After two years a correction appeared. I am sure everyone would be fine with waiting another two years for the next one.

Unfortunately, the odds of having another two-year unobstructed rally without a correction are very slim. Typically, we have one 10% dip per year, two 5% dips and two 3% dips. It has been 14 months since the last 3% decline so that was well overdue.

Declines are good for the market. They provide opportunities to take profits and enter new positions. Unfortunately, they are never fun. We were blown out of our entire portfolio the prior week. Some positions were profitable, some were not. Life goes on. I am bring back two of those positions and assuming the market continues to improve I may add back a couple more.

On Monday, the Dow posted a slow and steady gain to more than 500 points before falling back at the close to +410. Could we please have more days like this with minimal volatility? Historically, it takes 4-5 weeks to work through the post correction volatility. Given the strong earnings and the benefit of the tax reform, it may not take that long to recover. I do not expect a vertical V bottom bounce but we could have a moderately quick recovery. There will be additional volatility. The major indexes have clear resistance and there will be sellers at those resistance levels. However, remember how long investors have been waiting to buy a dip and there were none. Now that stocks are cheaper, it appears they are coming back into the market. The investors who were long and were hurt in the decline will probably be more cautious.

Typically, there is a retest of the initial lows. The 410-point gain today gave us a cushion against further selling. That means a retest may not return to the lows but just be another dip on the market road higher.

The S&P dipped to the 200-day average for the first time since November 2016. Today it rebounded to close above the 100-day. We need to see it rise and close over the 50-day for an all clear signal. That is still about 78 points above today's close.


On Friday, the Dow bounced from support just above 23,250 and closed back above the 10% correction level of 23,954. The index tested that level for four consecutive days an closed under it on only one day by about 100 points. Monday's rebound retested prior support at 24,700, which should now be resistance. As with the S&P we need to see the Dow close over the 50-day at 25,111, which also gets us over the psychological level of 25,000 once again.


The Nasdaq had another banner day with a 107 point gain and solid rebound back above the 100-day average. The 50-day is still the level we need to see conquered before we can assume most of the selling it behind us. The index has gained 100 points for two consecutive days although the upward velocity slowed on Monday afternoon at the 7,000 level.

Facebook and Nvidia have been drags for the last several days but Apple is exploding higher.



The Russell 2000 never closed in correction territory and only dipped that low on one day. The index declined -10 points this morning but recovered to post a decent gain. The 100-day level is going to be resistance on the way back up along with 1,508.


The economic calendar is busy this week but the reports will be ignored as long as the Dow is making large triple digit moves. The market is the only thing on investor's minds this week.


The earnings cycle is winding down with only 57 S&P companies reporting this week. Cisco Systems is the only Dow component with Walmart and Nike the only two left to report after Cisco. Walmart is next week. The earnings headlines will be second to the market movement headlines but a couple tame days in the markets could put earnings back into focus.


I would not expect uninterrupted gains in the days ahead. That would be too easy. The upward velocity did slow towards the end of the day and the S&P futures had been down -8 but have recovered to unchanged. I am sure there are investors who missed selling at higher levels and they will be thinking, "If these *&$!# shares ever get back to that level I am selling. That is what causes continued volatility as the markets begin to rebound. I would not hesitate to buy good stocks on dips because the worst volatility is probably behind us.

Enter passively, exit aggressively!

Jim Brown

Send Jim an email



NEW DIRECTIONAL CALL PLAY

HD - Home Depot - Company Profile

Comments:

HD was hammered in the correction and we were blown out of our position with a $8 gain. I feel strongly about HD's potential and they are reporting earnings next week. The correction did not change their earnings picture. If they post a big beat, the stock could return to the pre correction levels.

Original Trade Description: February 12th.

The Home Depot, Inc. operates as a home improvement retailer. It operates The Home Depot stores that sell various building materials, home improvement products, and lawn and garden products, as well as provide installation, home maintenance, and professional service programs to do-it-yourself, do-it-for-me (DIFM), and professional customers. The company offers installation programs that include flooring, cabinets, countertops, water heaters, and sheds; and professional installation in various categories sold through its in-home sales programs, such as roofing, siding, windows, cabinet refacing, furnaces, and central air systems, as well as acts as a contractor to provide installation services to its DIFM customers through third-party installers. It primarily serves homeowners; and professional renovators/remodelers, general contractors, handymen, property managers, building service contractors, and specialty tradesmen, such as installers. The company also sells its products through online. It operates through approximately 2,278 stores, including 1,977 in the United States, including the Commonwealth of Puerto Rico, and the territories of the U.S. Virgin Islands and Guam; 182 in Canada; and 119 in Mexico.

