There’s a couple of topics I’d like to briefly cover today. The first hails from the “I told ‘ya so” department and the second tries to answer the “Now what?” question.

1. A SKIL-ful illustration of misplaced hope
And yet another example of “How to lose money in the market” (see 2/19/10 & 3/9/10 blogs), takeover candidate SkillSoft (SKIL) today dropped 5% because no higher bidder stepped up during it’s “Go Shop” period despite the fact that it was presented to 45 potential acquirers. Now it appears that the original deal with private equity will proceed at the previously offered bid of $10.80 per share.

Moral of the story: Hope is not an investment plan!

2. The market is continuing to advance…what should I do?
The following indices have recently made new highs: Dow Transports (DTX), Nasdaq Composite (typically denoted by COMPX), Russell 1000 (RUI), and the Russell 2000 (RUT). Of these, the Dow Transports are typically viewed as a leading indicator of market movement, and the indication is that it’s heading higher.

The big question now is this: How can one take advantage of this rally in the face of less than propitious economic indicators?

To answer this question, here are a few suggested plays depending on your risk tolerance and trading expertise.

Conservative plays
Conservative investors should consider adding to their buy lists. Now would be a good time to capture dividend-paying stocks in sectors that still have significant upside potential. Although regional banks (KBE, KRE, XLF), insurance (KIE), and defense companies (PPA) have enjoyed a nice rise, they’re still a long way from their peak values. Another tasty feature is that they all have just recently broken resistance and stand to rally a lot further. The cherry on top is that they pay a dividend, albeit a small one (1% – 2% dividend yields).

One way to take advantage of this situation is to check out the major holdings of the sector ETFs to find specific value plays. Perusing the top ten holdings in each one, I like the following stocks for their combination of dividend yield (D/Y) and growth potential (based on technicals):

KBE: M&T Bankcorp (MTB), 3.5% D/Y; BB&T (BBT), 2% D/Y
KRE: CVB Financial (FFBC), 2% D/Y
XLF: There wasn’t much to shout about here except for the Bank of NY Mellon (BK). It’s been channeling between $26 and $31 and as such would make a good covered call candidate near the top of its range.
KIE: This group has been especially beaten down and the charts of its top 10 candidates look pretty good. Their dividend yields are also higher than the others, on average. My picks of the group are the following: Allstate (ALL), D/Y 2.5%; Aflac (AFL), D/Y 2.1%, Metlife (MET), D/Y 1.8%.
PPA: There’s a lot to like in this group, especially: Lockheed-Martin (LMT), D/Y 3%; Goodrich (GR), D/Y 1.5%; Honeywell (HON), D/Y 2.8%; Boeing (BA), D/Y 2.4%.

Note that many of the above picks would make good covered call candidates (discussed further below).

Since volatility as measured by the VIX is at a relative low, now is the time to pick up some cheap portfolio insurance. Here, being selective pays. If your portfolio is tech-heavy, buy put options on the Q’s (QQQQ); if it’s weighted towards only a few specific sectors, considering buying puts on the corresponding ETFs.

Mad money plays
Those with more tolerance to risk should consider playing the market to the upside. Index ETFs (SPY, DIA, QQQQ, etc.) offer fairly conservative exposure to upward momentum.

Riskier plays include the 2x and 3x ETFs; the QLD and the TQQQ are examples of double long and triple long Q-based ETFs. Options players may find call debit spreads to be attractive. Front-month put credit spreads can also bring in cash (at the expense of margin), but remember that this is a very fragile recovery and the market could move against you at any moment. I’d prefer to sell out-of-the-money bull-put spreads during a market retracement, not during a rally, and then I’d only take half positions, at least until economic factors (housing, employment) begin to firm up.

Considering that this market’s recovery will probably be slower rather than faster, covered calls might be an ideal way to generate income especially in retirement accounts. Best-of-breed stocks in rising sectors with liquid options is a winning recipe.

Bon appetit!

