Option Investor
Newsletter

Daily Newsletter, Wednesday, 1/9/2019

Table of Contents

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

Market Wrap

Dovish Fed Lifts Stocks

by Thomas Hughes

Click here to email Thomas Hughes

Introduction

The FOMC minutes reveal the committee is less hawkish than the policy statement led us to believe. The minutes include some relatively minor changes in wording that carry a lot of weight regarding the pace of future interest rate increases. Most notably, the FOMC now sees that 'some' further gradual rate hikes will be needed and qualified the change with a note. The committee wanted the market to know that 'some' is meant to convey the idea of a relatively limited number of future rate hikes and the market like what it heard. Indices that had been cautiously higher moved to the highs of the day on this news.


The committee also says the economy is still strong despite geopolitical headwinds and that labor markets remain strong. Regarding the pace of hikes; the committee says it is still data dependent although it has become more difficult to judge the need for hikes and that the number and pace of those hikes is uncertain. Basically, the FOMC has altered its stance and now expects to see only one (1) rate hike in 2019.

Today's slate of events included speeches from three FOMC members who agree the committee is patient. The need for rate hikes may still be present but it has lessened to the point a pause in hikes is the most likely scenario. The CME's FedWatch Tool shows only a 16.5% chance of one hike next year and a slim chance rates will be cut.


Regarding the balance sheet rundown, the committee will continue to allow their balance to wind down and cautions the market that it may spark volatility in other key rates. At the current pace of run-off, $50 billion monthly, it will be years before the Fed's balance sheet is back to pre-crisis levels.

Market Statistics

The trade talks ended today and there are signs of positive progress. Under Secretary of Agriculture for Trade and Foreign Agricultural Affairs, Ted McKinney said the talks went just fine and that it was good for us. Now the trade reps will have to report back to Trump to make the next step. Now that the talks have begun in earnest there is a chance they could progress quickly although no substantive change in Chinese domestic affairs is expected very soon. At best China will open up its markets, import more agricultural and energy products, and make promises we'll have to trust them to keep. Regardless, this is good news and will be a boost to 2019 global GDP.

Economic Calendar

The Economy

Only one macro-economic release today and that was the minutes. The minutes were a nice confirmation of the FOMC's new stance and a sign they will allow the economy to catch up with current interest rates. The weekly mortgage applications saw a 23.5% surge in the last week as pent-up holiday demand and lower rates spur activity. As a leading indicator, this is a good sign of increased real estate activity but won't likely show in that data for another month or two at least.

The Dollar Index

The Dollar Index began to fall well before the FOMC minutes were released. The decline was driven by an expectation for Fed dovishness that was reinforced by statements from Raphael Bostic, Charles Evans, and Eric Rosengren. While some of the committee members still see a need for rate hikes all have toned down their outlook and indicate future hikes are not on autopilot and are data dependent. Today's move in the dollar trimmed 0.75% from the index and broke below a key support level.

The index may move lower in tomorrows session, the indicators are in support of such a move, but the ECB meeting is on tap and that may reverse the index fall. If the ECB backs off of their policy stance as the FOMC has done I would expect to see the dollar index resume its sideways meandering rather than fall to new lows.


The Gold Index

Gold prices moved up on today's dollar weakness and look like they could go much higher. The metal is in an uptrend and forming a flat pattern that could add $45 to its price in the very near term. This move is set up by the softening expectation for future FOMC rate hikes and could be sent out of the park by the ECB if they maintain their own outlook. The ECB has indicated that they will begin tightening policy in the second half of this year, anything to that effect will be bearish for the dollar and bullish for gold. Resistance is currently at $1,300, a move above there would be bullish and could take gold up to the $1,345 to $1,365 range.


The Gold Miners ETF GDX moved up more than 1.0% in today's session and may move higher, is likely to move higher, if gold is able to move higher as well. Today's candle extends yesterday's bounce from support but was halted before the recent highs. The indicators are mixed and suggest and range bound trading or correction so there is a reason to be cautious. A move above resistance would be bullish and could take the ETF up to $22, $23, and $24 in the near to short-term. If resistance at the $21.50 holds or is confirmed by whipsaw action I would expect the ETF to trend sideways at current levels or pull back to retest support at or below $20.50.


The Oil Index

Oil prices surged more than 5.0% in today's session on two catalysts that are light on substance. The first is the Saudi Oil Ministers reaffirmation that Saudi Arabian oil production would fall in the coming months. The second, a positive conclusion to this week's round of trade talks. Both news bites are positive but I say light on substance because the Saudi's are manipulating oil prices with talk and tight control of supply, and the trade talks are far from conclusive. WTI is now trading just above $52 where there is a high potential for strong resistance. A move up from this level could be bullish, a fall from this level would confirm resistance and the near-term downtrend in prices.


