Daily Stock Market Equity and Options Trading Commentary

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Saturday, May 2, 2009

Derby Trade: Whos Bringing Home the Gold?

With the 135th Kentucky Derby on the way, many of us may be wondering how we can make some money on the race. However I am not a gambler (because I am a numbers person), and I know the odds... Therefore I am betting on something different... GOLD. With the stimulus package underway and another $1 trillion of borrowed money being added to our debt, gold is sure to sky rocket. Keep in mind gold trades in US dollars so if our dollar gets stronger it should help prevent it from climbing too fast. Overall gold should rise with how much money is being printed. One instrument to look at may be the GLD which mimics the movement of gold bullion, a possible way to make some money if gold sky rockets, like many predict. I like to think outside the box, so I chose a different way to make money off my expected gold spike. I did not do this by playing a gold mining company, but in fact a mining equipment maker... Caterpillar. I think CAT is a long term gem or in this case "goldie". CAT reported their first quarterly loss in 16 years; so this is a great time to take advantage of their low stock price. Given the economy and that type of business, it is expected. Recessions don't (and this one certainly won't) last forever. The recent GDP number stated exports were higher, with the CAT CEO stating that demand for excavators was at record numbers, thanks to China. This certainly sends a bullish signal for CAT. CAT has maintained their dividend at 42 cents a share, which at these levels comes to almost 5% a share annually. The chart below shows CAT over a year. If you think the market has bottomed, this chart may signal a clear bottom with the market near March 6, 2009.
Cat is a leading equipment maker for the mining industry, therefore my theory is: if the price of Gold spikes (with the amount of money being printed), gold will become more attractive and profitable to mine, therefore CAT equipment will be in higher demand. Some analysts have expected gold to hit $1500 an ounce by year end 2009, if this is the case demand for mining equipment is sure to rise. Check out some of CAT's mining equipment and their mining magazine in print for more details. In the last conference call CAT announced they were not looking to cut their dividend but to keep it steady (if not increase it). CAT was also recently upgraded by JP Morgan, even after a dismal earnings report. Signs on CAT are certainly bullish. Cat was the third best performer in the Dow Jones for the month of April-up over 25%. If you are relatively optimistic and think the market/economy has bottomed, and is bound to move higher in the months to come, you won't want to miss CAT... As it may be off to the races.

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Thursday, April 30, 2009

April Rain's Brought BIG Gain's

The month of April was an extremely good month for the bulls on Wall Street. Although ending today nearly flat, the major indices had their best monthly gains in years! The performance of the major U.S. stock market indices in April were: Dow +7.3%, S&P +9.4%, and the NASDAQ +12.3%. The chart below shows the major indices for the month of April (click to enlarge).
The Dow's best performer was American Express gaining over 85% since April Fool's Day, and I'm not joking! Some other names that have been strong for the past 30 days include Diedrich Coffee, Inc. (DDRX), Dendreon Corporation (DNDN), and Borders Group, Inc. (BGP) up 701%, 405%, and 333% respectively! For a trade idea, look into the options on BGP and DNDN (as DDRX does not have options), the volatility on these names has exploded and is bringing massive premiums! Two of my favorite speculation stocks for April were Palm and APWR climbing a steady 22% and 90% respectively for the month of April. I am still bullish on Palm, but they need to hurry up and release information about the Palm Pre, I think that could drive the stock a bit higher. My short term price target set on Palm is $12.50 a share, and that is where I have written covered calls for May for 50 cents a share.

To show a general picture of how the market performed broken down by individual stocks, below is a heatmap for the past month. Note that these stocks are sorted by sector and they are only for the stocks which have options available (click to enlarge).
To learn more about heatmaps check out my post. As you can see the health care sector was hammered, while financials did the best (it may look like one giant company, but it is actually about 30-40 in that large bright green area). Oil and gas did quite well, with the exception of Exxon Mobile and Chevron which together make up the large red rectangle in that group. Telecommunications was on the weaker side, but industrials performed well.

Using heatmaps is a great way to see where the money is moving in the market. Think of it like this: "the market moves together over time". I am not saying it moves together 100% but overall if the financials do well, telecommunications should eventually etc... If you're bullish and agree with this theory, you probably think the green boxes are leading indicators of the market, and should be putting money in the sectors which have not experienced these massive gains (with the exception of health care- need more info on where this administration is going). However if you're bearish, you'll most likely think the companies that did poorly for the month of April are the leading indicators, and may choose to short the companies/sectors that did very well.

