Archive for October, 2008
The week began in bullish fashion as the DOW posted a 413 point gain. The spotlight was on Bernanke as he exchanged ideas with the House Budget Committee. Mr. Bernanke admitted that the economy will likely be slowing for the next few quarters. He also hinted that the economy would benefit from another stimulus package.
Tuesday was highlighted by Kirk Kerkorian bailing out of Ford and earnings from MMM, CAT, DD and AXP. The DOW finished down 232 points.
All the rescue (bailout) package mess has distracted many from the fact that we’re in the thick of earnings season. Despite good numbers from the likes of AAPL and MCD, the market had another huge down day on Wednesday with the DOW ending 514 points south.
Thursday, former Fed Chairman Alan Greenspan ended up on the Hill defending his role in the current financial crisis and admitted that he may have gotten it wrong. Weekly jobs claims were up as the DOW posted a positive move of 172 points to offset less than half of Wednesday’s downdraft.
We woke up Friday morning to a “Limit Down” on the futures. Asian and European markets took a dive overnight and we were facing the possibility of a 1000 plus washout. It didn’t happen that way as the bulls stepped in to make a fight of it despite eventually closing down 312 points on the DOW. The NAR reported existing home sales up primarily due to foreclosures and low home prices. OPEC decided to cut production by 1.5 million barrels a day.
Week over week, the indexes fell. The DOW down 474 points, the SPX off 64 and the COMPQ retraced 218 points.
7 STEPS TO 40%
The following article is reprinted with permission from my business and trading partner. This information is very apropos considering our current market conditions. Robin
Just a couple of decades ago it would have been almost unfathomable for the retail investor to consider generating consistent returns above 20% per year. Indeed, those who competed in arguably the most competitive financial market place, the stock market, were considered gurus when they beat the S&P 500 year in and year out.
Others, such as Jerome Kohlberg, Henry Kravis and George Roberts made a name for themselves in private equity as did Peter Peterson and Stephen Schwarzman with the Blackstone Group. Gains in the stock market for Joe Public were subjected to a limiting factor - the inability to leverage substantially. Joe Public was also limited in participating in private equity investments; they were the domain of the rich - the insiders. These days, private equity still remains the domain of the rich, but leveraging is possible through the purchase of equity derivatives. And the sale of those same equity derivatives can be highly profitable too.
Whereas it would have been unthinkable years ago to consider making big profits year in and year out on a stock that doesn’t move much - because the only source of income, dividends, tended to be in the low single digits in percentage terms - these days options afford us the opportunity to sit tight and profit while holding stock positions. This can easily be achieved through the sale of short call options against stock holdings, otherwise known as the Covered Call strategy. While the Covered Call strategy may appear straightforward when first encountered, many applications may be employed. In this article, we will consider the application that Stock and Option Trades labels: 7 Steps to 40% per year!
Ok, so you want to skip this step and move on to Step 2. Wait!
One of the great quotes in investing comes from Jesse Livermore and pertains to this concept of patience. In Reminiscences of a Stock Operator, it is stated:
“It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight! It is no trick at all to be right on the market. You always find lots of early bulls in bull markets and early bears in bear markets. I’ve known many men who were right at exactly the right time, and began buying or selling stocks when prices were at the very level which should show the greatest profit. And their experience invariably matched mine–that is, they made no real money out of it. Men who can both be right and sit tight are uncommon.”
Because the Covered Call strategy comprises stock ownership, we should know that it’s close to a level that value investors will jump in, even if the stock drops lower in the short-term. Some simple metrics to look out for include:
Zero debt - in higher interest rate environments, debt-laden companies obviously suffer much more so than those with no debt.
Lots of cash - If you want to see an example of a company with lots of cash relative to its market capitalization, just check out OptionsXpress. With so much cash on hand, there is an automatic lower limit on how low the stock can go.
PEG: 0.65 - 1.0 A low PEG - anything less than 1.0 - indicates a company’s multiple is low relative to its earnings growth.
Return on Equity: 15%: A return on equity of 15% or more indicates the company is compounding value at a very attractive pace. Even if a stock isn’t matching the return on equity figure in the short-term, the likelihood is it will play catch up in the future.
A Story - Companies with a story are always attractive to Wall Street analysts. Whether it’s the iPod, global search, oil, consumer staples etc. companies in different sectors will come into vogue at different times and your job is to know what’s in vogue now! You can be stubborn and stick with a sector that isn’t moving much, but why remain so inflexible when another sector may be flying to the moon.
