Tuesday, September 30, 2008

Market Turnaround Strategies: VIX Options

While it's premature to discuss whether or not Congress will pass some sort of bailout package in the near future, it's not too early to discuss ways we can profit if and when the market does eventually stage a turnaround. I know you're tired of me talking about the VIX, but it has been a very good indicator of market climate and had you reduced your holdings according to the VIX levels that I've mentioned in the past (see July 14 blog: The VIX, the Market, and the Investor ) your portfolio would be mostly (if not all) in cash. But you won't need to wait for the VIX to drop below 20 to start investing again, even if your investment philosophy is ultra-conservative. Over the next few days, we'll be looking at strategies that I feel will be the most profitable once the market rebounds. Sure, some of the following strategies are risky, but there will be many that you non-risk takers will find palatable.

First of all, I don't think yesterday's huge drop constituted a market bottom. Why? The unscientific answer is that it just didn't feel like one, and chart-wise, it doesn't look like one, either. During the 2000-2003 tech shake out, the S&P spent over two years in decline putting in five lower lows before forming a triple bottom that marked the end of that bear market. This time, we're only 21 months or so into this decline with the S&P putting in only four lower lows. Of course, the dynamics of each bear market are different, so who knows if we're going to hit another low before capitulation? Although I'm not an economist and can't claim to understand the intricacies of credit swaps, I think we will see at least one more low and I also think that the VIX is going to break the 50 mark before heading back down.

That's the bad news. The good news is that we can spend some of this time on the sidelines figuring out our course of action when the market does recover. Here's a sampler of a couple of plays on the volatility index that you folks with a taste for adventure might want to consider. They're some of the riskier plays I'll be mentioning and unfortunately they do require knowledge of options, so please don't try these unless you know what you're doing.

VIX plays: higher risk options plays
The VIX, the index that measures market volatility, is the only major index that does not have its own tracking stock (ETF). Alas, there are only two ways to trade it—either with futures or options. If any of you want to trade the futures, I'd do so ONLY as a hedge unless you have extensive experience trading this instrument. (If you think options are risky, the leverage on futures is even greater.) For you options enthusiasts, here are a few spread plays to consider:

1. Bear call credit spreads using near-term options (October or November). A bear call spread is one where you sell the lower strike call and buy a higher strike call for a net credit. I'd recommend selling a 35 or 40 strike as the lowest strike and I'd do it ON THE DAY the VIX hits its next high. Remember that your maximum loss is limited to the difference in strike prices less the net credit.
2. Bear put debit spreads using medium term options (December and later). A bear put spread is one where you sell the lower strike put and buy the higher strike put for a net debit. If you're a nimble options trader, the best way to play this one is to leg into it by buying the higher strike put at VIX tops (market bottoms) and sell the lower strike put when the VIX has declined. The reason I suggest a debit spread instead of just buying a plain put is that the spread somewhat mitigates the higher cost of the puts as compared with the calls (because of higher implied volatility in the puts). I'd stick with spreads that have break-even points above 30; more conservative investors should stick to break-even points above 35.

I've found from painful personal experience that it's best to close out an options position when there's little profit left to be had just in case the market does the unthinkable, even if it's only one hour before expiration. When it comes to options, it's much better to be safe than greedy.

In the next few days we'll look at ways of playing other market indexes, sector ETFs, and select stocks.

Monday, September 29, 2008

Straddle Alert!

Back from vacation (boo!) and am watching the vote on the floor of Congress regarding the bailout. It's a real nail-biter as the vote is close as of the time of this writing, and I'm thinking that this is a great opportunity for those of you savvy options players. If the bailout passes, the market is poised to soar. If not, I do believe the market will tank and badly.

This type of situation screams for a straddle on the tracking stocks or the indices. I know I'm late getting this out, but if you don't have time to put on this type of trade, it'll still be interesting to watch. For all of you conservative players, I dearly hope you're in cash.

Monday, September 22, 2008

Gone Fishin'

Dr. Kris is out in the field doing research this week.

The Stock Market Cook Book will return to its regularly scheduled time slot next week. Stay tuned for some new recipes!

