Option Investor

Daily Newsletter, Wednesday, 1/20/2016

Table of Contents

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

Market Wrap

In the Eye of the Beholder -- An Ugly Day or Great Recovery

by Keene Little

Click here to email Keene Little
The market has been deeply oversold for nearly a week but that's not stopping the selling and this morning's decline had many thinking the market is crashing (if effect it has been and could still be). But the sharp recovery off the day's lows now has many thinking the worst is behind us. That could be wishful thinking.

Today's Market Stats

Today could have been the flush that refreshes. Kind of like a dunk in cold water to wake you up and give you the energy needed to take on a task, like rallying the market. Or it could have been nothing more than a bout of short covering that will not see any follow through. We all know rallies during bear markets, which I believe we're in, can be much sharper than rallies during bull markets but they tend not to last since real buying doesn't get behind the push to drive it higher. It remains to be seen what the recovery off today's low was.

This morning's decline had many analysts pointing out how strong the selling was and what it might mean (there was a lot of fear but interestingly, the VIX registered only a minor new high above last Friday's and not even close to the August 2015 high). Jason Geopfert (sentimentrader.com) had tweeted this morning that the lopsided selling, if the market didn't recover, was something the market had experienced only twice before since 1940 -- October 19, 1987 and August 8, 2011.

Another analyst had noted that there were 30 stocks down for every one up. A 10-to-1 ratio is considered extreme (a 90% day) and here we were experiencing a 30-to-1 ratio, which is why many thought we were in the middle of a crash lower. It does show how quickly the market can get lopsided because of a generally low liquidity environment without the market makers like we used to have. When HFTs, which account for about 80% of our volume now, either step aside or step on the market's throat we can see abnormal price action, although perhaps it's becoming more normal to see large fast moves.

The important point from today's price action is that the market could indeed be in the middle of what will become a much stronger crash leg lower. The recovery off the midday low was strong but short-covering rallies are almost always strong. Follow through will be the key and if there is no follow through on Thursday we could have a market that's in real trouble. But if we see more or less a choppy pullback with lower volume then I think we can expect higher prices or a longer consolidation before heading lower again. I don't think a bottom of significance is in yet but I do think we'll see a bounce/consolidation into the end of the month before heading lower. I don't believe we'll see the market crash lower from here but I am wary of one and I think traders should trade accordingly.

Coming into the new year I would say most did not believe we were already in a bear market or that January would turn into such a negative month. I had been saying for many weeks that the bearish interpretation of the pattern following the November high was in fact very bearish since it meant we had a series of 1st and 2nd waves to the downside, which called for essentially a crash leg lower that would look like the August decline but potentially stronger. This pattern calls for lower prices in a stair-step move down into February/March before putting in a decent low. I think we're now moving into the stair-step-lower part of the pattern. As always, my opinion will change based on what price tells me but at the moment price has confirmed the more bearish interpretation of the pattern.

While the S&P 500 index was holding up into the end of the year it was important to recognize that the majority of stocks in the index were already in bear markets (identified as -20%) and that was one of many market breadth indications that the market was sick. We had many important indexes not confirming the strength we were seeing in the major indexes but now we're starting to get confirmation with the broader market in decline. And it's not just the U.S. but in fact we're seeing the global markets in decline, which supports the idea we're all in this together now. A global recession is upon us and we know stock markets never do well when there's a recession (actually a depression when measured by the lack of growth, slowing money velocity and now a coming credit collapse will be added to the list).

We can now add another statistic that supports a coming bear market -- an observation from Jason Geopfert has to do with the back-to-back 10% corrections we've had in a short span (less than 6 months), which we've now had after the August and January declines. This has only happened three times in the past 100 years -- 1929, 2000 and 2008. Those of course were not good times to be long the market. The market will not decline in a straight line but obviously it's important to see the risk and act accordingly. We will have sharp rallies along the way, or some sideways choppy consolidations, but they're to be used to sell into rather than looking to buy bottoms. Fast traders can certainly catch reversals, like off today's low, but they're counter-trend trades and must be done carefully and with tight risk management.

I've mentioned many times in the past that I think the credit bubble we're in right now, created by the Fed's monetary policies, will be the cause of a stronger bear market than we've seen in the past. The level of distortion in the financial world is far greater today than it was in 2007. I don't say these things to scare people; I only say them to help motivate people move into safety, which means mostly cash, maybe some gold and maybe some short positions (such as bear ETFs). The level of debt today is like nothing we've experienced before and when it collapses it will be highly deflationary (paying off debt or declaring bankruptcy pulls money out of circulation). It's the main reason I've said the Fed is much more likely to announce another QE program before they raise rates again. I'm guessing there are more than a few Fed governors right now saying "Oh sh**, we might have made a mistake in December."

