Option Investor
Newsletter

Daily Newsletter, Thursday, 1/31/2019

Table of Contents

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

Market Wrap

Two Down, One To Go

by Thomas Hughes

Click here to email Thomas Hughes

Introduction

The market moved higher on strong earnings and confirmation the FOMC is close to ending quantitative tightening. Today's move wasn't strong but it was nice to see following Wednesday's FOMC driven rally.


The FOMC has confirmed what the market was already coming to believe; the pace and trajectory of future interest rate hikes will be much slower and lower, interest rates will stay low for a prolonged period of time, and the end of quantitative tightening. Quantitative tightening, otherwise known as the Fed's Balance Sheet Run-Off, has been sapping liquidity from the US economy and one of three hurdles for the bulls the market has now overcome.

Market Statistics

Another hurdle, fear of economic/earnings recession, has also been swept away. The fears, driven in large part by the FOMC tightening cycle and trade woe, were overblown in most cases. The earnings reports we've seen so far haven't been great compared to 2018 but they are much better than expected (on balance) and the outlook for 2019 isn't as bad as the sell-side analysts led us all to believe. With the FOMC off the tightening cycle, it is possible economic growth could begin to re-accelerate.

The final hurdle blocking the path to new all-time highs for the broad US equities market is the China/US trade impasse and even that seems to be gaining positive momentum. The trade-talks between Chinese Vice Premier Liu He and Trump's top aides have progressed to the point a meeting between Trump and Xi is in the works. There are still some sticking points to be hammered out, and the meeting would take place in late February after the next Trump summit with Kim Jong Un, but it's still big news for markets to latch on to.

Economic Calendar

The Economy

Initial jobless claims surged unexpectedly over the last week but maybe showing impact from the government shutdown. The report doesn't make special note of the shutdown and only tracks civilian government employees but the number of those has been steadily rising over the last few weeks. The number of initial claims jumped 53,000 to hit 253,000 and the highest level since September 2017 (that high was driven by storm-related outages).

The four week moving average of claims rose 5,000 to hit 220,500. The surge in claims is troubling and needs to be watched to see how long it lingers. Based on all other labor-based data points and the end to the shutdown I do not expect this figure to linger long at these elevated levels.


Continuing claims rose 69,000 to hit 1.782 million. This is the largest number of continuing claims since 4/28/17 and another red flag linked, at least in part, to the government shutdown.

The total number of jobless claims fell -66,958 to hit 2.148 million. This decline is in line with expectations and helps confirm the peak in claims reached last week, with one caveat. This data lags the initial claims data by two weeks and could easily see another spike as the impact of government shutdown works its way through the system. On a year over year basis claims are down 7.2% and consistent with long-term labor market trends.


The Challenger, Gray & Christmas report on planned layoffs shows the number of planned job cuts rose 20.7% in the last month to 52,988. This is 18.7% above the same month last year and evidence employers are downsizing their workforces post-holidays. The retail sector led the job cuts but cuts were fairly broad, looking at it relative to all January's this month's cuts are below average but skewed to the high-end of the range. More importantly, while job cuts linger in some sectors others are still hiring. The number of planned hires topped 74,000, oddly enough led by the retail sector, which suggests labor-market weakness in the retail sector is very isolated.


The fourth quarter employment cost data was a bit better than expected. The Employment Cost Index rose only 0.70% versus the 1.0% expected. The gains were driven by a 0.60% increase in wages and a 0.7% increase in incentives. On a year-over-year basis, civilian labor costs have risen 2.9% while private business labor costs have risen by 3.0%.

The Chicago Business Barometer (PMI) fell -7.1 points to 56.7. This is the weakest level in two years but still a solid read and well above 50. Four of the five sub-indices were lower in the last month led by new orders and production. Despite the decline, this is the 24 month of readings above 50 and evidence economic expansion is still underway. The risk is that PMI will continue to slacken until activity begins to contract but that has been mitigated in large part by the FOMC, earnings outlook, and labor data.


New Homes Sales was not originally scheduled for today, it is the first of the shutdown-delayed data to be released. The data is good but lagging by two months so take it with a grain of salt. The number of New Homes sold in November jumped 16.9% to 657,000. The increase was driven by fear of rising rates and helped to spur the homebuilders higher in today's action. On a year over year basis, sales are still trending lower by 7.7%, based on some recent mortgage app data that may change this year.


The Dollar Index

The Dollar was able to regain some of Wednesday's losses and may be confirming the bottom of a trading range. Today's action was driven by the data and trade news as one point to modest US economic growth and the other could open the doors to economic expansion. The FOMC's policy statement weakened the dollar but was as-expected so largely discounted by the market. Additionally, yesterday's ultimatum from the EU to the UK weakened the EUR and the GBP. The EU says there is to be no renegotiation on Brexit, the UK can take it or leave it, and puts the UK in a tight spot; take it or leave it. Support for the DXY is still at $95.50 and a reversal at this level looks possible.


