Jan162016

Weekend Update – January 17, 2016

Weekend Update


The world is awash in oil and we all know what that means.

From Texas to the Dakotas and to the North Sea and everything in-between, there is oil coming out of every pore of the ground and in ways and places we never would have imagined.

Every school aged kid knows the most basic law of economics. The more they want something that isn’t so easy to get the more they’re willing to do to get it.

It works in the other direction, too.

The more you want to get rid of something the less choosy you are in what it takes to satisfy your need.

So everyone innately understands the relationship between supply and demand. They also understand that rational people do rational things in response to the supply and demand conditions they face.

Not surprisingly, commodities live and die by the precepts of supply and demand. We all know that bumper crops of corn bring lower prices, especially as there’s only so much extra corn people are willing to eat as a result of its supply driven decrease in price.

Rational farmers don’t plant more corn in response to bumper crops and rational consumers don’t buy less when supply drives prices lower.

Stocks also live by the same precepts, except that most of the time the supply of any particular stock is fixed and it’s the demand that varies. However, we’ve all seen the frenzy around an IPO when insatiable demand in the face of limited supply makes people crazy and we’ve all seen what happens when new supply of shares, such as in a secondary offering is released.

Of course, much of what gains we’ve seen in the markets over the past few years have come as a result of manipulating supply and artificially inflating the traditional earnings per share metric.

When a deep Florida freeze hits the orange crop in Florida, no one spends too much time deeply delving into the meaning of the situation. The price for oranges will simply go higher as the demand stays reasonably the same, to a point. 

If, however, people’s tastes change and there is suddenly an imbalance between the supply and demand for orange juice, reasonable suppliers do the logical thing. They try to recognize whether the imbalance is due to too much supply or too little demand and seek to adjust supply.

Whatever steps they may take, the world’s economies aren’t too heavily invested in the world of oranges, no matter how important it may be to those Florida growers.

Suddenly, oil is different, even as it has long been a commodity whose supply has been manipulated more readily and for more varied reasons. than a farmer simply switching from corn to soybeans.

The price of oil still lives by supply and demand, but now thrown into the equation are very potent external and internal political considerations.

Saudi Arabia has to bribe its citizens into not overthrowing the monarchy while wanting to also inflict financial harm on anyone bringing new sources of supply into the marketplace. They don’t want to cede marketshare to its enemies across the gulf nor its allies across the ocean.

With those overhangs, sometimes irrational behavior is the result in the pursuit of what are considered to be rational objectives.

Oil is also different because the cause for the imbalance says a lot about the world. Why is there too much supply? Is it because of an economic slowdown and decreased demand or is it because of too much supply?

Stock markets, which are supposed to discount and reflect the future have usually been fairly rational when having a longer term vision, but that’s becoming a more rare phenomenon.

The very clear movement of stock markets in tandem with oil prices up or down has been consistent with a belief that the balance between supply and demand has been driven by demand.

Larry Fink, who most agree is a pretty smart guy, as the Chairman and CEO of Blackrock (BLK) was pretty clear the other day and has been consistent in the belief that the low price of oil was supply, and not demand driven. He has equally been long of the belief that lower oil prices were good for the world.

In any other time, supply driven low prices would have represented a breakdown in OPEC’s ability to hold the world’s economies hostage and would have been the catalyst for stock market celebrations.

Welcome to 2016, same as 2015.

But world markets continue to ignore that view and Fink may be coming to the realization that his voice of reason is drowned out by fear and irrational actions that only have a near term vision. That may explain why he now believes that there could be an additional 10% downside for US markets over the next 6 months, including the prospects of job layoffs.

That’s probably not something that the FOMC had high on its list of possible 2016 scenarios.

Ask John McCain how an increasing unemployment rate heading into a close election worked out for him, so you can imagine the distress that may be felt as 7 years of moderate growth may come to an end at just the wrong time for some with great political aspirations.

The only ones to be blamed if Fink’s fears are correct are those more readily associated with the existing power structure.

Just as falling stock prices in the face of supply driven falling oil prices seems unthinkable, “President Trump” doesn’t have a dulcet tone to my ears. More plausible, in the event of the unthinkable is that it probably wouldn’t take too much time for his now famous “The Apprentice” tag line to morph into “You’re impeached.”

So there’s always that as a distraction from a basic breakdown in what we knew to be an inviolate law of economics.

With 2016 already down 8% and sending us into our second correction in just 5 months so many stocks look so inviting, but until there’s some evidence that the demand to meet the preponderance of selling exists, to bite at those inviting places may be even more irrational than it would have been just a week earlier.

