Option Investor

Daily Newsletter, Thursday, 7/14/2011

Table of Contents

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

Market Wrap

Bernanke Buzzkill

by Jim Brown

Click here to email Jim Brown
Ben Bernanke must have thought investors got the wrong impression from his Wednesday testimony and he went out of his way today to say there would be no QE3 unless conditions got a lot worse. The little positive sentiment left from Wednesday evaporated like a n ice cube on a Texas sidewalk.

Market Statistics

The clarification from Bernanke during testimony today overcame better than expected jobless claims and retail sales. Bernanke said the Fed expects the economy to improve so the Fed would only step in with more economic stimulus if there were a significant downturn in the economy. "We are not prepared at this point to take further action." That means all stimuli not just a QE3 program. Stocks immediately rolled over and headed for negative territory. The Fed gives and the Fed takes away.

On the weekly Jobless Claims the headline number fell -22,000 to 405,000 but you should not get too excited over that number. Claims always drop in a holiday week because newly unemployed workers wait until after the holiday before signing up for unemployment and beginning the search for a new job. There are also some seasonal factors going into play where factories shut down for retooling for several weeks during the summer months.

The claims for the prior week were revised higher to 427,000 from 418,000. Today's report was the 14th consecutive week with claims over 400,000 per week.

Weekly Jobless Claims Chart

Retail Sales was touted as being better than expected but they were nothing to shout about. Retail sales for June rose +0.1% compared to a -0.1% decline in May. Basically sales have been flat for the last two months as a result of the higher gasoline prices and the soft patch worries. Consumers are spending only when they have to and there is no sign or improvement. Sales did decline slightly as gasoline prices declined and reducing the amount of sales at service stations. That sector decline was offset by a small increase in auto sales. Gasoline sales declined -1.3% while auto sales and parts rose by +0.8%. Home furnishings declined -0.8%, sporting goods -0.7% and food service -0.4%.

The same decline in gasoline prices helped push the Producer Price Index (PPI) lower for June. The headline number declined -0.4% compared to a +0.2% gain in May. The consensus was for a decline of -0.2%. The core rate, which excludes food and energy rose +0.3%. Energy prices rose +1.1% and food rose +0.6%. Inside the food component fresh vegetables rose +19.6% and fresh fruit rose +11.8%. Good thing we don't include food and energy in the Fed's core rate calculation. The Fed still does not have any inflation problems on the core rate but they are headed our way.

The Manufacturers Alliance Survey (MAPI) declined from 72% to 68% for Q2. This should be no surprise to anyone given the soft patch numbers we saw in May from the regional manufacturing reports. The ISM reports also showed declines. This is not a closely followed report.

The Consumer Price Index (CPI) is the highest profile report due out on Friday but Citigroup earnings will probably be more of a market mover.

Economic Calendar

JP Morgan (JPM) reported earnings this morning that increased +13% and better than analysts expected. JPM earned +$5.4 billion or $1.27 per share. That was slightly less than the $5.56 billion they earned in Q1 but still very healthy. They lowered reserves by $1 billion for the credit card division saying credit quality was improving and more people were paying on time. Income from credit cards nearly tripled to $911 million from $343 million in the comparison quarter. They took a charge of $2.3 billion for legal expenses related to the mortgage foreclosure problems. The mortgage unit lost -$454 million. Jamie Dimon ruled out any large-scale job cuts and claimed the bank had added 15,000 jobs so far this year.

Dimon also put some fears to rest on the banks exposure to Europe. Dimon said the banks total exposure to the PIIGS was about $15 billion. The bulk of that exposure is to Spain and Italy. In Dimon's worst case forecast they would lose about $3.5 billion. He said the bank was not cutting exposure to Europe and leaving his customers high and dry. He said, "I hope they appreciate this fact." Most of the exposure to Europe is to corporate clients but country debt. He also warned the U.S. markets would face a major upheaval if the U.S. went into default although he does expect the problem to be resolved before a default.

JP Morgan Chart

The biggest report for the day was Google (GOOG) after the close. Google posted earnings of $8.74 compared to consensus estimates of $7.85. That was a major beat. To put it into perspective the highest estimate on record was $8.25 and Google blew past that estimate as well. Google shares soared +$67 in after hours trading.

