Hindsight is always 20:20. If we had known last weekend that the markets were going to explode for a 7% gain there would have been a lot more plays on the play list. Unfortunately if you remember back to the prior Friday the charts were telling us the world was about to end. The S&P had closed right at support at 880 after a week of losses and it appeared the H&S breakdown could take the index to 800.
SPX Chart from Friday July 10th
What a difference a week makes. The bears were greeted on Monday morning by a banking upgrade by Meredith Whitney and a new price target of $186 on Goldman and the first short squeeze was born. Tuesday saw Intel knock the ball out of the park and the squeeze continued. This was the perfect storm for option traders with short positions going into expiration week.
This week the S&P closed right at strong resistance and a failure at that 950 resistance level is the most likely outcome. However, should we see buyers continue to press the index higher a breakout over 950 would be very bullish. Analysts are about equally divided on which outcome to expect. Obviously as put sellers we would love for the breakout to continue but risk reward ratio today is not in our favor. The odds of a significant breakdown still exist and loading the boat here with a bunch of positions would not be wise.
S&P-500 Chart today
Also last week the crude oil futures were flirting with $58 and threatening to test support at $52. I added several potential put entries to the watch list in anticipation of that breakdown. Monday's opening low of $58.32 was the low for the week and crude closed $5 higher on geopolitical concerns along with hopes that the recession is ending. The jump in housing start suggested to some that confidence was building and oil demand would be returning soon.
The API demand update on Friday showed that gasoline demand fell to its lowest level since 2003 in the first half of 2009. Diesel demand fell -6.6% and ultra low sulfur diesel fell by -9.2%. Jet fuel demand fell -12.8%. However, these numbers are all in the past and hopes for a rebound in demand are pushing crude stocks higher along with stock prices.
Had we known last Friday what we know today those would have been hard entries on the watch list instead of targets. The energy stocks on the watch list rose an average of 15% to 20% for the week and took themselves out of contention as potential plays. I am canceling all three targets.
As put sellers what do we do after a +600 point market gain. Personally I think we should buy puts but that is for another newsletter. In a perfect world we could sell calls on Monday in hopes of a failure at that strong resistance at 8800, 950. However, those short stocks and calls last week were the reason we got that 600-point rally. I would prefer not to be the person chasing my short calls higher and trying to reduce my losses. Since naked call margins are much higher than naked puts there is always the risk of lower returns.
We could do some call spreads to reduce the risk but in my opinion that just ties up money for a minimum of profit. Sometimes they are beneficial but normally I avoid them.
Anybody that has been reading the Option Investor newsletters for several years knows that I tend to be aggressive in my strategies. Selling puts $50 in the money does not phase me and I like to take chances. However, there needs to be a method to my madness. I believe writing puts this week could be a losing proposition so I am going to be very picky on any new plays. Lost profits from not taking an entry is far more preferable to lost money from taking the entry at the wrong time.
You probably noticed that volatility ($VIX) fell to a 10-month low at 24 on Friday. Shrinking volatility means shrinking premiums and higher risk for option writers. We want rising volatility to increase premiums in our favor. This 10-month low in volatility is another strike against writing options this weekend.
It is even tougher to find news plays because we are in the middle of earnings season. Anybody reporting over the next three weeks is a risk for a downside surprise and a sudden loss of altitude. Sectors are a risk because somebody in the same sector as one of our positions can take down the entire sector. For instance we saw housing fall -10% in the prior week and then rise +11% last week. Those are some giant swings.
I looked at over 1,000 stocks this weekend trying to find some decent put writing plays. Unfortunately the combination of last weeks rally, the low volatility and about 300 stocks reporting earnings next week the playing field was littered with land mines. I only came up with one that I would play myself.
If we could get a couple days of profit taking I think the opportunities would open up and there would be no shortage of decent plays. Until then we should just conserve our energy and wait for an opening. The two active plays in the portfolio are progressing smoothly. There is no reason to junk it up by taking chances.
New Recommendation - Conservative
MFLX $21.18 - Multi-Fineline Electronics
Multi-Fineline Electronix, Inc. (MFLEX) is primarily engaged in the engineering, design and manufacture of flexible printed circuit boards, along with related component assemblies. The Company is a provider of flexible printed circuits and component assembly solutions to the electronics industry. The Company targets its solutions within the electronics market. Multi-Fineline Electronix, Inc. focuses on applications, in which flexible printed circuits facilitate human interaction with an electronic device. Applications for its products include mobile phones, mobile devices, portable bar code scanners, personal digital assistants, computer/storage devices and medical devices. The Company provides its solutions to original equipment manufacturers (OEM), such as Motorola, Inc. and Sony Ericsson Mobile Communications, and to electronic manufacturing services (EMS) providers, such as Foxconn Electronics, Inc., Tech Full and Flextronics International Ltd.
Sell Aug $20 Put FUX-TD currently $.95, stop loss MFLX @ $19.25
New Recommendation - Speculative
None this week
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)