PREMIUM Watch (Running) List with ER Dates

This is only a partial list of stocks that have ER dates interfering with the May contracts (April 19th to May 21st). Four times a year, or one third of our contract opportunities, 50-70% of our watch list may contain equities that report in that cycle. Whenever Blue Collar Investors are faced with a challenge, we address it and then solve it. That being said, expect slightly lower returns in these months. Here is how I attack this issue and render it a non-event:

1- Check the stocks that ARE available and determine whether there are enough equities for my portfolio size that are well-diversified by industry segment. If there are, you’re good to go. If not, you can start to invest with these stocks and leave cash on the sidelines for the next entry point.

2- You will note that there are many stocks that report in the first week of the May cycle. Allow the ER to pass and re-check our system criteria. Once the post-ER dust settles and if the stocks are eligible, we can enter those positions. ***You will note that the May cycle lasts 5 weeks so entering in the second week or the start of the third should still generate favorable returns.

3- If the first two strategies fall short and you still need more “security-power” to write your calls, why not turn to ETFs? These are mutual funds that behave like stocks and many have options associated with them. I lean to the Qs (QQQQ) because of their inherent higher volatility due to the percentage of tech companies within this group and any sector ETFs that are currently performing better than the overall market. For example, here is a chart I am “borrowing” from our premium site that was posted a week ago:

PREMIUM Download-ETFs vs. the S&P 500

Premium members will find this in the “Resource/Download” section of the premium site.

You will note that sector ETFs XLY (blue), XLF (brown) and XLP (green) have all outperformed the S&P 500 (black) over the past three months as of that post. These would be CC candidates to consider if you couldn’t locate enough individual equities to populate your portfolio. Although many of the stocks within these ETFs do report, the fact that we are dealing with such a large basket of securities, the ER issue becomes much less of a concern as they tend to counterbalance each other.

Conclusion:

During the four earnings seasons, we must avoid selling calls on stocks that report in the current cycle, prior to those reports. In those instances, we look to candidates not reporting in the current cycle, wait for reports to pass and then enter into those positions and consider selling calls on the best-performing ETFs. Problem solved!

Premium and General Members:

This BCI team never sits still! We are constantly working to provide you with the best information to help you make your investment decisions. We feel that we owe it to you for all the support you have given to us over the past few years. We have made a few changes to the Weekly Stock Screen and Watch List that will make your interpretation of the information more user-friendly. We have also added more stocks to the initial IBD 100 for weekly screening. For an in-depth explanation of the current report, please view the latest video I produced:

http://www.thebluecollarinvestor.com/membership.shtml

We are also adding a few more ETFs to be evaluated against the overall market (S&P 500). Each week we will highlight those ETFs that are outperforming the market over the past three months. This is a feature we added as a result of your feedback. 

Market Tone:

The S&P 500 continues to diverge from the VIX, a bullish indication for the overall market. Although the high rate of unemployment and the lack of stability in the housing market remains a concern to this site, we continue to sell a higher percentage of O-T-M strikes to take advantage of the positive inclination of the market. Note on the chart below how the divergent pattern of these two entities continues to increase:

S&P 500 vs. the VIX- More Divergence

Summary:

IBD: Market in a confirmed uptrend

BCI: Mildly bullish

Event Update:

It was great seeing many of you at my Long Island presentation this past Thursday. Thanks for your support and motivating feedback. For my next seminar:

I have been retained by The Learning Annex to host a basic seminar on Covered Call Writing. It will take place in NYC on April 22nd from 6:45 to 9:30. To register, you will be dealing directly with the Learning Annex and not The Blue Collar Investor Corp.,  although I will be the only speaker at the event. Those planning to attend, use the coupon code “SPRING” and receive a $10 discount. Here is the link to register:

http://www.learningannex.com/live_classes/134

I will also be presenting an advanced  Long Island seminar on May 13th. More informtion to follow for that one.

The best in investing to one and all,

Alan

Definition:

An exchange-traded fund is a security that tracks an index, a commodity, or a basket of assets like an index fund, but trades like a stock on an exchange, thus experiencing price changes throughout the day as it is bought and sold. These securities provide the diversification of an index fund.

