Option Investor

Daily Newsletter, Tuesday, 11/16/2010

Table of Contents

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

Market Wrap

What A Revolting Development

by Jim Brown

Click here to email Jim Brown
Traders looking for an excuse to take profits did not have to look far today. China, Ireland, Portugal, economics and currencies combined to knock the U.S. markets back to support.

Market Statistics

China took top honors as a market mover this morning after a central bank governor said the country might resort to price fixing on commodities to contain inflationary pressures. China's inflation rate at 4.4% is the highest in two years but still inline with the average for the last 16 years at 4.25%. He said the government was preparing a one-two punch to rein in inflation.

These comments are designed to cause the U.S. economic pain. China is angry because of our quantitative easing and the forced decline of the dollar. China enjoys an artificially low currency and the developed nations have been trying to get China to raise the value of their currency for several years. They only made token efforts because they want their currency to be cheap compared to other nations so their exports will be more attractive on the world markets.

When the Fed announced QE2 China went ballistic. (Actually they did, more in a minute) They have been slamming the U.S. in the press for allowing our dollar to decline in value. How dare we push our currency closer to theirs and sabotage their competitive advantage.

They claim we are exporting inflation to other countries because we are trying to export our way out of our massive debt. That has been standard procedure for over 100 years and not just from the U.S. but anyone with a high deficit and control of their own money.

Global commodities like grains, meats, cotton, metals and oil are priced in dollars. By cheapening our dollar we are forcing prices on commodities to rise because it takes more dollars to buy the same bushel, ton, barrel or yard of that commodity. This is a fact. It is not open for discussion. This is why the topic of currencies was high on the list of problems at last week's G20 meeting.

In China's case they are supposedly planning multiple actions to restrain prices. One is fixing the price of commodities. As the world's biggest user of commodities a fixed price would be a knockout blow to the value of those commodities. Let's say they fixed gold at $750 an ounce and refused to allow purchases over $750. What do you think would happen to gold on the open market? Obviously that is an exaggerated example but you get the point. Now apply that to cotton, corn, wheat, soybeans and hogs and China could depress the entire U.S. economy very quickly in retaliation for the QE program.

All of these types of actions have repercussions not only to the U.S. but to the entire world and it would hurt China in other ways but evidently they think they have the power to deal with it.

The central bank governor said additional steps could include severely punishing people caught trading in corn or cotton. When they say severely you can bet it is really severe. China's food inflation rose +10.1% in October so they have a real problem. China used food price controls in 2007 with limited effect when inflation spiked.

Commodity prices completed their biggest five-day decline since July 2009 on worries about what China will actually do. The decline was led by nickel, wheat and aluminum. Wheat suffered the biggest decline in three months, copper four months. Gold hit a two-week low. From China's perspective their commodity costs have already declined sharply in the last several days. I am sure they love this move and will postpone their actual announcement in order to get the most impact.

CRB Commodity Index Chart

Chart of Gold

For China it is all about the dollar. If they can push the dollar higher then they win by keeping their currency low. In this battle they are fighting the Fed but they may actually have more weapons than the Fed. The dollar has shot up sharply with every statement from China and this week China has received help in the form of new problems in the EU. This forces the Euro lower and the dollar higher.

Dollar Index Chart

Lastly, you may have heard about the mystery missile launch 35 miles off the coast of California a week ago just before the G20 meeting. The U.S. military chiefs all canceled their engagements and spent two days in closed-door meetings. People familiar with the meetings claim they were trying to decide how to deal with the Chinese missile launch. Official government reports said it was a jet and not a missile or maybe an optical illusion. Fortunately KCBS TV caught it on video and it is all over YouTube.

The unofficial conclusion arrived at by numerous private security groups is that it was a missile fired from a Chinese sub 35 miles off the coast of Los Angeles at 5:30 on a Friday afternoon when there were millions of people commuting. Three star general Tom McInerney said it was absolutely a sub launched missile that exhibited a classic mid course correction as the guidance system kicked when it reached escape velocity.

