Daily Archives: January 14, 2013

Stocks to Watch (Part 3)

January 14, 2013 (6:00 pm)

We made some trades in our Long/Short and Multi-Strategy Portfolio’s during today’s trading session. We’ll explain those trades here, along with some other charts we’re watching.

Boeing: We got back into a BA short position today at $76.62. We previously shorted the first break of the rising wedge, and were surprised by the quick reversal off the $73.50 level. We held the short position expecting it to be a re-test of the lower trend line. On a subsequent breakdown, we covered our short position at a small gain. The chart pattern became too messy for our initial thesis.

However, this morning it ran back up to that lower trend line where it again faced resistance. We entered a new bearish position here expecting the resistance to hold. We will cover the position if the shares again re-take the rising wedge and have a stop at $77.12 ($0.50 above our initial position).


Bank of America: We took a bearish position in BAC as it broke through an 8-week rising channel. It may be forming a symmetrical triangle here as it consolidates at lower levels, which is a bearish indication. We will continue to hold this position unless it is able to retake its 50 DMA on volume.


Chipotle: We took a bearish position in Chipotle as it broke down from a multi-week rising wedge. It has since rebounded slightly and has re-tested the lower trend line twice. It failed both times. We expect lower prices from here.


Google: We covered our short and put positions in Google late this afternoon. We initially took these positions after it formed a clear negative divergence with RSI as it tested the upper trend line of a multi-week rising wedge. We took profits today in the put positions (26% gain) and short positions (3% gain) only three days after we got into the positions. The shares are becomming oversold just as they’re now reaching the lower trend line. They will likely find support there in the near-term.


Netflix: We took a short position in Netflix this afternoon as it reached the upper trend line of a multi-week rising wedge. It did so as it approached overbought conditions. One potential outcome is a false breakout to the upside as it jumps into overbought territory before falling back into (and eventually below) the wedge. Another outcome is consolidation within the wedge until earnings. Of course, the last option is for the shares to lose the lower support line. We are fine holding our short positions through any of these three eventualities and expect lower prices in the intermediate-term.


Nike: We entered a long position in NKE this afternoon. It has formed an ascending triangle and broke out this morning. One thing we’re watching for is confirmation of this breakout. We placed a stop at $52.72 ($0.50 below our opening price) in case this turns out to be a false breakout.


Research in Motion: RIMM has formed a fairly substantial ascending triangle and broke out on Friday. A 100% measured move would have brought the shares to $14.50, which would have been a huge move. It raced past that measured move, and we believe it is overextended here. We shorted the shares at $14.89 as it hit extreme overbought conditions. It should retrace at least 50% of its recent move.


VIX (Market Volatility): A few important findings in the VIX chart. First, market volatility is approaching the lowest RSI levels seen over the past year (orange). It moved down so quickly that it almost jumped below its lower Bollinger Band. Second, it has formed a long-term trend line (blue). Each of the past two instances where it touched this trend line over the past year, the SPY saw a 2 point decline within the following week. Just something to keep an eye on.


Conclusion: Our outlook remains bearish on the markets through the intermediate term. A majority of the charts we review have a bearish bias, either due to bearish chart patterns or overbought technical indicators. We will continue to keep in mind that the Fed is pumping liquidity into the system. However, a significant pullback is due within the next few weeks. We don’t expect a re-test of the November lows, but do expect to fill the gap created on the positive outcome of the financial crisis. Let us know your thoughts in the comments.

Apple’s “Generational Low”

January 14, 2012 (2:00 pm)

We’d like to share two quick charts on Apple. There has been much talk over the past few weeks about whether the $500 level will represent a “generational buying opportunity” when we look back in a few months. Let us know what you think in the comments.

Important Trend Lines

Apple bounced off the very significant blue trend line that it has formed over the course of the entire correction. Once it’s able to decisively take out the orange trend line, which has proven to be firm resistance thus far, the correction will officially be over.

AAPL Trend Lines

Falling Wedge

Apple dipped to just under $500 this morning. This new low formed the third touch of the bottom trend line and has validated our enormous falling wedge. This new low took place with rising RSI momentum, clearly forming positive divergence. Each of the lower low’s have been established on weaker and weaker selling pressure. A test of the upper trend line is due, with a potential breakout on earnings. Due to high call option OI this Friday, consolidation near $500 would make a lot of sense until next week.

AAPL Falling Wedge

Divergence Precedes Huge Changes in Trend

The chart below illustrates the power of divergence between price and the RSI/ChiOsc technical indicators. The dramatic trend changes in April and September were both preceded by a prolonged period of divergence between price and the momentum indicators. We’re currently seeing the same trend (but in the opposite direction). While the stock has been forming lower lows, the momentum indicators have been diverging from the downward trend. The selling pressure is decreasing on each subsequent move down. We expect an enormous shift in sentiment and price action after Apple reports earnings next week.

