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Weekend Trend Spotting and Virtual Portfolio Management

What a wild last 30 day's we've had! 

I'm going to do a little bit of charting today so we don't miss out on the next potential Meatball Market (where bad news "just doesn't matter") as we get past earnings season without any serious dings.  Of course, like Icarus, they higher we go, the further we have to fall, especially when we're getting there on wax wings but part of our fundamental outlook is looking at market sentiment along with the motives, means and opportunity of the manipulators

The Fed threw a little monkey-wrench into the works Thursday with a surprise rate move but the market was amazingly unphased and, as you'll notice on the chart below, we are neatly repeating the same move we saw in early November, when we waited 400 points for the correction that never came – until January 20th of course!  This week, we took a few pokes at short plays and got burned and we went into the weekend a little bearish but mostly neutral.  Our Buy List is off to the races, of course and only 2 of our 42 trade ideas there (AGNC and DF) are off course – I had meant to do an update this week but there's no point! 

We don't pay much attention to the Buy List in our daily posts or even in chat because those trades do their job with very little fuss.  Ideally, the bulk of your virtual portfolio should be made up of boring, low-touch trades that make nice, consistent returns and THAT allows us to have fun with our more aggressive short-term plays that do demand our regular attention.  Someone asked me about allocation the other day and I said that, generally, I feel 75% should be in long-term, well-hedged positions like the ones on our Buy List while the other 25% should be used for more opportunistic trading and, generally, we rarely stray from keeping 1/2 of that in cash to remain flexible. 

Of our aggressive virtual portfolio, we try to keep our allocations to no more than 10% of our cash on new positions (which means the more trades you make, the less you put into the next trade) and limit our losses to 20% of a full position or 2% of that virtual portfolio MAX.  2% of 25% is 0.5% of the total virtual portfolio.  If our Buy/Write Virtual Portfolio is on track, then 75% of our capital is making at least 2% a month in a nice, steady manner while we can have FUN with the rest.  I spend a lot of time trying to talk new members OUT of gambling so I think it's important to remind folks, once in a while, why our Virtual Portfolio Tab has our latest Buy List on it and not a bunch of day trades

In a crazy, choppy market like this one, we do a lot of day trading and short-term trading and, as you can see from the the Weekly Wrap-Up, those can be very profitable.  But do not confuse gambling, which is what short-term trading is, with investing.  Investing is studying stocks and finding ones you want to be in for the long-haul.  Investing is identifying value and having a plan to build a position in winning stocks over time.  Our current Buy List began Thanksgiving weekend, when we decided we were ready for another leg up and, on updates, we highlight which of the 42 make the best current entries. 

On our 2/6 update, we were not liking AGNC or DF.  My comment to Members on AGNC was " Best to see if they pull back a little now but totally great if you are in them from last time."  Our original entry was at $26.20 on 11/24 and they have since paid a $1.40 dividend (12/29).  I thought the Q4 earnings were very good and the company's main concern was that their borrowers would pre-pay their mortgages, forcing them to roll over to new loans.  I do still like them at $24.80 and we can sell the September $25 puts and calls for $4.70 to lower the basis to $20.10 and, if AGNC is below $25 at September expiration, we have another round put to us at $25, for an average entry of $22.55, which is 9% less than the stock is now.  If we get called away at $25, it's a 25% profit plus, in either case, the bonus of the anticipated $1.40 dividend at the end of March and May.  If all goes well, we will "roll" the contracts we sold out to longer dates, allowing us to collect the September dividend while continuing to lower our basis.  

How do we balance our long-term position in AGNC?  Aside from the options we sold to hedge our position, we can also utilize our short-term virtual portfolio to make offsetting trades.  Last week we made a short-term trade shorting IYR and this week we went back in on some SRS.  Not every trader makes every trade but, if your main virtual portfolio has AGNC and other real estate plays – then a short-term opportunity to profit from a dip in CRE is ideal.  The vulnerabilities of your long-term virtual portfolio should guide your betting in your short-term virtual portfolio!