Has the stock been beaten down? If so, it’s time to pay special attention to the turn. Wait for the bottom to form and the stock to take off. Chances are if Step 2 was executed properly, the stock that is fundamentally strong will blast off like a rocket ship when sentiment changes in the market. Make sure to be alert to the shift. You’ll know when it happens because suddenly everybody will be racing to buy as much as they can and greed will kick in!
As mentioned, many Covered Call strategies exist, but the one discussed in this article pertains especially to taking advantage of earnings. You can easily spot when earnings takes place by navigating to the investor relations department link on the website of the company under investigation or indeed by simply navigating to www.earnings.com
Step 5: Track Implied Volatility
By keeping a close eye on implied volatility, you will always know when options are expensive or cheap on a relative basis. In short, when implied volatility is high - as is usually the case right before earnings - options are very expensive. And when implied volatility is low - as is usually the case 1-6 weeks after earnings, options tend to be ‘cheap’ on a relative basis. Once the implied volatility starts to pick up, it’s time to start thinking about selling some expensive call options against the stock position you already own.
From steps 2 & 3, you should have ended up with a solid stock after it started to trend bullish. Obviously at the start of a bull run there is little reason to cap gains with short calls. But if a bull run has occurred and implied volatility is high because earnings is approaching, why risk all those gains? In fact, why not sell some expensive call options to lock in some of the gains?! And that’s where Step 6 comes in…
Step 6: Sell 2-3 month short call options at-the-money
Options at-the-money tend to have greatest premium compared to options in-the-money or out-of-the-money. Moreover, options with 2-3 months of time value can offer a nice compromise between choosing shorter term and longer term options. Shorter term options tend not have nearly as much premium obviously as longer term options but longer term options require that the Covered Call trader stick with a position for a long time. And while patience is key to successful long-term gains, it’s also important that you are not so bored with your positions that you lose interest in the game altogether!
Consider an example: GE at $29.15 offers an attractive entry point and with earnings coming up next month and the short calls at strike 30 close to the money offer $2.32 of premium for September, just slightly greater than 3 months away, the return on risk may be calculated as follows: $2.32 divided by $26.83 of risk (if the stock should stay flat). That equates to a return of 8.6% in 3 months. And, if the stock should rise to $30 within 3 months, which requires just a 2.9% increase in stock price, the Covered Call position would gain almost 12%. That is the outcome of purchasing the stock and entering the short call simultaneously. Obviously, by using some technical analysis to assist in timing the stock entry on the bullish turn and entering the short calls closer to earnings, the result could be improved.
Step 7: Wash, Rinse and Repeat
Now all that is necessary to produce gains of 40%+ per annum is to repeat each and every quarter! What would 40% per annum mean? On $25,000 of starting capital, 40% per annum for 5 years turns into $134,000+. Is that good? Perhaps, but it’s the next 5 years when the money really starts to mushroom. After another 5 years it turns into over $700,000! Obviously, taxes impact gains in non-qualifed accounts, but retirement accounts can be perfect for this type of strategy. Slow and steady wins the race!
ECONOMIC REPORTS
MONDAY 10/27
New Home Sales
TUESDAY 10/28
Consumer Confidence
WEDNESDAY 10/29
Durable Orders, Crude Inventories, FOMC Policy Statement
THURSDAY 10/30
Chain Deflator- ADV, GDP, Initial Claims
FRIDAY 10/31
Employment Cost Index, Personal Income, Personal Spending, Chicago PMI, Michigan Sentiment - REV
EARNINGS OF NOTE
MONDAY 10/27
ACV, ACI, BWLD, HUM, PPD, SOHU, TXRH, TZOO, VZ, WINN
TUESDAY 10/28
APOL, AJG, BYD, CP, CTX, CEPH, CRDN, DENN, ELNK, FLS, HMC, LNC, LCAV, MTW, MSO, OXY, PC, PEET, RFMD, RCL, SAP, TASR, EL, MHP, TUES, UA, X, USG, VLO, WDR, WLT, WHR
WEDNESDAY 10/29
AET, AMP, BWA, CAH, CME, CEA, GLW, FSLR, GRMN, GW, HIG, HES, HMN, JDSU, JNY, KFT, LM, MET, MGM, MUR, NEM, NBL, NUS, ODP, OC, MALL, PG, PRU, Q, SNE, SU, SYMC, TSO VCLK, V
THURSDAY 10/30
AKAM, APA, AVP, BLL, BTI, CAB, ELY, CAM, CBEY, CBS, CHK, CI, CL, EK, ERTS, EXPE, XOM, FDG, RAIL, IP, KLAC, LEA, LINTA, MRO, MEE, MDS, MNST, MORN, MOT, NANO, NWL, OII, OTTR, RJET, SWN, JAVA, TSM, BCO, SWIM, UIS, WYNN
FRIDAY 10/31
AOC, BKC, CVX, CMI, NSANY, OMX, SNY WPO, WY
COMMENTARY
The VIX remains at all time highs as fear continues to rule the markets. My sense is that the average retail investor through their 401K plan have taken a “head in the sand” approach by avoiding the reality of account depreciation.
