Option Investor

Daily Newsletter, Wednesday, 2/17/2016

Table of Contents

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

Market Wrap

Bulls Plow Through the Bears

by Keene Little

Click here to email Keene Little
The bulls have taken no prisoners since the stock market bottomed last Thursday. It's been a straight-up rally, the strongest we've seen since the August 2015 low, and now the bulls are hoping to make it an even stronger one to finish opex week on a high note.

Today's Market Stats

The day started with another big gap up and that makes it three in a row for the 3-day rally off last Thursday's low. Will it turn into an exhaustion gap or is it a breakaway gap? Only time will tell but the rally now has the short-term charts deeply overbought and looking for some relief. It's been a strong short-covering rally but it could easily draw in real buying and this being opex week we could see the market hold up for at least another day or two. What kind of pullback pattern follows will then provide clues for what to expect next.

This morning's economic reports showed some improving data, which theoretically could help the Fed stay on track with their desire to raise rates this year. The PPI numbers came in stronger than expected, up +0.1% and +0.4% for PPI and Core PPI, resp., which were better than the -0.2% and 0.0% expectations. The Fed desperately wants to see inflation so they were probably heartened by this morning's numbers.

Housing numbers were in line if not a little disappointing, which depressed housing stocks (they finished flat for the day). Industrial production for January improved +0.9% which was better than expectations for +0.3% and a big improvement over December's -0.7%. Capacity utilization ticked up marginally as well so overall, the numbers go into the "rate increase" column as the Fed debates whether or not to continue raising rates this year.

The FOMC minutes that were released this afternoon highlighted the fact that the committee members agreed they would need to see more supporting data before raising rates further. That gave the market a little extra pop higher just after 2:00pm so the market was pleased that the Fed showed it's at least acting cautiously. Apparently the committee members were a little surprised by the negative reaction to the rate increase and they wish to tread carefully from here. The stock market was relieved by the better economic reports this morning and the Fed's willingness to back off on their rate-increase desires.

Regardless of what the Fed thinks about the market it's important what the market thinks is going on. The junk bond sector has been crushed in the past year and it's a sign of stress in the weaker sectors that have borrowed a lot of Fed-created cheap money. We know the energy sector is starting to default at a higher rate on their loans, which amount to much more than we had in the sub-prime slime days before the 2007 top. But now there are more sectors joining energy in struggling with their debt loads and that's being reflected in the stock market plunge.

Moody's uses their Liquidity Stress Index to measure how many firms are in trouble and the index jumped up to 7.9% in January from 6.8% in December. This is the highest level since December 2009 and the biggest one-month jump since March 2009. The stock market has barely begun a descent and already we're seeing major cracks in the debt-burdened industries. As credit markets tighten there are many companies finding it more difficult to service their debts (lower earnings) and roll it over into new debt. Moody's has already warned of a spike in defaults in the energy sector and now it's starting to spread to other sectors.

As reported my Hoisington in their Quarterly Review and Outlook for the 4th quarter, public and private debt currently stands at 375% of GDP, far above the historical average of about 190% (1870-2014). In their opinion, the extremely high level of debt suggests it's been used for unproductive and counterproductive purposes, such as stock buybacks, Debt is good if it generates a return such that the debt payments are covered by the investment of the money (in capital improvements for example). One specific bad use of debt was to generate higher stock prices without a commensurate rise in corporate profits, which is where we are now.

The end result of all this bad debt and an increasing number of companies unable to service their debt has been an increasing number of defaults on loans. This in turn had been reflected in the decline of the junk bond funds. The bond prices drop, boosting the yield, as a way to entice investors to take the risk. Clearly investors have been shying away from this risk and this risk-off attitude is finally being reflected in the stock market as well. Using HYG as a measure of junk bond performance we can see how relatively poorly it has done compared to the stock market, but the stock market could be at the beginning of "catching up" to the falling junk bond index.

