Weekend Update – August 7, 2016

In the 57 years since “The Day the Music Died,” the S&P 500 has risen about 3800%

What’s not to like about that?

Among those perishing in that February plane crash was “The Big Bopper” whose signature hit song “Chantilly Lace” was telling the world what he liked. 

While it may be cute when a child gives you that kind of information, not much good is to come when an adult lets free with those unfiltered thoughts.

It may be even worse when they act upon those thoughts that no one needed to hear in the first place.

The Big Bopper’s album cover makes the words of the song even more creepy, but there must have been strains of that admittedly catchy tune playing as investors were awaiting last Friday’s Employment Situation Report.

Of course, as we all know, there is nothing creepy at all about being in love with money or letting it know what you especially like about it.

It was pretty obvious what investors wanted and liked when the data was released and seemed to put a nail into the shockingly low number of new jobs reported back in June 2016.

I don’t know what the equivalent is to the obligatory “chantilly lace” in the song, but the market definitely decided it was time to put a pretty face on the impending likelihood of an interest rate increase.

At one time reviled and probably misunderstood, now the market appears to understand that in the current economic context, a small rate increase is reflective of the early stages of an economy getting on its feet after many years of listlessness.

With a torrent of confusing data and false starts over the past couple of years and after 2 months of wildly diverging employment numbers, not only was it difficult to predict what the latest release would hold, especially after another disappointing GDP, but it was also difficult to predict or gauge the market’s reaction.

But now we know what the markets like, at least for now.

What they like heading into a week that begins quarterly earnings reports from national retailers is the sense of certainty about that interest rate increase that had been expected to occur on a serial basis during the course of 2016.

In hindsight, as good as low interest rates have been and as much as most everyone on the equity side of the equation has liked low rates, most recognized that something bad was obscured by the allure of that chantilly lace.

Sooner or later it’s time to grow up and move on and maybe Friday’s market response to another solid month of employment data was an embrace of a more mature outlook on things.

We’ll never know if The Big Bopper would have found a more mature approach in the pursuit of life’s happiness, but it’s not too likely that the market will be on an extended pursuit of logic and rational actions, despite Friday’s constructive embrace.

Of course, as we do await next Friday’s Retail Sales Report, it would be nice to get some confirmation by the retailers themselves, especially in regard to the guidance they are going to provide.

It’s one thing to make that creepy call and divulge your likes, but it’s an altogether different thing when the one on the other end of the line provides validation.

But it’s still hard to imagine how the FOMC goes forward if retail is lagging behind and there’s scant evidence of consumer participation, even as employment is growing strongly.

Next week, aside from those retail earnings and retail sales data, is going to be a quiet week on the economic front. In fact, not a single Federal Reserve Governor is scheduled to reveal what they like and we will all be spared of those inner thoughts.

That’s something that we could all like, as those are among the thoughts that should be kept to one’s self or solely in the company of consenting adults, who may still have to be prepared for what the chantilly lace has been hiding.

As usual, the week’s potential stock selections are classified as being in the Traditional, Double Dip Dividend, Momentum or “PEE” categories.

With the exception of considering adding some iPath S&P 500 VIX Short Term Futures (VXX), as a purely speculative trade, or even longer term holding, this week is one in which I think some quintessentially American brand names can strike gold without having to risk exposure to Zika or street crime.

Among the names that I might like to buy or add to existing positions are Coach (COH), General Motors (GM) and Starbucks (SBUX).

Coach reports earnings this week, as does its competitor for the hearts of investors, the non-dividend paying Michael Kors (KORS). I recently sold calls on a longstanding lot of Coach shares. While they aren’t underwater, they’re much too close to being so after having been treading water for far too long.  

Following the old axiom of “buy high and sell low,” I bought the existing lot at too high of a price and have held it for more than 2 years. At the time of the purchase, the share price was actually the lowest I had ever paid and so it seemed to be a bargain.

Funny thing about bargains.

