Posted on

Weekend Update – October 26, 2014

It’s too bad that life doesn’t come with highly specific indicators that give us direction or at least warn us when our path isn’t the best available.

Parents are supposed to do that sort of thing, but in real life the rules are pretty simple. You don’t go swimming for 30 minutes after a meal, you don’t kill people and you don’t swallow your chewing gum.

The seven additional commandments are really just derivative of those critically important first three.

Knowing the difference between right and wrong gives one the ability to change direction when getting too close to what is known to be on the wrong side of what society finds acceptable. Most people get the concept and also apply it to their personal safety.

In stock investing it’s not that simple, although there are lots of rules and all kinds of advance warning signals that may or may not work, depending on whether you were giving or receiving the information. As opposed to adolescents who eventually become adults and lose the “it can never happen to me” mentality, investors often feel a sense of immunity from what may await just beyond that point that others would avoid.

It would have been really, really nice if there was some kind of warning system that both alerted us to an upcoming decline and especially the fact that it would be abruptly followed by a reversal.

Much has been said about the various kinds of recoveries that can be seen, but if this most recent bounce higher will in fact be the recovery to the nearly 9% drop on an intra-day basis, then it is certainly of the “V-shape” variety.

This week came word that by a very large margin the activity in personal 401(k) retirement accounts had been to move out of equities, after the declines, and into fixed income instruments, after those interest rates had seen a 15% increase.

What may really complicate things is that there really is no society to provide guidance and set the boundaries. There are short sellers who like to see movement in one direction and then there are the rest of us, although we can all change those roles at any moment in time that seems to suit us.

For those that depended on the “key reversal” of a few weeks ago as a sign to buy or dipping below the 200 day moving average as a sign to sell, the past few weeks have frustrating.

On the other hand, news of rampant selling in 401(k) accounts may offer precisely the kind of prognostic indicator that many have been looking for, as being a perfectly contrarian signal and indication that the time to buy had come once again.

But what caused the sudden change that created the “V shape?”

Technicians and chart watchers will point to the sudden reversal seen on October 15th in the early afternoon as the DJIA had fallen more than 400 points. However, that 260 point mid-day reversal was lost, almost in its entirety at the following morning’s opening bell.

However, we may also want to thank serendipity that IBM (IBM) and Coca Cola (KO) didn’t report their earnings last week, and that reports of a New York City Ebola patient didn’t surface until market and contagion fears had abated.

It wasn’t until the afternoon following that 400 point drop that St. Louis Federal Reserve Governor James Bullard suggested that the Federal Reserve should consider delaying its ending of Quantitative Easing.

If you were looking for a turning point, that was it.

Even those that are critical of the Federal Reserve for its QE policies have been happy to profit from those very same policies. The suggestion that QE might continue would be a definite reason to abandon fear and buy what appear to be bargain priced stocks, especially as the fixed income side’s sudden 15% increase in rates made bonds less of a bargain..

I was either flatfooted or disbelieving in the sudden climb higher, not having made any new purchases for the second consecutive week. I was almost ready to make some purchases last Thursday, following what Wednesday’s decline, but that was followed by a 120 point gap up the following morning. Instead of adding positions I remained content to watch fallen asset values recapture what had been lost, still in the belief that there was another shoe to drop while en-route perhaps to a “W-shape”

That other shoe may come on Wednesday as the FOMC releases its monthly statement. Lately, that has been a time when the FOMC has given a boost to markets. This time, however, as we continue so consumed by the nuances or changes in the wording contained in the statement, there could be some disappointment if it doesn’t give some indication that there will be a continuing injection of liquidity by the Federal Reserve into markets.

If Bullard was just giving a personal opinion rather than a glimpse into the majority of opinion by the voting members of the FOMC there may be some price to be paid.

While there will be many waiting for such a word confirming Bullard’s comments to come there also has to be a sizable faction that would wonder just how bad things are if the Federal Reserve can’t leave the stage as planned.

Welcome back to the days of is good news bad news.

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

While the move higher this week was more than impressive, there’s still no denying that these large moves higher only happen in downturns. The question that will remain to be answered is whether the very rapid climb higher from recent lows will have any kind of sustainability.

For the coming week I expect another quiet one, at least personally. The markets may be anything but quiet, as they certainly haven’t been so for the past few weeks, but trying to guess where things may go is always a dicey prospect, just seemingly more so, right now.

Despite what may be continuing uncertainty I have increased interest in earnings related and momentum stocks in the coming week.

Among those is Joy Global (JOY) a stock whose fortunes are closely aligned with Chinese economic growth. Those prospects got somewhat of a boost as Caterpillar (CAT) delivered better than expected earnings during a week that was a cavalcade of good earnings, despite some high profile disappointments. While the S&P 500 advanced 4.1% for the week and Caterpillar rose 4.6%, Joy Global may just be warming up following only a 2.1% climb higher, but still trading well below its mean for the past year.

In that year it has generally done well in recovering from any downward moves in price and after two months in that kind of trajectory may be ready to finally make that recovery.

With “old technology” continuing to do well, EMC Corp (EMC) held up surprisingly well after its majority owned VMWare (VMW) fell sharply after its own earnings were announced. EMC typically announces its earnings the morning after VMWare announces and while showing some impact from VMWare’s disappointment, rapidly corrected itself after its own earnings were released.

EMC has simply been a very steady performer and stands to do well whether staying as an independent company, being bought out pr merged, or spinning off the large remainder of its stake in VMWare. Neither its dividend nor option premium is stunning, but there is a sense of comfort in its stability and future prospects.

Halliburton (HAL) has been trading wildly of late and is well below the cost of my most recent lot of shares. WHile the entire energy sector has fallen on some hard times of late, there’s little reason to believe that will continue, even if unusually warm weather continues. Halliburton, as have others, have been down this path before and generally investors do well with some patience.

That will be what I practice with my more expensive lot. However, at its current price and volatility, Halliburton, with its just announced dividend increase offers an exceptional option premium that is worthy of consideration, as long as patience isn’t in short supply.

Another stock having required more patience than usual has been Coach (COH). It reports earnings this week and as has been the case over the past 3 years it wouldn’t be unusual to see a large price move in shares.

The options market is expecting a 7% move in shares, although in the past the moves have been larger than that and very frequently to the downside. Lately, however, Coach seems to have stabilized as it has gotten a reorganization underway and as its competitor in the hearts and minds of investors, Michael Kors (KORS) has also fallen from its highs and stagnated.

The current lot of shares of Coach that I purchased were done so after it took a large earnings related decline and I didn’t believe that it would continue doing so. This time around, I’m likely to wait until earnings are announced and if shares suffer a decline I may be tempted to sell puts, with the objective of rolling over those puts into the future if assignment appears to be likely.

For those that like dabbling in excitement, both Facebook (FB) and Twitter (TWTR) announce their earnings this week.

< span style="font-size: medium;">I recently came off an 8 month odyssey that began with the sale of a Twitter put, another and another, but that ultimately saw assignment as shares dropped about $14. During that period of time, until shares were assigned, the ROI was just shy of 25%. I wouldn’t mind doing that again, despite the high degree of maintenance that was required in the process.

The options market’s pricing of weekly options is implying a price movement of about 13% next week. However, at current premiums, a drop of anywhere less than 18% could still deliver a weekly ROI of about 1.2%. I look at that as a good return relative to the risk undertaken, albeit being aware that another long ride may be in store. Since Twitter is, to a large degree, a black box filled with so many unknowns, especially regarding earnings and growth prospects, even that 18% level below could conceivably be breached.

Facebook seems to have long ago quieted its critics with regard to its strategy and ability to monetize mobile platforms. In the 2 years that it has been a publicly traded company Facebook has almost always beaten earnings estimates and it very much looks like a stock that wants to get to $100.

The option market is implying a much more sedate 7.5% in price movement upon earnings release and the decline cushion is only about 9.5% if one is seeking a 1% ROI.

Both Facebook and Twitter are potentially enticing plays this coming week and the opportunities may be available before and after earnings, particularly in the event of a subsequent share decline. If trying to decide between one or the other, my preference is Twitter, as it hasn’t had the same upside move, as Facebook has had and I generally prefer selling puts into price weakness rather than strength.

