Option Investor

Daily Newsletter, Wednesday, 7/27/2011

Table of Contents

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

Market Wrap

Debt Ceiling Trumps Earnings...Again

by Todd Shriber

Click here to email Todd Shriber
With four trading days left before the August 2nd deadline to extend the U.S. debt ceiling expires, things are getting worse, not better for stocks as the specter of a credit rating downgrade for Uncle Sam is suffocating equities. Sentiment was so bearish today that not even gold could muster a positive close, though its tiny loss was far better than the losses of more than 2% suffered by S&P 500 and the Nasdaq. The Dow Jones Industrial Average and the Russell 2000 were also harshly kicked around today.

Stats Table

In economic news, the big report of the day came courtesy of the Commerce Department, which said June durable goods orders slumped 2.1% after a revised 1.9% jump in May. Excluding automobiles and planes, durable goods rose 0.1% last month compared with 0.7% increase in May. For those looking for a silver lining, it should be noted durable goods orders were up 4.7% through the first half of this year. Add to that durable goods prices are higher on an annual basis, which some economists would argue indicates more growth ahead.

That theory would conflict with the recent downward revisions to the U.S. GDP forecast by a host of banks and economic agencies and it can surely be said that the debt ceiling debate on Capitol Hill is not a positive for economic growth.

Durable Goods Chart

Speaking of economic growth, the Federal Reserve's Beige Book survey said U.S. economic activity continued to grow last month, but the pace of that growth slowed in eight of the 12 regions the survey covers. Just four regions showed slower growth in the previous Beige Book update. This puts the Fed in a pickle to some degree. As some analysts and economists have been noting, the economy is not weak enough to justify a third round of quantitative easing. Unfortunately, it is not strong enough for Fed Chairman Ben Bernanke to say outright that there will be no more QE packages in our future.

The Beige Book survey indicated consumer spending grew modestly in most regions, but auto sales tailed off a bit. Friday's second-quarter GDP report, the first look at U.S. economic growth for the previous quarter, is expected to show an anemic increase of 1.8%, the slowest pace in a year, according to Bloomberg News.

Adding to the market's woes today were more international issues, and yes, some came by way of Greece, but I am referring to Brazil. The ''B'' in the BRIC quartet and the largest economy in Latin America was once an emerging markets superstar and it may be again one day. That is not the case in the here and now.

Perhaps even more than its largest trading partner, China, Brazil has been bitten hard by the inflation bug and the country's central bank has engaged in a scorched-earth interest rate increase cycle this year. Brazil's central bank has hiked rates eight times in the past 15 months, but that is not helping dampen inflation there. Policymakers in Brazil seem to think the annual inflation target of 4.5% will not be exceeded this year, but economists are forecasting higher inflation next year.

Brazil's recent inflation picture is not pretty, as the chart below indicates. Nor is the impact this issue has had on Brazilian equities. With Wednesday's tumble, Brazil's benchmark Bovespa index has slid 20% from its November peak. That is a bear market.

Brazil Inflation Chart

Lack of enthusiasm by the consumer when it comes to buying discretionary items such as high-end TVs is weighing on myriad stocks. Today, the obvious candidate was Corning (GLW), the maker of glass for pricey LCD TVs. Echoing sentiments made by Dow component MMM earlier this week, New York-based Corning warned of weakness in the LCD market and said TV makers are not exactly thrilled about the prospects the holiday season will bring.

Corning lowered its forecast for worldwide glass demand to between 3.3 billion and 3.4 billion square feet this year from 3.5 billion to 3.7 billion square feet, Reuters reported. Shares of Corning plunged more than 7% on volume that was more than triple the daily average.

Corning Chart

We are now far enough along into the second-quarter earnings season that it is safe to say those reports have been, for the most part, pretty good, but that was expected and in the face of the debt ceiling debate, ''good'' is not good enough. Even big oil stocks are not getting much love this week. Such is life for ConocoPhillips (COP), the third-largest U.S. oil company.

Houston-based Conoco, which recently announced plans to spin-off its downstream operations into a separate company next year, posted a second-quarter profit of $3.4 billion, or $2.41 a share, compared with $4.16 billion, or $2.77, a year earlier. Asset sales helped the figure in the year-earlier period. Analysts were expecting a profit of $2.19 a share and Conoco's exploration and production profit of $2.5 billion also topped the $2.4 billion Wall Street forecast.

