Option Investor

Daily Newsletter, Tuesday, 10/3/2017

Table of Contents

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

Market Wrap

Russell Weakness Ahead?

by Jim Brown

Click here to email Jim Brown

The Russell 2000 traded negative most of the day but squeezed out a gain at the close.

Market Statistics

The end of quarter retirement cash flows should be nearly over. The rotation into small caps may be nearly over as well. The Russell traded positive at the open and again at the close but was in negative territory most of the day. The large cap indexes were positive all day with a steady upward trend. That suggests at least some investors may be starting to take some small cap profits as they rotate back into large caps for the Q3 earnings cycle.

The Russell 2000 has gained 162 points since the August 21st lows. That is roughly 12.2% and it is time for a rest.

There were no market moving economics today. The CoreLogic Home Price index for August rose from 6.7% to 6.9%. Single-family homes, excluding distressed properties, rose +0.8% in price and were up 6.1% over the same period in 2016. The index has finally surpassed its prior peak from April 2006 after 58 months of consecutive growth. Demand is continuing to rise and there are only 4.2 months of inventory available for sale.

The New York ISM report for September declined from 56.6 to 49.7. That was the second consecutive decline from the peak at 62.8 in July. This was the second weakest month in 2017. The six-month outlook component remains positive at 58.4 but declined from 60.5. However, the employment component declined from 56.4 into contraction territory at 48.3. The quantity of purchase component did the same thing with a drop from 51.6 to 48.1.

Vehicle Sales for September hit 18.6 million, annualized. That was up from 16.1 million in August and way over consensus estimates for 17.1 million. The surge came from demand for replacement vehicles after Harvey and Irma. Current insurance estimates suggest there were 800,000 cars flooded by Harvey. Irma and Maria were not as deadly for cars but there will continue to be additional buying for the next 2-3 months as the insurance claims are paid. Harvey will go down in history as the most expensive storm ever in terms of vehicle damage.

Auto sales rose from 6.0 million to 6.8 million. Truck sales exploded from 10.1 million to 11.8 million on an annualized basis. Domestic vehicles rose from 12.6 to 14.6 million. At 65% of the total sales, that was a historic high. New vehicle prices rose to an average of $31,058 and also a record high. Auto manufacturers had a surplus of 500,000 to 600,000 vehicles in inventory as a result of slowing sales throughout the year. The storms rescued them from massive markdowns but the average sales incentive was still a record $4,050 per vehicle.

Wednesday's ADP Employment and ISM Nonmanufacturing are the main reports. The ADP estimates have been reduced from 172,000 to 140,000 over just the last three days. It appears everyone is afraid the hurricanes have really impacted the job market. The Nonfarm estimates have been reduced from 140,000 to 100,000 over the same period with Moody's projecting only 75,000. The actual numbers will not matter because everyone understands the storm impact is temporary.

The hurdle for Wednesday is the Janet Yellen speech. In the speech last Wednesday, she was alternating between dovish, hawkish and confused. She will probably try to clarify her presentation if she gets the chance.

After the bell, the API inventory report showed a decline of 4.079 million barrels of oil compared to estimates for a 750,000 barrel decline. Pushing prices lower in the evening session was a build of 4.19 million barrels of gasoline, four times larger than expectations. Prices declined to $50 on the news. Distillate inventories declined 584,000 barrels. Oil inventories at Cushing rose 2.084 million barrels. We also learned that OPEC increased production by 120,000 bpd in September according to a Bloomberg survey.

In stock news, Lennar (LEN) reported earnings of $1.06 that rose 5.6% and beat estimates for $1.01. Revenue of $3.26 billion rose 15.1% and beat estimates for $3.24 billion. They sold 7,598 homes in the quarter, up from 6,779 in the same period in 2016. The average selling price rose 3.6% to $375,000. They raised their guidance for the full year from $370,000-$375,000 to $380,000-$385,000. They warned that deliveries of about 950 homes would be pushed into the next quarter because of the hurricanes. Orders rose 8.4% to 7,610. The builder warned they saw higher costs ahead as hurricane rebuilding efforts consumed large amounts of lumber, sheetrock, carpet and paint.