AAPL Divergence

Shaking Out the Weak Hands

January 14, 2013 (12:00 pm)

Déjà vu. The Wall Street Journal reported late last night that Apple cut iPhone component orders due to “weaker than expected demand” for the Jan-March quarter. The report went so far as explaining that Apple seems to have cut orders by 50%. By the way, the WSJ attributed this to “people familiar with the situation.” It feels like we’re in the Matrix. Haven’t we been here before? It looks eerily familiar… déjà vu.

On November 9, 2011 (during the year ago holiday quarter), Business Insider reported: “There’s a troubling new [Digitimes] report that Apple is reducing component orders from Asia suppliers because of sales and production problems with the iPhone 4S.”

The article suggested that not only were sales weaker than expected in the holiday quarter, but that Apple was decreasing orders for the March quarter as well. Shares of Apple fell 3% that morning. Interestingly, Apple absolutely crushed iPhone estimates in the holiday quarter, selling 37 million iPhones vs. a mid-20 million estimate. The shares went on to climb $225 in the ensuing two months following the report. Further, Apple also blew past March quarter estimates. Shares jumped over $50 the day they reported earnings. These articles are meant to spread FUD (fear, uncertainty and doubt) through the Apple investing world.

*1:20pm UPDATE*

We found another article from the same November 2011 time period. CNET reported “Slower iPhone 4S demand making Apple rethink supply orders. Although the iPhone 4S appears to be selling well, a new report claims Apple has pushed back some supply shipments in the fourth quarter due to lower-than-expected demand.”

Let’s assume, for a moment, that Apple actually did cut orders from its supply chain. There are two rational explanations that would not have negative implications:

  1. The iPod Touch. The Touch shares the same screen as the iPhone, which the WSJ speculated saw orders cut dramatically this month. iPod’s tend to see robust holiday sales, followed by a fairly dramatic fall off in the March quarter. Apple could be decreasing supplies for those specific devices.
  2. Yield. Apple could have very likely ordered significantly more supplies for its iPhone as it expected to make due to low yields. As production yields improve, they can decrease supplies without impacting the projected numbers to be supplied.

The timing of the latest report from the WSJ could prove extremely beneficial. It restrains expectations for the March quarter as we head into the December earnings report. With decreased expectations for March guidance, it will be even easier for Apple management to deliver an earnings beat, not only in January, but also in April. An enormous rally is even more likely thanks to this report.

Our Suspicions: So why does this timing seem suspicious? As we’ve discussed at length here and here, there are nearly a million Apple calls above the $500 strike price that expire this Friday. There are literally billions and billions of dollars to be made by large institutions and hedge funds that sold those calls. If they expire worthless, those institutions are able to keep the premium they collected on the calls.

To make a somewhat complicated story more simple, let’s look at a brief example. When you buy an Apple call option (let’s say for this Friday, January 18th), somebody is selling you that option. That seller is typically a large institution, hedge fund or market maker looking to create income. They receive the premium that you pay for the option. If that option expires worthless, they get to keep the full premium without payout you anything. If it expires above the strike price, they pay out an amount equal to the closing price less the strike price. So the lower the strike, the better for the option seller.

The Bullish Effect. One thing we haven’t discussed is how these institutions hedge their risk. Most often, option sellers purchase 100 shares of stock to sell a single call option (since a single option contract is for 100 shares of the underlying stock). So they own 100 shares and have sold a call. You may know this as a covered call. If the option expires in-the-money, the institution can simply transfer the shares they own to the option holder. But if the option expires worthless, they received a bit of premium and are now sitting with 100 un-hedged shares of Apple.

If we think about how this is likely to work, these institutions are likely to make out with a hefty profit. As we expected, the shares are down to the very low $500 level heading into options expiration. This will have the effect of wiping out all of the call options above the $500 strike price level. There are almost a million call contracts above that level. Assuming a majority of these contracts have been hedged, this represents almost 100 million shares (one million contracts x 100 shares per contract). Next Monday morning, when these calls expire worthless and these 100 million shares have no upside hedge, the institutions have an enormous to allow the price to run.

What else is happening next week, just after options expiration? Oh yeah… earnings. Which are likely to come in well above consensus estimates. So just as the largest institutions and money managers see their 100 million shares become un-hedged, there’s a huge catalyst that will likely force shares to skyrocket.

This all seems too convenient. We’re buyers in the low-$500’s heading into options expiration.