1. Commentary
2. “Covering” General Electric
3. Earnings
4. Closed Trades
5. Current Trades
6. Monday Morning Playbook
7. Closing Thoughts

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1. Commentary

The market is at a crossroad and after a week that saw the Dow bend but not break, we could get a clear direction this week. The Dow managed to trade near 7,500 on Monday but tested 7,000 by the end of the day. That negative sentiment carried over into Tuesday but the market bounced off support and was gaining momentum before Citigroup (C, $1.50, dow $0.96) and the government crashed the party.

The $25 billion stake that the government took in Citigroup diluted shareholder value and “we”, meaning America, now own 36% of the company. Citigroup’s common stock tanked 40% on the news but the company’s “preferred shares” were up about a third as investors were dumping the common stock and snapping up the preferred.

Preferred stock holders get paid dividends before common shareholders and are the first to get paid in case there is a liquidation. Citigroup did announce that it would stop paying dividends on all preferred shares except “trust preferred securities” but the deal includes a slew of provisions. The main one is that Citigroup can’t “exercise voting rights” on common shares which suggests the government is clearly not interested in owning the common stock.

The deal was hardly a secret as news came out on Wednesday that the government would be willing to purchase common shares in large banks that they deem to need more cash. Citigroup expects to exchange all preferred shares to common stock at $3.25 per share.

The most amazing thing about this story was the volume in the stock reached nearly 2 billion shares on Friday.

Still, despite the havoc this caused in the marketplace, the Dow managed to hold its own. It’s clear the government is having a tremendous effect on Wall Street right now and the waters are still murky. The bulls appear to making a stand but the bears are threatening to take the market even lower. We could also get another stalemate again this week if the Dow holds 7,000 without a snap-back rally and even those have been limited to 300 or 400 points.

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2. “Covering” General Electric

General Electric (GE, $8.51, down $0.59) spent another week making headlines and most of them were negative. The only thing you need to know if you are a shareholder is the stock made another 52-week low on Friday and the company cut its dividend.

Brutal.

So is the glass half-full or half-empty for GE?

I don’t buy stocks so it is really hard for me to say if the stock is a good value down at these levels. I will put things in perspective though. GE cut its dividend from 31 cents per share a quarter to 10 cents. So if you held 1,000 shares of the stock, instead of getting $1,240 for 2009, you are going to get $100. The previous dividend yield represented a 15% return on your money assuming GE held $9 all year and paid this out.

So, instead of the shareholders getting rewarded for their good faith by holding the stock for years and years, GE will save $9 billion instead of paying it out. Angry investors were dumping their stock on Friday while the die-hard’s held on believing GE needed to make the move.

Some circles on Wall Street believed GE had to make the move because Moody’s (MCO, $17.95, down $0.06) was reviewing its ratings for the stock and was set to issue a possible downgrade. I’ve never valued Moody’s opinion anyway and everyone on Wall Street seems to be forgetting the fiasco from last May. Moody’s stock dropped 20% in one day, falling from $44 to $37, after saying a “computer error” was the reason behind the company giving out improper credit ratings. Fast forward to now and Moody’s is another 50% lower.

I guess the bright side is GE could have cut the dividend altogether and look for many other companies to follow this rapidly growing trend, but they didn’t. At current levels, the dividend still yields 4.5%. If GE continues lower, then that number will rise.

Another way to generate income if you start accumulating the stock is to sell call options against your position. This is known as covered call writing and it’s a way to get a little extra cash. The downside is that the stock could get “called” away from you.

For instance, if you bought 1000 shares Monday morning for $8,500, you could sell 10 April 9 calls (GEWDD, $1.15, down $0.25) and collect $1,150 in premium. This would lower your cost basis in the stock to $7,350.

If the stock falls to $7.50 like many believe it will, then it would have been better off waiting. However, if the stock holds these levels and rallies past $10, the option will likely be exercised meaning you would have to sell it at $9. That would still be a profit of $1,650 or over 20%.

We were successful in playing GE’s volatility last week as you will see in the “Closed Trades” section and it remains to be seen what happens over the long-term. Short-term, there are still risks but there are ways to offset that risk if you really believe in the stock.

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3. Earnings

Monday: American International Group (AIG, $0.42, down $0.10), DISH Network (DISH, $11.25, up $0.17), Eagle Bulk Shipping (EGLE, $3.76, down $0.18), Hospitality Properties Trust (HPT, $11.40, down $0.25) and Wendy’s / Arby’s Group (WEN, $4.53, down $0.36).