Paychex (PAYX) reported earnings of 62 cents that rose 11% and beat estimates for 60 cents. Revenue of $816.8 million rose 4% and barely beat estimates for $816.0 million. They ended the quarter with $368.2 million in cash and no long-term debt. During the quarter, they paid $179.1 million in dividends and repurchased $94 million in shares. The company guided for 6% revenue growth, up from 5% and revenues of $3.34 billion, slightly ahead of analyst estimates for $3.31 billion. Shares rose 3.6% on the news. The PAYX chart scares me. There is constant volatility and I would not be a buyer.

Stifel upgraded the restaurant sector with Dominos (DPZ), Darden (DRI), Wendy's (WEN) and Yum Brands (YUM) getting a buy rating. The analyst said these chains have healthy sales momentum, significant expansion plans and a desire to return cash to shareholders. He was negative on Brinker (EAT) and Buffalo Wild Wings (BWLD) because of declining traffic.

Deutsche Bank downgraded Urban Outfitters (URBN) to sell from hold. The analyst said peers L Brands (LB), Buckle (BKE) and Zumiez (ZUMZ) will report same store sales soon and we expect the multiple for these retailers to contract. URBN shares have rebounded nearly 45% from their August 15th low of $16.82 and they are expected to retrace some of those gains. DB put a $19 price target on the stock.

Wal-Mart (WMT) bought delivery startup Parcel. The company specializes in last mile delivery. Parcel is a 24/7 operation that delivers packages the same-day, overnight and in scheduled 2 hour windows. The acquisition price was not disclosed. Wal-Mart said they plan to leverage Parcel to deliver general merchandize as well as fresh and frozen groceries the same day they are ordered. Parcel will deliver for Wal-Mart and Jet.com, the online retailer Wal-Mart bought for $3 billion last year. These acquisitions are weapons to use against Amazon and Whole Foods.

Tesla (TSLA) reported production for Q3 and it was not pretty. They had previously expected to build 1,500 of the Model 3 and only produced 260. The company said there were no issues with the car, just growing pains as unexpected production bottlenecks appeared. They believe those have been resolved and Q4 production will be higher. They are still forecasting 5,000 a month in December and 10,000 a week by the end of 2018. Overall they delivered 26,150 vehicles. Elon Musk had previously warned the company was entering into "production hell" with the start of the Model 3 and apparently, he was correct.

Goldman Sachs rates Tesla a sell with a $210 price target. Morgan Stanley is neutral with a $317 target. Guggenheim said they see supply chasing demand for the next 2-3 years and have a $430 target. After the close today, Nomura initiated coverage with a buy rating and street high price target of $500. They see revenue increasing from $8 billion in 2016 to $58 billion in 2021. The average target for the street is $304.

Susquehanna downgraded MGM to neutral from positive after the disaster in Las Vegas. MGM owns Mandalay Bay. The analyst said business will rebound over the long term but in the short term, there is the possibility of earnings revisions due to lost revenue. I saw a long line of people checking in on Tuesday afternoon. I seriously doubt what happened will deter many people from completing their trips. Consumers will view the disaster as a lightning strike, a onetime event that is not likely to be repeated. They will probably refrain from large outdoor crowds but Vegas tourists are likely to be immune to almost anything. More than likely, they may turn into gawkers and go out of their way to view the scene.

Deutsche Bank cut F5 Networks (FFIV) to a sell with a $90 price target, warning that increased competition could detract from earnings growth. The analyst warned the stock could decline another 25% with revenue growth falling from 4% to 1%. Shares fell 5% on the news.

After the bell, Office Depot (ODP) said it was going to buy CompuCom for $1 billion and lowered its guidance. CompuCom is an IT company and ODP views it as the first step away from being simply an office supply company into an IT services company as well. Office Depot will issue new shares for the acquisition and pay down CompuCom debt with cash. ODP said operating income for the full year is now expected to be $400-$425 million, down from the prior guidance of $500 million. They blamed the hurricanes and lower back to school traffic. Shares fell 9% in afterhours. They cannot drop much lower.