I came across the chart below from an update from Harry Dent, which he found in Business Insider, and it shows how distorted the debt level is compared to corporate earnings. Debt has skyrocketed since 2014 while earnings have rolled over since 2015. It was the decline in earnings last year that turned me even more bearish than I already was in 2014. It was the reason so many stocks actually entered bear market territory last year, even though that was disguised by how well the major indexes were holding up. This parabolic climb in debt, creating the current credit bubble, will follow the path of all parabolic climbs -- it will come down faster than it went up and the sudden drying up of liquidity will make the stock market extremely vulnerable to more flash crashes.

Net Debt vs. EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization), chart courtesy Business Insider

OK, enough scare talk (have you moved into cash yet?), let's see what the charts are telling us. Before I get into my regular chart updates I do want to show some more examples of how the market has been talking to us and warning us of some bearish things to come. I hope I'm not beating a dead horse here but I think it's important to understand why I lean so bearish this market. I could be wrong but at least you'll understand where I'm coming from. I won't show another chart comparing SPX to the commodity index since I've shown that multiple times int eh past year -- I called it my alligator chart since the widening difference between the two (commodities heading strongly lower while SPX head strongly higher) was setting up the mother of all snappers. The alligator's mouth is now beginning to close but there's still time to get out of the way.

The chart below shows the comparison between SPX and the price spread between the 10-year Treasury and junk bonds (using the ETF HYG). That spread identifies how much traders are willing to take on risk and the larger the spread the more it's identifying risk-off, which of course will soon show up in the willingness to hold stock as well, even if it's a delayed response. The price spread began to widen after peaking in June 2014 and the lower peak in May 2015 coincided with a higher peak for SPX (the last high for SPX), a clear indication of a problem and why I kept saying the stock market was out of touch with reality and whistling past the graveyard. The collapse of the price spread (reflecting the collapse in junk bond prices) that started in June 2015 and another lower high in November was the time to listen to the market and get out of the stock market.

SPX vs. 10-year Treasury minus Junk bond prices, Weekly chart

The S&P 500 index is market cap weighted and therefore is more heavily influenced by the larger cap stocks. This is what held up the index while the majority of its component stocks entered their own bear market. An index that weights stocks evenly is the Valued Line (Geometric) index, whose symbol is $XVG in some charting programs, such as stockcharts.com. In my QCharts it's $VALUG and I added it to my list of indexes in the market stats at the top of this report). It's an important index to watch as a way to see how stocks as a whole are performing and not just the most-watched indexes, which can be more easily manipulated as a way to keep the sheeple placated. The monthly chart of this index is shown below.

I've shown the monthly chart of the INDU with its expanding triangle to highlight the downside risk (not a prediction but it shows the risk and why the INDU could drop below 6000). The VALUG shows the relatively weaker performance since 2000 with only retests of the 2000 high in 2007 and again in April 2015. Instead of an expanding triangle we have a descending triangle (flat top, descending lows) but the message is the same -- a 5-wave move inside it, labeled A-B-C-D-E, suggests another leg down to the bottom of the triangle to complete the pattern. That would be a drop from its 2015 high near 523 to 50-60, or a 90% "correction." Again, not a prediction but that's the risk if you simply want to be a buy-and-holder (how long do you think it would reasonably take to get back to 500 from 50?).

Value Line Geometric index, VALUG (or XVG), Monthly chart

Notice that today's decline had VALUG hitting its 38% retracement of its 2009-2015 rally, as well as its 200-month MA, near 383 and 385, resp. Not shown on the chart, the decline from June 2015 achieved two equal legs down near 383 and it's another reason why there's strong support here. There's even the chance, from an EW (Elliott Wave) perspective, to see a new rally leg from here, one that will take the indexes to new highs this year. Call me a Doubting Thomas but I don't think that will happen. It's not impossible but I'll want to see some impulsive action to the upside before I become a believer. One big reason for not believing in new highs is because of the overlap of the April 2011 high, which from an EW perspective negates the idea that the pullback from June 2015 is a 4th wave in a bullish pattern off the 2009 low. The a-b-c move up to 523.65 is a good fit for the completion of that bull market leg. Now we should be into the final bear market leg of the secular bear that started off the 2000 high.

OK, one more dead horse to beat -- the monthly chart below shows a direct comparison of SPX to VALUG and it's pretty obvious how poorly the index of stocks (VALUG) was doing against the index of big cap stocks since VALUG topped out in June 2015. While it was testing its 2000 and 2007 highs we saw SPX scream higher. VALUG has dropped below its May 2011 high and for SPX to do the same it has to drop below 1370, and I believe it will (maybe not this year but even that could happen). That would be a 36% decline, which is actually a typical bear market retracement. At any rate, you can see the downside risk.