In my February 19th blog: “How to lose a lot of money in the market,” we looked at how investing in companies that are the target of unsolicited takeovers could be detrimental to the health of one’s portfolio. To illustrate this point I chose scientific equipment maker Zygo (NASDAQ: ZIGO) as my posterchild.

A brief history of the proposed merger
Briefly, II-VI (Nasdaq: IIVI) made an unsolicited offer for Zygo in January for $10 per share, well over the current $7 per share price. Hoping for a bidding war, investors were willing to pay up to $11 for the stock, but Zygo’s board threw cold water on that notion by rejecting the deal. The stock instantly shed a buck in value.

As the saying goes, hope springs eternal, especially in the minds of traders. Still hoping that Zygo’s board would come to their senses, investors again bid up the price of the stock.

But alas, they got another kick in the shins today when II-VI formally withdrew its offer. Zygo shares shed 15% of their value, closing the day at $8.49. The real head-scratcher here is that it seems as if investors still believe there’s some chance that a takeover might happen as the stock is trading 9% above its pre-takeover high.

It’s not over ’til it’s over
It appears that the final chapter in this saga has yet to be written. We’ll find out if it will be a happy ending or a sad one for the shareholders.

Our age of technology has ushered in more ways of investing money and hedging bets. Futures products, along with ETFs and ETNs, have exploded. Lately, it seems as if there’s an investment vehicle for pretty much everything—everything, that is, except movies.

A brief history of movie futures
Enter the Hollywood Stock Exchange, aka HSX (not a ticker symbol). Launched in 1998 by two Wall Street ex-pats turned Hollywood deal-makers, Max Keiser and Michael Burns, HSX provided a virtual trading platform for at-home movie moguls to trade the expected profits of movie openings.

Keiser is referenced  as saying, “I suddenly looked at the movie industry like Michael Milken viewed the bond market. The original business plan of HSX was an exchange for predictive products that would lead to re-monetizing the industry and breaking up the Hollywood cartel. Using this platform we would allow many, many, many more people to have access to funds.”

The pair heavily promoted the platform, burning through tens of millions in venture capital, but they couldn’t realize their goal of actually turning it into something that traded real dollars, not just imaginary ones. They faced one big problem that at the time seemed insurmountable: the lack of transparency in studio accounting made it impossible to execute the strategy.

Still believing that the strategy could be made to work, the two pitched the product as a virtual economy and spent millions in promoting it. Their efforts did in fact pay off, at least in one respect. Web traffic was brisk and trading volume zoomed to over 2 billion contracts per day. But Blue Sky laws and lack of CFTC (Commodities Futures Trading Commission) approval hampered their efforts to turn the model into a real exchange.

Despite online ad sales, the company was rapidly losing money. After a failed merger attempt with another fantasy market company, HSX was eventually sold in 2001 to Cantor Fitzgerald, a company that owns a profitable spread-betting business in the UK. [Note: Michael Burns went on to become Vice Chair of Lionsgate Entertainment (LGF) and Max Keiser hosts The Keiser Report.]

Virtuality to reality
It’s taken nearly nine years for Cantor to jump through the necessary hoops in order to turn Pinocchio into a real boy. The company recently announced that it expects CFTC approval by April 20th after which it will commence trading its contract futures.

Termed Domestic Box Office Receipts (DBOR), movie futures contracts will be offered approximately six months before a project is set to be released. Contracts will be introduced for trading via a preliminary auction and will continue trading until four weeks after the movie has opened whereupon the contract will be closed and trading will cease.

Each contract is valued at one one-millionth (1/1,000,000) of the total gross box-office receipts expected for the first four weeks of a movie’s general release. At the end of the four week period, trading accounts will automatically be cash-settled in the contract holder’s account.  (As an incentive to begin trading “for real,” Cantor is offering current HSX account holders $10 in hard currency per every $1000 in virtual profit (up to $100) before March 31st. )

DBOR trading will be on a 24/7 basis. Account holders will be charged a monthly $2 maintenance fee plus a 25 cent per contract commission fee. Unlike other commodity futures which only require a relatively small percentage of the contract value to be present in one’s account, DBOR account holders must post 100% of a contract’s value for long positions and 50% or more for short positions. (Check out the Cantor website for account details.)

