Option Investor

Daily Newsletter, Tuesday, 8/23/2011

Table of Contents

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

Market Wrap

Market Earthquake

by Jim Brown

Click here to email Jim Brown
Shorts fled equities today on worries that Bernanke would say something positive on Friday. Now there is a serious risk of a sell the news event.

Market Statistics

Was today short covering or pent up buying? The rebound today came from support levels from the earlier August lows and could be seen as traders buying the dip. Buyers ignored bad news and tech stocks led the move higher. The tale of the tape suggests there were several major buy programs that could indicate an asset allocation move by more than one fund. Bonds are up so strongly and stocks dipping to support represented an opportunity for funds to bring their ratios back into balance by raising equity positions.

Futures were up +20 point overnight but had returned to the flat line before the open ahead of three possibly upsetting economic reports at 10:AM. The first was the Richmond Fed Manufacturing Survey for August. The headline number declined to -10 from the -1 reading in July. This was the third time out of the last four months the index has been in contraction territory.

The internal components were significantly negative. New orders fell to -11 from -5 an back orders fell to -25 from -18. Capital expenditure plans fell to 10.0 and the lowest level since September. This suggests manufacturers are going into hoard mode and conserving cash. The employment component fell to 1.0 and well off the 16.2 seen back in May.

The headline number at -10 was the lowest level of activity since March 2009. This decline in the Fed 5th district could be further incentive for Bernanke to ratchet up his market supporting comments on Friday. The debt debacle and the continuing worries over Europe have weighed heavily on business sentiment.

Richmond Fed Chart

New home sales declined to an annualized rate of 298,000 from the prior rate of 312,000. This was for the July period. Despite the decline the pace of sales was still +6.8% over the same period in 2010. The median home price decreased by -6.4% from June but is still +4.7% over the same period in 2010. Basically the spring spike has faded and sales should continue to slow as we move into the dormant winter season. We are bumping along the bottom until we can get a sustained move back over 400,000 per month.

New Home Sales

The Mass Layoff report for July showed a slight increase to 1,579 events from 1,532 in June. The number of employees impacted were 145,000, up only slightly from 143,444 in June. Manufacturing accounted for 28% of all layoff events and 33% of the initial jobless claims. This report is a lagging indicator since the nonfarm payrolls has more current data.

On a side note I heard presidential candidate Rick Santorum in an interview over the weekend and he had a novel approach for bringing manufacturing back to the USA. He advocates cutting the corporate tax rate from 35% to zero for companies that move their manufacturing back to the USA. This would provide an incentive for companies to bring manufacturing back to the U.S. and help offset the higher wages paid to U.S. workers over places like Mexico and China. Paying a U.S. worker $20 an hour compared to $5 in Mexico is a definite hindrance to companies wanting to stay in the USA. The U.S. has the second highest corporate tax rate in the world so that along with the high labor cost is forcing companies to go overseas or to South America.

A company with thousands of workers produces a major and long lasting economic impact on the mostly suburban or rural areas where they locate. The amount of economic activity generated by local manufacturing is enormous. Parts suppliers benefit, transportation companies benefit and local consumer retailers benefit. Having thousands of new workers produces tax revenue (sales and income) for local governments. Manufacturing used to account for 21% of the nations jobs but it has fallen to 9% thanks to the exportation of jobs to Mexico and China. That represents a loss of nearly 18 million American jobs. Bringing even 25% back would be a major victory and significant economic boost. Santorum has nearly zero chance as a candidate and I am not plugging him here but I thought the manufacturing tax cut was a good idea. I know I am in the minority here based on the comments on the web wherever his idea was discussed.

For the rest of the week the Kansas Fed Survey, GDP and Bernanke speech are the main events.

Economic Calendar

After today's rally I fear the Bernanke speech as a sell the news event. There is an almost zero chance he will announce anything with a QE in front of it and despite the Richmond Survey today the odds are good his speech will now be market neutral. The Fed has been criticized for supporting equities and coming out with a new program with the market already in rally mode would bring more criticism. I also heard several analysts claiming he can't say anything that could be seen as political because the President is going to announce his new jobs program right after Labor Day. "Bernanke can't be seen as upstaging the president" was the context of the conversations. All of this suggests Friday may be exciting but not in the way most traders would like.

The big news for the day was not earnings, IPOs or acquisitions. It was the 5.9 magnitude earthquake 3.7 miles deep below Mineral Virginia. The quake rocked nearly the entire northeast with tremors felt in New York City and as far west as Illinois. There did not appear to be any major damage from the "slow roller" but airports and trains all over the east coast were halted until damage could be assessed.

