Option Investor

Daily Newsletter, Tuesday, 10/5/2010

Table of Contents

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

Market Wrap

See Your QE2 and Raise You an ETF

by Jim Brown

Click here to email Jim Brown
Japan matched the U.S. quantitive easing on bonds and went two steps further to add ETFs and REITs.

Market Statistics

The Bank of Japan surprised everyone with a monster quantitive easing program to increase liquidity in the financial system as part of a comprehensive monetary easing policy. They also cut the interest rate to between zero and 0.1%. After an initial drop in the yen the currency rebounded to close higher to close near the 15-year high that it hit last month.

The surprising factor in this QE program was not that they would buy more bonds but they are going to expand the program into buying ETFs and REITs. Basically they are hoping to boost the equity market and the real estate market with this major program.

This move by Japan boosted expectations the U.S. Fed will expand its QE program by up to $1 trillion in November and possibly branch out into other asset classes following Japan's lead. The prospect of the Fed buying equities caused a major market spike at the open and another round of short covering was born. The Fed may be forced to buy equities or some other asset class because they are going to run out of available treasuries.

If you analyze the speeches from the various Fed governors there is a lot of disagreement on how future stimulus should be handled or even if there should be another round of stimulus. A QE2 program from the Fed is not a done deal but after today's rally it is baked into the market cake.

Friday's payroll report could give us a critical clue into the Fed's next move. This report will give us the first look at the annual benchmark revisions for the past year. Many analysts believe the revisions will significantly reduce the reported employment numbers and show that conditions were worse during the recession than we thought at the time. The revisions will cover the 12 months ending in March 2010. The final revision will be published with the January 2011 jobs report.

The Bureau of Labor Statistics produces estimates each month and then once a year they revise those estimates based on data received after those estimates were made. This revision could show that significantly more people lost their jobs than previously thought. The impact of a large downward revision would be a lengthening of the time analysts expect it will take for a recovery. For every million additional jobs lost it will take roughly another year to recover completely, if in fact we ever will recover completely.

Currently analysts are looking out to 2014-2015 for the economy to fully recover. Since the U.S. recessionary cycle runs about every 4-6 years that suggests we could see another recession in the 2012-2014 period and that would delay the recovery from the current recession even farther into the future, if ever. There are quite a few analysts that believe we will never recover because of the baby boomer wave set to retire in this decade. They believe the current rebound will end in 2012 and then begin a long decline into 2020 and beyond.

The boomer generation controls over 80% of personal financial assets and more than 50% of discretionary spending power. They are responsible for more than 50% of all consumer spending, buy 77% of all prescription drugs, 61% of all OTC medications and more than 80% of all leisure travel. More than 76 million people were born between 1046-1964 and they began retiring in 2009 with the peak expected over the next 5-7 years. That is 76 million people who will go from wage earners and spenders to social security incomes and hoarding savings for their old age. It will be a once in a hundred years economic shift as retirees downsize their lifestyles and spending.

The dollar collapsed again losing nearly -1% and reaching lows not seen since January. The dollar has declined -8% in the last three months. The dollar is dropping because of the expectations for a new round of Fed easing. Gold soared to a new intraday high at $1,342, a gain of +$24.70 or nearly +2%. There appears to be no end in sight for the gold rally.

Gold Chart

Dollar Index Chart

The only material economic report today was the ISM Non-Manufacturing for September. The headline number came in at 53.2 and a decent increase from the 51.5 in August. It did not completely erase the August decline of nearly three points but it was a move in the right direction.

Specifically interesting was the export component, which soared to 58.0 from 46.5 in August. This is a factor of the cheaper dollar that makes our goods and services more attractive in other countries. This was the largest monthly gain since records were started in 1997. New orders rose by 2.5 points to 54.9 but back orders declined by 2.5 points to 48.0 and into retraction territory.

This report and the ISM Manufacturing were not strong enough to prevent the Fed from easing. In fact these reports probably gave the Fed added incentive to provide extra stimulus. These reports are consistent to a Q3 GDP under 2%.

