This Week’s Commentary – September 15, 2007 – Apple, Google, Gold, and Waiting

by JDH on September 15, 2007

Well, that was a boring week. No huge volatility, and as a result not a whole lot of action over on the Buy High Sell Higher Forum. On the week most stocks were up, but not significantly.

Last week I advised that I am now sitting 79% in cash, on the basis that capitulation lows like we experienced on August 16 generally get re-tested before the uptrend continues, so I continue to expect choppy waters ahead. (Although, as you will read below, I have found a temporary use for some of that cash).

I did state that I think gold shares will be great investments over the next few months, but not quite yet.

Gold Chart

$700 was a major resistance level, but we have not yet reached the $728 high reached in May of 2006. I therefore continue to believe that while the long term trend for gold is obviously up, we will probably hit some resistance before we see $730. Also, the RSI (see chart) is also hitting historically high levels, so a pullback is likely from these levels.

Therefore, I think gold and gold shares will be a great investment in a few weeks time, as gold makes its next run for the sky. But not yet. Let’s let the overbought status of gold die down first.

Could I be wrong on this one? Sure. On Tuesday the Fed announces whether the Fed discount rate will go up, down, or stay the same. Most are assuming it will go down, either by 25 or 50 basis points. Ultimately that kills the dollar, since investors are now earning less for investing in the U.S., and that is good for gold as a “safe haven”. Gold had a good run this one, so that uptick is probably already priced in at these levels, which is why I’m betting that there will be better bargains ahead (at some point in late September or October, I suspect).

Uranium Stocks

Time to start buying uranium stocks yet? No, I think it’s still a little early. As an example, here’s the chart of LAM.TO – Laramide Resources:

Laramide Chart

If you go back three years, the uptrend is still intact. But it you look at this year, despite the recent bounce, the downtrend is still obviously intact, and therefore I’m waiting to get back in. Most of the other uranium plays look the same.

So what did I do this week?

Lest you think I just sat around and did nothing this week, I did start two plays.

First, I bought AAPL – Apple Inc. Why? Well, here’s the chart:


Apple is in an uptrend, which is more than we can say for our uranium plays (you can read my more detailed thoughts from back on July 7).

On September 6 I bought 1,000 shares of AAPL – Apple Inc. I paid $135.16 per share, so with commissions of $9.99 my total cost was $135,169.99. On September 10, 2007 I then sold 10 contracts of the Apple September 140 call at $2.55; commissions were $22.49, so I received net proceeds of $2,527.47

In other words, I did some covered writing.

(For those of you who have no idea what I’m talking about: an option is the right to buy or sell something at a pre-determined price at some date in the future. An Apple September 140 call gives the owner the right to call, or buy, a share of Apple for $140. All stock options in North America expire on the third Friday of the month (technically the third Saturday), so the September options expire on September 21. One contract gives you the write to buy 100 shares, so 10 contracts = 1,000 shares).

I didn’t buy the calls, because that’s too risky for me. If I had bought the calls on September 10 I would have been betting that Apple would increase to at least $142.55 over the next 11 days. That’s around a 5% increase in 11 days, and that would only allow me to break even (ignoring commissions), which is a stupid bet to make.

What’s going to happen on this trade? There are three possible outcomes:

1. Apple closes on Friday below $140. The options expire worthless, and I get to keep the $2,527.47 I took in. I could then sell my shares in Apple. As long as I can sell them for $132.61 or less (the $135.16 I paid for them, less the $2.55 I received from selling the options, ignoring commissions), then I break even. Since Apple closed on Friday at $138.81, I am obviously betting that it will not fall by $6 this week. If Apple closes on Friday September 21 at $138.81, my profit on the stock is $138.81 – $135.16, or $3.65, plus $2.55 on the option, for a total of $6.20, or 4.6% (ignoring commissions). Earning 4.6% over a two week period sounds good to me.

2. Apple closes Friday at $140. The options expire worthless, and I get to keep the $2,527.47 I took in. I could then sell my shares in Apple for $140, so my profit on the stock is $140.00 – $135.16, or $4.84, plus $2.55 on the option, for a total of $7.39, or 5.5% (ignoring commissions). Earning 5.5% over a two week period sounds good to me.

3. Apple closes Friday above $140. The options are “in the money”, so my shares are called, and I get $140 for them, and I get to keep the $2,527.47 I took in. In other words, just like in scenario 2, my shares are called for $140, so my profit on the stock is $140.00 – $135.16, or $4.84, plus $2.55 on the option, for a total of $7.39, or 5.5% (ignoring commissions). Earning 5.5% over a two week period sounds good to me.

What’s the flaw in my thinking?

First, if the stock increases to $160 this week, I lose out on the move from $140 to $160. Of course I could also buy back the options I sold, and then re-sell them next month (ie. sell an October 165 call, or whatever). I still keep the time premium, but I have lost most of the increase in value. This is not a good strategy if I expect a significant increase in the price of the stock over the next week.

Second, if the stock crashes to $120, I keep my $2.55 option premium, but I lost about $15 on the stock, which is not a great deal. However, I own the stock, so I don’t need to sell. I could just cover it again next month, and ride it out until the market recovers.

I am not planning this as a long term play. As I have discussed before, I like Apple, they are growing, so I think this trade will work out well. Let’s not forget that 4% in a month is the same as 48% in a year, which is the kind of returns we all like.

This type of trade does not have the upside that owning a mining stock that doubles may have, but the downside is also mitigated by the option premium.

I also did one other covered write this week: GOOG – Google Inc.:

Google Chart

If you like long uptrends, here’s one for you.

Here’s what I did: On September 13 I bought 500 shares of Google for $525.67 (Unlike the Apple trade above that I did in my US trading account, this trade was done in my Canadian account, so the numbers I am quoting here have been converted to Canadian dollars; the conversion rate was 4.39%, since the Canadian dollar trades at about the same level as the U.S. dollar, so in U.S. dollars the numbers are basically the same). I then sold 5 contracts of the Google September 530 call for $4.80

Google closed Friday at $528.75, so if it remains unchanged for the week, the options expire worthless, I keep the $4.80 premium, and I make $3.08 selling the shares, for a profit of $7.88, or 1.5%

Obviously this is not as good a trade as the Apple trade, but 1.5% in just over a week is not horrible, and it could be higher (Google over $530 makes the trade worth 1.7%).

I don’t plan to spend my life doing covered writes, although it wouldn’t be a bad way to make a decent return while mitigating risk. I still prefer to play for the bigger gains like I achieved last year.

However, since I plan to stay on the sidelines for at least the next week, and probably longer, this seems like a good use of my time, and money.

Comments? I’ve added a new board on the Forum to discuss Options and Covered Writing; let me know what you think. (Yes, I can take it; if you think I’m crazy, just say so; I’m sure some of you will comment on how switching to a covered writing strategy at this stage of the game is proof, using mass psychology, that now is the time to buy, but I’ll let each of you reach your own conclusions).

Thanks for reading, and as always please feel free to post your comments on the Buy High Sell Higher Forum. I’ll let you know next week how it all worked out.

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