I am the first to admit that I did not expect yesterday's jarring selloff after Barack Obama's reelection. But there still seem to be plenty of opportunities in this market to make money from the long side.
First, what was my mistake? Why was I too bullish too soon? The main reason is that I was emotionally invested from the long side, which blinded me to technical realities on the chart. I also placed too much emphasis on moving averages rather than true chart levels. The S&P 500, for example, bounced smartly at its 50-day moving average on Oct. 15, which made me too confident that the same thing would happen a week later.
Moving averages are useful for a lot of analysis, but they are abstractions. They can serve as support and resistance, but established historical levels are much more reliable. In the case of the S&P 500 now, that means previous highs around 1400 had to be tested. We might grind in this range for the next few weeks, but the longer we hold, the more likely it is that the third quarter's rally will resume.
The reasons I remain optimistic are that the U.S. employment picture continues to improve (see today's jobless claims) and incremental evidence points to recovery in China. This week, for instance, Australia's central bank shocked investors by not cutting interest rates--partly because of strength in its key trading partner to the north.
The recent weakness has also brought a lot of good companies back to some interesting levels. So here are some names to consider from the long side:
Pfizer (PFE): The pharmaceuticals giant has been a steady winner for more than two years and has now pulled back to the same $24 level that was resistance over the summer. This looks like a strong support area, with a very favorable risk/reward profile. I like the January 22.50 in-the-money calls for $2.05 or better. They have a delta of 0.77 and intrinsic value is about 85 percent of the premium. That means they'll give some nice leverage to the upside, but won't lose a ton of money to time decay if the stock goes nowhere.
DuPont (DD): The last earnings report was horrible, but this is a major blue-chip company. It's now down around the same $43-44 area that was support in late 2011. Implied volatility is also higher in the puts than the calls because everyone is nervous about further downside. (With the stock at $43.66, the 43 puts should be cheaper than the 44 calls but they're not.) That can be exploited by selling the December 43 puts for $1.22 and buying the December 44 calls for $0.96.
Consolidated Edison (ED): A similar volatility skew is at work in this New York-area utility, which got whacked by Hurricane Sandy. The December 55 puts can be sold for $0.60 and the December 57.50 calls can be purchased for $0.60, even though the stock at $56.85 is closer to the strike on the calls.
Travelers (TRV): This insurance giant gave us some incredible gains after its strong earnings report last month, and now it's looking good after pulling back. The shares have held steadily at the same $68 area that was resistance in September and look like they're headed back over $70. The December 72.50 - December 75 call spread for $0.45 or better could make sense. Fellow insurer Chubb (:CB) looks similar, although the option pricing isn't very favorable in that one.
As always, these are suggestions rather than outright recommendations.
Disclosure: I own PFE calls.
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