"Off the record" officials claim China was warning the U.S. not to do anything stupid at the G20 meeting. On the same day China downgraded our debt to A+ from AA claiming we have no intention of repaying our debt and our rapidly deteriorating debt repayment capability. "The serious defects in the U.S. economic model will lead to a long term recession of its national economy, fundamentally lowering the national solvency."

We are in a war with China and these antics are likely to cause the "currency manipulator" label applied to China by Congress. That legislation has already been passed by the house and it will probably be resurrected and pushed forward. It calls for specific penalties against China and will increase the current market anxiety.

Helping China in pushing the dollar higher was another wave of EU debt problems. Last week we found out that the situation in Greece was worse than originally thought after an audit of their books showed they were even deeper in debt than previously believed. This week Austria threatened to back out of a progress payment to Greece as agreed several months ago. Greece received a $149 billion bailout from the EU and IMF back in May. Those funds were scheduled to be paid in installments as Greece reached certain goals in cutting expenses and raising revenue. The Austrian Finance Minister said Greece is not making the required progress and they see no reason to give more money to Greece as the odds of repayment decline. Greece responded they would try and keep the budget shortfall to 9.4% instead of the 7.8% they had agreed to in order to get the first set of payments. More than 50% of analysts believe Greece will eventually default.

The Greek problem is contaminating other EU countries. Ireland is next in line for a bailout if you believe the EU administration. Ireland claims it does not need one but the sharks are circling and the EU wants to bailout Ireland before the contamination spreads to other EU countries. When everyone in the EU uses the same Euro currency a decline in one country drags down the currency for everyone else. Irish bond yields have skyrocketed in recent weeks on growing expectations for a default.

Ireland claims it does not need a bailout but the Irish banking sector is circling the drain. If something is not done soon the sector could implode and take other EU banks with them. Remember, the biggest assets most EU banks have is loans to other EU nations. Knock one domino over and several more could follow. The ECB is currently supporting all the EU banks but analysts fear the rescuer could be in trouble if they don't act quickly to stop the bleeding.

There was a meeting late today in Brussels where the EU ministers tried to force a bailout on Ireland. Analysts believe Ireland needs a minimum of 70 billion euros to shore up the current banking crisis. Ireland's public debt is 30% of GDP, 10 times the permitted EU limit and double that of Greece. The EU president Hermany Van Rompuy warned the crisis could endanger the entire 27-nation union. They fear further contagion to Portugal followed by Spain. Ireland does not want a bailout because it would come with tough conditions and forced austerity similar to that forced on Greece. 24 of the EU's 27 states are running deficits way above the EU limits.

The news from China and the EU was pretty negative for the U.S. markets. Unfortunately we had some negative economics of our own to deal with. The Producer Price Index for October came in with a headline number of +0.4% but the core prices for finished goods fell by -0.6%. That is the biggest drop since Oct-2009. Energy prices rocketed higher with a +9.8% jump in gasoline prices. Core crude goods are now up +26% from year ago levels. Airline travel was up +4.2%. Everywhere you look in this report were strong signs of future inflation. The Fed should be worried. Fortunately the spikes are from such low levels it will be several months before they become a real problem.

Industrial Production was flat for October compared to a -0.2% for the prior month. Unfortunately analysts were expecting a +0.4% gain. The majority of the drag came from a drop of -3.4% in utility output. That should be a welcome sign for consumers if the cost of gas and electric is declining. Manufacturing alone rose a decent +0.5% so there was a silver lining.

On the positive side the NAHB Housing Market Index rose by one point to 16 and it would have been more except for a -4 point drop in the Northeast. The Midwest rose +5 points and the west +3 points. Buyer traffic increased slightly and the expected sales component improved from 23 to 23. We are really grasping at straws here to find something positive in the housing sector but there are some faint signs of continued improvement.

There was some positive stock news today but it was very minimal. Home Depot (HD) reported earnings that grew +24% to 51-cents on a 21% rise in revenue. Shares of HD rose +2.7% early in the day but declined into the close to post only a fractional gain.