Revenue excluding traffic acquisition fees jumped +36% to $6.92 billion. Analysts were expecting revenue of $6.55 billion. An analyst at Stifel Nicolaus said Google should be viewed as a growth company again this quarter. "The combination of mobile search, Android, Ad Exchange, YouTube and the core search business are all doing well. Google just announced the Google+ service that is poised to go head to head with Facebook and that is expected to do well.

However, Google may be on the path to eventual destruction if the ever-growing behemoth begins to get stale. Expenses rose +49% in the quarter to $2.97 billion. That is a major jump. It is always easy to add people, offices and infrastructure when businesses are growing but eventually Google's growth will begin to slow and trimming the fat is going to be painful. Don't forget the government just began what will be years of antitrust investigations into all areas of Google's business.

Enjoy the gains now and in the quarters to come but remember Microsoft and Dell. Both were in the same growth mode not too many years ago but their time in the spotlight expired and the stocks crashed back to earth. Google is probably quite a ways from that point as long as they keep innovating but eventually their mass will simply become to large to lift any higher.

Google Chart

Conoco Phillips (COP) made news in the energy sector by announcing they were going to split the company into two separate companies. Conoco would remain the exploration and production company and the refining arm would be spun off separately. This is identical to what Marathon (MRO) did last month when they split off the refining and created Marathon Petroleum (MPC).

Conoco said it would conclude its three year restructuring program by shedding the refining business and concentrate on the more profitable oil and gas exploration and production. The breakup won't happen until early 2012 but it will be the culmination of a $17 billion asset sale program Conoco started in 2009. After the split Conoco will become the largest U.S. independent oil and gas producer. That category is defined as companies without refining, chemical or retail fuel businesses. Conoco expects to produce an average 1.7 million barrels per day in 2011. Currently Conoco has more than 2.0 mbpd of refining capacity and they have five refineries overseas.

Apache is currently the largest U.S independent with 732,000 bpd in Q1. Conoco expects to boost its production by another 800,000 bpd by 2015. That is going to be a major improvement for Conoco and the share price could be stratospheric by then since oil in 2015 is likely to be more than $175 per barrel.

Conoco plans to maintain its current 66-cent dividend and the spinoff of the refinery business will be done as a special dividend to shareholders. Conoco is currently buying back $11 billion in stock that will be completed before year-end. Conoco shares rallied +$7 at the open but declined to a gain of just more than a dollar as oil prices fell and the overall market sank.

Conoco Chart

Other than the Bernanke testimony, Conoco and earnings from JPM and Google the balance of the news was mostly on the debt limit crisis. Yesterday Moody's announced it had put the U.S. on credit watch negative on the rising expectations for the lack of a deal by lawmakers and eventual default. This roiled the futures markets overnight but the impact was negated by the open on the economic news. The real problem in the Moody's announcement was the warning that the lack of a deal and potential default, even if it was short lived, would force Moody's to keep the U.S. rating at a lower level for some period of time since it would indicate the potential for future defaults. Moody's has had a triple A rating on the U.S. since 1917.

It was learned today that S&P had privately told U.S. lawmakers and top business groups that it might cut the rating if the government fails to make any other payments but still makes its debt payments. Basically if the U.S. did not make social security payments or payments to contractors but still makes debt payments the S&P would cut its credit rating anyway. Late tonight S&P made it official and placed the U.S. on credit watch negative saying there was a 50% chance it would cut the triple A rating if a deal was not signed soon. S&P said it could cut the rating this month rather than wait for August 2nd if the talks appeared to not be progressing. S&P also said it might cut the rating if an eventual deal did not appear sufficient to start the U.S. on a patch to fiscal responsibility. "In an agreement is reached, but we do not believe that it likely will stabilize the U.S. debt dynamics, all things unchanged, we would expect to lower the long-term AAA rating."

The meetings over the debt limit are becoming increasingly hostile with reports President Obama stormed out of the meeting on Wednesday. Democrats today tried to tone down those news reports saying the meeting was over and he left quickly. The crisis is playing out in the press and it does not appear they are getting any closer to a solution.

