Option Investor

Daily Newsletter, Wednesday, 8/16/2017

Table of Contents

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

Market Wrap

Stock Market Fighting Off the Bears

by Keene Little

Click here to email Keene Little
Last week's week decline emboldened the bears but the recovery off the lows now has the bulls believing they can push the indexes to new highs. Today's political and Fed (one and the same?) news created some volatility but the bulls held the upper hand.

Today's Market Stats

Today finished with a small doji candlestick, which could be the mark of a top for the bounce off last week's lows or just an indecision day on its way to higher highs. The political news and then Fed news this afternoon caused a little bit of volatility but the VIX dropped back down a little more and the stock indexes added a couple more points to their rally from last week. The big question is whether the rally is just a bounce correction or the start of the next leg up to new highs.

The political drama surrounding the Trump administration probably is not causing much stir in the market anymore since most people think it's just a bunch of noise (they're right). But the disbanding of the President's business advisory councils, which I'm sure had nothing to do with the recent departure of key CEO's from the council (wink), has many wondering what that might mean for businesses. Keep in mind that much of the "Trump rally" was an expectation that there would be some important changes to help businesses. Much of what Trump wanted to accomplish has been blocked by people with different agendas.

The other news today was from the Fed and their FOMC minutes from their last meeting. They're turning a little more dovish as they recognize the fact that the low inflation rate might be more than something "transitory." As noted in the minutes, the Fed "saw some likelihood that inflation might remain below 2 percent for longer than they currently expected." The Treasury market took notice and rallied, which dropped the 10-year yield to 2.23% (-1.8%).

The Fed's economists, all essentially schooled in the same beliefs (can you say "group think"?), believe in the Phillips Curve thesis, which is a simple mathematical inverse relationship between unemployment and inflation rates. The theory is that the lower the unemployment rate the higher the demand for good workers and therefore the greater the demand for higher wages, i.e., inflation. The problem is the unemployment rate does not reflect the state of employment as more workers have been forced to find lower-paying jobs just to get employed.

The Fed seems unable to assimilate the information from this changed economy and how to plug it into their black & white formula. The Fed is truly befuddled by the lack of inflation in this "low" unemployment environment. It's a good example of what I call "intellectually intelligent, common sense stupid."

I saw the same thing happening with the Fed in the lead-up to the bursting of the housing bubble in 2006-2007 with the sub-prime debacle, which of course led to the collapse in the financial industry (which was bailed out by the government). Bernanke and the rest of the Fed heads were incapable of seeing it coming and the Fed is just as incapable of figuring out our new (weaker) economy. And yet the market still pays rapt attention to the Fed. I don't get it.

The other news from the FOMC minutes, as well as recent statements from some of the Fed heads, is an expectation for a reduction in the Fed's balance sheet. Expectations are for a Fed announcement following the September meeting. The market has been prepared for this and so far there's been no reaction and certainly to "taper tantrum."

Housing Starts and Permits were reported this morning and they came in a little weaker than expected (down -4.8% from June). This caused some concern today, also reflected in lower Treasury yields, since a slowing housing market can be a real drag on the economy. It's also a reflection of the fact that so many consumers are tapped out from carrying too much debt, although the blame for the slowing market was blamed on supply rather than demand. The slowing retail sector is another sign the consumer could be in trouble.

As for the "what, me worry?" market, the strong bounce off last week's lows shows we still have active dip buyers who believe the market has higher highs ahead. "Damn the torpedoes, full speed ahead." From a pattern perspective I can see a good possibility for a continuation of the rally but maybe after a little more of a pullback from today's highs. As always, we'll let the charts lead the way.

S&P 500, SPX, Weekly chart

It's possible the August 8th high was the final high for this rally but there's been no confirming evidence yet that the rally is finished. There are some market breadth indicators that are weakening but we don't have the usual strong negative divergences that we've typically seen at previous market highs. So we still need to respect the upside potential while watching for evidence of a top, especially since we've entered the typically weak period of the year (August-September).

The weekly chart of SPX, which I consider a good market proxy at the moment, shows how it has chopped its way higher since the end of March (where I've labeled the low the 4th wave of the rally from January 2016). The 5th, and final, wave for the rally has been in progress since March and it's showing the expected weakness as compared to the 3rd wave (which finished at the March 1st high), as seen on the MACD and RSI indicators.

For the longer-term rally, from March 2009, the 5th wave is the leg up from January 2016 (as I'm counting the pattern) and it would equal the 1st wave at 2516, which I've noted on the chart. That projection crosses the top of a rising wedge for the rally from January 2016 and the mid-line of the parallel up-channel from 2010-2011 at the end of this month. From a weekly perspective this is a good upside target for both price and time.

