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June 17 2011  / VISA Stock - Stock Symbol - V

VISA STOCK

Balancing Risk Against Reward

 

How To Determine Put Strike During Market Turmoil

With June Options expiry, VISA Stock actually looks pretty strong. The stock has been quoted between $76 and $74 for the past few trading sessions. While Visa share price is trading at around 16 times projected earnings, it isn't actually expensive. Mastercard stock is trading around 17X earnings. Visa's dividend is of no consequence with the yield less than 1%.

The recent downturn in the market has also hit VISA shares which are down 8% from its recent high. The problem with market downturns is, I want to sell naked puts for the higher option premiums, but I don't want to end up being assigned at too high a strike only to find that the put strike ends up deep in the money if the stock should unexpectedly collapses. In down markets or bear markets, stocks can fall further and faster than most investors expect.

Here is a strategy I have used many times to determine what put strikes to sell in an effort to minimize the chance of assignment while at the same time earning enough put premium to warrant risking my capital during a period of market uncertainty. It is important to get the risk I am willing to accept, balanced against the reward I want to earn.

The first thing I will do in a market correction or bear market, is reduce the number of puts I sell. Before June option expired, I was holding 18 naked puts. With the recent downturn I will reduce the number of puts to probably around 10. This means that should stocks really tumble, I will have cash available to take advantage of "fire sale" prices in stocks.

Put premiums are increasing almost daily now, so I want to continue to sell puts in VISA but I need to determine the safest strike for the summer period but at the same time I want to earn decent premiums. To try to figure out the best put strike to sell, I need to decide what is a realistic VISA stock value. Personally I think probably around the $68 to $70 range is fair value.

While resistance and support numbers are of some significance, in down markets stocks can slice right through support levels, particularly in panics.

Instead I prefer to look at the stock through charts and technical tools and then decide what levels to sell puts at.

The chart below shows the past year for VISA. Visa Stock is already below the lows of mid-April.

Each previous low is important as the stock retracing the uptrend it was in. I plot out on the chart the previous lows. Since we are already through the most recent lows, the next low is at $70.68. This goes back to March and I have labeled this the 1st low.

The second low goes to Jan 28 2011 when the stock reached $69.42.

The third low is $67.51 which occurred Jan 20 2011.

Of other significance is the Dec 16th crash which saw the stock fall to $66.59. Presently VISA is below the 200 day average and it looks like the 20 day SMA is going to cross the 50 day EMA. This is a pretty bearish sign.

On top of all this, the Ultimate Oscillator is at 42.09 which shows the stock is under pressure and falling. MACD is decidedly negative at -0.51. While both are momentum followers, they also are pretty good at indicating investor sentiment and stock direction, which for now appears to be down.

Looking at my charts and the options available to sell, I see that the $65 strike for September has a 2.3% return. The stock has also not been that low for the past 12 months.

VISA stock chart 2010-2011

I could wait a while to see how low VISA stock could fall over the next few weeks, or I could take my capital and sell some puts now and hold for a while longer, before selling more puts.

At $65, the stock looks fantastic. In my opinion not only does the stock look very strong at $65, but I think the chance of the stock falling this low is not great AND if it did, I will be getting the stock at the lowest level for the entire past 12 month period.

The question then is, will this market downturn, become nasty and move stocks a lot lower than anyone expects? Aside from the Greek debt crisis, I don't think stocks can fall more than 20%. At 20% that would be a serious correction.

VISA's most recent high was at $81.00. At $74.40 - the stock is already down 8%. If the stock fell to $65, that would be an additional 12.6%. This would bring the total pull back to 20%. Based on this, I think $65 is a pretty safe strike for me to sell puts against.

In order to add another layer of comfort to my decision to sell the $65 strike, I look at the stock chart during the most recent bear market in 2008 - 2009. Below is VISA's Stock chart for the worst period of the last bear market.

VISA Stock Chart - market collapse 2008 - 2009

I can see that until the panic from Oct 2008 to March 2009, the stock stayed above the $60 value. Then during the crash the stock fell on average between about $45 and $57. It took a market crash to push the stock below $60.00. Meanwhile when Visa began to recover, the move back above $60.00 was swift.

This adds that final layer of comfort. After looking at the above charts, I believe $65 is a pretty decent strike during the summer period, even if the market falls another 10% from here. If VISA falls steeper than expected, I have a nice pile of cash ready to buy some VISA shares at bargain basement prices.

To start off, I sold 5 puts for September $65 at $1.50. I will continue to monitor VISA and sell more puts at $65 if the stock falls over the next few days. I am hoping to sell the August $65 if the premiums reach above $1.00.

This type of charting can be used on any stock to assist an investor in deciding the best balance between risk and reward when selling put or call options, during a market correction or even a bear market.

RETURN TO VISA 2011 TRADES  

 

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