The only thing that has made it palatable have been the dividends and the other 19 times I’ve owned shares during a 4 year period.

I often like to sell puts before earnings, as Coach does have a history of large moves, often beyond what the option market had predicted or before earnings.

This time around, though, I’m thinking of adding more shares and selling calls beyond September’s ex-dividend date in anticipation of Coach finally breaking beyond its 2 year highs, as long as the broader market plays along.

Starbucks usually recovers nicely after taking an earnings related hit. It tends to do so when Howard Schultz offers a compelling series of reasons why everyone got things wrong.

This time around, he didn’t need to do that as earnings saw neither a strong move lower or higher. It was only on the following week that some analysts expressed ambivalence over near term prospects and Starbucks shares had about a 5% decline.

I wouldn’t necessarily buy a cup of Starbucks coffee if it was offered at a 5% discount, but having wanted to own shares again following a long hiatus, that 5% may be enough of an enticement.

As with Coach, I’m thinking of using a longer dated expiration date for the sale of calls, although not so long as to encompass the next ex-dividend date.

Also along with Coach, while there are continuing currency considerations, as long as the broader market stays at current levels or higher, there isn’t much reason to expect that Starbucks will do anything less than meet the broader market’s performance.

General Motors hasn’t had a particularly good month and guidance provided by  Ford (F) certainly raises into question that need for the consumer to be in the market for new cars. However, General Motor’s performance has still been admirable, given the headwinds.

To a very large degree, that has been the story of the new General Motors under the leadership of Mary Barra.

There has been so much bad news and yet it has been methodically digested and skillfully managed.

That’s not to say that General Motors shareholders haven’t paid a price, even if only in opportunity costs, but share performance would likely have been far worse in any number of earlier time periods.

As with Coach and Starbucks, my focus is on a longer term option expiration when selling calls. In the General Motors case, there’s an attractive dividend to be factored in before the expiration of the September 2016 contract.

Just as with Coach, that dividend has made the holding of my current lot of shares palatable and may provide some justification for considering a new position as a longer term holding, while trying to accumulate dividends, option premiums and some capital gains on the underlying shares.

Finally, just when I thought volatility couldn’t possibly get any lower, I recalled some similar lines of thought regarding energy prices.

When you’re on the wrong side of the expectation that prices really can’t get any lower you also come to the realization that there really is nothing funny about “bargain prices” that turn out not to be bargains, at all.

One of the things that I like about this product, despite the fact that it is definitely not designed for longer term holding, is that it is very easily traded in the options market and offers many opportunities, even if you’re wrong about its near term direction or magnitude.

At the current level, the premiums for selling covered calls or put options is really enticing and I’m thinking of doing so, but am undecided about thinking about a short term trade or betting that in the longer term there will be some sort of a market correction.

In that case, the sale of a longer term dated, in the money put option, could be a very lucrative trade and serve as some portfolio protection, as well.

The latter has been the predominant way in which I’ve used this product over the past few years, but haven’t exactly shunned the opportunity to generate short term option income, as well.

A number if weeks ago there was a disconnect between the typical relationship between volatility and the S&P 500, in that volatility fell, even as the broader market did, as well.

To many, and in this case, they were correct, that was a harbinger of continued deterioration of the volatility index as  markets would be poised to head higher.

I can’t begin to understand the mechanism, but sometimes pure observation is a great tool if you pull the chantilly lace from in front of your eyes and take a glimpse at the ugliness of the reality straight ahead.

 

Traditional Stocks: General Motors, Starbucks

Momentum Stocks:  iPath S&P 500 VIX Short Term ETN

Double-Dip Dividend: none

Premiums Enhanced by Earnings:  Coach (8/9 AM)

Remember, these are just guidelines for the coming week. The above selections may become actionable – most often coupling a share purchase with call option sales or the sale of covered put contracts – in adjustment to and consideration of market movements. The overriding objective is to create a healthy income stream for the week, with reduction of trading risk.

Weekend Update – July 3, 2016

We often have an odd way of accepting someone’s decision to change their mind.