SPX vs. VALUG, Monthly chart

So let's move on to the charts I typically update. The SPX weekly chart below shows how a "typical" EW pattern could play out if we're going to see a 5-wave move down from its high in May 2015. At the moment, as mentioned for VALUG, the move down is only a 3-wave move and it achieved two equal legs down at 1853.67. That 3-wave pullback could be a correction to the longer-term rally and now we'll start another rally leg to new highs. If the rally becomes impulsive (not overlapping highs and lows in a choppy climb back up) I'll get more serious about looking for dips to buy but at the moment I'm sticking with the bearish interpretation of the pattern until price tells me otherwise. That means I'm looking for only bounce corrections and then stair-step lower this year before potentially bottoming in the fall. After the completion of a 5-wave move down into the fall, as depicted on the chart, I would then look for a strong correction to the decline into early 2017 before again heading lower.

S&P 500, SPX, Weekly chart

The daily chart below shows a nice bullish hammer candlestick on support for SPX (October 2014 low). It should be good for a 4th wave correction in an expected stair-step pattern lower (if the bearish EW count is correct). As to what kind of bounce pattern we should expect over the next week or two, I have no idea yet (4th waves are horrible to figure out in real time as there are 11 different corrective patterns). But as cautioned today during the decline, it was risky chasing it lower since the setup was looking good for the v-bottom reversal we got. Now follow through will be key.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1950
- bearish below 1820

One bullish warning that we were getting from the 60-min chart, shown below, is the bullish divergence since the January 4th low. I was starting to wonder about that with today's low but the sharp reversal, so far, supports the idea for a higher bounce correction. Notice today's rally stopped at the top of its down-channel from the December 29th high and it could continue lower but a rally above this afternoon's high at 1876 would be a good sign for the bulls (at least short term). There is strong resistance near 1885-1888 (price-level S/R and the broken uptrend line from August-September 2015) and it would look more bullish above Monday's high at 1901. But again, while we could see a high bounce, there's a good chance it will be another shorting opportunity.

S&P 500, SPX, 60-min chart

After holding support near 16K on Friday and yesterday the DOW lost it today and dropped below it August closing low at 15666 and almost made it down to its February and August lows at 15340-15350. The midday low at 15450 was 100 points above that level but with the current volatility that measly 100 points could have been lost in less than an hour. But support held today and the setup looks good for a bounce into the end of the month before worrying about the next leg down.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 16,600
- bearish below 15,300

NDX finished more bullishly than the blue chips with a white candle body for its bullish hammer at support. The close held support at its uptrend line from March 2009 - August 2015 and should be good for a bounce before dropping lower. The NDX pattern is a little more bullish than the blue chips in that it calls for only one more drop after the coming bounce, which might only be a retest of today's low in February, to complete a 5-wave move down from December. That would then set it up for a much stronger bounce correction into March/April before heading lower again. Its pattern will be closely monitored and compared to the blue chips in the coming month.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 4360
- bearish below 4050

This morning the RUT dropped below its trend line along the lows from February-October 2014, as well as a price projection at 987.71 where its decline from June 2015 achieved two equal legs down. The short-term pattern does not look complete to the downside (it needs a bounce correction and then another leg down to complete a 5-wave move down from December 2nd) but from a longer-term perspective the RUT is at an interesting point. Not shown on the daily chart below is a trend line along the highs from March 2014 - June 2015 and between that trend line and the one along the lows from February-October 2014 it creates an expanding triangle (maybe the left half of a large diamond top pattern), which calls for a rally back to the top of the pattern. That would mean a rally to a new high this year, such as around 1350-1400 (the June 2015 high was 1296). Again, call me a Doubting Thomas on that one but if it happens you heard it here first, wink. I think the bulls have a LOT of work to do before proving the market can get bullish again.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 1057
- bearish below 967

With the strong selloff in the stock market it hasn't been surprising to see the bond market rallying (a run to relative safety of Treasuries). This of course has driven yields lower and the 10-year Note (TNX) has now dropped back below 2%. The next support level is 1.905% (today's low was 1.939%, down from yesterday's close at 2.035%), which are the August and September 2015 lows, and then below that is an uptrend line from July 2012 - Jan 2015, currently near 1.75%. Two equal legs down from June targets 1.729% and I think that's where the current decline is headed. From there I show another bounce to complete a sideways triangle off July 2012 low before heading lower. Below 1.72% would be more immediately bearish yields (bullish for bond prices).

10-year Yield, TNX, Weekly chart

The TRAN made it down to a price projection near 6500 where the decline from March has two equal legs down (a common theme for many indexes) and as such it could be decent support (these measured moves often result in good support). The bearish wave count says we should expect nothing more than a small bounce correction, maybe up and over to the broken trend line along the lows form December 2014 - August 2015, near 6710 at the end of the month, and then lower. Based on how it plays out into the end of the month I see downside potential to about 6000 before setting up a larger (in time if not price) bounce correction.

