Option Investor

Daily Newsletter, Wednesday, 9/20/2017

Table of Contents

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

Market Wrap

Fed's Plan For the Great Unwind

by Keene Little

Click here to email Keene Little
The market has been on hold since gapping up on Monday while it waited for this afternoon's FOMC announcement. The announcement of October as the start of the Great Unwind was initially met with selling in the stock market but the dipsters were ready and waiting to drive the indexes back up to save the day, maybe.

Today's Market Stats

Following Monday morning's gap up in the stock market it marched sideways while it waited to get through this afternoon's FOMC announcement. An initial negative reaction to the news that the Fed was going to start reducing its balance sheet in October (some were hoping not until December or next year) was followed by dipsters jumping back in and the market closed near the flat line, leaving us guessing what tomorrow's reaction might be.

It's been nine years since the Fed started its rampage through the forests in a reverse Robin Hood move by taking from the poor and giving to the rich. Today they announced that the rich need to start giving back some of its ill-gotten gains so that the Fed can start reducing its bloated $4.5T balance sheet. As a token of their appreciation they kept interest rates unchanged at 1.00%-1.25%.

The Fed intends to start small by rolling over its monthly expiring debt except for $10B of it each month. To put that into perspective, that's a reduction of 0.22% of its balance sheet each month, or 2.7% per year. At that rate they'll get back down to their pre-crisis level (about $600B) in a little over 32 years, or about the maturity of the 30-year bond. Well, it's a token amount and I'll bet the reduction program will be halted before this time next year as the market tumbles back down from being overly indebted and out of gas. The Fed will have to once again ride to the rescue of the rich.

If the stock market does start to falter and we enter a bear market, one has to wonder how long the Fed will tolerate that. They've made it their mission to rally the stock market so that people feel wealthier and spend money. A huge consequence of all the money the Fed created since 2009, along with abnormally low interest rates, is a huge increase in debt levels. It has become the MOAB -- the Mother of All Bubbles (some would say Mother of All Bombs and they would not be far from the truth).

Companies borrowed huge sums of money for dirt-cheap prices and then bought back large portions of their outstanding stock. Whether or not the company was improving earnings through higher sales/lower costs, the P/E of their stock was brought down through the buy-back programs. It was all smoke and mirrors to make it look like their stock was still fairly valued.

The consequence of all this, as stated in an article in the Wall Street Journal on Tuesday, is that "Financial assets across developed economies are more overvalued than at any other time in recent centuries." [Emphasis mine] We're not talking more overvalued since 2000 but instead more overvalued than in the past couple of centuries. That should be an eye-opener to many.

There are many examples of how badly out of whack the companies' stock prices have become. Exxon Mobil (XOM) is one example -- in 2006 (the last full year before the Fed started its monetary expansion policies) XOM reported $365B in revenue, profit of almost $40B and free cash flow (available to pay shareholders) of nearly $34B. In 2016 full-year revenue was $226B (down nearly 40%), profit was a little less than $8B and free cash flow a little less than $6B (down about 80%). One would think the share price would suffer accordingly. Nope, XOM's stock price is up 20%, from about $75 to $90.

General Electric (GE) is often thought of as a proxy for the economy and it has done terribly over the years (although it recovered nicely from its 2009 low). It reported free cash flow of nearly $14B in 2006 but last year its cash flow was negative. Its net worth dropped 37% from $122B to $77B. Its stock price in 2016, near $33, was roughly the same as it was in 2006 but up significantly from 2009's low at $5.73.

McDonalds (MCD) is another good example. The rise in its stock price has been steady since the low in March 2003 and it looks like the picture of health. But in the 10 years between 2006 and 2016 it has reported only a slight increase in revenues. It did well cutting costs because its profit improved by 30% over that time period. But it tripled its debt load from a little more than $8B to almost $26B. Its book value dropped from almost $16B to -$2B (in the hole by $2B). And over this time frame its stock price tripled (and was the strongest stock in the Dow 30 today, up +1.6%).

These are mere representatives of a stock market gone crazy and much of it has to do with too much money (from global central banks) chasing too few assets. It's all fake (like fake news) and the debt needs to be repaid. When the Fed tries to let tide water recede they will likely find the stock market reacting negatively. Lowering the water level exposes the rocks just below the surface that most investors have been ignoring.

The bottom line for the Fed and the stock market is that there has been an enormous positive impact on stock prices over the past 10 years from the Fed's supportive easy-money policies. It's hard to imagine that reversing those policies will go unnoticed by the stock market.

One of the big problems with the debt loads taken on by so many companies is that a lot of it is considered junk status. Think of the sub-prime mortgage market on steroids as many companies use "covenant-lite" loans, meaning they're not meeting the requirements of the loans but the banks look the other way. Not meeting profitability requirements, debt-to-asset requirements, etc. are violations that can trigger a loan recall by the bank.

