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Federal Reserve

October 31, 2007

The Smart Profits Report: Issue #469
Wednesday, October 31, 2007

The Federal Reserve: Will The Fed’s Latest Trick Bring A Treat For Investors?
By Martin Denholm
Managing Editor, Mt. Vernon Research

You scared yet? I bet the Federal Reserve bankers are.

It’s Halloween - and right on cue, there are some real gremlins prowling around Wall Street at the moment. Several scary scenarios for the bankers to ponder, as they prepare to make their latest monetary policy announcement this afternoon.

And the clamor for a cut has swelled so much that the bankers are actually worried about the high expectations.

In fact, the futures market has all-but guaranteed a rate cut. The Bloomberg Financial Markets’ Federal Funds Implied Probability Calculator pegs the chance of a 0.25% rate cut at 70% and a 0.5% cut at 22%. And if the market doesn’t get what it wants, the scene may resemble one where vampires have gone on the rampage - awash with red and lots of blood spilled.

Federal Reserve At The Mercy Of A Fickle Market

When the Federal Reserve slashed interest rates by 0.5% on September 18, it shocked the majority of economists, analysts and investors who had expected a more benign 0.25% cut.

It’s also pretty safe to say that once the bankers wielded the axe, they probably didn’t think the market would be so demanding next time around. But the market is fickle and spoiled. Let’s wrestle with the bulls and bears…

The one morsel of good news is that third-quarter GDP growth rolled in at a 3.9% annualized rate. It was the best since Q1 2006 and pretty impressive, considering the credit mess that resulted from the subprime collapse.

But now, the economy is contending with more upheaval, which makes the rumored revision to fourth-quarter growth rather bemusing.

Oil Prices Top $93 A Barrel

Blink and you might miss it. Oil prices recently topped $93 a barrel.

The market has cried wolf over oil prices before. As prices climbed to $50, then $60, then $70, then $80, each new mark triggered a fresh bout of, “OK, folks… this is it. Recession time. And this time, it’s serious. No, really.”

Have we seen a recession? Nope. But on October 26, one of Merrill Lynch’s leading bears, David Rosenberg, flatly stated, “We think a miracle is needed to avoid recession.”

With oil prices up one-third since mid-August, the market has $100 firmly in its sights. But Abdullah al-Attiyah, Oil Minister for OPEC nation Qatar, says this isn’t because of supply shortages, but rather geopolitical issues and rampant speculation that it is powerless to solve, no matter how much people want a hike in output.

Gasoline prices are heading north, too. The price per gallon is already over $3 in many areas of America. And Americans aren’t just going to get squeezed at the pump…

Heating Costs Set To Spike

According to the Energy Information Administration, home heating costs are set to spike, too…

  • Oil heating costs will jump 22% this winter. That’s an extra $319.
  • Natural gas users don’t escape either, with costs set to rise by 10% ($78).
  • Electricity costs will rise 4% ($32). Almost one-third of U.S. homes use electricity for heat.
  • Propane costs will climb 16% ($221).

Averaging out the costs for all the types of fuels, Americans will pay $977 to heat their homes this winter - 10% more than the $889 last season.

And even if the Federal Reserve provides some monetary relief again, I doubt whether it will be enough to offset other high costs. And that doesn’t bode well for one sector, in particular…

‘Tis The Season For Retail Struggles

Of the 12 months in the year, imagine if you depended on just two of them to generate half of your annual revenues. That’s the scenario that faces America’s retailers every year. But already, the National Retail Federation has projected a murky outlook, with sales growth of 4%, compared with last year’s 4.6% rise.

The group bases the projection on “too little, too late” from the Federal Reserve. Even after its September rate cut, same-store retail sales (stores open at least a year) edged up just 1.4%. And October wasn’t much better, with 2.4% sales growth expected, well below the 3% rise in October 2006. The benefits of rate cuts take time to filter to consumers, and many believe the Fed’s action won’t help holiday retail sales.

That’s bad news for a U.S. that depends on consumer spending to fuel two-thirds of its growth. And the real estate market certainly isn’t helping consumers much either…

Real Estate & Housing Hell

Rather than waffle on about the current real estate market, I’ll let the statistics tell the story…

  • Existing home sales slumped 10% from August to September, according to the National Association of Realtors.
  • New home sales were revised down in June, July and August. And although September sales rose, it didn’t factor in order cancellations. This is a crucial element, given that D.R. Horton reported that half its orders were cancelled between July and September.
  • Homebuilders slashed their housing investment by an annualized 20% during the third quarter.
  • Almost 18 million homes sat empty during the third quarter, according to the Census Bureau. That’s the largest amount ever. And only two million of them are for sale.
  • The Federal Reserve says overall house prices have declined between 2% and 5% over the past year. And the CEOs of Countrywide and KB Home both believe that the worst is yet to come.

Then there’s the dollar…

The U.S. Dollar Way Down, Gold Way Up

As the Federal Reserve prepares to cut rates again, the world’s currencies have taken it as their cue to rise further against the U.S. dollar.

  • Just yesterday, the British pound set a 26-year high of $2.06 and has $2.10 in its sights with U.K. inflation close to the Bank of England’s 2% target level and the likelihood of “no change” when the bankers meet again on November 8.
  • The euro also hit another record high of $1.44 on Monday, with the storming Canadian and Australian dollars also trading at two-decade highs.
  • And with the dollar sinking, gold prices haven’t wasted any time in racing to $794.40 an ounce this week - the highest level since January 1980.

A continuation of high oil prices, the flagging dollar, and an interest rate cut would clearly bode well for the gold market. But it’s a frothy market right now - and the smart money is pulling back. Hedge funds are “long” around 46% of the market and reduced their long positions by 7.7% last week, according to the U.S. Commodity Futures Trading Commission. Meanwhile, the “commercials” are “short” on almost two-thirds of the market.