After some disappointing earnings Ford Motor (F) goes ex-dividend this week. Everyone from a recent Seeking Alpha reader who commented on his Ford covered call trade to just about every talking head on television is now touting Ford shares.

Normally, the latter would be a sign to turn around and head the other way. However, despite still being saddled with shares of a very beleaguered General Motors (GM), I do like the prospects of Ford going forward and after a respite of a few years it may be time to buy shares again. The dividend is appealing and more importantly, appears to be safe and the option premiums are enough to garner some interest as shares are just slightly above their yearly low.

Finally, I don’t know of anyone that has anything good to say about Abercrombie and FItch (ANF), regardless of what the perspective happens to be. It, along with some other teen retailers received some downgrades this past Friday and its shares plummeted.

I have lost count of how often that’s been the case with Abercrombie and FItch shares and I’ve come to expect them to rise and plunge on a very regular basis. If history is any guide Abercrombie and Fitch will be derided for being out of touch with consumers and then will surprise everyone with better than expected earnings and growth in one sector or another.

I’ve generally liked to jump on any Abercrombie post-plunge opportunity with the sale of puts and while I’d be inclined to roll those over in the event of likely assignment, I wouldn’t be adverse to taking possession of shares in advance of its earnings and ex-dividend date, which are usually nearly concurrent, with earnings scheduled for November 20t, 2014.

Traditional Stocks: EMC, Halliburton

Momentum: Abercrombie and Fitch, Joy Global

Double Dip Dividend: Ford (10/29)

Premiums Enhanced by Earnings: Coach (10/28 AM), Facebook (10/28 PM), Twitter (10/27 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.

Posted on

More and More Earnings

After last week’s deluge of 150 of the S&P 500 companies reporting their earnings this week is a relatively calm one.

For all of its gyrations last week, including the sell-off on Friday, if you simply looked at the market’s net change you would have thought that it was a quiet week as well.

The initial week of earnings season did see seem promise coming from the financial sector. Last week was a mixed one, as names such as Facebook (FB) and Amazon (AMZN) went in very different directions and the initial responses to earnings didn’t necessarily match the final result, such as in the case of NetFlix (NFLX).

While some of the sell-off on Friday may be attributed to the announcement of additional European Council sanctions against Russia and perhaps even the late in the session downgrade of stocks and bonds by Goldman Sachs (GS), earnings had gotten most of the week’s attention.

The coming week offers another opportunity to consider potential trades that can profit regardless of the direction of share price movements, as long as they stay reasonably close to the option market’s predictions of their trading range in response to those reports.

In line with my own tolerance for risk and my own definition of what constitutes a suitable reward for the risk, I prefer the consideration of trades that can return at least 1% for the sale of a weekly put option at a strike level that is below the lower boundary defined by the option market’s assessment. Obviously, everyone’s risk-reward profile differs, but I believe that consistent application or standardizing criteria by individual investors is part of a discipline that can make such trades less anxiety provoking and less tied to emotional factors.

Occasionally, I will consider the outright purchase of shares and the sale of calls, rather than the sale of puts for such trades, but that is usually the case if there is also the consideration of an upcoming ex-dividend date, such as will be the case with Phillips 66 (PSX). Additionally, doing so would most likely be done if I had no hesitancy regarding the ownership of shares. In contrast, often when I sell puts I have no real interest in owning the shares and would much prefer expiration or the ability to roll over those contracts if assignment appeared likely.

This coming week there again appear to be a number of stocks deserving attention as the reward may be well suited to the level of risk, thanks to the option premiums that are enhanced before earnings are released.

As often is the case the stocks that are most likely to be able to deliver a 1% or greater premium at a strike level outside of the implied move range are already volatile stocks, whose volatility is even greater in response to earnings. While at first glance an implied move of 12%, as is the case for Yelp (YELP) may seem unusually large, past history shows that concerns for moves of that magnitude are warranted.

Among the companies that I am considering this coming week are Anadarko (APC), Herbalife (HLF), MasterCard (MA), Mosaic (MOS), Merck (MRK), Outerwall (OUTR), Phillips 66, T-Mobile (TMUS), Twitter (TWTR) and Yelp.

These potential trades are entirely based upon what may be a discrepancies between the implied price movement and option premiums that will return the desired premium. Generally, I don’t think very much about those issues that may have relevance prior to considering a purchase of shares. The focus is entirely on numbers and whether the risk-reward proposition is appealing. Issues such as whether people are tweeting enough or whether a company is based upon a pyramid strategy can wait until the following week. Hopefully, by that time I would be freed from the position and would be less interested in those issues.

Deciding to pull the trigger is often a function of the prevailing price dynamic. My preference when selling put contracts is to do so if shares are falling in price in advance of earnings. For example, last week I did not sell puts on Facebook (FB), as its shares rose sharply prior to earnings. In that case, that represented a missed opportunity, however.

Compared to the previous week’s close of trading when the market had a sizable gain, this past Friday there were widespread losses, perhaps resulting in a different dynamic as the coming week begins its trading.

While I would rather not take ownership of shares, there must be a realization that doing so may be inevitable or may require additional actions in order to prevent that unwanted outcome, such as rolling the put option forward, if possible.

If there is a large decline in share price well beyond that lower boundary, the investor should be prepared for an extended period of needing to juggle that position in order to avoid assignment while awaiting some price recovery. I have some positions, that I’ve done so for months. The end result may be satisfactory, but the process can be draining.

The table may be used as a guide for determining which of this week’s stocks meet risk-reward parameters. Re-assessments should be made as share prices  option premiums and strike levels may change. 

While the list can be used in executing trades before the release of earnings, there may also be opportunity to consider trades following earnings. I typically like to consider those trades if a stock moved higher before earnings and then plunged afterward, if in the belief that the response was an over-reaction to the news. In such cases there may be an opportunity to sell put options whose premiums will still see some enhancement as a reflection of the strong negative sentiment taking shares lower.

Ultimately, if large price movements are either anticipated or have already occurred there is usually some additional opportunity that arises with the perceived risk at hand. If the risk isn’t realized, or if the risk is managed appropriately, the reward can be very addictive.

Posted on

Weekend Update – July 27, 2014

It seems that almost every week over the past few months have both begun and ended with a quandary of which path to take.

Talk about indecision, for the previous seven weeks the market closed in the an alternating direction to the previous week. This past week was the equivalent of landing on the “green” as the S&P 500 was 0.12 higher for the week, but ending the streak.

Like the biology experiment that shows how a frog immersed in water that is slowly brought to a boil never perceives the impending danger to its life, the market has continued to set new closing record high after record high in a slow and methodical fashion.

With all the talk continuing about how money remains on the sidelines from 2008-9, you do have to wonder how getting into the market now is any different from that frog thinking about climbing into that pot as it nears its boiling point.

Unless there’s new money coming in what fuels growth?

That’s not to say that danger awaits or that the slow climb higher will lead to a change in state or a frenzied outburst of energy leading to some calamitous event, but the thought could cross some minds.

Perhaps Friday’s sell off will prompt some to select one path over another, although a single bubble doesn’t mean that as you’re immersed in a bath that it is coming to a boil. It may entirely be due to other reasons, such as your most recent meal, so it’s not always appropriate to jump to conclusions.

While the frog probably doesn’t really comprehend the slowly growing number of bubbles that seem to be arising from the water, investors may begin to notice the rising number of IPO offerings entering the market and particularly their difficulty in achieving pricing objectives.

I wonder what that might signify? The fact that suddenly my discount brokerage seems to be inundating me with IPO offers makes me realize that it does seem to be getting hotter and hotter around me.

This coming week I’ve had cash reserves replenished with a number of assignments, somehow surviving the week ending plunge and I see many prices having come down, even if just a little. That combination often puts me into a spending mood, that would be especially enhanced if Monday begins either on the downside or just tepidly higher.

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

The big news in the markets this week was Facebook (FB) as its earnings report continued to make clear that it has mastered the means to monetize a mobile strategy. While it produces nothing it’s market capitalization is stunning and working its way closer to the top spot. For those in the same or reasonably close sector, the trickle down was appreciated. One of those, Twitter (TWTR) reports earnings this week and the jury is still very much out on whether it has a viable product, a viable management team and even a viable life as an independent entity.