--Dr. Kris

Friday, September 19, 2008

Garden Green

There was an interesting article in Sunday's Los Angeles Times' finance section (which is also the real-estate/home section, another ugly by-product of downsizing) that said that because of the rising grocery prices and a renewed interest in all things great and green, gardens are suddenly becoming popular. According to the article, sales at Burpee and other seed companies are up 30% this year alone as are sales at Armstrong Garden Centers, a local garden supply chain.

Digging for profit potential, I looked at the charts of gardening-related companies. Unfortunately, there are no publicly traded companies along the lines of an Armstrong's which means that we'll have to look at the broad-based retailers in the home and garden category. This includes Home Depot (HD), Lowe's (LOW), Conn's (CONN), Tractor Supply (TSCO), and Sears (SHLD) which owns the Orchard Supply chain.

Now Home Depot and Lowe's have had a nice run-up since July, parroting the movement of the homebuilders. Lately, these stocks have been pulling back and I'm not exactly sure where they're headed in the short term. If you like these guys, I'd wait for some sort of price confirmation before entering. (They're both right at their 50dma's and at minor support.)

The charts of the other three stocks look much more compelling. I like Conn's and Tractor Supply the best. Conn's broke out of a nine month base last week on heavier than normal volume. Tractor Supply is breaking through overhead resistance at $45 and if we get another day of confirmation, this would be a good entry point. Sears has already risen over 40% since July and is butting up against the $100 level. If it can break through that, I'd suggest entering maybe a half position since it's already had a good run-up.

That's about it for today. I've heard from one reader how he's getting tired of me yakking about the VIX (and frankly, I am too) so I decided to go with something completely different. So plant some seeds into this group and watch your profits grow. Hey, who said money doesn't grow on trees?

Thursday, September 18, 2008

Spike in the VIX = Market Capitulation?

I've been talking about the VIX for the past several days saying that market capitulation is at hand. Well, today I do think we got our capitulation as the VIX (volatility index) hit a record high, at least since it was redefined in 2003. The major averages are all putting in bottoming tails, and are recovering nicely going into the close. Let's keep our fingers crossed that the worst is over.

Brave investors might want to buy some long-term calls (6 months or more) on the index tracking stocks, as I mentioned previously. An even more speculative play would be to buy puts on the VIX. (The Feb20 puts are trading for about 75 cents.)

M&A Update:
I gritted my teeth and hung in there with Bluegreen (BXG). The stock almost made it back to $9 but interest waned near the end of the day where it closed at $8.86.

M&A Activity Today:
Warren Buffett offered to infuse much-needed capital into Constellation Energy (CEG) after Standard & Poor's put the company on credit watch. Of course, the capital infusion comes with a hefty price tag, that being a $26.50 per share offer for the company's outstanding shares. This may seem like a nice premium over yesterday's closing price of $24.77, but considering that the company was trading at an all-time high of $107 last December and at $70 only a month ago, I'm sure Constellation's shareholders aren't going to be very happy, to say the least. But Wall Street is betting that Buffett can pull another rabbit out of his hat by sweet-talking company investors. All he has to say is, " Look what happened to Lehman."

Anyway, it's not a done deal until tomorrow when a definitive agreement is expected to be signed by the end of the day. Today's five point volatility in Constellation's stock may have been a reflection of investor uncertainty, and how can you blame anyone for thinking that the Constellation shareholders aren't going to have something to say about it?

Wednesday, September 17, 2008

Is There No End to this Misery???

I thought yesterday that perhaps we've seen the worst what with the VIX closing above 30. Silly me. Good thing I didn't buy those index calls! There's so much media speculation concerning how we got into this mess, how much further do we have to go, and who's ultimately to blame. The playing field is already too crowded and the focus of my blog is more on the interpretation and implementation of technical patterns rather than on the economic forces behind them. Okay, so the financial system is collapsing. Were our portfolios prepared for such a downturn? Do we have a plan for when the market turns around?

