It’s really hard to know what to make of the past few weeks, much less this very past one.
On an intra-day basis having the S&P 500 down 9% from its high point seemed to be the stop right before that traditional 10% level needed to qualify as a bona fide “correction.”
But something happened.
What happened isn’t really clear, but if you were among those that credited the words of Federal Reserve Governor James Bullard, who suggested that the exit from Quantitative Easing should be delayed, the recovery that ensued now appears more of a coincidence than a result.
That’s because a rational person would have believed that if the upcoming FOMC Statement failed to confirm Bullard’s opinion there would be a rush to the doors to undo the rampant buying of the preceding 10 days that was fueled under false pretenses.
But that wasn’t the case.
In fact, not only did the FOMC announce what they had telegraphed for almost a year, but the previously dissenting hawks were no longer dissenters and a well known dove was instead the one doing the dissenting.
I don’t know about you, but the gains that ensued on Thursday, had me confused, just as the markets seemed confused in the two final trading hours after the FOMC Statement release. You don’t have to be a “perma-bear” to wonder what it’s going to take to get some of your prophesies to be fulfilled.
Even though Thursday’s gains were initially illusory owing to Visa’s (V) dominance of the DJIA, they became real and broadly applied as the afternoon wore on. “How did that make any sense?” is a question that a rationally objective investor and a perma-bear might both find themselves asking as both are left behind in the dust.
I include myself in that camp, as I didn’t take advantage of what turned out to be the market lows as now new closing highs have been set.
Those new highs came courtesy of the Bank of Japan on Friday as it announced the kind of massive stimulus program that we had been expecting to first come from the European Central Bank.
While the initial reaction was elation and set the bears further into despair it also may have left them wondering what, if any role rational thought has left in the processes driving stocks and their markets.
Many, if not most, agree that the Federal Reserve’s policy of Quantitative Easing was the primary fuel boosting U.S. stock markets for years, having drawn foreign investor demand to our shores. Now, with Japan getting ready to follow the same path and perhaps the ECB next in line, we are poised to become the foreigners helping to boost markets on distant shores.
At least that what a confused, beaten and relatively poorer bear thinks as the new week gets underway.
As usual, the week’s potential stock selections are classified as being in Traditional, Double Dip Dividend, Momentum or “PEE” categories.
I love listening to Howard Schultz defending shares of Starbucks (SBUX) after the market takes the stock lower after earnings. No one defends his company, its performance and its outlook better than Howard Schultz.
But more importantly, he has always followed up his assertions with results.
As with many stocks over the past two weeks, Starbucks is one, that in hindsight I should have purchased two weeks ago, while exercising rational thought processes that got in the way of recognizing bargain prices. Friday’s drop still makes it too late to get shares at their lows of 2 weeks ago, but I expect Schultz to be on the correct side of the analysis once again.
There’s not much disagreement that it has been a rough month for the energy sector. While it did improve last week, it still lagged most everything else, but I think that the Goldman Sachs (GS) call for $75 oil is the turning point. Unfortunately, I have more energy stocks than I would have liked, but expect their recovery and am, hesitatingly looking to add to the position, starting with British Petroleum (BP) as it is ex-dividend this week. That’s always a good place to start, especially with earnings already out of the way.
While I continue to incorrectly refer to BP as “British Petroleum” that is part of my legacy, just as its Russian exposure and legal liabilities are part of its legacy. However, I think that all of those factors are fully priced in. Where I believe the opportunity exists is that since the September 2014 highs up to the Friday’s highs, BP hasn’t performed as well as some of its cohorts and may be due for some catch-up.
I purchased shares of Intel (INTC) the previous week and was hoping to capture its dividend, as its ex-dividend date is this week.
Last week Intel had quite a ride as it alternated 4% moves lower and then higher on Thursday and Friday.
Thursday’s move, which caught most everyone by surprise was accompanied by very large put option trading, including large blocks of aggressive in the money puts with less than 2 days until expiration and even larger out of the money puts expiring in 2 weeks.
Most of the weekly puts expired worthless, as there was fairly low activity on Friday, with no evidence of those contracts getting rolled forward, as shares soared.
While initially happy to see shares take a drop, since it would have meant keeping the dividend for myself, rather than being subject to early assignment, I now face that assignment as shares are again well above the strike.
However, while entertaining thoughts of rolling those shares over to a higher strike at the same expiration date or the same strike at next week’s expiration, I may also consider adding additional shares of Intel, for its dividend, premiums and share appreciation, as well. Given some of the confusion recently about prospects for the semi-conductor industry, I think Intel’s vision of what the future holds is as good as the industry can offer if looking for a crystal ball.
What can possibly be said about Herbalife (HLF) at this point that hasn’t already been said, ad nauseum. I’m still somewhat stunned that a single author can write 86 or so articles on Herbalife in a 365 day period and find anything new to say, although there is always the chance that singular opinion expressed may be vindicated.