SPX has rallied +6.7% from Thursday's low to today's high but HYG has rallied half that. The short covering in the stock market is not being matched by the buying/short covering in junk bonds and while that doesn't prevent the continuation of the stock market rally (look at how it continued to hold up after HYG started to nose dive in 2015) but as long as there's a lack of interest in junk bonds it will continue to warn us that risk-off trades should be preferred by investors.

The weekly chart of SPX vs. HYG, shown below, highlights the huge difference between the two. These two mimicked each other since the 2007 top (although HYG made a lower high in October 2007 while SPX made a new high, showing early weakness) and they only started to diverge after HYG peaked in May 2013. It tried to make a new high with the stock market in June 2014 but then started to sell off strongly from there. It's been a long-term bearish divergence since then but I think the stock market is going to play serious catch-up (catch-down?).

As I'll show with the daily chart further below, I'm expecting a higher bounce correction into March but there's something on the weekly chart below that has me feeling very cautious about upside expectations. There's a parallel up-channel for the rally from 2009, the bottom of which was tested in August/September 2015 and broken in January. The bounce up to the February 1st high was a back-test and kiss goodbye at the bottom of the broken up-channel. A second up-channel can be created by attaching another parallel line to the October 2011 low and that line was broken intraweek into the January 20th low. That line was broken again into last week's low and the bounce is now back-testing the line, near today's high at 1930. Is it a setup for another bearish kiss goodbye?

S&P 500, SPX, vs. High Yield Corporate bond fund, HYG, Weekly chart

As you can see on the daily chart below, SPX has run back up to its previously broken uptrend line from January 20 - February 3 and while I consider this to be a weak line of resistance it appeared to be respected this afternoon. Just another resistance level for the index to gap up over tomorrow morning (wink). I think the best fit for the decline from December 2nd is a completed 5-wave move down into last Thursday's low (this fits very well across the other indexes) to complete either the 1st wave down (techs) or the 3rd wave down from November (the RUT fits this interpretation particularly well for its decline from June 2015). To keep the indexes in synch, except for the RUT, I'm looking at the December high as the completion of the THE bull market rally (with truncated highs for the Dow and SPX. This sets us up for a strong bounce into March for a 2nd wave correction (bold red depiction). But the bulls need to keep this going since the weekly chart above is scary for the bulls.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1957
- bearish below 1195

One reason I like the idea of a stronger bounce correction into March is that it would help relieve the significant oversold conditions and it would turn the most traders bullish just before the 3rd wave down gets started. The 2nd wave is called the sucker wave for a reason, as is the name for the 3rd wave – the recognition wave. As I'll point out later for the RUT, it looks like it needs a 4th wave correction in the decline from June 2015 but it might get another 2nd wave to set it up for a 3rd of a 3rd down, to lead the market lower in a powerful 3rd wave decline into the summer. That's only speculation at this point but it's a theory I'll test along the way as the price pattern develops.

The previously broken uptrend line from January 20th is shown more clearly on the 60-min chart below and you can see how SPX tagged it to the penny today and then pulled back marginally. If it continues higher Thursday I'd look for a test of the February 1st high near 1947 and watch for possible resistance there. The 60-min chart is more overbought than it's been since last year's high and clearly due at least a pullback. The straight-up rally looks like a typical bear market rally and the risk for those chasing it higher is that we could see a deep pullback before heading higher (assuming we'll get a larger 3-wave bounce correction into March but that's certainly not a guarantee).

S&P 500, SPX, 60-min chart

On the Dow's chart I'm tracking the idea that we're only going to get a relatively short-lived bounce, which could be complete at any time now, and then one more drop down to test recent lows (to create a triple bottom). That would then be followed by a larger consolidation pattern into April before continuing lower. This idea suggests lots of choppy whipsaw moves in a multi-week consolidation. It wouldn't be a fun trading environment unless you're a good day trader and catch the tops and bottoms of the moves. I'm hoping for the sharper bounce pattern into March so we have some clearer trade setups.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 16,510
- bearish below 15,300