As usual, the week’s potential stock selections are classified as being in the Traditional, Double Dip Dividend, Momentum or “PEE” categories.

One stock that actually does look like a bargain to me reports earnings this week. Verizon (VZ) is the only stock in this week’s list that isn’t in or near bear correction territory in the past 2 months.

Even those few names that performed well in 2015 and helpe
d to obscure the weakness in the broader market are suffering in the early stages of 2015.

Not so for Verizon, even though the shares have fallen nearly 5% from its near term resistance level on December 29, 2015, the S&P 500 fell almost 9% in that time.

While there is always added risk with earnings being reported, Verizon and some of its competitors stand to benefit from their own strategic shifts to stop subsidizing what it is that people crave. That may not be reflected in the upcoming earnings report, but if buying Verizon shares I may consider looking beyond the weekly options that I tend to favor in periods of low volatility. Although I usually am more likely to sell puts when earnings are in the equation, I’m more likely to go the buy/write route for this position.

The one advantage of the kind of market action that we’ve had recently is the increase in volatility that it brings.

When that occurs, I start looking more and more at longer term options. The volatility increase typically means higher premiums and that extends into the forward weeks. Longer term contracts during periods of higher volatility allow you to lock in higher premiums and give time for some share price recovery, as well.

Since Verizon also has a generous dividend, but won’t be ex-dividend for another 3 months, I might consider an April 2016 or later expiration date.

One of the companies that is getting a second look this week is Williams-Sonoma (WSM), which is also ex-dividend this week and only offers monthly options.

Shares are nearly 45% lower since the August 2015 correction and have not really had any perceptible attempt at recovering from those losses.

What it does offer, however. is a nice option premium, that even if shares declined by approximately 1% for the month could still deliver a 3.8% ROI in addition to the quarterly 0.7% dividend.

Literally and figuratively firing on all cylinders is General Motors (GM), but it is also figuratively being thrown out with the bath water as it has plunged alongside the S&P 500.

With earnings being reported in early February and with shares probably being ex-dividend in the final week of the March 2016 option cycle, there may be some reason to consider using a longer term option contract, perhaps even spanning 2 earnings releases and 2 ex-dividend dates, again in an attempt to take advantage of the higher volatility, by locking in on longer term contracts.

Netflix (NFLX) reports earnings this week and the one thing that’s certain is that Netflix is a highly volatile stock when reporting earnings, regardless of what the tone happens to be in the general market.

With the market so edgy at the moment, this would probably not be a good time for any company to disappoint investors.

The option market definitely demonstrates some of the uncertainty that’s associated with this coming week’s earnings, as you can get a 1% ROI even if shares drop by 22%.

As it is, shares are down nearly 20% since early December 2015, but there seem to be numerous levels of support heading toward the $81 level.

If shares do take a plunge, there would likely be a continued increase in volatility which could make it lucrative to continue rolling over puts, even if not faced with impending assignment.

Of some interest is that while call and put volumes for the upcoming weekly options were fairly closely matched, the skew was toward a significant decline in shares next week, as a large position was established at a weekly strike level $34 below Friday’s close.

Finally, last week wasn’t a very good week for the technology sector, as Intel (INTC) got things off on a sour note, which is never a good thing to do in an already battered market.

Seagate Technology (STX) wasn’t spared any pain last week, either, as it has long fallen into the same kind of commodity mindset as corn, orange juice and even oil back in the days when things made sense.

Somehow, despite having been written off as nothing more than a commodity, it has seen some good times in the past few years. That is, if you exclude 2015, as it has now fallen more than 50% since that time, but with nearly 35% of that decline having occurred in just the past 3 months.

I usually like entering a Seagate Technology position through the sale of puts, as its premium always reflects a volatile holding.

For example the sale of a weekly put at a strike price 3% below Friday’s closing price could provide a 1.9% ROI. When considering that next week is a holiday shortened week, that’s a particularly high return.

Seagate Technology is no stranger to wild intra-weekly swings. If selling puts, I prefer to try and delay assignment of shares if they fall below the strike level. Since the company reports earnings the following week, I would likely try to roll over to the week after earnings, but if then again faced with assignment, would be inclined to accept it, as shares are expected to be ex-dividend the following week.

The caveat is that those shares may be ex-dividend earlier, in which case there would be a need to keep a close eye out for the announcement in order to stand in line for the 8% dividend.

For now, Seagate does look as if it still has the ability to sustain that dividend which was increased only last quarter.

