Weekend Update – July 26, 2015

At first blush it may be hard to comprehend how the following opening line from Charles Dickens classic “A Tale of Two Cities” could be possible.

“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness…”

If your existence knows only the best of times it’s hard to see how it could also be the worst of times. Ask anyone on the right side of the 1% divide about the other side of that line and you’ll likely get a very quixotic look in response.

Recognizing that the polar opposites can concurrently exist in plain sight, yet be so hidden, was part of the genius of Dickens’ tale, but it was more than just the telling of a story. He was also sending a message of warning much closer to home.

If you have been following the stock market lately, you’ll know that even as new highs were approached once again just a week ago, there wasn’t really a pervasive sense of feeling more wealthy.

At least not for me.

The signs that perhaps not all was well and equitable were all around, but they barely received any notice. There were increasing dichotomies among the performances of the DJIA, S&P 500 and NASDAQ 100 over the past few weeks. Outrageously strong moves higher by Google (NASDAQ:GOOG), Amazon (NASDAQ:AMZN) and others distorted market capitalization indexes, just as sharp moves lower by IBM (NYSE:IBM) and other high priced DJIA components served to magnify declines in that price weighted index.

It has certainly been the best of times for those owning a small sub-set of the universe of stocks that had the ability to move the indexes in which they resided. But like the Parisian aristocracy of centuries ago, the impression that all is well may be blind to reality as so many were being left behind.

The past few weeks have perhaps not really been the worst of times, as that would be an exaggeration of major proportion, but it certainly hasn’t been the best of times for the vast majority of that same universe of stocks.

So as the major indexes were once again approaching or exceeding previous highs, they were doing so having been unduly influenced by a small number of very large market capitalization stocks that have gotten all of the attention.

Last week’s abysmal performance of the S&P 500 came a week after an equally wonderful performance. However, that wonderful was very much a product of a narrow mix of stocks, while this week’s retreat was more broad in scope.

In the past few weeks the market has successfully tested support as it bounced back decisively from a 5% decline. What it has failed to do is successfully test resistance after having come within a hair of breaking through to new highs. The shoulders of a few high performers hasn’t been sufficient to do the really heavy lifting necessary to break through resistance.

With the S&P 500 now sitting about 3% below its all time highs some stocks have had their share prices ravaged by earnings in a manner that seems disproportionate to the news. However, some of those stocks looking like bargains after earnings became even greater bargains a day or two later.

With earnings season having taken a decided shift this week after some initial optimism, the focus remains on earnings this week as international events have quieted and even this week’s upcoming FOMC Announcement and GDP release aren’t likely to shake things up very much.

While some of the stocks mentioned this week may appear to be bargain priced, I’m continuing a relatively tight fisted approach to new positions as “buying on the dip” strategy may still work, but may need to be much more selective than at any time over the past 3 years.

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

Lexmark (NYSE:LXK) reported earnings last week and was among those suffering tremendous declines, well beyond what the options market had been predicting.

Like its one time parent company, IBM, Lexmark has re-invented itself from a hardware company to a services one and for the past 3 years as that transition had been made, it’s not entirely clear that investors understand what Lexmark has become. As with IBM, it may be time for yet another re-invention or risk falling into irrelevancy.

Still, sitting at a nearly 2 year low, but with some technical support, Lexmark offers an attractive option premium and a very attractive dividend which is due early in the September 2015 cycle.

For that reason I would consider the sale of September options and would likely choose an out of the money strike in the belief that there may be some bounce in price possible over the course of the next two months as the company and investors think about what comes next.

Apple (NASDAQ:AAPL) doesn’t need re-invention, although it may need to find a success in its recently introduced Apple Watch, whose sales statistics weren’t broken out in the recent earnings report.

On a YTD basis Apple shares are among those that have lifted the 3 major indexes, in part giving the impression that all is well.

It’s decline for the week following what was interpreted as a miss on earnings, came even as the company reported a nearly 33% revenue increase on a year over year basis. Some may also have interpreted the announcement of a $1 billion reduction is spending as reflecting a slowdown, forgetting that Apple has periodically done the same even as it moved forward with significant upgrade cycles.

With an upcoming ex-dividend date the following week, I would consider the purchase of shares and the use of an extended weekly option seeking to get some capital gains on shares in addition to an attempt to capture the dividend.

Dow Chemical (NYSE:DOW) is another that suffered a large loss for the week after announcing earnings. While revenue was lower, it beat analyst’s estimates on EPS handily and proved CEO Andrew Liveris’ contention that low oil prices were good for Dow Chemical, despite some oil interests, at a time that it’s shares were trading in sympathy with declining oil prices.

Declining material costs were significant in helping Dow Chemical overcome decreased revenues and with oil’s recent renewed decline, there may be more advantage for the company.

