Feb162014

Weekend Update – February 16, 2014

Weekend Update

Is our normal state of dysfunction now on vacation?

Barely seven trading days earlier many believed that we were finally on the precipice of the correction that had long eluded the markets.

Sometimes it’s hard to identify what causes sudden directional changes, much less understand the nature of what caused the change. That doesn’t stop anyone from offering their proprietary insight into that which may sometimes be unknowable.

Certainly there will be technicians who will be able to draw lines and when squinting really hard be able to see some kind of common object-like appearing image that foretold it all. Sadly, I’ve never been very adept at seeing those images, but then again, I even have a hard time identifying “The Big Dipper.”

Others may point to an equally obscure “Principle” that hasn’t had the luxury of being validated because of its rare occurrences that make it impossible to distinguish from the realm of “coincidence.”

For those paying attention it’s somewhat laughable thinking how with almost alternating breaths over the past two weeks we’ve gone from those warning that if the 10 year Treasury yield got up to 3% the market would react very negatively, to warnings that if the yield got below 2.6% the markets would be adverse. There may also be some logical corollaries to those views that are equally not borne out in reality.

Trying to explain what may be irrational markets, which are by and large derivatives of the irrational behaviors found in those comprising the markets, using a rational approach is itself somewhat irrational.

Crediting or blaming trading algorithms has to recognize that even they have to begin with the human component and will reflect certain biases and value propositions.

But the question has to remain what caused the sudden shifting of energy from its destruction to its creation? Further, what sustained that shift to the point that the “correction” had itself been corrected? As someone who buys stocks on the basis of price patterns there may be something to the observation that all previous attempts at a correction in the past 18 months have been halted before the 10% threshold and quickly reversed, just as this most recent attempt.

That may be enough and I suppose that a chart could tell that story.

But forget about those that are suggesting that the market is responding to better than expected earnings and seeking a rational basis in fundamentals. Everyone knows or should know that those earnings are significantly buoyed by share buybacks. There’s no better way to grow EPS than to shrink the share base. Unfortunately, that’s not a strategy that builds for the future nor lends itself to continuing favorable comparisons.

I think that the most recent advance can be broken into two component parts. The first, which occurred in the final two days of the previous trading week which had begun with a 325 point gain was simply what some would have called “a dead cat bounce.” Some combination of tiring from all of the selling and maybe envisioning some bargains.

But then something tangible happened the next week that we haven’t seen for a while. It was a combination of civility and cooperation. The political dysfunction that had characterized much of the past decade seemed to take a break last week and the markets noticed. They even responded in a completely normal way.

Early in the week came rumors that the House of Representatives would actually present a “clean bill” to raise the nation’s debt ceiling. No fighting, no threats to shut down the government and most importantly the decision to ignore the “Hastert Rule” and allow the vote to take place.

The Hastert Rule was a big player in the introduction of dysfunction into the legislative process. Even if a majority could be attained to pass a vote, the bill would not be brought to a vote unless a majority of the majority party was in favor the bill. Good luck trying to get that to occur in the case of proposing no “quid pro quo” in the proposal to raise the nation’s debt ceiling.

The very idea of some form of cooperation by both sides for the common good has been so infrequent as to appear unique in our history. Although the common good may actually have taken a back seat to the need to prevent looking really bad again, whatever the root cause for a cessation to a particular form of dysfunction was welcome news.

While that was being ruminated, Janet Yellen began her first appearance as Federal Reserve Chairman, as mandated by the Humphrey-Hawkins Bill.

Despite the length of the hearings which would have even tired out Bruce Springsteen, they were entirely civil, respectful and diminished in the use of political dogma and talking points. There may have even been some fleeting moments of constructive dialogue.

Normal people do that sort of thing.

But beyond that the market reacted in a straightforward way to Janet Yellen’s appearance and message that the previous path would be the current path. People, when functioning in a normal fashion consider good news to be good news. They don’t play speculative games trying to take what is clear on the surface to its third or fourth derivative.

Unfortunately, for those who like volatility, as I do, because it enhances option premiums, the lack of dysfunction and the more rational approach to markets should diminish the occurrence of large moves in opposite directions to one another. In the real world realities don’t shift that suddenly and on such a regular basis, however, the moods that have moved the markets have shifted furiously as one theory gets displaced by the next.

How long can dysfunction stay on vacation? Human nature being what it is, unpredictable and incapable of fully understanding reality, is why so many in need stop taking their medications, particularly for chronic disorders. I suspect it won’t be long for dysfunction to re-visit.