 

Traditional Stocks: General Motors

Momentum Stocks: Seagate Technolgy

Double-Dip Dividend: Williams-Sonoma (1/22 $0.35)

Premiums Enhanced by Earnings: Netflix (1/19 PM), Verizon (1/21 AM)

Remember, these are just guidelines for the coming week. The above selections may become actionable – most often coupling a sh
are 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.

Jan12016

Weekend Update – January 3, 3016

Weekend Update

The "What If" game is about as fruitless as it gets, but is also as much a part of human nature as just about anything else.

How else could I explain having played that game at a high school reunion?

That may explain the consistent popularity of that simple question as a genre on so many people’s must read lists as the New Year begins.

Historical events lead themselves so beautifully to the "What If" question because the cascading of events can be so far reaching, especially in an interconnected world.

Even before that interconnection became so established it didn’t take too much imagination to envision far reaching outcomes that would have been so wildly different around the world even a century or more later.

Imagine if the Union had decided to cede Fort Sumpter and simply allowed the South to go its merry way. Would an abridged United States have been any where near the force it has been for the past 100 years? What would that have meant for Europe, the Soviet Union, Israel and every other corner of the world?

Second guessing things can never change the past, but it may provide some clues for how to approach the future, if only the future could be as predictable as the past.

Looking back at 2015 there are lots of "what if" questions that could be asked as we digest the fact that it was the market’s worst performance since 2008.

In that year the S&P 500 was down about 37%, while in 2015 it was only down 0.7%. That gives some sense of what kind of a ride we’ve been on for the past 7 years, if the worst of those years was only 0.7% lower.

But most everyone knows that the 0.7% figure is fairly illusory.

For me the "what if" game starts with what if Amazon (AMZN), Alphabet (GOOG), Microsoft (MSFT) and a handful of others had only performed as well as the averages.

Of course, even that "what if" exercise would continue to perpetuate some of the skew seen in 2015, as the averages were only as high as they were due to the significant out-performance of a handful of key constituent components of the index. Imagining what if those large winners had only gone down 0.7% for the year would still result in an index that wouldn’t really reflect just how bad the underlying market was in 2015.

While some motivated individual could do those calculations for the S&P 500, which is a bit more complex, due to its market capitalization calculation, it’s a much easier exercise for the DJIA.

Just imagine multiplying the 10 points gained by Microsoft , the 30 pre-split points gained by Nike (NKE), the 17 points by UnitedHealth Group (UNH), the 26 points by McDonalds (MCD) or the 29 points by Home Depot (HD) and suddenly the DJIA which had been down 2.2% for 2015, would have been another 761 points lower or an additional 4.5% decline.

Add another 15 points from Boeing (BA) and another 10 from Disney (DIS) and we’re starting to inch closer and closer to what could have really been a year long correction.

Beyond those names the pickings were fairly slim from among the 30 comprising that index. The S&P 500 wasn’t much better and the NASDAQ 100, up for the year, was certainly able to boast only due to the performances of Amazon, Netflix (NFLX), Alphabet and Facebook (FB).

Now, also imagine what if historically high levels of corporate stock buybacks hadn’t artificially painted a better picture of per share earnings.

That’s not to say that the past year could have only been much worse, but it could also have been much better.

Of course you could also begin to imagine what if the market had actually accepted lower energy and commodity prices as a good thing?

What if investors had actually viewed the prospects of a gradual increase in interest rates as also being a good thing, as it would be reflective of an improving, yet non-frothy, economy?

And finally, for me at least, What if the FOMC hadn’t toyed with our fragile emotions and labile intellect all through the year?

Flat line years such as 2015 and 2011 don’t come very often, but when they do, most dispense with the "what if" questions and instead focus on past history which suggests a good year to follow.

But the "what if" game can also be prospective in nature, though in the coming year we should most likely ask similar questions, just with a slight variation.

What if energy prices move higher and sooner than expected?

What if the economy expands faster than we expected?

What if money is running dry to keep the buyback frenzy alive?

Or, what if corporate earnings actually reflect greater consumer participation?

You may as well simply ask what if rational thought were to return to markets?

But it’s probably best not to ask questions when you may not be prepared to hear the answer.

As usual, the week’s potential stock selections are classified as being in the Traditional, Double Dip Dividend, Momentum or "PEE" categories.

For those, myself included, who have been expecting some kind of a resurgence in energy prices and were disbelieving when some were calling for even further drops only to see those calls come true, it’s not really clear what the market’s reaction might be if that rebound did occur.

While the market frequently followed oil lower and then occasionally rebounded when oil did so, it’s hard to envision the market responding favorably in the face of sustained oil price stability or strength.

I’ve given up the idea that the resurgence would begin any day now and instead am more willing to put that misguided faith into the health of financial sector stocks.

