Stop and take a break.
I’ve been doing just that, taking a break, for about the past 5 years, but sometimes I think that I’m working harder than ever.
Lately, however, I don’t feel as if I’m on a forward path so it may be time to do exactly what the Chinese stock markets did last week and what the US stock markets are doing this coming week.
They both took some time off and perhaps it was timed to perfection. After a 42% decline in Shanghai in less than 10 weeks and a 10% drop in the S&P 500 in 6 weeks, it was definitely time to take a breather and smell the dying flowers.
China took a couple of days off for celebrations ostensibly commemorating the end of World War II. While doing so they may also have wanted to show the nation and the world just how together they have things and just how much in control they really are at a time when the image is becoming otherwise.
After all, if the Faustian Bargain in place can no longer deliver on the promise of a higher standard of living, the message of an all powerful government has to be reinforced, lest people think they can opt out of the deal and choose democracy instead.
Equally ostensibly, guided by environmental concerns and the health of its citizens, the Chinese government decided to have factories in and around Beijing closed for the days preceding the festivities in order to help clear the air a bit, but only in a non-metaphorical kind of way. The literal and figurative haze is far too thick for cosmetic actions to change anything.
Unfortunately, what we may be coming to realize is that the Chinese economic miracle we’ve come to admire may be the actual culprit for all of that pollution, through its extensive use of smoke and mirrors.
While taking some time off it’s not entirely clear whether any other “malicious short sellers” are disappearing from view and being prevented from polluting trading markets or whether arrests and detentions are also taking a much needed holiday.
Here in the United States we celebrate Labor Day by not working, rather than working extra hard and we rarely send anyone to prison for accelerating the process that leads to a financial slide.
As long as people are beginning to make comparisons between the current market correction that seems to be related to China’s market meltdown and our own financial meltdown of the past decade, it only seems appropriate to note that the key difference between our nations in that regard is that Countrywide CEO Angelo Mozilo could never have gotten a natural suntan in Beijing.
He also wouldn’t have ever seen the light of day, even it such a thing was possible through all of that haze, again after suddenly disappearing on a less than voluntary basis.
In the United States Labor Day comes every year, but a 70th anniversary celebration of the end of World War II comes but once and it may not have come as a better time, as the world is wondering just what is going on in China.
Putting the brakes on the ever-present haze and lung clogging air for a couple of days won’t make much difference and so far, neither have efforts to control market forces. Both have lots of momentum behind them and are likely to remain recalcitrant in the near term, even to the most totalitarian of governments.
When it comes to managing the economy we may be at the tip of the iceberg in terms of realizing that no one really knows what’s going on and just how accurately the modern miracle has been portrayed. But that’s the usual situation when smoke and mirrors are in place and the stakes so high.
While the Chinese markets were closed a little bit of calm overtook US markets, as there was some evidence with the release of the ADP Employment Report that bad news was again being interpreted as being good, insofar as it could delay interest rate hikes from the FOMC.
The subsequent fading of any meaningful rally to offset large losses earlier in the week was disappointing, but it was the good news and bad news nature of the Employment Situation Report that sent markets tumbling without any help from China.
The good news that was interpreted as being bad and, therefore, making a rate hike more likely at the next FOMC meeting was that the unemployment rate fell to 5.1% even in the face of mildly disappointing growth in employment and wage stagnation.
Even dusting off twice removed Federal Reserve Chairman Alan Greenspan to appropriately comment that there’s no logical reason to fear a small rate increase did nothing to re-introduce rational thought into those engaged in indiscriminate selling.
Ending the week with a large loss was bad enough. But doing so and being left behind the eight ball more than usual this week as the Shanghai market re-opens for business on Sunday makes this weekend more uncertain than usual. With Labor Day serving as an additional day to be handcuffed as passive observers we stand to have China once again put us in a position of reaction, rather than leading the world with its most vibrant and sustainable economy.
So, while I really welcome, want and need the day off on Monday for more reasons than usual, I can’t wait for Tuesday.
That makes about as much sense as everything else these days.
As usual, the week’s potential stock selections are classified as being in the Traditional, Double Dip Dividend, Momentum or “PEE” categories.
“Buying on the dip” hasn’t been as prevalent as in the past during what turned out to be a series of mini-corrections, as we’ve watched the market head into correction, then out of correction, back in and out again. For some reason, though, I’ve been a little more active in adding new positions than I would have expected at the beginning of each of the past few weeks, in the belief some price levels truly represented opportunities.