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).

Speaking of dysfunction, that pretty well summarizes the potash cartel. Along with other, one of my longtime favorite stocks, Mosaic (MOS) has had a rough time of things lately. In what may be one of the great blunders and miscalculations of all time, there is now some speculation that the cartel may resume cooperation, now that the CEO of the renegade breakaway has gone from house arrest in Belarus to extradition to Russia and as none of the members of the cartel have seen their fortunes rise as they have gone their separate ways.

In the interim Mosaic has traded in a very nice range after recovering from the initial shock. While I still own more expensively priced shares their burden has been somewhat eased by repetitive purchases of Mosaic and the sale of call contracts. Following an encouraging earnings report shares approached their near term peak. I would be anxious to add shares on even a small pullback, such as nearing $47.50.

^TNX ChartOne position that I’ve enjoyed sporadically owning has been MetLife (MET) which reported earnings last week. As long as interest rates are part of anyone’s equation for predicting where markets or stocks will go next, MetLife is one of those stocks that received a bump higher as interest rates started climbing concurrent with the announcement of the Federal Reserve;’s decision to initiate a taper to Quantitative Easing.

Cisco (CSCO), to hear the critics tell the story is a company with a troubled future and few prospects under the continued leadership of John Chambers. For those with some memory, you may recall that Chambers has been this route before and has been alternatively glorified, pilloried and glorified again. Currently, he has been a runner-up in the annual contest to identify the worst CEO of the year.

Personally, I have no opinion, but I do like the mediocrity in which shares have been mired. It’s that kind of mediocrity that creates a stream of option premiums and, in the case of Cisco, dividends, as well. With the string of disappointments continued at last week’s earnings report, Cisco did announce another dividend increase while it recovered from much of the drop that it sustained at first.

I’m never quite certain why I like Whole Foods (WFM). What this winter season has shown is that many people are content to stay at home any eat whatever gluten they can find rather than brave the elements and visit a local store for the healthier things in life. I think Whole Foods is now simply making the transition from growth stock to boring stock. If that is the case I expect to be owning it more often as with boring comes that price predictability that appeals to me so much.

This week’s potential dividend trades are a disparate group if you ignore that they have all under-performed the S&P 500 since its peak.

General Electric (GE) is just one of those perfect examples of being in the wrong place at the wrong time and perhaps not being in the right place at the right time. Much of General Electric’s woes when the market was crumbling in 2008 was its financial services group. Since the market bottom its shares have outperformed the S&P 500 by more than 50%, as GE has taken steps to reduce its financial services portfolio. Unfortunately that means that it won’t be in a position to benefit from any rising interest rate environment as can reasonably be expected to be in our future.

Still, coming off its recent price decline and offering a strong dividend this week its shares look inviting, even if only for a short term holding.

L Brands (LB) along with most of the rest of the retail sector hasn’t been reflective of a strong consumer economy. Having recovered about 50% of its recent fall and going ex-dividend this coming week I’m ready to watch it recover some more lost ground as its specialty retailing has appeared to have greater resilience than department store competitors. 

Transocean (RIG) still hasn’t recovered from its recent ratings cut from “sector outperform” to “sector perform.” I’ve never understood the logic of that kind of  assessment, particularly if the sector may still be in a position to outperform the broad market. However, equally hard to understand is the reaction, especially when the entire sector goes down in unison in response. Subsequently Transocean also received an outright “sell” recommendation and has been mired near its two year lows.

With a very healthy ex-dividend date this week I may have renewed interest in adding shares. While he has been quiet of late, at its latest disclosure, Icahn Enterprises (IEP) owned approximately 6% of Transocean and to some degree serves as a floor to share price, as does the dividend which is scheduled to increase to $3 annually.

However, as with L Brands, which also reports earnings on February 26, 2104, I would also consider an exit or rollover strategy for those that may want to mitigate earnings related risk that will present itself. Such strategies may include closing out the position below the purchase price or rolling over to a March 2014 option in order to have some additional time to ride out any storms.

There’s really not much reason to take sides in the validity of claims regarding the nature of Herbalife (HLF). It has certainly made for amusing theater, as long as you either stayed on the sidelines or selected the right side. With the recent suggestion that some on the long side of the equation have been selling shares this week’s upcoming earnings release may offer some opportunity, as shares have already fallen nearly 16%.