The Federal Reserve’s Best Option… And Yours, Too

The Federal Reserve has three viable options - but only one is best:

  • A 0.5% Cut: This would be too much and could artificially inflate the market while hurting the dollar. It wouldn’t take long before the rally ended and investors paid more attention to the damage done to the dollar instead. While helping exporters, a weaker dollar would further raise import costs and could send inflation higher, as well as reducing foreign investment in the U.S.
  • No Change: With the ongoing housing market woes, as well as high oil prices hitting consumers’ wallets at the gas pump and energy bills, and retailers braced for a struggle, the Federal Reserve is loath to ignore these factors. However, the bankers are also mindful that a cut might trigger higher inflation.
  • A 0.25% Cut: While certainly not the answer to all the problems, this is the middle ground and the best option. It would provide relief and send a message that the Fed is active without being overly aggressive or too weak.
  • Bottom line: The dollar is extremely oversold, but the chance of a recovery is very slim - especially as the Fed hacks away at interest rates and the “twin deficits” remain a key factor. Relative to what they can get from other countries, few investors are going to want U.S. dollars, since the interest rate and return is much lower.

On the bright side, a lower dollar is excellent for exports. For example, third-quarter U.S. exports jumped by an annualized 16.2% - the biggest rise since Q4 2003. Make sure you own U.S. companies with a strong international presence to give you diversity from the dollar. Industries like defense, technology and biotech should perform well.

Or for a more direct approach, invest in foreign countries with higher growth rates and stronger currencies (China and India are two examples). You can do so either through individual firms that trade in the U.S., or through foreign ETFs.

Best regards,

Martin Denholm

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Today’s Smart Profits Action Center

  • Another way to diversify out of the U.S. dollar and into stronger foreign currencies is through EverBank. The firm offers investors a great way to do so through one of its 15 World Currency CDs. For example, the annual interest rate on the Australian Dollar CD is 5.13%. For the British Pound CD, you get 4.5% (with further strength against the dollar expected as the Bank of England leaves interest rates unchanged next week). In addition to benefiting from further appreciation of foreign currencies against the U.S. dollar, the CDs have flexible maturity terms, has no monthly account fees, and is FDIC insured. For details, please click this link.
    (Disclaimer: The publisher of the Smart Profits Report has a marketing relationship with EverBank, but that’s because we believe it has the most competitive products on offer).
  • Get interactive! If you’ve got any views on the Federal Reserve, the dollar, oil prices… or any other economic/investment topics that you’d like to share with us and your fellow readers, feel free to drop us a line - we’d love to hear from you. While we may not be able to respond to all e-mails, we’re always interested to get our readers’ opinions on issues like this and may feature your thoughts in a future column. You can e-mail us here: editor@mtvernonresearch.com

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Spread Trading

October 24, 2007

The Smart Profits Report: Issue #467
Wednesday, October 24, 2007

Spread Trading: Lower Your Cost And Hedge Your Risk In One Profitable Bull Spread Trade
By Karim Rahemtulla
Investment Director, Mt. Vernon Research

One phrase that many regular investors don’t expect to come across when trading is “options spread trading.”

As it is, the options world can be a mystery to these folks, so tossing in option spreads seems doubly intimidating.

But we’re not regular investors. Once you cast your fears aside and learn how to use options and spread trading, you’ll find that they’re one of the best moneymaking tools in the market today. Let’s take a look at how they work…

Two Advantages Of Spread Trading

First of all, what exactly is spread trading and a spread?

Simply put, it’s a professional trading strategy that consists of two separate positions - no matter what type of spread you’re using.

The common goal is t

  • Initially lower your purchase cost,
  • Then hedge your risk throughout the duration of the trade.

However, as you probably know, there is no free lunch on Wall Street and spreads do limit your upside return. The best way to explain a spread trade is to show you how one works. And while there are many different types of spreads, I’m going to focus on one of the most common: Bull Spreads.

When Options Are Expensive, Spread ‘Em!

Let’s say we want to buy call options on Freeport McMoran (NYSE: FCX), but as we pull up the options chain, we see that they’re very expensive. Bummer, huh? Many folks would walk away at this point. But rather than just give up, spread trading is a particularly effective strategy when you’re faced with pricey options.

This was the exact scenario that my LEAPS Trader subscribers and I faced just a few months ago. So here’s what we did…

At the time, FCX shares were trading for $62 and I was optimistic that they would move higher. But the $60 1-year LEAP options were trading at $6 (remember, buying at the $60 strike price gives you the right, but not obligation, to buy shares at that price when the options expire).

So rather than risk $6, we decided it would be better to reduce the dollars at risk and go for a bull spread. You do this when you’re betting that the share price will move higher, and it involves buying the lower strike price option and selling the higher strike price option against it.

So I checked the price on the $70 option. It was trading at $3. So we sold those options against our $60 options. Here’s the next move…

Number-Crunching The Spread Scenario

The effect of buying the $60 option and selling the $70 option would result in the following scenari

  • We paid $6 to buy the $60 strike, so we were out of pocket $6 per share.
  • But we then sold the $70 option for $3, receiving $3 per share for our efforts. So our adjusted cost is $3 ($6 minus $3).
  • But remember, I said that with spread trades, your upside is limited. And in this case, the upside is $10 - the difference between the $60 strike and $70 strike.

Bottom line: We risked $3 to make $10. And as long as FCX close above $63, we will make money ($60 strike plus $3 cost of the option). If the shares close above $70, I will make $10 for each spread that I entered (less the cost of the spread). Sure, we could go higher - maybe to $80 - but then we’d receive less for selling the $80 option.

If FCX closes below $60, we lose our entire investment of $3. But we can never lose more than $3 as long as we hold the position until expiration.

In real life, however, spread trades aren’t always held until expiration. Instead, investors usually cover them early, in order to take advantage of the decaying time value of the higher strike.

It’s Easy… It’s Professional… And It’s Profitable

By executing a spread trade, you accomplish two things.

  • First, you invest in a very expensive stock for very little money.
  • Second, you reduce your risk by decreasing your cost.

In the real-life trade above, we didn’t wait until expiration. We got out of the trade by buying back the $70 strike and selling the $60 strike early. Result? A 65% profit - in just a few weeks.

My biggest returns have come from spread trading - and in some cases, we’re talking about thousand-percent returns. What’s more… trading spreads is not difficult. You just have to get your broker’s blessing before you can do it.

