Witch Hats - Bad on Halloween (and Every Other Day)
October 31st, 2007 by John BrasherAh, it’s Halloween, the time of year when the “Halloween Effect” - sometimes known as the Sell-in-May-and-Go-Away Effect - is about due to begin. Stocks very frequently begin rising on November 1st or thereabouts right through the end of April or sometime in May. It is a pretty consistent phenomenon, about which I’ve written before. Will we get the Halloween Effect this year? It would be nice if Messr. Bernanke and the rest of the FOMC committee would give us a 25-basis point rate cut today, which wouldn’t hurt the Halloween Effect one little bit. But like little kids waiting for Halloween to come, we have to wait and see.
Well, since it IS Halloween, let’s look at something really scary and dangerous. It’s real and it’s out there waiting for you. It doesn’t get little kids, though, gentle reader, it is looking for yoooouuuuu… the Witch Hat.
In years of writing covered calls and doing other types of trading, and years of seeing what CallWriter members have done, one thing sticks out: the Witch Hat. It is the sudden price spike that does not hold, but comes back down as fast as it went up, making a chart pattern that looks like a Witch Hat. It whipsaws unwary covered call writers (and other traders), spraying blood on the walls. OK, enough bloody metaphors, but the following chart provides a blood-chilling example:
Unsuspecting covered call writers sometimes see a violent up-move like this and rush to get in before it’s too late, perhaps buying the stock and writing calls to get in on the move, maybe rolling the short calls up if they’ve already written the stock. [Cue scary music] But only TOO LATE do they realize… the Witch Hat has gotten them. As the GM chart above indicates, bad things often happen to those who write price spikes, like the horror-movie teenagers who slip into the dark woods to neck… we already know what’s going to happen to them, don’t we?
I could show you other examples, but you get the “point.” Make the stock prove itself by holding the higher price; make sure it wants to live in the new trading range before getting in or rolling up. How much proof you want (how many closes at the new level) is up to you, but make sure you aren’t writing, or rolling up to, a Witch Hat. Keep your blood in your veins, where it belongs. (Whoops) They are out there every day of the year.
Continuing in this spooky vein, what is Microsoft doing now?
Witch Hat, or new higher trading range justified by the latest earnings release? Has the mother of all like-watching-paint-dry stocks finally become a tad less boring? [Hint: The premium is lousy, so it doesn’t matter.]
Watch out for all kinds of Witch Hats today, and happy trick or treating!
October 31st, 2007 at 5:58 pm
The dip happened, but it quickly recovered. When I bought some puts, the stock had already started recovery, however, I would like to keep those puts for a while as I see a lot of clouds on the horizon. 1) Bonds didn’t recover today. 2) US$ is getting cheaper against Euro. and 3) The oil spiked $4.
October 31st, 2007 at 8:51 pm
Anyone already in the MSFT covered call before the report could have closed after the earnings runup with a great profit, because the option premiums collapsed, even though the stock rose hard. Rolling up would have made no sense, because premium absolutely died. Reacting to these moves and trying to call the direction is tough for a retail trader. Anyone jumping in at the $35/36 level, though, was taking a real chance. MSFT could stick where it is, who knows? But that is the point - we don’t know, and playing bull or bear on MSFT now is just a guess. But like you, I would be loath to close the long put at a loss if you have some reaction time.