Option Investor

Daily Newsletter, Thursday, 7/15/2010

Table of Contents

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

Market Wrap

Late Day Turnaround

by James Brown

Click here to email James Brown

The stock market rally has stalled but stocks did manage to recover from their morning lows. The Dow Industrials were off more than 120 points at its worst levels and the S&P 500 dropped toward the 1,080 level before bouncing back. The DJIA settled near -7 points for the day and the S&P 500 managed to close in positive territory at 1,096. The market was initially weak on disappointing economic data that overshadowed better than expected earnings from J.P.Morgan Chase bank (JPM). Overall investor sentiment seems cautious with money flowing into the safety of U.S. treasuries. The yield on the two-year note fell to an all-time low of 0.58% before settling at 0.61% this afternoon.

The late-day turnaround was attributed to BP and Goldman Sachs. Oil stocks rallied into the closing bell after an afternoon announcement from oil giant BP who said the oil leak has been contained with the new cap recently attached. This is the first time since April that oil has stopped leaking into the Gulf of Mexico. This is a temporary fix and BP is testing to see if the valves will be able to withstand the pressure. The company is continuing its efforts to drill two relief wells that will eventually be able to cement the well and plug it permanently. There was also word late in the day that BP was close to a deal with Apache to sell part of its stake in Alaska's Prudhoe Bay oil field for approximately $10.5 billion. Shares of BP soared late in the session and closed up +7.5% at $38.92.

You can expect lots of headlines about Wall Street powerhouse Goldman Sachs (GS) tomorrow. Before the closing bell a bulletin hit that the SEC was going to make a major announcement. Traders correctly assumed that the SEC was going to announce a settlement with GS and shares of GS rallied +4.4% to close at $145.22. Back on April 16th the SEC shocked the markets by announcing civil fraud charges against GS for a mortgage securities deal. In June the courts granted Goldman Sachs a thirty-day extension to respond to the SEC's allegations and it was widely accepted that GS was probably negotiating a settlement. Today the SEC announced a $550 million settlement, the largest fine against a financial company in the SEC's history. About $300 million will go to the SEC and the rest will go toward victim compensation. Last year Goldman reported a net profit of $13.4 billion. Removing the black cloud of uncertainty surrounding GS for $550 million might seem like a deal to Goldman's management. GS will have to admit they made a "mistake" and adjust how they market some of their products. Shares of GS continued to rally in after hours and was up another +5% near the $153 level.

Chart of Goldman Sachs (GS):

It was a rough day for overseas markets. Major indices in Asia and Europe were down across the board. The Japanese NIKKEI lost -1.1% after tagging three-week highs yesterday. Investors ignored news that the Bank of Japan had upgraded their economic forecast for the rest of 2010. The big headline today was China's Q2 GDP number. Economists were expecting China's GDP to slow down from +11.9% growth in the first quarter to +10.5% growth in Q2. The headline today was +10.3%. On a positive note industrial production rose +13.7% and inflation at both the wholesale and consumer level declined. Yet investors are growing more concerned that China's economy may slow down too fast in the second half of 2010. The Hong Kong Hang Seng index lost -1.4% and the Chinese Shanghai index fell -1.8%.

European markets were holding on to minor gains the first half of the day but quickly turned south on the parade of disappointing economic data in the U.S. this morning. The Greek market was an outperformer with a +2.2% gain thanks to a rally in domestic banks. News that Piraeus Bank SA, a large Greek bank, had offered to buy up significant stakes in two of Greece's largest lenders fueled the rally. Another PIGS country to make headlines was Spain. The country was successful with a 3 billion euro ($3.8 billion) debt auction of 15-year bonds. The bidding was strong at 2.57 times versus the prior auction in April at 1.79. If demand for Spain's debt is rising it's a very positive signal that investor sentiment is healing for the EU region. At the end of the day the English FTSE lost -0.8%. The German DAX fell -0.9%. The French CAC-40 slipped -1.4%.