The tech indexes show the clearest reason why we should be looking for high bounce corrections. Looking at its bull market rally has having finished at its December 2nd high, the 5-wave move down gives us a larger-degree 1st wave. That calls for a sharp 2nd wave correction and the leg up from last Thursday is likely just wave-a of what should become a larger a-b-c bounce pattern. The big question at the moment is what kind of pullback we can expect for the b-wave before heading higher again.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 4225
- bearish below 3902

Like the techs, the RUT made a higher high in December than it did in November (unlike the blue chips with their truncated (lower) highs in December). The 5-wave move down into last Thursday's low also sets it up for a larger bounce but it could trade in more of big sideways choppy consolidation instead of a high bounce. How high a bounce we ultimately get will then provide clues for what to expect for the next leg down (either a 5th wave in the decline from June 2015 or a 3rd of a 3rd wave down following another 2nd wave bounce correction. For now we should simply expect some whippy price action so trade carefully.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 1040
- bearish below 940

Banks were a little weaker than the broader averages today and that's always a bit of a warning sign for the bulls to heed. The morning high stopped a little shy of the bottom of its previously broken parallel down-channel from July 2015, currently near 62.60 (today's high was 62.40), and then sold off for the rest of the day, giving back the bulk of its morning rally. The pattern is not clear enough to offer a high-probability setup here but as depicted on its chart below, there is the potential for one more new low, or a test of last week's low at 55.99, to complete the leg down from November 2015. If this happens it would likely drag the other indexes back down as well, even if it will be for just a deep pullback in a larger bounce/consolidation pattern.

KBW Bank index, BKX, Daily chart

Along with the broader market the TRAN has had an even stronger rally in the past 3 days and has now retraced 50% of its decline from its November 20th high. Today's high at 7383 is close to its previous low on August 24th, near 7453, and that's likely to be strong resistance if and when reached. The longer-term pattern suggests we should see only a pullback and then another leg up for a larger bounce pattern but from here it's looking vulnerable to at least a pullback as the next move.

Transportation Index, TRAN, Daily chart

The US$ has bounced with the stock market in the past few days, after both dropped together from their February 1st highs, and the bounce could make it higher but at the moment it's testing its 200-dma at 96.90 (it broke above it this morning but then closed 2 cents below it) and is nearing its 50-week MA at 97.10. With the dollar and stock market trading in synch, if the stock market is looking at a bigger bounce in the coming weeks we could see the dollar do the same, especially if it's able to get above 97.10 and hold above. It's even possible the dollar will rally to one more new high following the 3-wave pullback from December, up to 103-104 (light-green dashed line), to finish its longer-term rally but at the moment I'm sticking with the higher-probability pattern that calls for a continuation of its sideways consolidation for several more months before continuing higher (bold green line).

U.S. Dollar contract, DX, Weekly chart

In the weekend wrap I showed the monthly chart of gold with its down-channel for the choppy decline since August 2013. The top of the channel is near 1262 and last Thursday's high was 1263.90. Thursday's big spike up (+66.50 to the day's high) was quickly retraced with the decline into yesterday's low and now we wait to see if the bulls can break through the top of the channel or if instead it was a blowoff ending to the a-b-c bounce correction off the July 2015 low. Bullish above 1264 but gold remains bearish below that level since it's still in an established down trend.

Gold continuous contract, GC, Weekly chart

Silver has the same down-channel from 2013 as gold, the top of which is near 16.10. And there is a downtrend line from April 2011 - October 2012, which was tagged with last Thursday's high at 15.99. A broken uptrend line from last August is also near 16.10. So there was more than one reason why last week's rally ran into trouble where it did and like gold, the decline into yesterday's low completely retraced last Thursday's exuberant rally. So what's next? Was the parabolic spike just another bear market rally that completed with a blowoff top or are we in the middle of a powerful wave up? Last Thursday's highs are now important for the bulls to get above.