Now, there is a more aggressive way to play AGNC for a new entry.  We can buy the Sept $22.50 calls for $2.55 and sell the Sept $25 calls for $1.10, which is a net $1.45 entry on the $2.50 spread, which gives us a potential payoff of $250 for each $145 invested (72%).  Of course, if AGNC falls below $22.50 at September expiration, we end up with nothing for our troubles – that's why these plays are gambling!  If you are not sure, a good rule of thumb is A) Investing doesn't pay you 72% in 6 months and B) If you are not buying a tangible asset, you are gambling. 

"Hey Phil", you may ask, "are you good enough to turn this gamble into an investment?"  Of course I am!  This is what PSW is all about – TEACHING our Members to fish…  Here's a simple idea for this trade – take the above spread and it's 72% upside potential and add to it the naked sale of the Sept $22.50 puts at $2.  That changes our basis from a $1.45 debit to a .55 credit and reduces our break/even on the trade from $23.95 ($22.50 + $1.45) to $21.95 ($22.50 – .55), an 11% improvement!  Now your profit on the play is $3.05 at $25, or $305 for your cash commitment of -.55 and your margin requirement (on TOS – always check with your broker) of $460.  So, roughly a 75% return on cash + margin in 6 months and your worst-case scenario is you have AGNC put to you at net $21.95 (11.5% below the current price) on Sept 17th (expiration day), just 2 weeks before collecting (hopefully) a $1.40 dividend. 

Do you see the difference between gambling and investing?  We're making a commitment to own AGNC in the more complicated spread but they didn't make our Buy List for no reason – we WANT to own them long-term and this is a nice, mellow way to test the waters for an initial entry.  If we follow good practices of scaling into a position, we're only going to allocate, at most, 50% of a full position (which is, at most 10% of cash) to our initial entry.  Let's say a 10% allocation was $10,000.  That means we're going to normally allocate $2,500 to this entry but, since we're opting not to do a buy/write, where we purchase the stock in round one, we can commit to a 2x purchase at $21.95.  That means we buy 2 bull call spreads and sell 2 puts. 

With $4,390 (if 200 shares are put to us) allocated to this entry, we use a grand total of $810 in margin for the first 6 months while the rest is unused cash in our virtual portfolio, giving us useful margin flexibility in other trades.  If all goes well, we make $610 (2x $305), which is 75% off margin and 13.8% against our committed level.  That's in 6 months!  If 75% of your virtual portfolio is in nice, mellow trades like this – you can see how we can afford to have fun with the other 25%… 

The key to managing your virtual portfolio with option entries like this is you make as much money as you would if you bought the stock BUT and it's a BIG BUT (which I like) you still have 80% of your commitment in cash.  So, IF the market goes the wrong way, you have that $4,200 of cash ready willing and able to go with the flow, whether you cash out the long trade or not.  If you know your virtual portfolio and are clear on your allocations and balance, then it's relatively easy to slap on an ETF cover to slam your virtual portfolio into neutral to ride out an event or even tip it the other way and profit from the move against you.  Once the bottom is found, those downside momentum profits can be used to dollar cost average into your "losing" long trades.   

I say long because we are generally long on the markets now (hence the huge Buy List) but we do expect a rocky year and it always pays to be prepared.  For the most part, we set up our Buy List to make about 10% per quarter unless the market drops more than 10% – that helps us ride out most negative moves and, over the years, we push our basis so low on the longer-term positions that we no longer care about their current price – just about how much they will make us selling calls each month and/or paying dividends each quarter. 

Notice how our recent pullback coincides with the low Fibonacci chart (the one that assumes 12,000 is the market top) rather than the extended version that TA people use as they tend to assume the Dow's move to 14,000 was "real" even though it was based on Trillions of dollars worth of accounting shenanigans.  I prefer to throw out bad data – like the data that told us the world was ending between Nov '08 and March '09.  I feel confident doing this as it turns out the world is still here but do forgive me if that doesn't mean I'm going to jump on that 14,000 bandwagon either

Adjusting Dean Foods

DF, our second miss from the Buy List, is another one we soured on to the point they didn't make the 2/6 write-up.   When I first picked them on 12/21, they were looking steady but we went cautious with a Jan buy/write that gave us a net entry of $13.43/15.42 by selling the Jan $17.50 puts and calls.  Another trade we looked at was the Jan $12.50s at $5.50, selling the same $17.50 puts and calls for $4.20 for net $1.20 on the spread.  I had soured on DF as they were on the wrong side of our 2010 investing premise outlined in "A Tale of Two Economies" as they are one of those companies caught in the squeeze – trying to sell to the impoverished bottom 90% of American society while suffering themselves from rising commodity prices. 

