Recoup Your DOW and ROH Losses

The Dow Chemical Company [[DOW]] and Rohm and Haas Company [[ROH]] may be trading lower after their merger financial fell through, but clever shareholders bullish on a recovery still have options to speed up their recovery. The so-called Repair Strategy can be used to reduce investors’ breakeven point and speed up a recovery of the losses experienced.

The Dow Chemical Company and Rohm and Haas Company announced that financing for the deal fell through, but they would continue to work diligently towards completing the proposed transaction in early 2009. This means that many of the losses today could end up being offset in the future upon a consummated transaction assuming that the pricing remains attractive.

Concerns about the viability of this merger were already present in the options pricing over the past few weeks. The premiums being paid on long-term call options of Rohm and Haas offered large premiums – a great risk/reward for existing shareholders. The high premiums suggested that many investors were hesitant to get into the stock until the merger was completed and opted to purchase options instead. So, how can those investors remaining bullish reduce their breakeven point for free?

The repair strategy involves building an options position around an existing stock position in order to lower the breakeven point without committing any additional capital. This is done by purchasing one long call while simultaneously writing two calls for every 100 shares owned. The premiums collected typically more than offset the cost of the call while the 100 shares owned by the investor covers the second written call. Finally, the long call’s upside will decrease the investor’s breakeven point.

The viability or profitability of these positions depend on the individual investor’s entry price and other factors. See “Recouping Losses with the Repair Strategy” for a detailed look at how this strategy works and how it can be executed and checkout our Tools & Products for more ways to make money with LEAPS.

Amazon’s Holiday Results Raise Questions

Amazon.com, Inc. (NDAQ: AMZN) is one company that tends to profit when others in its industry do poorly. The retail industry has been crippled by sharply lower consumer spending and higher costs, which has begun to shift the trend towards online retailers like Amazon.com. The book store turned everything store recently reported its best Christmas ever in a recent press release.

The press release drew some criticism from the investment community as it lacks some key facts. CNBC’s Fast Money noted that it contained a lot of “black holes” with no mention of “margins” and “promotional activities”. The market reacted by opening higher and then falling all the way until the close while selling continued into today’s session.

The concern is that Amazon.com’s margins may have been hurt while trying to boost its sales. The factors behind the higher shipment numbers may have more to do with tax savings, bad weather, comparison shopping and discounted prices. As a result, the actual impact of the higher top-line sales on bottom-line results remains to be seen.

So, how can investors bullish on Amazon.com participate in the stock’s upside without taking the risk of stock ownership. One way is to purchase long-term options called LEAPS or long-term equity anticipation securities. These options allow investors to purchase the rights to shares over one or two years time at a fraction of the cost of underlying stock ownership.

Currently, investors can purchase $40 January 2011 LEAPS call for just $21.85 per contract compared to $49.50 per regular share. As a result, investors can spend $2,185 for the right to buy 100 shares anytime during the next 753 days versus spending $4,950 to purchase 100 shares of the underlying stock. Investors looking for a lower breakeven and shorter timeframe can also look at the January 2010 calls.

See “Using LEAPS as a Stock Substitute” for more information or check out our Tools & Products section to find more ways to profit using LEAPS.

Time to Buy Drybulk Shippers?

The dry bulk industry may be on the decline with lower asset valuations and tumbling freight prices, but some investors believe that the record-low valuations may spur some positive action. Dry bulk shipping rates have plummeted more than 90 percent since last summery while the net asset values of the ships have dropped 70 percent in some cases. The result has been record low valuations for the owners of those ships – those companies operating in the dry bulk industry.

The Baltic Dry Index, which measures day rates for dry shipments, recently moved below 800 signaling the worst pricing since around 2002. These lower day rates are the result of reduced demand due to slowing economies around the world. Less iron ore shipments need to be made given the slower construction in both the United States and growing economies like China. However, many important players in the market are predicting a recovery.