One pattern that has been common in silver's decline from 2011 is the consolidation patterns -- they've each been a descending triangle, starting with the one that ran from September 2011 to October 2012 (the a-b-c-d-e triangle on the top left side of the weekly chart below) and then the next one from June 2013 to July 2014. The last one, I think, is the one at the bottom right side of the chart that just completed, running from December 2014 to February 2015. The first two triangles ran 53 weeks and 54 weeks and the latest was a little long in the tooth at 62 weeks. The e-wave of a triangle is often a head-fake move that gets traders caught in the end of a move instead of the beginning a reversal and that could be the case again. The bulls need to rally silver above 16.37 (the October 2015 high) to prove it's a real breakout, otherwise look out below.

Silver continuous contract, SI, Weekly chart

It's looking like oil's bounce could make it up to at least the 32.20-33.20 area before turning back down. At least the larger pattern calls for another turn back down for one more new low to complete the wave count to the downside. A downside target is currently near 23 in March and then we should have a good setup to get long oil. If oil gets above 35 there would then be upside potential to about 38-39 and above 40, with a break of its downtrend line from June 2015, it would be much more bullish. But at the moment I don't think we've seen a tradeable low for oil yet.

Oil continuous contract, CL, Daily chart

Thursday's economic reports include the Philly Fed index, which is expected to improve somewhat from January's -3.5 to -1.8 but Monday's Empire Manufacturing index was also expected to improve from January's -19.4 to -6.5 and instead came in at a marginal improvement to -16.6. We'll have to see if that data point falls in the "raise rates" or "hold rates" column of the Fed's spreadsheet. She loves me, she loves me not, she loves me ... not

Economic reports


The big question following the strong 3-day rally off last Thursday's low is whether or not it's sustainable. We don't know yet if this is the start of a stronger bull run into the spring or if instead it's just another bear market rally in what will be a continuation lower (the slope of hope is a decline punctuated by brief but strong hope-filled rallies and then a continuation lower).

One sign of a bear market rally is how strong it is. That sounds perverse but it's a fact that the strongest rallies occur in a bear market, albeit relatively short-lived thanks to short covering. In fact today Bespoke Investment Group tweeted the chart below, which highlights the fact that the strongest stocks in the Russell 3000 the past three days have been the ones most heavily shorted. Today's advance-decline line actually started back down after this morning's open while the advance-decline volume continued to climb. Money was pouring into fewer stocks (sending the a-d line lower) but still powering the select few (the most heavily shorted) higher. If it's hard to read the note on the chart it says "Stocks with the most short interest have significantly outperformed stocks with the lowest short interest over the last two days."

Stocks with highest short interest rally the strongest, chart courtesy Bespoke

As I mentioned earlier, the setup is good for a higher bounce correction into March but it could be whippy with a deep pullback before heading higher. The weekly chart of SPX highlighted a concern for the rally if the bulls can't keep it going here so a higher bounce is by no mean guaranteed. We are in a bear market and all rallies are suspect. It's only a question (in my mind) of how high the bounce will get before stronger selling kicks in.

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

$650 Million Was Not Enough

by Jim Brown

Click here to email Jim Brown
Editor's Note

Everybody has a bad quarter occasionally. Some have them repeatedly because of their business model. Sometimes that is an opportunity.

Lions Gate said the last installment of the Hunger Games series, Mockinjay Part 2 brought in $650 million but that was not enough to prevent an earnings shortfall in Q4. Shares plunged and that is now a buying opportunity.


LGF - Lions Gate Entertainment - Company Description

Lions Gate reported earnings on the 5th and dropped like a rock from $26 to $16 on ten times normal volume. Adjusted earnings of 45 cents missed estimates for 47 cents. Revenue of $670 million missed estimates for $767 million.

Lions Gate earnings are always lumpy. As a film maker with 2-3 major motion pictures a year the quarter with a big release always spikes and the quarters without a release crash. In the latest quarter the Hunger Games Mockingjay Part 2 had a huge audience but it was sandwiched between James Bond's Specter and the Martian. Those big films sucked up the available screens and pushed Mockingjay out of the headlines. Even with the competition the film grossed more than $650 million.