Wal-Mart rallied after reporting profits that rose +9.3% and predicted Q4 same store sales would rise for the first time in the last six quarters. Wal-Mart said it will continue striving to be the lowest price seller in every market it serves. More than 68% of its customers have household incomes under $70,000. Net income rose to $2.44 billion or 95-cents per share. Analysts were expecting 90-cents. Wal-Mart said Q4 earnings would be in the range of $1.29 to $1.33 and analysts were expecting $1.28. Q3 sales were $62.2 billion. Sales are booming outside the U.S. with same store sales up +9.3%. WMT shares closed fractionally higher.

The big winner for the day was Urban Outfitters (URBN) with a +12% gain, +3.90. URBN posted earnings on Monday after the close and beat the street by a penny. Despite a significant drop in gross margins the stock spiked higher. Tonight they announced a ten million share buyback program and shares are up again in after hours.

Government Motors (GM) seized on the opportunity surrounding the IPO to bail out the government. Today GM announced it had upsized its IPO by adding another 113 million shares. Those shares will come from the government's stake (100M shares) and from the UAW stake (13M shares). The +30% increase in shares to 478 million and the hike in the anticipated price means GM will get about $22.4 billion and the IPO will be the biggest in U.S. history. Visa's was $19.7 billion in 2008. The midrange of pricing was raised to $32.50. Government ownership will still be sizeable at 26%.

In the daily hunt for an excuse to sell the market there was no shortage today. Unfortunately with the ones that mattered the most, China and the dollar, there is not much we can do. This undeclared war with China could last for weeks or even months because geopolitics moves at the speed of molasses on a cold day. It is parry and thrust then sit quiet for a week or two while you consider your next move and analyze the response from the other side. I hope it stays just that boring and does not escalate to trading missile launches and targeting each other's spy satellites. BTW, did you know that the U.S. loss contact with more than 50 nuclear missiles of its own about three weeks ago. The communications breakdown was attributed to Chinese hackers testing an intrusion program. The farm house in the country is starting to look a lot better every day.

The markets sold off hard on the multiple excuses but came to a solid stop at support. Dow 11000 and S&P 1175 were rock solid. This is exactly where they should have stopped but unfortunately there is no material reason for a rebound on Wednesday. All of these problems are still going to exist. The key for the market will be a decision by the bulls that the sudden stop at support is worth buying.

I have warned we could test 1175-1190 and 11000 on the Dow. I also said I would be a buyer of a dip to those levels and I am still a believer tonight. I am not surprised we reached those levels but I am surprised at the ferocity of the excuses. To wander down that low on a couple of missed earnings reports would have been perfect. To slam -200 points on potential price controls on commodities by China is a different matter. You have to consider the reasons for the declines as well as the levels reached.

Fortunately the magnitude of the decline has forcefully liquidated quite a few longs and millions of stop losses have been hit. That means there is extra cash in those trading accounts and we have a lot more traders ready to jump back in on the next rebound.

I am running long on time tonight so I will cut this short. The S&P came to a dead stop at 1175 but there was no material rebound. Normally when a key support level is tested so violently and holds there is an end of day short covering rebound. No rebound, no shorts covering. That worries me.

Secondly volume was high at 9.5 billion shares and the internals were horrible. Declining volume of 8.5 billion shares was 10:1 over advancing volume of 851 million shares. The new 52-week highs of 55 were the lowest since June 29th. The decline is broad based and the imbalance in volume should have triggered a capitulation rebound. The 25% retracement of the two-month rally was 1180. That threshold has been reached and passed. Now we are in danger of fulfilling that double dip formation I outlined on Sunday. I still believe it is unlikely but the possibility has increased.

While I believe we should see the markets recover we are at a pivotal point on the charts. Any further decline under 1175 on the S&P would be a short signal. Any rebound from here should be bought. It is rare when we get a signal so clear so we should be prepared to act on it when it occurs.

