Option Investor

Daily Newsletter, Sunday, 1/1/2017

Table of Contents

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

Market Wrap

Happy New Year

by Jim Brown

Click here to email Jim Brown

Regardless of what January brings, I expect 2017 to be a very good year!

Weekly Statistics

Friday Statistics

Dow 20,000 was not to be in 2016 but you can rest assured we will see it in 2017 and probably 21,000 and 22,000 as well. That would only take just over a 10% move from Friday's close.

The dreaded pension fund rebalance that was supposed to see selling of more than $38 billion in equities as December came to a close, turned out to be a dud. There was selling over the last three days but it was muted. Volume rose from 4.1 billion on Tuesday to 5.7 billion on Friday as a result of the rebalance and year-end adjustments.

The Dow was down -110 at its lows and just after 3:PM it looked like there would be $2 billion or more left to sell at the close. That paired off early and dropped to $1.2 billion at the close according to Art Cashin. The combination of short covering and end of quarter buying saw the Dow rebound to close only 57 points lower. The Nasdaq did see some heavy selling in the big caps and closed with a loss of 49 points with the Nasdaq 100 losing 55 points.

The S&P-500 gained 9.5% in 2016. More than 7.4% of that gain came post election. There were 265 stocks that gained 10% or more and 68 that lost 10% or more.

There was no economic news and almost zero stock news. There would have been nobody around to react to it since almost everyone had already left for the weekend.

Next week has a heavy calendar economically with the ISM, jobs and the FOMC minutes. None of it should matter because it will not change Fed direction and the market has already priced in at least two rate hikes for 2017.

What will matter is the market direction. This is going to be a critical week and it will be interesting to see if the expected January decline is a nonevent like the pension fund rebalance.

Apple shares lost $1 after news broke that it has asked component suppliers to reduce production by 10% in Q1. The Nikkei Asian Review cited calculations based on data from suppliers. Apple cut production by 30% in Q1-2016. The problem seems to be a lack of new features that create a buying urge by existing users. There are also the rampant rumors about the iPhone 8 that will be announced in September.

There continues to be leaks about various features and sizes and rumors of new technical breakthroughs. DigiTimes reported on Friday of another leak from suppliers confirming the available sizes will be 4.7, 5.5 and 5.8 inch screens. The two smaller models will use TFT-LCD panels and the 5.8 inch will use an AMOLED screen, with rounded edges. According to DigiTimes, Samsung will be the sole supplier of those AMOLED screens and they are predicting sales of 70-80 million. Reportedly, Samsung had to guarantee production rates of up to 20 million a month to get the order. If the big phone sold 70 million and the smaller phones had similar numbers to prior versions, this would be a record-breaking model. Since it is coming on the 10th anniversary of the phone's introduction, it is expected to be packed full of new features.

There was also news that Apple is going to start manufacturing iPhones in India. Foxconn was rumored to be exploring plans to build a plant in India but news broke that Taiwanese manufacturer Wistron Corp had won the bid and was opening a factory in Peenya, the industrial hub of Bengaluru. Wistron previously manufactured the 5C phone. Apple will have to buy at least 30% of its raw materials from Indian vendors as part of a new foreign direct investment program initiated in June. Rumors claim Wistron could begin iPhone production as early as April. Manufacturing labor costs in India run about 92 cents an hour compared to $3.52 in China. Manufacturing in India would also avoid the heavy import tariffs now in existence.

India's smart phone market will be larger than the U.S. market by 2018 and second only to China. IDC said Indian smartphone subscribers have surged to about one billion. Reliance Jio Infocomm, an Indian based mobile network operator, said last month they are rolling out 4G coverage in 18,000 cities and 200,000 villages. Drexel Hamilton said India's growth story for Apple is reminiscent of China's back in 2010. Apple exploded on that surge in growth. However, in 2016 Apple's share in China fell -30% as other suppliers multiplied.

