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Getting In—Getting Out

A. Pre-Announcement:

I’ve had a lot of luck guessing which stocks are going to split. Except for Mobil Oil (MOB) (which may still split), I’m batting a great average. I look at several things to see if the company may be ready to split.

1.    Do they have a history of splits—and how recent are they? Value Line charts have information on splits. Other sources can be used.

2.    Price range. Companies seem to split when they get near or above their previous high. Currently, I look for companies between $60 and $150.

3.   Profitability. Are they making money? Do they have growing revenues?

4.      Dividends. Companies which pay divi­dends and an­nounce larger dividends are good candidates for an increase in value. Compa­nies which ini­tiate dividends and do stock splits are great candidates.

5.     Sympathy Moves. When other similar compa­nies make stock split announce­ments, the hot potato passes on and can spread through a whole sector. Note:

Lilly Eli and Company (LLY), Pfizer Pharmaceuticals (PFE), Interneuron (IPIC) in 1995 and 1996.

6. Companies that have stocks which run up in value in the previous six months—more specifically stocks with almost a 90% angle. Look at the following charts:

Cascade Communications (CSCC) stock in February of 1996, in the $105 range and again in May 1996. I’m going to con­tinue to keep my eye on this chart.

Microsoft (MSFT) has run up nearly $40 in six months. This company looks like a prime can­didate for a stock split. Again, I’m going to keep watching closely.

U.S. Robot­ics (USRX) split their stock back in September of 1995 in the $150 range,then again in May of

1996 in the $170 range. If this stock gets up around $160 a split is probably imminent.

Iomega (IOMG) is one of my favorites. This company usually splits its stock in the $50 to $60 range. It is currently on an­other upward move.

Cambridge Technology (CATP): This stock doubled in price in ten months,     then they split their stock. It is currently on the rise.

7.    Find out when the board of directors meets, or when the annual shareholders’ meeting is scheduled.

8.    Check the information to be voted on at the shareholders’ meeting and see if there is to be an authorization of new shares. Usually, but not always, this means a split is imminent (sometimes at the same meet­ing). For an ex­ample, observe Monsanto (MTC) in May of 1996.

Note: the directors usually don’t need shareholder ap­proval to do a stock split. However, they do need shareholder approval for new authorization of stocks because the share­holders numerical position will be diluted, hence the need for a vote.

Check out Microsoft (MSFT) in the spring of 1994. They voted on more shares of stock. Shortly thereaf­ter, they an­nounced a 2:1 split scheduled to take place on May 23. Similar situations occur all the time, i.e. McDonalds (MCD) in May, 1996. Monsanto (MTC), voted on 140 million shares of addi­tional autho­rized stock, then almost immediately announced a 5:1 split.

I played another one called Zebra Technologies (ZBRA) that took almost six months, but it was still a good play.

The one that got my attention was Texas In-struments (TXN). It was near $140. I’m not making this up, but at 12:30 pm (PST —the stock market closes at 1:00pm Pacific Time), I bought some $140 calls for the next month, and a few $145 calls two months out. At 1:15 pm, fifteen minutes after the market closed the company announced a 2:1 split. They also increased their dividend. The stock shot up to $152 in the next few days and I got out at a huge profit.

Intuition? Maybe. Luck? Somewhat. But I do it all the time.

B.   AFTER THE ANNOUNCEMENT

There is stock movement upon a stock split announcement and, for several days thereafter, there is usually a lot of vola­tility.

1. The period of time around the stock split—the day before, the day of and the day after—has a lot of price fluctuations, usually positive in nature. Ob­viously, unless you pre-guess a split the day be­fore it is announced, it comes and goes and you know nothing. Watch for quick run-ups, large volumes, et cetera—something is usually afoot.

On May 8th, during my second Wall Street Work­shop (in San Diego), I bought 10 Cognos June $60 calls at $V/8 on announcement of a split. On May 14th, I sold them all at $16^llifor a profit of $6,927 and a return of 75.1%.

R.L.— San Diego, California

The day of the announcement is a good time to play, which brings us to #2.

2.    The day, actually the minute of the announce­ments, is one of my favorites. The problem is getting instantaneous information. If you have a news service or a broker with one (and one who will call you), and more specifically if he can do a word search on the word “split,” then you can move quickly. Sometimes, the stock moves up $2 to $3 in a minute. Your $4 can become $6 in seconds. No joke, in seconds. We love having a stock split announcement occurring during one of our live Wall Street Workshops. The attendees are amazed at how fast the options go up (and down). I do a lot of these as one day—even one to two hour plays.

3.    A day or so after the announcement. If there has been a huge increase there is a tendency for the stock (and therefore the option) to come back down. That’s why I:

A.   Sell almost immediately—even if I lose some potential profits—and get out at a profit.

B.   Wait to see a better trend or better support. If the stock doesn’t go up at first, I hold back and wait. This gives me time to really think about it, and wait for more news, earnings reports, dividends, et cetera.