A change of mind is frequently thought to be a sign of a poorly conceived conviction or a poorly conceived initial position.

Few politicians change their minds because they know that they will be assailed for weakness or for having caved in, as opposed to having given careful and objective thought to a complex topic.

Of course, then there’s also the issue of a politician changing their mind simply for political expediency or political advantage.

That kind of distasteful behavior, although perhaps pragmatic, just stokes our cynicism.

We sometimes get upset at a child’s frequent changes of mind and want to instill some consistency that ultimately stifles ongoing thought and assessment.

At the same time, as parents, we are often faced with alternating opinions as to whether we need to be consistent in application and formulation of the rules we set or whether there should be some ability to make the rules a living entity that is responsive to events and circumstances.

When I was a child, I attended a “Yeshiva,” which is a Jewish version of a parochial school. We were taught to abide by Biblical laws, include the law regarding Kosher foods.

One day, when I was about 10 years old, I found a package of ham in our refrigerator and confronted my mother about the blatant violation of a sacred rule.

Her response was, and I remember it some 50 years later, was “if it tastes good, it’s Kosher.”

Okay, then. There are rules and there are rules that can be changed.

Of course, we completely abhor it when someone changes their mind and moves away from a position that we hold near and dear, while at the same time rejoicing when someone changes an opinion to come over to our side.

Just a few weeks ago Janet Yellen was roundly criticized for changing her tone, as many asked what could possibly have happened in the economy in the intervening weeks to have caused a tangible shift in sentiment and more importantly, policy.

Yet, when it comes to the stock market, we accept incredibly rapid and seismic shifts on a regular basis, as if there had been tangible and readily identifiable reasons for those frequent 180 degree reversals.

Many seeking on air time express their changes of opinion without ever acknowledging their previous opinion. In those cases it’s not really a change unless the viewer remembers the preceding opinion, as the interviewer is rarely going to embarrass a guest or regular contributor.

In hindsight, it is sometimes easy to offer a rationale for sudden changes in direction. However, believing the rationale or believing the claim of identifying the variable at play, may be as delusional as offering the opinion.

The one thing that won’t change is that those hindsight and revisionist pats on the back will never change.

As usual, the week’s potential stock selections are classified as being in the Traditional, Double Dip Dividend, Momentum or “PEE” categories.

A month ago I wrote about one of the available investment tools that tracks “volatility.” When discussing the potential use of iPath S&P 500 VIX Short Term Futures ETN (VXX), it was in the context of the then upcoming FOMC announcement.

As the short term trade as which it was intended, that timing was fortuitous. However, if held onto or rolled over in an effort to milk even more of the rich premium, it would not have been very fortuitous as that trade really did end along with the FOMC announcement.

The reversal of volatility was a reflection of the suddenness with which change comes to investor sentiment.

The performance of the Volatility Index at the end of last week and the every beginning of this week had lots of people confused as the typically expected association between a declining market and an increasing measure of volatility broke down, especially during those periods that large declines were reduced heading into the close.

When that does happen and it happens infrequently, it is very often a sign of a real reversal ahead and that is certainly what we saw as the market completely changed its mind when the opening bell rang on Tuesday.

With volatility again at 2 year lows, there can be reason to believe that we are at an inflection point as the market may attempt to test its handful of resistance levels below its all time closing high.

But that inflection point can also bring a move in the opposite direction, as those points are a perfect place to teeter and either catapult or plunge.

With good liquidity and an always provocative premium, even an adverse movement can be played by rolling over to a longer term expiration. I almost always prefer initiating a position through the sale of put options.

Another potential opportunity could have come heading into the “Brexit” vote, but both the outcome of the vote and the response to the result were so unpredictable, that I didn’t consider its use at that time.

But that’s ancient history by now and more predictable opportunity may again be here.

With earnings season ready to begin just a week from now, the equation must again be mindful of the kind of havoc or opportunity that can be created when a penny here or a penny there comes as a surprise.

