Sponsored By:

Everybody Has a Plan

February 17, 2009

Dear Fellow Options Traders,

We all want the economy to recover, as evidenced by the number of recovery plans we are seeing.

Hank Paulson had a plan. John McCain had a plan. Barack Obama has all kinds of plans. Tim Geithner had a $2 trillion plan but forgot to clearly articulate it this past week as promised. And Congress has a $787 billion "fire-ready-aim" plan.

There's also a rumored plan to subsidize homeowners' troubled mortgages before the loans default, which helped our buy-on-the-rumor, sell-on-the-news market for a couple of hours last week. Barron's front cover this weekend was a large-type, one-page of its newfangled giveaway plan.

So far, all of the plans have two features in common.

First, they are all motivated by fear. The logic is as follows: "If we do not act," the plan sponsors plead, "we will all suffer dire consequences." But we have yet to see any serious attempt to analyze and quantify these "dire consequences."

Second, the plans assume we must fix the institutions that got us into this mess to stabilize our economy.

Common sense dictates that plans motivated by fear are generally not good ones. One begins to wonder if those much-talked-about, unspecified dire consequences would be less harmful than the consequences of our government throwing more than $9 trillion of good money after bad (which, by the way, is enough to buy back 90% of all U.S. residential mortgages).

Since Bank of America (BAC) and Citigroup (C) received billion-dollar initial cash infusions from the federal government in October 2008, the stock values of both companies have declined by more than 70%. Many analysts firmly believe the equity value of these two banks is zero.

Oy Vey! Enough Already

Watching the U.S. government withdraw money for the next great plan from the giant "taxpayer ATM" in the Treasury is akin to watching Ruth Madoff withdraw $15 million from phantom investor accounts last week. At some point, we all say, "Oy vey! Enough already."

If we are going to mortgage our children's' futures, why don't we invest in their futures rather than our past?

We would like to join the plan party; at Big Money Options, we would like to recommend a plan of growth and investment.

Forget saving the failed institutions that sank our economy. Forget being afraid of the unknown and spraying money at every bad asset in the hopes we never get to know the unknown. Let's move on with new and better institutions.

Let's take our taxpayer dollars and focus it on parts of the economy that will pay dividends for years to come. Let's shape a better future rather than try to bend our past into something we wish it had been.

We recommend spending our bailout dollars on the following endeavors:

1. Make the United States the world leader in new energy technology and supply. Leading the world in reduced oil dependency will make us more secure, wealthy and healthy.

2. Revamp our healthcare delivery system so all Americans have basic healthcare, while the cost of delivering care is substantially reduced. Energy and healthcare represent more than 20% of our national expenditures. They also represent huge areas for new growth and innovation that will immediately impact all of us.

3. Rebuild our public education system. Better-educated, more-competitive young workers will once again be a differentiating force for the United States in the world marketplace.

4. Rebuild the electrical grid, not the highway system. In 1950, Americans needed highways to travel and generate commerce. In the 21st century, we travel electronically. Invest in the future of commercial infrastructure, not the past.
Terminate the Credit Default Swap (CDS) market. This action will de-leverage our economic system by trillions of dollars without costing a single penny of taxpayer money.

5. Allow the free markets to write off bad assets and default on excessive debt. In a relatively short period of time, the sins of over-leverage will be washed away and new institutions will emerge to lead us forward. It should also do a fairly comprehensive job of removing those decision-makers who led us down the debt debauchery path.

Let the Trend Be Your Friend

Whether the government adopts any of our plans remains to be seen, but one basic rule of trading that we'll continue to follow is: Let the trend be your friend. In other words, go with the flow.

In a bull market, it is easier to make money investing long rather than short. In a bear market, just the opposite is true.

The question is: What is the trend today? If four weeks makes a trend, the trend is sideways. We are experiencing directionless volatility. Equity values have been moving sideways as investors wait and see if we are entering a depression or if the latest government bailout program will have positive effect. The market hangs in the balance.

Shown below is a chart of the S&P 500 year-to-date via the S&P 500 SPDR ETF (SPY). The SPY has traded in a range bounded on the top by about $87 and about $81 on the low end with a center line of about $84.




The Options Math

Another way of looking at the sideways trend shown above is through the CBOE Volatility Index (VIX). With the VIX at 45, it implies that the S&P 500 showed about 4% volatility during the past 23 trading days. When we buy call and put options, we are doing so in an environment where market-makers have priced this 4% movement into the options outlook.

