I am the first to admit that I did not expect yesterday's
jarring selloff after Barack Obama's reelection. But there still
seem to be plenty of opportunities in this market to make money
from the long side.
(A version of this article appeared in optionMONSTER's
What's the Trade?
newsletter of Nov. 8.)
First, what was my mistake? Why was I too bullish too soon? The
main reason is that I was emotionally invested from the long
side, which blinded me to technical realities on the chart. I
also placed too much emphasis on moving averages rather than true
chart levels. The S&P 500, for example, bounced smartly at
its 50-day moving average on Oct. 15, which made me too confident
that the same thing would happen a week later.
Moving averages are useful for a lot of analysis, but they are
abstractions. They can serve as support and resistance, but
established historical levels are much more reliable. In the case
of the S&P 500 now, that means previous highs around 1400 had
to be tested. We might grind in this range for the next few
weeks, but the longer we hold, the more likely it is that the
third quarter's rally will resume.
The reasons I remain optimistic are that the U.S. employment
picture continues to improve (see today's jobless claims) and
incremental evidence points to recovery in China. This week, for
instance, Australia's central bank shocked investors by not
cutting interest rates--partly because of strength in its key
trading partner to the north.
The recent weakness has also brought a lot of good companies back
to some interesting levels. So here are some names to consider
from the long side:
The pharmaceuticals giant has been a steady winner for more than
two years and has now pulled back to the same $24 level that was
resistance over the summer. This looks like a strong support
area, with a very favorable risk/reward profile. I like the
January 22.50 in-the-money calls for $2.05 or better. They have a
delta of 0.77 and intrinsic value is about 85 percent of the
premium. That means they'll give some nice leverage to the
upside, but won't lose a ton of money to time decay if the stock
The last earnings report was horrible, but this is a major
blue-chip company. It's now down around the same $43-44 area that
was support in late 2011. Implied volatility is also higher in
the puts than the calls because everyone is nervous about further
downside. (With the stock at $43.66, the 43 puts should be
cheaper than the 44 calls but they're not.) That can be exploited
by selling the December 43 puts for $1.22 and buying the December
44 calls for $0.96.
Consolidated Edison (ED):
A similar volatility skew is at work in this New York-area
utility, which got whacked by Hurricane Sandy. The December 55
puts can be sold for $0.60 and the December 57.50 calls can be
purchased for $0.60, even though the stock at $56.85 is closer to
the strike on the calls.
This insurance giant gave us some incredible gains after its
strong earnings report last month, and now it's looking good
after pulling back. The shares have held steadily at the same $68
area that was resistance in September and look like they're
headed back over $70. The December 72.50 - December 75 call
spread for $0.45 or better could make sense. Fellow insurer Chubb
(CB) looks similar, although the option pricing isn't very
favorable in that one.
As always, these are suggestions rather than outright
I own PFE calls.
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