The first sign of trouble for the bulls would be a break below the rising wedge (uptrend line from February-November 2016), currently near 2420. Confirmation of a top being in place would be a drop below the June 29th low near 2406.

S&P 500, SPX, Daily chart

As mentioned above, the 5th wave of the rally from January 2016 is the rally from March and I've drawn a parallel up-channel for the rally on the daily chart. The top of the channel will be near 2536 by the end of the month, so we have a 2516-2536 upside target zone to watch for if the rally keeps going. Currently SPX is struggling to get back above its broken 20-dma, near 2470, which it back-tested today. A drop back down would leave a bearish kiss goodbye and a drop below last week's low near 2437 would be a strong indication that the top is already in place. But until proven otherwise it's looking like we should keep looking higher for at least this week and possibly into the end of the month.

Key Levels for SPX:
- bullish above 2480
- bearish below 2437

Dow Industrials, INDU, Daily chart

The Dow's pullback into last week's low stopped just short of its 20-dma, showing some strength by not actually hitting it. Assuming we'll see the Dow make it up to another all-time high, the leg up from last Friday's low has two price projections to watch for. The first is based on two equal moves up from April 19th with the midpoint being the June correction, which points to 22352. That projection crosses a trend line across the April 26 - August 8 highs a week from today.

A higher projection, at 22459, is based on a price projection inside a rising wedge pattern. In this case it's where the 5th wave of the wedge would equal 62% of the 3rd wave (green labels). It's not clear what the wave count is so I'm looking at different ideas and price projections. The higher projection crosses the top of the rising wedge on September 1st, which is a good possibility if there will be an effort to push the market as high as possible for August and before it will have to deal with Congress's inability to get an agreement on a budget in September.

The first obvious sign of trouble for the bulls would be a decline below last Friday's low near 21843. In that case I would say the August 8th high has a good chance of standing for a while (possibly a long while).

Key Levels for DOW:
- bullish above 21,180
- bearish below 21,830

Dow Industrials, INDU, 60-min chart

The Dow's rally from June 29th has formed a parallel up-channel with two upper lines for the top of the channel. One parallel line is attached to the July 3rd high and the other is to the July 14th high. You can see how price chopped its way slowly higher between these two top channel lines between August 1-8 and then back down to the bottom of the channel by last Friday.

A return to the top of the channel could see the Dow hit 22400 by this time next week, which would place it inside the 22352-22459 target zone shown on the daily chart above. The other thing I'm watching is the mid-line of the channel, currently near 22130, since this is often resistance to the last leg of the rally inside a channel like this. Maybe just a retest of the 22179 high by Friday?

Nasdaq-100, NDX, Daily chart

NDX has a very similar pattern as the blue chips except for the lack of a new high on August 8th. Its pattern off the July 27th high looks like an a-b-c pullback correction, which keeps things pointing higher. Unless NDX drops below last Thursday's low near 5783, which would also be a break of its uptrend line from June 2016 - July 2017, a pullback from here should be a good buying opportunity for a run higher. Upside potential is to the trend line along the highs from November 2014 - July 2015, which will be near 6085 by the end of the month.

Key Levels for NDX:
- bullish above 5973
- bearish below 5783

Russell-2000, RUT, Daily chart

The RUT continues to be the weak sister and while it got a strong bounce on Monday, it looked to be primarily short covering. There was no follow through on Tuesday and while the other indexes traded sideways the RUT started to pull back again. This morning's bounce attempt failed to even test Monday's high while the others went on to make new highs above Monday's.

There remains the possibility for at least a larger bounce if the rest of the indexes press higher, in which case watch for a back-test of the broken support line along the lows since June 22nd, near 1405. Two equal legs up from last Friday points to 1410 so we have a 1405-1410 target zone for a higher bounce, if we get it. The bulls would be in trouble if the RUT drops below last Friday's low near 1368.

Key Levels for RUT:
- bullish above 1426
- bearish below 1368

10-year Yield, TNX, Weekly chart

I've been thinking for a long while that we haven't see the end of the bond's bull market (low for yields) but the weekly pattern is making me wonder. I see the potential for at least a much larger bounce off the July 2016 low with another rally leg following the pullback from December 2016. The pattern of the pullback is forming a bullish descending wedge and we could see a little further pullback to just below 2% before launching another rally leg. It might also continue to hold price-level support at 2.117%

A break above the downtrend line from 1988-2007, which stopped the rally into the March 2017 high, would be a bullish move. The next upside target after that would be the downtrend line from 1994-2007, which will be near 2.92% by the end of the year. If TNX makes it much below 1.95% I'd then start to think more bearishly sooner rather than later.

