Archive for July, 2009

Are Blank Check companies worth checking out?

Friday, July 31st, 2009

I surf hundreds if not a thousand stock charts per day and one unusual type of chart has been cropping up frequently on the “New High” hot list. They all have a very similar price pattern:  thinly traded and under $10. They also have another feature in common—the word “acquisition” is in the majority of titles. Evidently, there’s more here than meets the eye. Summoning up my inner Nancy Drew, I whipped out my magnifying glass and subjected these companies to closer scrutiny.

Blank Checks or SPACs 
It turns out that they’re what is known as special purpose acquisition companies, or SPACs. But they’re more commonly known as “blank check” companies because that’s really all they are. Think of them as another sort of private equity vehicle in which investors buy units in the company whose sole purpose is to use these pooled funds to acquire one or more companies. The reason they’re called “blank check” is because that’s what the investor is giving the company—a blank check for the company to select any (or no) targets for take-over. Because this is a blind-faith gesture, investor confidence is anchored to the reputations of the company principals.

The SEC has rules for blank-check companies. At least 80% of shareholder monies must be used in all acquisitions, and each acquisition is subject to shareholder approval. If the company cannot find or execute at least one transaction by a given date (generally two years from inception), the monies plus accrued interest and less operating expenses are returned to the shareholders.

Most blank-check companies IPO around $10 per share, but they can also raise money without shareholder approval by issuing other classes of stock. Many do this as a poison pill to prevent hostile take-overs. Some of these companies have more than one class of preferred stock and it’s difficult if not impossible to distinguish one from the other. A major problem in researching this field is that there is little to no information on blank-checks which could very well explain their sparse trading volumes.

There are probably sixty to hundred blank-check companies trading on US exchanges. The major players trade on the AMEX, and there’s less than forty of those that I was able to identify. Below is a list of the top ten players according to market cap:


And here’s a weekly chart that is representative of most:


You can see that prospects for M&A activity fell off a cliff along with the rest of the market last fall, but blank-check stocks have been making a slow, steady comeback. I don’t know how much higher they can go especially considering that many don’t have much time to effect an acquisition, but what this space is telling us is that there’s a lot of faith that M&A activity will rebound, and soon. It’s also interesting to note that the preferred stocks (or what I’m assuming to be the preferred stocks) of these companies are busting through the roof along with the preferred stocks of many other financials.

It could be that the real story behind the blank checks does not lie with the companies themselves, but with what they reflect as far as investor optimism. And if I have to write a check based on that indicator, it would be a big one.

Iron Condor spotted over Isle of Capri

Tuesday, July 28th, 2009

Condors of the feathered kind may be on the endangered species list but condors of the stock derivative kind are alive and well. One in full plumage was spotted over the Isle of Capri (ISLE), a gaming concern with operations in Mid-America, Florida, England, and the Bahamas. This condor is of the iron variety, and no, it is not a 70’s heavy metal band.

What is an iron condor and how is it used?
An iron condor is an options combination that is the sane person’s version of a credit strangle. A credit strangle is a neutral options strategy. It’s put on when the investor feels that the price of the underlying stock (or future) will stay within a certain range before options expiration. The strangle involves selling an equal number of out-of-the-money (OTM) calls with an equal number of OTM puts. The problem with this strategy is that if the unexpected happens (as it tends to do) and the stock zooms past either strike price, losses begin mounting quickly as options are leveraged instruments.

Options are also extremely versatile giving us a saner way to make a similar bet. In this case, that way would be the iron condor which is a covered version of the credit strangle. It consists of a bull-put credit spread where the higher strike put is sold and the lower strike put is purchased and a bear-call credit spread where the lower strike call is sold and the higher strike one is bought. The strike prices in both spreads are the same distance apart.

Novice options traders may find this confusing (and as always, please don’t try this or any other options strategy until you thoroughly understand it and have paper traded it), but the following example should clarify how it works.

