Gasoline Turnaround? Reducing exposure to refiners (VLO, TSO, FTO)

Valero (VLO), Tesoro (TSO), and Frontier Oil (FTO) are my favorite refiners. I use them to play the crack spread. They are ideal for put selling because of high volatility and strong book values (refineries are easy to value at replacement cost times some modifier).

After a 4.3M draw in gasoline inventories vs. 1.3M expected draw, refiners are up ~10%. So I am taking some positions off the table. In particular, FTO Aug 17.5/15 Put spread and TSO Aug 15/12.5 Put spread. I am hoping to sell another similar spread in Sep options on any pullback. If this is actually a turn around, naked puts in FTO, TSO, and VLO will be making money. So I am leaving those on the table as they are several months out and I am near breakeven.

Nice to have a stable day after a massive rally, even if you are taking loses are hedges.

Two Interesting Drops: Whole Foods Market (WFMI) and Otter Tail (OTTR)

During the day, Otter Tail (OTTR), a wind energy play, is down 20% and back to reasonable valuations after an earnings miss. Possible slow down trend in days to come as the Cramerica crowd get nervous. After that, it's a good put selling stock. High dividend payout means that there is some pricing support (and it's great to carry the stock while selling calls against it). I am looking at selling some longer term options.

Don't know much about OTTR. Did a rush read through the annual report during the day. They are a bunch of diversified businesses. So I am going to add some delta and then see where it heads. I like dividend stocks in interesting industries.

With the new lower multiple, it might be interesting to pair trade OTTR and FPL (i.e. short FPL and long OTTR).

Whole Foods Market (WFMI) misses and guides down. WFMI is down 20% after hours. I am short some Aug 24 calls against some naked Nov 25 puts. Looking to increase delta at these levels through a combination of events. Let the Aug 24 calls expire. Buy back the puts and the stock (artificial assignment). Then sell some more out of the money puts.

It wasn't hard to guess that WFMI would miss and guide down. High end groceries in a consumer led downturn. It's a matter of whether the news is priced in. On a huge rally day, the news seems particularly bad.

So, the interim plan is: Sell covered calls on banks (WB, BAC, BCS); sell front month naked calls (as a way of initiating a short position) on credit risk plays (COF, FNM, FRE); sell long term out of the money naked puts on commodities (CHK, FCX, VLO, TSO, FTO).

This liquidity injection is a bailout.

A 200 billion dollar liquidity injection was announced today. The Fed and other central banks are essentially willing to lend on mortgage backed securities (MBS). This includes agency backed (the stuff Annaly / NLY, holds) and AAA private label (the stuff Thornburg / TMA, holds). While NLY, TMA, and the like cannot directly borrow from the window, companies like Bear Sterns (BSC) can.

This is the capitalist version of nationalizing MBS. The Fed is essentially willing to be a buyer of last resort for these securities for a discount.

The market reacted with an incredibly strong rally. I am guessing it is a combination of short covering, bouncing of January support, and this bailout.

Leverage works both ways and this 3-4% across the board gain is a gift. While I believe the rally has legs, I took the opportunity to unload a bunch of positions into the rally. I need to de-leverage my portfolio and I am not going to give up such a chance. I closed my front month Mar 33.50 ADSK puts, Apr 33 GE puts, and Apr 35 WAG puts. Nothing wrong with those companies per se. Closed ADSK and WAG for the margin. Closed GE because it broke its long term 33 support and there might be a chance to grab it lower.

Given that there is P/E compression across the board, I am revising the price at which I am willing to take assignment of stock lower. So as a risk management move, I am closing many puts that have too little reward for the risk taken. Fading the rally, so to speak.

The 14% gain in Wachovia (WB) was great since that is the stock that is causing me margin calls. My strategy right now is to recover margin and stay in the game until March options expiration. Then I am going to sell some calls against the WB that I will likely be assigned.

Opportunity in Wachovia (WB) in market whipsaw?

