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.

EMC and VMW revisited

For those of you who are really hardcore, here's a paper that describes the sort of things that cause mispricing. To summarize, it's because VMW is/was hard to short. This supports my theory that once EMC can sell its shares of VMW, we are gonna see a price correction. Either EMC up or VMW down but probably VMW down.

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.

VMware earnings report - a case study in pricing

VMware shares are down 26% to 61.18 in after hours trading following its earnings release. But what exactly did they do wrong? Was it the tone of the conference call (I haven't heard it yet)? They posted an 80% rise in 4Q revenue but missed by 1% ($412M instead of $417M). Their earnings were 0.19 versus the consensus estimate of 0.24 but this included -0.07 of non-recurring line items.

From all metrics, this company is executing well. The problem is that they missed expectations. This is where risk vs. reward trade-off analysis comes in. At a price of 125 (the 52 week high), VMW was incredibly risky because all the upside is priced in. That doesn't mean it can't go higher in the short term. But in the long term, it's hard to see VMware (as it is now) as a $48B company. Some day, valuation ratios will come into play.

As I am sure everyone is already aware, there's a famous Benjamin Graham quote that goes "In the short run, the market is a voting machine, but in the long run it is a weighing machine."

Another interesting thing about the VMware drop is the correlation with the EMC drop. I have seen many articles about using EMC as a way to get VMW cheap. The argument usually goes as follows. Each share of EMC owns 0.155 shares of VMW. With VMW at 85, it accounted for 13.18 of EMC's price.

So with EMC at around 17, you would expect to see 78% of the move in VMW in EMC. But today, EMC dropped 13% while VMW is down 26% (about 50% correlation). So what's wrong?

This is where the Graham quote comes in; in the short term, the market is a voting machine. The market price for a share of stock is the price necessary that balances the number of buyers with sellers. It doesn't necessarily correspond to the long term value of the shares.

At any given time, there are many who are willing to sell, but only at a price above the market price (otherwise they would have sold). This is why most takeovers, LBO, etc. clear at 40% premium to the market price before the deal (or the rumor). This also explains why Countrywide Financial (CFC) dropped after the Bank of America (BAC) offer. It was below the market price.

The bid price is only valid for the bid size and the ask price is only valid for the ask size. To assume otherwise would be foolish. The market capitalization is a poor valuation metric. Stock being heavily sold will dip below the long term price and stock being heavily bought will go above the long term price. This is the same reason why technical indicators work. By looking at price action, you get a view of the supply and demand imbalance.

I think EMC is a good deal at these prices. The stock is supported by their core business. EMC has traded at a high of 14 for years. EMC was at 14 when they bought VMware for $635M of cash in December, 2003. Their business has gotten stronger as they acquired other franchises (like Mozy and Documentum). They are ready for the future reality of managed storage. If VMware is any indication, they are good at buying businesses.

VMware on the other hand is a risky proposition. Their business has great potential but there are also many competitors emerging. They promote the model of paying for licenses once whereas many other software companies are moving towards SaaS (Software as a Service). But the part I worry about trading short term options is that we are going to see a lot of selling pressure from EMC and other holders. EMC's cost basis in VMW is about 1.95 (if we ignore the money the put into it after the purchase). It's hard to compete with them. I may think that VMware is a good stock at 30 a share. For EMC, it's completely different. They need to sell (at least some) to raise cash for other acquisitions. They also need to diversify their assets while focusing on their core business. Buying VMW before EMC starts selling is dangerous. Profitable maybe, but dangerous.