Dear Fellow Big Money Options Traders,
Is the sell-off that started intra-day last Wednesday just a scare or a break? With two hours to go until the market close last Wednesday, investors collectively decided to hit the sell button in reaction to rating company Fitch’s warning that the “broad credit outlook for the U.S. banking industry could worsen” unless there’s a timely resolution to the eurozone debt crisis. From there, the market dropped 4% going into the end of the week.
Today, the news continues to disappoint, with The New York Times reporting that the Super Committee has failed to reach any agreement on cutting $1.2 trillion from the budget. Now we’ll see whether Congress allows forced cuts to take place early next year.
In Europe, there doesn’t seem to be a consensus in the European Union about how to handle their problems. As time passes, debt yields are rising and economic growth is becoming more uncertain. Rating agency Moody’s warned today that if French sovereign debt yields persist at its current high level and economic growth remains weak, there will be negative credit implications that’ll make borrowing even more expensive.
Technically, our bull flag formation on the S&P 500 (SPX) broke sharply to the downside, which generally isn’t good. Part of the problem is that trading volumes are light, so when sellers go to sell, volatility jumps higher as market-makers struggle to find a price where demand matches supply. Stock buyers have grown weary of the apparently never-ending euro debt negotiation. Many of them are simply sitting on their hands, waiting for a more definitive result from Europe before investing.
How do we know U.S. stock buyers are on strike? Just look at what didn’t cause the market to go up last week.
On Friday, the Conference Board published the Leading Economic Index (LEI) for the United States. The index accelerated upward. “LEI for the U.S. increased 0.9% in October to 117.4 (2004 = 100), following a 0.1% increase in September and a 0.3% increase in August.” The October rebound of the LEI was driven largely by a sharp pick-up in housing permits, and labor market indicators also made an important contribution. The Coincident Economic Index (CEI) also rose as a result of higher industrial production and employment.
If all you did was judge the state of the world by the LEI chart below, you’d think the world had never been better.

 
If you study the chart above and ask yourself, “Could I have used the LEI and CEI as a leading indicator of future stock direction?” we believe the answer is a resounding yes. Before the market drops in 2001/2002 and 2008, the LEI and CEI were declining. Today, we don’t see this pattern.
U.S. jobless claims for the week ended Nov. 12 were 388,000 versus consensus of 397,000. The four-week moving average for jobless claims is 396,750, which is down from 400,750 (revised). Below 400,000 is considered an important threshold for the health of the jobs market.
October U.S. housing starts were 628,000 versus consensus of 602,000; building permits were 653,000 versus consensus of 603,000. For the past two and a half years, housing starts have been moving sideways, with minor ups and downs. Housing starts may finally be making a sustained advance, albeit off of very low levels. Existing home sales for October will be released today.
On a monthly basis, retail sales were up 0.5% from September to October (seasonally adjusted, after revisions), and sales were up 7.9% from October 2010. This was well above the consensus forecast for retail sales of a 0.2% increase in October; no change ex-auto. To make the point more graphically, the chart below shows a steady up-and-to-the-right track.

 
U.S. corporations raised more than $20 billion in low-cost debt financing just last week. November is turning into the largest debt market money raise since May. A healthy U.S. corporate debt market translated into a healthy U.S. stock market over time, given the trickle-down effects of stock buybacks, dividend increases, and merger and acquisition activity.
Based on the above-mentioned economic metrics and the Empire manufacturing index, Philly Fed survey and proprietary business surveys, economists at JPMorgan Chase (JPM) now see gross domestic product rising 3% in the final quarter, up from a previous prediction of 2.5%. Macroeconomic Advisers in St. Louis increased its forecast to 3.2% from 2.9% at the start of November, while Morgan Stanley (MS) boosted its outlook to 3.5% from 3%.
The S&P 500 (SPX) has declined from a late October high of 1,284 to roughly 1,200 currently. At this level, the market break to the downside is just a scare. Our market sentiment indicator remains bullish, and the market now is modestly oversold as measured by the percent of stocks trading above their 10-day moving average.
It seems like it’s impossible to overuse the phrase “the beatings will continue until morale improves” when talking about the stock market today and our reliance on legislators to take responsible action in addressing debt and spending excesses. The light trading volume says it all: People are tired of the crazy market and highly skeptical that our elected leadership will have the courage to do what needs to be done.
The loss of faith and high levels of pessimism are laying the groundwork for the next market advance. Although it’s nearly impossible to forecast what politicians in Europe and the United States might do this week, we do know that the valuation of the 15 economies that comprise most of the world’s economy are trading 30% to 60% below their long-term valuation averages at a time when interest rates are near zero. If history is a guide, then stocks are likely to demonstrate mean-reversion, implying a strong, steady advance from current levels.