The studio has three movies for the first half of 2016 but none are expected to be blockbusters. Lions Gate also has a sizeable portfolio of TV shows like Orange is the New Black, Nashville, The Royals, The Wendy Williams Show and Casual, with more than 75 others across 40 networks. They have contracted future revenue from those shows of $1.3 billion at the end of December. They have a library of more than 16,000 motion picture and television titles.

One of the reasons the stock fell so sharply was the expectations for LGF to acquire a lot of other "free radicals" as John Malone calls them. Those are smaller studios that could help add to the LGF franchise. However, as a Canadian company they are prohibited from acquiring anyone bigger than themselves. When their market cap dropped from $7 billion to $3 billion after earnings it meant their potential acquisition candidates shrunk significantly. They were also rumored to be considering a merger with the Starz Network. That also played into the stock drop mix because owning their own TV network could present problems for selling their content to the other 40 networks they partner with. STRZA shares dropped from $31 to $20 on the earnings because it suggested there would be no merger.

Now that the smoke has cleared LGF shares are rising again. They closed just under $21 on Wednesday. They are heavily oversold and heavily shorted. The combination in a positive market could continue to push the shares higher.

The lumpy earnings will be forgotten and the stock will recover. It was trading at $41 back in November before the merger news appeared. If that is no longer an option we could see a swift rebound.

I am putting an entry trigger at $21.25, just over the $21.09 high for today. We will only enter the position on a continued move higher.

With a LGF trade at $21.25

Buy LGF shares, initial stop loss $17.85


Buy June $23 calls, currently $1.55, no initial stop loss.


No New Bearish Plays

In Play Updates and Reviews

Short Squeeze Fading

by Jim Brown

Click here to email Jim Brown

Editors Note:

Despite the strong market gains, the majority of those gains were in the first hour of trading. Volume was the lowest of the three-day rebound.

There was no follow through after the short squeeze at the open. Resistance on the Dow at 16,450 was rock solid and exactly where the Dow closed. With volume fading and no follow through buying the market will be tested on Thursday. If we break through that 16,450 level we could be off to the races but the 1,950 level on the S&P 500 is even stronger resistance and the S&P closed at 1,926.

Current Portfolio

Current Position Changes

OIH - Oil Service ETF

Close the short position in the OIH.

Profit Targets

Check the graphic above for any profit stops in green. We need to always be prepared for a profit exit at resistance.

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.

BULLISH Play Updates

GPRO - GoPro - Company Profile


GoPro shares spiked another 12% today as the shorts continue to be squeezed. At the end of January 42% of GoPro shares were sold short. That is a huge number and equates to 43 million shares. With average volume at 4.5 million that is ten days of trading. Volume the last two days has been around 11 million or more than twice normal. That would leave about 30 million shares short. With a $300 million buyback authorized they could be fueling the short squeeze by purchasing shares at the lows before shares move higher. I raised the stop loss again to $11.85.

Original Trade Description: February 8th

GoPro is the number one action camera maker and created the current market. They moved from a simple camera maker to a content creator over the last couple years. At least that is what they wanted people to believe so that their sky high PE would be based on something other than simply a hardware company.

Fast forward to 2015 and 5-6 companies began to compete with action cameras of their own. GoPro's market share began to dwindle. A botched roll out of a new model in Q3 and two prices cuts in Q4 has knocked their share price down from $65 in August to $9 on Thursday.

One of the problems that GoPro has been unable to conquer is the relatively hard method to recover, edit and publish videos produced by the cameras. They have promised new software for a couple years and it never seems to arrive or fails to satisfy when the updates appear. This is a drag on future camera sales because you have to be a geek to produce any quality videos.

News broke today that GoPro had licensed its video technology, certain file storage and other system technologies. While the details are still unclear this could be a Hail Mary pass to Microsoft for help with their software problems. If it is not related to that then there is something else going on that could provide a boost for GoPro in the future.

