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Options Insider

Jan. 14, 2008
Volume 3, Issue 2

IN THIS WEEK'S ISSUE:

1. DOC'S THOUGHTS: When Smart Money Talks, We Listen!
2. TRADE OF THE WEEK: Ruby Tuesday (RT)
3. WEEKLY TECHNICAL FORECAST: Brighter Days Ahead … Eventually
4. TRADING TIP OF THE WEEK: Learn to Say 'Game Over' and Mean It
5. ON THE LOOKOUT FOR MORE OPTIONS?


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1. DOC'S THOUGHTS: When Smart Money Talks, We Listen!

Dear Fellow Options Insider,

The start of a new year can seem so cathartic. You come into the office feeling renewed, thinking you have a clean slate and a brand-new year in front of you, but then something like $100-a-barrel crude oil brings you crashing back to reality. You realize that the only thing that changed in the world was the date on the calendar, and you're right back to where 2007 left off. Talk about a bubble bursting!

But even bursting bubbles create opportunities, and such is the case with $100 oil. The opportunities produced might not be quite the ones you'd expect. Your first instinct may have been to buy the big energy players like ExxonMobil (XOM), Chevron (CVX) and BP (BP), but then you would have made a pittance versus the trades we saw the fast-money institutional players getting into.

XOM, CVX and BP closed out a glorious 2007 at $93.69, $93.33 and $73.17 respectively, and the $4 pop to $100 helped them add between 1.5% and 2.5% in the first two sessions of 2008. But contrast that to the money made to the downside in the refinery names, and you see why we call the institutional investors the "smart money"!

Both Valero (VLO) and Tesoro (TSO) dropped during seven out of the first nine trading sessions of the new year, and we saw unusually heavy put buying in both issues as the year got off to a negative start.

Valero is the top refiner in the United States and had a stellar run in the first half of 2007, but then as crude oil rallied from the $50s in early January 2007 to $96 at year-end, the margins for refined products like gasoline got crushed. The math is relatively simple: Last year crude was up 60% and gasoline was up 30%.

Imports of gasoline from European and Caribbean refineries and a 5% drop in consumer demand further pressured refiners' profit margins. And if the early activity we picked up on in 2008 is an indicator, the smart money says the pressure is not off the refiners -- not by a long shot!

To kick off the new year, institutional investors were buying puts in big numbers with both January and February expiration dates, which tells me they were screaming from the rooftops that the pressure on refiners is immediate and that, in the short term, shares will fall. The institutional buying pushed volatility up nearly 20% in the first two sessions of the new year alone!

The other theme that has played out in the first few sessions of 2008 has been the run in the gold miners. This was tipped off in mid-December, when the institutional traders started accumulating Newmont (NEM), Goldcorp (GG) and Gold Fields (GFI) calls. The buyers have been rewarded handsomely, as these stocks have easily been the best performers of this young year.

And this was of course where the beauty of options has, if you'll pardon the pun, really shined! The leverage of options means rather than making 10% to 15% riding the stocks, the call buyers in NEM, GG and GFI had the potential to make 150% to 200% returns, as the options more than doubled from mid-December.

However, I will point out that despite the apparent breakout that the technicians are touting for the precious metal, the smart money has begun taking off these positions, an indication that gold may be getting ready to catch its breath.

So, the all-time highs in gold that we're seeing (in the neighborhood of nearly $900 per troy ounce), could very well ease up soon. At least, that's what the smart money seems to be saying … and when that kind of money talks, we listen!


Jon "Doctor J" Najarian
Editor
ChangeWave Options Trader


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2. TRADE OF THE WEEK: Ruby Tuesday (RT) -- by Michael Shulman

My ChangeWave Shorts subscribers and I recently donned our "Ruby" slippers to do some dancing in the streets in celebration of the short-side profits we were able to make from Ruby Tuesday's (RT) sliding share price.

The ChangeWave Alliance research has been showing a recession in consumer spending, and restaurants are one of the biggest sectors taking a hit.

We zeroed in on Ruby Tuesday as an appetizing short-side play. Its shares were trading near $31 in February 2007, but since then, they have been on a slow and steady decline. (Today they closed just shy of $6 per share.)

There are two keys to properly playing a stock to the downside -- first, you get in when "everyone else" is bullish, and second, you use put options instead of outright shorting the stock. This strategy ensures that you get in while put premiums are relatively inexpensive and that you use a limited-risk, potentially unlimited return.

On Oct. 25, we initiated what turned out to be a three-course meal of satisfying returns in Ruby Tuesday, via buying the RT Jan 15 Puts for $1.05 per share ($105 per contract). The stock was trading for $15.80 at the time, so we were betting on shares dropping through $15 before January options expiration rolled around.

Speaking of "rolling," that is a tactic that we use to squeeze as many short-side profits out of a falling stock as possible. You can roll "out" to a further expiration date, and "down" to a lower strike price to give yourself some great leverage. What you do is close your original position, pocket the profits and reinvest your original money into a new position.

It's way less complicated than it sounds, and you can be rewarded handsomely for the extra effort!

Such was the case with our RT Jan 15 Puts. We sat back and watched the stock slide easily through that $15 strike price, and less than a month later, the stock traded down to $13.34. At that point, our $1.05 puts were worth $2.10, and I recommended that subscribers bank the gains in "short" order.

But my research indicated that there was much more downside for RT, which meant more upside for short-side investors. This is where rolling a position comes in very handy. Since the stock was toppling, $12.50 per share looked like a reasonable destination, and the puts at that strike price with an April expiration date were a screaming bargain at $1.30 apiece.