REVIEW OF TRADES/POSITIONS
The full details of each trade are shown on the Big Money Options website.
 
Positions Opened 
American Axle (AXL) — On Nov. 16, we recommended you “buy to open” the AXL Jan 11 Calls (AXL120121C00011000for 35 cents or less. At market close on Friday, this position was 17 cents. We still like it up to our recommended limit price.
Corning (GLW) — On Nov. 15, we recommended you “buy to open” the GLW May 15 Calls (GLW120519C00015000) for $2.30 or less. At market close on Friday, this position was $1.90. We still like it up to our recommended limit price.
 
Positions Closed 
Forest Oil Corp. ( FST ) — On Sept. 7, we recommended you “buy to open” the FST Nov 23 Calls ( FST1 111119C00023000 for $1.30 or less. At market close on Friday, this position was 10 cents. Although FST made a strong bull run in the past several weeks, it failed to exceed its strike price, and our position expired worthless on Friday.
 
Top Trades Now
American Axle (AXL) — See Positions Opened above.
Applied Micro Circuits Corp. (AMCC) — On Nov. 8, we recommended you “buy to open” the AMCC Feb 7.50 Calls (AMCC120218C00007500for $1.05 or less. This position was 90 cents at market close on Friday. We recommend this trade up to our limit price.
Corning (GLW) — See Positions Opened above.
Harmonic (HLIT) — On Nov. 11, we recommended you either “buy to open” the HLIT Apr 7.50 Calls (HLIT120421C00007500for 30 cents or less — OR — open a combo by “buying to open” the HLIT Apr 7.50 Calls (HLIT120421C00007500for 30 cents or less, and simultaneously “selling to open” the HLIT Jan 5 Puts (HLIT120121P00005000) for 30 cents or more, for a net zero debit. (Please note that we bought April calls and sold January puts.) At market close on Friday, the HLIT April 7.50 calls were 30 cents, and the combo could be opened for a net credit of 5 cents. We recommend these trades up to our price limits.
NXP Semiconductors (NXPI) — On Nov. 2, we recommended you “buy to open” the NXPI Jan 17.50 Calls (NXPI120121C00017500for $2.30 or less. At market close on Friday, this position was $1.45. We like this trade on weakness up to our limit price.
ON Semiconductor (ONNN) — On Nov. 11, we recommended you “buy to open” the ONNN Jan 9 Calls (ONNN120121C00009000for 40 cents or less. At market close on Friday, the position was 25 cents. We still like this trade up to our limit price.
 
