Option Investor

Daily Newsletter, Wednesday, 1/2/2019

Table of Contents

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

Market Wrap

All Hope Is Not Lost

by Thomas Hughes

Click here to email Thomas Hughes


There are reasons to believe 2019 could be a good year for stocks. Secular economic trends are positive, GDP and earnings growth are still on tap, share-buybacks and dividend increases are expected, and the FOMC is set to leave interest rates unchanged. If only trade with China could get settled 2019 could be a perfect year.

Trump says the market had a glitch in December and will fix itself once a trade deal comes to pass. What he needs to understand is that his trade shenanigans, however needed, are having an impact on the global economy and that is what caused the stock market to glitch. Yes, the market will bounce back and with a vengeance, once a deal is signed, probably sooner, and I'm sure Trump will take as much credit for that as he hasn't for causing the market to meltdown.

Wharton School of Business professor Jeremy Siegel thinks we could see the market rise as much as 15% over the next year and I think that is a low estimate. A move to retest the all-time highs is closer to 20% and that could easily come in the first half of the year. A move to new highs is not out of the question by the end of the year.

Slowing GDP growth and slowing earnings growth has caused the market to reevaluate valuations and to revalue the market based on future earnings potential. Now that equity valuations have returned to earth, currently at historically low levels relative to the S&P 500's earnings power, the market can turn its eye to the future and what it might bring. Based on the estimates we're looking at 4-6% earnings growth the first half of 2019 and then a sharp acceleration of earnings growth to over 10% by the end of the year, an acceleration that could easily fuel a rally in the mid to second half of 2019.

Market Statistics

Today's action was influenced by some weaker than expected PMI data from China and the EU. According to Caixin/Markit, China's manufacturing PMI fell to 49.7 from a previous 50.2 and into contraction for the first time in 19 months. The data reinforces the official PMI data released on Monday, data that showed China's manufacturing economy had been in contraction for two months. The difference between the two are often great but together the Official (large cap, state-owned/backed businesses) and the Caixin (small to mid-cap/private) PMI gives a pretty good indication of conditions in China and right now tariffs are hurting growth.

PMI in the EU was also weaker than expected but positive at 51.4. This shows ongoing expansion within the EU economy but at a slower pace than before, the same thing we're seeing around the world. On the trade front, China's President Xi hailed progress made on trade and US/Sino cooperative efforts over the past four decades. While there is hope we're on the upswing regarding the trade war we are far from the end. Countering Xi's remarks are those from Robert Lighthizer to Trump, don't accept empty promises, you may need to increase tariffs to get meaningful concessions from Xi.

Economic Calendar

The Economy

There was only one economic release today and that is the Markit manufacturing PMI which is released the day before our 'official' PMI reading. Markit says the US manufacturing economy is still expanding but at a slower pace than the month before. PMI is now at a 15 month low due to slowing new orders, slowing output, and slowing hiring. While this is a concern the most important factors are that manufacturing is still expanding, and PMI readings are high relative to long-term trend. We may be in a period of slowing but we are not in a contraction. If I remember correctly, this recovery has been spotty and hurky-jerky from the beginning so it's really no surprise we're experiencing some minor turbulence now; it'll most likely pass.

The Dollar Index

The Dollar Index got a big boost from today's data. Global PMI shows manufacturing activity is slowing around the world but has slowed the least, and remains the strongest, in the US. This data gives a reason for both the FOMC and all other central banks to back off of their rate-hiking, policy tightening agenda's and allow global economies to adjust to today's conditions. What this means for the DXY is a continuation of the trading range provided this week's data doesn't support the need for FOMC tightening.

As an added risk, Jerome Powell will be attending an economic conference on Friday. At the conference, he, and two former FOMC chairs (Bernanke and Yellen) will be discussing key economic events. After his last major appearance at the Economic Club of New York Powell's statements will be closely watched. The market will be looking for confirmation the FOMC is going to hold off on future rate hikes, anything the least bit hawkish has the potential to send the dollar skyrocketing. As it is now, there is very little chance of a rate hike at all next year, and a growing chance the FOMC will cut rates at least once by December.

The index gained close to 0.90% in today's session but remains firmly within the near-term trading range.

The Gold Index

Gold prices were relatively steady in today's session despite the move in the dollar. The spot price was up in early trading, set a new high, and then fell later in the day. The candle is small and potentially bearish but not strong and of little consequence overall. The indicators remain bullish so upward drift in prices is expected but there is a risk. The MACD is showing signs of peaking and divergence from the new high that suggests there is a limit to how high gold prices can go. My next target for resistance is near $1,300, a break above that could go to $1,310 or $1,325.