Lastly, the drop in market cap from $8 billion to $1 billion makes them a very attractive acquisition target for somebody like Sony or even Under Armour. Microsoft could buy them with their pocket change.

Shares appear to have bottomed at $10 but just in case we can buy a March $10 put as protection for 97 cents. This means we have unlimited upside and almost zero downside risk. If somebody makes an offer for GoPro I would expect it to be $15 or more simply because the company is not in financial trouble. They currently has no debt and $474 million in cash. They just need to get over this technical problem and they will be fine.

Position 2/9/16

Long GPRO shares @ $10.65, no stop loss.

Long March $10 put @ 99 cents, no stop loss

Net debit $11.64.

JBHT - JB Hunt - Company Description


JBHT had another nice move thanks to the rally in the Transports. I raised the stop loss to $74.85.

Target $78.50 for an exit.

Original Trade Description: February 10th.

While the majority of the transportation sector has been in decline in response to lower energy costs trucker JBHunt has been expanding its fleet, hiring new drivers and increasing load volumes across the country. In its most recent earnings report the company produced EPS in line with estimates but it is the internal data that is most promising.

JBHunt Transport services and its wholly owned subsidiaries is a diversified transportation and logistics company operating throughout North American. Operations are centered in the United States with some portions operating in Canada and Mexico. The company operates in the intermodal space using its own fleet and to some extent third party operators in 4 sub-segments.

Fourth quarter results were good. Earnings were in line with expectations on flat revenue but as mentioned, it is the internals that are most interesting. Q4 operating income was up 5% over the previous year with a 9% increase in EPS. Full year results include a 13% increase in operating income with a 16% increase in EPS. Full year revenue was flat, not something we necessarily want to see, but when taken in light of lower fuel surcharges is not the red flag it would seem to be. Remember, in recent years revenues among the entire transportation sector have been inflated due to surcharges related to what were then record fuel prices.

Three of the four business segments showed notable increases. The Integrated Capacity Solutions segment, management of third party transportation services, showed a 4% decline in revenue due to decreased spot market activity and lower revenue per load. The other three segments; Intermodal, Dedicated Contract Services and Trucking all showed notable increases in revenue of 1%, 2%, and 3% respectively for a total operating revenue increase of 9%.

Drivers of the gains, no pun intended, include increases in new customers, revenue realizations from previous rate increases, improved fuel economy, lower maintenance costs attributed to newer equipment, less reliance on third party shippers, increased fleet size and improving margins. These were offset by higher wages and increased costs of recruitment and retaining employees but those cost are ultimately a sign of ongoing improvement in the labor market and the consumer that will eventuall spill over into this and other segments of the economy.

Earnings results are all well and good but the reason why we really like this stock is two-fold; a recent dividend increase and a couple of analyst upgrades. The board of directors approved and announced a 5% increase to the dividend on January 28th. According to the board earnings and free cash flow warrant the increase. As for upgrades, there were two; one in early January and another just after the earnings report was released. The stock was upgraded from hold to buy at BB&T and from peer perform to outperform by Wolfe Research. Based on the average analyst target of $87.14 there is still a minimum upside potential of 16%.

Buy the May $80 call with a trigger price of $74.00.

Position 2/12/16 with a JBHT trade at $74

Long JBHT shares @ $74. See portfolio graphic for stop loss.


Long May $80 call @ $2.25, see portfolio graphic for stop loss.

SWHC - Smith & Wesson - Company Description


Pulling back slightly from resistance at $24. I raised the stop loss to $22.25.

Original Trade Description: January 21st.

Smith & Wesson is a gun manufacturer. Business has been very good but they announced this week they are looking for some acquisitions in other outdoor areas so their business is not so tied to the cycles in gun sales. Whenever an administration begins talking about more gun control measures their sales soar. When there are no politicians trying to ban guns we see sales decline.

The current administration has been the best for gun sales since the Clinton assault weapons ban. The FBI said the increase in the number of background checks for gun purchases has been so strong that their system is overloaded and they have had to halt appeals for denials until they can add some more personnel.

