Option Investor

Daily Newsletter, Tuesday, 7/18/2017

Table of Contents

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

Market Wrap

Earnings Volatility

by Jim Brown

Click here to email Jim Brown

The Dow suffered from an extreme case of earnings volatility with a -162 point decline intraday.

Market Statistics

The Dow decline was prompted by the $6 drop in Goldman Sachs that erased more than 40 points off the index but there was also leftover negativity from the news late Monday that the healthcare bill was dead. That drove futures and the dollar down overnight and treasuries higher today. The earnings from GS and Bank of America depressed the entire financial sector and that weighed on the Dow stocks.

The sharp decline in the Housing Market Index at 10:00 was also a negative for the Dow.

The Housing Market Index for July declined sharply from 67 to 64. However, the June number was revised down to 66. The index peaked at 71 in March and has been declining steadily. The Northeast remained under 50 for the fourth consecutive month with a reading of 48, although that was a four-month high. The Midwest component fell from 68 to 64, the South from 68 to 63 with the West the only gainer from 71 to 74. The single-family sales component for the present declined from 72 to 70 and for six months out from 75 to 73. Potential buyer traffic declined 1 point to 48 after peaking in March at 53.

This shows a decline in homebuilder confidence but there is no reason for concern. The limited number of homes on the market allow them to raise prices and inventory turns over quickly. You have to wonder if the last two years of a strong market has led them to expect problems ahead when there really are none in sight.

The economic calendar for Wednesday only has one report that is material. That is new residential construction or housing starts. After the decline in builder sentiment for July, we could see a smaller number of starts. It would have to be a material drop to move the market.

The Philly Fed Manufacturing Survey on Thursday is the biggest report for the week because it is a proxy for the national ISM later in the month.

Once we get past Wednesday, the chatter about the Fed meeting will increase even though there are no expectations for a change in rates.

The death of the Obamacare replacement bill on Monday evening and then the rapid demise of the repeal proposal called for by President Trump and Mitch McConnell last night, caused the dollar to decline sharply to 10-month lows.

The death of the healthcare bill led investors to expect the efforts to reform taxes, pass infrastructure spending and pass a budget, to die a similar death in the Senate. This caused a flight to safety and rush into treasuries. The yield on the ten-year declined from 2.4% last Tuesday to 2.26% today.

These factors could combine to depress the market even more during the normally weak August and September period. Once tax reform appears to be dead for 2017, there will no longer be the enticement to continue holding profitable positions hoping for a lower tax rate.

There were multiple earnings stories moving the market today. Netflix (NFLX) spiked 13.5% or $22 despite missing estimates by a penny. They reported 15 cents and analysts were expecting 16 cents. The rocket fuel came from the surge in subscribers. Analysts expected 3.2 million and the company reported 5.2 million. They also guided higher above analyst estimates for Q3. The company is on track to see negative cash flow for 2017 of $2.5 billion because opening in new markets is expensive and it takes a couple of years for subscribers to build to the point to overcome the initial expense. In the U.S. where the market is maturing, they produced gross margin of 40%. When they get to significant penetration in international markets, they expect similar margins.

Netflix continues to spend on existing content and original content and doing it in multiple languages. The company now has more than 52 million international subscribers and 51.9 million U.S. subscribers. The U.S. had been seen as a saturated market but they still added 1.1 million domestic subs and 4.1 million international. Analysts believe the U.S. market will top out in the 60-80 million range with slower growth to those numbers. However, there are 126 million households in the U.S. so they have more than 75 million to pull from. Internationally, they have billions of potential subscribers limited only by Internet access and bandwidth. Analysts are talking 200 million subscribers in 4 years and 300 million within 10 years. At the rate they are accelerating, it could be a lot less than 10 years.

Before the earnings, the option premiums were out of sight with the premiums suggesting a potential $12 range after the release. Nobody in their right mind would have taken that bet but it would have proven profitable with the $22 gain. Now we have to wait for a significant pullback to deflate premiums before we can buy Netflix again. Given their cash burn rate and the stock performance, I would not be surprised to see another secondary offering to raise several billion for operations. Reed Hastings needs to strike while the stock is hot to capture the opportunity. Netflix market cap rose $9.482 billion today alone.

