OTM NP Strategy – MAR Week 3

Fellow Traders,

Well, a little bit of excitement this week, huh?  Hope everyone was able to find a trade or two with the uptick in volatility.  Unfortunately, I did not.  I had several I was keeping my eye on but either never got filled or didn’t pull the trigger.  Anyway, enough about the past.  This post is all about the future, what looks good in the coming week for our Deep OTM NP Strategy.  Below are the selections for this week.

The first thing I hope you notice is that we actually had a large-cap stock meet our selection criteria.  It’s been quite some time since this last occured.  Lorillard (LO) is a tobacco company.  More about it later as it is my pick of the week.  Two other stocks caught my eye this week as well.  They are  Rambus (RMBS), a semiconductor company, and Riverbed Technology (RVBD) which manufacturers networking and communications equipment.

Now back to Lorillard (LO).   It, through its subsidiaries, engages in the manufacture and sale of cigarettes in the United States. The company offers 41 different product offerings under the Newport, Kent, True, Maverick, Old Gold, and Max brand names. It sells its products primarily to wholesale distributors, who in turn service retail outlets, chain store organizations, and government agencies, including the United States Armed Forces. The company was founded in 1760 and is based in Greensboro, North Carolina.

Did you catch that?  The company has been around since 1760!  Over 250 years!  If we get caught having to accept assignment I don’t think we have to worry about it going out of business.  Now, how did such a conservative, well managed company happen to pass our screens?  Glad you asked.  Lorillard and one of its competitors, RJ Reynolds, are suing the FDA  seeking to block consideration of an imminent advisory panel report that could recommend a ban on menthol-flavored cigarettes.  The advisory panels recommendation is due to be released on March 23 (note: this is after option expiration on 3/19).  Menthol flavored cigarettes constitute a very large chunk of LO’s revenue.  Hence, the recent drop in price (see chart below) and the increased option premiums.

I don’t think we have to worry about the FDA pulling mentholated cigarettes off the market.  According to Euromonitor International, mentholated cigarettes make up roughly 30 percent of U.S. annual cigarette sales ($83 billion).  Does it seem reasonable to you that the government will let this tax generating cash cow go the way of the Dodo bird.  Not likely!

As you can see from the graphic above the recommend strike price for the LO naked put trade is $65.  That’s over $5 below the 52-wk low of $70.24.  The MAR $65 put closed today at $0.98 bid, a ROIC of 1.51% with over 17% DSP. 

Next up is Rambus (RMBS).  Rambus Inc. designs, develops, and licenses chip interface technologies and architectures that are used in digital electronics products.  It sold off sharply earlier this week dropping almost 10% before bouncing back strongly on Friday.  The 52-wk low is $16.76, and our strike is at $18.  Rambus has already announced 4th quarter earnings so you won’t have that hanging over your heads.  Here’s the 1-year chart:

The last pick to catch my eye this week is Riverbed Technology (RVBD).   It provides solutions to the fundamental problems of wide-area distributed computing in the United States and internationally.   You don’t have to worry about earnings with it either as it announced it’s 4th quarter results back on 1/28.  The put we’re interested in is the MAR $32.50.  You’ll notice it is almost 23% below Friday’s closing price of  $41.79.  My cursory glance through the headlines could find no reason for the high premium on a put that is so far OTM.  If anyone has any insights, please share them by posting a comment below.  Here’s the chart for RVBD:

One final note for this week.  I want to put in a plug for my investing buddy, Patrick.  I use his search engine to find our selections each week.  Check out his site at http://www.mtrig.com/.   Note: I am not compensated in any way for recommending his site.

Regards,

Troy

HGT – A conservative, repeatable, CC trade

All,

I wanted to share with you a trade that has worked out quite well for me.  It is unlike any other trade that I’ve previously shared with you.  As my headline states, in my mind it is a conservative, repeatable way to generate monthly cash flow.  I have executed this trade twice in the past 10 months.

The trade involves a natural gas royalty trust, Hugoton Royalty Trust (HGT).   Hugoton Royalty Trust operates as an express trust in the United States. It holds a 80% net profits interests in certain natural gas producing working interest properties of XTO Energy Inc. XTO Energy Inc. engages in the production and sale of oil and gas, and holds working interests in the Hugoton area, which covers Texas, Oklahoma, and Kansas; the Anadarko Basin of western Oklahoma; and the Green River Basin located in southwestern Wyoming. Hugoton Royalty Trust was founded in 1998 and is based in Dallas, Texas.  HGT makes monthly distributions to its share holders based on the net profits referenced above.

