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Julian Close's Insights

Financial Writer
Julian Close
Author Bio

June 24, 2013 - Everyone Loves a Winner

Mutual fund managers are obliged by market regulations to release a list of their holdings at the end of each quarter; they are not obliged to release a list of every trade they have made over the course of that quarter. This small sounding distinction is what creates the phenomenon known as window dressing, in which fund managers make sure that at the end of the quarter, they are holding only the stocks that they want the public to see. Sometimes there are strategic reasons for doing this. A highly successful mutual fund manager, for example, may be aware that the market is mimicking his moves, and to prevent this, he may change his holdings subtly, or even dramatically in the days before reporting his position and then change them back afterward.

Most mutual fund managers are not in this enviable a position, and while they may yet wish to keep certain positions a secret, their motivation is often a far more simple, and ultimately silly one: they don't want to look like they've been holding bad stocks as the result of having made bad choices. The simple solution is to sell the stocks which are down over the course of the quarter and buy stocks which are up. The solution is ultimately silly because fund performance is tracked day-to-day, so the fund manager's actual quarterly performance will be well known even before his quarter-closing positions are published. If a fund is down 50% at the end of a quarter, and the fund's published holdings are all stocks that have doubled over that same time period, no one is actually fooled into believing the fund manager was holding those positions all along.

Still, the desire look smart is a powerful motivation, and many managers are probably drawn into the window-dressing trap subconsciously. As the end of a quarter approaches, the thought of selling losing positions and buying into winning ones may grow more compelling. If that sounds altogether theoretical, consider the end result: window dressing trading, to the extent that it occurs, will cause stocks that are performing well to rise higher, and stocks that are falling to fall further, in the final days leading up to the end of a quarter. There may be a tug in the opposite direction after the quarter-end reporting is done, but it will not be as strong, since inevitably, some of those who move their money from laggards into  safer, better performing stocks, choose to keep it there.

As with many market-moving effects touted by conventional wisdom, this one cannot be counted on to affect any given stock. The effect is a real one, most analysts agree, but one that manifests only as a broad statistical bulge. That said, it still behooves us to consider the window-dressing effect when picking trades for the last week of a quarter. The timing is better for a trade on a truly great company with a high flying stock than for a trade on an out-of-favor company with an overly maligned stock. (AMZN) is a high flyer even by the standards of the current market and one of the greatest business success stories of modern times. Known as an Internet company, Amazon's real business is customer fulfillment by any means necessary, and this has caused the company to focus not on its website, but on its ground game: Amazon does more than allow anyone, anywhere to order anything?in a great many cases, it gets it there faster, more reliably, and cheaper than anyone else. Not to be outflanked by new technologies, Amazon blazed the trail into the tablet-era with its Kindle and Kindle Fire. While the Kindle Fire may not do everything Apple's (AAPL) iPad does, it does provide a platform for electronic delivery, which is exactly what Amazon needs. Amazon is also now feeling its way, along with Netflix (NFLX) and others, into the realm of digital media distribution. While no one knows how that is going to shake out, it can be said that Amazon is already one of the most well positioned companies in the game.

Analysts are expecting AMZN to earn $1.27 per share in 2013, up from $0.28 in 2012. Don't be fooled by numbers that appear to show Amazon losing money in the current quarter?that's due to a $0.37 charge from the acquisition of LivingSocial.

Given Amazon's continued relentless growth, its strong positioning for the future, and the probability of upward pressure in the coming week from fund managers who want to appear smart enough to have been holding this stock all quarter, we find the possibility of any significant near-term price drop for AMZN to be remote, and we seek to capitalize on the strength with a bull-put credit spread. Look at the August 235/240 bull-put spread for at least a $0.43 credit. This trade has a target return of 9.4% over 60 days, which is an annualized return of 57.2%, (for comparison purposes only) and the stock has to fall 14.6% to cause a problem. Be aware that this is an aggressive trade, best undertaken by investors with diverse portfolios and high tolerance for risk.

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