Daily Market Update – March 13, 2014 (Close)

This was already shaping up like another shapeless day before the distasteful afternoon occured, but at least the morning brought us closer to the end of what has not been a terribly good week, principally due to some poorly timed new positions. They not only faltered with a teetering market, but like General Motors, brought their own problems to the table.

As the afternoon unfolded the week only got worse as it was really anyone’s guess as to what caused the sell-off, although Crimean rumors caught some blame, as did more moaning about the Chinese economy being worse than thought.

For the first time that I can recall, this has been a week that I’ve made more personal trades than recommended trades. While that includes a trade in Cypress Semiconductor, the other trades were all put sales, none of which were included as Trading Alerts. 

That adds to my characterization of this week.

The Cypress Semiconductor trade was was never sent as an alert because it appeared as if I had gotten the last person willing to buy contracts at $0.20, the price I thought necessary to make it a worthwhile trade. For those that occasionally check “market depth” to see what the outstanding offers are at various prices, at the time my trade was executed there was no shortage of bids at $0.20, but literally as my trade was filled and right before sending that alert I watched the market depth indicate that all of those $0.20 bids were gone and instead replaced by $0.10 bids or nothing at all, despite the fact that the share price was unchanged or even $0.01 higher.

A couple of days later that $0.20 still hasn’t come back even though shares have gotten more expensive.

Back to the puts.

One of my reasons for being more reluctant to recommend the sale of puts is that I know that not all brokerage firms, including Scottrade, allows the sale of cash covered puts.

I know that some subscribers use that brokerage and while I don’t understand the basis for not allowing that kind of trade, as the alternative, buying shares and selling calls isn’t always an equal alternative. A cash covered put is no more of a risky trade, neither to the investor nor to the brokerage than a similar buy/write trade. The money is simply held in escrow by the brokerage until it’s absolutely certain that it won’t be needed to purchase the underlying security because of assignment.

There must be a reason and it must be for someone’s protection, but I still don’t understand, particularly since that need to protect someone doesn’t appear to be very universally appreciated by other brokerages.

Additionally, I tend to sell puts following some bad news and a precipitous drop in share price. That immediately is a more risky situation as for many stocks that first big move is the beginning of a new momentum that may carry it further in the same direction.

Selling the puts is a statement of bullish sentiment in the belief that the move won’t be continued to the level of the selected option strike. What often makes that kind of trade appealing is that the premium is enhanced because of the initial large move and emotion takes over as the supply/demand curve is shifted because people believe that momentum will continue.

While adherents of the belief that big moves beget more big moves in the same direction or even continued and sustained movement in the same direction, there are plenty of examples where that’s just not the case.

Although many refer to dead cat bounces and dismiss them as being meaningless in the big picture in terms of changing direction, the reality is that what really matters is the time frame with which one looks to create a specific outcome.

While a dead cat bounce may not mean much for the prospects of a stock or even an entire market looking months forward it may certainly buy some time until expiration a few days later.

My own use of puts has evolved over the years. To some degree it does require a modification of the thought process as the concept isn’t always intuitive. After all, most of us think in terms of good happening when shares go higher.

With puts the good can occur with both lower and higher moves, with the latter being simply a question of degree.

Additionally, the common belief is that if you sell a put and shares fall below the strike price you will be assigned shares.

The reality is that if the market exists and at prices that are attractive enough you can roll over the puts in an effort to continue to generate option premium and buy time for your hoped for rebound in price.

However, the further reluctance in recommending put sales very often is that often the rollover, if necessary, involves some wide bid and ask spreads and really works best when the trader executes the trade as a spread, rather than individually executing the BTC and STO legs of the trade.

Deciding on the appropriate NC (Net Credit) may appear daunting when the spreads are wide, but is actually fairly simple and uses the following formula:

STO bid price minus BTC ask price plus average of BTC bid – ask difference plus STO bid – ask difference.

Or you could just follow the NC that I provide, to make it even more simple.

The reason that I put all of this down is that I am probably going to make more put sale Trading Alerts, where it appears appropriate in the future as market conditions may warrant that additional strategy to not be overlooked.

For those that can’t sell put contracts, contact me to see if there is an equivalent buy/write alternative.

Today, however, did point out how momentum can build on itself as the market just kept going lower once it made it to a triple digit less. The next 150 points lower were far easier than the first 100. Having chosen to start testing the market when it was down 100 may often make sense, whether doing so via buy/writes or the sale of puts.

But not today.

 

 

 

 

 

 

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