Option Investor

Daily Newsletter, Monday, 4/26/2010

Table of Contents

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

Market Wrap

What Should Have Been...

by Todd Shriber

Click here to email Todd Shriber
If you were reading the headlines before the market opened Monday morning, you probably would have thought that stocks were poised to enjoy a solid day and that was the case for a part of the trading session, but by the time the closing bell rang, the S&P 500 had dropped 5.23 points to settle at 1212.05 and the Nasdaq lost 7.2 points to close at 2522.95. Only the Dow Jones Industrial Average closed higher on the day, gaining three-quarters of a point to finish the day at 11,205. I suppose that still qualifies as a ''gain'' and no matter how small it was, the Dow was able to extend its winning streak to six consecutive days.

Stats Table

There was plenty of mergers and acquisitions news to feast on before the market opened today and while none of the deals could be labeled as ''mega,'' an uptick in M&A activity is a good sign, particularly after the plunge in acquisitions during the financial crisis. Stifel Financial (SF) said it will acquire Thomas Weisel Partners (TWPG) for $318 million in stock. Oddly enough, Stifel is doing this deal to bolster its presence in M&A advisory services for the technology sector, a specialty of Thomas Weisel.

In other M&A news, car rental giant Hertz Global Holdings (HTZ) said it will acquire smaller rival Dollar Thrifty Group (DTG) for $1.2 billion in a transaction that will form the second-largest U.S. care rental firm. Shares of both companies were up sharply on the news and the deal fueled speculation that more consolidation in the car rental sector could be on the way as the industry is just starting show signs of bouncing back from the recession.

Another billion dollar deal on Monday came from Charles River Laboratories (CRL), which agreed to acquire China's WuXi Pharmaceuticals (WX) for $1.6 billion in cash and stock. The deal will help Massachusetts-based Charles River expand its clinical research and development operations on an international level and the company said WuXi would help Charles River bolster its toxicology business. Even when combining all of these deals, the price tag is not very large, but that is not the point. The point is an uptick in a M&A activity will probably be interpreted to be a good sign and that could help this rally along even more.

M&A Activity

Even with the economy improving, it seems companies in the travel and leisure business think consolidation is the way to go to streamline their operations and cut costs. Of course, the airline sector loves some good M&A talk , though talks between United (UAUA) and Continental Airlines (CAL) may have reached an impasse due to the proposed exchange ratio in the stock-for-stock transaction.

The New York Times reported both companies agreed to an ''at-market'' deal, but Continental wants to exchange shares based on United's price before news broke that the two companies were in talks. United wants to use a later share price, which would be more beneficial to its shareholders. The outcome for United here is interesting because it broke off talks with US Airways (LCC) as discussions with Continental progressed, but if no marriage with Continental materializes, United may have to find another partner to dance with.

United Chart

In addition to those deals, there was some good earnings news before the bell from a pair of companies that are considered bellwethers. Caterpillar (CAT), the world's largest maker of construction and mining equipment and a Dow component, not only reported strong first-quarter results, but offered a solid outlook as well. The Illinois-based company earned $233 million, or 36 cents a share, in the first quarter compared with a loss of $112 million, or 19 cents a share, a year earlier. Excluding a charge related to the health care reform legislation, Caterpillar would have earned 50 cents a share. Analysts were expecting a profit of 39 cents.

Revenue did fall 11% to $8.2 billion during the quarter, but investors seemed to digest that news easily because Caterpillar reported some stout international growth. Sales in Asia surged 20% during the quarter. And if you are among those investors that do consider Caterpillar a bellwether, comments from the company's management team bode well not only for shareholders, but perhaps the economy at large.

Chief Financial Officer Dave Burritt said ''we're in a revival'' and that emerging markets are undoubtedly driving growth for the company. Caterpillar has rehired about 2,000 workers after laying-off 19,000 full-time and 18,000 part-time and contract employees last year, according to the Associated Press. The shares touched a new 52-week high of $72.83 on Monday before closing up $2.87, or 4.2% to $71.65.

Caterpillar Chart

Another company that is, shall I say economically sensitive, that reported stellar first-quarter results on Monday was Whirlpool (WHR), the world's largest appliance maker. The maker of Maytag, KitchenAid and its namesake brand turned a profit of $164 million, or $2.13 a share, more than double the $68 million, or 91 cents a share, the company earned a year earlier. Revenue jumped 20% to $4.27 billion. Analysts had been expecting a profit of $1.33 a share on sales of $3.79 billion.