Production fell to 1.64 million barrels of oil equivalent per day in the quarter from 1.73 million barrels per day in the second quarter and those declines were attributable to asset sales and lost production in Libya. Conoco forecast 2011 production of 1.625-1.65 million barrels per day. Rival Exxon Mobil (XOM), the largest U.S. oil company, reports tomorrow before the bell and Chevron (CVX), the second-largest U.S. oil company, chimes in on Friday. For more news and commentary on the energy sector, register for a free trial of the OilSlick daily newsletter (HERE).

ConocoPhillips Chart

After the bell today Visa said its fiscal third-quarter profit jumped 40% to $1.5 billion, or $1.43 a share. On an adjusted basis, the company earned $883 million, or $1.26 a share, as revenue climbed 14% to $2.32 billion. Analysts were expecting a profit of $1.23 on revenue of $2.3 billion. International growth was the big driver of Visa's solid results. Credit card and debit card volume rose 25% and 27%, respectively, outside of the U.S., Visa said.

Visa and rival Mastercard (MA) need to grow international revenue in an effort to offset lost profits from the Federal Reserve's plan to cap fees on debit card transactions in the U.S. The Fed capped the fees banks collect from merchants for processing debit purchases at an average of 24 cents, down from the current average of 44 cents starting Oct. 1, according to the Associated Press.

Visa also gave bullish fiscal 2012 guidance, projecting single-to-low double-digit revenue growth and mid-to high-teens EPS growth. Even with that, shares of Visa were only moderately higher in the after-hours session.

Visa Chart

Looking at the charts, the S&P 500 had been holding up pretty well until today. Round number support at 1300 held, but the 2% drop took the index below its 50-day moving average, violating support around 1315 in the process. If 1300 does not hold, a return to 1260 may be in the cards. Above 1315, resistance lies in the 1330-1340 area.

S&P 500 Chart

The Dow is in similar trouble as just two components, BA and T, managed to close higher today. Support at 12,400 did not hold and as was the case with the S&P 500, the 50-day line has been broken. From here, there is a plenty of real estate for the Dow to cascade back to 12,000. Below there, we could be discussing 11,750-11,850. The Dow faces two near-term problems. First, earnings from XOM and CVX may not be enough to get the index headed back in the right direction. Second, old support at 12,400 may now be new resistance.

Dow Chart

A decent post-earnings performance from AMZN did nothing to help the Nasdaq. In fact, the index is now a mess after blowing past at 2830 and psychological support at 2800. Drop another 10 points and the Nasdaq will be at its 50-day moving average. From there, 2725 and then 2700 are next support. Now the Nasdaq must retake resistance at 2800 and then again at 2840 before addressing an even more firm ceiling at 2860.

Nasdaq Chart

It took the Russell 2000 less than a month to rally from the 770 area to 860, nearly challenging the May peak of 868.57. In a comparable amount of time, the index has fallen back to 800. If the Russell does not find support here, it should return to 780 and perhaps back to 770.

Russell Chart

Any hopes for a legitimate third-quarter rally have suffered a setback this week. Unfortunately, whether the setback is temporary or longer-lasting is a fate that will be decided by the folks on Capitol Hill. The Treasury Department reiterated that August 2nd is a hard and fast deadline, news that could pressure stocks the rest of this week. That may also be enough to motivate politicians to finally reach a debt ceiling accord over the weekend, setting stocks up for a rally to start August. Keene will be back with you next week.

New Plays

Only Three Sessions Left

by James Brown

Click here to email James Brown

Editor's Note:

Investors are starting to get spooked by the approaching debt ceiling deadline and no deal in Washington. Stocks accelerated lowered today. If lawmakers managed to get it together and produce a deal the market could rally. Yet a deal is not a guarantee the U.S. will avoid a credit rating downgrade. If we do lose our AAA trading then stocks would most likely fall.

You might hear some market pundits tonight and tomorrow talking about Dick Bove's dramatic call today. Bove is a widely followed banking analyst. He is suggesting investors sell everything and go to cash due to the weakness in the U.S. financial system and insurmountable debt issues. Essentially he feels there is no safe haven investment right now.