The Oil Index advanced more than 2.0% in today's session and has extended its climb above the short-term moving average. The index is rising on oil prices and may move higher if it can surpass resistance at 1,260. The indicators are bullish and suggest prices will continue to climb in the near-term. A move above 1,260 would be bullish but face another resistance target at 1,300.


In The News, Story Stocks and Earnings

Constellation Brands reported earnings before the bell and beat on the top and bottom lines. The company says revenue and adjusted EPS both grew in the last year but the outlook for future growth is not good. The company says softness is being felt in spirits, beer, and wine that I think may be linked to the budding marijuana boom that is sweeping the globe. Legalization of medicinal and recreational cannabis is accelerating and likely to lead to a Federal regulation at some point in the not-too-distant future. Shares of the stock fell nearly -12.0% in pre-market action.


Pricesmart reported December sales before the open and fiscal Q1 2019 after the close of the session. The December sales figures are positive and somewhat strong at 0.9% for the month and that was negatively affected by currency fluctuation. Comp-store sales rose 0.4% for the month and round out a solid year for the warehouse shopping club.

Earnings in the first fiscal quarter were good but revenue was only as expected which left shares flat in after-hours trading. Adding to investor malaise were mixed metrics on merchandise sales, up 0.3% in the quarter but down more than -2.0% on a comp-store basis. The mixed results were due in part to the opening of a new store that helped increase total sales while sales per store unit fell.


Shares of home builders were up on today's mortgage data and expectations for earnings scheduled to be released after the bell. Shares of KB Homes and Toll Brothers were both up more than 4.0% at the end of the session and KB Homes at least surged another 4% in the after-hours session. The builder reports revenue and earnings above expectations and provided a positive outlook for future operations. The company has a substantial amount of free cash flow and has been allocating towards reducing debt and preparing for growth this year and next.


The Indices

Today's index action wasn't very strong but it was bullish and set new multi-week highs for a broad swath of the market. What I really like is that the Dow Jones Transportation Average led the charge and it broke above its short-term moving average.

The candle is not large but opens at the close of yesterday's doji session and move up to close near the high of the day. The move shows that potential resistance at the 9,500 level is not present leaving the path forward open to advance. The indicators are bullish and suggest that upward momentum will carry prices higher in the near-term at least. Now that prices are edging above the 30-day moving average momentum may begin to build but we're not out of the woods yet. There are several targets for resistance just above today's close that may cap gains in the near-term.


The NASDAQ Composite posted the second largest advance at 0.70%. The tech-heavy index extended its move above the short-term moving average and poked its head above an important uptrend line. Today's move is cautious but bullish, let's hope there aren't bears waiting to play whack-a-mole with prices now that they are on the rise again. The indicators are bullish and suggest rising prices are at hand, my target for the next resistance is now 7,290.


The S&P 500 gained about 0.40% in the session and created a small spinning top doji. The candle is above the short-term moving average and at a new near-term high so bullish and possibly the precursor to higher prices yet to come. The indicators are both on the rise and support the idea of higher prices provided the 2,600 can be overcome. The 2,600 level is consistent with the November and December lows, a target for possible resistance. A move above 2,600 would be bullish and may take the index up to 2,700 in the near term.


The Dow Jones Industrial Average gained about 0.38% in today's action and may move higher. The caveat is that today's candle is small and shows resistance at the 24,000 level. The index is above the short-term moving average and the indicators are bullish so upward pressure is present. If it is enough to break above resistance prices will likely move up to 24,800 in the near-term.


The market used to be scared of trade wars, the FOMC, and slowing growth. Now the causes of those fears are gone or leaving, the FOMC has decreased the trajectory of interest rate hikes and trade talks are underway, both of which will help alleviate the third concern of slowing global growth. It's still early in the rebound, there is still cause for caution, but the price action looks bullish and so am I.

The next hurdle for the market is earnings. The Q4 2018 cycle is about to go into high gear and that could add fuel to the rally. Next week the season kicks off with reports from the big banks and some important industrial and transportation names like Alcoa and CSX. The expectations are high, not compared to last quarter, and the estimates have been falling so I think there is a good chance most S&P 500 companies will beat their consensus estimates. I am firmly bullish for the long-term and ever so cautiously bullish for the near-term.

Until then, remember the trend!