The upside
Cantor CEO Andrew Wing (formerly an exec at Nielsen) says that his company’s movie futures will create liquidity and provide studios with a hedging mechanism besides making the little guy an active participant. “The Cantor Exchange will provide a new component into the film finance formula to combat the uncertainties of the home video market and the growing 3D marketplace,” says Wing.

Looking further down the road, Cantor is hoping that movie futures will provide a direct link to the financing of new film projects. The idea is that producers will be able to come to them and if their projects meet certain standards, they would become part of an Intial Contract Offering.

Another potential industry bonus is that DBOR futures may affect how deals get done. Perhaps instead of stars taking a piece of the back-end in exchange for a large upfront fee (which happens on projects with smaller budgets), they’ll opt for a futures position. Hollywood agents now have one more bargaining chip at their disposal; they’ll just have to learn how to use it.

Potential risks
According to Cantor, movie execs with early access to box office data will be barred from making trades, but what’s to stop other insider activity?

Specifically, who will be considered an insider? Actors? Directors? Movie critics? They all have the privilege of viewing the final product before it’s released as do test audiences and others at pre-release viewing events. It’s clear (at least to me) that some type of oversight is necessary. The next question is who will conduct it?

Besides the problem of insider trading, what happens if a movie ceases production or if production is stalled? Also, it’s not unusual for a studio to push back a movie’s release date months or even years into the future. For example, the release date of the last Harry Potter film (Harry Potter and the Half-Blood Prince) was pushed back from November, 2008 to July of 2009. It’s unclear what would happen to futures trading positions under these circumstances.

Summary
These are some big questions that anyone interested in trading movie futures should be asking and I’ve not found any place that addresses them. One thing is for sure, though, movie futures will be an exciting addition to the futures markets—maybe even more interesting than the underlying commodity!

I found this income play today while posting on Twitter. The tweet was from Hedgefundinvest: “Sleeper value play WAC seems to be hanging in there post earnings call. Very rich dividend yield which mgmt has reiterated support for.” Sounded interesting so I did some research.

Walter Investment Managment (WAC) is in the mortgage investment field: “[A] mortgage servicer, asset manager and portfolio owner specializing in subprime, non-conforming and other credit-challenged mortgage assets,” according to the company website. Last April, it restructured itself into a REIT (real-estate investment trust) and has since been trading in the $12 – $18 range with most of the activity centered between $13 and $15.

The company pays a nice dividend in May, August, November, and December. Last year, the dividend was $2 (14% dividend yield) and as Hedgefundinvest twitted above, management is supporting the current dividend. (This fact wasn’t in any news story I could find so I’m surmising that it came from the company’s conference call on 2/12/10. Yes, I’m that lazy.)

You may feel that investing in subprime mortgages right now could be foolhardy since the other shoe is about to drop on adjustable rate mortgages (ARMs). But considering the experience of the company’s management team, major recent insider buying (and grants), the fact that coverage was initiated by three analysts late last year (two to outperform and one to buy), and the fact that the stock price hasn’t dropped below its recent price range for several months, I’m having a tough time finding a reason not to like this company.

Options plays
This company also has options, albeit only two months out. Front month near-the-money options are fairly liquid (2k-9k open interest) but there’s not a lot of premium to be had. Savvy options traders who want to own the stock might want to write the March 12.5 put at a better price than the $0.20 currently offered. Covered call writers should probably wait until the stock (or the VIX) heads higher before writing the March 15 call. The April 15 call is currently trading in the $0.30 – $0.45 range.