I believe Apple is on the cusp of a new growth surge despite the cutback in production for Q1. If they are truly, "breaking into India" sales are going to surge as well as expected strong demand for the iPhone 8. Apple's services businesses are on track to hit 25% of revenue in 2017 and continue growing from there. CEO Tim Cook said they have features in the planning stages that users will wonder how they ever lived without them. Apple accounted for 44% of all phones and tablets activated during the holiday season according to Flurry's Analytics Blog. That compares to 21% for Samsung.

Tesla (TSLA) was named best pick for 2017 by Baird's Ben Kallo with a target price of $338. The analyst said the battery business was going to surge as the Gigafactory nears completion and full production. The combination with Solar City will increase battery demand along with the initial production of the Model 3. Kallo said the storage battery business of already accelerating and all the other factors will just add to that acceleration. Tesla is going to offer an analyst tour of the Gigafactory on January 4th and that should be a positive catalyst for the stock.

The Dow gained 13.4% in 2016 or 2,337 points to end at 19,762.60. The biggest Dow gainer for the year was Goldman Sachs with a 32.9% gain and accounting for 392 Dow points. In the table below, I calculated the gain/loss for the year for each Dow component and the amount of Dow points they contributed to the Dow for the year.

Visa, Coke, Disney, Pfizer and Nike were the laggards with Nike subtracting 77 Dow points. I do not follow year to date gains and losses on a regular basis and I was surprised to see Home Depot near the bottom with only a 1.4% gain. I went back and looked at the HD chart and the company had plenty of volatility that kept erasing their gains.

UnitedHealth was a big gainer and is expected to be a big gainer in 2017. They have dropped the Obamacare exchanges and that was a big loser over the last two years. They are expanding services in multiple areas and should do significantly better in 2017 without the hundreds of millions of dollars of Obamacare losses dragging earnings down.

JP Morgan is the financial in the Dow that is expected to outperform in 2017. Interest rates are rising, regulation should be declining and the majority of the legal issues plaguing the big banks are now in the rear view mirror.

It is clear by looking at the list that the Dow was lifted higher by only about a third of its components. Stocks making a $3-$6 gain for an entire year should be kicked to the curb. Their day in the spotlight may eventually come but they are dead money until that day comes.

Stocks like Microsoft have a great business and they make a lot of money but with 8 billion shares outstanding, they just cannot move the needle on the share price. GE is actually getting their act together and should grow earnings this year but with 9 billion shares outstanding, they just cannot grow earnings per share by more than a couple pennies in each report.

I would not be surprised to see the Dow managers replace a couple stocks in 2017. Coke, DuPont and Cisco would be my targets to be replaced.

The FANG stocks were responsible for much of the market weakness over the last several weeks. While industrials and financials were leading, the big caps techs were stuck in a two steps forward, one step backwards pattern.

Google (GOOGL), yes I know they changed their name to Alphabet but they will always be Google to me, lost almost 50 points over the last three weeks. They have massive earnings power but their high stock price makes them a cash register for companies rotating out of tech stocks and into industrials. They will recover but it may take a quarter to get out of the rut. They need to get rid of the two stock symbols. Having GOOG and GOOGL is confusing to traders. Why are both in the S&P and Nasdaq? Google could easily come up with a plan to eliminate the GOOG symbol. The GOOG shares are the voting shares but they have no real impact since the B shares, which are not publicly traded, have ten times the voting power and are held by the insiders. The GOOGL shares are non-voting. Google is not issuing any new GOOG shares but they are issuing GOOGL shares to employees and for use in acquisitions.

Amazon shares have lost nearly $100 since their October high of $847 and they closed at a three-week low on Friday. Amazon had a 37% market share of online shopping in the six weeks before Christmas and Best Buy was number two at 3%. I get it! They control the online environment and I use them at least once a week. However, their PE of 168 is very high. If you buy their shares it is because you think they have something else up their sleeve to revolutionize the world rather than as a fundamental investment. Amazon now has a fleet of 40 cargo jets and "thousands" of 18 wheeler trucks and trailers. They claim they are not going into competition with UPS and FedEx but their fleets just keep growing. They have the largest cloud service in the world and nobody else is even close.

