Yesterday, the stock market dropped the most since November 2011. So, what was your take? Did it bother you that the value of your stocks dropped significantly or did you consider it an opportunity to buy stocks on sale? Matt makes a great contrast between the attitude of declining prices when it comes to stocks versus the response to declining prices with gasoline.
I look at the fact that my investment horizon is over 25 years. I figure that trying to pick up some shares on a down day is better for me in the long run. I bought several shares of STX last week for $25.82 on average when it was down over 8% in a day due to some poor guidance. I figured that the stock pays a dividend which should help create a floor under any sort of decline. I also figured that I could always sell some covered calls to decrease my basis if need be.
Yesterday Bought More AKS
Yesterday, I was able to purchase another 100 shares of AK Steel for $6.95. The plan is to sell some covered calls with the $7 strike and a May expiration. I put in the order today to do so at $0.65 per share. It hasn’t sold, but I wouldn’t be surprised if it did over the next two days before the weekend.
If it doesn’t happen and the stock ends up dropping again, I can pick up some more shares below $7. It is not a big deal and will lower the overall basis of the stock. The biggest risk is that AKS has financial difficulties and stops paying a dividend or even goes bankrupt. I don’t think that will happen over the next few months, but I do have to consider that if I increase my position too much, I will want to buy some protective puts.
I had some put options when my position was bigger. They paid off for me as the stock slid from the teens down into single digits. But now my overall exposure hasn’t been that large so I let the puts fall by the wayside. I figured I would save the cost and simply work with selling calls. However, it may be worth reconsidering if I want to purchase more shares over the next few days.
The other consideration is the fact that earnings will be coming out later this month. That can always be a big trigger for volatility and moves one way or the other. A big move down is bad and could hurt. The May $6 strike puts cost $0.15 each. It is probably worth it to buy some tomorrow and prepare to sell some calls as well.
Overall, the market has made a decent run over the past few months. I am not surprised that it is time for a breather. Summer is coming and earnings season is expected to be disappointing. Even though yesterday was a big down day and today saw a bit of a rebound, I would probably use the down days to add to positions but only a little bit at a time. That is what I will be doing.
So, are you buying any stocks?
On Monday, I stated that I was concerned about the stock market and listed several reasons why I thought I should assume a more defensive posture with regards to my retirement portfolio. Well yesterday, I began to execute my plan by selling covered calls on several of the stocks that I own.
In effect, selling a covered call is taking a bearish position on a stock since there is some benefit from a declining stock price. The premium received from selling a call option is added to the cash portion of the portfolio and can be kept regardless of the price of the stock at expiration. If the price of the stock is less than the strike price, then the stock can be kept and additional call options sold once the first contracts have expired.
Covered Calls Sold
I ended up selling covered calls on several stocks yesterday, bringing in cash to my accounts. I plan on using this cash to either purchase additional shares when prices are low or to use to purchase put options after the March expiration cycle.
The calls that I sold were for the April expiration date which occurs in a little over six weeks so there was a fair amount of time premium to be had. Here is a list of those that I sold followed by some rationale:
- AKS–Sold the April $7 calls
- SDRL–Sold the April $38 calls
- SLW–Sold the April $35 calls
- DRYS–Sold the April $3 calls
- INTC–Sold the April $26 calls
As you can see I was quite busy today. I feel that the market is going to be concerned about European debt and slowing growth in China. The prospect of a worldwide recession will be increasingly in the outlook so I suspect that many of these stocks will be hit. All of the calls were either at-the-money or even in-the-money when sold. I am preparing for a continued decline into April.
So What If I am Wrong?
That is the beauty of selling calls. I can be wrong and it won’t hurt me that much. I had previously sold higher strike calls when the stocks ran up in January and February. Of the stocks listed, I have outstanding March calls on SDRL at a strike of $42, SLW at a strike of $40, DRYS at a strike of $3.50, and INTC at a strike of $26. I would expect the calls for the first 3 to expire since I really don’t anticipate a rebound of 20% in the next eight trading days.
Once those calls expire, I might have a little more information that would suggest which way the market might start to trend. Then I can decide how to proceed. If the stocks rebound, I sell some higher priced calls or just let it ride. If the stocks continue to decline, then the current strikes will be out-of-the-money, and I can sell more to raise additional cash for purchasing more shares later. After all, the goal is to buy low and sell high.
Related articles concerning time premiums that you may want to check out.
I can’t help but remain somewhat pessimistic regarding the outlook for the stock market. I know that everyone says the economy is getting better, but I am concerned about a few things. First, the Dow is having a very difficult time breaching the 13,000 mark. It is proving to be very solid resistance.
Second, I can’t help but think that there is going to be another recession. I am siding with the Economic Cycle Research Institute (ECRI) on this one. Growth has been slowing down, and I just don’t see anything that will encourage growth to pick up going into the summer. Speaking of which, it is only a few months before May when the old adage, “Sell in May and go away” becomes a self-fulfilling market prophecy.
Finally, the increase in gas prices has been noticeable. You can debate whether or not this is causation or correlation or coincidence. Personally, it doesn’t matter to me. I view it as a decent strike against the economy going into the summer and fall so am looking to defend the portfolio. In summary, then I see four risks facing the stock market heading into summer:
- Technical resistance at DOW 13,000
- Slowing rate of growth
- “Sell in May” phenomenon
- Increasing gasoline prices
You might also add some uncertainty regarding the general election since the market supposedly dislikes uncertainty. Nevertheless, I will be relying on a few main techniques to help protect my portfolio heading into the summer months.
First and foremost, I have been making a shift into dividend stocks over the past 6 months. Purchases of Intel (INTC), Seagate (STX), and Seadrill (SDRL) have been especially good to me while paying out 4% to 8% yields. These stocks have been responsible for a nice increase in my quarterly dividends. My goal is to continue to add to these positions and a decline in the market will not be that unwelcome in aiding my purchases provided that these companies don’t decrease payouts.
Selling Covered Calls
I am also continuing to sell covered calls which is part of my on-going management of my retirement accounts. The difference is that I will be selling more at-the-money (ATM) and even some in-the-money (ITM) calls in order to prepare myself for a decline. I have already seen SDRL start to lag and so will probably sell some lower priced calls heading into April during this week sometime. Onyx Pharmaceuticals is another one which has exhibited some weakness and will also need some ATM or even ITM calls sold to raise some cash.
Buying Protective Puts
I also have put options protecting my stocks. I may very well tighten those up going into the summer and make sure that the difference between the strike price of the option and the market price of the stock is less than it has been recently. Between the lower strike calls and the higher strike puts, I should be quite adequately protected from a declining stock price.
I sincerely hope that I am wrong about both the market and the possibility of recession later this year. I hope the sovereign debt crisis in Europe gets pushed from the headlines and that growth continues at a decent pace. I hope that gas prices don’t influence vacation or spending plans this summer. I certainly wouldn’t mind seeing a strong bull market this year, but I am starting to prepare for the opposite.
Readers: What is your outlook for the economy and the stock market? Any evidence to share either for or against my position such as strong auto sales, IPO strength, etc? Will the election play a role? Feel free to discuss.