Are all of your stock picks winners? Sick and tired of making money hand over fist? Then look no further because I’ve got a couple of ways you can reconnect with the rest of us mere mortals by learning to spot losing propositions. If losing money is not your goal, that’s even more of a reason to read on because even seasoned investors can find themselves being lured into these money traps.

Losing proposition #1: The one-trick pony company
Although I’ve railed against this type of investment before, it bears repeating because apparently many people are still being taken in by this type of risky scenario. A one-trick pony company is one that makes only one product or offers only one niche service. Small biotechs that will be relying on FDA approval to market their lone drug or medical device is the most dangerous example of this breed. While product approval could translate into a lucrative payday for investors, the consequences of denial could be dire. The company’s stock most certainly will plummet and the company itself could very well go out of business.

You think this doesn’t happen? It financially ruined two personal acquaintances and inflicted so much psychological trauma on one that he suffered a nervous breakdown. Both were heavily invested in one-trick pony biotechs that were relying on FDA approval. Obviously, neither company received it causing their respective stocks to be flushed down the toilet. (The companies were Xoma (XOMA) whose stock plummeted from $30 to around $1 in the early ’90s and the other was Northfield Labs (NFLD) which went out of business last year.)

The latest addition to this list of biotech losers is Xenoport (XNPT). Citing pancreatic cancer concerns, the FDA yesterday put the kibosh on the company’s restless-leg syndrome drug that the company was developing with GlaxoSmithKline (GSK). Xenoport stock immediately shed two-thirds of its value while pharmaceutical giant Glaxo lost a mere 1% on the news.

Losing proposition #2: Unsolicited takeover bids
On January 7th, medical and scientific equipment maker II-VI (IIVI) made an unsolicited offer of $10 per outstanding share of Zygo (ZIGO). Zygo stock rose over 30% on the news, closing the next day well over the $10 offering price on hopes of a bidding war.

What followed were several lawsuits but no other offers. Facing an uncertain future and angry shareholders, the company appointed a new CEO, Chris L. Koliopoulos, on January 19th and made him board chairman on February 12th. Several days later, the company’s board rejected II-VIs offer causing the stock to drop over 9%.

Comparatively speaking, this loss wasn’t nearly as bad as it might have been as stocks typically drop back to pre-announcement prices or even lower following a merger rejection. Might shareholders still be hoping for a better offer? That’s something I certainly wouldn’t bet on!

Summary
You’re probably wondering why someone would even want to get mixed up in these types of situations in the first place. The answer is simple: If the drug gets approved or the unsolicited offer spurs higher bids, you stand to make a lot of money. If you’re playing with some mad money then by all means enjoy yourself, but if a potentially large loss will deprive you of a good night’s sleep, then it’s your fiduciary duty to yourself to put your funds into a more conservative investment strategy. ‘Nuff said.

If you’ve been in the stock market for more than a minute, I’m sure you’re familiar with the phrase “the trend is your friend.” What this means is that when the market rises, so do the majority of stocks, and when it sinks, stocks go down with it. There seems to be some debate about the exact definition of “majority.” The dictionary definition is anything more than 50%, but I’ve heard estimates that at least two-thirds of all stocks go with the market flow.

Being the naturally curious type, I thought I’d do my own test and see what would come up. I had an ulterior motive, though, and that was to see how the stocks that I picked in my daily *Blue Plate Specials* would measure up—would they fare better or worse than the overall market?

The set-up
Time Frame: I decided to look at the market rally between 12/18/09 – 1/11/10 in which the S&P 500 gained just over 4%. So as not to compare apples to oranges, I choose the 1/20/10 – 1/22/10 decline for my bear market analysis. Sure, it lasted only a few days, but when markets fall, they tend to fall fast and furiously. During this time the S&P lost 4%, an amount comparable to its recent gain.

