Monday, May 24, 2010

BACK TO THE FUTURE- A Look at Relative P/E and Return on Equity

The market hates uncertainty.  I used to teach new traders pricing options to make people pay for their uncertainty.  When the markets swoon, traders are making people pay (volatility premiums go up as they should in these conditions) and buyers are hitting the exits.  We have seen this in droves the last couple of weeks.  Most of the news surrounding the markets has had little to do with what companies are doing and the money they are making.  The markets need more decisive action by the Euro governments and seem to be getting it as of this morning.  So there is a bit less uncertainty.  The best way to make some money from all this noise is to add a little more here.  It might be unpalatable but the pricing is much better because so much worry is already priced in.

As I write this post of Friday the 21st, the SPX is up a bit, 3pts and the VIX is down a bit, 3 pts.  The market is about where it was after the panicky sell off on Thursday.  With this correction being compared to 2008 (Will it happen again?), I thought it would be instructive to include the 2008 Meltdown in a comparison of the Price Earnings Ratios of today with the absolute low of P/E’s over the last 3 years.  Adding 5 year Return on Equity as a barometer of performance over a difficult period should help too.  Since the market is smacking everything maybe something shakes out.  This should be a chance to pick up cheap earnings multiples and I want to find the best ones.CNX w logo I look for the tall red building in the lower left hand corner of each sector.  That would mean high Average Return on Equity over the last 5 years and a low P/E for today and relative to the last 3 years. For this market period, I am going to stick with the larger names for a buy write candidate.   You should look at each sector independently but what stood out the most were just the two names in Energy, Diamond Offshore (DO) and Consul Energy (CNX). Both have relatively high 5 year returns on equity but the market is marking down their earnings the most.  As of this writing CNX Jun 39 calls for 1.05 with CNX no higher than 35.60 looks interesting for a buy write opportunity. 

Notice a lot of red in Health Care.  No real surprise given health care reform but both Abbott Labs (ABT) and Gilead Sciences (GILD) made new P/E 3 year dead lows as of this writing.  Both are in the upper middle of 5 Year Average Return on Equity for Health Care in the S&P 1500.

The opinions expressed by the author are his alone, and do not reflect the opinions of Aqumin LLC, its shareholders, partners or affiliates.

Monday, May 17, 2010

What does the Market Volatility Landscape look like?

The Euro shivers still resonate.  No doubt.  Usually for a day or two lately but they are very real and drive our equity and volatility markets to hair raising swings.   The stock market does not seem to care about fundamentals or earnings anymore.  Does any of the recent volatility moves make anything standout as a possible opportunity?

I created a Volatility Landscape of 3 key components of activity on Friday the 14th- Daily Price Moves, Option Volume and Implied Volatility.  For Implied Volatility I am choosing the 90 Day ATM (at the money) Implied Volatility (IV90) to see if there has been long term assumption changes given the very violent short term movements. If the action in the Euro Zone looks like it is cooling down this week, I will be looking to take advantage of some of the volatility that ratcheted up from last week. More volatility means more premium!

4:50 ET Friday, 5/14/2010Volatility-Full Landscape 

First I look for the winners on Friday the 14th.  The entire landscape above shows stocks and ETF’S up on the day.  The big sector in the lower left is Industrial Materials- the Gold Stocks.  The short flat buildings in the upper right corners of TLT-closeupeach sector had no Call Option Volume on the day so I discount the names when I am surveying the Volatility Landscape.  For volatility movements to be interesting on a big day like Friday there should be option volume in the name.  The Tall, skinny buildings had a sharp change in 90 Day ATM Implied Volatility but no volume (just a wide market in an illiquid name) so out it goes.  Issues that were up on the day with increases in 90 Day ATM IV on decent volume get my attention.  I have the ETF’S highlighted because there is more activity there that is dispersed around the group. One ETF, in particular, stands out on volatility movement and option volume, the TLT (iShares Barclays 20+ Year Treasury Bond Fund).  The other names in the ETF group were mostly contra and short funds and some of the Gold ETF’s.  The TLT’s showed the greatest positive change in 90 Day ATM IV on names that were up with solid option volume on Friday. 