Karim Rahemtulla

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Today’s Smart Profits Action Center

  • Are you investing like a pro, or just like the rest of the crowd? Over 95% of investors prefer the high-cost, high-risk, low-return investing choice. Not only do they buy stocks for huge money down, they then compound it by exposing their money to more risk than necessary. Spread trading is one of the best ways that investors can both lower the original purchase price and minimize risk. For more information on spread trading, check out Smart Profits #330, Option Spread Trading: How a Bear Spread Can Make You More Than One Put Options Trade.
  • Our resident commodities expert Lee Lowell calls it his “all-star strategy” and “my favorite ‘option-selling’ strategy of all time… that I execute more than any other for my personal accounts.” That’s high praise from a guy who spent six years as a market maker at the New York Mercantile Exchange, setting the daily prices for commodities like natural gas. It’s a strategy he’s written about extensively in his book, Get Rich With Options: Four Winning Strategies Straight From The Trading Floor. Find out what it is - and how to execute it like a pro - by clicking this link.

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The Stock Markets

October 19, 2007

The Smart Profits Report: Issue #466
Friday, October 19, 2007

The Stock Markets: Using ESP To Chart The Next Move As The Indexes Race To All-Time Highs
By Jim Stanton
Technical & Quantitative Analyst, Mt. Vernon Research

So much for history… September is historically supposed to be the worst month of the year for the stock markets. But for the second straight year, it defied the trend and posted gains for the month.

Overall, the September-October period is supposed to be sluggish for stocks. But the Dow and S&P 500 don’t care about convention. Both indexes have raced to new all-time highs this month, with the Nasdaq indexes setting new highs for the year, too.

Great news, right? Well, yes and no. While plenty of folks are profiting, it’s also important to know how long this bullish action could last. And in order to confirm the higher prices over the intermediate-term, the smaller-cap indexes need to join their large-cap cousins in making new highs. They came fairly close to doing so recently, but if they don’t, we could see a meaningful correction.

Let’s see what this market has in store for us, fresh off yet another batch of poor housing data and oil prices blowing their way to $89 a barrel this week…

Dow Transports Out Of Gas… But Is Relief On The Way?

It’s not just the small-caps that need to pick up the pace here. According to Dow Theory, the Dow Industrials and Dow Transports need to move in unison in order for the rally to continue.

Problem is, the Transports have lagged the other indexes badly. If this continues, it sets up a potential longer-term downside issue. Right now, the Transports would have to rally more than 10% to join the Industrials at new highs. And right now, that’s a pretty tall order.

But it might get a little relief. While the market action since the August lows has seen the Dow Industrials and S&P 500 make new highs, it’s also moved the indexes into overbought territory. This is why they’ve pulled back recently and are currently trading below their July peaks. So it’s not yet clear if the correction is complete.

Throughout all this, one index has performed strongest…

Resilient Nasdaq Now At A Key Juncture

Since the August lows, the Nasdaq 100 has blazed forward and has shown more resilience than the others. And because it’s set the trend recently, I’ve put the index through some rigorous analysis, using the ESP Profit System (more on this below). So take a look at its daily chart below…

The Nasdaq 100 blazes trails for the stock markets

With the market having waffled its way through July, the ESP system generated a sell signal on the Nasdaq 100 on July 24. As the chart shows, it projected a minimum downside target of 1,880. The index hit that level on August 15, just one day before the index staged a reversal.

The sell sentiment didn’t last long. As the index headed north again, the ESP system triggered a new buy signal on August 24. This projected a minimum target of 2,066. However, since that was above its July high of 2,061, a new, longer-term target of 2,160 came into play. As you can see, the index reached its minimum target recently and the next week or so should give us a clearer picture of where it’s headed next.

The Stock Markets Race To All-Time Highs… Are They Out Of Breath?

While the Nasdaq is humming along smoothly, the Dow and S&P 500 have also traded above their July highs. This now projects longer-term minimum upside targets of 14,596 for the Dow and 1,626 for the S&P 500.

For now, however, both the Dow and S&P have moved into overbought territory and a correction may be in the cards.

If that happens, the S&P has trendline support around the 1,500 area. This would also represent a typical 38% Fibonacci retracement level (see today’s “Related Articles” for more on Fibonacci retracements). A move down to that level would probably set up a great buying opportunity, assuming that any sell signals have reached their downside targets.

Stocks Enter Bullish Period… But Here’s Why A Pullback Could Be Beneficial

Having navigated the tricky month of September and finished in positive territory, then sprinted its way into October right from the gun (if you remember, the stock market enjoyed a mammoth day on October 1 to kick off the fourth quarter), this time of year is usually bullish for stocks.

If the indexes, including the small-caps, can make new highs for the year, the Dow and S&P 500 should work their way up to the targets mentioned above.

However, not to rain on the parade here… but a pullback might not be so bad. That’s because with the stock markets having enjoyed a solid run recently, you can get better buying opportunities when stocks with bullish chart patterns pull back to support levels. On the flip side, it’s often possible to get better entry points when short selling or buying put options when stocks with bearish chart patterns rally up to resistance. This method reduces risk and increases the reward in a trade, but as we know, the market doesn’t always comply with our wishes!

Good investing,

Jim Stanton

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Today’s Smart Profits Action Center

  • Breaking news: There’s no stopping Google (Nasdaq: GOOG). After the closing bell, the tech giant said third-quarter profits bulldozed through the $1 billion mark to $3.38 per share. It was a whopping 46% surge over the same period in 2006. The news cushioned the heavy blow that Bank of America (NYSE: BAC) dealt this morning, announcing that its third-quarter profits slumped 32%, due to damaging losses and write-downs totaling more than $770 million and a $607 million loss from its investment bank division that actually offset strong earnings elsewhere. Expect major restructuring. Chairman and CEO Kenneth D. Lewis declared: “What I can’t say is that we’ll stay the course. The probability of changes and eliminations of some businesses and infrastructure… is very high.”
  • Why do the Dow Industrials and Dow Transports have such a symbiotic relationship? The answer lies with Dow Theory - one of the most reliable stock market trends in history. As Jim mentioned in today’s column, for a rally or pullback to be sustained, both indexes need to move in the same direction. Originally based on the work of Charles Dow, the actual logic behind the theory was later credited to his William P. Hamilton, Robert Rhea and E. George Schaefer. And it’s the theory on which Richard Russell has written the influential Dow Theory Letters for the past 50 years - and used it to make some remarkable predictions. To find out more about how to use this powerful theory to your own advantage, click here to continue.
  • Jim Stanton is the Investment Director of the ESP Profit System (ESP), a powerful, computerized trading platform that nails down the movement of stocks and indexes with pinpoint accuracy. Not only will you learn what’s going to happen, you’ll also find out when it will occur, and how much the asset could move, so you know exactly what action to take.