Transportation Index, TRAN, Daily chart

The U.S. dollar hasn't done much for the past several weeks and the choppy bounce/consolidation continues to point to a move back down in what I believe will be a larger consolidation pattern this year.

U.S. Dollar contract, DX, Weekly chart

Especially this morning we saw scared money running into gold but some of it was given back once the stock market started to recover. I continue to see upside potential for gold near 1140 (price-level S/R and its downtrend line from October 2012- January 2015) but the larger pattern continues to suggest lower prices for gold before we'll see a better buying opportunity.

Gold continuous contract, GC, Weekly chart

I like to keep my eye on silver to see if there's agreement/disagreement between it and gold. While gold has been attempting a bounce off the December 3rd low we've seen silver consolidate in a sideways triangle, which fits as a bearish continuation pattern. It's likely close to finishing and we should get another leg down, potentially to a price projection at 12.63 where it would also hit its trend line along the lows from March-August 2015. Silver's price pattern supports the idea that we're also going to see another leg down for gold.

Silver continuous contract, SI, Daily chart

Like the stock market, oil might finally be ready to get off the mat without being hammered back down to it. I've been eyeing 26 for support, an important price-level S/R line since 1984, which was last tested in 2003. And as noted on its weekly chart below, a 77% decline from May 2011, which would match the percentage loss in its 2008-2009 decline, gives us 26.40. Splitting the difference between 26 and 26.40 gives us 26.20 for a target price. Today's low was 26.19 (close enough for government work). There are many calling for $25 and I see the potential for it to drop down to $24 to hit the bottom of a down-channel for its decline from June 2014 but at the moment it's looking like a good setup for a bounce correction, perhaps back up to about 33 before rolling back over.

Oil continuous contract, CL, Weekly chart

There were no surprises in this morning's economic reports (would it have mattered?) and tomorrow will likely not be affected by the morning reports either. The Philly Fed index is very important and it's expected to show further slowing but I think at this point the market is starting to get it.

Economic reports


While I see lower prices into February, I think it's important to recognize that we're due at least a bounce and it could turn into a strong one. The setup was good for a low today and while it went lower than I thought it would, the strong reversal back up gave us a good short-term buy signal. Assuming we'll get a bounce correction into the end of this month, I'll then be watching for a setup to get short for another drop lower in February.

As for the bullish potential, I've mentioned the large 3-wave pullback pattern from last year's highs into today's lows for many of the indexes. This interpretation is very bullish since it calls for the resumption of the bull market with a rally to new highs. While I consider that to be a much lower probability than lower prices this year, it needs to be considered as a possibility when evaluating your positions. The market is deeply oversold and it's certainly possible we'll get a large, even if short-lived, bounce correction. If you're short and wanting to just hang on for more, you could give up a lot of profits before recognizing the market has much more bullish intentions. A bear market, which I believe we're in, deserves shorter-term trading and knowing when to take profits and when to get back in (e.g., back in short) is a difficult but necessary thing to do.

Is now the time to exit shorts and get long? I would say it's a good time to at least trim short positions but not necessarily get long. Active traders have a good opportunity to play both sides in a bounce correction but it's possible we'll see whippy price action that whacks traders on both sides. If we see some strong upside price action then we'll have some clues to buy the subsequent dip. But trimming profits on short positions would then enable you to bank some money and wait for the next shorting opportunity, which I believe will be by the end of the month if we get a typical bounce correction following today's low.

As has been true all month, there is the potential for the market to crash lower (SPX down at least another 100 points below today's low) but at this point I consider that a lower-odds probability. The risk is there so don't get long and forget about your trade (waking up and seeing SPX gapped down 50-75 points would not be pleasant if you're long the market). In a correction, which I'm expecting over the next week or two, it's easy to get whacked out of both sides of a trade (I've called 4th wave corrections "feed your broker" corrections) so I'd look at day trading only and consider any overnight holds as very risky. By this time next week I should have a much better idea about when a bounce correction should end (assuming we'll get the bounce). Until then, trade carefully.

Good luck and I'll be back with you next Wednesday.

Keene H. Little, CMT

In the end everything works out and if it doesn't work out, it is not the end. Old Indian Saying

New Plays

Lower Lows Ahead

by Jim Brown

Click here to email Jim Brown
Editor's Note

The major indexes may be rebounding today but there is one asset class that will be facing lower lows in the near future.

That asset is oil. Crude closed today at $26.55 and this was the last day of trading for the February contract. That probably had a lot to do with the -5% decline to 13-year lows. The March contract becomes the front month on Thursday. That contract is trading at $28.81 tonight. That is a long way from $26.55 but it will get there.