For all of those questions Twitter can be an exciting holding, if you like that sort of thing. I currently hold shares that were assigned to me after having fallen so much that I couldn’t continue the process of rolling over puts any longer. The process to recover has been slow, but speeded a bit by selling calls on the way higher. However, while that has been emotionally rewarding, but as may be the case when puts are sold and potential ownership is something that is shunned, has required lots of maintenance and maneuvering.

With earnings this week the opportunity arises again to consider the sale of new Twitter puts, either before earnings are released or if shares plunge, afterward.

The option market is implying an 11.7% move in shares upon earnings. a 1% weekly ROI may possibly be obtained at a strike price that’s 14.8% below Friday’s close.

While Twitter is filled with uncertainty, Starbucks (SBUX) has some history behind it that gives good reason to have continuing confidence. With the market having looked adversely at Starbucks’ earnings report, Howard Schultz gave an impassioned and wholly rational defense of the company, its operations and prospects.

In the past few years each time Starbucks shares have been pummeled after earnings and Schultz has done as he did on Friday, it has proven itself an excellent entry point for shares. Schultz has repeatedly shown himself to be among the most credible and knowledgeable of CEOs with regard to his own business and business strategy. He has been as bankable as anyone that can be found.

With an upcoming dividend, always competitive option premiums and Schultz standing behind it, the pullback on Friday may be a good time to re-consider adding shares, despite still trading near highs.

While I suppose Yelp (YELP) could tell me all about the nearest Starbucks and the experience that I might expect there, it’s not a site that gets my attention, particularly after seeing some reviews of restaurants that pilloried the businesses of places that my wife and I frequent repeatedly.

Still, there’s clearly something to be had of value through using the site for someone. What does have me interested is the potential opportunity that may exist at earnings. Yelp is no stranger to large moves at earnings and for those who like risk there can be reward in return. However, for those who like smaller dosages of each a 1% ROI for the week can potentially be achieved at a strike price of $58 based on Friday’s $68.68 closing priced and an implied move of 12%. Back in April 2014 I received an almost 3% ROI for the risk taken, but don’t believe that I’m willing to be so daring now that I’m older.

Following the market’s sharp drop on Friday it was difficult to not jump the gun a little bit as some prices looked to be either “too good” or just ready. One of those was General Motors (GM). Having survived earnings last week,
albeit with a sizeable share drop over the course of a few days and wading its way through so much litigation, it is quietly doing what it is supposed to be doing and selling its products. An energized consumer will eventually trade in those cars that have long passed their primes, as for many people what they drive is perceived as the best insight into their true standing in society. General Motors has traded nicely as it has approached $33 and offers a nice premium and attractive dividend, making it fit in nicely with a portfolio that tries to accentuate income streams even while shares my gyrate in price.

I never get tired of thinking about adding shares of eBay (EBAY). With some of my shares assigned this past Friday despite some recent price strength after earnings, I think it is now in that mid-point of its trading range from where it has been relatively easy to manage the position even with some moves lower.

Carl Icahn has remained incredibly quiet on his position in eBay and my guess, based on nothing at all, is that there is some kind of behind the scenes convergence of thought between Icahn and eBay’s CEO, John Donahoe, regarding the PayPal jewel.

With all of the recent talk about “old tech,” there’s reason to consider one of the oldest, Texas Instruments (TXN) which goes ex-dividend this coming week. Having recently traded near its year’s high, shares have come down considerably following earnings, over the course of a few days. While still a little on the high side, it has lots of company in that regard, but at least has the goods to back up its price better than many others. It, too, offers an attractive combination of dividend, premiums and still possibility of share appreciation.

Reporting earnings this week are both MasterCard (MA) and MetLife (MET). Neither are potential trades whose premiums are greatly enhanced by the prospects of earnings related surprises. Both, however, are companies that I would like to once again own, possibly through the sale of put options prior to earnings being announced.

MasterCard suffered on Friday as collateral damage to Visa’s (V) earnings, which helped drag the DJIA down far more than the S&P 500, despite the outsized contribution by Amazon (AMZN) which suffered a % decline after earnings. On top of that are worries again from the Russian market, which earlier in the year had floated the idea of their own credit system. Now new rules impacting payment processors in Russia is of concern.

MasterCard has been able to generate satisfactory option premiums during an otherwise low volatility environment and despite trading in a $72 – $78 range, as it has regular bounces, such as seen this past week.

I have been waiting for MetLife to trade down to about the $52 range for the past two months and perhaps earnings will be the impetus. For that reason I might be more inclined to consider opening a position through the sale of puts rather than an outright buy/write. However, also incorporated into that decision process is that shares will be going ex-dividend the following week and there is some downside to the sale of puts in the face of such an event, much as their may be advantage to selling calls into an ex-dividend date.

Finally, there hasn’t been much that has been more entertaining of late than the Herbalife (HLF) saga. After this past week’s tremendous alternating plunge and surge and the absolute debacle of a presentation by Bill Ackman that didn’t quite live up to its billing.

While there may certainly be lots of validity to Ackman’s claims, which are increasingly not being nuanced, the opportunity may exist on both sides of the controversy, as earnings are announced next week. Unless some significant news arises in addition to earnings, such as from the SEC or FTC, it is like any other high beta stock about to report earnings.

The availability of expanded weekly options makes the trade more appealing in the event of an adverse move bringing shares below the $61.50 level suggested by the implied volatility, allows some greater flexibility. However, because of the possibility of other events, my preference would be to have this be as short term of a holding as possible, such that if selling puts and seeing a rise in shares after earnings, I would likely sacrifice remaining value on the options and close the position, being happy with whatever quick profits were achieved.

Traditional Stocks: eBay, General Motors, MasterCard, MetLife, Starbucks

Momentum: none

Double Dip Dividend: Texas Instruments (7/29)

Premiums Enhanced by Earnings: Herbalife (7/28 PM), Twitter (7/29 PM), Yelp (7/30 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.

Posted on

Weekend Update – July 20, 2014

While I don’t necessarily believe that space aliens will descend upon us with laser rays blazing, there’s reason to increasingly believe that possibility as we learn more and more about the existence of conditions elsewhere in the universe that may be compatible with sustaining life.

Still, even with that knowledge, I don’t let it control my life and quite frankly will probably never do anything that in any way is impacted by the thought of an encounter with an alien.

The principle reason for not elevating the alarm level is that there is no point in history to serve as an example. The pattern of life on earth has been so far devoid of such occurrences, as best we know. Right now, that’s good enough for me.

However, I just don’t completely discount the possibility, because I believe that it’s of a very low probability. Besides, the vaporization process would be so swift that there would be no time for remorse or regrets. At least that’s what I expect.

By the same token I don’t expect a complete meltdown in the market, even though I know it has and can, likely occur again. Despite its probability of occurrence and my belief of that probability, I’m not really prepared for one if it were to occur, even with the extraordinarily low cost of portfolio protection. The chances of a complete meltdown, as we know, is probably more likely to occur in the near term than the prospect of laser waving aliens in our lifetimes.

For all practical purposes one is a real probability and the other isn’t, yet they aren’t necessarily placed into different risk categories at the moment.

This week’s events, however, served as a reminder that the unexpected should always be expected. With the nice rebound on Friday from Thursday’s news of the tragic downing of the civilian Malaysian airplane, the lesson may be lost, however.

One thing that we seem to have forgotten how to do in the past 5 years is to expect the unexpected. Instead our expectations have been fueled by the relentless climb higher and a feeling of invincibility. To a large degree that feeling has been justified as every attempt to fight back against the gains has been stymied in quick and due course.

I probably wasn’t alone in having that invincible feeling way back in 2007. The vaporization process was fairly swift then, as well.

Even when faced with challenges that in the past would have sent markets tumbling, such as international conflict, we haven’t seen the application of age old adages such as “do not stay long going into a weekend of uncertainty.” This Friday’s market rebound was another example in a long string of uncertainty being expected to not lead to the unexpected.