Still their nasty 2/10 drop off gives us a good chance to discuss adjustments for when you are in a trade like that and the stock suddenly drops 20%.  Step 1 is "do we still like the stock?"  That's a funny question because I wasn't liking them at $18 on 2/6 but I like them better now at $14.63.  As I say to Members, it's like buying jeans on the discount rack – sure they have a small tear but for 20% off I can live with it…  DF lowered their guidance for the year by 5% and the stock fell 20%.   Meanwhile, we are now within $3 of their spike low of Nov '08 and they were $22 last summer so, not a terrible stock for the price.

In the buy/write position at $13.43/15.42 – the question is, do we think they can recover to $17.50 by January?  While our break-even is $15.42 on this trade and we are at $14.63, it's still a good idea to see if adjustments can be made.  The Jan $17.50 calls have fallen to .80 while the $17.50 puts have gone up to $3.60 – not a big change in the total (was $4.20) but the underlying stock fell from $17.68 to $14.63 so a net loss of 24% ($3.25/$13.43) on the trade.  If we are scaling in and have a 1x position here – then it's a 24% loss on 2.5% (max) or 0.6% so cutting and running is sensible if we can't come up with a more attractive plan

The two main adjustments to stick with a trade like this are to either adjust the targets or stay aggressive and DD.  Since I'm not very confident in DF at the moment, I'd rather lower our targets and that's surprisingly easy as the Jan $17.50 put and call combo is $4.40 and the Jan $12.50 puts and calls are $4.  Rolling the short straddle down $5 adds .40 to our basis but, of course, drops our put-to price so we move from net $13.43/15.42 to net $13.83/13.17 – a bit more comfortable with the stock at $14.63.  We'll assume we can add stock or roll our callers longer if DF recovers but there's no reason to Double Down here, at $14.63 as DF does not pay a dividend.  If you are really gung-ho to own 2x on the stock, you can simply sell the 2012 $12.50 puts for $2, which means you will eventually DD at net $10.50 and that would put you (assuming you are assigned in Jan at $13.17) in 4x at an average of $11.84. 

This is not a terrible outcome for a stock you began scaling into 12/21 at $17.68 with an allocation of 4x (say 400 shares at $7,072) and in Jan 2012 you end up with 400 shares x $11.59 for $4,636 – that's 34% off in 2 years!  If you had bought all of your long-term holdings for 34% off would you be doing better in your virtual portfolio?  These are calculation you should do BEFORE entering any kind of long-term position.  If you are NOT willing, ready and able to follow your initial entry through to it's logical downside conclusion – why would you buy the first entry at such a high price?

Now Let's Apply That Logic to New Purchases

I like VLO at $17.89 and I will LOVE VLO at $11.80 (34% off) if someone is foolish enough to sell it to me for that price.  In fact, If I were to allocate the same $7,000 we have in the DF example to VLO and I ended up with 400 shares of VLO for $4,720, I already know I would be happy to do yet another buy/write and "risk" having another 400 shares put to me for another 20% off (9.44), which would give me 800 shares of VLO for an average of $10.62 or $8,496.  At that point, I can project that I'd get about the same premium at TSO ($12.23) commands now and the May $13 calls can be sold for .75.  If I can sell May $11 VLO calls for .75 off my $10.62 basis then I'm collecting $600 PER QUARTER off my $8,496 investment or 28% a year until I'm unlucky enough to get called away.  Keep in mind this is our "worst case" scenario for the stock (assuming nothing catastrophic, of course). 