    The trading platform is based on two separate proprietary systems. The first one identifies when buy and sell signals are triggered and the second uses a chart pattern recognition program that projects price targets once buy/sell signals are generated.

    Not only that, Jim is also incorporating a new feature into the system: Market “cycle” analysis that will help identify even more investment opportunities. Stay tuned… we’ll bring you further announcements on ESP very shortly.

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The Indian Rupee

October 17, 2007

The Smart Profits Report: Issue #465
Wednesday, October 17, 2007

The Indian Rupee: The One Trend That Could Derail The Tech Titans
By Karim Rahemtulla
Investment Director, Mt. Vernon Research

Talk about a jetset lifestyle… We just arrived in Bangalore - and believe me, the best tonic for all the traveling is a fantastic hotel at the end of the line. And the Oberoi fits the bill. I’ve stayed here before, and the place seems to have a staff-to-guest ratio of 2-to-1.

And while the luxury is great, that’s not the main reason we’re here. We’re here to see exactly what this hot emerging market has to offer and how much it’s progressing. And we saw some evidence yesterday with a visit to one of India’s biggest companies…

Upon arriving at the Satyam Infoway (NYSE: SAY) campus, there was only one reaction: Absolutely spectacular. The place is a sprawling oasis for its 18,000 workers. Like a modern company town, many Satyam employees live on-site, enjoying a fantastic lifestyle that clearly helps them with productivity. For some time now, the IT giant has racked up revenues and earnings growth in excess of 30% per year. And there doesn’t seem to be much blocking its path to further growth… except one trend. The Indian Rupee…

The Rupee Is Crashing The Party… But Firms Have Three Ways To Bolt The Door

You would think that a strong Rupee would bode well for India, since it could drive more investment to the country.

Granted, while hefty capital inflows to India are certainly helping the country’s growth, some of that is offset when the Rupee is strong against the U.S. dollar - as it is now (along with just about every other currency, it seems).

That’s not a good trend for companies like Satyam or fellow technology powerhouse Infosys (Nasdaq: INFY), India’s second-largest software firm (whose campus we’ll be visiting this afternoon).

While Infosys did report an 18.4% jump in net profits to $280 million in the last quarter, the fact that it does most of its business (over 60%) with American companies, or companies in dollar-based/pegged economies - means that over the long-term, it doesn’t want to see this trend continue.

That’s because with each day the dollar weakens, Indian firms like Satyam and Infosys have to offset the loss. And there are a number of ways it can do so:

  • Be more productive
  • Use dollar hedges
  • Raise prices

Right now, Satyam is doing all three, while Infosys says it is “proactively hedging our currency exposures to mitigate this impact.”

Right now, the impact of a U.S. dollar/Rupee ratio of 38 or higher should not have a huge impact. But should the Rupee rise another 10% or so (to the mid 30s), there will be pain all around. That will be the opportunity to buy both these companies, which have excellent futures.

So what does the Indian government and central bank make of this?

Policy Makers Concerned Over Rupee Appreciation

Simply put, they’re quite concerned about Rupee appreciation. But they have a history of active currency management, which leads me to believe that the current Indian pickle may be a short-term trend - 12 to 18 months at most before the Rupee will be back over 40-to-1.

We met with representatives of the State and Federal government, and, essentially, policy makers have little choice. They need to export goods and services in order to stay competitive with countries like Malaysia, South Africa and even Egypt and Slovenia - all up-and-coming countries in the IT sector which is crucial to India’s growth.

So far, everyone is rolling out the red carpet for our group - a neat way to tour an emerging market. Next up… an education on Indian real estate - information that promises to be pretty revealing. Indian real estate is currently experiencing a very dynamic phase, but it’s also very speculative. However, there are undiscovered pockets of the country that still hold bargains.

I will touch upon further opportunities for you in a future issue.

Karim Rahemtulla

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Today’s Smart Profits Action Center

  • Infosys enjoyed a solid second quarter, adding 48 new clients to its roster. This was the driving force behind its 18% income jump to $280 million. This led the company to hike its fiscal year earnings-per-share growth forecast from 13% to 15%. However, the firm also said that pricing rose by 1.9% during the quarter, due to the U.S. dollar buying an average of 40.19 Rupees, compared with 46.29 Rupees a year earlier. This dented earnings, considering that almost two-thirds of the company’s clients came from the U.S.
  • Investors today can’t afford to sit idly on the sidelines and watch the global expansion in India, China, and the world’s other fast-growing economies. Already, emerging markets are forecast to generate an additional $82 trillion in wealth by the end of this decade alone. This could be the greatest wealth boom in our lifetimes - and these markets give you an excellent way to diversify your portfolio.
  • Well, here’s your perfect “wake-up call”… no other daily news service offers the advice, research reports and, ultimately, the investment recommendations that Money Morning will bring to you via e-mail first thing each weekday morning. And it’s completely free of charge. To start getting it right away, log on to www.moneymorning.com and enter your e-mail address in the signup box. Once you do, you’ll receive our special report, direct to your e-mail: The Three Best Investments in Asia. So sign up today. There’s never been a better way to profit from the global boom. And it doesn’t cost you a penny.

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Contrarian Investing

October 10, 2007

The Smart Profits Report: Issue #463
Wednesday, October 10, 2007

Contrarian Investing: The Best Investment Strategy You Should Use Today
By Marc Lichtenfeld
Senior Analyst, Mt. Vernon Research

You’re crazy… You don’t know what you’re talking about… Are you serious? You’re going to get slaughtered…

These are just some of the things you might hear if you adopt a contrarian investing style. Having been in the public eye, I know this all too well. But you know what? I don’t blame them.