That's why I'm here. My goal is to educate the reader so that he or she will be able to discern the climate of the market and know what strategies to implement. There are plenty of financial blogs that thrive on speculation and finger pointing, and many interesting and sometimes heated discussions that ensue. This blog is not one of them. Sure, I'd love more feedback and I encourage it, especially comments that focus on the technical (although I certainly won't discourage thoughtful comments on other subjects either). Just in case you're still in the dark as to my mission statement, it's to educate the reader about market technicals (see Cooking Tools) and arm him with viable trading strategies that he can employ under the prevailing market climate (see Recipes).

Okay. I'll step off my soapbox. For now. So, where were we? Oh yes, the VIX. It took a huge gain today, marching steadily upward where it ended today's rotten session at 36 and change, closing in on its recent high of 37.5. Because of the unprecedented happenings in the financial market, nobody really seems to know much of anything with forecasts as to when this mess will end ranging from tomorrow to a generation from now. This is uncertainty at its best (or worst, depending on your point of view) and I'm betting that the VIX might hit 50 or even higher before everyone finally throws in the towel.

Yes, I'm speculating along with everyone else. I don't know, either. This type of market is something that hasn't been seen in at least a generation or two. So, what's the average investor to do? There are still some sectors that having been doing pretty well, most notably the regional banks (I wanted to cover them yesterday but other stuff got in the way), the retailers (see 8/21 blog), the airlines (because of falling oil prices), some of the homebuilders (see 9/8 blog), and of course our old favorites, the ultra-short contra ETFs. If you hold large positions in the latter stocks, I'd suggest taking some money off the table when the VIX heads below 25.

That's my rant for today. Maybe tomorrow Mr. Market will be in a better mood.

Note on Bluegreen (BXG) in MANDA porfolio
I said I'd sell this stock if it dropped below $9 which it did right at yesterday's close. I was thinking that perhaps some of these trades were limit sell orders and the floor trader decided to clean them out. I bravely or stupidly (probably the latter) hung in there today, waiting to see if the price would firm up, and it did. With all of the uncertainty swirling around deal financing, it's tough to know where the valuation on this stock should be. (The same could be said for Photon Dynamics (PHTN), another portfolio holding.) So, I guess I'll play this one by ear and hope that I'm not making a huge mistake. (Did I mention that hope was my downfall?)

Today's M&A activity:
Flash-memory maker Sandisk (SNDK) today rejected a $5.85 billion takeover bid by Samsung saying that it undervalued the firm. The offer translates into about $26 per share and represents a 73% premium over yesterday's closing price of $15. Although this bid seems juicy, Sandisk shares were trading as high as $30 just last May. Today's news caused the stock to jump $6 which probably represents a new price floor as the company said it's open to other offers. I'm not going to jump on this one until a deal is announced and approved by the board.

Tuesday, September 16, 2008

VIX Plays Reminder

As I've mentioned before, whenever the market volatility index, the VIX, spikes over 30 (and especially over 35), a market recovery follows. Historically, this has never failed. (See the weekly charts of the VIX versus the SPX below.) The only variable to this equation is the length of the recovery. Some recoveries last for years while others only last for several weeks. Whatever the case, what are the best ways to profit from this market phenomenon?

Fortunately we've already examined this in the July 15th blog, the last time the VIX rose over 30. This signaled a short-term rise in the market. In the four succeeding weeks, the S&P rose 90 points (over 7% ) before rolling over. Had we bought the tracking stock, the SPY, we would have made 8% (the tracking stock doesn't track the index exactly), but if we had bought, say, the December 120 calls, we would have made around 40% on the trade. Remember now that I'm assuming perfect timing, something that's much easier to accomplish in theory than it is in practice. We have the cue when to enter the trade, but the exit timing is more nebulous. A trailing stop or a trendline stop is better than no stop in this case.

So, if you want to make a play on declining volatility (although past performance is no indication of future success blah blah blah), check out your favorite tracking stock and put on a position in either the stock or a bullish options play, depending on your level of expertise and risk.

Popular tracking stocks with liquid options:
SPY-S&P 500
DIA - Dow Industrials
QQQQ - Nasdaq 100

New MANDA Position: Philadelphia Consolidated (PHLY)

On July 23rd, Japan-based Tokio Marine entered into a merger agreement with property and casualty insurer Philadelphia Consolidated (NASDAQ: PHLY). The $4.7 billion all-cash deal stipulates that Tokio Marine would acquire all outstanding shates of Philadelphia Consolidated for $61.50 per share and is subject to the usual shareholder and regulatory approval.