Ford (F) announced plans to slash $14 billion in costs over the next five years and move away from autos and internal combustion engines to develop more trucks and electric and hybrid cars. The savings are not expected to show up in earnings until 2019 and 2020. They will maintain their production of trucks and SUVs in North America. The company is open to more partnerships to reduce cost and risk in the restructuring. The CEO said shifting to only all-electric vehicles would be like walking off a ledge where we destroy the earnings power of the company. They still plan on one-third of their vehicles to be internal combustion in 2030. He said electric vehicles could have an assembly area half the size, require half the capital investment and 30% fewer labor hours per car. Maybe CEO Farley should check on how that production is working out for Tesla.


All in? After the rally over the last week, have investors gone all in on the stock market for Q4? While there has been a lot of price chasing and capitulation buying, I suspect there are still a lot of investors holding off on buying a market top. Everyone would like to buy a dip but unfortunately, there have not been any recent dips. The ones we have had were minor and not enough to really draw in the retail investor.

Hedgeye had a new cartoon out yesterday titled, "Gandalf's Wise Words."

With the end of quarter retirement cash flows nearly over, I could easily see the Russell retracing some of its gains. With the first two weeks of October normally volatile, we could see some window undressing and one last surge of portfolio restructuring before the Q3 earnings cycle begins. While I am not betting on a dip, we should always be ready. I do expect a positive market through the earnings cycle.

The S&P closed at a new high with a minor 5-point gain. There were 259 advancers and 196 decliners on the S&P for Tuesday but A/D volume was 2:1 in favor of advancers. The pace of gains slowed slightly but that does not mean they are over.

The S&P is well above prior resistance and in blue-sky territory.

The Dow shook off the 8-days of lethargy while investors were rotating into small caps, and surged with large back-to-back gains. That powered the Dow over uptrend resistance and round number resistance at 22,500. The sudden surge in gains was powered by end of quarter cash flows and a move back into the big cap stocks. On Monday, only 5 Dow components posted losses. Today, only 6 posted losses. This shows very good market breadth.

There is no specific reason for the Dow to retrace at this point but the market never needs a specific reason to take profits.

The Nasdaq has struggled with the big cap tech stocks being weak but the index has now posted five consecutive days of gains. The last two have been decent but rather anemic compared to the 40-60 point days we would like to see. The big caps were mostly positive for a change with the individual losses minimal.

The Nasdaq is well below potential resistance around 6,650 and the relatively minor advance is far from being overbought. If investors begin to buy the big caps ahead of earnings, we could see the Nasdaq move over the 6,600 level.

The Russell 2000 has gained 162 points nearly nonstop and it is due for a rest. With the cash flows fading and the rotation having run its course, I would be very surprised if we did not see a decent dip in the index. The A/D line in the small caps was 3:2 positive today but A/D volume was almost dead even. When I was doing my scans for potential Premier Investor plays today, there were a lot of small cap stocks with almost no movement. They were either up 10 cents or down 10 cents but overall the momentum had evaporated.

We have not had a seasonal trend this year where the market did what was expected. With the first two weeks of October normally volatile, the contrarian view would suggest a directional market. I am not going to bet on either direction. We need to trade what the market gives us this week rather than what we expect.

Yellen's speech could be a pothole or it could be ignored, depending on what she says.

The Russell "should" fade but it would be a buying opportunity if it happens. Be prepared.

Enter passively, exit aggressively!

Jim Brown

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New Plays

Small Cap Swoon?

by Jim Brown

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Editor's Note

There is no guarantee but the small cap sector is due for a rest. When I scanned my small cap list today the vast majority of the stocks were only fractionally positive or negative as in 10 cents or so. The Russell index traded down nearly all day only to ease into positive territory just before the close. The Russell is up 12% or 162 points since August 21st. It is due for a rest. Let's watch on Wednesday and see which direction it chooses.


No New Bullish Plays


No New Bearish Plays

In Play Updates and Reviews

Is the End Near?

by Jim Brown

Click here to email Jim Brown

Editors Note:

Small caps traded negative most of the day as the EOQ cash flows fade. The Russell came close to ending in the red but a last minute surge of buying pushed the index back into the green. The big cap indexes were positive all day and that suggests reverse rotation away from the small caps given their monster gains.

Wednesday will be a key day for market direction since retirement fund flows should have ended today for the majority of accounts. It will be interesting to see if the Russell can hold its gains or will we retest the 1,500 level as support.

