Friday's short squeeze faded on Monday after China's premier warned the economy was still slowing and U.S. economics weakened.

On Sunday China's Premier Wen Jaibao warned the recovery was not stable and trouble may continue for some time. He promised tax breaks and other types of aid to companies hurt by slowing global exports. On Monday the IMF warned that China still faced a hard landing if something did not change soon. The IMF warned the decline in Europe was increasing and should the EU leaders not move fast enough with enough firepower the continued slowdown would hurt China, Australia, Brazil and Africa. The IMF also cut its outlook for U.S. growth.

In the U.S. retails sales for June declined -0.5% and the third consecutive monthly decline. Building materials fell -1.6%, sporting goods -1.6%, service stations -1.8%, home furnishings -0.8%, electronics and appliances -0.8% and motor vehicles and parts -0.6%. This third monthly decline was clear evidence that consumers are pulling back into their shell and the economy is slowing ahead of the flurry of problems headed our way later this year. Year over year growth slowed to +3.8% and the lowest since August 2010.

This is going to be negative for hiring in the months ahead. Slow sales means retailers and manufacturers will be reluctant to hire and may trim jobs ahead of the election. Lower hiring numbers will mean consumers will be more cautious about spending and the combination of those factors generates a negative feedback loop that is self propagating.

Strangely the sharp decline in gasoline prices over the last two months has not energized consumers to spend more at the mall. Consumer sentiment is turning cloudy and visibility narrowing.

Earnings kick into high gear beginning on Tuesday and sentiment is pretty bearish. Earnings are expected to decline -2.4% or more than -5.0% if you remove Apple and US Bank. This bearishness could already be priced in and any minor surprises could create another short squeeze.

Bloomberg reported today that shares sold short reached 5.35% of all shares available for trading at the end of June. That is higher than the 5.28% levels reached in September 2011. That 2011 high for shorts turned into a +21% rally when October earnings were not as bad as expected. A +220 point S&P rebound began on Oct 4th and ended on Oct 27th. Some analysts believe we are setting up for a similar rebound today because of the severely bearish sentiment. That remains to be seen but the spring is wound pretty tight.

We will have a much better idea of the earnings picture and market direction by next weekend. Earnings from IBM, INTC and MSFT will control the outlook for tech stocks and earnings from BAC, AXP, GS, MS and USB will dictate direction for the financial sector. Those are the two sectors that will determine market direction.

I tried to pick a couple stocks last weekend that I thought might be immune from market volatility and both those plays were stopped out on the three days of declines. My personal outlook for the rest of the week is choppy to negative. I don't believe the tech giants will beat and guide higher.

Picking plays ahead of earnings is always difficult. Picking XYZ company because their earnings is not until late August still leaves us exposed to a sector crash if ABC company in the same sector misses estimates badly and crashes the entire sector. Think about the coal sector and you will get the picture. One bad apple spoils the entire basket.

With the big earnings reports this week, Bernanke testifying on Tue/Wed and the Fed Beige Book on Wednesday afternoon I think it is best if we not launch any new short puts. I am going to add some new calls to our covered call stocks. Patience is a virtue and our time to backup the truck on new plays will come.

Jim Brown

Send Jim an email



Current Portfolio


Current positions

Current positions


Current Position Changes


WLK - Westlake Chemical (Short Put - Stopped)

The three day market drop last week knocked WLK below our stop to force us out of the position for a loss.

Position stopped: Short Aug $50 Put, entry $1.30, exit $2.25, -0.95 loss

WLK Chart


LEN - Lennar Homes (Short Put Stopped)

Good news in the housing sector was not enough to keep Lennar from collapsing with the rest of the market early in the week. We were stopped out at $29.95 for a loss.

Position stopped: Short Aug $29 Put, entry $.83, exit $1.30, -0.47 loss

LEN Chart


New Short Put Recommendations


None


New Covered Call Recommendations


We currently have stock positions in Energy XXI and Transocean Offshore as a result of prior covered calls that expired out of the money. The rally in crude prices over the last week has reinflated the call premiums allowing us to sell some new calls in these stocks.

RIG - Transocean Offshore (Covered Call)

Transocean does not report earnings until August 1st. (Unconfirmed) Shares have rallied to a two month high at $47 on the rise in crude prices. I am recommending we sell the November $52.50 calls ahead of earnings.

Sell RIG NOV $52.50 Covered Call, currently $1.54, no stop

Transocean Chart


EXXI - Energy XXI (Covered Call)

Energy XXI has declined significantly since we wrote the first covered call. You can thank the 20% decline in crude prices over the last two months. That trend has reversed but we still have some losses to recover. EXXI could see some volatility on Tue/Wed because its partner in the ultradeep Gulf plays, McMoran Exploration (MMR) reports earnings on Tuesday. If they say something negative about the Davy Jones 1 well we could see a sharp decline. Conversely if they say something positive we could see a large spike.

Sell EXXI Dec $35 Call, currently $1.55, no stop.

EXXI Chart


Long Term Recommendations


None


New Aggressive Recommendations


None


Existing Play Recommendations


Links to original play recommendation

EXXI - Energy XXI (LT Covered Call)

RIG - Transocean (Covered Call)

SBUX - Starbucks (Short Put Spread)

HLF - Herbalife (Short Put)

MMR - McMoran Exploration (Short Put)

MOS - Mosaic Co (Short Put)

JPM - JP Morgan (Short Put)

CELG - Celgene (Short Put)

NUS - NuSkin (Short Put)


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.