Hitting A Double With News-Related Market Overreactions
Dr. Alan Ellman | Mar 18, 2018 02:03AM ET
Stock selection, option selection and position management are the 3 required skills for covered call writing and put-selling. One of our go-to exit strategies is “hitting a double” where we buy back the original option sold if share price declines and then re-sell that same option as share price recovers. Stock prices whipsaw and that is what gives value to our option premiums. Overall market movement plays a major role in our stock and option prices and news events is one of the main factors that impact these changes. In August 2017, Kim Jong-Un, the Supreme Leader of North Korea launched a series of nuclear missile tests over Japan that spooked the market and most stocks plunged dramatically. The market then re-thought its reaction and immediately reversed its course. Stock prices plummeted and then accelerated. This is the perfect scenario for “hitting a double.”
Real-life example with TAL Education Group (NYSE:TAL)
TAL Education Group was an eligible stock on our Premium Watch List in August 2017. Prior to the start of the September contracts, TAL had undergone a 6-for-1 stock split where the number of stock held was multiplied by “6” and the price-per-share was reduced by a factor of “6” As a result, strike prices were also reduced by a factor of “6” resulting in atypical strikes. The price chart shows how the news of the missile launches caused share price to first decline and then recover:
- 8/21/2017: Buy TAL at $30.20 (green arrow)
- 8/28/2017: TAL price closes at $28.00 (blue arrow)
- 8/30/2017: TAL price recovers and moves above $30.00 and then above $31.00 (red arrows)
“Hitting a double” with TAL and Kim
Our knowledge of the Delta in particular is confirmed by the direct relationship between stock price and call premium highlighted in the chart of the $30.83 call strike. Before the 6-for-1 stock split, this strike was a $185.00 strike:
- 8/21/2017: The $30.83 call option was sold (STO or sell-to-open) at $0.95 (red arrow on left)
- 8/28/2017: The $30.83 call option was bought back (BTC or buy-to-close) at $0.15 meeting our 20% guideline (blue arrow)
- 8/30/2017: The $30.83 call option was re-sold at $0.70 (STO) as share price appreciated (red arrow on right)
- Early September: Share price continued to rise (green arrows)
Get The News You Want
Discussion
Current events will frequently impact our stock and option prices. Market psychology (fear and greed) can result in overreactions and then a re-thinking of those outlooks. We must be prepared with our position management arsenal to take advantage of these situations to either mitigate losses or enhance gains as was the case with TAL in this article. In this scenario, premium returns were elevated an additional $55.00-per-contract, less small trading commissions ($70.00 – $15.00).
Cramer’s top picks…we had them first
***We should keep in mind that screens and recommendations are made for various strategies. The BCI screens are specific for short-term option-selling.
Market tone
This week’s economic news of importance:
- Consumer price index Feb 0.2% (expected)
- Core CPI Feb 0.2% (expected)
- Retail sales Feb (-)0.1% (under-performed)
- Producer price index Feb 0.2% (0.1% expected)
- Weekly jobless claims through 3/10 226,000 (slightly less than expected)
- Housing starts Feb 1.236 million (slightly less-than-expected)
- Building permits Feb 1.298 million
- Industrial production Feb 1.1% (better than expected)
- Consumer sentiment March 102.0
THE WEEK AHEAD
Mon March 19th
- None scheduled
Tue March 20th
- None scheduled
Wed March 21st
- Existing home sales Feb
- FOMC announcement
Thu March 22nd
- Weekly jobless claims through 3/17
- Markit manufacturing PMI March
- Markit services PMI March
- Leading indicators Feb
Fri March 23rd
- Durable goods orders Feb
- New home sales Feb
For the week, the S&P 500 declined by 1.24% for a year-to-date return of 2.93%
Summary
IBD: Market in confirmed uptrend
GMI : 5/6- Buy signal since market close of February 20, 2018
BCI: Still cautious selling 3 out-of-the-money strikes for every 2 in-the-money strikes.
WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US
The 6-month charts point to a neutral outlook. In the past six months, the S&P 500 was up 15% while the VIX (15.80) moved up by 58% but trending down.
Wishing you much success,
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