Goldman Sachs (GS) reported earnings of $3.95 compared to estimates for $3.36. It was a major beat on the earnings front. Revenue of $7.89 billion beat estimates for $7.57 billion. The stock was hammered because of a drop in trading revenues of 17%. Fixed income, currency and commodities revenue fell -40% to $1.16 billion. Stock trading revenues rose 8% to $1.89 billion. Overall trading revenues fell to the lowest level in 11 years. Revenues from investing and lending rose 42% to $1.58 billion. Equity securities rose 88% to $1.18 billion. This represents the rising value of startups in the portfolio. Assets under supervision rose $33 billion to $1.41 trillion.

The bank said low market volatility, low client activity and "generally difficult" market making conditions contributed to the decline in trading revenues. There was no shortage of volatility or volume in GS shares today. They fell $6 on more than double average volume.

On the surface, this looks like a buy the dip opportunity. They blew away earnings estimates in a "generally difficult" market and increased revenues in areas other than trading. When volatility returns, trading revenues will also return.

Bank of America (BAC) reported earnings of 46 cents that rose 11% and beat estimates for 43 cents. Revenue of $23.07 billion easily beat estimates for $21.78 billion. This was the bank's first $2 billion profit quarter. Shares were down after the report based on weak net interest income that rose only 8.6% to $10.99 billion. Analysts were expecting more than 10% growth thanks to the Fed's rate hikes. Shares rebounded to close down 12 cents after a sharp intraday drop.

Harley-Davidson (HOG) reported earnings of $1.48 compared to estimates for $1.38. Revenue of $1.58 billion misses estimates for $1.59 billion. In the year ago quarter they reported $1.55 and $1.67 so this was a decent decline. Worldwide motorcycle sales were down 6.7% and -9.3% in the USA. This compares to industry wide global sales decline of -2.3%. The company blamed it on "weak industry conditions." They sold 81,388 units compared to the 87,266 in the year ago quarter. They revised full year guidance to ship 241,000 to 246,000 units in 2017, which is roughly 7% less than 2016. In Q3 they expect to ship 39,000 to 44,000 units, which is down about 15% from year ago levels. Wedbush pointed out that with guidance cut this significant after a minor decline in the first half, that the second half could be "dire" in their words. Shares declined sharply at the open but rebounded to erase half the losses at -$3 for the day. I would be a seller on HOG.

UnitedHealth (UNH) reported earnings of $2.46 that rose 28% compared to estimates for $2.38. Revenues of $50.1 billion were in line with estimates. That was a 7.7% rise from last year. They are profiting from exiting the Obamacare business and the losses it was causing. They added 2.5 million to its health care benefits business. They also saw major growth in the Medicare business with revenue rising $2.5 billion or 17% to $16.7 billion. Their new Optum pharmacy benefits business saw revenues rise 10% to $2 billion.

UnitedHealth is on pace to do $200 billion in revenue for the first time in 2017. They guided for full year earnings in the $9.75-$9.90 range, up from $9.65-$9.85 per share.

Johnson & Johnson (JNJ) reported earnings of $1.83 compared to estimates for $1.79. Revenue of $18.8 billion missed estimates for $18.9 billion. They raised guidance for the full year for revenue of $75.8-$76.1 billion. Analysts were expecting $75.7 billion. They guided for earnings of $7.12-$7.22 and analysts were expecting $7.11. Shares were up sharply on the guidance.

CSX Corp (CSX) reported earnings of 64 cents on revenue of $2.93 billion. Analysts were expecting 59 cents on $2.85 billion. The company added another $500 million to its buyback authorization to raise it to $1.5 billion. However, the company said it was "evaluating" its cash deployment strategy with respect to shareholder distributions and is committed to an investment grade rating. That caused investor flight and shares were down $2.50 in afterhours.

United Continental (UAL) reported adjusted earnings of $2.75 that beat estimates for $2.68. Revenue rose 6% to $10 billion and beat estimates for $9.96 billion. Shares collapsed after the report on worries that the momentum from rising prices had run its course and price competition was increasing. Shares fell -$2.50 in afterhours.