Another sign of improving investor sentiment for the EU was a strong rally in the euro currency, which closed at $1.29 against the dollar. Normally euro strength and dollar weakness is bullish for commodities. Yet gold had a quiet day with a $1.30 gain to $1,208.30 an ounce. Crude oil fell 42 cents to $76.62 a barrel. The CRB commodity index still performed well but that was due to a +6.7% rally in wheat futures and a +6.5% rally in natural gas.

Most of the economic data this morning was a disappointment. The U.S. recovery has been led by a bounce in manufacturing but the manufacturing sector is quickly losing momentum. The Philadelphia Fed report showed an unexpected drop. Economists were looking for a rise from 8.0 in June to 10.0. Instead the Philly Fed said their general business conditions index fell to 5.1, the worst reading since August 2009 and a long drop from May's 21.4. New orders fell from +9.0 to -4.3. One of the few positives was the employment component, which moved from -1.5 to +4.0 but this remains a below average reading.

The New York Empire State manufacturing index was not any better. This time economists were expecting the general business conditions to decline from 19.6 in June to 18.8 in July. Unfortunately, the index plunged to 5.1. That is not a typo. Both the Philly Fed and Empire State reading came in at 5.1. Readings over zero suggest growth and expansion but this is moving the wrong direction. At 5.1 this is the lowest reading since December for the New York region. New orders dropped from 17.5 to 10.1. Back in April the new orders component peaked at 29.5. The shipments component dropped from 19.7 in June to 6.3 in July. The employment component slipped from 12.4 to 7.9. These two reports only confirm that the U.S. is seeing a slowdown in activity. Whether or not this is just a pause in the recovery or the beginning of the double-dip is the big question.

In other news the markets digested the PPI, industrial production, factory output, and the weekly initial jobless claims. The Producer Price index, a measure of inflation at the wholesale level, slipped -0.5% following a -0.3% drop in May. Economists were expecting a -0.1% decline in June. This is the largest drop in five months fueled by a big -2.2% drop in food prices, the biggest decline since early 2002. Energy prices slipped -0.5%. The core rate of PPI, which excludes the more volatile food and energy prices, rose +0.1%, which is in line with expectations. Finished goods saw prices pull back from May's +5.1% to +2.7% in June. The headline number's decline is the third monthly drop in a row and could start to fuel deflation fears.

This morning the Federal Reserve said June's industrial production unexpectedly rose +0.1% thanks to higher temperatures raising demand for electricity. Meanwhile factory output fell -0.4%. We're also seeing some volatility in the weekly jobless claims. Last week the media was hyping the sharper than expected decline in weekly jobless claims. Today weekly jobless claims fell another -29,000 to 429,000 but larger headlines dominated the news. The four-week moving average declined -11,750 to 455,250. Unfortunately the number of continuing claims spiked +247,000 to 4.68 million. You may recall that last week the Labor Department said continuing claims fell -224,000.

It is earnings season and corporate results will continue to dominate the headlines for the next couple of weeks. This morning investors were disappointed with JPM's earnings report. Our nation's second biggest bank reported a profit of $1.09 a share ($4.8 billon), which was 39 cents better than analysts' estimates. Revenues fell 7.6% to 25.61 billion compared to expectations of $25.59 billion. Looks like a blowout number, right? Yet these results were fueled by a huge release of loan loss reserves. CEO Jamie Dimon admitted these were not "normal ongoing earnings". The company did say that charge-offs and delinquencies were coming down but they remain at elevated levels. Management said it was too early to say how much improvement they will see from here and Dimon added that it was too early to tell how the new financial reform bill would impact their business. Shares of JPM rallied on the headline number early this morning but sank to -2.6% intraday only to bounce back into positive territory by the close.