In essence with the certainty of an ever climbing market having become the new reality there’s been very little reason to exercise caution, or at least to be prepared to act in a cautious manner in the expectation that perhaps the unexpected will occur.

Our minds are wired to like and identify patterns. That’s certainly the strategic basis for stock trading for many. Predictability brings a degree of comfort, but too much comfort brings complacency. The prevailing pattern simply argues against the unexpected, so we have discounted its probability and to a large degree its possibility.

While we may be correct in discounting complete market meltdowns, as their occurrence is still relatively uncommon, that complacency has us discounting intermediate sized moves that can easily come from the unexpected. The world is an increasingly complex and inter-connected place and as seen in the past week there needn’t be advanced warning signs for any of an infinite number of unexpected events to occur.

We did get lucky this past week, but we probably expected the luck to continue if the unexpected did strike. What would really be unexpected would be to draw a lesson from our fragility standing near market highs.

As usual, the week’s potential stock selections are classified as being in Traditional, Double Dip Dividend, Momentum or “PEE” categories. With many companies reporting earnings this coming week a companion article, “Taking a Gamble with Earnings,” explores some additional potential trades.

As Thursday’s trading was coming to its close at the lows of the session more and more stocks were beginning to return to what seemed to be more reasonable trading levels.

The problem, of course, is dealing with the unexpected and trying to predict what comes next when there are really no data points to characterize what we’ve seen. Someday when we look back at these events and the market impact we may see a pattern, but at the moment the question will be “which pattern?” Is it one that’s simply a blip and short-lived as the event itself is self-limiting or is the pattern consistent with the beginning stages of what is to become an ongoing and escalating series of events that serve to erode confidence and place continuing strains on the market?

In other words, did we just witness a typical over-reaction and subsequent rebound or are we ready to witness a correction?

I think its the former, but it opens the possibility of additional incidents and escalation of hostilities in a part of the world that is far more meaningful to the world’s economies than unheralded internecine conflicts occurring in so many other places.

Interestingly, with that kind of backdrop, this week, while we begin to sort out what the short term holds, “Momentum” kind of stocks, particularly those with little to no international exposure in the hotbed areas, may be more conservative choices than the more Traditional selections.

While I like British Petroleum (BP), General Electric (GE) and Deere (DE) this week, predominantly due to their recent price drops, there is certainly reason to be wary of their exposure to parts of the world in conflict.

British Petroleum certainly has known interests in Russia and could be at unique risk, however, I believe that we will be seeing a lesser chest thumping Russia in the n
ear term as there is some reason to believe that existing sanctions and perhaps expanded ones are beginning to get attention at the highest levels. Above all, pragmatism would dictate not injuring the source of hard currency.

I’ve been waiting a while to re-purchase shares of British Petroleum and certainly welcome any opportunity, even if still at a price higher than my last entry. With earnings scheduled to be reported July 29, 2014 and a healthy dividend sometime during the August 2014 option cycle there may be opportunities over the coming weeks with these shares to generate ongoing income.

General Electric reported its earnings this past Friday and also announced the impending IPO of its consumer finance business. The market was unimpressed on both counts.

I haven’t owned shares of General Electric with the frequency that it deserved. With a generous and increasing dividend, price stability, low beta and decent option premiums, it certainly has had the appeal for ownership, perhaps even using longer term option contracts to better  lock in some of those dividends. While it has significant international exposure the recent price weakness makes entry a little less risky, but even with the quality and size of General Electric unexpected bumpy rides can be possible when uncontrollable events create investor fear.

Deere is simply finally down to the price level that in the past was my upper range for purchase. With Caterpillar (CAT) reporting earnings later this week and trading near its 52 week high, there is room on the downside, as well as some trickle down to Deere shares. However, with Joy Global’s (JOY) recent performance, my anticipation is that Caterpillar’s Chinese related revenues will be enough to satisfy traders and offer some protection to Deere, as well.

On the Momentum side of the equation this week are Best Buy (BBY), Las Vegas Sands (LVS) and YUM Brands (YUM).

While Las Vegas Sands and YUM Brands certainly have international exposure, at the moment if you had to choose where to place your overseas bets, China may be relatively insulated from the unexpected elsewhere in the world.

Both companies are coming off weak earnings reports and the markets reacted accordingly. Both, however, have been very resilient to declines and finding substantive support levels in the past. With some shares of Las Vegas Sands recently assigned at current levels I would look for opportunity to re-purchase them. It’s volatility offers generous option premiums and the availability of expanded weekly options makes it easier to consider rollover opportunities in the event of unexpected price drops in order to wait out any price rebound, which has been the expected pattern.

YUM Brands is, like Deere, finally approaching the upper range of where I have purchased shares in the past. While I would like to see them even lower, I think that due to its dependence on the Chinese economy and market it may be a relative out-performer in the event of internationally induced market weakness.

Best Buy, unlike YUM Brands and Las Vegas Sands, has recently been on an upward price trajectory. I liked it much better when it was trading in the $26 range, but I believe it still has further upside potential in its slow climb back after unexpectedly bad earnings news 6 months ago. It too has an attractive option premium and a dividend and despite its recent price climb higher has come down nearly 5% in the past two weeks.

I have never purchased shares of Pandora (P) before, but love its product. At the moment I don’t particularly have any great desire to own shares, but Pandora does report earnings this week and is notable for its 10.8% implied price move. In the meantime a 1% ROI can be achieved at a strike price that is 16.4% below the current price. Those are the kind of characteristics that I like to see when considering what may otherwise be a risk laden trade.

Pandora has certainly shown itself capable of making very large earnings related moves and it is also certainly in the cross hairs of other and bigger players, such as Apple (AAPL) and Google (GOOG). However, even a scathing critic, TheStreet’s Rocco Pendola, has recently commented that its crushing defeat at the hands of those behemoths is not guaranteed.

Expected, maybe, but not guaranteed.

Facebook (FB) is also reporting earnings this coming week and in the two years that it has done so has predominantly surprised to the upside as it has quickly lived up to its vow to monetize its mobile strategy.

With an implied price move of 7.6% the strike level necessary to generate a 1% ROI through the sale of puts is 8.7% below Friday’s closing price. While shares can certainly make a move much larger than what is expected by the option market, in the event of an adverse move Facebook has some qualities that makes it an easier put option position to manage in the effort to avoid assignment.

It trades expanded weekly options and it does so with liquidity and volume, thereby having relatively narrow bid and ask spreads, even for deep in the money options.

Sooner or later, though, the expectation must be that earnings expectations won’t be met. I wouldn’t discount that possibility, although I think the options market may have done so a bit, so in this case I would be more inclined to consider the sale of puts after earnings, if share price drops on a disappointing report.

Finally, Apple reports earnings this week. It doesn’t really fulfill the criteria that I used when considering the sale of puts prior to earnings, in that it doesn’t appear that a 1% ROI can be achieved at a strike level outside of the range defined by the option market when calculating the “implied move.”

It’s probably useless trying to speculate on sales numbers or guidance. Based on its usual earnings related responses in the past, you would be justified in believing that the market had not expected  the news. However, this quarter the implied move is on the small side, at only 4.5%, suggesting that not much in the way of a surprise is expected next week.

With the current option pricing, the sale of Apple puts doesn’t meet my criteria, but I would again be interested in considering either the sale of puts after earnings, if the market’s response is negative or the outright purchase of shares and sale of calls, in anticipation of an ex-dividend date coming up in early August.

Sometimes it’s just
easier dealing with the expected.

Traditional Stocks:  British Petroleum, Deere, General Electric

Momentum: Best Buy, Las Vegas Sands, YUM Brands

Double Dip Dividend: none

Premiums Enhanced by Earnings: Apple (7/22 PM), Facebook (7/23 PM), Pandora (P)

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.

Posted on

Taking a Gamble with Earnings

The coming week stands to be a busy one as about 150 of the S&P 500 stocks will be reporting their quarterly earnings.

While earnings had gotten off to a good start last week with a strong showing from those in the financial sector, the market’s initial optimism was tempered a bit during the first day Janet Yellen’s Humphrey-Hawkins testimony and was sent into a pall with news of the tragic downing of a Malaysian civilian plan over the disputed Ukraine – Russian border area.