While the option market is only implying a 7.2% move in share price, the sale of a put can return a weekly 1% ROI even at a strike price 13.7% below the current price. That is about the largest cushion I recall seeing and does look appealing for those that may have an inclination to take on risk. I’m a little surprised of how low the implied price movement appears to be, however, the surprise is answered when seeing how unresponsive shares have been the past year upon earnings news.

Also reporting earnings this week is Groupon (GRPN), a stock that has taken on some credibility since replacing its one time CEO, who never enjoyed the same cycle of adulation and disdain as did John Chambers. While the “Daily Deal” space is no longer one that gets much attention, Groupon has demonstrated that all of the cautionary views warning of how few barriers to entry existed, were vacuous. Where there were few barriers were to exit the space. 

In the meantime the options market is predicting a 13.9% move related to earnings, while a weekly 1.3% ROI could possibly be achieved with a price movement of less than 19%. While that kind of downward move is possible, there is some very strong support above there.

Finally, there is the frustration of owning AIG (AIG) at the moment. The frustration comes from watching for the second successive earnings report shares climb smartly higher in the after-hours and then completely reverse direction the following day. I continue to believe that its CEO, Robert Benmosche is something of a hero for the manner in which he has restored AIG and created an historical reference point in the event anyone ever questions some future day bailout of a systemically vital company.

None of that hero worship matters as far as any proposed purchased this coming week. However, shares may be well priced and in a sector that’s ready for some renewed interest.

Traditional Stocks: AIG, Cisco, MetLife, Whole Foods

Momentum Stocks: Mosaic

Double Dip Dividend: General Electric (ex-div 2/20), L Brands (ex-div 2/19), Transocean (ex-div 2/19)

Premiums Enhanced by Earnings: Groupon (12/20 PM) , Herbalife (2/18 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.

Feb92014

Weekend Update – February 9, 2014

Weekend Update

Everything is crystal clear now.

After three straight weeks of losses to end the trading week, including deep losses the past two weeks everyone was scratching their heads to recall the last time a single month had fared so poorly.

What those mounting losses accomplished was to create a clear vision of what awaited investors as the past week was to begin.

Instead, it was nice to finish on an up note to everyone’s confusion.

When you think you are seeing things most clearly is when you should begin having doubts.

Who saw a two day 350 point gain coming, unless they had bothered to realize that this week was featuring an Employment Situation Report? The one saving grace we have is that for the past 18 months you could count on a market rally to greet the employment news, regardless of whether the news met, exceeded or fell short of expectations.

That’s clarity. It’s confusing, but it’s a rare sense of clarity that comes from being so successful in its ability to predict an outcome that itself is based upon human behavior.

As the week began with a 325 point loss in the DJIA voices started bypassing talk of a 10% correction and starting uttering thoughts of a 15-20% correction. 10% was a bygone conclusion. At that point most everyone agreed that it was very clear that we were finally being faced with the “healthy” correction that had been so long overdue.

When in the middle of that correction nothing really feels very healthy about it, but when people have such certainty about things it’s hard to imagine that they might be wrong. With further downside seen by the best and brightest we were about to get healthier than our portfolios might be able to withstand.

It was absolutely amazing how clearly everyone was able to see the future. What made things even more ominous and sustaining their view was the impending Employment Situation Report due at the end of the week. Following last month’s abysmal numbers, ostensibly related to horrid weather across the country, there wasn’t too much reason to expect much in the way of an improvement this time around. Besides, the Nikkei and Russian stock markets had just dipped below the 10% threshold that many define as a market correction and as we’re continually reminded, it’s an inter-connected world these days. It wasn’t really a question of “whether,” it was a matter of “when?”

Then there was all that talk of how high the volatility was getting, even though it had a hard time even getting to October 2013 levels, much less matching historical heights. As everyone knows, volatility comes along with declining markets so the cycle was being put in place for the only outcome possible.

After Monday’s close the future was clear. Crystal clear.

Instead, the week ended with an 0.8% gain in the S&P 500 despite that plunge on Monday and a highly significant drop in volatility. The market responded to a disappointing Employment Situation Report with what logically or even using the “good news is bad news” kind of logic should not have been the case.

Now, with a week that started by confirming the road to correction we were left with a week that supported the idea that the market is resistant to a classic correction. Instead of the near term future of the markets being crystal clear we are left beginning this coming week with more confusion than is normally the case.

If it’s true that the market needs clarity in order to propel forward this shouldn’t be the week to commit yourself. However, the only thing that’s really clear about our notions is that they’re often without basis so the only reasonable advice is to do as in all weeks – look for situational opportunities that can be exploited without regard to what is going on in the rest of the world.