The real surprises ahead may be related to forward guidance, as we can begin expecting lots of companies to begin moaning about the potential impact of the “Brexit” vote and currency exchange hardships.

At a time when very few companies have been winning fans over on the basis of their earnings the next few months can be especially challenging and I’m wary of selecting positions with a short term mindset if that short term crosses the date of earnings reporting.

In the case of MetLife (MET) that means almost a month before the risk of earnings is added to the continuing risk associated with plummeting interest rates.

If you could somehow go back in time to when the FOMC announced a small interest rate increase in December 2016, you would probably have a really hard time finding anyone who would have believed that 6 months later we would not have had another or even two increases and that the 10 Year Treasury would be offering a 1.46% yield.

What you would have found, as those yields went lower and lower, was that even the relative hawks within the Federal Reserve were squawking less and less as they changed their minds about where the future was going to take the US economy.

While General Electric (GE) recently lost its “Systemically Important” label and shackles by virtue of shedding significant financial assets, MetLife did it the old fashioned way.

They litigated in order to prevent such a designation and won in its battle.

It’s hard, however, to make a case that MetLife shares were rewarded in any way relative to their peers or the S&P 500 since having won that battle.

It’s that under-performance and that enhanced premium that have me interested in adding shares.

With earnings scheduled for August 3, 2016 and an as of yet unannounced ex-dividend date. Traditionally, the ex-dividend date is the same or following day of earnings, except for the 2nd Quarter report. There has typically been a one week lag when 2nd Quarter earnings are announced.

In this case, if a purchase of MetLife shares is warranted, I would consider the sale of a longer term call option, such as the August 19, 2016 and would also give strong consideration to the use of out of the money strikes, as opposed to the shorter term and near the money or in the money strikes.

While I still suffer with a much more expensive lot of Marathon Oil (MRO), that suffering has been attenuated a little bit in 2016 as I’ve now owned new shares on 4 occasions as it has been a repository of volatility.

That’s meant that it has had a really enhanced option premium as it has gone back and forth, changing its mind along the best of the undecided.

In doing so, its path has been higher and higher in 2016, yet those large moves have kept the premiums at very, very attractive levels.

After another assignment this past week, I would very much like to go for a fifth round of ownership, although this time, I think that I’m more inclined to consider the sale of out of the money put options, rather than the buy/writes that I had been doing.

I reserve the right to change my mind, though.

With West Texas Intermediate having fallen from and then rebounded back to the $50 level, Marathon Oil has followed suit and there isn’t too much reason to believe that the near term will bring an assault on the $47 level.

However, if it does, there is sufficient liquidity in the put market to be able to rollover those puts, although this is a position that I would also consider owning outright if faced with assignment of shares.

For those dealing with smaller lots the transaction costs differential between rolling over puts versus taking assignment and then writing calls may be a factor.

In either event, earnings are upcoming on August 3, 2016 and if owning shares or still short puts, I would likely consider utilizing an expiration date a little further out in order to withstand any possible large decline, but to also give an opportunity to secure the dividend, as paltry as it may currently be.

Finally, while the correlation between falling oil prices and rising airline prices has long ago withered and while there may not be much reason to suspect any sustained oil price decline, I’m ready to add more airline shares.

As with Marathon Oil, I still suffer from holding a much more expensive lot of shares of United Continental Holdings (UAL).

At the moment, it’s really hard to see anything positive at all, about the business.

Currency pressures, increasing fuel prices, worries over international travel are enough to include in a single sentence. However, as United Continental rebounds from its 2 year lows, I think that the slew of bad news and lowered expectations are mostly discounted.

Since United Continental does not offer a dividend and has been exceptionally volatile of late, this is one position that I would consider only through the sale of puts at this time. With that, however, you do have to be aware that earnings will be reported in just 2 weeks, so if still short those puts heading into earnings, there may be good reason to limit downside risk by rolling over the position to a date far enough into the future to allow some reasonable recovery time.