The trouble with violations of a loan's covenants and a bank calling in the loan is that the company might not be able to come up with the money to pay off the loan (think Greece as an example of this). The bank doesn't want to have to report a non-performing loan on its balance sheet and so everyone makes believe everything is still OK. Multiply this by hundreds, perhaps thousands, of companies, large and small, and you have a debt pot that's boiling and ready to blow the lid.

The problem with much of the junk bonds is that many of them are coming due in the next couple of years. The Wall Street Journal warned investors in yesterday's article to be cautious about both companies and their junk bonds that are rolling over between now and 2020. The market could soon freeze up as more and more companies experience tightening lending standards, especially if the Fed is drawing money out of the monetary system.

This week's announcement by Toys R Us that they're declaring Chapter 11 bankruptcy (another retailer bites the dust) is actually being done before they need to. It is believed management is trying to get ahead of others who will be doing the same thing. The chart below shows the amount of money involved in junk bonds that will be rolling over in the next three years -- $1.3T coming due by 2020. As the WSJ said, Toys R Us is "a canary in the coalmine" for the broader credit markets.

Whether or not Toys R Us will be able to refinance their debt under Chapter 11 bankruptcy, and perhaps more importantly, under what terms, will be watched carefully. It could start a stampede by other companies if they too sense the market is tightening. The bond market dwarfs the stock market and how it reacts could have a huge impact on all markets. As Wilbur Ross, the billionaire investor, commented, "Refinancing is the real issue because you have a wall of maturities starting 2018, building up through 2021 to 2022... but [this wall of maturities] really reflects in the market a year or so earlier... so it's really a 2017 issue."

Keep an eye on HYG since this is the junk bond ETF that will provide fair warning to stock investors. HYG typically leads the stock market and for a long time it's been showing caution while SPX throws caution to the wind with a "what, me worry?" attitude. I've shown the HYG weekly chart before to point out this year's broken rising wedge, with bearish divergence, and at the moment it has bounced back up to the bottom of the wedge for what could be a bearish back-test. If it drops away from here it will likely drop quickly and I'd use that as a warning signal for the stock market.

The weekly chart below compares the performance of HYG vs. SPX (the green line) and you can see how SPX continued to rally strong from last November while HYG had a shallow climb higher in a small rising wedge with bearish divergence. I don't believe SPX will be able to ignore a further drop in HYG, if in fact one is coming.

High Yield Corporate Bond ETF, HYG, vs. S&P 500, Weekly chart

I mentioned above that one consequence of all the cheap money the Fed has provided is that companies have borrowed huge sums, much of it used to pay dividends to shareholders (nice but not productive use of the money) and to buy back the company's own stock. That has provided the bulk of the buying pressure for the stock market and I've often discussed in the past that it will be difficult for the market to sustain its rally if the buybacks slow down significantly. There's still a lot of buying going on but as you can see from the chart below, it has been slowing since peaking in mid-2016.

S&P 500 stock buybacks vs. S&P 500 index performance, Quarterly chart 2006-2nd Quarter 2017, chart courtesy Eric Pomboy, @epomboy on Twitter

Interestingly, following the November elections we've seen a much higher participation rate by investors. Bullish sentiment, even among retirees, is hitting highs not seen since 2000. It seems the public is finally involved in the rally and likely a great contributor to the rally in the past year. This in turn has compensated for the loss of buying pressure from companies buying their own stock. But the last time bullish sentiment from the masses reached current levels they were buying the top. Only time will tell if they're doing the same thing again.

Having spilled a lot of electronic ink above in an attempt to show how vulnerable the stock market is, we of course know that the market can stay irrational far longer than a trader can fight it. The trend is up and that could continue for the rest of the year. There are plenty of reasons to believe the market is nearing an important top but it's been a frustrating battle for the bears who can't understand how this market could possibly be rallying.

One reason for the rally is simply money and lots of it. There's still a lot of money out there chasing too few assets and as long as that's true we'll see the stock market rise higher in spite of fundamental reasons why it shouldn't. There are many who believe we're in the end stage of the bull market but that could mean an explosive move higher in a fit of panic as investors chase prices ever higher. Think late 1990s.

Dow 30000, 40000 and higher are not unreasonable expectations if you think we'll get another melt-up like we did in the late 1990s. Those were some of the best years to be an investor, even while the stock values became extraordinarily high. This must be kept in mind by the bears while watching carefully for signs that the market's rally is going to end a lot sooner than most currently think.

One measure of a rally's strength is the cumulative advance-decline line -- as long as it's increasing with the climb higher in the indexes it means the rally is firing on all 8 cylinders. The NYSE advance-decline line shown below (red and black line) is not showing any negative divergence to the NYSE (black line) and therefore there's a lot of money behind this rally. While it's more or less a concurrent indicator, moving up and down with price, many market tops have been put in place after the a-d line makes a lower high (same with a positive divergence at lows). The divergence is not always required but it's a good leading indicator when it happens. Right now there is no divergence.

