Weekend Update – March 9, 2014

It was a week of conflict and uncertainty that nonetheless took the market to new highs.

That’s really not the way it’s supposed to work, as the market is said to dislike uncertainty and there’s certainly plenty of that at the moment. Then again, the market is also supposed to dislike being long going into a weekend of uncertainty, yet it can’t resist buying into the close of a trading week, having again done so the past two Friday’s, despite the breaking news and later developing situation in Crimea.

While news seemed to moderate early in the week there was new concern over escalation as the week came to its close, yet the market closed t another record high.

Granted that it was also a week in which the Employment Situation Report was released and as we all know by now that means a week in which the market goes higher, but conflicts on the ground threatened that certainty. While many finally discussed the recent relationship between the market and the Employment Situation Report, you heard it here, first, two reports ago.

Meanwhile, some of the week’s conflict may have had an historical basis going back centuries as Vladimir Putin’s Russia supported a split of Ukraine, while other conflicts, such as between Carl Icahn and Marc Andreessen are more recent and involve the split of eBay (EBAY). Despite the way in which we instinctively await the release of the monthly Employment Situation Report, the only stories that really mattered and garnered any attention were those of conflict.

Putin, Icahn and Andreessen. Two bullies and a visionary, although you can decide what role is assumed by each player, understanding that bullies can also be visionaries.

While Putin seeks to re-draw the map most of us have never really looked at, the battle between Icahn and Andreessen has temporarily pulled eBay off of my map, as it no longer trades in that comfortable range that I had come to appreciate in the quest to sell covered calls on a serial basis. 

Recent reports suggest that the decision to proceed in Crimea was a strategy that emerged haphazardly and was borne out of emotion and deep grievances. In contrast, the conflict surrounding eBay is very likely one that has it its basis simply in differing opinions about where investor value resides. Still, despite what may be well reasoned positions, as with most other aspects of life, I don’t particularly care for conflict and being put in a position to either choose sides or sit and wonder where the new reality will set up shop.

It seems a little surprising that another world leader, Chancellor Angela Merkel of Germany would describe her recent conversations with Putin as being with a man that she was uncertain was in touch with reality and “in another world.” If accurate, having a world leader possess a somewhat less tenuous grasp of reality should be a concern for markets, although the eBay marketplace is likely to be indifferent as both Icahn and Andreessen toil in worlds of more objective reality.

While international conflict is underway and its outcome is still far from certain that comfortable range is also being exceeded in the market as a whole as it works it way toward new highs despite a paucity of a rational basis. Here too, there’s some conflict, as we’ve all been taught that the market is rational.

I usually have new funds to start each week as the previous week typically has share assignments. This past week was no different. However, faced with cash looking to be spent, markets again at new highs and uncertainty abounding, I’m facing personal conflict as the coming week approaches.

The conflict isn’t over whether to invest that money, as that’s always a given, but what theme to adopt in seeking to find the balance between safety and reward.

Some weeks there a sense of a need to embrace risk and volatility and other weeks there’s an abiding feeling that boring is the new chique.

This week I’m split between the two and see a role for opening the portfolio to both sides of the range. Sometimes the solution is for differing sides to simply get together and understand what each can bring to the table.

As usual, the week’s potential stock selections are classified as being in Traditional, Double Dip Dividend and Momentum categories, with no “PEE” selections this week (see details).

If I were to focus on low beta and presumed safety, at least from the perspective of my trading strategy of utilizing covered options, I would give serious consideration to shares of Altria (MO), Coca Cola (KO) and Merck (MRK) this week, as they all go ex-dividend. However, the premiums of the former are just too low. While collecting both premium and dividend would present an acceptable return, the potential for early assignment would create a poor investment choice. On the other hand, Merck offers both an appealing premium and dividend, but a frightening appearing chart, unless you believe that little can go wrong in just a week.

If you believe that to be the case, you too may be living in another world.

Part of the conflict this week is pitting the desire to find bargain prices and learning to accept the fact that share prices may be creating new normal levels that are, unfortunately, higher and bring with them increased risk, but without concomitant offsets in risk reflected in option premiums.

Both Lowes (LOW) and Home Depot (HD) are now near their yearly highs. Taking a very narrow view, both hav
e out-performed the S&P 500 since the bottom of the most recent attempt at a correction early last month. Normally, that might send me looking elsewhere for a short term opportunity, but I find some solace knowing that they have lagged a bit in the longer term. Both offer reasonable option premiums during this period of low volatility, but Home Depot also offers the potential advantage of being ex-dividend this week.

