Tuesday, April 12, 2011

Coal Stocks Get Burned - Changes to ANR Options

ANR and all coal stocks went down in flames yesterday and today. Most everything in this sector is down 5+% over the last two days in yet another example of "efficient" markets.

It appears the main reason for the fall is a Goldman report that said it was time to get out of the energy/commodity trade. I am really " deeply concerned" that Goldman and their associates might have got caught in this down draft cause by their "independent, objective, and confidential" change in sentiment.......but......somehow I expect they were "lucky" enough to have hedged their way out of this unforeseen development...but enough about wall street.

Fortunately, common sense dictated that the highly volatile nature of ANR suggested a hedge be in place. The portfolio had previously sold a covered call. The rapid drop in price back to around $54 meant it was time to remove the hedge. Specifically, the Jan 12 $57.5o call was covered at $6.48 net of commissions. That specific option trade returned $1.57 or just less than 3% of invested capital in a little over 3 weeks. As importantly, it successfully provided some protection for this lot of stock. At this point, lot one of ANR consists simply of the stock held at about cost, and we will let that ride.

At the same time as the call was covered, we decided to totally reverse the sentiment of the trade position with the belief that the market is overreacting. One lot of April $52.50 puts were sold for $.32. Only three days until expiration.

Scenario 1 - The stock stops its slide before/near the chart support at $52.50 (another 3% down) and the portfolio makes .6% in 3 days on this lot (well over 30% annualized). To me this seems more likely to occur than the roughly 20% odds of the stock going below that level that was mathematically priced into the option at the time of sale and hence a good risk to take.

Scenario 2 - The potential for 30% annualized rerun does not come without risk. In this case the risk is the stock/sector continues to fall throughout the week and the portfolio is forced to buy a second lot of the stock at about $52.20. As discussed in previous posts, I feel that is an attractive price and hence not too risky. If the stock is put to me, I would likely write a deep in the money cover call against that stock for next month to try to unwind that lot for a profit.

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