Phillie's stock has been recently trading in the $59-$60 range but took a tumble yesterday along with the rest of the insurers. As soon as the stock showed some signs of life earlier this morning, I picked some up at $57.02 for an expected return of almost 8%.

MANDA Updates:
Bluegreen (BXG) fell below my target sell of $9.00, but is currently trading above that. If it can stay above $9.00, I'll keep holding onto it.

Photon Dynamics (PHTN) gapped down today on no news and is now trading at preannouncement levels. Barring a fundamental change in the company, I don't see any reason to get rid of it. However, if it falls below $12, I might have a change of heart. It sure would be nice to know what's going on, though. I've checked a few of the more popular message boards and haven't seen anything. Huh.

M&A Activity:
None today.
Yesterday: Best Buy (BBY) will buy Napster (NAPS) in a $2.65 per share all-cash deal valued at $121 million. The deal is subject to the usual shareholder and regulatory approval and is expected to close in the fourth quarter of this year. Put this on your watch list and if it falls below a certain point, say $2.50 (6% return), then you might want to pick some after first doing due diligence on the possible cause of the drop. (The stock is trading right now at $2.53 and was trading as low as $2.48 (7% return).)

Monday, September 15, 2008

MANDA Positions Update

Today's market implosion in the financials have spilled over into our mergers and acquisitions portfolio, the MANDA Fund. All of the funds five holdings are down today, and although the damage is hardly on par with AIG and Lehman, I do feel it's my fiduciary duty to examine the portfolio and give guidelines not only for current holdings but for future acquisitions as well.

Bluegreen Corporation (BXG) fared the worst today but not because of any financial fallout. A company press release said that Diamond Resorts, the acquiring company, needs more time to conduct its due diligence, extending its exclusive agreement to November 15th. No other details were given leaving already nervous investors to speculate as to why the deal is being held up. The stock closed down 13% at $9.54, just above its intra-day low. It's tough to say what would have happened under more normal circumstances, but I'm thinking investor reaction might not have been nearly so severe. But that doesn't mean that I'm going to watch the price slide much further. I'll give it a some wiggle room based on continued uncertainty but if it falls below $9, I'm getting out. I don't want to be there if the price sinks to its $6 preannouncement level.

Photon Dynamics (PHTN) was down over 5% on no new news. As has been noted in recent blogs, the stock tumbled several days ago on what appeared to be investor jitters over the soundness of the deal's financing. Today's decline pretty much mirrored the movement of the S&P so I'm thinking that the price action is just a reflection of investors' fears. I'm hanging onto this one until something happens, one way or another.

The other three holdings—Rohm & Haas (ROH), Community Bankshares (SCB), and Lincoln Bancorp (LNCB)--are all down slightly riding on the market's coattails. I won't be parting with any of these unless there's a good reason to do so. Community Bankshares just announced that it'll be paying a twelve cent dividend on September 30th, by the way.

Although we're going through a very rocky period, I still intend to add to positions to the MANDA portfolio but I'm going to be a bit more rigorous in my selection criteria. No way an I touching the Merrill/B of A deal, at least not until some of the dust clears. Besides, I don't particularly like stock-swap only deals. As always, cash is king. Especially in this market.

Update on Friday's speculative Lehman play
Good thing I didn't have time to buy any Lehman calls. That would have really hurt. (Had I only bought Merrill calls!)

A Note on Today's Ugly Market

It comes as no surprise that market volatility has spiked over the dreaded 30 mark twice today—once at the open and again going into the close. If history is any indication, we can expect volatility to be high for a while which means that now is NOT a good time for risk-adverse investors to be taking on new long positions, as if I even have to mention that! But I'm getting of the mind that a bottom in the financials could be put in the next month or so, providing that the previous bottom reached on July 15th holds. Below, the weekly chart of the XLF, the Financial Spyder (read: ETF), shows that its trendline has been hit four times. Predictive chartology tells us that the chances of a stock recovering after four such dips is much greater than with only three. Of course, that doesn't mean that further declines aren't possible, but what it does mean is that we should start keeping an eye on it and research individual companies for potential winners when the group finally does turnaround.