A critical requirement of my system is to be properly diversified both by industry and by cash allocation. No one industry should represent more than 20% of your portfolio holdings. Owning five different stocks in five different industries would require you to own at least 500 shares since each options contract represents 100 shares. This may require a cash allotment of $25,00 to $50,000 or more. By writing calls on ETFs, each share represents a basket of stocks and therefore, instant diversification.

There is also a benefit of a lesser time requirement. With individual equities, we are constantly changing our portfolio mix and factoring in earnings reports, technical and fundamental analysis. With ETFs, we are basically tracking just one security. Now if you are asking yourself why use stocks at all, the answer lies in the greater returns you will garner by writing calls on individual equities. In normal market conditions, a return of 2-4% is achievable compared to the 1-2% for selling options on ETFs.

Who should use ETFs?:

Investors with limited income, with low risk tolerance or with time retrictions should consider writing calls on ETFs.

Advantages of ETFs:

1- Broad diversification- by definition an ETF inherintly provides diversification across an entire index.

2- Lower costs- Most ETFs are not actively managed therefore decreasing marketing, distribution and accounting expenses and most do not have 12b-1 (advertising) fees.

3- Tax efficiency- ETFs have low capital gains because of the low turnover in their portfolios.

4- No need for a financial advisor- Why pay 11/2-2% a year to do something you could manage yourself?

5- Buying and selling flexibility- These securities maintain all the features of a stock, such as limit orders, short selling, stop orders and options.

Types of ETFs- Most ETFs are index funds and those are the ones I will focus on. For informational purposes, there are also leveraged (short), commodity, currency, actively managed ETFs and more. Here are three of the more popular ETFs for writing calls on heavily traded indexes:

1- QQQQ- follows a basket of 100 of the largest non-financial equities on the Nasdaq exchange.

2- VTI- Vanguards security that tracks the total stock market.

3- VV- Vanguards security that tracks the large cap universe.

Major issuers of ETFs:

1- Barclays Global Investors issues iShares.

2- State Street Global Advisors issues street Tracks and SPDRs

3- Vanguard issues Vanguard ETFs, formerly known as VIPERs.

4- Merrill Lynch issues HOLDRs.

5- PowerShares issuers ETFs and BLDRS (based on American Depository Recepts).

Did you know that there are ETFs based on Covered Call Writing?: 

There are several relatively new ETFs that use cc writing in at least 50% of its portfolio. Here are a few:

LCM, BEO, DPD, FFA, MCN, and BEP. These funds haven’t proven themselves over time plus we aren’t sure what’s going on in the other portion of the portfolio. My gut tells me that if I was going with an investment vehicle that was actively managed, I’d prefer to manage it myself, thank you.

The CBOE S&P 500 BuyWrite Index (BXM):

This is a benchmark index designed to track the hypothetical performance of a covered call strategy on the S&P 500 Index.

It is based on buying the index and selling a 1-month O-T-M call, similiar to the Blue Collar System although we consider all strikes. A study done by Ibbotson Associates in 2004 came to the conclusion that a 16-year history showed the BXM to have a 12.30% return compared to the S&P 500 with a 12.20% return but with two-thirds the volatility of the S&P 500. This means that by using the BXM an investor can get similiar returns to the S&P index but with less aggravation. I created the chart below to show the comparison of the BXM Index (black line) compared to the S&P 500 (blue line) over the past year:

BXM vs. the S&P 500- 1 year chart

VIX as of 4-3-09

Banking Industry 4-3-09

S&P 500 4-3-09

_____________________________________________________________________________________________

Last weeks economic news:

The one big negative this past week was the increase in the unemployment rate to 8.5%, the highest in 26 years. Several positives included an increase in consumer confidence, construction spending beat expectations, factory orders rose for the first time in six months, and the manufacturing indusrty continued its modest recovery. For the week, the S&P 500 was up 3.3% for a year-to-date return of -6.0%.

_____________________________________________________________________________________

Replay of radio interview:

For those who missed it, WNB Radio Network is replaying an interview I did several weeks ago. It will play all weekend:

• WnbRadioNetwork.com
• Click on the “MInd Your Bizness Program”.

