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'There is No Feast Which Does Not Come to an End'

February 23, 2009

Dear Fellow Options Traders,
The Chinese proverb, "There is no feast which does not come to an end," explains the situation in which banks are currently finding themselves.

Success in the banking world during the past 20 years was measured by a bank's capacity to devour its competition through acquisition. Banks acquired each other in the name of customer service, even though it was evident that the concept of a financial supermarket was not a synergistic business model.

The real driver of acquisition activity was to accelerate reported profit growth and paycheck expansion.

Bank of America (BAC), which is the product of an acquisition by NationsBank in 1998, in turn engaged in a major acquisition almost every year for the past two decades.

Wells Fargo's (WFC) history is not much different. Wells Fargo was originally acquired by Norwest Corp. After this acquisition, Norwest management changed the name of the overall company to Wells Fargo. Norwest was one of the most-acquisitive banks of the 1990s and ended the decade spread across 16 states as the largest contiguous bank franchise in the nation.

Citigroup (C) was formed by one of the world's largest mergers in history with the combination of Citicorp and Travelers Group.

For dessert, these banks ladled out consumer loan programs in huge servings to ensure that they were more bloated than their neighbors. But now, the feast is over -- and what's most shocking is the size of the bill.

Check, Please

On Friday, first BAC traded down 35.62% and then up 4.07% to close with a net change for the day of down 3.56%. All of the fear and uncertainty expressed by BAC and other bank-stock traders on Friday helped depress the overall market further. For the week, the S&P 500 (SPX) was reduced by 6.9%.

Although we are still far from having a final tally on what this credit binge has cost us, it appears it will include the loss of our largest insurance, automobile and bank corporations, along with many of our retailers. Millions of people have lost jobs and the world is in a coordinated slump that rivals any financial crisis measured all the way back to 14th-century England, according to Harvard economist Kenneth Rogoff.

As option traders, what this all means is the sideways trend we highlighted last week has been broken to the downside. With the CBOE Volatility Index (VIX) closing on Friday just below 50, it appears the selling is not climatic and could continue in a dispassionate manner.

A New Measure of Success

Robert Rodriguez of First Pacific Advisors said in this week's Barron's that his investment style involves "winning by not losing." Although this description of winning is not glorious, it provides a good working model for how to handle this market.

We strive to provide you with several option trade ideas every week that are major winners. But before we look at the possible gain, we are working double-time in this market to select trades that will not lose. By not losing, we leave ourselves in a position to win.

REVIEW OF OPEN POSITIONS

With the thought of winning by not losing firmly implanted in our option investment thinking, we made a couple of recommendations this past week. (Visit this link to review the full archive of trade alerts.)

Pool Corp. (POOL) -- On Dec. 10, we recommended buying the POOL April 17.50 Puts (QCLPW) for $3.80 or less. The company missed earnings and withdrew guidance this past week. Today, with the position becoming profitable, we recommended closing the trade favorable price of $4.40 or more for a 15% profit.
Novell Inc. (NOVL) -- On Jan. 19, we recommended using a spread order to simultaneously buy to open the NOVL Jan 5 Calls (WNNAA) for 50 cents or better and sell to open an equal number of the NOVL Jan 2.50 Puts (WNNMZ) for 25 cents or more for a net debit of 25 cents.

We are risking 25 cents per contract ($25) for upside exposure to a company with 80% of its market capitalization in cash, not to mention that its cash flow is positive and it's trading at less than two times earnings.

We have almost a year to make money in this position. We really like the risk/reward profile of this trade.

United Parcel Service (UPS) -- On Jan. 18, we recommended selling to open the UPS March 40 Puts (UPSOH) for $1.40 or more. We would rather go long options rather than sell puts or calls to open. But in this market, many great companies are being sold down to incredible valuations. By selling the puts, we collect premium and, in the worst case, take ownership of a great company at a great price.

We view UPS as a "new economy" stock that benefits from the shift of commerce from bricks and mortar to the Internet. Amazon.com could not beat estimates and raise guidance without the help of UPS.

Additionally, UPS is now carrying DHL freight in North America, which provides UPS a higher degree of pricing power in this difficult economy. These puts closed today at $1.75.

A Tough Expiration

The expiration clock ran out on Friday on several of our positions.

Wal-Mart Stores (WMT) -- Our big winner of the week was WMT. On Jan. 8, we recommended selling the WMT Feb 47.50 Puts for $1.45 or more. On Friday, these puts expired worthless as WMT closed the week well-above the $47.50 strike. Selling the puts for a 100% gain in a sideways market for most of the past month was a winning strategy.