The markets are beginning to take the debt risk seriously. While nobody wants to believe lawmakers will not reach an agreement there is always that risk and the results would be devastating. Everyone in the political process understands the game of brinksmanship they are playing but neither wants to be blamed for the outcome this close to the 2012 election cycle. Regardless of which side wins in the 11th hour there will be repercussions in the election process. Everyone is polarized on the issue and fairly evenly divided. There will be winners and losers regardless of the end result.

Unfortunately the market is very efficient discounting mechanism. Future expectations are priced into the market well before those events come to pass. In the case of the debt limit nobody expected it to continue this long so the market pretty much ignored it until now. As we head for August 2nd and the days tick off the calendar the impact to the market should increase. Fortunately once they come up with a deal the market will celebrate and the crisis will be forgotten within a matter of hours.

Gold closed at another new high at $1587 on debt limit worries and concerns over the continuing austerity scenario in Italy and further comments about a selective Greek default.

Gold Chart

News was leaked late this evening of a potential compromise for a $1.5 trillion cut in spending and equal hike in the debt limit that included an option for President Obama to request another hike if needed by the end of 2012. This is obviously a way to kick the can down the road and create a political event around the November 2012 elections. Reportedly the Treasury needs the debt limit raised by $2.4 trillion to get past the 2012 elections. Futures fell sharply on the S&P ratings warning and then rebounded on the news of the potential compromise.

The S&P-500 closed at a new low today after bullish market sentiment evaporated on the Bernanke comments. The increasingly hostile tone of the debt limit discussions was a wet blanket over the market despite the breath of fresh air from the JPM earnings. The S&P closed under the 100-day average at 1316 and appears to be targeting the 1295-1300 range once again. If talks do not produce a compromise soon we could easily see a return to the 200-day average at 1275.

S&P Chart

The Dow also closed at a new low despite the gains in JPM. Boeing, CAT and MMM were big losers that dragged the index lower. The Dow is hostage to debt limit sentiment and appears to be targeting 12,400 or lower if a settlement is not reached immediately.

Dow Chart

The Nasdaq closed right on the 100-day average at 2759. There was a $10 drop in Google and $12 drop in Netflix to help drag it lower. Obviously the Nasdaq will be up at the open on Friday thanks to the +67 gain in Google after the earnings. How long the index can maintain its gains based on one stock remains to be seen. Nasdaq futures are only up +10 overnight so the excitement appears to be fading already.

The Nasdaq has fallen to nearly a 50% retracement of the July gains at 2753. It took nine days to rally and five days to give back 50%. In theory, in a world without news events, this would be a good place for the Nasdaq to rebound but unfortunately we are going to be controlled by the headlines until the debt limit crisis goes away.

The Russell 2000 mirrored the Nasdaq and also closed on its 100-day at 822.

Nasdaq Chart

Russell Chart

This is an option expiration week but most of the fireworks should be behind us. Only the seriously hard core or those hoping for a miracle actually keep their options positions open until Friday. The impact on the market should be minimal because this is not a triple witch.

I believe the market's fate rests with lawmakers. The president is going to hold another press conference on Friday but nobody believes it will be to announce a settlement. If nothing new arises the outcome is likely to be negative ahead of the weekend.

However, with rumors of a deal in the works and lawmakers planning on working over the weekend it is very possible something of substance could be announced on Monday. That would be market positive. That potential may lure many traders back into the market on Friday for a buy the rumor trade.

Jim Brown

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New Plays

Another High for Gold

by James Brown

Click here to email James Brown

Editor's Note:

No new trades tonight.

Stocks could be volatile as they react to earnings from Google (GOOG) and Citigroup (C). GOOG reported a very strong quarter tonight. A lot of traders were leaning the wrong way and now GOOG is up +50 points after hours and nearing the $600 level. This could be bullish for the high-profile NASDAQ names.

Meanwhile Citigroup reports tomorrow morning. They are an extremely large financial company but they don't have the same strength that JPM does. C's results could disappoint. Thus the action tomorrow could be very sector specific.

If you are looking for a trade here is what's on my watch list:

HAL - Shares still have overhead resistance at $55.00 but I would consider bullish positions on a dip near $50.00.