Regardless of the direction a stock’s price takes upon the earnings parade that also includes forward guidance there is often opportunity to profit from either the expected or unexpected news that’s delivered.

Whenever I ponder whether an earnings related trade is worth consideration I let the option market’s measure of the “implied price move” serve to determine whether there is a satisfactory risk-reward proposition. That calculation provides a price range in which projected price movements are thought to be likely.

If selling options, whether as part of a covered call strategy or through the sale of puts, there may be opportunity to achieve an acceptable premium even though if it represents a share price outside of the bounds set by the option market. Of course, that does depend to some degree on your own definition of “acceptable” and what you believe to be the appropriate level of risk to accompany that reward.

This coming week there appears to be a number of stocks that may warrant some attention as the reward may be well suited to the risk for some, as premiums tend to be heightened before known events, such as earnings.

A unifying theme for stocks that satisfy my criteria of offering a 1% or greater premium for a weekly option at a strike price outside of the boundary defined by the implied move calculation is underlying volatility. While already heightened due to impending earnings release and the uncertainty that accompanies the event, stocks that typically satisfy the criteria I’ve selected are already quite volatile.

While the implied volatilities may sometimes appear to be high, they are often consistent with past history and such moves are certainly within the realm of probability. That knowledge should serve as a warning that the unthinkable can, and does, happen.

While individuals can set their own risk-reward parameters, I’m very satisfied with a weekly 1% ROI.  The other part of the equation, the risk, is less quantitative. It is merely a question of whether the necessary strike level to achieve the reward is above or below the lower boundary defined by the stock’s implied move. 

I prefer to be below that lower boundary.

Among the companies that I am considering this coming week are Apple (AAPL), Cliffs Natural Resources (CLF), Comcast (CMCSA), Chipotle Mexican Grill (CMG), Facebook (FB), Freeport McMoRan (FCX), Intuitive Surgical (ISRG), Microsoft (MSFT), Pandora (P) and VMWare (VMW).

The basis for making any of these trades is entirely predicated upon what may be an inefficiency between the option premiums and the implied price movement. I give no consideration to fundamental nor technical issues and would prefer not to be in a position to take ownership of shares in the event of an adverse price move.

My preference when selling put contracts is to do so when shares have already been falling in price in advance of earnings. Given the flourish with which this past week ended that is a bit more difficult, as a number of the shares listed had sizable gains in the session, recovering from the previous day’s drops.

While I would prefer not to take ownership of shares, the investor must be prepared to do so or to attempt to manage the options contract, such as rolling it forward, if assignment appears inevitable.

During periods of low volatility it may sometimes be difficult to do so and achieve a meaningful additional premium without going out further in time than you may have envisioned, however.

The table above may be used as a guide for determining which of these selected companies meets risk-reward parameters. Re-assessments need to be made as prices and, therefore, strike prices and their premiums may change. Additionally, the target ROI may warrant being changed as time erodes. For example, if the trade is executed with only 4 days of time remaining on the contract the 1% ROI may find its equivalent in a 0.8% return.

While the list can be used prospectively there may also be occasion to consider put sales following earnings in those cases where shares have reacted in an extremely negative fashion to earnings or to guidance. If you believe the response was an over-reaction to the news there may then be opportunity to sell put options to take advantage of the negative sentiment that may be reflected in option premiums.

In such a case the sale of a put is a bullish sentiment and there may be opportunity to make that expression a profitable one as the over-reaction faces its own correction. My recent observation, however, is that it seems to be taking longer and longer to see some stocks mount meaningful recoveries after earnings disappointments, which I interpret as a bearish indicator for the market as a whole, as risk aversion is a priority.

Recently, I’ve spent some considerable time in managing some positions that had greater than anticipated price moves, including taking assignment and then managing the  position through the sale of call options.

Ultimately, regardless of the timing of an earnings related trade there is always opportunity when large price movements are anticipated, especially if those worst and best case scenarios aren’t realized.

Best of all, if the extreme scenarios are realized a nimble trader may have opportunity to create even more opportunities and allow the position to accumulate re
turns while doing so.

 

Posted on

Twitter Fatigue

I’ve grown tired of Twitter (TWTR).

That may be a purely defensive position as I’ve noticed that my limited number of Twitter followers may, in fact, be more tired of me and I just wanted to be ahead of that curve. It’s probably no coincidence that my follower numbers increase the less I tweet and those tweets have now come to a crawl and not because I feel a need to be original nor have run out of anything to say.

After a couple of years of trying to “promote” myself, a sense of disinterest has set in and people like me may be the problem that Twitter is facing regarding its growth prospects. Not only does Twitter have to convince new people to join, understand the interface and actually use it, but they also have to convince existng users to stay and actively participate. Using Twitter as I now predominantly do as a “news feed” as Herb Greenberg suggests may have utility for the user but adds little to their bottom line. 

Like others, I may find the occasional advance reporting of an errant helicopter encircling what every local knew to be an Al-Qaeda compound, but I didn’t try to engage that tweeter and really don’t recall much in the way of anyone trying to capitalize on all of those re-tweets or “favorites.” Also, as with reports of the floor of the New York Stock Exchange being under three feet of water, sometimes that breaking news just has a way of getting broken. While Twitter can be lauded for getting breaking news out before the professionals can get mobilized it can also be criticized for its lack of oversight of those who might be prone to be reckless.

Like so many who use Twitter, I do so through some interface other than the web site. Unless my experiences are some kind of aberration, I just don’t see those revenue producing “promoted” Tweets that are there to pay the bills, yet I and millions of others get to promote themselves ad infinitum. For those that follow huge numbers of others, even having those promoted tweets appear can see them easily getting lost in the volume of their stream.

To its credit, Twitter has opened up some really nice opportunities to engage and even meet some people that I would have never encountered otherwise. It is a perfectly egalitarian society that can offer a real sense of ego inflation not only on the basis of follower numbers but by reciprocal engagement by celebrities of various stature. That kind of periodic engagement can be the Pavlovian reward that may keep people interested and actively using the product in hopes of those occasional rewards.

While tiring of the actual product, what I’m not  tired of is the investing opportunity that its beleaguered shares have offered and, I believe, will continue to offer. For those who recall Facebook (FB) at a similar stage of its public life as it readied itself for an expected onslaught of selling prior to a major stock lock-up expiration, the opportunity to take a contrary position to the crowd is compelling. In the case of the initial Facebook lock-up expiration, sometimes the crowd is vociferous, emotional and clings to the certainty of their opinion on their way to being very wrong.

I’ve found some delight in selling puts on shares well prior to Tuesday’s earnings, occasionally seeing them expire and occasionally having to roll them over to a forward contract date, because the last thing I want to do is to own shares, although I do want to continue collecting premiums. I know that the conventional wisdom is that you shouldn’t sell puts on a stock that you wouldn’t be comfortable owning, but I have a hard time justifying ownership, especially as my serial sale of puts has been during a period that has seen the out of the money strike levels utilized fall in a straight line from $56 to $33 and, if the crowd is correct, will drop even lower next week, as May 6th, the lock-up expiration date approaches.

Over the past 16 weeks I have sold puts on shares of Twitter on 10 occasions, even as share value sunk lower and lower. These days it seems that I make some sort of Twitter trade more often than some sort of tweet, which pleases both my followers and banker. In general I start by looking for a situation in which there exists a strike level below the lower range defined by the Implied Volatility that wll return my ROI objective, which is 1% to start off the process using a weekly option. It’s not a very high ROI, but like so many things, you try to make it up in volume. 

The cumulative results of those trades has been an ROI of 11.6% with a remaining potential liability, of $2.xx based on Thursday’s closing price. That compares to a return of 2.5% for the S&P 500 for the observation period beginning in January 2014. If the entire liability is realized, for example if the remaining open position was closed the ROI would be reduced to 7.9%

On a side note, while I don’t like to use margin other than to prevent free riding violations, selling puts in a margin account that is otherwise fully invested, is a great way to extend the reach of your assets without incurring margin interest costs. Those only accrue if you are actually assigned shares and not if you simply sell puts, which only reduces the amount available to you for use, but doesn’t represent actual borrowing. I look at it as “Portfolio Helper,” but without the calories.

