financial targets," said Troy Alstead, Starbucks chief operating officer. "We have more customers visiting more stores more frequently, both in the U.S. and around the world, than at any time in our history. And we expect both the number of customers visiting our stores and the amount they spend with us to accelerate in the years ahead. With a robust pipeline of mobile commerce innovations that will drive transactions and unprecedented speed of service, Starbucks is ushering in a new era of customer convenience. We believe the runway of opportunity for Starbucks inside and outside of our stores is both vast and unmatched by any other retailer on the planet."

The company believes they can grow revenues from $16 billion in FY2014 to almost $30 billion by FY2019. To do that they will expand deeper into regions like China, Japan, India, and Brazil. SBUX expects to nearly double its stores in China to over 3,000 locations in the next five years.

They're also working hard on their mobile ordering technology to speed up the experience so customers don't have to wait in line so long at their busiest locations. This will also include a delivery service.

Part of the five-year plan is a new marketing campaign called Starbucks Evening experience. The company wants to be the "third place" between home and work. After 4:00 p.m. they will start offering alcohol, mainly wine and beer, in addition to new tapas-like smaller plates.

The company recently launched its first ever Starbucks Reserve Roastery and Tasting Room in Seattle, near their iconic first retail store. The new roastery is supposed to be the ultimate coffee lovers experience. CEO Schultz said they will eventually open up about 100 of these Starbucks Reserve locations.

SBUX continues to serve up strong earnings and revenue growth too. The fourth quarter of 2014 saw a huge jump in SBUX gift cards. One out of every seven Americans received a SBUX gift card. SBUX has been reporting very strong overseas sales growth and consistently healthy same-store sales growth globally.

Position 2/8/16:

Long Jan 2017 $60 LEAP Call @ $3.05, no stop loss

Prior position stopped 2/5/16:
Long Jan 2017 $65 call, entry $4.01, exit $2.47, -1.54 loss.

WMT - Walmart - Company Profile


The play recommendation from the prior week suggested a long entry with a trade at $67.65 and the purchase of a protective put with a drop to $64.50. Unfortunately, Walmart never rebounded to trade at the $67.65 level so the play has not been opened. I am recommending we cancel the play.

Walmart reported a 7% decline in earnings to $1.49 and the sixth straight quarterly decline. That still beat estimates for $1.46 per share. The company said the $1 increase in the minimum wage for 1.2 million employees will cost the company $2.7 billion in a two year "investment" in workers.

Walmart guided for Q1 earnings of 80-95 cents and that was less than the $1.03 in the year ago quarter.

CANCEL the recommendation.

Original Trade Description: February 7th.

Walmart has been in a downtrend since trading at a high of $91 in January 2015. Same store sales were declining, stores were not being maintained, shelves were not stocked and investors fled the shares. Something happened in November 2015.

Q3 profits came in higher than expected and the company provided upbeat guidance. That was a huge change in direction for the company.

The CEO pointed out that Walmart has $485 billion in sales but only $15 billion is online. They hired about 2,000 people to work on improving the online business and competing with Amazon. At the same time Amazon announced it was going to open some retail brick and mortar locations. That suggests that you cannot do everything online. With revenue of $115 billion, Amazon is going to spend billions opening 300-400 retail locations. Walmart already has 11,500 locations. It is a lot easier to manage adding an online shopping website than open hundreds of locations.

Walmart has figured out that they need to have a big online presence and they are moving in that direction. They already have the backend distribution and warehouse network so the task ahead is a lot easier. They have plenty of cash to throw at the effort and they will get it done.

Walmart announced a wage hike for all their employees and improved benefits. The hikes will cost more than $1 billion a year. The stock was hammered on the news until analysts did the math. With $485 billion in revenue, they can raise the price of everything by only 0.22% or roughly 22 cents per $100 in sales and the entire wage hike is paid for and you still have the lowest prices. When you have that kind of scale, the numbers are mind boggling.

Walmart sales are improving as management got control of the internal problems. They hired more people and shelves are now stocked. Walmart is also adding significant numbers of organic products from produce to their private brands. They are significantly cheaper than Whole Foods and Fresh Market.