After the bell, IBM reported earnings of $2.97 that beat estimates of $2.74. Revenue of $19.29 billion, down -4.7%, missed estimates for $19.47 billion and was the 21st consecutive quarter of declining revenues. The company reaffirmed guidance for the full year of $13.80 per share. Cloud revenues rose 15% to $3.9 billion. Shares fell $3 in afterhours.

Earnings for Wednesday include Dow component American Express and tech giant Qualcomm. US Banks and Morgan Stanley will complete the bank earnings parade.

Thursday is another big day for the Dow with Microsoft, Travelers and Visa.

Shares of Vertex Pharmaceuticals (VRTX) spiked 24% in afterhours on news a new drug cocktail improved lung function in patients with cystic fibrosis.

Chipotle Mexican Grill (CMG) shares fell $17 or 4.34% on news they had closed a store in Sterling Virginia after a "small number" of illnesses had been reported by people eating at the store. Their symptoms were consistent with norovirus. The company has had multiple occurrences of this over the last several years but it had been some time since an outbreak. Norovirus can be spread by an infected person touching the food or the food coming in contact with an infected surface. This is likely a single store incident and not a chain problem. CMG has gone to great lengths to prevent these occurrences in their food transmission chain and have been largely successful.

The Maxim Group said this was a buy the dip opportunity and upgraded the stock from hold to buy with a $460 price target. Standpoint Research saw is slightly different with an upgrade from sell to underperform.


Which way do we go? With the market somewhat in shock from the -162 point intraday drop on the Dow and the negative earnings results after the bell you would think we could be looking at a negative day for Wednesday. However, even with the decline in IBM, the S&P futures are up 2 points and the Nasdaq futures are up 15 points. The Dow futures are down -7 thanks to IBM.

This would suggest traders are thinking about shaking off the earnings problems as stock specific and willing to buy the dip. Since the Dow and the Russell were the only two indexes to dip, that is not a bad assumption. We knew heading into this week there would be earnings volatility on the Dow. With nine Dow components reporting this week there was a chance for both positive and negative moves. Now that the shock of the big Dow drop is behind us, traders can be calmer about future reports.

The Netflix gain helped to power the Nasdaq to a new record high despite the sharp drop on the Dow. This is a positive reinforcement that there are some good reports in our future and there could be further gains ahead.

The Nasdaq big cap stocks were all positive except for Dow component Microsoft and a weak showing by Apple, also in the Dow. Facebook exploded higher with a $3 gain to a new high. If the big cap stocks are back in earnings ramp mode, the Nasdaq could continue to make new highs. That would eventually lift the Dow out of its slump.

The Goldman anchor kept the Dow in negative territory and the rest of the components were evenly matched. Crude stocks are down tonight because the API inventories showed a build of 1.628 million barrels compared to expectations for a decline of 3.0 million. Crude itself is only down about 17 cents in hopes Wednesday's EIA numbers will show a decline. If they also show a build, we could see the energy sector, led by Exxon and Chevron, decline on Wednesday. That would be a drag on the Dow.

Earnings from American Express will not impact the Dow on Wednesday because they report after the close.

If the Nasdaq remains positive, we could see the Dow shake off the IBM drag of about 28 points based on the afterhours decline. Resistance is 21,650 and support should be 21,525.

The S&P shook off the intraday dip to end slightly positive and at a new closing high. Coupled with the Nasdaq, a repeat performance on Wednesday would provide a strong lift to the broader market. With two failures intraday at the 2,463 level over the last three days, that is currently the resistance that has to be conquered. Support is 2,450 and the intraday low for today.

The Russell 2000 gave back 4 points because of the decline in the financial sector. That is the Russell's largest sector. However, the index avoided closing below support at 1,425 and could be poised to reclaim the new highs if the Nasdaq remains positive.