It is regrettable that most people have bought into the “hype” of “Buy and Hold” The public has been duped into believing that they cannot time the market. HOGWASH!!! By simply paying attention to the 50/200 day simple moving average crossover on a broad market index like the DOW, you could have saved yourself from this massive collapse in the market. The 50 sma crossed over the 200 sma in early January 2008. You may say that I am practicing Monday morning quarterbacking. So I encourage you to backtest this simple indicator and you will see that I am right. The rule is simple, get out of the market when the 50 day sma crosses over and below the 200 day sma and stay out until the 50 day sma crosses back above the 200 day sma. (see the INDU chart in the chart section above)
This is basic market timing that can be used by utilized by the average “non market” type of person. Those of us who make our living in the market use more in depth, finer point timing mechanisms to take advantage of shorter term swings in the market. But for overall broad market trends, the 50/200 crossover can keep you on the right side of the market. The type of mentality that has been perpetrated upon the hard working people of our country to their detriment angers me. These folks are just trying to make ends meet at the same time trying to help their kids get started, helping elderly parents and hopefully putting aside a little bit to retire on. In the meantime you have some “investment guru” telling you that you can’t time the market. “Just stay in and take a beating.” All the while they are getting paid to give you that advice. It’s shameful.
You might say, “All well and good Robin, but I can’t control my 401K. Yes you can! Most plans have investment choices inside the vehicle that will allow you to switch asset classes between various funds like income, growth, balanced funds, bonds and money market. The strategy is simple. When the 50 day sma crosses below the 200 day sma, switch to money market or bonds and stay there until it crosses back and then move back to equities.
Back to the market, we are due for a bullish move. I believe that most of the continuous bearish movement in the market is due to hedge fund redemptions which I first mentioned several weeks ago in the blog before it hit the headlines. Unfortunately, I think that we could see a major hedge fund or two going up in smoke soon.
From a technical perspective, I believe we could retest the lows from 10/10/2008 and possibly go lower. There will be a point when there will simply be no more selling pressure and stocks that are trading at or below book will just be too attractive to not be purchased. The shorts will begin to cover which will begin the bullish momentum and then others who see the train leaving the station will jump on board in a buying frenzy. It could be a massive move to the upside at that point. The move will not be long term and if you miss the first part you will miss a lot of it.
I am boarding the train early so I can get a seat. Under any circumstance, if you are a long term investor, you will probably not regret buying solid, undervalued best of breed stocks at these levels. However, again I must remind you to do your own due diligence and make your own trading decisions. Always remain within your risk tolerance. I’m the RobinHood Trader and I’m all for you!!
WOW!! Not enough volatility in this market!? Monday posted a record 936 point gain in the DOW on reaction to the G-7 meetings over the weekend. Fear appeared to be waning as the VIX fell from a high of 69 to close at 55.
Tuesday looked like the follow through day that most were hoping for as the DOW opened and traded up to 400 but retraced and spent most of the day flat. It made a charge up to 200 toward the end of the day only to finish down 76 points. The VIX remained steady at 55.
Wednesday we took a freight train downhill to lose 733 points on the DOW which nearly erased the massive gains from Monday. We had some decent earnings reports but they were outweighed by a host of less than stellar economic reports. The VIX took a ride back up to 69 as fear was returned to the market.
Thursday saw a 400 point gain on the DOW amidst lackluster CPI, Jobless Claims and factory numbers. Go figure!? Both George Bush and Warren Buffet had reassuring words on Friday. President Bush recapped the game plan and warned that “It took a while for the credit markets to freeze and it’ going to take a while for them to thaw”. Buffet espoused his well known and much quoted contrarian view to “Buy when others are fearful and sell when others are greedy” in an article in the New York Times. This is great advice but sometimes difficult to execute in the face of such volatility. The DOW closed down a “meager” 127 points as the VIX remained at a very high 67 to 70 closing out the week.
The major indexes had gains for the week which is a very positive sign. The DOW was up 401 points. The SPX moved 41 points to the positive and the COMPQ was 62 points better.
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