Unless the FOMC is going to toy with us further or the economy isn’t going to show the kind of strength that warranted an interest rate increase or warrants future increases, financials should fare well going forward.

This week I’m considering MetLife (MET), Morgan Stanley and American Express (AXP), all well off from their 2015 highs.

MetLife, down 12% during 2015 is actually the best performer of that small group. As with Morgan Stanley, almost the entirety of the year’s loss has come in the latter half of the year when the S&P 500 was performing no worse than it had during the first 6 months of the year.

Both Morgan Stanley and MetLife have large enough option premiums to consider the sale of the nearest out of the money call contracts in an attempt to secure some share appreciation in exchange for a somewhat lo0wer option premium.

In both cases, I think the timing is good for trying to get the best of both worlds, although Morgan Stanley will be among the relatively early earnings reports in just a few weeks and still hasn’t recovered from its last quarter’s poorly received results, so it would help to be prepared to manage the position if still held going into earnings in 3 weeks.

By contrast, American Express reports on that same day, but all of 2015 was an abysmal one for the company once the world learned that its relationship with Costco (COST) was far more important than anyone had believed. The impending loss of Costco as a branded partner in the coming 3 months has weighed heavily on American Express, which is ex-dividend this week.

I would believe that most of that loss in share has already been discounted and that disappointments aren’t going to be too likely, particularly if the consumer is truly making something of a comeback.

There has actually been far less press given to retail results this past holiday season than for any that I can remember in the recent and not so recent past.

Most national retailers tend to pull rabbits out of their hats after preparing us for a disappointing holiday season, with the exception of Best Buy (BBY), which traditionally falls during the final week of the year on perpetually disappointing numbers.

Best Buy has already fallen significantly in th e past 3 months, but over the years it has generally been fairly predictable in its ability to bounce back after sharp declines, whether precipitous or death by a thousand cuts.

To my untrained eye it appears that Best Buy is building some support at the $30 level and doesn’t report full earnings for another 2 months. Perhaps it’s its reputation preceding it at this time of the year, but Best Buy’s current option premium is larger than is generally found and I might consider purchasing shares and selling out of the money calls in the anticipation of some price appreciation.

Under Armour (UA) is in a strange place, as it is currently in one of its most sustained downward trends in at least 5 years.

While Nike, its arch competitor, had a stellar year in 2015, up until a fateful downtrend that began in early October, Under Armour was significantly out-performing Nike, even while the latter was some 35% above the S&P 500’s performance.

That same untrained eye sees some leveling off in the past few weeks and despite still having a fairly low beta reflecting a longer period of observation than the past 2 months, the option premium is continuing to reflect uncertainty.

With perhaps some possibility that cold weather may finally be coming to areas where it belongs this time of the year, it may not be too late for Under Armour to play a game of catch up, which is just about the only athletic pursuit that I still consider.

Finally, Pfizer (PFE) has been somewhat mired since announcing a planned merger, buyout, inversion or whatever you like to have it considered. The initially buoyed price has fallen back, but as with Dow Chemical (DOW) which has also fallen back after a similar merger announcement move higher, it has returned to the pre-announcement level.

I view that as indicating that there’s limited downside in the event of some bad news related to the proposed merger, but as with Dow Chemical, Best Buy and Under Armour, the near term option premium continues to reflect perceived near term risk.

Whatever Pfizer;’s merger related risk may be, I don’t believe it will be a near term risk. From the perspective of a call option seller that kind of perception in the face of no tangible news can be a great gift that keeps giving.

Traditional Stocks: MetLife. Morgan Stanley, Pfizer

Momentum Stocks: Best Buy, Under Armour

Double-Dip Dividend: American Express (1/6 $0.29)

Premiums Enhanced by Earnings: none

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.

Oct92015

Weekend Update – October 11, 2015

Weekend Update

If you’re a fan of “American Exceptionalism” and can put aside the fact that the Shanghai stock market has made daily moves of 6% higher in the past few months on more than one occasion, you have to believe that the past week has truly been a sign of the United States’ supremacy extending to its stock markets.

We are, of optiocourse, the only nation to have successfully convinced much of the world for the past 46 years that we put a man on the moon.

So you tell me. What can’t we do?

What we can do very well is turn bad news into good news and that appears to be the path that we’ve returned to, as the market’s climb may be related to a growing belief that interest rate hikes may now be delayed and the party can continue unabated.

While it was refreshing for that short period of time when news was taken at face value, we now are faced with the prospect of markets again exhibiting their disappointment when those interest rate hikes truly do finally become reality.

