Weekend Update – December 18, 2016

 

A long time ago there was a reasonably popular song by a group that itself was reasonably popular  at a time when Disco was dying, Punk Rock had out-grown its shock factor and Heavy Metal and long hair bands were taking root.
 
In that vacuum anything could have become reasonably popular and so it was that everyone was humming the tune of the song that cried out for the need for a new drug.
 
I always wondered why the lyrics didn’t include the requirement for a drug that won’t quit, as that’s the ultimate problem for anyone seeking to be taken to a better place through the modern miracle of chemistry.
 
At some point we develop a kind of tolerance to stimuli, to feelings and even to drugs. That’s why we always keep searching for something new. What was once good, or at least good enough, just quits on us.
 
Even when we may not fall prey to the human desire for more, bigger and better, we at least want to get the same kick at a bare minimum and we can’t possibly tolerate a drug or an emotion that quits on us.
 
This past week we came to a point when the FOMC sort of quit. It really didn’t take us any place new, even as it did finally take some action.
 
  
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Weekend Update – December 11, 2016

There are so many ways to look at most things.

Take a runaway train, for example.

The very idea of a “runaway train” probably evokes some thoughts of a disaster about to happen.

Following this past week’s 3.1% gain in the S&P 500, adding to the nearly 4.3% gain since the election result that most everyone thought to be improbable, the market may be taking on some characteristics of a runaway train.

But I don’t really think too much about the inevitable crash that ensues when the train does leave the tracks.

As every physics fan knows, the real challenge behind a runaway train is getting all of that momentum under control.

I don’t think about that, either, though.

What I do think about is trying to understand how to look at momentum.

Momentum, of course, is simply the product of the object’s mass and its velocity.

Mass, of course is nothing more than the force exerted by that object divided by its acceleration.

Acceleration, of course is nothing more than the derivative of an object’s velocity.

So, I like to look at momentum as an expression of the product of an object’s force and its velocity, while at the same time dividing by rate of change in that velocity.

In other words, depending upon how you look at things makes all the difference in the world.


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Weekend Update – March 6, 2016

Depending upon what kind of outlook you have in life, the word “limbo” can conjure up two very different pictures.

For some it can represent a theologically defined place of temporary internment for those sinners for whom redemption was still possible. 

In simple terms it may be thought of as a place between the punishing heat and torment of hell below and the divineness and comfort of heaven above.

Others may just see an image reminding them of a fun filled Caribbean night watching a limber individual dancing underneath and maybe dangerously close to a flaming bar that just keeps getting set lower and lower.

Both definitions of “limbo” require some significant balancing to get it just right.

For example, you don’t get entrance into the theologically defined “Limbo” if the preponderance of your sins are so grievous that you can’t find yourself having died in “the friendship of God.” Instead of hanging around and waiting for redemption, you get a one way ticket straight to the bottom floor.

It may take a certain balance of the quantity and quality of both the good and the bad acts that one has committed during their mortal period to determine whether they can ever have a chance to move forward and upward to approach the pearly gates of heaven.

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Taking a Gamble with Earnings

The coming week stands to be a busy one as about 150 of the S&P 500 stocks will be reporting their quarterly earnings.

While earnings had gotten off to a good start last week with a strong showing from those in the financial sector, the market’s initial optimism was tempered a bit during the first day Janet Yellen’s Humphrey-Hawkins testimony and was sent into a pall with news of the tragic downing of a Malaysian civilian plan over the disputed Ukraine – Russian border area.

Regardless of the direction a stock’s price takes upon the earnings parade that also includes forward guidance there is often opportunity to profit from either the expected or unexpected news that’s delivered.

Whenever I ponder whether an earnings related trade is worth consideration I let the option market’s measure of the “implied price move” serve to determine whether there is a satisfactory risk-reward proposition. That calculation provides a price range in which projected price movements are thought to be likely.

If selling options, whether as part of a covered call strategy or through the sale of puts, there may be opportunity to achieve an acceptable premium even though if it represents a share price outside of the bounds set by the option market. Of course, that does depend to some degree on your own definition of “acceptable” and what you believe to be the appropriate level of risk to accompany that reward.

This coming week there appears to be a number of stocks that may warrant some attention as the reward may be well suited to the risk for some, as premiums tend to be heightened before known events, such as earnings.

A unifying theme for stocks that satisfy my criteria of offering a 1% or greater premium for a weekly option at a strike price outside of the boundary defined by the implied move calculation is underlying volatility. While already heightened due to impending earnings release and the uncertainty that accompanies the event, stocks that typically satisfy the criteria I’ve selected are already quite volatile.

While the implied volatilities may sometimes appear to be high, they are often consistent with past history and such moves are certainly within the realm of probability. That knowledge should serve as a warning that the unthinkable can, and does, happen.

While individuals can set their own risk-reward parameters, I’m very satisfied with a weekly 1% ROI.  The other part of the equation, the risk, is less quantitative. It is merely a question of whether the necessary strike level to achieve the reward is above or below the lower boundary defined by the stock’s implied move. 

I prefer to be below that lower boundary.

Among the companies that I am considering this coming week are Apple (AAPL), Cliffs Natural Resources (CLF), Comcast (CMCSA), Chipotle Mexican Grill (CMG), Facebook (FB), Freeport McMoRan (FCX), Intuitive Surgical (ISRG), Microsoft (MSFT), Pandora (P) and VMWare (VMW).

The basis for making any of these trades is entirely predicated upon what may be an inefficiency between the option premiums and the implied price movement. I give no consideration to fundamental nor technical issues and would prefer not to be in a position to take ownership of shares in the event of an adverse price move.

My preference when selling put contracts is to do so when shares have already been falling in price in advance of earnings. Given the flourish with which this past week ended that is a bit more difficult, as a number of the shares listed had sizable gains in the session, recovering from the previous day’s drops.

While I would prefer not to take ownership of shares, the investor must be prepared to do so or to attempt to manage the options contract, such as rolling it forward, if assignment appears inevitable.

During periods of low volatility it may sometimes be difficult to do so and achieve a meaningful additional premium without going out further in time than you may have envisioned, however.

The table above may be used as a guide for determining which of these selected companies meets risk-reward parameters. Re-assessments need to be made as prices and, therefore, strike prices and their premiums may change. Additionally, the target ROI may warrant being changed as time erodes. For example, if the trade is executed with only 4 days of time remaining on the contract the 1% ROI may find its equivalent in a 0.8% return.

While the list can be used prospectively there may also be occasion to consider put sales following earnings in those cases where shares have reacted in an extremely negative fashion to earnings or to guidance. If you believe the response was an over-reaction to the news there may then be opportunity to sell put options to take advantage of the negative sentiment that may be reflected in option premiums.

In such a case the sale of a put is a bullish sentiment and there may be opportunity to make that expression a profitable one as the over-reaction faces its own correction. My recent observation, however, is that it seems to be taking longer and longer to see some stocks mount meaningful recoveries after earnings disappointments, which I interpret as a bearish indicator for the market as a whole, as risk aversion is a priority.

Recently, I’ve spent some considerable time in managing some positions that had greater than anticipated price moves, including taking assignment and then managing the  position through the sale of call options.

Ultimately, regardless of the timing of an earnings related trade there is always opportunity when large price movements are anticipated, especially if those worst and best case scenarios aren’t realized.

Best of all, if the extreme scenarios are realized a nimble trader may have opportunity to create even more opportunities and allow the position to accumulate re
turns while doing so.

 

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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.

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