EOT Position Update – August 13, 2008

| August 13, 2008

August 13, 2008

Market Snapshot

The Dow Jones Industrial Average just closed at 11,532.  We had a huge rally early in the week.  Then we gave it all back over the last two days.  This week is options expiration for August, so I’m expecting some added volatility.  Also we’re entering vacation season.  It’s well known that most of the big money managers take at least a few days off in August.  This leads to lower volumes and some interesting market swings.

The big news this week.

Russia invaded Georgia . . . and nobody cares.

JP Morgan posted a loss of $1.5 billion on mortgage backed securities.  Since they were seen as the strongest company in the banking herd the entire industry traded down in sympathy.  This news followed Wachovia’s bigger than expected loss due to auction rate securities.

AIG announced even more write downs . . . this time a mere $5 billion.

The US Dollar has shown some amazing strength over the last week.  The currency has rallied against most other currencies, some by as much as 10%.  This may hurt international exports of the larger companies.

Despite the Dollar rally, US Consumers are starting to hold their money tight.  Wal-Mart announced lower than expected same store sales. . . .  Not a good omen for the US economy.  No doubt adding to the concern was the US jobless rate holding steady at a 6 year high.

Now for the trade updates.

Position Updates

 CSCO January 2009 $27.50 Calls (CYQAY)
We just announced the CSCO trade this week.  The stock’s traded flat over the last few days so everybody should have been able to establish a position.  Support is at $22.50 and $21.  Resistance will be at $27 and $28.75.

  CLHB January 2009 $95 Calls (QPBAS)
We’ve seen a nice move this week in the CLHB stock.  Today it traded above $80 for the first time since the earnings announcement.  Resistance will be found near $85 and $90.  Support will be at $72 and $68.

  ROST November 2008 $42.50 Calls (REQKT)
ROST climbed above $40 again intraday on Monday.  News that same store sales were up 4% pushed the stock higher.  Not bad considering Wal-Mart can’t even hold sales steady.  The stock is now bouncing off its 50 day moving average.  Resistance is 40 and 45.  Support levels are 34 and 31.50.

Parting Shots…

Subscriber Questions:   Brian, why do you pick options that are several months out into the future?  Why not buy options that are closer to today?  Aren’t we expecting a quick move in these stocks?

Great question.

Let me see if I can help clear up some misconceptions.  When we identify a particular company for a trade we do lots of research.  We look at everything from their fundamental results, future news events, recent price action, and the prices of options.  We look at a lot more stuff . . . but I don’t want to bore you.

Once we’ve identified a stock to trade, we evaluate a range of different options on that stock.  One important factor is each option’s valuation.  Its important that we don’t overpay for the option.  That’s a recipe for disaster.

When we look at options we’re looking at several different factors.  Some indicators are very technical . . . and some are gut calls.  Trading options is just as much an Art as it is a Science.

We’re seeking out value not only in the stock but the option as well.  So that’s one of the first things we look at.  We don’t want to overpay for an option.

So why select options that are several months or longer in time value?

Options that are several months out can be more expensive.  But these options hold up better against the biggest destroyer of option value . . . time decay.  With each passing day, the expiration date draws nearer and a little more time value is lost.  Furthermore, time decay accelerates in the last few weeks before expiration.

That’s why you’ll see professional traders selling short-term options.  As an option approaches expiration it starts losing value very quickly.  It makes sense as the likelihood of a stock ending above or below the strike price at expiration is much easier to determine.  By selecting longer term options, we can limit the speed of time decay.

An additional benefit is that our fundamental analysis has more time to kick in and impact the stock.  Sometimes we see a trade developing but we don’t know exactly when we’ll get the move.

Remember the United Airlines puts we bought?  They traded flat for a while. Then the fundamentals started kicking in.  We started seeing more and more airlines announce bad news.  This ripple effect pushed the stock down, and the value of our put option up significantly.  If we hadn’t given the trade time to develop we’d have lost money instead of booking a gain of more than 200%!

I hope that helps.

Category: EOT Update

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