It’s not easy being contrarian. It’s tough to own a stock or sector that everyone thinks is headed south. It’s even more difficult to sell or short a stock that your friends, family and even the media are trumpeting as the next great thing.

That’s why although many people consider themselves to be contrarian or having a contrarian strategy, the concept of going against the grain actually scares them to death. But let me tell you why it works…

Contrarian Investing: Go Against The Grain Or Don’t Go At All

I’m not a contrarian investor just for the sake of it - and nor should you be. There’s no point trying to be a hero by picking a loser just so you can crow to people if it goes up.

The bottom line is that you need to have the conviction that you’re right and then discipline to stay in the position as long as it still makes sense.

When I worked at the deeply contrarian Avalon Research shop, my director of research taught me to be skeptical of everything management and sell-side analysts say and to leave no stone unturned in pursuit of the truth. These guys were some of the best contrarian minds in the business and we refused to cover a company unless our opinion went against the consensus.

Those lessons have served me well - and have worked. Let me give you a couple of examples…

A Triple-Play Of Contrarian Gains

When I wrote for TheStreet.com, I recommended selling or shorting real estate development company St. Joe (NYSE: JOE) in early 2006.

Given that the housing bubble was in full force at the time, you should have seen the hostility that came my way! But I argued that when the bubble eventually burst, people wouldn’t want to own the company’s luxury homes in the swamps of northern Florida.

You can see for yourself how much St. Joe’s strategy has bombed:

  • From a price just under $70 in January 2006, shares have since fallen off the cliff, losing half their value.
  • And just a week after a management reshuffle, St. Joe admitted failure, announcing that it will lay off 75% of its workforce (260 jobs cut or transferred; another 500 outsourced).
  • It’s also selling off 100,000 acres of land, 1,200 developed home areas.
  • And will cut its dividend as part of a wider restructuring plan (or as the company rather brazenly put it… a way to “significant accelerate its value creation process”).
  • It will suck up $25 million to $30 million in third-quarter charges, as well as a $7 severance charge.

I also recommended selling P.F. Chang’s (Nasdaq: PFCB), despite crammed restaurants and lines out the door. Problem was, though, that the restaurants were so jammed, there was no room for further growth. The only opportunity lay with its new casual concept Pei Wei, which was struggling to gain traction.

I also love to buy stocks that are out of favor or under-the-radar. In March 2006, I recommended the relatively unknown Dynamic Materials (Nasdaq: BOOM). The stock was trading at about $32 per share. I liked the company’s balance sheet and the fact that it had new orders several quarters in advance. That indicated strong revenue growth ahead. Today, BOOM is trading at $53, a gain of just over 60% from where I recommended it.

And now, I’m doing the same for investors like you…

Get In Early, Then Let The Lemmings Dish You Some Profits

I’ve used this contrarian strategy with my Xcelerated Profits Report recommendations so far, picking two undervalued biotech firms that Wall Street investors have ignored. Bad decision on their part. But their loss is our gain. As of today, we’re up 45% on one since July 23 and up 24% on the other since August 24.

The common denominator with these stocks - and indeed with many contrarian picks - is that Wall Street is missing the boat. When the crowd finally wakes up to the rich moneymaking potential they offer, they all pile in like a bunch of lemmings and move the share price significantly. And if we’re in the position first, we ride the wave.

Speaking of getting in first, I’ll have a new pick in the November issue of the Xcelerated Profits Report, due out at the end of next week. The firm makes medical devices that play to consumers’ vanity, and the balance sheet is rock solid. Again, it’s flying under most investors’ radars, but I think its long-term prospects are enormous. (For more information on how to jump in on this new pick, check out the Action Center below.)

Go Contrarian… But Remember The Core Investment Principles

Nothing compares to getting into a stock before the masses discover it and seeing your returns explode before they finally catch on. And while going against the grain isn’t easy, you can of course still employ other valid investing methods such as value investing, growth investing, or momentum investing (which I consider part of contrarian investing).

And of course, always remember to give yourself a safety set by employing stop-losses, position sizing your investments properly and never investing more than you can afford to lose.

Hoping your longs go up and your shorts go down,

Marc Lichtenfeld

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Today’s Smart Profits Action Center

  • You don’t have to be an investment expert, nor know everything there is to know about the financial markets in order to adopt a winning contrarian strategy. You can use simple technical analysis to spot when a stock might be taking a turn and could flush out simple investors. Tools like support and resistance levels, a close below a key moving average, or a break of a stock’s trendline can all be reliable and profitable contrarian indicators.
  • On a broader level, watch for widespread investor fear or complacency for hints to when a stock might be about to turn. In addition, look at the volume charts - are there any significant breaks from normal levels? Is bullish or bearish sentiment heavily one-sided? What is the mainstream media saying? Not only are they often worng, but they can also guide investors the wrong way, too. If you take the opposite course, you could trump them all.

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Better Investing

October 7, 2007

The Smart Profits Report: Issue #468
Monday, October 29, 2007

Better Investing: Steer Clear Of Embellished Earnings With A Position Sizing Strategy
By Marc Lichtenfeld
Senior Analyst, Mt. Vernon Research

There’s nothing worse for a writer than writer’s block. As time drifts away, we sit there, staring at the page, waiting for a flash of inspiration to hit. Possible solutions include: making a snack, chatting with someone, going for a run, doing laundry. Whatever it takes until the ideas start flowing and that blank page starts to get filled. Eventually, we find a way to battle through and complete the task - and feel mighty tired at the end of it!

But the same “block” theory can also apply to investing. And the better investors know that forcing the issue is more likely to result in a loss.

When the stock market is rolling, the best stocks practically yell at us to buy them - and buy them fast. But most of the time, you’ve got to dig deeper to find the gems. And even then, pouring over the financials, charts and company-related news can still leave you scratching your head.

But the key rule to better investing is this: If you don’t have any good investing ideas, don’t force the issue. Let’s see how to avoid it…

The Biggest Mistake That Rookie Investors Make

This key rule to better investing has served me well over the years. But many misguided investors find money burning a hole in their investment accounts and buy stocks for the sake of it, just so they’re “in the market.”