The chart below is showing some continued respect for the declining trend from March 2006. The next move higher needs to break this resistance and the Fed will want to reinforce that move.

ISM Chart

The biggest report left for this week is the Nonfarm Payrolls on Friday. With the benchmark revision causing additional concern about how the market perceives the data there is risk ahead of the report.

Economic Calendar

In earnings news Yum Brands reported earnings that beat the street and gave guidance that matched analyst expectations. Earnings were 73-cents compared to estimates of 72-cents on revenue of $2.87 billion. Sales were powered by gains in China. After sinking in Monday's afterhours trading the stock rallied slightly on Tuesday to an all time high at $47.50.

Wolverine Worldwide (WWW) posted earnings that beat the street and raised guidance. Earnings were 70-cents compared to estimates for 67-cents. Revenue rose +11% and profits +6%. Wolverine is a shoe manufacturer for brands including Timberland, Caterpillar, Harley Davidson and Hush Puppies. Wolverine raised guidance to $2.04-$2.08 from $1.98-$2.04. Wolverine shares rallied 3.5% on the news.

Diamond Foods (DMND) posted earnings that beat the street and raised guidance slightly. The company produces Pop Secret popcorn, Emerald snack nuts, Diamond nuts and Kettle Chips. Earnings were 30-cents compared to estimates for 28-cents. Their shares rallied +4% on the news.

Earnings due out on Wednesday include STZ, MAR, MON, RPM and RT.

Harley Davidson (HOG) shares spiked +9% to $32 after RBC Capital Markets raised his price target saying sales were improving significantly following the recession slump. Based on checks with dealers and their reports of improving business he raised his target to $36 from $33. He said this was the first indications of improving sales since April. Meanwhile there does not appear to be any expectations in the market for a business recovery. In July Harley said it would ship 5-10% fewer motorcycles this year in an effort to support prices. Nothing creates price support better than limited supply. If consumers are buying Harleys again then the recession is definitely over.

Harley Davidson Chart

Trader Jerome Kerviel was convicted on all counts, sentenced to three years in prison and ordered to pay $6.7 billion in restitution. Yes, Billion with a B. Kerviel was the rogue trader that nearly bankrupted France's second largest bank, Societe Generale. The court rejected arguments that he was a scapegoat for a failed banking system. This is the biggest fine on record for a trading violation. That is the amount of money SocGen lost unwinding his trades. Unfortunately for SocGen he has no money so the fine is not going to replenish their coffers. Odds are good Kerviel will not be working in the financial sector when he gets out of prison.

The term "bond bubble" is getting more airtime as each day passes. However, with competing governments racing to devalue their currency more than everyone else by purchasing their own bonds the bubble may persist for some time.

Mexico became the first government to issue a century bond when it offered $1 billion in 100-year bonds expected to yield 6%. The bond will become a benchmark rate for Mexico as it tries to sell additional debt before year-end. Mexico's debt was recently downgraded but remains investment grade and that gives them the low rate. Demand for the century bond was so strong they are considering doubling the offer. In a filing with the SEC they said they could issue up to $80 billion. Ironically their 10-year bond yields were only 6.14% so there was little difference between the two other than duration. Institutions like the 100-year bonds because they can lock in their yields for a very long time. Brazil is rumored to be considering a century bond offering. RBC Capital said they had clients lined up to buy century bonds and waiting for the next offering.

Goldman told investors today to avoid bonds and buy stocks because bonds were overpriced and stocks were cheap. One analyst believes the S&P will post record earnings in 2011 but stocks are still priced for a recession. This sentiment appears to be spreading.

Meanwhile a Bank of America analyst, Mary Ann Bartels, said she is expecting a 10% to 12% pullback in October. If she is right it would take the S&P below the September low and be the tenth major move of the year. She is expecting a decline to the 1000-1040 range on the S&P.

Eliot Spitzer launched a new career as a TV journalist this week on the Parker Spitzer show on CNN. The reviews were so bad that he will probably be looking for another new career within weeks. The disgraced ex-New York governor was forced to resign in 2008 after being caught paying for high prices call girls. The NY Post called the show "Freak show unbearable to watch" and the Baltimore Sun said it was "a load of obnoxious, self-important noise."