The Gold Miners ETF GDX tried to move higher in today's session but couldn't do it. The ETF moved up to touch resistance at the top of a near-term consolidation range that is beginning to look a bit like a rising wedge and not a bullish one. The price action is having a very hard time moving above $21 and the indicators don't look good, both are weak and suggest a correction is imminent, so a move higher is questionable at this point. A move up would have to break resistance at $21.50 to be of significance and that, I think, would require a jump in gold prices to accomplish.

The Oil Index

Oil prices went on a wild ride today, first down -3.0% and then up 3.0% as traders try to begin positioning for 2019. Among today's drivers is the start of OPEC's production cut. The cut is designed to create an appearance of global oil market tightening and has worked in the past. The trouble this time is that global growth outlook is under intense pressure and with it outlook for oil demand. And the US keeps on pumping. Whatever happens, WTI is now trading at $46.25 and indicated higher. The black gold may move up to retest resistance at $48 and possibly as high as $52 before resuming downward movement.

The Oil Index gained nearly 2.0% in today's session and looks like it wants to go higher. The sector may not have the support of triple-digit earnings growth anymore but it still has strong earnings, is buying back stock, and dividends are high. Integrated companies like Exxon, BP, and Shell are paying near 6.0% dividends which are attracting new money. The move higher may not last long, not without a move up in oil prices to support it, but a retest of 1,200 to 1,232 looks likely.

In The News, Story Stocks and Earnings

Tesla made the bears happy this morning when it released 4th quarter delivery figures. The company says it delivered 90,700 cars last quarter which is less than expected. Production of Model 3 was also a bit shy of expectations but, with the production of Model S and Model X vehicles, is on track to meet full-year production goals. Tesla also says it will be lowering the price of all three models by $2,000 to help offset the reduction of tax breaks in the US. Shares fell more than -7.0% in premarket trading but were able to catch a bid during the day to move up and reduce the loss to near -5.0%.

GM reports that it has sold a cumulative 200K electric vehicles and triggered the phase-out of tax credits that have until now helped fuel its sales. The credit, now at $7,500, will be cut in half come April and then in half again in October where it will remain for six months before phasing out entirely next April. Tesla reached its 200K cap earlier this year, Tesla and GM have lobbied Congress to extend the break which is intended to cover the difference in price between electric cars and similarly sized combustion engine vehicles. The loss of tax credits could impact sales of electric cars in the coming year, especially since gas prices are falling again. Shares of GM opened with a loss but were able to regain it and more before the close of the session.

Netflix was another stock to take a hit in today's session. The leader in streaming media had its price target downgraded by Suntrust analysts who think subscriber growth will fall short of expectations. The buy rating is held in place but the target was cut to $355 which is still a 30% upside from today's prices. The analyst says a strong mid-year slate of programming will help maintain business but meaningful improvements are not expected in the Q4 data. Shares of the stock opened with a loss but were able to claw their way back to break even and move higher to close with a gain near 0.75%.

Apple shares were halted in after-hours trading so the company could issue a guidance update. The company says it will miss revenue expectations by more than 6% due to slow sales in China, a weak round of iPhone upgrades (I got mine, buy one get one free iPhone X from Verizon), and the generally lousy backdrop for the business that is currently in effect. The news was not well received but is consistent with analysts warnings and other signs of slowing business around the world. Shares of the stock fell more than -6.0% in after-hours trading and likely to head lower in tomorrow's session.

The Indices

The indices began the day in the red and looked like 2019 would get off to a really bad start. The good news is that buyers were waiting to step in at the open and pushed stocks higher almost all day. The indices created green candles, set new near-term highs, and look like they could extend this bounce over the next few days.

The NASDAQ Composite was today's leader with a gain of 0.46%. The tech-heavy index may have trouble in tomorrow's session with Apple's after-hours warning but momentum is shifting to the upside and that may be enough to carry the index up to the next resistance target. The indicators are consistent with a bullish entry that is in line with the secular bull market but the signal is still early and weak. A move up may find resistance near the short-term moving average and the 7,000 level, a move above that could be bullish longer-term.

The Dow Jones Transportation Average posted the second largest gain for the first day of 2019, 0.34%. The transports created a medium sized candle that confirms support at the 9,000 level and suggests a move higher is on the way. The indicators are still weak but rolling into a bullish signal that will be in line with the secular trend once completed (if completed). A move higher may take the index up to 9,500 or 9,600, a break above that level could signal additional upside with targets near 10,500 or higher.

The S&P 500 posted the third largest advance in today's session with a gain of 0.12%. The broad market had been down more than -1.5% in early trading and was able to recover all of that loss. Today's candle is medium sized and green, it confirms the presence of support at the 2,500 level, and is supported by the indicators. The signal is still weak but both MACD and stochastic are showing bullish crossovers that are in line with the secular trend and suggest upward movement in prices is coming. A move up would confirm this outlook but resistance targets are close at hand. My first target for resistance is near 2,525, a move above that could go to 2,600.

