Option Investor

Daily Newsletter, Monday, 4/12/2010

Table of Contents

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

Market Wrap

Greece News Helps Stocks To Small Gains

by Todd Shriber

Click here to email Todd Shriber
News of a massive $61 billion loan package from European Union members and the International Monetary Fund (IMF) to Greece bolstered the Euro and in turn, led to small gains for the major U.S. indexes. The gains were looking far better earlier in the session, but another one of those sell programs kicked in during the afternoon and that left the Dow Jones Industrial Average with a gain of just 8.62 points for a close at 11005.97. The S&P 500 continued to inch toward 1200, gaining 2.11 points to settle at 1196.48 and the Nasdaq gained almost four points to close at 2457.87.

Stats Table

I mentioned last week that the spreads on Greek bonds over German bunds had blown-out to historical highs and the cost of insuring Greek debt via credit default swaps had also soared to record levels, but on news of the aforementioned loan package, those credit default swaps fell 62 basis points to 364 basis points. Spreads between Greek bonds and German bunds narrowed today by 49 basis points. That news helped the Euro appreciate against the 16 major currencies. The currency had been down almost 5% this year against the dollar. The bulls can only hope that this is the final chapter in the Greek saga that has been a real issue for equity markets.

Euro/Dollar Chart

Stocks also got a lift from a healthy dose of mergers and acquisitions news. Electric utilities Mirant (MIR) and RRI Energy (RRI) rose by 18% and almost 15%, respectively, on news that the two companies would combine through a stock-swap merger valued at over $3 billion. The combined company will be called GenOn Energy and have a market value of $3.1 billion and 24,700 megawatts of generating capacity, according to MarketWatch.

Under the terms of the deal, which was announced on Sunday night, Mirant shareholders will receive 2.835 RRI shares for each Mirant share they own. Mirant will own 54% of the new company and RRI will own the remaining 46%. GenOn will be based in Houston and the new board will have five directors from each company. The transaction is expected to close later this year.

Sure, M&A activity of this magnitude is a good sign for the broader market, but as it pertains to Mirant and RRI, one might argue that this is an example of two wrongs coming together with the hopes of forming a right. As you can tell from the chart below, Mirant has not been a stellar performer recently. Neither has RRI. Both stocks are down about 30% this year.

Mirant Chart

Moving over to the oil patch, Apache (APA), the second-largest U.S. independent oil and gas producer, said it will acquire Devon Energy's (DVN) shallow-water operations in the Gulf of Mexico for $1.05 billion. That is far higher than the $750 million Dow Jones reported Apache would pay Devon when news of the deal broke late last week.

The deal comes as part of Devon's plans to divest its international and offshore assets to focus on the North American natural gas market. After taxes, the sale to Apache should net Devon about $840 million in proceeds. Combine that with the $7 billion asset sale to BP (BP), Europe's largest oil company, that Devon announced last month, and Devon is going to be close to raising $7.5 billion, the high end of the range the company estimated for its asset sales.

In addition, Devon still has some assets in China that it wants to sell. The Gulf properties acquired by Apache are projected to produce 9,500 barrels of liquid hydrocarbons and 55 million cubic feet of natural gas per day, Reuters reported. The deal is expected to close in June.

Devon Energy Chart

Staying in the oil sector, ConocoPhillips (COP), the third-largest U.S. oil company, said it will sell its 9% stake in the Syncrude project in the Canadian oil sands to China's Sinopec, the largest oil refiner in Asia, for $4.65 billion. The deal is one of the largest to date by an Asian energy producer in North America. Canadian regulators are not expected to oppose the transaction.

Conoco's plans to divest $10 billion in assets to shore up its balance sheet have been well-known for at least several months. The company's leveraged balance sheet has hampered profits and led to a debt burden that is far greater than rivals Exxon Mobil (XOM) and Chevron (CVX), the two largest U.S. oil companies, both of which are much bigger than Conoco in terms of market value.