Do you remember all the talk about how the wide yield curve was going to fuel huge profits for the banking sector? It looks like those profits may not be so strong with JPM's revenues down quarter over quarter and year over year. This is not a good sign since JPM is considered one of the best of the best for the big banks. Investors will be focused on Bank of America and Citigroup's earnings tomorrow morning before the opening bell. Analysts expect BAC to report a profit of $0.22 a share and Citigroup to report a profit of $0.05 a share. Since we're talking about banks I should mention that the Senate passed the financial reform bill 60-39 this evening. Passage of the bill was not a surprise but Wall Street remains wary since the regulations to implement this bill are still unwritten. The effect of unintended consequences could be HUGE. This is a monster bill of 390,000 words. The Associated Press said that's the equivalent of half the King James Bible. Do you think any of the senators actually read the entire bill before voting on it? The bill goes to President Obama's desk to be signed next week.

The earnings parade continued this evening with Internet titan Google (GOOG) reporting results after the close. Wall Street was expecting a profit of $6.52 a share on revenues of $4.99 billion. The search giant delivered a profit of $6.45 a share on revenues of $5.09 billion. That is a 7-cent miss. You might see reports that revenues rose 24% to 6.82 billion but that includes the fees that GOOG has to pay toward its partners. The big drop in the euro last quarter had a negative effect on GOOG's European business. Investors are worried about the company's growing payroll with another 1,200 employees joining GOOG last quarter. Shares of GOOG were down about $20 in afterhours trading near $474 a share.

Chart of Google (GOOG):

Semiconductor maker and Intel rival AMD reported earnings after the closing bell tonight. AMD delivered a profit of 11 cents a share, which was 5 cents better than expected. Revenues rose 5.1% to $1.65 billion, better than the $1.55 billion estimate. Last quarter's profit of $43 million is a huge improvement over the $330 million lost a year ago. AMD's CEO said their success was due to strong demand for their mobile platform products.

Technically the market has stalled with the S&P 500 stuck under resistance near the 1100 level. If the index can breakout the next test is resistance near the simple 200-dma around 1,110-1,112 and then the 1,120 area. If the index rolls over I would look for very short-term support near the 1065 area. Thus far the S&P 500 remains in a bearish pattern of lower highs and lower lows.

Chart of the S&P 500 index:

The rally in the NASDAQ has stalled right at technical resistance with its 50 and 200-dma, which is conveniently located near the 2250 level. If the rally continues we can look for resistance near 2300. On a pullback look for support near 2150.

Chart of the NASDAQ index:

The situation in the small cap Russell 2000 is very similar. The oversold bounce has stalled near resistance. You can see this resistance near its 200-dma and the 640 level. All of the major indices still have a bearish trend of lower highs and lower lows.

Chart of the Russell 2000 index:

I cautioned readers last week that the rally was probably short-term and the duration of any rally would depend on corporate earnings and guidance. Tomorrow we're going to hear earnings from BAC and Citigroup. Plus we'll hear from market bellwether General Electric (GE). Next week there will be a virtual flood of earnings reports. Friday will also bring the CPI results and Michigan Consumer Sentiment report. Economists are expecting the CPI to fall -0.1% and the Michigan Sentiment numbers to slip from 76.0 to 74.5.

I'm not suggesting this oversold bounce is over yet but short-term traders may want to be looking for a bearish reversal in the next several days as a possible entry point. Tomorrow could see a lot of volatility. News from BP that they have successfully stopped the leak, even short-term, is bullish for BP and bullish from a psychological standpoint. News that Goldman Sachs has settled with the SEC is a huge market positive and should fuel gains for the banking sector. However, this could be derailed if BAC or C really disappoints in their earnings report. Reaction to GOOG's earnings report is certainly bearish and could weigh heavily on the NASDAQ.


New Plays

Narrow Portfolio Heading Into OPEX

by Scott Hawes

Click here to email Scott Hawes
Editor's Note: Good evening. Considering the news driven events this afternoon (see my comments in today's updates) and that OPEX is tomorrow we are not releasing new plays tonight. We plan to release several over the weekend and look forward to the August options cycle. There is one industry that is grabbing my attention to the long side and that is natural gas stocks. There was bullish inventory data released about natural gas today and stocks in this industry should follow, especially if there is broader market strength. I have provided two set-ups below that I like with relatively tight stops.

