Market Opinion: For three straight days, we have seen a positive volatility index (VIX). We have not seen a positive VIX close for a while since this market has rallied for some time. The VIX February contract is making it obvious that bearish investors are loading in on puts while the S&P moves higher.
One stock that we are interested in if this market is ready to make a turn downwards is Netflix (NFLX). Let's remember that historic returns for NFLX for the Dec-Feb option expiration time frame imply a max high/low for the stock at $97.04/$57.25 for Feb 17 ($166.39/$84.20 for Mar 16). Now, we expect our data to be wrong every once in a while because we do not believe NFLX will trade at or below $97.04 on Feb 17. Our max high/low estimates are not absolute. Please do not interpret the data as making a declarative statement as to where the stock is going, I'm simply estimating where the stock could go based on historical returns in certain time periods. Using this technique,we have successfully recommended many option trades in our Giorgio's Corner and Dollar and Sense portfolio.
Today, we are looking at historical data on Big Lots (BIG) and Transocean (RIG) to see how these stocks perform in the January-March period.
Big Lots Inc.
Big Lots, this discount store, has been on a tear this month, up 11.37% MTD vs. SPDR S&P 500 (SPY) at 2.95%. The stock gapped up on February 2nd after the company raised its EPS estimates for both full year 2011 and Q4. Additionally, the company pre-reported Q4 sales of $1.622B vs. $1.50B from Q4 2010.
Below is a monthly Finviz.com chart on BIG dating back to 2004.
Notice how the stock has always increased in value during the beginning of each year for the past six years. In fact to say the stock increased in value during the beginning of each year is an understatement. The stock practically zooms up.
The only explanation we can come up with to justify this phenomena (we say phenomena for those of you who do not believe in technical analysis and patterns in the stock market) is that BIG always reports its largest EPS numbers in first quarter of each year. Since investors know BIG reports the largest EPS numbers during the first quarter of each year, they rally the stock accordingly. See the earnings graph below to see the yearly bias in EPS numbers.
Naturally, I became interested in the performance of BIG from January to March option expiration since inception (nine years). The results are staggering.
Above you can see a very bullish bias in the performance of Big Lots stock during the Jan-Mar option expiration time frame. The average return throughout the nine years researched has been 16%, with an average positive gain of 23%, and average negative gain of -8.5%. Not bad, given that the market has been in rally mode this year coupled with the fact that BIG never booked a negative return during Jan-Mar '09. We are confident BIG will close at or above $40.21 on Mar 17. Although the stock is already trading at $43.98 which is 9.37% above this January's option expiration close of $40.21 we may still initiate the following trade based on an attractive premium.
Suggested Trade: BIG - Sell Mar 17 40/37.50 put spread (Bull Put Spread)
(Sell 40 Put/Buy 37.50 Put)
Size - 10% of Giorgio's Corner Portfolio Size = (4 spreads)
Entry: Sell Limit: 0.30
Stop Loss: 1.10
Exit Price: 0.00
Max Return: 13.63%
(Note: Return calculation does not include commission. Max Return is calculated as Return at Risk not Return on Margin.)
This trade has a sell limit of $0.30, but if you're expecting the market to pull back then we would wait to try and get a better price on this trade. I would really like to enter this trade for a $0.50 premium.
Transocean Ltd.
This oil exploration company has been under pressure ever since the BP (BP) Deepwater Horizon disaster in April 2010. BP filed a lawsuit against Transocean on April 21, 2011 for a whopping $40 billion. When the lawsuit was filed, the amount was worth more than the entire market cap of Transocean. Things have changed recently, Transocean has been receiving a number of positive comments/upgrades from analysts since a district judge said "that BP was required to indemnify Transocean for compensatory damages sought by third parties and caused by pollution from the Macondo well that did not originate on or above the surface of the water."
Since the judge's statements, investment companies issued the following comments/ratings on January 27th:
- Capital One upgraded Transocean to "Add" from "Neutral" with a price target of $53
- Gabelli reiterated its "Buy" rating
- USB viewed the judges statements positive and maintained its "Buy" rating with a price target of $62
Thus the stock has been gaining favorable recommendations. The fact that oil is trading at $100/barrel also helps in terms of getting rig contract prices back up. Fundamentally, the stock has quite a ways to go. EPS numbers have declined from 5.93 in 2010 to just 1.98 TTM. What is confidence inspiring is EPS numbers are expected to be 2.94 (2012) and 4.67 (2013). Additionally, CEO Steven L. Newman purchased $289K worth of shares on December 5th at $44.52. Remember the CEO bought these shares before the recent positive court ruling.
Technically, I looked through the Jan-Mar option expiration date returns for RIG since inception. I found the following:
It looks as though until recently RIG always rallied in the Jan-Mar option expiration time frame. Based on these historical returns, we estimated a max high/low price on the stock of $60.71/$39.80 for Mar 17th. The average return during this period was 4%. Given how Transocean's fundamentals seem to be improving and technically how the stock has had a historically bullish bias during the stated time frame, we're willing to make a small investment in the stock.
Suggested Trade: RIG - Sell Mar 17 40/37.50 put spread (Bull Put Spread)
(Sell 40 Put/Buy 37.50 Put)
Size - 7.5% of Giorgio's Corner Portfolio Size = (3 spreads)
Entry: Sell Limit: 0.25
Stop Loss: 1.10
Exit Price: 0.00
Max Return: 10.00%
(Note: Return calculation does not include commission. Max Return is calculated as Return at Risk not Return on Margin.)
The suggested trade on RIG is not available just yet due to the current price of the spread. The sell limit we suggested is based on whether a pullback occurs in the market. We realize that Transocean's chart remains in a long-term downtrend, and we want to make sure we are appropriately compensated for taking on the risk of a stock in a downtrend. One thing we like about selling the 40/37.50 put spread is that short strike (40) lies below possible support lines at the 20/50 day SMA.
Disclosure: I do not own any investments in BIG, or RIG. I'm short shares of VXX, TVIX, GLL, and ZSL. I own bear call spreads on SPY, VXX, GLL, and ZSL. I am short NFLX.
Charts are from Finviz.com.
Earnings data is from e*Trade.com.
Discounted Cash Flow information is from www.moneychimp.com.
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