Preparing for Options Expiration

The S&P 500 closed Friday at 1093 after a rally of just slightly more than 3%. It was another week, and another rally, as the bulls continued to reach for assets and depress risk premiums. With that rally came yet another decline in the implied volatility of options prices: The Market Volatility Index (VIX) declined from 24.19 to 23.36. But it is worth noting that the VIX is still nearly 2 points higher than the closing low of 21.43 on Oct. 16. So the market has not quite gotten all the way back to that level.

Expiration for the November options will take place this Friday. In the model portfolio last week, we made some adjustments in some of our November options positions in Potash (POT:NYSE) and Charles Schwab (SCHW:Nasdaq). See each summary paragraph below for more details on these trades. The rest of our November positions are basically "far out of the money" options for which no market maker would be willing to bid. So, unless we catch a bid for them, we will let them expire on Friday.

In addition to this being options expiration week, remember that it is the last full week before the holiday-shortened Thanksgiving week. Thus, many market players will likely be looking to square up their positions ahead of what is usually a very slow and illiquid week. Several economic reports are set for release this week, and we will also see the Producer Price Index (PPI) data on Tuesday and the Consumer Price Index (CPI) data on Wednesday. For the purposes of our model portfolio, the less movement there is in the market, the better, as we are net collecting theta every night.

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 want bid for them, but we will sell them if we get the opportunity. Otherwise, we will just wait for these options to expire in December.

-- Charles Schwab: Last week we bought back our short November $19 puts, and rolled them into a December bull put spread. We are now short 20 December $18 puts and long 20 December $14 puts at a cost basis of 95 cents per spread. We also have the residual long position in the November $15 puts, which we expect to expire worthless on Friday. Schwab's shares closed Friday at $18.25, up just over $1 on the week. We entered this December spread because we expect that 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 rallied again this week to $8.18, which occurred despite the fact that Cigna actually dropped 29 cents on the week. The continued passage of time and a dampening of implied volatility are making the spread work for us. 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 rose 57 cents on the week to close at $32.19 on Friday. We continue to believe 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 15 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 that Crox (CROX:Nasdaq) and NutriSystem (NTRI:Nasdaq) did in their respective heydays. Therefore, we bought a long- dated put as a bet that the gains will not hold. Green Mountain shares ended Friday at $68.46, up just 85 cents on the week, and the puts were recently trading at around $1. Green Mountain announced earnings of 34 cents per share last week, beating expectations by 1 cent.

-- 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 put this trade on. 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 $56.38, down 60 cents. The iron condor is currently trading for a price of around $4.80 as implied volatility has declined in the options. We still like this position, so we 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 $27.13, up 90 cents on the week. The spread is now trading at around 85 cents. We continue to think that shares of Johnson Controls can close above $25 at January expiration, so we will hold out in order to earn more.

-- 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 $8.55. Shares of McGraw Hill climbed $1.74 on the week to close Friday at $31.06. We still like the prospects for McGraw Hill, as the thesis for our play is based on the idea that the market is overly concerned about the company's potential legal problems stemming from the Standard & Poor's bond-rating service. Thus, we plan to maintain our long position.

-- Monster Worldwide (MWW:NYSE): 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 $4.50, putting our position in the red. Monster shares closed Friday at $14.68, down 33 cents on the week. This is still a position we would recommend considering closely, to those investors who have not already done so, as we believe Monster shares could see a rally from their currently oversold condition.

-- 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 $1.95 on the week, closing at $50.99 on Friday. We established this trade because we thought shares of gold-mining companies would rally, or at least not go lower, and they did so.

-- Occidental Petroleum (OXY:NYSE): This position is long 10 November $45 puts. The puts are too far out of the money for any market maker to want to bid for them, although we will sell them if the opportunity arises. Otherwise, we will just wait for these options to expire this coming Friday when November options expiration occurs.

-- Potash: This position is long 10 November $75 puts. The puts are too far out of the money for any market maker to want to bid for them, although we will sell them if the opportunity arises. Otherwise, we will just wait for these options to expire this coming Friday. This position marks the remnants of a put spread. We bought to close the November $90 puts last week.

-- Varian Medical (VAR:NYSE): We are long 10 of the November $22.50/November $35 call spreads. We initially bought the spreads at $10, and they are currently marked at $12.40. Because the stock is trading at a price that's quite far above the $35 strike, we will likely let this spread expire at its maximum profit.

-- Weatherford International (WFT:NYSE): 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 gained 6 cents on the week to close Friday at $17.78. The call spread is now marked at $4.55. Subscribers who have not bought this spread may want to give it another look, even though the spread is trading slightly higher than the original limit price.

-- 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 at $7.86, a drop of 7 cents on the week. The spread is still working for us, though, and is now trading at around 35 cents. We continue to like the prospects of 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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