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.

Daily Market Update – April 16, 2014 (Close)

 

 

Daily Market Update – April 16, 2014 (Close)

For most of the day yesterday it seemed as if the feeling of confidence that Monday’s close engendered was wasted. If your eyes have gotten to the point that it identifies almost everything on the basis of the relative amounts of red and green contained in the image you know that everything seemed dreary yesterday, particularly on the east coast and that included the New York Stock Exchange

But then, without the slightest cue or catalyst, the market simply reversed itself in the final 90 minutes and had a second successive strong close.

Sometimes it’s not just the net change for the day but it’s also the character of that change and the dynamics of how we arrived at the finish line. Yesterday was yet another day to inspire confidence in the overall market and maybe just another signal that this market just can’t get much beyond a 5% drop and just can’t do so for very long.

Not that anyone should let their guard down, but this morning’s pre-open market looks like it will be extending yesterday’s strong close. The fact that after a few days of nearly 80 degree weather there is some snow and frost on the ground outside my window is in no way a metaphor for what may happen in today’s market, although these rapid changes certainly get your attention and make you more cautious about planting the season’s vegetables or planting some new positions.

Today, as it would finally turn out was completely different from the two days preceding it. The market pointed higher from before the open and never wavered.

So far the way this week has developed as unlikely a scenario as you could imagine, especially considering the previous week and how that ended. The only suggestion that things were not as dire as they appeared was that despite nothing but bad news and mounting uncertainty on Friday, the market didn’t pile on at the close when there were renewed concerns about troops amassing on the Ukraine border and sell orders amassing at the close.

Still, the predominant evidence and the predominant thinking was that this time the market was going to get serious about approaching that 10% level so that most people could agree that we’ve finally had a correction.

Maybe, and it’s still early, the lesson to be learned is that the consensus is often short sighted. Or at lest it shows that we think we know what the catalysts are or will be, but we just don’t.

If Ukraine was going to be a near term catalyst last week it would be even more so after yesterday, but that’s just not the case, unless someone wants to claim that the market considers any armed confrontation in the area as a positive catalyst.

You just know that someone will do that, citing a version of “sell on the rumor and buy on the news” when it comes to rumors of bad news.

For certain, so far this earnings season hasn’t done anything to add to the concern. While there’s been nothing really stellar yet, neither has there been a developing forward looking theme that paints a negative picture. So while awaiting some kind of disaster on the Russian front or some really unexpected bad Chinese economic news, there’s not to much reason to suspect that the market will now chang
e what it has done so often in the past two years.

When faced with a downturn in prices it has just used that slightly lower level to spring to higher levels.

What may be different is that in the not too distant past we had seen many 5-10% downward moves and considered them to be a normal part of the market cycle. Now, everyone gets a minor sense of panic when the market falls 2% and strategies are immediately changed, as are behaviors that used to be reserved just for the periodic larger falls.

Maybe what’s called for is a re-definition of what constitutes a “correction.”  Maybe our minds don’t think in relative terms at all. Maybe we think in absolutes and a 5% drop when the DJIA is at 16000 seems much worse than a 5% drop at 12000.

While I had hoped that the market would use today as another opportunity to head higher, I’ve become resigned to this likely being the slowest week in years for opening new positions, although only one more is needed to tie that record and there’s still tomorrow.

Although I like to continually see positions rotate in and out of the portfolio, it’s only because I like to see positions generating fresh revenue. With cash reserves sitting at what I consider to be a minimum to really take advantage of a more classic “correction,” my hopes continue to be centered on seeing more new covered positions created and some rollovers to build up that cash level to start off the new monthly cycle on Monday.

Ultimately a sideways moving market depends much more on those rollovers than on opening new positions. It is also ultimately an easier market in which to outperform and manage positions, as well, as there are usually fewer total positions to clutter the landscape.

Hopefully that form of spring cleaning can start this week and this frost will be short lived

 

 

 

 

  

Daily Market Update – April 16, 2014

 

 

Daily Market Update – April 16, 2014 (9:30 AM)

For most of the day yesterday it seemed as if the feeling of confidence that Monday’s close engendered was wasted. If your eyes have gotten to the point that it identifies almost everything on the basis of the relative amounts of red and green contained in the image you know that everything seemed dreary yesterday, particularly on the east coast and that included the New York Stock Exchange

But then, without the slightest cue or catalyst, the market simply reversed itself in the final 90 minutes and had a second successive strong close.

