The decision last week to avoid opening new long positions was apparently the right decision.

I warned last week that conditions were so bullish and option premiums were so low there was no reason to try and initiate new positions. When the risk-reward ratio does not offer us the potential for a decent profit with a limited amount of risk there is no reason to be in the market.

The sell off last week declined exactly to strong support and was followed by a short covering rebound on Friday. The rebound was on low volume and lacked conviction and failed to recover even half of the prior decline. The short covering came from a heavy dose of Fedspeak and was aided by traders taking profits before the weekend.

Today the markets opened higher with the Dow gaining +81 at the open. Almost immediately the sellers appeared and the pressure did not let up all day. When the Italian press began releasing information on the outcome of the election it was not good news. The pro eurozone candidate finished last and anti-euro candidate Berlusconi was tied for first. The parliament will be split and another election may be called in the next several weeks. Worries about a return of the European debt crisis returned to haunt the markets.

While many market reporters blamed the market decline on Italy there were multiple clouds and Italy was only one. Ben Bernanke will testify for the Senate on Tuesday and the president's sequestration program will apparently hit as scheduled on Friday. Gloom and doom headlines are rampant and there appears to be no way to avoid the event.

Traders have assumed all along that politicians would pass something to either water down the impact or kick the problem well into the future. Neither happened and the threat of real spending cuts is roiling the market because of the impact on the economy.

The CBO claims it will cost 750,000 jobs over the next seven-months and possibly push the U.S. back into recession. Now that traders are being forced to accept the fact the sequestration will happen it is not a pretty picture.

As I wrote in the Option Investor commentary last weekend there are a dozen high profile events this week that can disrupt the market. When you consider the gains in the 2013 rally there are plenty of profits at risk.

The market on close orders today were large and mostly sell orders. This is institutions pulling the plug on their long positions and harvesting profits. As long as the institutions were willing to remain long the rally had a chance to continue.

Fund managers also pulled the plug on their longs and the Russell 2000 declined from 932 early last week to 895 today. That is below round number support at 900 and right on critical, and I repeat CRITICAL, support at 895. Any further decline in the Russell is going to be an immediate sell signal for the remainder of fund managers. I doubt they will get much sleep tonight and be updating sell stops instead.

The S&P-500 fell below the corresponding support at 1495 and that suggests the Russell is at risk for a further decline. The S&P chart pattern has failed.

Russell 2000 Chart

S&P-500 Chart

The market appears to be broken. We knew it was coming and last week's dip to initial support was too neat and clean to be the real deal. The volume today was 1.5 billion shares above Friday's rebound volume. It was not dramatic but it was important.

Decliners were 4:1 over advancers and volume was 6:1 declining over advancing.

I hope I am wrong in my assessment of the market today. I would love to see a strong rebound on Tuesday and head back to retest the highs. However, I would rather be wrong about a sell off and in cash than wrong about a rebound and be fully invested. As long as you have cash you live to trade another day.

I am not initiating new positions today and I am closing some that are open rather than risk giving back profits.

If the market dip continues it will be very beneficial for us. Option premiums will inflate and eventually a bottom will appear. We need to be ready when that happens.

Jim Brown

Send Jim an email



Current Portfolio


Current positions

Current positions


Current Position Changes


VIX - Volatility Index (Closed)

We launched a short put on the VIX back at the beginning of January in the expectation the VIX would rise once the initial January rally was over. The rally lasted until last week and the VIX continued to decline as sentiment became progressively more bullish.

I put an exit target on the VIX the prior week to get us out of the position on the first material bounce because our time on the March option was running short. We hit that exit target today and were able to close the position for a minimal 25 cent loss.

Short VIX March $20 Put, entry $3.60, exit $3.85, -0.25 loss

VIX Chart


SODA - Soda Stream (Short Put)

SODA declined to hit the stop loss at $48.50 on February 20th. Fortunately enough time had expired to allos us to exit for a small profit.

Stopped SODA March $45 Put, entry $1.70, exit $0.96, +0.74 gain.

SODA Chart


DECK - Deckers Outdoors (Short Put - Close)

After breaking above $43 for several days Deckers has broken below that support and is in danger of falling to a new four week low in the weak market. Close the position.

Close DECK March $37.50 Put, entry $2.55, currently $1.95, +0.60 gain.

DECK Chart


NFLX - NetFlix (Short Put - Close)

We have a short NFLX April $130 put. With NFLX at $180 you would think we are far enough out of the money to be safe. However, April is a long way off and a sustained market decline could inflate the premiums. We are up +$5.32 on the position with only $1.18 left in the put. There is nothing to be gained by continuing to hold this risk. I am recommending we close the position.

Close NFLX April $130 Put, entry $6.50, currently $1.18, +5.32 gain.

NFLX Chart


CAB - Cabelas (Short Put - Close)

Cabelas reported record earnings and raised guidance but the stock has lost its momentum. I am recommending we close this position at the current breakeven before the market deals us a loss.

Close CAB June $50 Put, entry $4.50, currently $4.10, +0.40 gain

CAB Chart


New Short Put Recommendations


None


New Covered Call Recommendations


None


New Long Term Recommendations


None


New Aggressive Recommendations


None


Existing Play Recommendations


Links to original play recommendation

RIG - Transocean (Covered Call)

WLT - Walter Energy (Covered Call)

NFLX - NetFlix (Short Put)

VIX - Volatility Index (Short Put)

CAB - Cabellas (Short Put)

DECK - Deckers Outdoors (Short Put)

IOC - Interoil (Short Put)

IOC - Interoil (Covered Call)

SODA - Soda Stream (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.