Weekend Update – August 16, 2015

Most everyone understands the meaning of “a bull in a China shop.”

Even I, who always had problems with idiomatic expressions, could understand that the combination of bull and china wasn’t very good. You simply did not want a bull any where near fragile china, especially if it was precariously placed so that everyone could enjoy its sight.

At the very least you had to keep a close eye on the bull in an effort to avoid or minimize damage. Even better would be to keep it on a tight leash.

Now, it’s China that you have to keep an eye upon lest your bull gets damaged as China continues to tighten its leashes.

Lately China has become a threat to the bull that everyone’s been enjoying. The bull market itself has already been precariously positioned for a while and its tentativeness has been accentuated by some of the recent unpredicted and unpredictable actions by the Chinese government and the Peoples Bank of China (“PBOC”), which are essentially the same thing.

Just to confuse things a bit, in the midst of a series of 3 moves to devalue the Chinese Yuan, came an interruption by the PBOC in the currency markets to support the currency.

That sort of thing, trying to fight the tide of the currency market doesn’t typically work out as planned, but you can’t blame the PBOC for trying, given how the government’s actions in the stock markets have seemed to stop the hemorrhaging these past few weeks.

The theory at play may be that the tighter the leash the easier it is to control things when oxygen is no longer fueling natural existence.

While many suspect that China is looking to jump start its economy with a 10% currency devaluation, that is being denied, at least in terms of the size of the devaluation. What isn’t being denied is that the Chinese economy isn’t growing by the same leaps and bounds as it had been, if those leaps and bounds were real in the first place.

It should come as no surprise that China is using bully measures to try and bring things under control, because while they may be new at this game we call “capitalism,” the rulers understand the consequences of failure.

In the United States and Europe, we’re accustomed to cycles and the kinds of depths to which we get taken while awaiting the inevitable upward return.

Plus, we can “vote the bums out.”

In China, where personal and societal freedom has been traded for growing prosperity, what does the population have left if the prosperity disappears?

They can’t necessarily exercise their constitutional right to change their government representatives every two, four or 6 years as is often the cry after currency devaluation is felt by citizens as a their standard of living is reduced.

Of course the rulers remember the lesson of popular dissent and how their forefathers came to be in power, so this may be a government especially willing to pull out the stops, including a currency war.

While currency wars aren’t terribly common, when the bull is cornered it typically lashes out.

That’s usually not good for the bull, but now I’m left confused as to which side of the metaphor I’m working.

That may sum up where the new week is set to begin.

With markets successfully steering clear of violating support levels and having done so in a dramatic way mid-week and actually managing to not fritter away the effort, you would believe that there is reason for optimism.

However, despite revisions to previous month’s government Retail Sales Reports, the actual earnings reports coming from national retailers isn’t necessarily painting a picture of a spending consumer. That’s even as the JOLTS report indicates increasing job turnover, presumably leading to higher wages for more workers and more job openings for incoming workforce members.

The coming week has more retail sales reports and hopefully will give the market a fundamental reason to begin a test of resistance levels, while we await the next stutter step from China.

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

With all of the concern about what happens next in China, it seems odd to begin the week thinking about adding another position in Las Vegas Sands (NYSE:LVS).

I have 2 much more expensively priced share lots and have been awaiting an opportunity to add another. With all of the bad news focusing around gaming p
rospects in Macau, one of only two special administrative areas within China, Las Vegas Sands has seen its share price plummet and then go into regular paroxysms of pronounced movements higher and lower, as the news runs sweet and sour.

However, its current price now represents the downward paroxysm that has taken shares below the mid-point of a reasonably stable price channel over the past 8 months. That seems like a reasonable entry point.

While the trading range has been fairly well defined, which would seem to limit uncertainty, the option premium seems to respect the continuing uncertainty of doing business in Macau, during a period of time that market volatility is otherwise so low. Whereas uncertainty has been very much under-estimated for many stocks, especially as they were in the throes of earnings releases, Las Vegas Sands seems to be getting its fair due in terms of option pricing.

While i still own those more expensive shares and while the dividend has made it minimally more palatable, my hope for a new position, if added, would be to have it assigned before its next ex-dividend date at the end of the September option cycle.

On a positive note, Microsoft (NASDAQ:MSFT) may not have the same worries about China as do some other companies. I suppose that having so much of your intellectual property getting pirated within China makes you a little more resistant to the effects of currency devaluation.

So there’s always that.

Microsoft hopefully has some other good things going for it, as reviews for its new operating system, Windows 10, have been generally favorable. However, one has to remember that we often tend to be less picky about things when they’re free.

Microsoft is ex-dividend this week and one thing that isn’t free is a dividend. You know that when you look at your stock’s share price on its ex-dividend date. Although studies show long term out-performance by stocks offering dividends, that’s not very different from saying people who run marathons live longer.

