Last week appeared mediocre on the surface but the indexes actually postes strong gains. Individual stocks did not appear to be surging ahead but the advance/decline line was positive for the entire week. This was a stealth rally with the Dow gaining 2.4%, S&P 2.5%, Nasdaq 3.4% and Russell 4.8%. Those gains are causing our current weakness. Anytime a market rises 3-4% in a week and especially at the end of a three-week gain, we are going to have profit taking.

The profit taking we are having is minimal. The Dow has declined at the open an average of 200 points on each of the last three days and then recovered the majority of the points before the end of the day. The round number resistance at 24,000 is forcing a consolidation of the prior three week's gains. This is normal. Fortunately, we are not seeing a material decline as the market consolidates its gains. The longer the Dow can continue testing 24,000 the more likely we will break through.


The key is that sellers have not been able to force the markets lower. Three days they tried and three days they failed. That encourages the buyers to pick up stocks on the dips.


The Nasdaq was a drag on Monday with four of the FAANG stocks well down in the losers list. Facebook was the only member to post a gain. Amazon was down on news of the Jeff Bezos divorce and worries over retail sales. However, Amazon has already said it was a record quarter.

The Nasdaq is facing round number resistance at 7,000, which is also the 50-day average, and then again at 7,300 where multiple resistance lines converge. Netflix is the big tech stock to report this week and then we have a dozen of more the next week. That will move the index, only the direction will depend on the earnings.



Like the Dow the S&P is facing round number resistance at 2,600 and the drop today put a little more space into the equation. The index can now get a running start at the hurdle rather than starting against the wall.



The Russell had a 12 of 13 day streak going until today. The 1% decline was finally a real bout of profit taking. After nearly a 5% rally last week and a 14% rally from the Christmas low, the Russell needed to pause. Small caps normally lead the market up and down. Rarely can the big cap indexes rally if the Russell is negative.


The calendar for this week has a couple of important events. The next vote on the Brexit plan will be on Tuesday and many analysts do not believe it will pass. With the hard exit date in March, they need to get a plan approved ASAP so everyone can begin preparations. A failure of the vote could put May back in hot water and eventually there could be a new election to decide her fate.

The Fed Beige Book on Wednesday outlines the economic conditions in each of the Fed regions. With several recent economic reports showing weakness this could tell us where that weakness is appearing. It is not normally a market mover unless there is an unexpected change in the outlook.

The Producer Price Index will give us the inflation rate at the producer level, and it is also expected to be benign.

Retail sales on Wednesday could be a surprise after multiple retailers lowered guidance after the Q4 holiday season. Since the weekly Redbook sales from Chain stores has been averaging about 9% growth, I would not expect the monthly overall report to be a disaster. We could see weakness, but sales should be rising.

The Housing Market Index could be a surprise after a persistent decline in the other home sales indicators.

The Philly Fed Manufacturing Survey will be on Thursday. In the last report the headline number declined from 11.9 to 9.1 and the lowest level since 2016. This weakness seems to be a trend in the various regional reports.


This week is the start of the Q4 earnings cycle and nearly every major bank is reporting along with several Dow components. JPM, Goldman and American Express should be the most watched financials but Bank America, Wells Fargo, US Bank, Blackrock and Morgan Stanley also report.

The biggest market mover will be Netflix on Thursday after the close. The stock is up $106 since the December 26th low at $231.

With 20 S&P 500 companies already reported the blended earnings growth is 14.5% and revenue growth of 5.6%. This is significantly under the forecast for 22% and represents several disappointing reports. However, 20 companies are just a small fraction of the total to report so that earnings number is going to change significantly as the weeks progress.

Even at 14.5% it is more than double the expected 6.8% growth for Q1. The S&P 500 is currently trading at a PE of 15.1 and the Russell 2000 at 19.5.

Total S&P earnings for 2018 are expected to be around $161.68. For 2019 that rises to a record $172.04 and 2020 is expected to hit $191.32.


The S&P futures are up +18 as I type this. The Asian markets are all up strong. The potential killer for Tuesday is the Brexit vote. That is a wild card with Theresa May between a rock and a hard place.


I would be cautious about buying a Brexit dip until it appears it has found a bottom. If this vote fails it will trigger some additional chaos and there is no telling what it will do to the market. Personally, I do not feel it will have any real monetary impact on the US in the short term, but that cloud of uncertainty is always a problem. You may remember the first Brexit vote and the market crash that followed. Now that investors have had two years to digest it and deal with the twists and turns, it could turn out to be a non-event.

