Too bad that market drop came a week later than we planned but as traders we know we have to roll with the punches. With two weeks left in January we have some lost ground to recover.
The market seems to know when we are the most exposed and takes pleasure in doing us as much harm as possible when the situation permits. We got off to a bad start in January because I was expecting the profit taking about a week earlier. But, that is water under the bridge and it is time to move on to new plays.
Despite the decline on Friday I still believe that earnings over the next two weeks will keep the market from going into full correction mode. The key is going to be to find those stocks that are bucking a down market because they should do better if the market decides to rally again.
In order to recover the losses from the beginning of the month I am going to suggest a high dollar stock where we could make up all the losses in one play. The margin will be a little steep but the payoff is also large. That stock is Baidu (BIDU). You probably heard last week that Google and 38 other U.S. companies including Yahoo were hacked by the Chinese government or hackers under contract to the government. Google became so hostile at the severity and technologies involved that they determined it had to be government sponsored. They told China they would no longer censor content going into China, which is a requirement by the Chinese government, and they might leave China completely.
I don't know what they hope to gain from pulling out of China because that is just one less problem the Chinese government would have to regulate. If they are hoping there will be a grass roots effort by Chinese citizens to keep Google then they don't understand the communist government.
While Google is issuing demands to the government and the government demanding back the price of Baidu is rocketing higher. A Google exit would be a big win for Baidu, which is owned in part by the government and by quite a few government officials. Because of the volatility last week the options in BIDU are very fat. If conditions hold over the weekend we can sell a $420 put with BIDU at $470 for over $9 in premium. Even if Google calms down about being hacked there will probably be repercussions for making demand on the Chinese government. Those repercussions could be limited access, more censorship, etc. All of this favors Baidu. If we keep a tight stop on the position the risk should be minimal. If you can't afford the margin on a $470 stock then convert the put write into a spread by going long a lower strike first.
NO OPEN POSITIONS
BIDU - Baidu Inc - $467.68 (Naked Put Write)
Baidu, Inc. (Baidu) is a Chinese-language Internet search provider. The Company conducts its operations in China principally through Baidu Online Network Technology (Beijing) Co., Ltd. (Baidu Online), its wholly owned subsidiary in Beijing, China. It also conducts its operations in China through Baidu Netcom Science Technology Co., Ltd. (Baidu Netcom), which holds the licenses and approvals necessary to operate the Companyâ€™s Websites and provide online advertising services. In January 2008, the Company launched a Japanese search service at www.baidu.jp, run by Baidu Japan. The Companyâ€™s Japanese search services enable users to find relevant information online, including Web pages, images, multimedia files and blogs, through links provided on its Websites.
Sell Feb $420 Put BPJ-ND currently $9.50, Stop at BIDU $449 .
Chart of BIDU
WLP - $66.65 - WellPoint Inc (Naked Put Write)
WellPoint, Inc. (WellPoint) is a health benefits company serving 35 million medical members, as of December 31, 2008. The Company is an independent licensee of the Blue Cross and Blue Shield Association (BCBSA), an association of independent health benefit plans. WellPoint is licensed to conduct insurance operations in all 50 states through its subsidiaries. In April 2008, the Company acquired Resolution Health, Inc. and DeCare Dental.
When the health care plan was initially started the health care providers were in danger of being eliminated or at lease drastically restricted. As the process wound its way through the House and Senate it became so watered down that the providers may actually be in a stronger position than they were when the process started. If Scott Brown gets elected on Tuesday the entire plan will be DOA to the Senate and probably for the next three years.
Investors are catching on to this point and the providers are moving up steadily. They were immune to any selling on Friday and are tacking on gains nearly every day. Tuesday will be a critical event that could blast them higher but I don't think there will be much selling if Scott Brown loses because the current plan is positive for the providers.
I am going to recommend the $65.00 strike for maximum depreciation but you can use any strike you like.
Sell Short Feb $65.00 PUT WLP-NM currently $2.10, Stop WLP at $65
Chart of WLP
DB - $69.73 - Deutsche Bank (Naked Put Write)
Deutsche Bank AG is a global investment bank. The Company offers a range of investment, financial and related products and services to private individuals, corporate entities and institutional clients worldwide.
Overseas banks were crushed on Friday with several down 4-5%. Deutsche fell -4.9% on the JP Morgan news. It closed at $69.73 and just over strong support at $69. I am betting that others see this as a buying opportunity given the drop from $78 to nearly $69 in only a week.
DO NOT ENTER THIS POSITION IF DB OPENS BELOW $70 on Tuesday. If DB opens below $70 wait for a rebound and a print over $70 before initiating the position.
Sell Short Feb $65.00 PUT DB-NM currently $1.60, Stop DB at $67
Chart of DB
January Recommendation History
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We do not sell out of the money puts for a few cents and then hope the market does not correct and cost us a fortune to exit. I don't like to risk a dollar to make a quarter.
The concept for Option Writer is to find solid momentum plays with enough volatility to inflate the option premiums. We will sell in the money naked puts ahead of the stock price and let the stock rally to our strike.
Selling in the money puts allows us to capture nearly dollar for dollar the movement in the stock price.
Because we are selling in the money that same dollar for dollar move can go against us as well. For this reason we establish tight stops to take us out of the play for a loss of a few cents rather than let the losers grow and "hope" they rally again. In a typical month we could get stopped out of twice as many plays as we close for a profit but those stops will be minimal and the winners worth the trouble.
If you do not have the ability to sell options you can turn the plays into spreads by buying a lower strike put. This will decrease your margin requirements but it will also decrease your profits.
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)