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).

If you’re looking for certainty, or at least a company that has taken steps to diminish uncertainty, Microsoft (MSFT) is the one. With the announcement of the appointment of Satya Nadella, an insider, to be its new CEO, shares did exactly what the experts said it wouldn’t do. Not too long ago the overwhelming consensus was that the appointment of an outsider, such as Alan Mullaly would drive shares forward, while an insider would send shares tumbling into the 20s.

Microsoft simply stayed on its path with the news of an inside candidate taking the reigns. Regardless of its critics, Microsoft’s strategy is more coherent than it gets credit for and this leadership decision was a quantum leap forward, certainly far more important than discussions of screen size. With this level of certainty also comes the certainty of a dividend and attractive option premiums, making Microsoft a perennial favorite in a covered option strategy.

The antithesis of certainty may be found in the smallest of the sectors. With the tumult in pricing and contracts being promulgated by T-Mobile (TMUS) and its rebel CEO John Legere, there’s no doubt that the margins of all wireless providers is being threatened. Verizon (VZ) has already seen its share price make an initial response to those threats and has shown resilience even in the face of a declining market, as well. Although the next ex-dividend date is still relatively far away, there is a reason this is a favorite among buy and hold investors. As long as it continues to trade in a defined range, this is a position that I wouldn’t mind holding for a while and collecting option premiums and the occasional dividend.

Lowes (LOW) is always considered an also ran in the home improvement business and some recent disappointing home sales news has trickled down to Lowes’ shares. While it does report earnings during the first week of the March 2014 option cycle, I think there is some near term opportunity at it’s current lower price to see some share appreciation in addition to collecting premiums. However, I wouldn’t mind being out of my current shares prior to its scheduled earnings report.

Among those going ex-dividend this week are Conoco Phillips (COP), International Paper (IP) and Eli Lilly (LLY). In the past month I’ve owned all three concurrently and would be willing to do so again. While International Paper has outperformed the S&P 500 since the most recent market decline two weeks ago, it has also traded fairly rangebound over the past year and is now at the mid-point of that range. That makes it at a reasonable entry point.

Conoco Phillips appears to be at a good entry point simply by virtue of a nearly 12% decline from its recent high point which includes a 5% drop since the market’s own decline. With earnings out of the way, particularly as they have been somewhat disappointing for big oil and with an end in sight for the weather that has interfered with operations, shares are poised for recovery. The premiums and dividend make it easier to wait.

Eli Lilly is down about 5% from its recent high and I believe is the next due for its turn at a little run higher as the major pharmaceutical companies often alternate with one another. With Pfizer (PFE) and Merck (MRK) having recently taken those honors, it’s time for Eli Lilly to get back in the short term lead, as it is for recent also ran Bristol Myers Squibb (BMY) that was lost to assignment this past week and needs a replacement, preferably one offering a dividend.

Zillow (Z) reports earnings this week. In its short history as a publicly traded company it has had the ability to consistently beat analyst’s estimates and then usually see shares fall as earnings were released. That kind of doubled barrel consistency warrants some consideration this week as the option market is implying an 11% move this week. While that is possible, there is still an opportunity to generate a 1% ROI for the week if the share price falls by anything less than 16%.

While I’m not entirely comfortable looking for volatility among potential new positions two that do have some appeal are Coach (COH) and Morgan Stanley (MS).

Coach is a frequent candidate for consideration and I generally like it more when it’s being maligned. After last week’s blow-out earnings report by Michael Kors (KORS) the obvious next thought becomes how their earnings are coming at the expense of Coach. While there may be truth to that and has been the conventional wisdom for nearly 2 years, Coach has been able to find a very comfortable trading range and has been able to significantly increase its dividend in each of the past 4 years in time for the second quarter distribution. It’s combination of premiums, dividends and price stability, despite occasional swings, makes it worthy of consistent consideration.

I’ve been waiting for a while for another opportunity to add shares of Morgan Stanley. Down nearly 12% in the past 3 weeks may be the right opportunity, particularly as some European stability may be at hand following the European Central Bank’s decision to continue accommodation and provide some stimulus to the continent, where Morgan Stanley has interests, particularly being subject to “net counterparty exposure.” It’s ride higher has been sustained and for those looking at such things, it’s lows have been consistently higher and higher, making it a technician’s delight. I don’t really know about such things and charts certainly aren’t known for their clarity being validated, but its option premiums do compel me as do thoughts of a dividend increase that it i increasingly in position to institute.