Don’t do it. Sure, when the market is headed higher, it’s tough to sit back and watch. And there’s nothing wrong with being “in the market” in the form of an index fund or ETF. But when you simply can’t find anything specific to invest in, sit tight. Don’t follow a “hot tip” from your friend’s dad who knows a guy who was walking down Wall Street and heard something about Company X.

Don’t just jump on the bandwagon and pile into the latest momentum stock. Be certain of the reasons that you’re putting your hard-earned money to work at someone else’s company and leaving it to the mercy of the market. If it doesn’t feel right, or is keeping you awake at night, think twice about the investment.

And right now, with earnings season in full swing, that’s more important than ever.

Don’t Fall For Embellished Earnings

Be aware that the information you act on for your investments is often massaged and embellished in the best way possible by either the company itself or by analysts before it’s released. For example, those “one-time charges” that are really recurring charges, or when a company conveniently blames the weather for its poor performance, in addition to the hype and rose-tinted outlook that some will feed the Wall Street spin machine, hoping to lure the little guy.

As you scour the financial newswires and read about the latest earnings reports, do so with a critical eye. Remember that many executives’ jobs, incentives and bonuses are based on short-term performance. They need to produce solid earnings (or at least solid projections) in order to grab that money.

You can avoid the trap with one simple approach…

Better Investing With Position Sizing

Rather than trying to time the market and cash in on unpredictable events like earnings announcements, I believe in better investing through proper position sizing.

  • For example, if you’d invested $100,000 in the S&P 500 on January 1, 1995, it would have grown to $309,000 by December 31, 2006.
  • However, if you’d missed the top 10 days in the market during that period, you’d only have $192,000.
  • Miss the top 20 days and it becomes $133,000.

Market timing is very difficult, so make sure you invest according to your life stage and tolerance for risk.

Do not pile into any one investment at the expense of others. This exposes your portfolio to needless risk if that stock (no matter how much of a “sure thing” you think it is) happens to take a tumble. There is no such thing as a “sure thing.”

As powerful and simple as position sizing is, however, few investors actually do it. Simply put, it means investing the same amount in your investments. Got $10,000? You could put $1,000 into 10 positions. Got $30,000? Select 15 stocks and put $2,000 in each one. Invest a little to make a lot, not the other way around.

Position Sizing Eliminates Clouded Judgement & Emotions

Position sizing helps eliminate the emotion and bias that can cloud judgment. If one investment gets stung, you don’t lose the farm. Rookie investors worry about every loss and try to correct it by over-extending themselves on the next one. This is a mistake. But it’s one you can avoid if you spread your money around equally from the start.

Sure, if you’ve done your research and you like a company’s prospects, go for it. But don’t force yourself into a trade just because you have the money. Those types of trades almost never work out. Save your ammo for a clearer target. And when you do invest, don’t go nuts! Disciplined position sizing and stop-losses will give you more control, more peace - and more money through better investing.

Hoping your longs go up and your shorts go down,

Marc Lichtenfeld

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Today’s Smart Profits Action Center

  • The most basic investing mistakes often have the simplest solutions. For example, many investors do all their research on a stock, then buy it… but have no idea when to get out. If you don’t have an exit plan, then any sized loss on the trade seems acceptable. Answer? Have a plan that anchors you. Ask yourself at what point you’ll sell the position, then stay disciplined and adhere to it. For example, if it’s short-term trade, make sure it stays that way. Don’t hang on longer than you want if it’s moving against you, merely hoping for a rebound. Sometimes, it’s best to cut your losses.
  • Avoid the desire to be “right.” Stick to your plan and make sure that your worst-case loss on each trade is no more than 1% or 2% of your overall account.

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Options Strangle

October 5, 2007

The Smart Profits Report: Issue #462
Friday, October 5, 2007

Options Strangle: Your Stock Is Poised For A Big Move… So Strangle Some Profits From It
By Lee Lowell
Futures Options & Commodities Specialist, Mt. Vernon Research

“Wow, you see what the market’s doing today?” “Hey, check out Stock X - it’s flying!” Boy, if I collected a dollar for every time someone said this to me whenever a market/stock makes a big move, I’d probably be kicking back on a beach right now.

If you’re in the investment world like we are, you hear this all the time - and this past Monday was a good example. Talk about getting a fresh start… the stock market shook off its third quarter woes and leapt into the fourth quarter with an impressive peformance. The Dow sprinted past 14,000 and set an all-time high, while the Nasdaq 100 galloped to new six-year highs. As many stocks sucked up Wall Street money and charged ahead, many investors simply looked on and admired the rally, wishing they were a part of it.

But you know what the professionals were doing? They were making money from it. And they were doing so using a very sophisticated, yet easy-when-you-know-how investment technique, called an options strangle, that is invaluable when assets make big moves. And today, I’m going to show you how to do it, too…

Straddle The Fence… Then Jump Down On The Profit Side

In this column two weeks ago, I gave you the nuts and bolts of an option trading strategy known as an “options straddle.” It’s the type of play where you buy both a call option and put option at the same time with the same expiration date and the same strike price.

You execute it when you want to take advantage of an explosive move in the underlying shares. And here’s the beauty: It doesn’t matter which direction the stock goes. You’re not making a bet on that - you’re simply betting that the move is going to be big, regardless of which direction. As long as the move is large enough to offset both option premiums that you’ve paid, you’ll have yourself a winner.

We Straddled A (Hypothetical) Win On Google… Now We’re Going To Strangle Some Gains, Too

When I discussed straddles, I used a hypothetical example on Google (Nasdaq: GOOG) options that expire this month. Specifically, we bought the $550 straddle ($550 was our strike price) that cost us a total of $35.80 for both options combined. This equated to a dollar value of $3,580 for one straddle purchase. Working on the theory that Google could see a large move, regardless of direction, we bought both the call and the put.

Right now, that straddle is worth $51. That means we could cash out for a hypothetical gain of $1,520 per straddle and a 42% return on investment in just a few short days. Not too shabby!

But the straddle play has a brother. It’s called the “strangle.” It’s exactly the same as a straddle, except that the strike price levels for the calls and puts are different.

