Option Investor

Daily Newsletter, Tuesday, 1/3/2017

Table of Contents

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

Market Wrap

Direction Change?

by Jim Brown

Click here to email Jim Brown

After a week of declines, the Santa Rally returned to lift the Dow by +175 points at the open.

Market Statistics

The Dow gave back all but 4 points of its gains intraday but a new wave of buying at the close squeezed the shorts once again to power the index to a +119 point gain. There was $1.4 billion in market on close buy orders. Before everyone begins to believe we are headed significantly higher, there were some mitigating headlines.

Chinese economic numbers came in better than expected to power a strong rally in the Chinese markets overnight. That pushed the S&P futures to a strong gain and caused significant short covering at the open. I warned about this possibility last week.

Oil prices surged to $55.25 on the Chinese economics and that added to the short covering in energy equities. U.S. economic reports were also positive and that added fuel to the fire. Midday, oil prices crashed back to $52.11 and that weighed on equities.

This is also the period where yearend retirement contributions hit fund desks and they put that money to work immediately. The last five trading days of December and first two days of January are considered the Santa Rally because of the impact of those retirement funds and the investment of holiday bonuses. The first week of trading in any year is normally very volatile with spikes and swings in both directions.

There is a saying, "As goes the first week, so goes January. As the S&P goes in January, so goes the rest of the year." This adage has an 87.9% accuracy rate with only 8 major deviations in the last 66 years. The first week is important but one day does not make a week.

The ISM Manufacturing Index rose from 53.2 to 54.7 and the highest level since December 2014. Analysts expected only a minor rise to 53.5. New orders rose from 53.0 to 60.2 and new export orders rose from 52.0 to 56.0. However, backorders were flat at 49. Production rose from 56.0 to 60.3 to continue eating away at the order backlogs. Twelve industries reported gains and four industries reported declines. The biggest declines were in furniture and printing.

This was a good report but many of the internal components still need to improve significantly.

Construction spending for November rose from +0.6% to +0.9%. Analysts were expecting +0.6% and this was the strongest gain in five months. Private spending rose +1.0% and public spending +0.8%. Total construction spending for November was $1.13 trillion. That was up 4.5% from November 2015. Private spending accounted for $843.1 billion, up +5.7% from 2015.

The CoreLogic Home Price Index for November rose 7.1%, up from 6.7% in October. This was the 23rd consecutive month of increases. Prices reached new highs in 14 states. Only Connecticut saw prices decline with a -0.5% drop. With mortgage rates rising and housing inventories falling the race is on to make a purchase while the interest rates are still relatively cheap.

Moody's Chart

The headline event for Wednesday is the FOMC minutes. Nobody is expecting a surprise but you can never tell from the post meeting statements exactly what happened in the meeting. Analysts will be looking for clues on whether we are more likely to have 2 or 3 rate hikes in 2017.

The ADP Employment report on Thursday is expected to post slower job growth of 172,500 jobs compared to 217,000 in November. A weak retail sector could be the culprit. The Nonfarm Payrolls on Friday are expected to decline only slightly from 178,000 to 175,000.

Stock news was still light with many analysts and reporters still absent for the holiday. Dow component Disney (DIS) received an upgrade from hold to buy from Evercore ISI. The analyst made Disney a top pick for 2017. The analyst said the ESPN risks were well-understood and short term growth challenges were already priced into the stock. HULU, which Disney owns 30%, is expected to launch a cable like service this year that features Disney programming. They announced last week an agreement with Disney to stream more than 50 classic Disney titles. They are expecting a slightly smaller box office for Disney in 2017 since they had 6 of the top ten movies in 2016. They are off to a good start with Rogue One already over $850 million globally.

Xerox (XRX) shares rallied 20% on a combination of factors. They completed the spinoff of services company Conduent (CNDT) and the shares were adjusted down to a closing price of $5.75 as of Friday to compensate for the $15 share price of Conduent. However, Credit Suisse upgraded them to outperform from neutral, citing a more focused print business and a bigger than expected cost savings. He said Xerox would be moving towards Managed Print Services (MPS) and graphics processing. Their price target is $8. JP Morgan also upgraded from neutral to overweight.

Abercrombie & Fitch (ANF) was downgraded by Oppenheimer from perform to underperform and Jefferies cut them from buy to hold. Analysts said their turnaround had stalled with same store sales down -6% in Q3. The actual Abercrombie brand saw sales fall -14% while the Hollister brand was flat. The last 8 ratings changes were all downgrades. Shares actually posted a minor gain after an early morning drop.

After the bell, Tesla reported deliveries for Q4 and all of 2016. For Q4 they delivered 22,200 cars compared to estimates for 26,000. The company said there was a production slowdown in October when they switched to new parts for some autopilot components. Production accelerated again late in the quarter once the glitch was resolved. They delivered 76,230 cars for all of 2016 compared to estimates for 80,000. Tesla said they do not count the cars until they are delivered and there were 2,750 vehicles that were delayed in transit or the customer was unable to take the delivery. At the end of December there was a total of 6,450 cars in transit that will be counted as Q1 deliveries. Shares fell -$4 in afterhours.

Shares of Regeneron (REGN) fell $9 in afterhours when a federal judge refused to throw out a court verdict upholding two Amgen patents for a cholesterol drug. Amgen filed the suit in an attempt to stop Regeneron and Sanofi from selling the drug Praluent, which lowers bad cholesterol.

