Email – #439

It’s the last place they leave… and the first place they go back to.

I am referring to casinos, specifically MGM Mirage Inc. (NYSE: MGM) a company that I first brought up a couple of months ago, but was reluctant to pull the trigger because I felt it would go lower. I was right. It has dropped from the mid $50s when I first looked at it to the low $30s today… down from a high of $100. Talk about a bad bet. These guys have suffered the greatest decline in fortune – along with all the casino stocks – in their history.

This sector has crashed more than the financials, just to put things in perspective. Who would have thought that white-shirted bankers would have something in common with the purveyors of sin. But they do have something in common…they are the “houses,” so to speak.

MGM recently reported its numbers and they were below expectations – no surprise here. But the shares rallied sharply in recent weeks in-spite of their lackluster results. Why? Because casino stocks have a very strong correlation to the price of oil and the economy in general. And, if oil continues its downtrend and the economy does stage a recovery in the next 16 months or so, casino stocks will rebound strongly.

The volatility in this sector is at all time highs indicating the possibility of very sharp moves either up or down. MGM is the strongest player in the industry, a bellwether of sorts and it will rally hard if there is a rally to come.

But, the high volatility also means a VERY high options price – a ton of premium, making it very expensive to play with a normal buy. So, we will use a bull spread to reduce risk and also reduce our cost substantially. This stock could easily rally to the mid $50s on good news or a dip in oil prices under $100… and we will be there to profit if that happens.

Here’s what you should d

Buy the MGM January 2010 $45 call options (YDM AI), currently offered at $7 with a huge spread.

Against this position SELL the MGM January 2010 $60 call options (YDM AL) currently bidding $2.80.

Based on the current prices, your cost would be $4.20 to make $15. However, because of the wide spread, you should place limit orders to try an reduce your cost. Use a $4 limit (buy minus sell) as your optimal entry point for this trade.

This means that you should only execute this transaction if you can get a net cost of $4 or lower. Be patient and use limit orders and you will likely be filled.

Karim