Daily Market Update – March 11, 2014 (9:30 AM)
It has been about a year, perhaps more, since we had to wake up and actually care how European markets were trading, because they were setting the cue for our own markets.
It’s nice when you’re in control of your own destiny, but that can’t always be the case. Sometimes it’s the weather and sometimes it’s the tanks in Crimea
For the past week that has been the case as markets have very much been reacting to the only story that mattered as it was slowly unfolding in all of its confusion in Ukraine and Crimea. We pretty much followed the European markets in whatever reaction they were having to overnight events that have been more muddled the past few days.
While those markets have set the tone for our own trading that noose is also released once the overseas markets close for trading, which now because of daylight savings time is 12:30 PM. Often that marks a change in our tone and direction.
Yesterday was one of those examples.
Yesterday was also one of those very rare days that we didn’t hit a new closing record, but you couldn’t help notice how nicely the market had acquitted itself in having rallied to nearly create another new record. For those final few minutes of trading it looked as if there may have actually been another new record in hand.
For many that will be a bullish sign and provide renewed confidence. I don’t really see any particular significance to yesterday’s late afternoon rally as long as the market is tied to a singular event and especially when we have no control over that event or its outcome. As NATO may find itself to be directly or indirectly involved in events that control may come a bit over to us. Whether that will benefit markets or not is another issue.
This morning appears to be very much like yesterday as the pre-open is indicating only a mild movement, albeit in the opposite direction this time around.
With a few new positions opened yesterday there’s still room for more to bring cash down to last week’s levels, but I’m not certain that there’s enough clarity to dig into the cash reserves beyond simply spending what was recovered through last week’s assignments, although the pre-opening trading is often no indication of how individual stocks will perform once the real trading begins.
While there are often notable movers in the pre-open based on some event driven news, such as earnings or analyst ratings, most others quietly go about their way never really waving a flag to get your attention.
This may likely be one of those mornings as the upgrades have already created the clear winners, at least for the day and the others are just taken along for whatever ride the market is taking as it awaits direction from overseas.
In a way it makes me look forward to just a few weeks from now when the next earnings season is about to begin. At least then there may be reason for the market to respond to what its component pieces are experiencing especially once the excuse of weather has been discounted and exhausted.
For this morning, as for the past month or so, I’ll be waiting for the early morning shake out to see what direction the market takes, as there have been many reversals of late and false indications of forward momentum, in particular.
PS: If you didn’t see yesterday’s “Close” edition of the Daily Market Update, here’s a re-print of the addendum:
For those surprised, or even shocked that your Kohls shares weren’t assigned early (and you were in the vast majority), it’s all a question of pennies and time.
Had these shares gone ex-dividend last Friday on a March 7, 2014 option or perhaps this Thursday with a March 14, 2014 option, those shares closing at $55.45 and offering a $0.39 dividend, would have been well above the threshold price of $54.89. That price represents the minimal price at which a break-even could be obtained if the option holder chose to exercise early. That break-even analysis, however covers neither the original cost to buy the option nor the commissions. In such a case, with very little time value left on the option it would have been better for the option holder to exercise early and then immediately sell shares the following morning, collecting any profit on shares and the dividend.
However, look at the situation of Kohls which went ex-dividend on a Monday and still had 5 days of time value left in the option premium.
Shares opened trading this morning at $54.90. For an option buyer who exercised his contract and took possession of shares he had to lay out $5450 to exercise. If he was able to immediately sell his shares he would have pocketed a $0.40 profit on shares and a $0.39 dividend, for a total of $0.79. Of course, you would then have to subtract the cost of the option he bought to actually calculate his net.
However, if instead he elected to sell his option contract at either Friday’s close or Monday’s open he would have gotten $0.85 for his efforts. Not only is that $0.06 more than if he would have exercised, but it was also without assuming the risk of owning shares, even if only for 10 seconds after the pre-open started trading on Monday. Professionals, or those holding large positions are going to be much more likely to take the certain profit rather than the risk and the large outlay of assets to exercise.
For the rational individual investor option buyer who was otherwise bullish on shares, they would have held onto their option in the belief that there was greater opportunity to trade it during the course of the coming week than to own shares and collect the dividend. Certainly it would require no additional need to tie up cash. For the bearish holder of an option contract the appeal of holding shares isn’t there, so they, too, are less inclined to exercise early. If anything, if they are bearish on shares they will move quickly to close their option position in order to squeeze out and keep any premium that may be left.
Those most likely to consider an early exercise would be those that had bought such option contracts at at a point that shares were well below the $54.50 strike and therefore were very inexpensive to buy. However, there would likely be very few of those original low cost option buyers remaining because the real profits would have come in selling their contracts during the course of Kohls‘ rise, that on a percentage basis would have brought them far greater profits due to leveraging than owning shares and collecting a dividend ever would.
So who then is left to exercise early? Anyone bullish on shares and recognizing that in a low volatility environment their option contract growth in premium would be limited by its upcoming expiration might consider early exercise, although the majority of those would more likely roll over their option contracts to a future week in the belief that greater share gains are to come.
There are also those that had intended to exercise shares anyway as it came upon its expiration date, because they wanted to own shares at the specified price. Instead of waiting 5 days why not take possession early and also get the dividend?
And finally, there are always an irrational few.
As in a game of blackjack you really don’t want to have an irrational player in the game even though there’s a chance that their actions will be to your benefit. That kind of wild card in the game just isn’t worth it and reduces the impact of your own skill set.
If I were to give homework assignments I would ask you to then explain why some people didn’t have their AIG shares assigned early on Friday morning when shares closed well above the threshold on Thursday.