BAX - Shares of BAX do not move very fast but the stock has been able to ignore a lot of the market volatility.

DGP - Gold has rallied to new all-time highs. A dip back toward $50 on the DGP could be a new entry point. Keep in mind this is a double-long ETF so it will see some volatility.

If you're looking for bearish trading ideas check out these symbols: MS, MXIM, and NVDA.

- James

In Play Updates and Reviews

Thursday Morning Rally Fails

by James Brown

Click here to email James Brown

Editor's Note:
Strong earnings results from JPM were not enough to keep the rally going and stocks rolled over.


Current Portfolio:

BULLISH Play Updates

Alexion Pharma - ALXN - close: 51.27 change: +0.02

Stop Loss: 47.75
Target(s): 52.25
Current Gain/Loss: unopened
Time Frame: up to its earnings report
New Positions: Yes, see trigger

07/14 update: ALXN did not see a lot of movement today. The stock traded sideways between $50.50 and $51.50. Shares still look overbought here and trading under resistance near $52.50. We will keep our buy the dip entry point at $49.00. More conservative traders could wait for a dip closer to $48.00. We don't have much time. Earnings are expected on July 21st and we do not want to hold over the announcement. FYI: The Point & Figure chart for ALXN is bullish with a $63 target.

Trigger @ $49.00

Suggested Position: buy ALXN @ $49.00

- or -

buy the AUG $50 call (ALXN1120H50)

Entry on July xx at $ xx.xx
Earnings Date 07/21/11 (confirmed)
Average Daily Volume = 1.1 million
Listed on July 11, 2011

American Express Co. - AXP - close: 51.38 change: -0.57

Stop Loss: 49.85
Target(s): 54.95
Current Gain/Loss: unopened
Time Frame: up to its earnings report
New Positions: Yes, see trigger

07/14 update: AXP is correcting lower as we expected. The low today was $51.30. I am suggesting a buy-the-dip entry point at $51.00, which AXP could hit tomorrow. More conservative traders could wait for a dip closer to the $50.00 mark instead. We have a stop at $49.85.

Remember we only have a few days for AXP to dip to our entry point and then bounce before earnings.

Trigger @ 51.00

Suggested Position: buy AXP stock @ 51.00

- or -

buy the Aug. $52.50 call (AXP1120H52.5)

07/13 AXP is underperforming. New trigger @ 51.00, stop @ 49.85
07/12 new trigger @ 51.75
07/11 new stop loss @ 50.90

Entry on July x at $xx.xx
Earnings Date 07/20/11 (confirmed)
Average Daily Volume: 7.0 million
Listed on July 2, 2011

Cheesecake Factory Inc. - CAKE - close: 32.70 change: -0.72

Stop Loss: 31.90
Target(s): 33.60, 37.00
Current Gain/Loss: + 3.7%
Time Frame: 8 to 10 weeks
New Positions: see below

07/14 update: After yesterday's relative strength the stock was underperforming today. CAKE gave back its gains and closed down -2.1%. There is no change from my earlier comments. CAKE looks poised to dip toward $32.00. More conservative traders may want to exit early. I am not suggesting new positions. We do not want to hold over the July 20th earnings report.

Current Position: Long CAKE stock @ $31.53

- or -

July $33 call (CAKE1116G33) Entry @ $0.75, exit 0.80 (+6.6%)

07/09 new stop loss @ 31.90
07/07 Target hit @ 33.60. CAKE +6.5%, option @ $0.80 (+6.6%)
07/05 adjusted 1st target to $33.60
07/02 new stop loss @ 30.75
06/30 consider the opportunity cost of staying in CAKE. maybe you should exit early
06/28 New stop loss @ 29.65
06/09 CAKE is bouncing from the 200-dma as expected.
06/04 More conservative traders may want to exit early. We are expecting a drop to the 200-dma.