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

HPE - Hewlett Packard Enterprise
The long position was entered at the open.

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BULLISH Play Updates

AMD - Advanced Micro Devices - Company Profile


AMD announced a new embedded GPU requiring less power and capable of driving five simultaneous 4K displays. The GPU requires less than 40 watts TDP and comes in a smaller, thinner package. The chip has a 1.25 TFLOPS speed and comes in three form factors including MCM, MXM and PCI Express. The 4K and 3D support works for games, medical imaging, advertising signage and industrial uses. The GPU has 4 GB of GDDR5 memory. Shares gained more than 5% on the news.

Original Trade Description: Sept 23rd

Advanced Micro Devices, Inc. operates as a semiconductor company worldwide. Its primarily offers x86 microprocessors as an accelerated processing unit (APU), chipsets, discrete graphics processing units (GPUs), and professional graphics; and server and embedded processors, and semi-custom System-on-Chip (SoC) products and technology for game consoles. The company provides x86 microprocessors for desktop PCs under the AMD A-Series, AMD E-Series, AMD FX CPU, AMD Athlon CPU and APU, AMD Sempron APU and CPU, and AMD Pro A-Series APU brands; and microprocessors for notebook and 2-in-1s under the AMD A-Series, AMD E-Series, AMD C-Series, AMD Z-Series, AMD FX APU, AMD Phenom, AMD Athlon CPU and APU, AMD Turion, and AMD Sempron APU and CPU brand names. It also offers chipsets with and without integrated graphics features for desktop, notebook PCs, and servers, as well as controller hub-based chipsets for its APUs under the AMD brand; and AMD PRO mobile and desktop PC solutions. In addition, the company provides discrete GPUs for desktop and notebook PCs under the AMD Radeon brand; professional graphics products under the AMD FirePro brand name; and customer-specific solutions based on AMD's CPU, GPU, and multi-media technologies. Further, it offers microprocessors for server platforms under the AMD Opteron; embedded processor solutions for interactive digital signage, casino gaming, and medical imaging under the AMD Opteron, AMD Athlon, AMD Sempron, AMD Geode, AMD R-Series, and G-Series brand names; and semi-custom SoC products that power the Sony Playstation 4, Microsoft Xbox One, and Xbox One S game consoles. Company description from FinViz.com.

Expected earnings Oct 24th.

Nvidia (NVDA) shares were rocked last week after news broke that Tesla was looking at moving to AMD and away from Nvidia for the chips to power the autonomous driving functions. The initial headline saw AMD spike and Nvidia decline. The actual story is that AMD and Nvidia are partnering on creating a chip solution for Tesla. It is no surprise that AMD is in the mix because Tesla hired Jim Keller to lead development of Autopilot. Keller previously worked at AMD and led the development of the Zen architecture and the new Ryzen processors.

It appears that Nvidia and AMD have a team of about 50 engineers working to develop a comprehensive solution for Tesla. Here is where it gets interesting. I would not be surprised to see Tesla make an acquisition bid for AMD. The company only has a $13 billion market cap compared to $110 billion for Nvidia. AMD has a lot of products that are different from the Nvidia product line even though they both make GPUs. AMD has only existed for years as a foil for Intel. The bigger company could not be considered a monopoly as long as AMD existed. Now with Qualcomm getting into the processor market and AMD and Nvidia in a high tech partnership, it would make sense for Nvidia to acquire AMD. Since GPUs are a small part of AMD's product line, there may not be that much regulatory concern. Is it a long shot? Absolutely, but definitely in the realm of possibilities.

Even if there is never an acquisition bid, just the combination of AMD and Nvidia in a partnership validates the technical capabilities of AMD and lifts them into the big league. Where AMD has always been a low cost alternative to Intel and always 1-2 generations behind in technical expertise, they have dramatically improved their game in the last 12-18 months. Instead of being road kill on the Intel superhighway to state of the art processors, they have surged to be a real competitor. Partnering with Nvidia is a real step up for the company.

The chart is ugly with no apparent trend but there is decent support at $12. They could easily catch fire as investors begin to understand the ramifications of the partnership and we could see another leg higher like the one that started the prior May. There are no guarantees but I do not believe anyone sees AMD's future as anything but positive given recent events.