Most of that interest in buying has been dividend driven and this week is definitely one that is likely to continue that trend if I can justify the faith necessary to add any new positions.
With the exception of Best Buy (BBY) which had a very nice week as the S&P 500 fell by over 3% and Altria (MO), which matched the index for its poor performance, the remaining selections going ex-dividend this week all badly trailed the S&P 500 last week.
That’s not exactly the basis for a strong recommendation, but with the exception of BHP Billiton (BHP), it may be difficult to find a really good reason for such under-performance.
Not that it’s much consolation, however, all but BHP Billiton have actually out-performed the S&P 500 since its top, although Best Buy is the only one to have actually appreciated in share value.
Some of the potential selections, such as Altria (MO) and Merck (MRK) haven’t been very attractive “Double Dip Dividend” selections for quite a while. In a low volatility environment in the context of a relatively large premium essentially spanning the distance from one $0.50 strike level to the next, there has been very little subsidy of the dividend by the option premium and those stocks were much more likely to be assigned early if in the money.
However, the volatility induced increase in premiums is beginning to make even these high yielders that also have large dividends in absolute terms more and more worthy of consideration.
In a week that pharmaceutical companies struggled to keep up with the S&P 500 I do like the potential trades, specifically to attempt to capture dividends and option premiums in Merck and Gilead (GILD). In both cases, that’s being considered without regard to issues of pipeline.
Due to the increased market volatility their premiums make them both especially attractive considerations this week. in addition as they have also lagged the S&P 500 over the past week and month.
Merck is ex-dividend on Friday and I would consider selling a weekly in the money strike, but being prepared to roll the position over to the following week if assignment seems likely. With a dividend of $0.45, that generally means that the closing price on Thursday would have to be at least $0.45 in the money for a logical investor to exercise their options, although Merck is frequently subject to dividend arbitrage and is more likely than most to be exercised even if there is just a very small margin above that threshold price, especially if there is very little time remaining on the contract.
Gilead, on the other hand is ex-dividend on Monday of the following week. For that reason I would consider selling an in the money option contract expiring at the end of the September 2015 option cycle and wouldn’t be disappointed if the contract was exercised early. In essence the additional premium received for the week of time value atones for the early assignment.
Pfizer (PFE), on the other hand, is not ex-dividend this week, but has finally returned to a price level that I wouldn’t mind once again owning shares.
During the period of its share price climb, as is so often the case, the option premiums became less and less enticing. However, now that it has had a 13% decline in the past month, that premium is finally at a point that it offers adequate reward for the risk of further decline.
As with Merck and Gilead, the consideration of Pfizer isn’t based on pipeline nor on fundamental considerations, but purely on price and premium.
While healthcare stocks generally out-performed the S&P 500 over the past week, one notable exception was UnitedHealth Group (UNH), which is also ex-dividend this week.
In my home state of Maryland the regulatory agency approved a 26% increase in rates for Anthem (ANTM), but small premium declines for UnitedHealth policies on Friday. The relative weakness in UnitedHealth shares, however, was week long and not likely influenced by that news, as Anthem is by far the major insurance carrier in that state.
However, as is so increasingly the case, the combination of an uncertainty induced higher option premium, a dividend and the potential for some bounce back in short term share price is very appealing.
Especially when logic would dictate that China poses no threat to UnitedHealth Group’s performance, as long as logic is permitted free expression for a change.
American International Group (AIG) also goes ex-dividend this week.
I haven’t owned shares in a while and certainly haven’t done so since the passing of Robert Ben Mosche, who I considered an essentially unsung hero. His calm and steady guidance of AIG, having returned from retirement on the beaches of Croatia, was an antithesis to the reckless actions of Angelo Mozilo.
However, with its return to respectability as a company and as a stock came a decrease in option premiums and even with the re-institution of a dividend, it wasn’t a magnet for investment.
This week, the situation is different.
With a significantly increased dividend, a nearly 10% decline in the past month, an enhanced option premium and the likelihood of interest rates moving higher, AIG may be ready to hit on all cylinders.