Yes, today is indeed one of the gloomiest trading days in recent history but being a contrarian, I'm finding some cheer here that everyone seems to have thrown in the towel, for a return to the happy days of yore will not occur before we experience complete capitulation. At least that's my humble opinion.

My stomach is growling so after a lunch of cheesy cauliflower soup that Fifi's whipping up, I'll post another blog discussing today's market action on the MANDA portfolio and what actions, if any, need to taken. See 'ya in a few!

Friday, September 12, 2008

Speculators Alert: Quick & Dirty Lehman Play

A quick play for all of you wildcat speculators:

Buy out-of-the-money Lehman (LEH) call options as maybe they'll be rescued over the weekend play.
Volatility is low on the calls and if you have a couple of bucks to burn, you might want to put this one.
Note that you can usually get your option order executed up to 20 minutes or so after the market closes.

To try:
January 10 call, NJSAB $0.50 bid x $0.56 ask
April 10 call, NJSDB $0.46 bid x $0.61 ask

Note: Try a entering a limit order between the bid and ask.
If nothing happens over the weekend, you can still try this next week.

Have a good weekend!

Thursday, September 11, 2008

Update on Photon Dynamics: A Buy Right Now?

Yesterday's blog was devoted to speculation as to why shares in Photon Dynamics plunged yesterday. Here's an update that was just posted by Eric Savitz at Barron's who also was wondering the same thing:

There’s still something not yet clear about the weird sell-off yesterday in shares of Photon Dynamics (PHTN).

To review: PHTN holders on Friday approved a pending $15.60-a-share cash takeover of the company by Orbotech (ORBK), an Israeli-based rival in the LCD display equipment business. But the stock yesterday hit an air pocket, dropping $2.19, or 14.5%, to $12.89, and trading as low as $10.74. I theorized that the drop might have had something to do with the role in the deal played by Lehman Bros., which has been an adviser to Orbotech. Late in the day, the company issued a release which said that the only hurdle left to completion of the deal is approval of the transaction by the Committee on Foreign Investment in the United States. Photon said CFIUS is supposed to respond by September 29, and possibly sooner.

In a research note this morning, Needham’s James Ricchiuti says there were concerns about possible exposure of Israeli banks - presumably those that are providing the financing Orbotech requires to complete the deal - to the problems at Lehman.

Ricchiuti also notes that Photon owns a small business called Salvador Imaging which has some exposure to the defense market. (Example: the company has a deal with Raytheon for high-performance surveillance cameras used in military aircraft.)

As for the status of financing on the deal, Richiuti writes that he talked to Orbotech yesterday, and that “management reiterated that the company has firm commitments for the financing with three Israeli banks.”

Thank you Mr. Savitz for investigating the situation in the first place and following up on it!

If this report is true, and I can't think why it wouldn't be, then Photon Dynamics is a great play right now at the current price of $13.60. The merger is expected to close in just a couple of weeks (or even sooner) at a price of $15.60 per share. This represents a 22% return on the trade or an annualized return of over 400%. Before the merger was announced, the stock was trading around $12 so even in the off-chance that the deal falls through, your loss should be less than $2 which isn't bad considering the rich potential profit.

Disclosure: I bought a full position of PHTN yesterday at $14.44/share for the MANDA Fund and purchased more shares this morning at $13.63 for my personal account.

Photon Dynamics: Partial Recovery, Partial Explanation, by Eric Savitz at Barron's Online. 9/11/08

What's Wrong with Photon Dynamics?, by Eric Savitz at Barron's Online. 9/10/08

Wednesday, September 10, 2008


(Click on image for larger view.)

MANDA Addition: Photon Dynamics, for Better or for Worse

While surfing the market this morning, my charting program alerted me via its quaint 1920s roadster eye-ooh-ga horn that Photon Dynamics (PHTN), a maker of test equipment for LCD displays, had crossed below the threshold I had set for possible inclusion in our M&A portfolio, the Manda Fund. (See below for merger details.*) This was around 8:45am Pacific time when the stock went into freefall. Hm. Something must be up. I scoured the news sites and even googled both companies searching for any clues as to the mysterious drop. Finding nada, I called Photon Dynamics and of course was directly connected to voicemail. (I can't even remember the last time I called a company and a human being answered, nor can I remember ever getting any of my messages returned. I wonder if Buffett has this problem...)