VLO hasn't spiked as low at $13.49 in '08 and there are no guarantees but if you keep working your way into blue-chip positions like this, you can build up a hell of a virtual portfolio from all the "losers" over the years!  When we're scaling in we're generally disappointed if the market takes off on us as we don't get the opportunity to build our positions cheaply and we have to "settle" for our quick 10-20% gains on 1/4 positions.  Since I KNOW that's how much I like VLO it sort of makes buying the stock for $17.89 and selling the Jan $17.50 puts and calls for $4.75 for a net entry of $12.75/15.13 sort of a no-brainer as an entry for a 1x position, doesn't it?  Just like in chess, once you get used to looking 3 or more moves ahead, spotting good current opportunities on the board becomes a lot easier! 

Also note that this is a fairly aggressive buy/write entry on a stock we really like.  All VLO has to do between now and January is hold $17.50 and we make the spread between $12.75 and $17.50, which is $4.75 or 37% of $12.75.  Going back to our above note – making 37% in one year is GAMBLING, not investing!  As a 1/4 scale on a stock you really love, you can be forgiven for a little gamble but consider that you can buy the stock for the same $17.89 and sell the Jan $15 puts and calls for $5.20 for net $12.69/13.84. 

What that adjustment does is lower your upside potential to $2.31, still a reasonable 9.7% but it also lowers your potential 2x entry by 10% and now you make that 9.7% if VLO holds $15 through Jan (down 16%) vs POSSIBLY making 37% as long as VLO doesn't go down at all with profits occuring between $15.13 and $17.50.  Many things come into play here:  Our overall market outlook, how correlated we think the stock is, where we are in our scale (we take less chances as we get more committed) and, of course, how we feel about the fundamentals going forward.  In the case of VLO, 37% in the bush does seem to be worth risking 9.7% in the hand…

BUT (another big but), if you don't work through these calculations BEFORE you enter a trade, if you don't develop a trading plan for up, down or neutral markets – then you are doomed to be "surprised" every time your positions move on you.  In the above trades I've outlines – we're pretty much HAPPY whether our stock goes up, down OR stays put BECAUSE WE HAVE A PLAN to make a profit in each direction.  Since 40 of our 42 Member selections from the Buy List ARE working and right on track to make 10-20% - you can see how we have plenty of time to get into deep detail on the 2 that aren't! 

Worth the Risk?

Despite the bullish-looking chart action noted above – we still have some serious economic headwinds to contend with so I continue to favor not only allocating the bulk of the virtual portfolio to buy/write type plays (see original "How To Buy Stocks For A 15-20% Discount" for overall strategy) that pay 10-20% on a flatline or even with a 10% cushion as described above but I continue to advocate disaster hedges (just reviewed in the Weekly Wrap-Up) - just in case

By giving ourselves 15-20% downside protection built into our bullish stock plays and adding another 10% downside protection by allocating 10% of the virtual portfolio to disaster hedges that give us at least a double if the market dips just 10%, we are able to ride out a drop all the way from 10,000 back to 7,000 while staying about even.  As we learned last year (and the year before) having cash at the market bottom can make for some excellent trading opportunities (the Karn Evil 9 school of investing) and we are not out of the scary woods yet so we'd rather take some fairly conservative overall returns unitl (if ever) things calm down. 

We'll feel better if our bounce levels (pretty much where we finished the week) start acting like support but I'm thinking we consolidate within 2.5% of our 5% lines (Dow 10,165, S&P 1,088, Nas 2,200, NYSE 7,000 and RUT 620) all the way through next earnings at which point we will either be seeing positive jobs numbers or looking for nice, self-sustaining tropical islands to move to.  In fact, the NY Times this weekend noted that millions of people face years of continued unemployment and 2.7M people will run out of benefits by April unless our gridlocked Congress approves another extension

Our state and local governments are feeling the strain ($134Bn in projected budget deficits) from supporting 18M (the real number) unemployed people and their families at the same time their tax base is dwindling and overall, the economy is in a state of DEflation, not inflation which does not bode well for a rapid return to former market glory despite what the commodity pits would have you believe.  China tightened twice as much 2 Friday's ago as our Fed did last Thursday and John Mauldin reminds us that we're not done worrying about Europe just yet

Despite Obama's plan to funnel $1.5Bn of foreclosure relief into the market this year, January saw a record drop in the median price of existing home sales in Orlando of 14%.  14%!!!  If you thought you have seen the bottom in housing prices – think again as the banks have been driving prices lower as they dump the properties that have been dumped on them, possibly trying to get ahead of the end of the Fed's support programs or possibly something to do with January as our previous record fall in housing prices came last January so we'll be very concerned if February doesn't show a big improvement.