On Friday, the markets was just plain ugly. A look at the advancers vs. decliners for all the major averages will tell you that almost everything was down.

In particular, I am options with intrinsic leverage on underlying securities with a high beta in sectors leading the market decline (consumer discretionary). So, my leverage vs. the market on a down day like this is somewhere between 3x and 4x. That's a 10% drop in one day.

I went through a did a through check of all my portfolio positions and I think I will be ok if I can make it through possible margin calls. I have a couple of positions (ADSK, NVDA, EMC) that were written at the money for the front month and are now in the money and at risk for assignment. I have enough cash and margin to take the assignment. I am more concerned about the overall margin. Since TD Ameritrade does not use portfolio margin, margin is often a concern for my style (which has high drawdowns). We'll see what happens next week. I might have to close some of my longer term puts (which are currently making money) for some buying power.

I spent most of Friday listening to conference calls (there's no reason to listen to CNBC on a day like that; it just makes you more emotional) but I did manage a few trades. With a review of the last Wachovia (WB) quarter, I am still convinced that they will be fine in the long run. I am not saying this is a bottom. I fully expect more writedowns. In the conference call, WB management gave the impression that they are properly reserved for a 60 basis point loss (triple their normal rate) on their Pick-a-Pay (what WB calls Option ARM) loan portfolio. However, looking at recent data and the 'vintage' charts, there is a good chance that losses will soon be estimated at 80 bps or higher. In addition, the auto portfolio looks pretty bad too but that's reasonably small. There is also the risk of canceling the dividend. They don't need to right now but it is an easy source of additional capital. Either of those things might pressure the shares. However, I think the risks are priced in for long term buyers. So I sold a bunch of WB naked puts for multiple months out and at various strikes. This should more than double my WB delta.

I also closed out my XHB naked calls. I am not going to be greedy so I took the 60% gain in two days.

We'll see what happens Monday. If we get additional downside, I am going get more defensive and close out everything that I don't need for additional buying power and then start adding more delta to all my conviction buys (to steal a Goldman Sachs term).

Missed Foster Wheeler (FWLT) again, caught Autodesk (ADSK)

Sold front month Autodesk (ADSK) Mar 22.5 puts after the earning disappointment.

Foster Wheeler (FWLT) down on further 'capitulation' type weakness (from Cramerica?). Tried to sell Apr 60 puts for 3.00, but didn't work. Will keep trying.

Gainskeeper working now in TD Ameritrade Izone. Spent all day playing with it. It gives a great view of how my trades have been going. It is not just for taxes; it is great for fine tuning trading strategy.

Shifted HD hedges to XHB

Yesterday, my GTC order to buy to close +HDCZ (HD Mar 32.5 call option) for 0.05 hit. This was a covered call I sold on some HD stock I was assigned from previous put selling at the 32.5-37.5 levels. At 0.05, it was not a good hedge and wasn't earning me much time premium. Given that HD reported today, I figured I'd want to get the upside if there was any. There wasn't and the reason I was able to close the options yesterdays was because other people already knew that and the implied volatility had fallen. Either way, I am just following my risk management plan.

I have been wanting to short some XHB for a while now but they are hard to borrow. So yesterday, I tried to sell some XHB Mar 21 call options naked at the ask but that didn't work. And for the first time in a while, luck was on my side. Despite more nasty economic numbers, we get another 6.4% gain in XHB lead by gains in HOV and LEN. So I sold a few front month call options naked at the 22 strike for around 1.50. This should give me a short position at 23.50 which is a little below the 200 day moving average. I haven't done much shorting before so I am just playing around. I figured that with my housing heavy portfolio (CBG, HD, BBBY), having a bit of a hedge on XHB couldn't be that bad.

I also tried to sell some April 65 FWLT puts (idea stolen from here) for 3.90 but it didn't execute. I like going long after a big drop but I have learned from experience. Stocks that fall hard tend to fall slowly afterwards. Often, you'll get another chance at the current price some time later or at a better price. So, I wasn't too eager to buy on an up day. But I will try again tomorrow, if it keeps dropping. 61.10 is an ok breakeven price for FWLT but not the sort of value I am looking for. For example, it is not as good of a value as AEO at 15.

