The Money Tree

Safely Generating Income in Retirement

OTM NP Strategy – MAR Week 3

Posted by mounddweller on February 25, 2011

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

4 Responses to “OTM NP Strategy – MAR Week 3”

  1. Dieter said

    Hello Troy,
    As a new comer to you site I do not wish to impose my opinion to the choice of NP but like to follow your selection with a small comment.
    LO Looking at the chart daily and weekly the stock broke through the 200 and 50 MA as well touching the 20 day MA. I have learned to select short put options
    a. only if you like to own the stock but more important,
    b. I learned to sell puts OTM only if the stock shows an uptrend not if the stock is breaking down through all MA. At LO we still do not know if the stock has reached a support level.
    I must however admit that you choice of a 65 strike is extreme low and even if they bring a total ban an cigarettes, they possible last for 30 days.
    RMBS. A very lively stock but the choice of strike 18 looks good, especially the stock shows an uptrend on Friday. Interesting to note, the stock dropped over 2.00 in six days.
    RVBD The stock traded on 1/25 still at 32.15. Just a bit more than a month ago. So we do not know where the stock will be in an other 30 days. However I do not consider .33 cents as a high premium with a delta of -.08. Mostly the outlook on the stock is positive.

  2. mounddweller said

    Dieter,

    I welcome all constructive comments. Your’s certainly qualify in that regard. I don’t disagree with any of your insights regarding these three trades. However, keep in mind this strategy is based solely on two factors, (1) the amount of down-side protection (DSP) relative to the number of weeks until expiration, and (2) the Put Factor (PF).

    The Put Factor is a proprietary indicator developed by Ron Groenke, inventor of the VISIONS CC and NP software. It gives you a standardized way of correlating and scoring the following variables: time to expiration, put premium, and the relationship between the current stock price and the strike price. You can read more about it on page 38 of Ron’s book, “Show Me the Money”.

    I devised this strategy using two assumptions (1) I need more DSP to compensate me for the risk associated with longer holding periods, and (2) the higher the PF the greater the amount of premium I am receiving relative to the amount of risk I am assuming.

    Thus far, the strategy has proven effective. Over 85% of the NP trades that pass my filter end up expiring OTM, regardless of how bad the company looks fundamentally or how bad their stock chart looks from a technical perspective.

    Again, thanks for sharing your insights. Keep them coming. I like hearing from other folks. It’s a good way to learn other techniques and gain an appreciation of how others are making me in the market.

    Regards,
    Troy

  3. […] Only one caught my eye.  That is Lorrilard (LO).  LO is a company that I’ve written about previously.  It is a very old tobacco company.  It specializes in menthol flavored cigarettes.  You can read more about it in my original write-up from a few months ago here: https://troysmoneytree.wordpress.com/2011/02/25/otm-np-strategy-mar-week-3/ […]

  4. […] RVBD: https://troysmoneytree.wordpress.com/2011/02/25/otm-np-strategy-mar-week-3/ […]

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