Amazon even has a patent for a floating "airborne fulfillment center" or AFC that could float over large cities and allow delivery of products by drones in a matter of minutes. The AFC would be held aloft by a dirigible or similar airship. The drones would drop from the AFC to deliver their packages and then congregate at a local pickup center where they would be loaded into shuttles making routine flights back to the AFC with more inventory, fuel and the accumulated drones to be reused again. The patent also says the airship could be used for advertising, think Goodyear Blimp, and as a floating Internet access point like Facebook is working on for Africa. While this is "wishful thinking", it is this kind of thinking that has put Amazon light years ahead of its competitors. As long as Jeff Bezos can continue to produce groundbreaking new ideas, the stock will trade at a ridiculous PE.

Amazon shares typically decline after the selling season so the drop from their $850 high was not unexpected. Bezos needs to be thinking stock split to get new investors interested in his shares. Shares are likely to decline to $685 in any Q1 weakness.

Facebook has been struggling since they warned in November that earnings would slow because of increased spending. Shares are close to breaking below support at $115 and that could trigger a new leg lower. Facebook has a lot of positive factors in their favor but the stock has lost its excitement. It is nearing two billion users but that user interaction has started to fade. The average user is not spending as much time on the site as before but the decline is minimal. Facebook already has more advertisers than it has ad spaces available for rent. The big expectation for 2017 is that Facebook will find a way to monetize Instagram and WhatsApp. The WhatsApp messaging service now has over one billion users. Instagram has more than 600 million users. Also, Oculus VR is expected to become commercial by the end of 2017. The next big thing in VR will be a courtside seat at a sports game or concert simply by putting on a HD headset in the comfort of your home. In a severe or prolonged market downtrend FB shares could retest $100. That would be a buying opportunity. The average analyst target price is $155.

Netflix (NFLX) is the only FANG stock still in rally mode. Shares are fighting resistance at $130, which is the high from 2015. In January 2016, the company added 130 countries to its service with multiple language offerings. The first couple of quarters the subscriber growth was slow but last quarter it finally exploded as the advertising took hold and word of mouth began to spread. The Q4 numbers should be huge. Netflix has been instrumental in accelerating the demise of the video rental business in the U.S. and now it is doing the same thing in 130 more countries. Remember Blockbuster Video? Netflix has a lot more competitors today but none of them can scale like Netflix. They may capture viewers in a geographic area like a cable company but Netflix has got them beat with the 1,000 hours of original programming due out in 2017. They recently announced an upgrade where you can download content to your devices and then watch it anywhere even if there is no internet or WiFi connection. They currently have 86 million subscribers in 190 countries. They will be printing money for the next decade and could be a takeover target by Apple, Disney or even Amazon. The average analyst price target is $150.

Nvidia (NVDA) was the biggest gainer on the Nasdaq in 2016 with a +224% gain. The last week has been rocky after a noted short seller said the stock had risen too far, too fast. He was looking for a drop back to $90. The next day Goldman Sachs said Nvidia was a "unique growth story in semis, levered to positive secular trends in gaming, VR, AI, ML and automotive." Goldman said buy calls ahead of CES, which begins on January 5th and runs for four days. The CEO of Nvidia will be giving the keynote address and the company will be unveiling new products in AI, self-driving cars and gaming. Goldman said this will be a high profile event and Nvidia normally gains 4-5% during CES.

I wish that short seller was right and we could see $90 again but I seriously doubt it. That would be a definite buying opportunity. Nvidia is the Intel for the next decade.

It is all in how you phrase it. I reported last weekend that Lipper said investors pulled $21.6 billion out of equity mutual funds over the prior week. This was the 41st consecutive week of fund outflows from stock mutual funds.