That's the past let's look ahead to May! Historically the market does perform poorly to weak at best in May (until about October), as the old saying goes "sell in May go away", however when coming out of a bear market the month of May does very well on average. It's up to you whether you think the market will do well in May or not... I can just say one thing for sure. The April rain's brought me BIG gains...

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Wednesday, April 29, 2009

Navigating the Next 100 Days... What do You Think?

All the talk today has been about the first 100 days of the Obama administration... To sum up the first 100 days: we are down 1.14% on the Dow, up 2.77% on the S&P 500, up 11.93% on the NASDAQ, we've passed the largest stimulus bill in the history of the U.S., that has yet to convince many economists that it will stimulate anything, and GDP and unemployment have hit their highest levels in years. However since January 20, 2009 we have formed a clear V bottoming pattern on the major indices, convincing many that the worst is behind us. But enough about the first 100 days... We should be worrying about the next 100 days! Below is a chart of the 3 major indices for the first 100 days (click to enlarge).

This post is to seek the comments and thoughts of others. My question to you is: After seeing the first 100 days, what do you think the next 100 days will bring us? The 200th day is August 7th, 2009.

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Double and Triple Leveraged ETF's Investor's Beware!

Today I'll tell you why investor's should never be confused with trading instruments. With the popularity of ETF's came these funds which use 200% and 300% leverage. These are extremely dangerous, and nobody should hold onto any leveraged ETF for the "long run", they are almost sure to lose you money! These instruments are ideal for traders not investors! Let's start by identifying what a leveraged ETF does. A double leveraged ETF uses 200% (triple uses 300%) leverage to capture a specific basket, sector, or index move. Let's take the very popular SDS which is a 2X inverse tracking the S&P 500, for every 1% move up in the S&P 500 index SDS will move down by 2%, and for every 1% move down in the index SDS will move up by 2%. Similarly is the SSO which is the 2X tracking the S&P 500, for every 1% move up in the S&P 500 index SSO will move up by 2%, and for every 1% move down in the index SSO will move down by 2%.

If you're the person who says: It's a great way to hedge my portfolio, so what's the problem with them? Then clear all your other thoughts and read this post carefully- it may save you some $!

It is basic math that so many people overlook! Let's use the benchmark S&P 500 index for an example. Let's say we start off on the S&P 500 at 1000 and a double and triple leveraged ETF both at $100 per. If the benchmark index moves down 10% in 1 week to 900, and assuming both ETF's track perfectly it would put the double leveraged ETF at $80 per share, and the triple leveraged ETF at $70 per share. Here is where investor's don't think and assume that when the S&P gets back to 1000, the leveraged ETF will trade at the identical value as before, when the S&P was at 1000... THIS IS FALSE! Basic math tells us this is not possible. In order for the benchmark to get back to 1000 it will need to go up by 11.11% which will correlate to a 22.22% and 33.33% move in the double and triple ETF's respectively. As we can see in order to get the double ETF back to 100 from 80, the benchmark will need to increase by 12.5% correlating to a 25% increase in the double ETF. The triple leveraged ETF will be even tougher to get back to 100. In order for the triple ETF to get back to 100 from 70, the benchmark will need to increase by 14.283% correlating to a 42.85% increase in the triple ETF.

To show how this works I have created an Excel spreadsheet. I have downloaded historical data on the S&P 500 Index for exactly one year, back to the closing index value on April 29,2008. Assuming these leveraged ETF's track perfectly with the change in the index (which is incorrect but they do track very closely), the spreadsheet shows the changes for 4 different leveraged ETF's. The ETF's tracked are: Double Leveraged Long index, Triple Leveraged Long index, Double Leveraged Short index, and Triple Leveraged Short index. I also started each ETF at 100 on April 29, 2008 (this is not where they started, but will not make a difference in the % change). These ETF's don't assume any capital gains distributions, splits etc...


As you can see, for the past year the index is down 38.52% but the double and triple leveraged Short ETF's are up 44.35%, and 26.61% respectively. Many would have assumed the double and triple leveraged short ETF's would be up 77.04% and 115.56 respectively over this period... This is certainly not the case. Also at the bottom of this spreadsheet I have created a simulation to show how the index (over the next 250 days) could get back to even (back to the index close on April 29, 2008) and the resulting % changes from $100 per share for each leveraged ETF. This proves how dangerous they are... They are all down even when the index is back to even!

It certainly depends on the price these ETF's are purchased, but over the long run, based on simple mathematics, they are sure to deteriorate. This is why these are great instruments to trade, not invest... Investor's beware!