They recently announced a restructuring program to close 154 stores. The vast majority are the smaller Walmart Express stores and the smaller Neighborhood Market stores. Those never did well for Walmart. When customers shopped there, they were frustrated by the lack of all the merchandise in a Supercenter.

At the same time they are adding Walmart gas stations to their stores. Previously some stores had stations operated by Murphy USA (MUSA). The company announced last week they were adding their own branded stations in order to create another revenue stream. This is a good idea since having cheap gasoline is yet another draw to get people to shop at Walmart. Gas stations and their attached convenience stores are very high profit businesses. Those fountain drinks, jerky, candy and chips are very high profit items.

Walmart has its own credit cards. If they can hook consumers into paying at the pump with those cards then they win again from the interest collected.

Walmart is turning itself around and the low gasoline prices are putting extra money in consumer pockets. Walmart is doing its best to get those consumers to spend it in their stores.

Shares rebounded from a four-year low at $56 and have been accelerating higher. The high last week at just over $67 was a six-month high. At $67 Walmart only has a PE of 14. That is less than Target at 16 and Costco at 28. Walmart paid total dividends of $1.96 in 2015 and it has increased its dividend annually since 1974. They recently announced a $20 billion share buyback program over the next three years starting in 2016. That is almost 10% of its stock at today's prices.

I am recommending the Jan $70 LEAP call, currently $3.85. In order to prevent being stopped out in market volatility I am recommending we add the March $62.50 put at $1.09 and not have a stop loss until Walmart shares are significantly higher and we can remain profitable. I am only adding the put position if WMT shares dip to $64.50. If Walmart shares move higher as expected the $1 spent for the put will be easily recovered.

Recommendation cancelled

If you like the trade setups you have been receiving and you are on a free trial then now is the time to subscribe. Don't wait until you miss a newsletter to decide you want to take the plunge.

subscribe now

Prices Quoted in Newsletter

At Option Investor we have a long-standing policy prohibiting the editors and staff from actually trading the individual recommendations in order to conform to SEC rules concerning trades.

The prices quoted in the newsletter are the end of day prices in most cases.

When discussing fills or stops the prices quoted are the bid/ask at the time the entry trigger or exit stop is hit. This is NOT a price that someone on staff actually got using a live order.

For entry/exit points at the market open the prices quoted will be the opening print. The majority of the time readers are able to get a better fill than the opening print because of market maker bias at the open.

For trades with an opening qualification the prices quoted will be the bid/ask at the time the qualification was met.

All of these rules normally produce worse prices than an active trader would normally get. Because they are standardized there may be some cases where a price quoted was better than an actual fill. If you received a price that was dramatically different than what was quoted please let us know.


Two New Plays

by Jim Brown

Click here to email Jim Brown
Time to go bargain hunting in shares of two companies that have been crushed by recent headlines but have an outstanding business and a bright future.

Stocks Dropped from Watch List:

No drops

Active Watch List Stocks:

DIS - Disney

Updated play recommendation.

JCI - Johnson Controls

Play remains unopened.

New Watch List Entry:

CSC - Computer Sciences Corp - Company Profile

CSC is an information technology and professional services Fortune 500 firm that provides solutions in North America, Europe, Asia and Australia. They reported earnings last week of 71 cents that beat estimates for 69 cents. However, revenue declined -10.2% to $1.75 billion and missed estimates for $1.859 billion. The stock was crushed for a nearly -20% loss from $31 to $24 on the news. Shares recovered to trade just over $27 for the last week.

During the quarter they spun off their public sector business and merged it with SRA International and the merged company began trading on the NYSE under the symbol CSRA. This was responsible for a portion of the revenue decline.

However, the Global Business Service (GBS) segment saw revenues decline -8.2% due to a decline in consulting revenues. Overall the segment produced $1.6 billion in revenues for the quarter, which were up +35%.

Global Infrastructure Services (GIS) revenues declined -12.2% to $854 million. This was due to a continued decline in their legacy business, which is being replaced by their new cloud offerings. New business awards rose +4% to $1 billion.