This week ETF Trends reported that 2016 saw record inflows of $283 billion into ETFs. The top three ETFs were the SPY at $24.4 billion, iShares IVV Core S&P at $13.5 billion and Vanguards VOO S&P-500 ETF at $11.4 billion.

There are currently 1,960 U.S. listed ETFs with $2.55 trillion in assets. In 2016, there were 237 new ETFs and roughly 150 were closed.

Investors are pulling money out of equity funds and buying ETFs instead. There has been a lot written recently about the growing danger of ETFs to the market. Because of the way ETFs operate, the large inflow of cash is setting the market up for an eventual crash. If the same money was in equity mutual funds, there is a manager that operates as a check valve when investors begin to get nervous and want to exit the market. There is a little interaction and a little more thought when an investor exits a fund. When the same money is in an ETF, the exit is instantaneous. Stop losses are common and that can lead to a loss of market liquidity when a bunch of stops are all hit at the same time.

Remember, the flash crash? ETFs lost liquidity for several minutes and sold at ridiculous prices, when they sold at all. I like ETFs but I understand the threat of a surge in selling. If an investor actually held individually the 50 stocks in a given ETF, the odds are good he would not sell all 50 at exactly the same time. There would be some thought given to the merits of each stock before the sell decision is made. Weak stocks would be sold first and stronger stocks held in hopes of a recovery. That would help slow any market decline. With ETFs there is only one decision and it impacts every stock in the ETF.

Crude prices held at $53 all week as traders wait for the production cuts to begin. Clearview Energy Partners said it is inevitable, "somebody is going to cheat." Kevin Book said there is little chance members of OPEC will stick to their production targets. "You get until January 21st to believe in your hoped-for outcome and then you converge with reality. Historically OPEC always blows past its targets." The 21st is the date the OPEC monitoring committee will meet. The agreement is for OPEC to reduce production by 1.2 million bpd and non-OPEC producers to cut another 558,000 bpd. Kevin also said the notion of "ROPEC," coordinated action by Russia and OPEC, is a myth. This has been attempted for decades and has never been successful before. Russia's energy minister Novak said recently, "We will look at the cuts within our technical parameters." That is hardly a convincing promise to cut.

Stephen Schork, editor of The Schork Report, said on Wednesday that oil prices have likely topped out at $53-$55 because or additional supply coming back onto the market from the U.S., Libya and Nigeria. Schork expects only a 60% to 70% compliance with the production cuts.

Tom Kloza, global head of energy analysis at Oil Price Information Service, predicted only a 70% compliance at most that would only equate to 700,000 to one million barrels per day. That is because OPEC plays games with the production numbers. Kloza said current prices are fully valued for the next 12-24 months.

The active rig count rose by only 5 rigs over the holiday week. That was 2 oil rigs and 3 gas rigs. Once the holidays are over, we should see the pace increase to about 10 per week as long as prices remain over $50.

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There is not a lot to say about the markets this week that has not been said over the last three weeks. The S&P made a new intraday high on December 13th at 2,277.63 and the selling was immediate. Resistance at 2,275 was tested on five days over the next two weeks and never broken again for more than a few minutes. The big decline began on Wednesday and Friday's close was a three week low.

The pension fund rebalance could have been responsible for those three days of declines but I am sure it was also a result of investors shutting down for the year ahead of the holiday.

The market has declined in January for the last three years and 2016 was the worst January in nearly two decades. None of those last three Januarys had a 9% rally in the prior six weeks. Also, none had the terror risk of a presidential inauguration to deal with. In theory, this makes January 2017 a potentially volatile month. Whether that volatility begins on Tuesday or at some later point in the days to come is of course unknown. About the only guarantee is that we will see some volatility. Even in normal election years, the market tends to decline around the inauguration event.