The basic elements of my trade are as follows:

(1) Buy the stock

(2) Sell the nearest price call 4-6 months out

(3) Collect the dividends

(4) Have HGT called away at expiration

(5) Repeat

Below are the details from my two previous rounds of making this trade.  For a conservative play, I think the returns are excellent.

For my third round in this trade I intend to do a buy/write on 500 shares, selling the AUG $22.50 calls which closed Friday at $0.55 bid.

Regards,

Troy

FEB Expiration – Results

Fellow Traders,

Just a quick post to update everyone on my trades that closed at expiration on Friday.  I had a number of NP trades  that closed OTM.  They are as follows:

As you can see one mistake can do a heck of a lot of damage to what otherwise was a good month.  So, lesson learned.  STICK TO YOUR GAMEPLAN!

Regards,

Troy

DLB – the Obituary

Fellow Traders,

As promised, I am posting the final results of my ill timed NP trade in Dolby Labs (DLB).  You’ll recall on 2/7 I STO 2 FEB $55 puts at $0.55.  I closed out the position 8 days later having suffered a small loss of money and a huge amount of self-esteem.  Mr. Market always has a way of putting us in our place.  On 2/15 I BTC my 2 FEB $55 puts at $3.50.  Net loss, including all commissions, fees, and expenses was $610.94.  I won’t spend anymore time repeating why I initially entered the position or my mistakes.  You can read about those here: https://troysmoneytree.wordpress.com/2011/02/13/np-trade-dlb/. 

Best of luck to all in your upcoming trades.  I would suggest “strapping your self in” and tightening your stop-losses.  I suspect the ride is going to get a lot bumpier from here.

Regards,

Troy

Deep OTM NP Strategy – MAR Week 4

Fellow Traders,

Below is the list of potential trades meeting our Week 4 criteria.  You’ll recall the Week 4 criteria are as follows:

(1) Downside Protection (DSP) >= 17.5%

(2) Put Factor (PF) > 2.0

Twenty-seven options met our criteria.  However, it is easy to see we may be approaching a top in the mark as none of the underlying stocks in the options presented are fundamentally strong.  I would procede with caution.  Consequently I do not have a favorite pick this week.

Best of luck to all of you in your trading this week.

Regards,

Troy

Deep OTM NP Strategy – February Results

Fellow Traders,

February results are in for our Deep OTM NP Strategy.  Overall our results were slightly better than those experienced in January.

This month we had 56 trades in our strategy to choose from.  After the market close on Friday (2/18), 50 of them closed OTM.  That’s a success rate of 89.3%.  I feel good about the “win rate” especially considering we are in the middle of earnings season.  Five of the six trades that finished ITM were the result of poor earnings releases.  The sixth, LPHI is a “special situation” as it is embroiled in a class action lawsuit.

Had you chosen to sell puts (using the capital allocation plan I outlined in an earlier post) on all 56 selected trades this month it would have required a capital balance of $423,600.  Remember, this assumes you are trading in a tax-advantaged retirement account which does not allow the use of margin.   Doing so would have generated total premiums of $6,136.05 (net of commissions).  This equates to a 1.45% ROIC, which is 18.23% annualized.

How did the losers impact our results?  Glad you asked.  We had 6 trades that finished ITM.  On Monday we will have to purchase these 6 stocks.  They are ENTR, LPHI, CHTP, SWIR, TKLC, and OMX.  Assuming we did nothing to mitigate our losses by either (1) buying to close the puts at the first sign of trouble, or (2) holding the stock after assignment and possibly selling CCs against it, our total capital losses (based on Friday’s closing prices) would equal $5,763.70.  The net result (premiums plus capital losses) would be a very small gain of $372.35.

However, once again (like last month) on most of the trades we had an opportunity to cut our losses at the first sign of trouble  and could have ended the month with a more substantial gain had we proactively managed the trades.  Let’s look at each of the six losers and see what our best course of action might have been.

ENTR:  We sold 10 FEB $10 puts at $0.20 back on 01/21/2011 when the stock was trading at $12.26.  It closed Friday at $9.65.  This leaves us with a capital loss of $0.35/share or $350.00 on 10 contracts.  However, we had plently of time to recognize the trade was in trouble and could have avoided the loss by not holding the contract to expiration.  The stock has steadily moved lower over the past few weeks.  On Tuesday, February 15th it finally closed below our $10 strike price.   Alternatively, we could have chosen to take assignment and hold the shares until they get back above $10.  It’s not unreasonable to assume this could occur over the course of the next week.  We could also accept assignment and immediately sell the MAR $10 calls which today closed at $0.50 bid.  Doing so would give us a cost basis of $9.30.