Our indexes still have a lot to prove so let's watch those red lines (200 dmas) with the Hang Seng looking like our weakest indicator at the critical 20,200 mark (declining 50 dma) with the Transports (1,925), the DAX (5,750) and the NYSE (7,100) all having something to prove if we're going to buy into this global rally story:

What kind of rally can it be if we are not making progress on the Nikkei (10,400), the BSE (16,500) or the Baltic Dry Index (3,000).  After all, if the commodity pushers want us to believe that prices should be back near last year's highs – why wouldn't shipping rates be at least 2/3 of last year's highs – or, is it pure speculation driving these markets with no actual demand for physical product delivery???  We do have several shippers on our Buy List – just in case

Keep in mind that our economy is being driven by stories about how great things are in China and India and India and China are being driven by stories about how great things are here while the Europeans are told how great things are in Asia AND America even though they themselves are miserable and we are told we're very lucky not to be in Europe, where socialism is really screwing things up (although somehow Communism is the engine of global growth?), especially that nasty health care system that gives them, on average, a 5% longer life expectancy than us (but you spend those extra years waiting in line at the doctor's office is the official GOP joke).

So, whether we are worried about too much safety net bankrupting Europe or not enough safety net creating a nation of Joe Stacks over here, it does pay to remain cautious until we start seeing firm support above those red lines across the board


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  1.  Phil
    Working in tech I like ORCL long term, I like the Sun acquisition, (as much for MySql as anything else). and am in the Jan 15′s now half covered by the Mar 24′s – but don’t mind getting a bit more aggressive. I think they’re rangebound for a while. Any suggestions?

  2. Phil, you state above--, "over the years, we push our basis so low on the longer-term positions that we no longer care about their current price – just about how much they will make us selling calls each month." So are we shorting straddles just when we want to accumulate the stock long term? Or do we indeed short straddles even in our long term stock positions to collect theta? Perhaps a simple question, but I reallly need to solidify my understanding of your strategy. Thanks in advance.

  3. I meant SELL theta.

  4. jburgess:
    Let me take a stab at this. If you have a long position – say either through owning the stock or a longer-term long call – and you sell both front-month puts and calls – it is because you’re willing to increase your long position if your putter is assigned. Generally, you don’t want to sell puts unless you’re happy with the consequences of assignment.
    If you sell only calls against your long position and the stock trends down over several months, you’re going to keep all the premium you got from your callers, and that tends to lower your basis in your longs quite significantly over time on a downtrending stock. The long then becomes a means whereby you’re generating significant income through premium selling.
    An example is VLO. I still have 2011 calls I sold last spring when VLO was in the 20s. Since then the stock has generally stayed lower with several periods of prolonged downtrends. My continual selling of front-month calls has made what I paid for those long calls immaterial.

  5. Phil, This article and the weekly wrap up were really great-- good pieces. The weekly wrap up reminded me about a theoretical question on scaling that as a 3 month member know I still really need some help on. How do you know when the right time to make that 2nd or 3rd scale into a position when that position is doing well (but where near "cash-in" level eg- 20-25% up), or is at least around break-even?  I have a few positions from your buy list, and over the last several weeks the 1st scale ins are in decent shape, despite the pull back we had. So when it is time to deploy more capital?  I know we should be patient, especially with 2011/2012 LEAPS spreads. But that said, are there any rules of thumb we can apply? 

  6. Chaps:  Thanks for the response. I understand the premise of selling time value against long position, it’s just that one time I asked Phil about how to deal with a long position in PM and his response was… do what you are supposed to do, sell the x put and sell x call for $$. So I thought perhaps we are to collect premium on both, and adjust in the future IF NEEDED.

  7.  Phil
    Also – how about a spread on NTRI – Buying the Jun 17.5′s, selling the Jun 20c, selling the 17.5 puts, net .10 credit on a $2.5 spread that’s already in the money (assuming I’ve done the math properly). I don’t think the weight loss biz will ever go away!

