Daily Market Update – March 10, 2014 (Close)

Even though I know that hoping for something to happen doesn’t have as much power as I might like, that doesn’t stop me from continuing the process.

Following weeks in which I’ve had a fair number of assignments my hope is usually for a lower open on Monday and maybe finding an opportunity to pick up some replacement positions as they’re (hopefully) on temporary bargain status.

The pre-open trading to begin the week looks as if it’s going to offer one of those opportunities, which haven’t been very frequent, but weighing on the markets is still the situation in Crimea.

As it would turn out the market was down the entire day, but well off of its lows as there really wasn’t any news to confuse things today.

While there’s not likely to be a substantive longer term impact from most likely outcomes from the area, there’s no doubt that a short term impact can easily come and it can come with  no notice. Rarely is there the simple courtesy of being given advanced notice, although after the fact many will point to the signs that predicted the unpredictable.

Looking at the mildly declining prices that appear set to begin the trading week it makes me wonder more than usual whether they represent an opportunity or a trap. Either of those is only possible when you have spare money in hand, so there may be advantages to not being burdened with that state of liquidity.

There’s no doubt that erring on the side of caution has exacted its own price as we celebrate the 5th year of the inflection point as the market turned around from its 2009 lows. Pardon me for mixing Latin and French phraseology, but It has really been as if Mardi Gras’ sine quo non expression “Laissez les bons temps rouler,” has been in force non-stop since then. Having been to New Orleans on multiple occasions no one can keep up that level for more than a few days, but the market has done so for 5 years.

Whatever cautionary note may be struck today could easily have been struck a year ago, which is about the time that I started feeling the need to develop cash reserves and the related need to spend down those cash reserves.

In addition to continuing concern over events there is new news from China that their economy isn’t as strong as we had recently believed it to be, after already having factored in a less robust economy. Japan wasn’t much better, but our expectations there have been low for 20 years.

So with the week starting with expressions of economic weakness and continued international uncertainty, I’m less inclined to spend money this Monday morning as I would have anticipated while tallying the previous week’s results just a few days ago.

This is another week that has a number of positions going ex-dividend and already has a good representation of positions with contracts expiring. Hopefully, some of those positions will be assigned and others rolled over to keep the process going and going.

But because of some concern about the potential for weakness this week there may be reason to look for expirations next week or even further for any new purchases considered. Of course, that is still tempered by the realization that time isn’t as valuable as it used to be back in the good old days when volatility was a reliable partner in creating profits. Sometimes when looking at the paltry marginal premium rece
ived for each additional week of time it’s difficult to justify tying up a position when the past 5 years has shown a market that just proceeds higher.

I’m currently at approximately 42% cash and was willing to get down to 25%. I don’t believe that I’m now willing to get to that level and will again try to focus on lower beta, and where available, dividend paying positions, for the week.

As always, events and sentiments can and do change so quickly.

Hopefully, they will.

 

 

 

PS: For those surprised, or even shocked that your Kohls shares weren’t assigned early (and you were in the vast majority), it’s all a question of pennies and time.

Had these shares gone ex-dividend last Friday on a March 7, 2014 option or perhaps this Thursday with a March 14, 2014 option, those shares closing at $55.45 and offering a $0.39 dividend, would have been well above the threshold price of $54.89. That price represents the minimal price at which a break-even could be obtained if the option holder chose to exercise early. That break-even analysis, however covers neither the original cost to buy the option nor the commissions. In such a case, with very little time value left on the option it would have been better for the option holder to exercise early and then immediately sell shares the following morning, collecting any profit on shares and the dividend.

However, look at the situation of Kohls which went ex-dividend on a Monday and still had 5 days of time value left in the option premium.

Shares opened trading this morning at $54.90. For an option buyer who exercised his contract and took possession of shares he had to lay out $5450 to exercise. If he was able to immediately sell his shares he would have pocketed a $0.40 profit on shares and a $0.39 dividend, for a total of $0.79. Of course, you would then have to subtract the cost of the option he bought to actually calculate his net.

However, if instead he elected to sell his option contract at either Friday’s close or Monday’s open he would have gotten $0.85 for his efforts. Not only is that $0.06 more than if he would have exercised, but it was also without assuming the risk of owning shares, even if only for 10 seconds after the pre-open started trading on Monday. Professionals, or those holding large positions are going to be much more likely to take the certain profit rather than the risk and the large outlay of assets to exercise.

For the rational individual investor option buyer who was otherwise bullish on shares, they would have held onto their option in the belief that there was greater opportunity to trade it during the course of the coming week than to own shares and collect the dividend. Certainly it would require no additional need to tie up cash. For the bearish holder of an option contract the appeal of holding shares isn’t there, so they, too, are less inclined to exercise early. If anything, if they are bearish on shares they will move quickly to close their option position in order to squeeze out and keep any premium that may be left.

Those most likely to consider an early exercise would be those that had bought such option contracts at at a point that shares were well below the $54.50 strike and therefore were very inexpensive to buy. However, there would likely be very few of those original low cost option buyers remaining because the real profits would have come in selling their contracts during the course of Kohls’ rise, that on a percentage basis would have brought them far greater profits due to leveraging than owning shares and collecting a dividend ever would.

So who then is left to exercise early? Anyone bullish on shares and recognizing that in a low volatility environment their option contract  growth in premium would be limited by its upcoming expiration might consider early exercise, although the majority of those would more likely roll over their option contracts to a future week in the belief that greater share gains are to come.

There are also those that had intended to exercise shares anyway as it came upon its expiration date, because they wanted to own shares at the specified price. Instead of waiting 5 days why not take possession early and also get the dividend?

And finally, there are always an irrational few.

As in a game of blackjack you really don’t want to have an irrational player in the game even though there’s a chance that their actions will be to your benefit. That kind of wild card in the game just isn’t worth it and reduces the impact of your own skill set.

If I were to give homework assignments I would ask you to then explain why some people didn’t have their AIG shares assigned early on Friday morning when shares closed well above the threshold on Thursday.

 

 

 

 

 

 

 

 

 

 

 

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