DryShips (DRYS) is one stock that has nearly tripled from its 52-week lows on speculation that things will improve. Chief executive and 34% owner George Economou believes that the company will be able to weather the storm over the long-term. These sentiments have even led to speculation that that billionaire shipping mogul would take the firm private at its cheap valuation and take it public in a few years to yield several times the return.

Many experts believe that the current Chinese iron ore negotiations are moving in favor of dry bulk shippers. Jefferies & Co. said in a research note that a successful downward adjustment to iron ore prices in China could spur demand for the dry bulk market by increasing the number of shipments. Meanwhile, much of the capacity expected to go online has been canceled and fuel / labor prices have also decreased over the past several months.

Unfortunately, many dry shippers are highy leveraged. The risk is that dry bulk owners will simply default on their payments, go into bankruptcy, and emerge under a new name after cleaning out shareholders. It wouldn’t be anything new for DryShips, which was created from the bankruptcy of predecessor Alpha Shipping. That entity was also owned by Economou and went bankrupt in 1998 and resulted in 37 cents on the dollar being paid to creditors and most of the fleet under his ownership.

Safe bets within the sector may be those dry bulk carriers with low debt, few new builds, and limited spot market exposure. These companies include names like Eagle Bulk Shipping (EGLE), Genco Shipping & Trading (GNK), and Star Bulk Carriers (SBLK). Unfortunately, even some of these companies are struggling with Star Bulk already defaulting on a $106,500 a day long-term contract after its client filed for bankruptcy and killed the contract.

So, how can investors get involved with these companies with limited risk? One way may be through long-term options call LEAPS – or long-term equity anticipation securities. These options provide investors with the upside of stock ownership without the risk of owning the stock. Investors can purchase the right to a set number of shares at a fraction of the cost of owning the underlying shares.

See “Using LEAPS as a Stock Substitute” for more information on this strategy or see our Tools & Products section for products to help you invest with LEAPS.

Rohm and Haas Options Present Opportunity

Rohm and Haas Company (NYSE: ROH) manufactures specialty materials but options traders may find something else special with the company’s stock. The company’s $65 January ’09 calls are currently trading with a return on investment approaching 12.5%, making it a very strong covered call play for conservative options investors.

A covered call involves writing calls against stock that the investor already owns in order to collect the options premiums. In this case, ROH investors that own 100 shares can write call options against the position and collect $800 per 100 shares they own. With a current market price of $63.36, or $6,336 for 100 shares, this equates to a return of roughly 12.5% in just 21 days until expiration.

The risk with establishing this position is that the underlying shares will decline and you’ll lose money on the stock that exceeds the $800 that you gain for writing the option. Moreover, if the stock goes above $65, you will be forced to sell the shares at that price and make only about $1,000 on the position. However, if the stock remains roughly the same, you’ll make about 12.5% on the firm.

Investors looking to make even more money with less money at risk may want to consider using LEAPS calls as a stock substitute. Instead of owning 100 shares for $6,336, investors can instead purchase the right to 100 shares over the next year at $55 for only $1,700 total down. This equates to a hefty 47% return on investment with the additional risk being that you could lose $900 – or 14.2% if you owned the stock itself.

See “A Better Alternative to Covered Calls” for more information on this strategy or check out our Tools & Products for more strategies that can help you make money!

Hedge Your Bets on Target with LEAPS

Target Corporation (NYSE: TGT) may be hurting from lower retail sales, but at least one investor has found value in the stock. Pershing Square’s Bill Ackman believes that the real estate under Target’s stores could be worth much more than its current market capitalization. As a result, the activist investor proposed spinning off the land into an REIT that would lease it back to unlock value.

The problem with the plan is that it is seen by Target as being risky in today’s environment. The new REIT may have a great renter and properties collateralized by hundreds of millions of dollars in buildings, but the retailer that is left over may be left in a weaker position. As a result, Pershing Square opted to wait until after the holiday season was over before resuming discussions.

The season is now over and investors are left with a predicament. The retail sector is expected to have one of the worst holiday seasons ever, which has pushed down shares of all retailers. However, Pershing Square’s analysis has clearly shown substantial value in Target’s real estates. So, how can investors get exposure to Target while reducing the risk of further declines in retailers?