In New York some traders left the trading floors as the minute long quake struck fear into those not used to feeling the earth move. However, the electronic trading systems never blinked. Closed to Virginia nuclear power plants were knocked offline by earthquake sensors that triggered shutdowns but all were operating normally on backup diesel generators. The damage appeared to be limited to cracked windows, chimneys and a few water main breaks. We are very lucky the quake was so deep and relatively mild because residents in that area are not used to earthquakes. One historian said a quake of that magnitude in that area was last recorded back in the 1880s.

In equities Sprint was a high flyer with a +10% gain after a report in the Wall Street Journal said the company would begin selling the iPhone 5 in October. Sprint has never sold the iPhone before so this is a new surge of business for them. According to the WSJ Sprint will be selling both the iPhone 4 and the iPhone 5 when it launches in October. Sprint has 52 million subscribers. Verizon has 106 million and AT&T 99 million. That represents a big audience boost for Apple as well. Piper Jaffray predicted Sprint would sell six million iPhones in 2012. Piper raised estimates for Apple's iPhone sales growth in 2012 from +30% to +37%. They also boosted expected calendar year earnings to $34.59 per share from $33.72.

The Arm Holdings CEO tried to squash the takeover talk by Apple saying the company already made the chips for Apple devices and any such takeover attempt would incur significant regulatory issues. He also said a deal with Intel would also face insurmountable objections. He said Arm needed to remain independent and agnostic. He was referring to its role as a license dealer to a broad field of chip and device makers. ARM shares rose +9% on the rumors.

Apple Chart

Gold hit a new high overnight at $1917.90 overnight but the rally in equities and the Libyan civil war ending produced some profit taking in the yellow metal. Shares fell -$60 to close at $1831. That is a -3% decline in gold and a +3% rally in the Dow. Helping to push gold lower was a sharp rally in the dollar that started at 7:30 this morning. The dollar had plunged sharply overnight after China's PMI came in better than expected. Ironically the World Gold Council reported today that gold demand soared to its second highest quarterly level in Q2. China and India led purchases totaling more than $45.5 billion for the three-month period. China represents 55% of jewelry demand and 52% of bullion demand. The global growth rate for gold in Q2 was +7% but India saw demand rise +38%. More than 46% of the increase in global demand came in the form of jewelry with a whopping 442.5 tonnes going into jewelry. 102.9 tonnes of that jewelry went to China. Gold ETFs consumed 291 tonnes, the highest increase on record compared to only 51.7 tonnes in Q2-2010. Technology demand for electronic circuits rose +4% at 83.8 tonnes. Central banks purchased 69.4 tonnes and the second highest quarterly purchases in the last two years.

Gold Chart

Financials rallied strongly today after several analysts said the sell off was seriously over done. Claims from Monday that Bank America needed to raise another $50 billion in capital were countered by various analysts on Tuesday. Dick Bove said there was no reason for BAC to raise more capital unless there was another undisclosed loss in the tens of billions. He said of the 28 analysts following BAC none of them were expecting a loss for the next two quarters or even in 2012. He said, "if they continue shrinking their balance sheet the way they are and continue to show a profit the way they are, then there is no reason to raise capital. He repeated the recently coined phrase, "this is not 2008" and banks do not have to payoff all their short-term debt immediately because counter party transactions seized up.

Bove has been very negative on the markets for the last three weeks and he said today investors should be buying banks with both fists.

Bank America Chart

Hurricane Irene lost a lot of strength and changed direction significantly and may not hit Florida or even make landfall as a hurricane at all. Irene had strengthened to category three but after moving eastward from Cuba it unexpectedly fell to a category one status as it veered to the northeast. Florida appears to have dodged another disaster but North Carolina and Virginia are next in the crosshairs.

Irene Chart

I think some of the market bounce was due to better than expected economics. Yes, I know all three reports were negative but the Richmond Manufacturing Survey was expected to be a lot worse. There is not really a whisper number for the Richmond Survey but analyst chatter were clearly expecting a major decline similar to the Philly Fed decline to -30.7 last Thursday. A decline to only -10 was seen as a minor victory and maybe conditions are not as bad as feared.

The Kansas Manufacturing Survey on Thursday is going to be a key report now in hopes of another better than expected showing. The Kansas survey was barely positive at +3.0 for July.

The S&P rebounded +3.4% and ignored bad economic news and a major earthquake that rattled trading floors. That would appear to be somewhat bullish but we have to realize that most of the gains were powered by short covering.

