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Options Insider

February 25, 2008
Volume 3, Issue 7

IN THIS WEEK'S ISSUE:

1. OPTIONS THOUGHTS: Don't Be Fooled By the Market
2. CASE STUDY: Options Make a 'World' of Difference to Your Portfolio
3. TRADE OF THE WEEK: Teva Pharmaceuticals Nearing Its All-Time High
4. TRADING TIP OF THE WEEK: 'Exercising' Has Its Price
5. ON THE LOOKOUT FOR MORE OPTIONS?


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1. OPTIONS THOUGHTS: Don't be Fooled by the Market -- by Michael Shulman

Dear Fellow Options Insider,

In a word, the market outlook is lousy.

After a day like today, when the Dow (DJI) rockets up 189 points, it may be hard news to swallow, but it's not me that's saying it -- it's the data.

Like most of you, I'm generally long the market and this is the kind of market that makes you want to go to cash -- and for the first time since 2001, I hear analysts recommending investors should do just that.

But make no mistake: I am not saying that you should head straight for the hills -- I am just using their comments as an indicator that the market is in trouble and that having some holdings on the short side is a great way to stay in the markets with defensive plays.

The trouble stems from the unknown. The folks on Wall Street, as well as individual investors, just don't know how much bad news is still coming about banks, investment firms and others living in and off of the credit markets.

A Wall Street Journal article last week talked about new credit risks of global financial problems that are spreading to corporate-debt markets. Pundits predicted that this malaise would be contained inside financials, but it has caught the attention of the entire market and has taken on a life of its own.

So what should we do in the meantime? What we do best -- make some dough on the short side.

I'm pounding the table about getting in now -- that is what we need to do. But none of my recommendations are based on the current market trading frenzy. My tried-and-true methodology for establishing strong short trades has been, and will continue to be, finding companies with the weakest fundamentals and prospects for growth.

And the newest names in our ChangeWave Shorts portfolio are picture-perfect examples of companies that are facing declining sales and profits for the foreseeable future. Of course, a general market meltdown helps -- but our portfolio is always about investing on falling fundamentals, not current chart action.

THERE'S A METHOD TO MAKING MAD MONEY

I have several particular theses right now driving my portfolio picks that are based on economic data and information from the ChangeWave Alliance survey results:

* The banking sector's slide due to the credit squeeze has opened up a bevy of opportunities in the generally stalwart sector. Our newest opportunities are short-term but, as fundamentals crumble, we'll find more and more short-side plays in this sector.

* The homebuilding market will not rebound until 2010. The housing recession is going to hit those with biggest exposure to the weakest market segments -- starter homes, first-time upgrades, condos and second homes -- the hardest.

* The homebuilders' close cousins -- the material suppliers and home improvement retailers -- are in for a very rough time of it, as well.

* The recession that we are most definitely in will continue to impact retailers and restaurants, who will see some lean days in the quarters ahead as consumers tighten their belts.

* The ChangeWave Alliance survey data and my own work in life-sciences research will continue leading us to some niche names.

For months now, I've been recommending that my ChangeWave Shorts readers establish short-side plays to capitalize on an impending recession. Now, let me tell you what not to short when fears of a recession are running high: the cocoon, the cozy home and the place to retreat. This cocooning has supported flat-panel TV sales, as well as gasoline sales for more visits to grandma.

It will also spill over into day-to-day luxuries -- so don't short Starbucks (SBUX) or Whole Foods (WFMI). And never short pet-related companies -- people don't neglect their pets during a recession. At least, that's what I tell my cockapoo, Sumo.

When you're going short -- we do it by buying put options in my ChangeWave Shorts service, we're not looking at the stocks that might lose a point or two before going back up to new highs. No, instead we're making bets on stocks that are going to slip a few points thanks to losing market share, making useless products and running out of people to sell them to, for starters.

There are always a lot of reasons to buy a good stock, but there are usually twice as many reasons to short a bad one. If you're ready to start playing -- and profiting from -- stocks that are about to topple, click here to learn more about playing the downside to win!

Michael Shulman
Editor
ChangeWave Shorts


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2. CASE STUDY: Options Make a 'World' of Difference to Your Portfolio -- By Bryan Perry

We can trade options on thousands of U.S. stocks, indexes and Exchange-Traded Funds (ETFs). But with America's growing interest in trading foreign stocks, how can an options trader take advantage of, and profit in, the international stock market?

One region receiving a lot of attention is Asia -- particularly China and India, which Wall Street also refers to as "Chindia." These emerging markets have caught the attention of many traders, both those who are bullish on continuing growth in these areas as well as bearish investors who want to be positioned for a global market sell-off.

The easiest way to play this is by purchasing bundles of foreign stocks safely through ETFs. These are created by firms that are willing to assume the risk of buying the underlying stock, while you sit back and leverage your position with options. This way, you're investing in a basket of stocks, but with one single transaction to make a sector play.

