Options Trader: Plays on Dow Components

Here we go again...

All aboard the market train as the GM strike ends, oil prices rebound (XOM, another Dow component) so we’re in for a retest of 14,000. I’m going to dispense with the news today as it doesn’t seem to affect the market anyway and let’s take a look at our 30 Dow components - perhaps we can find some bargains as the tide of index buyers lift all ships (plus they are nice and liquid so we can get our when it all hits the fan!).

Just for fun I’m going to make a Dow page, as it should be a fun group to watch if the global market catches fire. We can allocate $3K per position in a $100K portfolio and see how it goes. These are plays for a Dow rally, with the assumption we are going to break and hold 14,000, otherwise we take the money and run:

AA - I don’t understand why they dumped China's Chalco for $2Bn, perhaps they were guessing the top of the market… Earnings were 7/9 and the company jumped from $42 to $48. My pal Icahn owns 3.5M shares and the stock has taken a beating in Q3 and their forward p/e of under 11 is a good 30% below historical averages. Did not buying AL put them at a huge disadvantage? I say they’re still worth $40+ but let’s give them time and go long with the Jan ‘09 $35s for $7.40, selling the current $37.50s for $1.30.

AIG - Hmm, no hurricanes and they are still going down? I suppose the concern was that they tie up a lot of their reserves in mortgage-backed securities but as long as everyone seems to have forgotten about that, we should too. I like the May $70s here at $4.10, if they can’t break $73 by the month’s end we can consider selling calls against.

AXP - People keep confusing these guys with a credit card company but the majority of AXP’s revenues is purely transaction based. I simply don’t remember these guys having a bad Q3 (last year was a 3% beat) and I think estimates are low here. The Apr $60s are $4.70 but we’ll be out by January and we can sell the current $60s if they hit $2+ (now $1.20) as $62 has been tough resistance so it will be good to have some insurance there.

BA - We already have the Jan ‘09 $95s from the beginning of the month that are up 36% already in the LTP. I expect a retest of the ATH at $107 but, if we don’t break that we may want to cover with the $105s, now $2.45, probaly $4 on a good run but only selling on a failure. As a new position, I’d go with the May $110s at $6.80 and I would sell the $105s if we don’t break it today and for no less than $2.

C - They are all over Asia and paying a 4% dividend and they have gotten whacked over phantom sub-prime issues. If they fall below $46, we’re out of this one and if they break $47.50 we should be off to the races so let’s go with Mar $47.50s at $2.65 with a stop at $2, where we will wait for the next bottom (maybe $40) and then buy LOTs of leaps.

CAT - We have the Jan ‘09 $80s, now $9.20 covered with the $75s, now $3.25 (these should stop out at $4). As a new entry I would go naked and hope to get $2+ for the $80s, which is what we’ll flip the $75s to on a run.

DD - Low natural gas prices are good for these guys and no one talks about their biobutanol partnership with BP, which will roll out this fall in the UK. They are also heavily involved in ethanol and they run a nice little company with a p/e of 14 that’s growing at a 10% clip. Talk about no respect! Earnings are on 10/23 and the last ones went pretty well - despite a 2% miss, the stock went from $46 to $50 so if those charges were indeed one-time, we could get a nice pop. Let’s gamble on this one and spread the Nov/Oct $50s for net .75 since earnings come after expirations, not so good for our caller!

DIS - These guys killed us in the last $10KP but now they are squeezed between the 50 ($33.80) and 200 ($34.26) dma so an upside breakout would be a great sign. HOWEVER, they did just break out to $34.95 and got rejected right back under the 200, which shouldn’t be so easy to fold but the 50 held yesterday and we’re coasting along there. I’ll say this is another one we can play to stop out and take the Jan $35s at $1.45 but get out at $1.25.

GE - Why do I have no GE in my folder? It’s in my retirement account but somehow I never reestablished it in the active portfolios. I gess they got high enough to scare me at $41.50 (I sold the $40s against my shares) so it’s hard to pull the trigger on a call here but I don’t have the heart to short them. When in doubt, go long - the Jan ‘10 $45s are $4.17 and we can roll down to the $40s for another $1.50 if things go south. Meanwhile we can sell the current $42.50s for .40 but I’ll be greedy and wait for .50+, not even going to consider selling until the Dow pulls back and makes me.

GM - Well I sure played them wrong with the $35 puts! Sorry, I just can’t buy these guys. They just spend $35Bn to save $3Bn a year (maybe) in benefit costs and they gave concessions to keep jobs in the US which means now they are committed to either building overseas plants they will have to unload or running even more excess capacity than they have now as they crank out cars they can barely get people to take with $3,000 rebates and 0% financing. Forget it! I am not going to place a buy on them… I hope Uncle Rupert swaps them out for TM when he takes over so we can have a real automotive indicator in the Dow!

Oh wait, I’m sorry, I do have a play. Sell some idiot the $35 calls at the open, if they keep going up, buy the Jan $37.50s to cover and we’ll roll the caller to the November whatevers.

HD - How LOW can they go? Well, if he market takes off, $33 should about do it. If the market heads further south, they will be a bargain around $25. I guess we’d better give them until May with the $35s at $2.55 and give up at $2.

HON - Earinings are 10/19 and they have great growth but great growth is now expected of them. They supply stuff for war and peace which means we don’t have to worry about the election so all they need to do is follow through from the last earnings report and they should take out the ATH at $62.50. The 50 DMA for them is $57 so we can be aggressive with the Dec $57.50s at $3.85 and we can always sell the $60s, currently $1.12 ahead of earnings if we get a good run to capture the premium.

To be continued...

Comments

[tmmcnay:]

Hi Philip, Please add a more complete description of the option to your articles i.e. a call or a put. Since 2002 i have good luck writing LEAP puts on good companies and am slowly increasing the amount committed at each downturn. Your article on the Dow options has my intense interest because of the quality of the companies but with the option not being fully identified I can't follow your strategy.

2007 Sep 26 10:37 AM

[Uncle Bill:]

Writing LEAP puts? About 2/3 of option premium is expected to waste away during the last six weeks of an option's life. By selling so far away, you never get the advantage of that premium erosion. Your gain is limited to the amount of the put you've sold, while your loss is limited only by the price of the stock. You're essentially betting on the direction of the stock, and you've capped your upside gain in order to invest more money in the strategy than if you just bought the stocks on margin. If the market falls dramatically one day while you're holding these puts, you'll lose all the money you've made since '02. The best way to avoid this is to sell puts on stocks that already have fallen more than two standard deviations below their mean prices. Also, don't employ this strategy once the market itself has moved more than two standard deviations above its mean price. If the market falls after an extended rise, your short puts will get killed by volatility expansion too. This is a very dangerous strategy in this market environment.

2007 Sep 26 11:09 AM