First, a rundown on our latest trades.
Last week, we spoke of our February 28th trade recommendation, a zero premium initiative that pitted Exxon Mobil (NYSE:XOM) against the United States Oil Fund ETF (NYSE:USO). We wrote thus:
[T]hose same options are trading with a nice spread. The XOM July 80's are going for $2.55, and the USO July 38's are fetching $1.76. Almost $80 is now on the table today for each pair traded. We see more potential for the trade, but we're advising those of a more risk-averse bent to take profits here.
To those who took profits as directed, congratulations. To those who held on and weathered another week's worth of risk, we say take the current opportunity to jump.
The spread has widened even further – as we expected – with the XOM PUTS now going for $3.45 and the USOs for $2.13. That's $132 per pair traded, a better than 60% rise over the last seven days.
It's looking good.
As many of our readers have commented, the zero premium trade does require margin – as we have detailed in previous letters. To reiterate: in most cases, your brokerage will require you to put up 25% of the value of the underlying security on which the short option is written. If you trade multiple pairs, naturally, you may be required to have a significant hoard of cash on hand. Essentially, the higher the price of the underlying stock, the bigger the bankroll you'll require.
Moving on, our February 22nd recommendation, another zero premium trade that saw us purchase SPDR Consumer Discretionary Select Sector ETF (NYSE:XLY) PUTS and sell iShares Dow Jones U.S. Telecommunications Sector Index Fund (NYSE:IYZ) PUTS, is now making money, but the spread still hasn't widened to the point of maximum profitability, in our estimation. The XLYs last traded at $0.95 and the IYZs at $0.70. The spread is $25 per pair traded, but should continue to expand when, as and if the market pulls back in earnest.
Again, the trade is predicated on the thesis that consumers will be less willing to take on new discretionary spending – but will continue paying their telecom bills – as fears of a market pullback become reality.
Next: the trade we opened on Valentine's Day was a calendar spread using SPX options, the first leg of which was sold and expired worthless at February expiration for a profit of $690 per option traded. The second leg was an open PUT purchase on the SPX (April, 1330 strike) that we paid $32.20 for.
The last trade on the PUTS was $50.10, though the spread appears now to be sliding, and looks likely to open in the $40-$42 range on Monday morning. For those who want to cash in here, we love ya. You can take your $1000 profit on the long PUT and add it to the $690 you pocketed on the short PUT last month for a $1690 total take per pair traded.
For those still interested in holding, likewise, no problem here, either. But we do have some advice for you at the conclusion of this week's missive (see below).
Finally with regard to our two-way, Exxon Mobil/S&P 500 zero premium trade, we are now recommending you unwind it. Unseen cataclysmic events like those we witnessed last week in Japan are nothing to be fiddled with.
Half our trade is profitable and the other half is under water, with the latter representing the weightier proportion.
On the CALL side, the long SPY 137s now fetch $0.42, while the short XOM 90s sell for $0.19 , giving us a credit of $0.23 per pair traded. On the losing (PUT) side, the April SPY 120s last traded at $0.65, while the short XOM 80s are now at $1.30. Our loss on the PUT side totals $0.65, making for a total loss on the two sides of $0.42 per pair traded. Those with very deep pockets, who traded, say, 50 pairs both ways, will take a loss of roughly $2000 on the trade.
Because of Events in Japan
We Now Face an Even Murkier Investment Reality
It's very difficult to tell when the Japanese disaster will end. Events of the sort witnessed last week are years in the repair, and the loss of life that will impact families for a lifetime brings scars that – to reduce it to its basest level – produce a drag on a national economy.
On the material side of the ledger, too, the cost of battling disease, broken bones, radiation exposure, mental illness and depression will be exorbitant. The cost to insurers and reinsurers of replacing, rebuilding and repairing what's still salvageable will also be massive. The cost to GDP that's incurred by delays in getting back to work, at this stage, is still not possible to determine. And the potential fallout that's engendered by a massive nuclear failure is, of course, unfathomable in both economic and human terms.
To sum, Japan's market drop of roughly 6% on Monday may or may not be an accurate reflection of the losses suffered by Japanese corporations at this stage and those going forward. What is sure is that the markets are backpedalling in the face of the Japanese tragedy, confidence is shaken and investors large and small are scanning the landscape for safety outlets, not more risky bets, no matter how manageable they may be.
Recent action in treasuries is proof-in-part that safety is now paramount. Look here at the iShares Barclays 20+ Year Treasury Bond Fund (NYSE:TLT) for the last six months:
Long bond investors can take solace in the fact that both RSI and MACD are above the waterline and price action appears to be six weeks into an uptrend.
Our Trade
This week's trade is a coda on our earlier calendar spread, and is applicable only to those who are still holding their long April SPX 1330 PUTS.
With March options expiry falling this Thursday, we recommend selling the March 1330 PUTS for $40.10. As you can see, to reach that strike the market has to punch back through resistance in the face of the Japanese disaster, a Middle East on fire and a slew of worry in the Eurosphere.
It's a reasonable bet.
Wall Street Elite recommends selling the SPX March 1330 PUTS for $46.50 for holders of the April 1330 long PUTS.
With kind regards,
Hugh L. O'Haynew,
Analyst, Oakshire Financial