Once the market came to its old realizations it moved from its intra-day lows hit after the most recent Employment Situation Report and the S&P 500 rocketed higher by 6% as a very good week came to its end on a quiet note.

While much of the gain was actually achieved when the Shanghai markets were closed for the 7 day National Day holiday celebration, it may be useful to review just what rockets are capable of doing and perhaps looking to China as an example of what soaring into orbit can lead to.

Rockets come in all sizes and shapes, but are really nothing more than a vehicle launched by a high thrust engine. Those high thrust rocket engines create the opportunities for the vehicle. Some of those vehicles are designed to orbit and others to achieve escape velocity and soar to great heights.

And some crash or explode violently, although not by design.

As someone who likes to sell options the idea of a stock just going into orbit and staying there for a while is actually really appealing, but with stocks its much better if the orbit established is one that has come down from greater heights.

That’s not how rockets usually work, though.

But for any kind of orbiting to really be worthwhile, those premiums have to be enriched by occasional bumps along the path that don’t quite make it to the level of violent explosions.

It’s just that you never really know when those violent explosions are going to come and how often. Certainly Elon Musk didn’t expect his last two rocket launches to come to sudden ends.

In China’s case those 6% increases have been followed by some epic declines, but that’s not unusual whenever seeing large moves in either direction.

As we get ready to start earnings season for real this week we may quickly learn whether our own 6% move higher was just the first leg of a multi-stage rocket launch or whether it will soon discover that there is precious little below to offer much in the way of support.

Prior to that 6% climb it was that lack of much below that created a situation where many stocks had gone into orbit, taking a rest to regain strength for a bounce higher. That temporary orbit was a great opportunity to generate some option premium income, as some of the risk of a crash was reduced as those stocks had already migrated closer to the ground.

While I don’t begrudge the recent rapid rise it would be nice to go back into orbit for a while and refuel for a slower, but more sustainable ride higher.

As usual, the week’s potential stock selections are classified as being in the Traditional, Double Dip Dividend, Momentum or “PEE” categories.

There aren’t too many data points to go on since that turnaround last week, but Apple (NASDAQ:AAPL) has been uncharacteristically missing from the party.

It seems as if it’s suddenly becoming fashionable to disparage Apple, although I don’t recall Tim Cook having given Elon Musk a hard time recently. With the opening of the movie, Steve Jobs, this week may or may not further diminish the luster.

Ever since Apple joined the DJIA on March 19, 2015 it has dragged the index 109 points lower, accounting for about 11% of the index’s decline, as it has badly lagged both the DJIA and S&P 500 during that period. The truth, however, is that upon closer look, Apple has actually under-performed both for most of the past 3 year period, even when selecting numerous sub-periods for study. The past 6 months have only made the under-performance more obvious.

With both earnings and an ex-dividend date coming in the next month, I would be inclined to consider an Apple investment from the sale of out of the money puts. If facing assignment, it should be reasonably easy to rollover those puts and continuing to do so as earnings approach. If, however, faced with the need to rollover into the week of earnings, I would do so using an extended weekly option, but one expiring in the week prior to the week of the ex-dividend date. Then, if faced with assignment, I would plan to take the assignment and capture the dividend, rather than continuing to attempt to escape share ownership.

In contrast to Apple, Visa (NYSE:V) which joined the DJIA some 2 years earlier, coincidentally having split its shares on the same day that Apple joined the index, actually added 49 points to the DJIA.

For Visa and other credit card companies there may be a perfect storm of the good kind on the horizon. With chip secured credit cards just beginning their transition into use in the United States and serving to limit losses accruing to the credit card companies, Visa is also a likely beneficiary of increasing consumer activity as there is finally some evidence that the long awaited oil dividend is finding its way into retail.

When it comes to bad news, it’s hard to find too many that have taken more lumps than YUM Brands (NYSE:YUM) and The Gap (NYSE:GPS).

Despite a small rebound in YUM shares on Friday, that came nowhere close toward erasing the 19% decline after disappointing earnings from its China operations.

YUM Brands was a potential earnings related trade last week, but it came with a condition. That condition being that there had to be significant give back of the previous week’s gains.

Instead, for the 2 trading days prior to earnings, YUM shares went higher, removing any interest in taking the risk of selling puts as the option market was still anticipating a relatively mild earnings related move and the reward was really insufficient.

Now, even after the week ending bounce, YUM’s weekly option premium is quite high, especially factoring in its ex-dividend state. As discussed last week, the premium enhancement may be sufficient to look into the possibility of selling a deep in the money weekly call option and ceding the dividend in order to accrue the premium and exit the position after just 2 days, if assigned early.