The company reported Q3 earnings of $1.84 that rose 15% and beat estimates for $1.81. Revenue rose 8.1% to $25.026 billion, up from $23.154 billion. This beat estimates for $24.523 billion. Same store sales rose 7.9%. HD said the hurricanes added about $282 million in sales but also cost them about $51 million in store damages and inventory shifting costs. The company guided for Q4 revenue growth of 6.3% and same store sales of 6.5%. Those numbers were up from 5.3% and 5.6% in prior guidance. Earnings are expected to grow 14% to $7.36 for the full year, up from prior guidance of $7.29. Full year 2017 sales are expected to be $100.6 billion. They had $8 billion unspent on a $15 billion share repurchase program.

In early December, Home Depot (HD) announced a new $15 billion buyback and raised guidance for annual sales between $114.6-$119.8 billion by the end of 2020. The new repurchase program replaced the existing $15 billion program. The company expects to buy back $8 billion in shares total in 2017 with $2.1 billion in Q4. Since 2002, Home Depot has bought back 1.3 billion shares worth $73 billion.

Home Depot had an effective tax rate of 37% in Q3. Under the new tax plan that would drop to about 23%. Analysts believe this could boost HD's 2018 earnings by as much as 25%. That means their earnings could rise as much as $1.81. They currently have a PE of 25 and that would equate to about a $45 rise in the stock price. However, I would expect that PE to decline somewhat in the conversion.

Shares are already up after their November earnings guidance but I believe they can still go higher. Options are not cheap. In order to get the benefit of the rise in expectations I would like to reach out to May but the options are too expensive but not enough to make a spread worthwhile. I am recommending a March position and hopefully analyst projections will do the work for us.

Earnings are Feb 20th and I would plan to hold over that report because they will give tax guidance at that time.

HD is reportedly talking to XPO Logistics about an acquisition of the $9 billion company. HD uses them to deliver large items like refrigerators and other appliances. There could be a battle with Amazon since that large item shipping is a problem for Amazon.

Option premiums are high because of the correction and rebound. Shares were trading at $210 two weeks ago and now they are trading at $185. With earnings next week, they could be back at $200 or higher very quickly.

Buy April $190 call, currently $5.65, no initial stop loss.



NTGR - Netgear - Company Profile

Comments:

Shares crashed with the market to stop us out the prior week. This should be a new buying opportunity.

Original Trade Description: January 8th

NETGEAR, Inc. designs, develops, and markets innovative networking solutions and smart connected products for consumers, businesses, and service providers. The company operates in three segments: Retail, Commercial, and Service Provider. The Retail segment offers home WiFi networking solutions and smart connected products. The Commercial segment provides business networking, storage, and security solutions. The Service Provider segment offers made-to-order home networking hardware and software solutions, including 4G LTE hotspots sold to service providers for sale to their subscribers. The company also offers commercial business networking products, such as Ethernet switches, wireless controllers and access points, Internet security appliances, and unified storage products; broadband access products, including broadband modems, WiFi gateways, and WiFi hotspots; and smart home/Internet-of-Things connectivity and products comprising WiFi routers and home WiFi system, WiFi range extenders, powerline adapters and bridges, remote video security systems, and WiFi network adapters. It markets and sells its products through traditional retailers, online retailers, wholesale distributors, direct market resellers, value-added resellers, and broadband service providers worldwide. Company description from FinViz.com

Expected earnings May 8th.

Several weeks ago Amazon bought Blink. You may not have heard about Blink but they launched in 2016 with an inexpensive wireless camera and video doorbell. This is the hot new sector for video surveillance. You have probably heard about Ring video doorbells, which is a different company.

The point to this commentary is that Netgear is making the very popular Arlo security camera and sales are booming. Netgear also has 48% of the market for home routers.

