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Options Insider

Jan. 21, 2008
Volume 3, Issue 3

IN THIS WEEK'S ISSUE:

1. DOC'S THOUGHTS: Profit Like Buffett
2. TRADE OF THE WEEK: Never be Afraid to Take a Profit
3. WEEKLY TECHNICAL FORECAST: More Selling Ahead
4. TRADING TIP OF THE WEEK: Take Options Profits in STRIDES


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1. DOC'S THOUGHTS: Profit Like Buffett

Dear Fellow Options Insider,

Recently one of my heroes, Warren Buffett, agreed to pay $4.5 billion for 60% interest in Marmon Holdings through his Berkshire Hathaway (BRK) company.

And since this man seems to have the Midas touch when it comes to making money, let's examine what made this such an attractive investment opportunity.

The Marmon Group began in 1953 when brothers Jay and Robert Pritzker acquired the Colson Corp. with continuing sales of $3.5 million. The Pritzkers have grown Marmon into an enviable conglomerate, excelling where others have failed. Between 2002 and 2007, Marmon's operating income more than tripled. During that same period, operating margins increased from 4.9% to 12.4%.

Marmon has upward of 125 companies, but here are the ones I'd concentrate on, given their growth potential:

TRANSPORTATION SERVICES

Marmon added a state-of-the-art railroad tank car production plant. This hits the sweet spot that alternative energy has created demand for (i.e., bio fuels and the Canadian oil sands). And, given Mr. Buffett's recent trip to China, he had to like Marmon's ownership of a Chinese intermodal tank container leasing company -- the first wholly foreign-owned company providing such services within China.

Best Coat-tailing Stocks

* FreightCar America (RAIL) -- As a manufacturer of aluminum-bodied railcars in North America, it specializes in the production of coal-carrying railcars, which represented 96% of its deliveries of railcars in 2006.

* The Greenbrier Companies (GBX) -- This company manufactures and markets railroad freight car equipment in North America and Europe and provides railcar refurbishment and parts, leasing, and other services to the railroad and related transportation industries in North America.

* Trinity Industries (TRN) -- As a holding company of diversified industrial companies, Trinity manufactures and sells railcars and railcar parts, inland barges, concrete and aggregates, highway products, beams and girders used in highway construction, tank containers and structural wind towers.

* American Railcar Industries (ARII) -- As a manufacturer and marketer of covered hopper and tank railcars, ARII also repairs and refurbishes railcars, and provides fleet management services.

WATER TREATMENT

Marmon is big and, under Buffett, will get bigger in Water Treatment. It recently announced a joint venture with Singapore- and China-based Hyflux (HYFXF), a big player in Asian residential and industrial water treatment.

Part of the Hyflux story is desalinization (i.e., salt and other mineral removal) and wastewater recycling, which makes water infrastructure the oil of the future.

Best Coat-tailing Stocks

Worldwide, the consumption of water is doubling every 20 years, at more than twice the rate of the increase in human population -- placing enormous pressures on aquatic ecosystems.

I trade several individual stocks based on our institutional money flows that we track with our HeatSeeker technology. Here are three of the most liquid Exchange-Traded Funds to follow and profit from this inevitable trend:

* S&P Global Water (CGW) -- Fifty stocks from around the globe are contained in this ETF, which focuses on Water Utilities/Infrastructure and Water Equipment/Materials.

* PowerShares Water Resources (PHO) -- This ETF is comprised of 25 publicly traded companies that exist in such sectors as water utilities, treatment, analytical monitoring, infrastructure/distribution, water resource management and conglomerates.

* PowerShares Global ETF Trust (PIO) -- Launched in June, this ETF has great international exposure, with 14 countries/regions represented in its 41 component stocks.

As for some individual stocks that can help you to ride the Water Treatment wave, here are two:

* Flowserve (FLS) -- This company makes pumps, valves and seals for water flow systems and also performs installation, advanced diagnostics, repair and retrofitting.

* Consolidated Water (CWCO) -- Treating and providing water for residential, commercial and government users, Consolidated services the Cayman Islands, Belize, Barbados, the British Virgin Islands and the Bahamas.

