Option Investor

Daily Newsletter, Tuesday, 6/1/2010

Table of Contents

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

Market Wrap

Another Late-Day Sell-Off Punishes Stocks

by Todd Shriber

Click here to email Todd Shriber
All things considered, stocks were holding up relatively well until just after 3:30 PM Eastern time when another late-session sell-off knocked the Dow Jones Industrial Average to another triple-digit loss. The blue chip index shed almost 113 points to settle at 10024.02. The S&P 500 lost almost 19 points to close at 1070.71 while tech outside of Apple (AAPL) was weak, leading to a decline of almost 35 points for the Nasdaq, which settled at 2222.23.

Stats Table

Stocks were once again held hostage by headlines from other parts of the globe and failures to stop the Gulf of Mexico oil leak. The latest geopolitical news to roil equity markets actually did not come from Europe, but from Israel. Press reports said that Lebanon fired on Israeli warplanes that flew into Lebanon's airspace.

Given that political tensions are always high in the Middle East, this was not the type of news that skittish investors needed to hear on the first trading of June, especially when considering that May 2010 was one of the worst Mays in several decades. Not surprisingly, Israeli stocks were hammered on the news with the iShares MSCI Israel Capped Investable Market Index Fund (EIS) plunging 4.32%. The ETF has been in a tailspin since mid-April.

EIS Chart

Once again some positive economic data was overshadowed by negative catalysts originating outside of the U.S. The Institute for Supply Management (ISM) said manufacturing activity slowed a bit in May from April's blistering pace, but still remains robust. The ISM's manufacturing survey for May came in with a reading of 59.7%. Economists were forecasting a reading of 59%. Anything above 50% is considered bullish.

New orders for May held steady at 65.7% and the employment index jumped to 59.8% from 58.5% in April. Another bullish sign was a rise in export orders to 62% in May from 61% in April. The inventories index fell to 45.6%, its lowest level in five months.

ISM Chart

Construction spending also sported some impressive gains with private construction spending rising 2.9% in April and public spending rising 2.4%, making March and April the first months of consecutive gains since 2007. The April 2010 gains were the strongest since August 2007.

Construction Spending

Last Thursday, it looked things were finally starting to get better for BP (BP), the embattled oil major that has consistently floundered in its attempts to cleanup what has now become the worst oil spill in U.S. history. The shares saw some relief last Thursday on positive headlines regarding the company's ''top kill'' effort to plug the leaking Macondo well was actually working. By Friday, essentially of Thursday's stock price gains were gone and by the weekend, the U.S. government told BP to halt the top kill plan.

BP is trying yet another risky plan to plug the well, but at this point, nearly everyone that turns on the nightly news is doubting the company's ability to fix what has become an incredibly dire situation. BP's inability to plug the well and effectively cleanup the spill is, quite simply, killing the stock. The shares shed another $6.43, or 15%, to close at $36.52 today after media reports said U.S. Attorney General Eric Holder is considering criminal charges against BP.

The drop was the biggest for BP's U.S.-listed shares since 1980. In London, the stock saw its largest decline since 1992, according to Bloomberg News. BP has lost about 39% since the Deepwater Horizon rig exploded on April 20, erasing roughly $70 billion in market value in the process. Allow me to put $70 billion into context: That would essentially wipe out McDonald's (MCD) and destroy Kraft Foods (KFT) not once, but almost 1.5 times.

An interesting aside about how negatively the broader market has been reacting to BP's failures in the Gulf of Mexico is that BP is not even a member of the S&P 500 because the company is not based here in the States. I did not research the particulars, but BP now has a market cap of $114.33 billion, so add $70 billion and that is BP's market value before April 20. That would make BP a fairly important part of the cap-weighted S&P 500, so it might just be a good thing that BP is not a member of the index. If it was, we might be looking at 1050, not 1070 for the S&P 500.

