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Options Insider

Feb. 18, 2008
Volume 3, Issue 7

IN THIS WEEK'S ISSUE:

1. OPTIONS THOUGHTS: 'Put' Your Money Where Your Faith Isn't
2. CASE STUDY: Louisiana Pacific (LPX)
3. TRADE OF THE WEEK: Goldcorp Catching up with Gold Bullion's Spike
4. TRADING TIP OF THE WEEK: 'Putting' the Squeeze on Short-Side Plays
5. ON THE LOOKOUT FOR MORE OPTIONS?


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1. OPTIONS THOUGHTS: 'Put' Your Money Where Your Faith Isn't -- by Ken Trester

Dear Fellow Options Insider,

There is no hiding the obvious: The Fed's actions are a huge deal in the eyes of Wall Street, as lower interest rates are seen as good for stocks. So, don't let last week's mild performance fool you -- the waves of volatility will start again, likely as soon as next week, when the minutes from the Fed's January meeting are released on Wednesday.

And it's amazing how Fed minutes -- a document that we already have a general idea of what it contains -- can impact the market, good or bad.

Of course, as options players we have the distinct advantage of playing either side of the market. That's why options trading is one of the greatest games on earth -- you can be the investor, betting on the action of stocks, or you can be the "house" (i.e., the bank), taking the bets instead of making them.

You pick the role and have the fun (and profits!). With options, gains of more than 1,000% are not unusual, and you can design strategies that will win up to 90% of the time.

Considering that the markets will go up nearly as often as they go down, ensuring that your strategy allows you to profit 90% of the time means incorporating put options, which let you capitalize on downside movement in a particular stock, a sector or the overall market.

'PUT' YOUR MONEY WHERE YOUR FAITH ISN'T

Because the markets are so challenging to predict, let's zero in on a more-manageable trading approach: determining whether a specific company's stock will go up or down. In particular, when would we want to establish a bearish bet on a company? Here are some of the signs to look for:

* A lackluster product line -- In the fast-moving tech world, for instance, if a company's competitors are infiltrating the market with newer, better, faster, and sleeker items, the brand may fade from customers' radar.

* Lack of potential success -- You may notice that the FDA gives "fast-track" status to certain drugs in development and assists the manufacturers in meeting its guidelines for bringing a drug to market. Other companies are making drugs that are considered high-risk and whose data seems to indicate that the therapies might hurt more patients than they might help. Also take note of the companies that the FDA requires more information from, thus delaying the drugs from coming before an FDA advisory panel for review, let alone approval.

* Poor management -- If you read news articles and press releases and get the perception that a company is poorly run because of high turnover in the top brass or due to a series of bad decisions, these aren't necessarily problems that can be fixed in a short amount of time.

There are many other signs that a company's stock is set to hit the skids, but once you do identify a potential loser, you have a unique advantage as an options trader because you can buy put options as a bet that a series of unfortunate events will result in the stocks taking a tumble. And that's a move that can bring you BIG profits!

OPTIONS CAN EARN -- AND SAVE -- YOU MONEY

Buying put options is a great way to profit from stocks. Rather than plunking down a significant cash outlay to buy shares, you can instead make some profits while you wait for the stock to fall to a more-favorable price where you'd be interested in buying it.

Whether you anticipate a stock's fall will be temporary or you foresee a long slide ahead, you can ride a stock to the downside through the purchase of put options.

When stocks close higher for the day, especially after a downdraft, you can bet that lot of traditional short-sellers will scramble to cover their positions -- or, if they already did, it can explain some of the upward movement in stock prices.

Short-sellers are traders who "sell to open" shares of various stocks in hopes that the stocks would drop and they could buy back shares (or cover their short positions) at a lower price, thus resulting in a profit.

But if they perceive a stock to be going up -- or they see it rising -- they "cover" at the first-available price they can get, just so they don't lose any more money if shares KEEP gong up.

A trader's losses can be unlimited when he or she establishes a short stock position. But when you purchase a put option, you define your risk from the outset. Buying a put option is as easy as buying a call option. And your risk is the same -- you can only lose what you pay for the option, nothing more.

Put options allow you to ride a stock to the downside and they give you the right, but not the obligation, to "put" shares to someone who had decided to sell to open a short put option position.

Like a call option, a put has a limited lifespan -- and it may expire before the stock makes the move you are anticipating. While you will take a loss in such a case, you know what the maximum potential loss is before you even add the position to your trading account. And while a loss of any kind is never a comfortable thing, a small, defined loss is a lot better than a big, potentially unlimited one!

You never know when the market might suddenly catch another bad case of the chills. And you certainly want to be in the game and ready to profit when it does. Buying put options is the least-risky way to do just that.

In Fast Options Profits, I provide a balance of call and put recommendations to ensure that you are positioned to benefit from stocks on the move, whether they're going up or down. Get two hot-off-the-presses options trades every Friday -- click here to join today!


Ken Trester
Editor
Fast Options Profits

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2. CASE STUDY: Louisiana-Pacific (LPX) -- By Michael Shulman

Wall Street is finally starting to catch up to my way of thinking, which is to find companies that are about to fall flat on their faces and to short them through buying put options in my ChangeWave Shorts service.