4.   On volatility: if the stock has been volatile before the split announcement (check out USRX and IOMG), then

it will probably continue to be volatile after the announcement and even after the actual stock split. If the com­pany is a slow plodder—it will probably continue to be so. The play is to buy on dips and sell at peaks. Remember: don’t worry if you miss the first move. Be happy.

5.     Before the actual split. Usu­ally, the stock splits about four weeks after the announcement. Sometimes, it’s six to 10 weeks. Sometimes one week. Just before the split it may be a sale candidate. I’ve seen a lot of nice price increases during the short period before the actual split (exdividend date) and the day of the split. Then many stocks dip down. For example: an $80 stock runs up to $90 from the time of the announcement to the split date. The day before the split, it goes up to $92. It splits to two shares at $46. By the end of the day it’s $47 and then a few days later it falls either to $44 or an $88 pre-split price. I’ve run across too many charts which show this pattern.

John Deere and Co. (DE) ran up almost $5 in one day, and continued to slowly climb for two or three days before it split. After the split, it immediately ran up $2 to $3 and then slowly continued its upward trend for nearly one month before it backed off.

P a i r g a i n Technologies (PAIR) went from the $100 range to $118 in a matter of days just before it split. Once it split, it gained another $4 before it dropped back down.

Bed, Bath and Beyond (BBBY) went from the $45 range up to around $60, one and a half weeks before its split. Post split, it continued to climb steadily for one month.

Computer Associates (CA) split its stock in the $65 range in September, 1995. At the time this chap­ter was being written, CA was in split range again. I am go­ing to watch this one closely.

The option for Synopsys (SNPS) peaked up around $7 in the four days be­fore it split. It peaked one day, and then gradu­ally backed off a little.

Phycor Inc. (PHYC) split in September, 1995, and again in June   of   1996.

Look at this chart. The trend was the same right after the split. This one is predictable.

Iomega (IOMG): another one of my favorites. This was a very volatile stock before and after the split. I play this one often.

U.S. Robotics (USRX) is an­other favorite. Like Iomega, this is a very volatile stock. They split their stock two times in a nine month period.

United Air­lines (UAL): an­other favorite. I played this stock many times. UAL stock was at $220 when it split. Post-split it lost a little ground. We are still watching this stock.

Coca-Cola (KO) took quite a run up three days before it split. Then after it split, it ran up another $4 in the first week.

Fannie Mae (FNM) is one I play a lot. This stock stayed steady for about six months before it finally split. The steady trend is the same as post split.

T . R o w e Price (TROW) hadalready reached its split range in No­vember, 1995. They waited un­til May to split their stock. It will be interest­ing to see what happens if (TROW) reaches $55 again.

B. F. Good-r i c h ( G R ) climbed steadily to an $80 high over the course of nine months, then they split their stock. Now, it is run­ning between $35 and $40 ev­ery month.

H.B.O. and Company (HBOC) took a nice steady run up to the $130 range. After its split in June of 1996, it went down a little, but is recovering nicely.

Ascend Communica­tions (ASND): look at this chart. This stock has played out a mirror image of itself every time it split.

Warner-Lambert ( W L A ) , McGraw-Hill (MHP), and Chubb (CB) are typical of high priced stocks. They show very stable trends and pre-dictability.

These will probably continue to rise at aslow, steady pace. This shows stability and strength in a company. I like to see charts like

these.

C a m -bridge Tech-n o 1 o g y (CATP)ranup on the split an­nouncement, then  backed off a little. After the stock split, it had an incredible run upward before it leveled off. This one is worth watching.

I can hardly ever find a stock that breaks this trend. I guess the quick pop-up cannot be sustained and it weakens once reality sets in. Investors start really examining it. (What is the stock really worth?) The euphoria is over; new news comes out, like lower projected earnings or similar news.

Also, here’s a quick observation I’ve made. The stock (during and just after the split) moves, as do a lot of stocks, in sympathy with the market in general.

What does all this mean? If you’re profitable you may want to exit just before (a day or hours) or just after the actual split. There will always be more time to buy back in. Yes, you might lose some potential profits, but this is more often the case: you purchase an option for $4, the stock was at $81. You own the $85 call. The company announced the split on June 2, and it is to take place July 5. You own the August 19 expiration date options. You’ve done it right. On July 8, the stock is at $87 and your option is $6, a nice 50% profit. On July 18, the stock shoots up to $90 and your option is worth $8—a double. On the 20th, the stock is at $46 ($92 pre split) and your option is now $5.25.

Should you sell or wait for it to go up more? On the 22nd, the stock dips $4 to $42 and your option (now the August $40 call) is $3. You are still profitable, but a lot less so. What if it dips further?

In this case, I would have sold. (I’m not just conjecturing here. I mean, not only would I have, I did sell at $5 or so.) I do this all the time. My people on WIN wonder why I sell so quickly and so often?

Think about it. Wouldn’t it be better to sell at $5.50, wait for a dip (even if it takes weeks or months) and buy back in at $3 (for the August) or even $4 for the September options? If the stock doesn’t go down and there is more good news—if there is still plenty of time—buy back in at the September or October $45’s or $50’s.

