It was another tough week for investors with the major indexes down for the third consecutive week. Historically the May option expiration cycle is a tough week. In 2009 and 2010 the markets declined more than 3% each year. Last week was tame by comparison.
The major problems remain the suddenly slowing economy, the projected end of QE2, almost daily news events from the European debt crisis to knock the dollar around and the downturn in the quality of earnings. It seems to be the perfect storm for investors and leading the market lower.
However, the decline from the May 2nd highs has been only a little more than -2%. That is a drop in the bucket relatively speaking and that means investors are not yet willing to run and hide. There are still some hopes for the market to pull out of this swoon.
I am not betting on it simply because of the number of problems. Stranger things have happened that the markets overcame but I don't see the subtle signs this time around. Volume is slowing and we have a solid pattern of lower highs and lower lows on the charts.
High gasoline prices are pushing consumers back to the couch and retail spending is declining. If it was only for a month or two it would be healthy but oil price fundamentals suggest any declines will be temporary. The rest of the world is growing. India and China, the two biggest populations on the planet, are increasing demand on a daily basis. The top ten percent of consumers in China don't care what gas costs. China is building 20 million cars a year and they have six-month waiting lists to buy a car. We can expect the U.S. to eventually get priced out of the market as China's demand grows. U.S. consumers are going to have to live with higher gas prices and U.S. retailers and manufacturers are going to have to survive on this squeeze in discretionary income. I only mention this here because the price squeeze, caused by high fuel prices, has already started and that is going to weaken our markets.
The weekly gyrations in the European debt crisis is tanking the euro and pushing the dollar higher by default. A higher dollar forces down equities and commodities. On Friday it was Fitch cutting Greek debt three notches and warning about further downgrades to come. On Saturday S&P cut it's rating on Italy from stable to negative implying another debt downgrade to come. The dollar is up strongly on Sunday night and S&P futures opened down -6 points.
Investing in our markets, or in our case selling puts, is going to be a struggle until a new uptrend appears. Until then we need to be selective in our plays and carry a smaller portfolio. Eventually there could be a serious downturn and we don't want to be carrying a full load if it happens. There are stocks worth writing puts against as we saw from the Lorillard and Weight Watcher positions last week. The trick is to find more defensive positions like those.
We were stopped out on three positions last week but only one was a loss. I will take a win on two out of three every time as long as we keep the losses small.
I did not send any emails during the week because there was nothing happening. The markets were in a slump and opportunities were limited. I will continue to send emails only when there is something to say or do. That way your inbox is not cluttered with repetitive updates. With the market trending lower there is not much for us to do until the trend changes. If you get a midweek email it will be because something changed or we have a new play.
Current Position Changes
HUM - Humana $79.78 (Short Put)
Humana is bucking the market and closed near a new high on Friday. The health care sector has been outperforming and there seems to be no indications of that pattern weakening. Health care is seen as a defensive sector and a good place to park money in a weak market.
Do not enter this position unless HUM and the S&P are both positive.
Sell short HUM June $75.00 Put, currently $0.80, stop loss $77.75
Chart of HUM
APC - Anadarko Petroleum $74.53 (Short Put)
Anadarko got a boost on Friday after BP settled with Mitsui/MOEX for just over $1 billion for their ownership position in the Horizon well. MOEX was a 10% non operating owner. Anadarko is a 25% non operating owner. Analysts had originally thought Anadarko could have up to $10 billion in exposure given the $40 billion loss to BP. A 25% piece of that loss would be $10 billion. However, the MOEX settlement for 10% at $1 billion suggests Anadarko could make a similar settlement for $2.5 billion using the same percentage ratio. This represents a significant load off Anadarko's future liabilities. If they did settle with BP they could pay it out over several years and it would be a minimal drag on earnings. Anadarko should continue higher from here on expectations of a deal.
Do not enter this position unless APC and the S&P are both positive.
Sell short APC June $70.00 Put, currently $1.18, stop loss $72.50
Chart of APC
RRC - Range Resources $54.25 (Short Put)
Range has put in a nice bottom at the 100-day average at $51 and closed at a two week high on Friday. High oil prices are very good for Range as they move to drill more liquids rich plays instead of natural gas. I think the May weakness for Range is over.
Do not enter this position unless RRC and the S&P are both positive.
Sell short RRC June $50.00 Put, currently $0.65, stop loss $51.25
Chart of RRC
New Long Term Recommendations
New Aggressive Recommendations
There are several different formulas for determining margin requirements for naked put writing. These are normally broker specific and some can require larger margin requirements than others.
Here is the most common margin calculation for naked puts.
100% of the option premium + ((20% of the Underlying Market Value) - (OTM Value))
For simplicity of calculation simply use 20% of the underlying stock price and you will always be safe. ($25 stock * 20% = $5 margin)
Prices Quoted in Newsletter
At Option Investor we have a long-standing policy prohibiting the editors and staff from actually trading the individual recommendations in order to conform to SEC rules concerning trades.
The prices quoted in the newsletter are the end of day prices in most cases.
When discussing fills or stops the prices quoted are the bid/ask at the time the entry trigger or exit stop is hit. This is NOT a price that someone on staff actually got using a live order.
For entry/exit points at the market open the prices quoted will be the opening print. The majority of the time the readers are able to get a better fill than the opening print because of market maker bias at the open.
For trades with an opening qualification the prices quoted will be the bid/ask at the time the qualification was met.
All of these rules normally produce worse prices than an active trader would normally get. Because they are standardized there may be some cases where a price quoted was better than an actual fill. If you received a price that was dramatically different than what was quoted please let us know.