ISLE stock trading in a range
The Isle of Capri (ISLE) has been trading in a zone between $11.50 and $14 for the past several months. Conflicting coverage may have something to do with the stock’s constrained movement. For example, on July 22 Zacks gave the company its highest rating say that the it crushed analyst estimates and earnings consensus is up sharply for the next year while on the very same day the Motley Fool published a completely opposing view giving the company its lowest rating. No wonder investors are confused!


Continued confusion means that the stock could be range-bound for a while making it a perfect candidate for a neutral options strategy. Let’s look at how an iron condor would work on the Isle of Capri.

The Isle of Capri Iron Condor Strategy
The options field for ISLE isn’t terribly robust.  When I write options, I like to write them for the shortest time possible but in this case I’m going to have to look out to October where there’s decent open interest. One good thing, though, about writing farther term options in a market of declining volatility is that I will have collected some excess premium on top of declining theta (time value).

Using Monday’s options prices (since that’s all I have to work with at the moment), here are the calculations for an October iron condor combo on ISLE:

October Bear-Call Credit:
Buy 17.50 Call @ $0.20
Sell 15 Call @ $0.55
Credit = $0.35

October Bull-Put Credit:
Buy 10 Put @ $0.60
Sell 12.50 Put @ $1.55
Credit = $0.95

Total Credit (Reward): $0.95 + $0.35 = $1.30 (not including commissions & fees)
Max. Risk: Difference in option strike prices – Total Credit = $2.50 – $1.30 = $1.20
Lower Break-even point: Strike price of sold put – Total Credit = $12.50 – $1.30 = $11.20
Upper Break-even point: Strike price of sold call + Total Credit = $15 + $1.30 = $16.30

Profit is realized if the stock price is between the break-even points at options expiration. However, since expiration is a ways away and anything can happen during that time, what I would do (and have done in the past) is to close out a leg when the difference between the two options prices are very low, say less than $0.10. For the call spread, this will happen when the stock price nears its channeling low around $11.50, and for the put spread, this will happen when the stock nears its channeling high of $14. Whatever you do, make sure to close out both options on each side simultaneously (that is, don’t leg out of it) as you DO NOT want to be left with an uncovered options position.

The risk/reward for this strategy is very attractive, although the commission costs are high. For this reason, it’s recommended to go with a deep-discount broker if you intend to make a lot of butterfly and condor plays.

What’s going on with Centennial Communications (CYCL)?

Friday, July 24th, 2009

As manager of the MANDA fund—a portfolio composed of companies that are in the process of being acquired—I feel it’s my fiduciary responsibility to comment on the recent downward price swings in the stock of Centennial Communications (CYCL). Not that there is much to say other than that the merger date with AT&T (T) was pushed into the third quarter because of customary regulatory hurdles.

The merger was announced 11/10/08 at a take-over price of $8.50 per share. I purchased it that day for $7.80. Since then, the stock price has been relatively stable reflecting the fact that most folks believed that the deal would go through without any hitches…that is, until recently.

Centennial shareholders approved the deal back in February and all that was left was for it to clear regulatory and anti-trust issues with the FCC and DOJ. It was expected to clear those by the end of 2Q 09. But that didn’t happen, and it was on July 1st when the price of Centennial stock began to roll-over.

On July 8th both companies issued press releases saying that the deal was pushed back to the third quarter, but they didn’t mention foreseeing any problems with the government.* But jitters were already setting in as the stock began to tumble from around $8.40 to $8.20 two days before the announcement. Volume began picking up as the price continued to drop. On July 14th a week later, the stock took a nose-dive, dropping 15% at its lowest point and closing the day off 10% on more than ten times normal volume. It was ugly for Centennial shareholders, like me.

I scrambled to find out what had happened but there was no news from either company nor from any of the ten analysts covering Centennial. There was, however, a lot of speculation that the sell-off was due to insiders acting on illegal information, hedge fund margin calls, or a merger arbitrage fund liquidation. I’m thinking that it’s probably one of the latter reasons as the SEC will be all over any hint of insider trading.