Whirlpool also said emerging markets are contributing to its growth, namely Brazil and Asia. More importantly, the company raised its full-year guidance in a big way, saying it now expects to earn $8 to $8.50 a share, up from previous guidance of $6.50 to $7 a share. So what can be extrapolated from the Whirpool news and outlook? Perhaps that home sales are going to pick up in latter half of this year. New home buyers buy new appliances and buyers of existing homes often like to replace the appliances that came with the house they just purchased.

Appliances are considered durable goods and durable goods orders are an important economic data point. So it might be fair to say that strong guidance from a company like Whirlpool indicates consumers are getting stronger. Yet it should be noted that trade in Whirlpool's shares was somewhat deceiving on Monday. Yes, the stock finished the day higher by $10.20, or almost 10%, and rallied to a new 52-week high of $118.44 on volume that was more than six times the daily average, but the stock opened at $112.28 and closed at $112.42.

Whirpool Chart

I frequently voice my personal frustration over how an economy with the stature (or lack thereof) of Greece can weigh on U.S. stocks and I think a similar scenario was at play on Monday. What I mean is it was financials that derailed what should have been a nice day for stocks on Monday. Financials were the worst performing industry group within the S&P 500 as the usual post-earnings retreat was seen in shares of the big retail banks. That hurt shares of JPMorgan Chase (JPM) and Bank of America (BAC). Citigroup (C) retreated on news of the Treasury Department's plan to sell its massive stake in the bank.

Of course, I cannot forget to mention Goldman Sachs (GS), which shed $5.37, or 3.41%, to close at $152.03 on Monday. Goldman's CEO Lloyd Blankfein and other key executives will be testifying on Capitol Hill regarding allegations that the bank misled investors in convoluted mortgage securities and by misled, I mean whether or not Goldman was shorting securities it was recommending to clients on the long side. Blankfein maintains Goldman did not have ''a massive short'' against the mortgage market nor was the firm betting against its clients.

Goldman Sachs Chart

I would agree that these big banks are ''important'' companies in the U.S. corporate lexicon, but to echo the sentiments of several politicians, these firms do not produce anything. Companies like Caterpillar and Whirlpool do and the longer doubt remains about the health of the U.S. financial system, we could see at least few more disappointing trading days like we saw today.

Fortunately or unfortunately, depending on your perspective, the now infamous financial reform bill the Senate wants to consider will have to wait another day as Republicans mustered enough votes to block cloture on the bill. The vote was 57-41 with Sen. Bill Nelson (D-Neb.) the lone Democrat voting with the Republicans. Sixty votes are need for cloture.

It may seem like good news for financial stocks that an up-or-down vote on the bill was delayed, but the longer this issue lingers, financials cold remain under pressure, so it might be best for the markets to get this vote over and done with.

Looking at the charts, the Dow still resides right around uptrend resistance in 11,200 neighborhood. On the upside 11,245 would be the next hurdle and support can be found at 11,000. There are still some earnings reports that could be meaningful for the index, namely 3M (MMM) and DuPont (DD) both of which report before the open tomorrow. Outlook on chemical shipments is the news to watch regarding DuPont.

Dow Chart

The S&P 500 cleared resistance at 1214 last week, but Monday's drop has the index a couple of days worth of average gains away from resistance at 1222. The FOMC meeting starts tomorrow as do the Goldman hearings on the Hill and the combination of those events could be enough to generate another day of selling, but not to a large extent. If 1200 is broken on the downside, 1190 should act as support.

S&P 500 Chart

Considering the Nasdaq's recent bullish ways, Monday's decline is hardly enough to represent a reversal of the current trend. Netflix (NFLX) continues its parabolic ascent, gaining more than 8% on Monday and Amazon (AMZN) turned in a nice day as well, but Google (GOOG) got whacked and Apple (AAPL) and Baidu (BIDU) both traded lower as well. Either way, the Nasdaq has broken out and a move above 2540 may stoke some fresh buying.

Nasdaq Chart

I agree with Jim's sentiments from the weekend that stocks are certainly due for a breather, but betting against the obvious trend would likely prove foolhardy. If not for the decline in financials I would likely be telling you about Dow 12,260, S&P 500 1220 and Nasdaq 2535.

Noteworthy is a report from Bloomberg News that says despite the huge rally enjoyed by stocks over the past 13 months, U.S. equities still look as cheap as they have looked at any point over the past 20 years. The report says that the S&P 500 is trading at 14.1 times earnings forecasts, its lowest level since 1990, excluding period immediately following the Lehman Brothers debacle. Headlines like that may be one catalyst to jolt retail investors who are feeling they have missed the rally off the sidelines.