I am practicing market discipline right now and keeping buying power high while hedging any of my positions that hit near term highs. I want to get out of as much stock as I can while maintaining positive delta. If EMC keeps going up, I am going to sell calls on my stock and start closing the puts I recently put on.

Adding to EMC and GE amidst pullback

As some readers may be aware, I own some EMC with a cost of around 16.50 and have sold several naked front month puts (+EMCOC / EMC Mar 15 Put).

Today as EMC hit lows around 14.90, I sold some more naked puts in EMC. In particular, I sold some +EMCPP (EMC Apr 14 Put) for 0.50 and +EMCSO (EMC Jul 13 Put) for 0.70.

The time to show conviction in your ideas is when the market moves against you.

GE is trading near 52 week lows so I also sold some +GEPU (GE Apr 33 Put) for around 1.15. I was going to do this a few days ago but I wanted it to go ex-dividend first.

GE is a core holding for international exposure (hedge against dollar weakness), infrastructure (e.g. the new GE industrial investments in Malaysia), and credit (solid AAA in a market of questionable commercial paper). It is also a part of my money management strategy (which I hope to elaborate more on someday).

Bought back put options in SiRF Technologies (SIRF), swayed by emotions or smart trading?

I closed out my Mar 7.5 naked puts in SiRF Technologies (SIRF) today at 1.10 right before the end of day market rebound. I have been trying to close it on the ask for two days (chased it at 0.85 to 0.95 to 1.10) and finally decided to hit a small 10 lot that was splitting the bid/ask. I still managed a small gain. I lost money on the 1.00 of intrinsic value (delta) but that was more than canceled out by the money I made on vega (i.e. the decrease in implied volatility). The small gain came from theta (i.e. time decay).

For reference, I first sold Feb and Mar puts in SIRF when it dropped 50%+ (Added delta to SIRF and WB amid market freefall). I closed the Feb puts on expiration day for a small gain (Last minute juggling of SIRF and BBBY).

I am not sure whether this was an emotional trade or a smart trade. So I will give both view points.

Emotional:
I thought this was a great business with a large cash reserve with a market leading position in GPS chips. I don't doubt the cash on the books but the recent Garmin conference call has led me to doubt myself on the second point. There was a small hint that Garmin is shifting away from SIRF chips.

I am also becoming of the similarity between SIRF and NLS. I sold some NLS puts a while back at the 10 level and now the stock is around 4. I believe in NLS and I am buying more at these levels but it taught me the market can take a long time to recognize value. SIRF can go a lot lower before it bounces back. I don't want to get caught in a downtrend. I need to save buying power to add delta to the rest of my positions on the way down. (Can't decide whether this is fear talking or risk management.)

Smart:
As outlined in my trading plan (A naked put selling focused options trading strategy explained), I generally try to sell time premium. When SIRF hit 6.50 today, most of the value of the option was intrinsic value and I had earned all the time value I could. Therefore, there was no reason for me to be in the option. I should either take delivery (artificially by buying the stock and the put at the same time) or just close out the position (by buying back the put).

I shouldn't go against the trend. It was relatively stable at the 7.25 level while buyers added more positions to average down their costs. However, capitulation hasn't occurred and SIRF can go much lower (although it is supported by its cash position).

Going Forward:
I am going to keep a close eye on SIRF. I was interested in selling the Apr 5 puts at 0.20. That would give me a cost basis of 4.80 which is much closer to the cash value of the company. However, if I assume I am a smart trader and my pseudo-technical sentiment analysis is correct, it should go lower and I should be able to sell it for more premium.

The other reservation is also from my experience with NLS. Selling puts with tiny time premiums are a bad idea. It is the equivalent of selling super-catastrophe insurance. And if you believe in the black swan theory, markets have catastrophic swings more often than the options models would predict.

