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Jan 20 2011 / Stocks - NUE, JNJ
The Cautious Bull Strategy
STRATEGY
DISCUSSION
For those who are following my last two trades (Jan 20
2011), they are
in tune to my strategy of the CAUTIOUS BULL. On Jan 1
2011, I indicated my stance this
year would be the CAUTIOUS BULL.
In Oct 2008 to March 2009 Stocks set new lows during the
market collapse. However since then many have recovered
to their old trading ranges. While many have not hit the
highs they saw in 2007 (which is a possible warning that
this bull market may not recover all stocks) before the bear market took hold,
most have recovered to the trading ranges they were in
from 2006 to early 2007 and certainly many blue chips
have put the Lehman Brothers collapse behind them.
But from spring 2009 to December 2010, selling naked
puts was an easy strategy on many stocks, mine included.
As stocks recovered it was a matter of selling naked
puts at the money and just out of the money and for the
most part stocks just kept climbing, leaving me with
naked puts that expired or could be rolled.
In my view based on being an option seller for 35 years,
the easy money has been made and this now requires a
more cautious approach. I call this my Cautious Bull
Strategy.
I believe stocks have to perform based on earnings or at
least the belief that earnings are improving. Once the
Fed money taps start to dry up the floor under this
market may get a little "creaky". (Read
the article Dance Near The Exit) Remember that markets
are driven by fear and big players with billions of
dollars in the market - the so called "smart money". A
whiff of a trouble and they will bail like they are
fleeing the Titanic. In my opinion "smart money" is
really no smarter than the retail investor, but their
sheer size of holdings can push a stock to extremes both
up and down if they are fearful. I have always believed
that it isn't fear and greed that drives stocks, but
FEAR alone. There is fear of missing out on the rally
and fear of losing capital in a decline.
For those who believe "smart money" really knows what
they are doing I can only point out that while retail
investors sustained large losses in the 08-09 collapse,
it pales in comparison to what "smart money" lost. When
stocks like Citicorp fell to .99 cents, it was not
caused by the retail investor fleeing ship. It was
caused by "smart money" bailing out. When I put in my
offer to buy Citicorp for 1.00 I laughed because my
offer was for 1000 shares. A thousand shares is not
going to move Citicorp. If "smart money" was buying
Citicorp with billions throughout the crisis the
likelihood of it falling to .99 cents would have been
unthinkable. In Canada my son and I started buying Bank
of Montreal in March 2009 at $28.00 in lots of 300
shares until we owned 3000 shares. We bought it all the
way to $25.00 over a period of 5 days. The dividend is
2.80 which was our pivot to jump in. At 2.80 they are
paying us 10% a year to hold their stock. Our buying did
not support the stock. Retail investors did not move any
of these stocks, but "smart money" with billions of
shares traded certainly did. As we bought BMO it
continued to fall on huge volume. My son and I wondered
if we were the "dumb money". I think the important
aspect of "smart money" is to remember that when they
buy or sell, it is their fear that can really hurt your
position. Years ago my mentor told me, that the only way
to beat smart money is to stay out of their game, be
patient, watch volumes and charts. This is why I sell
options only against stocks I would own, because in the
past I have been assigned in market meltdowns.
I like to be prepared for any eventuality. While some
see another collapse, I doubt anyone can truly predict
what is going to happen. There are many analysts who
have recently (Jan 20 2011) predicted that the NASDAQ will hit 3700
this year. I have a section about Gurus, so you know
what I think. The overall market
trend is what is important. Right now the trend seems
intact, BUT the Russell 2000 is showing signs of
"strain" which may mean a pullback is coming before a
move higher.
My strategy for a market that has recovered is to create
my list of stocks (and yes I write them down on paper).
Then I look at the charts each day to see those that are
pulling back and wait for a jump in volatility. Normally
when a quality company pulls back, it can be dramatic,
like VISA has been and it can also be short lived. I
then write on paper the strikes I would be happy to own
the shares at, if I WAS ASSIGNED, because it is
important to remember that once I have sold the put, if
the stock falls I am open to assignment at any time. I
then write down the premiums I would like and then I
wait.
It's a simple strategy and doesn't require a lot of
watching. If you look at my
VISA chart
(Jan 20 2011), you can see that
VISA reached the lower Bollinger a few sessions ago.
That's when I get ready. I watched it, saw Wednesday's
selling, and I put in my price of .85 cents on the Feb
$65. I got a fill which actually rather surprised me.
Today (Jan 20 2011) I saw $65 naked puts go through for 1.10 and then
1.15, I put in my offer for 1.20 and waited. I got filled on the 1.20.
The same with NUE. Today I got some filled on the Feb
$41 put and I had offers out to sell the April $38 at
.90. I saw some puts of other investors get filled at .70, so perhaps in the next
few sessions I may get a fill.
The Cautious Bull strategy is not to hold onto these
naked puts until expiry. Far from it. If the stock holds
or climbs and I can close those puts for decent profits,
then I close them and free up my capital to go back to
my list.
The important point here is to stay as liquid as
possible. When the trade has worked, close it, take the
profit and keep cash on hand. I set a realistic goal of
12% for the year. Many of my readers know that I aim for
about 1% a month. If though I have realized 6% within 4
months, then my goal is now 6% for the remaining 8
months. This reduces my having to take higher risks to
reach my goal and reduces the amount of cash I need to
have in the market.
My return is still 12% for the year, but with each
passing month of gains:
I can reduce the amount of capital I need use
I can stay further out of the money with my
naked puts or naked calls
I can turn to less profitable but more secure
option strategies such as spreads
I can focus on fewer trades and stay with those
that are more profitable with less risk
I have no set amount for what I would consider
decent profit. I pick and choose as the trade unfolds.
This will be a major part of my strategy throughout the
year. I have used this strategy in every recovered
market since 1979 and it has served me well. The last
time I used it was during the bear market of 2001 to
2003 and after stocks
had recovered. This also
reminds me to mention that it is is important to
remember, just because stocks have recovered just as
they did in 2004 - 2005, doesn't mean the uptrend is
over. It just means it may be more difficult to judge
when that maturing bull market is ready for a rest. For me, it just means the easy money has been made
and now I have to watch for my opportunities and take
advantage of them, when and as they appear.
