Option Investor

Portfolio Review - ERICY, EL

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What's The Deal With ERICY?

Tuesday's activity in LM Ericsson (NASDAQ:ERICY) was a bit unexpected as the issue dropped $0.50 to $29.87 on moderate trading volume. The sell-off occurred in the wake of positive comments by Chief Executive Carl-Henrik Svanberg made in a letter to Ericsson's shareholders. Svanberg said the company was "cheered by improvements in the technology sector amid renewed spending, adding it would seek to improve its margins." Apparently, investors were not impressed with the outlook and after today's decline, the trend is (at best) lateral with a fairly well-defined resistance level near $30.50.

The move below the sold strike at $30, while favorable for readers in the original spread, is not making life easy for us as we bought the stock to create a covered-call position. Looking forward, our plan is to hold the stock as long as it remains technically neutral (or bullish) and then sell additional "covered" calls for April when the short-term options expire on Friday. The current price of the APR-$30 call is $0.90 X $1.05, so a trader could realistically expect to reduce the cost basis in the issue by $0.90-$1.00, as long as the share value does not move significantly lower during the next few days. Considering our "buy-to-cover" cost of $30.55, the MCM portfolio would have a new break-even point of roughly $29.60 in the (long) stock position.

Another alternative would be to sell the stock on any further downside activity, locking-in a small ($0.25-$0.30 per share) loss now with the expectation that the share value will remain below $30.00 for the next three days. While this may seem prudent in light of ERICY's recent retreat, the potential for a short-term rebound can not be overlooked as it increases the possibility of yet another adjustment trade (especially with such a short distance to the sold strike). A trader pursuing that strategy might have to buy and sell the stock a number of times before the end of the week, depending on their individual cover/exit points in the underlying issue.

Obviously, there are other, more complex methods to adjust this position but for most traders, they do not warrant consideration due to potential risk and capital expense. In addition, we have not mentioned the calendar spread strategy (outlined on Monday) but that technique would likely have been a better way for the average trader to "cover" the sold (call) option, given its conservative risk-reward outlook and the technical character of ERICY.

EL Rallies!

One final note...we just noticed that Estee Lauder (NYSE:EL) shares closed up $1.02 at $44.22 in the wake of an upgrade by J.P. Morgan. Today the brokerage raised its investment rating on the company to "overweight" from "neutral," citing valuation and noting that "concerns over the merger between Federated Department Stores and May Department Stores are somewhat overblown." While the issue is at the top of our "watch" list, we are not ready to initiate a closing (or adjustment) trade for the suggested spread. At the same time, we encourage traders to monitor the issue closely in the coming sessions and consider which of the recently discussed strategies they should use to limit losses in this position.

Trade Wisely!

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