LPHI:  This was one of our biggest losers ($1,918.95).  However, it could have been easily avoided.  You’ll recall LPHI was one of our losing trades last month as well.  Common sense (which isn’t always so common) hopefully would have kept us from executing another trade in this stock.  As I mentioned earlier the company is facing a class-action lawsuit and allegations of fraud. 

CHTP:  On 1/30/2011 we sold 10 FEB $5.00 puts at $0.25.  CHTP was trading at $5.96.  Friday it closed at $4.32.  CHTP gapped down on 2/2/2011 closing at $5.02.  It then hovered around our $5.00 strike price for several days before resuming its fall again earlier this week.  Clearly the best course of action here would have been to close out the trade at a small loss after it failed to recover from its gap down on February 2nd.

SWIR:  On 2/4/2011, with the stock at $14.30, we sold 5 FEB $12.50 puts at $0.15.  On Friday the stock closed at $11.11.  On February 9th after announcing earnings it gapped down closing at $11.45.  There really wasn’t a good way to avoid this loss.  However, we could have slightly lessened the size of the loss by buying to close our puts when the stock gapped down on 2/9.

TKLC: On 2/4/2011 we sold 10 FEB $10 puts at $0.15.  The stock was at $11.58.  On February 10th it gapped down closing at $8.36.  Once again the culprit was a bad earnings release.  This was our biggest loser ($1,928.95).  I have egg on my face with this one as it was my favorite pick back on February 4th.  I still like the stock though.  It has zero debt, substantial cash reserves in the bank and now trades at less than book value.

OMX:  We sold 5 FEB $15 puts at $0.15 back on 2/13/2011 when the stock was trading at $17.00.  It closed Friday at $14.69.  This leaves us with a capital loss of $0.31/share or $163.95 on 5 contracts.   Like most of our other losers it gapped down earlier this week after announcing earnings.  Given the closing price of $14.69  the best course of action would seem to be accept assignment and immediately sell the MAR $15 calls which today closed at $0.50 bid.  Doing so would give us a cost basis of $14.35.

Well, there you have it my friends.  I’ll be back later this weekend with another post to announce the first round of March selections in our Deep OTM NP Strategy.  I’d be interested in hearing if anyone selected any of the picks from my strategy in February.  If you’d like please post your results as a comment to this message.

Regards,

Troy

Other Trades from the Week of Feb. 7-11, 2011

Fellow Traders,

Wanted to update you on a couple other trades I made this past week.   First up is XOM.  I opened my position in XOM just over a year ago.  My goal was to accumulate 400 shares with the intent to hold them long-term and periodically sell CCs against them.  My goal remains the same but I chose to exit the XOM position for the time being since XOM has moved up significantly in the past several months.

On Wednesday, I BTC my JAN ’12 $65 put for $1.74.  I made $252 (3.89%) on this specific trade in exactly 3 months.  My annualized return worked out to 15.41%.  In just over a year I made a profit of $1,922.25 in XOM.  This was accomplished using a combination of NPs, taking assignment, selling CCs, being assigned, and selling more NPs.  On average I would say I had around $13K committed to the position throughout the year so that would give me an overall return of better than 14%.  Not bad for a blue-chip stock like XOM.  I will look to get back into XOM if it falls back below $70.  Below is a complete history of my trades in XOM.

My other trade this week was in CSCO.  CSCO fell sharply after reporting disappointing earnings.  Actually it was there operating margin which caused all the fuss.  CSCO falling sharply after reporting earnings is becoming a rather common occurence.  It happened last quarter and I took advantage of it by selling OTM NPs.  I did the same this quarter.   On Thursday, I STO 5 MAR $18 puts at $0.21.  My ROIC with 36 days to expiration is 1.17%.

OK, that’s it.  Three posts in one day is my limit.  Best of luck to everyone this week.  I’ll be back next week with another round of Deep OTM puts for your consideration.

Regards,

Troy

NP Trade – DLB

Fellow Traders,

Wanted to update you on a trade I made this past Monday (2/7/2011).  I had a busy week so wasn’t able to get it posted sooner.  Not to worry though, after reading this post you’ll be glad you missed it!

This trade is a perfect example of what happens when you abandon your rules and start flying by the seat of your pants.  This trade didn’t come from either my VISIONS trading strategy or my Deep OTM NP Strategy.  