I wish I had better things to say about today's rally. Unfortunately I have no confidence it will last. The opening spike was pure short covering. After last week's lack of a gain and solid halt under 1150 the Monday decline was an open invitation for shorts to back up the truck in expectations for an October decline.

Internals were negative 3:1 on Monday and the number of declining issues was the highest since September 7th at 4,716. Everyone was definitely setting up for a bearish week. That setup was trashed at the open today and the strength of the spike was a testament to how broadly the market was shorted on Monday.

The opening spike took the S&P to 1150 in the first 30 minutes where is stalled for a very short time before the move higher continued. Once over 1150 it triggered an entirely new set of stop losses and buy stops. Once these dominoes began to fall the rest of the day was clear. I suspect there are quite a few traders still in disbelief and still short overnight with futures already moving higher.

Even though I don't believe in this rally we have to respect the move. Going counter trend to the market bias can continue for days if not weeks as we saw in September. This is really going to confuse fund managers. Do they follow through on plans to sell their losers or wait on the outside chance they turn back into winners if they wait long enough?

Don't forget option expiration comes early this month only eight days from today. That means an increased sense of urgency for managers that have options as part of their insurance and income strategy. They have to close positions before the 15th or face a loss of those positions.

For the rest of the week S&P 1130 remains support but that is 30 points below where we closed. That means we could see some serious volatility without endangering the September trend. Meaningful overhead resistance is now 1175.

S&P Chart

The Dow managed to hold over resistance at 10,920 at the close but only barely. Only one Dow stock was negative and that was American Express. The first Dow stock to report earnings will be Alcoa on Thursday.

I don't believe the Dow closed far enough over 10,920 to be free from its influence. If we dip down below that level tomorrow it would reinforce its value as resistance. Conversely if it continues to move higher the 10,975-11,000 range will become a resistance magnet and setup a test of the market strength.

Dow Chart

It was an amazing day for the Nasdaq with a 2.3% gain. That gain was powered by AMZN +5%, AAPL +4%, GOOG +3%, PCLN +4% and FFIV +5% to name just a few. Every stock was heavily shorted and every short paid the price.

The Nasdaq Composite slammed into 2400 at the close and screeched to a sudden stop. This is psychological resistance rather than a technical level but sometimes those levels have an even bigger influence on traders. Next resistance at 2415-2420 is minimal and I believe a move over 2400 will have legs.

Nasdaq Chart

The chart with the most positive impact for me is the Russell 2000. The Russell is clearly in breakout mode and it appears at least some fund managers are buying in self-defense. The breakout over 670 last week lagged the big caps but when that same 670 level acted as support on Monday's dip it was a solid buy the dip signal.

I still believe the Tuesday rally was almost completely short covering but many times a long-term rally begins with a heavy dose of shorts getting creamed. Just looking at the Russell chart I would say the rally has legs but this is only one part of the market. Use continued strength in the Russell as a confirming indicator.

Russell 2000 Chart

In summary the global governments are racing each other to the bottom to see who can have the cheapest currency. Cheap currency values mean your exports are more desirable around the world. It is an offensive tactic and a defensive move at the same time. When the dollar is getting cheaper you need to own stocks and that could eliminate a normal October decline.

Most analysts would claim any future QE move by the Fed was now baked into the market cake. However, we are probably faced with no move until November and that allows plenty of time for economics to improve and take the Fed move off the table. We could be setting up for a big disappointment in the weeks ahead. The jobs report on Friday could be a downer if the benchmark revisions are ugly. However, an ugly jobs number could provide even more reasons for the Fed to act.

This is going to be an event driven market until after the elections so keep your seatbelts fastened and your stop losses in place.

Jim Brown

New Plays

Short Candidate

by Scott Hawes

Click here to email Scott Hawes


Microsoft - MSFT - close 24.35 change +0.44 stop 25.60

Company Description:
Microsoft Corporation is engaged in developing, manufacturing, licensing and supporting a range of software products and services for different types of computing devices. Its software products and services include operating systems for personal computers, servers and intelligent devices; server applications for distributed computing environments; information worker productivity applications; business solutions applications; computing applications; software development tools, and video games. It operates in five segments: Windows & Windows Live Division (Windows Division), Server and Tools, Online Services Division, Microsoft Business Division, and Entertainment and Devices Division.