As is often the case after a large price decline there is an increase in uncertainty that becomes reflected in the option premiums buyers are willing to pay and as shares dropped 10% last week the premiums are reflecting belief that some recovery is likely.

Unlike some more volatile positions that may be used in a covered option strategy and that are best when held for short periods, Dow Chemical is a very suitable long term holding thanks to its option premiums and dividends.

Texas Instruments (NASDAQ:TXN) reported earnings last week and in the minefield that the semiconductors currently represent, it did reasonably well after having fallen short of most analyst’s estimates.

Texas Instruments is ex-dividend this week and its option premiums reflect the perception that there is continued volatility ahead, as shares have fallen about 15% in the past 3 months. That combination may be a compelling one to consider a buy/write on shares prior to its ex-dividend date.

Ford (NYSE:F) reports earnings on Tuesday morning and is ex-dividend the following day. General Motors (NYSE:GM) reported much better than expected EPS last week, despite lower revenues and its shares were rewarded after some weakness the previous month.

While Ford hasn’t fallen as much as GM over the past month it may also be due for a some relief after it reports earnings.

There are a number of different potential approaches that could be taken with Ford as both earnings and a dividend are part of the options pricing equation this week.

One possibility is a buy/write selling an in the money call option. While the options market is predicting a 4.5% price move, the premium provides about 3.5% downside protection based upon Friday’s closing prices. If selling the $14 weekly call, shares would have to close at above $14.15 to have a likelihood of being assigned 3 days early.

However, if assigned early, the 2 day ROI of approximately 0.8% and the ability to recycle the funds into another income generating vehicle may have some appeal.

If, however, of the belief that Ford may also move higher as did General Motors, the use of a weekly out of the money strike price could offer a very nice return, especially if the dividend is also able to be captured. In the case of a $14.50 strike, that would mean that shares would likely have to exceed $14.65 for early assignment in order for the option buyer to capture the dividend.

Facebook (NASDAQ:FB) is one of those whose gains have been a boon for the S&P 500 and NASDAQ 100 as its market capitalization well exceeds that of IBM and is beginning to rival Microsoft (NASDAQ:MSFT) and other much longer establish
ed companies.

As everyone was getting on the bandwagon for Facebook shares to breach the $100 level the shares did exactly what you might expect them to do. The louder and more universal the calls came for that price ascent the more quickly it did just the opposite, although shares still ended the week on an up note and again out-performing the NASDAQ 100 for the week.

Facebook reports earnings this week and in its brief history as a public company has almost always pleased investors with their numbers and ability to both formulate strategies and execute them.

In the last 3 months Facebook shares are up nearly 19% while the NASDAQ 100 is absolutely flat. The options market is implying a 9.8% price move next week. Meanwhile, a price decline of less than 13.3% could still deliver a 1% ROI for the sale of a weekly put contract. However, in this instance, particularly in light of the 13% share price increase in July, I’d be more inclined to consider put sales after earnings are released, if shares fall in any meaningful way.

Finally, Twitter (NYSE:TWTR) is both a company and a stock that can generate concurrent polar opposites of reaction from users and investors, respectively. With its co-founder and interim CEO concurrently serving as CEO at start-up payment processor, Square, comes word that it has reportedly filed a confidential IPO.

In Dorsey’s case it may be the best of times and the best of times, but the jury is still out on Twitter, which reports earnings this week.

Twitter was my single most profitable position last year, not because of its stellar performance, but because it was so predictably volatile and offered wonderful option premiums along the way, as I sold puts repeatedly through the year and occasionally took assignment of shares and then sold calls.

I currently am short Twitter puts and am considering adding to that position as the premium itself is enticing, but knowing that in the event of a poorly received earnings report there will be heated up talks about Twitter’s viability as an independent company and whether it fits perfectly into Google’s need to own up to the minute information for its search engine behemoth.

The option market is implying a significant 13.8% price movement next week as earnings are released. However, a 1% ROI may be able to be achieved by selling put options a full 21% below Friday’s closing price. That represents one of the biggest dichotomies that I’ve seen in a while, particularly at a time when option premiums have been extraordinarily low, even for positions that hold more volatility than is usually the case.

While I usually don’t want to take ownership of shares when I’ve sold puts, Twitter has been one instance of a stock that I haven’t minded taking shares when assigned, rather than trying to evade that possibility by rolling over put options.

In Twitter’s case, if taking ownership, patience comes in handy, while awaiting either good news on performance, change in strategic direction or continued rumors of an inevitable buyout.

Traditional Stocks: Apple, Dow Chemical

Momentum Stocks: Lexmark

Double-Dip Dividend: Ford (7/29), Texas Instruments (7/29)

Premiums Enhanced by Earnings: Facebook (7/29 PM), Ford (7/28 AM), Twitter (7/28 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.