Profiting From Good Fortune Or Bad

While most of the more meaningful companies in the S&P 500 have already reported earnings and new earnings season is barely 7 weeks away, there’s still time to profit from remaining earnings reports coming this week.

Whether a company’s shares respond to earnings by going lower or higher there is often opportunity to profit from either the good or the bad fortunes that they may endure as a result of their past performance and outlook for future fortunes.

As always, whenever I consider whether an earnings related trade is worth consideration I let the option market’s measure of “implied volatility” serve as a threshold in determining whether there is a satisfactory risk-reward proposition. That simple calculation provides an upper and lower price range in which any anticipated price movements will be contained.

Occasionally, for those selling options, whether as part of a covered call strategy or simply through the sale of puts, there may be an opportunity to achieve an acceptable premium even though it represents a share price that is outside of those bounds set by the option market.

This week there appear to be a number of stocks preparing to release their quarterly earnings that may warrant some attention as the reward may be well suited to the risk for some.

A number of the companies that I’ve highlighted are volatile in their own rights, but even more so when event driven, such as before earnings. While the implied volatilities may sometimes 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.

While individuals can certainly set their own risk-reward parameters, I tend to look at a weekly 1% ROI as meeting my threshold on the reward side of the equation. I measure the degree of risk as whether I need to look above or below the implied volatility to achieve that desired return for what is anticipated to be a week’s investment.

Satisfactory risk exists when the strike price necessary to achieve the ROI is outside of the range predicted by the option market.

The coming week is replete with earnings reports and presents more companies than I usually find that satisfy the above criteria and are in companies that I usually already follow. Among the companies that I am considering this coming week are Abercrombie and Fitch (ANF), Best Buy (BBY), Deckers (DECK), JC Penney (JCP), Macys (M), salesforce.com (CRM), SolarCity (SCTY), Soda Stream (SODA) and T-Mobile (TMUS).

Since the basis of these trades is purely upon what may be considered an inefficiency between the option premiums and the implied volatility, I give no consideration to fundamental nor technical issues. However, my preference, when selling put contracts is to do so when shares have already been falling in price in advance of earnings. As the current week came to its end that included JC Penney, SolarCity, Deckers and Best Buy, although the coming week may define other possibilities.

For those not having sold put contracts in the past, one caveat when considering such trades, is that the investor must be prepared to own the shares if assigned or to manage the options contract, such as rolling it forward, if assignment appears inevitable.

 The table may be used as a guide for determining which of these selected companies meet the risk-reward parameters that an individual sets, understanding that re-assessments need to be made as prices and, therefore, strike prices and their premiums may change.

While the list can be used on a prospective basis in anticipation of an earnings related move there may also be occasion to consider the sale of puts following earnings in those cases where shares have reacted in a decidedly negative fashion to earnings or to guidance.

While some believe in hitting someone when they’re already down, there can be much more satisfaction gained in giving them support in their effort to rise again. Inherently the sale of a put is a statement of bullish sentiment and there may be opportunity to make that expression a profitable one as the response of many when knocked down is to get back up again.

Whether prospective or reactive, there is always opportunity when big movements are anticipated, but not fully realized.

And if they are realized? Think of it as simply more opportunity for opportunity.

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Copyright 2014 TheAcsMan

Weekend Update – February 17, 2013

It’s all relative.

Sometimes it’s really hard to put things into perspective. Our mind wants to always compare objects to one another to help understand the significance of anything that we encounter. Having perspective, formed by collecting and remembering data and the environment that created that data helps to titrate our reaction to new events.

My dog doesn’t really have any useful perspective. He thinks that everyone is out to take what’s his and he reacts by loudly barking at everyone and everything that moves. From his perspective, the fact that the mailman always leaves after he has barked out reinforces that it was the barking that made him leave.

The stock market doesn’t really work the way human perspective is designed to work. Instead, it’s more like that of a dog. Forget about all of the talk about “rational Markets.” They really don’t exist, at least not as long as investors abandon rational thought processes.

It’s all about promises, projections and clairvoyance. Despite the superficial lip service given to quarterly comparisons no one really predicates their investing actions on the basis of what’s come and gone.