NYSE Cumulative Advance-Decline Line vs. NYSE, Weekly chart

Not all is rosy with the picture above. RSI for the a-d line is overbought and as can be seen in the past this has warned of a pullback coming. What kind of pullback, and whether or not it will lead to something more significant to the downside, can only be guessed here.

Moving to my regular charts, since I show the NYSE chart above, I'll start with a weekly chart and work my way in.

NYSE Composite Index, NYA, Weekly chart

The decline in the first half of August had NYSE breaking its uptrend line from February-November 2016 and the recovery off the August 18th low has it making a new high but so far only a back-test of its broken uptrend line. The highs since March are showing bearish divergence. There's a lot of money behind this rally but from a technical perspective NYSE is in a vulnerable position here since it's typically a very good setup to play a reversal back down.

If the bulls can keep things going into October there is the potential for NYSE to make it up to the top of the rising wedge pattern, which will be near 12560 by mid-October. While I wouldn't bet on that outcome right here I'd turn more bullish if it can climb above a couple of resistance levels between here and about 12220.

NYSE Composite Index, NYA, Daily chart

The daily chart of the NYSE shows a closer view of the back-test of its broken uptrend line as the oscillators have reached overbought. It could run out of gas as it completes the back-test but slightly higher is a trend line along the highs for the rally from April, currently near 12220. Watch that level carefully if reached.

S&P 500, SPX, Daily chart

A few price projections for SPX, based on its wave pattern and prior moves, provide us with an upside target zone at roughly 2510-2516. Today's high at 2508.85 is close to the bottom of the zone and therefore any new highs from here bear close scrutiny for signs of topping. A trend line along the highs since March is currently near 2516, which is another reason why the bulls could run into trouble soon if they manage to press a little higher. With oscillators back into overbought it makes it tougher to get the energy to power through resistance. But if the bulls can get SPX above 2520 (and stay above) it would be a stronger bullish statement.

Key Levels for SPX:
- bullish above 2520
- bearish below 2480

S&P 500, SPX, 60-min chart

The 60-min chart for SPX shows some loss of momentum since September 12th as it approaches what I believe will be a tough resistance zone. Two equal legs for its rally from August 21st (August 21 - September 1 and the leg up from September 5th) points to 2509.58. The 127% extension of the previous decline (August 8-21), which is often a reversal level, is at 2510.87. For a longer-term projection, the 5th wave of the rally from 2009 (which started at the January 2016 low) would equal the 1st wave at 2516. The close correlation of several price projections, along with trend lines, tells me to watch this area closely for a possible top. I see a little more upside potential for this rally but not much (unless it can get above and stay above 2520).

Dow Industrials, INDU, Daily chart

The Dow is firmly in its up-channel for the rally leg from April and could rally a little further before reaching potential resistance at its broken uptrend line form November 2016 - May 2017, currently near 22515. There's higher potential to the top of its up-channel from April, which will be near 22775 by the end of the month. The oscillators are hinting of rolling over from overbought but if we see only small choppy corrections to its rally it will signal higher highs. A drop below its August 8th high at 22179 would be a bearish heads up.

Key Levels for DOW:
- bullish above 22,179
- bearish below 22,038

Nasdaq Composite index, COMPQ, Daily chart

The tech indexes have been relatively weak this month but the price pattern continues to look more bullish than bearish (even if less bullish than the others). The Nasdaq could rally to trend line along the highs from April 2016 - March 2017, near 6530, and while I don't see it happening, it would be more bullish above that level. There's an ending pattern for its leg up from September 5th and it suggests we could see a top at 6490-6495, about 40 points above today's close. One more new high on Thursday, maybe into Friday, could do it and that would leave a double top with its July 27th high, with bearish divergence, if it happens.

Key Levels for COMPQ:
- bullish above 6535
- bearish below 6334

A big drag on the tech indexes lately has been weakness in the FAANG stocks. F & N have been doing OK but the A's and G have been weak (although NFLX is looking vulnerable to putting in a double top against its July high with a large bearish divergence). AMZN's daily chart below shows a possible H&S top (with a confirming volume pattern) between its left shoulder in June, head in July and now the right shoulder. If it breaks its neckline, near 938, the downside objective for the pattern is 785. There's still time for AMZN to pull out of the dive but bulls can't waste too much time and it ideally needs to hold above its uptrend line from November 2016, currently near 956.

Amazon, AMZN, Daily chart

AAPL's weekly chart shows bearish divergence at its September high vs. its May/June highs and is threatening to break down from its up-channel from May 2016 (daily and weekly oscillators have rolled over). I show the potential for a rally to a price projection near 169 for the 5th wave of its rally from May 2016 but the minimum projection near 159 has already been achieved. Which way AAPL goes from here is very likely to lead the broader market.