Long XEC: The stock is forming a bull flag above its 20-day and 50-day SMA's. It looks poised to retest its all-time highs near $80.00 which is about +6% higher than current levels. The stock has maintained a beautiful series of higher highs and higher lows since March of 2009.

Long APC: The stock is breaking out above its 50-day SMA and looks poised to fill a gap near $52.00 which is nearly +6% higher from current levels.

In Play Updates and Reviews

OPEX Friday

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:
Good Evening. Our short positions looked promising this morning but they were saved on the news of the Goldman Sachs settlement and progress on capping the leaking well in the gulf. These two stories essentially lifted the entire market this afternoon despite the terrible economic data released this morning. We'll have to see if there is any follow through tomorrow in what is shaping up to be a very interesting OPEX Friday. Personally, I don't believe this afternoon's news is all that material in regard to the economy but if the market goes higher we'll have to follow. As I have said in recent days we need a close and follow through above 1,105 on the S&P 500 for me to get behind this rally. And even if that happens we will keep a very tight leash on long trades. I have made further adjustments to targets on most short positions. We will get meaningful pullback in the broader market soon and when we do we will take advantage of exiting these positions at better prices than today. Please email me with any questions.

Current Portfolio:

BULLISH Play Updates

Emulex Corp - ELX - close 9.84 change +0.17 stop 9.18 *NEW*

Target(s): 10.40, 10.85, 11.20
Key Support/Resistance Areas: 11.40, 11.00, 10.50, 10.10, 9.70, 9.25
Current Gain/Loss: +1.85%
Time Frame: 1 to 2 weeks
New Positions: Yes

7/15: ELX hit our trigger to enter long positions at $9.75 this morning. The stock tested the backside of the broken bounced hard. The good news is that ELX rallied off of its lows early this morning before the market and before the GS and leaking well news. I'm looking for a move up to the 50-day SMA. I've tightened the stop to $9.18.

7/14: ELX broke out of a short term downtrend line today and has been making higher lows since its lows on 6/8. I like the volume patterns recently and over the past two days ELX has surged higher on much heavier volume than its daily average of 1.76 million. I've also been waiting for this stock to close above its 20-day SMA (currently $9.69) which it did today. I believe ELX will easily make a run up to its recent highs near $10.40 which is our first target. The stock may experience a some resistance at this level but ultimately I think it heads toward the $11.00 area. Today's candlestick could be considered a reversal pattern but I don't think ELX will trade below its 20-day SMA ($9.69) unless there is a big drop in the market which is certainly possible. However, I'm viewing the afternoon sell-off from its highs as a test of the 20-day SMA from above and a second chance to get on board the momentum ELX is building. In addition, the stock has made two consecutive higher weekly highs. Our initial stop will $8.95 which is below two upward trend lines. A tighter stop could be placed at $9.20 which is below yesterday's low. I would like to use a trigger of $9.75 to enter positions. NOTE: I view this as a potentially volatile trade so please use proper position size to limit risk. For options traders I am pushing the recommended option out to October as buying the additional time value is cheap.

Current Position: Long ELX stock, entry was at $9.75

Options Traders: October $10.00 CALLS

Entry on July 15, 2010
Earnings Date 8/5/10 (unconfirmed)
Average Daily Volume: 1.76 million
Listed on 7/14/10

Merck & Co - MRK - close 36.49 change +0.29 stop 34.79

Target(s): 37.20, 37.75, 38.60, 39.35
Key Support/Resistance Areas: 39.50, 38.75, 38.00, 36.35, 35.80
Current Gain/Loss: +1.79%
Time Frame: 1 to 2 weeks
New Positions: Yes

7/13: MRK closed above resistance of $36.35 and looks like it is headed towards our targets. If the broader market continues bouncing we should have no issues hitting our target(s) and MRK could also act as a defensive play if there is a pullback.

7/12: MRK traded down to $35.84 in early trading which triggered our long entry. The stock then drifted higher throughout the day. MRK appears to be forming a bull flag on its daily chart. A break above Thursday's high of $36.40 should get things moving higher relatively quick. Since we were able to get the lower entry trigger today I am going to offer a lowered 1st target of $37.20 which is a good place to consider at least consider tightening stops. I've also adjusted our primary target of $37.95 down 20 cents to $37.75.