For right now, I’m holding on to my current position, but if the stock doesn’t turn around soon, I’ll be selling it. In the interest of full disclosure, I did buy a small amount of Centennial at $7.35 a couple of days ago. Assuming the deal does close as expected, that represents a 15.6% return on investment. It’ll be interesting to see how this trade plays out.


*One poster on the Yahoo! message board said that the FCC is having “issues” with Centennial’s holdings in Puerto Rico which may have to be divested for the merger to clear.

*Blue Plate Specials* – July 23

Thursday, July 23rd, 2009

Breaking Out on lower volume: ANN, ANR, DYAX, GAP, IGT, TXI
Breaking Down: DHR (to $57.50), ZEUS (to $22)
New Lows: None
Low-priced leaders: CKSW, CLWR, OMN, SCLN, SMP
Speculative Leaders: ACTG, AFFX, IMAX, MVIS, OMN, SCLN, SMP
Darlings of the Day: AMZN, ISRG, NVEC
Sector Highs: Semis (XSD, SMH), Retail (XRT), Info Tech (VGT), Tech (XLK), Telecom (VOX), Utilities (XLU), Consumer Discretionary (XLY), Health Care (XLV), Biotech (BBH, FBT)
Sector Break-outs: Homebuilders (XHB)
Commodity Break-outs: Aluminum (JJU), Sugar (SGG)
Profit taking?: HITK, KONG, STEC
M&A: BMY to buy MEDX for $16/share in a $2.1B deal
Country ETFs-New Highs: China (GXC, PGJ, FXI), Emerging Mkts (GMF, PXH, EEM), Mexico (EWW), Sweden (EWD), Malaysia (EWM), Hong Kong (EWH), S. Korea (EWY), S. Africa (EZA), Belgium (EWK)
Market Notes: EXTREMELY BULLISH SIGNS: All major avgs (including Dow Transports) have broken major resistance and are above 200dma; Explosion in new highs and in break-outs; Tech-heavy Nasdaq only index with 50dma above 200dma–best performing index

How market timing saves an MPT-allocated portfolio

Tuesday, July 21st, 2009

I’ve been receiving numerous inquiries into the Stock Market Cook Book’s portfolio analytical tool, the SMC Analyzer, which is a powerful software tool that applies proven market timing strategies to Modern Portfolio Theory (MPT). Although Analyzer results have been discussed in previous blogs (see 5/12-13/09, 7/07/09), I feel that some of the points made earlier need to be reiterated.

One of the most frequently asked questions is this:  How did a portfolio based on market timing perform during the recent credit crisis as compared with a traditionally long-only MPT portfolio? Although I’ve already answered this question in the May articles, I decided to update the results to this July and take an in-depth look at how both portfolios would have been allocated on a month-by-month basis beginning in July 2008.

Modern Portfolio Theory (MPT) in a nutshell
Briefly, MPT tries to maximize returns given a certain level of risk. It attempts this by allocating a portion of one’s portfolio over a spectrum of asset classes, each with varying degrees of inter-correlation. For example, an MPT-allocated portfolio would most likely contain the asset classes from both large and small-cap domestic (US) stocks, US government and corporate bonds, real-estate (typically in the form of REITs), and international stocks and bonds. Commodities such as precious metals and oil are also popular asset additions. (Hedge funds can also play a role in portfolio diversification.)

MPT attempts to achieve the desired return via the robustness (that is, the degree of return versus the associated risk) of a particular asset class combined with the degree of correlation (or rather, un-correlation) among the other candidate asset classes. It’s a complex mathematical model for which Harry Markowitz won the Nobel Prize. So far, the theory works well over a very long time-frame, but it does dismally over short, volatile periods because of the requirement that it always must be long in the asset classes determined by the model.

Not so for the SMC Analyzer!