While Lowes and Home Depot may be near their highs some of the typically lesser volatile positions that I follow and also currently own are at lower prices, having lagged the market and may offer the opportunity and price combination that is becoming more difficult to locate.

There’s not too much reason to recount the recent trials of Target (TGT). In addition to its own security breach issues it has also had the unfortunate experience of being a retailer at a time that retail hasn’t fared terribly well. Following recent less than stellar earnings it did what other retailers did a few weeks ago when those earnings weren’t as disappointing as expected and shares surged. In the meantime shares have come down a bit, but are still far from their not so distant peak.

Marathon Oil (MRO) is also fairly far from its recent peak and has little reason for having suffered such a fate. It is now trading slightly above the mid-range of what had been a comfortable trading range in the past and I believe is a good entry point and hopefully an exit point as well. If Marathon Oil can stay in this range for a little while it option premiums can make this a very attractive recurrent purchase and sale of calls. Already owning some slightly more expensive shares I wouldn’t be adverse to adding to that position and using option premiums to offset paper losses on the initial lot of shares.

A portion of my Holly Frontier (HFC) holdings were assigned this week after a very unexpectedly sharp climb. Shares go ex-dividend this week after having distributed a special dividend earlier in the month. Having bounced back from some recent near term lows its shares are a little higher than that mid-point of the range that I generally like to use when considering adding shares, however the upcoming dividend adds incentive to restore the position. These shares often exhibit large price swings in a narrow time frame and those help to support a very appealing option premium that’s even more generous if the dividend is captured, as well.

While all of the recent excitement has centered around the rumored buyout of Lorillard (LO) by Reynolds American (RAI), Phillip Morris (PM) has languished of late. With events heating up a bit on the European continent perhaps increasing nerves will boost sales of their products, but more likely share price will be supported by talks of merger activity in the sector and visions of new markets in electronic cigarettes and even marijuana for domestic players. Although the prices of both Lorillard, the purchase target, and Reynolds American, the rumored purchaser fell quite a bit after the story was digested, this isn’t likely to be the end of the story. Phillip Morris has protected the $80 level of late and shouldn’t be at risk to decline if such buyout talks fail to move forward, as it didn’t participate in the rumor rally.

While prudence may dictate that priority be placed on re-populating a portfolio with lower risk positions at this time there may still be some room for more adventurous positions.

One of my favorites, despite still holding more expensive shares purchased prior to the dissolution f the potash cartel is Mosaic (MOS). While I haven’t enjoyed their continued position in my portfolio, other than their dividend income production, I have enjoyed the climb from $40 to $50, having owned shares on numerous occasions in the interim. Despite now being at the high end of its post-cartel break-up range, I think that shares are still poised to go higher and continue to offer short term opportunity. Enough so that I would consider not hedging my entire position.

Citigroup (C) is significantly below its highs reached earlier in the year. It has, however, seemed to find support at about the $48 level and responded reasonably well to some recent bad news coming from their Mexican unit. While Citigroup hasn’t been an especially good core long term holding for many, other than those smart enough to have purchased shares at its nadir, it does have the potential to be more rewarding for those looking for small and short term opportunities. Someday, perhaps in my lifetime, it may also increase its payout ratio from its current 0.9% as soon as regulators give that clearance.

Finally, Seagate Technology (STX) is a good example of a stock that saw its price exceed my own comfort level and to which I eventually adapted by accepting a new normal. In the case of Seagate that has happened on any number of occasions over the past two years as it continues to surprise by its continued relevance as a company.

After waiting for a while, I increased that comfort level from $48 to $49.50 by virtue of having sold puts this past Friday. That new higher level itself was some 20% below its January 2014 high.

However, in a tiny fraction of the time that I waited to finally adapt, I found myself having to roll over the put contract to the next week as shares suddenly added to their day’s losses, before recovering near the close. That recovery gives me some additional confidence in recognizing comfort at this level and suggesting that others do so, as well.

Hopefully, if all goes as planned, these disparate selections may find a way to get along and provide a lesson to others.

Traditional Stocks: Lowes, Marathon Oil, Phillip Morris, Target

Momentum Stocks: Citibank, Mosaic, Seagate Technology

Double Dip Dividend: Holly Frontier, Home Depot (ex-div 3/11)

Premiums Enhanced by Earnings: none

Remember, these are just guidelines for the coming week. The above selections may become actionable, most often coupling a share purchase with call option sales or the sale of covered put contracts, in adjustment to and consideration of market movements. The overriding objective is to create a healthy income stream for the week with reduction of trading risk.