Weekend Update – June 22, 2014

There’s an old expression that advises that it’s generally a bad idea to fight the Federal Reserve.

They have pretty powerful tools even when there’s some concern that the quiver is beginning to empty.

Janet Yellen, its Chairman, may give every indication of being a dove, but my guess is that when on the canvass and feeling threatened, she would be a formidable foe to anything that creates a threat.

Right now, the most immediate threat that can be recognized is that of a rising interest rate environment, although there are still those that worry about deflation, as well. But at least most everyone is agreed that interest rates have more than just mere relevance.

I don’t think Yellen was using the old “Rope-a-dope” strategy to ultimately beat inflation, because sooner or later we all know that it is the end result of a whirring economy and if that is the goal then there has to be some acceptance of inflation’s return.

So when Janet Yellen, during her press conference that followed the release of the most recent FOMC statement suggested that inflationary signals didn’t threaten low interest rates that could only be construed as a green light to buy stocks and that’s exactly what happened as more new highs were the ultimate outcome.

The current market reminds me a little of the glitchy computer software that allows you to build roller-coasters of your dreams that only go higher.

At some point even a zealous non-engineer can realize that something is missing from the formula that creates the real excitement. The climb higher is only the anticipation and can never be realized without the drops.

Stocks, I suppose, are a little different. The real excitement comes during the climb higher, but only as long as you get off of the ride before the actual drop.

Maybe that’s one of the reasons I like a covered option strategy. On days like this past Friday, which was the conclusion of the June 2014 option cycle, I was forced off of many rides, as lots of assignments were my fate.

It was exciting going up and I can get back on. There’s always another ride coming along and maybe even one that will come at a discount on the ride down.

On the meantime, I don’t know if I want to be on the ride whenever the dove bears her teeth and puts on the brakes. As much as we like Janet Yellen’s actions that help to support the market’s continued trajectory it may be a prelude to the same characteristic that would lead to tough medicine when needed, but before we are ready to accept it.

Either way, it’s probably a good idea to stay on the same side as the Federal Reserve, taking and throwing the same punches, in the knowledge that they’re aligned with investors. Even if that alignment is unintentional it signals favoring investing over saving. That in turn belies a mindset that reduces the role of a defensive posture, so there may be some sporadic punches taken in the name of advancing the offense.

I have a lot more money this week after last week’s assignments and while still concerned about approaching that point at which a drop seems sooner rather than later, for now it seems as if the Federal Reserve just keeps adding more and more track to make the ride up more giddy and the ride down more of a “white knuckle” experience.

As usual, the week’s potential stock selections are classified as being in Traditional, Double Dip Dividend, Momentum or “PEE” categories.

As Apple (AAPL) gets ready to begin trading its third week following the 7 to 1 split, what is clear is that for those expecting a quick profit once the shares became priced in a more egalitarian fashion it has been two weeks of disappointments. in that time Apple shares dropped 1.7% while the S&P 500 climbed 1.1%.

As I suggested at the time of the split announcement that may have been timed with earnings to help deflect closer scrutiny of results, Apple would become a better trading vehicle as it settled into that phase of its corporate identity that no longer scoffed at dividends, buybacks and stock splits.

While the speculation regarding new products and innovations will continue and there will undoubtedly be occasional elation and occasional disappointment, Apple shares will be less likely to reflect fervor that enhances risk and reward. For me, that makes it a much more logical covered option trade than at anytime over the past 30 months.

Kohls (KSS) is to me an ideal kind of stock. It just muddles along and has some occasional earnings surprises that propel shares higher or lower only to see it somehow return to more familiar territory. It has an attractive dividend and has relatively recently started trading expanded options that are available at many strike levels.

It neither stands out at the upper nor lower ends of the consumer spectrum and sees little reason to bring too much attention for itself as it is very comfortable being in the middle. That kind of comfort also brings a lot of comfort when considering its use as part of a covered option strategy.

While I already have some shares of Kohls that are hoped to be assigned away or rolled over this coming week, at the current price I think it’s time to add additional shares and perhaps make use of some of the expanded option opportunities.

Lowes (LOW) is another stock that just seems to do its job, as long as its job is not to stay for prolonged times at elevated or depressed levels. While that may describe the worst rollercoaster ever designed, it is a perfectly good design for a stock used in a covered option strategy.

I had shares assigned this past week and would consider adding them again despite a small increase in its price in that time. It is currently trading at about the mid-point of the price range that h
as worked very nicely over the past year if using such a strategy.

While the Federal Reserve may be easing some defenses as it continues to ignore some inflationary pressures I’ve been looking increasingly to a more defensive position over the past years in seeking dividends, where possible.