High Yield Corporate bond fund, HYG, Daily chart

While on the subject of bonds, HYG is a junk bond and worthwhile to watch for clues about the stock market. The same bullish sentiment that drives the stock market higher also drives junk bond prices higher. The search for higher yields drives many bond bulls into the junk bonds as long as they believe the risks are on the low side. When they think junk bonds are getting too risky they step away and look for the relative safety of AAA bonds and Treasuries.

For this reason HYG is often a good leading indicator for how well the stock market will do. As long as corporate performance continues to look good we'll see investors continue to buy HYG. When they start to get spooked and sell HYG we'll often see the stock market not far behind. The daily chart of HYG below shows a reason to start being concerned.

After the low on July 6th I thought we'd get one more minor new high to complete the 5th wave of the rising wedge for the rally off the November 2016 low. The July 26th high (ahead of the stock market) fit well as the completion of its rally and from there it dropped below the bottom of the wedge on August 9th. Yesterday's and today's highs were back-tests of the bottom of the wedge (uptrend line from March-July) and now we wait to see if it will be followed by a bearish kiss goodbye. This is a bearish setup for HYG and if it follows through to the downside it will be a warning sign for the stock market.

Transportation Index, TRAN, Weekly chart

The transports started diverge after the July 14th high for the TRAN since the Dow went on to make new highs into the August 8th high. It will be interesting to see if the divergence continues if and when the Dow makes more new highs. If the Dow is unable to push higher from here and instead drops below last week's low we'll then be able to look back and say the TRAN was warning us the Dow would soon follow in a reversal back down. But at the moment it's not clear if the TRAN is going to try again for a new high.

The pullback into the August lows was supported by the uptrend line from June 2016 - May 2017, currently near 9225 (arithmetic price scale). Short term I see upside potential for its current bounce to about 9470 but not above price-level resistance near 9490. A rally above 9490 would tell me there's a good chance new highs are coming, which would be a bullish sign for the broader stock market. Conversely, a drop back below its August 11th low at 9117 would be a bearish sign.

U.S. Dollar contract, DX, Daily chart

Off its August 2nd low I expected to see the US$ bounce up to the bottom of a previously broken down-channel for the initial decline off the January high and the top of a steeper down-channel for price action since May. So far the bottom of the shallower down-channel is holding as resistance, including for today's high shortly before the FOMC minutes were released. Dovish comments by the Fed is bearish for the dollar.

A little 3-wave bounce off the August 2nd low looks like it might now be followed by a drop lower towards a downside target near 90. But if the dollar can get above this morning's high at 94.05 we'll likely see at least a larger choppy bounce/consolidation before heading lower.

Gold continuous contract, GC, Daily chart

Gold is looking like it could break finally break free of its downtrend line form September 2011 - July 2016, which had stopped the rally into the June 6th high. It broke the downtrend line last week but was stopped at the previous highs in April and June near 1298. A drop back below the downtrend line was bearish but today's recovery back above the line is bullish. Gold bulls need some bullish follow through to open the door to higher highs for the current rally. A drop back below today's low at 1273 would be trouble for the bulls while a rally above 1293 would be a bullish sign.

Silver continuous contract, SI, Daily chart

I like to watch silver to see if it's confirming a move by gold and so far I'm not seeing bullish confirmation. Silver has been struggling to get back above both its 200-dma and its broken uptrend line from December 2015 - December 2016, currently at 17.09 and 17.17, resp. It has not yet had to deal with its downtrend line from July 2016 - April 2017, near 17.60. If silver rolls back over from here I would not bet long on gold either.

Oil continuous contract, CL, Daily chart

Oil's rally into the August 1st high was a back-test of its broken uptrend line from April-August-November 2016 and the selloff from there is a bearish kiss goodbye. That puts it on a sell signal that can only be negated with a rally above the high at 50.43. If the current decline continues we'll likely see oil test its uptrend line from February 2016 - June 2017, currently near 44, bounce and then continue lower.

Economic reports

Thursday's economic reports include the usual unemployment data and the Philly Fed, Industrial Production and Capacity Utilization before the opening bell. The Philly Fed is expected to show some slowing but nothing major.


The stock market's bounce off last week's lows looks bullish but we might see a little more of a pullback before the indexes continue higher. If the market does continue higher into the end of the month there is the potential for the Dow to reach at least 22400 and SPX to make it a little higher than 2500, which would ring the bell for many analysts. Betting higher than that could be a lot riskier and those highs will only be if we see new highs above the recent highs for the indexes. The RUT is one of the few indexes that look doubtful for new highs but never say never.