Both may be true, but the underlying reason a company can afford to pay a dividend or the underlying reason that someone can run a marathon may be related to pre-existing financial health or physical health, respectively.

However, when the option premium tends to subsidize some of that decline in a stock’s share price, part of that dividend really may be free, thanks to the buyer of the option premium.

In this case, Microsoft is offering a relatively large option premium for a weekly at the money option helping to offset some of the obligatory price decline as shares go ex-dividend.

Also going ex-dividend this week are Cablevision (NYSE:CVC) and Dunkin Donuts (NASDAQ:DNKN). While watching television and eating donuts may not be the formula necessary to be able to run those marathons, there’s more to life than just good health.

A broad selection of television offerings, fast internet speed, hot coffee and a jelly donut can be its own kind of health.

You have to enjoy yourself, as well, and a combination of price appreciation, a satisfactory dividend and an option premium can create an enjoyable atmosphere.

Both companies offer only monthly option contracts, but this being the final week of the August 2015 cycle, there is a potential opportunity for them to effectively offer a weekly option during their ex-dividend week.

Cablevision is a company firmly in the grip of a single family and one that is perennially rumored to be for sale. Back in May, the last time I owned shares, not coincidentally just prior to its ex-dividend date, shares surged upon news of a foreign buyer for a privately owned cable company. That rumor took Cablevision along for a ride as well, especially since Cablevision indicated that it was now willing to sell itself.

While recent activity in the sector is focused on the changing landscape for product distribution and introducing the phrase “skinny bundle” into common parlance, Cablevision has fared better than the rest during recent sector weakness. In fact, after years of lagging behind, it has finally been an out-performer, at least as long as rumors and deep pockets or willing lenders are available.

When thinking about stocks that should have relatively little to be concerned about when China is considered, Dunkin Donuts comes to mind, but perhaps not for long. Earlier this year it announced plans for a major expansion in China, but it will hopefully shelve any thoughts of emulating its New England model.

I still am amazed after years of living and working in and around Boston how so many locations could exist so close to one another.

I don’t know whether it was Dunkin Donuts or its more upscale competitor that discovered that cannibalization doesn’t seem to extend to coffee purveyors, but there is still plenty of room around the rest of the nation for more and more of their outlets and maybe reason to slow down some overseas expansio
n.

While I would prefer a single week’s holding in order to capture the dividend, I would also consider the use of a longer term call option sale to try for capital appreciation of shares while other companies may have significant currency exchange concerns.

On that same day that it was revealed that activist Nelson Peltz took a large position in a food services company, DuPont (NYSE:DD) received an analyst upgrade and shares did something that they haven’t really done ever since Peltz was rebuffed when seeking a seat on the Board.

DuPont isn’t alone in seeming to be bargain priced, but it has actually accounted for 17% of the DJIA decline since coming off of its highs in the aftermath of Peltz being sent packing. So it has had more than its fair share of angst of late.

The option market doesn’t appear to expect any continued unduly large moves in share price and this is also a position that I would consider purchasing and using a longer term option in order to capitalize on share gains and a competitive dividend.

Finally salesforce.com (NYSE:CRM) reports earnings this week. Its share price has been the beneficiary of two successively well received earnings reports and rumors about a buyout from Microsoft.

In the nearly 4 months that have passed since those rumors the stock has given up very little of what was gained when the speculation began.

The option market is predicting up to 9.2% price movement, but as has been the case on a number of occasions this earnings season, the option market has been under-estimating some of the risk associated with earnings, particularly when they are disappointing.

While selling puts prior to earnings can be rewarding when shares either move higher or fall less than the implied move, I generally like to consider doing so when the stock is already showing some weakness heading into earnings.

salesforce.com hasn’t been doing that, although it is about 3% below its closing high for the year. What makes a put sale tempting is that a 1% ROI for the week may be obtained even if the shares fall 11%.

However, considering just how often the option market has missed the risk associated with earnings this quarter, salesforce.com is another in a series of earnings related put sales that I would only seriously consider after earnings and in the event of a precipitous fall in the market’s response.

While salesforce.com may have the expertise to know how to most efficiently utilize a herd of bulls to exact the greatest amount of damage its own recent rise carries significant risk in this market if there is the slightest disappointment in its earnings report and guidance. If that report does disappoint, there may still be reward to be found in selling put contracts as sellers pile on to depress the price, while helping to maintain a relatively high option premium even after the carnage.

Traditional Stocks: DuPont

Momentum Stocks: Las Vegas Sands

Double-Dip Dividend: Microsoft (8/18 $0.31), Cablevision (8/19 $0.15), DNKN (8/20 $0.26)

Premiums Enhanced by Earnings: salesforce.com (8/20 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.