Increasing Our Defense
PLAY: Buy the DXD October 65 Calls (DXD JM) at market, good for the day. Place a protective stop limit at $2.30, and implement our scaled-selling technique to lock in portions of your profits as these calls achieve 50% returns (and greater).
Dear Bottarelli Research Member,
One look at the Dow Jones Industrial Average (INDU) chart and you would think that the upside move from 10,827 to 11,698 would have pushed stocks in every sector group higher across the board. Unfortunately, that’s not the case.
As it turned out, this rally was fueled primarily by the financial sector — combined with a historic drop in oil prices. With financial strength and oil weakness occurring at the same time, we continued to experience weakness in sector groups such as oil, oil service, agriculture, steel, coal, and global engineering.
As frustrating as this near-term weakness is, demand-driven market sectors (such as all of these) continue to represent the very best investment opportunities your money can buy. Therefore, when you look at forward demand projections, backlogs, and earnings/revenue forecasts, companies that have experienced near-term weakness (like FWLT, WFT, RIO, PBR, and OSG) all continue to represent very strong 6-8 month investments. In fact, many of the savviest traders I know are actively buying into PBR, WFT, and RIO at current levels (more on these plays below in the updates). But in terms of this week’s newest LEAPS pick, a handful of powerful opportunities have attracted my attention.
The first is the powerful recovery in JP Morgan Chase & Co (JPM – NYSE). As you know, JPM is a financial holding company that operates investment banking, commercial banking, treasury and securities, and asset management services. When we look back at the sub-prime credit crisis 6 to 12 months from now, I firmly believe that JP Morgan will be the one company that emerges as the ultimate winner.
Lead by super-CEO Jamie Dimon, JPM’s ability to acquire struggling financials for absurdly-cheap values (like Bear Stearns) will allow them to rise from the ashes of bank “runs” and FDIC-rescues that haven’t been seen since the Great Depression. And in the process, I feel JPM stock will reach $100.00 per share by this time next year.
Bold prediction? I don’t think so. In fact, On January 22nd 2008, Jamie Dimon bought $14,500,031.00 worth of JPM stock for the average price of $39.83 per share. As of this week, his purchase just turned profitable, and we now have the opportunity to buy JPM at these same levels. If we witness any sort of JPM pullback, I’ll look to add a new LEAPS position.
Another possible LEAPS pick comes on iShares FTSE/Xinhua China 25 Index (FXI – AMEX). FXI is an ETF that seeks investment results that correspond to the FTSE/Xinhua China 25 Index, and the shares just engaged in a 3-for-1 stock spilt on July 24th. This split has substantially lowered the cost of a longer-term LEAPS position.
As you probably know, China’s Shanghai Composite Index gained 130% in 2006 and 97% in 2007. But thus far in 2008, Chinese stock valuations have been cut in half, and this could represent a very strong entry opportunity. After all, China is a $75 billion investment opportunity, and despite a weak U.S. economy, strong growth in China will continue for years to come. With exposure to companies such as China Life Insurance, China Mobile, China Petroleum & Chemical, CNOOC, and PetroChina, FXI looks like another strong opportunity to add LEAPS on any forthcoming price dips.
Another potential play is found in the precious metals sector. From a historical perspective, fall is usually the strongest season for metals plays (that’s when they report the findings from their spring and summer exploration). Combine this seasonal strength with a weak market environment, and you may soon see investor dollars flooding back into metals as a safe-haven play.
The most over-sold metals play is Southern Copper (PCU – NYSE), which is one of the best all-around metals plays your money can buy. PCU offers you exposure to copper, molybdenum, zinc, silver, lead, and gold, and after splitting 3-for-1 on July 11th, shares have become grossly over-sold.
In terms of a pure-gold play with strong upside potential, it doesn’t get much better than Yamana Gold (AUY – NYSE).With operations in Brazil, Chile, Argentina, Honduras, and the United States, AUY is another metals play that has been severely over-sold. With the January options now trading at super-cheap valuations, this could be a powerful LEAPS play coming in the very near future.
But in terms of today’s pick, the smartest move is to increase our downside protection by adding calls on the UltraShort Dow 30 ProShares (DXD – AMEX).
By definition, the DXD is a special investment that moves at a rate of twice the inverse of the Dow Jones Industrial Average. In other words, if the Dow moves down 2%, the DXD will move up 4%. That is why it’s called an “ultra-short” position.
A recent article from Ivestopedia.com titled “Hedge Fund Mojo For A Sinking Portfolio” summarized how to prosper in the current market environment by saying, “If you’re avoiding looking at your latest statement of account, rest assured that you are not alone. No one enjoys a bear market, but there are ways to protect your portfolio. To accomplish this, investors will have to think creatively and become familiar with non-traditional investments that most people ignore.”
In my view, the UltraShort Dow 30 ProShares (DXD – AMEX) is one such investment. Not many investors realize this, but they can own an asset that moves at a rate of twice the inverse of the major market averages. And if you combine this ultra-short movement with the leverage of options, you end up with a powerful way to profit off any forthcoming market downside moves.