Monday's +200 point Dow rally at the open saw all the gains erased by the close and if it were not for a small buy program at the close Monday would probably have been negative. That -200 point fade probably attracted a large number of shorts with the S&P actually dipping negative just before the close. When the market shook off a +20 point gain in the S&P futures overnight to open flat there were probably more shorts adding to their positions. The sudden rebound on "less bad" economics caught them flat footed and racing to cover. The real key is the resistance at 1200-1205 ahead of the Kansas Fed, GDP and Bernanke speech. Remember, one day does not make a trend.

S&P-500 Chart

The Dow dipped to prior support at 10,800 on Friday and failed to move lower on Monday. Like with the S&P this is a textbook retest of the lows although the time frame may be too short for a valid retest. The rally today was powered by the energy sector and the industrials. Only one component closed in the red and that was Bank America. The Dow rallied +3% but remains well below resistance at 11,400-11,500.

Dow Table

Dow Chart

The Nasdaq was a carbon copy of the other indexes except it did dip lower over the prior three days before rebounding +4.3% today and a +100 point gain. Apple +17 and Google +20 were the leaders of the bounce. The Nasdaq finished in the middle of its recent range with another 100 points needed to test resistance at 2550.

Nasdaq Chart

The Russell rebounded +4.9% and was power by what was clearly short covering. The intraday chart of the Russell was nearly vertical. Small caps had been more heavily shorted than the blue chips and today's rebound was the covering of those shorts. Russell 700 is the next battle zone.

Russell Chart

The market rebound makes it less likely for Bernanke to do something drastic if at all. If market were still in decline he would have had more incentive to act. Now his message will likely be "the Fed is react to act if the situation warrants but for now we believe the recovery is underway only slower than we expected." However, if he does not have any specific actions to announce he will probably turn into a cheerleader for the economy instead. If he can improve consumer and investor confidence by pointing out economic positives then he can still be a hero.

I fear the market is expecting too much and may be disappointed. If the Kansas Survey and GDP come in less bad than expected then maybe there is hope the rebound will stick. Unfortunately until we see some continuation of today's gains and a break over short-term resistance this is just a bear market bounce. I will be rooting for a breakout but there are a lot of potholes in our path that could produce a breakdown instead.

Jim Brown

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New Plays

Energy & Steel

by James Brown

Click here to email James Brown

Editor's Note:

Investors need to be careful here. We are facing the possibility that Ben Bernanke could disappoint the markets on Friday. Therefore we need to keep our position size pretty small to limit our risk.

- James


Ultra Oil & Gas ETF - DIG - close: 40.65 change: +3.33

Stop Loss: 36.75
Target(s): 48.50
Current Gain/Loss: unopened
Time Frame: 2 to 6 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
The DIG is the double-long (2x) ETF focused on the Dow Jones U.S. Oil & Gas index. The group was hammered in the late July and early August sell-off. Now it looks like the market and oil stocks could be forming a bullish double bottom.

I am suggesting small bullish positions now but only if both the DIG and the S&P500 both open positive tomorrow. The low this week has been $36.94 and the August low was $35.78. We will use a stop loss at $36.75. More aggressive traders may want to place their stop lower.

There is potential short-term resistance at $44.00 but We're aiming for a rally to $48.50.

open small bullish positions if DIG & the S&P500 both open positive tomorrow.

Suggested Position: buy this ETF @ open

- or -

buy the SEP $45 call (DIG1117I45) current ask $1.50

Annotated chart:

Entry on August xx at $ xx.xx
Earnings Date --/--/--
Average Daily Volume = 1.4 million
Listed on August 23, 2011

Steel ETF - SLX - close: 51.87 change: +2.17

Stop Loss: 49.45
Target(s): 55.75, 59.75
Current Gain/Loss: unopened
Time Frame: 2 to 6 weeks
New Positions: Yes, see below

Company Description

Why We Like It:
The SLX mimics the NYSE Arca Steel Index. This ETF appears to have found significant support near the $50.00 level, which was also support and resistance back in 2009. Now the SLX is forming what looks like a bullish double bottom pattern. I am suggesting we take advantage of the bounce to launch new bullish positions but only if the SLX and the S&P500 both open positive tomorrow morning. We need to keep our position size small. I am concerned that Bernanke might disappoint investors on Friday and his comments could send the market lower very fast.

We'll use a stop loss at 49.45. Our first target is $55.75. Our second, more aggressive target is $59.75. Note, the option spreads are a little wide.

open small bullish positions if SLX & the S&P500 both open positive tomorrow.

