Option Investor

Daily Newsletter, Monday, 8/1/2011

Table of Contents

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

Market Wrap

Debt Deal Awaits, Stocks Still Fall

by Todd Shriber

Click here to email Todd Shriber
On the eve of the expiration of the U.S. debt ceiling, politicians appear close to ratifying a deal that is less bad than the alternative: A default on U.S. debt. ''Less bad'' is also an appropriate way of measuring the performance of stocks today as last week's declines seeped into this week, providing a gloomy start to the new month, but the S&P 500 and the Nasdaq were both down less than half a percent and the Dow's loss was negligible.

Stats Table

The debt ceiling, currently $14.3 trillion, will be raised by at least $2.1 trillion while federal spending will be slashed to the tune of $2.4 trillion. Perhaps the best feature of the legislation being considered is the fact that the debt ceiling issue will not need to be considered again until 2013. Vice President Biden touted this virtue to the press today, but it also underscores just how toxic the partisan environment is on Capitol Hill.

The debt ceiling was raised multiple times under the previous administration and dozens of times before with little difficulty. Bragging about putting off the debate for another two years just highlights how difficult it is to do business in D.C. these days.

No matter what your personal politics are, it is doubtful the debt ceiling agreement will truly thrill you. Some will be disappointed that the agreement does not address tax reform (increases) in any substantive fashion. Others will not be happy to learn that entitlement reform has once again been put off until another day. There you have it: Not good or great, but just less bad than defaulting.

If there was any overnight enthusiasm regarding the debt ceiling news on Sunday evening, it was short-lived because investors across the globe woke up to a spate of disappointing economic data Monday morning. China's PMI Manufacturing number fell to a 29-month low at 50.7, though that actually topped the 50.2 consensus estimate.

Taiwan's HSBC Manufacturing PMI number hinted at contraction with a reading of 46.1. Russia's reading was also below the important 50 level, coming in at 49.8. The Eurozone's final July PMI manufacturing number matched the 50.4 expected while the U.K. reported 49.1, below the 51 expected and good for the lowest reading since June 2009.

Here in the U.S., the Institute for Supply Management said the July manufacturing report was 50.9, well below the 55.3 seen last month and sharply below the 54.3 economists were forecasting. New orders slid to 49.3 and backlog orders fell to 45. Overall readings above 50 are considered positive and that is probably the best thing that can be said of this ISM update.

ISM Chart

Losers at the hands of the debt ceiling debate have been pretty easy to identify for the past couple of weeks now, but with the debate looking like its drawing to a close, the sectors and stocks that will be truly impacted by Uncle Sam's flirtation with austerity are coming to light. With politicians looking to save more than trillion over a decade, defense spending is a prime candidate for some trimming and it will see a haircut.

By some estimates, $325 billion could be cut from the Defense Department budget over 10 years, according to Bloomberg News. Somehow Boeing (BA) escaped a big decline today, but that is just one aerospace/defense name. The PowerShares Aerospace & Defense ETF (PPA) was down nearly 1.3% on volume that was roughly 14 times the daily average today.

PPA Chart

One sector that was home to some major declines today at the hands of government spending cuts is one that does not get much attention: Skilled nursing providers. On Friday, the Centers for Medicare and Medicaid Services issued its final ruling, resulting in an 11.1% haircut to Medicare skilled nursing facility rates.

The cuts go into effect on Oct. 1 and analysts were predictably pessimistic on the group as a result. Oppenheimer called the cuts a ''worst case scenario'' while downgrading Sun Healthcare Group (SUNH) to ''underperform'' from ''outperform.'' That stock plunged 52% on volume that was nearly 80 times the daily average. Skilled Healthcare Group (SKH) tumbled 42.5% on volume that was nearly 12 times the daily average after Morgan Keegan downgraded the stock to ''market perform'' from ''outperform.''

In a note to clients, Morgan Keegan analyst Robert Mains called the CMS cuts to skilled nursing providers ''a stinging setback'' and while noting the cuts were ''considerably worse'' than the industry or analysts were expecting, according to the Associated Press.

