Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

DARK HORSE TRADERS' HEDGE - I Love Rock 'n ROLLing January Options

|Includes: GameStop Corp. (GME), SNP, WDC

By Scott Brown

An we’ll be movin’ on
An’ singin’ that same old song
Yeah with me, singin’

I love rock ‘n roll
So put another dime in the jukebox, baby
I love rock ‘n roll
So come an’ take your time an’ dance with m
e – Joan Jett

Option expiration week is my favorite time of the month, because our hedge sells premium, and once per month we get to “put another dime (or more) in the jukebox (i.e. our pockets)” and roll to another month for more premium.

As always, we need to evaluate each position independently and decide if we roll or let it go. For January 2011, we’ve already decided what to do with the four Buy/Write positions in our virtual portfolio, so that leaves us with GameStop (GME), Western Digital (WDC) and China Petroleum & Chemical (SNP), which are covered calls.

Gamestop Corporation was added to our virtual portfolio July 23, 2010 at $19.92. On August 17, 2010, we sold a Sept. $20 call in the virtual portfolio to bring in $1.31. We rolled the Sept. $20 call to Jan. $20 call, recording $1 in profit for September and adding an additional $1.19 on the Jan. 2011 $20. So, to make a long story short, we have reduced the cost basis on GME from $19.92 to $17.73, and the stock closed on Jan. 13 at $20.60.

GME is in the Sabrient Baker’s Dozen 2011 list and soon to be released Top-10 Earnings Buster Stocks report, so we want to continue to own shares of GME in our virtual portfolio and continue lowering our cost basis by selling covered calls. On Friday, January 21, 2011, we will be able to buy back the Jan. $20 call for the difference between $20 and GME stock price that day. In other words, with no time premium left. We will sell the Apr. $20 call for approximately $1.80 (give or take for stock price movement during the week) and have lowered our cost basis in GME to approximately $16 and “singin’ that same old song.”

Western Digital Corp. was added to our virtual portfolio on July 13, 2010 at $31.90, and quite frankly, I haven’t managed the position very well. We sold an Oct $26 call on August 17, 2010 after the stock had fallen for $1.61 (in retrospect, not a very good idea). On October 15, 2010, I bought the Oct. $26 call back for $3.95 and sold the Jan. $28 call for $3.65 in our virtual portfolio, leaving us with a cost basis of $30.24 and a strike in January 2011 of $28. With WDC closing on Jan.13 at $32.75, I have turned a very average trade into a bad one. At this point, rather than continuing to chase my tail on this one, I am thinking “we’ll be movin’ on” and call a spade a spade.

China Petroleum & Chemical Co. is a better story than WDC and should have a better ending. SNP was recommended on October 17, 2010 at $96.54 as a covered call strategy. Our virtual portfolio sold a Jan. $100 call for $4.40. SNP is expected to make $14.25/share in 2011, which gives us a forward P/E of 7.11 and we have already reduced our cost basis to $92.14. SNP closed on Jan. 13 at $101.36. During the next week we will want to buy the Jan. $100 call back when the time premium has expired. We will need to monitor the position closely next week, as the stock could trade under $100, which would allow us to simply let it expire. Or if it remains over $100, we will need to spend the difference to buy the call back. The Apr. $100 call is currently bid $6.30 and ask $7.00 and will be the option we want to sell going forward.

Over the next week we will look to replace WDC, World Acceptance Corp. (WRLD) and Veeco Instruments (VECO) in our virtual portfolio.

Actions Recommended:

  • GME: Over the next week buy back the Jan. $20 at the market (at a price with no time premium left). Sell GME Apr. $20 (GME110416C00020000) call for approximately $1.80.
  • WDC: Allow stock to be called away at $28.
  • SNP: Over the next week, buy back the Jan. $100 call at the market (at a price with no time premium left). Sell SNP Apr. $100 (SNP11041600100000) call for approximately $6.50.