And last week, the "top" homebuilders hit the skids, with Hovnanian (HOV) dropping 6% and D.R. Horton (DHI) and Lennar (LEN) falling nearly 4%. Ouch. But "everyone" seemed surprised about this but me, because while Wall Street donned its rose-colored glasses when looking at these names, I'd told my subscribers long ago, "Short 'em all!"

I know Wall Street's had hopes and dreams that the builders would turn around soon, which helped the stocks outperform the broader markets this year so far. But I'll tell you a secret that will put you years ahead of the gang on the Street -- wishing and wanting won't make it so.

It's undeniable that the homebuilders have a lot further to slide, but you might be wondering how to make money in the sector when so many of its stocks have already fallen off a cliff. Well, there's no need to skip the party if you've come late to it -- in the case of the housing sector, the pickings at the short-side buffet were anything but slim.

There's another saying I like to use: "When you hear hoofbeats, don't think zebras." It's often used in the medical profession, to remind doctors not to overlook the obvious. So, when we were looking for the next batch of stocks that were going to fall, common sense and some digging told us to look at where the housing contagion was going to spread.

AS BUILDERS FELL, WE SAID 'TIMBER!'

We found bountiful opportunities in the home-renovation market, which is impacted by how housing stocks are performing. That is, when housing is in the tank, it takes down its suppliers, which serves as the cherry on top of the short-side sundae for those of us who are buying put options on these troubled companies' stocks.

Based on this premise, in September 2007, I identified a trio of building supplier kings -- Louisiana-Pacific (LPX), Masco (MAS) and Universal Forest Products (UFPI) -- whose stocks I was certain we would be yelling, "Timber!" as they fell.

One of my favorite plays was Louisiana-Pacific, a $2.2 billion outfit whose branded line of building products had too much exposure to the low-end home and home renovation market. The company creates paneling, siding, decking, molding and trimming materials.

When we shorted it back in September, it was losing money … and had been for a few quarters. At the time, it was a $17.50 stock that had the potential to fall to $12 within six months.

In fact, it only took two months for our puts to become profitable. We had bought the Feb 15 Puts for 90 cents on Sept. 13, and on Nov. 27, we banked a nice 122% gain when the stock plummeted to $13.50 and our puts jumped to $2.

Louisiana-Pacific has the same story as many of the material suppliers and homebuilders who are still in our Shorts portfolio -- decent management, but shrinking sales, prospects and profits.

I don't expect any of these guys to go out of business. And, in fact, when housing does find a bottom, they may even get started on the long, hard road to recovery. But in the meantime, it doesn't hurt to make some money from their misery.

In fact, after the beating that many of our long-side holdings might have taken, it behooves us to make profits wherever we can … and as often as possible!

Home may be where you hang your hat, but my hat is definitely off to the homebuilders and their suppliers for giving us many spectacular short-side profits … and many more to come.


Michael Shulman
Editor
ChangeWave Shorts

P.S. There's no doubt about it: We're in a bear market. Don't be fooled by temporary market rallies -- we're in for some more pain before the markets perk up again.

Adding some bearish positions to your portfolio via put options can send your profits charging upward while others are growling when they open their brokerage statements. Check out my Shorts service now and stay out of hibernation during these bearish times!

3. TRADE OF THE WEEK: Goldcorp Catching up with Gold Bullion's Spike -- 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!

Goldcorp Inc. (GG) is a precious metals mining company that engages in the acquisition, exploration, development and operation of precious metal properties in the Americas and Australia. GG has been in a bull market for more than five years.




Even though it has exceeded its November high, GG is still trading below the record high made in May 2006 at better than $41 a share, while gold bullion is exceeding the old records made in 1980. The stock appears to be lagging behind the price of bullion, and for that reason it will likely continue to drive higher.


Sam Collins
Editor
Daily Trader's Alert

4. TRADING TIP OF THE WEEK: 'Putting' the Squeeze on Short-Side Plays

It's got a nasty reputation on Wall Street: the dreaded short-squeeze.

You have probably heard this term and suffered from its effects often than you care to remember, but what does it really mean?

A short-squeeze is a market event when the price of a stock rises quickly, prompting short-side investors to "cover" -- which means they must buy the stock in the open market to repay their broker for the shares they have borrowed.

This generates higher prices, which in turn prompts more people to sell and take a profit, which leads to brokers calling more loans, which then forces many short-sellers to go into the open market to cover their loans. And so on.

Short-squeezes can be ferocious, can last quite a while and can be very expensive, which is why it's important to keep a mix of both long- and short-short side plays, as well as puts and calls, in your portfolio.

You can avoid being "squeezed" out of a short position by buying put options and staying "put" in a stock you believe is going down while traditional short-sellers are getting forced to the sidelines.

You can continue holding your puts in your trading account as the falling stock makes what might be a temporary run-up and get back on the profit track if it resumes its downtrend. Or, you can close your puts for a small loss and stay out of that particular name until you're sure of its trading direction.


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5. ON THE LOOKOUT FOR MORE OPTIONS?

Options Trader editor Jon "Doctor J" Najarian will appear at the New York Traders Expo Tuesday, Feb. 11 at the Marriott Marquis in Manhattan.

It's not too late to register -- click here for more information.