Next Monday we'll have a unique event with a total solar eclipse across the U.S. and only the U.S. Many believe these events have a strange effect on people and that effect often shows up in stock market reactions. With opex ending on Friday and normal post-opex price action next Monday, this one could be different than the others. If we are heading higher into next Monday I would not be at all surprised to see some kind of volatile event and maybe even a blow-off top or strong reversal. Many poo-poo this kind of thing but I've seen too many "coincidences" with astrological events to ignore the possibility (even if I don't understand them). Just be aware that it might be one more factor in the market's moves next Monday.

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

Keene H. Little, CMT

New Plays

Did Something Change Today?

by Jim Brown

Click here to email Jim Brown
Editor's Note

The unprecedented political events today could have a material impact on market direction. Today's political events and earnings disappointments are increasing market uncertainty. The Trump agenda suffered a major blow and that could be market negative. We are already in a seasonally weak period and the recent flurry of earnings disappointments is a problem for stocks. Add in the political circus in Washington and the unprecedented events of this week and investors may decide it is time to take some chips off the table. With the S&P futures down -4 and slowly declining we could be setting up for that seasonal weakness after option expiration. We should never put money in the market unless we have a good idea on direction. There is no current direction despite the slight rebound this week.


No New Bullish Plays


No New Bearish Plays

In Play Updates and Reviews

Danger Will Robinson!

by Jim Brown

Click here to email Jim Brown

Editors Note:

Anyone over 40 should understand that warning from Robby the robot. The market is at a pivotal point and nearing the midpoint of the seasonal Aug/Sep weakness. The political events of the last couple days makes it even more dangerous. When world leaders are in trouble, there is a tendency to try and stir up a geopolitical event in order to distract from the problems at home. With North Korea cooling, there is always Venezuela. While there are no signals that President Trump will try to distract from his current time in the spotlight, he did call VP Pence home from overseas before his tour was finished. This has all the political commentators buzzing that something may be coming.

With earnings winding down and the earnings after the close negative, the S&P futures are down $4 and falling. Trump's latest problems could have killed his legislative agenda with GOP lawmakers rushing to disavow and relationship. If the market believes the agenda is dead, the rally could die a slow death as well.

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

No Changes

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

GIII - G-III Apparel - Company Profile


No specific news. With LB disappointing after the close we could see another dip tomorrow. I do not think GIII can recover from the Tuesday implosion in time to produce a gain. I am recommending we close the position. The Tuesday drop on the bad retail earnings was simply too much to overcome.

Original Trade Description: June 29th.

G-III Apparel Group, Ltd. designs, manufactures, and markets men's and women's apparel. It operates in two segments, Wholesale Operations and Retail Operations. The company's products include outerwear, dresses, sportswear, swimwear, women's suits, and women's performance wear; and women's handbags, footwear, small leather goods, cold weather accessories, and luggage. It markets swimwear, resort wear, and related accessories under the Vilebrequin brand; footwear, apparel, and accessories under the G.H. Bass brand; and proprietary products under the DKNY, Donna Karan, Andrew Marc, Marc New York, Black Rivet, Wilsons, Eliza J, Jessica Howard, G-III Sports by Carl Banks, and G-III for Her brands. G-III Apparel Group, Ltd. also licenses its products under the Calvin Klein, Tommy Hilfiger, Karl Lagerfeld Paris, Guess?, Kenneth Cole NY, Cole Haan, Levi's, Vince Camuto, Ivanka Trump, Ellen Tracy, Kensie, and Jessica Simpson brands, as well as has licenses with the National Football League, National Basketball Association, Major League Baseball, National Hockey League, Hands High, Touch by Alyssa Milano, Collegiate Licensing Company, Major League Soccer, Starter, and Warrior by Danica Patrick, as well as approximately 140 U.S. colleges and universities. The company offers its products to department, specialty, and mass merchant retail stores in the United States and internationally. As of January 31, 2017, it operated 411 leased retail stores, which included 190 Wilsons Leather stores, 163 G.H. Bass stores, 50 DKNY stores, 5 Calvin Klein Performance stores, and 3 Karl Lagerfeld Paris stores. The company also operates Wilsons Leather, G.H. Bass, and DKNY branded online stores. Company description from FinViz.com.

G-III shares were pressured in May by the weakness in the retail sector in general. They rebounded in early June on better than expected earnings but were hit again in early July by the next wave of retailer warnings.

