Email – #475

We are at a critical juncture in the markets today. Stocks, right now, could go in either direction from here. A strong rally in the past few weeks is bound to correct… but corrections are hard to call. Volume is light, technicals are poor and sentiment is a little too bullish… yet for some reason, we’re not breaking down. I’ve been here before and likely you have as well, so let’s just face the facts and admit that it’s pretty murky. But, there is a way to profit regardless.

Right now we’re sitting on a lot of profits from our positions in Petrobras, Yamana, Motorola, Freeport and Akamai. We have a loss in US Steel and a slight loss in USAir… but we have more than a year and a half to go and if this economy recovers, we will clean up.

Next week, I am going to issue at least one pick, maybe more. We will be taking a new tack and instead of trying to pick what’s going to go up or down, we are going to start betting both ways using LEAPS Straddles and Strangles. Before I send out the recommendations, I wanted to give you a quick primer.

First, you can do these trades in any account, even retirement accounts if you have permission.

Straddle vs. Strangle

A straddle is a bet on a position that requires you to buy a PUT and a CALL at the same strike price. In other words, if we were going to Straddle JPMorgan – currently at 35 – we would buy the $35 calls and the $35 puts.

What we’re looking for with a straddle is strong move in one direction, either up or down. Of course, when a stock and option moves strongly in one direction, the opposite play loses. The objective here is to make enough money from the move in one direction that it more than covers the loss from the opposing position.

There are some excellent straddle opportunities out there right now, with many of them reasonably priced. So, when I issue a straddle play, you will be buying a PUT LEAP and a CALL LEAP as well. Of course I’ll issue clear instructions at the time of the recommendation. With a straddle, there is unlimited profit potential while the risk is known right off the bat – the risk is the amount we paid. Straddles work best in volatile markets, something we definitely have today.

A Strangle is very similar to a straddle in that it requires buying a put and a call option. However, instead of using the same strike prices, we buy options at different strike prices.

The thinking here is that the underlying shares may move in such a wide range that even an option that isn’t near the current price will make money. And, because the options may be out of the money on one side or the other (out of the money means not close to the current price) they may be priced more reasonably than an option that is at the money (close to the current price).

For example let’s say we like Goldcorp at $35 and think it’s going to 70. We don’t have to buy the $35s for $10. Instead we could look at the $45s for $5 and still have significant upside. On the downside, to protect ourselves, we may buy the $25 puts for $5 instead of the $35 puts for $10. We have established a range. Our risk is that the share price stays within a tight range causing us to lose money on both sides. But, in this market, that is unlikely because of the level of volatility.

So, keep an eye out next week and make sure you have this “cheat sheet” handy. Of course you can also read up on Strangle and Straddles in our free archives at www.smartprofitsreport.com – a free service for you.

Have a safe Memorial Day Holiday.

Karim