Option Investor

Portfolio Update

Printer friendly version

There was lots of activity in the MCM Portfolio today as the equity markets retreated from multi-year highs. With less than two hours remaining until the closing bell, the Dow is down 73 points at 10,838, the NASDAQ is 5 points lower at 2,067 and the S&P 500 has shed 7 points to 1,212.

Despite the relatively mild profit-taking among broad-market stocks, Harman International Industries (NYSE:HAR) suffered extensive losses, plunging almost 15% after being downgraded to "neutral" by Fulcrum. Fortunately, our position in the issue is "bearish" so the move is beneficial, if not unexpected. Others issues moving favorably include Estee Lauder (NYSE:EL), down 2.1% at $42.50; Silicon Laboratories (NASDAQ:SLAB), down 4.8% at $32.37; Biotech HOLDRs (AMEX:BBH), down 1.1% at $134.16; and of course, Netease.com (NASDAQ:NTES), which is currently 2.8% lower at $45.49. With regard to NTES, we always expect a constructive change in the underlying AFTER we have suggested an exit or adjustment in the position. It's our way of using Murphy's Law to the advantage of our readers (e.g. when we close a play in the model portfolio, it should move in your favor).

One issue that is not moving in our favor is LM Ericsson (NASDAQ:ERICY) and based on today's activity, we have "covered" our short position with the underlying stock. The purchase price of the issue was $30.55, which corresponds to our "break-even" basis in the spread. While we still don't see much upside potential in ERICY's share value, the exit plan for this position was outlined shortly after it was offered and we are going to utilize this opportunity to teach readers about the covering strategy commonly used for short options. The technique was outlined in the "Strategy Review" posted on 2/15/05 and we will follow its success (or demise) as the ERICY play approaches expiration. Our current position is:

Long 500 shares ERICY @ $30.55 = $15,275 / 2 (50% margin) = $7637.50

Short 5 contracts MAR-30 Call (RQC-CF) @ $0.50 = $250.00

The sold strike price of the covered-call position is $30.00, thus a successful outcome will occur if the issue remains above that level. However, there is still a small loss ($0.05 per contract) in the overall position due to the difference in the purchase price of the stock and the initial spread credit. While the collateral requirement has increased substantially, the actual account margin for ERICY will drop to 30%, or about $4582, after the stock is in the portfolio.

Looking forward, our primary threat is a large decline in the share value of ERICY, so it is critical to initiate a sell STOP order on the stock near $30.00. If the order is executed, the original "buy-to-cover" order will be reinstated, and so on, until the short options expire. Obviously, the effects of "slippage" may cause small losses as additional trades are executed but unless the underlying gaps lower (or higher), this strategy should provide a relatively painless way to exit the position.

MCM Staff

Monthly Cash Machine Newsletter Archives