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Visa on Deck to Report Earnings Option Straddle VS Option Strangle

With Visa on deck to report earnings after the bell on April 29, 2009 some option strategies come to mind right away. Although Visa is not a financial it has been tracking like one for the majority of the time it has been listed. Let's compare Visa to American Express, although Visa is only a transaction provider and has no business collecting money like AXP whatsoever. However it is the closest financial we can compare Visa to because they both involve credit cards. Assuming V reacts like AXP, Visa will have a huge move (20%+).

If Visa beats significantly we could see a 10% move up in the stock or about $6, if they miss we could also see a 10% drop in the stock or about -$6, based on today's close price for V at $60.71. Below are two option strategies to play before earnings. One is playing the option straddle, and the other is playing the option strangle.

Playing the straddle. The current ask for the May 60 PUT option is $260 per contract and the current ask for the May 60 CALL contract is $330. The total for 1 contract of each would be $590. Using the current Delta and assuming Visa beats and moves 10% up or $6.07 after earnings, the CALL contract will get to at least $670 (however the delta would increase with the price increasing, therefore each $1 move up would increase by more than the delta I used for this example), while the PUT contract drops to $0 (with delta used in this example), however this is not the case because just as delta increases as the option is further in the money, the delta decreases as the option is farther out of the money; this means each $1 up will result in less of a decrease in the PUT contract- meaning it will still likely go for something. Again using the current Delta and assuming Visa misses and moves down 10% or $6.07 after earnings, the PUT contract will get to at least $520, while the CALL contract drops to $0 (however the same rules apply but just the opposite).

Therefore assuming Visa will be very volatile this may be a good trade, however if Visa is stable after earnings this straddle could be a disaster.

Now let's analyze playing a strangle before earnings on Visa. With Visa being closest to the $60 strike we would pick the two closest strikes surrounding the Visa 60 which are the 57.50 and the 62.50 for May. The current ask for the May 57.50 PUT option is $160 and the current ask for the May 62.50 Call option is $205. The total to open this strangle position would be $365. Now lets assume the same 10% move in either direction occurs after earnings. Using the current deltas, if Visa beats earnings, the Call option contract will get to at least $460 while these deltas indicate the PUT contract will drop to about $0, which again is extremely unlikely. Now if Visa misses earnings and slides $6, using current deltas the PUT contract will increase to at least $340 while the call option decreases to $0.

Strangles are a bit cheaper, but even more dangerous, because if Visa does not pop or drop, and moves within the 57.50-62.50 range these contracts will certainly lose you money.

A major factor in making the decision will depend on where Visa is trading at 3 PM Wednesday. But straddling Visa is a much safer bet...

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Monday, April 27, 2009

Blazin' HOT Option Strategy

Today I will post about an option strategy that has made me money every time I've used it. It involves a small cap stock and an options straddle. First of all I'd like to start by giving a background of a small cap company known as Buffalo Wild Wings. It is a restaurant with a nice atmosphere and known for their delicious wings-hence the name. They they have 14 different sauces for their wings- the hottest being Blazin' (if you're daring, you should try them sometime... HOT!). In the past 2 years they have gained a lot of popularity by having Mixed Martial Arts (MMA), notably Ultimate Fighting Championship (UFC) pay-per views. As you may know MMA has become extremely popular in the past 5 years and Buffalo Wild Wings has these featured "fight nights" and are able to attract a HUGE crowd. Personally I think Buffalo Wild Wings (BWLD) will blow away the quarter, but I certainly don't want to be too sure in this market/economy. Therefore I'm playing on both sides of the fence, or in the options world we call this fence the strike price. Historically when BWLD misses the quarter they get beaten down (20%+), and if they beat the quarter they seem to have a massive gain (20%+). First I'd like to state 5 reasons why I think BWLD is a great company and even investment worthy. Then I'll tell you about the strategy I implement before they report earnings every quarter.

First of all BWLD has a very good product, it is a cool and clean atmosphere (they have like 60 TV's tuning into sports from all around the world on all the time), not to mention they have a well designed interactive website. Second, like every restaurant chain, they have massive margins, however they make most of their money on the sales of alcohol (which as you may know are even bigger margins). Third, the price of chicken was down in Q1 from the previous quarter and their major food items are all chicken products, this means margins on these items are even greater than the previous quarter. Fourth, these guys are growing at a phenomenal rate and will continue to grow rapidly, they are expected to grow earnings by 24% in 2009, and another 23% in 2010. And fifth, quarter 1 includes one of the busiest days for Buffalo Wild Wings... Super Bowl Sunday. It is like the black Friday for retail stores, and each BWLD location had a super bowl party.