Short-term the market is at a major crossroads. We have the potential for a huge rally on a deal or a huge sell-off on no deal. In situations like this trading options offers an advantage. Simple long or short equity strategies don't help when the market direction could move violently in either direction. The safest move would be to exit the market and go to cash, like Bove is suggesting. Alternatively, if you have some long-term positions you'd rather not sell due to tax reasons then consider buying put options to protect your portfolio (granted they'll be more expensive today than they were yesterday).

Another alternative would be to actually pick a direction. If you think the market is going to move one way or the other then you have plenty of options. We only have three trading sessions left until the Tuesday, August 2nd deadline. Tonight I'd rather not try and pick a direction so we're not adding any new plays. Aggressive traders who feel strongly about their choice for market direction may want to consider the double long or double short ETFs to maximize the move.

- James

In Play Updates and Reviews

Debt Concerns Fuel Widespread Losses

by James Brown

Click here to email James Brown

Editor's Note:
Market participants are losing patience with the lack of progress in Washington on the debt ceiling deal. Meanwhile today's lackluster Beige book report and bearish durable goods orders failed to inspire anyone.

We had KALU, M, and WNR get stopped out after we recently raised their stop losses.


Current Portfolio:

BULLISH Play Updates

China Sunergy Co. Ltd. - CSUN - close: 1.52 change: -0.07

Stop Loss: 1.48
Target(s): 2.00, 2.25
Current Gain/Loss: - 8.9%
Time Frame: 3 to 4 weeks
New Positions: see below

07/27 update: This dip back toward support near $1.50 looks like a new entry point. However, with the ugly market action today I would hesitate to launch new bullish positions. You could go ahead and buy CSUN here since our risk at this level is about 2.6%.

Earlier Comments:
We should consider this an aggressive, higher-risk trade given the trend lower so trade small. Our first target is $2.00. I would expect some resistance at the 50-dma. Our final target is $2.25 but we do not want to hold over the earnings report in mid August.

Current Position: Long CSUN stock @ $1.67

07/27 the dip toward $1.50 looks like a new entry point.

Entry on July 25 at $ 1.67
Earnings Date 08/15/11 (unconfirmed)
Average Daily Volume = 325 thousand
Listed on July 23, 2011

Sandridge Energy, Inc. - SD - close: 11.70 change: -0.31

Stop Loss: 11.20
Target(s): 13.20, 13.90
Current Gain/Loss: - 0.6%
Time Frame: 2 to 3 weeks
New Positions: see below

07/27 update: I hope readers were not surprised by the dip in SD today. We were expecting a pull back. I was suggesting we buy dips in the $11.60-11.50 area. Unfortunately now with the market's major indices plunging on Wednesday we may want to hold off and wait before initiating new bullish positions. Nimble traders could try buying a bounce from the $11.50 level.

Earlier Comments:
SD could see a short squeeze. The most recent data listed short interest at almost 10% of SD's 346 million-share float. We do not want to hold over the August 4th earnings report so we don't have much time. FYI: The Point & Figure chart for SD is bullish with a long-term target at $31.

Current Position: Long SD stock @ $11.78

Entry on July 25 at $11.78
Earnings Date 08/04/11 (unconfirmed)
Average Daily Volume = 12.1 million
Listed on July 23, 2011

Vanguard Natural Resources - VNR - cls: 30.01 chg: -0.18

Stop Loss: 28.99
Target(s): 33.25
Current Gain/Loss: - 1.9%
Time Frame: 3 to 4 weeks
New Positions: see below

07/27 update: I am impressed that VNR held up as well as it did today. Shares only lost -0.59%. I don't see any changes from my prior comments. More conservative traders may want to exit early now or raise their stops. You could raise your stop to the $29.70 level or closer to the $29.50 level. Currently our stop is at $28.99, under the simple 200-dma. I am not suggesting new bullish positions at this time.

Current Position: Long VNR stock @ $30.61

- or -

Long AUG $30 call (VNR1120H30) Entry @ $1.20

07/19 Play is opened @ 30.61
07/18 The requirements to launch positions was not met. Try again. Both VNR and the S&P 500 need to open higher tomorrow.

