Pullback End May Be in Sight

Last week began with such promise for the bulls but ended with another victory for the bears as the broad market clocked a narrow loss. Monday and Tuesday's positivity was quickly erased on Thursday when the market swooned.

The S&P 500 finished the week at 1066, down about 7 points. This is the lowest level we have seen in this index since early November. Volatility, as measured by the CBOE Market Volatility Index (VIX) rose from 24.62 to 26.14, which is a sign of investor apprehension. This indicator was mirrored by the rallying U.S. dollar, as investors reduced their appetite for risk.

Increasing implied volatility and a sliding market were not good ingredients for the model portfolio again this week. But, our recently established bearish positions will allow us to make a little money if this market continues to slide.

We continue to believe that the S&P 500 will hold the 1000 level. So, while the market might have another 6% to drop, it could be reaching the end of its pullback. A correction like this could help to consolidate the market's gains from last March and is healthy, in our opinion.

Now, let's review our current positions:

-- Abercrombie & Fitch (ANF:NYSE): This is a bear put spread. We own 10 March $37 puts, are short 10 March $31 puts, and paid $4.15 for the spread. We need the shares to finish lower than $32.85 at March expiration to make money. Shares of Abercrombie closed at $33.18 Friday, currently making our put spread a small loser. The strength in the stock came from strong same store sales announced Thursday. The thesis for this play is that if the market is going to continue selling off, this position will be profitable for us. Also, even if the market stops sliding and starts to rally, Abercrombie might not. Despite the losses this week, we remain firm in our convictions.

-- Amazon (AMZN:Nasdaq): This is another bear put spread. We own 10 of the April $155 puts and are short 10 of the April $130 puts. We paid $18.75 for each spread. The idea here is with Amazon's valuation, this spread offers us some protection against a further slide in the market. Shares closed Friday at $117.39, which has our position making money, as the spread closed near $22.

-- Charles Schwab (SCHW:Nasdaq): We are short 20 March $18 puts and long 20 March $14 puts at a cost-basis of 95 cents per spread. Schwab's shares closed Friday at $18.07, down about 20 cents on the week. The spread is still trading for around 75 cents, so this position remains profitable for us. We will hold this position because Schwab operates with a different business model than the bigger investment banks, and we expect it to continue to trade above $18.

-- Cigna (CI:NYSE): This bull call spread is long 20 February $30 calls and short 20 February $35 calls with a cost-basis of $3.50 per spread. Shares closed Friday at $33.36, down 40 cents on the week. Despite the slide in the stock, which now has our position as a loser, we will sit tight as our fundamental belief is that Cigna will be trading above $35 by February expiration. Cigna released earnings on Thursday, and with that catalyst out of the way, we believe that the shares might rally.

-- Dell (DELL:Nasdaq): We are now long 30 May $11 calls and short 30 May $15 calls with a cost-basis of $1.85 per spread. The stock finished the week at $13.24, up a little over 30 cents on the week. The spread closed the week at $2.20, up 20 cents. The company has confirmed that it is scheduled to announce earnings on Feb. 18 after the market close. We are still bullish on the prospects for Dell, so we will stay the course in this position.

-- Expeditors International of Washington (EXPD:Nasdaq): The current position is long 20 of the February $25 calls and short 20 of the February $35 calls, at a cost-basis of $8.50 per spread. Expeditor's shares closed Friday at $33.03. The spread is currently trading in the market at $7.85, which has us slightly under water, but we remain convinced that the shares can get back above the $35 level. The company has not confirmed when it will release earnings, but it will likely happen much later in the cycle toward the end of February.

-- Green Mountain Coffee Roasters (GMCR:Nasdaq): We are long 10 of the January 2011 $25 puts. This is a highly speculative play because we will need the shares to drop precipitously over the next 13 months in order to make money. We view this trade as essentially a lottery ticket, so anyone entering into this play should be prepared to lose all of the money they invest in it. Our thesis is that Green Mountain shares have appreciated too much due to the hype surrounding the company's product, similar to the way Crox (CROX: Nasdaq) and NutriSystem (NTRI:Nasdaq) did in their respective heydays. Therefore, we entered a long- dated put play as a bet that the gains will not hold. Green Mountain shares ended Friday at $82.60. The puts closed out the week at 38 cents. We have sunk so much into these puts now that we will hold on for the remaining 11 months on the chance that our thesis will come to fruition.

