An Indirect Housing Boom Play

Plus, FRO, BDX, and DRS Updates

Dear Bottarelli Research Member,

As I mentioned last week, I plan to release a special Bottarelli Research Investment Report. The point of this report is to recommend to you a series of options plays that are less volatile than what you’ve seen in February and March — but are still just as profitable. That way, you can get positioned in these longer-term plays (3-6 month time horizon) and make solid returns at the same time as playing the quicker-moving “lock and load” plays. This new report will offer you the best of both worlds in today’s trading environment. And of course, as a Bottarelli Research Charter Member in good standing, this newest comes to you free of charge.

Having said that, I wanted to tell you that I started my research for this report. My first plan was to engage in an intensive study of the S&P 400 Mid-Cap index, and I must tell you, the more I study this group of 400 equities, the more I believe that this group will make up 90% of the recommendations you’ll see in your upcoming report.

Why focus so heavily on the mid-caps?

That answer is simple. In my experience trading options, I’ve come to realize that the biggest winners — bar none — are found in the mid-cap sector. When you’re looking at a mid-cap stock, you have the perfect combination of risk versus reward.

On one hand, a mid cap stock is not nearly as risky as a small cap stock, which means you’re not subjecting yourself to violent market swings.

On the other hand, a mid cap stock is not nearly as stagnant as a large cap stock, which means you can participate in tremendous price appreciation that’s much larger than what’s possible in the large cap sector.

Armed with this scenario, trading the top mid-caps puts you in a remarkable position for success without opening yourself up to unnecessary risk. That’s why I began my research exclusively on the S&P 400 Mid-Cap sector — and I’ve narrowed down the 400 mid-cap stocks to around 35 potential candidates — both on the upside and on the downside.

Of course, I still have many hours of due-diligence left, so I’d expect this report to launch sometime in mid-to-late April. But in the meantime, I’ve uncovered an opportunity within the mid-cap sector that I want to play immediately. That company is Scotts Miracle-Gro (SMG – NYSE).

To be quite honest, I never knew this company was publicly traded until I scanned the S&P 400 Mid-Cap component list. But when I saw the name, I immediately liked the trading thesis. With more than $2.3 billion in worldwide sales, The Scotts Company is the world’s largest marketer of branded consumer products for lawn and garden care. They also own Smith & Hawken, a garden-inspired company that sells pottery, watering equipment, gardening tools, and outdoor furniture. (*sidenote: we just got a Smith & Hawken catalog in the mail, and my wife already have 3 pages ear-marked)

I primarily like the stock because the United States has just undergone an incredible real estate boom — one in which first time homebuyers are at an all-time high. In addition to first time homebuyers, everyone who could possibly take advantage of a zero-down or interest only loan has now upgraded to a bigger house with a massive yard. This is incredibly bullish for SMG.

Not only that, but the supply of new homes on the market is also at an all-time high — meaning that brokers must keep the homes looking sparkling new for potential buyers. This real-estate boom thesis points to record sales here in the beginning stages of the spring yard maintenance season for Scott’s Miracle-Gro. I personally feel that both new and old homebuyers alike will flock to hardware stores to stock up on Scott’s market-leading lawn fertilizers, which means the stock is in for a great spring and summer season. Just look at the chart:

As you can see, the stock just recently dipped under the 50-day moving average (in purple), found support right at the $46.00 level, and has started to move higher. This $46.00 support line marks a higher-support level than it set in early 2006 when it bounced at $45.00 and then rallied up to a new high at $50.00. The fact that the stock has now established a support point at $46.00 confirms a higher-low, which supports a continued rise up to the recent high at $50.00 with a subsequent move up a new 52-week high.

Further supporting the upside thesis is the fact that SMG really doesn’t have any significant competition. Aside from the hardware store generics, the only other competitor in the space is a company called Spectrum Brands (SPC – NYSE) which focuses on pet food and moonlights in the insect control products for lawn maintenance. Unlike SMG, which is looking to set new highs, SPC just hit a 52-week low of $16 in November 2005 and is roughly unchanged so far in 2006. ServiceMaster (SVM – NYSE) could also be considered a competitor, but their stock is stagnant and looks to be dismissed by Wall Street.

Armed with this situation, I’m a very large bull on SMG for the next 3-6 months. So let’s get positioned in some longer-term SMG calls:

PLAY: Buy the SMG June 45 Calls (SMG FI) at or under $3.50, good for the day. Current bid/ask spread is $3.10 to $3.40. I’m targeting a move between $5.00 and $5.50 in the next 1-2 months. If you plan to be away from your desk, pre-program a sell at $4.50, which would represent a 32% gainer. As a protective measure, set a protective stop loss that only triggers if these calls trade for $2.00.

UPDATES

Both your FRO May 35 Puts (FRO QG) and your DRS April 50 Calls (DRS DJ) are moving the way we want today. After last week’s one-day pop, FRO is retreating back down to $35.00 and looking to push even lower. You entered the May 35 Puts for $1.95, and I’m looking to sell them around $2.40. DRS hit another new 52-week high at $56.34 on the news that defense spending is up another 9%, but since hitting that high the stock has come off a little. Nevertheless, the April 50 calls you bought for $5.60 have traded as high as $6.30. I’d look to sell them at $6.90, good for a 23% gainer.

Your BDX June 60 Calls (BDX FL) keep trying to inch higher towards a new high above $66.00. I’m not sure if you’ve noticed, but our past plays in Chemed (CHE – NYSE) and Intercontinental Exchange (ICE – NYSE) are each moving the way I forecasted, despite adhering to our protective stops (which is a sound trading principle). The point is, each play would have been profitable had we taken on more risk and held longer, thus supporting the trading thesis behind the system and the rationale behind each play. Having said that, I want to be patient with BDX and let the trend play itself out.

Lock and load!

Sincerely,