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Bulls Have Momentum

1. Market Summary: Bulls Have Momentum

2.  Psychemedics (PMD) Reports Another Good Quarter

3.  Weekly Wrap Portfolio Update  

 

1.  Market Summary: Bulls Have Momentum

October is usually a “bear-month killer,” but the talking heads and suit-and-ties once again doubted the bulls’ resiliency and were surprised to see all-time highs reached on Halloween.

Wall Street was worried that a pullback would occur once the Fed ended its monthly quantitative easing (QE) program, as has occurred in prior markets. However, every market is different, which is why it is important to do the daily, weekly and monthly research.

I know the whipsaw action was frustrating for a lot of traders, but my homework paid off, and that is why it is important to keep your emotions in check. I am expecting a smoother ride until year-end, but the waters could get choppy again with the mid-term elections coming up tomorrow, Nov. 4.

The Dow jumped 195 points or 1.1%, to finish at 17,390 on Friday. The blue-chips opened at 17,208 and reached an all-time intraday high of 17,395 while holding the previous high of 17,350. This sets up a run to 17,500-17,600 over the near-term, with a chance at 18,000 coming into play. Support is at 17,200-17,000 on a pullback.

INDU11314

The S&P 500 surged 23 points, or 1.2%, to settle at 2,018. The index opened above the 2,000 level by a point and missed clearing its all-time high of 2,019 by the same amount. If cleared, a push to 2,050 could come, and that would get my year-end target from February of 2,100 back in play. Support is at 2,000-1,975.

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The Nasdaq zoomed 64 points, or 1.4%, to end at 4,630. Tech opened at 4,639 and above its previous 52-week high of 4,610 that was set back in mid-September. The bulls made a late-day run to 4,641 and are on track for a run to 4,700-4,750. Support has moved up to 4,600-4,550.

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The Russell 2000 jumped 17 points, or 1.5%, to close at 1,173. The small-caps cleared 1,160 at the start of trading, and I mentioned that a pop past this level should get 1,175-1,180 in play. The index reached a peak of 1,174 and will likely challenge 1,200 if cleared. The all-time high is at 1,213. Support is at 1,160-1,150.

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The S&P Volatility Index ($VIX, 14.03, down 0.49) fell 3% after trading down to 13.72. The next signs of higher highs for the market will come if the bulls can get below 13.50-12.50. The bears are looking to get the action back above 15, which would keep 17.50 in play.

VIX11314

The Dow came into October at 17,042, while the S&P was at 1,972. The Nasdaq started the month at 4,493, and the Russell 2000 at 1,101. For the month, the Dow gained nearly 348 points, or 2.2%, and the S&P 500 added 46 points, or 2.4%. The Nasdaq jumped 137 points, or 3.2%, while the Russell 2000 zoomed 72 points, or 6.5%. The small-caps got back all of the September losses, and the whipsaw action has been breathtaking to watch and trade. The victory also evens the score at five months each between the bulls and bears for 2014.

RRMO1

 

The Monday/ Friday closes have turned bullish as the Dow has posted two-straight Monday wins.

RRMO2

The bulls have also won the past three Friday Dow sessions.

RRMO3

 

For new subscribers, Monday/Friday up sessions on the Dow are bullish and indicate that money is still “flowing” into the market. Negative Monday/Friday closes are bearish and usually mean cash is leaving the market. Mixed Monday/Friday closes can signal a choppy market or a trading range.

The financial stocks reported a mixed bag of earnings but were mostly ahead of expectations. In mid-October, I talked about them being my main focus, as I said they would have to lead the next leg of the market higher. As you can see from the chart below, the Financial Select Spiders (XLF, $23.84, up $0.27) bottomed at $21.55 on Oct. 15, and the V-shape recovery pushed the index to within a penny of its 52-week high.

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In mid-October, I talked about the Dow Jones Transportation Average ($TRAN) needing to show some strength after falling below its 200-day moving average as well. I said I wanted to see a recovery of 8,250-8,300, but also that a close above 8,500 was needed to confirm a real rebound. The index closed Friday at an all-time high.

TRAN11314

 

I mentioned last week that prior quantitative easing (QE) cutbacks resulted in 10%-12% pullback, but on Thursday I said this time might be different. Some Wall Street pros believe that the market won’t be able to hold up following the historic ending of QE and were once again on the wrong side of the trade.