BP Chart

Of course, the BP news combined with President Obama's six-month moratorium on Gulf of Mexico drilling projects is bad news for a slew of other stocks, namely the oil services group. A couple of weeks ago, I wrote a piece on OilSlick.com about an analyst report saying select oil services such as Cameron International (CAM) and National Oilwell Varco (NOV) would benefit as rig operators were forced to update equipment on their rigs to bolster safety protocols.

That thesis may still prove to be valid, but in the moment of BP's incompetence and the drilling moratorium, these stocks are getting bludgeoned. NOV was down 11% today and Cameron was down almost 12%. Transocean (RIG), the largest provider of offshore drilling services and a villain in the same vein as BP, shed almost 12% on Tuesday. On April 20, Transocean was a $92 stock. On Tuesday, the shares closed just above $50, a decline in dollar terms that is even more breathtaking than that endured by BP.

None of this is good for the Oil Services HOLDRs (OIH), which was a $130 ETF on April 20. OIH closed below $89.50 today and looks poised for a move to the high 60s or low 70s before it sees $100 again.

OIH Chart

There were some bright spots on Tuesday, though they were few and far between. Radio Shack (RSH) caught a bid (no pun intended) after the New York Post reported that the auction for the electronics retailer is heating up with Blackstone Group (BX) the reported front runner. Radio Shack has hired Goldman Sachs (GS) to help it explore strategic alternatives, including a possible sale that could fetch as much as $3 billion, the Post reported.

Other private equity giants such as Bain Capital and Kohlberg Kravis Roberts are believed to be interested in Radio Shack and the Post mentioned an unidentified ''strategic'' bidder as well. That very could be Best Buy (BBY). Radio Shack gained almost 3% to close at $21.79 on the news.

Radio Shack Chart

Apple was a standout as well, gaining $3.95, or 1.54%, to close at $260.83 after reporting that 2 million iPads have been sold since the product's debut on April 3rd. The iPad made its debut in Australia, Canada, France, Germany, Italy, Japan, Spain, Switzerland and the U.K. just days ago and the product will be available in nine more international markets in July.

Analysts said the 2 million mark would have broken sooner had Apple done a better job of anticipating brisk demand for the iPad. Apple founder and CEO Steve Jobs said the company is working to meet demand and analysts are saying the iPad will immediately impact Apple's bottom line in a positive way.

UBS said Apple is on pace to sell 3 million iPads by the end of the current quarter and Broadpoint AmTech boosted its price target on Apple to $340 from $320, saying the iPad could account for more than 10% of Apple's total revenue for the current quarter. I have included a poll below from the Web site ipad.org to illustrate how robust some Apple fans think demand for the iPad will be going forward.

iPad Sales Poll

Looking at the charts, the Dow is still having problems conquering 10,200, though 10,000 held as support, for today at least. The problem is the Dow continues to languish below its 200-day moving average of 10,285 and the longer the index resides below that level, the gloomier the picture becomes. A move below 10,000 could mean a return to last Tuesday's low of 9774.48.

Dow Chart

The S&P 500 is plagued by a similar problem, meaning an inability to reclaim its 200-day line at 1105. If the index moves below 1065 and support at 1050 does not hold, a move to 1000 or lower could easily be in the cards.

S&P 500 Chart

The Nasdaq was looking a tad better last week as it was the only one of the three major U.S. indexes to close above its 200-day moving average, but that scenario did not last for long as the index closed at 2222 on Tuesday. If round number support at 2200 does not hold, a return to the May low of 2140.53 could be in the offing. Sans Apple, there are a lot of reasons to be cautious with the Nasdaq.

Nasdaq Chart

The bulls have an array of problems to deal with in the form of Europe, now Israel, wilting commodities prices and BP's fiasco in the Gulf and all of those factors being issues simultaneously simply makes it easier and more prudent to either be short or sit on the sidelines. The longer the bears remain in control, the more I believe we could be in for a cruel summer and that is my pop culture reference for the day.