Entry on May 20 at $31.53
Earnings Date 07/20/11 (confirmed)
Average Daily Volume: 1.0 million
Listed on May 19th, 2011

Dr. Pepper Snapple - DPS - close: 40.87 change: -0.60

Stop Loss: 39.90
Target(s): 46.00
Current Gain/Loss: - 2.0%
Time Frame: 6 to 8 weeks
New Positions: see below

07/14 update: Hmm.... DPS has broken down under what should have been support near $41.00 and its 50-dma. Odds are the stock will now correct lower to the $40.00 level. We have a stop at $39.90. I am not suggesting new positions at this time.

Earlier Comments:
Normally I would avoid holding over earnings but I am tempted to hold over DPS' late July earnings report. Our multi-week target is $46.00.

Current Position: Long DPS stock @ $41.71

- or -

Long Aug. $45 call (DPS1120H45) Entry @ $0.30

Entry on July 11 at $41.71
Earnings Date 07/28/11 (unconfirmed)
Average Daily Volume: 1.8 million
Listed on June 30, 2011

Ecolab Inc. - ECL - close: 55.48 change: -0.60

Stop Loss: 53.90
Target(s): --.--, 59.90
Current Gain/Loss: + 3.9%
Time Frame: 6 to 8 weeks
New Positions: see below

07/14 update: I have been warning readers to expect a dip toward $55.00 or possibly the $54.00 level in ECL. Shares gave up another -1% and will probably test these levels soon. Wait for a bounce before considering new positions. We do not want to hold bullish positions over the late July earnings report.

Current Position: Long ECL stock @ 53.35

07/09 new stop loss @ 53.90
07/08 planned exit. July $55 call @ $1.45 (+141.6%)
07/07 Plan on exiting our July calls tomorrow at the close
07/02 Sell half. ECL @ 56.76 (+6.3%), Option @ $1.75 (+191.6%)
06/30 new stop loss @ 53.45
06/18 new stop loss @ 52.45
06/04 new stop loss @ 51.90

Entry on May 26 at $53.35
Earnings Date 07/26/11 (unconfirmed)
Average Daily Volume: 1.5 million
Listed on May 18th, 2011

Globe Specialty Metals, Inc. - GSM - close: 24.37 change: -0.53

Stop Loss: 23.40
Target(s): 27.25, 29.50
Current Gain/Loss: - 3.2%
Time Frame: 6 to 8 weeks
New Positions: see below

07/14 update: Our aggressive trade on GSM is not off to a very good start. Last night I said do not buy this stock unless the S&P 500 is positive this morning. The market was positive thanks to strong earnings from JPM but the rally in stocks reversed. GSM opened higher at $25.18 and rallied toward yesterday's highs before reversing course. Shares eventually gave up -2.1% for the day.

At this point I would wait for a bounce in the $24.00-23.50 zone before initiating new positions. We have a stop at $23.40. The plan was to keep our positions small to limit our risk.

Earlier Comments:
We should consider this an aggressive, higher-risk trade so let's keep our position size small to limit risk. We can always add to positions down the road. FYI: The Point & Figure chart for GSM is bullish with a $28.50 target.

- SMALL positions -

Current Position: Long GMS stock @ $25.18

- or -

Long AUG $25 call (GSM1120H25) Entry @ $1.60

Entry on July 14 at $25.18
Earnings Date 09/15/11 (unconfirmed)
Average Daily Volume = 874 thousand
Listed on July 13, 2011

Kaiser Aluminum - KALU - close: 54.47 change: -0.36

Stop Loss: 51.90
Target(s): 59.75
Current Gain/Loss: + 1.7%
Time Frame: 3 to 5 weeks
New Positions: see below

07/14 update: KALU weathered today's session pretty well. The stock consolidated sideways most of the day and settled with a -0.6% decline. I would wait for another dip or a bounce in the $53-52 zone again before launching new positions.

Earlier Comments:
Our target is the $59.75 mark since the $60 level looks like resistance. Investors could certainly aim higher. KALU has a high amount of short interest and the stock could experience a short squeeze. We do not want to hold over the early August earnings report but the date is not yet confirmed. FYI: Investors should note that the most recent data listed short interest at 9.9% of the very small 18.5 million share float.

