Anatomy Of A Trade

I’ve been asked by my investment group to present an anatomy of a trade I made last month.  It was a trade based on a company with a good business model but trading on what I can only say is a lot of hype.  A dangerous combination but the plan and the rules I followed can apply to any trade or investment.

The key to any successful trade is having a plan and following your rules.

For this example, depending on how one looks at it, I broke at least one rule and followed many others.

Wednesday November 8th:

ROKU closed at $18.84 per share.  They were due to report their first quarterly report since going public and most everybody was pessimistic.  The company had yet to make money and were set to continue their losing streak.

I considered them a popular, trendy streaming, cord cutting alternative product that had a good business model.  I have been exploring cutting the cable cord and have purchased a long range HD antennae as well as one of ROKU’s streaming sticks.  The tech is not what impresses me.  In fact, they are practically giving it away.  That is not where they plan on making their money.  Roku intends to make their money on programming and selling advertising.  In order to do that successfully, you need market penetration.  Roku is making their hardware cheap to get it into people’s homes and build up market share.  But Roku is also teaming with HDTV makers and having their streaming service imbedded in today’s popular smart TV’s.

If you think about Microsoft in the early years of the PC, they basically gave away the OS so that they could gain market share and sell software and ultimately services.  ROKU is attempting to gain market share with the adoption of HD 4K smart TV and imbedding their platform (the OS) in each TV sold.  From there, they focus on selling content and advertising.

So I was really torn.  On the one hand I really liked the company.  On the other, they were still young and had yet to prove that they could succeed in this highly competitive online content streaming world.  So I held off on buying until I saw which direction the stock moved based on their report and outlook.

Well, it turns out that ROKU is still not profitable but they lost a lot less than expected and absolutely killed it on user activations and loyalty.  So much so that ROKU even tossed out the possibility of becoming profitable as soon as next year.

What happened next was Simply Amazing.

Thursday November 9th:

ROKU opened at $24.75.  A 31% increase over the previous day’s close.

I bought 100 shares.

Here are the rules I broke.

  1. Chased the money
  2. Bought after the stock had already passed profit taking zone. (see notes below)

Here are the rules I followed or (at least) did not break.

  1. I bought on volume.  Institutional confirmation
  2. I bought at an early entry point below the buy point.  IBD had the buy point at $30 per share based on previous highpoint shortly after initial IPO.  But this early entry is OK based on institutional buying.

Yes, these rules are a little fuzzy and subject to interpretation.  Here is my point of view.

Depending on how one looks at this, from an IBD perspective, I may have broken 3 rules…. or not.  Technically the profit taking zone (20% – 25%) is after a breakout past a buy point.  Sometimes it is OK to buy a small position before a buy point if institutional buying is there.

As soon as I bought my shares and saw that they did not stage a reversal, I placed a trailing stop.

Rules I followed:

  1. Protect capital and gains.  At this point I was protected from taking a loss.  –  Unless the stock happened to gap down at the next open….

Friday November 10th:

I canceled my trailing stop and sold 50 shares shortly before close at $35.16 for a 41% profit.

Note: The stock closed at 33.21 which would have been below my trailing stop, but because I had cancelled it to sell half my gains, I still had 50 shares invested.

Rules that I broke:

  1. Changed my rule of setting and keeping my trailing stop to protect profits.

Rules that I followed:

  1. But this was done to protect my profit from the downside risk of a gap down.

I reset my trailing stop right before close.  I fully realized this would not protect my remaining shares from a gap down on Monday’s open but I truly believed that the “hype” was not over.  After all, we still had all the weekend traders (those who only follow the market and their stocks on the weekend).  Sure enough, there were many articles hyping the breakout stock.  Even IBD got in on the action and published a “hype” article.

Monday November 13th:

No gap down at open!  Hype and irrational exuberance was still in full force!

But even hype has it’s limits and …

Sometime during the lunch hour my trailing stop got activated for $45 a share.

And… I was out with a 81% profit on those remaining 50 shares.

And an overall profit of 61%.

 

Lessons Learned:

Rule #1 to investing is not to lose money.  Or at least minimize your losses.

  • I utilize trailing stops on almost all my trades.

Rule #2, see #1  😉

  • But seriously, I also use trailing stops to protect my profits.
  • Yes, I sometimes get stopped out of a stock on a sudden drop or as those who think of conspiracy theory, on a sudden drop by MM to flush out weak hands.  But, hey I usually make a profit and if I still like the stock, I can always get back in.

Rule #3 I base a lot of my buy and sell points on percentages and not dollar values.