Mattel (MAT) announced a competitor to Amazon's Echo device that is being called a virtual assistant for babies. The device is called Aristotle and has an artificial intelligence that responds to voice commands. Mothers can reorder diapers, formula, etc, have it play music for the baby, soothe infants back to sleep, read bedtime stories, play games and teach toddlers different words. It has an HD camera for observation from another room. This device will cost $300 and will begin selling this summer. This is actually a very good move for Mattel, whose sales have been declining. Announcement

Every company wishes the market would reward them for a downgrade. McKesson (MCK) was downgraded by Mizuho from buy to neutral. Shares rallied $7 on Tuesday. However, there was other news. The company said it completed the $2.1 billion acquisition of Rexall Health from privately held Katz Group. That gives the company 470 pharmacies in Canada.

AmerisourceBergen (ABC) was also downgraded by Mizuho from buy to neutral and there was no other news. Shares spiked 6%. That has to be frustrating to the analysts that issue the downgrades in hopes of profiting from their shorts.

The brain drain at Twitter (TWTR) is continuing. Kathy Chen, hired only 7 months ago to be managing director of Greater China, announced her resignation. Twitter has lost 11 top-level executives in 2016 as the outlook for the company dims. Adam Messinger, chief technology officer, resigned in December. Analysts believe these resignations may be part of a targeted 9% reduction in force that some believe is necessary before Twitter can sell itself.

Crude oil crashed on the rising dollar and some technical issues after trading at a high for 2016. The $55 level was seen as psychological resistance and it hung at that level for about 60 minutes before falling off the cliff. Traders with long positions probably tightened their stops when that $55 level was reached and once the decline began, it was dramatic.

Coupled with that the dollar traded at a new 14-year high and that caused a decline in all the commodities.

Natural gas was also a big loser for the day. After touching $4 last week on the return of the polar vortex, the new weather report calling for a warm spell, sent prices crashing. Apparently, they were not talking about Colorado with 6-12 inches of snow expected on Wednesday and zero degree lows the rest of the week in Denver.


The first week of the year is normally volatile. The first day of trading for 2017 saw 7.43 billion shares exchange hands. That is high given the volume over the last couple weeks but it is still lower than the 8.4 billion shares on the first day of trading in 2016. The difference is that the Dow lost 277 points on the first day of 2016.

One day does not make a trend. We cannot tell anything about market direction for January after only one day of trading. That is especially true given the 175-point intraday range on the Dow. Sellers were definitely waiting and resistance was not broken.

Tonight the Asian markets are in rally mode with the Nikkei up more than 2% as I type this. That has caused the S&P futures to rebound from negative territory to slightly positive at +2 points.

My analysis and expectations for January have not changed. I still believe we will see some downside volatility over the next three weeks. Until the indexes break through overhead resistance, I am going to cling to those beliefs.

The S&P rebounded back over prior support at 2,250 and closed at 2,257. Strong resistance remains at 2,275. It would take a decent move from here to break through that resistance.

The Dow rebound was mostly a short squeeze prompted by the strong S&P futures overnight. The +175 at the open only held about an hour and the selling was dramatic. The rebound at the close is troubling. This appeared to be a major buy program and another short squeeze given the speed and timing of the move.

The Dow chart is inconclusive but this appears to be a normal post decline rebound that is destined to fail. We will not know for sure until the end of this week.

The Nasdaq posted a decent rebound but closed well off its highs and right on prior support at 5,425. Were it not for the 20-point rebound right at the close, the chart would look a lot different. The index is at risk for repeating its Friday decline back under 5,400. It would take two good days of gains to return to the resistance highs at 5,490.

The Russell 2000 is the broadest index we track daily. The 8-point rebound was lackluster and it closed well off the highs and just above support. The Russell is typically our market sentiment indicator and it is the weakest of the four charts.

The simple answer is that the market is due for a rest. However, like an unruly 3 yr old, it is fighting naptime. This is the second longest bull market ever and the third strongest post war bull. However, earnings could be challenging because of the strong dollar. Valuations are high and once earnings begin to appear, we could have another reason for some profit taking to add to the other handful of reasons I have been writing about for the last two weeks.

Sam Stovall of S&P said today's trading was mechanical (robots, algos, program trades) and not human based. He also expects weakness in mid January.

I am sticking to my outlook for a decent bout of volatility between now and the inauguration. Once this week is over, I will restudy that outlook and put the update in my weekend commentary. I would definitely refrain from adding a bunch of long positions based on Tuesday's gains. There is no compelling need to be long the market. There is always another buying opportunity in the future.



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New Plays

Extended Holiday

by Jim Brown

Click here to email Jim Brown
Editor's Note

We cannot determine January's market direction from one day's activity. One day does not make a trend. One day of market gains does not mean the potential January decline has been cancelled. The first two days of January are part of the Santa Rally period because of the end of year retirement fund inflows. We need to wait for a couple days to see if this is just a fund flow event or something that can continue. There is no compelling need to be long the market. There is always another buying opportunity in the future.


No New Bullish Plays


No New Bearish Plays

In Play Updates and Reviews


by Jim Brown

Click here to email Jim Brown

Editors Note:

The market detoured from the end of week declines after better than expected numbers from China sparked a rally. This is also the time of year when the end of year retirement funds hit the market. The first two trading days of January are the last two days of the Santa Rally period.

I do not believe this rally will stick but time will tell.

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

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

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BULLISH Play Updates

No Current Bullish Plays

BEARISH Play Updates

AKS - AK Steel - Company Profile


No specific news. Minor rebound in a bullish market.

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 rebounded from support at 1,350 to a high of 1,375 before closing well off the highs. This should be temporary.

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.

VXX - Volatility Index Futures - ETF Description


Big drop in the VXX after the +175 point spike in the Dow. This is just a temporary event. Be patient.

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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