To be fair to Conoco, analysts were saying that the sale of Syncrude may have been worth only $4 billion, so the company got a better price for its stake than was originally expected and that helped the shares gain over 1% to touch a new 52-week high at $56.17 before closing at $55.96. If anything, this deal highlights the fact that China's demand for oil remains strong and if the country's oil companies need to overpay a bit to acquire new assets, they will do so. The deal is expected to close in the third quarter.

ConocoPhillips Chart

In smaller scale M&A news, California Pizza Kitchen (CPKI) gained almost 1.6% on news that the company was holding talks with private equity firms about a possible sale of the company. The stock popped to $22.92, a new 52-week high, in the morning before steadily selling-off for the rest of the day. Specific buyers were not mentioned in press reports and the CEO of Domino's Pizza (DPZ) said in a CNBC interview after the market closed that his company would not be interested in California Pizza Kitchen.

Just a few weeks ago, it appeared that smart phone maker Palm (PALM) was headed for zero. After all, it is hard to argue that the Pixi has been a legitimate competitor to Apple's (AAPL) iPhone or Research In Motion's (RIMM) BlackBerry. Yet it has been hard to be short Palm recently as takeover news, perhaps the only reason to be long this name, has propped the stock up.

That was the case on Monday as Palm shares gained more than 17% on news that the company hired Goldman Sachs (GS) and Qatalyst Partners to perhaps find a buyer. Monday's headlines follow rumors that swirled last week China's Lenovo and Taiwan's HTC may be interested in Palm. You may remember Lenovo as the company that acquired IBM's (IBM) personal computer business a few years ago.

Palm Chart

I cannot forget to mention that earnings season starts in earnest this week and Alcoa (AA), the Dow component and largest U.S. aluminum producer, got the ball rolling after the market closed today with its first-quarter earnings report. Maybe it is because Alcoa is a commodities producer, a Dow member or because it is always the first marquee name to report earnings, but this report is always closely followed.

The company said it lost $201 million, or 20 cents a share, compared with $497 million, or 61 cents a share, a year earlier. Excluding one-time charges, Alcoa earned 10 cents a share, which was inline with analyst estimates. Revenue surged almost 20% to $4.9 billion.

Outlook is normally the thing to look at when evaluating Alcoa's earnings report and the company had some positive things to say as it is forecasting sales growth in the automotive, heavy truck and trailer markets this year. The company said it is seeing improving demand for aluminum, which hit an 18-month high Monday.

The company said 2010 ''will clearly be better than 2009,'' but that is expectation for nearly every company in every sector and it should be noted that analysts had substantially reduced their estimates for Alcoa, so meeting estimates that had been revised lower is no big feat. Either way, it pays to remember that the Dow is a price-weighted index, meaning that the stocks with the highest price tags account for bigger percentages of the index than the lower-priced members. Alcoa has the lowest price tag of the 30 Dow stocks and is the worst performer in the index thus far in 2010.

Alcoa Chart

Looking at the charts, sure, the Dow closed above 11,000 at a fresh 18-month high, but Monday's trade was not exactly awe-inspiring. The 11,000 figure, as I noted last week, is nothing more than round-number resistance, but a real hurdle can be found around 11,125. With earnings season upon us, the catalysts are there to keep moving the Dow higher or to finally drag it back to Earth.

Tomorrow afternoon is big in terms of earnings reports. I would not underestimate the importance of CSX's (CSX) report because rail carriers offer a good glimpse as to how the broader economy is performing. CSX is not a Dow member, but it is a member of the transports average. The big kahuna will be Intel (INTC). The biggest semiconductor maker in the world and Dow component reports after the close tomorrow. JPMorgan Chase (JPM) chimes on Wednesday morning and Bank of America (BAC) and General Electric (GE) report on Friday morning, so yeah, this is an important week for the Dow.

Dow Chart

Of course, all of those stocks are also members of the S&P 500 which is trying to break real resistance at 1200. As Jim mentioned over the weekend, 1200-1250 was the year-end target offered by many analysts and for those brave enough to boost their targets beyond 1250, earnings and full-year guidance had better be strong to help the S&P 500 toward 1300.