The Dow Jones Industrial Average brings up the rear in today's session. The blue chips advanced a mere 0.08% but staged a 400-point day and created a medium-sized green candle in the process. The index is showing support at the 23,000 level and may move higher if it can surpass 23,350. The indicators are consistent with a bullish shift in momentum that is in line with prevailing trends so a move higher is expected. The next target for resistance, once 23,350 is broken, is near 25,000.

I have to be honest, it didn't look like 2019 was going to get off to a great start but that outlook changed almost as soon as the opening bell sounded. Today's action is not definitive, there are still a lot of hurdles to overcome, but it is a good sign that 2019 will be about buying equities rather than selling them.

The risks to the market are still present but so too are the drivers of the secular rally. The risks include Trump, growth outlook, earnings outlook, trade, and the FOMC. The drivers include share buybacks, dividend increases, and labor trends; I think the drivers are a far more powerful force. I am cautiously bullish for 2019 and long-term positions, I am also bullish for the near-term but even more cautious because you never know what tomorrow will bring.

Until then, remember the trend!

Thomas Hughes


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New Plays

Chip Sector Rout

by Jim Brown

Click here to email Jim Brown
Editor's Note

Apple's guidance warning is going to crush the chip sector tomorrow. All of the Apple suppliers and anyone that ever wanted to be a supplier will be punished on Thursday. The Apple guidance warning could have lasting market impact. The company warned of a rapid slowdown in China saying nearly 100% of their revenue miss came from greater China. Sales are crashing. The company now expects to post $84 billion in revenue for Q4 and this is down from their prior guidance just two months ago of $89-$93 billion. Analysts believe it is strange that Apple did not see this coming. Economic events don't tend to occur overnight. They take months to develop.

Some analysts believe that Apple may be using the China slowdown story as cover for their already falling sales. Apple had held firm to its aggressive pricing strategy in China and maintaining the high prices on its top of the line phones. With dozens of smartphones now having more or equal capabilities than the iPhones and some selling for half as much, this could be more of an Apple problem than a China problem. This is going to ripple down through the chip sector as unit expectations plummet

The S&P futures are down -35 as I type this, so we will not be adding a new play for tomorrow.


New positions are only added on Wednesday and Saturday except in special circumstances.


No New Bullish Plays


No New Bearish Plays

In Play Updates and Reviews

Another Winner

by Jim Brown

Click here to email Jim Brown

Editors Note:

The small cap index fell less and rebounded more than the volatile big caps. The Russell followed the big caps lower at the open but the decline was quickly bought and the index posted a decent 7 point gain and several points over resistance at 1,351. Tomorrow will be a challenge because the chip sector could fall hard on the Apple guidance warning. Chips stocks are a big component of the Russell.

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

REI - Ring Energy
The long position was entered at the open on Monday.

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

Short term Calls and Puts on equities = Option Investor Newsletter

Credit spreads and naked puts = OptionWriter

Long term option investments = LEAPS Investor

3-6 month Option Trades = Ultimate Investor

Full updates on all plays on Wednesday and Saturday. Only closed plays are updated on other days.

BULLISH Play Updates

AMD - Advanced Micro Devices - Company Profile


AMD's president and CEO, Dr Lisa Su, will give the keynote address at CES 2019 on January 9th at 9:AM PST. This is bound to be a market moving speech.

Original Trade Description: Dec 22nd.

Advanced Micro Devices, Inc. operates as a semiconductor company worldwide. It operates in two segments, Computing and Graphics; and Enterprise, Embedded and Semi-Custom. The company's products include x86 microprocessors as an accelerated processing unit (APU), chipsets, discrete and integrated graphics processing units (GPUs), and professional GPUs; and server and embedded processors, and semi-custom System-on-Chip (SoC) products and technology for game consoles. It provides x86 microprocessors for desktop PCs under the AMD Ryzen, AMD Ryzen Pro, Threadripper, 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; microprocessors for notebook and 2-in-1s under the AMD Ryzen processors with Radeon Vega GPUs, 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 brands; and microprocessors for servers under the AMD EPYC and AMD Opteron brands. It also offers chipsets under the AMD brand; discrete GPUs for desktop and notebook PCs under the AMD Radeon and AMD Embedded Radeon brand; professional graphic products under the AMD Radeon Pro and AMD FirePro brands; and customer-specific solutions based on AMD's CPU, GPU, and multi-media technologies. In addition, it provides 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, G-Series, and AMD Embedded Radeon brands; consumer graphics under the AMD Radeon brand; and semi-custom SoC products. It serves original equipment and design manufacturers, datacenters, system integrators, distributors, and add-in-board manufacturers through its direct sales force, independent distributors, and sales representatives. Advanced Micro Devices, Inc. was founded in 1969 and is headquartered in Santa Clara, California. Company description from FinViz.com.

