Russell’s Round-Up – Weekend Review

Last week the market lost a little luster and failed to put together two winning weeks in a row. The S&P 500 is now down seven of the past eight weeks. Let’s see if a new streak can get started before the upcoming long holiday.  Sort of like putting something good together before the All Star Break.

With that stretch of an analogy, let’s get down to business…

Options Action –

The focus of the initial discussion was Technology stocks. The feeling was the weakness in shares of Oracle (ORCL) and Micron (MU) after their earnings reports may be a sign of things to come. This focus on tech led right into the first stock specific recommendation in IBM (IBM).

IBM reports after July expiration, but the trade involves using that expiration. The stock is up 12% year to date so may be a candidate to sellers of tech to put on short positions. The trade recommendation was a put spread buying the July 160 Put for 1.10 and selling the July 155 Put at 0.50. The net cost of this trade is 0.60 and it would pay off 4.40 if the stock is at 155 or lower on July expiration. If bearish, this is a pretty attractive risk – reward. 

The second recommendation was a bullish outlook on Jet Blue (JBLU). The expectation is that the stock is primed for a break out to the upside. Lower energy prices are part of the catalyst behind this trade as there is a definitive inverse relationship between the price of oil and JBLU stock. The idea is a long Sep 7 Call, with the thinking that if JBLU starts to trade higher into the end of the summer the 7 Call will move up as well. 

Barron’s –

The Striking Price column discusses the end of QE2 and the unwinding of what is referred to as the ‘world’s most crowded trade’. The trade is short the dollar and long commodities. The long commodity side of this may explain the rise in energy prices over the past few months. A couple of Commitment of Trader (COT) reports back in the spring showed that the long positions in oil were mostly held by speculators. The recent weakness in oil (and some other commodity markets) may be partially attributed to the unwinding of speculative long positions.

The column goes on to address something that’s actually been on my mind lately and an area of study at the Options Institute. A handful of exchange traded funds that focus on specific industries are heavily weighted with holdings of just a few stocks. The performance of the Select Sector Energy SPDR (XLE) is dominated by ExxonMobil (XOM) and Chevron (CVX) with those two stocks representing 33% of the ETF. A drop in the price of oil would put pressure on the XLE. Long out of the money put option positions that expire a few months out may be worth consideration. To get a little more exotic combining long XLE put positions with selling out of the money call options on CVX and XOM was recommended. This does involve naked option positions, so check with your broker before trying something this unique. A good substitute for the short calls could also be out of the money call credit spreads. Since the implied volatility on individual equity options is generally higher than on option contracts on exchange traded funds this may be a good method of selling higher volatility and buying lower volatility. My plan is to check options on XLE, CVX, and XOM this week and return with some more insight.