Update 9/25/17: AMD and Nvidia declined after Intel announced the next generation in the Core CPU line for desktops. This 8th generation Core-i7-8700K is the bet gaming processor ever with an internal clock frequency of 4.7 Ghz and Intel's fastest ever. They will also support 4K video. This is a challenge for AMD but the company is still ahead of Intel in the GPU race.

Position 9/25/17:

Long AMD shares @ $13.25, see portfolio graphic for stop loss.
Alternate position: Long Jan $14 call @ $1.25, see portfolio graphic for stop loss.

DSW - DSW Inc - Company Profile


No specific news. Shares fell back below initial resistance. Hopefully it is temporary.

Original Trade Description: Sept 30th

DSW Inc., together with its subsidiaries, operates as a branded footwear and accessories retailer in the United States. The company operates through two segments, DSW and Affiliated Business Group. The company offers dresses, casual and athletic footwear, and accessories under various brands for women, men, and kids. It also provides handbags, hosiery, jewelry, and other accessories. As of August 29, 2017, the company operated 511 stores in 43 states; dsw.com, an e-commerce site; and m.dsw.com, a mobile site, as well as supplied footwear to 379 leased locations in the United States. DSW Inc. was founded in 1917. Company description from FinViz.com.

The CEO recently said "we seen an opportunity to acquire market-share as the retail industry consolidates." "We have reinvigorated and positioned DSW to benefit, beginning with a new brand mission: We inspire self-expression."

They have reorganized their stores, updated their marketing, added customer merchandise and expanded their online presence. Marketing statement

They reported Q2 earnings of 38 cents compared to estimates for 29 cents. Revenue of $680.4 million beat estimates for $669.2 million. They guided for the full year for earnings of $1.45-$1.55 and analysts were only expecting $1.44.

They announced a new $500 million share buyback program on top of $33 million left over from the prior authorization.

Expected earnings Nov 21st.

Shares closed at a 5-month high on Friday and on the verge of breaking out of a 10-month consolidation period.

I really like the option on this position.

Position 10/2/17:

Long DSW shares @ $21.60, see portfolio graphic for stop loss.
Alternate position: Long Jan $22.50 call @ $1.50, see portfolio graphic for stop loss.

DVAX - Dynavax - Company Profile


No specific news. Shares holding Monday's big gain.

Original Trade Description: Sept 20th

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.

Update 10/2/17: Shares spiked nearly $2 on news it was considering strategic alternatives on its Hep-B vaccine. Those would include selling the drug to someone else or licensing it to a larger company. DVAX is a small company and does not have the infrastructure to market it on a worldwide basis. The drug Hellisav-B is expected to receive FDA approval in the coming weeks. Whichever route they take would provide upfront cash to enable them to continue development on their immuno-oncology pipeline.

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

Postion 9/21/17:

Long DVAX shares @ $21.10, see portfolio graphic for stop loss.

HPE - Hewlett Packard Enterprise - Company Profile


Shares down slightly on news they allowed Russia to examine the source code of security software used to guard Pentagon secrets. The review was required by Russia and other countries prior to those countries considering HPE as a cybersecurity vendor for their secrets. However, by letting Russian software engineers view the source code, supposedly to make sure there was no hidden back door access for US spies, they learned how the code worked, what the software was guarding against and gave them insights as to how they could defeat it. The top White House cyber security official said this was becoming a bigger problem because everyone (other countries) was demanding to see the source code and that has now become a security risk.