In the last quarter, G-III saw sales rise 16% to $529 million. Because of costs associated with the acquisition of Donna Karan they posted a loss of 18 cents but analysts were expecting a loss of 37 cents. Wholesale sales are growing by double digits in most brands. The Wilsons Leather and Bass Stores are the exception and they said they were closing some stores and repurposing some others. The Donna Karan brand is rapidly expanding with new merchandise and G-III thinks it could eventually be their biggest brand. The company is expected to earn $1.27 in 2017 and $1.72 in 2018.

Expected earnings September 5th.

Shares have risen over the last three weeks despite the market volatility. They closed only 20 cents below a five-month high on Friday. A breakout could trigger short covering and additional buying.

Position 8/15/17:

Long Sept $30 call @ 30 cents, see portfolio graphic for stop loss.

Previously closed 8/14: Long GIII shares @ $26.10, exit $25.85, -.25 loss.
Previously closed 8/14: Long Sept $30 call @ 72 cents, exit .80, +.08 gain.

KTOS - Kratos Defense - Company Profile


No specific news. No material movement in a weak market.

Original Trade Description: August 14th.

Kratos Defense & Security Solutions, Inc. provides mission critical products, solutions, and services in the United States. The company operates through three segments: Kratos Government Solutions, Unmanned Systems, and Public Safety & Security. The Kratos Government Solutions segment offers microwave electronic products; satellite communications; technical and training solutions; modular systems; and defense and rocket support services. The Unmanned Systems segment provides unmanned aerial, ground, and seaborne, as well as command, control, and communications systems. The Public Safety & Security segment designs, engineers, deploys, operates, integrates, maintains, and operates security and surveillance solutions for homeland security, public safety, critical infrastructure, government, and commercial customers. The company serves national security related agencies, the department of defense, intelligence agencies, and classified agencies, as well as international government agencies and domestic and international commercial customers; and critical infrastructure, power generation, power transport, nuclear energy, financial, IT, healthcare, education, transportation, and petro-chemical industries, as well as government and military customers. Kratos Defense & Security Solutions, Inc. was founded in 1994 and is headquartered in San Diego, California. Company description from FinViz.com.

Kratos builds drones for target practice for the U.S. military. They are also building drones for combat for air to air and air to land. They also provide communication systems for missiles, satellites and various other platforms.

China and Russia are rapidly militarizing space and Kratos is working with the U.S. military to improve satellite communication to defend against attacks. The DoD is currently spending a lot of money to prepare for war in space. Kratos owns and operates a global satellite demonitoring business with revenues rising 61% in Q1.

Kratos has so many new programs in operation it would be impossible to list them here and several of them are secret programs for unnamed clients.

Kratos guided for a return to profitability in Q2 and sharply rising revenue for the full year. Shares spiked 30% in the four weeks after Q1 earnings. Their next report is August 3rd. I am recommending we buy an option and hold over the report. If the earnings are as positive as they teased in the Q1 report we could see another sharp reaction. This company is in all the right places for the increase in defense department spending.

Kratos unveiled its newest high performance class of military unmanned aerial system technology at the Paris Air Show. The XQ-222 Valkyrie and UTAP-22 Mako drones provide fighter like performance and are designed to function as wingmen to manned aircraft in contested airspace. The Valkyrie can carry various weapons and intelligence systems and has a range of 3,000 miles. The Mako is designed to carry sensors and stealthily infiltrate hostile airspace to gather intelligence. Both are designed to operate with or without manned flights. The Air Force recently pitched the functions of the Valkyrie saying a F-35 with a group of fighter/bomber drones could maximize control of airspace and ground attack operations. The F-35 can select targets and pass information to specific drones while maintaining situational awareness from a stealthy and relatively safe position.

Just over the last couple weeks Kratos announced a $2.9 million order for an airborne communications system, a $10 million order for a ballistic missile defense system, $23 million for a military radar system and $8 million for a GPS Satellite protection system. Analysts are expecting a record $800 million in revenue for 2018. They expect to do $150 million in unmanned revenues in 2018.

Kratos posted earnings of 1 cent and a $10.4% increase in revenue to $186 million. They guided to be free cash flow positive by $25 million in 2017.

Expected earnings Oct 26th.

With the daily new contract awards shares have risen $1.50 in the last week and closed at a 5-week high on Monday. They are very close to breaking out to a new high.

Position 8/15/17:

Long KTOS shares @ $12.78, see portfolio graphic for stop loss.
Alternate position: Long Nov $15 call @ 65 cents, see portfolio graphic for stop loss.

With shares just crossing the $12.50 strike price, we had to reach out to $15 and a distant month.

RCII - Rent A Center - Company Profile


No specific news. Shares did not decline further and that was the good news. Even with the retail sector implosion on Tuesday RCII is holding near resistance.

Original Trade Description: August 2nd.