Total company bookings rose +21% to $2.7 billion. Operating income rose +9.2% to $190 million.

CSC ended the quarter with $1.83 billion in cash and long-term debt at $2.67 billion.

On February 11th the Supreme Court of Victoria, Australia, approved the acquisition of WXC Limited for (AU)$427.6 million. CSC believes the acquisition of UXC will strengthen their global commercial business by adding the UXC platform to the CSC cloud, cyber and big data offerings. Back in August CSC acquired two other companies, Fruition Partners, a service-management technology provider and London-based Fixnetix, a provider of front-office managed trading software for capital markets.

They are also acquiring Xchanging, a UK company that provides software and outsourcing services for the insurance industry for $697 million. That deal is currently going through the regulatory approval process.

The point here is that CSC is a leading provider of information technology and they are growing rapidly through acquisitions. They are moving towards a mix of cloud based higher margin products that will be beneficial over the long term. They are also buying back stock with a new authorization in January. They paid a special dividend of $10.50 when they spun off the public sector business in Q4. That accounts for the $10 drop in the stock price at the end of November.

The big drop in the stock last week came from lowered guidance. The company guided for earnings in the range of $2.40-$2.60 because of their acquisition expenses, reduced revenue after the spinoff and delays in the government order renewal process and constricted federal spending.

They have plenty of business as evidenced by the $2.7 billion in new bookings and 16% earnings growth.

I believe the selloff it overdone and long-term the value will return to CSC shares. The options are cheap and the stock does not have to rebound far to put us into the money. This is purely a value play on an oversold stock that should move higher in a positive market.

I do not want to enter the position until that rebound appears so I am putting a $28.50 entry trigger on the position.

With a CSC trade at $28.50

Buy Jan $30 LEAP call, currently $2.05. no initial stop loss.

TRN - Trinity Industries - Company Profile

Trinity Industries manufacturers rail cars, highway guard rails and steel beams for infrastructure projects, structural towers for wind turbines and electrical distribution grids, oil and chemical storage tanks, barges to transport grain, coal, aggregates, tank barges to transport oil, chemicals and petroleum products. The company was founded in 1933.

Shares crashed last week after they reported earnings that beat the street but guidance that disappointed. Earnings of $1.30 easily beat estimates for $1.07 but revenue of $1.55 billion missed estimates for $1.61 billion. They had full year earnings of $5.08 per share.

They guided for 2016 to earnings of $2.00 to $2.40 per share. The challenge is the slowdown in orders for railroad tank cars and barges to transport oil. With oil prices crashing the producers and refiners are cutting back on capex spending until prices recover. Trinity said revenue in 2016 could decline -32%. Shares declined -35% over two days on the news.

They are also divesting their galvanizing business, think galvanized highway guardrails, and are slowing production in the highway products division and aggregate business.

The key here is that Trinity is now trading at a PE of 3. Yes 3.47 to be exact. With earnings in the middle of their range at $2.20 and a PE of 10 that would equate to a $22 stock price.

Here is the good news. The company has $2.12 billion in cash and undrawn credit. They are not in financial trouble. They authorized a $250 million share buyback starting January 1st. They have an order backlog of $5.4 billion in orders for 48,885 railcars. They received orders for 2,455 cars in Q4 and their backlog stretches out to 2020. The barge division received orders for $190.1 million in Q4 and had a backlog of $416 million as of December 31st. The structural tower segment has $371.3 million in order backlogs.

They recognize that tankcar and barge orders are going to remain slow until oil prices recover, which should happen later this year.

This stock is extremely oversold and should recover as the shock of the post earnings drop wears off and oil prices begin to rise. Note on the chart that the stock price began to decline at the same time the price of oil began to crash in August 2014. I view this as a remarkable opportunity for long-term investors.

I am recommending the $23 2018 LEAP to get us well past the recovery in oil prices and any further weakness in the sector. Remember, Trinity produces a lot of railcars for carrying all types of products other than oil. That demand is not going to disappear and they already have order backlogs stretching into 2020.