S&P Chart - 90 Min

S&P Chart - Weekly

S&P Chart - Daily

The Dow broke support at 11072. This was the 25% retracement level and continued to a dead stop at 11000. This is also a critical level for the market at least psychologically. A decline under 11000 would be seriously negative for sentiment. The next material support could be in the range of 10700 and a 50% retracement of the rally.

With Cisco ruining it for techs and commodities taking out another ten Dow stocks and financials declining on the bond/currency problem there is a lot of Dow risk here.

Dow Chart - 90 Min

I don't have anything positive to say about the Nasdaq other than it came to a dead stop on the 25% retracement level at 2469. With Dell's earnings on Thursday there is a potential bright spot but we thought that about Cisco too.

A break of 2469 targets 2420 and the support from March and May. I think the Nasdaq is the weakest link and we need to key off the S&P rather than techs.

Nasdaq Chart - 90 Min

The Russell remains our beacon of hope with strong support at 700 still untouched. The spike may have eroded but it took a week of selling and the Russell is still well above the other indexes on a relative basis. The -2% decline today was not that bad considering a real sales event could have knocked off substantially more if money managers lost their nerve. As long as the Russell holds over 700 I will retain a tinge of bullishness.

Russell Chart - 90 Min

In summary the China problem is not over. They have not even formally announced their so-called "one-two punch" of coordinated actions to restrain inflation. There is no telling what they have up their sleeve or how the market is going to react to it. The markets will eventually ignore the EU debt problems but they can't ignore China's actions. Whatever they do to commodities will be felt in U.S. equities. The EU debt problem causes a rise in our currency but the QE2 program will eventually fix that. A serious clamp down on inflation by China is a problem we can't fix. We depend on China today to power the global economy. They are in recovery with 10% GDP and we are struggling at 2%. Our economy may be larger but they are the tail wagging the dog today.

I would look to buy a bounce from 1175 and short a break of that level.

Jim Brown

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New Plays

Dip or Reversal?

by James Brown

Click here to email James Brown
Editor's Note:
Traders have been waiting for a real correction for weeks so they could "buy the dip" as an entry point into the fourth quarter. Now stocks are sinking on a number of different worries. Yet the market is holding near support levels with the S&P 500 in the 1185-1175 zone. Is this the dip we've been looking for? Unfortunately, my crystal ball is a little cloudy.

If the correction continues we will see the S&P fall into the 1160-1150 zone, its next major zone of support. I want to see how the market behaves tomorrow before adding new candidates to the Premier Investor newsletter.


In Play Updates and Reviews

CSCO Sinks

by James Brown

Click here to email James Brown

Editor's Note:
Tech giant CSCO sinks to new relative lows but some stocks did not participate in the market's widespread declines. I have dropped CVS as a bullish candidate. MSFT is nearing our entry point.


Current Portfolio:

BULLISH Play Updates

Alcoa Inc - AA - close: 13.03 change: -0.37

Stop Loss: 12.45
Target(s): 14.95, 15.95
Current Option Gain/Loss: - 1.1%
Time Frame: 6 to 8 weeks
New Positions: Yes, but see below

11/16: Our new play in AA has been opened but I'm not sure we want to be long any more. The debt worries in Europe is pushing the euro lower, which fueled a big gain for the U.S. dollar. A rising dollar is normally bad for commodities. Plus there is talk that China wants to put caps on commodity prices. The CRB Commodity index took a tumble.

Shares of AA gapped open lower at $13.18 and dipped toward its simple 40-dma before paring its losses. Our trigger was at $13.20 so the play was opened first thing this morning. Technically this looks like a new bullish entry point but given the market's decline today readers may want to take a wait and see approach first.