Entry on July 19 at $30.61
Earnings Date 08/04/11 (unconfirmed)
Average Daily Volume = 193 thousand
Listed on July 16, 2011

BEARISH Play Updates

Jack Henry & Associates Inc. - JKHY - close: 29.13 change: -0.47

Stop Loss: 30.70
Target(s): 28.10, 26.25
Current Gain/Loss: + 0.8%
Time Frame: 3 to 4 weeks
New Positions: see below

07/27 update: Our new bearish play on JKHY is off to a good start. Shares gapped open lower at $29.39 and then fell to a new three-week low on above average volume. The close under potential support at $29.50 is another bearish development.

Earlier Comments:
More conservative traders could try a tighter stop loss (maybe $30.45ish). I do see potential support near $28.00 so we'll set our first target to take profits at $28.10. Our secondary target is $26.25. We do not want to hold over the mid August earnings report so the secondary target is unlikely to get hit. NOTE: The option spreads are too wide to trade options on JKHY. I would keep our position size small. If lawmakers do agree on a debt ceiling deal the entire market could rally.

- small positions -

Current Position: short JKHY @ $29.39

Entry on July 27 at $29.39
Earnings Date 08/16/11 (unconfirmed)
Average Daily Volume = 427 thousand
Listed on July 26, 2011


Kaiser Aluminum - KALU - close: 53.75 change: -1.77

Stop Loss: 54.25
Target(s): 59.75
Current Gain/Loss: + 1.2%
Time Frame: 3 to 5 weeks
New Positions: see below

07/27 update: We have been stopped out of KALU at $54.25. The plan was to exit today at the close but the market weakness forced our exit early.

I'd keep KALU on your watch list. We might see another entry point next week. After hours the company reported earnings that wee 10 cents better than expected.

- Small Positions -

closed Position: Long KALU @ $53.56, exit $54.25 (+1.2%)

- or -

AUG $55 call (KALU1120H55) Entry @ $1.30, exit $1.20 (-7.6%)

07/27 stopped out @ 54.25
07/26 new stop loss @ 54.25, prepare to exit tomorrow at the close
07/23 new stop loss @ 53.75
07/23 Prepare to exit on July 27 at the close
07/20 New stop loss @ 52.49


Entry on July 11 at $53.56
Earnings Date 07/27/11 (confirmed)
Average Daily Volume = 183 thousand
Listed on July 9, 2011

Macy's Inc. - M - close: 29.19 change: -0.73

Stop Loss: 29.25
Target(s): 29.90, 32.25
Current Gain/Loss: + 3.3%
2nd Position Gain/Loss: - 2.0% Time Frame: 6 to 8 weeks
New Positions: see below

07/27 update: The stock market's widespread decline was strong enough to push Macy's through the bottom of its recent trading range. Shares dipped toward $29.00 and its 50-dma. Our stop loss was hit at $29.25. Our plan was to keep positions small to limit our risk.

- small positions -

closed Position: Long M stock @ $28.30, exit 29.25 (+3.3%)

- or -

Aug. $30 call (M1120H30) Entry @ $0.85, exit $0.75 (-11.7%)

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

closed position: Long M stock @ $29.86, exit 29.25 (-2.0%)

Aug. $32 call (M1120H32) Entry @ $0.63, exit $0.25 (-60.3%0

07/27 stopped out @ 29.25
07/23 new stop loss @ 29.25
07/16 new stop loss @ 28.90
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

Western Refining Inc. - WNR - close: 20.36 change: -0.74

Stop Loss: 20.35
Target(s): 22.00, 24.50
Current Gain/Loss: + 4.3%
Time Frame: 6 to 8 weeks
New Positions: see below

07/27 update: Last night we raised our stop loss on WNR to $20.35. Today shares dip to $20.20. The five-week rally has lost its momentum. WNR appears to be correcting. I would definitely keep WNR on your watch list. We'll be looking for a new entry point.

closed Position: Long WNR stock @ 19.50, exit $20.35 (+4.3%)

- or -

AUG. $22 call (WNR1120H22) Entry @ $0.65, exit $0.45 (-30.7%)

07/27 stopped out @ 20.35
07/26 new stop loss @ 20.35
07/21 new stop loss @ 19.75
07/20 expect a dip toward the $20.35 area.
07/19 New stop loss @ 18.90. New targets @ 22.00 and $24.50


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