During earnings season one can see how all perspective may be lost. It’s hard to account for sudden and large price moves when there’s little new news. Although I can understand the swift reaction resulting in a 20% drop when Cliffs Natural Resources (CLF) announced that it was slashing its dividend, filing for a secondary stock offering and also creating a new class of mandatory convertible shares, I can’t quite say that the same understanding exists when Generac (GNRC) drops 10% following earnings and guidance that was universally interpreted as having “waved no red flags.”

Of course, the use of perspective and especially logic based upon perspective,  can be potentially costly. For example, it’s been my perspective that Cliffs and Walter Energy (WLT) often follow a similar path.

What has been true for the past year has actually been true for the past five years. So it came as a surprise to me, at least from my perspective that the day after Cliffs Natural plunged nearly 20%, that Walter Energy, which reports earnings on February 20, 2013 would rise 6% in the absence of any news. From my perspective, that just seemed irrational.

But of course, perspective, by its nature has to be individually based. That may explain why Forbes, using its unique perspective on time, published an article on February 12, 2013, just hours before Cliffs released its earnings, that it had been named as the “Top Dividend Stock of the S&P Metals and Mining Select Industry Index”, according to Dividend Channel. In this case, Cliffs was accorded that august honor for its “strong quarterly dividend history.”

Apparently, history doesn’t extend back to 2009, when the dividend was cut by 55%, but it’s all in your perspective of things. I’m not certain where Cliffs stands in the ratings 24 hours later.

What actually caught my attention the most this past week is how performance can take a back seat to  perspectives on liability, especially in the case of Halliburton (HAL) and Transocean (RIG). On Thursday, it was announced that a Federal judge approved a mere $400 million criminal settlement against it for its seminal part in the Deepwater Horizon blowout. That’s in addition to the already $1 Billion in fines it has been assessed. In return, Transocean climbed nearly 4%, while it’s frenemy Halliburton, on no news of its own climbed 6%. Poor British Petroleum (BP) which has already doled out over $20 Billion and is still on the line for more, could only muster an erasure of its early 2% decline. For Transocean, at least, the perception was that the amount wasn’t so onerous and that the end of liability was nearing.

From one perspective reckless environmental action may be a good strategy to ensure a reasonably healthy stock performance. At least that’s worked for Halliburton, which has outperformed the S&P 500 since May 24, 2010, the date of the accident.

I usually have one or more of the “Evil Troika” in my portfolio, but at the moment, only British Petroleum is there, at its lagged its mates considerably over the past weeks. Sadly, Transocean will no longer be offering weekly options, so I’m less likely to dabble in its shares, even as Carl Icahn revels in the prospects of re-instating its dividend.

Perhaps the day will come when stocks are again measured on the basis of real fundamentals, like the net remaining after revenues and expenses, rather than distortions of performance and promises of future performance, but I doubt that will be the case in my lifetime.

In fact, the very next day on Friday, both Transocean and Walter Energy significantly reversed course. On Friday, the excuse for Transocean’s 5% drop was the same as given for Thursday’s 4% climb. Walter Energy was a bit more nebulous, as again, there was no news to account for the 3% loss.

So what’s your perspective on why the individual investor may be concerned?

As always, this week’s potential stock selections are classified as being either in the Traditional, Momentum, Double Dip Dividend or “PEE” categories (see data).

Technology stocks haven’t been blazing the way recently, as conventional wisdom would dictate as a basic building block for a burgeoning bull market. My biggest under-performing positions are in technology at the moment, patiently sitting on shares of both Microsoft (MSFT) and Intel (INTC). Despite Tuesday’s ex-dividend date for Microsoft, I couldn’t bear to think of adding shares. However, despite a pretty strong run-up on price between earnings reports, Cisco (CSCO) looks mildly attractive after a muted response to its most recent earnings report. Even if its shares do not move, the prospect of another quiet week yet generating reasonable income on the investment for a week is always appealing.

Although I was put shares of Riverbed Technology (RVBD) this week, which is not my favorite way of coming to own shares, it’s a welcome addition and I may want to add more shares. That’s especially true now that Cisco, Oracle (ORCL) and Juniper (JNPR) have either already reported or won’t be reporting their own earnings during the coming option cycle. With those potential surprises removed from the equation there aren’t too many potential sources of bad news on the horizon. The healing from Riverbed’s own fall following earnings can now begin.

MetLife (MET) is, to me a metaphor for the stock market itself. Instead of ups and downs, it’s births and deaths. Like other primordial forms of matter, such as cockroaches, life insurance will survive nuclear holocaust. That’s an unusual perspective with which to base an investing decision, but shares seem to have found a comfortable trading range from which to milk premiums.