AMD was always the red-headed stepchild that Intel kept around to prevent Intel from being called a monopoly. They let them have just enough business to keep them going. After decades of picking up Intel's scraps, the company has finally come of age and has announced multiple processor families that are more technological advanced than Intel's chips and they are 12-18 months ahead of Intel's first foray into this level of manufacturing.

Cloud operators are taking notice of the faster, cooler, cheaper processors and this sector buys hardware by the truckload. AMD is stealing market share from Intel and this is likely to accelerate as these new processor families flood the market before Intel can catch up.

Earnings Jan 23rd.

Over the last two weeks of Nasdaq decline, AMD pulled back to uptrend support and could be ready to rebound sharply if the market cooperates.

Position 12/24:
Long April $20 Call @ $1.70, see portfolio graphic for stop loss.

REI - Ring Energy - Company Profile


No specific news. Shares rebounded after the opening market drop thanks to the rebound in oil prices.

Original Trade Description: Dec 29th.

Ring Energy, Inc., an exploration and production company, acquires, explores for, develops, and produces oil and natural gas in Texas, the United States. As of December 31, 2017, the company's proved reserves consisted of approximately 31.9 million barrel of oil equivalent. As of the above date, it also had interests in 8,102 net developed acres and 61,772 net undeveloped acres in Andrews and Gaines counties; and 10,235 net developed acres and 9,682 net undeveloped acres in Culberson and Reeves counties. It primarily sells its oil and natural gas production to end users, marketers, and other purchasers. The company was formerly known as Transglobal Mining Corp. and changed its name to Ring Energy, Inc. in March 2008. Ring Energy, Inc. was founded in 2004 and is headquartered in Midland, Texas. Company description from FinViz.com.

Ring is an up and coming shale oil producer. With oil prices down so sharply over the last three months, Ring shares were knocked back to $4 after trading above $16 in May. The decline in crude prices is about over. The current $45 level is not economic for many producers and a major pain level for the OPEC nations. They are rapidly cutting production to lift prices higher. This will lift all the US energy stocks as well.

Their Q3 earnings were 14 cents beating estimates for 11 cents. Revenues of $32.7 million rose from $16.4 million in the year ago quarter. Revenues for the first 9 months of 2018 rose from $43.4 million to $92.5 million. Production rose from 346,900 barrels to 555,020 barrels, a 59.9% increase. Gas volumes increased 39.2% to 280,200 Mcf. On a Boe basis production rose 58.1% from 380,426 to 601,720 Boe.

They closed an acquisition of 4,763 net acres in Andrews County Texas on December 26th that gave them 55 new horizontal drilling locations. The leases are adjacent to Ring's currently operated properties. The seller was Tessara Petroleum, a wholly owned subsidiary of the Carlyle Group. The Carlyle Group took payment in stock saying, "We have chosen to receive consideration in the form of stock as we believe Ring is a best-in-class operator and the assets being transferred are synergistic with Ring's existing properties that lie just across the lease line. We are fortunate to have found a partner that we admire and trust and look forward to seeing Ring increase its scale and value over time."

The Carlyle Group are smart people. If they believe Ring is going to appreciate, it is likely to happen. Ring's production is growing rapidly and with oil prices rebounding the stock should continue rising as well.

Position 12/31/18:
Long REI shares, currently $5.28, see portfolio graphic for stop loss.

BEARISH Play Updates

VXX - Volatility Index Futures - ETF Description


We started the year off with a nice decline as the market recovered from the opening dip but Thursday will likely have an opposite reaction.

When the market eventually rebounds successfully, this will drop like a rock.

The VXX will eventually be single digits but it could be months in the future.

Previously: Earlier this year, a reader emailed me saying a friend was short 1,000 shares. When the $21 spike came in afterhours, Ameritrade closed that position for a $35,000 loss. They did not have a protective stop loss.

I wrote in the prior newsletter that we were not using a profit stop in this position because it could be hard to re-short the shares after a volatility event. That is just trade management for a profitable position. In ANY SHORT POSITION, you should have a catastrophe stop loss to avoid the position turning into a major loss. Had this person had a stop loss at their entry point, they would have been closed for a breakeven and they would be sleeping a lot better tonight.

Readers should always assume the potential for the worst possible outcome of a short position. Trade smart!

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.
Position 9/6/18:
Short VXX shares @ $54.27, see portfolio graphic for stop loss.

Average cost = $47.61.