That time may be longer than anticipated, however, as my current lot of shares sits uncovered and had previously sold options with expirations 3 or more months into the future.

My actuary tells me that I may not live to regret that, so I do take some comfort in that knowledge.

Hopefully, he won’t change his mind.

Traditional Stocks: MetLife

Momentum Stocks: iPath S&P 500 VIX Short Term Futures ETN, Marathon Oil, United Continental Holdings

Double-Dip Dividend: none

Premiums Enhanced by Earnings: none

Remember, these are just guidelines for the coming week. The above selections may become actionable – most often coupling a share purchase with call option sales or the sale of covered put contracts – in adjustment to and consideration of market movements. The overriding objective is to create a healthy income stream for the week, with reduction of trading risk.

Weekend Update – May 29, 2016

We’ve all been part of one of those really disingenuous hugs.

Whether on the giving or the receiving side, you just know that there’s nothing really good coming out of it and somehow everyone ends up feeling dirty and cheapened.

Every now and then someone on the receiving end of one of those disingenuous hugs believes it’s the real thing and they are led down the wrong path or become oblivious to what is really going on.

This week the market gave a warm embrace and hug to the notion that the FOMC might actually be announcing an interest rate hike as early as its June 2016 meeting.

The chances of that even being a possibility was slight, at the very best, just 2 or 3 weeks ago. Since then, however, there has been more and more hawkish talk coming even from the doves.

The message being sent out right now is that the FOMC is like a hammer that sees everything as a nail. In that sense, every bit of economic news justifies tapping on the brakes.

Traditionally, those brakes were there to slow down an economy that was heating up and would then lead to inflation.

Inflation was once evil, but now we recognize that there are shades of grey and maybe even Charles Manson had some good qualities.

With the market’s deep hug of affection the S&P 500 ended the week 2.3% higher, seemingly sending the message that investors had grown up a lot in the past week or so and were now able to realize that another small increase in the interest rate was a reflection of an improving economy.

That should be good for everyone, right? 

Hugs all around.

So before anyone gets too giddy, it may be worthwhile to look at that last embrace that the market gave when it suspected that an interest rate hike was imminent.

That was in December 2015.

The market started to act in a mature fashion in what would turn out to be 5 days in advance of the FOMC’s December 16th announcement.

click to enlarge)

Maybe in what is best an example of “buy on the rumor and sell on the news,” the market started a swoon that was far in excess of the climb.

The first 6 weeks of 2016 were as bad as the first 6 weeks of any preceding year.

In the nearly 4 months since the market’s post-interest rate increase correction, we are left barely 1.5% away from the S&P 500’s all time high level.

Whether the FOMC’s read on the economy is correct or not, having now made that embrace, the market is likely at some kind of an inflection point heading into the June meeting.

I’m not entirely convinced that the hug this week was entirely disingenuous, after all, what were the other choices left to investors?

Continue following oil for the wrong reasons?

As usual, the week’s potential stock selections are classified as being in the Traditional, Double Dip Dividend, Momentum or “PEE” categories.

In the “Comments” section of  last week’s article a reader asked about my opinion on iPath S&P 500 VIX Short Term Futures ETN (VXX).

I’ve scanned my computer for malware to see if he had been reading my draft for this week. I think that malware may have placed the “Charles Manson” reference earlier.

For those that do look at volatility and various volatility instruments, there can be lots of risk and potentially reward in being on the correct side of a bet.

A bet. Not an investment.

In this case, there is simply the question of where the market is going and in how big of a leap and bound.

I think that the next leg is lower, although that next leg may not start for another few weeks.

However, I generally like to consider the use of iPath S&P 500 VIX Short Term Futures ETN in advance of those moves.

In a very superficial explanation, the volatility, which is a measure of uncertainty, generally moves lower when the market heads higher and reverses course as the market reverses course.

“The VIX” is now at a 2 year low after having hit a nearly 1 year high on February 11, 2016. If you believe in coincidences, that happened to be the market low point for 2016.

