Correction Wants to Resolve, Oh Yeah
September 18th, 2007 by John BrasherI predicted this market correction a week or so before it happened in July, which subsumes the fact that I consider it a correction - meaning that the market will find the July highs again and go on to higher ground. I’m not always right, so it feels good. 336 points on the DOW today; biggest one-day gain in five years or so.
To recap, I’ve been saying for a while that we’re in the waning stage of a bull market, that a correction was due, that the summer sell-off was a correction only, and that the market will recover to the July level and new highs. Sometimes we really have no clue what comes next, but - love me or hate me - I was rock-solid on this call.
So we recover; but then what?
The bull doesn’t have a whole lot farther to run, that’s what. I’m guessing the stumble will come by next summer, if not sooner. Like a doctor examining a terminal patient, I cannot say the date, but like the doctor, I have no doubts, either. With nearly five years under its belt, how much longer can the bull run, with a global credit crisis occurring and housing dragging our economy down further by the day? I’ve written about this extensively, so I won’t regurgitate it here.
I get emailed newsletters DAILY urging me not to panic, not to lose faith in the market, that the powers-that-be have the potential economic crises well in hand, and that the market will go on to incredible new highs. We’ll see some new highs, yes (barring the other economic shoe dropping too soon), but the market’s end is in sight; get serious. I’m not selling this blog or any newsletter, nor do I market hot stock picks, so these are my actual, unexpurgated thoughts. It’s not about faith or reading the tea leaves, it’s about applying common sense to the data.
When corporate profits start to falter, the market will go bearish for real. Actually, the market will turn south before the cascade of bad earnings, because certain forces always are, shall we say, ahead of the economic curve. But even these “forces” don’t know the “date.”
If you were on the fence whether we’re just having a correction or the bear market had begun, does the resurgence of the brokers like Lehman (LEH) in the last few days provide any reassurance? They have some of the largest credit-crunch and mortgage-meltdown exposure of any, other than mortgage and directly housing-related companies. Yet the brokers are soaring. This would not be happening if the bull were not getting back on its legs. Even Lowes (LOW) and Home Depot (HD) have been showing strength lately, not exactly a bearish sign for the near term.
I know, sigh, we had an artificial boost today from the FOMC, and the Fed can’t cut rates every day. But the market wants to go back up, and this provided a terrific morale boost. The bets placed on a rate cut are winning big.
We’ll probably have a hiccup or two on the way back to the market top, but I am bullish now for the medium term. The market may pull back again one or more times on the way back uptown, and I won’t panic if it does. The market usually surges in November (Halloween Effect), and may well surge earlier this year. Even at new highs, expect a lot of volatility - think of it as lots of chances to trade the calls!
TRADING:
Covered calls have been tough in the last two months for straight writers, though not bad for those adept at trading calls. But better times are a’coming. I think it’s about time to get long, actually. Buying calls or writing covered calls will work for a while yet, as will naked puts. In fact, OTM covered calls should be very productive in coming months as the market gathers its last strength. However, the real gainers, the safer stocks, are the large caps.
If you are not a well-practiced covered call writer, stick with the S&P 100 and Nasdaq 100; or at least the top half of the S&P 500. Quality, quality, quality.
Covered writers and naked put writers should in my opinion avoid small caps and all but the strongest mid-caps with the least exposure to housing woes, because if they fall it could be hard and fast. The market is cutting these stocks VERY little slack any more. A few will be great, yes, but you’d better be able to pick them. You will have a greater comfort level with covered calls on these if buying a cheap, long-term protective put.
September 19th, 2007 at 12:45 am
John, I agree with everything except the past couple of months having been tough. I’ve written covered calls for about ten years, and the past couple of months haven’t been particularly challenging if someone is using a sound strategy. I’ve averaged around 7% monthly the past couple of months, writing shorter terms (nothing over 56 days for a while), and sticking to my strict guidelines for quality. I’m going to probably close a couple of October expiration covered calls tomorrow because I can do so within a tenth of a percent or so what they’d net being called out. It’s one of the reasons that I personally stick with stocks with good average volume, and calls with a lot of open interest. I like to see a pretty good delta as well. It may take cherrypicking only the best companies that appear on the Callwriter lists, and fewer overall trades, but there are still plenty of worthwhile, profitable covered call trades to be made. I personally am comfortable having higher average position investments when they’re quality companies, I just don’t have more than one in any given sector, and prefer to have a sector leader if the premium is worthwhile.
September 19th, 2007 at 11:45 am
Not everyone is as careful, experienced or disciplined as you, though. And some were in stocks of lesser quality that really took a bath when the correction got underway. We always get a flurry of cancellations when the market drops - a hallmark of inexperienced call writers. You should consider writing a blog or newsletter article about how you approach CC writing and stock selection. I think readers would enjoy hearing how other members do it.
Think about it.
September 19th, 2007 at 5:05 pm
I suspect you’re right John. That is interesting about the cancelations when things turn down a bit. I can honestly say that there isn’t a better site at any price than Callwriter for providing worthwhile information in an excellent format. You’ve obviously put a lot of thought into the content and the way it’s presented, and it just plain makes research much faster. I’ve tried a lot of sites, but using Callwriter as a major starting point I’ve really cut down the time I spend narrowing down good trades.