The answer is simple: Hedge your bets using broad industry indexes! The Retail HOLDRs (NYSE: RTH) exchange traded fund is considered to be the best retail industry index. Investors looking to hedge against a decline over the long run may want to purchase LEAPS puts to hedge out their retail exposure. Currently, the $70 January 2011 LEAPS puts are trading for just $14.90 per contract. This means that investors can purchase roughly 100 contracts to offset every 200 shares of Target.

The resulting position is one that is hedged against a decline in the retail sector. As a result, investors can only make money when Target outperforms the retail sector as a whole and lose money when Target underperforms the retail sector as a whole. Since Target’s real estate is undervalued, this outperformance will occur when the value is unlocked over the next two years.

See “Using LEAPS as a Hedge” for more information on this strategy or take a look at our Tools & Products for more ways to make money!

Brooks Automation Seen as Undervalued

Brooks Automation (NDAQ: BRKS) shares have recovered from their lows, but many value investors insist that the stock remains undervalued. David Nierenberg of D3 Family Funds is one of these investors that first made a case for the stock at this year’s New York Value Investing Congress. Despite the compelling arguments, Brooks’ stock continued to slide to their current levels.

Brooks Automation is now trading for roughly its net asset value, which makes it an attractive stock in the eyes of Jonathan Heller of Value Investing Congress. The CPA noted in the organization’s blog that buying the stock at its current price of $5.10 is like buying $2.25 in cash, $1.17 in other assets, and getting an additional $5.11 in long-term assets, $1.82of which are PP&E and LT marketable securities.

Despite the deep value, many investors are concerned about Brooks Automation’s recent earnings. The company reported progressively worse earnings throughout 2008 and is expected to report growing losses into the third quarter of 2009 before things begin turning around. This cash burn could end up reducing the amount of cash on the books and deteriorating the value of the stock.

The bright side of the situation is that Brooks Automation has accrued more than $114 million in net operating loss carry-forwards to offset taxes on future income. Moreover, the company has no debt on its books and a strong capital position, which means it would likely have no problems if it were to obtain debt to pay its bills and use the cash to unlock value through a buyback or other action.

So, how can investors take advantage of this steep discount while committing less capital upfront? One way may be to use long-term options. While there are no LEAPS available on the stock, investors can purchase options with an expiration date set in April of 2009. Currently, the $2.50 April 2009 call options are trading for $2.60 per contract. This means investors can purchase the right to 100 shares at $2.50 anytime over the next 115 days for just $260 versus $510 purchasing the underlying stock.

See “Using LEAPS as a Stock Substitute” for more information or check out our e-book “Trend Trading on Steroids” for a more comprehensive strategy.

Is Activision Undervalued?

Activision Blizzard, Inc. (NDAQ: ATVI) consumers may be playing games, but the company is making some serious cash. The videogame manufacturer has seen its shares cut in half over the past 52-weeks, but the industry is very resilient and several big name titles could provide a much needed catalyst. So, when is a good time for investors to pick up a stake?

Activision Blizzard is well known for its strong portfolio of notable titles. Guitar Hero has become a household name with commercials featuring NBA All Stars and singers. Meanwhile, World of Warcraft has grown to become the largest online multiplayer game – it even has a rock legend in its commercials! And the company’s upcoming release of StarCraft promises to be another blockbuster release.

Activision Blizzard is also very strong from a financial standpoint. The firm has no debt with a relatively modest price-earnings ratio of 24x. The company also continues to benefit from low overhead costs via online sales and limited capital expenditures. In fact, Activision is one of the few remaining profitable companies in its industry, unlike competitors like Electronic Arts (NDAQ: ERTS).

Overall, Activision represents a strong growth play that could pay off in the long-run despite some short-term volatility. Investors looking to buy into Activision without taking on all the risk might want to take a look at long-term options called LEAPS – or long-term equity anticipation securities. These options can help investors dramatically improve their return on investment while putting less capital at risk.

