I keep hearing the term "new normal" and I sure hope analysts are wrong in thinking this kind of volatility is going to stick with us. In fact I am betting they are wrong.

The Dow declined -283 points after the FOMC meeting on Wednesday and another 531 points at the lows of the day today. I would hate to think 800 point two day swings were normal.

We lost three more positions today on the -400 point drop at the open. We were stopped on COG for a 25-cent loss. The IWM position imploded past the stop for a loss of -1.35. The Dresser Rand position was stopped but we still squeezed out a 44-cent gain. It was not a good day since all of those positions were strongly positive earlier in the week.

Stuff happens and we have to deal with the results. We can either run to the bedroom, turn off the lights and pull up the covers until the evil market returns to some form of normalcy or we can pick up the pieces and launch a couple longer term plays to get us past this lunacy. Personally I don't believe we are going into a bear market because corporate earnings have yet to turn down with a couple notable exceptions like FedEx today. However, a 10-cent revision to their full year earnings estimates of $6.25 is hardly a disaster. The market was looking for somebody to pound and FedEx was the sacrificial offering.

I think there are several opportunities today. The sharp decline boosted option values so we have less risk at this point as long as we choose wisely.

I can't tell you that the market "will" go up tomorrow or on any specific day in the future. I can say the internals and the support levels are conducive to a rebound. If we pick some stocks that have already been battered significantly then our risk declines in that environment.

I am going to offer several different plays today but as always nobody is obligated to take them. If your risk profile says stay in cash then that is where you should be. There will always be another day to trade.

Jim Brown

Send Jim an email



Current Portfolio


Current positions


Current Position Changes


None


New Short Put Recommendations


None


New Covered Call Recommendations


None


New Long Term Recommendations


YHOO - Yahoo! $14 (Combination)

Yahoo is a target in search of an acquirer. They have failed at everything they have tried and yet they continue to exist with a market cap of roughly $18 billion. For the right manager it represents a platform to search and many forms of paid content, email and even streaming video. There are plenty of ways for Yahoo to prosper even if they never come close to being a competitor to Google.

Stifel Nicolaus upgraded Yahoo on Thursday with a price target of $18 saying a deal is near. Several analysts have said recently that various companies are considering how they could do a deal and what they would do with the platform once they got it.

Yahoo owns a 39% stake in Alibaba, which is worth $12.5 billion. That means the rest of Yahoo is only carrying a valuation of roughly $6 billion and that is cheap for a company with Yahoo's breadth. The majority shareholder in Alibaba, Jack Ma, would be a natural acquirer. He would get his 39% back and have a perfectly good Internet company left over.

Private equity firms Silver Lake, DST Global and Yunfeng Capital just offered $1.6 billion for a 5% stake in Alibaba. According to Dan Loeb of Third Point that means Yahoo's value could be between $19 and $31 per share. Loeb values all of Yahoo at $27-$28 per share on a takeout basis. They have $2.78 per share in cash and Yahoo Japan worth another $3.10 and the value of Alibaba $5.24 per share. At today's price that means the core business of Yahoo is only $2.78 and that would be a bargain. Yahoo shares closed positive today in a horrendous market so that suggests nobody is willing to sell. The bet is on that Yahoo is going to be acquired.

Microsoft offered $31 for Yahoo back in 2007 and was declined.

I am going to recommend another combination play on Yahoo. I suggest we sell an April $14 put, currently $2.38 and buy the April $14 call, currently $2.52. That gets us into the Yahoo call at basically a breakeven and we have more than six months for a buyer to appear. The downside "should" be limited since Yahoo has withstood some severe market conditions and the buyout rumors are swirling.