With shares of Twitter having fallen to post-IPO lows following its recent earnings report and with some additional nervousness related to the increased share float next week, I believe that there is continued opportunity to capitalize on the pessimism, through the continued sale of out of the money put options. With an implied volatility of 7.6% based upon premiums for the May 9, 2014 contract, one can still derive an ROI of 1% for the week if shares close above $35.50, which would represent a 9.2% drop in price, considerably in excess of what the option market is anticipating.

If the loss is greater, then the process of attempting to roll the contract over to a new date and perhaps even a lower strike level is begun and continued until it’s eventual expration which typically occurs when the price descent has come to its end. Unless shares are destined for some kind of death spiral at some point what has already been a sustained drop lower will come to its end, as will the series of trades.

While the argument may be made tha
t the gains could have been greater by simply shorti
ng Twitter shares, doing so requires a downward move, whereas selling puts may profit regardless of the direction of the price move. What matters is size and not vector. Additionally, other than commission expense, there is no associated interest expense as would be incurred in carrying a short position in shares that can become a burden with a longer time position.

Not a strategy for everybody and certainly one that has its own risk, but the initial use of well out of the money strike levels to achieve a defined ROI goal that’s not too greedy can be a reasonable way to generate returns that you might be proud to tweet about if only there was someone to acknowledge its receipt.

Posted on

Weekend Update – April 20, 2014

I really didn’t see this past week coming at all.

Coming off of an absolutely abysmal week that saw the market refuse to follow up good news with further gains and instead plunging some 400 points in 2 days there were so many reasons to believe that markets were finally headed lower and for more than just a quick dip.

While I strongly believe in not following along with the crowd there has to be some bit of you that tells the rest of you not to completely write off what the crowd is thinking or doing. On horse racing, for example, the favorite does still have its share of wins and the Cinderella long short story just doesn’t happen as often as everyone might wish.

To completely ignore the crowd is courting disaster. At least you can occasionally give the crowd their due.

But this past week wasn’t the week to have done so. This was absolutely the week to have ignored virtually everyone. Unfortunately, this was also the week that I chose not to do so and went along with the crowd. The argument seemed so compelling, but that probably should have been the first clue.

What made this past week so unusual was that hardly anyone tried to offer a reason for the inexplicable advance forward. Not only did the market climb strongly, but it even reversed a late day attempt to erase large gains and ended up closing at its highs for the day. We haven’t seen anything like that lately, as instead we’ve seen so many gains quickly evaporate. For the most part I felt like an outsider because i didn’t open very many new positions last week, but it was rewarding enough to have heard such little pontification, as few wanted to admit that the unexpected had occurred.

With the S&P 500 now less than 2% from its high, it does make you wonder whether the concept of a correction being defined on the basis of a 10% decline is relevant anymore. Although its much better to think in terms of relative changes, as expressed by percentages, but perhaps our brains are wired to better understand absolute movements. Maybe we interpret a 400 point move as being no different from any other 400 point move, regardless of what the baseline is for either and simply take the move as a signal to reverse.

It’s tempting to think that perhaps we’re simply returning to the recent pattern of small drops on the order of 5% and then returning to unchecked climbs to new records. Of course, that would be in the realm of the "expected."

I have little expectation for what the next week may bring, as trying to figure out what is now driving the markets seems very futile of late. While I don’t think of "going along for the ride" as a very satisfying strategy I may be content to do so if the market continues moving higher for no apparent reason. But without any real indication of a catalyst I’m not terribly excited about wholeheartedly endorsing the move higher in a tangible way.

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

Not all stocks shared in last week’s glory. JP Morgan Chase (JPM) and Unitedhealth Group (UNH) in part accounted for the DJIA lagging the S&P 500 for the week.

JP Morgan and Unitedhealth both felt some backlash after some disappointing earnings reports. For JP Morgan, however, it has been about a year since there’s actually been anything resembling good news and yet its stock price, up until the past week had well out-performed the S&P 500. I’ve been waiting for a return to a less pricey entry point and after the past week it’s arrived following a 9% drop this month. With little reason to believe that there’s any further bad news ahead it seems to offer low enough risk for its reward even with some market weakness ahead.

Unitedhealth Group’s decline was just slightly more modest than that of JP Morgan and it, too, has returned to a price level that I wouldn’t mind owning shares. I haven’t done so with any regularity but the entry price is getting less expensive. As more news emerges regarding the Affordable Care Act there is potential for Unitedhealth Group to go in either direction. While its most recent earnings disappointed, there may be some optimism as news regarding enrollments by younger people.

Fastenal (FAST) is a company that I like very much, but am a little reluctant to purchase shares at this level, if not for the upcoming dividend that I would like to capture. I’ve long thought of Fastenal as a proxy for the economy and lately shares have been trading near the upper end of its range. While that may indicate some downside weakness, Fastenal has had good resilience and has been one of those monthly contracts that I haven’t minded rolling over in the past, having owned shares 5 times in the past 6 months.

You probably can’t get much more dichotomous than Kohls (KSS) and Abercrombie and FItch (ANF). While Kohls has reliably sat its current levels and doesn’t live and die by fads and arrogance, Abercrombie has had its share of ups and downs and always seems to find a way to snatch defeat from victory. Yet they are both very good covered option trades.

With Kohls having recently joined Abercrombie in the list of those stocks offering expanded weekly options it is an increasing attractive position that offers considerable flexibility, good option premiums and a competitive dividend.

Abercrombie, because of its volatility tends to offer a more attractive option premium, but still offers an attractive enough dividend. Following some recent price weakness I may be more inclined to consider the sale of puts of Abercrombie and might be willing to take assignment of shares, if necessary, rather than rolling over put contracts.

This week there are a number of companies reporting earnings that may warrant some consideration. A more complete list of those for the coming week are included in an earlier article that looks at opportunities in selling put contracts in advance of, or after earnings. Of the companies included in that article the ones that I’ll most likely consider this week are Cree (CREE), Facebook (FB) and Deckers (DECK).

All are volatile enough in the own rights, but especially so with earnings to be released. I have repeatedly sold puts on Cree over the past few months with last week having been the first in quite a while not having done so. It can be an explosive mover after earnings, just as it can be a seemingly irrational mover during daily trading. It has, however, already fallen approximately 8% in the past month. My particular preference when considering the sale of puts is to do so following declines and Cree certainly fulfills that preference, even though my target ROI comes only at a strike level that is at the very edge of the range defined by its implied volatility.

Deckers has only fallen 5% in the past month and it, too can be explosive at earnings time. As with Cree, for those that are adventurous, the sale of deep out f the money puts can offer a relatively lower risk way of achieving return on investment objectives. In this case, while the implied volatility is 10.1%, a share drop of less than 13.2% can still return a weekly 1% ROI.

Facebook has generally performed well after earnings announcements. Even the past quarter, when the initial reaction was negative, shares very quickly recovered and surpassed their previous levels. As with all earnings related trades entered through the sale of puts my goal is to not own shares at a lower price, but rather to avoid assignment by the rollover of put contracts, if necessary, in the hope of waiting out any unforeseen price declines and eventually seeing the put contracts expire, while having accumulated premiums.

Finally, it seems as if there’s hardly a week that I don’t think about adding or buying shares of Coach (COH). Having already owned it on 5 occasions in 2014 and having shares assigned again this past week, it’s notable for its stock price having essentially stayed in place. That’s what continually makes it an attractive candidate.

This week, however, there is a little more risk if shares don’t get assigned, as earnings are reported next week and Coach has been volatile at earnings for the past two years.

For that reason, this week, Coach may best be considered as a trade through the sale of puts with the possible need to rollover the puts if assignment seems likely. That rollover, if necessary, would then probably be able to be done at a lower strike price as the implied volatility will be higher in the week of earnings.

Traditional Stocks: Momentum Stocks: JP Morgan, Kohls, United Healthcare

Momentum: Abercrombie and Fitch, Coach

Double Dip Dividend: Fastenal (ex-div 4/23)

Premiums Enhanced by Earnings: Cree (4/22 PM), Deckers (4/24 PM), Facebook (4/23 AM)

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.

