Summer Natural Gas Trade (UNG)

I am sure this is old news but natural gas (UNG) tends to bottom every summer and then improve near the fall. This is mostly due to the fact that natural gas is a relatively local commodity. Excess natural gas is stored during the summer and then used for heating in the winter.

So, an idea is to sell the at-the-money natural gas ETF (UNG) puts. For example, the Sep 37 Put for 2.50 is a 7.2% return on risk over a month. As any commodity, it's very volatile which is why the premiums are good.

It's not as risk free as the chart would seem because there is an underlying trend in natural gas, but with options, it is possible to mitigate that risk and profit.

This can also be done with natural gas stocks, e.g. Chesapeake Energy (CHK).

Blizzard deal brings opportunity in The9 Limited (NCTY)

NCTY does online gaming (i.e. MMORPGs) in China. Blizzard is licensing some games to one of The9 Limited (NCTY)'s competitors, NetEase (NTES). This lead to a ~20% drop in NCTY to 18.16. The 52 week low is at 15. P/E is reasonable at 10.

Combined with the recent downturn in the Shanghai composite, this seems like an interesting trade.

When the market opens tomorrow, I am going to look at selling puts at the 15 strike. The Dec 08 15 Put looks interesting at 1.75. A 10% return on risk in 4 months.

I am looking to diversify out of high concentrations in financials so this would be a good fit. Need to do some more due dilligence but definitely interesting.

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).

Wachovia (WB) surprises, but not in the way you think

Wachovia (WB) reported Q1 2008 today with a loss instead of the profit expected by analyst consensus. Dividend was cut to $1.50 per year. Neither of those things were surprising. In fact, I would argue that it was mostly priced into the options premiums.

The surprise was that they pushed up earnings from Friday to Monday. This hasn't happened to in recent memory and as a result, I was caught with some positions that I wanted to close / roll down. But overall, it was a cheap lesson. A few hundred dollars for a lesson that there are temporal surprises.

Still long Wachovia (WB) through a variety of naked puts. I am trying to figure out how exactly to position myself going forward. The pricing of new common stock at $24 is reassuring since that sets a near term bottom (the new issuance was oversubscribed).

I have been building reserves (not unlike banks) so that even with a 10% drop in a core holding no longer threaten margin calls. I have been deleveraging by reducing the number of share I hold. For example, suppose I have 200 shares of BBBY get called away at 30. I would normally write 2 naked puts at 30 for the next month. Recently, I would instead write 1 contract. This is a natural deleveraging that does not force me to realize losses unnecessarily. Also, I have been closing winning positions that no longer have sufficient reward for the margin required.

General Electric (GE) gets hit by an earnings miss

From GE investor relation: GE announced first quarter 2008 earnings from continuing operations of $4.4 billion with $.44 per share, down 8% from first quarter 2007.

As they say, "the market has a paddle big enough to give anyone a spanking". Nothing could be more fitting when the second largest company in the world by market capitalization (eclipsed by XOM due to the recent rise in crude). GE is down a whopping 14.66% or 4.70 to 32.05.

Not long ago, Jeff Immelt all but promised 15% growth this year. GE hasn't missed a quarter in years and even when it did in 2003, the miss was a penny. A 7 cent miss is huge for GE.

This is another example of the long tail of equity pricing. Stock prices do not follow a normal distribution; they have long tails. This is also known as Taleb's Black swan theory. Every options trader should be very comfortable with the idea that substantial moves happen more often than predicted by models. Such rare events is what makes naked options more dangerous than the statistics would predict.



Now back to GE. Industrials were strong due to currency and rest of world demand. Appliances down due to housing crisis. Financials down due to mark downs. Healthcare down due to lower demand for capital diagnostic equipment. None of this is surprising, per se. I don't know why analysts didn't bring down estimates.

I was slightly long GE before this (long the stock, selling calls against). I see this as an opportunity for me to pick up for shares for a great price, 15x trough earnings. I am selling at the money puts for June and September. The options markets are not increasing the implied volatility. This is bad since it means I get less time premium. This is good because it says that options traders are optimistic. Either way, I am reserving extra capital to handle a dip (since I am at the money) and in case of a volatility spike (since IV is low).

Covered calls, straddles, and strangles as hedges

As they say, the trend is your friend. S&P 500 is failing to breakthrough 13 day exponential moving average (EMA). I am taking this opportunity to fade the rally by adding hedges to my positions.

Most of the losses I have been suffering in this downturn have been to long positions I am holding. So today, I sold a bunch of calls slightly out of the money (OTM) 2-3 months out on many of my positions (i.e. covered calls). In addition, I am trying something new and selling call options naked against in the money puts, essentially turning them into short straddles or short strangles. I also sold some calls about support on my mess of Wachovia (WB) puts that gives me a weird P/L curve. It is basically a weird ratioed straddle with different months on the different legs. The P/L curve shifts right and up over time. The up shift is due to time decay (i.e. positive theta) and shift right is because my positive delta positions are longer duration than the negative delta positions. That is, the puts I sold are farther out than the calls I am selling.

