Options Trader: Monday Morning Ideas

by: Philip Davis

China is running into inflation issues and fear of the Chinese CB tightening is giving Asian markets fits this morning. Japan’s economy also looks like it’s slowing as machinery orders dropped a huge 16% in July, meaning there is no way the BOJ can raise rates. This dropped the Nikkei 2% for the day and should at least give us a weak open as Japan is the world’s second largest economy. I’m not too concerned about the data because the June numbers were ridiculously high (+26%), so there was no way they would keep it up. But Bloomberg’s survey of 30 economists expected just a 5% monthly decline, which shows they are not much brighter than analysts.

Quick statistics lesson: When you bowl and you have a 200 average, you will generally bowl 180-220, game after game. Of course, once in a while, you have an exceptionally good or bad game. When you bowl 252 (52 points over average), do 30 of your drunken bowling buddies predict your next game will be 242—or are they smarter than economists?

Japan hasn’t grown at all in years. They had one good quarter (Q1) where they shot up to a 3.3% pace, but no one expected more than 1.5% for the year. Q2 is coming in at 1%, which is fine(ish), yet somehow our nation’s best economic thinkers come to the conclusion that two consecutive months should come in with orders at close to 20 times that pace…

So let them sell off this morning on that headline so we can pick up our General Electric Co. (NYSE:GE) and Caterpillar Inc. (NYSE:CAT) (see last weeks calls) nice and cheap.

I’m watching India where industrial production is through the roof:

Will India’s ($500b GNP) 12.4% year-over-year gain offset Japan’s ($4t GNP) 1.2% (that’s all it really is) year-over-year decline? Until we replace those economists with our more statistically aware bowling buddies, anything can happen!

So it’s another 300 point down day in Japan, and China is off 200 points. Europe is down about a point in early trading, and energy and commodity stocks are leading the declines.

Today will be a good day to see how firm our bottoms are all of our indices finished just below key technicals on Friday:

  • The Dow needs to hold 11,300. Anything over 11,400 will be a buy signal as it has provided a strong ceiling for most of August.
  • The S&P will make me very happy if it holds 1,295, but with the commodity sell-off, just holding 1,290 will be a sign of strength.
  • The NYSE will be our first sell indicator if it slips below 8,200 with it’s 50 dma at 8,220.
  • The NASDAQ needs to establish 2,150 as a floor, which will allow it to establish some badly needed leadership as investors swap out of prior leaders.

It’s all up to the SOX, which should get a little boost on the Freescale Semiconductor Inc. (NYSE:FSL) deal as an LBO group looks to take out the former Motorola Inc. (MOT) division for $16b (30% premium). SOX 440 is our key level, and the Nasdaq is going nowhere without it.

The transports need to lead the Dow and the S&P out of the dip, and this is a good day to test our coiled spring theory as any move below 2,350 will be a warning of a serious breakdown, while 2,400 could signal a huge rally.

Obviously I’m in the bull camp and am looking for a move up, but I am also half hoping for a nice pullback here so I can add to my positions (using profits from commodity puts) if we can just hold our levels.

Leadership change is a painful thing to watch and, as you can see from some of the comments I posted earlier from the world’s largest fund managers, a lot of people are getting caught with their pants down in commodities.

There are not enough dollars in circulation for these guys to all go to cash in short order, which will only exacerbate the problem for commodity holders as the dollar rises on a rare case of actual demand, as it takes a whole lot of dollars to get rid of a lump of gold.

This comes just as the EU and Asia are having a scheduled meeting to talk about how they need to decouple their fate from the US economy (which is funny because Asia already has, Europe has not).

Oil is below $66 in European trading, even with the OPEC meeting well underway. It should be noted that after 9/11 oil prices plunged as demand fell-apart as US and International transports ground to a halt. So, again, I remind you that you are still paying a fear-premium for all, and there is NO LOGICAL BASIS FOR IT!

We are still $10 above last winter’s levels with our oil-and-gas storage at 20 year highs, 15% above normal. And last winter a 2 hurricanes knocked out US production! We didn’t run out of oil; we discovered 15 Billion barrels off our own shores, so let’s see if $65 holds. If not, we have a lot of shorting to do!

The fear factor is being sucked out of gold at a pretty rapid clip; dropping commodity prices are taking the teeth out of inflation as well, allowing corporations to begrudgingly accept rising wages. Without anniversary attacks or more tension in Iran, the gold bugs’ hopes for global catastrophe are fading fast. Look for them to turn their attention back to our deficits this week in order to place some kind of floor on gold; perhaps $590 will be a firm floor, but below that, look out!