How the SMC Analyzer is different
The SMC Analyzer uses a market timing oscillator that is specifically optimized to each asset class. When the oscillator is positive, it will tell you to be long that asset class; when it turns negative, you’ll be instructed to either go short (if that is what you selected and if that asset class is “shortable”) or else move into the safety of T-bills or another risk-free asset.

So, how did both of these approaches compare over the past year?

Portfolio comparison
Below is a chart that graphically depicts how a traditionally MPT-allocated portfolio would have fared compared with a market-timed portfolio as determined by the SMC Analyzer. In the latter portfolio, it was assumed that when the oscillator for that asset class was negative, those funds that would have been designated by MPT for that asset class would be put into the safety of Treasury bills. In both portfolios, a compounded annual return of 10% is assumed.


You can see that the tradition portfolio failed miserably—not only could it not yield a positive return but the investor would have been down 26% and at a huge risk of nearly 27%. Note, too, that the maximum draw-down was a whopping 45%, on par with the major averages.

However, had you been in a market-timing adjusted portfolio, not only would you have realized a positive return, but also at greatly reduced risk and without any significant draw-down. This is truly amazing!

To see how these differences in results were achieved, let’s look at the asset allocations recommended by MPT for each portfolio on a month-per-month basis. The top table gives the recommended allocations for the traditional MPT portfolio while the bottom portfolio gives the recommended allocations for the market timing portfolio.


Here are several observations derived from the above tables:

1. The risk, as measured by the standard deviation of possible returns, is less than half that in the market timing model.

2. The reason that MPT failed so miserably during the recent downturn is because it is looking towards the longer term and it figures that the only way the portfolio will ever be able to achieve a 10% return is by being long in the highest risk (as well as the highest returning) asset classes, i.e., stocks.

3. In contrast, the SMC Analyzer saw that the market was heading down and re-allocated the monies apportioned to Small-Cap Stocks into the safety of Medium Term Government Bonds and T-bills. It wasn’t until March of 2009 that the stock oscillators began to turn positive indicating it was safe again to invest in those asset classes.

4. You can also see that in order to achieve the monthly asset allocations as recommended by the market timing model involves significantly less trades, a plus for those investors who are worried about commission costs eating into their portfolio profits.

I hope this exercise will put to rest many of the questions that have been raised about the SMC Analyzer’s market timing model. For further information regarding the SMC Analyzer, take the features tour or test drive the Analyzer for yourself. Both are located in the left-hand column of the home page,

*Blue Plate Specials* – July 20

Monday, July 20th, 2009

Breaking out on lower volume (there are many but these are the most compelling): GFA, IBN, JCI
Breaking down: HAR, INFN (to $6.50)
New Highs on lower volume (most compelling): FFIV, IMMU, LFC, UFPI
New Lows: ASBC
Low-priced leaders: BAMM, IMMU, MHLD
Speculative leaders: CRNT, EST, LIOX, TZOO, WPTE, YDNT
Profit taking?: AMKR
Turning around?: GRNB
Sector Watch: New highs: China stocks (GXC), Biotech (FBT—heavy in HGSI), Real-estate (RWX), Tech (XLK), Information Tech (VGT)
Country ETFs: Breaking out: China (FXI), S. Korea (EWY), Mexico (EWW)
Commodities: New 9 month highs: Nickel (JJN), Copper (JJC); Breaking out: Oil&Gas Exploration (XOP), Oil (DBO), Oil Services (OIH), Energy (XLE)
Bonds: Corporate bonds at relative high (CFT)
Market Watch: Bullish signs: VIX below 25 for second day; VXX at new low; most major indexes now above 200dma; Dow Transports at 200dma; many major indexes on verge of breaking out

Is insider buying a meaningful indicator of future stock price?

Thursday, July 16th, 2009

Traders and investors use all types of technical and fundamental indicators in the attempt to predict future price action with insider trading being one that falls into the latter category. What is insider trading and can it be used as a tool to predict future price action?