While I am optimistic about Wednesday, I am concerned the events in Washington could remain a cloud over the market. The rise in the bond market suggests investors are starting to be concerned about the future for equities with a legislative agenda dead in the water. If the housing starts tomorrow are weak, I would expect bonds to continue to rally and pressure equities. If the EIA reports a build in oil prices that would be another market cloud. There are plenty of cross currents in the earnings cycle and as we have seen this week, not all of them are positive. The expectations may have been overly optimistic. I would recommend caution in being overly long and let's see how this week plays out.

There will always be another day to trade if you have capital in your account.

Enter passively, exit aggressively!

Jim Brown

Send Jim an email


If you like the market commentary you have been receiving and you are on a free trial then now is the time to subscribe. Don't wait until you miss a newsletter to decide you want to take the plunge.

subscribe now


New Plays

Take a Breath

by Jim Brown

Click here to email Jim Brown
Editor's Note

The combination of a 162-point drop in the Dow and new highs on the Nasdaq show the conflicting currents. We have recently exited the majority of our positions and I would rather not add a play in this environment just because it is a newsletter day. Secondly, I went through my scans and nothing was screaming buy me but there were a surprising amount that looked like shorts. Since this could be a rocky week in the markets, I am going to pass on adding a new position. There is always another day.


No New Bullish Plays


No New Bearish Plays

In Play Updates and Reviews

Winner, Winner

by Jim Brown

Click here to email Jim Brown

Editors Note:

The Nasdaq posted a winning session despite the Dow falling -162 points intraday. The Nasdaq closed at a new record high and the S&P squeezed out another high as well. The Dow suffered from the decline in Goldman Sachs and their earnings depressed the financial sector. That weighed on the Russell and kept that index from closing at a new record.

The Nasdaq and S&P record closes "could" be a signal that the Dow dip will be bought. However, IBM reported after the close and declined sharply and there are more Dow components reporting on Wednesday.

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

BOX - Box Inc
The long position was entered at 2:40 when S&P turned positive.

ACOR - Acordia
The long position was stopped at $19.85.

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

Short term Calls and Puts on equities = Option Investor Newsletter

Credit spreads and naked puts = OptionWriter

Long term option investments = LEAPS Investor

3-6 month Option Trades = Ultimate Investor

Iron Condors = Couch Potato Trader

BULLISH Play Updates

ACOR - Acordia Therapeutics - Company Profile


No specific news. The resistance that formed at $20.85 was fatal. Shares decline to our stop at $19.85 to take us out of the position. I will watch for another rebound through resistance to add the play back into the portfolio.

Original Trade Description: June 21st.

Acorda Therapeutics, Inc., a biopharmaceutical company, identifies, develops, and commercializes therapies for neurological disorders in the United States. The company markets Ampyra (dalfampridine), an oral drug to improve walking in patients with multiple sclerosis (MS); Zanaflex capsules and tablets for the management of spasticity; and Qutenza, a dermal patch for the management of neuropathic pain associated with post-herpetic neuralgia. It also markets Ampyra as Fampyra in Europe, Asia, and the Americas. In addition, the company develops CVT-301 that has completed a Phase III clinical trial for the treatment of OFF periods in Parkinson's disease; CVT-427, which has completed a Phase I clinical trial to treat migraine; Tozadenant that is in Phase III clinical trial for reduction of OFF time in Parkinson's disease; SYN120, which is in Phase II clinical trial to treat Parkinson's disease-related dementia; and BTT1023 (timolumab) that is in Phase II clinical trial for primary sclerosing cholangitis. Further, it develops rHIgM22, which is in Phase I clinical trial for the treatment of MS; Cimaglermin alfa that has completed a Phase I clinical trial in heart failure patients; and Chondroitinase Program that is in research stage for the treatment of spinal cord injury. The company has collaborations and license agreements with Biogen International GmbH; Alkermes plc; Rush-Presbyterian St. Luke's Medical Center; Alkermes, Inc.; SK Biopharmaceuticals Co., Ltd.; Astellas Pharma Europe Ltd.; Canadian Spinal Research Organization; Cambridge Enterprise Limited and King's College London; Mayo Foundation for Education and Research; Paion AG; Medarex, Inc.; and Brigham and Women's Hospital, Inc. Company description from FinViz.com.