You needn’t look to China to explain The Gap’s problems. Slumping sales under its new CEO and the departure of a key executive from a rare division that was performing have sent shares lower and lower.

The troubles were compounded late this past week when The Gap did, as fewer and fewer in retail are doing, and released its same store sales figures and they continued to disappoint everyone.

Having gone ex-dividend in the past week that lure is now gone for a few months. The good news about The Gap is that it isn’t scheduled to report news of any kind of news for another month, when it releases same store sales once again, followed by quarterly results 10 days later.

The lack of any more impending bad news isn’t the best of compliments. However, unlike a rocket headed for a crash the floors for a stock can be more forgiving and The Gap is approaching a multi-year support level that may provide some justification for a position with an intended short term time frame as its option premiums are increasingly reflecting its increased volatility.

Coach (NYSE:COH) has earnings due to be reported at the end of this month. It is very often a big mover at earnings and despite some large declines had generally had a history of price recovery. That, however, hasn’t been the case in nearly 2 years.

Over the past 3 years I’ve owned Coach shares 21 times, but am currently weighed down by a single lot that is nearly 18 months old. During that time period I’ve only seen fit to add shares on a single occasion, but am again considering doing so as it seems to be building upon some support and may be one of those beneficiaries of increased consumer spending, even as its demographic may be less sensitive to energy pricing.

With the risk comes a decent weekly option premium, but I might consider sacrificing some of that premium and attempting to use a higher priced strike and perhaps an extended weekly option, but being wary of earnings, even though I expect an upward surprise.

The drug sector has seen its share of bad news lately, as well and has certainly been the target of political opportunism and over the top greed that makes almost everyone cringe.

AbbVie (NYSE:ABBV) is ex-dividend this week and is nearly 20% lower from the date that the S&P 500 began its descent toward correction territory. Since its spin-off from Abbott Labs (NYSE:ABT), which is also ex-dividend this week, AbbVie has had more than its share of controversy, including a proposed inversion and the pricing of its Hepatitis C drug regimen.

Shares seem to have respected some price support and have returned to a level well below where I last owned them. With its equally respectable option premium and generous dividend, this looks like an opportune time to consider a position, but I would like it as a short term holding in an attempt to avoid being faced with its upcoming earnings report at the end of the month.

Finally, Netflix (NASDAQ:NFLX) reports earnings this week and had been on a tear until mid-August, when a broad brush took nearly every company down 10% or more.

Of course, even with that 10% decline, Icahn Enterprises (NASDAQ:IEP), would have been far better off not having sold its shares and incurring its own 13% loss in 2015.

With earnings coming this week I found it interesting that Netflix would announce a price increase for new customers in advance of earnings. In having done so, shares spiked nearly 10%.

The option market is implying a 14% price move, however, a 1% ROI could possibly be achieved by selling a weekly put at a strike level 19% below Friday’s closing price.

That’s an unusually large cushion even as the option market has been starting to recover from a period of under-estimating earnings related moves in the past quarter.

While the safety net does appear wide, my cynical side has me believing that the subscription increase was timed to offer its own cushion for what may be some disappointing numbers. Given the emphasis on new subscriber acquisitions, I would believe that metric will come in strong, otherwise this wouldn’t be an opportune time for a price increase. However, there may be something lurking elsewhere.

With that in mind, I would consider the same approach as with YUM Brands last week and would only consider the sale of puts if preceded by some significant price pullback. Otherwise, I would hold off, but might become interested again in the event of a large downward move after earnings are released.

Traditional Stocks: Apple, The Gap, Visa

Momentum Stocks: Coach

Double-Dip Dividend: AbbVie (10/13), YUM Brands (10/14)

Premiums Enhanced by Earnings: Netflix (10/14 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.

Jan162015

Beware of Earnings Unless You Dare

No categories

Although the first week of this most recent earnings season has been less than spectacular, as the financial sector has suffered under a low interest rate environment, I continue to look at the more speculative portion of my portfolio as being available to generate quick income from stocks before or after earnings are announced.

During a week that stocks, interest rates, oil, precious metals and currencies have all gyrated wildly, what’s a little added speculation with earnings?

The process of trading in anticipation or after earnings news is one that seeks to balance risk with reward, accepting a relatively small reward in exchange for taking on a level of risk that appears to be less than the market is expecting.

The basic concepts and considerations in the approach are related to:

  • personal ROI goal;
  • individual temperament for risk, and
  • time and ability to trade in or out of risk in response to events.