Sun Healthcare Chart

Over in the energy patch, there was some M&A news that kind of flew under the radar, though it was not of the announced or completed deal variety. Peabody Energy (BTU), the largest U.S. coal producer, and ArcelorMittal (MT), the world's largest steelmaker, have taken their $5.2 billion takeover bid for Australia's Macarthur Coal directly to the Australian company's shareholders, marking the start of a hostile bid.

As I have noted about this bid in the past, Missouri-based Peabody tried to acquire Macarthur last year for $3.4 billion on its own, but was rejected. Macarthur makes for an alluring takeover target not only because it is the world's largest maker of pulverized coal for use in steel production, but also because of Australia's proximity to China, India and other key emerging markets.

Obviously, Macarthur knows these things about itself and that apparently makes for a difficult negotiating partner. Macarthur rejected an offer from Peabody and ArcelorMittal of about $17 a share, saying it wanted an offer closer to $19.80 a share. Peabody and ArcelorMittal are willing to pay the equivalent of $27 for each ton of Macarthur's coal reserves and $3 a ton of its coal resources, Bloomberg News reported, citing a Morgan Stanley report.

Crucial to appealing to Macarthur shareholders for Peabody and ArcelorMittal is getting China's Citic Group, which owns 24% of Macarthur, to go along with the deal. If the deal is successful, it would be the second-largest takeover in the coal sector this year behind the $7.1 billion Alpha Natural Resources (ANR) paid for Massey Energy. For more news and commentary on the energy sector, sign up for a free trial of the OilSlick daily newsletter (HERE).

Peabody Energy Chart

Looking at the charts, by the time the market closed, the S&P 500 barely closed above its 200-day moving average just over 1285, though that support was violated by 11 points on an intraday basis. The index remains well below resistance in the 1310, though 1295 would have to be conquered first before 1310 can be addressed. If 1285 does not hold, 1265 is the next stopping point. Below there, it is time to drop long positions.

S&P 500 Chart

At least the Dow did not drop below its 200-day line today and it did close more than 50 points above that area, but the chart is only barely more attractive than that of the S&P 500. Another source of encouragement could be the fact that the Dow found psychological support at 12,000 and never came close to more critical support at 11,925. Resistance can be found around 12,320 and then again at 12,500. Pfizer (PFE) and Procter & Gamble (PG) are the big Dow earnings reports for the week, though I doubt either will materially impact the index.

Dow Chart

The Nasdaq finished the day in decent shape today, all things considered, and made a valiant effort to reclaim its 50-day moving average. While falling short of that mark by just seven points, the Nasdaq is at least a comfortable distance removed from support at 2700 and if it can clear the 50-day line, can run another 25 points to next resistance. After that, resistance is of the round number variety at 2800. There are enough brand-name earnings reports this week to help or hinder the Nasdaq.

Nasdaq Chart

The Russell 2000 fell through its 200-day line on Friday with hardly any fight, but the small-cap index made a decent effort to get back there today. There are two ways to look at Monday's action on the Russell 2000. First, it can be viewed as disappointing the index did not close above 800 after trading as high as 808. Or it can be said at least support at 775 was never an issue. I am cautiously leaning in the former camp as the Russell held up decently at the end of last week.

Russell 2000 Chart

Alright, so I will work on the assumption that a debt ceiling deal will pass, if not tonight, then sometime on Tuesday, but I am not convinced it will deliver the required euphoria for the market to make substantial headway toward erasing more than a week's worth of losses. There might be some initial positivity, but the harsh reality is even if a debt ceiling accord is reached, investors still have to contend with poor economic data. The ISM number today got that ball rolling and it is doubtful Friday's jobs report will surprise to the upside.