No new bullish plays


OIH - Oil service Index

The OIH ETF represents 25 oil service stocks including Schlumberger, Halliburton and Baker Hughes. Once you get past those three largest holdings the rest of the pack has little balance sheet strength and we could easily see multiple bankruptcies or credit defaults. The bottom of the list contains Tidewater (TDW), Carbo Ceramics (CRR), Seadrill (SDRL), etc. The risk of default is high for the bottom half of the list. View Full List

The "perceived" bounce in oil prices by shifting to a new contract at $28.81 instead of the $26.55 close may cause some investors to buy energy stocks in a knee jerk reaction. Do not be fooled. The bottom in oil prices is still ahead.

The API Inventory report tonight after the close showed a larger than expected gain of 4.6 million barrels of oil and 4.7 million barrels of gasoline. The more accurate EIA inventory report comes out at 10:30 on Thursday.

The inventory build season runs from January 6th to the end of April. Last year inventories rose a whopping +106 million barrels to record levels during that period. There is not likely to be another rise like that because there is very little available storage capacity in the USA. Canadian oil is now selling for $15 below WTI because all the Midwest storage locations are virtually full. Bakken oil is selling for $8-$10 below WTI prices for the same reason plus transportation is expensive to other locations.

I believe we will see WTI at $25 or below over the next two months and possibly even $20 because of the price pressure from the Iranian oil sales. They have about 50 million barrels stored on tankers and that oil is now available for sale. Prices are going lower.

This will probably drag the equity market lower as well but eventually there will be a disconnect between equities and oil prices at some level. The constant headlines about lower oil prices will eventually become old news. Of course, key levels like $25, $22, $20 could cause some additional market weakness.

Energy stocks will continue to react to the low oil prices because every dollar of decline is very painful and impacts their ability to service debt and keep the doors open. Analysts claim as many as 50% of the U.S. producers could default or worse if prices remain low for very long.

I am recommending we short the OIH and expect to hold the position until April. The plan will be to close it about the time inventories top out in early April. We could see a minor uptick at the open on Thursday because of the new front month contract. When inventories are announced at 10:30 we should see a decline in WTI if they are high as expected.

Short OIH shares, currently $21.25, stop loss $24.25


Buy long July $20 put, currently $1.93, no initial stop loss.

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Jim Brown

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In Play Updates and Reviews

Bunge Market

by Jim Brown

Click here to email Jim Brown
Editors Note:

Not every big market dip is followed by a monster rebound but when it happens, we should rejoice. The rebound today was a very powerful short squeeze and we have not seen one like that in 2016.

The monster decline of -566 Dow points was nearly reversed but some late day sellers arrived to offset a high volume of buy on close orders. Hopefully that was the bears last gasp. Large short squeezes like we saw today are normally followed by another day of gains from those traders that did not get the memo that the bottom was in. This does not always happen but the setup today was nearly perfect. With 30:1 decliners to advancers at the lows of the day that is serious capitulation statistics. Let's hope it sticks.

Current Portfolio

We are changing the format slightly this week. The entry date, earnings date, current price, change for the day and stop loss are all in the portfolio graphic. They will no longer be listed in the individual play descriptions. Everything you need is now available in a single location.

Current Position Changes

Stop Loss Updates

Check the graphic above for any new stop losses in bright yellow. We need to always be prepared for an unexpected decline.

CHUY - Chuys Holdings

The only play that was stopped out was the new position in CHUY. The stock dropped -6% in the market downdraft.

KRE - Banking ETF

The KRE play was triggered on the market decline. Let's hope from a continued rebound.

BULLISH Play Updates

CHUY - Chuy's Holdings


Chuy's dropped -6% in the market decline and knocked us out of the new position. There was no news on the stock, just an ugly market.

Original Trade Description: January 14, 2016:

Small cap stocks underperformed last year with the small cap Russell 2000 index falling -5.9% in 2015. CHUY is one small cap that bucked the trend with shares surging +59% in 2015. That relative strength continues in 2016. The Russell 2000 index is already down -9.7% this year. Meanwhile CHUY is up +14% year to date and looks poised to hit new highs.

CHUY is in the services sector. According to the company, "Founded in Austin, Texas in 1982, Chuy's owns and operates 69 full-service restaurants across fourteen states serving a distinct menu of authentic, made from scratch Tex Mex inspired dishes. Chuy's highly flavorful and freshly prepared fare is served in a fun, eclectic and irreverent atmosphere, while each location offers a unique, 'unchained' look and feel, as expressed by the concept's motto 'If you've seen one Chuy's, you've seen one Chuy's!'."

CHUY's earnings and revenues have been hotter than a jalapeno. The company has beaten Wall Street's earnings estimates the last four quarters in a row. They have beaten analysts' revenue estimates in three of the last four quarters. Management has raised guidance three quarters in a row.