Let’s hope for more good news this week,

Alan (alan@thebluecollarinvestor.com)

Implicit in the term covered call writing is the fact that we are selling call options. They are covered because we first own the underlying equities prior to selling the option. Since this is my first article of the new year and given the fact that we have so many new members of the Blue Collar family, I felt it would be prudent to review the basics of the call option. I will follow this up with a video of a current example taken from the IBD 100 list.

The seller or writer of the call option (that’s us) gives the buyer or holder of the option the right, but not the obligation, to purchase our shares (usually in 100 share increments), at an agreed upon sales price (strike price), by an agreed upon date (expiration date). In return for undertaking this obligation, the option writer receives a premium. This option is termed a call because the holder can “call in” the stock at any time from the sale of the option to expiration Friday (the 3rd Friday of the month that the option expires).

The Option Contract:

The option sets the terms of a contract about a possible future transaction involving the underlying stock. Since the option value is directly related or derived from that security, options are said to be derrivatives. When the holder of the option makes use of the right granted by the option, the contract is said to be exercised. It is important to remember that until that option is exercised (it may never be exercised) the option writer retains all rights conferred by stock ownership. For example, if a dividend is distributed prior to the security changing hands, the option seller will enjoy those profits.

Here is the information contained in  a call option contract:

Sell 2 XYZ February 50 Calls @ 2

We are selling some unknown option buyer (who we never meet or speak with as all transactions are accomplished online) the right, but not the obligation, to purchase 200 shares of company XYZ @ $50 by the 3rd Friday in February. In return for undertaking this obligation, we will generate $200 (less commissions) into our account immediately upon that sale. Except for the premium which changes with various market conditions, all other elements of the option contract are set by the Options Clearing Corporation (OCC).

Options are traded by auction on exchanges including some stock exchanges (recently ther NYX became a major player in this arena when it purchased the American Stock Exchange). Unlike stocks, options are NOT issued by individual companies (Google does not issue Google options). Instead, the OCC, which is jointly owned by the exchanges and regulated (I use that term loosely!) by the SEC, issues all options. The OCC standardizes option terms and keeps track of buyers and sellers to guarantee that both parties meet their obligations.

The Premium or Value of the Call Option is determined by 2 factors:

1- Intrinsic Value: This is the amount the holder will gain by exercising the option. It is the difference between the stock’s market price and the strike price. For example, if the stock is selling at market for $53 and the strike is $50, there is $3 of intrinsic value in the option premium.

2- Time Value: Depends on the time left before expiration. It is the total option premium minus the intrinsic value. In the above example, if the option premium was $5 and $3 was intrinsic value, then the time value would be $2 ($5 – $3).

Behind both intrinsic and time value are several market and economic factors as well as investor expectations. Here is a link to an article I published in July that explains many of these influences:

http://www.thebluecollarinvestor.com/blog/the-factors-that-determine-the-value-of-your-option-premium-plus-our-readers-pick-their-favorite-stocks/

The Call Option as it relates to the strike price:

1- In-the-money: The market price of the stock is higher than the strike price of the option. This is the only situation where we have intrinsic value. Example: stock price is $53; strike is $50.

2- At-the-money: The stock’s market price is the same as the option’s strike price.

3- Out-of-the-money: The stock’s market value is lower than the option’s strike price. Example: stock price is $48; strike is $50.

Opening and Closing a position:

When we sell (write) a call option, it is referred to as opening a position. Since we sold the contract we are said to be opening a short position. The holder (buyer) has opened a long position. We, as the option seller, can close our position by purchasing the same contract. That will cancel the original sale and now you will own the stock long. Buying back options contracts is the basis for our exit strategies which can be found in chapter 11 of my book, Cashing in on Covered Calls. More on exit strategies later in this article.

Important upcoming events:

IBD is enhancing its website:

I recently posted the fact that this site will be upgraded and slightly change our screening process. I have been in touch with the technical and educational departments of IBD regarding these changes. I am also in the process of testing hundreds of stocks with the enhanced version. My conclusion thus far is that the new screening process will be easier, more time efficient, and as accurate as the original screen. All those on my mailing list will receive a free update on the enhanced screen. Those of you not on my mailing list but would like to join, use the following link:

http://www.thebluecollarinvestor.com/joinlist.shtml

I promise you that the changes will be easy to follow and on the money (pun intended). I will send the upgraded information when the site changes are made which should be in February or March (I am told).