Sometimes it’s not just the net change for the day but it’s also the character of that change and the dynamics of how we arrived at the finish line. Yesterday was yet another day to inspire confidence in the overall market and maybe just another signal that this market just can’t get much beyond a 5% drop and just can’t do so for very long.

Not that anyone should let their guard down, but this morning’s pre-open market looks like it will be extending yesterday’s strong close. The fact that after a few days of nearly 80 degree weather there is some snow and frost on the ground outside my window is in no way a metaphor for what may happen in today’s market, although these rapid changes certainly get your attention and make you more cautious about planting the season;’s vegetables or planting some new positions.

So far the way this week is developing is as unlikely a scenario as you could imagine, especially considering the previous week and how that ended. The only suggestion that things were not as dire as they appeared was that despite nothing but bad news and mounting uncertainty on Friday, the market didn’t pile on at the close when there were renewed concerns about troops amassing on the Ukraine border and sell orders amassing at the close.

Still, the predominant evidence and the predominant thinking was that this time the market was going to get serious about approaching that 10% level so that most people could agree that we’ve finally had a correction.

Maybe, and it’s still early, the lesson to be learned is that the consensus is often short sighted.

For certain, so far this earnings season hasn’t done anything to add to the concern. While there’s been nothing really stellar yet, neither has there been a developing forward looking theme that paints a negative picture. So while awaiting some kind of disaster on the Russian front or some really unexpected bad Chinese economic news, there’s not to much reason to suspect that the market will nowhan what it has done so often in the past two years.

When faced with a downturn in prices it has just used that slightly lower level to spring to higher levels.

What may be different is that in the not too distant past we had seen many 5-10% downward moves and considered them to be a normal part of the market cycle. Now, everyone gets a minor sense of panic when the market falls 2% and strategies are immediately changed, as are behaviors that used to be reserved just for the periodic larger falls.

Maybe what’s called for is a re-definition of what constitutes
a “correction.”

While the market hopefully uses today as another opportunity to head higher, I’m resigned to this likely being the slowest week in years for opening new positions, although only one more is needed to tie that record.

Although I like to continually see positions rotate in and out of the portfolio, it’s only because I like to see positions generating fresh revenue. With cash reserves sitting at what I consider to be a minimum to really take advantage of a more classic “correction,” my hopes continue to be centered on seeing more new covered positions created and some rollovers to build up that cash level to start off the new monthly cycle on Monday.

Ultimately a sideways moving market depends much more on those rollovers than on opening new positions. It is also ultimately an easier market in which to outperform and manage positions, as well, as there are usually fewer total positions to clutter the landscape.

Hopefully that form of spring cleaning can start this week and this frost will be short lived

 

 

 

 

  

Daily Market Update – April 15, 2014 (Close)

 

 

Daily Market Update – April 15, 2014 (Close)

Yesterday was a really interesting day in the market. Today turned out to be every bit as interesting.

I didn’t get too much done yesterday but I did enjoy most of the day as that old adage about a rising tide played true.

Today most of the day wasn’t very enjoyable and I still didn’t do very much, but that rising tide came back in.

After a month or more of disappointing fizzled rallies to start the day the one from yesterday seemed to be the real thing until the final 90 minutes of trading. Today the same 90 minute theme was at play and in the same direction as yesterday’s

It seemed sort of cruel to watch paper gains disappear after putting in nearly a full day but given how the market has been going lately it should have been expected. At least if the deterioration of gains started after only an hour of trading you didn’t feel as if you had that much invested on an emotional level. But to go nearly the whole day and then watch everything disappear is really deflating.

What wasn’t expected was the reversal rally that occurred in the final 30 minutes that restored the market to its highs for the day. That bounce really went against every logical scenario that anyone could have envisioned.

While there was reason to believe that Citigroup’s earnings helped the market get the week off to a good start, there was plenty of reason to believe that some would take the opportunity to take some cash off the table. What there was little reason to believe was that there would be strong and sustained buying going into the close of trading.