DLB came to my attention as a selection in one of the several newsletters to which I subscribe.  The author of that newsletter thought they would come out with good earnings and resume their climb higher.  Shortly after the new year they had fallen from around $67 down to $60.  On this past Monday I noticed they were at $56.50, having fallen sharply after reporting earnings the previous Friday and the FEB $55 put was selling for $0.55.  At the time it looked to me that the stock had found a bottom and would not fall much further.  Looking at the chart below you can see this wasn’t the case.  The stock continued to fall all week long before finally catching a bid on Friday, closing up $0.06.

So  here’s where I stand on this trade.  I sold the FEB $55 put at $0.55.  Thus, my break-even price is $54.45.  Friday, the stock closed at $53.80.  It is currently sitting right at support levels it established back in late August.  I am going to watch the position closely this week.  If it fails to hold at this support level I am going to buy back the puts at a loss and chalk it up as a lesson learned.  If the stock remains flat or begins to recover slightly I will probably roll the FEB puts out to MAR.

Now, let’s get to the real purpose of why I posted this trade.  I wanted to share with you why I think this trade is not working out.

(1) First and foremost, I didn’t follow my trading strategy.  I did something on a whim.

(2) I didn’t look close enough at the support levels.  Had I did I would have seen the stock had the potential to fall below my chosen strike price.

(3) I didn’t look at what my options (no pun intended) would be if the trade moved against me.  DLB option strike prices are in $5 increments.  I don’t have a lot of flexibility going forward if I choose to stay in this trade.

(4) Last, but not least, I let my desire to achieve a certain level of monthly option premium income cloud my judgement.  This caused me to miss or ignore some of the things I referenced above.

I’ll let you know how it all turns out when I close out the trade.

Regards,

Troy

Deep OTM NP Strategy – FEB Week 1

Fellow Traders,

Well, here we are just one week remaining until FEB expiration.  Before we get to the selection’s for this week I want to comment briefly on my favorite selection from last week.  You’ll recall my favorite last week was Tekelec (TKLC).  I liked it because it was cheap and had lots of cash on its balance sheet.  However, you’ll recall I cautioned that it was due to release earnings.  Well, earnings came out and they were not to the street’s liking.  The stock fell sharply, 28.7% to be exact.  It now is well below our $10 strike price, closing Friday at $8.55.  It is also now trading at less than book value.  Given it’s large cash hoard I don’t think it will remain below book value for long.  If it does someone is going to come along and buy it, lock, stock, and barrel.

If you sold the TKLC FEB $10 puts I would hold off doing anything until we get closer to expiration on Friday.  On Friday if it remains < $9 (book value is $8.96) I would roll the FEB $10 puts out to MAR.  If it bounces back above $9.50 I would accept assignment and sell the $10 calls on the following Monday.

Now, let’s look at the selections for this week.

Two stocks caught my eye this week, Sketchers (SKX) and La-Z-Boy (LXB).  They have a lot of similarities.  Both are retail stocks, one sells shoes and the other furniture.  Both are rated TA (i.e., “take action”) in VISIONS.  Both trade around 1.2 times book value.  Both have positive net cash.  SKX has over $4.50/share of net cash (over 20% of its market cap.)  And, unfortunately, both have earnings releases this week.  LZB reports Tuesday and SKX on Wednesday.

If I had to choose one over the other I think I’d go with SKX.  I like the one-year price chart on it a little better than LZB. 

One final comment.  If you didn’t sell puts on STEC last week, put them back on your list of potentials for this week.  Last week the $20 put looked nice, this week the $19 strike looks a little better.  It has a ROIC of 1.3% with 20.13% DSP.  However, remember it too reports earnings this week.  Anything is possible.

Best of luck in your trades this week.

Regards,

Troy

MRK – New NP Trade

Fellow Traders,

I executed a new naked put trade today on Merck (MRK).  Specifically, I STO 4 MAR $31 puts at $0.35.  Merck is a large multi-national pharmaceutical company that has fallen out of favor since its late 2009 purchase of the Schering-Plough Corporation.   As you can see in the below one year chart, MRK has been range bound for several months.  Roughly it has been trading between $34 and $37.50.    It recently broke to the downside of this range, however it’s 52-wk low is $30.70.  Thus, I think selling the MAR $31 puts is a fairly low risk trade.  If assigned, my net cost will be $30.65, just below the 52-wk low and I will own a stock with a dividend yield of 4.96%.

One additional reason I executed this trade, look at the money flow indicator.  It bounced off a severely oversold level of 20 just a few days ago.  That leads me to believe that by March expiration Merck will have rebounded back into its trading range.  Only time will tell if I’m right.

Best of luck to all my trading buddies.

Regards,

Troy