Aetna (AET) on the other hand, may just be a good example of the ability to evolve to meet changing environments. Regardless of what form or shape health care reform takes, most people in the health care industry would agree that the health care insurers will thrive. Although Aetna is trading near its yearly high, with flu season coming to an end, it’s time to start amassing those profits.

It’s not easy to make a recommendation to buy shares of JC Penney (JCP). It seems that each day there is a new reason to question its continued survival, or at least the survival of its CEO, Ron Johnson, who may be as good proof as you can find that the product you’re tasked with selling is what makes you a “retailing genius.” But somehow, despite all of the extraneous stories, including rumored onslaughts by those seeking to drive the company into bankruptcy and speculation that Bill Ackman will have to lighten up on his shares as the battle over Herbalife (HLF) heats up, the share price just keeps chugging along. I think there’s some opportunity to squeeze some money out of ownership by selling some in the money options and hopefully being assigned before earnings are reported the following week.

The Limited (LTD) is about as steady of a retailer as you can find. I frequently like to have shares as it is about to go ex-dividend, as it is this coming week. With only monthly options available, this is one company that I don’t mind committing to for that time period, as it generally offers a fairly low stressful holding period in return for a potential 2-3% return for the month.

While perhaps one may make a case that Friday’s late sell-off on the leak of a Wal-Mart (WMT) memo citing their “disastrous” sales might extend to some other retailers, it’s not likely that the thesis that increased payroll taxes was responsible, also applied to The Limited, or other retailers that also suffered a last hour attack on price. Somehow that perspective was lacking when fear was at hand.

McGraw Hill (MHP) has gotten a lot of unwanted attention recently. If you’re a believer in government led vendettas then McGraw Hill has some problems on the horizon as it’s ratings agency arm, Standard and Poors, raised lots of ire last year and is being further blamed for the debt meltdown 5 years ago. It happens to have just been added to those equities that trade weekly calls and it goes ex-dividend this week. In return for the high risk, you might get am attractive premium and a dividend and perhaps even the chance to escape with your principal intact.

I haven’t owned shares of Abercrombie and Fitch (ANF) for a few months. Shares have gone in only a single direction since the last earnings report when it skyrocketed higher. With that kind of sudden movement and with continued building on that base, you have to be a real optimist to believe that it will go even higher upon release of earnings.

What can anyone possibly add to the Herbalife saga? It, too, reports earnings this week and offers opportunity whether its shares spike up, plunge or go no where. I don’t know if Bill Ackman’s allegations are true, but I do know that if the proposition that you can make money regardless of what direction shares go is true, then I want to be a part of that. Of course, the problem. among many, is that the energy stored within the share price may be far greater than the 17% or so price drop that the option premiums can support while still returning an acceptable ROI.

Also in the news and reporting earnings this week is Tesla (TSLA). This is another case of warring words, but Elon Musk probably has much more on the line than the New York Times reporter who test drove one of the electric cars. But as with Herbalife and other earnings related plays, with the anticipation of big price swings upon earnings comes opportunity through the judicious sale of puts or purchase of shares and sale of deep in the money calls.

From my perspective these are enough stocks to consider for a holiday shortened week, although as long as earnings are still front and center, both Sodastream (SODA) and Walter Energy may also be in the mix.

The nice thing about perspective is that while it doesn’t have to be rational it certainly can change often and rapidly enough to eventually converge with true rational thought.

If you can find any.

Traditional Stocks: Aetna, Cisco, MetLife

Momentum Stocks: JC Penney, RIverbed Technology

Double Dip Dividend: The Limited (ex-div 2/20), McGraw Hill (ex-div 2/22)

Premiums Enhanced by Earnings: Abercrombie and Fitch (2/22 AM), Herbalife (2/19 AM), Tesla (2/20 PM)

Remember, these are just guidelines for the coming week. Some of the above selections may be sent to Option to Profit subscribers as actionable Trading Alerts, most often coupling a share purchase with call option sales. Alerts are sent in adjustment to and consideration of market movements, in an attempt to create a healthy income stream for the week with reduction of trading risk.

Some of the stocks mentioned in this article may be viewed for their past performance utilizing the Option to Profit strategy.

 

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Copyright 2013 TheAcsMan