Check out their revenue growth: Q4 2014 revenues +21.7%, Q1 2015 +19%, Q2 2015 +19%, and Q3 2015 saw revenues +15%. That's on top of a tough comparison to Q3 2014 where revenues rose +20%.

Technically shares appear to be in breakout mode. The surge on January 12th lifted CHUY out of a five-month consolidation and on big volume. Traders bought the dip today exactly where they should have near $34.00, which as prior resistance is now new support. If this rally continues CHUY could see a short squeeze. The most recent data listed short interest at 21% of its small 16.0 million share float. The point & figure chart is bullish and forecasting at $44.00 target.

Today's intraday rebound lifted CHUY back to the $36.00 level. Tonight we are suggesting a trigger to launch bullish positions at $36.65.

Position 1/19/16:

Closed CHUY shares, entry $36.15, exit $33.40, -2.75 loss
Closed April $37.50 call, entry $2.86, exit $1.60, -1.26 loss

KRE - SPDR S&P Regional Banking ETF


KRE shares dipped to $34.78 intraday and triggered our long position at $35.50 on the way down. The ETF bounced from the support at $35.20 to end the day with a minimal 50-cent loss.

The initial stop loss on the stock position is $34.25. However, I took the stop loss off the option position. Our entry was 63 cents and any stop would give us nothing back. That means we can hold the option side until expiration without any additional risk.

Original Trade Description: January 13, 2016:

Many people thought banks would be winners after the Federal Reserve hiked rates in December. While the Fed did raise rates (barely) the financial stocks didn't see much progress.

The Fed is still talking about raising rates multiple times in 2016. There is a growing camp of market watchers who believe the Fed will be forced to back track. Deteriorating economic conditions both in the U.S. and abroad may force the Fed to pause their rate hike plans or even cut rates again.

Even if the Fed does try to raise rates the yield curve, where many banks make their money, could struggle. If the stock market remains sour throughout 2016 it will drive money into the perceived safety of U.S. bonds and that will keep yields on the 10-year low. So now that I have painted a rather unappetizing picture for the banks I'm adding a new bullish play.

All of the issues above are long-term troubles that could plague financials throughout 2016. On a short-term basis the banks are oversold and due for a bounce. Tonight's trade is a short-term technical one. The KRE is nearing major support and should rebound.

If you are not familiar with the KRE it is an ETF that tracks the S&P regional banks select industry index. The top ten holdings in this ETF are: PNC, BBT, KEY, STI, HBAN, CIWV, RF, FITB, MTB, ZION,

You can see on the daily chart below the KRE is plunging. On the weekly chart I have highlighted long-term support at the $35.00 level. Odds are good that if the KRE is going to bounce that is the spot to watch. Tonight I am listing a buy-the-dip trigger at $35.50. We will start this trade, if triggered, with a stop loss at $34.40. Remember, this is a short-term trade. We want to get in, catch a bounce, and get out.

Position 1/20/16:

Long KRE shares @ $35.50, initial stop loss $34.25


Long March $38 call @ 63 cents, no stop loss.

BEARISH Play Updates

CF - CF Industries


CF rebounded $3 in the afternoon as shorts covered. I lowered the stop loss to $30.95 to avoid giving back profit.

More conservative investors may want to take some money off the table early, especially if you're trading the option.

Original Trade Description: January 5, 2016:

CF underperformed the broader market and its sector in 2015. The S&P 500 lost -0.7% for the year while the IYM basic materials ETF lost -14.4%. Shares of CF returned a -25% loss last year. Momentum remains to the downside.

According to the company, "CF Industries Holdings, Inc., headquartered in Deerfield, Illinois, through its subsidiaries is a global leader in the manufacturing and distribution of nitrogen products, serving both agricultural and industrial customers. CF Industries operates world-class nitrogen manufacturing complexes in Canada, the United Kingdom and the United States, and distributes plant nutrients through a system of terminals, warehouses, and associated transportation equipment located primarily in the Midwestern United States. The company also owns a 50 percent interest in an ammonia facility in The Republic of Trinidad and Tobago."

It is important to note that CF is currently in the process of merging with OCI. Here's a brief description, "OCI N.V. is a global producer and distributor of natural gas-based fertilizers and industrial chemicals based in the Netherlands. The company produces nitrogen fertilizers, methanol and other natural gas based products, serving agricultural and industrial customers from the Americas to Asia. The company ranks among the world's largest nitrogen fertilizer producers, and can produce more than 8.4 million metric tons of nitrogen fertilizers and industrial chemicals at production facilities in the Netherlands, the United States, Egypt and Algeria."

Once the merger is completed they plan to move the new company's headquarters to the Netherlands to reduce their tax burden. Last year some U.S. government officials voiced their displeasure at these tax-inversion mergers to avoid paying U.S. taxes. There is a chance (albeit a small one) that the U.S. tries to stop this merger before it's completed.

