TSM Repair Strategy (NUS on 1/17/14)Though the TSM approach limits its trading to quality companies (based on 32 fundamentals based screens) that have values left in their stock price (next two year PEG ratios), occasionally we'll get hit with a large loss that invariably occurs when the market is closed, i.e., you go to bed with a winning position and wake up with one deep in the red. TSM initiated the short NUS Jan $125 Put on 01/07/14 with NUS trading at $134.60 (a conservative 9.57% downside protection with 11 days before expiration). Nine fundamentals based screens supported the pick: Vector Vest Best, IBD 50 and 4 other IBD screens, Navellier Blue Chip, Barrons MarketGrader and Zacks 1s ratings. Further, the 0.33 and 0.62 PEG ratios over the next two years reflected good value left in the stock's price. But, as shown in the chart below, by expiration NUS had dropped to $79.47 and produced a $44,830 loss if I were to immediately close the position. Nu Skin Enterprises Inc., the beauty and cosmetics direct seller, began to free-fall once news broke midweek of an investigation into how the company conducts its business in China. According to a report in People's Daily, the Utah-based business has been accused of operating an illegal pyramid scheme, triggering Chinese regulators to launch an investigation. NUS develops and distributes anti-aging personal care products and nutritional supplements under the Nu Skin and Pharmanex brands worldwide. Nu Skin sells and distributes its products in North Asia, Greater China, the south Asia/Pacific, the Americas, and Europe, the Middle East, and Africa. At the end of 2012, the company also operated approximately 40 stores in China.
Usually, when something of this nature occurs, it's best to take the early loss as invariably, the losses will continue, as they certainly did here. But when all is said and done, this is still a quality company throwing off good earnings. A good enough company for Navellier and TheStreet to recommend it, the former as one of its five February buys. From Navellier: This
week we've had an unprecedented opportunity to pick up shares at an attractive
price. On Wednesday and Thursday NUS shares pulled back from a 52-week high
after China's People's Daily Report published a negative article on the company.
The publication alleged that Nu Skin's marketing practices skirted China's laws,
and China's commerce department responded with a statement that it will
investigate Nu Skin. However, the company immediately countered that the report
contained inaccuracies and exaggerations, and the smart money tends to agree.
Analysts from Bank of America and Deutsche Bank have already come out in defense
of the company and the consensus is that the stock is oversold. TheStreet Ratings team rates NU
SKIN ENTERPRISES as a Buy with a ratings score of A. The team has this to say
about their recommendation: Powered by its strong earnings
growth of 106.89% and other important driving factors, this stock has surged by
237.21% over the past year, outperforming the rise in the S&P 500 Index during
the same period. Regarding the stock's future course, although almost any stock
can fall in a broad market decline, NUS should continue to move higher despite
the fact that it has already enjoyed a very nice gain in the past year. NU SKIN ENTERPRISES reported
significant earnings per share improvement in the most recent quarter compared
to the same quarter a year ago. The company has demonstrated a pattern of
positive earnings per share growth over the past two years. We feel that this
trend should continue. During the past fiscal year, NU SKIN ENTERPRISES
increased its bottom line by earning $3.52 versus $2.37 in the prior year. This
year, the market expects an improvement in earnings ($5.82 versus $3.52). The net income growth from the
same quarter one year ago has significantly exceeded that of the S&P 500 and the
Personal Products industry. The net income increased by 104.7% when compared to
the same quarter one year prior, rising from $54.18 million to $110.90 million. The gross profit margin for NU SKIN ENTERPRISES is currently very high, coming in at 85.84%. It has increased from the same quarter the previous year. Along with this, the net profit margin of 11.95% is above that of the industry average. Rather than taking the immediate loss, I plan to execute a repair strategy to mitigate the current loss (1,000 shs put to me at a $44.83/sh loss: $124.3/sh basis and Friday's $79.47 close). 1. I will buy 10 contracts of the Feb $75 Calls($11.60 at Friday's close) 2. I will sell 20 contracts of the Feb $85 Calls (2 x $6.30 at Friday's close) 3. The above spread will generate a +$1.00 premium for the position Over the next month, I expect NUS shares to climb, ideally to $85. That then will generate: 1. +$5.53/sh for the 1,000 shs held 2. +$10/sh for the $75 Calls 3. a total gain for the position of $16.53 for $5.53 gain in NUS' price If NUS doesn't quite reach $85, I'll repeat this strategy in March. If it goes beyond $85, the shares will be lost, and I will have just reduced my initial loss. If NUS continues to drop, I will have only reduced my basis by $1 and my losses will mount. Repair Strategy for NUS 1. Your short Put puts shares to you (say 1,000 shares); 2. As a result, you have incurred a large loss (put to you at $124, trading at $79); 3. You feel shares are worth holding; 4. Buy 10 Calls near the current value or the 1st strike below it; 5. Sell 20 Calls with the same expiration month at a several strikes above the current value; 10 contracts are covered by your 1,000 shares and 10 by your long calls; 6. The strike price for the short Calls is chosen so that its premium covers or exceeds the cost of the long Calls; 7. The advantage is that your basis for the 1,000 shares drops substantially if the share price does in fact rise. Possibilities for NUS above at the February expiration in 33 days. 1. NUS shares could continue to drop, think ENRON; (at some point you have to close the position and take the loss) 2. NUS shares could climb to the $85 value of the short Calls strike; (basis would drop dramatically) 3. NUS shares could continue to climb beyond $85; (shares would be lost unless the Calls were bought back before expiration) Contrast How Your Basis Changes with Various Strategies when Price Rises to $85 1. If I just hold the 1,000 shares, their value gains $5.53; 2. If I sold 10 $85 Calls, my shares would have still gained $5.53, but I would also have gained $6.20 in premium (gain $11.73); 3. If I executed the above repair strategy, I would have gained $16.53. This Excel Program will help you analyze these (and other) option strategies. _____________________________________________________ DECK - A Second Example On 1/13/14 DECK was trading at $86.90 when I sold 10 contracts of its Jan $81 Puts, which provided a $0.60/sh premium. If I was forced to take the shares my basis would be $80.40. I had 7.48% downside protection and an annualized 53.96% return over the next 5 days. But again, by expiration on 1/17/14, DECK was trading at $75.02, and I faced a $5,380 loss.
Because DECK's fundamentals still looked good, on 1/17/14 I decided to hold the shares and put on the spread repair strategy: 1. Bought 10 Feb $75 Calls for $5.04/sh; 2. Sold 20 Feb $85 Calls for $2.57/sh (10 contracts covered by my 1,000 shares and 10 covered by the 10 long calls; 3. This spread generated a $0.10 credit and reduced my basis to $80.30;
4. This spread reduces our break-even point to between $77 and $78 as seen in the above chart; 5. DECK's price continued to climb, and on 2/10/14, I closed the position: Sold 10 long Feb $75 Calls:
+$7.00/sh
+$0.40 to reduce basis to $79.90 6. Turned losing position (-$5,380) into win +$2,100 ____________________________________________________________
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