Now that I have given you 5 reasons to invest in BWLD here is one reason why I speculate with them and capture either the upside or downside. BWLD being so volatile after earnings makes it an ideal candidate for purchasing an option straddle on. BWLD closed today at 42.10 so this makes it hard without there being a strike for 42.50 (at times like this I'd look at playing the 40 put and 45 call which is a bit cheaper, but even more dangerous). However the price as of today's close is closer to the 40 strike therefore I'd most likely be buying both PUTS and CALLS on the 40 strike. Best case scenario would be for BWLD to trump earnings and for the overall market to be having a good day. BWLD has a 32% short interest, so if they have a real good quarter and give good guidance, we could see a huge short squeeze. As I said BWLD usually moves at least 20% one way or the other which gives us $8.42 up/down. Last time they reported good earnings it moved up 34% in a single day, followed by about 3% additional in the following 5 trading days. A straddle for BWLD will cost about $700 with 18 days left until expiration, but if we can get a good move up or down from BWLD, I think breaking even at worst won't be a problem. The key is to flip the straddle while it still has a decent time value- I usually flip it the next day. Historically shorts have about 12 days to cover, this implies we could see a nice rally for 12 days before it pulls back, however I usually don't get greedy and I take my profits immediately. The worst case scenario is if BWLD meets expectations and does not move that much in one way or the other. This is something you need to be careful of especially if debating to purchase a spread like the 40 PUT contract and 45 CALL contract. Ideally I would like to purchase the straddle while the stock is closest to 40 or 45 and would look at doing a spread if it was near 42.50. Good luck!

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U.S. Futures Looking Dismal but Possible Swine Flu Profit Play

Looking at the U.S. stock market futures we seem to be down quite a bit. The Dow is down 152, S&P 500 down 19, and the Nasdaq is down 23.75. Looks like tomorrow could be a rough day, with the likelihood of some depressing earnings reports as well as people worrying about the Swine flu we could be down significantly. Speaking of the swine flu, that story may actually shine some light on the Pharma sector tomorrow. A way to profit off of this highly talked about illness may be to flip some med stocks. I remember when Severe acute respiratory syndrome (SARS) was highly covered I was able to make some profits. One of the drugs given to patients that for SARS was Ribavirin. Two publicly traded companies which distribute popular forms of this drug are Roche (OTC) and Valeant. As one can see from the Google News Timeline below, the media heavily covered SARS in March-June and peaking in April. (Click on picture below for larger more clear image).

Now if we look at the Google Stocks charts for both Roche (RHHBY) and Valeant (VRX), as well as other major drug stocks such as Wyeth (WYE), Pfizer (PFE), and AstraZeneca (AZN) we notice an uptrend in these stocks. (Click on the picture below for larger more clear image).

The overall trend looks to be an initial pop as the possible first stories were reported of SARS in January, then a minor dip through February for both Roche and Valeant, but more or less a sideways move for the three giants. However as the story gained more coverage the stocks rose very sharply riding the wave until about mid-June. There is certainly a correlation here between the coverage of SARS in the media and the stock prices of these drug makers. For tomorrow I would watch Roche very closely as they make Tamiflu which is a popular flu treatment and prevention drug. Also watch for large drugstores to move such as CVS (CVS) and Walgreen (WAG). Depending on how long this is HOT news in the media will certainly impact the stock prices for these companies. Just don't get burned by holding anything too long!

I am hoping they find a treatment quickly, and can contain this ASAP. My heart goes out to everyone affected, and I am hoping the best...

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Sunday, April 26, 2009

6 Stocks To Keep A Close EYE on for the Week Ahead

Here is a newly generated list of stocks I will be keeping my eye on for the week of April 27, 2009. Below is a list of the highest bull to bear rated stocks my screener generated April 26, 2007. To get a detailed definition of the bull/bear components check my Bull/Bear Ratio Defined post under Hottest Blog Posts.

ARCA biopharma, Inc. ABIO (14:0)
Diedrich Coffee, Inc. DDRX (14:0)
Cornerstone Strategic Value Fund, Inc. CLM (13:0)
DTS Inc. DTSI (13:0)
Informatica Corporation INFA (14:1)
Ford Motor Company F (12:0)

All of these stocks have made had extremely large gains the past 30 days, which is good reason to use caution when looking into trading any of them.

**I would use extreme caution and would do some extensive research before planning to purchase any of these stocks. These stocks will certainly be on my watch list the next few trading days. As always I'll wait for a 7-10% pull back to purchase any of them and set a tight stop loss if I happen to purchase any of them. If I purchase any of them, I will be selling into strength.**

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