It's been a busy week around Chez Melvin. The phone has been buzzing as friends, acquaintances, traders and investors called to discuss the issues of the day. The topics covered a lot of ground between the Orioles' ongoing war with the win column, Korea, politics, the SEC compared to the ACC, and, of course, the market.
Some of my more technically oriented friends pointed out various patterns, lines and squiggles that indicate the market may be putting in a top. Others think the macro outlook indicates low rates and continued efforts to stimulate both the U.S. and European economies will power the markets higher. I am not much of a chartist, but the handful of market indicators that I trust have moved into overbought territory, and that raises a caution flag for me.
I am always aware that markets can remain overbought or oversold far longer than anyone anticipates, and acting blindly on chart-based indicators is a great way to lose a lot of money. That is not to say that chart-based indicators don't work. I know many successful technicians, and I've even had a few over for dinner. The success of chartists like Helen Meisler and Bob Byrne indicates that chart-based trading can be a very profitable approach to the market. I have experimented with technical analysis over the years, but I'm not good at trading off of chart patterns. The market has had a nice run, and I am reluctant to go to cash or get net short. My stocks have also had great runs, but most of them trade below book value and at very low enterprise-value/EBITDA ratios, so I'm in no rush to take money off the table.
When I hear technical- and statistical-based traders whom I respect say the markets are heading lower in the short- to intermediate-term, I think about what I should do if they are right. I start thinking about what stocks I might want to buy if the stock market moves lower and creates an opportunity to continue scaling into cheap stocks. My next thought is to ask if there's a way to back into these stocks with put options and collect some premium along the way. Volatility has been low, although it has moved up a bit this week, so I am looking for stocks that have been falling and are generally unloved enough that the premiums for selling puts is high enough to be worthwhile. This creates a win-win because if my macro friends prove smarter than my technical friends, I get to keep the premiums for selling cash-secured puts.
I recently wrote a column about selling puts on RadioShack (RSH) after its shares collapsed on poor earnings. I sold some March $7 puts and I still believe RSH is a good trade. The stock is selling below book value and the company should see better results as it continues to expand kiosks at Target (TGT) and benefit from iPhone popularity. Some of the air has come out of the March options, but the April $7 strike looks like a good sale. Conservative investors could consider selling the April $6 puts on weakness.
SuperValu (SVU) is another stock that plummeted after a poor earnings report. Although the grocer was profitable in the quarter, the company missed Wall Street estimates and the stock was punished, falling by about 20% since the earnings release. The company is struggling, but it has achieved permanent expense reductions of more than $100 million as it continues to look for ways to support its bottom line. The company has been using its free-cash flow to pay down debt, and total long-term debt outstanding has declined for five straight years. This should continue, aided by the sale of SuperValu's gas stations. The April $6 strike looks safe to sell, and more enterprising traders who don't mind selling a little intrinsic value could consider selling the slightly in-the-money April $7 strike.
I have consistently proven that I have no clue where the market is going next. By preparing a strategy that allows me to win no matter what, I can enjoy the conversation without sacrificing portfolio value.