  • For me this is a pure psychological rule.  I learned early on that I could get hung up on “making money”.  Sometimes people start seeing all the $$$ signs and let their emotions rule their investment and trading decisions.  I am no different.  So I try and base all my buy and sell decisions on percentages.
  • Do I ever sell too early and miss out on future gains?  Yes, but if my goal is 20% profit, then I am happy.  Would you be happy with a 20% gain on your investments?  The percentages are there to manage risk and avoid letting my emotions (such as greed) take over.
  • Do I ever sell too early and get stopped out of a loss before the stock recovers?  Yes, but not all stocks immediately recover and the stop loss is there to minimize my losses and protect my capital.

Rule #4 is you need money to make money.

  • Don’t lose all your hard earned money to the stock market, irrational exuberance, or emotional trading decisions.
  • Follow rules # 1 and # 2.

 

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Lots Of Options With A Broadcom Qualcomm Merger

If you believe the news, a Broadcom / QCOM merger makes for some interesting and complicated questions.

  • An unsolicited $100 billion plus-offer to buy Qualcomm Inc. — a company that’s trying to close a $47 billion deal to buy NXP Semiconductors NV (NXPI) — is pretty stunning.
  • I see a lot of cost and product synergies and cost saving for Broadcom
  • Add in the QCOM and NXPI valuations, and the proposed $70/share could be a bargain in the long run.
  • But, Broadcom may not even want to pursue or finance the NXPI deal.
  • And there are potential settlements with Apple on QCOM’s side which would affect the price. Since Broadcom is already such a big Apple supplier, a merger might work in AVGO and QCOM’s favor.
  • One can count on a lot of push back from the anti-trust encampments. There will most likely have to be some concessions in the form of asset sales to make this deal work.
  • AVGO recently announced it would re-domicile from Singapore to the U.S. regardless of the fate of proposed corporate tax reforms.
  • My guess is, regardless of the outcome, their rates will go up.
  • I think this deal aids in the good PR factor for any questions regarding approving the merger.

This potential merger also creates some very interesting option strategies.
When the news was announced Friday afternoon during trading hours, both stocks witnessed volatile price movements. Interestingly, both ultimately went up on the news. Sometimes, the price of the company making the offer goes down. But in this case, most investors seem to think this merger could be beneficial to both Broadcom and QCOM.

However, with a potential buyout price of $70 per share, QCOM’s price action stopping at $61 makes for some opportunity in my opinion.

If you believe the news and believe this will happen then it is safe to say that a minimum price of $70 for QCOM is very attainable.

If you don’t believe the news, or think this is an impossible deal, then the price movement on QCOM from $55 to $61 is not sustainable.

Based on the price movement alone, I think the rest of the investment world is more than slightly skeptical. This would warrant looking for the price of QCOM decreasing.

  • One could sell out of the money calls and purchase out of the money puts.
    Conversely, believing this is a done deal, one could anticipate QCOM’s price increasing to $70 per share.
  • One could sell out of the money puts and buy out of the money calls.
  • One could also buy 100 shares or more of QCOM, (remember you believe the price is going up) and sell covered calls and puts to reduce your cost and collect the premiums.

Taking a look at various option dates and prices, I am particularly interested in the short term play with the December monthly pricing.

Personally, I think buying a December 15 $70 Call and a $55 Put is worth the gamble.

But other time frames, such as April ’18 and January ’19, would make worthy candidates for options trading. At this point in time, I am really on the fence believing the validity of the buyout/merger actually happening.

I think if the rumors aren’t killed soon or if the news is confirmed, then hype and bidding wars will help drive this up in the near term but, with all the regulatory and legal hurdles involved, the deal will ultimately fail.

So what are your thoughts on this? How would you play this scenario?

Tracking The IBD 50

I love looking at data, discovering new trends, and finding hidden cause and effect relationships.  That is probably why I like spending hours analyzing computer event and security logs.   I also tend to do the same thing researching the stock market, especially when I notice a dramatic change.  In this case, I noticed a lot of new stocks listed on the weekly IBD 50 list.  So, I started something that I have been meaning to do for quite some time but never really got around to it.  Until now.

Tracking the IBD 50 list.

We all know the only state the market stays in is a constant state of change.  Prices fluctuate every day, every minute.  And it stands to reason that any watch list will do the same, though not necessarily on a daily basis.  My “gut” was telling me that the IBD50 list had been fairly stable and now quite a few new members had joined the list.  Conversely, this meant quite a few had fallen off of the list.  Of course I wanted to see the evidence for myself.  So I sat down and started plotting out the last two months or so of reports.

This is what I came up with.

Listed below is the stock symbol, IBD’s Group Classification, and the week the stock appeared / or not on the list.  If it appeared on the list the number is the ranking IBD gave it from 1 – 50 with 1 being the best of the best.  If it did not appear on the list then that week is left blank.

