11/14/11

Dear Fellow Big Money Options Traders,

Between now and year’s end, the U.S. stock market is going higher. We’ll be putting on a lot of trades in the next few weeks to take advantage of the rising market. Last week, we added three new positions

On Nov. 4, our market sentiment indicator turned bullish. Throughout the past 40 years, the indicator has turned bullish 57 times. The signal was correct 37 of those times, with an average gain of 16.9%. The 20 incorrect signals produced an average loss of 2.3%. The market currently has high positive expectancy.

Third-quarter earnings season officially ends Tuesday morning with WalMart’s (WMT) pre-market report. Since Alcoa (AA) kicked off the reporting period Oct. 11, 2,197 U.S. companies have released their Q3 numbers. Of those 2,197 companies, 61.9% have reported earnings that were better than the consensus analyst estimate.
The graph below shows that 61.9% is not the strongest record, but it’s better than the prior two quarters.
 
Source: Bespoke Investment Group
 
Warren Buffett, through Berkshire Hathaway, invested $23.9 billion in stocks in the third quarter. That was the firm’s biggest commitment of new cash in at least 15 years. This figure includes the outright purchase of chemicals maker Lubrizol for $9 billion and another $5 billion in Bank of America preferred shares and warrants. The company also raised its ownership of IBM to 5.5% during the quarter and laid out $7 billion for a smattering of common stocks under the label “commercial, industrial and other.”
About a month ago, Warren Buffett offered to buy back an unlimited number of shares of Berkshire Hathaway in an open-ended share repurchase program. The plan allows Buffett to buy back lots of stock at a price not to exceed a 10% premium-to-book value. Buffett’s buyback isn’t designed to boost Berkshire shares. The plan is in place because he believes that buying back Berkshire Hathaway stock at the right price is the best use of the company’s money to generate returns for current shareholders. He believes Berkshire, which is broadly invested in the U.S. economy, is going higher.
Investment institutions are in accumulation. We finally have sustained buying pressure supporting stock valuation.
Italy has calmed the bond market with the resignation of Prime Minister Silvio Berlusconi, the formation of an interim government and the passage of a new 2012 budget with further austerity measures. The Italian 10-year debt yield has dropped well below 7% and is trading now at 6.45%. Last week, it jumped to 7.48%, which triggered a “the euro is coming to an end” doomsday-type initial reaction. More than 7% is considered unsustainable and is the point when Greece, Portugal and Ireland had to start receiving bailout funds.
Below is the one-year chart for the Italian 10-year bond yield.
 
 
The two most troubled parts of our economy — housing and jobs — are showing signs of reaching a bottom or modest acceleration in the right direction. The four-week moving average of jobless claims is at 400,000 now. Under 400,000 and closer to the mid- to low-300,000 range, we should see major strides in the reduction of the unemployment rate.
In the graph below, you can see that unemployment claims were in the low-300,000 range from 2004 through 2007. During those years, we experienced a bull market. Breaking below 400,000 on a four-week moving average basis is an important threshold for job growth.
 
 
In October, the Case-Shiller 10- and 20-city indexes of home prices both remained higher than their March lows. The year-over-year graph below of the Case-Shiller data shows that the change in year-over-year percent decline in sales prices bottomed in May and June.
 
 
Although real home prices may continue to decline, nominal prices are what matter in housing. Your loan isn’t adjusted up for inflation. If you owe $200,000 on your home and its value stays flat at $200,000 for several years, then your house is depreciating in real terms relative to inflation, but you aren’t building negative equity versus your loan. Conversely, while nominal home prices stay flat and incomes rise with inflation, home affordability keeps improving.
Currently, housing affordability is near record levels. These circumstances create fewer distressed sales and increased housing demand over time.
This Friday, we’ll see the Leading Economic Indicator (LEI) index, which is expected to rise once again in October. Sustained bear markets are almost always preceded by a declining LEI index.
 
REVIEW OF TRADES/POSITIONS
The full details of each trade are shown on the Big Money Options website.
 
Positions Opened 
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 $1.15 at market close on Friday. We recommend this trade on pullbacks to our recommended limit.
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 35 cents, and the combo could be opened for a net debit of 10 cents. We recommend this trade on pullbacks to our recommended limits.
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 40 cents. We still like this trade.
 
Positions Closed 
MGIC Investment Corp. (MTG) — On Oct. 27, we recommended you “buy to open” the MTG Mar 4 Calls (MTG120317C00004000for 41 cents or less, and simultaneously “sell to open” the MTG Mar 2 Puts(MTG120317P00002000for 41 cents or more, for a zero net credit. The pricing moved a bit, and our entry price was a 6-cent debit. On Nov. 8, we closed this position for 28 cents, a 366% profit in less than two weeks.
 
Top Trades Now
Applied Micro Circuits Corp. (AMCC) — See Positions Opened above.
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 48 cents. We like this trade on weakness up to our limit price.
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 75 cents. We like this trade on weakness up to our limit price.
Harmonic (HLIT) — See Positions Opened above.
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 $1.80. We like this trade on weakness up to our limit price.
ON Semiconductor (ONNN) — See Positions Opened above.
 
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.
Forest Oil Corp. (FST) — On Sept. 7, we recommended you “buy to open” the FST Nov 23 Calls (FST1 111119C00023000for $1.30 or less. At market close on Friday, this position was 10 cents. On Sept. 21, FST announced a final distribution ratio for the special stock dividend of 0.61248511 of a share of Lone Pine common stock (LPR). The FST option symbol changed to FST1. The new deliverable per contract is 100 shares of Forest Oil (FST), 61 shares of Lone Pine Resources (LPR) and cash in lieu of the 0.248511 fractional LPR share. Until the cash in lieu amount is determined, the underlying price for FST1 will be determined as follows: FST1 = FST + 0.61248511 (LPR). Hold. This position should expire worthless on Friday.
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 90 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 two 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 $1.20 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 15 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 $3.40. With the stock trading below our put strike, we don’t recommend adding new money to this trade.
 
Parting Shot: Bull Pennant?
The S&P 500 (SPX) is forming a triangle shape, shown below bounded by the two orange lines. Chartists believe that as the market wedges into the apex of the pennant, it will make a sharp move either up or down. We believe the weight of the evidence of this formation is setting up for a strong end-of-year rally.
 
 
As we’ve said, we expect the volume of our trading to increase. We put on two new trades Friday alone. So stay alert for more new trades this week as we gear up to make Big Money through the end of December.
 
Have a great week trading,

Nick Atkeson and Andrew Houghton
Editors
Big Money Options
 

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