The remaining open trades are:
Amkor Technology Inc. (AMKR) — On Sept. 16, we were put AMKR stock at $6, plus 1 cent for the cost of the original combo trade. On Sept. 19, we recommended you “sell to open” the AMKR Dec 5 Calls(AMKR111217C00005000) for 40 cents or more in a 1:1 ratio against the stock you own. As of the market close on Friday, you could get 25 cents for this option. Do not open this position unless you own the stock and can sell the option for at least our limit price.
Celestica (CLS) — On Sept. 15, we recommended you “buy to open” the CLS Mar 10 Calls (CLS120317C00010000for 60 cents or less. At Friday’s market close, this position was 47 cents. We still like this position, but because it has aged a bit, we’d rather put fresh money into our newer trades (see Top Trades Now).
Chemtura (CHMT) — On Oct. 18, we recommended you “buy to open” the CHMT Dec 12.50 Calls (CHMT111217C00012500for 90 cents or less. At market close on Friday, this position was 25 cents. We still like this position, but because it has aged a bit, we’d rather put fresh money into our newer trades (see Top Trades Now).
Leggett & Platt (LEG) — On Sept. 16, we were put LEG stock at $22.50, plus 5 cents for the cost of the original combo trade. On Sept. 19, we recommended you “sell to open” the LEG Dec 22.50 Calls(LEG111217C00022500) for 85 cents or more in a 1:1 ratio against the stock you own. As of Friday’s market close, this short position offered 50 cents. If you already own the stock but are not in the option, sell the stock with it near our cost basis. If you are in the stock and the option, do not take any action. We’re waiting through the expiration period. If you aren’t already involved in this trade, do not open a position.
SBA Communications (SBAC) — On Sept. 16, we were put SBAC stock at $40, plus 3 cents for the cost of the original combo trade. On Sept. 19, we recommended you “sell to open” the SBAC Dec 40 Calls(SBAC111217C00040000) for $1.20 or more in a 1:1 ratio against the stock you own. The company reported earnings a few weeks ago. The stock has almost fully recovered, and we would like to see our stock called away in December.
Telefonica (TEF) — On June 27, we recommended you either go long by “buying to open” the TEF Dec 25 Calls (TEF111217C00025000for 95 cents or less — OR — open a bullish combo by “buying to open” the TEF Dec 25 Calls (TEF111217C00025000) for 95 cents or less, and simultaneously “selling to open” the TEF Dec 20 Puts (TEF111217P00020000) for 80 cents or more, for a net debit of 15 cents or less. At market close on Friday, the long TEF Dec 25 Calls were 5 cents, and the combo offered a $1.45 credit to open. However, we don’t recommend adding new money given that the signal has aged considerably. Continue to hold.
Tellabs (TLAB) — On April 29, we recommended you “buy to open” the TLAB Jan 2012 5 Calls (TLAB120121C00005000for 65 cents or less. At market close on Friday, the position was 5 cents. The company has about $3.50 per share in cash, which should limit further downside. Hold; don’t add fresh money.
USEC Inc. (USU) — On Nov. 16, we recommended a bullish risk-reversal on USU by “buying to open” the USU Jan 2012 7.50 Calls (USU120121C00007500) for 70 cents or less, and simultaneously “selling to open” the USU Jan 2012 5 Puts (USU120121P00005000for 95 cents or more, for a net credit of 25 cents or more. We entered the trade for a 30-cent credit. At market close on Friday, the calls were 5 cents, and the puts were $3.80. With the stock trading below our put strike, we don’t recommend adding new money to this trade.
 
Parting Shot: One Tough Market
October U.S. existing home sales were 4.97 million versus consensus expectations of 4.85 million. Excess home inventory is slowly being absorbed: The market has eight months of supply, down from 8.3 months supply in September. This is just another example of better-than-expected economic news that’s being overwhelmed by negative, indecisive government action as the market declines today.
The private sector is slowly healing from the debt excesses of the past decade. Consumers and companies are working hard to reduce debt and improve their balance sheets. Home prices have declined dramatically, which is an important step in reaching a level where healthy market conditions can be restored.
Government, on the other hand, has yet to do this. While governments delay, uncertainty increases and economic activity slows. The choices that governments must make become dire as their debt ratings are downgraded and debt expense soars relative to declining tax receipts.
What has made 2011 such a difficult market-year is the sharp contrast between private and public enterprise. The positive steps that private enterprise and individuals have taken have had a measurable positive impact on the economy. These positive developments historically have been sufficient to raise market valuation on a sustained basis.
What has been incredibly difficult to forecast and trade is the lack of positive action by governments, which has more than offset this positive private-sector activity from a market-price standpoint. Additionally, having headline news regarding government debt management activity control stock valuations has contributed to stocks trading as a group rather than on the basis of their individual merits. Stock correlations have never been higher.
As we go through this holiday-shortened trading week, we’ll have to continue to assess whether this has been just a scare or a break.
 
Have a great week trading,

Nick Atkeson and Andrew Houghton
Editors
Big Money Options
 

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