In October, there were dozens of slick-talking pros that said the market had reached its peak for the year. Some of the knuckleheads were even repeating their statements ahead of last week’s Fed minutes despite the strong momentum the bulls were showing.

November is historically a bullish month for the market. December is also a bullish month for stocks, and my year-end targets I gave in February 2014 could be back on the map on continued smooth sailing. I also predicted that the VIX could trade to single-digits. However, all pullbacks need to be watched, as October was a good reminder of how dangerous the bears can be.

Ahead of the open, futures look like this: Dow (-37); S&P 500 (-3.5); Nasdaq 100 (-5.75).

 

2.  Psychemedics (PMD) Reports Another Good Quarter

I wrote about Psychemedics (PMD, $14.38, up $0.96) in the Weekly Wrap on June 3, 2013, and made subscribers 11% in a month.  The stock was $11.65 at the time, and I believed it was a good long-term buy.  Unfortunately, we were stopped out of the trade at $12.75 and collected a dividend in the process.

Since then, the stock rose to a high of $18.64 in February before pulling back.

The $77.29 million service company based in Acton, Massachusetts tests for drug abuse through the analysis of hair samples.  The company offers its services in the United States, internationally, Federal Reserve Banks, physicians, treatment professionals, law enforcement agencies, school administrations, and parents concerned about their children’s drug use.

In addition, thousands of corporations worldwide rely on Psychemedics patented hair analysis technology for pre-employment and employee drug screening, 10% of which are Fortune 500 companies.

The current most common drug testing procedure is by urine.  However, many drugs including methamphetamine, opiates, cocaine, and PCP are rapidly excreted from the body and are usually undetectable in urine 48-72 hours after use.

One testing process that solved this problem was conducted by Dr. Werner Baumgartner in the 1970s.  At the Janus Institute in Los Angeles, he found that chemicals of most drugs are absorbed and stored in human hair cells for months or even decades after drug use.  Thus, a drug user cannot evade the test by simply abstaining for a few days.  And since hair grows at a constant rate in most people, hair cut close to the scalp could give a fairly accurate history of drug use for a period of six months.  Shampoo, excessive sun, and bleach do not appear to have any effect on testing results.

In 1978, he patented his method for accurately detecting drug use from hair.  He then founded Psychemedics in 1985, which has grown to become the world’s largest provider of hair analysis drug testing.

The company utilizes a patented hair analysis method involving digestion of hair, enzyme immunoassay technology, and confirmation by mass spectrometry to analyze human hair to detect abused substances.  It is the only biotechnology company to hold a U.S. patent on hair analysis technology that detects the presence of narcotics, stimulants, depressants (sedatives), hallucinogens, and cannabis, such as marijuana.

On January 24, 2012, Psychemedics earned a patent that focuses on liquefying hair and releasing drugs trapped in the hair without destroying the drugs.  The patented method can be used with a broad range of biochemical screen techniques, mass spectrometry methods, and chromatographic procedures.  Its RIAH (or Radioimmunoassay of Hair) tests use this patent and can detect the approximate amount of drug ingested and patterns of use over time.

On February 29, 2013, the company partnered with TruTouch Technologies to market TruTouch’s rapid optical alcohol detection and biometric test in the United States.

Alcohol measurement is performed by transmitting light into the skin via contact with an optical touch pad.  The collected light is analyzed to determine the tissue alcohol concentration.  This new approach costs less than breath or blood alcohol testing.  Such technology is hoped to address the challenge of alcohol use in the workplace.  Psychemedics will exclusively distribute the tests within the United States.

PMD1

 

The company has issued a dividend every quarter since March of 1997.  For the most part, dividends have grown over time.  Dividend growth stocks also have a tendency to increase in value.  On October 30, 2014, the company declared its 73rd consecutive quarterly dividend, a dividend of $0.15 per share.

The dividend will be paid on Nov. 20 to shareholders of record on November 10th, 2014.  Based on the current stock price, that is a yield of about 1%, so one can expect that the stock may fall 1% on Nov. 20.

Last week, the company released third-quarter earnings.  Revenues hit a record high, rising 9% to $7.7 million from $7.1 million a year ago.  Net income for the period was $0.17 a share, down from $0.20 a share from the year ago period, but came in higher than expectations.  Revenue growth was offset by expenditures related to an increase in capacity for an opportunity in Brazil along with research and development of additional tests for drugs of abuse.  Testing volume, primarily from new clients, increased 10%, offsetting a 1% decline in average revenue per sample.