Rent-A-Center, Inc., together with its subsidiaries, leases household durable goods to customers on a rent-to-own basis. The company operates through four segments: Core U.S., Acceptance Now, Mexico, and Franchising. It offers durable products, such as consumer electronics; appliances; computers, including tablets; smartphones; and furniture, including accessories under rental purchase agreements. The company also provides merchandise on an installment sales basis; and offers the rent-to-own transaction to consumers who do not qualify for financing from the traditional retailer through kiosks within retailer's locations. It operates retail installment sales stores under the Get It Now and Home Choice names; and rent-to-own and franchised rent-to-own stores under the Rent-A-Centre, ColorTyme, and RimTyme names. As of December 31, 2016, the company owned and operated approximately 2,463 stores in the United States, Canada, and Puerto Rico, including 45 retail installment sales stores; 1,431 Acceptance Now kiosk locations in 40 states and Puerto Rico; 478 Acceptance Now virtual (direct) locations; and 130 stores in Mexico, as well as franchised 229 rent-to-own stores in 31 states under the Rent-A-Center, ColorTyme, and RimTyme names. Company description from FinViz.com.

Earnings were not good. The company posted a loss of 1 cents compared to estimates for earnings of 7 cents. Revenue of $677.6 million did beat estimates for $664.7 million. The problem was a number of new initiatives that take time to manifest into gains. This is a company with a portfolio of loans on household goods and there is not much they can do to change that on a qtr to qtr basis. The new initiatives only apply to new business so it takes a while to generate a large portfolio under the new rate plan. Core U.S. sales rose 230 basis points in Q2. Acceptance Now, a new initiative, saw sales rose 380 basis points. The average monthly rate of new finance agreements rose 5.7%. Higher end products now compromise 65% of store inventory. Same store sales in existing stores rose 6.7%.

Expected earnings Oct 25th.

Hedge fund Marcato Capital Management demanded the company sell itself or it would start a proxy war to replace the entire board. Hedge fund Engaged Capital has already been demanding a company sale arguing that a restructuring could best be done by new owners. Engaged won a proxy fight and now has 3 board members. RCII turned down offers from HIG Capital, Lone Star Funds and Vintage Capital over the last several months. Marcato said the $15 offer from Vintage was the opening offer and would rise if RCII would negotiate with Vintage and open its books.

The stock appears to be rising on takeover interest. Resistance is $16 and the stock traded as high as $37 in the last couple of years. If Vintage does raise their offer it would probably be in the $16-$16.50 range. Whether RCII would accept it is unknown.

With multiple sharks circling and two hedge funds demanding a sale, there could actually be competing offers once RCII decides to negotiate. The downside would appear limited.

Position 8/3/17:

Long RCII shares @ $13.63, see portfolio graphic for stop loss.
Alternate position: Long Sept $15 call @ 30 cents, see portfolio graphic for stop loss.

UCTT - Ultra Clean - Company Profile


No specific news. Decent gain to extend the rebound.

Original Trade Description: Augusy 12th.

Ultra Clean Holdings, Inc. designs, develops, prototypes, engineers, manufactures, and tests production tools, modules, and subsystems for the semiconductor capital equipment and equipment industry segments primarily in North America, Asia, and Europe. It offers precision robotic systems that are used when accurate controlled motion is required; gas delivery systems, which include one or more gas lines consisting of small diameter internally polished stainless steel tubing products, filters, mass flow controllers, regulators, pressure transducers and valves, component heaters, and an integrated electronic and/or pneumatic control system; and various industrial and automation production equipment products. The company also provides subsystems, such as wafer cleaning sub-systems; chemical delivery modules that deliver gases and reactive chemicals in a liquid or gaseous form from a centralized subsystem to the reaction chamber; frame assemblies, which are support structures fabricated from steel tubing or folded sheet metal; and top-plate assemblies. In addition, it offers liquid delivery systems; process modules, which are the subsystems of semiconductor manufacturing tools that process integrated circuits onto wafers; and other high level assemblies. The company primarily serves original equipment manufacturing customers in the semiconductor capital equipment, consumer, medical, energy, industrial, flat panel, and research industries. Company description from FinViz.com.

We have played UCTT several times before with varying results. The stock is volatile based on the direction of the chip sector. Since UCTT sells to chip makers, their good/bad fortune impacts UCTT. Fortunately, we are in a tech world where every year, more chips are required to make more gadgets including computers, tablets, phones, TVs and now the billions of IoT devices to be installed over the next several years.

The company reported earnings of 62 cents and analysts were expecting 51 cents. Revenues rose 75% to $228 million and beat estimates for $214 million.