December saw a record of 3.3 million background checks, which was more than 500,000 above the prior record for December in 2012. On Black Friday alone there was a record 185,345 checks and a new single day record.

While this surge in gun sales has powered Smith & Wesson to record profits the company realizes that the election of a pro gun administration will slow those sales. For this reason S&W announced this week they were looking into getting into the $60 billion outdoor sporting goods market. They will likely be trying to acquire brands that they can add to their lineup that are not directly related to guns.

S&W said they were on the hunt for candidates but did not have any announcements at the current time.

This is a good move for S&W for obvious reasons. By branching out into other products, it will also help widen the S&W brand even if those new products have their own brand names.

Shares spiked to record highs over $26 when they reported earnings in early January. The post earnings depression appears to be over and shares dropped back to support at the 100-day average. This is a good spot for people to launch new long positions and once the current market weakness is over the small cap stocks like S&W with strong growth will be in demand.

Earnings March 8th.

Position 1/25/16:

Long SWHC shares @ $21.35, see portfolio graphic for stop loss.


Long June $23 call @ $1.75, see portfolio graphic for stop loss.

USO - US Oil Fund ETF - ETF Description


Multiple headlines out of the Middle East spiked crude back to $31.50 as Iran made positive comments about limiting production. So far there is no limit and just limiting production will not reduce the glut. Eventually something will stick and prices will rise. That could be in April when inventories begin to decline or earlier if OPEC reaches a real agreement.

This is a long term position so be prepared to see lots of volatility before the final long-term rally begins.

Original Trade Description: January 27th

The USO ETF attempts to reflect the performance of West Texas Intermediate crude oil. The ETF invests in futures contracts for oil, diesel, heating oil, gasoline, natural gas and other fuels traded on the Nymex in an effort to track WTI and avoid futures roll over bleed.

Typically, a futures oriented ETF buys forward contracts. As those contracts expire, the funds are rolled over into the next series of futures contracts at higher prices. This causes a disconnect between the actual price of the underlying commodity.

The USO attempts to reduce that as much as possible by spreading the terms and types of futures contracts it holds.

If you are still reading this you are probably wondering why I am recommending a somewhat perishable ETF on oil when we all expect oil prices to go lower. Good question!

Yes, oil prices "should" go lower as inventories build over the next two months. However, the entire world of professional investors understands this but prices have spiked twice in the last week on rumors of a Russian - OPEC agreement to cut production. If such an agreement was actually reached, we could see prices back over $50 very quickly.

I am proposing we try to buy the USO on the next dip on the chance that an agreement will eventually be reached. Last week it traded down to $7.92. When oil was $38 in December the USO was $11. If we can buy it in the $8.50 range we could see a 30% gain on any deal announcement and even more once oil prices reacted to the change in production dynamics.

Obviously, we cannot predict that a deal will happen. Saudi Arabia and Russia are enemies. However, they both have the same problem and that is they are hemorrhaging cash. In July 2014 when oil prices were $105, Saudi Arabia was taking in about $1.06 billion a day in revenue. Today at $30, they are receiving $303 million. That is a loss of $757 million a day, every day, and the kingdom is suffering from it. Russia is losing about $650 million a day. They both have millions of reasons to put their differences aside and reach an agreement.

While we cannot guarantee this will happen the headline chatter is growing daily. They may not be ready to call a truce just yet but together they are losing more than $1.4 billion a day. That is a huge incentive to do something. The next regular OPEC production meeting is early June. I am recommending we buy the USO on the next dip and hold it until July. I cannot imagine OPEC continuing the madness past the June meeting and they are likely to hold an emergency meeting earlier if crude drops back into the $20s again.

Typically, prices rise when inventories begin to decline in late April as refiners ramp up production for the summer driving season. Even if Russia and OPEC do not reach an agreement, we should see a rise in prices starting in May or earlier.

I am not going to try to buy the bottom because we may not see it again. I am recommending we buy the USO at $8.50 and hold it with no stop loss because it could go lower. I believe we will be rewarded over the next few months and with the right set of circumstances, we could be very well rewarded.