New Plays

Bearish Bet on a Rating Agency

by Scott Hawes

Click here to email Scott Hawes


Moody's Corp. - MCO - close 26.06 change -0.18 stop 28.60

Company Description:
Moody's Corporation (Moody's) is a provider of credit ratings; credit and economic related research, data and analytical tools; risk management software, and quantitative credit risk measures, credit portfolio management solutions and training services. The Company operates in two segments: MIS and Moody's Analytics. MIS, the credit rating agency, publishes credit ratings on a range of debt obligations and the entities that issue such obligations in markets worldwide, including various corporate and governmental obligations, structured finance securities and commercial paper programs. Revenue is derived from the originators and issuers of such transactions who use MIS ratings to support the distribution of their debt issues to investors. The MA segment develops a range of products and services that support the risk management activities of institutional participants in global financial markets.(source: company press release or website)

Why We Like It:
MCO's chart is broken and a lot of damage has been done. The stock is forming a bear flag on its daily chart and I believe conditions are ripe for the decline to continue. The stock has been hanging on to a recent support level and its 200-day SMA, both just below the $26.00 area. I think it is only a matter of time before this level is broken. I am bearish on MCO and if the market starts to pullback MCO could be a nice winner for us. I would like to place an initial wide stop at $28.60 just in case there is a spike in the stock from short covering or a news event. If that happens I am confident MCO will be sold by many who may still be holding long shares creating additional pressure. There is plenty of resistance and congestion just overhead as well. Our target is $23.25 and our time frame is a couple of weeks.

NOTE: The ratings agencies are also under the microscope in Washington as reports have surfaced that they were overly influenced by Wall Street firms and they used outdated models for rating complex securities, i.e. mortgage-backed securities, CDO's, etc. I would be surprised if they are not regulated as part of the financial reform bill which traders will probably view as a negative for the stock.

Suggested Position: Short MCO at $26.25

Option Traders:
Suggested Position: Buy JUNE $25.00 PUT, current ask $1.23

Annotated chart:

Entry on April xx at $xx.xx
Earnings Date Over two months
Average Daily Volume: 3.5 million
Listed on April 26, 2010

In Play Updates and Reviews

FSYS and ENZ Triggered

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:

Good evening traders. The markets made more 52-week highs today before retreating at the end of the day. I expect to see some weakness in the markets heading into Wednesday's FOMC announcement but the dips are probably going to be short lived as they have been for the past 3 months. Although the democratic version of the financial reform bill was voted down tonight so that may give a boost to the financials tomorrow. It will be interesting to see what the Fed says on Wednesday. If their language changes it could spark some serious selling so please stay nimble with any long positions. If the language remains consistant we sould get another spike higher. We are looking to exit QQQQ in the coming days. Our long plays on FSYS and ENZ were tiggered today and we also released a short play on MCO.

Current Portfolio:

BULLISH Play Updates

Enzo Biochem, Inc. - ENZ - close 6.49 change -0.18 stop 5.91

ENZ was strong this morning before selling off in the afternoon. The stock sold off and our trigger to buy shares $6.52 was hit. The stock has plenty of support down to its 20-day SMA which is currently at $6.22. I've also been monitoring the Accumulation/Distribution studies on ENZ and they are bullish. This essentially means that institutional money has been flowing into the stock as evidenced by the fact that volume is higher on days when the stock has been increasing, and volume has been lighter on days when the stock has been decreasing. Traders can initiate new positions. I'll repost my comments from the new play release on Saturday: ENZ broke out of horizontal resistance, which should now act as support, in the $6.45 area on Friday. I expect the stock to turn back and retest this area which is where I would like to enter the stock. I consider this to be an aggressive play so please use small position size to limit risk. There are two things to be aware of. First, the average daily volume on this stock is 160,000 but it has been increasing on the breakout which is a bullish sign. Second, there are two areas where traders can place stops: 1) just below the 20-day SMA at $6.10 which will limit risk but could also shake you out of the trade; or 2) just below the 50-day SMA at $5.91 which is a little more aggressive if ENZ reverses. Our official stop will be $5.91. Our first target is $7.20 and our second target is $7.70. Our time frame is a couple of weeks.

From a fundamental perspective, ENZ may benefit from the healthcare reform bill as they provide technology to reduce costs and streamline biotech research and development. If this story becomes more mainstream these types of stocks could see shares spike. These are just my thoughts about some recent articles I've read about who will benefit from the bill.