Currently, investors can purchase $10.00 January 2011 LEAPS calls for just $4.00 per contract. This would give investors the right to 100 shares at $10.00 per share anytime during the next 760 days. The breakeven point would then be $14.00 per share – a 40% premium over the next two years. Meanwhile, investors would risk only $400 upfront versus the $918 required to buy the underlying stock now.

See “Using LEAPS as a Stock Substitute” for more information or check out our e-book “Trend Trading on Steroids” for a more comprehensive strategy.

CVS Remains Strong, Could Benefit from Acquisition

CVS Caremark Corporation (NYSE: CVS) may have dropped on lower earnings over at Walgreen Company (NYSE: WAG), but a closer look at the earnings report may not justify the move downwards. Walgreens reported profits that fell 10 percent in its fiscal first quarter, but the lower results were primarily attributed to costs to open more than 200 new stores.

Prescriptions, which represent the majority of sales at both CVS and Walgreen’s, are widely expected to be flat in 2009. Walgreen’s reported a 6.2% increase in overall prescription sales, but saw only a 2.6% growth in same-store sales for the segment. Many analysts expect the industry to report a 0.5% drop in prescriptions during the same period, according to IMS Health and Walgreen’s figures.

CVS investors may not have high expectations for prescription sales figures, but will be watching the firm’s acquisition of rival Long’s Drugs very closely. The hotly debated acquisition drew at least one activist who insisted that the acquisition sharply undervalued Long’s real estate portfolio. Investors will be watching how management unlocks this value and leverages its infrastructure to improve the brand.

Activist investor William Ackman’s Pershing Square believed that the real estate under Long’s stores were worth some $1 billion and even found parties willing to pay substantially more than CVS’s $71.50/share offer. CVS also noted that it intends to make money off of these assets by either selling them or generating cash through sale-leaseback transactions. This could spell substantial value for CVS shareholders over the long-run.

Investors looking to take advantage of the long-term prospects for CVS given its low multiple and strong prospects may want to take a look at long-term options called LEAPS – or long-term equity anticipation securities. Currently, investors can purchase $25 January 2011 LEAPS call options for just $8.10 per contract. This would give the holder the right, but not obligation, to purchase 100 shares of CVS at $25 per share anytime during the next 760 days.

See “Using LEAPS as a Stock Substitute” for more information on this strategy.

InterMune Options Present Opportunity

InterMune, Inc. (NDAQ: ITMN) shares may present an opportunity to investing experienced writing covered calls. Currently, the $12.50 January 2009 calls are trading for $2.30 per contract while the stock trades for just $11.79 per share. As a result, shareholders who purchase 100 shares for $1,179 can earn a 19.5% return on investment in just around one month. The trade-off is that the shareholder takes on the risk if the stock declines during that time period.

InterMune is set to report its Pirfenidone data in the first quarter of 2009 before the call option expires. This has led to a high level of expected volatility which increases the options premiums demanded by those that write options. The success or failure of these results will likely determine whether or not these options are in the money. Investors unwilling to risk 100 shares worth of capital instead purchased the options at a cheaper cost for upside.

Luckily, long-term options called LEAPS can help shareholders reduce their risk and increase their returns. By using these long-term options as a stock substitute investors can reduce their capital at risk to just $680 versus the $1,179 needed to purchase the actual stock. How? The $10 January 2010 LEAPS calls are trading for just $6.80 per contract (ask price), which means investors can buy the right to 100 shares for just $680 down. The return on investment for writing the short-term calls would then be around 33%.

Using LEAPS investors can increase their returns while reducing their capital at risk. The only downside is that if the stock’s price rises above $12.50 over the next month or so, the investor will either have to buy back the call option at a loss (offset by the increase in LEAPS value) or exercise the LEAPS option and immediately sell the shares to make good on the written call. Typically, it is cheaper to simply buy back the written call option and take the profit on the LEAPS as it involves less transactions costs.