  8. jburgess:
    If you sell both puts and calls, you collect premium on both. But when you sell the call, it’s hedged by your long position. In contrast, selling the put increases your long exposure. A downturn makes both your long and your short put move against you. So, IMO, it’s something you generally do if you’re inclined to add to your position – or if you’ve got some other hedge somewhere against this double exposure.
    If you don’t want assignment, you can DD or "roll out and down." But the issue in my mind is that you still have doubled your long exposure – so there’s simply that inherent risk if all you’re looking to do is collect premium and not increase your long exposure.

  9. ORCL/Deano – If you want to be more aggressive, roll out to 2x the 2012 $20s at $6.20 (+$3) and sell 1x the $25s at $3.40 to get that money back and PRESTO, you now have another year to sell the same number of open calls and you collect the same $20 (2x $10) at $25 that you would with the 2011 $15s and you have the same naked upside above that on your uncovered half.  Now, if you want to get more aggressive than that you can either add a few 2012 $20s or subtract a few 2012 $25s and either way you have more uncapped calls to sell against (I would full selll March $25s if they hit $1 though – the naked half that is!) and you can always sell 10 June $21 puts for .45 which TOS tells me nets out to $2,085 in margin to make $450 as long as you REALLY want 1,000 shares at net $20.55 (or at least you are willing to roll along).  That’s a nice, mellow way to be more agressive without being silly.  After all, they are up 100% since last March!  If ORCL does drop again, the roll from the $25s to the $20s is $2.75 so if you offer $2.75 to roll down the next $5 on the next dip – that’s another way to play it aggressively. 

    Long-term/Jbur – What Chaps said for sure!  Also, see what I just said about ORCL.  As long as you REALLY don’t mind owning more of the stock, then sure, sell puts but think of it this way.  Let’s say you have 200 ORCL at $24.32 (4,864) and it’s 5% of your portfolio and you sell the June $24 puts and calls for $2.85 for net $21.47/22.74.  That’s knocked your basis down about 10% in 4 months.  Assuming 1/2 of your sales go this well and the other half wash out over 3 years, you’ll still knock 60% more off in 12 attempts so let’s say you end up at roughly $10/20 because, at that point, you are selling $30 puts and calls each quarter but your basis is down to $10.  ORCL may still be 5% of your portfolio at $6,000 but your basis is down to $10.  Probably there will be a point when you don’t REALLY want to buy another round of ORCL at $30 or more, considering your base is $10.  Since you can still get $1 a month for selling out of the money calls you may want to start just selling the calls. 

    If just one of your 10 long-term trades a year works out this well, then after 10 years you can have 10 5% positions that you are in for less than 1/3 of their current value so say you have a $50,000 basis on $150,000 worth of stock that’s paying you $5,000 a month in premium sales.  The other 80% of your portfolio would just keep grinding it out and every year, if you can add just one more winner to your "retirement collection" well, I’m sure you get the idea.  This all goes back to "The Man Who Planted Trees" school of investing.  It’s very hard to sit here today and think that if you work a dozen trades and make 20% for the year and only end up with one keeper that hits the mark and doesn’t get called away and doesn’t go too low – that that’s a great year – BUT IT IS!   Do it for 40 years and you’ll have 40 of them.  After a while, you’ll be like one of those old people who has 100 original shares of IBM in their closet from 1948 and it’s now worth $8M…

    It’s funny, I just went to the mall (PACKED by the way!  Riverside Square in NJ, couldn’t get a space, upscale mall, huge lines at CAKE from 2pm until 5:30 when I left) and there was on of those investment advisors there from a real firm (I forget which) that had crappy whiteboard signs that said GET 8% RETURNS!  How?  Buy their REITs, which pay 8% dividends but only if you lock in for 3 years and if you cash out early you forfeit a year.  I said why would I do that when I can buy REITs in the market and he says "Oh, you can’t trust the market, you never know if it will go up or down on you."  I said so your REIT is guaranteed not to go down and he said "No, but it’s not publicly traded so it’s better."  I said but if I buy REIT stocks I can sell options against them to hedge or I can collar them to prevent losses or I can offset with SRS or short IYR and I can withdraw my money any time with no penalty at all and he said "You seem like a smart investor - why don’t you come to our seminar and we’ll show you how good these REITs are." 