Suggested Position: buy this ETF @ open

- or -

buy the SEP $55 call (SLX1117I55) current ask $1.30

Annotated chart:

Entry on August xx at $ xx.xx
Earnings Date --/--/--
Average Daily Volume = 126 thousand
Listed on August 23, 2011

In Play Updates and Reviews

Another Big Move

by James Brown

Click here to email James Brown

Editor's Note:
Stocks produced another big move but this time it was higher. Nearly every sector participated in this widespread rebound.

RGR produced a very big turnaround after yesterday's potential bearish reversal.


Current Portfolio:

BULLISH Play Updates

Alexion Pharmaceuticals - ALXN - close: 51.73 change: +1.32

Stop Loss: 47.90
Target(s): 54.00, 57.00
Current Gain/Loss: + 2.0%
Time Frame: 2 to 5 weeks
New Positions: see below

08/23 update: It was a big day for the market. ALXN's +2.6% gain could not keep up with the NASDAQ's +4.2% rally. Once again traders bought the dip in ALXN near support at $50.00. Today's move looks like a new bullish entry point but I want to warn you that stocks could drop fast if Bernanke disappoints on Friday. Cautious traders may want to use a stop loss closer to $49.40 instead.

Our plan was to keep our position size small to limit our risk.

Current Position: ALXN stock @ $50.67

- or -

Long SEP $55 call (ALXN1117I55) Entry $1.40

08/15 new stop loss @ 47.90
08/12 trade is open.
08/11 open positions if ALXN and S&P500 are positive Friday morning
08/09 new entry point strategy, new stop loss, new targets.

Entry on August 12 at $50.67
Earnings Date 10/20/11 (unconfirmed)
Average Daily Volume = 1.7 million
Listed on August 8, 2011

Auxilium Pharma - AUXL - close: 17.00 change: +0.87

Stop Loss: 14.95
Target(s): 17.95, 19.75
Current Gain/Loss: +5.3%
Time Frame: 6 to 8 weeks
New Positions: see below

08/23 update: AUXL managed to outpace the rally in the NASDAQ with a +5.3% gain today. Volume was strong again, which is a good sign. Our first target is at $17.95. We will add a secondary, and much more aggressive target at $19.75 but that means AUXL will need to rally past multiple levels of resistance to get there.

Please note our new stop loss at $14.95. More conservative traders may want a stop closer to $15.50 instead.

Given the market's recent volatility we do want to keep our position size small.

Current Position: Long AUXL stock @ $16.13

- or -

Long SEP $17.50 call (AUXL1117I17.5) Entry $0.45

08/23 new stop loss @ 14.95.
08/23 added 2nd target at $19.75

Entry on August 22 at $16.13
Earnings Date 11/03/11 (unconfirmed)
Average Daily Volume = 1.4 million
Listed on August 20, 2011

Avon Products Inc. - AVP - close: 21.36 change: +0.71

Stop Loss: 19.95
Target(s): 23.50, 24.40
Current Gain/Loss: - 2.5%
Time Frame: 6 to 8 weeks
New Positions: see below

08/23 update: AVP delivered a +3.4% gain but has yet to fill the gap down from Aug. 18th. The $21.70 level could be short-term resistance. I would be tempted to launch new positions here but I have to warn you that if Bernanke disappoints the market on Friday then stocks could drop pretty quickly.

- small bullish positions -

Suggested Position: Long AVP stock @ $21.91

- or -

Long SEP $23 call (AVP1117I23) entry $0.50

08/20 new stop loss at $19.95

Entry on August 17 at $21.91
Earnings Date 10/27/11 (unconfirmed)
Average Daily Volume = 5.1 million
Listed on August 15, 2011

Giant Interactive Group Inc. - GA - close: 7.94 change: +0.26

Stop Loss: 7.38
Target(s): 9.30
Current Gain/Loss: - 6.1%
2nd position Gain/Loss: +0.0%
Time Frame: 4 to 8 weeks
New Positions: see below

08/23 update: GA produced another bounce near support at $7.60 and its 200-dma. This time there was some follow through and shares added +3.3%. The rebound looks like a new bullish entry point. I would consider new positions here. We will raise our stop loss up to $7.55.

Earlier Comments:
Readers should consider this a higher-risk, more aggressive trade. We want to keep our position size small to limit our risk.