Posted on

Rolling the Dice with Earnings

With earnings season ready to begin its second full week there are again some opportunities to identify stocks whose earnings may represent risk that is over-estimated by the options market, yet may still offer attractive premiums outside of the presumed risk area.

While in a perfect world good earnings would see increased share prices and bad earnings would result in price drops, the actual responses may be very unpredictable and as a result earnings reports are often periods of great consternation and frustration.

For the buy and hold investor, while earnings may send shares higher, this is also a time when paper profits may vanish and the cycle of share appreciation has to begin anew. Other than supplementing existing positions with strategic option positions, such as the purchase of out of the money puts, the investor must sit and await the fate of existing shares.

Occasionally, a covered option strategy, either through the sale of puts or buy/write transactions, may offer opportunity to achieve an acceptable return on investment while limiting the apparent risk of exposure to the large moves that may accompany good, bad or downright ugly news. Although a roll of the dice has definable probabilities, when it comes to stocks sometimes you want something that seems less predicated on chance and less on human emotion or herd mentality.

As always, whenever I consider whether an earnings related trade is worth pursuing I let the “implied volatility” serve as a guide in determining whether there is a satisfactory risk-reward proposition to consider action. That simple calculation provides an upper and lower price range in which price movement is anticipated and can then be compared to corresponding premiums collected for assuming risk. It is, to a degree based on herd mentality in the option market and has varying degrees of emotion already built into values. The greater the emotion, as expressed by the relative size of the premiums for strike levels outside of the range defined by the implied volatility the more interested I am in considering a position.

My preference in addressing earnings related trades is to do so through the sale of put contracts, always utilizing the weekly contract and a strike price that is below the lower range defined by the implied volatility calculation. Since I’m very satisfied with a weekly 1% ROI, I then look to find the strike level that corresponds to at least a 1% return.

While individuals can and should set their own risk-reward parameters, a weekly 1% ROI seems to be one that finds a good balance between risk and reward, as long as the associated strike level is also outside of the implied volatility range. If the strike level is within the range I don’t assess it as meeting my criteria. I sometimes may be less stringent, accepting a strike level slightly inside the lower boundary of the range if shares have already had some decline in the immediate days preceding earnings. Conversely, if shares have moved higher in advance of earnings I’m either less likely to execute the trade or much more stringent in strike level selection or expecting an ROI in excess of 1%.

While conventional wisdom is to not sell puts on positions that you wouldn’t mind owning at a specified price, I very often do not want to own the shares of the companies that I am considering. For the period of the trade, I remain completely agnostic to everything about the company other than its price and the ability to sell contracts and if necessary, purchase and then re-sell contracts repeatedly, until the position may be closed.

However, for those having limited or no experience with the sale of put contracts, you should assume a likelihood of being assigned shares and the potential downside of having a price drop well in excess of your projections. For that reason you may want to re-consider the agnostic part and be at peace with the potential of owning shares at your strike price and helping to reduce the burden through the sale of calls, where possible.

Since my further preference is to not be assigned shares, I favor those positions that have expanded weekly options available, so that there is opportunity to roll contracts over in the event that assignment appears likely using a time frame that offers a balance between return and brevity.

This week there are a number of stocks that will release quarterly earnings that may warrant consideration as the reward may be well suited to the risk taken for those with a little bit of adventurousness.

A number of the companies highlighted are volatile on a daily basis, but more so when event driven, such as with the report of earnings. While implied volatilities may occasionally appear to be high, they are frequently borne out by past history and it would be injudicious to simply believe that such implied moves are outside the realm of probability. Stocks can and do move 10, 15 or 20% on news.

The coming week presents companies that I usually already follow. Among them are Amazon (AMZN), Cliffs Natural Resources (CLF), Cree (CREE), Deckers (DECK), Facebook (FB), Gilead (GILD), Microsoft (MSFT) and Netflix (NFLX).

The table above may be used as a guide for determining which of these stocks meets personal risk-reward parameters, understanding that re-calculations must be made as share prices, their associated premiums and subsequently even strike level targets may change.

While I most often use the list of stocks on a prospective basis in anticipation of an earnings related move, sometimes the sale of puts following earnings is a favorable trade, especially in instances in which shares have reacted in a decidedly negative fashion to earnings or to guidance.

Regardless of the timing of the sale of puts, before or after earnings are released, being more pessimistic regarding the potential for price drops may be an enticing trade for the generation of income.

Posted on

Earnings Still Matter

Last week confirmed that I still like earnings season, which as behavioral adaptations go, is a good idea, as it never seems to end. Better to learn to like it than to fight it.

Based upon comments heard over the past few weeks, approximately 25% of the year represent critical earnings weeks. You simply can’t escape the news, nor more importantly the impact.

Or the opportunity.

Of the earnings related trades examined last week, I made trades in two: Facebook (FB) and Seagate Technolgy (STX). The former trade being before earnings and the latter after, both involving the sale of out of the money puts. Both of those trades met my criteria, as in hindsight, did Chipotle Mexican Grill (CMG), but there’s always next quarter.

While hearing stellar numbers from Netflix (NFLX) and Facebook are nice, they are not likely to lead an economy and its capital markets forward, although they can lead your personal assets forward, as long as you’re willing to accept the risks that may be heightened during a weakening market.

With “implied volatility” continuing to serve as my guide there are a number of companies that are expected to make large earnings related moves this week and they have certainly done so in the past.

Again, while I seek a 1% ROI on an investment that is hoped to last only
for the week, the individual investor can always adjust the risk and the reward. My preference continues to be to locate a strike price that is outside the range suggested by the implied volatility, yet still offers a 1% or greater ROI.

Typically, the stocks that will satisfy that demand already trade with a high degree of volatility and see enhanced volatility as earnings and guidance are issued.

The coming week is another busy one and presents more companies that may fit the above criteria. Among the companies that I am considering this coming week are Anadarko (APC), British Petroleum (BP), Green Mountain Coffee Roasters (GMCR), International Paper (IP), Michael Kors (KORS), LinkedIn (LNKD), Twitter (TWTR), Yelp (YELP) and YUM Brands (YUM).

As with all earnings related trades I don’t focus on fundamental issues. It is entirely an analysis of whether the options market has provided an opportunity to take advantage of the perceived risk. A quick glance at those names indicates a wide range of inherent volatility and relative fortunes during the most recent market downturn.

Since my preference is to sell puts when there is already an indication of price weakness this past week has seen many such positions trading lower in advance of earnings. While they may certainly go lower on disappointing news or along with broad market currents, the antecedent decline in share price may serve to limit earnings related declines as previous resistance points may be encountered and serve as brakes to downward movement. Additionally, the increasing volatility accompanying the market’s recent weakness is enhancing premiums, particularly if sentiment is further eroding on a particular stock.

Alternatively, rather than following the need for greed, one may decide to lower the strike price at which puts are sold in order to get additional protection wile still aiming for the ROI objective.

As always when considering these trades, especially through the sale of put options, the investor must be prepared to own the shares if assigned or to manage the options contract until some other resolution is achieved.

Strategies to achieve an exit include rolling the option contract forward and ideally to a lower strike or accepting assignment and then selling calls until assignment of shares.

The table above may be used as a guide for determining which of selected companies may meet the risk–reward parameters that an individual sets, understanding that adjustments may need to be made as prices and, therefore, strike prices and premiums may change.

The decision as to whether to make the trade before or after earnings is one that I make based on perceived market risk. During a period of uncertainty, such as we are presently navigating, I’m more inclined to look at the opportunities after earnings are announced, particularly for those positions that do see their shares declining sharply.

While it may be difficult to find the courage to enter into new positions during what may be the early stages of a market correction, the sale of puts is a mechanism to still be part of the action, while offering some additional downside protection if using out of the money puts, while also providing some income.

That’s not an altogether bad combination, but it may require some antacids along the way.

Posted on

Weekend Update – November 10, 2013

Is there life after momentum slows?

There was no shortage of stocks taking large price hits last week, as earnings season had already begun its slowdown phase. However, for some of the better known momentum stocks the slightest mis-steps were all the reason necessary to flee with profits.