Apple, AAPL, Weekly chart

Russell-2000, RUT, Weekly chart

I'm having a devil of a time trying to slap a meaningful EW count on the RUT but it has such a choppy pattern, including for its rally from February 2016, and that makes several different wave count possibilities. Because of its large megaphone pattern, the bottom of which starts from the February 2014 low and the top from June 2007, the legs inside this expanding triangle pattern are expected to be corrective rather than impulsive. In this kind of situation I depend a lot on price projections for 3-wave moves and trend lines.

The rally from the August 18th low would have two equal legs up at 1459, which is just above the top of its megaphone pattern, currently near 1456. The top of the megaphone has been resistance since first tested in December 2016 and I'm expecting it to remain resistance, especially seeing the bearish divergence since last December. Obviously it would be more bullish above 1460 but until that happens I think we're looking for a major top for the RUT.

Key Levels for RUT:
- bullish above 1460
- bearish below 1396

10-year Yield, TNX, Weekly chart

Treasuries sold off sharply on the FOMC announcement, presumably from worry that a less active Fed in the bond market will depress prices from a higher supply. That popped yields higher and TNX has seen a sharp bounce off its September 7th low at 2.034 to today's high at 2.289. Today the rally stopped at its broken 50-week MA at 2.284 and closed at 2.277.

The top of a down-channel for its decline from March is currently near 2.36 so there's a little more upside potential to that line but like the 2-week rally off its June 14th low, there's a good chance this upside reaction is going to falter. If the stock market does in fact roll over soon we could see a flight to safety in Treasuries and drive yields back down. It takes a rally above the July 7th high at 2.396 to suggest something more bullish could be playing out.

U.S. Dollar contract, DX, Daily chart

The US$ snapped to the upside this afternoon following the FOMC announcement. The Fed's decision to reduce its balance sheet and raise rates (presumably in December) strengthens the dollar. This afternoon's rally bounced the dollar up to the top of its narrow down-channel that it's been since May, as well as its broken 20-dma at 92.23. It would be more bullish if the dollar can continue its rally and break out of the down-channel but then it would soon have to fight through price-level resistance, the bottom of a previous down-channel from January and its broken 50-dma, all of which are currently near 93.

If the dollar can fight through all that resistance near 93 and then get back above its August 16th high near 94 I'd turn more bullish the dollar sooner rather than later. I think the dollar is setting up for a big rally into next year but I've been looking for a low near 90 before starting the rally. We'll soon find out whether or not the dollar has one more new low or if instead it will start its rally from here.

Gold continuous contract, GC, Daily chart

Gold has pulled back to price-level support near 1300 and its uptrend line from December 2016 - May 2017 that it had recovered with its rally from July into the September 8th high. A drop below 1298 would likely see a test of its 50-dma, which is climbing and currently near 1290. There are multiple support levels between here and 1200 to catch a fall but ideally gold bulls will get a rally off support here. The bearish price pattern suggests gold has started the next leg down, one that will take it below 1100. If the dollar starts a larger rally that could put pressure on gold.

Oil continuous contract, CL, Daily chart

With today's rally and this evening's jump higher oil has now made it up to two price projections that I've been watching for, which are based off its bounce pattern from June, one at 50.75 and the other at 50.84 (this evening's high so far is 50.79). That's not to say oil should turn around from here but that's the bearish setup.

Its bounce pattern from June suggests it's just a bounce correction and not something more bullish (although there's certainly additional upside potential for the bounce, such as to the price projection at 53.96 for two equal legs up). If oil can get above 52 I'd look for it to continue higher to the 54 area. But the bearish potential is for a little double top against its August 1st high.

Economic reports

Today's existing home sales report, which came in lower than expected (Hurricane Harvey got the blame), continues to show weakness in sales but primarily due to lower inventory levels and higher prices. That's a mixed message since we're seeing the same thing in the new home sales. Home builders are trying to control how much they build so that they don't get stuck with inventory in the next slowdown. It's currently more of a seller's market than a buyer's and as long as rates stay low the higher prices can be more easily absorbed.

There are no major economic reports on Friday and Thursday's reports include unemployment numbers and the Philly Fed index, which is expected to show some slowing from August. There are more signs of a slowdown in the economy and that's another worrisome sign for a bull market that's long in the tooth.


The VIX is back down in the weeds with today's close below 10, at 9.78, and fear has once again left the building. The CNN Fear & Greed index is now back into Extreme Greed territory. Retail investors have jumped back into the market in a big way, which often happens when the market is hitting the last of its new highs. There's obviously a lot more upside potential but this excessive bullishness comes when the indexes are showing waning momentum and that's usually not a good combination.

