Downgrades on downgrades in Europe and new worries over Greece should continue to keep pressure on the U.S. markets as earnings season kicks into high gear.

On Friday nine European countries were downgraded by S&P but the markets shook off the news and rebounded to close with only minor losses. In Europe and Asia on Monday the markets opened lower but rebounded with Europe closing slightly positive in most cases. The bad news was already priced in it appears.

Late Monday S&P downgraded the European Financial Stability Fund (EFSF) by one notch to AA+ as a result of the downgrade on Friday of France and Austria from AAA to AA+. As significant guarantors of the fund their falling credit made the fund less credit worthy. Unfortunately S&P is not done. They will be downgrading other government entities, agencies, banks and insurance companies as part of this downgrade cycle.

The U.S. markets were closed Monday for Martin Luther King Day and have not yet reacted to the S&P news. Since the European markets rebounded into the green I would suspect the U.S. markets to behave positively. However, the news on Greece could be a cloud.

The private bond holders, who were supposed to agree to a 50% haircut on their principal, have revolted due to German pressure to take a coupon rate in the 2% to 4% range on their new debt. This would make the actual haircut closer to 75%. Secondly Greece will not agree to guarantee the new debt. That means they could take a haircut and agree to the new debt only to have Greece default on that debt six months from now. The hedge funds that currently own Greek debt are resisting any half hearted deal and would rather execute their credit default swaps than take a questionable haircut.

Multiple analysts including an IMF staff member have theorized that Greece will soon default because they simply have too much debt to pay off and the IMF and Germany are refusing to raise the bailout by tens of billions more. The next "agreed" bailout of 130 billion euros is contingent on Greece getting the 50% haircut in place over the next two weeks. Statements from the IMF suggest they would rather have Greece default now instead of loaning them another 130 billion and then have them default. This increasingly bearish scenario is going to remain a cloud over the markets. However, does anyone still believe Greece is not going to default? I seriously doubt it so that news is probably baked into the market as well.

Back in the U.S. the earnings cycle will kick into high gear this week. The big day is Thursday with AXP, BAC, MS, GOOG, IBM, INTC and MSFT. Microsoft has already given a soft warnings by saying PC sales declined more than expected in Q4. That suggests sales of Windows will come in light. Intel has also warned that PC sales were slower than expected and revenue could be significantly lower. Despite the warnings we could still see some volatility around the earnings announcements. If they act like Alcoa, which warned and then rallied on the actual earnings, the markets could be in good shape. I am not holding my breath on that possibility.

Earnings growth estimates for Q4 have declined to only +6% compared to +14% a quarter ago. That means a lot of bad news is already priced into the market. If companies report "less bad" earnings than analysts expect then we could see the Alcoa syndrome where stocks rally after bad news.

The problem we face is the volatility as a result of the earnings uncertainty and the reaction to the reports. We have seen over the last two weeks some massive moves in stocks that warned along with declines of other stocks in the same sector. That makes it tough to write options and assume the associated risk.

The market is VERY skittish. Investors are not showing any conviction in their positions. For instance Hi-Tech Pharma (HITK), an existing play last week, dropped -20% at the open on Tuesday because a competitor got a drug approval by the FDA. Investors sold first and asked questions later.

We obviously don't want to be on the receiving end of -20% moves and during earnings season those types of events can occur with regularity. Over 1,000 companies report earnings over the next two weeks making it tough to find a safe place to hide a trade. I chose Molycorp as one position because there is nobody else in their sector and they don't have earnings until March. Now we just have to hope the market remains positive.

Jim Brown

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Current Portfolio


Current positions

Current positions


Current Position Changes


SLV - Silver ETF (Long Term Combination Play)

The SLV position was closed as recommended at the open on Tuesday for a minor loss.

Closed Long Jan-14 $35 Call, cost $5.05, exit $4.25, -0.80
Closed Short Jan-14 $40 Put, cost $14.60, exit $15.00, -0.40


HITK - Hi-Tech Pharma (Covered Call)

When HITK plunged -20% at the open on Tuesday we were stopped out at $36.75. The rapidly dropping call premium eliminated much of the pain in the stock drop but we still lost money.

Closed HITK stock position, cost $38.94, exit $36.75, -2.19
Closed Short Jan $40 Call, premium $1.64, exit $0.30, +1.34

Net loss -0.85 cents


New Short Put Recommendations


MCP - MolyCorp (Short Put)

Molycorp is a rare earth miner and the stock has been severely beaten down over the last eight months. Recent news suggests the rumors were overdone and the company is actually stronger than previously thought. Some analysts still have price targets over $100 with the stock currently at $29.

I am recommending we sell the February $25 put currently at $1.02. Earnings are not until March 8th and there are really no companies in its space to report early and tank the sector.

Do not enter this position unless the S&P and MCP are positive at the open.

Sell short MCP Feb $25 put, currently $1.05, stop $26.50

MCP Chart


IOC - Interoil Corp (Short Put)

We played IOC several times last year because of its extremely high option premiums. I quit recommending it when the volatility increased and it was prone to sudden declines. The trend has improved and it is currently attempting a breakout over resistance at $60.

I checked the options chain and we can sell a $47.50 put for $2.53 and be $12.50 out of the money. A $12 decline would be 20% of the stock price. George Soros owns a block of IOC and he has been a long time bull on IOC.

Earnings are Feb 13th so we need to exit this position the Friday before expiration if not sooner.

Do not enter this position unless the S&P and IOC are positive at the open.

Sell short IOC Feb $47.50 Put, currently $2.53, stop loss $54.50

IOC Chart


New Covered Call Recommendations


None


Long Term Recommendations


None


New Aggressive Recommendations


None


Existing Play Recommendations


Links to original play recommendation

BAC - Bank of America (Long Term)

BAC - Bank of America (Update 8/31)

BZH - Beazer Homes (Long Term)

MDR - McDermott International (Long Term)

BK - Bank of New York Mellon (Long Term)

YHOO - Yahoo (Long Term Combo)

PHM - Pulte Homes (LT Leveraged Combo)

JEF - Jefferies (LT Leveraged Combo)

HITK - Hi-Tech Pharma (Covered Call)

LEAP - Leap Wireless (Covered Call)


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.