Gross profit decreased 5% to $4.0 million from $4.2 million a year ago.  In the third quarters of 2013 and 2014, general and administrative expenses were 15% of revenue for both years.  Total marketing and selling expenses remained 16% of revenue in both 2012 and 2013.  Research and development expenses were 5% of revenue in 2014 and 3% of revenue in 2013, a 79% increase.

The graphs above clearly show that revenue and earnings seem to peak in the second or third quarters, and hit a trough in the fourth (December 2011 and December 2012) quarter – although the last earning trough was in the third quarter.  The long-term revenue trend is increasing, which is positive.  Long-term earnings has been oscillating around the same range, but the last trough (March 14) was much higher than the previous two, a sign that the company’s operations may be improving.

The company is one of the few pure play drug-testing businesses.  Its major competitors do more than just drug testing.  Quest Diagnostics (DGX) provides diagnostic testing information services and offers clinical testing services, including routine testing, gene-based and esoteric testing, anatomic pathology services, and drugs-of-abuse testing.  Bio-Reference Laboratories (BRLI) provides clinical laboratory testing services for the detection, diagnosis, evaluation, monitoring, and treatment of diseases.

The company offers chemical diagnostic tests, including blood and urine analysis.  Laboratory Corporation of America (LH) provides clinical laboratory data, including blood chemistry analyses, urinalyses, blood cell counts, thyroid tests, Pap tests, HIV tests, HCV tests, microbiology cultures and procedures, and alcohol and other substance-abuse tests.

Compared to these three competitors, PMD seems undervalued at current levels, with positives (green) outnumbering negatives (red) 15 to 10.  Value-wise, the stock looks slightly expensive, with a high price/book, price/assets, and an EV/EBITDA.

However, gross margin, profit margin, return on assets, and return on equity are all high.

The current ratio says it is liquid at the moment, but the decrease in the current ratio is a caution.  Insiders are buying, meaning they may think the stock will rise.  Further, short interest is very low and suggests that the majority of short sellers do not think the stock will fall.

At $14.38, the stock is below its target of $22.00 made by 1 analyst recorded by Thomson/First Call.  Using a scale of 1.0 as a strong buy and 5.0 as a sell, the average rating of the stock is 1.0, unchanged from a week ago.

This is a thinly traded stock as the average daily volume is just over 10,000 shares so it is best to use limit orders when getting into a position of this nature.  The longevity of the company and its solid earnings history offset the volume and the current yield is 4.2%.  I like the stock up to $14.50 for a possible run back to 52-week highs.  Options do not trade on the stock.  If I take action this week, I will send out a New Trade alert.

All prices given in this update are current as of Oct. 31, 2014.

The Weekly Wrap Closed Trade Track Record for 2014 is 28-7, for an 80% win rate (113-14, or 89% win rate, overall since the start of 2011).

To download the most current Weekly Wrap returns of closed positions in Excel format, click here.

Amazon (AMZN, $287.06, down $26.12)

AMZN November 360 calls (AMZN141122C00360000, $0.10, down $1.70)

Entry Price:  $2.25 (10/22/2014)

Exit Price:  Closed at $0.30 on 10/24/14.

Return:  -87%

AMZN November 260 puts (AMZN141122P00260000, $0.30, down $0.20)

Entry Price:  $1.75 (10/22/2014)

Exit Target:  $6 (Limit Order)

Return:  -83%

Stop Target:  $1.25

Action:  The move back above $300 was bullish and has forced us out of the remaining leg of the trade after closing the AMZN November 360 calls on Oct. 22.  Close the AMZN November 260 puts at Monday’s open but use limit orders to get the best fills.  I will send out a Trade Alert as a reminder.

AMZN’s two-year chart showed a break below $280 might have led to $260-$240 but the low of $284 held up after the recent earnings announcement.

AMZN11314

 

Flextronics International (FLEX, $10.72, up $0.46)

Original Entry Price:  $9.12 (10/21/14)

Lowered Price from Selling Options:  None

Exit Target:  $12+

Return:  18%

Stop Target:  Raise from $8.25 to $10 (Stop Limit)

Action:  I have raised the Stop Limit from $8.25 to $10 to protect profits.  I would still like to wait before selling a covered call against the stock as shares are showing strong momentum.

