Email – #406
***NOTE – The Fed will announce direction on interest rates and whether it will cut .25 or .50 basis points today. Regardless of what it does, the market will likely move wildly in both directions before settling down in the coming days. I have used strict limit prices in this alert – prices that you should adhere to religiously. That pricing will fluctuate noticeably in coming hours and days based on what the Fed does. However, the entry points that I am using are where I consider them to be of excellent value looking forward.***
Before I get to today’s picks, I’d like to extend a warm welcome to all our new members. This is a great time to be investing in LEAP options. With the stock market more volatile than ever bouncing around violently and unpredictably, the Federal Reserve and government are desperately tossing money at consumers and investors in a bid to re-ignite the economy and stock market.
But no matter what happens in the short-term, LEAPS give us the luxury of long-term protection and more time to be right with our picks.
LEAPS allow us to control shares of underlying securities for a period of one, two, or even three years in some cases. It allows us to risk a little bit of money and use the leverage of options to ride the trade to profitability. Our mission is to make money by going long or short on stock options and ETFs via LEAPS, but you have to understand how LEAPS work, how they look in your portfolio and why we do it the way we do it!
I’ll go over the basics of LEAPS and the way our recommendations work in just a moment, so everyone is on the same page. It’s really very simple. But right now, let’s get to our picks…
Mylan Labs (NYSE: MYL)
Mylan is one of the largest generic drug makers in the world. Its shares got decimated last year because of a major acquisition – Germany’s Merck AG. Many institutional investors thought Mylan paid too much for Merck and that the resulting dilution would hurt shareholders in the short term.
It did. The price tanked and the debt used to buy Merck was priced in the favor of the institutions that lent Mylan the money – no surprise there.
But today, Mylan is much stronger. The company is profitable, growing and is a major player able to take advantage of the clear trend towards making healthcare available to more people – especially true in the current election year political environment.
Fundamentally, Mylan is a very strong company with dozens of drugs (some non-generic) that adds cash to the books every day. And while some doubted the Merck AG acquisition, it gives Mylan a strong foothold in Europe, plus additional research and development capability. It’s also a new revenue stream, given that Merck has established products and sales flow.
If you need solid support for the Mylan story, just look at what the company’s executives are doing. They’ve recently snapped up millions of dollars worth of shares well above current prices and CEO Robert Coury has publicly denounced the irrational stock price action.
Buy the Mylan January 2010 $20 LEAP calls (WYQ-AD). These options are currently trading at $1.65 on the offer. Do not pay more than $1.80. If Mylan approaches its highs around $23 from May last year in the next 12 months, this option will more than double in value.
Bank of America (NYSE: BAC)
Don’t be put off by the fact that it’s a bank stock and the battered reputation of the financial sector at the moment.
Yes, BAC shares have sold off recently because of the subprime crisis. But they’re recovering strongly and will continue to do so in the months ahead.
“Don’t fight the Fed” is not just a throwaway adage – it’s reality. Whenever the Fed has raised interest rates, the stock market has corrected at some point within 12 months. The opposite is also true. And today, we’re in the midst of another major Fed liquidity event. This is great news for the strong banks in the months ahead – and Bank of America certainly falls into that category. The company has money to lend and the price of that money is very cheap.
In recent weeks, banks have had the opportunity to throw in the towel and lower their dividends. Bank of America has not done so. In fact, it’s actually reaffirmed that its dividend is safe. That puts a floor under the price and will drive more investors to buy shares as the gap between treasuries and bank dividends widens.
Bank of America’s recent acquisition of Countrywide (if it goes through) is actually very bullish. Why? Because Countrywide adds billions in deposits (remember it is also a bank) that BAC will now make money from.
In addition, thanks to low rates, homeowners will likely go on another refinancing boom – and Countrywide has a lot of people looking to refinance at lower rates. Countrywide’s recent earnings release also showed that its books are healthier than many people thought and that it may end up contributing to Bank of America’s earnings sooner than expected.
We will give the “financial crisis” two years to turn around and buy the Bank of America January 2010 $55 LEAP calls (WBA-AK), currently trading for $1.65. Do not pay more than $1.80.
Beware that with the Fed announcing its interest rate decision this afternoon, this will make the market gyrate for the coming week. Chances are that the market will not like the size of the rate decrease and with the current rally in financials, there may be another small dip in the horizon. So be sure to stick to the buy price religiously. We’re looking for BAC to make a run to $50 per share in the coming months before we take profits.
Pfizer (NYSE: PFE)
This is a defensive selection that boasts a very good risk/reward ratio for its LEAPS.
There is little need to describe what Pfizer does – it’s one of the largest pharmaceutical companies in the world. But what makes Pfizer compelling at current levels is the prospect of one of the biggest turnaround stories in market history.
The stock has gone nowhere for three years, trading in a very tight range between $21 and $30. The slumber is such that people have written off this massive (and massively profitable) company as another has-been. So far, they’ve been proved right. But they’ve also been too optimistic – looking for a huge price spike, based on some blockbuster drug like Viagra.
Instead, they should be looking deeper at what Pfizer is doing to realign itself to a newer reality – competition and lower drug prices. Although it’s lost the exclusive patents on drugs like Zoloft and Norvasc, with Zyrtec and Camptostar to follow very shortly, Pfizer does have several new potential; blockbusters in its pipeline.