Therefore, owning DXD calls will hand you a strong profit if the Dow continues to fall. As you can see below, the DXD recently fell from a high of $70.00 down to $60.00. But this last Thursday marked a powerful up-tick that could extend into August. If the Dow re-tests its July 15th low of 10,825, you better believe that the DXD could break to a new high above $70.00 in short order. Therefore, as a way to profit off any forthcoming market downside, let’s add DXD calls to our LEAPS ledger now!
PLAY: Buy the DXD October 65 Calls (DXD JM) at market, good for the day. Place a protective stop limit at $2.30, and implement our scaled-selling technique to lock in portions of your profits as these calls achieve 50% returns (and greater).
UPDATES
I received a note from LEAPS member R.J. that said, “Bryan, I failed to put in a stop loss on my positions. It appears that two portfolio LEAPS have passed through the stops. FWLT stop at $2.10 and WFT stop at $1.80. The question is, should I sell at the current market level or ride it out? I noticed that the positions are still in your current portfolio and you have not sent out any sell alerts.”
In response to this question, I wrote, “I’m a little hesitant to call a position stopped with so much expiration time left, so at this point, I’m still going to follow these positions.”
This type of LEAPS management is the trading mentality that’s part of my bloodline. In other words, I have established stop prices for the benefit of LEAPS members who wish to limit their total draw-downs on any one position. If you are the type of investor who has rules about managing draw-downs, then I will not fault you for adhering to the designated stop-loss prices. After all, that is why I offer them to you.
But for me, stomaching a draw-down on a strong company that’s being taken lower in the midst of a weak market environment — all with plenty of expiration time — is a risk versus reward scenario that I’m willing to live with. After all, I’ve seen positions like this come roaring back all the time. In fact, if you’re a Bottarelli Research Options member, you’ll probably remember the January 2010 LEAPS that I played on DR Horton (DHI – NYSE).For three straight months, the position looked like an absolute dog. But then, in the blink of an eye, DHI staged an impressive rally that shot our position back into the black, and we ended up selling the total play for a strong return. This very same situation is what we’re facing with some of our current LEAPS positions. Therefore, I remain bullish and confident that we’ll see recoveries across the board prior to our various expiration dates. Specific comments on each position are noted for you below…
VLO January 35 Calls (VLO AG): After taking half of our profits off the table, shares of VLO continue to represent one of the best turnaround stories on Wall Street. An earnings announcement on July 29th could further trigger an upside move. Hold, with a profit-target for the remaining half of your position at the 50% level.
DECK September 90 Puts (QUK UR): After taking half of our profits off the table, shares of DECK have bounced around, but I still feel that the overall trend is down. On Friday, shares of fellow footwear company CROX lost another 40% of their stock value after dramatically reducing their forward sales expectations, and this could be the same fate for a trendy footwear company like DECK. Hold, with a profit-target for the remaining half of your position at the 50% level.
CRM November 55 Puts (CRM WK): Our second downside put play is basically trading at exactly our entry price. In my view, CRM’s price valuations are simply unsustainable in this market environment, and when the market realizes this, shares could drift lower. Maintain your puts with the first profit-target at the 50% level.
FWLT November 75 Calls (UFB KO), RIO January 37.5 Calls (VOH AU), & WFT January 2009 50 Calls (WFT AJ): These three positions represent, what I call, the “beaten up babies.” All three positions are below our entry prices, but all three companies are high-quality names operating in very strong market sectors. I fully expect major recoveries on all three positions, and considering we have expiration dates of November 2008 and January of 2009, we have time to see the turnaround. Therefore, I’ll continue to monitor all three positions going forward.
VIX October 25 Calls (VIX JE): Our volatility position continues to offer us downside protection, so maintain these calls for further pops.
OSG January 95 Calls (OSG AS): After adding to our calls, we witnessed a strong recovery this week that pushed our call prices up to a high of $6.30, representing a 17.10% gain from our average entry price of $5.38. This is the same type of recovery we could see in RIO, FWLT, and WFT, but I expect OSG to continue moving up in the coming weeks. Therefore, maintain your calls with the first profit target at the 50% level.
AMX January 2009 70 Calls (AMX AN): After mounting a slight comeback, disappointing earnings news out of fellow international telecom company Millicom International (MICC – NASDAQ) pushed the entire sector lower. I still feel that AMX will fill the upside gap, and now the stock’s valuations are better than ever. Hold.
PBR January 90 Calls (PMJ AR): Shares fell this week as oil prices moved lower, but I feel the down-move is a temporary event. In fact, rumors are swirling that PBR could join OPEC. Now wouldn’t that be something? PBR remains the very best oil play you can buy, so maintain your January calls.
ETR January 140 Calls (ODF AH): A strong downside move on Wednesday took the stock down to its near-term support point at $105.00. This should be the floor for ETR. With both Democrats and Republicans agreeing on the nuclear power issue, shares of ETR look like a great position without any political risk. Therefore, maintain this position going forward.
HOV January 2010 12.50 Calls (YZX AV): These calls traded as high as $1.80 this week, good for a 24.14% gain off our adjusted entry price of $1.45. Maintain these calls for more upside, and be sure to lock in profits on half of your position at the 50% level.
Until next week, have a good weekend.
Sincerely,
© 2012 CSR Group, LLC. All rights reserved. Published in USA.
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