So, on the same day that we banked the 100% gain in the Jan 15 Puts, I recommended rolling down and out to the April 12.50 Puts.

Although the stock was "down and out," we were anything but … especially when shares dropped through our new strike price and kept on going!

On Jan. 3, a day that shares traded at a "whopping" high of $9.47, our puts traded up -- way up -- to $3.60 apiece. While everyone else was bemoaning the terrible start to the new year that the broader indices were experiencing, we banked our first gain of the year -- to the tune of a 176.92% winner. Now THAT was something to celebrate!

So, by this point, we'd enjoyed an appetizer of 100% returns, followed by a second course of 176% gains. Could we enjoy a main course of even more happy returns, with a gain that rivaled those we'd already enjoyed? Actually, the final play in this trilogy was more like the main course plus dessert with a cherry on top!

On Jan. 3, when we cashed out of the second Ruby Tuesday put option play, we decided to "roll" with the punches one last time -- this time via the RT July 7.50 Puts. Again, we saw the stock falling to (and, ultimately, through) $7.50 a share. And although we expected it long before July, that still gave us plenty of time for the trade to work in our favor.



While ChangeWave Shorts wasn't designed to be a trading service, per se, it is an investing service that uses option trading tactics (i.e., buying put options) to achieve spectacular returns while being in a position (including rolled positions) for a period of time.

Our third and final position felt like a whirlwind, but with that stiff breeze came a pile of cool profits in just seven trading days. We bought the July 7.50 Puts for a mere 75 cents, which were poised to offer us a chance to double or even triple our money.

Actually, we did better than that -- on Jan. 11, as shares slid below $6, our puts spiked to $2.60 apiece, where we closed the position. After all, we were staring at our best return yet -- 246.66%!

All told, we spent two and a half months playing Ruby Tuesday on the short side, enjoying an average gain of 174.53% and a total gain of more than 500%. And it all started with a dollar ($1.05, to be exact) investment.

So, the next time you're about to spend a dollar on something insignificant, keep in mind that you can either get a candy bar or a bottled water from a vending machine, or else it can pay you back two-, three- or even fivefold (or more!) in the options markets.

And it was almost as easy as clicking our "Ruby" slippers together and saying, "There's no place like the short side!" Click here to see how profitable it can be to follow the road to short-side profits!

3. WEEKLY TECHNICAL FORECAST: Brighter Days Ahead … Eventually -- by Sam Collins

Get Sam's Trade of the Day featuring a stock that's gearing up to break out, along with market commentary that will help you to kick off your trading day with a bang. Click here to sign up FREE today!

Some investors are still bullish, as the major indices hold onto a thin thread of hope by teetering just above their major support lines: Dow Industrials (DJI) at 12,800, S&P 500 (SPX) at 1,375, the NYSE Composite (NYA) at 9,100 and the Nasdaq at 2,400.

However, group after group of stocks is rolling over, and despite the damage already done to the financial stocks (though some rallied on Friday), even they appear to be headed lower.

Last week, our internal indicator (Collins Bollinger Reversal, or CBR) flashed a "strong" sell signal immediately after a "trading" buy signal. That relatively unusual pattern in the CBR, when it occurs on the major indices, has led to declines in the past and so it, along with a package of other indicators, should not be ignored.

So how does an investor cope with a possible short-term bear market in which the indices could fall another 10% to 20%?

First, sell until you can sleep at night, and that means taking out of portfolios those stocks that are not performing well and thus raising cash reserves. It also means investing in or holding counter-cyclical and defensive stocks like utilities, pharmaceuticals, biotech, precious metals, healthcare, some energy (i.e., coal), etc.

But foremost, protect against further losses and ease the trauma -- again, "Sell until you can sleep at night." There will be a brighter day.

This week, more write-offs are expected from financial companies, and Citigroup's (C) write-offs could be as high as $24 billion, according to CNBC. But there is optimism that the huge write-offs will force the Fed to cut rates and this may temporarily support stocks.


Sam Collins
Editor
Daily Trader's Alert

Sam Collins is ChangeWave's Chief Technical Analyst and is a Registered Investment Advisor who manages portfolios for a fee. He can be reached at samailc@cox.net.

4. TRADING TIP OF THE WEEK: Learn to Say 'Game Over' and Mean It -- By Ken Trester

Taking losses is part of the game, and if you don't take them in a timely manner and move on, you will soon be out of the game.

There are two ways to cut losses:

1. Set a stop loss on the underlying stock. If the stock closes below (for a call option) or above (for a put option) its stop loss, close the option position the next day.

2. Cut losses using the option price. If an option falls in value by 50% after you buy it, it's time to sell your position before you incur any additional losses.

I can't stress this enough -- cut your losses; otherwise, you're likely get discouraged like a lot of rookies and quit the options game too early. I don't want you to lose all of your steam in the scrimmage games -- save some strength for the championships!

That is exactly how we maximize profits with options. It is a system that takes profits when they are available and cuts losses when necessary. Most importantly, it removes emotions from your decision-making. If you approach your portfolio management logically and even academically, this can help you to avoid making exceptions and opening yourself up to more risk than you'd normally feel comfortable taking.

Follow this system -- and you'll have your best shot at real success.


Ken Trester
Editor
Maximum Options


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5. ON THE LOOKOUT FOR MORE OPTIONS?

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