My next book on exit strategies is headed to the publisher next week:

Thanks to your feedback, I was motivated to write (what I believe to be) the only book ever written totally devoted to the subject of exit strategies for cc writing. I am putting the finishing touches on the manuscript and will be sending it off to the publisher next week. I anticipate that the book will be published and available to the public in the spring. After publication, I plan to host a seminar on this subject which will be professionally filmed for purposes of creating a DVD and CD series on this subject. I will keep all those on my mailing list informed of dates and times.

Last Weeks Economic News:

Two negatives and a positive describes the last week of the year. On the downside was an economic report indicating that manufacturing had contracted substantially and another that reported consumer confidence at a historic low. On the brighter side, the stock market began the new year on an up note: the S&P 500 rallied 6.8% to 931.80.

Market Tone:

The Volatility Index continues to decline to 39 (a positive) and the S&P 500 is trading above its short-term moving average, also a positive. Can things be turning around? This market is still news-driven and we need all that cash on the sidelines to start filtering back in. But for now, it appears that the market could be bottoming. We’ll continue to monitor market tone on a weekly basis until we are confident that market conditions have turned around. Here are the charts:

VIX: 1-2-09

S&P 500: 1-2-09

Selling a Covered Call Option- Current real life example:

I’ve made a video (Spielberg, I’m not!) of how easy the Cashing in on Covered Calls system is. ALL CALCULATIONS YOU SEE IN THIS VIDEO ARE DONE FOR YOU AUTOMATICALLY BY THE ELLMAN SYSYEM OPTIONS CALCULATOR (ESOC). I hope you enjoy it:

Wishing you all a healthy and prosperous 2009.

Alan

The Federal Reserve announced a 1/2% rate cut in the Fed Funds Rate to 1% and a 1/2% rate cut in the Discount Rate to 1.25%. The market was strong prior to the announcement because it anticipated this exact decision. So instead of going up even more once confirmed, the market went down; then up; then down again; then down dramatically; and finally back up slightly to finally end the day down 74 points. I was so dizzy from watching these market fluctuations that I thought I was developing an inner ear infection. As I was reaching for a bottle of Amoxicillin, I had the calming thought that this was, in fact, only the third time in October that the blue chips had JUST a double-digit loss.

So what’s up with Fed Funds and Discount Rates and why are they so important that CNBC even had a count-down timer in the lower right portion of the screen leading up to the announcement? It certainly wasn’t important enough for the financial media to explain to the average investor (Joe the Plumber?) what this all means. They don’t speak to us; we’re not the folks with the big bucks. Sometimes I think they should have some guy with a sign exlaining the terminology being thrown around on these shows. This could be analogous to the signers for the hearing impaired. Joe Kernen throws out the term Keynesian economics, Becky Quick cracks up at the reference, and Sid the sign guy shows us the definition….could work.

I should give credit to Jim Cramer who stated to his viewers that evening, “today’s rate cut means individuals and businesses will find it cheaper to borrow money because the federal funds rate is tied to the banks’ prime rate”. But he also tells us to do our homework. In my view, this applies to macroecenomics as well as individual stocks.

Let’s take a Blue Collar look at macroeconomics and give some meaning to what transpired on Wednesday. The U.S. Government has a myriad of tools and policies that it can utilize to manage the economy. They fall under two general categories:

FISCAL POLICIES:

The government’s taxation and spending programs designed to promote economic growth and maintain high levels of employment. Much of this policy is based on the Keynesian economic theory alluded to above. It states that greater government spending is needed during economic downturns and that higher levels of taxation are called for during times of expansion. The former would combat insufficient private demand and head off a path to recession and the latter would hedge against inflation. Currently both presidential candidates are calling for decreased taxes thereby allowing consumers to spend more and stimulate our sagging economy.

MONETARY POLICIES:

These are methods used by our central bank to control the money supply. This will impact interest rates, inflation, and therefore the economy. Here are the key players:

1- The Federal Reserve System (the Fed): The central bank of the U.S. consisting of 12 regional Federal Reserve banks and numerous member banks. All are under the supervision of the Federal Reserve Board which formulates and executes monetary policy. Fed policies have immediate and significant economic impact and therefore are closely watched by investors like ourselves.