New Plays

No New Plays Tonight

by Scott Hawes

Click here to email Scott Hawes
Editor's Note: Good evening. We are not releasing new trades tonight. The S&P 500 is in no man's land without a break above 1,100 or below 1,070, which is where the SPX closed after the late day sell off today. The market is being driven by news and the volatility is making it almost impossible to manage swing trades unless you are trading intraday. We'll release more trades tomorrow assuming we have a better sense of market direction. I have listed a trade set-up below for those that are interested:

Long NCR - The stock is approaching a prior resistance and support area from January and February, respectively. In addition, the stock is approaching a recent upward trend line and its 20-day and 200-day SMA's from above. All of this should provide good support for a move higher.

In Play Updates and Reviews

PRGO, CNX Closed

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:

BULLISH Play Updates

Cypress Semiconductor - CY - close 11.11 change -0.28 stop 10.35

Target(s): 11.95, 12.25, 12.95
Key Support/Resistance Areas: 12.40, 12.00, 11.75, 11.40, 11.00, 10.75
Current Gain/Loss: -0.80%
Time Frame: 1 to 2 weeks
New Positions: Yes

CY hit our trigger to enter long positions at $11.20 late today as the market sold off. My comments from the play release remain valid so I'll leave them for convenience. CY has found a long term support/resistance area in the $10.50 to $11.00 range that dates back to August 2009. This area was prior resistance in July, August, and September of 2009 and again in December 2009. The stock broke out of the resistance in January and again in February of this year after the February 5 lows, which were just below $10.50. There is a lot of congestion in this area over the past year that is now providing solid support for the stock. I am looking for CY to trade down near the $11.20 area which is where I suggest readers initiate long positions. This would also be an area that would form a bullish inverse head and shoulders pattern (see ovals on chart) which may be a catalyst for CY to trade higher in the coming days. CY also remains above its 200-day SMA. On Tuesday when the S&P 500 double bottomed with February lows, CY peeked its head below the 200-day SMA and then rallied up to its 20-day SMA where it reversed on Friday. The stock has also retaken its long term upward trend line drawn from the lows of 11/08 to 11/09. Finally, CY has broken out of its recent downward trend line and has some room to rally up into the $12.00 area, or higher if the overall market can continue its bounce off of Tuesday's lows. A 75 cent rally from our anticipated entry would constitute a +6.75% gain. I have listed three targets above as areas to take profits or tighten stops. We'll use an initial stop $10.35, but a more conservative stop could be placed at $10.70 which is just below the opening print from Tuesday.

Current Position: Long CY stock at $11.20

Option Traders:
Suggested Position: Buy July $11.00 CALL

Entry on 6/1/2010
Earnings Date 7/22/10 (unconfirmed)
Average Daily Volume: 4.7 million
Listed on 5/29/10

Diana Shipping, Inc - DSX - close 13.31 change -0.25 stop 12.90

Target(s): 14.00, 14.35, 14.75
Key Support/Resistance Areas: 15.00, 14.40, 14.15, 13.50, 13.25, 13.00
Current Gain/Loss: -1.41%
Time Frame: 1 to 2 weeks
New Positions: Yes

DSX is hanging on to a key support level at $13.30. In reality it is closer to $13.25 so I have changed that level above. I mentioned a pullback to $13.25 is possible in the play release and that's what DSX did today. This fills the opening gap higher from last Tuesday to Wednesday and I am looking for DSX to bounce from here. I have also listed a lowered target to $14.00 for readers looking for a quicker exit. This level is just below last Thursday's highs of $14.16 and is a good area to consider tightening stops. Our stop remains at $12.90. My comments from the weekend remain mostly the same. DSX found long term support near the $12.35 area and has bounced nicely. The stock broke through its recent downtrend line and I am looking for it to retrace some of the recent gains prior to entering long positions. DSX has good fundamentals trading at a PE below 10 and has beaten earnings estimates in recent quarters. I am looking for a pullback near $13.50 which I suggest readers use as a trigger to enter long positions. This would also be a logical area for the stock to make a higher low and then proceed higher, although a pullback to $13.25 is possible as well. We are looking to make about a dollar in this trade.

