Stock Options Trading Idea of the Week
Expiration Day Roll-Over Strategy: For a normal third-Friday expiration, we have maintained that it doesn't make any real difference whether you buy back expiring out-of-the-money options on Friday (if they cost $.05 or less, there is no commission at thinkorswim) and also sell the next-month-out options on that day, or whether you let them expire worthless and wait until the following Monday to sell those options.
There are several reasons why the next-month-out options usually sell for less on Monday than they do on the previous Friday (especially if they are calls):
Two extra days elapse for decay to take place (Saturday and Sunday).Many investors who sell covered calls do that selling on Monday, and that depresses the prices of those calls.Markets are generally weaker on the Monday after an expiration.
All three of these reasons support the notion that even though there is a small cost to buying back out-of-the-money soon-to-expire options on Friday, the new options can be sold for sufficiently higher prices on Friday to more than cover that small cost.
Next Tuesday we have a mini-expiration when the September quarterly options expire 11 days later than the normal September options. At this expiration, none of the above three reasons is in effect.
Therefore, the proper strategy will be to allow out-of-the-money options to expire worthless, and sell new options (the October series) on Wednesday.
Here is the risk profile graph of our Durable Diamond portfolio going into next week's mini-expiration. You can see that we will make substantial gains if the stock ends up at any price above $110 in two days. If it falls below $110, we will do just fine as well because we will roll over September 110 quarterly puts to October at a very high price, and use the substantial cash we collect to add on new calendar spreads.
How often do you have the opportunity to make 18% on your total investment in only two days? That is what we are looking at right here, just as long as DIA does not fall below $110.
More next week.
Andy's Market Report
It was another crazy week for the stock market. After watching the Dow move over 1000 points in a 24 hour period from Thursday to Friday everyone knew that this week would most likely be no different. Certainly more madness was ahead."The only thing that is predictable for this week is the volatility, which will remain high," Vidak Radonjic, managing partner of Beryl Consulting Group, which works with hedge funds. "The market is a real mess right now, fundamentals do not count, and fear and greed rules."
Mr. Radjonic was correct. Bad news continued to trickle in while the bailout circus changed on a daily basis. All of this combined led to more volatility and lower markets.
The week began with Wall Street attempting to absorb the historical bailout plan that had trickled out over the weekend.
On Friday, the market rallied hard on the news that the government was offering a bailout plan. However, after a weekend to think about the consequences of the $700 billion plan and its effects on taxpayers and the uncertainty surrounding the monumental event led to a skittish market. Sellers moved in from the opening bell and continued to move the market lower as the day progressed.
On Tuesday, Wall Street was presented with news that Warren Buffett's Berkshire Hathaway, had struck a deal with Goldman Sachs. Under the terms of the agreement, Berkshire Hathaway would purchase $5 billion worth of preferred stock at a 10% annual interest.
"We are pleased that given our longstanding relationship, Warren Buffett, arguably the world's most admired and successful investor, has decided to make such a significant investment in Goldman Sachs. We view it as a strong validation of our client franchise and future prospects," Lloyd Blankfein, Goldman chairman and chief executive, said in the statement.
"This investment will further bolster our strong capitalization and liquidity position," he added.
The market looked as though it would gap substantially higher on the news, but as the opening bell approached the close to 200 point gain in the futures had depleted to almost nothing. After an initial surge the market would collapse to new lows for the week and remain there for the majority of Wednesday's trading.
During Thursday's session the bailout proposal seemed imminent so traders wanted to get a head start on what would most likely be perceived as bullish news for the stock market. Unfortunately, after the bell it was reported that Congress continued to be stuck in a quagmire and as a result futures fell dramatically.
More bad news was reported before the bell Friday. First, the bailout plan that was reported as a go on Thursday was later retracted later that evening.
Next was the failure of Washington Mutual, the largest bank failure in United States history.
WaMu "was under severe liquidity pressure," FDIC Chairman Sheila Bair told reporters in a conference call.
The collapse of Washington Mutual was anticipated by many traders even though the company continued to send out positive messages to its investors. The mortgage related losses were just too much to handle and the most recent downgrade by Standard & Poor's officially sent it over the cliff.
The company's stock price fell 95 % from a 52-week high of $36.47 to its close of $1.69 Thursday. On Friday it traded for a paltry $.16 a share.
Lastly the Commerce Department reported that the GDP was well below economists' expectations. The U.S. economy grew at a 2.8% rate during the April-June Quarter which was a 0.5% lower than the estimates a month ago.
"It pretty much corroborates the fact that the weakness in the U.S. economy is really starting to take hold," said Boris Schlossberg, director of currency research at GFT Forex in New York. "All the latest data that we have seen on the employment front and the production front ... suggest that GDP growth is going to slow materially into the second half of the year."
Technically speaking, the market has pushed to near oversold levels, but with strong support underneath we might not see oversold extremes come to fruition. My guess is that a bailout plan would lead to an initial spike in the market, but once short selling commences in early October we should see witness a test of the most recent lows and possibly a breach into new lows. Only time will tell.
Overbought/Sold Condition Report
Overbought/Oversold for September 29, 2008
Major Benchmarks- Dow (DIA) - 28.4 (oversold)
- S&P 500 (SPY) - 24.3 (oversold)
- Russell 2000 (IWM) - 27.6 (oversold)
- Nasdaq 100 (QQQQ) - 20.8 (oversold)
- Emerging Markets (EEM) - 23.2 (oversold)
Testimonial of the week
As you can expect, when 2 of our 6 portfolios gained 38% in a single expiration month, and then went on to ring up additional great gains in the following week, our mailbox was full of happy campers who were mirroring our trades. Mostly, they were just thanking us for doing such a good job during this most volatile market environment.