Over-Extended?

Add two puts to your ledger

PLAY: Buy the BOL May 65 Puts (BOL QM) at or under $5.10, good for the day. Place a protective stop loss at $3.70.

PLAY: Buy the SPY May 130 Puts (SFB QZ) at or under $1.65, good for the day. Place a protective stop loss at $1.00.

Dear Bottarelli Research Member,

Maybe you didn’t notice, but the major market averages are having one of the best quarters in the past few years.

The NASDAQ up more than 6.1% on the year. The S&P 500 is up more than 3.7% on the year (and is closing in on a 5-year high). Not only that, but the Stock Trader’s Almanac says that April is the best month of the year for blue-chips. They’ve averaged a 1.8% gain since 1950. Perhaps that’s why the Dow is posting a 100-point gain here in the first trading day of April?!

At the same time, the CBOE Volatility Index (VIX) is trading for a low level of 11.11. This muted volatility level signals that fear is evaporating in the markets, and options are becoming cheap. This low level also signals that a market downturn could soon be in the cards.

So today, we’re going to balance our three upside calls with two puts: one broad-based put on the SPY and one put on Bausch & Lomb (BOL – NYSE).

We’ll start with BOL. The stock came up on my screener because it was a big loser on a day where the broader markets were in rally mode. For a stock to drop on a market down day is one thing — but it’s an entirely different situation when a stock drops on a big market up-day. This is a clear sign of extreme weakness — which can be clearly seen as BOL is getting hit with horrible news from two different sides.

The first round of news came on March 23^rd when Moody’s put their debt under downgrade review when BOL failed report their financials. So-called “accounting problems” in their foreign subsidiaries forced the contact lens maker to delay their 2005 report — plus revise their reported revenues for 2002 through the first half of 2005. Hearing this made Moody’s consider moving their debt over to junk status.

As if that weren’t bad enough, BOL is also dealing with a new story that hit the tape on March 31st that says a rare fungal infection is propping up in contact-lens wearers in Singapore, Hong Kong, and Malaysia. This infection is called Fusarium keratitis, and although BOL says their products don’t appear to be causing the infections, they’ve nevertheless initiated contact with the Centers for Disease Control to investigate.

The combination of these news events can be clearly seen in the BOL chart:

Currently trading for $61.81, it appears like the stock could realistically move down to $55.00 in short order — especially as the rash of negative news continues to spook investors and debt raters alike. So let’s get positioned in some downside BOL puts:

PLAY: Buy the BOL May 65 Puts (BOL QM) at or under $5.10, good for the day. Current bid/ask spread is $4.80 to $5.00. Place a protective stop loss at $3.70.

The second play is a put on the S&P Spiders (SPY). This represents an overall way to use the low volatility figure to buy protective put options on the cheap. If we witness any sort of snap-back move in the markets — which appear to be overextended at current levels — we’ll make a quick 20% to 25% gain playing these puts.

As you can see by the chart, all it will take is for the SPY to dip back below 130 and re-test the 128 level for us to make a quick hit. So let’s get positioned in some SPY downside puts as well:

PLAY: Buy the SPY May 130 Puts (SFB QZ) at or under $1.65, good for the day. Current big/ask spread is $1.55 to $1.60. Place a protective stop loss at $1.00.

Lock and load!

Sincerely,