Weekly Stock Options Trading Tips: June 22, 2009

Stock Options Trading Idea of the Week

Beware of ETF Expiration Dividends

If you sell short-term calls against LEAPS as we do in our portfolios, you probably like to collect all the time premium possible, even if that means waiting until expiration Friday to buy back calls that will expire on that day.  If those calls are in the money, and the underlying is one of the popular ETFs, there is danger in that strategy.  That will our topic this week.

Terry

Beware of ETF Expiration Dividends

Since ETFs are made up of a basket of stocks, owning an ETF entitles you to receive any dividends paid by members companies in the ETF.  For some strange reason, many ETFs have decided the best time to pay those dividends is on the exact same Friday that monthly options expire.
 
For example, the S&P 500 tracking stock (SPY, often called Spyders) declares a dividend (usually in the $.50 -$.60 range) on the third Friday of December, March, June, and September).  The financial ETF called XLF (one that we use at Terry's Tips) follows the same policy.
 
If you are short an in-the-money call on one of these expiration Fridays, there is an excellent chance that the holder of the option will exercise the call (the deeper the call is in the money, the greater the chance of exercise).  If you have sold that call against a LEAP, you will find that you are short shares of the company stock in your account.  You will have to buy those shares back on the market with the cash that was put in your account by the person who exercised the call.
 
However, in addition to the cost of buying the shares, you are responsible for paying the dividend that was due on that day.  Your account will be charged the dividend amount about 30 days later.
 
To avoid this dividend charge, it is important to close out (i.e., buy back) in-the-money call options no later than the Thursday preceding one of those expiration Fridays.
 
This action is called for more frequently in the Dow Jones Industrial tracking stock (DIA, better known as Diamonds) which declares a dividend (usually in the $.15 -$.30 range) on the Friday expiration every month.

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June 18, 2009 5:00 PM - 6:00 PM PDT (8:00 PM EDT)
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Any questions?   I would love to hear from you by email (terry@terrystips.com), or if you would like to talk to our guy Seth, give him a jingle at 800-803-4595 and either ask him your question(s)  or give him your thoughts.
 
You can see every trade made in 7 actual option portfolios conducted at Terry's Tips and learn all about the wonderful world of options by subscribing here.   Why wait any longer to make this important investment in yourself?
 
I look forward to having you on board, and to prospering with you.
 
Terry 

Andy's Market Report

The stock market took a step back this week after what has been a sharp three month rebound. It was the first weekly loss since early May. The Dow, S&P, Russell and NASDAQ finished the week lower -2.9%, -2.6%, -2.7%, and -1.7%, respectively.
 
The summer doldrums are here as witnessed by the lackluster volume. Moreover, market participants seem to waiting for more market-driven economic reports to be released and the upcoming second quarter earnings season before any convictions are made on the short-term and intermediate-term direction of the market.
 
"There's no question in my mind that the economy is improving," said Phil Orlando, chief equity market strategist at Federated Investors. "But investors are betting on some sideways consolidation rather than a continuation of a sharp spike in share prices."
 
Stocks declined early in the week as a handful of weak economic reports, including news of a seventh straight monthly drop in industrial production. The market rebounded modestly on Thursday, on the back of a series of better data on economic activity, including a report that showed a decline in unemployment.

Market participants have been anticipating a pullback after such a sharp rally over such a short period. Typically, a 40% move like the one that has recently occurred in the S&P 500 takes years to develop, not months.

Next week brings to light several key economic reports including existing home sales and durable goods orders, among others. Wall Street will also be paying close attention to the Federal Reserve for any clues on its monetary policy going forward as the central bank conducts a two-day policy meeting.

On the technical front, the market is currently situated in a neutral stance so we could see a move in either direction going forward. My guess (yes, a guess) is that the summer doldrums will once again bring sideways trading to the market particularly after such a large run-up over the past three months. As we all know only time will tell, but premium selling portfolios should do quite well in this environment over the intermediate-term.

Overbought/Sold Condition Report

Overbought/Oversold as of June 19, 2009

• S&P 500 (SPY) - 44.4 (neutral)

• Dow Jones (DIA) - 34.5 (neutral)

• Russell 2000 (IWM) -  46.1 (neutral)

• NASDAQ 100 (QQQQ) - 54.3 (neutral)

Testimonial of the week