With Amazon likely to go big in this category after the acquisition of Blink, that means Netgear is suddenly a target. Global Equities said Facebook, Google or even Apple could acquire Netgear because that gives them a top position in the space. Google would be the prime candidate because they could link the Arlo system to Google Home. It would also allow Google access to trillions of terabytes of data related to the home routers and networking equipment. Monitoring those devices would be like keeping their finger on the pulse of technology. They would know how many people are watching Netflix, how much data was being consumed by what subset of users, etc. This could be very important in their planning for the future.

Apple is not likely to make a play for Netgear because they do not do big acquisitions and Netgear has too many "common" products for Apple to manage. They would be more likely to buy Tesla or Netflix if they were going to make a big splash.

Arlo is an entirely new category for Netgear and a category that is exploding in sales. In their Q4 earnings they said the Arlo cameras posted record sales that exceeded their already optimistic expectations.

Since I wrote that in the initial play description Netgear has announced a spinoff of the Arlo security cameras. They will spin less than 20% and retain the rest. The cameras are so popular the IPO should be a big success and a good way for Netgear to monetize their investment. This will provide them a significant amount of capital to expand on their other product lines.

In reality, nobody has to buy Netgear for them to succeed. Netgear demonstrated new products at the CES show and the crowd loved them. Apparently, so did investors. They announced the Nighthawk Pro Gaming system of network gear that will cut lag time and enhance multiplayer game play for serious gamers. They also demonstrated the Orbi Wi-Fi system, which has also been very successful. With the rapid ramp of the Arlo video cameras for security, they have completed an entire cloud support system that allows storage of video, multiviewer capability for home monitoring, etc.

They reported Q4 earnings of 71 cents on revenue of $397.1 million,, up 7.9%. They guided for the current quarter for revenue of $330-$345 million. Analysts were expecting $348.2 million. However, Netgear has beaten estimates for six consecutive quarters so they may have been guiding lower so they can beat again.

The combination of the light guidance and the market declined knocked $15 off the stock in February. Shares appear to have bottomed at $56 and have risen for the past two days. This is proving a buying opportunity on a previously strong stock.

Buy June $65 call, currently $3.40, no initial stop loss because of market volatility.



VXX - Volatility Index Futures - ETF Description

Comments:

The VXX futures ETF is a flawed product. The recent volatility spike WILL erode as volatility returns to normal. We cannot use options on the VXX because the premiums are ridiculous. We can short it. We have shorted it multiple times over the last three years in the Premier Investor Newsletter. Each time it eventually declines to $10 and does a reverse 1:4 split and then we launch a new position at the higher price.

The recent volatility event in the VXX is a once in a decade event. Without a nuke going off somewhere in the US, the odds of seeing the ETF over $50 again over the next year, is very remote.

Original Trade Description:

The VXX is a short-term volatility ETF based on the VIX futures. As a futures product it has the rollover curse. Every time they roll to a new futures contract, they have to pay a premium and that lowers the price of the ETF. It is a flawed product with a perpetual decline built in from the monthly roll over in the futures contracts.

As evidence of this flaw, they have now done five 1:4 reverse stock splits. The last five reverse splits occurred at $13.11 (11/2010), $8.77 (10/2012), $12.84 (11/2013), $9.52 (8/8/16), $12.77 (8/22/17). The prospectus says it can reverse split anytime it trades under $25 for a prolonged period and the splits will always be 1:4.

We know from experience that the VXX always declines.

Unfortunately, put options are expensive with a volatility instrument at this price level. The only recommendation is to short the ETF and forget it. If we do get a new rally into the Q1 earnings cycle we could see a sharp decline in the VXX over the next 2-3 months. This will be a long-term position. This is not a 2-3 week play. I can guarantee you, if history holds, we can play this until it splits 1:4 again at $10. Once we are in the position and profitable I will put a trailing stop loss on it. We will take profits and then look for a bounce to get back in.

The VXX is hard to short. There are 34.2 million shares outstanding and ShortSqueeze.com says 44.5 million are short. The shares are out there and being traded because the volume on Monday was 46.5 million. More than 221 million traded on Feb 5th. This ETF is a favorite vehicle for the computer traders so the volume is always high. You have to tell your broker you really want to short it and make them find the shares. Sometimes it takes days or even a week before your broker will find you the shares. Trust me, be persistent and it will be worth the effort.