If you're not interested in researching all of the companies in a particular ETF -- as there are hundreds of ETFs to choose from and each contains approximately 20 stocks -- and instead have one company in mind for purchasing options, you can look into American Depositary Receipts (ADRs).

With ADRs, foreign companies can trade on their home exchanges but also maintain separate securities on U.S. exchanges by committing to domestic listing and accounting regulations. But, just because a foreign company is transparent and adheres to accounting regulations doesn't mean its underlying price won't decline in sympathy with trading activity in its home market.

Best of all, though, finding options for ADRs is as easy as finding them for domestic stocks. In fact, just today, my Tactical Trader subscribers closed out an 83% options trade in an ADR called China Medical Technology (CMED).

On Feb. 20, I knew the time was right to establish a position in CMED calls at the $50 strike, and I predicted that it would be a fast track to profit. And today, just five days later, I recommended my readers take our profit off of the table after the position moved from $4.10 to $7.50 -- in less than one week's time!

While this trade was nothing but smooth sailing, keep in mind that when you purchase stocks on overseas markets, such as the Shanghai Composite or the Hang Seng, you are buying stocks in the local currency. Although your account with be debited in dollars, ultimately those dollars must be converted and given exchange and commission fees.

Also, given that options premiums are based on the price of the underlying stock, volatility and time (among other factors), the premiums for foreign options can become inherently more expensive.

It's also important to note that, after the host of U.S. corporate scandals, the Sarbanes-Oxley Act came into play to keep domestic companies honest and investors in the clear. But, those accounting regulations only apply to U.S. companies, and stocks that are listed on foreign exchanges are not obliged (or even expected) to follow the same regulations. In China, where many companies are government outfits, this is especially true.

Yet, no one is arguing that there is the potential for profit by the rise or decline of today's "hot" stocks, but you can reduce your risk by playing foreign stocks by buying options on them in the domestic markets.

While domestic markets offer a seemingly unlimited amount of "options" for traders, you can satisfy your craving for some international flavor without having to stay up all night, watching your portfolio to see what happens during the overseas trading day!

Bryan Perry
Editor
Bryan Perry's Tactical Trader

P.S. We're playing the options markets for profits in Bryan's Tactical Trader service, with a healthy balance of put and call options in names that have some serious movement in store. Click here and get in on this week's options trade!

3. TRADE OF THE WEEK: Teva Pharmaceuticals Nearing Its All-Time High -- by Sam Collins

EDITOR'S NOTE: Sam Collins shares a trading idea with you each day before the opening bell through his Daily Trader's Alert. Plus, he equips you with all you need to know to get a running start to the trading day. Sign up for his FREE daily alert by clicking here!

Teva Pharmaceutical (TEVA) is a global healthcare company specializing in pharmaceuticals that has been in a bull market since 1999.

TEVA has been on our radar for quite some time now. On Nov. 13, we noted that "The long-term chart on TEVA shows that it could break from a big double-top with a new price objective of over $60."

On Jan. 9, we noted that "The pharmaceutical group is generally considered defensive (advancing while other groups decline), and TEVA illustrated that this month by breaking out on a high-volume breakaway gap -- a very bullish signal. The target of $60-plus is still viable."

And again on Feb. 4, with TEVA at $46.45, we said, "Following the breakout, TEVA consolidated just above the 200-day moving average and recently issued a stochastic buy signal."

Since then, TEVA has picked up impressive volume and is driving against its all-time high. The target remains above $60.

Sam Collins
Editor
Daily Trader's Alert

4. TRADING TIP OF THE WEEK: 'Exercising' Has Its Price

Many options traders close their positions long before expiration occurs, but most options traders have exercised an option at least once -- whether by accident or on purpose.

(Exercising occurs when an investor who bought options to hold long, notifies the option seller of his intent to buy shares of the underlying stock, if it's a call, or to sell shares of the underlying stock if it's a put option. Conversely, exercise can also occur on an in-the-money option if you don't tell the broker not to exercise the option for stock.)

When you exercise an option or it is exercised on your behalf, you are required to pay the aggregate exercise price because the value of the option, or the premium, is a separate figure not included in the aggregate exercise price. Aggregate exercise prices are simply used to figure out the required dollar amount for the option to be exercised.

How do brokers determine the aggregate exercise price? They simply multiply the option's strike price by its contract size. For example, if you wanted to exercise the Apple (AAPL) March 90 Calls and you had one contract, which is worth 100 shares of AAPL, the aggregate exercise price will be $9,000 if exercised on or before the March 21 expiration day -- or the $90 strike prices times the 100 shares.

Again, it's a good reminder that if you don't want to end up with the underlying stock, be sure to tell your broker not to exercise your in-the-money options if you're still holding them at expiration and to simply close the trade outright so that you can pocket the profits and not find yourself purchasing or selling stock when you didn't really want to!

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