Anyway, the stock was starting to firm up so I thought I'd take a chance and buy some. This was at 9am and the price was $14.44, which would be a nice 8% yield for a two week trade. As fate would have it, I had to go rush out to a meeting and upon returning I saw that the stock had plunged even further to $10.74. Yikes! Did the CFO abscond with company funds?

I did another news search where I found a fellow compatriot, Eric Savitz, at Barron's who noticed the same thing. He too called the company, got the same voicemail, and left a message which has not been returned. But what he does have is a theory, and I quote from his article**: So, now I’m wondering if the completion of the deal has been affected by the issues at Lehman, which has been Orbotech’s financial advisor on the transaction. The deal, which was for about $290 million, was to be financed by a combination of internal and external funds. If there were issues raising enough cash to close the transaction - Orbotech’s balance sheet cash was not sufficient to complete the deal - it might put the acquisition in jeopardy. Just a theory, mind you.

And a valid one. Orbotech will need a source of outside financing considering that last year's revenues were $392 million with only $154 million in cash. The burning question is whether Lehman is able to provide those extra funds at this time. If not, is there another investment bank willing to step in and lend a helping hand, so to speak?

Later this morning in a possible attempt to soothe panicky investors, Photon Dynamics issued a press release saying that the only closing condition left for its merger is clearance from the Committee on Foreign Investment in the U.S. The waiting period for the body, which examines deals involving foreign investment, expires on Sept. 29, but a response could come sooner. Although they sidestepped the issue of today's panic sell-off, the announcement did seem to assuage investor fears somewhat with the stock trimming its loss—up almost two points—going into the closing bell.

If indeed this deal is being queered by Lehman, I wouldn't be surprised to see some angry shareholders showing up in Photon Dynamics' executive suite. For me, I've learned that perhaps sometimes it's better to wait until the dust settles before jumping into a trade—a mistake that I have made a few times in the past, sorry to say. The failure rate of the MANDA strategy is low (see Recipe #13: Post-Takeover Tacos), and unfortunately this might be my first one. Wah!

*Merger Details: Briefly, the company is being acquired by Israeli-based Orbotech (ORBK) for $15.60 per share in cash. Just last week, Photon Dynamic's shareholders approved the deal which is expected to close by the end of this quarter.

**What's Wrong with Photon Dynamics?, by Eric Savitz at Barron's Online. 9/10/08

Tuesday, September 9, 2008

Making Money in this Volatile Market

Today is one of those “Life Happens” days so I don't have time for my usual in depth analysis, but I do want to alert all of my faithful readers to the fact that the VIX, the volatility index, crossed the 25 mark today. We've looked at the VIX before and have seen that bear markets happen when the VIX heads above 20, and bull markets occur when the VIX drops below 20 and stays there. The 25 level is of special note to traders because it strongly indicates that the market will be heading lower, at least for the near-term.

How low can we expect to go? The weekly chart of the S&P below shows a trendline drawn through the lows of previous market bottoms. We can expect the next bottom to be put in when it hits that line, probably in the region of 1150-1175.

So how can we profit from this down market, besides shorting Lehman? Well, the ultrashort ETFs are sizzling hot especially those covering the energy and materials sectors, such as the DUG (Oil & Gas), DZZ (Gold), and the SMN (Basic Materials). Other ultrashort funds on fire are the FXP (China), the EEV (Emerging Markets), the EFU (Europe, Australia, Far East), and the SSG (Semiconductors). If you throw a dart at a list of the ultrashorts, you probably can't go wrong. (See July 1st and 2nd blogs for further info on ultrashort exchange-traded funds.)