    I said no thanks and then he says "How about tax-free municipal bonds that pay 5%?  You can’t go wrong with those!"  And I said did you know there are municipalities declaring chapter 9 and he said "Oh not the ones we buy."  I mean geez, this guy is a "certified financial planner" - It’s just frightening! 

    Scaling/Bord – Generally, I’ll want to see either a pullback of 20% of more so I can DCA down, especially from a 1/4 entry and, to the upside, I’m looking for "good" behavior so if we are still under a 20% gain and I’ve knocked my basis down about 20% after maybe 3 months (especially after another earnings) then I may decide it’s time to double up.  Keep in mind these are LONG-term plays and we are talking months out of YEARS of intended ownerhsip.  In the above ORCL example, my initial buy is $21.47/22.74 off a $24.32 base so if it drops, I KNOW I’m in 2x at around $22.74 (maybe we roll or adjust) so that’s my decision done for me there.  

    If we flatline, then that’s Ka-ching as we’re collecting our 13% a quarter so if that works 2 quarters in a row and my basis is down to $19/22 (because we’re still selling $25 puts and calls, with the stock around $25) and I’m still in 1x I can just buy more at $25 which will raise my basis to $22/23.50 on 2x OR I can get more aggressive and sell the $26 puts for an extra $1 which would change my 1x net to $19/22.50, sort of daring them to put it to me but happy to collect an extra buck (5%) per quarter if they keep steadily going up. 

    If we head up fast, of course you may get called away with a profit but let’s say we enter the ORCL trade at $21.47/22.74 (sold the $25s) and it jams up to $26 and looks to be breaking higher.  If I don’t want to be called away I can add 1x at $26 with a stop at $25.50.  Since I make $3.53 if called away, my 1x basis would be $22.47 with ORCL over $26 on the 1x that did not get called away.  Of course, I could just sell more puts or roll the puts higher if I intend to go 2x.  If ORCL falls back and I stop out at $25.50, the .50 loss would only change my 1x basis to $21.97/22.99 so it’s not risky, really.  

    Of course if we have the 2x position at $22.47 avg and we have 1/2 covered with $25 calls at, say $2.50 – then it’s no big deal at all to roll them along to the Sept $27.50s at $1 or so each and, of course, we can still sell puts.   Lots of flexibility is the key to scaling in but the key is to make decisions based on goals – not the current movement.  If ORCL went up to $27 now, I’d have to seriously consider if it was getting too far ahead of itself (as I said above, if I can get $1 for the March $25s, I’d take it).  Each month, you have to evaluate positions.  If doubling up on a 1x is a better use of your money than buying something new that hasn’t already moved up – then do that but it’s all very situational, not the kind of thing you can have hard rules about…

    PM/JBur – As above, it’s always situational.  It also depends on WHY you are in THAT position.  PM is a dividend payer ORCL is not (well, just 1%) so that changes your goals as it’s more worthwhile to own PM stock than ORCL so you may want to be more aggressive with the puts from a 1x position as it’s costing you 5% a year NOT to have the stock.   Another consideration with dividend payers is they often have awful call premium but good put premium as the distributions tend to tank the stock so lots of arbitrage goes on on the put side.  

    NTRI/Deano – I like them a lot and they are getting reasonable again as we lost interest once they passed $25.  This should be their last rough Q.  I agree with your entry as it’s a nice way to play the upside and fine to have it put to you at net $17.40 but I’d be willing to go more aggressive with the Sept $17.50/22.50 bull call spread at $2.40, selling the $17.50 puts for $2.20 for net .25 on the entry to make $5 to the upside with the risk of assignment at $17.75 as the b/e is just .35 higher with the extra $2.50 of upside

  10. Phil and Chaps, thanks much,, really helps clarify the issue. Have a good weekend.

  11. Phil, any thoughts on RHT (RedHat)

  12. Phil / REIT / Munis / Financial Planner :  The salesmen are just getting started.  Here’s a NYTimes piece quoting a guy whose pimping REITs as well.  Does that make the NYT a pimp?  That financial planner you spoke with, was he in a kiosk?, sounded more like a timeshare or car salesman. 
    This guy in the article is saying that dividend growth from REITs is going to go double digit in 2011.  I say, the last extraction of wealth from the middle class has begun..

