Option Investor

Daily Newsletter, Wednesday, 4/7/2010

Table of Contents

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

Market Wrap

Consumers, Greece Drag Down Stocks

by Todd Shriber

Click here to email Todd Shriber
In what was the worst-single day performance for stocks since February, slumping consumer credit and a familiar concern in the form of Greece weighed on U.S. indexes. Another one of those 2 PM sell-offs had the Dow Jones Industrial Average off by triple-digits, but the Dow finished the day down about 72.5 points to close at 10,897.52. The S&P 500 shed seven points to settle at 1182.45 and the Nasdaq lost less than six points to close at 2431.16. Much as the gains on the up days are nothing extraordinary, Wednesday's losses were tolerable and volume was, as is the case on the up days, fairly weak.

Stats Table

After Wednesday's trade, investors are probably quite ready for issues related to Greece to finally subside and quit being a thorn in the side of equity market bulls. To be fair, it feels like it has been a couple of weeks since Greece was a problem, but that theme ended on Wednesday on news that Greece's financing costs have markedly increased in the near-term. In turn, that problem raises the specter of a sovereign debt default, which has been the heart of the matter regarding Greece all along.

Greece has the dubious distinction of holding the largest budget deficit in the Eurozone and those concerns were exacerbated today when the yield on Greek 10-year bonds increased by 405 basis points over German bunds, the highest level since the Euro debuted in 1999, according to Bloomberg News. Yields on Greek bonds topped 7.2% on Wednesday, not good news considering that when bond yields rise, bond prices fall.

Greece, the 28th largest economy in the world, now faces higher borrowing costs than Iceland, which you may remember had some fiscal issues of its own last year. The bottom line is if you want to insure the equivalent of $10 million in five-year Greek debt, it will cost you $415,000. Credit default swaps on Iceland now look more bullish than their Greek counterparts. To that I say ''Wow.''

Greek Bond Spreads

Comments from the Federal Reserve also played a leading role in equities' decline today. The Fed said consumer borrowing fell by $11.5 billion in February, indicating that consumers are reluctant to incur more debt. That is not good news for credit card companies, so it was not surprising to see American Express (AXP) fall 75 cents, or 1.74%, to $42.37 making it the biggest loser in the Dow. Then again, it should be noted is rare to see stocks move up in a straight line and American Express was the Dow's best performer in 2009. And hey, the stock was up 6% year-to-date before today's drop, again outperforming the Dow.

American Express Chart

Federal Reserve Chairman Ben Bernanke gave a speech in Dallas today in which he said the U.S. economy is ''far from out of the woods.'' Investors also reacted to what Bernanke did not say. He did not mention plans to keep interest rates low for an ''extended period'' and stocks reacted to that omission in negative fashion.

Another marquee name that was weak on Wednesday was agriculture seed maker Mondsanto (MON). The company released disappointing fiscal second-quarter results that showed a decline in profits of 19%. Monsanto said it earned $887 million, or $1.60 a share, compared with $1.09 billion, or $1.97 a share, a year earlier. Revenue fell to $3.89 billion from $4.04 billion. Analysts were expecting a profit of $1.73 a share on sales of $1.9 billion.

Keep in mind that it was just three years ago that Monsanto said it would double its profits by 2012 by making bigger bets on biotech seeds. Now the company is saying that market is proving harder to navigate than previously expected and is forecasting profit growth in the mid-teens through 2012. The problem is genetically engineered seeds costs twice as much as their traditional counterparts and farmers, already faced with rising fertilizer prices, are not willing to pay for pricier seeds. Another way of saying this is that farmers need fertilizer, but they do not need biotech seeds when a legitimate, cheaper alternative exists.

Monsanto's chemicals business saw its sales fall 35% in the second quarter and analysts are saying this division will continue to be a drag on the company's profits. Monsanto gave a tepid affirmation of 2010 EPS guidance, saying it expects its full-year earnings to be at the low end of a $3.10 to $3.30 a share range.

Monsanto Chart

Speaking of not moving up in a straight line, oil prices took a breather today, ending a six-day winning streak that had carried crude futures to 17-month highs. NYMEX-traded crude for May delivery fell $1.20 a barrel to $85.64 after the Energy Information Administration said inventories rose by 2 million barrels last week. That is double the amount the American Petroleum Institute said inventories rose by yesterday.