Finally, if you’re looking for certainty you don’t have to look any further than at Chesapeake Energy (CHK) which announced a significant decrease in upcoming capital expenditures, which sent shares tumbling on the announcement. Presumably, it takes money to make money in the gas drilling business so the news wasn’t taken very well by investors. A very significant increase in option premiums early in the week suggested that some significant news was expected and it certainly came, with some residual uncertainty remaining in this week’s premiums. For those with some daring this may represent the first challenge since the days of Aubrey McClendon and may also represent an opportunity for shareholder Carl Icahn to enter the equation in a more activist manner.

Traditional Stocks: Lowes, Microsoft, Verizon

Momentum Stocks: Chesapeake Energy, Coach, Morgan Stanley,

Double Dip Dividend: Conoco Phillips (ex-div 2/13), International Paper (ex-div 2/12), Eli Lilly (ex-div 2/12)

Premiums Enhanced by Earnings: Zillow (2/12 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.

Feb12014

Weekend Update – February 2, 2014

Weekend Update

Volatility is back!

That’s all you heard this week as the S&P 500 dropped 0.4% to end the unrequited January Rally that we had all been told was the historical norm.

As a covered option seller I have learned to embrace the uncertainty that ushers in a period of volatility, although I make no pretense of really understanding exactly how “volatility works. Like many things in life sometimes it’s simply easier to take one’s word for it.

 

 

 Just like when you’re told that volatility is back.

Or when social media suggests a relationship that isn’t borne out in historical fact, such as very notably in 2010 or about 50% of the other times January opened the year with a loss in the past 63 years.

While the expression “greed is good,” may be far more memorable, there’s not much debate for those who follow it that “volatility is good.” Not only does it create enhanced option premiums but it may also be the ultimate portfolio insurance.

For many people hearing that volatility has returned the only reasonable course of action is to head for the exits, because the very mention of the word is associated with wild rides, mostly in the wrong direction. For them volatility is far from good and is something to be feared and avoided.

That picture isn’t entirely accurate. Volatility is simply a measure of uncertainty and size. 2013 was a year of low volatility as there was a high degree of certainty when you arose each morning that the stock market would move higher on any given day. Additionally, it did so in a largely non-dramatic fashion. The movements were small, but consistent and sustained.

Suddenly the movements are now larger and can just as easily go in one direction as in the opposite one. The range has expanded, too. You don’t need a complex formula to have a qualitative sense that something is different. Not necessarily bad, just different.

But as long as we were talking about historical norms and how disappointing it was waiting for the historically predicted January Rally that never came, the cries welcoming back volatility may have lost track of what historical levels of volatility have been.

The volatility of this past week hasn’t even reached the levels seen in October 2013 back when the S&P 500 stood at 1655, which represented a loss similar to that currently at hand. The current level of volatility is certainly dwarfed by that seen in 2011, which itself was far smaller than that seen in late 2008.

2011 which was one of my favorite years saw the S&P 500 end the year precisely unchanged. However, during the course of the year there were regular triple digit moves, often in alternating direction and ultimately accomplishing nothing. That was a covered option seller’s greatest fantasy come true.

Yet the cries of the return of volatility weren’t making the rounds in October and spreading the specter of an imminent collapse of all that has preceded the market’s climb. While so many have spoken of a 5-10% decline being a healthy thing, some began to utter an heretofore unheard 15-20% range correction in the making.

For those that have been counting on an inflow of money that has been said to still reside on the sidelines to continue fueling the market’s rise the past week’s $12 billion in outflows from equity funds represented the highest level in two years. That represents selling that won’t likely be put back at risk very quickly, but it also represents money that won’t contribute to downward pressure on prices any time soon.

While volatility has risen significantly in the past week it has done so from 5 year lows. There is also certainly more upside to volatility than there is downside. It is with an understanding of the mathematical basis for volatility that there comes an appreciation for the manner in which volatility may be quickly magnified far beyond the seeming disruption in the market.

So no. Volatility isn’t back yet, but it can be in an imperceptible instant.

With the uncertainty that awaits low beta stocks may have special value and the sale of options may increasingly become inviting even at out of the money strike levels, something that hasn’t been the case in quite a while. The market may be said to not like uncertainty but it does have its rewards.

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).

