Option Investor

Portfolio Review

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Some Thoughts on Position Management...

Obviously, it's been a tough month for the MCM Portfolio. Despite the unusual market volatility, we had a variety of great candidates to work with and it is disappointing to see the (losing) results when only two of the recommended spreads were unsuccessful. Among those selections, the original Lennar (NYSE:LEN) position finished only $40 in the red and that loss was adjusted into a small profit by transitioning to a short-term calendar spread. In contrast, the bullish play involving Infospace (NASDAQ:INSP) was a disaster as the stock plunged nearly 20% after the company posted solid earnings but forecast mediocre profits in the coming year. Fortunately, traders who used a stop-loss order for the short (put) options in the spread were able to substantially reduce their losses even with the massive "after hours" sell-off in the underlying issue. Although the monthly summary reflects the maximum possible debit in the (INSP) spread, the position was generally much less costly to the few readers who participated in the speculative play. In addition, those readers who opted for the alternate position; Baker Hughes (NYSE:BHI), were rewarded with a successful outcome - as long as they used a slightly more aggressive stop-loss price in the bullish spread.

That brings us to the real point of this narrative, which is the ultra-conservative approach we have been using to manage the portfolio. The fundamental reason for this tactic is to protect less experienced traders against catastrophic losses but looking back, it seems like the current plan may be costing more money than it is saving. The Baker Hughes (NYSE:BHI) play mentioned above is one example of that fact and similar situations occurred in Black & Decker (NYSE:BDK), Pixar (NASDAQ:PIXR) and most recently, Legg Mason (NYSE:LM). Obviously, the need to limit large draw-downs is a prerequisite for this type of option trading but as the market has demonstrated time and again, there is simply no way to avoid losses with positions such as INSP.

Given that shortcoming, the best course of action is to strive for a reasonable measure of (mechanical) loss prevention while using proven position management techniques to adjust the character or risk-reward properties of the spread when a change in the outlook for the underlying issue occurs. The techniques we use currently - a "stop-loss" order on the short option or a net-debit order to exit both positions - are common methods of mechanical loss prevention. At the same time, we rely far too heavily on these simple exit techniques rather than initiating more complex (and generally, more appropriate) methods of position management. Since most of the MCM Portfolio subscribers have become comfortable with basic adjustment strategies, we are going to pursue this approach on a more frequent basis. In addition, we will make every effort to update the stop-loss prices when the technical condition of the stock warrants a different exit point.

Along those lines, the first order of business is to close the existing (long) position in Lennar (NYSE:LEN). Readers who transitioned to the neutral-outlook calendar spread have (5) JUN-$55 calls to offset the closing debit from the "in-the-money" (MAY-$55) call options that were repurchased on Friday. In the portfolio summary, we published the potential credit based on the option prices at expiration. However, adept traders may be able to increase the position profit through the timely sale of the remaining calls. With roughly four weeks until the June expiration period, there is plenty of opportunity for upside activity. Unfortunately, a number of key economic reports are due to be published in the coming week and at least two of these may significantly affect the trend in the homebuilding sector. Existing home sales data from the National Association of Realtors comes out Tuesday, with the Commerce Department reporting on new home sales Wednesday. With this fact in mind, it may be prudent to close the position prior to Tuesday morning, while investors are optimistic about the recent surge in home sales and new construction.

Among the current positions, Toro (NYSE:TTC), Oil Service HOLDRs (AMEX:OIH) and Dreamworks Animation (NYSE:DWA) are comfortably profitable and we will stick with the original exit points for now. Those readers who made it through the consolidation in Legg Mason (NYSE:LM) obviously have a better feel for its daily gyrations, so the only observation we can offer is the neutral-to-bullish trend should continue in the near-term. The adjusted position in Chiron (NASDAQ:CHIR) appears to be "back on track" and yet concerns about the company's future Fluvirin sales continue to weigh on the company's share value. The recent bullish trend could end abruptly on negative news, thus readers who are in the (JUL-$30/JUL-32.5) put-credit spread should monitor the issue on a regular basis. Estee Lauder (NYSE:EL) has rebounded sharply during the past week however it remains to be seen if the stock can break through the extensive overhead supply that exists slightly above the current price. Since there is little premium in the JUN-$45 call options, we can not establish another calendar spread until EL's share value increases. If this doesn't occur in a timely manner, our only alternative will be to unload the JUL-$45 call options for a small (overall) loss.

Last, but not least, is the bearish position in Biotech HOLDRs (AMEX:BBH) and this play continues to be a "thorn in our side" as the issue has moved higher despite the mediocre performance of the Biotechnology sector. Of course, the catalyst for this activity is the recent rally in Genentech (NYSE:DNA), which comprises 40% of the value of BBH. Considering this relationship, one alternative is to initiate another bullish position in DNA (we have listed DNA as a Supplemental Position for the past few weeks) to offset additional gains in the Biotech HOLDRs. This might include a limited-risk spread or an outright option purchase with a more-distant expiration date. In addition, readers with large collateral holdings could leverage that capital through short-term bullish positions in the BBH, taking advantage of the current trend while limiting exposure to a future decline in the issue. Since there is a wide range of possibilities to explore, we'll try to compose a separate narrative on this subject in the coming week.

MCM Staff

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