This week’s potential purchases reflect the difficulty in re-allocating funds when prices are at or near their highs. Both Dow Chemical (DOW) and Deere (DE) are ex-dividend this week, but are also near those one year highs. Both favorites over the past few years, while having owned shares of Dow Chemical recently, I haven’t owned Deere in almost a year, while awaiting it to give back some gains.

Inevitably, that should be the case for both Dow Chemical and Deere, but as long as the Federal Reserve keeps adding that track I’m not certain I can see a specific reason why the drop should come at this particular time for either of those stocks. While the share prices are higher than I would like they both continue to have those characteristics that made them frequent trades for me in past years and always in consideration from one week to the next.

I haven’t owned EMC Corp (EMC) as frequently as Dow Chemical or Deere, but it too goes ex-dividend this week and it, too, is one that I’ve been waiting upon to shed some of its gains. While its dividend isn’t as attractive as some others, shares would fill a void for me as I’m currently under-invested in the technology sector. That itself may not be a good reason to add shares, but EMC has been a steady and reliable performer, although I would prefer to be out of the position, if purchased, prior to earnings during the early part of the August 2014 option cycle, as it is frequently moved by its more volatile progeny, VMWare (VMW).

AS earnings season now winds down in preparation for the next one that begins in just two weeks I’m somewhat less inclined to engage in risk, despite the recent recovery of many momentum stocks.

Apollo Education (APOL) has been beleaguered for a while, along with others in the for-profit education business. Having Bill Ackman place you in his cross-hairs isn’t necessarily good for your share’s health, either.

While the option market is anticipating an 11.1% move in share price upon earnings announcement in either direction, the sale of put contracts at a strike level 14.9% below Friday’s closing price could still deliver a weekly 1% ROI, if not assigned.

I like that kind of gap between what the market is expecting and the risk level where I may be able to achieve my desired ROI. One negative factor, however, which limits the ability to respond to an adverse price movement that might make unwanted assignment possible, is the lack of expanded option availability. I like to have those available in the event that a rollover of the put contracts is necessary, in order to avoid assignment, while then awaiting a bounce back in share price.

Micron Technology (MU) also reports earnings this week and a look at its chart makes you believe that it may be ready for a rest.

While the option market is anticipating only a 7.5% move in price, the 1% ROI threshold may be able to be achieved if shares drop less than 9.3%. The availability of expanded weekly options makes this a bit more attractive than the Apollo trade, however, I tend to prefer those earnings related trades in which shares are already trading with a negative bias, such as Apollo.

A few days ago, Josh Brown asked on Twitter if anyone could find a worse looking chart in the S&P 500 than Coach (COH), he would be impressed. Well, Bed Bath and Beyond (BBBY) reports earnings this week and its chart isn’t the most beautiful of sights to behold.

As opposed to Micron Technology and Apollo Group, there isn’t the same kind of gap between the implied price move and the strike level that gives me a sense of security if selling puts. However, Bed Bath and Beyond is a stock that I wouldn’t mind owning if faced with the prospect of assignment of those puts, although I would still consider the possibility of rolling over puts, as expanded weekly options are available.

Finally, Sinclair Broadcasting (SBGI) was a stock that I kept a close eye on this past week. As the nation’s largest independent broadcaster it potential had something to lose as it awaited a decision by the Supreme Court on whether the Aereo device would be allowed to continue its re-broadcasts of programs coming over what are considered public airwaves.

I was watching closely not because I had any great interest in the legal basis for any decision, but rather because I had shares of SInclair and had sold options that were expiring this Friday. Mid-week came word that a decision might come as early as Thursday or Friday and that sent shares moving in alternating directions. Added to that was news that one of the founding family Vice-Presidents sold all of his shares earlier in the week was enough to prompt me to close the positions, pare down the profit and look for another roller coaster car.

By the time the market closed on Friday the decision had yet to be released, but selling again got the better of the shares and Sinclair lost its past month of gains.

The decision to do anything will essentially be binary. If the decision favors Aereo I would be very interested in re-purchasing shares of Sinclair Broadcasting. If the decision favors the traditional broadcasters then I’d anticipate a rebound in share price and would look elsewhere for opportunities.

For now, the Federal Reserve is giving us all of the opportunities we need and I’m certainly not going to become a fighter at this stage in my life.

Traditional Stocks: Apple, Kohls, Lowes, Sinclair Broadcasting

Momentum: none

Double Dip Dividend: Deere (6/26), Dow Chemical (6/26), EMC Corp (6/27)

Premiums Enhanced by Earnings: Apollo Education Group (6/25 AM), Bed Bath and Beyond (6/25 PM), Micron Technology (6/23 PM)

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.