Enter passively and exit aggressively!

Jim Brown

Send Jim an email



NEW DIRECTIONAL Call PLAY

COST - Costco - Company Profile

Costco Wholesale Corporation, together with its subsidiaries, operates membership warehouses. It offers branded and private-label products in a range of merchandise categories. The company provides dry and packaged foods, and groceries; snack foods, candies, alcoholic and nonalcoholic beverages, and cleaning supplies; appliances, electronics, health and beauty aids, hardware, and garden and patio products; meat, bakery, deli, and produces; and apparel and small appliances. It also operates gas stations, pharmacies, optical dispensing centers, food courts, and hearing-aid centers; and engages in the travel business. In addition, the company provides gold star individual and business membership services. As of September 2, 2018, it operated 762 membership warehouses, including 527 warehouses in the United States, 100 in Canada, 39 in Mexico, 28 in the United Kingdom, 26 in Japan, 15 in Korea, 13 in Taiwan, 10 in Australia, 2 in Spain, 1 in Iceland, and 1 in France. Further, the company sells its products through online. The company was formerly known as Costco Companies, Inc. Costco Wholesale Corporation was founded in 1976 and is based in Issaquah, Washington. Company description from FinViz.com

Everyone should know by now that Amazon and Costco are not competitors. They do sell some of the same items, but Amazon is not a threat. Costco is Amazon proof. If anything, they are becoming more of a threat to Amazon because their online business is growing rapidly.

For December, Costco reported sales of $15.42 billion a 7.8% increase over the year ago quarter. For the quarter ended on January 6th sales rose 9.5% to $52.99. Same store sales rose 7.5% in the US and 6.1% globally. Ecommerce sales rose 13.6%. For the quarter US same store sales rose 10.0%, globally 7.9% and Ecommerce 27.9%. These are dynamite numbers and show no weakness when other retailers are floundering.

Earnings are March 6th.

Shares are recovering from a monster crash in December. I am going to recommend an April call because there are no March options at this time. We will exit before their earnings. Having the expiration after earnings will retain premium until after earnings. Decay should be minimal.

Buy April $220 call, currently $5.35, stop loss $198.85.




Current Portfolio


Open Positions

Check the graphic below for any new stop losses in bright yellow. We need to always be prepared for an unexpected decline. Any items shaded in blue were previously closed.




Current Position Changes


CRM - Salesforce.com
The long position was entered at the open on Tuesday.

IBM - International Business Machines
The long position was entered at the open on Tuesday.

CAT - Caterpillar
The long position was entered at the open on Tuesday.


Original Play Recommendations (Alpha by Symbol)


CAT - Caterpillar - Company Profile

Comments:

CAT was doing ok until China posted the worst import/export numbers since 2013. Shares dipped sharply at the open on Monday but recovered to close down only 30 cents. Earnings are the 28th so we will hold it at least one more week and then make a decision on an exit. The market posted a gain last week but it was lackluster. It has gone nowhere for the last four days. CAT is reactive to the Dow so no Dow movement, no CAT movement.

Original Trade Description: Jan 7th

Caterpillar Inc. manufactures and sells construction and mining equipment, diesel and natural gas engines, industrial gas turbines, and diesel-electric locomotives for heavy and general construction, rental, quarry, aggregate, mining, waste, material handling, oil and gas, power generation, marine, rail, and industrial markets. Its Construction Industries segment offers backhoe, compact, track-type, small and medium wheel, knuckleboom, and skid steer loaders; small and medium track-type, and site prep tractors; mini, wheel, forestry, small, medium, and large track excavators; and motorgraders, pipelayers, telehandlers, cold planers, asphalt pavers, compactors, road reclaimers, and wheel and track skidders and feller bunchers. The company's Resource Industries segment provides electric rope and hydraulic shovel, landfill and soil compactor, dragline, large wheel loader, machinery component, track and rotary drill, electronics and control system, work tool, hard rock vehicle and continuous mining system, scoop and hauler, wheel tractor scraper, large track-type tractor, and wheel dozer products; longwall, highwall, and continuous miners; and mining, off-highway, and articulated trucks. Its Energy & Transportation segment offers reciprocating engine powered generator set and engine, integrated system, turbine, centrifugal gas compressor, diesel-electric locomotive and component, and other rail-related products and services. The company's Financial Products segment offers finance for Caterpillar equipment, machinery, and engines, as well as dealers; property, casualty, life, accident, and health insurance; and insurance brokerage services, as well as purchases short-term trade receivables. Its All Other operating segments provides parts distribution and digital investments services. The company was formerly known as Caterpillar Tractor Co. and changed its name to Caterpillar Inc. in 1986. Company description from FinViz.com.

