Option Investor

Daily Newsletter, Thursday, 11/18/2010

Table of Contents

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

Market Wrap

Bears Beaten Badly

by Jim Brown

Click here to email Jim Brown
After a week of declines the bears had plenty of time to load up on their shorts. After today's short squeeze they are regretting that decision.

Market Statistics

I wish I could say today's rally was due to an acceptance of positive economic data and a positive outlook for the future. While there was some of that, the real motive power was a simple short squeeze driven by better news from Ireland and China. It was purely a news driven squeeze and I saw very little evidence of bullish buying.

All the gains came in the first 45-minutes of trading and resistance at Dow 11,200 was rock solid. This was a textbook short squeeze. After the week of declines the Dow found solid support at 11,000 where it stabilized for two days. The bears were loading up on Wednesday at the close and they suffered when the overseas news sent futures up +12 points overnight. The opening spike higher came to a dead stop at 11,200 with no follow on buying by investors. It was just a short squeeze and not a change in investor sentiment.

Dow Chart - 15 min

There were two major news items from overseas that helped power the squeeze. The Irish debt problem took a positive turn when Ireland acknowledged it was seeking aid from international lenders, the IMF, ECB and the European Union. A team from those groups were meeting in Dublin today to discuss the terms of any bailout. A spokesman for the Irish central bank said the talks would lead to a loan in the tens of billions of euros.

Residents and investors had been losing confidence in banks and the bailout would recapitalize the banking sector as well as ease the debt problem. Ireland has been attacking its debt problem at a more aggressive rate than other EU countries so getting a loan is not expected to be a problem. The British government also signaled it could provide direct financial aid to Ireland.

The sudden rush by major entities to bail Ireland out of its fiscal mess was a strong positive for an equity market that had declined for a week on worries of a default.

Adding to the relief rally was positive news out of China. The markets had been worried that China would announce some radical new actions to curb inflation. On Thursday morning China's premier tempered those fears by saying things like "China will implement actions if necessary to restrain future inflation." The "if necessary" phrase seemed to indicate there was no rush to act and it toned down the expectations for drastic actions. The Shanghai composite had declined -10% over the last week on worries about impending actions. It was necessary for the premier to calm the markets rather than bash them with a huge anti-inflation club.

China also enacted some price controls for food that were much less severe than had been expected. The premier said China would work to increase stockpiles of food commodities to offset future price pressures. That was a positive because is suggested China would be active in the market and buying large amounts of grain and food stocks. The fear over potential market crippling actions was extremely overdone and the result of the premier's comments was a relief rally. Asian markets finished strongly positive. The Hang Seng gained +422, Nikkei +202. Commodities soared on the news. Corn and soybeans gained over 3% each with wheat up +2%. Rice spiked nearly 3%. Cotton was up +4% and sugar +6%.

In the U.S. the positive economic data added to the early morning market sentiment. The Jobless Claims were 439,000 and slightly less than expected. Claims have been trending down for several weeks so this was market positive.

The Philly Fed Survey spiked more than 21 points to 22.5 and equaled its highest level since 2005. New orders gained 15.4 points to rocket back from a minus 5.0 in October to a positive10.4 and the employment component jumped to 13.3 from 2.4. Backorders rallied back to positive territory at 3.7 from a negative 8.9 in October. The headline of business conditions has rebounded nearly +30 points from -7.7 in August to the 22.5 in November. This was solid report and suggests the national ISM in two weeks could also see a dramatic improvement. Estimates are for a strong +5 point increase to 53.7 for November.

Philly Fed Chart

The Mortgage Bankers Association said mortgage delinquency rates fell to 9.13% in Q3 for the second consecutive quarterly decline. Also, the number of homes currently delinquent more than 90 days declined from more than 4 million in Q2 to 3.8 million in Q3. Burrowing down a bit showed that 13.31% of prime adjustable mortgages were still delinquent and 29.8% of subprime adjustable mortgages were behind in payments. Both numbers have declined slightly.

This shows the housing sector is improving steadily but until jobs begin to improve it is going to be a long process. Lenders still have nearly three million home foreclosures to process before the pace of buying can actually impact prices. Mortgage interest rates are at 50-year lows and the Fed plans on keeping them at that level well into 2011 in hopes of making a dent in the housing glut. For those with credit this is a once in a lifetime opportunity.

There are no economic reports of note on Friday but Ben Bernanke will be giving a speech in Europe on monetary policy. His speech is 5:15 ET so whatever he says will have a bearing on our open.