The answer to the first question is that there are two types of insider trading—legal and illegal, although the line between them can sometimes be blurry. If you’re an officer of a company, a member of the company’s board of directors, or hold more than 10% of the company’s stock, the SEC considers you an insider and as such you are required to file a Form 4 with them when you buy or sell positions in your company’s stock. This public disclosure is the government’s way of legitimatizing insider stock trading.

Certainly, the legalities of insider trading can make for an interesting discussion but my focus today is to answer the second question: Can insider trading be used as a tool to predict future price action?

Does insider buying presage an increase in stock price?
The general theory is that if insiders are trading their stock, they may be doing so on some special knowledge such as an especially good or bad upcoming earnings release, favorable or unfavorable drug study results, or the company is involved in takeover talks. Trading on this type of information is illegal but in most cases it can be very hard to prove, and the SEC just doesn’t have the person-power to look into every such instance of possible abuse.

Is this general theory accurate? In the attempt to answer this thesis, I decided to look at the top insider purchases from the middle of May to the middle of June of this year (2009). I included the top insider trades made by company officers and directors and disregarded those with a 10% or more interest (mostly private equity firms and mutual funds) on the assumption that these outside firms would not be privy to the same information as the company’s insiders. Ideally, I would have liked to include only those trades made by the CEO, COO, and CFO, but that would have drastically limited my sample space.

Here’s a table of the top 24 insider trades made during this time period. Note that some trading days are absent due to the lack of insider trades. Also note that each trade represents a single purchase made by only one individual. [Click on table to enlarge.]


We can see from the above table that if insider buying has any influence on stock price, it only extends for a couple of weeks at most with the average gain being only a modest 4%. This increase could arise not only from improving company internals as perceived by the insider, but also from external market conditions. As shown near the top of the chart, the S&P 500 increased from the middle of May to the middle of June–also a gain of 4%. And when it turned back down, the average insider gain turn into a loss.

Certainly, a larger sample space taken over a longer time-frame would give us more confidence in these numbers, but I do think that even with this limited data set we can see that purchasing stock along with company insiders may not be the most profitable way to invest.

In an upcoming article I’ll test whether or not insider selling can be used to predict stock declines.

Note: I reviewed the news on the largest movers (BID, ECLP, OSG, VVTV) to see if there were any significant reasons for the increase in price following insider buying but I couldn’t find anything that I thought was compelling.

Another lower high or the start of a bullish trend?

Tuesday, July 14th, 2009

The positive market action of the last two days might trick some into thinking that the market is resuming its bullish course that begun in March and ended last month.  Investor exuberance might be tempered by taking into consideration some of the technicals that indicate this rally could be short-lived:

1.  The only major index trading above both its 50 and 200 day (exponential) moving averages is the tech-heavy Nasdaq. 

2. The S&P 500,  the Dow Transports, and the Russell indices are only barely trading above their 50 dmas and are not close to breaking their 200 dmas. 

3. The VIX (volatility index) is trying to poke through major support at 25.  If it can break and stay under that, chances for a bull rally improve.  (See Chart below.)

4. The major indices seem to be making lower highs and lower lows.  (See chart of S&P below.) The previous high needs to be broken convincingly for a bullish rally to occur.

5. Volume is light but that could well be a seasonal effect.



Website news & MANDA updates

Monday, July 13th, 2009

Website news
First of all, Dr. Kris wishes to thank Professor Pat for taking up the slack last week while I was on vacation. His two articles on the effect of adding gold to a diversified portfolio and his other article on the difference between compounded and average returns are not to be missed, especially for you long-term investors.

The second order of business is that the interviews I did at the Los Angeles Trader’s Expo last month are available for viewing. I did four short interviews and they are listed as links below the Blue Plate Specials on the right. Just so you know, Dr. Kris does not photograph well at all and looks infinitely better in person.

MANDA Portfolio Updates
The last trading day for Nova Chemicals (NCX) was July 6th. It was successfully acquired by Abu Dhabi’s state-owned International Petroleum Investment Company at $6 per share. The updated portfolio table reflecting this change is given below.