Meanwhile the company continues to struggle with weak prices for nitrogen fertilizer. Looking at CF's last four quarterly earnings reports they have missed Wall Street's earnings estimates three of the last four quarters (and two quarters in a row). Revenues were down -8.3%, -15.8%, -10.9%, and -0.7% in the most recently reported quarter.

CF faces tough competition from fertilizer producers in China and in Russia and the Ukraine. It is worth noting that Bank of America just recently came out with a bullish call on CF. The BoA analyst suggested that fertilizer prices are too low and will bounce and CF's stock price should bounce with it. CF claims demand remains strong but that doesn't help if prices keep falling (obviously demand isn't strong enough or prices would rise).

Technically the path of least resistance is down and CF just broke support near $40.00. These are new two-year lows. Tonight we are suggesting a trigger to launch bearish positions at $38.85. Plan on exiting prior to CF's earnings report in mid February.

Position 1/6/16:

Short CF shares @ $38.65, initial stop loss $38.75


Long Feb $35 put @ $1.20, initial stop loss $38.75

Trade History:
01/20/16 new stop @ 30.95
01/16/16 new stop @ 33.25
01/13/16 new stop @ 33.60
01/11/16 new stop @ 34.15
01/09/16 new stop @ 35.75
01/07/16 new stop @ 37.05
01/06/16 new stop loss @ 38.75
01/06/16 triggered on gap down at $38.65, suggested entry was $38.85

ETN - Eaton Corp


ETN rebounded sharply after dipping to a 52-week low. I lowered the stop loss to $48.35 just in case sellers have run out of stock.

More conservative investors may want to take some money off the table early, especially if you're trading the option.

Original Trade Description: January 9, 2016:

Industrial stocks did not have a good 2015. The XLI industrials ETF and the Dow Jones Industrial Average both fell more than -6% last year. ETN significantly underperformed its peers with a -23% decline for 2015. Part of the problem is weak demand overseas compounded by a stronger dollar. Plus, the manufacturing sector in the U.S. is in recession.

ETN is in the industrial goods sector. According to the company, "Eaton is a power management company with 2014 sales of $22.6 billion. Eaton provides energy-efficient solutions that help our customers effectively manage electrical, hydraulic and mechanical power more efficiently, safely and sustainably. Eaton has approximately 99,000 employees and sells products to customers in more than 175 countries."

Earnings and revenue growth for ETN was challenging last year. The company lowered guidance four times in 2015. Their most recent earnings report (Q3 results) from October 30th showed revenues were down -9.2% from a year ago. Earnings were down -25%.

ETN management is trying to be proactive. They plan to expand their restructuring efforts into 2016. Hopefully they will be able to cut costs by another $190 million if all goes as planned. The one positive side of ETN's slide has been the surge in its dividend. The stock just closed at three-year lows, which as boosted the dividend yield to 4.2%. Although I don't know why you'd buy ETN for the dividend if you are in jeopardy of losing more than 4% in the stock. The point & figure chart is forecasting a $42.00 target.

The ISM index measures manufacturing activity in the United States. December's ISM reading was negative for the second month in a row and marked the sixth monthly decline in a row. Numbers under 50.0 on the ISM index represent contraction. November's was 48.6. December's slipped to 48.2. Odds are it will be under the 50.0 again this month.

With the industrial sector in recession, revenues and earnings falling, the bearish momentum in ETN should continue. Last week's market decline has pushed ETN below round-number, psychological support at the $50.00 level. Now shares are poised to accelerate lower. Tonight we are suggesting a trigger to launch bearish positions at $48.85. My only caution is our time frame. ETN has earnings coming up in early February (no confirmed date yet). This could be a short-term three-four week play.

Position 1/11/16:

Short ETN shares @ $48.85, stop loss $49.25


Long Feb $47.50 put @ $1.55, stop loss $49.25

Trade History
01/20/16 new stop @ $48.35
01/13/16 new stop @ $50.75
01/11/16 triggered @ $48.85

HOG - Harley Davidson


HOG is clinging to that $40 level after a dip to $39 this morning. Chart still looks weak.

More conservative investors may want to take some money off the table early, especially if you're trading the option.

Original Trade Description: December 9, 2015:

HOG was a big winner during the market's rally off the 2009 bear-market low. Shares surged from about $8 in early 2009 to over $74.00 in 2014. Unfortunately that bullish momentum is long gone.

