Options Trader: Monday Morning Ideas

by: Philip Davis

Phil Davis submits: Where's the KABOOM? There was supposed to be an earth-shattering KABOOM... Well, we finally got that out of the way. North Korea proved they could do what any properly motivated country can do. The question is, what could possibly motivate someone to go nuclear in this day and age?

"States like these, and their terrorist allies, constitute an axis of evil, arming to threaten the peace of the world... We will develop and deploy effective missile defenses to protect America and our allies from sudden attack. (Applause.) And all nations should know: America will do what is necessary to ensure our nation's security.

"I will not wait on events, while dangers gather. I will not stand by, as peril draws closer and closer. The United States of America will not permit the world's most dangerous regimes to threaten us with the world's most destructive weapons. (Applause.)

"It costs a lot to fight this war. We have spent more than a billion dollars a month -- over $30 million a day -- and we must be prepared for future operations."

Oh yeah, I guess I'd be looking to defend myself too.

Even after Bush's fiery rhetoric, North Korea didn't restart their nuclear program until 2002, when we violated the nonproliferation agreements we had made with them under the Clinton administration. Some could say we made this bed ourselves, but who would want such a thing?

Today will be a great test of our "just doesn't matter" Meatball Market rally as one would think nothing matters more than nukes.

It matters in Asia, as Hong Kong dropped 1.2% and South Korea lost 2.4%. Don't be fooled by the Nikkei being flat; they're closed. Europe is trending down about 1/2 point as Russia shows our Republicans how to handle criticism!

In the "move-along-nothing-to-see-here" department: Fidelity's 2 largest funds, the $45B Magellan fund and the $65B Contrafund (wasn't that started by Reagan?) are lagging the S&P by 7 and 4 percent respectively. Lagging the S&P by 4.4% still places the Contrafund in the top 20% YTD though, as it has been an awful quarter for funds. Why? Heavy reliance on commodities!

Like I've been saying since last week -- we've just got to be ready to go with the flow here. If we get new highs, we're ready to rally, but if the market reverses, we have plenty of bets covered.

Anything up would be amazing today, so let's just keep an eye on our downside targets so we know when to panic.

The Dow looked like it was going to be clear sailing to 11,900, but now we have to watch that 11,800 mark, which was tested briefly on Friday. Previous ceiling 11,700 must act as proper support!

The S&P impressively held 1,350 (ok, .42 below) Friday and needs to impress us on the 1,340 line in a downturn. As is often the case, the NYSE shall lead the way as the 8,500 line will be a powerful warning to the downside.

Nasdaq support is (hopefully) at 2,275, but the 200 DMA looms large at 2,225. We need to watch the SOX, which seems to have run out of gas and may test the 50 DMA at 440 where it MUST bounce or become an indicator of BIG TROUBLE!

After waiting for 3 weeks to get there, it would be a real shame if the Transports can't hold 2,550, but I think that will fall at the open so let's keep a more realistic eye on the hard-fought 2,500 line which would be the second sign of a potential market apocalypse.

As I mentioned above regarding Fidelity and another trillion dollars that is still placed on commodities, we can expect a continued push to spin both the Korea test and OPEC cuts for all they are possibly worth -- the question is how long can it last?

From a charting perspective you can expect a boost for a week or two that will do little more than confirm a head and shoulders formation that will give us a clear indicator of the next leg down. I'm sure Tom will be covering this a lot better than I can!

Tom and I go head to head today as we anxiously await the Royal Swedish Academy of Sciences' choice today for the Nobel Prize in Economics! Will it be the GOAX or Valero Rule? Jagdish Bhagwati thinks he has a shot, as the Nobels sometimes like to make a political statement, but I say there's no place for that sort of thing in business (wink, wink)... Phelps is the safety bet as they like to give it to the oldest living candidate!

Oil could go all the way to $68 without giving us a positive break, but let's watch that $61.69 mark to see if they are serious. Rather than dumping my oil puts below that mark, I will be taking some defensive long positions, following the Valero Rule to the letter!

Gold will give us a good idea of how serious the world views the Korean situation as it will surely reverse a downtrend and fight a strong dollar to post gains today. If gold can't break $585 today it will be in serious trouble tomorrow when the treasury markets resume, as we should get a nice move in the dollar as a global flight-to-safety play.

I don't know why everyone is so shocked at this latest Washington sex scandal; the last two they buried in 1989 and just back in April seemed worse to me. Kind of puts that Clinton thing in perspective doesn't it? Here's a great rundown of the timeline and the people involved!

Truly nothing matters but earnings this week with little economic news until Thursday's trade report, where analysts will be "surprised" that a 10% drop in the $27B a month we spend on imported oil will narrow the trade gap. Wednesday brings us the Fed minutes and the slightest sighting of hawks there will worry the bulls. Tomorrow night will be a shocker if $60 oil and a month-long rally can't boost consumer confidence, but my own polls say there are still some issues to be resolved.

Q3 is shaping up to be a danger zone, as the energy sector will have a very hard time adding much to last Q3's 40% average earnings gains. While the average price of a barrel was 8% higher this year, costs have certainly gone up along with expectations. If they can't get oil firmly back into the $60s then forward projections will quickly suffer.