The Gold Index

Gold prices were able to hold steady in today's session. The metal tried to move higher but fell back to break even by the end of the session. The candle is small and doji-like so may mean nothing but for now, there is a potential for resistance at the $1,320 level. If resistance holds at this level a retracement to support may follow. A consolidation and move above $1,320 would likely continue to $1,340.


The Gold Miners ETF has extended its break of the $22.50 level and looks like it could go higher. The near-term rally in gold stocks seems to be gaining momentum and likely to continue to gain momentum while gold prices are on the rise. The indicators are both bullish and rising so higher prices are expected. My next target for resistance is $23.00 and then $24.00.


The Oil Index

Oil prices moved up strongly on word the Saudi's were cutting exports to the US. The cuts are part of the OPEC deal to curb production and more than the Saudi's quota. The news helped push WTI above $55 for the first time in nearly 3 months but the outlook for US production and concerns for global demand capped the gains. By the end of the session, WTI had given up all the days gains to close beneath resistance and within the near-term consolidation range.


The Oil Index moved up to close with a new near-term high but the candle is small and continuation is questionable. The index may be ready to move higher but, based on the expectation for earnings decline in 2019, I am not to optimistic about it. A move up is likely to find resistance at the 1,300 level and then the long-term moving average if it does materialize. If not, support may be found at 1,275 or1,250.


In The News, Story Stocks and Earnings

GE saw strong gains in today's session after it beat earnings expectations. The company produced a 60% decline in profits over the last year but revenue grew and some other positive factors were announced. The number one is that GE has settled its DOJ investigation of accounting practices for $1.5 billion dollars. CEO Larry Culp says the company's turnaround is progressing nicely and the worst is nearly over.

The company's cash flow is going to be hurt by restructuring charges and efforts to deleverage the balance sheet, investments in the healthcare business, and some other one-time items but those costs will pay off over the long-term. Shares of the stock jumped 10% at the open and moved higher from there. The only negative I see is that some shareholders took this opportunity to get out of GE and that sentiment may cap gains in the near to short-term.


Shares of Amazon were flat in the after-hours session after reporting blowout earnings. The company says revenue grew 20% led by a 46% increase in AWS revenue and EPS is $6.04. The EPS beat is substantial, nearly $0.40, but EPS is hit-or-miss with this company depending on how much they spend and where. Guidance for the next quarter is strong but on the low side of consensus which is likely what shares held steady after the report.


Shares of Yum China were up more than 6% in after-hours trading after it reported earnings. The company says sales have not been hurt by the US/China trade situation but growth is mixed at the segment level. Total same-store sales increased by 2.0% led by 3% increase at KFC and lagged by a 4% decrease at Pizza Hut. Operating margins narrowed slightly but operating profits are up 77% so investors didn't care.


Shares of Symantec were also sharply higher in the after-hours session. The company beat on the top and bottom lines and provided better than expected forward guidance on strength in both consumer and enterprise segments. Symantec also increased its buyback program to $1.3 billion which will provide a lot of support in the future. Shares were up more than 6% on the news.

The Indices

Today's index action was mixed in terms of result but generally bullish relative to the market. The day's leader is the NASDAQ Composite with a gain of 1.37%. The tech-heavy index created a small green bodied candle moving up to break the long-term moving average and extend the bounce from the short-term moving average. The indicators are confirming this move with a strong bullish crossover so higher prices are expected over the next few weeks. A move up from here may find resistance at 7,500, a move above there could go as high as 8,000.


The S&P 500 closed with a gain of 0.85% and above its long-term moving average. The index is extending the bounce from the short-term moving average support zone and is indicated higher. The indicators both show bullish activity that suggests a move to 2,775 is possible. The caveat is that the signal is still weak so tight stops are recommended for bullish positions and profits should be taken on short-term positions if resistance targets are reached.


The Dow Jones Industrial Average closed with a loss of -0.06 but it created a green candle in the process. The index opened with a slight loss and then moved up for most of the day as traders scooped up discount stock. The index is consolidating above the long-term moving average and supported by the indicators so another push higher is expected. The next targets for resistance are 25,250 and 25,750, a move above there would be bullish.


The Dow Jones Transportation Average closed with the largest loss, -0.19%, and created a red candle but the action is still more bullish than not. The index opened with a gain that would have been a new closing high and then moved lower to test support near yesterday's close. The candle shows that there is some support present and the indicators concur so a move higher is expected. Both indicators are bullish but momentum is weakening so resistance at the long-term moving average may cap gains. A move above the 150-day EMA would be bullish.


The market is slowly coming back to its senses. The fears that drove stocks to a 20% correction are dissipating. We're not out of the woods yet but earnings aren't as bad as the analysts thought they would be, the FOMC has taken its foot off the economic brakes, and trade tensions on are on the mend so I think it is safe to say the risk is to the upside. Economic activity could easily re-accelerate in 2019, analysts outlook could brighten, and earnings could beat expectations so there is a solid chance we could see a sustained bull market rally this year. I am firmly bullish for the long-term but still only cautiously bullish for the near-term. Better safe than sorry.

Until then, remember the trend!

Thomas Hughes


New Plays

Replacement Trade

by Jim Brown

Click here to email Jim Brown
Editor's Note

This ETN had been a good position for us but we need to replace it. The VXX ETN expired and was replaced by the VXXB.