Target(s): 23.50, 23.10
Key Support/Resistance Areas: 25.50, 24.75, 23.75, 23.00
Time Frame: 1 to 2 weeks

Why We Like It:
Microsoft was downgraded by Goldman Sachs yesterday and Janney today from Buy to Neutral, citing limited upside in share value due to an elongated PC refresh cycle and a newer threat from tablets where windows does not have a presence. The stock has been underperforming the broader market for months and I view today's bounce as a shorting opportunity. Let's use a trigger of $24.65 to initiate short positions. Our targets are -4.5% and -6% lower than our entry.

Suggested Position: Short MSFT stock if it trades to $24.65

Options Traders: Buy November $24.00 PUT, current ask $0.81

Annotated chart:

Entry on September xx
Earnings: 10/28/10 (unconfirmed)
Average Daily Volume: 60 million
Listed on October 5, 2010

In Play Updates and Reviews

Two Positions Closed

by Scott Hawes

Click here to email Scott Hawes
Current Portfolio:

BULLISH Play Updates

Itron, Inc - ITRI - close 60.86 change +1.03 stop 55.80

Target(s): 63.75, 65.00
Key Support/Resistance Areas: 42.00, 40.75, 39.50, 37.38, 34.70
Time Frame: 1 to 3 weeks

10/5: Let's remain patient and wait for the pullback in ITRI to enter long positions. I want to raise the trigger 15 cents to $59.50.

10/4: We are adding a long candidate engaged in the smart grid technology industry. This will also provide more balance in our portfolio as we currently have a firm short bias. ITRI has broken a downtrend line from its April highs and looks poised to make a run higher. The stock is consolidating above its 50-day and rising 20-day SMA's which should also provide support. ITRI has solid support near $59.00 so let's use a trigger of $59.50 (updated) to enter long positions. More nimble traders may want to consider a deeper pullback to the $58.00 area but I'm not convinced the stock will trade there prior to moving higher. If triggered our profit targets are +7% and +9.5% higher.

Suggested Position: Long ITRI stock if it trades up to $59.50

Options Traders: Buy November $60.00 CALL, current ask $1.60

Entry on October XX
Earnings 10/28/2010 (unconfirmed)
Average Daily Volume: 412,000
Listed on October 4, 2010

Logitech Intl. - LOGI - close: 17.39 change: +0.37 stop: 15.75

Target(s): 18.50, 19.50
Key Support/Resistance Areas: about every 50-cents (17.50, 17.00, 16.50)
Current Gain/Loss: Unopened
Time Frame: 3 to 4 weeks
New Positions: Yes, see trigger

10/5: The market is not following through on any dips. Buying LOGI at this level is a higher risk situation so I suggest we remain patient. Our trigger of $16.60 remains the same.

10/2: LOGI spent the better part of a year consolidating lower in a long, slow trend of lower highs and lower lows. It looks like the momentum has changed in the last couple of months. More recently LOGI has surged from $16.00 and created a new higher-high this past week. The move was fueled by short covering. LOGI has about 16% short interest. I believe there is more upside in store but we don't want to chase LOGI at current levels. Wait for a little dip and use a trigger to launch bullish positions at $16.60. We'll put the stop loss near the 50-dma. Our targets are $18.50 and $19.50. FYI: The recent rally has created a new point and figure chart buy signal with a $23 target.

Trigger to open positions @ $16.60

Suggested Position: Buy LOGI stock @ $16.60, stop $ 15.75

Entry on October xx
Earnings Date 10/27/10 (unconfirmed)
Average Daily Volume: 1.6 million
Listed on October 2nd, 2010

Noble Corp - NE - close 33.76 change +0.62 stop 32.85

Target(s): 33.95, 34.70, 35.90
Key Support/Resistance Areas: 36.95, 38.50, 33.50
Current Gain/Loss: -2.43%
Time Frame: 1 to 3 weeks
New Positions: Yes

10/5: I believe there is more selling to come in NE and think the stock trades lower before going much higher. I suggest readers remain cautious. Honor stops or use bounces as opportunities to exit positions. 33.95 and 34.70 are the immediate exit targets to consider.

