Don't Add Any New Positions, Unless . . .

As you can see over there to right there is big red flag flying.  This is a market in correction.  Friday sucked all of the life from a couple of decent up days giving hope for a green flag environment.

We have said many times here that the trend is your friend.  Market direction plays a huge role in the performance of your individual stocks.  When we have a red flag flying, and this is not me saying this, it is a market in correction, it is the consensus based upon very strict technical analysis from various resources.

So why would we add a new position over the weekend and add to another existing position.  Well it was options expiration on Friday, which is why volume was up on the indexes.  That means all those folks who made bets on what a stock would be a week ago, a month ago, two months ago etc, had to settle those bets. 

We had several put options we sold expire worthless.  Now pay attention. That is a good thing.  We got the money betting the stocks would be higher than the strike price.  If the price was higher, the contracts expire worthless letting us keep the premium.

Now we had two where the price was lower than the strike price, which means we have to buy the stock at the strike price.  This is a great lesson for you, the readers as it show the opportunities and the challenges of picking the correct options and the correct decision to buy or sell those options.

Here is the lesson of WAG Walgreen Co., together with its subsidiaries, operates a chain of drugstores in the United States. It sells prescription and non-prescription drugs; and general merchandise, which include household products, convenience and fresh foods, personal care, beauty care, candy, photofinishing products, and seasonal items, as well as home medical equipment, contact lens, vitamins and supplements, and other health and wellness solutions. The company offers its products through drugstores, mail, telephone, and online. It also provides specialty pharmacy services; customers infusion therapy services consisting of administration of intravenous medications for cancer treatments, chronic pain, heart failure, and other infections and disorders; and clinical services, such as laboratory monitoring, medication profile review, nutritional assessments, and patient and caregiver education. In addition, the company operates Take Care Clinics to treat patients, give prescriptions, and administer immunizations and other vaccines. As of October 08, 2012, it operated 7,944 drugstores in 50 states, the District of Columbia, and Puerto Rico, as well as approximately 700 worksite health and wellness centers, and in-store convenient care clinics in the United States. The company has a strategic partnership with Alliance Boots GMBH. The company was formerly known as C. R. Walgreen and Co. and changed its name to Walgreen Co. in April 1916. Walgreen Co. was founded in 1901 and is based in Deerfield, Illinois.

First off, remember a PUT option is a bet that the future price of a stock will go down and a call options is bet that the price will go up.  That is true if you are buying those contracts.  The opposite is true if you are selling the contracts. 

In August, WAG came up on my watch list.  I did all my homework and liked what I saw.  It was a stock I would not mind owning but I had a few choices.  I could buy it long, I could buy call option, or I could sell a PUT option.  I chose the latter. 

After looking at the direction of the market (Green Flag), the RSI 20 (relative strength, and the current price ($35.69), and felt very comfortable going out 60 days and selling a $36.00 contract for 1.53 a contract.  Now that meant, if October 20^th rolled around and WAG was below $36.00 I would have to buy 100 shares of WAG for each contract I sold.  We sold quite a few, but I liked the stock and felt even at $36.00 it was a good price.

We had WAG PUT to us over the weekend.  I will do more homework to see if I want to make this a core holding or wait for the 38-40 target price to occur and take more profits. 

Keep in mind that I bought it at $36.00, BUT I sold the PUTs for 1.53 for the contract.  That initial premium actually means I bought the stock for $34.47.  The stock closed Friday at $35.79.  BTW, it throws a very sustainable 3.07% dividend. 

The other stock I added to was one I told you about last week.  Again in August I thought 95 cents was a nice premium for a PUT sale for an October $30.00 MSFT.  The stock was selling for 30.59, it was already a sizable core holding that I would not have minded adding to at 30.00 a share. 

Then the last week of September happened and the market softened and we have had a string of less than flattering tech earnings numbers and negative guidance and then MSFT goes well below 30.  Well I got more of the stuff PUT to me at 30.00 a share.  Happy to have it thought it makes it the second largest holding I have at the moment.  BRK/A is the largest.

Now should you go out and think about selling PUTs to make some money or pick up stocks you like?  Not while a red flag is flying.  Remember a PUT you would buy is a bet the stock will go down.  If you sell a PUT you are betting a stock will go up.  Don't bet on ANY stock that it will go up during a Red Flag.  (Ok there a few exceptions, but I am trying to make it simple.)

In closing, I could break out the crystal ball and tell you what I think might happen this week or answer a couple of questions I have been asked this week.

Someone asked, "Isn't playing options just another form of gambling?  You might as well play Craps in Las Vegas."  Great question.  I have been playing options since the middle of 2010.  Yes my first year and half was a monthly or weekly gambling junket.  I won a few and lost a few and like in Vegas, I left more money in the casino that I came home with. 

I read a lot and spent a small fortune on some one on one training that did not really help too much.  I read some more and realized it still came down to the basics of doing your homework, choosing a fair value, determining the direction of the market and managing your risks.