After the bell today Dell reported earnings of 45-cents compared to analysts estimates of 32-cents. This was strong but revenue missed the market. Revenue was $15.39 billion compared to street estimates of $15.74 billion. Dell shares rallied +7% in after hours. Gross margins rose to 19.5% from 16.8%. Dell guided analysts to revenue growth in the middle of its prior range of 14% to 19%. That was slightly below analyst estimates.

While Dell crushed the earnings the mediocre guidance and slight miss on revenue was far from bullish. However, they did not repeat Cisco's warning. Apparently Dell does not have the same problems that Cisco reported. Other companies like Juniper and F5 Networks have also avoided the Cisco flu. This suggests the Cisco problem is simply a Cisco problem and not one that is impacting the entire tech sector. This should be positive for the market because it downplays the Cisco weakness.

There are continuing rumors that Michael Dell is considering taking Dell private. The business has changed since Michael started it in his college dorm room. If he takes it private the estimate is for $16 per share so the upside is limited from here. I would rate Dell an avoid because the upside is limited. If Michael thinks the future will improve he is more likely to take it private now. If he thinks the sector is going to weaken he will probably delay his move in hopes of getting a cheaper price later.

Dell Chart

Salesforce.com posted earnings of 32-cents compared to estimates of 31-cents. However the stock is up +$10 in after hours because they raised guidance for revenue to $448 million compared to street estimates of $425 million. Revenue growth for Q3 was up better than 30%.

Intuit (INTU) reported a loss of 12-cents, which was inline with estimates. The loss was attributed with the seasonality of the tax preparation business. Shares of INTU declined about $2 in after hours.

Gap (GPS) declined slightly in after hours after reporting earnings of 48 cents that was inline with estimates. Same store sales were flat and the CEO said sales trends were still choppy and competition for holiday sales would be fierce. He said they were not expecting Q4 sales to be any better than Q3. This level of pessimism is going to weigh on the stock. The company said it was making a huge investment in black denim and accessories for the holiday season. Analysts said this was a risk since holiday apparel is normally bright and cheerful.

GM finally completed its IPO and in doing so sucked all the energy out of the market. The stock opened at $35 and climbed to $35.99 almost instantly and then declined for the rest of the day to close at $34. That is supposedly a level where the underwriters will mount a defense in hopes of keeping the price over the IPO price of $33.

The GM IPO sucked about $23 billion out of the market. Some analysts feel this was a minor factor in the market decline over the last week as investors dumped other stocks to make room for their allotment of GM shares. Apparently quite a few investors were looking only for a quick flip since 458 million shares were traded out of the 478 million shares offered. Anyone who did not get an allotment in the IPO and bought at the open this morning is losing money tonight. GM may be profitable but they are still under the government's thumb. GM shares will have to rally to $50.50 for the government to break even on their remaining $28.8 billion unpaid balance. The government still owns 554 million shares.

GM Chart

The GM IPO was credited with taking the fizz out of the rally. That much money going into a single stock is a drag on the market. Late today Burlington Coat Factory pulled a $1.5 billion debt offering for lack of interest. Harrah's Entertainment is reported to be pulling their IPO because there is a lack of interest at the $15-$17 price. These casualties come from scheduling your events in the same week that GM sucked all the IPO money out of the market. Harrah's may be rescheduled for late next week but that is hearsay.

If GM's IPO had rallied to close higher analysts claim that would have invigorated the IPO market. The decline to close on the lows depressed the market. Anyone who bought the open and put in a stop could have already been knocked out of the trade.

After hours futures are flat and suggesting traders don't have a clue what the market is going to do on Friday. The short squeeze today demoralized the bears but the dead stop at S&P-1200 was a warning for the bulls as well.

The better than expected economics continue to paint a picture of a slowly improving economy and one that may actually be accelerating but comments like we saw from the Gap tonight are depressing sentiment. Supermarket chain Ahold missed earnings by a mile and warned not to expect a U.S. recovery anytime soon. The CEO said weak competitors were getting weaker because of fierce competition for the available consumer dollars. He blamed high unemployment for the decline in supermarket sales.

Those kinds of negative guidance are keeping investors from rushing back into the market despite a bounce off critical support at 1175. It was just a short squeeze and not a sentiment change.

What we do have now is a clear chart pattern from which to trade. The bottom end of the range is that 1175 support and the top end 1200. A breakout in either direction would be a clear trading signal. If the Fed would take a couple billion of its QE2 cash and buy enough equities on Friday to push the S&P over 1200 I think that would be a spark for a year-end rally. I am not holding my breath.