2/1/16: Position entered with a USO trade at $9.00:

Long USO shares @ $9.00, no stop loss.


Long USO July $10.00 calls @ $.85. No stop loss.

WU - Western Union - Company Description


WU spiked at the open and then pulled back into negative territory before recovering at the close. The $18.50 level is resistance. I raised the stop loss again to take us out at a breakeven if WU rolls over.

Original Trade Description: February 12th

Western Union is one of the more recognizable names in the market. Although the mode of transport has changed from stagecoach to digital the basic business model has remained the same for 165 years, the transfer of wealth. Western union is money transfer and payment solutions provider operating in 34 countries with 3 business segments; person to person, person to business and business solutions.

The company reported earnings earlier this week and results were good. Despite the negative impact of currency conversion, the company was able to meet expectations and provide forward guidance in line with expectations. Merely meeting expectations is not really enough to get the market excited but the inclusion of a -$0.15 impact into the forward guidance and the recent decline in dollar value is reason enough to think guidance could be low.

Speaking of the dollar. I don't mean to completely discount the impact of currency conversion. Merly to point out that the projected impact for 2016 may be too high. Looking at the chart of the DXY it is clear that the dollar is declining in value and trending in the average range we saw in 2014. If it continues to fall back to the bottom of the range negative impact in 2016 should be no worse than 2015.

Results for the 4th quarter and full year 2015 were good. The company reported earnings of $0.42 on revenue of $1.38 billion; earnings were in line with estimates, revenue was short by 0.02 billion. In constant currency this is a 3% gain in revenue for the fourth quarter and a 4% gain for the full year. There were a couple of other red flags in the report but all related to currency conversion. One was margin. Margin improved from 20% to 20.9% in 2015 but is expected to fall back to 20% in the coming year.

Any reduction in earnings due to narrowing margin should be more than overcome by increased revenue. Economies in North America and Europe, the two largest segments by region totaling more than 40% revenue, are both strong and growing. Speaking solely of the US labor trends and earnings point to strength and should fuel person to person transactions, 80% of total business.

Another reason to expect revenue expansion is the expanding footprint. The company operates in over 200 countries, 34 added in the past year, including 100,000 kiosks and ATM's and is planning to continue expanding into 2016. At the same time the company is expanding its services and has recently added a 3rd payment solution, the WU Connect, which enables users to offer Western Union services on their platforms.

On a technical basis the stock looks like it is in reversal and heading higher. The stock is moving up off of a double bottom with increasing volume. Volume has been on the rise for the last month, the last week has been more than 2X average daily. Today the stock jumped 4% to break above the short term moving average. MACD momentum is bullish and on the rise, confirming the break. Stochastic is still weak but consistent with a signal early within a bullish movement. Today's action saw prices hover around $0.85 with a Delta of 0.48. The average analyst estimate for the stock is just over $18.79, not high, but the data pool is skewed to the upside with low outliers dragging down the mear. The high target is $24.

The option is cheap so I chose the May expiry to give the stock time to move.

Position 2/16/16 with WU trade at $18

Long WU shares @ $18, see portfolio graphic for stop loss.


Long May $18 call, entry .79, see portfolio graphic for stop loss.

BEARISH Play Updates

OIH - Oil service Index - ETF Description


The OIH rallied 4% on the news from Iran on limiting production sometime in the future. It was just another headline in a long list of headlines but they have succeeded in lifting prices for crude back over $31.

I am recommending we exit this position even though the OIH remains under resistance and the Middle East headlines will eventually fade.

Original Trade Description: January 20th

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.

Position 1/21/16:

Closed 1/29/16: Short OIH shares, entry $21.26, exit $24.25, -2.99 loss


Still long July $20 put @ $1.92, no stop loss.

VXX - VIX Futures ETF ETF - ETF Description


The two-day short squeeze knocked $3 off the VXX. If the market gains continue the decline should accelerate. Investors are still cautious. 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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