  13. Thank you Phil, this helps

  14. Hi Phil, a while back I put on a rut spread which is negative $1, the moment.
    I bot the March 600 put and sld the March 590 put for a debit of 2.52, 10x . 
    How would you handle it? Thanks, Phil

  15. Phil, Great read.
    What is it about VLO that you like so much ?

  16. Phil, Please put this article into the Strategy or Beginner section (or both!)
    Great learning material for everybody!

  17. RHT/Foss – They are too speculative for me.  Conceptually, Linux is nice and all but the reality is free software doesn’t catch on in our media-conditioned world.  Open Office is great, for example, costs $395 less than MS Office and does everything you need.  How many people use it?   I was surprised that RHAT didn’t catch a big upsurge in the past 18 months, as things got tight but it seems that companies cutting back on IT are in no particular mood to swich platforms – even if it does save money.   Of course I always have trouble paying $5.5Bn for a company that make $75M a year.  I liked RHAT when they went on sale in ’08 but not at the all-time highs…. 

    If you do want to start a bullish position on them, I’d sell the March $30 puts for $1.55 and buy the Jan $22.50 puts for $1.45 to cover so you get a net .10 credit (and, if you REALLY want to own some for net $28.45 then you can do a small ratio spread for a bigger credit, maybe 5:3 so you collect $775 and spend $435 for a $340 credit and, if things go the wrong way, you can roll to the Sept $25 puts, which are now $1.45 and add a couple of Jan puts to even things out.  That’s a nice way to play for positive earnings without over-committing. 

    NYT/Matt – Well they gets their checks from those REITs don’t they?  Double digit dividend growth – does that mean going from 7% to 7.7%?  I won’t be holding my breath…  If America had 95% employment and we fit in 100% of the office space – what is the long-term effect of having 90% employment?  Unless Americans have gotten 5% fatter (very possible), it seems like we would need 5% less space and, with companies cutting back wherever possible and outsourced employees generally working in shifts of 3 people to each chair a long way away from where Boston Properties gets a rent check – I just find it hard to get all excited about REITS.  Are we opening new malls?  Are we adding auto dealerships?  Are we putting up new restaurants?  Are companies adding office space?  Maybe, maybe more people are moving into apartments but, other than that, WTF is the premise for REITs doing well?  It’s crazy…

    RUT/Phlit – Those trades suck you know.  The least flexible trades you can make are short verticals like that – you have more flexibility just buying a put or selling a call if you want to be bearish.   I’d say either sell your puts for $5.70 and hope the $590 putters expire worthless (7% out of the money and you can always roll them), which will net you a $3.18 profit or roll out to a June vertical with a $2.50 ish spread if you want to keep playing for a sell-off.  If you are going to play those trades, you must stop out with a 20-25% loss unless you can adjust right there because, with the tight delta differential – the trade has to be going pretty badly for you to be losing 20%.  You could also scrap the trade entirely and go with a sale of 20 IWM March $61 puts at .80 ($1,600) and buy 20 May $60 puts at $1.95 ($3,900) and play the time decay game to get your $1,600 back.  They have about the same delta so you shouldn’t get burned to the downside and, if you want to stay bearish on the RUT, it’s a more flexible way to play it for not too much more money. 

    VLO/DK – I like them because they dominate the space and they are a very well-run company.  They get squeezed when oil goes up and gas stays flat but, over time, they always find a way to get back to profits and profits were $5Bn in ’06 and ’07 for a company with a current market cap of $10Bn.  Sales are actually up 20% over that time so it’s not about their revenues – just about the crack spread, which comes and goes and right now you are catching them at the worst crack spreads in decades but, if you plan to own them for decades, not only are they great on the rebound in the spreads but they also make a great long-term inflation hedge.  Don’t forget – competition is VERY limited as the only thing people want less of in their backyard than Nuclear Reactors is a new Refinery! 

    Sections/Cwan – I’ll post it under Education, which newbies are supposed to read through anyway.