They guided for earnings in the current quarter of 62-68 cents and analyst estimates were only 39 cents. At the midpoint of 65 cents that would be 66% higher than estimates. Very few companies are growing earnings that fast. Shares declined after the CEO said he was taking two months off to addess a treatable medical condition.

Expected earnings Oct 26th.

Shares are starting to rebound from the post earnings dip.

This is a short-term call because the next option series is December and options are too expensive. We have to buy just out of the money because the next strike at $25 requires a 10% move in the stock in only 4 weeks. That is very possible but we are entering a weak market period.

Position 8/14/17:

Long UCTT shares $22.70, initial stop loss $20.55, see portfolio graphic for stop loss.
Alternate position: Long Sept $22.50 call @ $1.50, see portfolio graphic for stop loss.

BEARISH Play Updates

DDD - 3D Systems - Company Profile


No specific news. Holding at the 52-week lows. Support still $12.

Original Trade Description: August 7th.

3D Systems Corporation, through its subsidiaries, provides 3D printing products and services worldwide. The company's 3D printers transform data input generated by 3D design software, CAD software, or other 3D design tools into printed parts using a range of print materials, including plastic, nylon, metal, composite, elastomeric, wax, polymeric dental materials, and Class IV bio-compatible materials. It offers various 3D printing technologies, such as stereolithography, selective laser sintering, direct metal printing, multijet printing, and colorjet printing. The company also develops, blends, and markets various print materials, such as plastic, nylon, metal, composite, elastomeric, wax, polymeric dental materials, and Class IV bio-compatible materials. It offers its printers under the Accura, DuraForm, LaserForm, CastForm, and VisiJet brand names. In addition, the company provides digital design tools, including software, scanners, and haptic devices, as well as products for product design, mold and die design, 3D scan-to-print, reverse engineering, and production machining and inspection. Further, it offers proprietary software and drivers that provide part preparation, part placement, support placement, build platform management, and print queue management; and 3D virtual reality simulators and simulator modules for medical applications, as well as digitizing scanners for medical and mechanical applications. Additionally, the company provides warranty, maintenance, and training services; on-demand solutions; and software and healthcare services. Company description from FinViz.com.

3D reported adjusted earnings of 8 cents compared to 12 cents in the year ago quarter. Revenue rose less than 1% to $158.4 million but sales of 3D printers declined -4%. Analysts were expecting 12 cents and $162.5 million.

The company guided for the full year for revenue of $643-$671 million, down from $643-$684 million. They guided for earnings of 46 cents, down from 51-55 cents.

3D keeps talking about new products adding to revenue in 2018 but that is a long way off and could be wishful thinking.

Expected earnings November 1st.

Shares fell $5 on the earnings and guidance miss but I expect them to fall further. If shares break support at $12, they could fall to $6 and a 7-year low.

Position 8/8/17:

Short DDD shares @ $13.00, see portfolio graphic for stop loss.
Alternate position: Long Sept $12 put @ 44 cents, see portfolio graphic for stop loss.

DF - Dean Foods - Company Profile


No specific news. Minor rebound but not a material gain.

Original Trade Description: August 9th.

Dean Foods Company, a food and beverage company, processes and distributes milk, and other dairy and dairy case products in the United States. The company manufactures, markets, and distributes various branded and private label dairy case products, such as fluid milk, ice creams, cultured dairy products, creamers, ice cream mixes, and other dairy products; and juices, teas, bottled water, and other products. It sell its products under approximately 50 national, regional, and local proprietary or licensed brands, and private labels, including DairyPure, TruMoo, Alta Dena, Berkeley Farms, Country Fresh, Dean's, Friendly's, Garelick Farms, LAND O LAKES, Lehigh Valley Dairy Farms, Mayfield, McArthur, Meadow Gold, Oak Farms, PET, T.G. Lee, Tuscan, and others. The company sells its products to retailers, distributors, foodservice outlets, educational institutions, and governmental entities through its sales forces. Company description from FinViz.com.

Dean Foods reported earnings of 21 cents that declined -47.1% and missed estimates for 31 cents. Revenue of $1.93 billion, which also missed forecasts. The lowered their full-year guidance from $1.35-$1.55 to 80-95 cents. That is a major haircut.

Expected earnings Nov 8th.

Dean Foods handles a lot of milk brands and the USDA said milk sales nationwide declined -2.9% in May alone. Management said competitive and volume pressures are hurting the company and the negative dynamics are expected to continue the rest of the year.

Milk has been found to cause diabetes or at least make it worse and the news is spreading fast. I have a friend that has been taking insulin for 20 years. I talked him into dropping milk from his diet and he was able to get off insulin within 3 weeks. A year later he backslid and began to drink milk again and he had to go back on insulin. He was quickly convinced and has sworn off forever and now leads a normal life with no diabetes meds.