Current Position: Long GA stock @ $8.46

- or -

Long SEP $7.50 call (GA1117I7.5) Entry $0.95

- Add 2nd position - keep it small!

buy GA stock @ the open

buy SEP $7.50 call (GA1117I7.5) current ask $0.65

08/23 new stop loss @ 7.55
08/23 adding a 2nd position
08/20 new stop loss @ 7.38

Entry on August 15 at $ 8.46
Earnings Date 11/16/11 (unconfirmed)
Average Daily Volume = 1.3 million
Listed on August 13, 2011

Sturm Ruger & Co - RGR - close: 30.67 change: +2.19

Stop Loss: 27.25
Target(s): 33.75
Current Gain/Loss: + 1.3%
Time Frame: 6 to 8 weeks
New Positions: see below

08/23 update: The bullish reversal in RGR was impressive. After yesterday's sharp decline, the stock reversed our -5% loss thanks to today's +7.6% surge to new all-time closing highs. The stock is acting pretty frothy here and the big volatility could be a warning signal. We definitely want to keep our position size small. Readers might want to raise their stop loss closer to the $28.00 level instead.

Current Position: Long RGR stock @ 30.25

- or -

Long SEP $30 call (RGR1117I30) Entry $1.95

08/22 RGR gaps open higher at $30.25 (entry point)

Entry on August 22 at $30.25
Earnings Date 10/27/11 (unconfirmed)
Average Daily Volume = 310 thousand
Listed on August 20, 2011

RealD Inc. - RLD - close: 15.17 change: +0.70

Stop Loss: 11.99
Target(s): 18.00
Current Gain/Loss: + 8.0%
Time Frame: 6 to 10 weeks
New Positions: see below

08/23 update: RLD continues to outperform. Shares added another +4.8% and closed above potential resistance at the $15.00 level. My only concern today would be the very light volume behind today's move. The next level of resistance is the $16.00 mark. Cautious trades may want to take profits near $16.00. I would not chase it here. More conservative investors might want to raise their stop toward the $13.00-13.20 area.

Earlier Comments:
We want to use small positions to limit our risk. NOTE: If you trade options you may want to use the November instead of Octobers but the spreads are a little wider.

current Position: Long RLD stock @ $14.04

- or -

Long SEP $15.00 call (RLD1117I15) Entry $0.60

08/22 gap open entry at $14.04

Entry on August 22 at $14.04
Earnings Date 11/02/11 (unconfirmed)
Average Daily Volume = 1.4 million
Listed on August 20, 2011

BEARISH Play Updates

Nordic American Tanker - NAT - close: 17.46 change: +0.58

Stop Loss: 18.55
Target(s): 12.75, 10.50
Current Gain/Loss: - 2.4%
Time Frame: 6 to 12 weeks
New Positions: see below

08/23 update: The highly shorted shipping stocks saw a strong bounce and yet NAT's +3.4% gain was only in line with the rebound in the S&P500 index. I would wait for a rise to or a failed rally near $18.00 as our next entry point.

Start small and add to positions later. You may want to consider using put options instead since your risk is limited to the cost of the put you purchase.

- small positions -

Current Position: short NAT stock @ $17.05

- or -

Long OCT $15 PUT (NAT1122V15) Entry $0.75*

08/22 gap open entry @ 17.05
* option entry is an estimate. option did not trade today

Entry on August 22 at $17.05
Earnings Date 11/07/11 (unconfirmed)
Average Daily Volume = 583 thousand
Listed on August 20, 2011

Overseas Shipholding Group - OSG - close: 15.81 change: +0.87

Stop Loss: 17.55
Target(s): 12.50, 10.25
Current Gain/Loss: - 1.8%
Time Frame: 6 to 12 weeks
New Positions: see below

08/23 update: OSG experienced a +5.8% bounce thanks to some short covering. The stock has been very oversold for a long time. Readers may want to wait for a bounce near $16.50 or the 10-dma before considering new bearish positions. I would keep positions very small to start.

- Small Bearish Positions -

Current Position: short OSG stock @ $15.52

- or -

Long OCT $14 PUT (OSG1122V14) Entry $1.50

08/22 gap open entry at $15.52

Entry on August 22 at $15.52
Earnings Date 11/02/11 (unconfirmed)
Average Daily Volume = 981 thousand
Listed on August 20, 2011


Susser Holdings - SUSS - close: 20.79 change: +0.89

Stop Loss: 17.30
Target(s): 21.75
Current Gain/Loss: unopened
Time Frame: 4 to 8 weeks
New Positions: see below

08/23 update: It's very unfortunate that our entry point on SUSS was not triggered. The stock has continued to outperform. Now shares are looking overbought with the sharp rally from $16 to almost $21. I would not chase it and we are removing SUSS as a candidate. Yet I would definitely keep this stock on your watch list for a pull back.

Our trade did not open.


Entry on August xx at $ xx.xx
Earnings Date 11/09/11 (unconfirmed)
Average Daily Volume = 88.5 thousand
Listed on August 18, 2011