2- The Money Supply: Broken down into categories based on the degree of liquidity:

 - M1- currency in circulation plus demand deposits(like checking accounts).
 - M2- all money in M1 plus time deposits under $100,000 (CDs, savingsetc.).
 - M3- all money in M2 plus time deposits over $100,000 and some institutional
              holdings.

The value of money is determied by supply and demand.  If supply is too great, the value of money declines thereby driving up prices and interest rates. The Fed has numerous tools to control the money supply. One is Reserve Requirements.

3- Reserve Requirements: The % of customer deposits that commercial banks must maintain in cash as mandated by the Fed. By lowering the reserve requirement, the Fed can increase the amount of money that banks can lend, thereby increasing the amount of money in the economy. Conversely, raising the reserve requirement will shrink the money supply.

4- Federal Funds (Fed funds): Money lent or borrowed overnight between banks in order to meet their reserve requirements. The rate at which these funds are lent is known as the Fed funds rate (Wednesday lowered to 1%). The Fed establishes a “target” Fed funds rate and increases or decreases the money supply to move the actual rate closer to the target. The Fed can also influence the money supply by altering the Discount Rate.

5- Discount Rate: This is the rate at which the Fed itself loans money to banks that are members of the Federal Reserve System. On Wednesday it was dropped to 1.25%.  These are the lowest rates available in the economy. Banks then set their own rates at a level above discount. By raising or lowering discount rates, the Fed influences the degree of difficulty for businesses to borrow money. Investors get a look into the Fed’s evaluation of our economy based on it’s decisions regarding discount rate.. The Fed can also control money supply on a daily basis via open market operations.

6- Open Market Operations: This refers to the Fed’s purchases and sales of government securities in order to adjust the money supply. When the Fed buys Treasury securities from banker-dealers, money is injected into the banking system. When the Fed sells them back, money is withdrawn from the banks. If the economy is expanding too rapidly and inflation is becoming an issue, the Fed might raise interest rates. If the economy is in (or heading towards) a recession (hello!) the Fed can lower interest rates in an effort to encourage new borrowing which will lead to renewed growth. That is precisely what we encountered on Wednesday.

Click on the link below to see a chart summarizing the above discussion:

federal-reserve-actions-and-consequences

Monitoring the Health of the Stock Market: 

 Last week I responded to a readers question about what I look for in market conditions before I started selling options again. Here was my response:

A- I am looking for an upturn in the housing and financial sectors as well as a loosening of credit requirements. Once this occurs, there is a strong likelihood that the institutional investors will start re-investing all that cash that is currently on the sidelines. One technical indicator I check is the VIX which is the Volatility Index that tracks the S&P 500. It is a measurement of market risk and is often referred to as the “investor fear gauge”. Values greater than 30 is indicative of investor fear and uncertainty while values under 20 infer calmer, less stressful times in the market. Needless to say, the current chart below is above 30 and approaching the planet Pluto! Use the ticker symbol $VIX to pull up the chart:

VIX 10-25-08

 

Now take a look at the chart of the VIX as of now. You see a dramatic improvement and thus a positive sign:

VIX 10-31-08

 

I have also prepared for you the charts of the housing and financial industries which are improving but still need some work:

Housing and Building Services 10-31-08

Financial Services 10-31-08

 

Financial Services seems to be strengthening first. That makes sense to me as money has to be available before builders have the financing to get back to work and consumers can get the financing to buy their homes. Let’s continue to monitor the markets together. Whether you use the same parameters that I use or others, this sure is a better way to plan your strategy than to hope and pray or completely depend on others. As I say adnauseam, I listen to EVERYONE collectively, but NO ONE individually.

________________________________________________________________________________________________

Last Week’s Economic News:

___________________________

GDP declined .3% for the third quarter, the worst performance in 7 years. By technical terms we are NOT yet in a recession since the first two quarters rebounded after a contraction in the fourth quarter of 2007. For a true recession, we need two consecutive quarters of negative GDP growth (some economists differ on the precise definition of a recession). Consumer confidence fell to an all-time low. On two positive notes, new-home sales rose 2.7% (although prices kept falling) and durable goods orders got a boost from the airline industry.