For Q3, they reported a 47% increase in profits but that was not good enough. In Q1 earnings rose 99% and 120% in Q2. Expectations were high. Earnings per share were $2.86, up from $1.95 but just barely over estimates for $2.85. The company affirmed their full year guidance of $11-$12 saying nothing had changed since the last quarter. That should be good news. Any changes would have been expected to be negative. They said the China market remained healthy and produced a 40% rise in excavators in 2018. They previously guided for a $100-$200 million hit from tariffs and said with the year 75% over it looked like the impact would be at the lower end of the range.

In any normal period, a 47% increase in profits would be outstanding. Given the sharply declining market and the dumping of anything related to China and tariffs, CAT shares were crushed.

In late November CAT said the three-month rolling sales growth for the October quarter rose 18%. That was still good but down from the 21% in September. Total industry sales rose 46% after a 47% rise in September and 35% in August. Energy and transportation retail sales were up 7%, with oil and gas up 20%. The report showed some slight moderation, but it was still a good month despite the tariffs.

With the Chinese trade talks accelerating the odds of a deal are improving. The Chinese Vice Premier showed up unexpectedly at Monday's talks signifying China's interest in actually doing a deal.

Earnings are January 24th. ANY positive news on China will cause this stock to rocket. I am proposing a short term call and then decide ahead of earnings if we want to hold over.

Position 1/8/19:
Long Feb $135 Call @ $3.52, see portfolio graphic for stop loss.



CRM - SalesForce.com - Company Profile

Comments:

We were stopped on the original position the prior week. We reloaded using the February $150 calls on Tuesday. There was no specific news and shares were up slightly for the week despite the Nasdaq weakness on Monday.

Original Trade Description: Dec 10th.

SalesForce.com, inc. develops enterprise cloud computing solutions with a focus on customer relationship management. The company offers Sales Cloud to store data, monitor leads and progress, forecast opportunities, and gain insights through analytics and relationship intelligence, as well as deliver quotes, contracts, and invoices. It also provides Service Cloud, which enables companies to deliver personalized customer service and support, as well as a field service solution that enables companies to connect agents, dispatchers, and mobile employees through a centralized platform, which helps to schedule and dispatch work, and track and manage jobs in real-time. In addition, the company offers Marketing Cloud to plan, personalize, and optimize one-to-one customer marketing interactions; Commerce Cloud, which enables companies to enhance engagement, conversion, revenue, and loyalty from their customers; and Community Cloud that enables companies to create and manage branded digital destinations for customers, partners, and employees. Further, it provides Quip collaboration platform, which combines documents, spreadsheets, apps, and chat with live CRM data; Salesforce Platform for building enterprise apps, as well as artificial intelligence (AI), no-code, low-code, and code development and integration services, including Trailhead, Einstein AI, Lightning, Internet of Things, Heroku, Analytics, and AppExchange; and solutions for financial services, healthcare, and government. Additionally, the company offers cloud services, such as consulting and implementation services; training services, including instructor-led and online courses; and support and adoption programs. It provides its services through direct sales; and consulting firms, systems integrators, and other partners. salesforce.com, inc. has a partnership with Apple Inc. to develop customer relationship management platform. The company was founded in 1999 and is headquartered in San Francisco, California. Company description from FinViz.com

When the market is weak, go with strength. CRM shares rallied on the strong earnings then pulled back only slightly during the latest Nasdaq crash. The Nasdaq was the strongest index on Monday and hopefully we are nearing an actual bottom. With CRM shares showing relative strength, this may be a safe port in a volatility storm.

SalesForce.com reported earnings of 61 cents that beat estimates for 50 cents and the year ago quarter of 39 cents. Revenue rose 26% to $3.39 billion and beat estimates for $3.37 billion. The company guided for revenue as much as $3.56 billion in Q4 and analysts were expecting $3.53 billion. They said they were on path for $16 billion in revenue in 2020 and $22 billion by 2022.

Billings, metric of future performance, rose 27% to $2.89 billion and beat estimates for $2.68 billion. Revenues rose 25% in the Americas, 26% in APAC and 31% in EMEA using constant currency. Sales cloud revenues rose 11%, service cloud rose 24% and marketing and commerce cloud rose 37%. Platform and "other" cloud revenues rose 51% or 30% if you exclude the acquisition of Mulesoft. The number of deals for more than $1 million rose 46%.