Apple (AAPL) briefly closed below $500 this week. Since not too many stocks occupy that kind of rarefied neighborhood it’s not too surprising that the last couple of times a big fuss was made about a stock falling below $500 it was Apple eliciting the anguish. While there has certainly been lots of debate following Apple’s recent disappointing sales, especially of its iPhone franchise, it does go ex-dividend this week and in its short history of paying a dividend it has generally performed well in its short term aftermath. That alone has me interested in addition to Apple’s low beta and head start on any market inspired drop. Others can debate Apple’s near term future and product cycles and innovations, but the combination of dividend and volatility enhanced premiums makes it look especially good as a choice for this week. The fact that Carl Icahn seems to have made a longer term commitment and has increasingly increased that commitment at least allows for misery to have company if the short term thesis is incorrect.

Another stock that has taken quite a significant fall in the past two weeks has been Starbucks (SBUX) down nearly 10% YTD and even down 4% since its earnings related jump in share price on a day when the market itself tumbled. Perhaps the market is concerned that CEO Howard Schultz may be removing himself more from daily operations, recalling the last time that occurred. However, the root cause of Starbucks’ difficulties earlier last decade, the unbridled expansion during a period of economic contraction, isn’t likely to be repeated. Starbucks is ex-dividend this week and may also be ahead of the curve of any further market declines. It too is showing some enhancement of its option premiums, particularly when dividend capture is also considered.

EMC Corporation (EMC) and its spin off VMWare (VMW) both reported earnings last week. Both declined as a result, with EMC suffering its own disappointment and also bearing some of the VMWare burden, owing to its continuing 80% ownership. While much attention was directed toward Microsoft (MSFT) this week as speculation heated up that an insider, whose own emphasis was on cloud based strategies would be the new CEO, EMC stock continues to languish in relative obscurity and trades in a fairly defined range. A low beta, despite its connection to VMWare,a decent dividend and option premium makes EMC an ever present consideration when seeking to round out the technology sector of my portfolio without wanting to take on undue risk.

On January 8th Transocean (RIG) was cut to “sector perform” from “sector outperform.” A week later it started a decline from the $48 level but without any company specific news, although similar companies, such as Seadrill (SDRL) and ENSCO (ESV) moved in unison. Transocean, after its decline is sitting at an 18 month low which occurred at the time of the temporary suspension of its dividend. With a dividend rate now standing at over 5% and a miniscule payout ratio, combined with its option premium it is one of those few stocks that I would consider owning at this moment without concomitant call sales on shares.

Mondelez (MDLZ) is most everyone’s idea of a lackluster and unexciting company. Because of its perceived mediocrity and uninspired leadership it has gotten the attention of the activist investment community. Unfortunately for pre-existing shareholders the ascension of Nelson Peltz to the Board of Directors was accompanied by the statement that he wouldn’t pursue a deal with PepsiCo (PEP) and subsequently shares significantly under-performed the S&P 500, despite a very low beta. As a result of its recent increased volatility its option premium is beginning to perk up and is getting interesting as it share price is returning to a more manageable level.

Joy Global (JOY) and Las Vegas Sands (LVS) speak to the differing fortunes found in China. While construction and infrastructure projects are slowing, as is the manufacturing index, apparently gaming is alive and well in Macao. After an initial plunge in shares in the after hours as Las Vegas Sands reported its earnings a better understanding of the details behind the report saw a quick reversal.

Las Vegas Sands was frequently owned stock in 2012, but less so in 2013 as I had been waiting for a price retreat that never came. The recent drop from $82 may be the best such drop to be had. While shares do trade at a higher beta than I am interested in pursuing to broadly round out my existing portfolio, indications are that the engines running Las Vegas Sands’ operations aren’t going to slow down in response to Chinese economic woes.

Joy Global on the other hand has engines that literally could be stalled by a faltering Chinese economy. Like many other companies highlighted this week it has greatly underperformed the broad market of late. While doing so shares have returned to near the mid-point of a very comfortable trading range and continues to offer an option premium in line with its volatility.

The coming week is another busy one for earnings. A more detailed look at this week’s earnings related trade considerations is available in an accompanying article. This week more candidates stand out as opportunities by virtue of meeting my ROI and risk criteria in addition to Twitter (TWTR) and Green Mountain Coffee Roasters (GMCR) identified in this article.

Green Mountain Coffee Roasters somehow continues to confound everyone by remaining relevant. While shrouded in controversy it has to be hailed as one of the great share comebacks in recent years, although it is throwing so many concepts into the air these days one has to wonder whether focus is getting dissipated as its core product lines increasingly become commodities and held hostage by agreements with other companies, such as Starbucks.

