Earnings reports represent the greatest risk for price gap-downs for our covered call writing and put-selling stocks. Problem solved…we avoid earnings reports. However, from time-to-time unexpected negative news will be reported that will cause significant price decline. On July 25th, 2018, Earl shared with me a trade he initiated with Stamps.com (NASDAQ: STMP) and was subsequently impacted by such a negative news story.
- 6/18/2018: Buy STMP at $283.94
- 6/18/2018: Sell 6/22/2018 (Weekly) call at $4.80
- 6/22/2018: STMP closed at $252.65 after President Trump hinted at re-structuring the US Post Office
- 6/25/2018: Earl writes Alan expressing concern about selling at a loss needing guidance on managing these scenarios
1st step: Check the news
A reliable free resource for stock news is www.finviz.com:
What happened on June 22nd?
Shares of Stamps.com (NASDAQ: STMP) slumped on Thursday after the Trump administration proposed a federal government reorganization, including an overhaul and potential privatization of the U.S. Postal Service. The stock was down 10.2% when the market closed.
The next day
Maxim Group analyst Allen Klee defended Stamps.com Inc. STMP, which moved up +8.44% on Friday and said that the stock’s sizable selloff in the prior session was “an overreaction.” Stamps.com’s stock slid more than 10% Thursday after the Trump administration released a broad array of proposals, which included a plan to potentially privatize the post office. “We think it is unlikely that changes to the USPS would negatively impact Stamps.com and would use the pullback as a buying opportunity,” Klee wrote.
- Yellow field: Bullish chart pattern leading into the trade initiation
- Purple field: Trump announcement resulting in price gap-down
- Brown field: Price recovery after initial emotional market reaction passes
- Green field: Price gradually declines prior to earnings announcement and then gaps-up after positive earnings surprise
Planning gap-down management
The BCI rule is to never sell an option with an upcoming earnings report. Our guidelines tell us that we can either avoid the stock through the report or retain it and write the call after the report passes. When unexpected negative news presents itself, we must check the news to investigate the reason(s) for the share decline. In this case, it appears the 10% decline was an over-reaction as share price immediately recovered. Had the news been more egregious like corporate fraud or FDA rejection of a key drug approval, then selling at a loss would have been most appropriate…take a loss to avoid taking an even greater loss.
- If a stock price drops significantly by expiration, the original purchase price should not cloud our decision as how to proceed. If we paid $50.00 for a stock and at expiration it is $40.00, we now have $4000.00 cash invested in that stock (per contract) and we must decide if that $4000.00 should be in invested in the original security or a different one. In other words, which stock will give us the best chance to grow our wealth? This applies even if we paid $10.00 for the stock
- When a stock drops a significant amount, our exit strategy arsenal must be implemented, whenever possible. One of the reasons I prefer Monthlys over Weeklys is that we have more opportunities to mitigate losses and enhance gains. In this case, closing the short call after the gap-down and writing additional calls would have assisted in mitigating potential losses
- When a stock price drops 10% from one day to the next, we must check the news (www.finviz.com is a good, free resource). If egregious (like corporate fraud, a drug not getting FDA approval, a negative earnings pre-announcement etc.), we may look to cut our losses and move to a better-performer. Some set a percentage stock loss to sell (8% – 10% is a typical range used by investors)
- We must first close the short call, so limit orders can be set up after the initial trade is established (20%/10% guidelines)
- In this case, share price almost fully recovered so perhaps this story had a happy ending?
Position management is one of the 3-required skills essential for maximizing our option-selling returns. This includes managing gap-downs resulting from unexpected negative news reports. Evaluating the news, not emotions, should guide us as to the next-step exit strategy trades to execute.
Put Calculator updated
We have enhanced the BCI Put Calculator in the “resources/downloads” section of your member site (scroll down to “P”) with the following additions:
- Added the 3% exit point (based on exit strategy found in Selling Cash Secured Puts).
- Added a comments section
February 7th – 10th, 2019
Orlando Money Show
Omni Orlando Resort @ Champions Gate
February 7th – 10th 2019
1. Getting Started with Stock Options: Creating Monthly Cash Flow with Covered Call Writing
February 8, 2019, 3:10 pm – 3:40 pm
2. Video Interview Q&A
3. Getting Started with Stock Options: How to Select the Best Options in Bull and Bear markets
February 9, 2019, 2:00 pm – 2:45 pm
Your generous testimonials (new feature)
Over the years, the BCI community has been incredibly gracious by sending our BCI team email testimonials sharing stories as to what our educational content has meant to their families. Moving forward, we have decided to share some of these testimonials in our blog articles. We will never use a last name unless given permission:
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This week’s economic news of importance:
- Existing home sales Dec. 4.99 million (5.10 million expected)
- Weekly jobless claims 1/19 199,000 (218,000 expected)
- Markit manufacturing PMI Jan. Jan. 54.9 (53.8 last)
- Markit services PMI Jan. 54.2 (54.4 last)
- Leading economic indicators Dec. -0.1% (0.2% last)
***Other reports not available due to government shutdown.
THE WEEK AHEAD
Mon Jan. 28th
- Chicago national activity index Jan.
Tue Jan. 29th
- Advance trade in goods
- Case-Shiller house prices
- Consumer confidence index Jan.
Wed Jan. 30th
- ADP employment
- Gross domestic product Q4
- Pending home sales Dec.
- FOMC announcement
Thu Jan. 31st
- Weekly jobless claims 1/26
- Employment cost index Q4
- Personal income Dec.
- Consumer spending Dec.
- Chicago PMI
Fri Feb. 1st
- Nonfarm payrolls Jan.
- Unemployment rate Jan.
- Average hourly earnings Jan.
- Markit manufacturing PMI Jan.
- ISM manufacturing index Jan.
- Construction spending Dec.
- Consumer sentiment index Jan.
For the week, the S&P 500 moved down 0.22% for a year-to-date return of 6.30%
IBD: Market in confirmed uptrend
GMI: 3/6- Bearish signal since market close of November 13th, 2018 as of 1/17
BCI: I am favoring out-of-the-money strikes 3-to-2 compared to in-the-money strikes. Earnings season has been a positive and market volatility has subsided.
WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US
The 6-month charts point to an improving market tone. In the past six months, the S&P 500 down 6% while the VIX (17.42) moved up by 43%. We can’t forget that the VIX was more than double the current rating on December 24th (36.07).
Wishing you the best in investing,
Alan and the BCI team