Having spent 13 years in Las Vegas, there are smart bets in the casino and stupid bets in the casino.  The physical layout of a casino tells you a lot.  What is the most square footage devoted to?  Slot machines and poker machines.  Think they have a great payoff for the customer?  No.  They will even advertise how bad their payoff to the customer is.  "Our Slots have a 97.3% payout."  Notice they do not say 97% return.  In essence for every 100.00 you spend, on average you will get back $97.30.

Now you can improve your odds at the casino by doing your homework.  What is the best odds for the player (who can't count cards) in the casino?  I'll give you a hint. 

When the Mirage Hotel was completed (We were very involved in the selling of the wire and cable to the electrical and electronic contractors.) in 1993 it had 111,000 square foot of casino (Not including two secluded High Roller areas).  In that casino there were 34 craps tables providing about 1700 square foot of craps enjoyment on the casino floor.  Of that, there was 136 square feet allowed for the Don't Pass Line on those crap tables.  So out of 111,000 feet, there was only 136 square foot allotted for the don't pass line?  Accident or oversight?  Probably not.

If you understand the crap game, you have two die with 6 sides.  The two die create any combination of numbers totaling from two to twelve.  There is one combination for two (1 and 1) and one combination for twelve 6 and 6).  There are two combinations of 3 (1/2 and 2/1) and 11 (5/6 and 6/5).  There are 3 combinations of 4 (3/1, 1/3, and 2/2) and 10 (4/6 and 6/4 and 5/5).  There are 4 combinations of 5 (1/4, 4/1, 2/3, and 3/2) and 9 ( 4/5, 5/4, 3 and 6/6 and 3). There are 5 combinations of 6 (1/5, 5/1, 2/4, 4/2, and 3/3) and 8 (2/6, 6/2, 3/5, 5/3, and 4/4).  Then you have 7.  There are 6 combinations of getting a 7.  (1/6, 6/1, 2/5, 5/2, 3/4, 4/3, 5/2, and 2/5).

There are two primary areas to place initial bets on a craps table.  The Pass Line and the Don't Pass Line.  There is a lot more room in a casino devoted to the pass line than the don't pass line.  If you put your money on the pass line and the first roll (The Come Out) is a 2 or a 3 you loose.  If a 7 or an 11 is rolled you win.  If a 12 is rolled you push or tie.  All other numbers become your point.

Now of you play the don't pass, just the opposite it true. 2 and 3 you win, 7 or 11 you loose, and 12 is a push.  All other number become the point.

If a seven is rolled before the point, you loose if your money is on the pass line.  If you are on the Don't Pass, you win.  Think about it.  Once a point is established the odds are in your favor.  You have a 20% better chance of getting a 7 that a 6 or 8.  You have a 50% better chance of getting a 7 before a 5 or a 9.  And you have a 200% chance of getting a 7 before a 4 or 10.

Here is what I used to do when I lived in Vegas.  I only played live poker and the don't pass line.  When I wanted to play craps, I would go to a nice place with the highest table odds, usually times 3.  I would put my money, say 5 dollars on the don't pass.  If I got 4 or a 10 as the point, I would take the odds.  In this case I would back up my 5 with 15 dollars more, making it a 20 dollar bet.  I knew statistically, I was betting with the house.  There were only three ways to roll a 4 or 10 and 6 ways to roll a 7.  More often than not it would be winning bet.

So what does that have to do with options.  Just like gambling, if you do your homework you can reduce your risks.  You cannot eliminate them but you can reduce them.  Know the underlying stock.  Know the direction of the market.  Know any critical announcement during the life of your option contract.  Know when you want to get out of the contract to the upside and the downside.

The other answer we would like to take a crack at was posed to me in the middle of the SMHS game.  What should the next president do about China?

Tough but great question.  During the debate and during the campaign, there is a lot of rhetoric about how tough we should be with China.  Obviously a lot of people have lost their jobs over the last 3 plus years.  Some of that is do to outsourcing, the placement of work and process outside our borders to cheaper labor markets.  That makes China an easy target.

Then we can say that China is dumping product in the United States because their currency is so low.  One action a President can deploy is to call China a currency manipulator.  That is a country that takes action to lower their internal interests rates through relaxing capital requirements for their central banks or buying their own treasure notes to keep interest rates down making their currency cheaper on the world market.  Mmmmm, that sound a bit too familiar, but heck I am trying to get elected so I will say, "On day one I will name China a currency manipulator (Romney October 17, 2012)."  Obama made the same pledge in his first run for office, got in office and realized he would have to buy a gob of US treasuries to drop interest rates and in essence be a currency manipulator.

The other thing a President can do is to pass tariffs or sanctions on imported goods to make product hard to enter a market.  We must keep in mind that the only thing we still make in the US are Big Mac's.  Imposing draconian fees on imported goods would make your Nike shoes cost about 113 dollars a pair versus 60-70.  Your iPhone would cost about 800 dollars versus the 400-500 it cost now.  Your T shirt would be 30-40 versus 20.  How is that going to help?

One last word of caution before we consider what a President might do about China.  Our two largest landlords are China and Japan.  They each hold about 1.1 Trillion in our debt.  Devin and I learned early on, you don't piss off your landlord.  Good advice for the next president.