Keep in mind this is a year ending in 7 and you can think whatever you want about the silliness of such a thing, but years ending in 7 have not been kind to bulls in the fall. Octobers have a reputation for being bear killers as the stock market typically swoons in August-September/October, finds a bottom in October and then rallies into the end of the year. But October 1987 (big crash), October 1997 (little crash) and October 2007 (the top before a monster crash into 2008) could easily be described as bull killers. I think we're facing something like October 2007, or who knows, maybe a combination of 1987 and 2007.

Another common occurrence is for a market to turn on the spring and fall equinox, which is Friday, September 22nd. With a market looking vulnerable here I'm thinking this October is not going to be kind to bulls and kicking them in the teeth might not wait until October arrives. Just keep a close eye on the market's signals (and watch AAPL). While we're in an uptrend and you don't want to try catching rising knives, this is a potentially dangerous time of the year to be a complacent bull, especially with the number of new bulls who have joined the party. Don't be caught without a chair when the music stops. Keep in mind that portfolio insurance (LEAP put options anyone?) is real cheap right now.

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

Keene H. Little, CMT

New Plays

Vaccine News

by Jim Brown

Click here to email Jim Brown
Editor's Note

You can either pay a lot to treat an illness or be vaccinated. Hepatitis drugs are very expensive but there is a vaccine.


ETSY - Etsy Inc - Company Profile

Dynavax Technologies Corporation, a clinical-stage immunotherapy company, focuses on leveraging the power of the body's innate and adaptive immune responses through toll-like receptor (TLR) stimulation. Its product candidates are being investigated for use in multiple cancer indications, as a vaccine for the prevention of hepatitis B and as a disease modifying therapy for asthma. The company's lead product candidates include HEPLISAV-B, an investigational adult hepatitis B vaccine, which is in Phase III clinical trials; and SD-101, an investigational cancer immunotherapeutic that is in Phase I/II studies. Its product candidates also comprise AZD1419, which is in Phase II clinical trial for the treatment of asthma; DV230F that is in preclinical stage for the treatment of liver tumors; and DV1001, a TLR 7&8 agonist, which is in preclinical stage for the treatment of for multiple malignancies, as well as DV281 for the treatment of non-small cell lung cancer. It has collaboration and license agreements with AstraZeneca AB to develop AZD1419 for the treatment of asthma; and Merck & Co. to develop SD-101 for varios immuno-oncology therapies. Company description from FinViz.com.

Dynavax has a vaccine for Hepatitis B. Shares crashed on August 10th when the FDA asked for more information despite a 12-1 vote to approve it. The results of the request for info will be released no later than November 10th according to the company. They are confident the drug will be approved and they are already targeting an early 2018 release date.

Cathy Reese of Empire Asset Management said investors should use the current volatility to buy the stock and she has a $38 price target.

Earnings Nov 1st.

Shares have rebounded from the early August dip as investors become more confident the vaccine will be approved. Shares peaked a $21.85 on September 11th and then faded for a week as profit taking appeared. Wednesday's close was a 7-day high.

I am not planning on holding this position into the announcement. I would like to exit by the end of October to avoid any unplanned declines.

Options are very expensive because of the big expectations. This will be a stock only position.

Buy DVAX shares, currently $21.05, initial stop loss $19.15.


No New Bearish Plays

Entry disclaimer: To avoid an unfavorable entry point, we will not launch a new play if the stock gaps more than $1.00 at the market open.

In Play Updates and Reviews

Rotten Apple

by Jim Brown

Click here to email Jim Brown

Editors Note:

Multiple news headlines on Apple tanked the stock and the Nasdaq. News broke that the cellular connection in the series 3 Apple Watch was not reliable. Multiple sources reported it. An analyst at Rosenblatt said preorder numbers for the iPhone 8 were lower than the 6 and 7 and suggested demand would be considerably lower than expected. There were only 1.5 million preorders on JD.com compared to 3.5 million for the model 7. On China Mobile there were 1 million preorders compared to 2.5 million on the model 7 and 3.5 million on the model 6. Apple shares fell as much as $5 intraday but recovered to close with a -$2.66 loss. This was a sentiment drag on the Nasdaq and even a buy program at the close could not lift it back to positive territory.

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

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BULLISH Play Updates

ETSY - Etsy Inc - Company Profile


No specific news. Shares still flat after the big decline on Friday.

Original Trade Description: Sept 13th.

Etsy, Inc. operates as a commerce platform to make, sell, and buy goods online and offline worldwide. Its platform includes its markets, services, and technology, which enables to engage a community of sellers and buyers. The company offers approximately 45 million items across approximately 50 retail categories to buyers. It also provides various seller services, including direct checkouts, promoted listings, and shipping labels, as well as Pattern by Etsy to create custom Websites; and seller tool and education resources to start, manage, and scale businesses to entrepreneurs primarily through Etsy.com. In addition, the company operates A Little Market, a handmade and supplies market for sellers and buyers. Company description from FinViz.com.