Now, when we look at an SPY trendline that is flat at $84 (give or take 3 points), it is indicating 3.6% volatility. Broadly speaking, market-makers are asking to be paid for more volatility than what is actually occurring in the market. Having paid heavily for volatility (evidenced by higher premiums) in a flat market, our long option positions are suffering from time decay without going into the money.

The math generally says that going straight long calls and puts has been a tough way to make money for the past several weeks. And while there are solid, strong straight-option plays out there -- and we are working around the clock to find and recommend them to you -- we've also added some new strategies to our trading arsenal to help you to keep some more skin in the game and keep the profits coming.

The Right Tool for the Job

Almost all of us have experienced trying to do a job without the right tools. As traders, many of us are looking at the U.S. equity market and wondering what tool is required to make money.

So far this year, using straight-equity and long-option transactions as the tools to make money was equivalent to attempting to drive a Phillips-head screw with a saw. With the wrong tool, the task of money-making becomes almost impossible.

How do you make money when the trend is horizontal? You sell (i.e., write, or sell to open) options. Although there is lots of daily volatility, it is volatility around a trendline that is flat.

Rather than pay for overpriced volatility, we recommend selling volatility and letting the trend be our friend. We've made several of these kinds of recommendations in the past and, if the trend remains, you can plan on seeing more in the days ahead.

For now, let's look at the positions we currently have open.

REVIEW OF OPEN POSITIONS

This past week, we recommended selling volatility in two new positions.

Research In Motion (RIMM) -- On Feb. 11, we recommended selling the RIMM June 25 Puts (RUPRE) for 95 cents or better. RIMM was knocked down 17% on lowered guidance. With the stock down and the options volatility up, we believe selling the RIMM 25 Puts when the stock is near $50 for almost a dollar is a great way to make money. We like this trade. These puts closed the week at 73 cents.

B/E Aerospace (BEAV) -- On Feb. 12, we recommended that you use a risk/reversal order "buy to open" the BEAV April 15 Calls (BQVDC) for 40 cents or less, and simultaneously "sell to open" an equal number of the BEAV April 7.50 Puts (BQVPU) for 25 cents for more, for a net credit of at least 15 cents. In this case, we are collecting options premium while retaining upside exposure to a company that is fundamentally executing very well. Being paid to wait is almost as good as it gets in this market. By the end of the week, rather than colleting 15 cents, you would have had to pay 5 cents to put this trade on. We would not execute this trade unless you are able to collect some premium.

The remainder of our trades are:


Ametek Inc. (AME) -- On Feb. 6, we recommend buying the AME March 35 Calls (AMECG) for $1 or less. This position closed the week at 70 cents. We continue to like this trade.

Phase Forward (PFWD) -- On Jan. 21, we recommended you buy a half position in the PFWD Feb 15 Calls (UTOBC) for $1.30 or less because we believe option investors are making a directional bet based on the company's Feb. 5 earnings announcement. The stock has failed to advance above the strike price although it has staged a rally in the past couple of days. We will be looking to exit this trade on any strength. This trade closed the week at 10 cents. Given this position expires on Friday, do not invest new money in this trade.

Red Hat Inc. (RHT) -- On Jan. 28, we recommended buying the RHT March 17.50 Calls (RHTCW) for 45 cents or better. This position closed on Friday at 35 cents. We continue to like this trade.

Grupo Televisa SA (TV) -- On Jan. 23, we recommended buying the TV April 15 Calls (TVDC) for $2 or less. They closed the week at 75 cents and we continue to like this trade.

Canadian Solar (CSIQ) -- On Jan. 15, we recommended using a spread order to buy the CSIQ July 5 Calls (GQAGA) for approximately $1.85 and simultaneously sell an equal number of the CSIQ July 10 Calls (GQAGB) for approximately 60 cents, for a net debit of $1.25 or less. The spread position closed the week at 85 cents. We continue to like this trade. CSIQ is an incredibly volatile stock and we have lots of time to expiration.

CBRL Group (CBRL) -- On Dec. 10, we recommended buying the CBRL March 20 Puts (CBQOD) up to $3.50. We closed half the position on Jan. 14 for $4.80. This is a volatile stock with earnings still ahead. These options closed the week at $3.10.

Supertex (SUPX) -- On Jan. 6, we recommended selling to open the SUPX March 25 Puts (SQOOE) for $2.75 or more. These puts closed the week at $2.55. We continue to like this trade.

