A strong four day short covering rally powered the indexes higher but will it continue?

The S&P broke through initial resistance at 1390 to close at 1403 and only 17 points from major resistance of the multiyear high at 1420. The Dow sprinted to 13,228 and only 72 points from strong resistance at 13,300. The Nasdaq managed to squeeze past resistance at 3060 by +9 points.

The factor powering all the indexes was better than expected earnings reports from a few high profile companies. Apple, Ebay, Amazon, etc. Earnings the prior week showed a remarkable 82% of reporters beating estimates. That torrid pace declined to 65% last week with 42% of reporters warning on future expectations.

The major market moves came on obscene short squeezes in companies like Apple and Amazon. Apple rallied $58 at the open after their earnings release and that was the high for the week. Amazon rallied +$31 to $227 on Friday and will likely lose some of that froth on Monday.

The question is whether a market driven by enormous gains in a few stocks can maintain its momentum? The earnings schedule for this week contains hundreds of companies but the monster blue chips that can move the market have already reported. There are still big companies like Visa, MasterCard and AIG but they are not the kind of names that will move the market.

There is a chance the markets could continue higher on the better than expected earnings. Three weeks ago analysts were expecting earnings growth to be no more than +0.1% and possibly a decline. Now three weeks into the cycle the S&P earnings growth is +6.9%. That is far better than zero or possibly negative. Whether it is enough to keep the rally alive is unclear.

Futures are flat across the board on Sunday night. Markets are flat and commodities are flat. Asian stocks rose slightly in light holiday trading. News from Europe was quiet and no headlines about Spain.

The dollar is weakening because our economics are weakening. The big reports for this week are payroll and manufacturing related. If the Nonfarm Payroll report on Friday comes in weak like March the Fed could move closer to adding new stimulus. That could push the dollar lower and commodities higher. We are still a long way from that possibility with the next FOMC meeting not until late June.

The markets have to stand or fall on their own in May. Some analysts are claiming there will be no sell in May cycle this year because of the election cycle. That remains to be seen since the weak economy is going to be a major campaign point.

The volatility in the market early last week knocked us out of our final long term position. The short put on the GLD ETF ended with a $9.10 gain. The portfolio is looking pretty bare and I am going to add a couple longer term plays this weekend while we wait to see if the direction for next month will be "sell in May" or "Up, up an away."

Jim Brown

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Current Portfolio

Current positions

Current positions

Current Position Changes

GLD - Gold ETF (Stop change)

I raised the stop loss on the GLD naked put to $158.75 last Sunday. The news from overseas caused a dip on Monday that hit our stop to force an exit. The option was trading at $11.50 when the stop was hit.

Closed Short Jan 2013 GLD $160 Put, entry $20.60, exit $11.50, +9.10 gain

GLD Chart

New Short Put Recommendations


New Covered Call Recommendations


Long Term Recommendations

SBUX - Starbucks (Short Put Spread)

Starbucks reported earnings Thursday night and said same store sales in Europe had not grown +2.2% as expected but declined -1%. From the reaction in the stock you would have thought they said they were leaving Europe. Shares declined -5% on the news. What investors did not seem to get was the major gains in other countries.

Starbucks reported earnings that rose +19% and raised guidance. Globally sales rose +7% and thanks to Europe that was also below the 8.2% analysts expected.

The CFO said Europe has taken a turn for the worse over the last couple of months. However, he said that was transitory and the company was taking steps there to rebuild the business similar to what Starbucks did to revive the U.S. during the financial crisis.

Starbucks said growth in China was exploding with same store sales up +18% and revenue up +32%. That is the seventh straight quarter of revenue growth over 20%. In the Americas sales rose "only" 8.1%. The CFO said they were not seeing the fall off in sales in China as reported by McDonalds and Yum Brands. They plan on accelerating store openings in Asia to 400 in 2012 with half in China.

The company also reported coffee prices reduced operating income by $63.5 million and cut 200 basis points off operating margin, which was flat at 13.5%. Starbucks raised coffee prices at some of its 17,200 stores to keep pace with rising costs. Starbucks hedges its coffee prices and they expected costs to decline in the second half of the year. The company raised revenue growth guidance to the "low teens" from an earlier target of 10%. They raised earnings guidance to $181-$1.84 from $1.78-$1.82. They expect to open 1,000 net new stores in 2012 and expand sales of packaged coffee. They are going to accelerate the delivery of the Verismo coffee machine in China. Currently Starbucks has a 19% share of the k-cup market and they expect to increase that share as well. Howard Schultz was also bragging about how well the Evolution Juice brand is going to do and expectations for it to quickly become a billion dollar brand. The first store was opened in Bellevue Washington in March.

I am a believer in the Starbucks brand. You can't always anticipate things like the collapse of Europe but you can manage it and I believe they will succeed. SBUX shares declined ahead of earnings from the $62 April high but still gave back another $3 to close at $57.45 on Friday. I believe this is a bump in the road and a buying opportunity. Long term support is in the lower $50s.

I am recommending we sell a January $60 LEAP Put, currently $7.25 and buy a June $55 put, currently $1.35 as protection against a further decline.

DO NOT enter this trade unless SBUX trades over $58.10.

Sell Short Jan 2013 SBUX $60 LEAP Put, currently $7.25, no stop.
Buy Long June SBUX $55 Put, currently $1.35, Stop loss $59.05

Starbucks Chart

XHB - Homebuilder ETF (Short Put)

Surprising improvements in the builder earnings, strong order increases, improving traffic and extremely low interest rates are combining to push the home builders higher. I looked at each builder and I think it is too late to try and pick an individual winner. Instead I am going to recommend we sell a put on the XHB Homebuilder ETF. The volatility is very low and we can receive about $2 in premium for a September put.

The risk here is that the U.S. economy rolls over thanks to high fuel prices or uncertainty about the election and the regulatory and taxation aftermath. This is why I am recommending a September put. We want to capture any summer rally as the homebuilders report their spring sales and then exit the play for a profit before the fall slump begins.

Do NOT enter this trade until the XHB hits $22.10.

Sell Short Sept XHB $23 Put, currently $2.08. No initial stop.

XHB Chart

New Aggressive Recommendations


Existing Play Recommendations

Links to original play recommendation

GLD - Gold ETF (Short Put)

EXXI - Energy XXI (LT Covered Call)

RIG - Transocean (Short Put Spread)

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.