If we travel back to an article I wrote on Dow Chemical (DOW) at the end of April, we can see how the stock was moving up slowly. I saw a huge negative divergence taking place in the RSI, which often points to a weakening of the bullish trend. So I wrote my article on how Dow was seeing a slowdown and accordingly advised on a short-term income play on the stock.
Well, just after the article (perhaps, by luck), the stock dropped in value in line with the bearish moves of the market as a whole. It declined from $36 down to $30 by the third week of May. This made the income play worth cashing in.
Here is the original play and how it developed:
The Options Play (Stock was trading at 34.90)
- Buy a July 2012 put with a '35' strike (prices at $1.39)
- Sell a July 2012 put with a '34' strike (priced at $0.99)
- Net Debit to Start: $0.40
- Maximum Profit: $0.60
Reasoning behind the trade:
- Dow is in a cost-cutting stage.
- It missed revenue projections last quarter, so there is nothing to get excited about.
- The Broadening Ascending Wedge is a fairly accurate reversal pattern.
Today, as the stock was trading at $31.63, I reversed the position:
- Sell July 2012 '35' put (priced at $3.70)
- Buy July 2012 '34' put (priced at $2.95)
- Gross Profit: $0.75
- Subtract Gross profit from original net debit: ($0.75 - $0.40)= $0.35
- Final Profit: $0.35
- ROI- 87.50%
As you can see from this play, the potential to increase one's income using a combination of long-term investing and short-term income plays can be very rewarding.
If we look at Dow Chemical today, it is still in a bearish pattern, but may have found support on the 200 MA. With the economic turmoil still very real in the global economy, I am not of the opinion that the company will be moving up real soon. Its first-quarter earnings slumped 30%, as the chemical giant saw slow demand early in the quarter, as well as restructuring charges.
Last year, Dow Chemical's earnings and revenue soared on a resurgence of manufacturing on low natural gas prices. But now, we have the faltering European economy that has taken a toll lately. The company said earlier this month that it would shutter manufacturing plants in Europe and the U.S. and cut 900 jobs, about 1.7% of its workforce, in an effort to control costs. So I do not see any catalyst to send this stock searching for the bulls in the next quarter.
Its competitors are not doing much better. BASF (OTCQX:BASFY) has lost almost 20% of its value since mid-March. Market worries and warnings have hampered sales since the second half of last year. The company even warned last summer that the second half of 2011 would start to see sales slow down.
We also have mixed sales results from DuPont (DD). The Company increased sales in the first quarter of this year, but figures were helped by an 8% price hike, with a 2% drop in volume. Sales of Kevlar, Nomex and other safety equipment slipped 2 percent due to weak demand from industrial customers. Consumers aren't spending and manufacturing continues to slow down. As these companies are struggling with revenue right now, I would continue to cash in short term on income trades.
Click to enlarge
The Options Play
- Buy a September 2012 put with a strike of '32' (priced at $2.35)
- Sell a September 2012 put with a strike of '31' (priced at $1.91)
- Net Debit to Start: $0.44
- Maximum Profit: $0.56
- Maximum Risk: net debit
- Maximum Length of Trade: 3 months