New Plays

Potential Short Squeeze

by James Brown

Click here to email James Brown

Editor's Note:

The market's failure to hold its early morning gains on the debt deal news was a shock for a lot of investors. I know that a lot of traders have exited the market as they wait to see what happens next. That's not a bad plan. There may be a debt deal but it hasn't been voted on in congress yet, nor has it passed.

The S&P 500 saw an intraday violation under its simple 200-dma but it bounced at the exponential 200-dma. This is also a test of its long-term trendline of higher lows. Essentially the market is at support. You have to ask yourself, will you buy the dip to support expecting a bounce? Or do you adjust your strategy and expect a breakdown? While there is plenty of negative economic news lately I am going to argue that support remains support until its broken. Thus we are adding a new bullish trade tonight.

FYI: While looking for candidates tonight I noticed that ATW, MDW, SHOO, and TSU all looked like bullish candidates. Unfortunately most of them have earnings this week. ATW reports on Aug. 3rd. Both SHOO and TSU report on Aug. 2nd. I couldn't find a report date for MDW.

- James


GATX Corp - GMT - close: 39.37 change: -0.06

Stop Loss: 38.15
Target(s): 42.50
Current Gain/Loss: unopened
Time Frame: 4 to 8 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
I listed GMT as a trading idea in my weekend editor's note. Shares held up pretty well today. Traders were buying the dip near $39.00 midday. If the market rallies this week shares of GMT could see a short squeeze. The most recent data listed short interest at 13.6% of the 46 million-share float.

I am suggesting we launch bullish positions now but only if both GMT and the S&P 500 open positive tomorrow morning. We will want to keep our position size small to limit our risk. If the play is opened we'll use a stop loss at $38.15. Our first target is $42.50.

buy GMT if both GMT & S&P 500 open positive tomorrow morning.

Suggested Position: buy GMT stock @ current levels

Annotated chart:

Entry on August xx at $ xx.xx
Earnings Date 10/20/11 (unconfirmed)
Average Daily Volume = 754 thousand
Listed on August 1, 2011

In Play Updates and Reviews

Stocks Extend Their Losses

by James Brown

Click here to email James Brown

Editor's Note:
News of a debt ceiling deal wasn't enough to end the stock market's losing streak. In spite of the broad market weakness we had a few candidates showing relative strength (MPC, SD, and VNR).


Current Portfolio:

BULLISH Play Updates

China Sunergy Co. Ltd. - CSUN - close: 1.54 change: -0.04

Stop Loss: 1.48
Target(s): 2.00, 2.25
Current Gain/Loss: - 7.7%
Time Frame: 3 to 4 weeks
New Positions: see below

08/01 update: There was a headline this morning that a Norway appeals court ruled in favor of CSUN in a legal dispute with REC Wafer Norway AS. The combination of the positive news and the debt ceiling deal in the U.S. helped push CSUN to a gap open at $1.65. Yet the rally immediately reversed and shares eventually gave back Friday's 4-cent bounce. This is another new lower high and CSUN looks headed for the $1.50 level again. More conservative traders may want to start thinking about an early exit! I am not suggesting new positions at this time.

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

EZCorp Inc. - EZPW - close: 32.87 change: -0.41

Stop Loss: 30.90
Target(s): 37.75
Current Gain/Loss: - 3.1%
Time Frame: 4 to 8 weeks
New Positions: see below

08/01 update: We were expecting a gap open higher if there was a debt deal. Sure enough EZPW opened higher. The stock gapped open at $33.93 and hit $34.19 before losing altitude. The reversal lower across the market was definitely unexpected. It looks like EZPW might retest technical support at its simple 100-dma again. Readers may want to wait for a dip near $32.00 or $31.75 before considering new bullish positions.