After so much discussion about healthcare and insurance related stocks, it only seems fair to give Altria some attention. Prior to spinning off Philip Morris (PM), which was the real engine of its growth from its international activities, this was a true triple threat stock. It had great option premiums, a generous dividend and room for share appreciation, as long as you were willing to let other people participate in their own Faustian deal.
However, with the loss of Philip Morris’ growth and with declining option premiums, it has lost its luster for me, just as it has the ability to take the sheen off from health pulmonary tissue.
However, a recent 6% decline, a growing option premium and a great dividend are reasons to consider welcoming it back into the fold, even if not permitting its use in your home.
I already own two lots of Best Buy shares and rolled both over early in order to have a better chance of capturing the dividend. As with Merck, those shares go ex-dividend on Friday.
However, as opposed to Merck and so many others that are near some near term price lows, Best Buy gained in price the past week and has been doing so since reporting its earnings recently.
I would consider purchasing another lot of Best Buy shares but would be willing to cede the dividend to early assignment, based on the generous option premiums. To do so, that might be accomplished by purchasing shares and selling in the money weekly calls or even deeper in the money calls expiring the following week.
Palo Alto Networks (PANW) reports earnings this week and as with even relatively “safe” stocks of late, it may not be for the faint hearted, as it can and has made some fairly significant price moves in the past when earnings have been released.
As it is, shares of this enterprise security company are already 14% lower in the past month and meaningful price support is still about another 10% lower.
The option market is implying a 7.8% price move next week. However, a 1% weekly ROI may be potentially obtained through the sale of a weekly put contract at a strike price 10.2% below Friday’s closing price.
While the options market is beginning to do a better job of estimating price performance after a period of under-estimating downside risk, I think that there may still be some additional risk, so I would probably defer those put sales until after earnings and only in the event that there is a sharp decline in shares that could bring it closer to that support level.
For those willing to play in the land of risk, BHP Billiton is ex-dividend this week and offers a semi-annual dividend that appears to be safe, despite a nearly 8% yield. While it has decreased its dividend minimally in the past, nearly 14 years ago, it has never suspended it, despite some significant decreases in commodity prices over the years and in contrast to others, such as Freeport-McMoRan (FCX).
BHP Billiton offers only monthly option contracts and doesn’t have strike levels gradated in single or half dollar units. With its current price almost perfectly between the $32.50 and $35 strike levels and its ex-dividend date occurring early in the week, the potential short term strategies are to either sell an in the money option with a high likelihood of early assignment, or an out of the money option in the hopes of getting it all.
Finally, I missed the last strong move higher by LuLuLemon Athletica (LULU) and had shares assigned after that climb that left me in the dust. I was still happy to be out of those shares after a 13 month holding period. While it had an ROI of 10.3% that was only 0.6% better than the S&P 500 for the same period of time, so not a very worthwhile way to park money, all in all.
LuLuLemon reports earnings this week and it’s no stranger to large price moves.
Prior to this very recent increase in market volatility the options market has been under-estimating the price range that a number of stocks might move upon earnings release and I was more inclined to consider a trade, such as the sale of puts, only after earnings were released and shares plummeted beyond the lower boundary implied by the options market.
However, as volatility has made a return, the price ranges implied by the options market is beginning to increase and it is getting easier to find strike levels outside of the range that can return my threshold 1% ROI on the sale of a weekly put contract.
The option market has implied a price move of 9.6% and a 1% ROI could potentially be achieved through the sale of a put option if shares fall less than 11.5% following earnings.
Unlike Palo Alto Networks and unlike so many other stocks in the investor’s universe, LuLuLemon is within reach of its 52 week high, which certainly makes it stand out in a crowd, even if not bent over sufficiently to bring any defectively sheer garments to their limits.
While on a different recent path from Palo Alto Networks, LuLuLemon is also a trade that I would consider only in the event of a sharp price decline and would seek to take advantage of any selling done in panic mode.
Unless of course that turns out to be the theme for the week, in which case I would rather wait for some calmer heads to prevail before loosening the grip on cash.
Traditional Stock: Pfizer
Momentum Stock: none
Double-Dip Dividend: Altria (9/11), American International Group (9/10), Best Buy (9/11), BHP Billiton (9/9), Gilead (9/14), Merck (9/11), UnitedHealth Group (9/9)
Premiums Enhanced by Earnings: LuLuLemon Athletica (9/10 AM), Palo Alto Networks (9/9 PM)
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.