Stock Selection:
Using my *Blue Plate Specials* list from 12/18/09 and from 1/20/10, I selected all of the stocks from the “Breaking out to new highs” list for my bullish candidates and used all those from the “New Lows” and “Breaking Down” lists for my bearish candidates. (The exact stocks are listed at the bottom.) The bullish candidates were all bought at the closing price of the day while the bearish candidates were all shorted at the closing price. No margin, commissions, or fees were used (although you need to have a margin account to short stocks).

Results
The bullish portfolio was closed out at the end of the day on 1/11/10, and the bearish one was closed out on 1/22/10. I’m not claiming that this is a highly rigorous study, but you can see from the tables below that even this ad hoc test does show a significant correlation between the market and stocks.

It’s interesting that the percentage of winners in both markets is roughly equal (85% vs 88%). The percentages here might be higher than are typically reported because of the fact that these stocks are specifically selected to outperform their peers. For example, stocks breaking out to new highs on greater than normal volume show a strong tendency to keep climbing as long as the market rallies. The table shows these stocks beating the market 5.7% to 4.1%, a significant difference in only a few weeks. Similarly, stocks breaking down as well as those hitting new lows tend to underperform their peers during market declines.

The tables also show that it’s no picnic being long in a down market but it’s even worse to be short in a rising one. Noteworthy, too, is the fact that stop/losses wouldn’t have helped you except if you were caught short in a bull market.

Summary
The take-aways from this little test are two-fold. The first is that the trend is indeed your friend. The second is that you can potentially increase your total returns by judiciously selecting your stocks according to the prevailing market climate and being quick to exit when the wind changes.  Isn’t that exactly what trading (not investing) is all about?

Stocks used to generate the table stats:
1: ACAT, AHC, AIRV, AME, ARE, CAVM, CSKI, EPE, HVT, ITWO, LGCY, LPL, LPSN, NFBK, NOG, NPO, OCNW, ORCL, PODD, PRM, RBCN, RDWR, RDY, SBUX, SENO, SMOD, SNDK

2: AGU, BBY, BEC, BT, CTCM, EM, NCTY, PTR, PTRY, SUSS, TUP, WLBC

3: ALD, APL, CBRL, COF, COV, CPTS, IIT, LHO, MTB, PFCB, PNC, PONE, SLA, TMRK, VSH, YUII

4: ANV, CAJ, CDE, CRIC, IDI, SUPX, TNDM, TOWN

Economists aren’t expecting the sovereign debt problems plaguing Europe to go away any time soon, and this bearish outlook is wreaking havoc on the euro, the continent’s major currency. The following weekly chart of the FXE, the euro trust fund, shows how important support and resistance levels are for the currency.

You can see how key support levels were violated during the 2008 global credit crisis. The FXE put in a double bottom late in 2008 at the $125 major support level before climbing back up. It took a second turn for the worse beginning last November, just around the time the US dollar staged its own reversal to the upside.

How to profit from a euro decline
Where’s the euro heading now? If you believe the European crisis isn’t close to being cleared up, a test of the $125 level is certainly not unreasonable. Now, how to play it…

Without setting foot in the futures market, you can still get a lot of bang for your buck (sorry!) by buying either of the double short euro exchange traded instruments, the DRR or the EUO. (You can buy these in your IRA accounts, FYI.)

The DRR is an ETN while the EUO is an ETF. The difference between them is the manner by which their investment objectives are achieved. Chartwise, they both perform similarly, although the DRR seems to exhibit more intraday volatility.

What type of return might we expect? If the FXE falls to $125, that drop represents an 8% decline from today’s closing price which translates into an 16% profit on the double-shorts. And if the euro is indeed headed downward, the general sentiment is that it will happen sooner rather than later, meaning that you shouldn’t have to wait too long to book your profit from this trade.

Update 2/11/10:   A reader wrote in saying that I forgot to mention another possible play using bullish options positions on the FXE.  The FXE, like many ETFs, does offer options.  Its the near-the-money strikes are quite liquid and may offer options traders another attractive alternative to futures.