The first material support level is the 2185-2190 resistance range from August. That would be my first target if a market decline appears as expected. In the Index Wrap last weekend, I laid out the various support levels for January for all the major indexes.

A long time reader emailed me last week asking if I had my Dow 19,000 hat yet. It took me a few seconds to understand what he meant. The odds of us retracing to 19,000 before 20,000 are very good. The initial support for the Dow is about 19,250 but is very light. The most likely target would be 18,850 and the stutter step from mid November after the initial post election bounce.

Because the Dow is being powered by only 10 of the 30 stocks and most of those are very over extended, we could see a significant decline. There was a very active rotation cycle out of tech stocks and into those Dow stocks that led the charge. There is a lot of profit that needs to be captured as the Trump honeymoon rally meets the reality of governing.

The Nasdaq Composite Index broke through two levels of support with a 49-point decline on Friday. The weakness in the big cap techs is dragging both indexes lower. You may remember earlier in the year when the big cap techs were outperforming and leading the indexes higher. That has now reversed and the decline could continue now that we are into a new tax year.

The Composite index could easily retest the early December level at 5,240 and the Nasdaq 100 could retest support at 4,650.

The Russell 2000 small caps led the post election rebound with a gain of 20.1% at the highs. While the index has been volatile the last two weeks it has not yet broken below support. What goes up fast normally comes down fast but that has not yet happened. With many small cap stocks up 30% to 50% since the election there will be profit taking once 2017 opens for trading. The Russell will again be out market sentiment indicator and once it breaks lower, the big cap indexes are sure to follow. Initial support is 1,310 and 1,300.

Just because the pension fund rebalance did not tank the markets, we cannot assume that January will not begin 2017 the same way we began 2016. There is no guarantee there will be selling just like there is no guarantee we will spring past 20,000 at Tuesday's open.

We simply take into account all the reasons why the market may go up or down at any time and there is an abundance of bearish reasons today and zero bullish reasons. However, the market tends to act in the opposite direction people expect in order to make fools out of the most traders possible.

With everyone leaning bearish for January, it might not take much to create a monster short squeeze. While I do not expect it, that possibility always exists.

I strongly suggest that readers not initiate new long positions for the first couple days and let the market pick a direction for us to follow. The New Year has 52 weeks in which to trade. We do not have to jump in on the first couple of days without any clue as to market direction.



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Random Thoughts

There was an interesting switch last week. When investors should have been turning more bearish they actually turned less bearish. In typical contrarian fashion investors tend to be the most bullish at market tops. This survey ended on Wednesday.

Last week results

The home market received a once in a generation gift in 2015. The yield on the 30-year treasury fell to 2.1% in July and mortgage rates were at lifetime lows. Despite that volatility, the 30-year yield closed up only 5 basis points for the year. The 2015 closing yield was 3.01% and the 2016 close was 3.06%. Most analysts believe the post election yield bounce will fade and homebuyers will get one more chance at low rates in 2017. The expected low yield is in the 2.75% to 2.80% range. If you have not yet refinanced this would be the time to do it.

The year 2016 saw us lose a large number of entertainers. Every year takes its toll but it seems like 2016 was especially harsh.

Carrie Fisher
Debbie Reynolds
George Michael
David Bowie
Glenn Frey
Maurice White
Leon Russell
Leonard Cohen
Merle Haggard
Doris Roberts
Garry Shandling
Patty Duke
Alan Thicke
Anton Yelchin
Gene Wilder
Florence Henderson
Garry Marshall
Morley Safer
Nancy Reagan
Harper Lee
Zsa Zsa Gabor
Muhammad Ali
Alan Rickman
John Glenn
Abe Vigoda
Arnold Palmer

As we get older, we need to take special care of our health. Our families depend on us and with a little extra diet and exercise, we can extend our lifespan by several years. That could mean meeting an extra grandkid or two, being less of a burden to our children or even staying out of a retirement home.