Shares fell sharply to a 5-year low but given the severity of the guidance warning and the size of the earnings miss, the stock could continue to decline.

Position 8/10/17:

Short DF shares @ $11.37, see portfolio graphic for stop loss.
Alternate position: Long Sept $11 put @ 30 cents, see portfolio graphic for stop loss.

SABR - Sabre Corp - Company Profile


No specific news. Only a minor decline but new 2-yr low close.

Original Trade Description: August 5th.

Sabre Corporation, through its subsidiary, Sabre Holdings Corporation, provides technology solutions to the travel and tourism industry worldwide. It operates through two segments, Travel Network, and Airline and Hospitality Solutions. The Travel Network segment operates as a business-to-business travel marketplace that offers travel content, such as inventory, prices, and availability from a range of travel suppliers, including airlines, hotels, car rental brands, rail carriers, cruise lines, and tour operators with a network of travel buyers comprising online and offline travel agencies, travel management companies, and corporate travel departments. The Airline and Hospitality Solutions segment provides a portfolio of software technology products and solutions through software-as-a-service and hosted delivery models to airlines, hoteliers, and other travel suppliers. This segment offers SabreSonic Customer Sales & Service, a reservation system that provides capabilities around managing sales and customer service across an airline's diverse touch points; Sabre AirVision Marketing & Planning, a set of airline commercial planning solutions; and Sabre AirCentre Enterprise Operations, a set of solutions for planning and management of airline, airport, and customer operations. The Airline and Hospitality Solutions segment also provides software and solutions to hoteliers through SynXis, a central reservation system; SynXis Property Manager Solution for property management; and marketing, professional, and revenue management services. Company description from FinViz.com.

American Airlines founded the company in 1960 and spun it off in 2000. Texas Pacific Group and Silver Lake Partners acquired it in 2007. They listed on the Nasdaq in 2014. Sabre is the largest global distributions systems provider for air bookings in North America.

Sabre closed its first week of trading at $16.50 in April 2014. The odds are good we are going to see that level again soon. They recently reported earnings of 35 cents that matched estimates. Revenue rose 6.6% to $900.7 million and beat estimates for $895 million.

The company announced a new "cost reduction and business alignment program" with the goal of saving $110 million a year in expenses. They are going to reduce global headcount by 9%. They reiterated their full year guidance of $3.54-$3.62 billion and earnings of $1.31-$1.45. However, they said earnings would likely come in at the lower half of guidance. Think about that for a minute. We are going to affirm our guidance but earnings will be at the low end of that guidance. Did they actually affirm guidance of lower guidance?

They said the poor results were related to multiple factors. They halted work on the implementation of their new SabreSonic reservation system, no reason given but clearly it was not going well. They said they were seeing higher stability, security and technology costs related to a "security incident" in their Sabre Hospitality central reservation system during the quarter. Were they hacked? They did not say. Lastly, they said they were dealing with accounting changes for revenue collected from customer Alitalia, which is going through a bankruptcy process. Typically that means you get pennies on the dollar for receivables. The guidance was not good. Shares crashed from $22 to $19.50.

There was a dead cat bounce over the next couple days and now they are heading lower again. I do not see any reason why anyone would want to own Sabre when there are much better companies like Priceline, Tripadvisor, Trivago, Expedia, etc.

Expected earnings Oct 31st.

Shares closed at a two-year low on Friday at $19.73 and could be headed for a retest of the post IPO low at $15.

In addition to the short on the shares we have two ways to play the option. We can buy the October $17.50 put for 10 cents and forget about it. It will expire before earnings so it will have to be in the money at some point in the future to make any money. It is $2 OTM now and October has 75 days until expiration. If we want to roll the dice, the January $17.50 put is only 45 cents. That lets us hold over the October earnings, which should be disappointing. And gives us an extra 90 days to profit. The difference is $35 in cost. The key here is that January is well out of our normal 30-45 day play scenario. I am going to recommend the October option but you should choose the one that best suits your risk reward profile.

Update 8/7/17: Bank of America downgraded the stock from neutral to underperform (sell) and shares fell sharply at the open. It would have been nice if they had waited until after we were in the position. Shares fell about $1 at the open, rebounded slightly and then rolled over again in the afternoon. I think BAC helped us overall since it will put added pressure on the stock.

Position 8/7/17:

Short SABR shares @ $19.02, see portfolio graphic for stop loss.
Alternate position: Long Oct $17.50 put @ 40 cents, see portfolio graphic for stop loss.

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