Current Position: Long AA stock @ 13.18


Entry on November 16 at $13.18
Earnings Date 01/10/11 (unconfirmed)
Average Daily Volume: 26.1 million
Listed on November 6th, 2010

Citigroup Inc - C - close 4.22 change -0.10

Stop Loss: 4.08
Target(s): 4.60, 4.75, 4.95
Current Option Gain/Loss: + 1.4%
Time Frame: 4 to 6 weeks
New Positions: NO

11/16: Banks were easy targets for the bears with most banking stocks falling about -2%. Shares of C gave up -2.3% but found support near $4.20 as expected. I'd wait for a dip or bounce near $4.10 as a potential entry point.

Current Position: Long C stock, entry was at $4.16
Options Traders: Long December $4.00 CALL

Entry on October 27, 2010
Earnings Date 01/19/11 (unconfirmed)
Average Daily Volume: 523 million
Listed on October 25, 2010

Hansen Natural Corp. - HANS - close: 49.63 change: -0.02

Stop Loss: 47.25
Target(s): 51.75
Current Option Gain/Loss: unopened
Time Frame: 6 to 8 weeks
New Positions: Yes, see trigger

11/16: I'm somewhat impressed by HANS' relative strength. Shares are holding above the 20-dma and closed virtually unchanged on the session. I still don't want to open positions here. Look for a dip toward $48.00 and its rising 50-dma. Keep your positions small to limit your risk.

Earlier Comments:
Use a trigger at $48.25 to buy HANS or buy calls. If triggered we'll use a stop loss at $47.25.

Suggested Position: BUY the stock at $48.25

- or -

BUY the December $50.00 calls (on a dip at $48.25)

Entry on November xx
Earnings Date 11/04/10 (confirmed)
Average Daily Volume: 4.5 million
Listed on October 16, 2010

Kroger Co. - KR - close 22.44 change -0.41

Stop Loss: 21.45
Target(s): 23.70, 24.75
Current Option Gain/Loss: - 0.49%
Time Frame: 6 to 8 weeks
New Positions: Yes, but see below

11/16: Market wide declines have pulled KR back down toward support near $22.50. The close under this level is short-term bearish and I suspect KR may retest the $22 area and its 50-dma soon. While today's dip looks like a new entry point to open positions I'd rather wait for a dip (or bounce) near $22.00 instead.

Current Position: Long KR stock @ 22.55

Entry on November 9th @ 22.55
Earnings Date 12/8/2010 (unconfirmed)
Average Daily Volume: 6 million
Listed on November 3, 2010

Microsoft Corp. - MSFT - close: 25.81 change: -0.23

Stop Loss: 24.90
Target(s): 27.45, 29.00
Current Option Gain/Loss: unopened
Time Frame: 8 to 10 weeks
New Positions: Yes, see trigger

11/16: MSFT almost hit our trigger today with a dip to $25.65. I am tempted to lower our trigger down to the 50-dma near $25.40 or even the $25.00 level. However, I'm suggesting we keep our trigger to buy MSFT at $25.55 and we'll just raise our stop loss to $24.90.

Suggested Position: buy MSFT stock @ 25.55

- or -

Buy the 2011 January $25.00 calls (symbol: MSFT1122A25) current ask $1.70

Entry on November xx at $xx.xx
Earnings Date 01/27/11 (unconfirmed)
Average Daily Volume: 68.4 million
Listed on November 15th, 2010

Onyx Pharmaceuticals - ONXX - close: 29.51 change: -0.28

Stop Loss: 26.45
Target(s): 32.00, 34.50
Current Gain/Loss: unopened
Time Frame: 8 to 10 weeks
New Positions: Yes, see trigger

11/16: ONXX was downgraded to an "underperform" this morning but shares really didn't react that much to the headline. ONXX is holding up pretty well but if the market corrects much further I am expecting ONXX to participate and retest support near $28.00. We want to buy a dip at $28.60. Patient traders could wait for a dip closer to the $28.00 mark instead. If triggered our first target is $32.00.