For those who live long enough, it should never come as a surprise that some things are just destined to slow down.

Momentum fits into that category, although based on the past week it’s more of a question of falling down than slowing down for some.

After the fact, no one seemed to be surprised.

In a week that saw a decrease in the ECB’s main lending rate that was widely described as being a “surprise'” later in the day came reports that most economists expected the cut. The market clearly didn’t, however, as the economists may have neglected to pass on their views.

And then there was a surprisingly large increase in non-farm payroll jobs. Somehow everyone was taken off guard and the market responded by interpreting good news as good news and finished the week with a flourish.

What surprised me, however, was that there was such a disconnect between the anticipated numbers and the actual report, which covered the period of the government shutdown. The disconnect had to do with methodology, as forecasts didn’t take into account that government statistics considered furloughed employees to be employed, since they were to receive back, through legislative action.

Oops.

In effect, Friday’s rally was based on a misunderstanding of methodology. It will also certainly be interesting to see what impact Ben Bernanke’s statement after the market’s close may have on Monday’s trading.

I think the unemployment rate probably understates the degree of slack in the labor market. I think the employment-population ratio overstates it somewhat, because there are important downward trends in participation

Unfortunately, Friday’s gains complicate the goal of finding bargain priced stocks in the coming week, but with a little water having been thrown on the fire there may be opportunity yet.

Everyone, including me, likes to look for clues and cues that have predictive value. Parallels are drawn at every opportunity to what we know from the past in the expectation that it can foretell the future.

For some the sudden increase in IPOs coming to market and the sudden fall of many momentum stocks heralds a market top. In hindsight, if it does occur, it will be regarded as “no surprise.” If it doesn’t occur within the attention span of most paying attention it will simply be conveniently ignored.

For others the reversal of fortune may represent values and not value traps.

But no matter what the case there is life after momentum slows. It’s just a question of accommodation to new circumstances.

As usual, the week’s potential stock selections are classified as being in Traditional, Double Dip Dividend, Momentum and “PEE” categories this week (see details).

eBay (EBAY) like so many stocks that I consider tends to trade in a range. While eBay is often criticized for being “range bound” there is some comfort in knowing that it is less likely to offer an unwanted surprise than many other stocks. My shares were assigned this past week and are now trading at the upper range of where I may normally initiate a position. However, having owned shares on ten separate occasions this year I would be anxious to do so again on the slightest of pullbacks.

Although hardly a momentum stock, Mondelez (MDLZ) had some earnings woes this past week, although it did recover a bit, perhaps simply being carried along by a rallying market. Shares are still a little higher than I would like for an entry point, but I expect that as a short term selection it will match market performance, while in a market turn-down it will exceed performance.

Fastenal (FAST) is another fairly sedate company, yet its stock often has some large moves. I see Fastenal as a leading indicator of economic activity, but also very sensitive to the economy. I think its most recent price weakness will be reversed as the impact of a resolution of the government’s shutdown trickles down to the economy. I currently own shares with a contract set to expire this week, but at this price am considering doubling down on what in essence can be a weekly option contract during the final week of the November 2013 cycle.

Deere (DE) is another range bound stock, that in hindsight I should have bought on numerous occasions over the past few months. Good option premiums, a good dividend and not facing some of the same external pressures as another favorite, Caterpillar (CAT), makes Deere a perennially good selection within its sector.

I currently ow
n shares of both Eli Lilly (LLY) and International Paper (IP), both of which go ex-dividend this week. Unlike many other stocks that I discuss, I have not owned either on multiple occasions this year and my current shares are now below their cost. Both emerged unscathed after recent earnings reports, although both are down considerably from their recent highs and both have considerably under-performed the S&P 500 from the time for its first in a series of market highs on May 21, 2013. That latter criterion is one that I have been using with some regularity as the market has continued to reach new highs in an effort to identify potential late comers to the party.

Which finally brings me to the momentum stocks that have my attention this week, some of which may be best approached through the sale of put options and may be best avoided in a weakening market.

Much has been said of the “ATM effect” on Facebook (FB), as speculation that investors were selling Facebook shares to raise money to buy Twitter (TWTR) shares. Following an abrupt reversal during its conference call when there was a suggestion that adolescents were reducing their Facebook use shares have just not regained their traction. Sometimes it’s just profit taking and not driven by the allure of a newer stock in town. But assuming that the “ATM effect” has some validity and with a large gap between the Twitter IPO price and its 7% lower price on its first full day of trading, I can’t imagine now taking the opportunity to sell Facebook in order to purchase Twitter shares. On its own merits Facebook may be a momentum stock that has a cushion of protection until its next earnings report, unless an errant comment gets in the way, again.

Chesapeake Energy (CHK) is much higher than the level at which I last owned shares at $21. Waiting for a return has been fruitless and as a result, rather than having owned shares on 15 occasions, as in 2012, thus far, I’ve only had five bouts of ownership. With the melodrama surrounding its founder and ex-CEO in its past, Chesapeake may begin trading a bit more on fundamentals rather than hopes for a return to its glory days. at such, its price action may be less unidirectional than it has been over the past four months. After last week’s earnings report related drop, while still higher than I would like, I think there may be reason to consider a new entry, perhaps through the sale of put options.

Freeport McMoRan (FCX) is a stock that has been testing my patience through the year. More precisely, however, I’ve had no real issue with Freeport McMoRan’s leadership, in fact, given metal prices, it has done quite well. What I don’t understand is how it has been taking so long for markets to appreciate its strategic initiatives and long term strategies. For much of the year my shares have been non-performing, other than for dividend payments, but with a recent run higher some are generating option premium income streams. Despite the run higher, I am considering adding more shares as the entire metals complex has been showing strength and some stability, as well.

Finally, while I’ve said before that I don’t spend too much time looking at charts, a recent experience with Tesla (TSLA) was perhaps a good reason to at least acknowledge that charts can allow you to look at the past.

While it’s probably always a good week to be Elon Musk, relatively speaking last week wasn’t so good, as both Tesla and Solar City (SCTY) were treated harshly after earnings were released. The spin put around another reported car fire that its resultant heat could be garnered to power several mud huts didn’t give shares much of a boost, perhaps because that might have cannibalized SolarCity sales, with the two companies likely having much overlap in ownership.

Tesla reported earnings last week and took a drubbing through successive days.

A reader of last week’s article asked:

“George, what are your thoughts on a sale of Puts on TSLA which reports Tuesday?”

My response was:

“TSLA isn’t one that I follow, other than watching in awe.

But purely on a glance at this week’s option pricing the implied volatility is about 12% and you can get a 1% ROI on a strike that’s about 17% lower, currently $135

It looks as if it may have price support in the $134-$139 range, but it’s hard to know, because its ascent has been so steep that there may not be much of a real resting point.

In a very speculative portion of my portfolio I might be able to find some money to justify that trade.”

As it turned out Tesla closed the week at $137.95 and now has my attention. You do have to give some credit to its chart on that one. WIth disappointment over its sales, supply chain issues and reports of car fires and even Elan Musk suggesting that “Tesla’s stock price is more than we have any right to deserve,” it has fallen by nearly 21% from the time of that comment, barely 2 weeks prior to earnings. Although to be entirely fair shares did fully recover from a 7.5% decline in the aftermath of the statement in advance of earnings.

While still not knowing where the next resting point may be in the $119-$122 range, representing as much as another 13% price drop. With earnings out of the way to
enhance option premiums the risk-reward proposition isn’t as skewed toward reward. However, for those looking to recapture of bit of their own momentum, despite the realization that the end may be near, a put sale can return an ROI of approximately 1.4% at a strike price nearly 6% below Friday’s close is not breached.

The nice thing about momentum slowing is that if you fall the floor isn’t as far away as it used to be.

Traditional Stocks: Deere, eBay, Fastenal, Mondelez

Momentum Stocks: Chesapeake Energy, Facebook, Freeport McMoRan, Tesla

Double Dip Dividend: Eli Lilly (ex-div 11/13), International Paper (ex-div 11/13)

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.

Disclosure: I am long CAT, CHK, DE, FAST, FCX, IP, LLY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.