-- Hartford (HIG:NYSE): This position is short 10 of the March $15/March $24/March $28/March $33 iron condors. We collected $3.29 to establish this trade. The thesis for this play is that the stock is range-bound between $20.71 and $31.29 and we expect that it will remain that way in the near term. Hartford shares finished the week at $23.53. The iron condor is now trading for $2.25. We will continue to let this position ride as we just need the stock to close above $24 or below $28 at February expiration in order to attain the maximum profit.

-- Hess (HES:NYSE): This position is an iron butterfly in which we are short 10 of the May $40/May $60 put spreads, and short 10 of the May$60/May $70 call spreads. We collected $7.70 to establish this trade. The thesis for this play is that the stock will be range-bound between $52.30 and $67.70 by the time May expiration arrives. Hess shares finished Friday at $57.98, basically flat on the week. The spread is currently trading for $8.40, so subscribers who do not have this position on may still want to establish one. We remain comfortable with this position because of the company's strong fundamentals.

-- Jacobs Engineering (JEC: NYSE): This holding is short 30 April $35 puts, long 30 April 30 puts. The cost-basis for the spread is 55 cents, so we are betting the stock can close above $34.45 at April expiration. Jacobs's shares closed the week at $35.93, down almost $2. The spread is currently trading for $1.35 cents, so we are taking some lumps. But we remain confident that the satisfactory earnings results will prove to make this a profitable spread for us. Subscribers who have not set up a trade in this spread should consider giving it another close look.

-- Johnson Controls (JCI: NYSE): This holding is short 10 April $25 puts, long 10 April $15 puts. The cost-basis for the spread is $1.15, so we are betting that the stock can close above $23.85 at April expiration. Johnson Controls closed Friday at $28.06, higher by almost 20 cents on the week. The spread closed the week at 70 cents. We remain confident that Johnson will be above $25 come April expiration.

-- McGraw Hill (MHP: NYSE): This holding is short 20 May $35 puts and long 30 May $25 puts. The cost-basis for the spread is $3.25, so we are betting that the stock can close above $31.75 at May expiration. The shares finished Friday at $34.22, down a little more than $1. The spread is now trading for $2.70. -- Red Hat (RHT:NYSE): This bull call spread is long 20 of the June $22.50 calls and short 20 of the June $30 calls. We paid $5.05 for the spread and stand to make money if the stock finishes above $27.55 at June expiration. Shares finished at $27.24 on Friday, up 2 cents. We are losing money on this spread, but still like our chances that it will work out for us. Subscribers who do not have a position in this spread can now buy it for around $4.20, which is lower than what we paid. The company last released earnings on Dec. 22, so its next report will likely be in March.

-- Simon Property (SPG:NYSE): This is another bear put spread. We own 10 of the April $85 puts and are short 10 of the April $70 puts. We paid $10 for each spread. The idea here is that if the broad market fails to start a rally, this stock could fall if concern about the commercial real estate market intensifies. Simon released earnings this past Friday and shares finished at $73.36, a gain of $1.36 for the week.

-- Weatherford International (WFT:NYSE): We are long 20 of the February $12.50/February $18 call spreads. We bought these spreads at a price of $4.85 each. The spread currently trades for $2.80 because the stock is currently trading down $15.17. We feel that we have seen this scenario play out in this stock before, however, where it falls out of favor and becomes oversold. Therefore, we will sit tight for a few more days.

-- Yamana Gold (AUY:NYSE): We are short 30 April $13/$7 puts spreads in this name. We collected $1.41 per spread to enter the trade. The bet in this name is that shares of gold miner stocks will fare well as the U.S. dollar stays weak and the demand for gold remains firm. We still believe in our long-term thesis, so although we are taking it on the chin in this position, we will hold on. The stock closed Friday at $10.46, which was actually a rally of almost 40 cents. The spread is trading for $2.70. We will remain patient with this holding, as we believe that 2010 will continue to be a bullish year for this name.

Thanks for reading. Now let's get out there and make some money.

Regards,

Jud Pyle

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