I actually started an online journal a while back outlining my trades on the day that I make them, whether it’s a buy/write, rollup, sale, etc. It’s a site that has incredible security and clearly shows if anything has been edited. I figure I’ll eventually post the address for it, and maybe a few thoughts. I’ve thought for a long time that the reason more people aren’t successful with options is a pure lack of patience. I think it’s a lot better to enter a trade with a likely 4% return on a solid company that to chase a 10% return on a highly speculative company. Even at 3% money grows really quickly. I think too many folks have their capital commited and get frustrated because they see other potential trades pop up and they can’t take advantage of them, and they get impatient and greedy and start chasing big gains. In reality, the most conservative of trades is capable of offering a return that will blow most mutual funds out of the water. It isn’t to tough to get more return in a month than a CD will currently pay in a year. I’ve tried to help some folks over the years, and from my limited experience with that, it seems that lack of patience and trade discipline were usually the killers. In this day and age with so much information available so quickly, it’s so easy to conduct research in a methodical manner quite quickly. I don’t see any excuse for not doing it. When I started out I did most of my isolation of potential trades on Friday, and then spent the weekend researching them. Over time if good records are kept, and time is taken to go over every single trade, good or bad, obvious patterns jump out. I like worksheets. I have some of them in Excel, but I prefer to do them by hand somewhat as it gives me more time to absorb what it is I’m writing down. Everyone that stays with it seems to come up with their own system, and then it’s much easier to plan your work and work your plan, at least it is for me.
There is a wealth of awesome information right here on Callwriter, people just need the discipline to take the time to read it, and keep reading it until they understand it. I think for folks starting out they should pay special attention to only writing calls on stocks that trade 2mil+ shares per day, and that have a minimum of 500 open interest, and preferably 1,000+. That’s info that’s right here on Callwriter. The information on not writing over earnings announcements should be gospel as well, until people get a lot more experience, again, right here on Callwriter. I personally only like profitable companies, I look for at least 12 quarters with a bar above the line, not neccessarily beating expectations, but at least in the black.
My best advice to anyone would be to read everything here on Callwriter, and read it until you understand it and believe it. Paper trade if you need to prove it to yourself. Buy every book you can on options. I have most of them, and will be one of the first in line to buy yours when it’s out.
September 21st, 2007 at 7:31 am
John,
Could you explain the naked puts spreadsheet. It has consistently listed ALL which trades around $56 will a put premium of 0.75 on a price of $22.5
I can not find this put option on OPXS or any chain that I have looked at. Is there some bug in your screen?
Maybe you could run thru an example trade.
thanks,
Monte
September 21st, 2007 at 1:33 pm
Hi Monte,
The ALL data we were getting was wrong - wrong strike and a non-standard option. Sometimes screwy data comes off the feed. We can’t fix it, so we eliminate the symbol.
April 27th, 2008 at 7:10 pm
I am preparing myself to enter Options Trading. I really like the Covered Call strategy, especially volatile stocks that are are trading near the money with premiums that offer above average income. My strategy is to wite calls that fall under the previous explanation with 25 days or less until experiation. My long-term goal is to build capital through premium income so I may write larger calls and multiply the income even more. My question is why are more investors not using that strategy. One example: Sears Holding is trading at $99.75 a 100 May08 call has a premium of 3.5. As part of my strategy to use the premium as income, I am not concerned with the potential profit loss above 100. From the oustide looking in, it’s a no lose situation. If the stock rises above the break even point for the buyer and is excercised, in practical terms I have made my strategy. If the price holds at strike or decreases and allowed to expire, again I have made my strategy. I wish to do this monthly after careful research of investments. Again why are more investors, especially non professionals like myself not using this strategy. Please explain any pitfalls other than paper losses or profit potential loss.
Thanks,
John
April 28th, 2008 at 10:06 am
Hi John,
There is not space here to cover all the in’s and out’s of covered call writing. If you are content with the notion of - possibly - giving up price appreciation in the stock in return for the call premium, then the only real downside is the possibility of loss. If the stock holds price or rises, it is a fine trade. But… suppose Sears tanks rather suddenly to $60 or $70? That call premium would be little comfort. Of course, there are techniques to manage a price drop, but sometimes they are unmanageable, because we are unable to watch the position, or it happens overnight and results in a gap down, or is simply too violent to be handled. Thus an unprotected covered call position can never be said to be in a no-lose posture.
This is the reason I developed the SuperPut strategy, discussed on CallWriter.com: to limit risk while preserving our ability to pull an income out of the position. If you stick with great, established companies that are doing better than the market (e.g., compare Target to the DOW since December) and - better yet - companies that are poised for success in the current market environment, you should do quite well. If I may be permitted a small promotion here, consider buying my new book (available on CallWriter), which you can also buy with two free months of CallWriter service. It will get you off with a jet assist.
John Brasher