Rackable Systems (RACK) -- On Jan. 8, we recommended you buy the RACK June 5 Calls (RQOFA) for 95 cents or less. These options closed on Friday at 45 cents. We continue to like this trade given the company's $5.88 per share in cash, no debt and June expiration.

Shaw Group (SGR) -- On Nov. 26 we recommended selling the April 12.50 Puts (SGRPV) for $2 or more. We covered half the position on Jan. 29 for 25 cents or better. Given the continued strength of the stock, we feel there is no rush to clear the entire position. This position closed the week at 10 cents. Do not add new money to this trade as it has moved substantially in our favor.

Novellus Systems (NVLS) -- On Jan. 8, we recommended buying the NVLS Feb 15 Calls (NLQBC) for 75 cents or less. It is showing tremendous volatility which we hope will eventually work in our favor. This position closed the week at 5 cents. We would not add new money to this position as we are now within two weeks of expiration.

Wal-Mart Stores (WMT) -- On Jan. 8, we recommended selling the WMT Feb 47.50 Puts (WMTNW) for $1.45 or more. WMT had a good week as it reported better-than-expected same-store-sales and benefited from the market rally. These puts ended the week at $1.62.

With expiration on Friday, we are paying close attention to this position. WMT reported better-than- expected earnings this morning (Q4 EPS was 96 cents versus guidance of 91 cents to 94 cents). On the conference call, Wal-Mart's management said February is "off to a good start," the company is considering buying back stock and its forward guidance looks within the range of expectations.

Again, in the event WMT drops below the strike price, we do not mind taking ownership of the stock in the mid-$40s. We will keep you informed of any required action if necessary.

Cadence Design Systems (CDNS) -- On Jan. 9, we recommended buying the CDNS May 5 Calls (CDNEA) for 60 cents or less. This position closed at the end of the week at 30 cents. The company posted excellent earnings. We like this trade.

Hain Celestial Group (HAIN) -- On Oct. 21, we recommended you buy the HAIN Feb 25 Calls (QQHBE) as part of a bull-call spread for $3.40. HAIN was badly damaged by the market crash. We are hopeful to recover more than the current 3 cents from this position but we do not recommend adding new money to this trade.

Pool Corp. (POOL) -- On Dec. 10, we recommended buying the POOL April 17.50 Puts (QCLPW) for $3.80 or less. These options closed on Friday at $2.70. With job losses and home foreclosures mounting, we continue to be amazed at the resilience of this stock. We continue to like this trade.

MSCI Inc. (MXB) -- On Dec. 11, we recommended you buy the MXB March 15 Puts (MXBOC) up to $2.50. These puts closed the week at 40 cents. With the financial sector melting down, we wonder how much longer MXB will defy the trend. Given the separation developing between the strike price and the current stock price, we would not commit new capital to this position.

Vasco Data Security International (VDSI) -- On Nov. 4, we recommended buying the VDSI March 15 Calls (QFNCC) for 95 cents or better. This position closed the week at 5 cents. Unfortunately, the company had a negative earnings pre-announcement that halted the positive upward trend the stock was in the process of establishing. Although the stock has pulled back, the original signal is still valid and we are staying with the trade. However, we would not add new money to this position.

PowerShares WilderHill Clean Energy ETF (PBW) -- On Oct. 9, we recommended buying the PBW March 10 Calls (PBWCJ) up to $2.45. These options closed the week at 15 cents. The initial option signal continues to be there, so we are staying with the trade.

PARTING SHOT: THE ONLY PLAN THAT REALLY MATTERS

The only plan that really matters is making money with options trading in this market. Given the sideways trend, our plan is to sell volatility. We will make every effort to find short option trades that carry limited risk.

In the meantime, take a look at your stock portfolio. Consider writing calls on some of your stock positions where you believe the volatility is priced too high and you would not mind being a seller of stock at the strike price. For stocks you are interested in owning at lower prices, look at selling the puts.

Market trends can change quickly. Many investors expect the market to make a sharp and sizeable move either up or down from the current trading range. It is somewhat ironic (and characteristic of this market) that on the day we publish a description of the flat trend, stock futures suggest we are about to break out to the downside.

If the market does trend down, our plan is to be in line for profit with calls and puts that have expiration dates that accommodate the market's next move.

As always, keep a close eye on your inbox. We plan to stay at least one step ahead of this market, and we may need to move quickly to capture profits.

Have a great week trading.

Nick Atkeson and Andrew Houghton

Editors

Options Trader