Market Moves Into The Great Wide Open, Option Review September

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 |  Includes: AAL, HUN, STX, WDC
by: Dark Horse Traders' Hedge

Eddie waited till he finished high school

He went to Hollywood, got a tattoo

He met a girl there with a tattoo too

The future was wide open

They moved into a place they both could afford

He found a nightclub he could work at the door

She had a guitar and she taught him some chords

The sky was the limit

Into the great wide open

Under the skies of blue

Out in the great wide open

A rebel without a clue

Tom Petty and The Heartbreakers

The European Central Bank (ECB) announced a bond-buying plan Thursday that lifted U.S. markets to levels we haven't seen since 2007. China followed suit with a post on the National Development and Reform Commission's (NDRC) website announcing plans to boost infrastructure spending. Together, these announcements helped investors feel better about global growth.

Just as the market was feeling like the "sky was the limit," the U.S. payroll report Friday morning was so bad that the market reacted like "a rebel without a clue" by continuing higher. The reason for Friday's continued rally "into the great wide open" is predicated on the belief that the Fed will announce some version of QE3 next week.

As I mentioned in the June 25, 2012 article, most of the global risk was priced into the market creating more upside opportunity than downside. Many factors are at play heading into next week, which will determine if we are truly "under the skies of blue" as we wait on the Fed to take action. At least for Friday, bad news was good news for the market and should provide Fed Chairman Ben Bernanke the same lift Eddie got when "she had a guitar and she taught him some chords. The sky was the limit."

As always, it comes down to what we should do with the information we have today. On June 6, 2012, we recommended adding Seagate Technology (NASDAQ:STX) for the second time in 2012. It seems a foregone conclusion at this point that our position will be called away at $24 on September 22, 2012. After buying STX at $23.63 on June 6, 2012 and selling the Sept $24 call (+$2.63 premium) and Sept $24 put (+$3.20 premium), we will net a profit of +$6.24 or +26.4%. Seagate participated nicely in the summer rally but has been a no-show thus far in the post ECB rally. I continue to like STX and will watch it closely for a 3rd chance to trade it this year.

US Airways Group Inc. (LCC) has been in our portfolio since January 27, 2011, and if we don't take action, it will also be called away on September 22, 2012 at $10/share. The stock rallied Friday +6.26% to $12.14 on news that the creditors for American Airlines expect a decision on a potential merger with LCC by year-end. Our cost basis after the Sept $10 call and Sept $10 put sold on April 27, 2012 is $8.14, providing us with a +18.6% profit. While I believe the merger could happen and would be beneficial for LCC, I am not inclined to recommend extending our current position if LCC remains above $10/share during the next two weeks. I will monitor the stock closely and post a recommendation to roll the options if the risk/reward turns more in our favor.

Western Digital Corp. (NASDAQ:WDC) is the last of our option positions to review for September. With two weeks remaining, it appears that the Sept $46 call recommended on August 14, 2012 will be a success. WDC, like STX, hasn't been a participant in the post ECB rally. As we anticipated, the RSI5 signal that was indicating overbought in August has retraced to a more neutral reading of 49. I prefer to close these options when the price drops under $0.25, and so I am recommending buy to close on the Sept $46 call for $.12 at the open on Monday. We sold the call for $1.29 a month ago and therefore will lower our cost basis in WDC by another $1.17.

So, what should we add to our portfolio to position us to benefit if the market continues to rally "into the great wide open?" Huntsman Corporation (NYSE:HUN) is a company that has the metrics I like for long exposure in Dark Horse Traders' Hedge, starting with the levered free cash flow of $558M and a forward P/E of 7.03. HUN is expected to grow earnings by 15.1% over the next 5 years, and the company has beat expectations every quarter over the last 12 months. The forward annual dividend is 2.9%. HUN closed Friday at $14.63, so I recommend purchasing ½ the number of shares you are willing to own at the open Monday. As usual, we will recommend selling the Jan $15 call ($1.20) and Jan $15 ($1.75) put to earn time premium and gain exposure (through the put) to the other ½ shares we are willing to own.

There is still risk in the market which could very well play out next week if we don't get the response expected from the Fed. My intuition is telling me the Fed will respond and that we will continue higher heading into the election. For now, we will buy HUN "into the great wide open."

Recommendations:

Allow STX Sept options to expire and stock called at $24

Allow LCC Sept options to expire and stock called at $10

Buy to close, WDC Sept $46 call for $.12

Buy HUN (1/2 the number of shares willing to own) at the market, Monday September 10, 2012

Sell to open, HUN Jan $15 call (HUN130119C00015000) (approx. $1.20)

Sell to open, HUN Jan $15 put (HUN130119P00015000) (approx. $1.75)

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.