_________________________________________________________________________________________________

Industries in the Spotlight:

________________________

In the last several weeks a few industries starting showing some strength:

Schools

    DV

Railroads

    NSC

     GWR

Although I’m not ready to jump in, keep your eye on Financial-Investment banks and Services, an industry surging of late:

     SF

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Looking forward to hearing from you,

Alan

alan@thebluecollarinvestor.com

Alan’s last article stressed the importance of ascertaining where the “Big Boys” were headed with their investment dollars. I also did some digging and found a gem, with the help of J. Cramer,  that goes along with what Alan wrote about in his last article.

Let’s run it through our Blue Collar System:

Overall A+

Technical A-

Fundamental B+

Attractive A-

Group Technical A-

Scouter rating of 7

EPS on 10/23/08 not confirmed

Industry is Medical/Dental

Now let us look at the chart:

MHS from StockCharts.com 9-16-08

-The EMA is just breaking through a trading range.

-The MACD is just breaking positive above the zero line and the MACD  is above its trigger signal.

-The histogram is above the zero line (MACD minus trigger).

-The slow STO is breaking upwards above 80, and above its trigger.

-Heavy volume gave a boost up the hill around the second week of September (Hedge funds)?

-Looking good

 
Let’s make some Blue Collar money:

If we buy MHS at $49.52 (at the time of this writing) and sell the Oct.50 call we can get a 3.7%, 5-week return . In essence, this is an A-T-M Strike. Although there are some exceptions, it usually doesn’t  pay to sell I-T-M or O-T-M strikes in a situation like this for conservatively priced equities.

Cramer quote:

“Medco is one of the great recession stocks” He is bullish on this stock. I discovered thisstock gem while watching the ‘Lightning Round” where I usually have a pen handy because of Cramer’s fast pace during this segment. In addition, this has been a “Cramer favorite” for some time.
Thanks for your time, I hope to hear from you all and tell me what you think.

Tony

________________
Keep an Eye on Stock Splits:
Another way to locate potential equities for your watch list is to be alert for the announcement of stock splits. Oftentimes,  Board of Directors will decide to increase the number of outstanding shares via a split. Common splits include 2-for1, 3-for-1, and 3-for-2. Since market capitalization (# shares x price) must remain the same before and after the split, the price per share is decreased. This lowering of the equity cost allows average Blue Collar Investors the opportunity to buy more shares. We must also make sure that the split announcement was truly based on an appreciating equity with sound financial and technical indicators.
I noticed today that BKE announced a 3-for2 split (effective Oct. 30, 2008) and a .05 cent increase in its quarterly dividend. I checked our system criteria and was quite impressed.

See what you think.

___________________
At the time of this writing, BKE can be purchased for $58.78 per share.

 I-T-M Strike (Oct. 55):

- Sell (1) BKE-JK @ $5

- ROO is (5 – 3.78) or 122/5500 = 2.2% for 5 weeks or 22% annualized

- Downside Protection is (378/5878) = 6.4%

 O-T-M Strike (Oct. 60):

- Sell (1) BKE-JL @ $2.10

- ROO is (210/5878) = 3.6% for 5 weeks or 36% annualized.

- Upside Potential is (222/5878) = 3.8%

Here’s the chart for you to analyze: 

BKE from StockCharts.com 9-16-08

If the fundamentals, technicals, and calculations meet with your approval, it may earn a spot on your watchlist. 

Hedge Funds: Follow-up Information

As an addendum to my last article  the deleterious effect of some hedge funds on our economy in general and the stock market in particular, new information is beginning to surface.

The Wall Street Journal reported today that the SEC will begin enforcing a rule that requires short-sellers to actually verify access(to borrow) to shares they sell short. This will dramatically slow down the process of share depreciation due to short selling.

Next on the agenda should be re-instatement of the “uptick rule” which allows traders to short a stock ONLY on an uptick (price increase). Cramer has been screaming about the repeal of this rule the last few months and I am hoping the SEC listens and responds.

Finally, I would not be surprised if the SEC took more dramatic steps to control the glut of short-selling and start instituting NEW rules and regulations. It’s a shame that it takes an historic collapse of the financial and housing communities for our “protective” agencies to take appropriate actions. I’ll keep an eye out for this and report to you if now information comes out.

Thanks to Tony for his Cramer article and to all of my readers for your tremendous support,

Alan