Buffett is investing in Marmon's collective vision for the myriad energy, water, transportation, construction and distribution companies it oversees. And while the Pritzker family is welcoming him into their world, we don't need to be mega-rich to invest like the "Oracle of Omaha." Like him, though, if we are going to invest capital into promising opportunities, we're doing it because we expect to make back that money (and then some!).

To do this, we need to look at the companies and sectors that are generating interest among the Buffetts of the world and use option plays to position ourselves for princely returns without having to hand over a king's ransom in the process.


Jon "Doctor J" Najarian
Editor
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2. TRADE OF THE WEEK: Never be Afraid to Take a Profit -- By Ken Trester

Finding undervalued options is the cornerstone of making profits when you speculate with options. But just as important as selecting the right option to buy and paying the right price for it is knowing when and how to take profits. Many option buyers lose not because they take the wrong positions, but instead because they fail to take profits properly.

To make the biggest-potential returns, your first objective is to protect profits, and your second objective is to hit home runs. Most importantly, when your option begins to profit, you must be ready to act because time really is money!

I have found that the best way to do this is to know exactly what you will do with a position when the option hits a specific price. Deciding this in advance, and sticking to your decision when the time comes, removes a lot of emotion from your decision-making.

When you buy an option, you should decide in ahead of time what your target price for the option is. We always give you our target prices and sell-stop levels when we recommend options to buy in Maximum Options and Fast Options Profits to help you remove the guesswork from your trading.

If the option hits the target price, sell half of your position. This takes your original money off the table. Capital preservation is paramount when you speculate with options.

Then let the rest of your position ride for possible future gains, using a 3%-5% trailing stop on the underlying stock. A trailing stop can be a "mental" stop, though more and more brokerages are allowing this to be done automatically. The trailing stop adjusts when the stock moves in your direction, and stays the same when the stock moves against you.

For example, when an American Airlines (AMR) call option we recommended hit its target price, we advised subscribers to sell half their position. Then if the stock kept rising, they would hold the option and adjust the trailing stop higher so that it would still be 5% under the current stock price. But if the stock fell, they would keep the trailing stop the same.



The process is reversed for a put option. If the stock continues to fall, keep lowering the trailing stop. But if the stock rises, keep the trailing stop the same.

Another key for taking profits: If your option is in-the-money (or trades past the strike price -- above it for a call, or below it for a put) and enters its last week before expiration, close the entire position and take profits. Don't wait for it to expire because you might find yourself holding stock (with a call) or being short stock (with a put) if the option closes in-the-money and you haven't told your broker not to exercise the option for stock.

Remember, options give you the right but not the obligation to buy stock at the strike price (with a call) or to sell stock (with a put). To ensure you close your options for profits without having to go near the underlying shares, set stops to take you out of the trade before it expires or close the trade yourself so that you know what's happening in your trading account at all times.

Taking half of your profits at the target price serves two purposes. One, it forces you to take some money off the table, protecting you from a sudden reversal in the stock price. And two, it leaves money on the table for possible future gains. Protecting profits and preserving capital is critical when you buy options.


Ken Trester
Editor
Maximum Options, Fast Options Profits

P.S. Ken Trester offers two options trading services so that, whether you're a part-time trader or a more-active one, you can get positioned for full-time options profits. Get two trades a week in Fast Options Profits, or get up to 10 recommendations each week in Maximum Options. Click on either of these links to get started!

3. WEEKLY TECHNICAL FORECAST: More Selling Ahead -- by Sam Collins

The very tenacious trading pattern that began early last year, bounded by S&P 500 (SPX) 1,375 and 1,565 (closing high), finally cracked.

The move completed a triple-bottom break from a double-top -- one of the clearest patterns of the beginning of a major downtrend. Measuring from the point of the break at 1,375 to the closing top of 1,565 gives a difference of 190 points. This subtracted from 1,375 results in a rough target of the coming downturn -- S&P 1,185.

Standard & Poor's, the "keeper of the 500," gives a target of 1,250 during the next three to six months, but whatever the target, it is clear that investors must take defensive action or be crushed in a rush to sell.

A dramatic break like we saw late last week usually means that there will be more selling without a temporary climax for several days. But don't let a rally draw you in -- with the exception of the defensive sectors that we've discussed, most groups will be heading lower before a base is formed later this year.