All the option expiration pressures should be behind us but we still need to get the actual expiration out of the way on Friday. We rarely have big moves on an expiration Friday or the following Monday so the best guess is a range bound market until next week. The closing print worries me because the spike is very unsupported and precariously perched on the edge of a cliff. The Bernanke speech at 5:15 Friday morning could upset that delicate balance. Without some external news event I believe the path of least resistance is a slight decline on Friday.

S&P-500 Chart

The outlook for the Dow is rougher than the S&P. The Dow has stronger resistance to overcome at the 11,200-11,225 level. Producing a move over that 11,225 resistance could require an even larger news event. Of course a return to a rapidly falling dollar would help. The range on the Dow is clearly 11,000 to 11,225 and I would bet that range is honored on Friday. However, should we get a news event that pushes the Dow over 11,225 it could trigger significant short covering and follow on buying.

Dow Chart

In my opinion the Nasdaq chart is neutral. The short squeeze looks almost like a cliff diver launching into a jackknife before plunging to the depths below. I doubt that formation description will make it into the technical trading books. The spike took the Nasdaq back over the 2500 level and that should be support but a lot depends on the big techs following through on gains they made today. AMZN, AAPL and GOOG were all weak into the close but still up strongly for the day. Traders that bought the dip on Tue/Wed may be interested in taking profits ahead of the weekend just to be safe.

A dip back below 2500 is a serious danger signal for me.

Nasdaq Chart

In summary I believe today was all squeeze and no substance. Since Friday is expiration the volatility will all be at the open and then decreasing volume the rest of the day. Normally the markets trade in a narrow range on expiration Friday and again on the following Monday. However, Thanksgiving week is normally bullish. How traders will position themselves ahead of next week is unknown but I do expect to see the market move up next week unless we get some more bad news from overseas. Overall, I am still in buy the dip mode to S&P 1175.

Jim Brown

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New Plays

Semiconductor Equipment

by James Brown

Click here to email James Brown
Editor's Note:
After breaking out from a major trading range this semiconductor stock looks poised for more gains.



Lam Research - LRCX - close: 46.03 change: +1.30

Stop Loss: 42.75
Target(s): 48.50, 52.50
Current Option Gain/Loss: unopened
Time Frame: 8 to 10 weeks
New Positions: Yes, see trigger

Company Description:
Lam Research Corporation is a major provider of wafer fabrication equipment and services to the world’s semiconductor industry. (source: company press release or website)

Why We Like It:
The SOX semiconductor index still looks a little overbought with its September through November rally but the index has seen a -5% correction. Shares of LRCX have seen a -9% correction and look a lot healthier with a bounce from support near $44.00. LRCX was stuck in a major trading range between $35 and $44 for months. The breakout from this range looks very bullish. The Point & Figure chart is forecasting a $71 target. The current bounce in LRCX looks like a bullish entry point but I would rather wait for a little dip. I'm suggesting a trigger to buy LRCX (or calls) at $45.25. We'll use a tight stop loss at $42.75 near the 50-dma. More conservative traders could probably use a stop a lot closer to the $44.00 level. If triggered our first target is $48.50.

Suggested Position: Buy LRCX stock @ 45.25
- or -
Suggested Position: Buy the 2011 January $45 calls (LRCX1122A45)

Annotated chart:

Entry on November xx at $xx.xx
Earnings Date 01/27/11 (unconfirmed)
Average Daily Volume: 4.5 million
Listed on November 18th, 2010

In Play Updates and Reviews

Commodities Surge

by James Brown

Click here to email James Brown

Editor's Note:
A drop in the dollar helped send commodities surging higher, especially the metals. Our AA play is looking stronger. Unfortunately most of the stocks that did rally today saw the rise fail near overhead resistance. I remain cautiously bullish here.


Current Portfolio:

BULLISH Play Updates

Alcoa Inc - AA - close: 13.38 change: +0.44

Stop Loss: 12.45
Target(s): 14.95, 15.95
Current Option Gain/Loss: + 1.5%
Time Frame: 6 to 8 weeks
New Positions: Yes, but see below

11/18: It was a strong day for commodities and the metals. This was due to a drop in the dollar and China backing away from recent comments about price caps on commodities. The market's big bounce didn't hurt either. AA gapped open at $13.21 and posted a +3.4% gain by the closing bell. If you're looking for new positions I would wait for another dip toward the $13.20-13.00 zone.