Short VXX shares, currently $47.93, no initial stop loss.




Current Portfolio


Open Positions

Check the graphic below for any new stop losses in bright yellow. We need to always be prepared for an unexpected decline. Any items shaded in blue were previously closed.




Current Position Changes


ABBV - AbbVie
The long call position was entered at the open on Tuesday.


Original Play Recommendations (Alpha by Symbol)


ABBV - AbbVie - Company Profile

Comments:

Winner, winner! The new ABBV play was entered at the open on Tuesday and that was the day the market gapped down -500 points. ABBV gapped down -8 points and we got an excellent fill on the position. No specific news this week.

Original Trade Description: February 6th.

AbbVie Inc. discovers, develops, manufactures, and sells pharmaceutical products worldwide. The company offers HUMIRA, a biologic therapy administered as a subcutaneous injection to treat autoimmune diseases; IMBRUVICA, an oral therapy for the treatment of patients with chronic lymphocytic leukemia; and VIEKIRA PAK, an interferon-free therapy, with or without ribavirin, for the treatment of adults with genotype 1 chronic hepatitis C. It also provides Kaletra, an anti- human immunodeficiency virus(HIV)-1 medicine used with other anti-HIV-1 medications as a treatment that maintains viral suppression in HIV-1 patients; Norvir, a protease inhibitor indicated in combination with other antiretroviral agents to treat HIV-1; and Synagis to prevent RSV infection at-risk infants. In addition, the company offers AndroGel, a testosterone replacement therapy for males diagnosed with symptomatic low testosterone; Creon, a pancreatic enzyme therapy for exocrine pancreatic insufficiency; Synthroid to treat hypothyroidism; and Lupron, a product for the palliative treatment of prostate cancer, endometriosis, and central precocious puberty, as well as for the treatment of patients with anemia. Further, it provides Duopa and Duodopa, a levodopa-carbidopa intestinal gel to treat Parkinson's disease; Sevoflurane, an anesthesia product for human use; and ZINBRYTA, a subcutaneous treatment for relapsing forms of multiple sclerosis. The company sells its products to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies, and independent retailers from its distribution centers and public warehouses. AbbVie Inc. has collaboration agreements with C2N Diagnostics; Calico Life Sciences LLC; Infinity Pharmaceuticals, Inc.; M2Gen; and Principia Biopharma Inc. Company description from FinViz.com.

Next expected earnings April 27th.

A lot of companies have 1-2 real drugs in the pipeline that may be approved. Several companies have one drug that could be a blockbuster and reach $1 billion in sales annually. AbbVie has multiple blockbusters in the pipeline and dozens of other drugs already in the market.

Analysts claim AbbVie's pipeline is the strongest in the industry. The post earnings market drop is a buying opportunity. The company's other drugs are going to be cash cows. Imbruvica generated $1.8 billion in sales in 2016 and could reach $7 billion annually over the next couple of years. Venclexta was approved in 2016 for leukemia and sales could peak at $3.5 billion a year. An experimental cancer drug called Rova-T could hit $5 billion a year when approved. A psoriasis drug called risankizumab could produce $4 billion a year and arthritis drug upadacitinib could peak at $3.5 billion.

AbbVie was a spinoff from Abbott Laboratories in 2012 and they are doing great.

ABBV reported Q4 earnings of $1.48 that beat estimates for $1.45. Revenue of $7.74 billion beat estimates for $7.51 billion. The company guided for 2018 adjusted earnings of $7.33-$7.43, up from $6.37-$6.57 and analysts were expecting $6.66.

The blowout guidance spiked the shares to $125 from $108. We had closed our prior ABBV position the day before the earnings. With the market crash, shares have now declined to $109 and giving us a chance to reenter the position.

Position 2/6/18:
Long May $115 call @ $3.70, see portfolio graphic for stop loss.



Prices Quoted in Newsletter

At Option Investor, we have a long-standing policy prohibiting the editors and staff from actually trading the individual recommendations in order to conform to SEC rules concerning trades.

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