Regardless of how you look at things its hard to come up with an interpretation that’s anything other than optimistic. Who in their right mind would rush in to save a market that had a failed effort to break out of its downward trajectory?

The fact that it actually happened that way is what made it such an interesting day. Triple digit gains and losses are a dime a dozen but that late recovery of early gains was really a thing of beauty and rarity.

Even if the pre-open futures weren‘t showing much in the way of follow through to the strong close it had to leave an encouraging feeling among those invested or thinking of investing. Unfortunately, that positive feeling didn’t linger, but it did return.

I’d like to take some of that encouragement and continue to apply it toward the rest of this holiday shortened week, but I still feel a need to stay on course and hope to secure premiums from existing positions this week instead of depleting cash even further.

Adding two to that list was nice, but still short of where I’s like to be.

My confidence could be supremely restored if I could see a nice assortme
nt of assignments and rollovers on Thursday and toward that end some continuance of yesterday’s strength, even if muted, would be very nice.

While I’m not averse to adding new positions this week it may end up being among those very quiet weeks. With a fair number of expiring positions this week I really would prefer to have any remaining new positions expire at some other time. That may mean looking for new positions later in the week for those that will have their April 25, 2014 options appear only later in the week.

Also, with just a 4 day week, which is now down to 3 days, those premiums are somewhat lower, so there is reason to consider a slightly longer term contract.

For now I’d be happy just adding to the bottom line and letting the tide keep doing its thing as we all try to figure out where exactly the market is getting its cues.

If you haven’t been confused, you just haven’t been paying attention.

That may put you at an advantage. Trying to over-think what we’re seeing isn’t a very good strategy. Hopefully there are two more days of some strength remaining and maybe even some renewed confidence to start the next monthly cycle.

  

Daily Market Update – April 15, 2014

 

 

Daily Market Update – April 15, 2014 (9:15 AM)

Yesterday was a really interesting day in the market.

I didn’t get too much done but I did enjoy most of the day as that old adage about a rising tide played true.

After a month or more of disappointing fizzled rallies to start the day the one from yesterday seemed to be the real thing until the final 90 minutes of trading.

It seemed sort of cruel to watch paper gains disappear after putting a nearly a full day but given how the market has been going lately it should have been expected. At least if the deterioration of gains started after only an hour of trading you didn’t feel as if you had that much invested on an emotional level. But to go nearly the whole day and then watch everything disappear is really deflating.

What wasn’t expected was the reversal rally that occurred in the final 30 minutes that restored the market to its highs for the day. That bounce really went against every logical scenario that anyone could have envisioned.

While there was reason to believe that Citigroup’s earnings helped the market get the week off to a good start, there was plenty of reason to believe that some would take the opportunity to take some cash off the table. What there was little reason to believe was that there would be strong and sustained buying going into the close of trading.

Regardless of how you look at things its hard to come up with an interpretation that’s anything other than optimistic. Who in their right mind would rush in to save a market that had a failed effort to break out of its downward trajectory?

The fact that it actually happened that way is what made it such an interesting day. Triple digit gains and losses are a dime a dozen but that late recovery of early gains was really a thing of beauty and rarity.

Even if the pre-open futures aren’t showing much in the way of follow through to the strong close it has to leave an encouraging feeling among those invested or thinking of investing.

I’d like to take some of that encouragement and apply it toward the rest of this holiday shortened week, but I still feel a need to stay on course and hope to secure premiums from existing positions this week instead of depleting cash even further.

My confidence could be supremely restored if I could see a nice assortment of assignments and rollovers on Thursday and toward that end some continuance of yesterday’s strength, even if muted, would be very nice.

While I’m not averse to adding new positions this week it may end up being among those very quiet weeks. With a fair number of expiring positions this week I really would prefer to have any remaining new positions expire at some other time. That may mean looking for new positions later in the week for those that will have their April 25, 2014 options appear only later in the week.

Also, with just a 4 day week, which is now down to 3 days, those premiums are somewhat lower, so there is reason to consider a slightly longer term contract.

For now I’d be happy just adding to the bottom line and letting the tide keep doing its thing as we all try to figure out where exactly the market is getting its cues.

If you haven’t been confused, you just haven’t been paying attention.

That may put you at an advantage.