InterMune is a biotech company focused on developing and commercializing therapies in pulmonology and hepatology. Shares of the company rose $0.27, or 2.33%, to $11.48 during Friday’s session.

See “A Better Covered Call Alternative” for more information on this strategy.

Top 3 Retailers for a Tough 2009

Retail stocks have had a rough year that just keeps getting worse with last month’s drop in consumer spending being the largest since the data began to be tracked in 1947. Unfortunately, things do not look much better for 2009 with some 44 percent of consumers saying that they would further cut spending after the holidays, according to a study conducted by America’s Research Group. However, some investors see opportunity for strong retailers that can weather the storm…

Many investors looking at the retail sector will find no shortage of value in the form of low multiples, but relative value is no longer a valid measure in today’s environment. Investors should instead look at brand strength, asset valuation, cash flow generation and debt load to find retails that will be able to not only survive but thrive in the economic crisis. So, without further ado, here are our top three retail stock picks for 2009:

Wal-Mart Corporation (NYSE: WMT)

Wal-Mart’s stock has continued to perform well throughout the economic crisis as consumer sought lower prices. The discount retailer has also attempted to reinvent its image to include quality along with price while expanding its presence internationally. Combined, these changes have resulted in a 9.4 percent jump in third quarter net sales with the international segment leading growth.

Despite a modestly lower guidance for the full year, Wal-Mart continues to be one of the strongest retailers in the United States given its strong value proposition to customers. Meanwhile, the retailer’s efforts to reinvent itself as a quality retailer may end up paying dividends down the road when the economy recovers and consumers open up their billfolds, especially against rival discount retailers like Target Corporation (NYSE: TGT) and Macy’s (NYSE: M).

Investors interested in taking advantage of Wal-Mart shares over the long-term may want to consider purchasing long-term options called LEAPS (or long-term equity anticipation securities). Currently, investors can purchase $55 January 2011 LEAPS calls for $12.95 per contract. This means that investors can buy the right to 100 shares at $55 anytime over the next 764 days for only $1,295 compared to $5,519 by purchasing the underlying stock.

Target Corporation (NYSE: TGT)

Target has recently been the target of activist investor William Ackman’s Pershing Square. The hedge fund noted the fact that the retailer owns the real estate under the vast majority of its stores and estimates that it could be worth roughly as much as the company’s current market capitalization. As a result, Pershing Square recommended that the firm spin-off the land portion of the real estate into an REIT that would lease-back the property to the stores via a ground-lease.

Theoretically, this plan would unlock tremendous value for Target shareholders. The new REIT would be forced to trade at a reasonable valuation given its massive size and security (having Target stores as collateral in the unlikely case of default). Meanwhile, Target’s strong cash flows and balance sheet make it one of the best tenants that any real estate owner could desire. Finally, Target would be unencumbered with many of the costs associated with purchasing land for new stores (now covered by the REIT.

Investors looking to take advantage of this situation may want to consider a pair trade between Target and the retail ETF (NYSE: XRT). One Target LEAPS call and one retail ETF LEAPS put with the same dollar amounts will create a situation where investors will only profit when Target outperforms the retail sector. This means that no losses will be incurred when the retail sector declines, only when Target sees its value unlocked or comes to value.

Aeropostale Inc. (NYSE: ARO)

Warren Buffett chose to invest in this specialty retailer for a good reason: Aeropostale has no debt, strong cash flows, and an easy to understand business. Shares may be down some 32 percent over the past year, but the firm’s fundamentals remain very strong. Return on equity stands at a huge 54 percent while operating and profit margins remain strong despite the uncertain economy. Finally, the firm’s $100 million in free cash flow generation certainly has many investors interested.

Investors looking to make a bet on this stock may also want to take a look at long-term LEAPS options. Currently, investors can purchase $20 January 2011 LEAPS calls for just $6.60 per contract. This means that investors can have the right to 100 shares at $20 per share anytime during the next 764 days for just $660 down compared to $1,747 for the underlying stock.

See “Using LEAPS as a Stock Substitute” for more information.

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