Current Position: Long EZPW stock @ $33.93

- or -

Long SEP $35 call (EZPW1117I35) Entry $1.45*

08/01 *entry price is an estimate. Option did not trade today

Entry on August 1 at $33.93
Earnings Date 11/03/11 (unconfirmed)
Average Daily Volume = 643 thousand
Listed on July 30, 2011

Marathon Petroleum Corp. - MPC - close: 44.97 change: +1.18

Stop Loss: 41.85
Target(s): 47.00, 49.75
Current Gain/Loss: - 0.1%
Time Frame: 4 to 8 weeks
New Positions: see below

08/01 update: MPC displayed relative strength today. Shares gapped open higher like most of the market. Yet instead of selling off the stock rebounded from the $44.00 level intraday and closed up +2.6% on the session. This strength is encouraging but the action in the market today is a warning signal. I would be careful when it comes to opening new positions. If we're patient we might get another entry point in MPC near 443.50 or even $42.50 later this week.

Current Position: Long MPC stock @ $45.04

- or -

Long SEP $45 call (MPC1117I45) Entry $2.00

08/01 MPC gapped open at $45.04

Entry on August 1 at $45.04
Earnings Date --/--/-- (unconfirmed)
Average Daily Volume = 4.8 million
Listed on July 30, 2011

Sandridge Energy, Inc. - SD - close: 11.70 change: +0.18

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

08/01 update: SD was also showing some relative strength. The stock gapped open at $11.93, hit $12.14 intraday and then slowly faded lower. Shares still managed to close with a +1.5% gain. While I remain bullish on SD I am growing more cautious on the market as a whole. Don't forget that we plan to exit ahead of the Aug. 4th earnings report.

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 (confirmed)
Average Daily Volume = 12.1 million
Listed on July 23, 2011

Proshares Ultra Russell 2000 ETF - UWM - cls: 43.36 chg: -0.36

Stop Loss: 40.99
Target(s): 50.00
Current Gain/Loss: - 0.8%
Time Frame: 3 to 4 weeks
New Positions: see below

08/01 update: The UWM opened higher and briefly traded above $45.00 but quickly faded as the market sold off on bearish economic data. This ETF seemed to find some intraday support near $42.50 but I would hesitate to launch new positions. The market's inability to rally on the debt deal is a warning sign.

Earlier Comments:
This is an aggressive, higher-risk, speculative trade. We're betting that lawmakers will come to some sort of agreement by Monday morning. If there is a deal on Monday then the market and the UWM will likely gap open higher and rally. If there is no deal then the UWM will probably gap open down. That's why we want to keep our position size small to limit our risk.

- SMALL positions -

Suggested Position: Long UMW @ $43.72

- or -

Long AUG $45 call (UWM1120H45) Entry $2.05

07/30 stop loss @ 40.99

Entry on July 29 at $43.72
Earnings Date --/--/--
Average Daily Volume = 2.1 million
Listed on July 28, 2011

Vanguard Natural Resources - VNR - cls: 31.56 chg: +1.03

Stop Loss: 29.70
Target(s): 33.25
Current Gain/Loss: + 3.1%
Time Frame: 3 to 4 weeks
New Positions: see below

08/01 update: VNR is breaking out from its two-week consolidation pattern. Shares gapped open higher with the rest of the stock market. Yet in stead of selling off with the market shares of VNR churned sideways and eventually accelerated higher into the closing bell for a +3.3% gain. It would be tempting to buy the breakout but we're almost out of time. We are planning to exit on Aug. 3rd at the closing bell to avoid earnings on the 4th.

Please note our new stop loss at $29.70.

Current Position: Long VNR stock @ $30.61

- or -

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

08/01 new stop loss @ 29.70
07/30 new stop loss @ 29.40
07/30 prepare to exit on Aug. 3rd at the close.
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: 28.44 change: -0.51

Stop Loss: 30.70
Target(s): 28.10, 26.25
Current Gain/Loss: + 3.2%
Time Frame: 3 to 4 weeks
New Positions: see below

08/01 update: The gap open in JKHY this morning was pretty anemic. Shares hit $29.21 and plunged to new relative lows. The stock settled with a -1.7% decline. The low today was $28.14. Our first target to take profits is the $28.10 level. I am not suggesting new positions at this time.

Earlier Comments:
Our first target to take profits is $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