Option Investor
Market Updates

Futures Mixed

HAVING TROUBLE PRINTING?
Printer friendly version

We look to be in for a mixed open, with Dow futures down 17 points, and Nasdaq futures up 6.50. Fair value for the S&P 500 is $3.02. Buy programs are set at $4.86, and sell programs at $1.28. With no economic news due out until Friday, bonds are lower across the board.

Bear signal reversed

Perhaps the most bullish and rewarding pattern for a bullish trader to trade is the supply/demand pattern known as the bearish signal reversed. This pattern most often depicts that of a stock that has been setting a series of lower lows and lower highs, but then quickly reverses itself higher as institutions find the stock attractive just before its next leg higher. The following are some stocks that all trade options that investors my want to keep an eye on and have recently given this signal. If you are fortunate enough to identify this pattern prior to its action point, you may find the bottom line account also reversing higher.

Discount Auto Parts (NYSE:DAP) $12.98: On April 16th, shares of DAP signaled a bear signal reversed when the stock traded $8.50. Currently the stock trades below long-term trend, but the current bullish price objective of $28 has the stock looking attractive on a pullback near $10.

D.R. Horton (NYSE:DHI) $22.67: On March 29th, shares of DHI triggered a bear signal reversed when the stock traded $22. From their the stock jumped to a high of $25.99 and Friday's close at $22.67 makes an attractive entry point. With a rising 200-day MA just below at $20.50 making for an ideal stopping point and longer-term bullish price objective $39.50, this stock represents a favorable risk/reward profile for the options trader that doesn't mind looking out three or four months.

Sempra Energy (NYSE:SRE) $27.37: On January 25th, shares of SRE signaled a bear signal reversal when the stock traded $21. While the stock isn't actionable currently, it does give credence to how powerful this pattern is. Here's a utility stock that has jumped nearly 30% since late January. Meanwhile stocks like Cisco Systems (CSCO), Sun Micro Systems (SUNW) continue to get the bulk of the markets attention in the press.

Corrections Corp. of America (NYSE:CXW) $8.73: Here's a stock that just gave a bearish signal reversal pattern on May 17th when the stock traded $9. Stock/options can be bought here at $8.73, with a stop below at $5.50. Long-term bullish price objective is currently $15.50. You might find this one profiled in PremierMarkets.com hot list soon.

PremierMarkets.com PLAY UPDATE for Barrick Gold (NYSE:ABX)

PremierMarkets.com is going to drop coverage of our profiled covered call play in ABX originated on 04/26 at $16.05 should shares of ABX trade under $18.95. We'd suggest that those subscribers currently trading our strategy look to exit the underlying stock at $18.95 and then buy back the offsetting covered call and close their positions. The trade performed well above our expectations and current hedge strategy is only beneficial if the stock continues higher, but the hedge strategy becomes more of a "liability" should the stock decline from current levels. We remain bullish for shares of ABX near-term and would consider profiling the stock in the future. However, we will drop coverage on a break below $18.95.

Is your hedge strategy working?

On April 26th, PremierMarkets.com profiled a bullish trade for a 1/2 position in the underlying stock of Barrick Gold (NYSE:ABX) when the stock traded $16.05. Then on May 9th, we decided that it may have made sense to sell call premiums and initiate a "mini-hedge" by selling enough June 17 calls covering the underlying stock. PremierMarkets.com strongly recommends that every trader not only pay special attention to the trades you implement, but also concentrate account performance and how their strategies are performing. Lets take a look at PremierMarkets.com strategy in ABX as currently profiled and see what is taking place.

Hypothetical trade as recently profiled in PremierMarkets.com

I could write a book on the above information. There is so much to be extracted from this trade that it is impossible to cover here. Here's how to make a very informed decision on future buy/sell decisions as it relates to the covered call strategy. While not every subscriber may have played our strategy in ABX, take what you learn here and carry it forward to other stocks you may currently be trading.

Let's start on May 9th, and what a trader would have been doing when he/she sold the June $17 (ABXFW) covered call. At that point, the trader was basically saying "I'm willing to sell my 300 shares of ABX for $17 and keep $0.80 per share on June 15th (option expiration for June). Not considering commissions, this would result in a 10.9% gain from origination of the purchase of ABX on 04/26 to June 15th. Note the CURRENT hypothetical profit of the total strategy as of Friday's close. The P/L% column shows an 11.39% gain currently.

This tells the trader a lot about CURRENT risk and potential reward doesn't it? If a trader was willing to settle for a 10.9% reward on May 9th, then why wouldn't he/she lock in an 11.39% gain today and eliminate all future risk in the trade? The answer only comes from perceived future reward! The risk in the trade is "known,", while the future reward is unknown. Only when the trade is closed, does the profit or loss become realized. For a trader who's main source of income is their trading account, realized gains are more important that unknown profit potential.

What's a trader's current risk in shares of the ABX covered call trade? The risk is that the stock declines to zero resulting in a hypothetical loss of $4,575 ($4,815 stock, but keep the $240 sale of call). That's the ultimate risk that I always plan for in any type of trade. This sound ludicrous to many, but it can become a reality in a very short amount of time.

The biggest questions currently then is what the potential reward is, and is the current strategy worth holding onto. Here's where account management and monitoring of the trades makes it VERY, VERY, VERY easy to make the selling decision of the stock and offsetting purchase of the call. At this point, a trader has profits to lose and reward is uncertain. That's when I like to challenge the stock as much as possible and snug up a stop to generate a gain for the account. Especially if I've got a gain that is more than I thought it would be when I decided to hedge it with a covered call.

When to close the trade is easily identifiable by this. We would NOT want to close the trade as long as the trade stays profitable by more than 11%. We said before that by selling the covered call on 5/09 that a trader was willing to take 10.9% gain from the trade and he/she has that now with an 11.39% gain. All we have to do is establish at what point below Friday's close of $19.02 does our strategy become less attractive. That's the most difficult to explain and to try and calculate due to the option and volatility calculations along with time remaining until expiration. However, if your trading software is set up like the picture above, you can simply monitor how the trade is acting, and when the % profit drops below 11%, then it's probably time to close out both trades (stock and calls) and move on to the next trade.

Currently, a trader that doesn't want to wait until June 15th to free up their capital, should simply set a tight stop under shares of ABX and when triggered, sell the stock and then buy the covered call back and close it out too. The loss resulting in the covered call can be used come tax season to offset that capital gain on the underlying stock.

Jeff Bailey
Senior Market Technician
www.PremierMarkets.com

Intraday Update Archives