Original Trade Description: Oct 2nd

Hewlett Packard Enterprise Company provides technology solutions to business and public sector enterprises. It operates through Enterprise Group, Software, Enterprise Services, and Hewlett Packard Financial Services segments. The Enterprise Group segment offers servers, management software, converged infrastructure solutions and technology services; hybrid cloud solutions, including private cloud platform; business critical systems; storage products, as well as 3PAR StoreServ, a Storage platform; and networking products comprising switches, points, controllers, routers, and wireless local area network and network management products. This segment also provides software-defined networking and communications capabilities; network access solutions for mobile enterprises; and consulting services. The Software segment offers software to capture, store, explore, analyze, protect, and share information and insights within and outside organizations; enterprise security, application delivery management, and IT operations management software products. This segment provides HP Vertica, an analytics database technology for machine, structured, and semi-structured data; and HP IDOL, an analytics tool for human information, as well as solutions for archiving, data protection, eDiscovery, information governance, and enterprise content management. The Enterprise Services segment offers consulting, outsourcing, and support services across infrastructure, applications, and business process domains; and application and business services that help clients to develop, revitalize, and manage their applications and information assets. The Hewlett Packard Financial Services segment provides leasing, financing, IT consumption and utility programs, and asset management services. Company description from FinViz.com.

Expected earnings Dec 5th.

HPE has been undergoing an intense reorganization for several years. That included splitting off from HPQ in an effort to separate the corporate business from the consumer business. Meg Whitman has done a superb job in trimming excess departments and selling off non-core assets.

Recently, she announced another 10% reduction in the workforce that would result in 5,000 job cuts. She said the reductions would result in fewer lines of business and a more streamlined decision process. The current 3-year plan calls for savings of $1.5 billion and shift the focus towards research and development.

When Whitman took over in 2011 Hewlett Packard had 350,000 workers before the spinoff. Now HPE has 52,000.

The company now specializes in cybersecurity, enterprise WiFi, cloud services, servers and other corporate technology. Whitman recently said the company is seeing rapidly growing demand across key areas of the business.

Shares closed at a new high on Monday after trading in a $2 range for almost a year. I believe the latest announcement on reductions and streamlined operations has finally struck a chord with investors.

Position 10/3/17:

Long HPE shares @ $14.97, see portfolio graphic for stop loss.
Alternate position: Long Jan $16 call @ 50 cents, see portfolio graphic for stop loss.

KTOS - Kratos Defense - Company Profile


No specific news. Shares closed at a 4-week high.

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.

Update 9/21/17: KTOS successfully completed the third test of AN/SPY-6(V) Air and Missile Radar (AMDR) against a live ballistic missile target. The new radar is slated to begin service on the Navy's next generation Arleigh Burke Class Guided Missile Destroyer currently under development. This is a big step for Kratos.

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. Another resistance test at $18.60.

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.

BEARISH Play Updates

FDC - First Data - Company Profile


No specific news.

Original Trade Description: September 16th.

First Data is a global leader in commerce-enabling technology, serving approximately six million business locations and 4,000 financial institutions in more than 100 countries around the world. The company's 24,000 owner-associates are dedicated to helping companies, from start-ups to the world's largest corporations, conduct commerce every day by securing and processing more than 2,800 transactions per second and $2.2 trillion per year. Company description from FDC.

First Data earnings will be impacted by the three hurricanes because retail activity was slowed significantly over the weeks following the hurricane impacts. FDC said retail activity declined 72% in the first three days and was not expected to resume significantly for weeks. Stores need to recover from the floodwaters and flooding. They need electricity restored in order to run registers and POS terminals.

Expected earnings Nov 6th.

FDC also had the unfortunate luck of filing for a secondary offering of 85 million shares with an overallotment allowance of another 12.75 million on September 11th, just after the twin storms. The shares were sold by New Omaha Holdings, a major shareholder in FDC. With only about 300 million shares actively traded that is close to a 25% increase in the float. The shares were priced on Sept 18th at $17.75 each.

Selling nearly 100 million shares when your shares are already depressed would be expected to depress them even further. Shares closed at $17.55 on Wednesday and the 4-month low close is $17.47. Any further decline could put them into free fall to major support at $15.

There is always the potential for an earnings warning over the next several weeks.

Update 9/28/17: FDC announced a new service called Disburse-to-Debit to allow companies that hire temporary workers or "gig" workers to pay them instantly upon completion of a task by sending the money to their debit cards. This works for people like Uber drivers, part time workers at special events or even insuranve companies paying claims. An agent can upload the user data and the debit card payment arrives instantly. This is a smart service and FDC shares rallied 33 cents on the news.

Position 9/28:

Short FDC shares @ $17.56, see portfolio graphic for stop loss.
Alternate position: Long Jan $17 put @ 70 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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