On July 8, AT&T (T) announced that it expects its acquisition of Centennial Communications (CYCL) to close in the third quarter instead of the second. The deal still needs the seal of approval from regulatory agencies.


The Relationship Between Arithmetic and Compounded Average Returns

Thursday, July 9th, 2009

I first wrote about this topic on 6/2/08 and Dr. Kris herself covered another aspect of the subject on 4/13/09. My article was entitled “MPT Part VI: Arithmetic vs Compounded Returns.” Since that time monthly data has been assembled for each of the nine asset classes back to 1928 and the development of the SMC Analyzer software now permits graphic analysis. So let’s have another look at this important topic.

When optimizing the allocation of assets in an investment portfolio the goal is that they will produce a certain average annual return in addition to doing so with a minimum variation about this average. There are two ways in which returns can be evaluated, as an Arithmetic Average or as a Compound Average. These two can be significantly different from each other and the consequences of this difference to the value of a portfolio can grow significantly with time.


An example of an Arithmetic Average return is as follows: An asset class produces annual returns over a three year period of +8%, -5% , and +12%, the Arithmetic Average return is:

(8 – 5 + 12) / 3 = 5.00%

The Compounded Average annual return is a bit more complicated to calculate. For this same example it is:

(((1 + 8/100) x (1 + 5/100) x (1 + 12/100) )1/3 – 1 ) x 100 = 4.74%

The Arithmetic Average is higher because it unfairly weights percentage gains equally with percentage losses. If one asset class experiences a 50% loss in any one year then a 50% gain the next year will not entirely recoup the earlier loss but will in fact recoup only one half that loss. The Arithmetic Average return of the two years is zero but there is still an overall loss over the two years as shown by the Compound Average return which in this case would be -13.4%. It actually takes a 100% gain to recover from a 50% loss. In this way, a Compounded Average return actually numerically weights losses more heavily than gains.

In general, the Arithmetic Average will be greater than or equal to the Compounded Average with the difference between the two averages positively related to the Arithmetic Average standard deviation of the data. In the following approximation formula the variance is the standard deviation squared.

Compound Average = Arithmetic Average-variance/(2*(1+Arithmetic Average))

An ideal compounding rate would be unbiased in the weighting of gains and losses. For short investment horizons the Arithmetic Average is closer to this ideal and is a better measure for predicting what is more likely to occur in a single time period. A Compounded Average on the other hand is more representative for what is likely to occur over many time periods in terms of the long term accumulation of wealth.

Portfolio Return Data:

Let’s look now at some actual portfolio return data using data for nine asset classes provided with the SMC Analyzer to compute the approximate relationship between Arithmetic Average and Compound Average for two strategies. The first graph is the application of classic Modern Portfolio Theory optimum asset allocation where all assets classes are held in the recommended allocation percentages with no market timing strategy applied. These graphs were not computed using the approximation formula above. 


You can look up the Compound Average return along the bottom of the graph and see what equivalent Arithmetic Average return would be required to produce about the same level of portfolio growth. In this scenario a 13% Arithmetic Average rate of return would be required to equal a 10% Compounded Average annual return.

The two return values will have the same standard deviation about their respective averages. What makes this approximate is that the portfolio allocations are not the same and the actual distributions of returns are not exactly the same. The equality of the measures of risk (standard deviations) implies equality in level of return.

The graph below shows the relationship between the two averages using the Modern Portfolio Theory market timing enhancement of placing a particular allocation for an asset class in the safety of T-Bills when a significant and durable downward market trend in that asset class is identified.


As can be seen, this graph expands the range of returns achievable to 17% Compounded and 19% Arithmetic Average. You will notice that the two averages are closer to each other than in the graph further above for the classic Modern Portfolio Theory application. This is due to the lower variance (lower risk) in the distribution of returns with the market timing strategy applied.