Suggested Position: Buy ONXX stock @ 28.60

Entry on November xx at $xx.xx
Earnings Date 02/23/11 (unconfirmed)
Average Daily Volume: 1.1 million
Listed on November 13th, 2010

Tractor Supply Co. - TSCO - close: 40.46 change: -0.07

Stop Loss: 38.75
Target(s): 44.75
Current Option Gain/Loss: unopened
Time Frame: 6 to 8 weeks
New Positions: Yes, see trigger

11/16: Profit taking in TSCO was very mild on Tuesday. The stock is inching closer to our preferred entry point at $40.10. Nimble traders could try and time an entry on a dip near the rising 50-dma (currently $39.15).

Buy-the-Dip Trigger @ $40.10

Suggested Position: Buy TSCO stock @ 40.50

Entry on November xx at $xx.xx
Earnings Date 01/27/11 (unconfirmed)
Average Daily Volume: 751 thousand
Listed on November 11th, 2010

SPDR Financial ETF - XLF - close 14.76 change -0.25

Stop Loss: 14.45
Target(s): 17.25
Current Option Gain/Loss: - 3.2%
Time Frame: 6 to 8 weeks
New Positions: Yes

11/16: Financials were hit hard by profit taking with most banks falling about -2%. Shares of the XLF slipped -1.66%. Today's close under the simple 200-dma is bearish but the XLF managed to bounce back above its 50-dma. I have been warning readers to look for a dip near $14.70. Technically this looks like a new bullish entry point to buy this ETF but readers may want to take a wait and see approach.

Earlier Comments:
You might want to buy call options instead of the ETF because the XLF doesn't move very fast (I'm thinking the 2011 January calls).

Current Position: Long the XLF (etf) @ 15.25

- or -

Options Traders: Long the 2011 January $15.00 call, entry @ $0.85

Entry on November 9th @ 15.25
Earnings Date N/A (unconfirmed)
Average Daily Volume: 83 million
Listed on November 4, 2010

BEARISH Play Updates

Corporate Office Properties - OFC - close: 34.27 change: -0.75

Stop Loss: 37.05
Target(s): 32.25, 30.25
Current Change: - 2.28%
Time Frame: 6 to 8 weeks
New Positions: Yes

11/16: Tuesday's market declines were enough to finally push OFC out of its trading range and into new relative lows. Shares lost -2.1%. If you're looking for a new entry point watch for a bounce or failed rally under $35.00.

Current Position: Short OFC stock @ 35.07

Entry on November 10 at $35.07
Earnings Date 02/09/11 (unconfirmed)
Average Daily Volume: 1.0 million
Listed on November 9th, 2010


Cisco Systems - CSCO - close: 19.44 change: -0.52

Stop Loss: 19.75
Target(s): 22.25, 23.75
Current Gain/Loss: -3.0%
Time Frame: 6 to 8 weeks
New Positions: No

11/16: Our CSCO trade didn't last long. I guess not everyone believes all the bad news has already been factored into the share price. The stock gapped open lower at $19.88 and quickly fell to new 52-week lows, hitting our stop loss at $19.75 and closing this trade. The breakdown in CSCO looks pretty bearish. The next level of support seems to be the $18.00-17.75 zone.

Closed Position: Long CSCO stock, Entry @ 20.37, exit @ 19.75 (-3.0%)
- or
Long the 2011 January $20.00 calls (symbol: CSCO1122A20) entry @ $1.24, exit near $0.85 (-31.4%)


Entry on November 15 at $20.37
Earnings Date 02/03/11 (unconfirmed)
Average Daily Volume: 72 million
Listed on November 13th, 2010

CVS Caremark Corp. - CVS - close: 29.65 change: -0.40

Stop Loss: 30.45
Target(s): 33.50, 34.90
Current Option Gain/Loss: unopened
Time Frame: 6 to 8 weeks
New Positions: no

11/16: I'm giving up on CVS as a bullish candidate. Shares closed at new relative lows. The stock never hit our trigger to open positions.

Entry on November xx at $xx.xx *Never Opened*
Earnings Date 02/08/11 (unconfirmed)
Average Daily Volume: 10.1 million
Listed on November 8th, 2010