The concepts are covered in previous articles, but in summary, the objective is to find a stock that can deliver an acceptable ROI when selling a weekly put option at a strike level that is lower than the bottom of the range defined by the option market’s implied volatility for that stock.

For my tolerances I seek a 1% ROI for a weekly position at a strike price that is outside the boundaries implied by the option market.

While achieving the desired ROI is an objective metric, and should be done within the context of acceptable risk, the decision process to initiate a trade is frequently based upon share behavior.

My preference, when it appears that both the risk and the reward measures are satisfactory, is to sell puts into share weakness in advance of earnings. If that condition isn’t met, I may also consider the sale of puts after earnings if there is significant price weakness after the report.

After Friday’s strong close, which may have come as a surprise to most everyone after a week of declines, many stocks reporting earnings next week may now be coming off of Friday’s advances. Insofar as Friday’s performance may have represented a reflexive bounce higher, I would be initially reluctant to jump into any put sale related trades for concern about an equally reflexive drop lower.

However, a number of the positions covered in this article have already suffered large losses in advance of their earnings report, some perhaps due to altered guidance and many are already well off from their highs, even as the S&P 500 is barely 4% lower after a quick triple bottom.

I tend to be more interested in those stocks that have already fallen than I am in those whose shares are moving higher prior to earnings, as that moves the strike level that I would have to use to achieve my desired 1% ROI for the week higher, and may also shift premium enhancement on the call side of the equation, rather than to the put side, which also contributes to a lower ROI.

While the traditional opinion and belief is that put sellers must be willing to own the shares in which they have sold puts, I often do not want to take ownership unless an ex-dividend date is approaching. While many sell puts in order to gain an entry into share ownership at a lower and more attractive price, I do so generally in order to capture the income stream from the option sales.

For that reason, it is important to have liquidity in the options market in order to be able to concurrently close the position and open a new one for a forward week if assignment is unwanted. Ideally, that would also be done at a lower strike price, however, in an otherwise low volatility environment, as we currently have, despite some recent increase, that is a difficult objective unless there is additional stock specific volatility, as may be seen in the energy sector currently.

Whether able to rollover to a lower strike level or not, the primary goals are to delay or prevent assignment and to collect additional net premiums in an attempt to ultimately see the position expire or be closed.

Among the stocks for consideration this week are many that can be readily recognized for inherent risk, which may also influence price behavior on a regular basis regardless of upcoming earnings or guidance.

This week I’m considering the sale of puts of shares of Cree (NASDAQ:CREE), Freeport McMoRan (NYSE:FCX), F5 Networks (NASDAQ:FFIV), General Electric (NYSE:GE), International Business Machines (NYSE:IBM), Intuitive Surgical (NASDAQ:ISRG), Netflix
(NASDAQ:NFLX), Starbucks (NASDAQ:SBUX), SanDisk (NASDAQ:SNDK) and United Continental Holdings (NYSE:UAL).

 

 

Generally I don’t spend too much time considering the relative merits of the stocks being considered for earnings related trades, preferring to remain agnostic to those issues and simply following guidelines outlined above.

Looking at this week’s list, there is no shortage of stories in advance to scheduled earnings, such as SanDisk releasing altered guidance or Freeport McMoRan feeling the sudden weight of collapsing copper prices, in addition to its growing exposure to gold and energy prices.

While I don’t use margin to add stock positions, it is often perfectly suited for this kind of trading activity. I generally use these trades in an account hat has margin privileges. While selling cash secured puts decreases the amount of margin that is available to you, it does not draw on margin funds and, therefore, doesn’t incur interest expenses. Those expenses will only be incurred if the shares are assigned to you and are subsequently purchased through the use of the credit extended.

One thing noticed among the positions cited above is that fewer are meeting my criteria and being assigned a “YES” designation. That may reflect an increasing sense of pessimism among option market traders as compared to previous quarterly earnings periods. Normally I would only consider those with a “YES” rating, but may now also consider those that are “MARGINAL.”

If considering the sale of put options, there is always a possibility of early assignment, especially if shares go far below the strike price and when using a weekly contract. If that occurs, the seller of the put contracts should be prepared to either own shares or attempt to rollover the put option to a forward date.

The lower the volatility environment the less benefit there is to the put holder to delay assignment for deep in the money positions. In the event of early assignment the opportunity is then created to begin managing shares and enhancing return through the sale of call options. However, where possible, it may be best to consider pre-emptive action in order to prevent or delay assignment.

Finally, in the current market environment, moves, especially downward, seem to be sudden and magnified. If pursuing any of these earnings related trades it helps to have exit strategies planned in advance and to limit falling prey to surprise, as that may be the one thing that can be counted upon.

