Playing the Limits

(Editor's Note: This Weekly Roundup issue of Options Alerts, which normally publishes on Monday morning, was delayed due to a power outage where the author was working. The recap covers last week and was written with Monday publication in mind, although other numbers have been updated with Monday's closing prices where appropriate.)

The S&P 500 closed Friday at 1091, finally not having an up week. But it was not really a very big down week either. Rather, in terms of our model portfolio positions, the market played right into our hands. We have several positions that do best if the stocks sit still or rally only slightly. So the flat market paid us to wait. Market volatility as measured by the CBOE Market Volatility Index (VIX) declined from just above 23 to 22.30.

The market started last week with a Monday rally (Nov. 16) and then proceeded to sell off slowly the rest of the week. Yesterday, on Nov. 23, the market also started with a rally, and the S&P 500 closed back above 1100, at 1106. Time will tell if it is déjà vu all over again and if the market will sell off for the rest of the week.

We have noticed in the past few months that when the VIX has reached the low end of its trading range like this, the market has turned and sold off, while the VIX has moved back towards the 25 level. We will have to be cautious of that, but we continue to believe that between now and Dec. 31, the bulls will be in charge, so any selloff could be short-lived. Earnings season is largely over with, and the results were good enough to support the market's current valuation. Further, many fund managers are going to be reluctant to open big short positions before the end of the year.

This past Friday marked November option expiration. It came and went without incidence. Our Varian (VAR:NYSE), Potash (POT:NYSE) and Occidental Petroleum (OXY:NYSE) positions expired, which has freed up some capital in the model portfolio. This week, Thursday is obviously the Thanksgiving holiday, so the markets are closed. And with the market open only until 1 p.m. EST on Friday, the action should be very quiet. But prior to that, Wednesday promises to be a big day of data releases as we will get a look at reports on durable goods orders and personal income.

The way to play our market view of limited downside and limited upside is to continue to buy call spreads and sell put spreads. It is difficult to buy calls in this environment, because implied volatility is somewhat expensive still as a result of the recent turmoil, and we just don't think the market can jump enough to pay off the way that short put spreads can. Any subscribers that do not have the Monster Worldwide (MWW:NYSE) or Weatherford International (WFT:NYSE) positions on might want to take a close look, as those positions can still be entered for better prices than we paid.

Now, let's review our current positions: -- Amedisys (AMED:Nasdaq): This position is long 10 December $20 puts. These puts are too far out of the money for any market maker to bid for, but we will sell them if we get the opportunity. Otherwise, we will just wait for these options to expire in December.

-- Charles Schwab (SCHW:Nasdaq): We are short 20 December $18 puts and long 20 December $14 puts at a cost basis of 95 cents per spread. (We also had the residual long position in the November $15 puts, which expired on Friday.) Schwab's shares closed Friday at $18.25, unchanged on the week. We entered this December spread because we expect the shares will finish above $18 at December expiration.

-- Cigna (CI:NYSE): This bull call spread is long 20 January 2010 $20 calls and short 20 January 2010 $30 calls with a cost basis of $6.70 per spread. The spread dropped slightly to $8.10 from $8.18 last week, and Cigna's shares dropped 56 cents on the week to close Friday at $30.03. We still like the stock's prospects for closing above $30 at January expiration, so we will hang on to this position.

-- Expeditors International of Washington (EXPD:Nasdaq): The current position is long 20 of the January $20 calls and short 20 of the January $30 calls, at a cost basis of $8.75 per spread. Expeditors' shares dropped 1 cent on the week to close Friday at $32.18. We maintain our belief that these shares can continue trading above the $30 level.

-- 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 14 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 $65.01, down $3.45 on the week. The puts are marked at $1.25.

-- Hess (HES:NYSE): This position is short 10 of the January $40/January $55/January $60/January $75 iron condors. We collected $5.80 to establish this trade. The thesis for this play is that the stock is range-bound between $49.20 and $65.80 and we expect it will remain that way in the near term. Hess shares finished the week at $58.84, up $2.46. The iron condor is currently trading for a price around $4.25 as implied volatility has declined in the options. We still like this position, so will let this iron condor play continue to decay.

-- Johnson Controls (JCI:NYSE): This holding is short 10 January $25 puts and long 10 January $15 puts. The cost basis for this trade was $2.55. Shares closed Friday at $26.86, down 27 cents on the week. The spread is now trading for around 90 cents. We continue to think that shares of Johnson Controls can close above $25 at January expiration, so we will hold on as we expect to earn more from this position.

-- McGraw Hill (MHP:NYSE): This bull call spread is long 10 January $20 calls and short 10 January $30 calls. The cost basis of this trade was $6.40, and the spread is now marked at $8.75. Shares of McGraw Hill dropped 7 cents on the week to close Friday at $30.99. We still like McGraw Hill's prospects , as the thesis for our play is based on the idea that the market is overly concerned about the company's potential legal problems that are stemming from the S&P bond rating service. Thus, we plan to maintain our long position.

-- Monster Worldwide: This bull call spread is long 20 December $10 calls and short 20 December $17.50 calls. The cost basis of this trade was $6 per spread, and the spread is now marked at $5.08, putting our position in the red. Monster shares closed Friday at $15.40, up 72 cents on the week. This is still a position we would recommend to those investors who have not already done so to consider closely, as we believe Monster shares could see a rally from their currently oversold condition. For example, this past Wednesday the stock popped and managed to close at $16.29 because of rumors that the company might be a takeover target. With that type of speculation swirling around, we think that the stock price can get back above $16 by December expiration, which is what we need to break even on this play.

-- Newmont Mining (NEM:NYSE): This bull put spread is short 20 December $40 puts and long 20 December $30 puts. The cost basis of this trade was $1.63 per spread, and the spread is now marked at 10 cents. Newmont gained $1.27 on the week, closing at $52.26 on Friday. We established this trade because we thought shares of gold mining companies would rally, or at least not go lower, but that's what happened. We will likely just hold on and let this position expire worthless next month.

-- Weatherford International: We are long 20 of the January $12.50/January $19 call spreads. We bought these spreads at a price of $4.10 each. Our thesis is that, despite its solid fundamentals, this stock has underperformed its peers and has been oversold recently as a result of its disappointing earnings results. Weatherford dropped 85 cents on the week to close Friday at $16.93. The call spread is now marked at $4.05. We suggest that subscribers who have not bought this spread may want to give it another look.

-- Xerox (XRX:NYSE): We are long 100 January 2010 $5 puts and short 100 January 2010 $7.50 puts in this bull put spread. Our cost basis for this trade is 65 cents. Xerox shares closed Friday at $7.83, which was a drop of 5 cents on the week. The spread is still working for us though, and is now trading for 25 cents. We continue to like the prospects for the stock closing above $7.50 at January expiration, so we will sit tight here.

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

Regards,

Jud Pyle

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