What “The VIX” really offers, as a result of its own volatility is an attractive option premium, whether buying shares of the ETN and then selling calls, or selling puts. It also tends to have great liquidity, which is especially important if faced with a move that goes counter to your expectation.

At this level, with an expectation that the market could be heading lower on a “sell on the news” reaction, I would expect “The VIX” to head higher.

If buying shares and selling calls, I might consider using the June 2016 expiration, while I might use the weekly expiration if selling puts. In the latter case, I would be prepared to rollover those puts if faced with assignment and then might elect to do so using that same monthly expiration date.

As long as I’m considering a bet, this may also be a good time to add some shares of Las Vegas Sands (LVS) to my existing shares that are in deep loss territory.

It’s hard to know what Las Vegas Sands really has going for it, as the story for the past few years has been entirely focused on Macau and Sheldon Adelson’s politics.

What has kept me holding shares has been the dividend and the belief that there will be either a reversal of fortune in the long term in Macau or official Chinese government economic data will give an impression of a resurging economy in the short term.

With an ex-dividend date coming up on the first day of the July 2016 monthly option cycle, my preference would be to steer clear of the long term and hope for some short term reward.

With the appearance of some base forming at its current level, I might be interested in buying shares and selling either an extended weekly call on a date after the ex-dividend date or simply going to the July 2016 monthly option contract.

In the years that I have been offering this weekly take, I’ve never included a stock position that I had absolutely no intention of buying, but this week, I do like Bank of America (BAC).

I like it for the obvious reasons.

As long as the market continues embracing the idea that an interest rate increase is a good thing, then financial sector stocks may be a reasonable place to park money.

In Bank of America’s case, it is also ex-dividend this week. However, instead of considering selling an in the money weekly option in an effort to get some of the dividend subsidized by the option buyer, I would rather try to get some stock appreciation and the dividend, in addition to the option premium.

The reason I won’t be buying shares is that I already own 3 lots and I trade with a particular set of rules. One of those rules is that I not hold more than 3 lots of any stock.

Someday I may fine tune that to give me some more flexibility, but as long as it is still a rule, I follow it and try to stay away from making decisions on the fly.

Finally, I never like Abercrombie and Fitch (ANF) as anything other than a chance to make, hopefully, a quick trade.

Often times, that’s not how it works out for me, but I insist on going back for me, over and over again.

This time, it’s hard to ignore the steep decline after earnings. That’s true, despite the fact that a steep decline after earnings shouldn’t be anything exceptional when it comes to Abercrombie and Fitch.

What attracts me to it is that it is back below the last price that I purchased shares and also happens to be ex-dividend this week.

For my temperament, that’s a good combination when faced with the “hot mess” that Abercrombie and Fitch shares have been for quite some time.

The option market clearly has low expectations for Abercrombie and Fitch this week as the in the money call premium, in what is a holiday shortened week, is really very high, particularly with the dividend factored into the equation.

Can those shares go substantially lower?

If you don’t know the very probable answer to that question, this is one stock and call sale you should avoid, just as Abercrombie and Fitch did strive to avoid a certain “uncool” demographic.

That demographic certainly included me and maybe nearly everyone i have ever known and that turned out to be a problem when your accountant doesn’t really care where the money is coming from.

But I hold no grudge as those shares, beaten down as they are, may offer a reward far in excess of the slight that Abercrombie and Fitch cast toward my people.

Maybe it’s time for that mutually rewarding embrace.

 

Traditional Stocks: none

Momentum Stocks: iPath S&P 500 VIX Short Term Futures ETN, Las Vegas Sands

Double-Dip Dividend: Abercrombie and Fitch (6/1 $0.20), Bank of America (6/1 $0.05)

Premiums Enhanced by Earnings: none

Remember, these are just guidelines for the coming week. The above selections may become actionable – most often coupling a share purchase with call option sales or the sale of covered put contracts – in adjustment to and consideration of market movements. The overriding objective is to create a healthy income stream for the week, with reduction of trading risk.