S&P 500 Chart

The Nasdaq continues to hover just above resistance at 2450 and another long-term resistance point at 2465 is not that far off. A near-term move to 2500, while possible, is not probable, but this is an important week for the Nasdaq as well. The Intel report is followed by Google (GOOG) on Thursday and if those reports feature upside surprises and bullish guidance, the Nasdaq may able to traverse 2465, or at least challenge that level, this week.

Nasdaq Chart

While the earnings schedule is decent for this week and it is an options expiration week, I think small gains will continue to be the order of the day, unless the earnings reports I mentioned are really disappointing. I will go back to something that I have mentioned several times in the past and that is if JPM and BAC beat to the upside AND can offer clarity (by that I mean a specific date) on dividend increases, that could be the news the market needs to notch some solid gains this week.

New Plays

Indices Are Stuck in Technical Limbo

by Scott Hawes

Click here to email Scott Hawes

Editor's Note: We are going to sit tight for now before initiating new plays. We have a good balance in the portfolio and bearish plays (long SRS, short WCRX) ready to be opened should the market correct. We are also now short QQQQ.

In Play Updates and Reviews

Indices Trade at New 52-week Highs

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:

We sold LLTC today on the late afternoon strength and are recommending readers get defensive this week. We have moved up some of our stops and lowered targets on a few of our plays.

Current Portfolio:

BULLISH Play Updates

AU Optronics - AUO - close: 11.58 change: +0.11 stop: 10.90

AUO continued its bounce today closing higher by almost +1.00%. AUO looks poised to rally from here but needs to get moving soon or we will be looking to exit this trade. We need AUO to break above $12.00 for this trade to work and hit our target $13.25. If it breaks below $11.00 we will honor our stop at $10.90 and step aside to preserve capital. Aggressive traders could still consider entering the trade as I believe there is a lot of support with the SMA's just below AUO. However, if the market sells off AUO probably won't be spared. Our time frame is one to two weeks. Note: I consider this an aggressive trade and recommend small position size to limit risk.

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: 34.06 change: -0.22 stop: 33.25

The SOX semiconductor index is at a new 52-week high. BRCM is not. The stock the SOX index are both holding their upward trend lines and both are above their respective 20-day SMA's. BRCM also bounced off its 20-day SMA. In addition, BRCM and the SOX are at the bottom end of their upward channel which continues to remain intact. However, at some point the stock will have to break-out of this channel and my guess is it will be to the downside. There is no question the stock is bullish and looks poised to rally higher but the broader market must also cooperate. Our target on BRCM is $34.95 but I would like to lower that $34.40, which is just below today's highs, and will exit the position if the stock trades to this level. I am suggesting conservative traders exit positions now. I moved our stops up to $33.25 on Saturday. This will ensure a winning trade if BRCM can't rally.

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: 38.74 change: +0.55 stop: 36.90

BWA closed up +1.44% on Friday. Officially our trigger to open positions is at $40.25. If triggered our target is $44.75. BWA doesn't move very 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. Aggressive traders may consider opening positions if BWA trades above $38.60 but I would view this as a quick trade with a tight 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 $2.40

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: 40.73 change: +0.06 stop: 38.99

CSH was relatively quiet today. The stock is finding resistance just below the $41.00 level which about break-even for our trade. CSH looks poised to continue its rally and we are looking for the stock to at least retest its highs from last week at $41.50. If the stock trades to this level conservative traders should begin to tighten stops or sell into strength. We need to see CSH follow through or we will be looking exit our position. I am not suggesting new positions at this time. I am going to lower our target on CSH to $42.90. Our time frame is one to two weeks.

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

MAXIMUS Inc. - MMS - close: 62.33 change: +0.01 stop: 59.75

MMS hit a new 52-week high today and is above our key $62.00 level. The stock looks poised to breakout higher and I expect follow through. This is a new all time high for MMS so I am suggesting readers be careful. I would like to place a stop at $59.75 to give this some room but if there is overall market weakness readers may want to exit the position early. Our time frame is several weeks. Our target on MMS $67.00 and our time frame is several weeks. I want to remind traders that this is a somewhat aggressive trade since we normally do not trade stocks with average volume under 250K a day.