Adjusted gross profit of $2.6 billion came from gross margin of 76.9%. They ended the quarter with $3.45 billion in cash.

This company can seemingly do no wrong. When the tech sector eventually recovers SalesForce will be a leader.

Position 1/8/19:
Long Feb $150 call @ $4.50, see portfolio graphic for stop loss.

Position 12/11/18:
Previously closed 12/20: Long Feb $150 call @ $4.40, exit $1.54, -2.86 loss.



IBM - International Business Machines - Company Profile

Comments:

We did not get a bounce from the CEO speech at CES 2019. The stock has not declined in a choppy market but as a Dow stock it is reactive to the Dow.

Earnings are the 22nd after the close. I propose we wait until the next newsletter to decide if we want to hold over or close at the open on the 22nd.

Original Trade Description: Jan 7th

International Business Machines Corporation operates as an integrated technology and services company worldwide. Its Cognitive Solutions segment offers Watson, a computing platform that interacts in language, processes big data, and learns from interactions with people and computers. This segment also offers data and analytics solutions, including analytics and data management platforms, cloud data services, enterprise social software, talent management solutions, and tailored industry solutions; and transaction processing software that runs mission-critical systems in banking, airlines, and retail industries. The company's Global Business Services segment offers business consulting services; delivers system integration, application management, maintenance, and support services for packaged software applications; and finance, procurement, talent and engagement, and industry-specific business process outsourcing services. Its Technology Services & Cloud Platforms segment provides cloud, project-based, outsourcing, and other managed services for enterprise IT infrastructure environments. This segment also offers technical support, and software and solution support; and integration software solutions. The company's Systems segment offers servers for businesses, cloud service providers, and scientific computing organizations; data storage products and solutions; and z/OS, an enterprise operating system. Its Global Financing segment provides lease, installment payment plans, and loan financing services; short-term working capital financing to suppliers, distributors, and resellers; and remanufacturing and remarketing services. International Business Machines Corporation has a strategic partnership with Samsung Electronics to manufacture microprocessors. The company was formerly known as Computing-Tabulating-Recording Co. and changed its name to International Business Machines Corporation in 1924. The company was founded in 1911 and is headquartered in Armonk, New York. Company description from FinViz.com

IBM is buying Red Hat to significantly increase their cloud offerings. This is a major deal and will completely change the focus and add to market share for IBM. Most analysts are just waking up to the fact this is a game changer.

The IBM CEO will present the keynote speech at CES 2019 on Tuesday. This could be a market moving speech. I propose we enter at the open and then hold until earnings on January 22nd and then decide whether to hold over.

Position 1/8/19:
Long Feb $125 call @ $2.00, see portfolio graphic for stop loss.



BEARISH Play Updates

VXX - Volatility Index Futures - ETF Description

Comments:

The VXX has fallen over 10 points since the recent high at 52. As the market continues higher the ETF will continue lower. Even if the market just set still for a month the ETF would decline because of the futures decay. We just need to be patient and it will be back under 30 soon.

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 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 history that the VXX always declines.

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 new rally into the Q1 earnings cycle 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. There are 34.2 million shares outstanding and ShortSqueeze.com says 44.5 million are short. The shares are out there and being traded because the volume on Monday was 46.5 million. More than 221 million traded on Feb 5th. This ETF is a favorite vehicle for the computer traders so the volume is always high. 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.

Previously: On Feb-5th a reader emailed me saying a friend was short 1,000 shares. When the VXX spiked $21 in afterhours, Ameritrade closed that position for a $35,000 loss. They did not have a protective stop loss.

We are 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 today.

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

Position 2/13/18:
Short VXX shares @ $49.16, no initial stop loss.



Prices Quoted in Newsletter

At Option Investor, we have a long-standing policy prohibiting the editors and staff from actually trading the individual recommendations in order to conform to SEC rules concerning trades.

The prices quoted in the newsletter are the end of day prices in most cases.

When discussing fills or stops the prices quoted are the bid/ask at the time the entry trigger or exit stop is hit. This is NOT a price that someone on staff actually got using a live order.

For entry/exit points at the market open the prices quoted will be the opening print. The majority of the time readers are able to get a better fill than the opening print because of market maker bias at the open.

For trades with an opening qualification the prices quoted will be the bid/ask at the time the qualification was met.

All of these rules normally produce worse prices than an active trader would normally get. Because they are standardized there may be some cases where a price quoted was better than an actual fill. If you received a price that was dramatically different than what was quoted please let us know.