I'm going to be looking at last November's pricing as my rule of thumb on where an energy stock should be trading, as oil had just broken below $60 and oil companies had just announced record profits while we were all worried that Iran was going nuclear (sound familiar?).


I hate to say it but I'm still on the sidelines today. Oil back over $60, underground testing in Asia, Iran still a hot issue, Iraq a catastrophe, commodities racing higher... this may not be the recipe for success we have all been hoping for!

On the other hand, I'm not going short just yet either. The markets have been exceptionally strong, no earnings warnings to speak of, OPEC is historically ineffective at controlling prices and the North Korean test may have been faked.

That's right, the pressure on Il to put up or shut up has become so intense that it is slightly possible that he blew up a conventional weapon in an underground test and claimed it was a nuke. Wouldn't that be funny?

Here's one I never added to my tracking list. My old pals BRK.A and B, which I picked as my stock of the year last fall, way down at $86,000, and again here on August 5th. Friday's close: $98,400.

This is a play money only environment and every pick is a slot bet as news flow can turn the market on a dime until we get some earnings clarity so be extra super careful and protect those profits!!!

Today's Picks:
Let's look for some day-trading opportunities today in commodities:

  • Phelps Dodge Corp. (PD) still has room to grow if copper stays positive, and I like the $87.50s for $1.30 as a momentum play. We need to watch Southern Copper Corp. (PCU) and the price of copper (currently $338.85) over $340 to stay with this one.
  • Alcoa Inc. (NYSE:AA) has earnings tomorrow and I don't see any reason not to take a gamble on the Nov $30s at .35 as a balance to my bearish trades. If the economy is as on-fire as the Dow would have us believe then why would this stock be trading 30% off its high? We already have the Nov $27.50s at $1.25 (up 32%), so this is a nice pre-roll that let's us sell into earnings excitement.
  • I borrowed my cousin's Q phone yesterday and WOW! It's like having a tiny little computer with full web access all the time. $79 a month on Verizon Communications Inc. (NYSE:VZ) for unlimited browsing and 500 minutes with a screen size double the Pearl's. I've been waiting for a pullback that may never come on this stock!
  • I'm not generally a big fan of buybacks but Sonic Corp. (NASDAQ:SONC) is taking 19% of its stock off the table for less than the 2005 high of $24. Their forward P/E of 22.5 will be reduced to a very respectable 18, conveniently in the buyout zone ahead of the 10/17 earnings. Also very interesting, they wanted to buy $560M but could only get $366M back from shareholders! The Nov $22.50s for a buck are still .50 under what management is willing to buy it for today ...

If oil can break above $60.50 (we expect major resistance at $61.69) and, of course, following the Valero Rule:

  • ExxonMobil Corp. (NYSE:XOM) was at $55 last November, but the $70s for .25 may come into play this week, but I will be loading up on puts on the way up. We already have 2 rounds of Nov $70 calls at .95 (down a dime) as parts of spreads, so this is just a slight protective weighting.
  • I will also be adding to our XOM Nov puts on any upturn as their $12B Russian project is getting squeezed by Putin -- and I just dare them to say something! As reported here last month, when faced with Exxon's 33% cost overruns, Putin said: "Do they think I am Bush? I don't put up with this nonsense from oil companies!"
  • Tesoro Corp. (NYSE:TSO) (which held up well last fall) $60s for $1.20 should track Valero Energy Corp. (NYSE:VLO) up.
  • ConocoPhillips (NYSE:COP) $60s are reachable at .45.
  • BP PLC (NYSE:BP) $65s for .85 and get out/don't buy below $65. These guys are still causing trouble!
  • Veritas DGC Inc. (VTS) is expected to have grown earnings by 380% this quarter and they should be up 100% for the year so I don't mind taking a chance on the Nov $70s for .55 as long as the stock can hold $65.

If oil doesn't break $60.50 or is rejected at $61.69 -- Party On! We have lots of puts already but I still like:

  • Chevron Corp. (NYSE:CVX) $65 puts below $1.25 or the Nov $60 puts we already have at .80 (up a nickel).
  • EnCana Corp. (NYSE:ECA) is still 10% above last October's level when nat gas was about $12 and Katrina/Rita put them in the catbird seat. Analysts expect them to earn .93 on 10/25 vs. .83 last year, but it looks to me that sales are off 10% already and that will be tricky. The Nov $45s are $1.95 and I would love to get them closer to $1.50. Get out/don't buy if this one breaks $47.
  • Oceaneering International Inc. (NYSE:OII) was at $25 last November so you've gotta like the Nov $30 puts for $1.20 just in case they don't make the 66% gain in earnings the street is looking for. My danger zone for these guys is a very tight $32
  • Royal Dutch Shell (NYSE:RDS.A) is in love with that $65 line, and the Nov $65 puts are reasonable at $1.40.
  • Transocean Inc. (NYSE:RIG) is quite a bit down from May but quite a bit up from last year when Q3 earnings dropped them to $52.34 in October. We have to wait until 11/2 to find out if they really can bear last year's earnings by 50%, and this one does make me nervous as the deep-water sector has been strong, but the Nov $65 puts are just too tempting at $1.90 with a get/out don't buy at $70.50.

Don't take today too seriously -- let's just watch and have some fun!

Read all of Phil Davis's articles on Seeking Alpha.