Blah. That's about how I feel about the market right now. It's
been knocked down and there are plenty of reasons to expect a slow
and frustrating period of consolidation in coming weeks and months.
Before considering how to trade it, I'd like to briefly explain my
view on sentiment now. The first concern is the global economy,
which is grappling with crisis in Europe and a potential slowdown
in China. There are no clear solutions to either of these problems.
The next issue is that several key charts are flashing warning
signs: Treasury yields, for instance, remain near long-term lows
and could stay there well into the future. The euro, once a proxy
for risk appetite, has also taken a beating and shows no signs of
recovering anytime soon.
Oil doesn't look much better. At the same time, the Japanese yen
has proven much more resilient than I
On the bright side, however, valuations are extremely low and
stocks are underowned. The S&P 500 also seems to be finding
support above its 200-day moving average and is in the process of
making a higher low versus 2011 and 2010. Bearish momentum from
earlier in the month makes a quick rally unlikely, but it also
looks as if the bottom is in.
Selling options is usually a good policy when the market is
grinding sideways. This is especially true when premiums are higher
than they should be and stocks are due for a bounce.
So today I am considering "strangled longs," which entails buying
. This can let you leg into a position while avoiding the angst
that often occurs when attempting to time an entry.
Let's consider Imax, which is in the midst of a long-term growth
cycle as its cinema technology spreads around the world. The stock
has pulled back to key support above $21 and yesterday we saw
bullish call buying
, so it looks potentially attractive from the long side.
Say you want to own 200 shares. Instead of doing the full amount,
buy only 100 and also sell 1 contract each in the June 20 puts and
the June 23 calls. The stock costs about $21.50, while the options
bring in $0.45 and $0.40, respectively, reducing your cost basis to
You now have a built-in cushion of $0.85. If IMAX climbs above $23
in the next 2-1/2 weeks, you'll have to unload your shares for $23.
Not a huge profit, but not bad either. Alternatively, if the stock
drops below $20, you'd have to purchase 100 shares for that price.
But at that price you might well want to add to the position
anyway. (Remember, we're trying to build a position of 200 shares.)
The benefit of this strategy is that the credit earned from selling
the strangle reduces risk. And the fact you're short puts
effectively programs a buy order if the stock falls, saving you the
difficulty of calling a bottom. The drawback is that it
relinquishes big profits if a big rally takes place in a hurry--but
I don't expect such a move anyway, given the bearish macro factors
Strangled longs also make a lot of sense in fertilizer names such
as Potash (POT) and Mosaic (MOS). This sector has been beaten down
hard, but recent reports suggest that demand is finally starting to
rise. Juniper Networks (JNPR) and Morgan Stanley (MS) could also
make sense at these long-term support levels.
Kodiak Oil & Gas, which is bouncing at its 200-day moving
average, is another to consider. The only difference in KOG is that
it would be better to go one month further into the future using
the July 8/9 strangle, which could bring in a full $1 of income.
If you decide to pursue this strategy, just remember to only buy
half the number of shares initially and then let the options do the
rest of the work!
(A version of this article appeared in optionMONSTER's
What's the Trade?
newsletter of May 30.)