For example, fourth-quarter sales of new pain reliever Lyrica leapt 60% to $564 million, compared with Q4 2006. Its other well-known pain treatment, Celebrex, saw fourth-quarter sales rise 18% to $637 million. In addition, Chantix, a drug to help smokers quit the habit saw fourth-quarter sales rocket 312% from $68 million in Q4 2006 to $280 million. Kidney cancer drug Sutent enjoyed a 75% sales spike to $182 million.
What Pfizer is doing is going lean, cutting out layers of dead wood that is not bringing home the bacon. Instead it’s doing what all big pharmas should be doing: Readying for a new environment of drug patent expiration, generic drug competition and political uncertainty by focusing on efficiency and profitability, just in case growth is not there. The company already laid off 11,000 employees from its massive workforce in 2007.
For us, it means a share price currently trading at the low end of its range, but should test the upper range at some point in the next 24 months. And since the options on this one are quite cheap – less than 9% of the underlying price for two years and less than $2 out-of-the-money, the play becomes more compelling.
Buy the Pfizer January 2010 $25 LEAP calls (WPE-AE), currently trading at $1.95. Do not pay more than $2.10. We’re looking for Pfizer to hit $27.50 to $30 in the next two years for a return of between 50% and 100%.
The LEAPS Basics And The Way We Trade
If you’re a newcomer to LEAP options, there are some basic things you should know. If you’re a veteran, this will serve as a good refresher.
The Cost: First of all, LEAPS cost more than your run-of-the-mill options. This is because of the extra time premium embedded in the option’s price. This extra time means we can hold a company through minor hiccups without watching our position disappear because of a one-time event or a bad earnings release.
For example, the recent market meltdown would have seen short-term options go to zero and many stock positions sold because trailing or sell stops were hit. With LEAPS, we may lose some premium, but with months or years left to go until expiration, there is ample opportunity for the situation to mend itself and for the position to become profitable. We’ve seen this happen time and time again in this service.
Entry Points: The entry point of each option is critical. We trade LEAPS that are very liquid, which means there are a lot of options trading on the bid and the offer. This makes sense, since we’re buying calls or puts on very liquid stocks.
You must adhere to the limit prices – without fail. I always add an extra 5-cent or 10-cent cushion to the current prices when I make a pick to take into account any supply/demand issues. We do not move markets, so do not pay more than the limit price for any pick. If it’s trading higher than the limit when you receive the pick, wait for it to come back or wait for the next pick.
Rest assured, the market makers will be more than happy to sell you LEAPS at a higher price if you so desire, but it won’t benefit you to bid up a price needlessly. In the last six years, there have been less than three or four cases of the LEAPS price moving out of range and that was due to an unforeseen event immediately after the recommendation. Simply put, be patient and use limit orders. Never use a market order.
The Spreads: LEAPS also have big spreads between the bid and offer. In your portfolio, the prices are usually marked at the bid (the lower price) and not the offer. This distorts the value of your positions because the position is immediately “worth less” than you paid for it. Our intention is not to day trade, but to take profits when the underlying security moves strongly in our direction. Day-to-day prices are not really meaningful when you’re investing with a longer horizon.
Speed Of Price Movement: It doesn’t take much for a LEAP option to move higher and they move faster than the underlying shares. For example, a 10% move in the underlying shares can easily result in a 30% to 40% gain in the LEAP position. Our intention is not always to hold LEAPS until expiration, but to trade out of the positions when we reach certain targets, or engage in a spread trade to increase our returns and reduce our dollars at risk.
That’s all for now. Good trading – but remember: Do not pay more than the limit prices stated above for the Mylan, Bank of America, and Pfizer recommendations.
Karim
Current Portfoli
Company / Option: Pfizer Jan. 2010 $25 calls
Option Symbol: WPE AE
Current Price: $1.95
Comments: Buy. Do not pay more than $2.10.
Company / Option: Bank of America Jan. 2010 $55 calls
Option Symbol: WBA AK
Current Price: $1.65
Comments: Buy. Do not pay more than $1.80.
Company / Option: Fifth Third Bancorp Jan. 2010 $30 calls
Option Symbol: YJF AF
Current Price: $4.00
Comments: Hold
Company / Option: Viropharma Jan. 09 $12.50 calls
Option Symbol: ZCG AV
Current Price: $1.60
Comments: Hold
Company / Option: American Eagle Outfitters Jan. 2009 $30 calls
Option Symbol: VXX AF
Current Price: $1.80
Comments: Hold
Company / Option: Sun Microsystems Jan. 2009 $5 calls
Option Symbol: XOG AA
Current Price: $0.40
Comments: Hold
Company / Option: Mylan Labs Jan. 2010 $20 calls
Option Symbol: WYQ AD
Current Price: $1.65
Comments: Buy. Do not pay more than $1.80.
Company / Option: Cirrus Logic Jan. 2009 $10 calls
Option Symbol: VUR AB
Current Price: $0.10
Comments: Hold
Company / Option: Coeur D’Alene Jan. 2009 $2.50
Option Symbol: ZYB AZ
Current Price: $2.45
Comments: Hold
Company / Option: Microsoft – bull spread
Jan. 2009 $32.50 call(bought)
Jan. 2009 $40 call (sold)
Option Symbol: VMF AZ
Option Symbol: VMF AH
Current Price: $3.76
Current Price: $1.00
Comments: Hold
Company / Option: Tenet Healthcare – bull spread
Jan. 2010 $5 call (bought)
Jan. 2009 $7.50 call (sold)
Option Symbol: YTX AA
Option Symbol: ONZ AU
Current Price: $1.75
Current Price: $0.45
Comments: Hold