Sam Collins
Editor
Daily Trader's Alert

P.S. Sam Collins shares a "Trade of the Day" each morning before the bell, complete with why the stock looks like it's ready for a breakout. Plus, he shares his take on how the current market activity is shaping up to impact your trading day.

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4. TRADING TIP OF THE WEEK: Take Options Profits in STRIDES

Typically when you're trading options and want to employ something more than a basic strategy such as buying a call or a put, you have to either "know your stuff" or have a broker who knows theirs.

However, you can make a multi-part trade in one single step. And this one doesn't even require you to have an options-approved account!

Callable Stock Return Income Debt Securities (STRIDES) are like purchasing an all-in-one Thanksgiving dinner package from your local supermarket. You get the main course (in the form of a play on the stock), side dishes (a bond and dividends) plus a dessert (an option strategy). But instead of leading to a tryptophan coma, this package deal can reward you for partaking of a veritable investment buffet in one trip.

To participate in a stock's potential upside, STRIDES use a short-term bond coupon that is married to an option strategy. These are Merrill Lynch (MER) products that serve as hybrid-types securities that are structured like bonds and that mature in a fairly short time frame (one to two years). Even better, they pay dividend yields, the target percentage of which is listed in its name.

For example, if you think JetBlue (JBLU) is about to take off, you may want to look into the Merrill Lynch's JetBlue 10% Callable STRIDES (CSJB). Unlike "regular" options, which can trade on any combination of the six U.S. options exchanges, note that CSJB only trades on the Nasdaq (NASD), as that is where its parent stock is listed.

But not all STRIDES show up on the Nasdaq. ExxonMobil (XOM), which trades on the Amex, has its XOM 9% Callable Strides (MIX) listed on the Amex as well.

The dividends you receive are based on the STRIDES and not on the underlying stock itself, as you don't technically own the stock and therefore don't receive the same rights as a shareholder (i.e., dividends, tender offers, voting rights).

Essentially, the STRIDE functions as a covered call strategy in which you are theoretically holding the stock and selling a call against it; in this case, Merrill is the call buyer and thus has the right to exercise the rights it gives them. As the call seller, so to speak, you are entitled to premium collected during the life of the investment.

Just like options, these "Callable" securities can be "called" away before their term is up. If Merrill Lynch makes the call, then you will not receive shares of the stock or any scheduled yields between the call date and the maturity date.

If the underlying stock should fall, Merrill can choose to redeem your STRIDE, whereupon you can receive shares, unpaid interest and interest that would have been due to you during the remaining life of the STRIDE.

Merrill Lynch's Web site explains how this can protect you if the stock falls: "If the Callable STRIDES pay an annual coupon of 6% over two years but, at maturity, the underlying stock is down 10%, you will actually be up approximately 2%, due to the fact that you have received a 6% coupon in both the first and second years."

Like any type of investments, STRIDES are not foolproof money-making vehicles. Because they are not widely known, they are not highly liquid. Typically, when you're trading stocks and options, liquidity is a huge "must have" on the checklist because not only do you want to be able to easily buy them, but you also want to be able to sell them when you want to.

Less-liquid securities are more-challenging to cash out of when buyers aren't easy to come by. For example, the JetBlue STRIDES are currently trading at $15.71 a share and carry a dividend yield of 2.7%. However, they haven't moved since May 2006, but those who have been in this position since then enjoyed a 35-cents-per-share dividend in November 2007.

STRIDES are also available in Apple (STRIDE ticker: AVN), Best Buy (STRIDE ticker: BLB) and Caterpillar (STRIDE ticker: STF). Note that because STRIDES function similar to covered calls, they may be best utilized when you anticipate the underlying stocks won't make a dramatic movement (up or down), as these strategies are designed to generate income in exchange for a capped downside risk/upside return potential.

You should talk to your broker to see whether STRIDES are right for you. But if you are looking to buy any of these stocks and sell calls against them for income, or if you're looking at buying LEAPS on any of these names in lieu of the stocks themselves, STRIDES can serve as a one-stop shop to let you be in a name for the same amount of time as holding an option, while collecting income in the interim.


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