Option Investor
Educational Article

Hedging

HAVING TROUBLE PRINTING?
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By: David Popper

Like many of you, I have a trading partner. I have known Tim for many years because our children go to the same school. I never knew that Tim was an aggressive trader until we both ended up in the local Borders purchasing a Barron's in May of 1998. We talked that day for about a half an hour and have talked every Monday night since. Tim has done extremely well in the market and could easily retire at this point. However, he, like many others, love the game. Last year, our strategy was simple. Buy stocks going into earnings or splits. Sell on the day of the event. Buy stocks going into an event, such as an analyst meeting. Sell after the spike. Buy stocks on dips, sell after a reasonable gain. For the last two years, these strategies worked like a charm. Yearly returns were in the triple digits. Then came March 2000. Splits meant nothing, earnings meant nothing. In March, stocks taking dips did not have springs, they were trap doors. Something changed. I do not know if it is temporary or permanent, but it has changed. It does not matter if the change is temporary or permanent, it is a trader's duty to play the market at hand.

Over the past several weeks, Tim and I have discussed the market changes and how to adapt to the new environment. We have discussed missed opportunities, mistakes and perhaps better methods of trading. We realize that many of our trading strategies over the last year, though profitable, were perhaps not as precise as they should be. Bull markets, however, do not punish traders for purchasing stock at improper entry points. Bull markets do not often punish traders for purchasing too large a position or for behaving in an emotional manner. When the market turns, however, a trader's every weakness is immediately exposed.

We concluded that the market, between now and May 16 will be volatile. There will be endless discussions on whether the Fed will increase interest rates 1/4 point or 1/2 point. The emotions of the market will be not unlike that of a teenager. Somedays teenagers are human, somedays they are not. We concluded, as traders who cannot watch a screen all day in this volatile environment, that perhaps covered call writing would be appropriate for the next two weeks. I personally have purchased quality stocks and written covered calls with one-half of my cash portfolio leaving the other one-half in cash. This cash is available to buy quality stocks on dips to support level.

Currently, I purchased PMCS, BRCM, JDSU, SUNW, ORCL and CHKP on dips and have sold calls on the spikes. All have provided me with a 10% premium and a chance to earn even more if the options are exercised.

Again, the key point here is not necessarily to persuade you to try to write covered calls. The purpose is to convince you that it is important to trade the market as it is today, not how it was three months ago or how it will be three months hence. The issue du jour is the Fed meeting on May 16th and all short term trading must be done in light of that meeting.

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