For Q2, the company reported earnings of 10 cents that rose from a 6-cent loss in the year ago quarter. Revenue rose 19.1% to $101.7 million. Active sellers rose 10.9% to 1.83 million. Gross merchandise volume rose 11.7% to $748 million. Sales on mobile devices rose 47%. International sales rose 31% to 32% of gross sales. The number of employees in the workforce declined 23% thanks to an aggressive push by the CEO to expand profitability.

They guided for gross merchandise sales to rise 12% to 14% for the full year, up from prior guidance of 11.7%. Full year revenue is expected to rise 18% to 20% and in line with the 19.1% in Q2.

The company is growing rapidly, especially internationally and they are reducing costs significantly. Over the last several months, they replaced the CEO, CFO and CTO in their push to grow the company and profits quickly.

Expected earnings Nov 2nd.

On Sept 7th a Davidson's analyst, Tim Forte, went all in on ETSY with a glowing forecast. Shares spiked to $17.50 and then faded for a couple days. They have rebounded over the last three days and closed at a new high on Wednesday.

Position 9/14/17:

Long ETSY shares @ $17.79, see portfolio graphic for stop loss.
Alternate position: Long Dec $20 call @ 70 cents, see portfolio graphic for stop loss.

HIMX - Himax - Company Profile


No specific news. Support held despite a big drop in the Semiconductor Index.

Original Trade Description: Sept 9nd

Himax Technologies, Inc., a fabless semiconductor company, provides display imaging processing technologies to consumer electronics worldwide. The company operates through Driver IC and Non-Driver Products segments. It offers display driver integrated circuits (ICs) and timing controllers used in televisions (TVs), laptops, monitors, mobile phones, tablets, digital cameras, car navigation, and other consumer electronics devices. The company also designs and provides controllers for touch sensor displays, liquid crystal on silicon micro-displays used in palm-size projectors and head-mounted displays, light-emitting diode driver ICs, power management ICs, scaler products for monitors and projectors, tailor-made video processing IC solutions, and silicon IPs. In addition, it offers digital camera solutions, including complementary metal oxide semiconductor image sensors and wafer level optics, which are used in various applications, such as mobile phone, tablet, laptop, TV, PC camera, automobile, security, and medical devices. The company markets its products to panel manufacturers, agents or distributors, module manufacturers, and assembly houses; and camera module manufacturers, optical engine manufacturers, and television system manufacturers. Company description from FinViz.com.

Himax produces video drivers for 4K TVs and that accounted for 36% of total revenue in Q2. However, the big news comes from the 3D sensing chips. They are expecting a 90% increase in revenue from this technology in Q3. There are rumors that Himax is going to supply the 3D sensing technology for the new iPhones. Since several companies are rumored to have been selected, somebody is riding the rumor wave.

Since Himax guided for a 90% increase in revenue in Q3 from those sensors, it would suggest there is a surprise in store for the chip community.

They also provide chips for vehicle display panels and they recently guided for demand to jump from 135 million units in 2016 to 200 million by 2022.

On August 30th, Qualcomm and Himax jointly announced a new high resolution, low power, active 3D depth sensing camera system to enable conputer vision capabilities such as biometric face authentication, 3D reconstruction and scene perception for mobile, IoT, surveillance, automotive and AR/VR. They specifically said it would enable Android smartphones to have unparalleled 3D experiences. They called it "game changing technology for smartphones." This technology is the culmination of 4 years of research and development by these two firms.

Shares rallied on the announcements but then faded last week. The company issued a press release suggesting an Oppenheimer analyst had become too excited about the prospects and they reaffirmed their recent guidance. The fading excitement erased $1.50 in gains but support appeared at $10 and the overall uptrend should resume.

Expected earnings November 7th.

Position 9/11/17:

Long HIMX shares @ $10.31, see portfolio graphic for stop loss.
Alternate position: Long Dec $11 call @ $1.20, see portfolio graphic for stop loss.

KTOS - Kratos Defense - Company Profile


No specific news. Minor 12 cent decline.

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.

Update 9/5/17: New high in a weak market. Unfortunately, after the close they announced a secondary offering of 12.5 million shares that will increase the float by 14%. If I recommended we sell at the open on Wednesday, we are going to get hit with the normal "sell the news" decline. If we retain the position, stocks normally rise after a secondary is completed. We can either take a loss on Wednesday or hang on for a bigger gain later. I am recommending we hold the position. I am removing the stop loss to avoid being knocked out of the position for a loss. Shares declined to $12.80 in afterhours, a drop of $1. If that is all the decline we get, I would be very happy.