The reality is that we all need to await some kind of regulatory and/or legal decisions regarding the fate of this company and its business practices.
So, like any other publicly traded company, whether under an additional microscope or not, Herbalife reports earnings this week, having announced it also reached an agreement on Friday regarding a class action suit launched by a past dis
tributor of its products.
The options market is predicting a 16% movement in shares upon earnings release. At its Friday closing price, the lower end of that range would find shares at approximately $44. However, a weekly 1% ROI could still be obtained if selling a put option 35% below Friday’s close.
That is an extraordinary margin, but it may be borne out of extraordinary circumstances, as Monday’s earnings release may include other information regarding pending lawsuits, regulatory or legal actions that could conceivably send shares plummeting.
Or soaring.
On a more sedate, and maybe less controversial note, Whole Foods (WFM) reports earnings this week. I’m still saddled with an expensive lot of shares, that has been offset a bit by the assignment of 4 other lots this year, including this past week.
After a series of bad earnings results and share declines I think the company will soon be reporting positive results from its significant national expansion efforts.
While I generally use the sale of puts when considering an earnings related trade, usually because I would prefer not owning shares, Whole Foods is one that I would approach from either direction. While its payout ratio is higher than its peers, I think there may also be a chance that there will be a dividend increase, particularly as some of the capital expenditures will be decreasing.
While not reporting earnings this week, The Gap (GPS) is expected to provide monthly same store sales. It continues to do so, going against the retail tide, and it often sees its shares move wildly. Those moves are frequently on a monthly alternating basis, which certainly taxes rational thought.
Last month, it reported decreased same store sales, but also coupled that news with the very unexpected announcement that its CEO was leaving. Shares subsequently plummeted and have been very slow to recover.
As expected, the premium this week is significantly elevated as it reflects the risk associated with the monthly report. As with Whole Foods, this trade can also justifiably be approached wither from the direction of a traditional buy/write or put sale. In either case, some consideration should also be given to the fact that The Gap will also report its quarterly earnings right before the conclusion of the November 2014 option cycle, which can offer additional opportunity or peril.
Also like Whole Foods, I currently own a much more expensive lot of Las Vegas Sands (LVS), but have had several assigned lots subsequently help to offset those paper losses. Shares have been unusually active lately, increasingly tied to news from China, where Las Vegas Sands has significant interests in Macao.
Share ownership in Las Vegas Sands can be entertaining in its own right, as there has lately been a certain roller coaster quality from one day to the next, helping to account for its attractive option premium. In the absence of significant economic downturn news in China, which was the root cause of the recent decline, it appears that shares have found some support at its current level. Together with those nice premiums and an attractive dividend, I’m not adverse to taking a gamble on these always volatile shares, even in a market that may have some uncertainty attached to it.
Finally, Facebook (FB) and Twitter (TWTR) each reported earnings last week and were mentioned as potential earnings related trades, particularly through the sale of put options.
Both saw their shares drop sharply after the releases, however, the option markets predicted the expected ranges quite well and for those looking to wring out a 1% weekly ROI even in the face of post-earnings price disappointment were rewarded.
I didn’t take the opportunities, but still see some in each of those companies this week.
While Twitter received nothing but bad press last week and by all appearances is a company that is verging on some significant dysfunction, it is quietly actually making money. It just can’t stick with a set of metrics that are widely accepted and validated as having relevance to the satisfaction of analysts and investors.
It also can’t decide who to blame for the dysfunction, but investors are increasingly questioning the abilities of its CEO, having forgotten that Twitter was a dysfunctional place long before having gone public and long before Dick Costolo became CEO.
At its current price and with its current option premiums the sale of out of the money puts looks as appealing as they did the previous week, as long as prepared to rollover those puts or take assignment of shares in the event the market isn’t satisfied with assurances.
Facebook, on the other hand is far from dysfunctional. Presumably, its shares were punished once Mark Zuckerberg mentioned upcoming increased spending. Of course, there’s also the issue of additional shares hitting the markets, as part of the WhatsApp purchase.
Both of those are reasonable concerns, but it’s very hard to detract from the vision and execution by Zuckerberg and Cheryl Sandberg.
However, the option market continues to see the coming week’s options priced as if there was more than the usual amount of risk inherent in share pricing. I think that may be a mistake, even while its pricing of risk was well done the previous week.
Bears may be beaten and wondering what hit them, but a good tonic is profit and the sale of puts on Facebook could make bears happy while hedging their bets on a market that may put rational thought to rest for a little while longer.
Traditional Stocks: Starbucks, The Gap
Momentum: Facebook, Twitter, Las Vegas Sands
Double Dip Dividend: British Petroleum (11/5), Intel (11/5)
Premiums Enhanced by Earnings: Herbalife (11/3 PM), Whole Foods (11/5 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.
October 27 – 31, 2014