There is one other key difference, too. While it’s best to pick at-the-money options with straddles, when playing strangles, we choose options that are out-of-the-money (OTM). This means the overall cost will be less than the straddle because OTM options are cheaper to buy.

While this sounds great on the surface, be warned… the cheaper cost comes with a caveat: Since the options are OTM, it’s going to take a bigger move in order to see a profit. But if you’re confident of a large move, the strangle can give you a larger return.

So let’s see how it works in reality, again using Google as an example…

At-The-Money For Option Straddles… Out-Of-The-Money For Option Strangles

Take a look at the Google option chain below and we’ll construct a hypothetical strangle play.

Hypothetical Options Strangle Play on Google

While we played the October options for the straddle, we’re going to go out to November for the strangle. The price of GOOG at the time of this screen capture was $585, so we would pick OTM strikes to form the strangle.

You could pick whichever OTM strikes agree with your wallet, but for the typical strangle, you want to focus on strikes that are roughly equidistant from the current price of the stock. So for this example, we’re going to use the $600 call (GOO-KT) and the $570 put (GOP-WQ), which are both $15 OTM and equidistant from GOOG’s price of $585. The cost to buy both options at their “ask” prices would give us a total cost of $35.20 for the strangle ($19 for the call + $16.20 for the put), or $3,520 in total dollars.

Next step… figuring out your breakeven level…

Crunching The Numbers… Finding Your Breakeven And Profit Levels

You always want to know what your breakeven prices will be if you are going to hold onto this play until option expiration. This lets you know how far GOOG must go before you’re profitable. All you do is add the total strangle price to the call strike and subtract it from the put strike to find your breakeven levels.

So we have $600 + 35.20 = $635.20

… and $570 - $35.20 = $534.80.

Bottom line: Until/unless GOOG gets past either level, you won’t be profitable if you held until expiration. The graphic below shows you how the breakevens look on a chart.

Options Strangle Breakevens

Of course, you don’t need to hold until expiration. You can sell at any time. So if GOOG makes a large move soon after you buy the strangle (just as it did with our hypothetical straddle play), you could easily sell it for a profit.

Take a look at the profit & loss table below to see how the strangle will fare on expiration day at various GOOG share prices.

Profit & Loss for Options Strangle at Expiration

You can see from the chart and the spreadsheet that if GOOG stays between $570 and $600, you will lose the maximum amount. However, that can be no more than what you paid for the strangle.

But once you move either lower than $570 or higher than $600, you’ll see your losses decrease. And once you get past the breakeven points of $534.80 or $635.20, you’ll move into profitability.

**Please note that the Google example above is just an example of how a straddle works, not an actual recommendation.

Don’t Let An Options Strangle Choke Your Profits

Of course, there are a couple of downsides to buying a strangle - and you need to know about them before you execute this options play.

First of all, remember that you’re buying two different options and paying two premiums. So instead of just buying the call or put and hoping it makes the move you anticipated in one direction, GOOG needs to make a very large move in order for you to profit. In fact, GOOG must make double the move in either direction to offset the total $35.20 premium.

So one thing you might want to consider is to execute an options strangle strategy on a stock that has shown the ability to make big moves. That certainly applies to Google. However, while it could move past either breakeven level and become profitable, keep in mind that it can also trade in unprofitable areas. It’s essential that you keep an eye on the underlying stock’s activity, so you can book profits quickly before you lose them.

Lastly, since the options for a strangle play are OTM, GOOG has to move a little more than it would need to for a straddle. The tradeoff to that larger move is the strangle will always cost less than a straddle. Bottom line: You need to strike a balance between how big you expect the move to be and what you can afford to risk.

Good investing,

Lee Lowell

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Today’s Smart Profits Action Center

  • When you’re looking at options strategies such as straddles and strangles, the most important factor to look for before you even start looking at strike prices or expiration dates is the volume of the underlying shares. Since both strategies require a big move in the shares, you’ll need to find a stock that is active and has enough volume to move the price as much as you want. To read more on straddles, check out Smart Profits #458, Option Straddles: Don’t Worry Which Way Stocks Are Headed… Here’s How To Play The Upside And Downside.
  • In addition to the comprehensive investing archives that we have on the Smart Profits Report website, we’ve also compiled an in-depth glossary for you - an essential reference point so you know key option phrases like “strangle,” “strike price,” “out-of-the-money” and many more. Check it out here.
  • Having spent six years as a market maker on the NYMEX, setting the prices for commodities like oil and natural gas, Lee Lowell knows is one of just a few hundred traders who truly understands how the market works and what makes it move. Armed with that rare, first-hand knowledge, he’s now putting it to profitable use for a select group of investors in his Triple-Zone Profit Trader service, walking them step-by-step through specific trade recommendations. So far this year, Lee has locked in profits of 143%, 111%, 100% and 71% - and boasts an average gain of 38% per trade. For more information on how you can win on 80% on your trades - guaranteed - please call our VIP Services Team at: 888.570.9830 or 410.454.0498. And for more information on Lee, visit this link.

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Stock Market News

October 3, 2007

The Smart Profits Report: Issue #461
Wednesday, October 3, 2007

Stock Market News: Gold & Oil Reach Upside Targets As The Dollar Falls
By Martin Denholm
Managing Editor, Mt. Vernon Research

I’d barely ripped the month of September off my desk calendar and turned to October before the stock market was off to the races on Monday morning. Fresh off a quarter in which the Dow Industrials posted a 3.6% gain, the index blasted past 14,000 for the first time since July. It gained almost 200 points and hit new all-time intraday and closing records of 14,147.30 and 14,087.55 respectively. Elsewhere, the tech-stuffed Nasdaq Composite bounced to its highest level since February 2001, while the S&P 500 and small-cap Russell 2000 rose 1.3% and 2.4%.

But hang on a second… what about the subprime mess? Rising oil prices? Higher energy and food prices? The trainwreck dollar? The sharp spike left some folks scratching their heads. Plus, Citigroup (NYSE: C) and UBS (NYSE: UBS) announced some pretty awful earnings guidance, due to their subprime exposure.