- Small Positions -

Current Position: Long KALU @ $53.56

- or -

Long AUG $55 call (KALU1120H55) Entry @ $1.30

Entry on July 11 at $53.56
Earnings Date 08/01/11 (unconfirmed)
Average Daily Volume = 183 thousand
Listed on July 9, 2011

KLA-Tencor - KLAC - close: 40.75 change: -0.88

Stop Loss: 39.95
Target(s): 45.75
Current Gain/Loss: - 4.1%
Time Frame: 6 to 8 weeks
New Positions: see below

07/14 update: Cautious traders may want to exit our KLAC play right here! The rally this morning failed under the $42.50 level and KLAC plunged -2.1% to close back under its 50 and 200-dma. There is still a chance KLAC will hold support at $40.00 but I am not suggesting new bullish positions at this time.

We do not want to hold over the late July earnings report.

Current Position: Long KLAC @ $42.49

- or -

Long AUG $45 call (KLAC1120H45) Entry @ $1.20

07/14 Traders may want to exit early here.

Entry on July 11 at $42.49
Earnings Date 07/28/11 (unconfirmed)
Average Daily Volume = 2.4 million
Listed on July 9, 2011

Macy's Inc. - M - close: 30.06 change: +0.24

Stop Loss: 28.49
Target(s): 29.90, 32.25
Current Gain/Loss: + 6.2%
2nd Position Gain/Loss: + 0.6% Time Frame: 6 to 8 weeks
New Positions: see below

07/14 update: Macy's rallied off its intraday lows to close in positive territory. I will point out that the MACD on the daily chart has a lower high and is edging closer to a new sell signal in spite of M's up trend. I am not suggesting new positions at this time. At the moment our final target is $32.25 but we might consider adjusting this target higher.

Earlier Comments:
Our plan was to keep positions small to limit our risk.

- small positions -

Current Position: Long M stock @ $28.30

- or -

Long Aug. $30 call (M1120H30) Entry @ $0.85

- 2nd Position, entry 7/11/11 -

suggested position: Long M stock @ $29.86

Long Aug. $32 call (M1120H32) Entry @ $0.63

07/09 new stop loss @ 28.49
07/09 Add 2nd position, buy stock/calls now
07/08 Planned exit. July $29 call @ $1.50 (+167.8%)
07/07 plan on exiting July calls tomorrow at the close
07/02 new stop loss @ 27.90
07/01 1st Target Hit @ 29.90 (+5.6%), options @ +107.1% (July) & +52.9% (Aug)

Entry on June 28 at $28.30
Earnings Date 08/10/11 (unconfirmed)
Average Daily Volume: 8.6 million
Listed on June 27, 2011

UnitedHealth Group Inc. - UNH - close: 52.27 change: +0.54

Stop Loss: 49.85
Target(s): 54.75
Current Gain/Loss: + 1.9%
Time Frame: 3 to 4 weeks
New Positions: see below

07/14 update: UNH outperformed with a +1% gain. The stock could have see money inflows as a safe haven trade with the market looking vulnerable. I am not suggesting new positions at this time. We do not want to hold over the July 19th earnings report.

- small positions -

Suggested Position: Long UNH stock @ $51.25

- or -

Long July $50 call (UNH1116G50) Entry @ $2.07

07/02 new stop loss @ 49.85

Entry on June 24 at $51.25
Earnings Date 07/19/11 (confirmed)
Average Daily Volume: 7.9 million
Listed on June 23, 2011

Western Refining Inc. - WNR - close: 20.09 change: +0.26

Stop Loss: 18.45
Target(s): 24.00, 27.50
Current Gain/Loss: + 3.0%
Time Frame: 6 to 8 weeks
New Positions: see below

07/14 update: Oil and energy stocks were mixed on Thursday but WNR outperformed again with a +1.3% gain. I would prefer to launch new positions on a dip near the simple 10-dma. Aggressive traders may want to put their stop under support near the $18.00 level instead.

FYI: The Point & Figure chart for WNR is bullish with a $28.50 target. Plus, the most recent data listed short interest at 38% of the 54.2 million-share float.

Current Position: Long WNR stock @ 19.50

- or -

Long AUG. $22 call (WNR1120H22) Entry @ $0.65

Entry on July 11 at $19.50
Earnings Date 08/04/11 (unconfirmed)
Average Daily Volume = 4.0 million
Listed on July 9, 2011