Current Position: Long DSX stock at $13.50

Option Traders:
Suggested Position: Buy July $12.50 CALL

Entry on 5/28/10
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 1.4 million
Listed on 5/27/10, 2010

K12 Inc - LRN - close 25.03 change +0.01 stop 23.65 *NEW*

Target(s): $27.35, 28.25
Key Support/Resistance Areas: 25.35, 24.40, 24.00
Time Frame: 1 to 2 weeks

We are waiting to be triggered on LRN and my comments from the play release remain the same. Except that I would like to move up the lower trigger to $24.70 and move up the stop to $23.65 to protect capital should we get triggered. The new lower trigger is 1 penny above today's highs. LRN is a relative strength play that continues to make higher lows despite the recent weakness in the market. I am looking for LRN to break out above its recent highs and then test its prior highs from 2007 and 2008, which are near our targets of $27.25 and $28.25. The stock's volume has been increasing in recent weeks as the price has been increasing which signals accumulation and may indicate institutional money is being put to work in LRN. This is normally a bullish indicator. We'll use one of two triggers to enter long positions. If LRN trades down near $24.70 or if it trades up to $25.50 which would be the highest print of the past 52 weeks. Our stop will be $23.65 which is below the LRN's 20 and 50-day SMA's. *NOTE: LRN's average volume is about 200,000 shares. Therefore I consider this an aggressive trade so please use proper position size to manage risk.*

Suggested Position: Long LRN stock if it trades down near $24.70 or up to $25.50, whichever occurs first.

Entry on June xx
Earnings Date 9/9/10 (unconfirmed)
Average Daily Volume: 200,000
Listed on 5/29/10

Rino International - RINO - close 11.92 change -0.99 stop 11.70

Target(s): 13.25, 13.65, 14.00, 14.50, 15.95, 16.90
Key Support/Resistance Areas: 15.00, 14.50, 13.75, 12.75, 11.75
Current Gain/Loss: -33%
Time Frame: Several weeks
New Positions: Yes, with a tight stop

RINO had a terrible day probably because China's PMI Manufacturing report came in at a 3 month low and we are close to being stopped out of this position. If the market gaps down tomorrow we will use our gap rule to manage the stop in RINO. When there is an opening gap up or down through, or very close to stops/targets/entries we have a rule for exiting/entering positions. For long positions that gap below stops here is the rule of thumb: If a stock gaps down below the stop that has been established, wait for the first 15 minutes of trading before doing anything. Then place a new protective stop just under the low of that first 15 minutes of trading. Reverse the entire scenario for shorts. The reason I do this is because I want to measure the real strength or weakness in the stock. I don’t want a Good Til Cancelled (GTC) stop to be unnecessarily triggered at the open because often times stocks gap and reverse immediately, which keeps us in the position and looking for a better exit. Considering today's weakness I've listed a couple more lower targets of $13.25 and $13.65 for readers looking for a quicker exits. Fundamentally, RINO trades at a low PE ratio of about 5 and I think there is a lot of room to for this stock to run. But the overall market weakness is proving too much for RINO, at least for now. If RINO breaks here we'll probably see $10.70 or lower in the near future so I urge readers to not hang on to positions hoping for a rebound.

Current Position: Long RINO stock at $12.70

Option Traders:
Suggested Position: July $12.50 CALL

Entry on May 27, 2010
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 926,000
Listed on 5/25/10, 2010

BEARISH Play Updates

Smith International, Inc - SII - close 34.45 change -3.11 stop 35.75 *NEW*

Target(s): 34.55 (hit), 33.60, 32.15
Key Support/Resistance Areas: 42.00, 40.90, 39.00, 37.00, 34.00
Current Gain/Loss: +3.50%
Time Frame: 1 to 2 weeks
New Positions: No

