Email – #421
The casino industry has been shellacked of late. A slowing economy, high fuel prices, and decreased gambling has taken its toll. Companies in this sector have lost 50% or more in the past few months. But casino stocks are almost always the first to rebound on any signs of an economic turnaround. We are going to set ourselves up for a trade – I am giving you advance notice. BUT DO NOT DO THIS TRADE UNTIL I GIVE THE SIGNAL .
The problem is that the options are very expensive, an indication of the volatility and potentially sharp movement of these shares. With LEAPs we can mitigate some of that risk by investing in 2010 options that should react very well when the economy does indeed bottom. Of course, right now no one thinks that will happen. The news is all bad. Granted, it could get worse, but timing a bottom in the economy is impossible. An educated guess is not. With all the liquidity in the system right now, we should see a turn in the economy by the end of the year if the past is any guide.
For LEAPs we don’t need the underlying shares to go to our target strike price, all we need is a strong turn in the right direction. To mitigate our risk and cost even further, we have the ability to be a little creative by using a spread trade. In this case, we are going to be buying just prior to earnings releases from these companies. Our goal is a potential short-term pop if the news that is baked into these shares is not as bad as investors think. There is risk here – if the news is worse, the option values will go lower… but with a spread, we are better protected since our short option will also lose value, defraying some of the loss in our long position.
It really does not matter which sin stock we buy. But the best of the breed is also one of the least expensive. We are going to go with MGM Mirage (NYSE: MGM). Not only is the company a dominant operator in Las Vegas, it also has a 50% interest in the MGM Macau which caters to the up and coming gamblers from Asia.
Things are not rosy at the company during this slowdown. They are noticing a decline in all segments – which is to be expected. They are running leaner than last year to reduce costs, but should the downturn be prolonged, the shares will face difficulties. But, with sentiment so negative, and the market beginning to look forward, we may see a turn in the stock market long before we see a turn in the economy. If that happens, economically sensitive shares like casinos will take off in a hurry.
As I said earlier, we will use a BULL-SPREAD for this position. Again, the reasoning for this is to preserve upside while reducing our cost. There is no way around this unless you want to pay through the nose. By using the BULL-SPREAD we have the potential almost six to one returns, while risking less than 10% of the cost of the underlying shares… for a period of almost two years.
Here is the trade:
We will buy the MGM January 2010 $70 LEAP CALLS (YDM-AN) currently offered at $6.70. Against this position we will sell the MGM January 2010 $90 calls (YDM-AR) currently trading at $2.50 on the bid . The 52-week high is $100.50 and the 52-week low is under $50, where it is today. I am going to wait until I see some other casino releases before pulling the trigger, and may wait until MGM releases numbers and offers guidance. We may be able to get in at more favorable prices or decide not to do the trade at all .
For now, be sure to set up your account for spread trading so you can take advantage of this, or any other spread trade, when the opportunity arises. If you are having issues, contact Greg Long at Gunn Allen Financial, at 800.329.1984 and he can answer any questions or help you set up an account. As I said last week, making trades during earning season, especially the current season, is not always prudent, so we will wait to pick our points and do this trade or any other when we have better clarity.
Current Portfoli
Company / Option: Unisys Jan. 2010 $5 calls
Option Symbol: WUI AA
Current Price: $1.40
Comments: Hold
Company / Option: Pfizer Jan. 2010 $25 calls
Option Symbol: WPE AE
Current Price: $1.00
Comments: Hold
Company / Option: Bank of America Jan. 2010 $55 calls
Option Symbol: WBA AK
Current Price: $1.25
Comments: Hold
Company / Option: Fifth Third Bancorp Jan. 2010 $30 calls
Option Symbol: YJF AF
Current Price: $1.55
Comments: Hold
Company / Option: Sun Microsystems Jan. 2009 $5 calls
Option Symbol: XOG AA
Current Price: $0.15
Comments: Hold
Company / Option: Mylan Labs Jan. 2010 $20 calls
Option Symbol: WYQ AD
Current Price: $1.20
Comments: Hold
Company / Option: Cirrus Logic Jan. 2009 $10 calls
Option Symbol: VUR AB
Current Price: $0.20
Comments: Hold
Company / Option: Coeur D’Alene Jan. 2009 $2.50
Option Symbol: ZYB AZ
Current Price: $1.50
Comments: Hold
Company / Option: General Electric – bull spread
Jan. 2010 $35 calls (bought)
Jan. 2010 $45 calls (sold)
Option Symbol: WGE AG
Option Symbol: WGE AI
Current Price: $3.15
Current Price: $1.00
Comments: Hold
Company / Option: Powershares QQQ Trust – bear spread
Jan. 2009 $43 put(bought)
Jan. 2009 $39 put(sold)
Option Symbol: OZC MQ
Option Symbol: OZC MM
Current Price: $3.41
Current Price: $2.12
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: $1.26
Current Price: $0.20
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: $1.80
Current Price: $0.40
Comments: Hold