Acordia took a fall at the end of March when two Multiple Sclerosis patents were invalidated by a court. This is normal stuff and happens all the time to biotech companies when competitors want to introduce a generic. Shares crashed but the outlook for Acordia did not.

They fell another 5% in late April when revenue of $112 million missed estimates for $121 million. The company did reaffirm guidance for ful lyear Ampyra sales in the range of $525-$545 million.

Recently, their experimental Parkinsons drug CVT-301 was named Inbrija. In early June they presented Phase III data which met its primary endpoint of improvement in motor function compared to a placebo. Multiple secondary endpoints were also met. The company plans to file a new drug application with the FDA by the end of this quarter.

Expected earnings July 27th.

Shares have been rebounding sharply and cleared resistance from the April/May decline. They have a long way to go to recover their highs and that is a potential for profit.

Position 6/22/17:

Closed 7/18/17: Long ACOR shares @ $18.80, exit $19.85, +$1.05 gain.

BOX - Box Inc - Company Profile


No specific news. Shares are nearing the resistance at $19.50.

Original Trade Description: July 17th.

Box, Inc. provides cloud content management platform that enables organizations of various sizes to manage their enterprise content from anywhere. The company's platform enables users to collaborate on content internally and with external parties, automate content-driven business processes, develop custom applications, and implement data protection, security, and compliance features. Box, Inc. offers its solution in 22 languages. It serves healthcare and life sciences, financial services, legal services, media and entertainment, retail, education, energy, and government industries primarily in the United States. The company was formerly known as Box.net, Inc. and changed its name to Box, Inc. in November 2011. Company description from FinViz.com.

Expected earnings August 30th.

Box is making a lot os smart moves lately. The recently partnered with Microsoft to jointly offer Box cloud management to Azure enterprise customers. Box will use Azure as a strategic public cloud platform and the companies have committed to share go-to-market investments, including initiatives to co-sell Box with Azure. Any time you can get Microsoft to partner with you, share the expenses and market your product, it was a good move.

Last week Box appointed Stephanie Carullo as the new COO. Carullo led U.S. sales for Apple's education business. Before that whe led the data center and virtualization architecture group at Cisco Systems. That is a good pedigree.

Shares have ticked up since both of those events last week and could be headed for a breakout over $19.50.

S&P futures are down -$3.50. DO NOT enter this position unless the market is positive. If the market opens down, wait for the S&P to turn positive before entering.

Position 7/18/17:

Long BOX shares @ $19.21, see portfolio graphic for stop loss.
Alternate position: Long Sept $20 call @ 90 cents, see portfolio graphic for stop loss.

HZNP - Horizon Pharma - Company Profile


No specific news. Minor 5 cent gain in a weak market.

Original Trade Description: July 15th.

Horizon Pharma Public Limited Company, a biopharmaceutical company, engages in identifying, developing, acquiring, and commercializing medicines for the treatment of orphan diseases, arthritis, pain, and inflammation and inflammatory diseases in the United States and internationally. The company's marketed medicine portfolio consists of ACTIMMUNE for the treatment of chronic granulomatous disease and malignant osteopetrosis; RAVICTI and BUPHENYL/AMMONAPS to treat urea cycle disorders; PROCYSBI for the treatment of nephropathic cystinosis; QUINSAIR for the treatment of chronic pulmonary infections due to pseudomonas aeruginosa in cystic fibrosis patients; and KRYSTEXXA to treat chronic refractory gout. Its products also include RAYOS/LODOTRA for the treatment of rheumatoid arthritis, polymyalgia rheumatic, systemic lupus erythematosus, and multiple other indications; DUEXIS to treat signs and symptoms of osteoarthritis and rheumatoid arthritis; MIGERGOT for the treatment of vascular headache; PENNSAID 2% to treat pain of osteoarthritis of the knees; and VIMOVO for the treatment of signs and symptoms of osteoarthritis, rheumatoid arthritis, and ankylosing spondylitis. The company has collaboration agreements with Fox Chase Cancer Center to study ACTIMMUNE in combination with PD-1/PD-L1 inhibitors for use in the treatment of various forms of cancer; and Alliance for Lupus Research (ALR) to study the effect of RAYOS on the fatigue experienced by systemic lupus erythematosus (SLE) patients. Company description from FinViz.com.