SII gapped below our trigger of $36.90 to enter short positions so we implemented the gap rule similar to the one mentioned in the RINO position. I strongly urge readers to consider devising a gap rule similar to the ones I have been utilizing and writing about in the updates over the last several weeks. These rules are especially helpful when markets are as volatile as they have been recently. In SII's case, when the stock broke below the first 15 minute bar it showed the overall relative weakness of the stock and gave the green light to enter short positions, otherwise we would not have entered. We are now short SII stock at $35.70, or long July $37.00 PUTS at $3.30 for options traders. The stock traded all the way down to our first target of $34.55. I have listed a higher second target of $33.60 which would complete the gap fill in February. I suggest readers take profits or tighten stops at this level if SII trades down here. The oil service sector could reverse on a dime on any good news so I urge readers to protect profits. My comments from the play release remain valid so I'll leave them. SII looks vulnerable and is on the verge of possibly filling a gap all the way down to the $34.00 area. The oil services sector has been beaten down recently and SII has not been spared. SII remains below its downtrend line and if it trades below $36.95 there is a lot of air underneath. I'm looking for SII to fill this gap and I suggest readers initiate short positions if the stock trades up near $38.95 or down to $36.90, whichever occurs first. I view this trade as a good candidate to buy options as opposed to simply shorting the stock so that you know how much money is at risk. Our new stop is $35.75 which should be breakeven trade if the stop is hit. *NOTE: I view this trade as aggressive so please use proper position size to manage risk.

Current Position: Short SII stock at $35.70; For options traders: Long July $37.00 PUT, entry at $3.30

Entry on 6/1/2010
Earnings 7/28/10 (unconfirmed)
Average Daily Volume: 7.6 million
Listed on May 29, 2010


Console Energy - CNX - close 36.48 change -0.62 stop 34.50 *STOOPED OUT*

Target(s): 37.50, 38.25, 38.80, 40.75
Key Support/Resistance Areas: 41.00, 39.50, 37.55, 35.80, 34.90
Current Gain/Loss: -4.83%
Time Frame: 1 to 2 weeks
New Positions: Stopped Out

CNX fell out of bed with all other energy stocks today and our stop was hit for a -4.83% loss. For readers who may have still have positions the above support/resistance areas can be used as a guide to exit positions. There is not much more short term support below until $32.30 so please don't hang on to positions hoping for a reversal, especially if the overall market is weak like today.

Closed Position: Long CNX stock at $34.50, entry was at $36.25

Annotated Chart:

Entry on 5/28/10
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 7.0 million
Listed on 5/25/10, 2010


Perrigo Company - PRGO - close 56.52 change -2.89 stop 61.75

Target(s): 59.05 (hit), 58.25 (hit), 57.25 (hit), 56.10, 54.30
Key Support Areas: 59.00, 58.00, 57.00, 56.00
Key Resistance Areas: 60.50, 61.50
Current Gain/Loss: +3.94% Time Frame: Closed
PRGO gapped lower and quickly traded to our target of $57.25 which is where we closed short positions. The stock proceeded to regain almost all of the morning losses before reversing and closing at $56.52 which is below our morning exit. We have another target at $56.10 (raised from $56.00) which is also a good place to take profits or tighten stops. This would close the gap higher from 5/25 to 5/26. I also want to urge readers to protect profits as PRGO could just as easily reverse higher from here as it could continue lower. I'll leave some of my comments from the weekend as they are still valid. If the market reverses lower from here which is a possibility I think PRGO could trade down to our original target at $54.30. However, I'm anticipating a higher low to be made in the market and I suggest buying short PRGO positions back an any weakness in the stock. I've also tightened the stop to preserve capital if PRGO doesn't turn down from here. Technically, PRGO is testing its 20-day SMA from below and it appears it wants to put in a lower high. If this in fact happens we will have a winner, but if it doesn't we need to step aside at our stop price of $61.75. The stock was stuck in the middle of its 20-day and 50-day SMA but broke lower today.

Closed Position: Short PRGO stock at $57.25, entry was at $59.60

Annotated Chart:

Entry on May 27, 2010
Earnings More than 2 months (unconfirmed)
Average Daily Volume: 1.3 million
Listed on May 22, 2010