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Morning Update

This morning markets were moving pre-open on the unexpected news that Q4 US real GDP contracted 0.1% on expectations for a 1% increase. The news caused a kneejerk reaction in S&P 500 futures to the downside but at the open the index was back to near unchanged. Overall the market does not appear to be too worried about this. Part of it is the Bernanke put in the market, part is expectations of an upward revision, and part is hesitation to make big bets ahead to eh Fed meeting today. Although no major changes are expected to come from the Fed meeting traders will be looking to see if this has any effect on the duration of the Fed’s stimulus. In contrast to the poor GDP growth housing is strong, earnings are slightly better than last quarter, and the S&P 500 is at multi-year highs. Friday’s NFP report will be important in that it could confirm the slowdown in growth seen in the GDP report or confirm the bullish case for equities with a beat.

Yahoo reported earnings after the close on Monday and fell 3% in trading yesterday. Revenue and profit per share beat expectations but guidance was slightly below expectations. Nevertheless one option traded used the stock’s weakness to sell 4000 July 19 puts for $0.91 with the stock at 19.74. This trade suggests that the trader is willing to buy Yahoo at an effective price of 18.09 (8% lower) in July, and is happy to collect $0.91 (5% return on capital) if Yahoo is above 19 at July expiration.

The Yahoo earnings report was full of mixed news. On one hand they did beat expectations, posted lower TAC (“Traffic Acquisition Costs”), and improved search revenue and paid clicks (+11% Y/Y). However, guidance was weaker than expected and display advertising revenue was disappointing. The key going forward for Yahoo will be to better engage visitors on its sites to drive display ad growth, which is traditionally Yahoo’s bread and butter. Search advertising was surprisingly strong and investors should look for this growth to continue, which will help to offset the structural decline of the display ad market. The big question that remains is can CEO Marrisa Meyer and the Yahoo management team revitalizes Yahoo and drive growth. Their goal is to achieve higher user engagement by identifying products that create a daily digital habit with users and to create products that appeal to a wider demographic. This is all easier said than done, and only time will tell if Yahoo will be successful at this.

After the earning release analysts all such to their recommendations but most raised price targets slightly. The outlook for Yahoo looks optimistic but I, like this options trader, prefer to hold off on outright stock purchases for now. Selling a put is a good alternative to buying shares here because it will allow you to appreciate in some of the upside the stock could see and also locks in a future purchase price at a better valuation should the stock stumble in the next 6 months.

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