12,000 Reasons to Sell

I don't want to dampen the enthusiasm, and if you find this yet another occasion worth celebrating, then be my guest. But my own view is that celebratory occasions, if indulged in too frequently, begin to lose their effervescence. That strikes me as especially true when the occasion is a big, round number of no fundamental significance. Two weeks ago I urged some modest profit-taking, and now the timing strikes me as even more propitious.

To bring you up to date, I predicted then that the euphoria triggered by the Dow's new record was likely to put investors in a buying mood, making it a good time to raise some cash by selling covered calls. It turned out that I underestimated the bullish sentiment, with all the major averages significantly higher today than they were then. I rode the wave by implementing my strategy of selling calls on stocks I considered overvalued based on their high price-to-growth ratios and recent advances. So I sold calls on two technology stocks: BMC Software (BMC) and Network Appliance (NTAP).

I was also going to sell calls on Ciena (CIEND), the telecommunications-equipment maker that ranked a lofty third out of the universe of overvalued stocks. Because it seemed so overvalued, and because my position was small, I simply sold the shares. Had I waited to do this until now, I would've generated even more cash, since all these stocks have risen even more in the ongoing rally. But who has perfect timing? My mantra is to buy lower, sell higher. Perfection is possible only with the benefit of hindsight.

Several months ago I recommended buying Microsoft (MSFT) shares and especially long-term calls since the call premiums were so low. The calls I bought then have rallied impressively recently, especially since market leadership has been shifting to quality, large-capitalization blue chips for the first time in years. I thought this might be a good time to sell a few Microsoft calls, but was surprised to discover that the call premium is still very low. It's a reminder that options premiums are a function of volatility, and until recently Microsoft has been one of the stodgiest of stocks. I'll take another look again later this week if the Dow heads further into record territory.

Another stock in my sights, though not on the overvalued list, is my perennial favorite Google (GOOG). Because of its volatility, Google options carry large premiums. Selling the September calls with a strike price of $420 earlier this year turned out to be highly profitable, since the calls expired worthless in September but are now trading above $420. That's in large part thanks to last week's YouTube deal. There aren't many stocks in acquiring companies that rise on news of a takeover, especially when it's paying $1.65 billion for a company that doesn't earn any profits. But Google usually defies expectations. While I like the logic of the deal, and remain a big fan of Google, we may be nearing the point where expectations are so high, and call premiums so generous, that I won't be able to resist selling calls again.

I've said repeatedly in this column that I never try to predict where the market is going, and I'm not going to try now. I do know where the market has just been, which is why my conviction is even stronger that some modest profit-taking is in order. Two weeks ago I noted that there were two major props under the rising equities markets: falling oil prices and falling interest rates. One of those props has since been removed. Oil has continued its decline, but interest rates on the 10-year Treasury note have jumped from around 4.5% three weeks ago to near 4.8% now. Traders are no longer betting that the Federal Reserve is close to cutting short-term rates. This is a significant change in fundamentals, and sooner or later it's likely to be reflected in lower stock prices.

In my view, this is no cause for long-term concern. This bull market has been going on since 2002, which already exceeds the average. I hope it keeps going. But if stocks never declined, there'd be no risk — and no opportunity for superior returns.