Note: HPT paid a 77 cent quarterly dividend last week to shareholders that was declared back in January. Folks, that is $3.08 annually which equates to a yield of 27% if you own HPT stock. The company declared the dividend when the shares were at $15 but be leery.

Tuesday: AutoZone (AZO, $142.23, up $1.15), Bank Of Montreal (BMO, $22.13, down $0.64), Jackson Hewitt Tax Service (JTX, $7.48, down $0.55) and Tech Data (TECD, $17.29, down $0.01).

Wednesday: Big Lots (BIG, $15.51, up $0.46), BJ’s Wholesale Club (BJ, $29.88, up $1.71), Foot Locker (FL, $8.31, down $0.38), Joy Global (JOYG, $17.46, up $0.22), PetSmart (PETM, $20.04,up $0.56) and Weight Watchers International (WTW, $18.10, down $0.08).

Thursday: Anheuser-Busch InBev (ABI.BR, $21.80, up $0.91), Fuel Systems Solutions (FSYS, $19.81, up $0.68), K-Swis (KSWS, $9.96, down $0.01) and Urban Outfitters (URBN, $16.64, up $0.09).

Friday: AnnTaylor Stores (ANN, $6.58, up $0.27) and Perficient (PRFT, $3.52, down $0.02) are a couple of names as we wind down 4Q earning reports. April is right around the corner which is when 1Q earnings come out.

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4. Closed Trades

Bank Of America (BAC, $3.95, down $1.37)

I should have known the left hook BofA delivered on Friday was coming. The March 6 calls (BYOCF, $0.24, down $0.27) and the March 7 calls (BYOCG, $0.12, down $0.15) got absolutely crushed on Friday. It was an omen as I wrote this in Thursday’s blog:

“The March 6 calls traded to a high of 80 cents and the March 7 call options traded to a high of 45 cents. This represented a loss of 10% and 33%.

It looks like I was a week early on the recommendations and maybe they should have been sold today for a small loss. Remember what I have been telling you. If you can limit your losses to 25%-50% on options trades while making 100% then you will do fine. I don’t mind taking a small loss on the trades and will probably close them on Friday. There are better opportunities out there for us to make some money.” -

These puts were closed on Friday at the open for 35 and 20 cents, respectively. The losses were about 60% which is higher than our standard 50% stop. We were crushed when the Citigroup (C, $1.50, down $0.96) news came out Friday morning.

Dow Jones Industrial Average Index (DJX, $70.63, down $1.19)

This trade was closed on Tuesday, 2/24. The March 75 puts (DJXOW, $5.20, up $0.75) were profiled on 2/18 and closed out at $4.50 when the Dow rallied 250 points on Tuesday. The March 74 puts (DJXOV, $4.10, up $0.25) could have been bought for $2.75 and sold for $4.00.

I said the Dow could slip below 7,300 and we got that on Monday when the Dow dipped below 7,100. Tuesday, we got a bounce off the lows but that only proved to be technical for the time being. Both trades returned 45% before Friday’s rebound and although the puts are higher than where they were closed out, the risk of holding them was too great when we bounced off the lows. I’m sure we will be back in the trade…either long or short.

International Business Machines (IBM, $92.03, up $3.06)

This was a tough one to close. On Friday at noon, the March 95 calls (IBMCS, $2.20, up $1.10) were trading at $2.10 and I provided an update:

“International Business Machines (IBM, $92.03, up $3.06) is on fire this morning and I said last night this is a strong stock in a weak market. The March 95 calls (IBMCS, $2.10, up $1.00) have doubled with today’s big move. These calls were profiled at 70 cents yesterday morning and some of you may have gotten in at higher prices. That’s okay because even if you got in late, they are still rocking. It’s a tough call to leave these open and you will have to see how the market is acting before the closing bell. If it looks like the Dow is headed below 7,000, you may want to get out.” -

The calls traded as high as $2.55 when IBM hit a high of $93.28 a couple of hours later. The fade back down was enough for me to get out. I really didn’t want to get out of the position but we opened a couple of others on Friday. Once the calls hit over a 200% return, a stop of $2.25 locked in profits of 220%. I’m sure we will be playing IBM again in the future.

General Electric (GE, $8.51, down $0.59 )

The market volatility did bring us a quick trade in GE. On Tuesday morning, I had this to say about the stock at 11:30AM (stock and option quotes are from 2/24)…

“General Electric (GE, $8.90, down $0.48) continues to set new 52-week lows after falling below $10 last week. Wow. It is really hard to believe this stock is in the single digits. The stock is getting so cheap to where it can be actually be traded but option traders are still loading up on the puts.