HOG is in the consumer goods sector. According to the company, "Harley-Davidson, Inc. is the parent company of Harley-Davidson Motor Company and Harley-Davidson Financial Services. Since 1903, Harley-Davidson Motor Company has fulfilled dreams of personal freedom with custom, cruiser and touring motorcycles, riding experiences and events and a complete line of Harley-Davidson motorcycle parts, accessories, general merchandise, riding gear and apparel. Harley-Davidson Financial Services provides wholesale and retail financing, insurance, extended service and other protection plans and credit card programs to Harley-Davidson dealers and riders in the U.S., Canada and other select international markets."

The company has seen sales slow down. Their most recent earnings report was October 20th. Q3 earnings growth was flat (+0%) from a year ago at $0.69 a share. That missed estimates by 8 cents. Revenues only rose +0.9% to $1.14 billion, which also missed estimates. The company said their dealer new motorcycle sales were down -1.4% worldwide from a year ago. Their U.S. sales fell -2.5%. Shipments came in below guidance.

Matt Levatich, President and Chief Executive Officer, said, "We expect a heightened competitive environment to continue for the foreseeable future." The company lowered their shipment guidance for 2015. They also lowered their margin guidance. The stock reacted with a big drop on the earnings miss and lowered guidance. Multiple analyst firms downgraded the stock in response to the news.

Technically HOG is in a bear market. Shares have a bearish trend of lower highs and lower lows. HOG spent most of November struggling with resistance at $50.00. The recent weakness has pushed shares to new two-year lows. The next drop could push HOG toward $40 or lower. Tonight we are suggesting a trigger to launch bearish positions at $45.75.

My biggest concern is some analyst deciding that HOG looks "cheap" on valuation. At this point HOG could be a value trap. Cheap stocks can always get cheaper.

Position 12/11/15:

Short HOG shares @ $45.75, stop loss $41.25


Long Feb $45 put @ $2.59, stop loss $41.25

Trade History:
01/16/16 new stop @ 41.25
01/11/16 new stop @ 44.15
01/06/16 new stop @ 44.55
12/16/15 new stop @ 47.35
12/11/15 triggered @ $45.75

VXX - VIX Futures ETF


The VXX only gained 70 cents despite the extreme volatility. These highs never last long and only a few weeks at most. Be patient. The volatility will eventually die.

Original Trade Description: August 24, 2015

The U.S. stock market's sell-off has been extreme. Most of the major indices have collapsed into correction territory (-10% from their highs). The volatile moves in the market have investors panicking for protection. This drives up demand for put options and this fuels a rally in the CBOE volatility index (the VIX).

You can see on a long-term weekly chart that the VIX spiked up to levels not seen since the 2008 bear market during the financial crisis. Moves like this do not happen very often. The VIX rarely stays this high very long.

How do we trade the VIX? One way is the VXX, which is an ETN but trades like a stock.

Here is an explanation from the product website:

The iPath® S&P 500 VIX Short-Term Futures® ETNs (the "ETNs") are designed to provide exposure to the S&P 500 VIX Short-Term FuturesTM Index Total Return (the "Index"). The ETNs are riskier than ordinary unsecured debt securities and have no principal protection. The ETNs are unsecured debt obligations of the issuer, Barclays Bank PLC, and are not, either directly or indirectly, an obligation of or guaranteed by any third party. Any payment to be made on the ETNs, including any payment at maturity or upon redemption, depends on the ability of Barclays Bank PLC to satisfy its obligations as they come due. An investment in the ETNs involves significant risks, including possible loss of principal and may not be suitable for all investors.

The Index is designed to provide access to equity market volatility through CBOE Volatility Index® (the "VIX Index") futures. The Index offers exposure to a daily rolling long position in the first and second month VIX futures contracts and reflects market participants' views of the future direction of the VIX index at the time of expiration of the VIX futures contracts comprising the Index. Owning the ETNs is not the same as owning interests in the index components included in the Index or a security directly linked to the performance of the Index.

I encourage readers to check out a long-term chart of the VXX. This thing has been a consistent loser. One market pundit said the VXX is where money goes to die - if you're buying it. We do not want to buy it. We want to short it. Shorting rallies seems to be a winning strategy on the VXX with a constant trend of lower highs.

Today the VXX spiked up to four-month highs near $28.00 before fading. We are suggesting bearish positions at the opening bell tomorrow. The market volatility is probably not done yet so we are not listing a stop loss yet.

Position 8/25/15:

Short VXX @ $21.82, no stop loss.

Second Position 9/2/15:

Short VXX @ $29.01, no stop loss.

Trade History
11/07/15 adjust exit target to $16.65
11/02/15 adjust exit target to $16.50
10/19/15 add an exit target at $16.25
10/15/15 planned exit for the October puts
10/14/15 if you own the options, prepare to exit tomorrow at the close
09/02/15 2nd position begins. VXX gapped down at $29.01
09/01/15 Double down on this trade with the VXX's spike to 6-month highs
08/25/15 trade begins. VXX gaps down at $21.82

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