Instead of wishing you a simply Happy New Year, I would like to extend that to a long string of Happy New YEARS!


Enter passively and exit aggressively!

Jim Brown

Send Jim an email


"The time of maximum pessimism is the best time to buy and the time of maximum optimism is the best time to sell."

John Templeton


New Plays

Take the Day Off

by Jim Brown

Click here to email Jim Brown
Editor's Note

Tuesday is an official trading holiday while we look for market direction. Take Tuesday off from trading. You have my permission. While one day does not make a trend, it could give us insight for what to expect over the next couple of weeks.

There is no reason to add more positions because we are already heavily weighted to the downside. Take it easy and enjoy the weekend. Next week could be a roller coaster.


No New Bullish Plays


No New Bearish Plays

In Play Updates and Reviews

Ready to Rumble?

by Jim Brown

Click here to email Jim Brown

Editors Note:

The market avoided a sharp decline as buyers paired with sellers on the pension fund rebalance. However, the Nasdaq broke below support at 5,400 and the Russell closed right on support at 1,355. The next move lower could be the trigger for a sharp decline. The end of year window dressing is over and the undressing could begin on Tuesday.

There is no reason to try and enter new long positions in this market. We should avoid additional risk and limit our exposure until the market picks a direction in January.

Current Portfolio

Stop Loss Updates

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

Profit Targets

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

Current Position Changes

SHLD - Sears Holdings
The short position was stopped at $9.25 for a small gain.

VXX - VIX Futures ETF
The short position remains unopened until a trade at $29.50.

If you are looking for a different type of trading strategy, try these newsletters:

Short term Calls and Puts on equities = Option Investor Newsletter

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BULLISH Play Updates

No Current Bullish Plays

BEARISH Play Updates

AKS - AK Steel - Company Profile


No specific news on AKS. Testing support.

Original Trade Description: December 17th.

AK Steel Holding Corporation, through its subsidiary, AK Steel Corporation, produces flat-rolled carbon, stainless and electrical steel, and tubular products in the United States and internationally. It produces flat-rolled value-added carbon steels, including coated, cold-rolled, and hot-rolled carbon steel products; and specialty stainless and electrical steels in sheet and strip forms. The company also produces carbon and stainless steel that is finished into welded steel tubing, which is used in the automotive, large truck, industrial, and construction markets; buys and sells steel and steel products, and other materials; and produces metallurgical coal from reserves in Pennsylvania. It sells its flat-rolled carbon steel products primarily to automotive manufacturers and to customers in the infrastructure and manufacturing markets, including electrical transmission, heating, ventilation and air conditioning equipment, and appliances; and coated, cold-rolled, and hot-rolled carbon steel products to distributors, service centers, and converters. The company sells its stainless steel products to manufacturers and their suppliers in the automotive industry; manufacturers of food handling, chemical processing, pollution control, and medical and health equipment; and distributors and service centers. It also sells electrical steel products to manufacturers of power transmission and distribution transformers, as well as for use in the manufacture of electrical motors and generators. Company description from FinViz.com.

The steel sector rallied on expectations for Trump to place additional tariffs on imported steel and make American steel more competitive. While I am all for fair trade changes, that is likely to take many months if not a year or more to implement any changes what will help the U.S. steel companies. It will be months or quarters after that before the changes actually begin to show up in the earnings of these companies.

Earnings January 24th.

AKS rallied from $4.93 before the election to $11.39 for a +131% gain. Shares faded somewhat last week but still closed at $10.38 on Friday. When the post election balloon bursts, this stock could decline significantly. I would expect that to happen in the first week in January. I definitely do not expect the stock to be making higher highs.

Position 12/19/16:

Short AKS shares @ $10.17. See portfolio graphic for stop loss.


Long Jan $10 put @ .69 cents. No initial stop loss.

IWM - Russell 2000 ETF - ETF Profile


The Russell 2000 closed below initial support at 1,350 and could be headed for 1,300. Next week will be key to market direction.