I am going to sleep on it and then we'll see what happens next week.

A naked put selling focused options trading strategy explained

Selling puts naked is a money making machine. You make money on most trades due to the positive theta and life is good. However, sometimes you bet wrong and you lose big. Winning in this game means we have to avoid the big losses while preserving the opportunity to profit. That requires risk management.

First, I want to say that I have no official system for this. No quantitative models, no portfolio insurances, nada. Just some gut feel. This is just my system. You could have a completely different system, and that would be fine. However, let me point out a couple pros and cons about this system.

Pro: Quantitative models and portfolio insurance give you a false sense of security. Equity issues are more correlated than ever and hedging correctly (without paying too much) is very difficult. Think LTCM.

Con: Basing large $$ decisions on gut feel makes it prone to emotions and mood swings.

Pro: This is how many traders operate. They make lots of money so they must be right, right?

Con: This is how many traders operate. They play with other people's money so it is easier to isolate emotions. Even then, we get an Amaranth Advisors once in a while.

My put selling focused options trading strategy is as follows:
1. Identify a good quality stock that I would want to own forever (or at least 5 years).
2. Identify a price at which I would buy right now. I usually do this by looking at fundamentals. I assume future earnings are either at or below the trailing twelve month (TTM) earnings. Given that, I low ball a P/E ratio based on historical lows of the stock or industry.
3. Take a quick look at technical support levels.
4. Try to pick a stock that satisfies the above and has high implied volatility relative to historical volatility (IV/HV).
5. Check that there is no news shocks coming up. This may include earnings reports, acquisitions, law suits, economic indicators, etc. Obviously you can't avoid all such outside factors but avoid the big ones. For example, do not trade RIMM on the day of earnings (at least in this strategy).

Take either track a or track b depending on how badly you want to own the stock now. Track a is good for a stock that I really want to own now since it maximizes theta. Track b is good for a stock that I want for the long term but not necessarily right now. I generally use track a for bottom fishing / knife catching and track b for long term Buffett style portfolio building.


6a. Write a near term at the money (usually front month ATM) put above a technical support but higher than my would buy right now price. The idea is to make money either from time decay or a drop in volatility. The front month ATM has the most theta and thus the most time decay. Since we picked something that had high IV, we benefit from a drop in IV.
7a. If I get assigned, I tried to sell a covered call on it such that the if the covered call is assigned, I would at least break even.

6b. Write a long term out of the money put such that if assigned, the cost basis is at or below than my would buy right now price.
7b. Sell a covered call if the stock becomes overvalued or is nearing near term resistance.

8. Repeat step 7 until stock is gone or if fundamentals shift greatly. Nothing says I can't change my mind and dump the stock. The above is the options trading strategy given that I like the stock.

Risk Management:

• Only sell options with enough time premium such that if I buy it back at 0.05, I can make a good return. Failing that, it must be close enough to expiration (I usually only do close to a week).


• Since I would not sell options for small time premiums unless they are close to expiration, I buy back options with small time premiums unless they are close to expiration. This is not a hard rule. Some times it does not make sense to only buy back an option that has huge unrealized losses. In that case, I usually either: give up and buy back the option (reduce my delta), roll the options down and/or out (maintain delta), write additional options (increase delta). That really depends on my outlook for the underlying.


• This requires a large amount of capital and is very high risk. The drawdowns will kill you. A more sane person would probably utilize stops. One of the obvious risks is that during a market downturn, you take assignment on a lot of stock and need to be able to carry that stock (either with cash or margin). To make things worse, when you are carrying stock during a down turn, you cannot make money by selling more options since you run out of buying power.


• This is just a strategy that I sometimes may follow. This is not a recommendation for you to use this strategy. In fact, it is a warning to those who choose similar strategies. It's feast and famine. When volatility is high and markets are range bound, it is all profit. In most other cases, it's not so happy.

