VMWare (NYSE:VMW) took a pounding today and dropped nearly 9%. I have searched for specific news about the company and did not find anything today. As the Nasdaq pulled back today, cloud computing companies were worse off, perhaps in part because these companies are all high flyers. If the rally is losing steam, overbought companies are the ones taking the cliff dive. F5, Salesforce and Ebix also took big hits today. What concerns me is the huge volume spike that went along with the steep downward price movement. Somebody sold a ton of VMW shares.
I am torn here between not wanting to just take a loss of a stock that has done superbly in an emerging new technological field, especially with no major news or guidance; and wanting to play it safe when I think the overall market could be dropping as well. I am going to give three potential solutions and you can decide what fits your risk profile. I would encourage you to read this article in the Financial Times first.
Option #1 - Just get out and take the loss, which is probably going to be about 5 to 6 percent if I close out tomorrow. The volume spike and steep drop would favor this course. Most of the rest of my portfolio is still holding above strikes and I can live to fight another day if I get out here. If you are really jittery about the market, especially over the long haul, I advice this course.
Option #2 - Buy the April $75 put for around $9 and turn this into a collar. If the stock continues to fall you can at least gain a hedge with the put and keep selling calls against the stock. If you go this route, buy back the October calls and sell the November $85 calls, and roll these down if the stock continues to fall. You can sell out-of-the-money calls till April to make your money back. The downside is that you increase your cost basis but buying the put and that will hurt if VMW rebounds quickly. Which is why I'm choosing option #3.
Option #3 - I'm going to roll down and out by buying back the October $85 call tomorrow and selling the November $80 call for $4.50 or higher. This would drop my cost basis about $4, and at the current closing prices that would mean I will be down less that 1% if the stock stays where is right now, and I can then sell December calls on it. If the stock rebounds back over $80, I will make at least 2%, depending on the fill tomorrow. That's not great for 2 months, but it is better than taking the 5 % loss now. I could also roll out to the November $85 (same strike as October) and reduce my cost basis while allowing for more of a snap back on the stock. This move would allow for a 6% profit if the stock rebounds back up to its price of two days ago.
Unless I find out something different before market open, I'm doing a version of option #3, leaning towards the $85 strike. Given the long term growth prospects I think VMW will make its way back and this can be a profitable trade. If the stock continues to fall, I can roll down again before November and capture more premium. I just hate to take a 5% loss on a stock with such incredible growth unless I can find a better reason for todays drop. If you are in VMW, let me know how you are playing it! Remember this is the fun part of adjusting covered calls.
Disclosure: Long VMW, short MOS, BIDU, TLT