Expected earnings August 7th.

Horizon posted and earnings disappointment in May that saw the stock collapse from $15.50 to $9.50. They reported earnings of 21 cents that missed estimates for 25 cents. Revenue was $220.9 million and missed estimates for $248 million. They guided for the full year for revenue of $1.0 to $1.03 billion. The problem was a shift in the contracting model with pharmacy benefit managers that was not performed in accordance with expectations.

That contracting problem has been solved. They also announced that three patents cases against Dr Reddy's, Lupin Ltd and Mylan Labs were upheld by a US District Court, which will prevent generics for VIMOVO until 2022 at the earliest.

Horizon is small company with numerous drugs in the pipeline and in trials. Shares are recovering from the May disaster and there is still $2.50 to gain to fill the gap from the post earnings crash.

Position 7/17: Alternate position:
Long Aug $14 call @ $.50, see portfolio graphic for stop loss.

BEARISH Play Updates

FRGI - Fiesta Restaurant Group - Company Profile


No specific news. Shares closed at a new 4-year low.

Original Trade Description: July 12th.

Fiesta Restaurant Group, Inc., through its subsidiaries, owns, operates, and franchises fast-casual restaurants. It operates its fast-casual restaurants under the Pollo Tropical and Taco Cabana brand names. The company's Pollo Tropical restaurants offer various Caribbean inspired food, and Taco Cabana restaurants offer a selection of Mexican food. As of January 1, 2017, it had 177 company-owned Pollo Tropical restaurants, 166 company-owned Taco Cabana restaurants, and 29 franchised Pollo Tropical restaurants in the United States, Puerto Rico, Panama, Trinidad & Tobago, Guatemala, the Bahamas, Venezuela, and Guyana, as well as 5 franchised Taco Cabana restaurants located in New Mexico, 2 non-traditional Taco Cabana licensed locations on college campuses in Texas, and 1 location in a hospital in Florida. Company description from FinViz.com.

Expected earnings August 7th.

On May 8th, Fiesta reported earnings of 25 cents compared to estimates for 30 cents. Revenue of $175.6 million missed estimates for $178.2 million. Same store sales declined -6.7% at Pollo Tropical and transactions declined -8.9%. Sales at Taco Cabana decreased 4.5% and sales transactions fell -4.0%. The company closed 30 stores that were losing money.

The company is under attack by JCP Investment Management, which has a 3% stake. JCP had lobied for changes to be voted at the June shareholder meeting. The company and JCP have been trading hostile press releases. The shareholder meeting went in favor of Fiesta but JCP is not giving up. Shares began to decline further when JCP did not gain control of the board.

Shares closed at a 4-year low on Wednesday at $18.80 and the IPO price in 2012 was $11. Shares had traded as high as $69. With the chain closing stores at a rapid pace, their long term future is in doubt.

Position 7/13/17:

Short FRGI shares @ $18.75, see portfolio graphic for stop loss.
Alternate position: Long September $17.50 put @ $1.05, see portfolio graphic for stop loss.

VXX - Volatility Index Futures - ETF Description


Decent drop despite the weak market. New closing low.

We are nearing the point where the ETF will do a 1:4 reverse split. That will be an excellent opportunity for us to get short again at a higher level.

Barron's is reporting current short interest at 59 million shares out of 66 million outstanding.

Original Trade Description: April 12th.

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.

Unfortunately, put options are expensive with a volatility instrument at this price level. The only recommendation is to short the ETF and forget it. If we do get a prolonged rally as some are expecting we could see strong market gains in the next 2-3 months. 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. Once we are in the position and profitable I will put a trailing stop loss on it. We will take profits and then look for a bounce to get back in.

We know from experience that the VXX always declines. The last time we shorted this ETF we had a $7.23 gain.

Position 4/13/17:

Short the VXX @ $17.98, no stop loss because it always declines eventually.

If you like the trade setups you have been receiving and you are on a free trial then now is the time to subscribe. Do not wait until you miss a newsletter to decide you want to take the plunge.

subscribe now