News trumps Trend on RACK

Yikes. A bit of news has caused Rackable Systems (RACK) to drop 33%. Earnings are scheduled for release on Feb 1, but the company released a warning about those earnings. Over 30 million shares traded yesterday.

I saw the intermediate uptrend since the 52 week lows in Aug. I didn't really pay much attention to the exhaustion gap in Jul as it came after a 4 month drop from the 55 area.

The stock is not that strong fundamentally, but I was long term bullish to neutral. My trade included a Jan 08 30 call (LEAPS) and a Feb 35 call cover. I just needed RACK to drift slowly up to the $35 price range by the Feb expiration. I planned to write the covers every month as an income strategy.

I saw support at 30 and resistance at 37.50. The slow bounce off of support and previous uptrend provided my bullish to neutral outlook.

My flaws on this trade included a lack of downside protection. A stop loss order on this position would have done absolutely nothing to prevent the losses. Gaps are the one thing that cannot be avoided with stop loss orders, your just going to have to take the hit. The proper method of protection would have been to buy an OTM protective put option on the position. Obviously there is some cost involved with buying insurance on your portfolio. This cost will eat into the monthly income of this strategy.

So what about the future of RACK? I don't know, but we can look at the chart for some clues. The stock dropped straight to the $20 neighborhood where if found support just 5 months ago. There might be some bargain buying at this level after the panic subsides. Obviously there was plenty of supply at the $20 mark to absorb 30 million shares.

Against my better judgment and because I already took my beating, I'm going to hang onto my $30 LEAPS and wait for the recovery. The $35 cover will expire worthless in Feb and I will wait for another cover back up at the $30 area in coming months.