Jul272014

More and More Earnings

Daily Market Update

After last week’s deluge of 150 of the S&P 500 companies reporting their earnings this week is a relatively calm one.

For all of its gyrations last week, including the sell-off on Friday, if you simply looked at the market’s net change you would have thought that it was a quiet week as well.

The initial week of earnings season did see seem promise coming from the financial sector. Last week was a mixed one, as names such as Facebook (FB) and Amazon (AMZN) went in very different directions and the initial responses to earnings didn’t necessarily match the final result, such as in the case of NetFlix (NFLX).

While some of the sell-off on Friday may be attributed to the announcement of additional European Council sanctions against Russia and perhaps even the late in the session downgrade of stocks and bonds by Goldman Sachs (GS), earnings had gotten most of the week’s attention.

The coming week offers another opportunity to consider potential trades that can profit regardless of the direction of share price movements, as long as they stay reasonably close to the option market’s predictions of their trading range in response to those reports.

In line with my own tolerance for risk and my own definition of what constitutes a suitable reward for the risk, I prefer the consideration of trades that can return at least 1% for the sale of a weekly put option at a strike level that is below the lower boundary defined by the option market’s assessment. Obviously, everyone’s risk-reward profile differs, but I believe that consistent application or standardizing criteria by individual investors is part of a discipline that can make such trades less anxiety provoking and less tied to emotional factors.

Occasionally, I will consider the outright purchase of shares and the sale of calls, rather than the sale of puts for such trades, but that is usually the case if there is also the consideration of an upcoming ex-dividend date, such as will be the case with Phillips 66 (PSX). Additionally, doing so would most likely be done if I had no hesitancy regarding the ownership of shares. In contrast, often when I sell puts I have no real interest in owning the shares and would much prefer expiration or the ability to roll over those contracts if assignment appeared likely.

This coming week there again appear to be a number of stocks deserving attention as the reward may be well suited to the level of risk, thanks to the option premiums that are enhanced before earnings are released.

As often is the case the stocks that are most likely to be able to deliver a 1% or greater premium at a strike level outside of the implied move range are already volatile stocks, whose volatility is even greater in response to earnings. While at first glance an implied move of 12%, as is the case for Yelp (YELP) may seem unusually large, past history shows that concerns for moves of that magnitude are warranted.

Among the companies that I am considering this coming week are Anadarko (APC), Herbalife (HLF), MasterCard (MA), Mosaic (MOS), Merck (MRK), Outerwall (OUTR), Phillips 66, T-Mobile (TMUS), Twitter (TWTR) and Yelp.

These potential trades are entirely based upon what may be a discrepancies between the implied price movement and option premiums that will return the desired premium. Generally, I don’t think very much about those issues that may have relevance prior to considering a purchase of shares. The focus is entirely on numbers and whether the risk-reward proposition is appealing. Issues such as whether people are tweeting enough or whether a company is based upon a pyramid strategy can wait until the following week. Hopefully, by that time I would be freed from the position and would be less interested in those issues.

Deciding to pull the trigger is often a function of the prevailing price dynamic. My preference when selling put contracts is to do so if shares are falling in price in advance of earnings. For example, last week I did not sell puts on Facebook (FB), as its shares rose sharply prior to earnings. In that case, that represented a missed opportunity, however.

Compared to the previous week’s close of trading when the market had a sizable gain, this past Friday there were widespread losses, perhaps resulting in a different dynamic as the coming week begins its trading.

While I would rather not take ownership of shares, there must be a realization that doing so may be inevitable or may require additional actions in order to prevent that unwanted outcome, such as rolling the put option forward, if possible.

If there is a large decline in share price well beyond that lower boundary, the investor should be prepared for an extended period of needing to juggle that position in order to avoid assignment while awaiting some price recovery. I have some positions, that I’ve done so for months. The end result may be satisfactory, but the process can be draining.

The table may be used as a guide for determining which of this week’s stocks meet risk-reward parameters. Re-assessments should be made as share prices  option premiums and strike levels may change. 

While the list can be used in executing trades before the release of earnings, there may also be opportunity to consider trades following earnings. I typically like to consider those trades if a stock moved higher before earnings and then plunged afterward, if in the belief that the response was an over-reaction to the news. In such cases there may be an opportunity to sell put options whose premiums will still see some enhancement as a reflection of the strong negative sentiment taking shares lower.

Ultimately, if large price movements are either anticipated or have already occurred there is usually some additional opportunity that arises with the perceived risk at hand. If the risk isn’t realized, or if the risk is managed appropriately, the reward can be very addictive.