However, for an earnings related trade those issues may share a lack of relevancy with the company’s future prospects. Always volatile around earnings, with 20% price moves not unusual, the options market is implying an 11% earnings related move. For those content with a 1% ROI for a trade that may last a week or less, a price move of less than 15% lower could fulfill that objective.

Twitter reports its first earnings since its IPO this week.

That thought should be enough to convince people to stay away from shares even had it not had such a surge in share price since a shaky start. Last week it held onto Facebook’s earnings coattails and rose even higher. This week as it faces its first real scrutiny and potential pressure on shares, the options market is implying a 15.8% move in either direction. Again, for those content with a 1% ROI a strike price 22% below Friday’s close can deliver the reward. With at least one good support level and a couple of additional minor ones below that, the risk appears attenuated enough for at least consideration. That is until the next real challenge in mid-February when the first lock-up period comes to an end.

Finally, what’s a week without owning shares of eBay (EBAY)? After announcing earnings the week before last which were widely expected to be disappointing came the announcement from eBay itself that Carl Icahn had taken a position and was putting forward some ideas. The initial reaction was to propel shares toward the high point of its trading range, but eBay CEO Donahoe was quick to dismiss the idea of separating the PayPal unit from eBay and he seemed to have convinced the world that Icahn offered nothing new. He also convinced the world to give back the knee jerk gains.

While shares fared reasonably well this past week they are back in the range that I like to consider ownership, albeit at the upper end of that range. However, eBay, for all of the reasons people have disparaged its ownership has consistently been an excellent covered option purchase and wouldn’t be expected to melt under the pressure of a market at siege.

In the absence of any market moving international news particularly in the currency or debt markets I don’t expect much in the way of increasing volatility this coming week, but I wouldn’t mind the opportunity to party like it’s 2011.

Traditional Stocks: eBay, EMC, Mondelez, Transocean

Momentum Stocks: Joy Global, Las Vegas Sands

Double Dip Dividend: Apple (ex-div 2/6), Starbucks (ex-div 2/4)

Premiums Enhanced by Earnings: Green Mountain Coffee Roasters (2/5 PM), Twitter (2/5 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.

Jan312014

Earnings Still Matter

Weekend Update

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.

Jan192014

Weekend Update – January 19, 2014

Weekend Update

As you get older you realize certain truths and realities and they aren’t always warm and fuzzy.

One of those realities is that often many years of marriage come to an end once the children have left the household. Without the diversion of children always in need comes the realization that there is nothing of substance to hold together a failing foundation. Sometimes the realization is there, but swept under the rug as other events take precedence, but you always know that someday reality can no longer be delayed.

With my youngest child having graduated college that appears to be the story that we’ve heard on multiple occasions from like aged acquaintances and friends. Like most everything else in life there are parallels to the stock market.

We now find ourselves in a market faced with certain realities but without the diversions offered by European monetary crises, sequestration, fiscal cliffs, government shutdowns, quantitative easing, credit downgrades and budgetary deadlines. Those diversions conveniently removed focus from the very foundation upon which stocks find their fair price and to which markets have traditionally responded.

All that is now left behind is earnings and it’s not a pretty prospect.

Perhaps in a manner similar to those in long standing unions who suddenly suffer from improved judgment following a youth blinded by the superficial, the market went through a period of not being terribly discerning and always finding reason to go higher. Interpreting economic news to be something other than what it is has its counterpart in idealizing the idea more than the hard facts.

The reality that is being faced is that of earnings and the failing of earnings to support an ongoing rise in the stock market.

Early suggestions that this earnings season would result in a 6% increase could only be the result of optics as publicly held shares have diminished through massive stock buybacks. However, it doesn’t take much insight to realize that the abysmal state of retail earnings has to have some meaning with regard to the ability of individuals to find discretionary spending within their reality.

As with the past two quarters with the big money financial centers reporting positive earnings, there is little reason to believe that will extend to the other members of the S&P 500 as they begin their reporting in earnest this week.

I’m prepared for the reality, but I still like the fantasy, so I expect to continue playing along this week, just a little more mindful of the obstacles that have a lot of catching up to do.

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).

