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No Really, this Time it's Different

Updated: Feb 24, 2019

Usually, there is a decent gap between big news events. However, on February 21, after the market closed, Kraft Heinz (ticker KHC) announced that: it had written down the value of its brands by $15 billion, it posted a $12.6 billion loss for the quarter, it cut its dividend by 36%, and its accounting practices were under investigation by the SEC. That is a lot of bad news, but it also seems to be a corporate strategy. When a lot of bad things are happening to your company, save them up and announce them all at once. Most corporations believe that one dose of really bad news hurts less than a continuing series of bad news.

Although I was fully invested in other stocks and really did not have any money left to trade in KHC, I thought it would be instructive to watch what happened to KHC when the market opened on Friday, February 22. KHC opened at $35.85 after closing at $48.18 the day before (a 25% drop). Based upon previous experience, I thought there might be as much a 6% bounce during the first few hours of trading. However, KHC moved steadily downwards from there and seemed to be heading for a price of $35.00. There was no money to be made on a dead cat bounce and at no time did I think it was worth it to buy based upon the price alone.

Once I saw that the price was not moving upwards, I started looking at the options market. Before the market opened, all of the options trades were showing 0 interest. All of the outstanding orders had been cancelled. However, once the market opened, KHC options started trading heavily. At some point between about 30 minutes and 45 minutes after the market opened, I noticed an attractive covered call trade opportunity. KHC was selling for about $35.10, and there were people willing to pay $1.40 for the March 15, $35.00 call. So, at the cost of a $0.10 loss per share on March 15, you could collect $1.40 per share now. Once you subtracted the commission cost, my estimate was that you could make $1.20 per share on this trade. This would represent a 3.4% gain over the course of about 3 weeks. If you could find a trade like this once per month, you could make more than 36% for the year. But, keep in mind that the list of people who can make 30%+ a year in the stock market is very small and those people tend to have almost as many years where they lose 30%+ in the stock market.

So, obviously the covered call trade could end up losing money as well. The big downside is that the stock price could continue to fall. If the stock price falls below $34.00, the loss in the stock starts to exceed the gain from selling the call option. The way to protect yourself is to buy back the call options and then sell the underlying stock. If you are lucky, the cost of buying back the options and selling at a loss will just about be equal to the gain from selling the options in the first place. To protect myself, I would have set price alerts at $34.25 and $34.10. I would also have to be ready to make the trade at all times. Luckily the interface for the trading app on my phone (I use eTrade) is good enough that I can execute this from anywhere as long as my phone has power and a network connection.

At the time I was looking at these options trades, the lowest strike price available was $35. About an hour later or so, I saw a full option chain with strike prices all the way down to $20. So, in a fast moving market, it can take the options exchange an hour or two before the options you really want to trade even become available. By that time, the price movement you need to get the prices you want can already have passed. So, one has to stay vigilant in order to make money based on big news events.

If it seems like options trading is a full time job, good. There is no shortcut. To make significant money in any task, you have to be willing to put in the time and effort required to succeed. The key to making this work for a FIRE investor is flexibility.

You need the flexibility to take a few hours out of the day to really work on stock trading at least a few days a month and perhaps even 2 or 3 days in a row. In addition, you need the flexibility to treat each trading situation as being unique. You have to be flexible in your trading strategies. Wait long enough to see if what you have predicted actually seems to be happening. Then, be open to different trading strategies to benefit from what you are seeing. You also have to be flexible enough to recognize when your trade is not working out. Do not fall in love with your trades. Even investing geniuses make mistakes. Warren Buffet has held KHC since at least August 2015 inside Berkshire Hathaway. Over that time Berkshire Hathaway may have lost more than $15 billion on KHC. The sooner you acknowledge failure and get out of a trade, the better you can limit your losses.

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