Original Trade Description: December 10th

The IWM ETF seeks to track the investment results of the Russell 2000 Small cap Index.

The Russell is up +232 points or 20.1% in the last 22 trading days. It is grossly over extended and many small cap Russell stocks are up 30% to 40%. I understand the bullish sentiment that believes the economy will be better in 2017 but it will not be because of President Trump. His proposals will take months to get through the House and Senate and there is likely to be some major battles. Obamacare will not go away until 2018 or longer because it takes a long time to plan and execute a change that big. Lower taxes will not happen until 2018 because it will take months for both houses to vote on an acceptable tax bill. I seriously doubt they will change rates in the middle of the year. Any change will not occur until 2018.

I could go on but you get the picture. Typically, there is a honeymoon phase after a new president is elected. This phase has run its course. There are 14 trading days left in 2016 and any new highs are likely to be made before Christmas. After Christmas, investors may begin to worry and once into January and a new tax year, the selling could be dramatic. Do you remember January 2016? The market was not nearly as overextended as it is today and the Dow fell -2,150 points in just two weeks. Entering into a new tax year allows traders to capture profits and invest that money for another year before paying taxes.

Dow - January 2016

We also have the potential for a really messy inauguration or even a terrorist attack at the event. That potential will give cautious investors another reason to take profits in January.

I am recommending a long put on the Russell ETF. There is no stock vehicle we can use other than the VXX to capitalize on a market sell off. The VXX is flawed and while it may go up, it may not go up enough to make it worthwhile and it is volatile from day to day. I chose the Russell ETF because the premiums are cheap and the volatility should work in our favor. If you cannot use options then I suggest you buy the VXX shares at the first sign of market weakness after Christmas.

There is also another trigger factor to consider. The Dow is approaching 20,000 and that could be a massive sell the news event given the big gains. Since the Dow could hit that level this week I am recommending we initiate our long put position in advance.

Because the market could still rise, I want to follow the IWM higher and enter the position only when the ETF rolls over.

The ETF has short-term support at 137.75 and again at $137.25. I am recommending we enter the position with a dip to $137. If the Russell continues higher, I will continue raising the entry point as needed.

Position 12/12/16 with an IWM trade at $137.00

Long Feb $134 put @ $3.38, see portfolio graphic for stop loss.

SHLD - Sears Holdings - Company Profile


On Thursday Sears announced a standby letter of credit backed by CEO Eddie Lampert to keep the company afloat for a few more months. Since they lost $748 million in Q3 alone, this is only a band-aid. However, it did produce a short covering bounce of 10%. That bounce continued with another 3% gain to stop us out at $9.25 for a minor gain. Once the short covering on this news is over we will jump right back into Sears again ahead of a potential January bankruptcy.

Original Trade Description: December 15th

Sears Holdings Corporation operates as a retailer in the United States. It operates in two segments, Kmart and Sears Domestic. The Kmart segment operates retail stores that offer a range of products, including consumer electronics, seasonal merchandise, outdoor living, toys, lawn and garden equipment, food and consumables, and apparel; and in-store pharmacies. It provides merchandise under the Jaclyn Smith, Joe Boxer, and Alphaline labels; Sears brand products, such as Kenmore, Craftsman, and DieHard; and Kenmore-branded products. As of October 31, 2015, this segment operated approximately 952 Kmart stores. The Sears Domestic segment operates stores that provide appliances, consumer electronics/connected solutions, tools, sporting goods, outdoor living, lawn and garden equipment, apparel, footwear, jewelry, and accessories, as well as automotive services and products, such as tires, batteries, and home fashion products. It also offers appliances and services to commercial customers in the single-family residential construction/remodel, property management, multi-family new construction, and government/military sectors; appliance and plumbing fixtures to architects, designers, and new construction or remodeling customers; parts and repair services for appliances, lawn and garden equipment, consumer electronics, floor care products, and heating and cooling systems; and home improvement services, as well as protection agreements and product installation services. This segment provides merchandise under the Kenmore, Craftsman, DieHard, Covington, Canyon River Blues, Metaphor, Outdoor Life, Structure, and Apostrophe brands, as well as under the Roadhandler, Ty Pennington Style, and Alphaline brands. As of October 31, 2015, this segment operated 735 Sears stores. Company description from FinViz.com.