Update 9/6/17: KTOS announced a $46 million contract with the Saudi Royal Navy to assist in increasing military communications and preparedness. They also announced the QWK Integrated Solutions LLC, a partnership of multiple defense firms had won a $3.038 billion five year contract. The partnership will provide for rapid development and integration of space, missile defense, cyber, directed energy and related technologies to support SMDC/ARSTRAT and the warfighter.

Update 9/11/17: The company announced it had successfully completed a required number of missions with their jet powered unmanned drone system. The missions are part of the performance demonstrations prior to delivery of ten drones over the next six months. The customer was not announced for security reasons. However, a program they announced with the Navy several months ago called for delivery of 10 drones in 2017 with the potential for multiple follow on orders in 2018. This could be part of that project.

Update 9/18/17: Kratos deployed the first fully autonomous vehicle in Colorado with the Colorado Dept of Transportation. The robot vehicle replaces the trailing vehicle in a work construction crew. It follows the crew throughout the day and acts as a mobile crash barrier. Previously, a CDOT employee had to drive a specially built truck mounted with impact absorbing rear bumpers. Basically, this protects the work crew on the road by giving erratic drivers something to hit other than the work crew. There is still the problem of the driver in this truck when a car, truck or semi plows into the truck at 70 mph. In Colorado these bumper trucks were hit an average of 7 times per year, sometimes with injury to the CDOT drivers. The Kratos robotic crash guard truck has no driver so nobody is injured with an errant civilian vehicle crashes into it. The robot vehicle monitors the work crew and maintains a safe distance behind them with enough lane coverage to keep them from getting hit.

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.

MRVL - Marvel Technology - Company Profile


No specific news. Only a minor decline.

Original Trade Description: August 30th.

Marvell Technology Group Ltd. designs, develops, and markets analog, mixed-signal, digital signal processing, and embedded and standalone integrated circuits. It offers a range of storage products, such as hard disk drive (HDD) and solid-state drive controllers, as well as HDD components, such as HDD preamps components; and develops software enabled silicon solutions consisting of serial advanced technology attachment port multipliers, bridges, serial attached SCSI, and non-volatile memory express redundant array of independent disks controllers and converged storage processors for enterprise, data centers, and cloud computing businesses. The company also provides networking products comprising Ethernet solutions comprising Ethernet switches, Ethernet physical-layer transceivers, and single-chip network interface devices; and embedded communication processors. In addition, it offers a portfolio of connectivity solutions, including Wi-Fi, and Wi-Fi/Bluetooth integrated system-on-a-chip products, which are integrated into a variety of end devices, such as enterprise access points, home gateways, multimedia devices, gaming products, printers, automotive infotainment and telematics units, and smart industrial devices. Further, the company provides printer-specific standard products, as well as full-custom application-specific integrated circuits; and communications and applications processors. Company description from FinViz.com.

Marvel reported earnings of 30 cents that beat estimates for 28 cents. Revenue of $605 million beat estimates for $601 million. Free cash flow more than doubled from $38 million to $89 million. Core revenues rose 6%, storage controller revenues rose 13%. SSD chips rose from 20% to 25% or revenue. The new SSD products are rapidly gaining market share and remain a high profit item. Gross margin was 60.4%. They guided for Q3 for revenue of $595-$625 million with earnings of 30-34 cents per share.

Expected earnings Nov 23rd.

The company is in the midst of a restructuring process while they are changing their product mix for the better. Apparently it is working.

Shares spiked from $15.75 to $17.25 after earnings then pulled back slightly on post earnings depression. They rebounded today to a new 2-month high and very close to a new high.

Position 8/31:

Long MRVL shares @ $17.79, see portfolio graphic for stop loss.
Alternate position: Long Oct $18 call @ 64 cents, see portfolio graphic for stop loss.

SYMC - Symantec - Company Profile


Bloomberg disclosed Symantec had considered buying Splunk (SPLK) but passed on the opportunity after seeing their financials. SPLK shares rose, SYMC shares declined slightly.

Original Trade Description: August 26th.

Symantec Corporation, together with its subsidiaries, provides cybersecurity solutions worldwide. It operates through two segments, Consumer Digital Safety and Enterprise Security. The Consumer Digital Safety segment provides Norton-branded services that provide multi-layer security services across desktop and mobile operating systems, public Wi-Fi connections, and home networks to defend against online threats to individuals, families, and small businesses. This segment also offers LifeLock-branded identity protection services, such as identifying and notifying users of identity-related and other events, and assisting users in remediating their impact; and digital safety platform designed to protect information across devices, customer identities, and the connected homes and families. The Enterprise Security segment provides endpoint protection products, endpoint management, messaging protection products, information protection products, cyber security services, Website security, and advanced Web and cloud security offerings. Its enterprise endpoint, network security, and management offerings supports evolving endpoints and networks, as well as provides an integrated cyber defense platform. This segment delivers its solutions through various methods, such as software, appliance, software-as-a-service, and managed services. The company serves individuals, households, and small businesses; small, medium, and large enterprises; and government and public sector customers. Company description from FinViz.com.