How much is gold really worth? Gold Fields Ltd. (NYSE:GFI) is buying Barrick Gold Corp.'s (NYSE:ABX) South Deep mine for $1.5b—that’s $100 per ounce. We know it costs $200 an ounce to get it out of the ground so, effectively, when gold producers sell to each other, $300 seems to be the right number.

This is the same sort of cartel action I spoke about in the Goldcorp Inc. (NYSE:GG) deal last month.

Thought for the day: How come a chip company like FSL is purchased by private investors for a 30% premium, while a strategic industry buyer like GFI buys gold for a 50% discount?

Until we have some new leadership it will be foolish to start buying heavily. I would rather conserve capital for a real move up when it comes. It would be much, much healthier for the markets to have their long overdue 2-3% correction before starting the next leg of this rally, where I fully expect us to test some new highs.

It is not our job to start a rally; we only need to catch the train before it leaves the station, so let’s concentrate on making sure we have enough money for the ticket. Take losses off the table quickly if we fall below our levels, and let’s wait for a real bottom if it comes to that.

We are currently up 700 Dow points since mid-July, so it will be a question of how quickly we can establish new leadership. The brokers report this week, and may disappoint us if they gambled on commodities and lost. This will hurt the whole market if we lose yet another leading sector.

Be very, very, very careful out there and don’t panic—we’ll give it one more day before we do that!

Corporate insiders are on my side of the fence, with insider buying doubling during August (and that’s even with massive dumping by oil insiders):

Today's Picks:
I am going out for the day to stop myself from buying things. I already have enough calls and I’m setting automatic stops on those if the indices break my technical points.

I’ll be watching General Electric Co. (GE), Apple Computer Inc. (NASDAQ:AAPL), CAT, International Business Machines Corp. (NYSE:IBM), Toyota Motor Corp. (NYSE:TM), Motorola Inc. (MOT), Microsoft Corp. (NASDAQ:MSFT) and my beloved Texas Instruments Inc. (NYSE:TXN) to see if what kind of shape we’re really in, but it’s the transports and SOX that will tell the story of the day.

  • Continental Airlines Corp. (NYSE:CAL) and other airlines may have a sell-off as headlines read advanced bookings are running behind last year. This is because they raised prices! Holy cow people, guns and butter, the Laffer curve... does anyone actually study economics anymore or is it just a catch phrase now? Load factors are up, prices are up, and the company made more money last quarter than in the past 3 years. Anyway, I still like the Dec $30s ahead of earnings, but if the $25s come down around $2 I will like them more.
  • Rio Tinto plc (RTP) makes a risky play, but the $190 puts are within reach at $1 for a momentum trade as copper is sure to follow oil to the downside.
  • We already have puts on Phelps Dodge Corp. (PD), but a conservative fellow could short Southern Copper Corp. (PCU) at $94.20, and sell the Oct $95 puts for $5.70 (probably more this morning) for a 6% return in 30 days and 5% upside protection. I know, 6% in a month—how dull!
  • I still really like E.I. DuPont de Nemours (NYSE:DD) here, and we are already in the Oct $42.50s at .20 (down .10). But I also like the $40s at $1.05. They raised prices to cover high oil cost, and oil is going down and the prices stay high so... Bah, I must be the only person who thinks this way!

  • Remember we are watching and waiting for another shot at Hewlett-Packard Co. (NYSE:HPQ). I have an auto bid on the Oct $35s for $1, but I doubt I’ll get that lucky. $34.50 is my hoped for bottom if it really sells off, but can people really believe a board squabble is going to derail a $100b company?
  • I think the REITs have gotten ahead of themselves, and I’m going to take a big chance with the Vornado Realty Trust (NYSE:VNO) Oct $105 puts for $3.50 and the November $100 puts for $2.30 as a pre-roll. I’m out of not buying if it makes a new high at $107.10, but I have faith that $107 will firm up as a ceiling here.
  • Brookfield Properties Corp. (NYSE:BPO) is another out-of-control property manager trading at 20 times forward earnings, but sadly has no options—currently at $36.19 for a short.
  • Ventas Inc. (NYSE:VTR) just bought $649m worth of senior-housing properties which they expect to be cash-flow positive, so I will be watching the market reaction to this high flyer, currently at $39.95.

If we break to the upside (and remember I am avoiding the markets today to stop myself from going on a buying frenzy) there are lots of nice lagging positions from the Weekly Wrap-Up.

Don’t forget MSFT, TXN and GE if things do get moving!

Have fun today,

- Phil