We played Sears as a short before and excitement about the coming holiday shopping helped lift shares in early November. Now that the holiday numbers are starting to come in, the results are very dismal. Sears is closer to bankruptcy today than they have ever been.

Last week they posted a GAAP loss of $748 million and an adjusted loss of $333 million. Gross margins fell to 19.2% compared to JC Penny at 37.2%. Sears is forced to severely discount items to attract what few shoppers they have. Same store sales at Kmart fell -4.4% and -10% at Sears. Revenue fell -12.5% to $5.0 billion.

Earnings March 9th.

Fitch warned Sears will burn through $1.5-$1.8 billion in cash this year and even selling off the Craftsman brand as planned will only gain them an additional 12 months of life.

Sears closed at a new 14-year low on Thursday and the outlook is growing increasingly dim. Suppliers fear a bankruptcy in January once the holiday shopping is over. Several suppliers have halted shipments to Sears on fears they will not be paid.

Update 12/19/16: Sears is desperate. They are offering a 20% discount on Sears.com this week if you pick up the merchandise at a store. The offer applies to apparel, jewelry, luggage, furniture, bed & bath, home decor and air mattresses.

Starting 12/21 coats are 60% off, up to 60% off women's boots, up to 75% off jewelry.

Starting 12/23 sleepwear is 60% off, watches 30%, Craftsman's tool sets 50% off.

Position 12/16/16:

Closed 12/30/16: Short SHLD shares @ $10.17, exit $9.25, +.92 gain.

No options recommended because of price.

VXX - Volatility Index Futures - ETF Description


The VXX is creeping higher without any material decline in the market. If we do get a big decline in January it should easily hit our entry target.

Original Trade Description: December 28th

The VXX is a short-term volatility product based on the VIX futures. As a futures product it has the rollover curse. Every time they roll to a new futures contract, they have to pay a premium and that lowers the price of the ETF. It is a flawed product with a perpetual decline built in from the monthly roll over in the futures contracts.

As evidence of this flaw, they have now done four 1:4 reverse stock splits. The last four reverse splits occurred at $13.11 (11/2010), $8.77 (10/2012), $12.84 (11/2013), $9.52 (8/8/16). The prospectus says it can reverse split anytime it trades under $25 for a prolonged period and the splits will always be 1:4.

After the August split the ETF moved sideways for four weeks at $36. I think everyone was waiting for the typical August volatility. When it did not show up and the market rallied on Friday that support broke. And the decline began.

We exited the last short at $26.65 for a $7 gain back on December 13th. I am expecting the January volatility to lift the VXX back to $30. That will give us a great entry for the expected market rally in Feb/Jan where the VXX will crash again.

Unfortunately, put options are expensive with a volatility instrument at this price level. The only recommendation is to short the ETF and forget it. This will be a long-term position. This is not a 2-3 week play. I can guarantee you, if history holds, we can play this until it splits 1:4 again at $10. We may have to rotate in and out a couple times but it will eventually go to $10. Once we are in the position and profitable I will put a trailing stop loss on it. If the stop is hit we will take profits and then look for a bounce to get back in. We could keep this play in the portfolio on a trading basis permanently.

I am putting an entry trigger on the position at $29.50, a level we saw on December 1st. I would expect this to be hit in early January. The VXX could rise well over $30 if the market really corrects so I am not putting a stop loss on the position until the correction is over.

With a VXX trade at $29.50

Short VXX shares, currently $24.62, no initial stop loss.

No options recommended because of price.

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