This is the recipe for making my secret sauce. In theory, theory and practice are the same; in practice, they are not. Making money requires stock picking skill and trading ability. The key to this whole house of cards is step 1 which I gloss over.

Last minute juggling of SIRF and BBBY

It's finally here; February options expiration is today (technically tomorrow).

NVIDIA (NVDA) is down again and my Mar 22.5 puts are now in the money. I am not adding more delta until either I can write a lower strike for enough time premium. Through no fault of my own, I sold the puts near the maximum time premium. The option contracts are quoted 1.90/2.00 right now. NVDA is around 22.15 so they have 0.35 intrinsic value and 1.55/1.65 time value.

I tried to close out my AEO/+AEOBD covered call but TD Ameritrade is dumb and won't let me. It says I don't have enough margin sell short AEO and buy +AEOBD. Little does it understand that I am simply trying to close the position. No big deal though, was trying to save a couple of cents on commissions.

As I suspected, BBBY would be interesting. It's down 0.84 to 29.07 so it appears my Feb 30 calls are going to go worthless. In a stupid move (to save a couple dollars), I am selling Mar 30 calls without buying back the Feb 30. Essentially, rolling out a month and then shorting the near month option. If you look at the transaction as two parts, the first part is smart (another 1.05 a share of time premium) and the second part is a little dumb (0.05 on a bet that BBBY won't rally this afternoon above 30). I would be ok if it did because I have naked puts for the May and Aug expirations so I have enough delta that I would be net long this position no matter what (for reasonable rallies).

I closed some Feb 7.5 puts on SIRF for a small 20% gain (Added delta to SIRF and WB amid market freefall). I am leaving the Mar 7.5 position on for now. I am currently in the black on that position due to reduction in implied volatility. There is a lot more calls than puts at the Feb 7.5 strike. I think this is contributing selling pressure to keep the price below the 7.5 strike (SIRF touched 7.5 a few days ago). So there is a chance that after the expiration, the stock could drift higher once the selling pressure is removed. So I am going to spin the wheel on the Mar 7.5. I will probably try to close it when the time premium goes down some more.

Added delta to SIRF and WB amid market freefall

Another day with blood in the streets. Institute for Supply Management (ISM) non-manufacturing survey results are out early and they don't look good. Survey says: Recession. Panic ensues and we get another 3% drop across the board.



Keep in mind that this is a survey and if everyone is flooded with recession news, they will believe that a recession is coming. This is also known as anchoring bias.

The hedges that I put on a week ago seemed dumb at the time (and a bit early) but they drastically cut my losses today. Without hedges, I am about ~4x leveraged and with them, I am about ~2x leveraged. However, some of my hedges are running out of premium (probably a good time to buy the calls back). In general, my portfolio has a naked put / covered call profile where I am long delta with negative gamma. So as the prices decrease, I am getting more delta. This fits well with my value based strategy. As prices decrease relative to value, there is a better risk/reward tradeoff and I am willing to take on more delta.

I have been reluctant to buy after the rally last week since I've turned more bearish while the market sentiment turned more bullish. I also could not understand why prices should go up given the constant stream of bad news. The rationale that bad news => fed cut => financial recovery is silly. It's like saying mortgages are good cause the government gives you a tax break on the interest. Rate cuts are weakening the dollar and causing a rise in commodity prices which are increasing costs for businesses. On the other hand, rate cuts are not increasing consumer spending due to constrained credit (i.e. banks are do not want to lend at these lower rates since they would rather use it themselves as capital). The 'consumer led recession' is leading to demand destruction. When supply decreases (due to higher inputs) and demand decreases (due to lower income), equilibrium output decreases (i.e. GDP decreases). And GDP decreases define recession. So, recession, here we come. But the word doesn't really mean much to me per se. I see it as an opportunity to pick up more assets at a lower cost. Capitalism at its best. I actually hate bull markets because it is hard to make a living as a put seller since I try to have enough discipline not to chase stocks. On the other hand, I love to sell insurance for quality companies at low prices and high premium (thanks volatility).