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

Abercrombie & Fitch - ANF - close: 46.68 change: -0.38

Stop Loss: 43.95
Target(s): 49.95
Current Option Gain/Loss: unopened
Time Frame: 8 to 10 weeks
New Positions: Yes, see trigger

11/18: The RLX retail index ended the session with a gain but the sector trailed behind the rest of the market thanks to a terrible earnings miss by Sears (SHLD). Many of the high-flying retailers actually saw some profit taking today. ANF spiked to $48.00 this morning but closed with a -0.8% loss. I am still suggesting a trigger to open bullish positions at $46.10.

Trigger to buy ANF @ $46.10

Suggested Position: Buy ANF stock @ $46.10

Entry on November xx at $xx.xx
Earnings Date 02/15/11 (unconfirmed)
Average Daily Volume: 3.1 million
Listed on November 17th, 2010

Citigroup Inc - C - close 4.30 change +0.11

Stop Loss: 4.08
Target(s): 4.60, 4.75, 4.95
Current Option Gain/Loss: + 3.3%
Time Frame: 4 to 6 weeks
New Positions: Yes

11/18: Financial stocks saw a decent bounce today and Citigroup outperformed the banking indices with a +2.6% gain. Readers can buy this bounce or look for a dip near the $4.25-4.20 zone.

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: 50.21 change: +0.37

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

11/18: Gains in HANS were pretty mild compared to the rest of the market. I don't see any real changes from my prior comments. I am still expecting a correction toward $48.00. 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 22.76 change -0.05

Stop Loss: 21.45
Target(s): 23.70, 24.75
Current Option Gain/Loss: + 0.9%
Time Frame: 6 to 8 weeks
New Positions: Yes, but see below

11/18: The bounce in KR stalled with its short-term trend of lower highs. This would suggest we might see another dip near $22.50 soon. There is no change from my previous comments. I would still consider new positions in the $22.60-22.00 zone. Cautious traders may want to raise their stop closer to $22.00.

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: 25.84 change: +0.27

Stop Loss: 24.90
Target(s): 27.45, 29.00
Current Option Gain/Loss: + 1.1%
Time Frame: 8 to 10 weeks
New Positions: Yes

11/18: Hmm... the rally in MSFT should have been stronger. The initial rally this morning stalled near $26 and shares slowly faded lower the rest of the day. I remain bullish here but readers can wait for another dip near $25.50 to launch bullish positions. More conservative traders may want to wait for more strength and look for a close over $26.00 before launching positions.

Current Position: Long MSFT stock @ 25.55

- or -

Buy the 2011 January $25.00 calls (symbol: MSFT1122A25) Entry @ $1.39

Entry on November 17 at $25.55
Earnings Date 01/27/11 (unconfirmed)
Average Daily Volume: 68.4 million
Listed on November 15th, 2010

Onyx Pharmaceuticals - ONXX - close: 30.20 change: +0.57

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

11/18: Uh-oh! It looks like ONXX might run away from us. Shares rallied +1.9% and look poised to breakout higher from this current consolidation pattern. The November highs are in the $30.57 area. Nimble traders may want to consider aggressive positions on a move over $30.60. If you do you'll need to raise your stop loss significantly. If we see ONXX close over $30.50 I might adjust our entry point strategy. For now we're waiting for a dip.

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: 40.90 change: +0.18

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

11/18: TSCO spiked higher this morning but the rally failed near resistance at $42.00 and shares abruptly reversed lower. Given the bearish action today I am lowering our trigger to open positions and moving it toward the 50-dma. Our new trigger is $39.55 and we'll adjust the stop loss to $38.49.

Buy-the-Dip Trigger @ $39.55 <-- new trigger

Suggested Position: Buy TSCO stock @ 39.55

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 14.86 change +0.20

Stop Loss: 14.45
Target(s): 17.25
Current Option Gain/Loss: - 2.5%
Time Frame: 6 to 8 weeks
New Positions: Yes, see details below

11/18: After a two-week correction we're finally see a bounce in the XLF yet it failed to close over technical resistance at its 200-dma. Depending on your appetite for risk you could buy this bounce, wait for a close over $15.00, or look for another dip near $14.70 as our next entry point. I do expect the sector to bounce although it may not be immediately.

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: 34.45 change: +0.13

Stop Loss: 37.05
Target(s): 32.25, 30.25
Current Change: - 1.7%
Time Frame: 6 to 8 weeks
New Positions: Yes, see below

11/18: The initial spike higher in OFC failed and shares pared their gains back to just +0.37%. I remain bearish and would use this move as a new entry point.

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