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'Trumped'!

December 20, 2006

EDITOR'S NOTE: ChangeWave OptionsTrader will not be published next week, but we'll be on standby to send alerts as needed. We will return to our regular schedule on Wednesday, Jan. 3. Happy holidays to you and yours!

Dear Fellow Options Trader,

"The Donald" (Trump, as if there could be another known by just a first name!) can't be in a very good mood today, given that his bid to build a casino in Philadelphia was shut down by the Pennsylvania Gaming Board. Five other companies -- HSP Gaming, Philadelphia Entertainment, Majestic Star, Mount Airy Casino and Las Vegas Sands -- were the awardees of licenses to operate slot-machine facilities in the commonwealth.

Meanwhile, traders holding Trump Entertainment (TRMP) clearly weren't happy, either, as they hit the exits en masse when they realized that the road to expanding his gaming empire from Atlantic City to the City of Brotherly Love wasn't exactly paved with gold. Shares dipped 12% at mid-session to $20.15, but went as low as $19.41 (down four points from the day's high reached just before 10 a.m. Eastern) on turnover of 4 million shares -- which is more than 10 times the normal full-session volume.

Traders who'd made bearish bets in advance of the announcement might have been able to afford to stay at Trump's Taj Mahal hotel that's in development for 2008, but for the most part, Depth Charge (our bearish indicator) saw big buying of TRMP put options as well as calls being sold. Nearly 8,000 calls changed hands as disappointed institutional investors dumped their holdings in wholesale fashion.

Trump wasn't the only one to get "trumped" during this usually quiet time of the year for the markets. Even though the Dow keeps hitting new highs, lots of names are getting hammered. Given all the recent blowups (e.g., Northfield Labs and Nuvelo, for starters), long stockholders might have gotten killed or at least had a really bad couple of days, but traders of their options generally took on much less risk, and those who had established short positions were probably gleefully taking their profits from those who'd counted on those stocks going up!

All this negative activity begs the question of whether to follow the leaders or wait for a change in the weather. Now, when we're making trade recommendations based on unusual activity that we see on HeatSeeker (our bullish indicator) and Depth Charge, we're following the big-money investors into trades that they're making based on no (public) news -- trades that are blowing the volume and open-interest numbers straight out of the water compared to a typical day of trading.

But when you start to see mass buying or selling when there's a clear impetus (and yes, headlines -- however outlandish and unfounded, oftentimes -- do count as catalysts), it begs the question of following the rest of the herd or placing your bets in the opposite direction.

Case in point: It might be genetically impossible to keep anyone or anything bearing the Trump name down for very long. So if you're thinking of shorting the stock via the purchase of put options or the writing (i.e., selling to open) of call options at a time like this when the stock could very well sit tight for awhile or even recover, be sure to keep your stop-losses tight, particularly if you're short calls when the stock goes up, as the call buyer can assign you to take a short position in the stock. Which, if the stock would do an about-face and keep falling, might not be a bad thing!

A possible way to play a stock that you know is going to move, but you're not sure in which direction, is with what's called a straddle. This strategy employs the use of both a call and a put option at the same strike price with the same expiration date, with the same underlying stock.

Because the call is a bullish play and the put is a bearish play, you've technically placed a bet on both red and black. Straddles can be long or short (i.e., you go long both the call and the put, or you short both options) and are done on a 1-to-1 basis. Long straddles are best when you think the stock is in for a sharp movement, and short straddles function well when you're expecting a slow period for the underlying instrument.

The regular rules of options-trading apply -- you pay a debit to initiate the long straddle (which is your maximum risk), and you collect a credit when initiating the short play (which is your maximum profit). And, as always, the risks that come along with short options are greater, as the profit potential with a long straddle is unlimited but the loss scenario could be unlimited with the short play.

I mention the straddle strategy particularly because in Northfield Labs, an at-the-money straddle would have yielded $7 per share ($700 per contract) before yesterday's 20% drop and the 60%-plus overall haircut shares took in the past two days. Particularly with the long straddle, you want to jump out of it as soon as you get significant stock movement.

Keep in mind, though, that straddles are intended to help get you situated for a move. And just like you might say you're "straddling the fence" when you're faced with a decision in your life, eventually you pick the "right" path to follow. The same is true in trading this way -- you can't sit on the decision for too long because opportunity can slip away.

Accordingly, I assure you that just thinking and not acting isn't how The Donald made his billions! No one knows what his next move will be, but I have no doubt that after today's tumble in the stock, we're going to see a lot more trading right in front of his next move as well as after it!

Good luck trading and remember, pigs get fat but hogs get slaughtered!


Jon "Doctor J" Najarian
Editor
ChangeWave Options Trader