10/2: Ouch! NE was downgraded again. That's the second time in two days. The early morning bounce failed at its 10-dma overhead but so far traders are still buying the dip at its rising 50-dma. Short-term indicators are suggesting the stock is rolling over. I'm worried that NE is headed for $32, which would means we would get stopped out at $32.85. Since we're already looking for a market pull back I'm not suggesting new bullish positions in NE at this time.

Current Position: Long NE stock, entry was at $34.60

Options Traders: Long October $36.00 CALL

Entry on September 15, 2010
Earnings 10/20/10 (unconfirmed)
Average Daily Volume: 3.7 million
Listed on September 11, 2010

iPath S&P 500 VIX ST Futures - VXX - close 16.43 change -0.93 stop 16.23

Target(s): 17.55, 18.45, 19.25
Key Support/Resistance Areas: 17.50, 19.75, 20.60
Current Gain/Loss: -7.18%
Time Frame: 1 to 2 weeks
New positions: Neutral

NOTE: I view this as an aggressive trade so small position size is recommended. Long VXX is a bearish play on equities, however, it is listed as long play because we are long the underlying instrument.

10/5: A surprise shift in monetary policy suggesting significant quantitative easing by the Bank of Japan caused volatility to collapse today. This provides more liquidity in the market and traders are feeling more and more comfortable buying stocks. If there is follow through tomorrow we will likely be stopped out of the position.

10/4: VXX is moving in our direction as the market sold off today. I suggest picking your exit and sticking with it. My primary targets are $18.45 and $19.25. If a market correction gains momentum VXX may surge higher than these targets but tightening stops and protecting profits at these levels is suggested. 10/2: The stock market posted +10% gains in September but upward momentum has stalled. Odds of a market pull back on the back of some disappointing Q3 earnings are pretty high and thus the VXX has a lot of potential to move higher. I don't see any changes from our previous comments, although I would be tempted to aim higher and set my first target at $18.75 and my second target at $19.90.

Current Position: Long VXX stock, entry was at 17.70

Entry on September 14, 2010
Earnings N/A (unconfirmed)
Average Daily Volume: 21 million
Listed on September 13, 2010

BEARISH Play Updates

FLIR Systems - FLIR - close 25.28 change +0.22 stop 27.55

Target(s): 24.25, 21.00
Key Support/Resistance Areas: 28.00, 27.00, 26.50, 25.50, 24.00
Current Gain/Loss: Unopened
Time Frame: 4 to 6 weeks
New Positions: Yes, see trigger

10/5: FLIR was downgraded today to Outperform from Strong Buy at Raymond James and the stock was a big underperformer compared to its peers and the broader market. There is resistance at $25.50. If FLIR breaks through this level it should trade up towards our trigger of $26.20 fairly. More nimble traders may want to try a short trade at current levels.

10/4: The stock got hit hard today closing down -2.64%. I suggest we lower the trigger to enter short positions to $26.20 which should act as a brick wall. If we are patient the trade should pay off.

10/2: In August shares of FLIR broke down from a huge consolidation pattern. The market's widespread rally in September lifted FLIR toward resistance but the stock couldn't breakout. Now shares are under performing their peers and the major indices. Aggressive traders could launch positions now. I think we'll get a better entry point if we wait for a bounce. I'm suggesting a trigger to launch bearish positions at $26.50. If triggered we'll use a stop loss at $27.55. Our first target is $24.25. Our longer, more aggressive target is $21.00 although you may not want to hold over the earnings report! FYI: The point and figure chart is bearish with a $17 target.