 

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


NEW BULLISH Plays

No New Bullish Plays


NEW BEARISH Plays

VXXB - Barclays VIX Futures ETN - ETN Description

The investment seeks return linked to the performance of the S&P 500 VIX Short-Term Futures Index TR. The ETN offers exposure to futures contracts of specified maturities on the VIX index and not direct exposure to the VIX index or its spot level. The index is designed to provide investors with exposure to one or more maturities of futures contracts on the CBOE Volatility Index. Company description from FinViz.com.

The VXXB is a short-term volatility ETN 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 ETN. 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, the prior VXX ETN had done five 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 VXXB and its predecessor the VXX always decline long term.


Unfortunately, put options are expensive with a volatility instrument at this price level. The only recommendation is to short the ETN and forget it. 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. We could keep this play in the portfolio on a trading basis permanently.

The VXXB will be hard to short. The shares are out there and being traded because the volume on Thursday was 22.1 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.

Short VXXB shares, currently $35.43, no initial stop loss.




In Play Updates and Reviews

New Leg Higher

by Jim Brown

Click here to email Jim Brown

Editors Note:

The Russell did not post a big gain, but it was 1% and a new leg higher. The Russell broke out of congestive resistance and consolidation at 1,462-1,493 and moved convincingly higher. This could be the start of something good. If the broader market can shake off Amazon's earnings drop, and close positive again we could be headed significantly higher.



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


VXX - VIX Futures ETN
The short position was closed when the VXX expired.

YRCW - YRC Worldwide
The long call position was stopped at the open.



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

YRCW - YRC Worldwide - Company Profile

Comments:

YRCW reported earnings of 6 cents that missed estimates for 12 cents. That was still a 50% increase from the year ago quarter. Revenues of $1.25 billion beat estimates by a fraction. Shares spiked to $7.26 at the open before fading back to $6.

I messed up on this position. I recommended the position with no stop losses on either side. However, somewhere in the transposition to the portfolio graphic I inadvertently added a $6.65 stop loss to the call. That means we were stopped out of the call side at the open. Even though it was not supposed to be there, I have to take the exit because that is what was in the newsletter.

The long put has no value today but YRCW missed estimates. If the market was not so bullish, we could have seen the stock head back towards the lows. I am recommending we keep the put and see if the recent gains begin to erode.

Original Trade Description: Jan 26th.

YRC Worldwide Inc., through its subsidiaries, provides various transportation services primarily in North America. Its YRC Freight segment offers various services to transport industrial, commercial, and retail goods; and provides specialized services, including guaranteed expedited services, time-specific deliveries, cross-border services, coast-to-coast air delivery, product returns, temperature-sensitive shipment protection, and government material shipments. It serves manufacturing, wholesale, retail, and government customers. As of December 31, 2017, this segment had a fleet of approximately 7,600 tractors comprising 5,900 owned and 1,700 leased; and 30,900 trailers consisting of 23,800 owned and 7,100 leased. The company's Regional Transportation segment provides regional delivery services, which include next-day local area delivery and second-day services, consolidation/distribution services, protect-from-freezing and hazardous materials handling, truck loading, and other specialized offerings; guaranteed and expedited delivery services consisting of day-definite, hour-definite, and time definite capabilities; interregional delivery services; and cross-border delivery services, as well as operates hollandregional.com, newpenn.com, and reddawayregional.com, which are e-commerce Websites offering online resources to manage transportation activities. This segment had a fleet of approximately 6,500 tractors, including 4,700 owned and 1,800 leased; and 13,700 trailers comprising 10,500 owned and 3,200 leased. The company was formerly known as Yellow Roadway Corporation and changed its name to YRC Worldwide Inc. in January 2006. YRC Worldwide Inc. was founded in 1924 and is headquartered in Overland Park, Kansas. Company description from FinViz.com.

YRCW has a problem with earnings reports. They either gap up or gap down immediately afterwards. Their performance has been so spotty on earnings there is no accurate expectation of what they will report.

The stock is cheap at $5.75. Over the last two weeks shares have risen to that level from the December market crash and have plateaued there with no further movement. For any normal stock this would appear to be staging for a post earnings breakout.

Since the options are so cheap, I am recommending a combination play where we buy a cheap option on either side of the stock price and hope for a strong move in either direction.

Earnings Thursday January 31st.

Position 1/28/19:
Closed 1/31: Long Feb $6 call @ 40 cents, exit $1.10, +.70 gain.
Long Feb $5 put @ 25 cents, no stop loss.



BEARISH Play Updates

VXX - Volatility Index Futures - ETF Description

Comments:

Now I know why there was no decline on the VXX on Thursday. The ETN expired at the close on Wednesday. Holders were liquidated in cash at the $38.66 closing price.

The VXX was a 10-year ETN created by Barclays. Wednesday was the expiration. Barclays has replaced it with the exact same product only with a 30 year expiration and the symbol is VXXB. I am recommending a new position in that ETN today.

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.

Closed 1/30: Entry $47.61, exit $38.66, +$8.95 gain.