The news hampered oil equities on Wednesday as 37 of the 40 energy stocks in the S&P 500 declined on the day, according to Bloomberg. That compares with 39 of those names making gains on Monday. One of the biggest losers among that group was Occidental Petroleum (OXY), which slid $2.19, or 2.47%, to close at $86.30 on volume that was roughly 50% higher than the daily average. Occidental is one of the ''oilier'' names out there as more than three-quarters of its production comes from crude, so the stock price is tightly correlated to oil prices. The shares were up almost 9% year-to-date prior to today's decline and it appears that Wednesday's drop may lured some buyers back into Occidental as the stock is back above $88 in after-hours trading.

Occidental Petroleum Chart

There was bigger news to emerge in the after-hours session today as some fodder for the ''two wrongs do not make a right'' crowd emerged. The New York Times is reporting that United Airlines (UAUA) and US Airways (LCC) are in merger discussions. Citing people close to the talks, the Times said an announcement is not imminent and should not be expected for several weeks. Of course, the talks could fall apart and neither airline commented on the rumors.

The news has US Airways trading up by over 25% in the after-hours session and United is up by more than 8% as of this writing. Based on market cap, United is nearly triple the size of US Airways, so it might be logical to assume that United will be the acquirer here. It also might be reasonable to say that old habits die hard and the airline industry really has not learned from past mistakes. These companies are constantly looking to acquire and partner with each other, but along the way they create little in the way of shareholder value. US Airways in its current form is the combination of US Air and AmericaWest and it is difficult to claim that was a rewarding move for shareholders.

United and US Airways went down this road in 2000 and the deal fell apart due to antitrust concerns and labor opposition. If the two companies are successful this time around, the combined company would surpass Delta (DAL) as the largest U.S. carrier, but size has proven to be less than rewarding for long-term investors in the airline sector. At the end of the day, a bigger airline is just that: Bigger. Customer service is not likely to improve, nor are returns to shareholders. This news will probably give a very short-term boost to airline stocks, which have performed surprisingly well recently, but an airline, no matter its size, still has to contend with high oil prices, a very real problem in the current market. (Go to OilSlick.com for more on the oil issue as it pertains to airlines.)

Airline ETF Chart

Even with today's decline, the Dow is still locked in the 10,825-10,950 range. The 11,000 mark is merely round-number resistance, but a more legitimate hurdle can be found over 11,100, a level last seen in fall 2008. It can certainly argued that the Dow is looking overbought at this point and I would not contend with that point, but it will be interesting to see if today's drop represents enough of a dip to induce some fresh buying for the rest of this week.

Dow Chart

Likewise, one could argue that the S&P 500 is overbought, but Wednesday's down move did not even challenge support at 1170. The intraday low was 1177.25 and resistance remains at 1200. As Jim noted yesterday, 1200 and above have been common price targets for more than a few analysts. Assume that earnings season is strong and that means the S&P 500 could be at 1200 before the end of April. That is almost engraved invitation to ''sell in May and go away'' before stocks regroup for another move higher later this year.

S&P 500 Chart

The Nasdaq, also known as the index where Apple (AAPL) makes its home, took a small loss today, but is still a fair bit removed from support at 2420 and even further removed from what is likely a firmer floor at 2400. Apple continues to move in parabolic fashion and if you look at analyst price targets, many of which range from $265-$300, the low end of that range could be reached in a few months if Apple keeps up its current pace. Still, the Nasdaq needs more help and that means Intel (INTC) had better deliver another blow-out quarter next Tuesday.

Nasdaq Chart

I am not going to become a bear because of one down day, but I am anxious to see what earnings season holds. The market realizes the comparisons to the first quarter of 2009 are going to be easy to beat and there will be little to no tolerance for companies that disappoint or beat profit targets through cost-cutting. Full-year guidance had better be robust as well or we could be in for a cruel summer for stocks.

New Plays

The Bulls Take a Breather

by Scott Hawes

Click here to email Scott Hawes
The S&P 500 Index sold off to 1,177 in trading today which was broken resistance from last week. We going to wait and see if there is any follow through to this downward move prior to initiating any new plays at this time.