Phase Forward (PFWD) -- On Jan. 21, we recommended you buy a half-position in the PFWD Feb 15 Calls for $1.30 or less because we believed option investors were making a directional bet based on the company's Feb. 5 earnings announcement. The company did post strong earnings and the stock put up a good fight during a tough week, but it was unable to clear the $15 strike hurdle.

We will continue to watch this option situation closely, as it appears the stock may eventually make a run. If we see strong new option signals develop, we will explore ways to win without losing with PFWD.

Novellus Systems (NVLS) -- On Jan. 8, we recommended buying the NVLS Feb 15 Calls for 75 cents or less. At times, this stock showed promise but eventually was overcome by a negative sentiment toward technology in the past two weeks.

Hain Celestial Group (HAIN) -- On Oct. 21, we recommended you buy the HAIN Feb 25 Calls as part of a bull-call spread for $3.40. HAIN was badly damaged by the market crash. HAIN was one of the last "legacy" trades that was put on just before we entered the "black hole" phase of the market. The position became impaired as we suffered a market crash and was unable to make up the lost ground before expiration.

The remainder of our open trades are:

Research In Motion (RIMM) -- On Feb. 11, we recommended selling the RIMM June 25 Puts (RUPRE) for 95 cents or better. RIMM shares were hit hard during last week's sell-off, and the June 25 Puts closed today at $1.85. We like this trade even more as we believe RIMM at $25 per share represents good value.

B/E Aerospace (BEAV) -- On Feb. 12, we recommended that you use a risk/reversal order to "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.

BEAV suffered substantially in the sell-off last week. As of today's close, you could execute this trade and collect as much as 55 cents worth of premium. We still like this trade.

Ametek Inc. (AME) -- On Feb. 6, we recommended buying the AME March 35 Calls (AMECG) for $1 or less. Like most stocks last week, AME declined sharply. Our option position closed today at 25 cents. Although the original option signals are still in place, we would take a wait-and-see approach before adding to this position given current market conditions and the distance developing between the stock and strike price.

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 today at 6 cents. We continue to like this trade as the original option signals are still in place.

Grupo Televisa SA (TV) -- On Jan. 23, we recommended buying the TV April 15 Calls (TVDC) for $2 or less. They closed today at 20 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 today at 55 cents. We continue to like this trade. CSIQ is an incredibly volatile stock and we have lots of time till 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 this week. These options closed today 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 today at $4.60. 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 today at 30 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 today at 20 cents. Do not add new money to this trade, as it has moved substantially in our favor.

Cadence Design Systems (CDNS) -- On Jan. 9, we recommended buying the CDNS May 5 Calls (CDNEA) for 60 cents or less. This position closed today at 10 cents. The company posted excellent earnings. We 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 today at 80 cents. A while ago, we wrote "never say never" when it comes to options. MXB might fit this category of trade. The company posted missed earnings about a month ago and sold off 10% on the announcement. Since the report, the stock has been amazingly robust until this past week. MXB is finally headed back in the right direction, so hold on to this position if you're in it.

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 today at 5 cents. This once high-flying stock has slammed into the wall called recession and is really struggling. We would not add new money to this position.

PARTING SHOT

With the banks engaged in a winner-take-all race to acquire everything in sight, the U.S. financial system lost diversification. Most of the wealth became concentrated in a small number of institutions whose collective skill was acquisition rather than management.

We now have a crisis that requires management. Unfortunately, not only are our leading bank executives lacking prudent management, but we also appear to be stuck with some of the most-aggressive gamblers on Earth who now have a fresh line of capital, courtesy of U.S. taxpayers.

In reviewing who the biggest political donors were from 1989 to 2008, it is no surprise to find many of the largest banks on the list.

To create a regulatory environment that allowed for rampant merger-and-acquisition activity, loose lending and 40-to-1 leverage standards, political contributions appear to have been a principal part of the strategy.

During this time, contributions by Goldman Sachs rank No. 4, Bank of America and Merrill Lynch combined rank No. 5, Citigroup comes in at No. 15, JPMorgan Chase & Co. was No. 25 and Morgan Stanley holds the No. 30 spot, according to OpenSecrets.org, a research firm that tracks political money flows.

The contributions ranged from more than $30 million to about $17 million.

It is often difficult to proactively separate oneself from a current income source. But, if this economy is going to have a chance, the U.S. government will have to wean itself from some of its biggest political contributors of the past and focus on investing in a future that improves the earnings prospects for all citizens and the broader economy.

In the spirit of making changes, we also are required to adjust our options trading strategy to stay in-tune with current market conditions. The tune that sounds good right now is "winning by not losing."

To outsmart this market, we need to quickly take advantage of sudden moves to seize profits. And we will do that whenever opportunity arises so, as always, watch your inbox for our latest trades.

Have a great week trading.


Nick Atkeson and Andrew Houghton

Editors

Options Trader