In addition, I also sold some Washington Mutual (WM) short to hedge against my WB position. I don't usually short stock so this is somewhat of a toy position to gain experience.

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.

Glad I avoided Thornburg Mortgage disaster (TMA)

After its recent margin call woes, I was thinking of going long Thornburg Mortgage (TMA). In particular, I was looking to buy the F series preferred and hedge by an artificial short of the underlying. The Thornburg preferred (TMA-F) is cumulative and convertible to 2.2 common shares.

Today, I watched TMA and TMA-F carefully and almost wanted to chase the stock. I avoided doing so only because of the Ambac offering. I didn't want to get caught in any market volatility.

I am glad I didn't take any position on TMA despite the numerous calls of 'value' and bounce heard around the web.

Today, after hours, news of TMA's failure to meet margin calls of 20 million was released. Apparently JP Morgan is tired of extending the margin deadline and is serious about seizing assets. TMA is down 1.40 to 2.00 in incredibly heavy trading.

20 million seems small to me and the fact that no one wants to give TMA 20 million is a bad sign of the tightness of credit markets. It might just be a raid to grab some marked down assets on the cheap. Leverage + market failure = losses.

I am slightly concerned about the continued downtrend in WB. I am watching the resistance at 28. Maybe the market knows something I don't but as far as I know, the dividend seems reasonably well covered. I am not going to sell my positions but I am preparing to clean up other positions to make sure I don't get margin calls like TMA. I am going to be ready to take assignments as my naked puts at various strikes become in the money.

It's rough out there but there is plenty of opportunity. Defense is the best offense even if you are a perpetual long.

USEC (USU), an interesting Uranium / nuclear energy play

With oil hitting new records, everyone is looking towards other energy sources. Natural gas is no help, that's expensive too. In fact, the reason we have so many natural gas power plants is because we thought it would stay cheap. For an example of how difficult it is to predict natural gas prices, look up the Amaranth Advisors disaster. Coal, solar, and nuclear plays are all being bit to new highs.

I think most of this is irrational. Energy prices are high due to a speculative bubble and market manipulation (by OPEC and others). Stocks in those sectors are also incredibly expensive. Take Exelon Corporation (EXC), a nuclear plant operator. It is in a great position because no nuclear plants are being constructed. However, I do not like owning any utility at a P/E of 20. That's just silly.

While doing some research on nuclear energy, I did find an interesting little company called USEC (USU). It is the owner of the United States Enrichment Corporation. USEC (USU) was privatized over a decade ago. It currently operates a gas diffusion enrichment plant which is barely breaking even. (Enrichment is a part of the process that creates fuel for nuclear power plants). It also performs some contracting services for the United States Government.

A company with only one operation that's barely breaking even -- that doesn't sound very good at any price. However, the story behind the stock is that it is building a new gas centrifuge enrichment plant. It is expected to use 95% less energy than the current plant (rising energy prices is why the current one is barely breaking even).

So, why is the stock in the dumps? Well, the project is 50% over budget and likely to be behind schedule. There are lots of other companies doing the same thing. In this credit environment, a small player like USEC (USU) may not be able to get funding to finish this plant.

So, why buy the stock? Well, recently President Bush passed a series of bills that includes loan guarantees for nuclear companies. USEC (USU) is likely to qualify. Its competitors face difficulty in placing their new plant due to NIMBY (not in my back yard). USEC (USU) has two properties on lease from the DOE for this purpose.

With the current price, there is a lot of upside for moderate downside. I've been picking it up since the 6.50 level and will continue to accumulate. I am also looking at selling some puts at the 5.00 strike.

Lots of risk, but if you believe in the nuclear renaissance, USEC (USU) is definitely a ticker for the watch list.

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.

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.

Senate hijinks on a Thursday of expiration week

I am not sure why politicians want to create havoc for options traders but apparently that's the thing to do. There is a banking committee hearing where Bernacke and Paulson testified. Bernacke some how mentioned that there are more write downs to come. As a result, the market is down across the board.

Also interesting is the NY investigation into the monoline bond insurers. There's a lot of stick waving to convince them to merge or sell assets to Buffett. Somewhere in the conversation, there was threats to strip the muni assets forcibly. All the bond insurers have to say is: Blame it on the shorts. Interesting situation to watch.

Since it's a crazy day, here's a quick take of the positions I am working on:

Wachovia (WB): Looking to add additional delta in the form of March / April 30 puts on the pullback. I think the banks have been kitchen sinking it and we might even get write ups.