Sell Short YHOO April $14 Put, currently $2.36, no stop
Buy Long YHOO April $14 Call, currently $2.52, no stop

Chart of Yahoo


PHM - Pulte Homes $4.06 (Combination)

Pulte has bottomed. Yes a brave call but at $4 there is very little risk because the bottom is not that far away. The hit $3.40 back in August and while down -7% today they came to a dead stop at $4. The home builder sector is far from healthy but every indication suggests the worst is over. Buyer activity has picked up. Interest rates are going even lower and builders have quit giving away have the store with each purchase in a desperate attempt to sell homes. They have cut land holdings, lowered costs and shrunk inventory to the bone. When the recovery does come these are going to be lean mean money making machines.

UBS upgraded Pulte to a buy from neutral earlier this week saying that even if the weakness continues for another couple of years they have enough cash and assets to survive and eventually prosper. Pulte is not without warts. They have $2 billion in loans coming due over the next five years but they have $1.2 billion in cash and they can add to that by future inventory sales or sales of land holdings.

Obviously at $4 it would be just as easy to buy the stock and forget it. I would rather buy it cheaper and leverage the transaction. I am going to recommend we sell the Jan-2013 $7.50 puts, currently $3.75 and buy two of three of the Jan-2013 $5 calls, currently $1.01. We will enter the trade with a net credit and a close over $7.50 in Jan-2013 give us three times the return of simply owning the stock and we have nothing invested but a little margin. There is plenty of open interest so the possibility of assignment is limited. (If you are ever assigned on any position simply sell the stock and resell the puts the same day you are assigned and no harm, no foul. Normally it will only cost you a few cents and your back in the trade.)

Sell short PHM Jan-2013 $7.50 Put, currently $3.75, no stop.
Buy Long (3) PHM Jan-2013 $5.00 calls, currently $1.01, no stop.

Chart of PHM


New Aggressive Recommendations


HPQ - Hewlett Packard $22.80 (Short Put)

Hewlett Packard kicked its CEO to the curb and installed Meg Whitman, former CEO of Ebay, as the CEO they will trust to turn the company around. This is a big job for Whitman but the woman has a lot going for her. She really does not have any enterprise experience but she did manage to shape Ebay into a global company that fended off challenges from dozens to would be competitors. I think she has the determination to prove she can do it or die trying. Whitman was an existing board member of HPQ and her prior mentor while she was at Ebay, Ray Lane, was just installed as Executive Chairman of the board.

This team could be the ticket. There are some disagreements with that concept but regardless of her eventual success Hewlett Packard is better off than under the management of Leo Apotheker. He led Hewlett to a successful launch of the Touchpad tablet and then cancelled it only weeks after it hit the stores. Billions in expenses down the tubes in a classic example of bad management. They could have easily sold off the division rather than scuttle it.

I believe HPQ will rally from here. It may not be dramatic and there may be bumps in the road. Whenever a new CEO takes over there is typically a period of consolidation. The opportunity is useful for dumping costs and charges in an effort to get rid of the old and in with the new. The charges reflect on the failed policies of the earlier management and the newcomer gets to start off with a clean slate.

I am going to suggest we sell a January put just in the money on expectations HPQ will rally 10-15% on the change in command. Since it may be a rocky road for Whitman I don't want to go any farther out. I would prefer to be out of the position before the Q4 earnings in February since that will be the first full quarter under her direction. She could pull a rabbit out of the hat but why risk it? If we can capture $4 in the next 90 days then our job is done.

James will be adding HPQ as a LEAP play this weekend in the LEAPS newsletter.

Sell short HPQ Jan $25 Put, currently $4.05. Stop will come later.

Chart of HPQ


Existing Play Recommendations


Links to original play recommendation

COG - Cabot Oil & Gas (Short Put)

BAC - Bank of America (Long Term)

BAC - Bank of America (Update 8/31)

DRC - Dresser Rand (Long Term)

BZH - Beazer Homes (Long Term)

MDR - McDermott International (Long Term)

BK - Bank of New York Mellon (Long Term)

NVDA - Nvidia (Long Term)

TSCO - Tractor Supply (Short Put)

IWM - Russell ETF (Aggressive Combo)

SD - Sandridge Energy (CC + Long Term Combo)


Margin Requirements:

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.