So the market is in correction mode and the volatility has increased…what’s a trader to do? Well, one thing one probably shouldn’t do is buy overpriced put protection. The reason is that even if the market goes down, a decrease in the put’s implied volatility can erase any price gains. Instead of buying high volatility, the smart trader instead sells it, and here’s one way to accomplish that.

The covered put, put simply
During market rallies, covered calls offer a fairly conservative way of generating monthly income; during market corrections, the covered put offers a similar situational risk/reward profile. Basically, a covered put involves shorting stock and writing put contracts against the short position. If the underlying stock falls below the strike price, the stock will be “put” to you which you can use to close out your short position.

Caveats
Keep in mind margin requirements for this position and understand that although the credit you receive from selling the put can offset a small loss if your stock starts to rise, it won’t protect you against major losses if the stock rallies violently. Like the covered call, also be aware that the profit made from this strategy is capped by the strike price of the sold put, i.e., the further out of the money the strike, the greater your potential for profit, but at the expense of position risk as we’ll soon see.

Stock selection
Okay. The market is beginning a corrective phase (which you can tell by the fact that good news is met by price declines). Fear and uncertainty are reflected by an increase in market volatility. You think that now might be a good time to reap some of that volatility by selling covered puts, but what stocks should you choose?

You want to find those issues that have a good reason to continue losing steam. They can be found among the following criteria:

1.Companies that miss earnings estimates, and more importantly, those that have lowered future guidance.
2.Those that are being downgraded by analysts. {Analysts typically do this as a reactionary move after a negative event has already occurred, but if the downgrade comes during a period of no news and is based on something different, such as a revised earnings estimate, then I’d give more creedence to it.)
3.Companies issuing bad news such as: a new product that isn’t as well-received as anticipated (the iPad?); a biotech’s latest drug doesn’t pass clinical trials; the company’s novel products suddenly have competitors, etc. And the best of the bad news…
4.Accounting scandals; key management changes; government intervention; new regulations that will adversely affect the company’s bottom line, etc.

Certainly, there are many other reasons why a stock will underperform; these are only a few of the more typical explanations.

A current covered put play: Sandisk (SNDK)
On Friday (1/29), the stock of chip-maker Sandisk (SNDK) fell almost 12% from the close on Thursday to the close on Friday.

Why? On the not particularly bad news that revenues were what analysts expected. (See? This is a sign of a correction in progress!) According to a Wedbush-Morgan analyst, expectations for the company were running high (particularly since it’s part of the iPad story) and investors were disappointed that the company didn’t beat expectations.

Taking in the broader picture, shares of fellow chip-makers Micron Technologies (MU), EMC (EMC), and Seagate (STX) all lost ground along with the semiconductor ETF, the SMH.

Looking at the stock chart of Sandisk, we can see that it gapped through key support at $28. It’s showing minor support at the even $2 levels ($24, $22) with major support at $20.

Using end of day data for stock and options prices, here’s how the February covered put fares for the closest strike prices (the stock closed Friday at $25.42).

Depending on your risk/reward profile, you can see how investing in OTM (below $25) strikes differs from the ITM (above $25) strikes. If you think that your particular stock and/or the market may rebound before expiration, sell an ITM strike (the exact strike price depending on your degree of unbearishness). On the other hand, if you believe the opposite, sell an OTM strike.

Repair strategies
If the stock in your covered put starts to move up, you can either buy back your put option and close out your short stock position, or keep your short  position and roll up your put position to a higher strike price. This is where experience in playing this type of option strategy is very helpful.

Summary
The point of this post is to educate those of you who are options savvy and unafraid of shorting stocks as to a strategy that can be used to your advantage when the market is in a correctional phase. If you need a springboard for candidates to short, check out my Blue Plate Specials that lists the new yearly lows as well as those stocks breaking down. The list is posted daily both here on my website and on SeekingAlpha, usually one to two hours before the market closes. Please remember to do your own due diligence before attempting this type of trade!