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.