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Portfolio Review

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Back to Basics

After a review of recent (E-mail) requests from MCM readers, we have identified a number of common needs among less-experienced traders. Without doubt, the most critical requirement is the ability to enter and exit combination positions and in fact, today's market activity suggests we should be prepared to close or adjust a few of the bullish spreads in the coming sessions. With that idea in mind, let's review some of the positions and the planned trades for the MCM portfolio:

Chiron (NASDAQ:CHIR)
- Despite Tuesday's small decline, CHIR remains in a relatively lateral pattern near a recent trading range from $32 to $36. Currently, the cost to close the spread is approximately $0.70 per contract; a loss of $0.35 per contract, or $175 in the position. While it may be prudent for some traders to exit the position now, our suggested loss-limit point is $34.50 and we are going to initiate the previously recommended "roll-out" strategy if the issue closes below that price. This technique involves buying back the short option (APR-35.00 put) and selling the long (APR-32.50 put) option for a small debit. Then a new spread is initiated using the (short) JUL-30.00 put and the (long) JUL-32.50 put. The lower credit in the new spread will result in a smaller potential profit, but this amount might be improved through the use of individual trades for the long and short positions. Keep in mind, all of the option values will change with the movement in the underlying issue so you must focus on the "net" cost or gain when determining the prices for each order.

Estee Lauder (NYSE:EL)
- Last week, the issue climbed above the sold (call) strike at $45 in the wake of upgrades from J.P. Morgan and Smith Barney. Fortunately, the rally was short-lived and after today's retreat, we remain convinced the stock can not sustain a lengthy move beyond $46 without a substantial catalyst. At the same time, the lateral trend is well-established and that condition favors a "time-selling" adjustment for traders who want to remain in the position. While our intention is to stay with the initial spread until a major change in technical character is observed, we believe a transition to a calendar spread is the most viable strategy beyond simply closing the play outright. New readers can learn more about that technique in the narrative posted on 3/13/05.

Research In Motion (NASDAQ:RIMM) - RIMM started the week in fairly good shape as signs of buying support emerged during Monday's session with a lateral trading pattern forming near $74. However, the issue dipped near Tuesday's closing bell in conjunction with the widespread retreat in equities. If the decline continues, the next level of technical support exists near $70 and a move below that area would certainly confirm a bearish outlook for the issue. Since this position was not recommended for conservative traders (or the MCM Portfolio), it seems appropriate to follow an approach best suited for readers who are more experienced with exit and adjustment strategies. Our current plan is to repurchase the short (APR-65 put) option with a contingent order if RIMM closes below $68. If this order is executed, the stock should continue to move lower (as there are no substantial support areas remaining) and we will hold the long option until the downward activity begins to subside. Obviously, the objective is to replace a portion of the position losses with the sale of the $60 puts. However, the eroding time value and the potential for a positive earnings surprise are factors that must be considered by anyone using this strategy.

Regarding the new positions in Cerner (NASDAQ:CERN) and KB Home (NYSE:KBH), we listed conservative and aggressive loss-limit/exit points to give each trader reasonable starting points at which they could plan for a potential exit or adjustment in the recommended spreads. We use the conservative numbers (initially) for the MCM Portfolio, however these prices may need to be modified based on a person's risk/reward outlook, experience level, portfolio capital, etc., and we expect each reader to initiate some type of loss-limiting mechanism as soon as a new position is open. In its simplest form, this would involve a "buy to close" order on the short option coupled with a "sell to close" order on the long option. If you do not want to utilize a "net debit" order to exit the spread, consider using a contingent order based on the underlying issue, where the price of the stock determines the exit point in the short position (or the entire spread). Regardless of the approach you favor, please remember that the key to success with a strategy such as selling (OTM) credit spreads is the position management after the initial trade and that's why it is so important to take small profits regularly and try not to let losing plays significantly erode portfolio capital.

MCM Staff

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