Flextronics reported a nice quarter last week after beating Wall Street’s estimates by 2 cents and also topped revenue numbers.

There are several clusters of resistance from $11-$11.50 but a move above the latter should lead to a run past $12.  This is where I would like to sell a deep in-the-money call option, or possibly take profits.

FLEX11314

 

Aruba Networks (ARUN, $21.58, up $0.58) Covered Call Trade

Sold to open the ARUN November 20 calls (ARUN141122C00020000, $2.30, up $0.60)

Original Entry Price:  $19.24 (10/17/14)

Lowered Price from Selling Options:  $18.04

Exit Target:  $25+

Return:  20%

Stop Target:  $15

Action:  Friday’s close above $21.25 and the 50-day moving average was bullish.  The next wave of resistance is at $22-$22.50.  Short-term support is at $21 followed by the 100-day/ 200-day moving averages.

Earnings aren’t due out until later this month, so I don’t believe there will be headline risk until then.  On that front, I have said the company is taking market share away from some of the bigger players like Cisco Systems and I believe it will have a beat-and-raise quarter.

Wall Street is expecting 25 cents a share on revenue of $204 million.  The company has matched or beaten estimates the past 4 quarters by two, zero, one and two cents, respectively.

If the company misses estimates and shares pull back, I can continue to write covered calls or close the position for a profit once the November calls expire.

On Oct. 17, 2014, I recommended buying ARUN shares at $19.24 and selling to open the ARUN November 20 calls for $1.20 to lower the cost basis to $18.04.  If the position is “called-away” by mid-November, the trade will make 11%.

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Bank of America (BAC, $17.16, up $0.13)

Original Entry Price:  $16.23 (10/17/14)

Lowered Price from Selling Options and Dividends:  None

Exit Target:  $20+

Return:  6%

Stop Target:  Raise from $16.30 to $16.50 (Stop Limit)

Dividend Yield:  1.2% (20 cents/ 5 cents quarterly)

Action:  I have raised the Stop Limit from $16.30 to $16.50.

Shares held $16.50 and the 50-day moving average on Monday while clearing $17 on Thursday.  I mentioned I might write a covered call once shares cleared $17 but there is a good chance BAC could trade to $20.  The 52-week high is roughly $18, set back in March.  Support is at $17-$16.75.

 

Previous comments:

I started recommending covered call trades on BAC when shares were near $5 back in late 2011.  Since that time, I have recommended 7 profitable trades on BAC but the last time was in August 2013 when shares were pushing $15.  The gains were 20%, 26%, 6%, 14%, 9%, 1% and 6%, respectively.

I should have stuck with this trade into 2014 as shares have stayed in a tight range throughout the year and a great environment to write covered calls in.

BAC11314

 

Pizza Inn Holdings (PZZI, $6.55, up $0.06) Stock Trades

Original Entry Price:  $8 (8/13/14)

Lowered Price from Selling Options:  No options available

Exit Target:  $12

Return:  -18%

Stop Target:  $5

 

Original Entry Price:  $8.10 (10/11/13)

Lowered Price from Selling Options:  No options available

Exit Target:  $12+

Return:  -19%

Stop Target:  $5

Action:  Shares fell to a low of $6.39 midweek on a downgrade.  There is further risk to $6.25-$6.00 on another drop below $6.50.  Near-term resistance is at $6.75-$7.00.

I certainly don’t agree with TheStreet.com’s assessment from a hold to a sell rating on the shares of Pizza Inn.  The company beat estimates last quarter and only have a handful of newer Pie Five stores contributing to earnings.  Once more stores come on-line in the comings quarters, earnings will continue to improve.

 

Previous comments:  This is still a small-cap company with a market cap of just $66 million.  I haven’t mentioned Pizza Inn Holding as a takeover target but the company has international stores (tax inversion) and is in one of the fastest growing food concepts hitting America.  A larger company looking for growth might get jealous of this gem’s growth.

Click here to read my in-depth commentary and write-up on Pizza Inn.

The company recently reported stellar growth in its Pie Five Pizza franchises.  Although Pizza Inn reports a loss of 4 cents a share, it was better than the 8-cent loss from a year ago quarter.  Revenues came in at $10.9 million versus $10.4 million last year.  The revenue numbers will continue to improve with the number of stores opening this quarter and I’m looking for the company to turn a profit in early 2015.