Trigger to open positions @ $26.20

Suggested Position: Short FLIR stock @ $26.20, stop loss @ $27.55

Entry on October xx
Earnings Date 10/21/10 (unconfirmed)
Average Daily Volume: 1.7 million
Listed on October 2nd, 2010

PowerShares QQQ Trust - QQQQ - close 49.66 change +1.18 stop 50.05

Target(s): 47.25
Key Support/Resistance Areas: 49.75-50.00, 47.25
Current Gain/Loss: -1.33%
Time Frame: 1 to 2 weeks
New Positions: Yes, with tight stops

10/5: The Q's surged more than +2% higher today. Our stop is just overhead so our loss will be limited if it is hit. If we are taken out watch $50.65 as another possible shorting opportunity with a double top bearish set-up.

10/2: Over the next three months I'm actually bullish on the market and the NDX (and QQQQ). Yet short-term this tech-heavy index (ETF) is very overbought and due for a correction. Normally trying to call tops and bottoms can be very dangerous but after a week of moving sideways it looks like the upward momentum is gone. I'm suggesting small bearish positions now. We'll use a stop loss at $50.05. Our short-term target is $47.25 (near the 38.2% Fib retracement). Once the QQQQ has reached our target I would switch directions and start looking for a bullish entry point somewhere in the $47-46 zone. My time frame for this pull back is less than two weeks. Readers may want to consider trading the options instead of the ETF.

Current Position: Short QQQQ stock, entry was at $49.01
Options Traders: Long November 47.00 PUT

Entry on October 4, 2010
Earnings Date N/A (unconfirmed)
Average Daily Volume: 77.6 million
Listed on October 2, 2010


Stifel Financial Corp - SF - close 47.20 change +1.90 stop 48.60

Target(s): 46.05 (hit), 45.05, 44.05
Key Support/Resistance Areas: 50.00, 48.00, 45.75, 45.00, 43.50
Final Gain/Loss: +5.20%
Time Frame: 1 to 2 weeks
New positions: Closed

10/4: SF gapped higher this morning and quickly sold off to our 2nd target of $45.05. We have closed the position for a +5.20% gain. SF proceeded to close nearly +5% off of its lows. With the news out of the Bank of Japan closing positions and protecting profits is the right thing to do.

10/2: The oversold bounce from the first half of September continues to fade. At the moment SF is clinging to short-term support near $46.00. When earnings start to come out this stock is likely to decline. Trading volumes for the third quarter were terrible and that doesn't bode well for a brokerage stock like SF.

9/30: SF tried to make run higher today but fell flat on its face. If the broader market corrects our more aggressive targets should be easily be reached. Our stop is above the 9/27 high so if we are wrong our loss will be small.

Closed Position: Short SF stock at $45.05, entry was at $47.52

Annotated chart:

Entry on September 23, 2010
Earnings: 11/09/2010 (unconfirmed)
Average Daily Volume: 250,000
Listed on September 22, 2010

Financial Sector SPDR - XLF - close 14.73 change +0.33 stop 14.75

Target(s): 13.85, 13.55
Key Support/Resistance Areas: 15.00, 14.60, 14.20, 13.70, 13.30
Final Gain/Loss: -2.01%

Time Frame: 1 to 2 weeks
New Positions: Closed

10/5: XLF broke out of a consolidation area from the past 8 days and hit our stop for a small loss. There has been no follow through lower in the broader market so we will step aside for a small loss. The next resistance area is $15.00.

10/02 (James): I don't see a lot of changes from our previous comments. The financial stocks have been a drag on the market but in the last few days stocks have been chopping sideways, including the XLF. The technical picture is a little muddy so I'm less include to launch new positions at current levels. Do I think financials will trade lower on a market pull back? Yes. Do I think the XLF will retest its lows near $13.35, of that I'm not very confident.

9/30: XLF spiked higher at the open but tanked the remainder the day, closing at its lows. We are short the ETF at $14.46. Any broader market correction should send XLF below $14.00 fairly quick and we have a tight stop if we are wrong. I've adjusted the targets up 10 cents each. My comments below have not changed.

Closed Position: Short XLF stock at $14.75, entry was at $14.46

Annotated chart:

Entry on September 30, 2010
Earnings: N/A (unconfirmed)
Average Daily Volume: 74 million
Listed on September 29, 2010