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Contingency Plans

|Includes: AKS, Keurig Green Mountain Inc (GMCR), SPY, VMW

 This weekend I am preparing contingency plans for what can happen between now and expiration day on October 15.  First, I will talk about how the wider market view effects by thinking about writing calls. Second, I want to talk about three stocks that may need some need some action over the next two weeks as well as possible hedging strategies.  Third, I want to share some thought about when to deploy cash I have on hand for November.


Let's start with a look at SPY, the ETF that tracks the S&P 500.  My market bias (which could easily change) is not bearish or bullish, but "range-ish."  I'm borrowing this term from Phil at PSW, who has been remarkably accurate about current trends.  You can see this with a look at the chart below.  Look at the set of parallel blue lines that extend the furthest to the right of the chart.  This is a slow rising bullish channel.  The market first touches that top line of resistance on September 20 and has been nudging along the line for two weeks at about 115.  Unless we bust through that line, I am expecting a pullback that will probably hit before October 15 options expiration.  It is likely the SPY will move down to support and touch the bottom line at 105.



SPY 10-2-10 

Notice the RSI (14) chart right below the SPY chart.  If you look at the far right of this chart, you will note a little red arrow pointing downward.  This is a sell signal that says the market is ready to roll over.  Until something changes, I am expecting a pullback this month.  So what will I do with my covered calls?


For most of my positions I won't do anything at all.  Many of my positions grew fat in September, and are nearly 10 percent above my call strikes, so they should survive for two weeks and get called out for a profit.  Most of these stocks will at least stay above my cost basis and I will write a call again in November if they are still in my portfolio.  I'm hot sweating a pullback since I wrote all these calls in-the-money.  But I do need a few contingency plans.


On Friday I got out of Green Mountain Coffee Roasters (NASDAQ:GMCR) at a loss of about 3 or 4%.  I has sold the $31 calls and the stock was at about $29.50 when I bought back the calls and got out.  This was a hard decision for me because I like the company and I drink their coffee every morning.  GMCR is a has a compelling growth story and I will probably re-enter the trade down the road.  But their potential financial and accounting problems are too risky at the moment.  Cramer killed them on Thursday and people started jumping ship.  I think the company will be a great buy, but this may take some time to sort out.  Until then I can limit my loss to a small amount and redeploy cash elsewhere until a new uptrend occurs.  Too many uncontrollable unknowns are not good for covered call writing.


AKS is a steel company that also dropped on lower earnings expectations and is hovering around the $14 strike price.  While this is also bad news I have held on to the stock because steel is in an uptrend and the steel ETF (NYSEARCA:SLX) has moved above the 200 day moving average.  The premiums are compelling and if the stock doesn't get called out I plan to sell a new set of calls for November.


VMW is the only other stock close to the strike price and that is because I sold nearer to at-the-money with the call.  As I showed in this chart previously, VMW has a strong trend and may be pulling back, but I don't it to fall apart.  I will write calls on it again and again until it does not hold support.  


Friday I took two small bearish positions on MOS and TLT.  I only put about 3% of my portfolio in this small trades, buying a few puts on each.  I'm not trying to create a major hedge here, since I already have sold calls in-the-money and don't feel a huge threat from a pullback.  I would just like to make back some of the GMCR losses and anything else that doesn't get called out if we do indeed pullback before October 15.  I am not hedging for an October 2008 type black swan event, just a normal pullback.  


I am still holding about 30 percent of my IRA in cash.  I plan to do very little the next two weeks accept read, watch and learn while the market pulls back.  I want to be prepared when the market hits support and starts to come back.  Then I will grab some bargains and write some out-of-the money calls.  I am also thinking through some tricks to use in an IRA to improve gains during that time, such as writing calls on LEAPs too, not just on stocks.  More about that later.  Until then, don't let the crazy markets and even crazier prognosticators get to you.  Buy good companies in an uptrend and held with covered calls.  Sell your favorite coffee company at a small loss if you have to do so.  If the market surprises me with a break out, I have cash to deploy and can write out-of the money calls so I don't miss the move.  Stick to the plot!

Disclosure: Long AKS, VMW, not position GMCR, SPY