The March 7.50 puts (GEWOU, $0.55, up $0.10) have been pretty active as over 28,000 contracts have traded so far this morning. The put options opened at 30 cents, down 14 cents from Friday’s close as GE’s share price was higher to start the day. However, that has all changed as the Dow has given back all of its gains and is currently down about 80 points to 7,284.

You could buy the puts at current prices and look to exit them at 75 cents with a stop of 25 cents. Very high risk/ high reward trade.” -

The puts traded up to 72 cents which was close enough and could have been sold there or at 70 cents. The trade made 27%. GE went on a roller-coaster ride on Friday after announcing a dividend cut.

The March 7.50 puts closed at 53 cents on Friday.

Research in Motion (RIMM, $39.94, up $0.40)

The stock rebounded sharply with the market on Tuesday and closed above $40 that day. That was enough to crush options traders who stayed in the position too long. We had stops in place to protect our profits when the stock hit a low of $37. Greedy traders hoping the stock would test its 52-week low of $35 got left holding the bag.

The March 40 puts (RUPOH, $2.65, down $0.40) were profiled on 2/18 at $2.15. We got out of these calls on Monday, 2/23, at $4.50 for over a 100% return.

The March 35 puts (RUPOG, $0.90, down $0.10) were recommended at 85 cents and could have been closed at $2.10 and higher. This trade hit nearly a 150% return.

Once again, you can see the importance of holding open positions for too long. I only bring this up to keep the importance of having stops in place to protect your profits on your mind.

Safeway (SWY, $18.50, up $0.13)

This was strictly an earnings play which made it a lottery trade….The stock was at $21.13 and I said to wait right before the close to buy the puts. You could have gotten into the puts at 65 cents on Wednesday before the closing bell. On Thursday, I had this to say:

“We closed the Safeway (SWY, $18.37, down $2.75) trade this morning.

The March 20 puts (SWYOD, $1.95, up $1.25) were profiled at 70 cents on Wednesday and you could have bought them before the market closed at 65 cents. I said to sell them this morning at $1.80 and yes, they finished higher but after hitting a high of $1.90, the puts traded back to $1.40. That was the difference between 150% and a 100% trade.

The put options still closed higher than where we sold them at but our trade parameters were already meet. New options traders will hold onto these positions instead of taking what the market gives them. That is the main reason between having winning and losing option trades. Safeway could continue lower but when our goals are meet, ring the register and move on to the next trade.” -

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5. Current Trades

Amgen (AMGN, $48.93, down $2.30)

Amgen had a tough couple of days and saw its share price fall from $55 to below $49 in the blink of an eye. I had talked about buying the April 55 calls (YAADK, $0.90, down $0.70) on Friday and with the market heading lower, it was a tough call to buy them before the close.

I jumped on the April 55 calls (YAADK, $0.90, down $0.70) faster than a pit bull on a pork chop but failed to mention the March 47.50 puts (AMQOW, $1.45, up $0.60) as insurance. The puts were trading for $1.25 at the time of the blog. Friday was a busy day but I wanted to point this out in case Amgen continues its spiral. If you did a 2-to-1 ratio and the stock continues to fall then the March puts might make enough to give you a free trade in Amgen until April.

AutoZone (AZO, $142.23, up $1.15)

We entered this trade on Tuesday, 2/24. The stock was at $143 at the time and the March 160 calls (AZOCL, $1.70, up $0.20) were going for $2.30 while the March 130 puts (AZOOF, $3.50, down $0.20) were going for $3.90.

A very astute reader asked why I didn’t wait until Friday to buy this position and I could see where he was coming from. I was hoping from AutoZone to drop below $140 after we got into the trade which would have made enough for us to close the put options side of the trade to cover the call option. Basically, I was hoping for a free ride on the calls because AutoZone has a chance to explode if their numbers rock the Street.

The company reports earnings on Tuesday morning so Monday there will a battle going on as to which strike price we settle at going into earnings.

Freeport-McMoran (FCX, $30.42, up $0.33)

I mentioned the March 35 calls (FCXCG, $0.85, up $0.03) on Friday when they were trading slightly higher and the call options moved from $1.00 to $1.20 shortly afterwards. I only plan on keeping this trade open for a week due to the March option contract. They don’t expire for another three weeks but it’s time we start thinking about April contracts.

Genentech (DNA, $85.55, down $1.93)

Shares of Genentech made it a high of $89 last Wednesday.

The March 95 calls (DWNCS, $0.25, down $0.05) were mentioned back on 1/12 at $1.50 and came to life on Wednesday, albeit, if only for a brief time. Getting a deal done between Roche and Genentech has been like watching paint dry.