I understand that buying a 2018 LEAP is a stretch of the imagination for some investors. However, at $2 you will not have much at risk and it becomes a buy and forget investment. If Trinity returns to the 2015 highs at $35 that LEAP would be worth $12 and a 500% return. With a PE of 3.47 there is very little risk.

At their current valuation they could also be an acquisition candidate. This is a great business that has been overly punished by the oil crash.

I am still going to put an entry trigger on this position. Since the post earnings drop is only one day old we do not know if it will continue. I would love to buy this stock as cheap as possible but I also do not want it to run away from us. If it continues lower, I will change the strike price and entry to keep pace.

With a TRN trade at $17.75

Buy 2018 $23 LEAP Call, currently $2.45, no initial stop loss.

Active Watch List Play Descriptions:

DIS - Disney - Company Profile


Disney reported strong earnings but was punished again as shares fell to $86 despite the record earnings. Earnings of $1.73 compared to estimates for $1.45 and revenue of $15.2 billion compared to $14.75 billion. Earnings rose +36% and revenue +14%. They reaffirmed strong guidance and the stock was still knocked for a -5% loss. Once the smoke cleared and calmer heads prevailed the stop rallied back to pre announcement levels at $96.

There is nothing wrong with Disney. The CEO said they even saw a rise in ESPN subscriptions in January and they were expecting big gains as they offered their sports package in various other bundles. The worry over Disney's revenue growth has become so pervasive that everyone is afraid to buy the stock.

However, this is only going to be a temporary situation. Disney released a teaser for Star Wars episode VIII last week so the hype is already beginning. Episode VIII Teaser The current Star Wars movie has grossed over $2 billion and still going strong.

I am reactivating the recommendation for Disney with an entry trigger at $97.50. If the market goes lower I will lower the strike and the entry in the weeks to come.

Original Trade Description: February 1st:

Disney has been pummeled since its $120 high in November. The problem for Disney was comments that ESPN subscribers are declining. This was attributed to cord cutting from the cable companies as consumers move to sites like Netflix and Amazon for streaming downloads. This is not the case although I am sure there are some losses for that reason.

However, Disney said there was a lack of a large number of major sporting events in 2015 that would keep ESPN subscribers happy. Disney said the 2016 Olympics would help bring those subscribers back. ESPN is only one of dozens of Disney networks and the rest are doing just fine.

In case you missed it Star Wars: The Force Awakens has earned over $2 billion worldwide and still going strong. This compares to only $572 million for Episode VI the Return of the Jedi that was the most popular movie in the prior seven movies. Merchandise sales are approaching $1 billion. This is a cash printing machine and it is only going to get better from here.

Remember, Disney now has Marvel, Pixar and Star Wars (Lucasfilm) all under the same roof.

Disney Movie Schedule

Jan 29th, 2016 - "The Finest Hours"
Mar 4th, 2016 - "Zootopia"
April 15th, 2016 - "The Jungle Book"
May 6th, 2016 - "Captain America: Civil War"
May 27th, 2016 - "Alice: Through the Looking Glass"
June 17, 2016 - "Finding Dory"
July 1st, 2016 - "The BFG"
Aug 12th, 2016 - "Pete's Dragon"
Nov 4th, 2016 - "Doctor Strange"
Nov 23rd, 2016 - "Moana"
Dec. 16, 2016 - "Star Wars Anthology: Rogue One"
Mar 17th, 2017 - "Beauty and the Beast"
April 14th, 2017 - "Ghost in the Shell"
May 4th, 2017 - "Guardians of the Galaxy II"
May 26, 2017 - "Star Wars: Episode VIII"
June 16, 2017 - "Toy Story 4"
Mid 2017 - "The Incredibles 2"
July 17th, 2017 - "Pirates of the Caribbean"
Late 2017 - "Thor: Ragnarok"
Early 2018 - "Frozen 2"
May 4, 2018 - "Avengers: Infinity War - Part I"
2018 - "Untitled Star Wars Anthology Project"
May 3, 2019 - "Avengers: Infinity War - Part II"
2019 - "Star Wars: Episode IX"

We should not overlook their theme parks, which are also doing great. Disney said they are considering a tiered pricing for tickets with high volume attenfance dates costing more. The three levels for the season pass holders would be gold, silver and bronze. Gold passes could be used any day at any time and would obviously be the most expensive. Silver would only be good for off peak days and not valid for holidays. Bronze would be the cheapest and would only be valid on certain off peak periods. Currently discounted tickets for those customers spending multiple days and with children under the age of ten begin around $100.