By limiting names to only those issues that perform positively on the daily gyrations of the Euro/Greece problems, I am selectively looking for securities I think will decline the sharpest as the Euro events subside. The long term US Treasury is performing as the flight to quality instrument and the longer term volatility in the TLT rose sharply because of it.  The out of the money call spreads in the TLT are starting to look interesting at these levels. Maybe there is a trade to be had here for someone?

The opinions expressed by the author are his alone, and do not reflect the opinions of Aqumin LLC, its shareholders, partners or affiliates.

Friday, May 7, 2010

Market Gyrations create opportunities as Options Premiums expand

The insane market gyrations over the last week have had one positive note for investors.  Option Premiums have increased because the market volatility has gone up (VIX is over 30 as of the close).  Volatility is a key component of option prices and has a direct effect on the premiums of calls and puts.  The market is presenting a good entry point today for investors looking for more yield by selling options against equity positions (buy write).  Let’s focus on the At the Money (ATM) options that will yield at least 6% until June expiration (June 18th, 2010).  Also, I want to take earnings out of play by only looking at companies that have already released .  The stocks have to be down only 5% or so over last 30 days to avoid “problem” names, so I filtered for that.  The strategy here is to collect the yield from the option premium and offer some downside protection (at least 6%) while things are still choppy.

Buy Write

I have ordered the landscape so that stocks with the most expensive ATM Implied Volatility in June relative to the 30 Day Historical Volatility of the underlying stocks are in the lower left hand corner.   Pay attention to the green issues in the lower left corners of each sector as they fit my Buy Write Filter to a higher degree.   With stocks falling and volatility moving up sharply, there is much more (green) to chose from.  The PDE At the Money buy write yields +6% on the options alone until June Expiration.

The opinions expressed by the author are his alone, and do not reflect the opinions of Aqumin LLC, its shareholders, partners or affiliates.

Monday, May 3, 2010

The Earnings Picture

Yes…and it really is a picture.  With all the ink spilled on the bad news headlines over the past four weeks, I thought it would be a good time to see just how good the earnings looked directly, and to compare them side by side with everyone reporting.  Organizing the Earnings Season in one place seemed to be the most reasonable way to find companies that are moving out of synch with their peers.  Because I concentrate on stocks that trade listed options, about 1,000 of the stocks in the universe I follow have reported.  The first landscape shows all stocks that beat estimates in green.  Stocks that beat estimates by 25% or more are darkest green.  The Earnings Landscape is the color of money as it turns out.  There is a lot of green out there.  Issues in white are even with earnings expectations and red issues are below expectations. The height of each building is total 1 month returns (buildings above the horizon are positive shown in first figure).    Negative returns are below the horizon and shown in the next figure.  You can see that most of the stocks that beat estimates by 25% or more are up for the last month.  I highlighted SUN in the Energy GICS Sector that had beaten estimates by the greatest percentage and is also in positive territory for the last 30 days.  All issues that had the highest return AND were up the most in the last 30 days are sorted from lower left to upper right within each GICS sector.SUN-Earnings1

Now - lets flip the landscape over (Below -building height is now negative returns) so we can see who had positive earnings relative to estimates AND had negative returns for the last month.  I picked the Energy Group  because I noticed a company that beat estimates by a solid amount (+60%) but was down the most for that group.  The building stood out across the entire landscape.   After I zoomed in I discovered it was Massey Energy (MEE) and the stock is suffering from the mining tragedy.  As I clicked through, I noted British Petroleum (BP) swooning on the oil spill, and Diamond Offshore (DO) had beaten estimates - but were the worst performers in the Energy Group that posted positive earnings surprises besides MEE.  This only took a couple of seconds to spot using my software, AlphaVision from Aqumin.  All these names have been in the news lately for various reasons, none of them good (except earnings news).  DO (at 8.5 PE ratio) catches my interest because it beat estimates but lagged peers in performance over the last 30 days.  Off to check the options…

MEE Earnings

The opinions expressed by the author are his alone, and do not reflect the opinions of Aqumin LLC, its shareholders, partners or affiliates.