Current Position: MMS stock at $62.25

Entry on April 9 at $62.25
Earnings Date 05/06/10 (unconfirmed)
Average Daily Volume: 83 thousand
Listed on March 31st, 2010

Patterson Companies - PDCO - close: 31.03 change: -0.10 stop: 29.95

PDCO continues to see resistance at $31.30. It is forming an ascending triangle on its daily chart. We are waiting for PDCO to breakout to new relative highs prior to initiating long positions. 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

Powershares UltraShort Real Estate - SRS - close: 5.62 change: +0.08 stop: 5.63

We are waiting for SRS to break above its downtrend line which started in early February. Real Estate stocks have had a monster rally off of their February lows and we believe a pull back is overdue. If a pullback in RE stocks gains steam SRS will benefit. Officially, I am suggesting we initiate positions if SRS trades to $6.10. Use a trigger to open long positions in SRS (which is a bearish play on RE stocks) at $6.10. Our first target is $6.85 which is just below prior support from December. Our second target is $7.15 which is just below the low on January 19 and I anticipate SRS reaching this level if there is overall weakness in the market. Aggressive traders may want to consider positions at current levels with a stop at $5.38. This is an aggressive play so please use smaller position size to limit risk. If triggered, our stop at $5.65 which is just below the recent swing low on March 25. Our time frame is about two to three weeks. *NOTE: Although this is listed as a long position in our portfolio, this is a bearish position on real estate stocks*

Trigger to open long positions at $6.10

Suggested Position: Buy SRS if it trades to $6.10, Stop Loss $5.65 (unopened)

Entry on (unopened)
Earnings Date Not Applicable
Average Daily Volume: 11.0 million
Listed on April 8, 2010

BEARISH Play Updates

Corrections Corp. of America - CXW - close: 19.71 chg: +0.05 stop: 20.55

Our comments on remain the same. CXW still looks vulnerable here but we need the stock to break down through $19.00 which has been acting as support. The stock's 20-day and 50-day SMA's are overhead which should provide resistance. If CXW breaks down we should have a good chance of hitting our target of $18.00. Our time frame is a couple of weeks.

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

Powershares QQQQ Trust - QQQQ - close: 49.07 change: +0.04 stop: 50.95

QQQQ traded in a tight range today closing marginally higher. I am looking for QQQQ to initially trade down to its 20-day SMA which is currently at $48.18. The ETF should find some support at that level but we are ultimately looking for a target of $47.00 which is just above the lows from March 15. Our stop is $50.95 and our time frame is a couple of weeks.

Current Position: Short QQQQ at $49.05, Stop Loss $50.95

Option Traders:
Suggested Position: Buy PUT May $40.00, current ask $1.00

Entry on (unopened)
Earnings Date Not Applicable
Average Daily Volume: 49.4 million
Listed on April 10, 2010

Warner Chilcott - WCRX - close: 25.46 change: -0.23 stop: 26.26

Our comments remain the same on WCRX. The stock has been bouncing off of the $25.00 level since late January. The stock appears to have formed a new lower high and may be forming a descending triangle. Its 20-day, 50-day, and 100-day SMA are all overhead. We're still waiting for a breakdown under support at $25.00 but will need the overall market to cooperate.

I am suggesting we use a trigger to open bearish positions at $24.80. If triggered our first target is $23.00. The 200-dma is nearing the $23.00 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 MAY $25.00 PUT (WCRX 10P25.00) current ask $1.00, estimated ask at trigger price $0.60

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


Linear Tech. - LLTC - close: 29.34 change: +0.23 stop: 28.90 *NEW*

As mentioned in the weekend update we closed our position in LLTC today at $29.50 as the stock rallied in the afternoon. LLTC reports earnings on Friday and we wanted to ensure a profitable exit before their announcement. We had a nice +4.42% gain. Traders who haven't exited the position may want to move up their stops to protect profits. A logical stop would be $28.90 which is just below today's low. I suggest selling the LLTC prior to their earnings on Friday.

Closed Position: Sold LLTC stock @ 29.50, entry was at $28.25

Annotated Daily Chart:

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