Shanghai Disney will open on June 16th and they expect 40-60 million people in the first year. At $100 or more per ticket the revenue is astromonical. The park is located within 4 hours drive time of 330 million people.

Don't forget their theme cruises. Disney is not having any problems filling up their cruise ships and prices have remained strong.

The only real challenge to Disney today would be a slowdown in consumer spending. The company said they are not seeing any decline despite the drop in retail sales numbers over the last several months. Consumers are just spending their money on diffrent things like cable movies, theme parks and iPhones.

Disney has earnings on February 9th. Normally I would not recommend a stock ahead of earnings but this could be a blowout given the unbelievable cash flow from Star Wars. Even if they disappoint there is decent support at $90 and profits are only going to rise in subsequent quarters from the items mentioned above.

Shares have found support in the $92-$93 range despite the recent market volatility. I expect shares to rise as we approach earnings. I am putting an entry trigger just slightly above $96 just to make sure we have upward movement after Friday's big gain. If shares decline again I would be thrilled to enter the position at $92.

With a DIS trade at $97.50

Buy 2017 $105 LEAP Call, currently $4.75, no initial stop loss.

JCI - Johnson Controls - Company Profile


JCI was rebounding strongly until news broke that the JCI executive that was to be president of the merged company Adient had resigned. There was no news about what triggered the abrupt departure and the stock fell -$2 on the news. Beda Bolzenius, current VP and president of Automotive Experience will leave the company at the end of March. He has entered into a transition agreement but that is all we know. His 2015 compensation was $6.5 million, a decline of -21.7% from 2014.

I considered dropping the play but decided to give it another week. The combination of JCI and Tyco (TYC) is a great deal and once this executive exit is digested we should see the stock begin an upward trend. No change in recommendation.

Original Trade Description: February 8th

JCI is a diversified technology and industrial company worldwide. They design, produce and market building efficiency systems including heating, air conditioning, security, controls and mechanical equipment. They also have a division that manufacturers interior products, control systems, instrument panels, seating and passenger systems for cars and trucks. Their Power Solutions division makes batteries for normal cars and trucks as well as hybrid and all electric vehicles.

What makes JCI important to us today is their recently announced merger with Tyco (TYC). Tyco manufacturers fire and security systems and is headquartered in Ireland. After the merger JCI shareholders will own 56% of the combined entity to be called Johnson Controls Plc. Once the merger is completed the company will spin off the automotive segment to be called Adient leaving Johnson controls with a pure play on the HVAC, controls, fire, security products marketplace plus the Power Solutions division that will produce batteries for electric vehicles. Current JCI shareholders will own 56% of Adient.

The Johnson Controls company will have about $32 billion in revenue and Adient around $17 billion in revenue. The synergies to the merger include $150 million in tax savings because of the Ireland domicile. Another $500 million will come from eliminating corporate redundancies and from operational synergies. There will also be additional revenue synergies which has not been quantified. Both Tyco and JCI existing customers will immediately have a new range of products available to them. This should result in a significant sales boost in the first three years.

Normally when a merger is announced one of the companies sees their stock decline. That did not happen in this case. Tyco shares spiked 10% and are continuing to move higher while JCI shares moved sideways for the last two weeks but made a four-week high on Thursday. Friday's market crash knocked some of the wind out of JCI shares but they only declined -66 cents.

The actual merger has a long way to go since it was just announced on January 25th. With Tyco shares rising and JCI shares having put in a solid base at $34 I expect JCI shares to return to growth mode in the coming weeks.

This is a good deal for both companies. It will not only create a powerhouse in the building systems market but throw off the automotive business into another entity where it can be acquired by one of the larger players.

Earnings are April 28th.

With a JCI trade at $36.75

Buy Jan $40 LEAP Call, currently $2.30, no initial stop loss.