Among those reporting earnings this week is Coach (COH) which had fallen 6.2% last week, in preparation for what has become a near regular occurrence in the past 18 months upon earnings. While its most recent past has been to shed significant value when all is bared the option market is expecting an implied move of nearly 10%, in addition to the recent weakness. While Coach has had its competitive challenges it has somehow been able to find a fairly well defined trading range, punctuated with some significant moves and periods of recovery or occasionally, decline. In 2013, I traded Coach for all earnings reports, three of which were through the sale of puts. Despite the dramatic moves following all of last year’s earnings reports, predominantly lower, Coach has been and may continue to be an erratic position that offers acceptable reward for defined risk.

Cypress Semiconductor (CY) also reports earnings this week. Just a few months ago, prior to its last report, it did what many have been doing of late and offered some earnings warnings and saw shares plummet more than 20%, leaving virtually nothing more to fall. Like Coach, Cypress Semiconductor has a habit of seeing its share price gravitate back toward a set level with some regularity. Having already fallen approximately 4% in the past two weeks. While the option market is implying a 9% move this week as earnings are announced, I think that it will be much less pronounced and more likely to have some upside potential. After having shares assigned this past Friday, rather than selling puts,as I often do when earnings are at hand, I am considering the purchase of shares and sale of calls on only a portion of shares or at both the $10 and $11 levels to potentially capitalize on share appreciation.

Anadarko (APC) had a brief spike in price this past week, nearly three weeks after plummeting upon news that it might be facing a $14 billion judgment in a case involving a company that it had purchased several years ago. The spike came as Anadarko stated that it believed the judge in the case set damages that were punitive, rather than remedial and believed that the appropriate amount was more in the $2 billion range. It will likely take a long time to come to some resolution, but even at $14 billion there is certainty and the ability to move forward. As shares seem to be creating a new base I think this is a good entry point, as well as a good point to add shares to start the process of offsetting the paper losses from older shares.

Chesapeake Energy (CHK), while trading in a range of late, has also been trading with relatively large daily and intra-day moves. As a result shares enjoy generous option premiums that reflect the volatility, despite having traded in a very stable range for the past 5 months. Offering expanded weekly options I would consider selecting an expiration prior to the scheduled February 20, 2014 earnings report date.

Having already announced earnings Unitedhealth Group (UNH) added to its recent losses and is now down approximately 5% since its recent high. It appears to have some price support a dollar lower than its current price, which may be a good thing considering the unknowns that await as more news trickles in regarding registration demographics and utilization among newly enrolled health care policy holders. While I never move into a position with the idea that it will be a long term holding, I don’t hold too much concern for that unwanted possibility as it’s as likely to recover from any price drops as most anything else and could easily be justified as being a core holding.

The potential dividend choices this week share a “household theme” covering aspects of the kitchen, laundry room and bathroom, but represent different ends of the consumer spectrum when defensive investing is foremost.

While Clorox (CLX) and Colgate Palmolive (CL) may be best known for consumer staples and nothing terribly ostentatious, Williams Sonoma (WSM) offers products that are every bit as critical to some. Those who would sacrifice anything to ensure that they can purchase an oversized block of Mediterranean pink salt have money every bit as valuable as those that like bright white shirt collars and bright white teeth.

More importantly, at least for me, they have all recently under-performed the S&P 500 and all trade with a low beta at a time that I want to balance risk and still generate a reasonable income stream from premiums and dividends. While both Clorox and Colgate Palmolive have earnings reports due in the February option cycle, WIlliams Sonoma, which tends to trade with more volatility upon earnings, does not report until the end of the March 2014 cycle.

Finally, for those who really seek reckless adventure, perhaps only frolicking in a landfill brimming with its products offers more excitement than considering shares of LED light bulb maker Cree (CREE) in advance of earnings. The last time I considered an earnings related trade in Cree I didn’t recommend the purchase or sale of puts to my subscribers, but did make the put sale for my personal account. However, I did so only after earnings, believing that the 16% drop offered sufficient protection to make an out of the money put sale with relative impunity.

Like some other stocks this past week that continued to fall even days after earnings plunges, that’s what Cree did. Rolling over the puts on a few occasions, eventually taking assignment and then selling calls until its final assignment at a strike level 5% higher than the original put strike price made it worthwhile, but more thrilling than necessary.

So unnecessary that I may be ready to do so again.

Traditional Stocks: Anadarko, Unitedhealth Group

Momentum Stocks: Chesapeake Energy

Double Dip Dividend: Colgate Palmolive (ex div 1/22), Clorox (ex-div 1/27), Williams Sonoma (ex-div 1/22)

Premiums Enhanced by Earnings: Cree (1/21 PM), Coach (1/22 AM), Cypress Semiconductor (1/22 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.