Options Market Recap

Market Beating Foresight – Profit Taking Rules

Profit taking on low trading volume was the theme last week. Investors were selling early in the week and cashing in on profits from the strong market run since March 9. The good news is that trading volumes were low which suggest that conviction on the sell side was lacking. Profit taking seemed to be the biggest driver as the overall market news and trading was relatively light. On the economic front, housing starts were better than expected, however that was offset by greater than expected declines in industrial production. The rate of economic decline has slowed considerably, but it has not yet reversed course. We think the market has fully baked into current stock prices the improving outlook. We also think the market is currently trading in a reasonable range given the current market and economic outlook. It will likely take more significant and upbeat news on the corporate and economic fronts before the market goes on its next big advance. That advance will happen and we plan to stay fully invested to make sure we do not miss out. However, we think that market prices could remain trade range bound over the near term, at least until those big market moving events unfold. We plan to increase our investment allocation in long term call options as we do think the market will continue the advance over the next six months. We will also begin pruning our stock portfolios for stocks that are currently lagging the market returns. Our goal is to pick winners – stocks that perform better than the market benchmark - in seven out of ten stocks we purchase. However, that also means that we expect to pick at least three losers. In other words, 30% of our stocks will fail to beat the market. That is why portfolio pruning is necessary, with the intent to replace laggards with better performing alternatives. Replacing laggards with better performing alternatives is one of the key principles in our portfolio management strategy and investment approach. This approach has been a big factor in our success and helps ensure that we remain unemotionally attached to any one stock. We would also add that as a goal, a 70% success ratio represents an extremely high bar. Most investors would be lucky to achieve a success ratio of 50% over the relatively short trading periods we follow. In fact, the data would suggest that the majority of investors fail to consistently beat the market and that includes professional money managers!

Option Tips For Investors?

We expect the market (S&P) to swing between a trading range of 900 and 1000 over the near term. We also expect volatility (VIX) to trade between 25 and 35 through the end of July. The volatility or fear gauge continues to trend down, a good sign for long term investors. In light of our recent success, we are looking again for another opportunity in a short spread position on the VIX index having a July expiration. If we can get in with an attractive net credit position, we will sell the call above 35 and sell the put below 25. Again, these positions are an excellent way for us to generate portfolio income. However, risk is high as these positions theoretically offer unlimited loss. However, we try to minimize that risk with other holdings that would offset potential losses. Overall, the economy remains fragile, but there appears to be a growing sense that the worst is over. The economy is not yet in recovery mode, but declines have slowed considerably. In that light, we are now more optimistic over the long term health of the stock and options markets. We like the following call options PQOLW (Innophos Holdings), QYKLD (Chart Industries), and CYHLE (Community Health Sys), all of which are based on stocks selected from our Momentum and Value screen.

Remember, our complete list of options is Available Online At: http://www.marketbeatingstocks.com