Current Position: Long MRK stock, entry was at $35.85

Options Traders: August $36.00 CALLS

Entry on July 12, 2010
Earnings Date 7/30/10 (unconfirmed)
Average Daily Volume: 18 million
Listed on 7/10/10

BEARISH Play Updates

Lululemon Athletica Inc. - LULU - close 39.60 change +0.298 stop 41.30

Target(s): 38.00, 37.20, 35.80
Key Support/Resistance Areas: 42.25, 39.75, 37.00, 35.16, 32.75
Current Gain/Loss: -1.15%
Time Frame: 1 week
New Positions: Yes

7/15: LULU is being contained by its 20-day and 50-day SMA's. I expect this to hold and LULU to turn lower. $37.20 is the primary target but $38.00 (raised 5 cents) is also an area of interest to exit positions or tighten stops.

7/13: LULU managed to eek out a 26 cent gain today as the market catapulted higher. This is under performance and confirms my bearish outlook for the stock. We could get a little more bounce in this position but when the market pulls back LULU should go lower relatively quick. However, in the spirit of following the market we need to be careful and not get too greedy by expecting LULU to simply rollover and give us a big gain. As such, I've added $37.95 as the first target which just above yesterday's low. This level is -3% lower from our entry price and if you bought options they should return about +15% at $37.95. Tightening stops at this level is suggested to see if we cn get more out off the position.

7/12: Finally, LULU hit our trigger of $39.15 to enter short positions. The stock immediately lost $1.25 and then recovered. One thing is clear on the intraday charts and that is the volume when the stock was declining this morning was much greater compared to its recovery. I like the volume pattern and think LULU retests its lows before breaking higher. Should it break higher the 50-day SMA sits at $39.87 which should keep things under control. I've also listed a target of $37.20 which is just above a key support/resistance area of $37.00. Some might view this level as forming an inverse head and shoulders pattern on the hourly chart so it would be prudent to consider tightening stops at this level. This level will also produce a decent gain in the position.

Current Position: Short LULU stock, entry was at $39.15

Option Traders: August $35.00 PUTS

Entry on July 12, 2010
Earnings 9/9/2010 (unconfirmed)
Average Daily Volume: 1.89 million
Listed on July 1, 2010

PowerShares QQQQ Trust - QQQQ - close 45.60 change +0.04 stop 46.90

Target(s): 45.00, 44.40, 43.75, 42.55
Key Support/Resistance Areas: 46.77, 45.25, 44.46, 43.50, 42.50, 41.00
Current gain/loss: -2.93%
Time Frame: 1 to 2 weeks
New Positions: Yes

7/15: Google is down -$20 in the after hours after their earnings report. This should keep the Q's in check tomorrow. However, the good news about the GS settlement and the oil spill in the gulf is boosting sentiment despite the terrible economic data that was released today. My comments from 7/13 remain the same except I would place the tighter stop at $46.25 as opposed to $46.15. QQQQ's close on 12/31 was $45.75 which is near the highs of the past two days. We are at the bottom of January's congestion area and this is an important reference point. We've got some wiggle room and think the market moves lower prior to any significant move higher. I've tightened the targets and added $45.00 which is just above QQQQ's 20-day SMA. This is good place tighten stops. 7/13: It appears the Q's are going to spike higher in the morning as a result of earnings from Intel. The NASDAQ 100 futures are currently up over 1% as of this writing. This equates to a price in the Q's of approximately $45.85. The recent patterns after Intel reports show significant market sell offs in the ensuing days after the initial spike. If you believe this time is different and we continue to go higher I suggest exiting early tomorrow or place a new stop above the highs of tomorrow. $46.15 gives you some room and is above the 200-day SMA (near QQQQ's close today) and the 50-day SMA's. But this level could also get picked off as a stop on a spike higher, only to see QQQQ reverse lower. I believe we will see our first target of $43.75 before our official stop of $46.90 so I am sticking with the original plan for now.