In Play Updates and Reviews

Semiconductors Show Strength

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:

BULLISH Play Updates

AU Optronics - AUO - close: 11.57 change: -0.09 stop: 10.90

Shares of AUO continued to correct after touching resistance at $12.00 on Monday. We have been suggesting readers use a pull back toward the $11.50 region as a new bullish entry point but you could wait for a bounce first. Cautious traders could just wait for AUO to clear resistance at the $12.00 mark before initiating positions. Our target is the January highs in the $13.20-13.30 zone. FYI: The Point & Figure chart is very bullish and forecasts a $21 long-term target. I suggested we keep our position size small.

Current Position: AUO stock @ 11.77

Entry on April 05 at $11.77
Earnings Date 04/22/10 (unconfirmed)
Average Daily Volume: 2.5 million
Listed on April 3rd, 2010

Broadcom Corp. - BRCM - close: 34.13 change: -0.27 stop: 31.75

The SOX semiconductor index displayed relative strength with a 0.3% gain but that didn't stop shares of BRCM from seeing a little profit taking. On a positive note traders did buy the dip twice near the $33.75 level intraday. The stock looks poised to rally higher as long as the broader market doesn't collapse on us. More aggressive traders could use the intraday bounce as a bullish entry point but if you do I would consider a tighter stop loss. Our first target is $34.95. Our second, more aggressive target is $37.40 with a time frame of several weeks.

Current Position: BRCM stock @ 32.66

Entry on March 11 at $32.66
Earnings Date 04/21/10 (unconfirmed)
Average Daily Volume: 8.0 million
Listed on March 10th, 2010

BorgWarner Inc. - BWA - close: 37.47 change: -0.58 stop: 36.90

We remain cautious on BWA as a bullish candidate. Originally our plan was to open bullish positions on a breakout over the $40.00 level. Upon further review we might want to consider buying the stock on a bounce from the $37.00 level and its rising 50-dma. I'm a little concerned that the consolidation over the last three months might be considered a bear-wedge pattern. On a short-term basis Monday's session was a bearish reversal and now we have two days of follow through lower. For the moment we are still on the sidelines and will wait for a breakout over $40.00 but more nimble traders may want to keep a close eye on the $37.00 level.

Officially our trigger to open positions is at $40.25. If triggered our target is $44.75. BWA doesn't move super fast so this could take a few weeks for the stock to get there. Our initial entry point and stop loss set up is somewhat aggressive. More conservative traders may want to use a tighter stop. The Point & Figure chart looks very bullish and is forecasting a long-term $55 target.

Trigger to open bullish positions $40.25

Suggested Position: BWA stock @ 40.25 (unopened)

Option Traders:
Suggested Position: Buy CALL May $40.00 (BWA 10E40.00) current ask $1.15

Entry on April xx at $xx.xx
Earnings Date 04/29/10 (unconfirmed)
Average Daily Volume: 1.8 million
Listed on April 3rd, 2010

Cash America - CSH - close: 40.23 change: -1.02 stop: 38.99

CSH experienced some profit taking today which sent the stock lower -2.47%. I have concern with the stock's daily chart but it still has trend line support and its 20-day SMA average in the $40.00 area. We are looking for the stock to bounce from here. Today's sell-off could have shaken out the weak hands before it continues higher. Conservative traders should consider tightening up stops or selling into strength if the stock rallies. Aggressive traders can consider opening positions at current levels. Our first target is $44.90.

Current Position: CSH stock at $41.05

Entry on April 06 at $41.05
Earnings Date 04/22/10 (unconfirmed)
Average Daily Volume: 263 thousand
Listed on April 5th, 2010

Linear Tech. - LLTC - close: 29.03 change: +0.25 stop: 27.70

Strength in semiconductors was certainly evident in shares of LLTC today. Traders bought the dip near $28.50 and the stock was rebounding higher into the closing bell. LLTC looks poised to breakout past short-term resistance near the $29.00 level. If it does we expect the stock to challenge its 2010 highs. If you own April options don't forget that they expire in less than two weeks. Our first target is $29.95. Our second target is $30.95.