Nautilus (NLS): Down after earnings as I expected. They reported total kitchen sink quarter. Tried to pick up some more (I already have a huge position put on from 10 to 5 with an average cost of 8) on the way down at 3.75 but missed it. Not going to chase it on a day like this. Got orders in place for 3.75 and 3.50.

NVIDIA (NVDA): Saw it on the newsfeed and reflexively trying to add March 22.50 puts for 1.50.

EMC (EMC): Trying to buy to close the Feb 17 puts I have for even (take a hit on the commissions). Already have some Mar 15 in place, will sell more naked puts on movements down.

Amazon (AMZN) buyback is noise

Amazon is up 3% after announcing a $1B buyback. That's just ridiculous. Either it's all talk and no action (and thus the pop is silly) or it's a stupid move. Amazon should be using its cash to expand its operations and keep up its growth. We have seen plenty of examples of what happens to your stock price if you miss expectations. Amazon can use its cash to: a) decrease the probability of missing estimates, b) more aggressive acquisitions and technology development, c) buyback its stock. A is a good thing for medium term stock price. B is good for long term stock price. C is good for short term stock price.

Guess which one helps Amazon insiders who want to sell soon before it dips further? The best Amazon shareholders can hope for is that this is solely for insiders to unload some shares and will not actually be executed.

Despite what some market mavens say, Amazon does not actually have the cash to do this. Sure, they have a couple billion in short term assets but they need much of it to cover the $2B in accounts payable. Yes, Amazon can use future earnings to do this but that is hardly 'cash in the bank'. Given Amazon's razor thin margins, it can easily swing from profit to loss. Combine its heavy investment in web services (an unknown sector) and the consumer led recession and I can imagine Amazon posting negative earnings growth.

The best scenario I can come up with: Amazon wants to buyback its shares at the absolute minimum price. It knows that announcing a buyback will boost its stock price which will cause it to pay more for the shares it buys back. So announce it down, before the drop. Wait for it to drop to 15 and then execute the buyback. That's great for owners of the company, probably not so good for management stock options or careers.

In other news: I am currently looking to sell medium term naked puts on high dividend Dow components. I am already heavy on HD so I am going to look to write some puts on JNJ and GE. Probably looking at Jun/Jul puts that are 10% OTM.

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.

Cadence (CDNS) - Decision making in the face of uncertainty

Today was one of those days that I hate. Everything is up and by a lot. As an options trader who makes money from selling time premium, this isn't my thing. Sure, I make money since I am generally positive delta and negative vega. (I will probably explain all the option greeks sometime -- mostly to help myself gather my thoughts learn them better. I mostly only use delta and I am trying to learn to use vega.) However, I write options expecting them to expire. So a market rally just helps to speed up that process a little bit. However, I ran out of margin a while back during the big dip and thus do not have many open positions for March. If the market is up, then it is hard for me to find a good risk/reward balance in options to write since I am mostly selling puts naked. So the ideal market is one that is perfectly flat (historical volatility of zero) while having a high implied volatility. That's what I dream about. Of course, the markets aren't so nice.

So I was looking for options to sell and noticed that CDNS (Cadence Design Systems) was down 33% to 10 a share. Cadence makes CAD (computer aided design) software for the electronics industry (some people call it EDA -- Electronic Design Automation). CDNS is to semiconductors as ADSK (Autodesk) is to buildings. Brought up a maximum length chart on Yahoo finance and saw:



CDNS is basically back to 1996 levels. Always a good sign. I like things that are at long term lows (that's my style of investing most days).

Took a look at the AP bulletin which was pretty useless. I am convinced that they are written by robots (or people playing robots). It calls CDNS a "semiconductor manufacturing equipment maker". Never a good sign.

Basically 4Q '07 was ok but guidance for 2008 is bad. 1Q is going to be a loss and full year guidance is down to non-GAAP EPS of $1.11 to $1.19 (GAAP EPS tends to be lower since EDA companies take write-offs for their acquisitions). The current Street consensus estimate $1.53 a share. With earnings potentially down over 28%, the price drop seems reasonable, right?

I disagree. I think the bad new was already mostly priced in. I am more than happy to go long this company at P/E of 10 (after lowered guidance, even better!). I sold a bunch of Mar 10 puts at 0.85 which would give me a basis of 9.15 if assigned. Otherwise, I get about an 8% return on maximum risk or a 50% return on initial margin (for 50 or so days).

I also feel good about the fact that 53 million traded out of 268 million outstanding. Combine that kind of volume with the flat intraday price action, it smells of major buying. There was a floor around 10 all day and a volume spike and the end of the day. We might see an SEC filing some time soon.

We'll see what happens. It could prove really dumb to try to catch this falling knife. Sometimes, there is no time for analysis, and it's mostly gambling with an estimate of the odds.