7/12: QQQQ backed off right at its 20-day SMA this morning which also corresponds to the ETF's February highs. This level is a logical reversal point for QQQQ, however, Intel reports earnings tomorrow after the bell so that is the wild card for the short term price direction. I've adjusted our near term target to $43.75 which is just above the lows on 7/8.

Current Position: Short QQQQ stock, entry was at $44.30

Options Traders: August $45.00 PUTS

Entry on July 8, 2010
Earnings N/A (unconfirmed)
Average Daily Volume: 100 million
Listed on July 7, 2010

Starbucks Corp. - SBUX - close 26.13 change +0.67 stop 26.75

Target(s): 25.30, 24.85, 24.25, 23.70
Key Support/Resistance Areas: 26.50, 26.00, 25.25, 24.80, 24.00, 23.60, 22.50
Current Gain/Loss: -5.58%
Time Frame: 1 to 2 weeks
New Positions: Yes, with a tight stop

7/15: SBUX was headed for our target this morning but reversed with the broader market. The stock has retraced about 50% of its recent decline and is below its 50-day SMA. We need a reversal and are looking to exit. I've tightened the targets and suggest readers exit on weakness. Ultimately SBUX should fill its gap higher on 7/13 (near $25.30) and I think it will prior to moving much higher. But the stock may be headed for $26.40 to close the gap down on 6/29. This is about +1% higher than current levels. I suggest being patient and waiting for a pull back to exit positions.

7/13: SBUX is just not giving us the pullback I anticipated. The stock has rallied +10% from its lows last week in five trading days. It bounced straight up from its 200-day SMA right into its 50-day and 20-day SMA's. I keep anticipating a reverse lower and if it doesn't happen soon I suppose the concerns of strapped consumers buying $5 latte's are a thing of the past. There is a gap to be filled up to $26.39 and that might be where this is headed before a turn back down. I've tightened the above targets and suggest we begin to exit positions on weakness. These levels are good places to at least tighten stops.

7/12: SBUX sold off this morning but drifted higher the remainder of the day. SBUX has resistance at current levels and I am looking for the stock to make a lower high and reverse to retest its lows.

Current Position: Short SBUX stock, entry was at $24.25

Options Traders: August $25.00 PUTS

Entry on July 8, 2010
Earnings 7/21/2010 (unconfirmed)
Average Daily Volume: 10 million
Listed on July 3, 2010


SPDR S&P 500 ETF - SPY - close 109.65 change -0.00 stop 112.60

Target(s): 108.20, 107.25, 106.25
Key Support/Resistance Areas: 110.50, 108.80, 107.60, 106.00
Time Frame: DROPPED

7/15: This would have been a perfect trade had the overnight futures held on to their gains but they were gone before the open. SPY proceed to trade down to our target 108.20 almost to the penny. In light of the near miss entry I think it is best to simply drop the play. We may release another play on SPY soon.

7/14: This is fairly simple. I'm looking for SPY to spike a tad bit higher to the 110.50 area (equivalent to 1105 in the S&P 500) and then retrace to fill its gap higher on 7/13 which is also just above its 20-day SMA. This is the primary target and is a good place to tighten stops to see if we can get more out of the trade. If we get filled I like this set-up a lot and I think the retracement could come quick. Our trigger to enter short positions is $110.35 and our stop will be above all recent closing highs $112.60 and the 200-day SMA. If we get filled on this trade I will be thoroughly amazed if we get stopped out prior to hitting our target. But the market can do anything so it is possible, but nor probable in my opinion. I think we have a 50/50 chance of getting filled so traders may consider entering at current levels with a tighter stop just above the 200-day SMA at $111.75.

Suggested Position: August $108.00 PUTS, current ask $2.64, estimated ask at entry $2.35

Annotated chart:

Entry on July xx
Earnings N/A (unconfirmed)
Average Daily Volume: 251 million
Listed on July 14, 2010