Symantec is the largest provider of security products for retail buyers. They have an excellent suite of firewalls and antivirus programs. I have used everyone in the market at one time or another and Symantec has always been the best for me.

Last week they announced something different. They announced a secure router that handles everything in your house. It has special security for smartphones, tablets, PCs, IoT devices, etc. It has a handy user friendly interface and you can set at the router level, individual passwords for everyone in the family with individual settings by password. Say you have a 12 year old boy in the house. You can set different parental exclusions for him than you would for an 8 year old in the same house. You are in charge of everyone's access regardless of what device they are using.

The secure router blocks attacks before they get to your PC and before Windows has to deal with them. The router is not cheap but compared to what it does, it is cheap for the number of functions. How much does it cost to have your PC compromised? The router is $300 and comes with a year of service. After the year is up it goes to $10 a month. That is an entirely new revenue stream for Symantec. Obviously, it will not show up in their earnings for several quarters but the stock is rising on the news.

You can read the full press release HERE.

Expected earnings Nov 1st.

The stock is at the upper end of the range that I recommend in Premier Investor. With the potential for volatility in September, I am not recommending we go long the shares. This will be an option only position so we can try and ride out some of the volatility with minimum risk.

Update 8/28: Symantec said over the weekend they have identified a sustained cyber spying campaign, likely state sponsored, against Indian and Pakistani entities. The espionage effort began in October. India, China and Pakistan have raised military readiness over the last several weeks.

Update 9/6/27: Symantec said the US and EU power grid had been hacked by state actors and they had gained access to core systems that would have allowed them to be shutdown. The hacks were loosely tied to a recently dormant group called Dragonfly with links to Energetic Bear or Kola, widely believed to be sponsored by Russia.

Update 9/11/17: Shares of Symantec continue to soar after Google reported that searches for "LifeLock" had exploded and surged even higher than after the Anthem hack in 2015. Symantec's LifeLock monitors the credit bureaus and notifies you if anyone tries to open an account in your name. It carries a $25,000 reimbursement for stolen funds and retails for $9.95 a month. This is going to be a boost to Q3 earnings.

Update 9/14/17: The halt to US sales of the Kapersky virus suite, made in Russia, is another plus for Symantec.

Position 8/28/17:

Long Oct $31 call @ 48 cents, see portfolio graphic for stop loss.


BEARISH Play Updates

DF - Dean Foods - Company Profile


No specific news. Shares closed at a new 5-year low.

Original Trade Description: September 16th.

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 CEO warned, that volume and mix challenges are occurring at a higher-than-planned rate. As such, given the resulting volume shortages, they lowered their full-year guidance from $1.35-$1.55 to 80-95 cents. That is a major haircut.

On August 22nd the CFO resigned unexpectedly, effective Sept 1st. That is never good when a CFO exits with only one-week's notice.

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.

We shorted this stock on August 10th at $11.37 and shared dipped about 60 cents then rebounded to take us out of the short. The long put ended 6 cents in the money after shares began to roll over again. I believe we are going to see new lows.

Position 9/18/17:

Short DF shares @ $11.02, see portfolio graphic for stop loss.
Alternate position: Long Dec $10 put @ 40 cents, see portfolio graphic for stop loss.

VXX - Volatility Index Futures - ETF Description


No specific news. Since this is a long-term position, there will not be daily commentary.

Original Trade Description: September 18th.

The VXX is a short-term volatility ETF 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 five reverse splits occurred at $13.11 (11/2010), $8.77 (10/2012), $12.84 (11/2013), $9.52 (8/8/16), $12.77 (8/22/17). The prospectus says it can reverse split anytime it trades under $25 for a prolonged period and the splits will always be 1:4.

We know from experience that the VXX always declines. The last two times we shorted this ETF we had a $7.23 and $5.98 gain.

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 into year-end we could see a sharp decline in the VXX over 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.

The VXX is hard to short. Shortsqueeze.com says there are 19.9 million shares short out of 26.7 million shares outstanding. The shares are out there and being traded because the volume on Monday was 29.6 million. You have to tell your broker you really want to short it and make them find the shares. Sometimes it takes days or even a week before your broker will find you the shares. Trust me, be persistent and it will be worth the effort.

I had held off after the 1:4 reverse split because the options were expensive and I was expecting volatility in September from the budget battle and debt ceiling hurdle. With those issues pushed out into December, the volatility is dropping like the proverbial rock. Several readers have already emailed me asking when I was going to put this position back in the portfolio.

Position 9/19/17:

Short VXX shares @ $40.95, see portfolio graphic for stop loss.

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