Thomas Hughes


New Plays

High Risk

by Jim Brown

Click here to email Jim Brown
Editor's Note

Multiple earnings warnings have dented sentiment and futures are down sharply. Multiple companies have warned on earnings guidance over the first three days this week. The sectors are not connected and suggests there may be more economic softness than originally thought. Homebuilders, chip makers, retailers, etc have all warned. The S&P futures are down -15 as I type this suggesting we are finally going to get the profit taking and consolidation I wrote about over the last several days. Since the small cap sector has been up for 10 of the last 11 days it could be hardest hit if we do get a material decline. I am going to refrain from adding another small cap position today.

 

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


NEW BULLISH Plays

No New Bullish Plays


NEW BEARISH Plays

No New Bearish Plays



In Play Updates and Reviews

10 of 11

by Jim Brown

Click here to email Jim Brown

Editors Note:

The Russell 2000 has posted gains for 10 of the last 11 sessions. Each day has been smaller than the last this week but 12 points was still a decent gain. As I said on Tuesday night, we are due for some consolidation and the Russell could be the weakest index when it appears.



Current Portfolio


Stop Loss Updates

Check the graphic below for any new stop losses in bright yellow. We need to always be prepared for an unexpected decline.


Profit Targets

Check the graphic below for any profit stops in green. We need to always be prepared for a profit exit at resistance.





Current Position Changes


No Changes



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

Short term Calls and Puts on equities = Option Investor Newsletter

Credit spreads and naked puts = OptionWriter

Long term option investments = LEAPS Investor

3-6 month Option Trades = Ultimate Investor


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

Comments:

AMD's president and CEO, Dr Lisa Su, gave the keynote address at CES 2019 on Thursday. She announced the fastest GPU video card they have ever produced running on a 7nm process. The card has 60 compute units, 3840 stream processors, 16gb of ultra-fast HBM2 memory with a 1 TB memory bandwidth for stunning high speed graphics on 4K and 8K monitors. Shares popped at the open but faded in the afternoon.

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.



INFN - Infinera - Company Profile

Comments:

The Australia to Japan undersea cable completed a major upgrade of the 12,700 kilometer cable system using Infinera ICE4 devices allowing multi terabit capacity.

Original Trade Description: Jan 5th.

Infinera Corporation provides optical transport networking solutions, equipment, and software and services worldwide. The company's product portfolio consists of Infinera DTN-X Family of terabit-class transport network platforms, including the XTC Series, XTS Series, and XT Series; Infinera DTN-X XTC series multi-terabit packet optical transport platforms that integrate digital OTN switching and optical WDM transmission; and Infinera DTN-X XT series for terrestrial applications and XTS series for subsea applications. It also provides Infinera XTM Series packet-optical transport platform that enables high-performance metro networks with service-aware, application-specific capabilities; and Infinera Cloud Xpress Family designed to meet the varying needs of ICPs, communication service providers, Internet exchange service providers, enterprises, and other large-scale data center operators. In addition, the company offers Infinera FlexILS open line system platform that connects various Infinera and third-party terminal equipment platforms over long-distance fiber optic cable providing switching, multiplexing, amplification, and management channels. Further, it provides software solutions, including Xceed Software Suite that address long-haul, subsea, and metro networks, as well as a range of support services for all hardware and software products. The company also serves telecommunications service providers, Internet content providers, cable providers, wholesale and enterprise carriers, research and education institutions, enterprise customers, and government entities. It markets and sells its products and related support services primarily through its direct sales force. The company was formerly known as Zepton Networks. Infinera Corporation was founded in 2000 and is headquartered in Sunnyvale, California. Company description from FinViz.com.

Earnings Feb 5th.

Infinera is a global supplier of terabyte speed network equipment. They are in nearly every country. Their products handle long haul data transmission even in undersea links.

Shares collapsed back in early November when they reported earnings. The CEO said the company had seen a pause in sales as buyers evaluated the combined company. They had just purchased Coriant. The CEO said revenue in Q4 would increase by 50% because of the acquisition but they would post a bigger loss on acquisition expenses.

For Q3 they lost 4 cents and analysts were expecting a 5-cent loss. The guidance for Q4 was a loss of 26-30 cents because of the acquisition.

Shares fell to $3.50 post earnings. Over the last week they have recovered to $4.25 and appear to be accelerating higher. Resistance is $5.

This is not a fast mover, but all the bad news is now priced into the stock.

Readers have been requesting more low dollar stock recommendations and this would fit that scenario.

Position 1/7/19:
Long INFN shares @ $4.22, stop loss $3.75.

Optional: Long April $5 Call @ 31 cents, no stop loss.



REI - Ring Energy - Company Profile

Comments:

No specific news. Shares rebounded thanks to the rise 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

Comments:

Outstanding decline of more than 10 points since the market began its recovery. We just need the market to remain positive for another week without any major hiccups.

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.





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