You can’t say that you have unlimited risk in selling puts because the lowest the stock can go is to zero. That is your downside. If the stock is below the strike price, it will get put to you.

You have one other strategy that can be played right up to and through the expiration date. It is called “rolling out.” Here’s the way it works. Let’s say the stock is at $46. Last month you sold the $50 put for $2.25 when the stock was at $48.50. You had hopes it would go up. It hasn’t. If you have to buy the stock, your basis will be $47.75, as you have received $2.25. One problem is the heavy duty amount of cash you’ll need to purchase the stock—even $25,000 on margin.

You think you could find a better use for the money. The put is currently $4.25—buy it back. Actually, you’re just purchasing the same put (strike price, month) as you sold. This will close the position—it’s a wash on your broker’s computer. If you had ten contracts, you would have lost a little over $2,000 after you add up the commissions. You could just end it here, but don’t. There’s another play.

Remember, you liked this company’s stock at this price. Check it out. Is the story line still in place? Yes, it didn’t go above the $50 like you planned—at least, not yet. If you still think it will do so, roll on out to the next month.

Let’s continue. Try to catch the stock on a dip—even if in a roll or slam in trading. Say it’s going between $46⁵/8 and $46^3/4. It occasionally drops to$46²/8. At that point sell the November $50 put. It’s going for $4.50. That’s $4,500. You’re back in the money again, and you’ve made a profit.

If you don’t think it will go above $4.50, look at the $45 put. It’s going for $2′/8, or $2,125. If you sold this you’d about break even on the original loss. Yes, you have an open position to buy the stock at $45, but your homework says it will go up.

Another method would be to split the contracts. Say, sell five of the $50 puts and five of the $45 puts. You should and could consider purchasing $45 or $50 calls. Maybe the $45s for November, and the $50s for February.

It keeps going down. Believe me, there will be an end to this—you will eventually make money. The next month the stock is at $44. Let’s stick with the $50 puts as that will be most drastic. You sold the November 50 puts for $4.25. It will cost $6.50 to buy them back. This purchase will throw you back in the loss column. Not by much, though.

You’re sure, this time, that the stock will turn around. It just has to (or so you hope). So spend the money—$6,500. Now the December $50 puts are going for $8 and the $45s are going for $2. Sell the $45 puts. You’re profitable again. Also, look at the $40s—there might be some premiums there.

Now the stock moves back up to $47. Your December $45 put expires worthless, and you’ve made over $2,000 for all this trouble.

This could go on several months—but sometime (hopefully) the stock will turn around. When it does, you end it and keep the best batch of each. When you buy back this month’s put, you can always sell the next month out for more money.

And Finally

There are two more considerations.

1.    You may want to consider only selling, or at least primarily selling out of the money puts, i.e. you sell the $50 put when the stock is at $52. This gives you a cushion. The problem is that the premiums are smaller and you have to weigh out the amount of margin tied up for the smaller option premium.

2.    Stick with stocks in the $5 to $25 range. Selling puts and writing calls have a lot of the same risk/reward features—only in reverse. If you want nice premi­ums on stocks which won’t kill you to buy, the lower priced stocks may work better.

Remember, when you sell you have many ways of making money (see “Tandem Plays”). When you buy call options or put options you only have one. This rolling out strategy lets you stay in the game until you make money.

It’s simple: you generate cash whether you have to perform or not. If you do have to buy the stock, you purchased it at a less expensive price than otherwise. I love selling puts because you get the best of both worlds—cash now and wholesale prices.

The margin requirements for selling puts is actually 20%. Your broker will also hold the put premiums you’ve received (until the expiration date) minus any out of the money amount. It will come out around 25 to 35%. Other factors figure in, too. How many other stocks and options you own. How strong is your relationship? Each broker is different. Yes, they have strict SEC rules to follow, but they have their own concerns. The primary one being this: what is the exposure if there’s a major market downturn—say 30%? Can you purchase all you’ve requested to purchase, or is their neck on the line too? They will err on the side of caution.

Remember, you’ve agreed to buy stock you don’t own. Now you’ve borrowed stock you don’t own—you’re covered. Sounds crazy, doesn’t it?

Think of it this way. If you have to purchase the stock at $15, and your broker immediately sells 1,000 shares in a short sale, your obligation is covered. Now if there is a dip in the stock price, the stock you buy (at this lower wholesale price) will cover your short position.

This is a hedge. Now, let’s double hedge. You hedge a short sale by purchasing call options. If the stock is at $13 and you still think there will be an increase, buy a $15 call option. Now you have the right to buy the stock at $15. The risk of short selling is an increase in the stock price. With the $15 call options, you’ve purchased insurance.

If the last several paragraphs frustrate you, read them again, discuss them with your broker, and don’t worry too much. I’ve sold dozens and dozens of puts. I’ve only had to do short sales a couple of times. If you do your homework, and then sell the puts when the stock is way down and rising, you won’t have to worry about this.