Current Position: LLTC stock @ 28.25

Option Traders:
Current Position: CALL APR 28.00 (LLTC 10D28.00) @ $1.00

Entry on March 16 at $28.25
Earnings Date 04/13/10 (unconfirmed)
Average Daily Volume: 3.9 million
Listed on March 11th, 2010

Patterson Companies - PDCO - close: 30.82 change: -0.24 stop: 29.95

Wednesday proved to be a quiet session for PDCO. The stock's consolidation has narrowed, which might be considered indecision on the part of investors. We are waiting for a breakout to new relative highs. Currently PDCO has resistance near $31.30. I am suggesting we open bullish positions at $31.50. If triggered we'll use a stop at $29.95. Our multi-week target is the $34.50 level.

Trigger to open bullish positions at $31.50

Suggested Position: PDCO stock at $31.50(unopened)

Entry on April xx at $xx.xx
Earnings Date 05/17/10 (unconfirmed)
Average Daily Volume: 975 thousand
Listed on April 6th, 2010

Palomar Medical Tech. - PMTI - close: 11.33 change: -0.24 stop: 10.80*new*

I have yet to find any news behind Tuesday's spike over the $12.50 level. Shares displayed some relative weakness this morning but traders bought the dip at the $11.00 mark. PMTI eventually lost 2% on the session. The trend of higher lows is still in place. The simple 20-dma has risen to $10.89. I am raising our stop loss to $10.80. I would hesitate to launch new bullish positions at this time. Please note our new target below.

PMTI has already hit our first target at $11.45. We're adjusting our second and final target down from $12.75 to $12.40.

Current Position: PMTI stock @ 10.55

1st Target Hit (03/22/10) @ 11.45

Entry on March 16 at $10.55
Earnings Date 04/29/10 (unconfirmed)
Average Daily Volume: 132 thousand
Listed on March 13th, 2010

BEARISH Play Updates

Corrections Corp. of America - CXW - close: 19.55 chg: -0.12 stop: 20.55*new*

The roll over in shares of CXW continues. The oversold bounce's failed rally at round-number resistance near $20.00 and its 50-dma looks like a new bearish entry point. We are adjusting our stop loss down to $20.55. Our target is $18.00. The low in February 2010 was $17.50.

Current Position: SHORT CXW stock @ 19.90

Entry on March 19 at $19.90
Earnings Date 05/06/10 (unconfirmed)
Average Daily Volume: 1.1 million
Listed on March 17th, 2010

MAXIMUS Inc. - MMS - close: 61.55 change: +0.37 stop: 62.11

MMS remains stuck inside its $60.00-62.00 trading range. However, if you look more closely shares appear to be coiling more tightly and inching toward a breakout higher. I do not see any changes from our prior comments. We have two different triggers - one for a bullish trade and one for a bearish trade.

If MMS hits our bearish trigger for shorts at $59.80 our target is $55.25.

If MMS hits our bullish trigger at $62.25 our target is $67.00. I do need to label this trade somewhat aggressive since we normally do not trade stocks with average volume under 250K a day.

TWO TRIGGERS, One Bearish, One Bullish

Trigger for bearish positions at $59.80

Suggested Position: (SHORT) MMS stock at $59.80 (unopened)

Trigger for bullish positions @ 62.25

Suggested Position: BUY MMS stock at $62.25 (unopened)

Entry on April xx at $59.80 (unopened)
Earnings Date 05/06/10 (unconfirmed)
Average Daily Volume: 83 thousand
Listed on March 31st, 2010

Warner Chilcott - WCRX - close: 25.78 change: -0.54 stop: 26.26

The bounce in WCRX has failed and the stock appears to have formed a new lower high with today's 2% decline. I do not see any changes from our prior comments. We're still waiting for a breakdown under support at $25.00.

I am suggesting we use a trigger to open bearish positions at $24.80. If triggered our first target is $22.60. The 200-dma is nearing the $22.50 region and could offer technical support. Our second, more aggressive target is the $20.25 mark.

Trigger to open bearish positions @ 24.80

Suggested Position: SHORT WCRX stock at $24.80 (unopened)

Option Traders:
BUY the April $25.00 PUT (WCRX 10P25.00) current ask $0.50

Entry on March xx at $xx.xx
Earnings Date 05/11/10 (unconfirmed)
Average Daily Volume: 1.5 million
Listed on March 29th, 2010