SIRF gave really bad 2008 guidance. 6+ brokerages smacked it with downgrades. Stock is down 55%. GPS technologies are good, but consumer electronics are bad. Niche analog semiconductor companies are good, but semiconductors are bad. Basically, I see SIRF as a good growth company hit with bad macro trends. However, I think they will do ok in the coming slow down. GPS devices are so competitive that the price reductions will be hitting the device manufacturers hardest. Sure things are bad but not 7 a share bad. SIRF has never traded at this level before. Although they have been issuing shares and diluting shareholders, it isn't that bad. Take a look at the past annual reports. I checked the current ratio and did a few quick solvency tests and they seem to be able to whether the storm. I doubt they will continue to issue shares at these prices (if they do, the management need to be replaced). We might even see a share buyback. The 1.4 a share in cash also doesn't hurt.

I sold a bunch of Feb 7.5 puts at around 0.5 and a bunch of Mar 7.5 puts at around 1.25. That would give me an average cost basis of approximately 6.75. Backing out the cash, that means I'd be paying 5.35 a share for a growing business in a great segment. That's me rationalizing my purchase; it could turn out to be stupid but analyst downgrades always make me over confident.



I also sold some Mar 30 WB puts as I have been doing for the last couple of months.

And here comes the crash, well maybe.

I am all excited because the markets are down and I don't feel so bad about putting on hedges. I really wished I had been able to short XHB. Instant 8% right there. Oh well, all my consumer discretionary are tanking (AEO, BBBY, HD) as well as many of my financials (WB).

I am short a bunch of the near month in the money calls so today is not bad. I am still losing a 5% on my portfolio but given the leverage I am using, that's a good day.

EMC dragged down by plunging VMWare

As TheNetFool pointed out in a comment to my previous post, EMC was down 13% to an after hours low of 14.70 before recovering to around 15.



My position in +EMCNR (Feb 17 put) was at 0.85 before the close. My Black-Scholes model says it's going to open at 2.14. This is unreliable since any number of things could happen at the open. EMC can gap lower, it can go up early and then come back down, or it can go higher. I don't know. Implied volatility will also change (either higher to reflect the increased historical volatility or lower since this unknown event is out of the way). Even though it is unreliable, the model gives us a good estimate to work with.

The same models say the Feb 16 put will open at 1.33 and the Feb 15 put will open at 0.69. I am seriously considering selling the Feb 15 put for 0.75 instead of trying to sell the Feb 16 put for 1.75. Since EMC is at 15 right now, I maximize the time value of the option by selling the at the money. I am still going to stick with my 14.25 target price.

VMW earnings could be opportunity to pick up EMC

VMW (VMWare) reports earnings after the close today. It could be a surprise either way. If there is a surprise down, it will probably drag EMC down in trading tomorrow and could be an opportunity for me to implement the plan described in a previous post.

Considering selling front month EMC puts

I have been looking at EMC for a while now. Not only does it own the majority of VMWare, its storage franchises are also the ones to beat. ZachStocks' recent post about VMW (VMWare (VMW) - A Creative Way to Own the Stock) explains the VMWare situation really well so there's no reason for me to do repeat it. I have been looking at selling some front month puts in EMC at the 16 and 15 strikes. In particular, I would be delighted if I could sell the Feb 16 for a credit of 1.75. That would give me a cost basis of 14.25 should I get assigned. Given my (dumb) propensity to hold assigned stock, I'd probably hold this for a while until the general market turned around.

From the 3 month daily chart, we can see that EMC has been trending down but has been finding some support at the 16 level. So this could either work really well or we could see EMC start another leg down. Nothing like trying to catch a falling knife for some excitement.

According to the Yahoo options tables, +EMCNQ (Feb 16 Put) traded at a high of 1.40 and is now trading at 0.53. We'll see what the market does next week. If we get a week like last week (entirely possible given the expectations for another rate cut), there is a good chance of hitting my target.