So is the investment glass half-full, or half-empty? Let’s take a look at the most recent stock market news…

The Nasdaq 100 Leads The Way…

If you read last Thursday’s article from my colleague and technical analyst Jim Stanton, you’d have seen this move coming. Jim stated: “As the market has rebounded, the Nasdaq 100 has led the way, impressively surging to new 6-year highs this week. Obviously, this is a bullish development that should lead to higher prices. But… while the Dow Industrials and S&P 500 are within striking distance of setting new all-time highs, they need to do so in order to confirm the rally.”

Bingo. It only took the Dow two days to come through. And the S&P 500 is just 10 points away. On Monday, 28 of the 30 Dow Industrials finished higher, despite an ugly warning from Citigroup that third-quarter earnings would plunge 60%. The reason? That pesky subprime sector again, with the company swallowing a $3 billion loss on subprime exposure. Not to be left out, UBS also announced that it will take a $3.4 billion third-quarter write-down and post a loss.

Glass half-empty? Not quite. Industry barometer Citigroup said it was likely to be a one-time hit, with better prospects in the current quarter. So rather than triggering more strife, investors figured the worst is over and promptly sent the market barreling higher.

But Citigroup wasn’t finished talking. It decided to upgrade several big homebuilding stocks, too. Eh?

Real Estate Continues To Endure The Gloom

Real estate has endured a savage few months and more gloomy projections are everywhere.

  • Falling new home sales.
  • Falling existing home sales.
  • Today’s news that pending sales fell to a record low in August, declining house prices.
  • Record high foreclosures.
  • A 16-year housing supply engulfing demand.

The list goes on. But that didn’t stop Citigroup from upgrading homebuilders. But it believes those with stronger balance sheets will fare well. And like clockwork, several large-cap homebuilding stocks rose.

Man, are these Citigroup guys bankers or cheerleaders? You’d think that having got burned on the subprime sector, they would keep real estate predictions to themselves. Maybe they should just grab their pom-poms and start waving them around in the middle of Wall Street. Must… buy… homebuilder stocks.

Let’s get serious here…

The Stanton Synopsis On The Sad, Sad Dollar

While Citigroup waffles and the stock market does its thing, many eyes are still trained on the U.S. dollar - the Fed’s favorite piñata.

As Bernanke and his boys bash away at the greenback, the U.S. Dollar Index (which measures the dollar against a basket of other currencies) slumped to a 40-year low below 78 last Friday. The euro is hovering at its highest level against the dollar since it began trading in 1999.

And since his market analysis was spot-on, I asked Jim Stanton for his take:

“Needless to say, the dollar weakness has set up the ‘perfect storm’ in commodities. Not only has worldwide demand increased dramatically, especially in China, but the slump has also helped push oil and gold prices even higher.

“It’s no secret that Wall Street bears have mauled the dollar for a while now. So far, they’ve been right. But it’s worth remembering that since the late 1970s, the Dollar Index has tested the 78-80 area six different times. And each time, it has rallied. We can expect that to happen again, at least in the short-term.

“Since hitting a new low last Friday, the index has rallied over the past two days. I expected some short covering in the dollar around this level, but it just so happens that with the oil and gold markets simultaneously reaching their short-term upside targets over the past few days, both commodities have seen some selling pressure today.”

Stock Market News On The Dollar, Oil And Gold

Thus far, the dollar’s slide has boded well for commodities. Last Friday, crude oil hit an all-time high of $83 a barrel, meaning that September saw oil’s biggest month-over-month price rise in three years. Meanwhile, gold hit a 28-year high of $746.50 an ounce on Monday.

  • Oil: The decline from $83 on Friday back to $80 today gives weight to the idea that the current fundamentals do not support the current high price. In the long-term, however, prices will remain high. Slow export growth, constant supply fears (due to geopolitical issues, weather and natural disasters) and the sluggish pace of new reserve discoveries are the main reasons.
  • Gold: When the dollar goes down, gold goes up. It’s a pretty reliable, time-tested relationship - and we’re seeing it again now. With the greenback finally showing some fight, gold prices took a beating today, sliding almost $18 to around $736. The price has remained above $700 for three weeks now, which is an impressive streak. But unless the dollar drops back down again, gold could drift or consolidate for a while.

Of course, if the Fed decides to cut interest rates again at the end of the month, all bets are off. And with the Institute for Supply Management saying that the U.S. manufacturing sector grew at the slowest pace in six months in September, the Fed could make a move.

  • The Dollar: As Jim says, “If the dollar continues to strengthen, it will probably take the froth out of the gold and oil markets and we could see the stock market pull back. With historical support around 78-80, a change in the trend is possible. But it may just be undergoing an oversold bounce before the downtrend resumes.”

Either way, the Fed may have done the damage already. Former Fed chief Alan Greenspan believes it will take double-digit interest rates to restore the dollar’s long-term value (easy for him to say, now that he’s retired!) In the meantime, commodities like gold and oil remain a pretty solid bet.

Best regards,

Martin Denholm

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Today’s Smart Profits Action Center

  • Over the past few days, we’ve seen some big moves in stocks and commodities. When you get big moves like this - whether up or down - it’s a good time to execute a professional options strategy known as a “strangle.” Not many “ordinary” investors have even heard of this, never mind thought about using it. But in Thursday’s message, our commodities expert Lee Lowell will show you exactly how to use this technique to build wealth. In the meantime, check out his column on the strangle’s sister play - the options straddle in Smart Profits #458, Option Straddles: Don’t Worry Which Way Stocks Are Headed… Here’s How To Play The Upside And Downside
  • The Nasdaq is still the lead dog. While the Dow Industrials backed off from Monday’s all-time high and shed 40 points as investors took some profits, and the S&P 500 remained flat, the Nasdaq nudged ahead by 6 more points. In closing at 2,747.11, the index set another new high. The next big market mover could be Friday’s September job report.
  • With the Canadian dollar having now hit parity with the U.S. dollar (it set a 31-year high of $1.009 on Monday), the next in line to do the same is the Australian dollar. Second-quarter GDP growth hit 4.3% from a year earlier - the fastest pace in three years - as the country’s strong commodity-based economy continues to bolster the Aussie dollar. And with 4% GDP growth expected “Down Under” in 2008, that trend is set to continue.

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