*NOTE: Please use small position size to limit risk as I consider this to be an aggressive play. The stock's average daily volume is 160,000 shares which can add to volatility.*

Current Position: Long ENZ stock @ $6.52

Entry on April 26 at $6.52
Earnings Date 6/15/10 (unconfirmed)
Average Daily Volume: 160,000
Listed on April 24, 2010

Excel Maritime Carriers Ltd. – EXM – close 6.81 change +0.06 stop 6.06 *NEW*

Overall EXM had a good day considering the markets were mostly lower. The stock has overhead resistance at $6.88 which it hit and backed off of today. EXM closed above its 200-day SMA today and is still in an uptrend on its daily chart. I am looking for EXM to break through the overhead resistance levels near $6.88. I want to place our first target at $7.10 with a more aggressive target at $7.45. The reason I moved our target down to $7.10 on Saturday is because of the price action on January 11 and 12 of this year. The stock lost about -10% in those two trading days (from high to low) and then proceeded to tank -30% in the ensuing weeks. If anyone was caught holding the bag at these levels and still owns the stock, they will most likely be looking to dump shares which could put pressure on EXM. I suggest readers either take profits or tighten stops if EXM trades to this level. We will make a healthy +8.4% on the trade if that happens. Readers who have not entered positions can do so if there is any weakness in the stock. Our stop was moved up on Saturday to just below the 50-day SMA at $6.06. If EXM trades down here it will have broken the upward trend line and broken through all of its SMA's. Our time frame remains a couple of weeks.

Current Position: Long EXM stock @ $6.55

Entry on April 20 at $6.55
Earnings Date 05/19/10 (unconfirmed)
Average Daily Volume: 1.2 million
Listed on April 19th, 2010

Fuel Systems, Inc. – FSYS – close 32.48 change -1.20 stop 29.39

We got our retracement on FSYS and our trigger to buy shares at $32.75 was hit. I see fairly good support down to $31.85 which is also the stock's 20-day SMA. The 50-day SMA at $30.84 is also a support level. FSYS is still in an upward trend on its daily chart and is also forming an ascending triangle that has some time to play out. The company trades at about an 11 PE and its earnings have been steadily increasing over the past year. I believe FSYS will have no issues rallying to $34.65 prior to its earnings report on May 6. Our first target is $34.65 and our second target is $37.00, but there is probably not enough time to reach this level prior to the earnings report. If we get filled and FSYS reaches our target we will earn +5.8% on the trade. We will use a stop at $29.39 which is below its 50-day SMA and a recent swing low. Traders can initiate positions but please be prepared for a quick exit as FSYS tends to be volatile. Our time frame is about two weeks.

Current Position: Long FSYS stock @ $32.75

Entry on April 26 at $32.75
Earnings Date 05/06/10 (unconfirmed)
Average Daily Volume: 720,000
Listed on April 22, 2010

Medicis Pharmaceutical Corp. – MRX – close: $25.53 change -0.03 stop: $24.29

MRX got knocked down again at $25.80 level. If my counting is correct this makes 6 times the stock has tested $25.80 since April 12. If the stock keeps knocking I expect the door to open soon. If it breaks out we should hit our target of $26.45. I suggest traders consider tightening stops if MRX rallies into to $25.80 again to protect profits. MRX continues bouncing back and forth between its SMA's and the price is still compressing. We should know which direction the price will ultimately go in the next day or two. Our stop is $24.29 which is below the 50-day SMA. Our first target is $26.45 and our second target is $27.75, which is just below its 52-week high. I am not suggesting new positions at this time.

Current Position: MRX stock @ $25.00

Entry on April 14 at $25.00
Earnings Date 5/06/2010 (unconfirmed)
Average Daily Volume: 1.0 million
Listed on April 13th, 2010

BEARISH Play Updates

Powershares QQQQ Trust - QQQQ - close: 50.52 change: +0.21 stop: 50.95

QQQQ made another 52-week high today before retreating at the end of the day. I expect to see some weakness in the markets heading into Wednesday's FOMC announcement but the dips are probably going to be short lived as they have been for the past 3 months. My comments from Saturday remain the same on how to exit this position. I expect the markets to continue their volatility this week as the bulls and bears continue the battle. This should give us some good potential exit points on this trade. I have two targets: the first is $49.55 which is just above the lows on Tuesday, and the second is just above QQQQ's 20-day SMA (now at $49.26). I will tighten stops if these levels are approached with the assumption that I will be taken out. QQQQ has not touched to its 20-day SMA since February 5 and it is way overdue. Our aggressive target on this trade is $47.00 but we are looking to exit close to the above mentioned levels. Our time frame is 1 to 5 days.

Current Position: Short QQQQ at $49.05

Option Traders:
Suggested Position: Buy PUT May $49.00, Ask at entry, $1.00

Entry on April 12th, 2010
Earnings Date Not Applicable
Average Daily Volume: 49.4 million
Listed on April 10, 2010