Pizza Inn recently announced further expansion plans and is now on track for 200+ stores.  I believe this will be a $15-$20 stock in 1-2 years with insiders and mutual funds owning nearly 40% of the company.  Institution ownership is over 17%.  I have already recommended two profitable trades for the Weekly Wrap when shares were near $3.

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Huttig Building Products (HBP, $3.63, up $0.01) Stock Trade

Original Entry Price:  $4 (8/13/14)

Lowered Price from Selling Options:  No options available

Exit Target:  $6+

Return:  -9%

Stop Target:  $2 (Stop Limit)

Action:  Shares came close to clearing the 50-day moving average and a move above this level could lead to $4.  Short-term support is at $3.40.

 

Previous comments:

This is a small company with a big presence in the housing industry and a market-cap just south of $100 million.  Huttig has been around for over 100 years and there is little Wall Street coverage with only 1 analyst following the stock.

This is a “cheap” way to play the housing sector with a quality stock.  Despite the fits and starts the industry has been going through the past few years, this is a solid company with an improving balance sheet.

HBP11314

 

Limelight Networks (LLNW, $2.44, up $0.04) stock trade

Original Entry Price:  $3.00 (6/9/14)

Lowered Price from Selling Options:  None

Exit Target:  $5

Return:  -19%

Stop Target:  $1

Action:  Shares cleared the 50-day and 200-day moving averages last week.  The next areas of resistance are at $2.60 and the 100-day moving average.  Earnings are due out Nov. 10, and I will provide an update on expectations next week.

 

Previous comments:

Shares traded to a high of $3.25 on 6/20 after Tuition Build offered roughly $645 million, or $6.55 a share, for Limelight.  The company dismissed the Silicon Valley’s private-equity firm’s offer after basically saying they weren’t experienced enough to run the business.

I have been suggesting a buyout offer would come for Limelight Networks with the company’s cheap market cap and said they would make a very luscious takeover target.

Its litigation issues have decreased dramatically following their recent win against AKAM and they are open to a much bigger marriage.

Roth Capital lifted its Price Target for Limelight Networks to $4.50 from $3 following its recent court win against AKAM.  I have already covered the acquisition appeal of the stock and Captain Obvious echoed those comments last week.  I was hoping shares would go unnoticed by the suit-and-ties and perhaps they have been reading my updates but I have a much higher target for Limelight.  I have said shares could make a run to $5, possibly $8 if the takeover talk heats up over the summer.

Apple, Google, Facebook, Microsoft and Verizon, just to name a few, could take a look at this company as it looks to build out its CDN network.  Limelight has a market cap of just $280 million and would be a great acquisition target for Apple.

LLNW11314

 

Alexza Pharmaceuticals (ALXA, $2.26, down $0.29) Covered Call Trade

Original Entry Price:  $5.53 (3/4/14)

Lowered Price from Selling Options:  $4.68

Exit Target:  $6+

Return:  -52%

Stop Target:  $1.50 (Stop Limit)

Action:  Shares made a run at $3 to start the week, topping out at $2.96 on Tuesday following the expansion of its partnership with Grupo Ferrer for its drug, Adasuve.  Ferrer has also agreed to buy 2 million shares of Alexza’s stock for $4.00 and will become its largest shareholder.

Deals like these usually lead to a takeover and shares should react accordingly by trading up to $4 over the next few months.

Earnings are due out this week.  The results will likely have an impact on shares although I’m more interested in Alexza’s pipeline and partnerships.  Wall Street is expecting a loss of 74 cents for the quarter on revenue of $1.73 million.

 

Previous comments:

On March 4, 2014, I recommended buying shares at $5.53 and selling the June 6 calls for 50 cents to lower the cost basis to $5.03.

On June 23, 2014, I recommended selling to open the ALXA September 5 calls for 35 cents to lower the cost basis of the trade to $4.68.

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Trades on Hold:  AKS Steel Holding (AKS, May 2011), DryShips (DRYS, January 2011), Rambus (RMBS, November 2011), Bebe Stores (BEBE, February 2012), Vivus (VVUS, July 2012), Dendreon (DNDN, April 2013), Zynga (ZNGA, March 2014), Galena Biopharma (GALE, 2014)

 

Trade on!

Signed

Rick Rouse
Editor and Chief Options Strategist
Weekly Wrap

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