Now I have not had a chance, nor enough back testing evidence, to find out if these changes are due to quarterly reports, market conditions, changes in market cycles, investor/consumer sentiment, hype, fear, or some combination of all of the above.   But at least I seem to have enough proof that my gut was right.

Breaking it down into adds, drops, returns (on,off,back on again), and stay(remains on the list each and every week) and by sectors we get the following.  This was an attempt to see which sectors are strong and remain on the list, weak and dropping off, and gaining by being added to the list.

I’ll be tracking this further as time goes by and reposting any additional insights but I thought I would get it out there for those of you who might be interested.

I Can’t Complain

. . . but sometimes I still do.

–   Joe Walsh

Why do people complain even when things are going well?  Is it because of what could have been?   Is it because they feel that they have missed out on something even better.

“What could have been?”

In regards to investing, most people have rules by which we use to govern when to buy and when to sell.

Sometimes these rules, designed to protect us, or rather our capital / profits, can be seen as preventing us from earning even greater returns.

Some personal examples from the past month or so for me are . . .

OLED:

  • Bought 200 shares in April at $81.90.
  • Soon after OLED went on a nice 10% run (~$1800) but leveled off the week before earnings.
  • Happy with my quick profit, I sold 100 shares.  Still up ~ $900.00
  • But then I started thinking about all the “what if” scenarios around earnings.
  • Long story short, I bought a May 19 $95 call for $2.70 and sold an $85 put to finance it.
  • The stock reported record blow-out earnings and revisions and jumped 22%.
  • My remaining equity position made an additional $1900.
  • My out of the money call ~$900. Oh and the premium for the put brought that up to ~ $1200.
  • Yes, there was that voice saying I should have just kept my original investment.  Even though I was up a good $3000.

Greed is a terrible emotion.

EA:

  • I actually liked both EA and ATVI but EA was reporting after ATVI and had really good (cheap) options.  So I bought 3 May 12 $96 calls of EA before ATVI reported for $1.8 each.
  • Basically nothing happened.  The stock didn’t move much at all as a result of ATVI’s earnings.
  • So I sold 2 of the 3 for a very, very measly profit right before EA earnings report.
  • The next day those calls were worth somewhat north of $1100 each.
  • Who knew EA was going to pop 12% on earnings.
  • Certainly not the market.  They had options priced in for less than half that amount of a move.
  • Again, that little voice in the back of my head gave a very vocal 2200 cough.
  • Even though I was in the money by nearly another $1000 or so.

This week presents another “alternative” like minded play on earnings.  Similar to EA and ATVI.

Not that I am predicting a double digit return but the price is right.  IMHO.

Home Depot (HD) reports on the 16th.

Lowes (LOW) reports on the 24th.

The retail sector has taken a beating lately thanks to the likes of Macy’s and other big name brick and mortar retailers.  As a result LOW stock has fallen along with the sector.  HD has actually held up quite well.

One could very easily be tempted to buy HD before earnings because they are more directly related to the housing industry which has experienced remarkable strength lately.  LOW falls into this same category.

So even though they are “retail” companies.  They both play to a fairly strong housing sector.

Why am I looking at LOW instead of HD.  Because their weekly option premiums and volatility are significantly lower than that of HD because HD reports this week and LOW does not.  If HD has a really strong quarterly report and forward looking estimate, the market could very easily drive up the price of LOW before they report a week later.

Indeed, if one looks at the numbers, the market is already pricing in the moves for each companies reports.

HD reports on the 16th and options are reasonably priced with the market pricing in approximately a 3.3% price move based on May 19th expiration date.

LOW reports a week later on the 24th and options are even more reasonably priced with an approximate 2.3% price move for this weeks May  19th expiration.

But all those numbers for LOW’s more than double for the “after” report expiration date for May 26th.

What do you think?

Would you invest in both or play one off of the other?

Financial Independence !!!

Financial independence has always been a goal of mine. It is the primary reason I invest in the stock market.

Over the years I have developed and refined my trading style from investing in standard mutual funds, to investing in individual stocks to recently, trading options.

Thanks to Oracle, Adobe, Darden, Western Digital and Amazon, the month of March was a very good month for me on the option front.

However, that is not the reason I can claim financial independence.

Last night I hit the jackpot!

Ironic, after all these years of working like a dog, scraping and saving and investing to eventually retire comfortably and all I had to do was win the lottery.

YAY!

But don’t worry, I will still keep blogging about the stock market and finances. But don’t be surprised if I throw in a couple posts about some exotic vacation spot from time to time.

My biggest worry now is how to properly set up trusts and funds for myself and my family. I never thought I would do this but now I guess I will also start looking for a financial management advisor and or estate lawyer.

It’s a nice problem to have.

Oh, and no I have not told my boss yet.  Shhhh . . .

I’m going to wait until the check clears to do that.

Until next time.

Trade well my friends.

Cheers!