Monthly Cash Machine Newsletter, Wednesday, 04/27/2005 10:21:52 AM ET
Portfolio Activity - INSP
HAVING TROUBLE PRINTING?
Lost in Infospace...
Shares of Infospace (NASDAQ:INSP) opened Wednesday's session sharply lower, down over 20% as traders showed their frustration with the company's profit outlook. To say we were surprised by the magnitude of the sell-off would be an understatement and looking back, the risk was obviously NOT worth the potential reward. But, as with any speculative trade, the downside was balanced with (far too much) optimism about the current trend, which was based on expectations of a favorable quarterly earnings report.
Now the problem is how to limit losses in the wake of the unexpected activity and the alternatives are somewhat limited. The maximum debit in the position (with no action) is $2175 - roughly a month's normal income from the portfolio. Traders who close the position now, while there is still "premium" in the options, can reduce that loss slightly. Those who expect an eventual recovery in INSP's share value can roll out and down to more distant, lower strike options with the intent of either locking-in a lower debit or, through the sale of additional contracts, maintaining a small credit in the position. Finally, adept players can try to "leg" out of the position by selling the individual options (or the underlying stock - to cover the short position) at different times, in order to minimize the overall loss.
While we would like to say we have a "magic" answer for this dilemma, there simply isn't one. Any action taken now should be based on your personal outlook for the issue and it's difficult for us to recommend a specific strategy, give our original (incorrect) bias in the recommended position. However, the most common alternatives are quite simple:
A trader who expects a near-term bounce should probably wait to close the position - nothing is lost by further declines (below $35) in the stock price. A trader who believes the issue will move lower should "buy-to-close" the short MAY-$40 put options now and plan to sell the long MAY-$35 put options in the coming weeks, as the share value moves lower. In contrast, someone who expects a sizeable rebound should sell the long options now and hold the short position in anticipation of repurchasing the options at a lower price. Finally, a trader who believes that the stock will eventually rebound might want to transition to a longer-term/lower strike credit spread, selling enough (10-15) additional contracts to offset the losses from the original position.
Considering the collateral requirements of the existing adjustments in the MCM Portfolio, we have little choice but to close the spread for a loss prior to the May options expiration. But, we expect at least a small bounce in the stock price and will use any upside activity to reduce the drawdown from this position. While we hope the exit trade will be marginally effective, we hesitate to claim that our timing will be better than yours. In any case, a "trade alert" will be issued when the spread is officially closed.