Roche reportedly has issued bonds to help finance the deal of getting Genentech at $86.50. Expect that to get formally rejected within the next week or so. Genentech still wants over a $100/ share bid and we have been punished by Roche pulling the lowball offer.

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6. Monday Morning Playbook

Here’s what I’m watching this week. Obviously, many of you don’t have the luxury of watching your positions all day long or follow the blog. Having said that, I thought it might be helpful to show you what I’m looking at.

IBM (IBM, $92.03, up $3.06) is giving all the signs that it wants to go to $100 and if the market can get some legs, that is a real good possibility. However, that is when the trade will get crowded unless IBM breaks through that level with conviction.

In the meantime, watch the March 95 calls (IBMCS, $2.10, up $1.10) and the March 100 calls (IBMCT, $0.80, up $0.50) and confirm momentum before jumping in. For those of you who kept the March 95 calls open from last week, set stops at $1.50.

Potash (POT, $83.97, up $0.13) also is looking like a “par” stock as it too appears ready to make a run at $100. At least that is what the bulls think. The sector is heating up so anything is possible. I’m not sure about $100 but the March 100 calls (PYPCT, $1.75, down $0.05) could make a run to $3-$3.50 if the stock makes it to $90. Mosaic (MOS, $43.05, up $3.39) is another name and the March 50 calls (MOSCJ, $1.80, up $1.15) were hot on Friday. The March 55 calls (MOSCK, $1.00, up $0.75) might be a reach. Again, confirm market conditions and direction of these two before jumping in.

Oil has been getting interesting and is in the same boat as the Dow. A couple of oil plays are the Exxon Mobile (XOM, $67.90, down $3.05) March 70 calls (XOMCN, $1.85, down $1.34) and the ConocoPhillips (COP, $37.35, down $1.10) March 40 calls (COPCH, $0.85, down $0.40). These options may get cheaper but there will be a rebound.

Celgene (CELG, $44.73, down $4.01) could get hurt if HealthCare stocks continue to suffer. Shares made a fresh 52-week low Friday. The March 40 puts (LQHOH, $0.80, up $0.60) will be getting more attention if Celgen fails to hold the $40’s. If the stock starts off Monday lower, these calls could pop 50% or more.

Retail was hot last week, especially on Friday but you can only trust a handful of these names. One name that popped back on the Watch List Friday was Dollar Tree (DLTR, $38.82, up $1.76) which could be making a run back over $40. The stock was crushed at the beginning of February, falling from $44 to $35 after the company said earnings would be above the middle of the $1.07 to $1.15 a share range they gave.

The selling was too excessive and bulls have pushed the stock higher after the company reported that it earned $1.15 a share last week. Wall Street had been expecting $1.13 a share. Dollar Tree is gaining market share and sells most everything for a dollar. Plus, more of their stores are taking food stamps given the current economic conditions which is also helping steal market share. Keep the March 40 calls (DQOCH, $1.05, up $0.55) on your radar.

We did a Family Dollar Stores (FDO, $27.44, up $0.35) trade back in January that was good for 25% and this one looks like it could copy those results.

Again, confirm market direction, stock direction and entry prices before jumping in any of these positions.

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7. Closing Thoughts

There seems to be a lack of interest in the market right now as Wall Street continues to viewed as the bad guy by the general public. Yeah, greed and shady practices have popped up and bonuses may have been excessive but Wall Street is no different than some of the fat cats who run the government. It’s almost as if this is the new battle developing but lets not get carried away.

The market needs clarity and until we get it the market will remain nervous. The art of business should have been left alone by the government and the bailouts to some degree but it certainly feels like the cold shoulder is being thrown.

It is what it is and we have to deal with it. The point I want to make is that smart investors are still making money in this market and they will continue to do so. You can see from the aforementioned trades that there is plenty of opportunity to make money going both long and short the market.

If you are still new to options or just getting started, take this time to watch how the market works. There is so many moving parts that it can be overwhelming but take the time to make Watch Lists and learn the trading patterns of some of your favorite stocks. Watch which sectors are hot and which ones are turning cold. HealthCare is a good example of how quickly the tide can turn.

Once again, we are headed towards a busy week and earnings will be notable but light. The longer we stay in this range the bigger the breakout to the upside or downside will be. There will be some economic reports that impact the market but if the Dow fails to hold 7,000 or 6,800 then we are going to see investors running for the hills.

Rick Rouse
Rick@OptionsMentoring.com

Editor’s Note: The 2008 and 2009 portfolios should be posted soon. What is neat about them is that you can look up the date on a certain recommendation and follow it in the blog. They should be posted in the next week or so. Other than that, keep the emails coming and feel free to share any success stories you may have!