That's it for today. I apologize for the grim outlook but even the darkest thunder cloud has a silver lining, and the ultrashort ETFs are a good way to make a buck--at least as long as market volatility remains high.
Note: You can find a list of short and ultrashort Proshare ETFs here: http://www.proshares.com/funds

Monday, September 8, 2008

Hopping on the Home Building Express

Much has been made about the comeback of the home builders in the last several days, especially today when Uncle Sam announced that he would step in and bail out the major mortgage lenders, Fannie Mae and Freddie Mac. Good thing, too, because if he didn't, there's no telling what the international ramifications of such a spectacular fallout might be. The news was greeted by joyous investors who showed their appreciation by buying stocks, pushing up the major averages by a couple of percentage points.

As you would expect, the home builders all responded to the good news by rocketing higher, with most gaining between 10%-20% in value—wow! The thing is, this rise wasn't entirely without precedence. In fact, the home building group has been in an uptrend since July 15th—that fateful day when all of the major markets experienced a turnaround. Up until then. the housing sector index, the HGX, was particularly hard hit, off 33% from recent highs compared with only 15% for the S&P 500. In many cases we that the harder they fall, the faster they rise, and so it is with many of the home builders.

Best of Breed
Fundamentally, the best stocks in this group are also the ones faring the best technically. One analyst today upgraded Lennar, D. R. Horton, and Toll Brothers--all three of which are posting impressive gains. According to the home building sector cognoscenti, Toll Brothers tops everyone's list as best of breed mainly due to the efforts of their talented CEO who has managed to keep inventories in-line and cancellation rates down, but I'll admit it's a head-scratcher as to why he recently sold 1.5 million shares of his own stock...unless he has so much that he wants to divest himself of some it. The company's product is targeted towards those with higher incomes which many see as being more resilient to market downturns—another plus for the company.

But Toll isn't the only company worth your consideration. All of the stocks listed below sport good fundamentals and have done exceptionally well since the middle of July. Not surprisingly, all of them broke out of their bases today, although many did it on ho-hum volume. The exceptions are Toll, D.R. Horton, Ryland, Pulte, and Champion.

The Good Guys
(Note: Stock symbol, current price, and dividend yield are in parentheses.)
Toll Brothers (TOL: $26: D/Y = 0): Broke to a new yearly high on three times normal volume.
Meritage Homes (MTH: $27: D/Y = 0): Also broke to a new yearly high but on less than normal volume.
Beazer Homes (BZH: $8.90: D/Y = 0): Broke out on half normal volume. Heavy resistance at $12.
D.R. Horton (DHI: $14: D/Y = 2%): Broke out on twice normal volume. Next resistance around $17.50.
Pulte Homes (PHM: $16: D/Y = 1%): Broke major $16 resistance on nearly three times normal volume. Minor resistance at $20.
Centex (CTX: $18: D/Y = 0.9%): Broke out on less than half normal volume. Heavy resistance at $20.
Lennar (LEN: $15; D/Y = 4.2%): Broke out on half normal volume. Minor resistance at $16.
Ryland (RYL: $26: D/Y = 1.8%): Broke out on more than twice normal volume. Resistance at $27.50 and $31.75.
Champion Ent. (CHB: $5.80: D/Y = 0): Not a homebuilder in the usual sense, the company is the third largest maker of factory-built housing. The stock has doubled in price since mid-July and doesn't face major resistance until the $8 level. This company represents the lower end of the housing market and that can't be a totally bad thing considering current economic conditions. Also, company insiders have been doing some heavy purchasing in recent weeks.

The Okay Folks
(Note: None of the below companies pay a dividend.)
NVR, Inc. (NVR: $620): A pricey stock with good fundamentals. It also broke out of its recent trading range today on twice normal volume. Heavy recent insider trading is a potential negative.
Hovnanian (HOV: $7.20): Although it traded on heavier than average volume, it couldn't quite break above $8 resistance. I'd wait to see if it can break that level.
M/I Homes (MHO: $19.50): Needs to break $20 resistance.

The Stinker
KBR, Inc. (KBR: $20): Currently testing its $20 support level (also it's all-time low). If it breaks through that, I'd put on a shorting strategy.

Other plays
If you don't want to play an individual stock, you could buy either of the home building ETFs—the ITB or the XHB. They sport similar charts but the XHB is more heavily traded than the ITB. The XHB also pays a bigger dividend (2.2% compared to 1.6%).

Note that the majority of these stocks are optionable for all of you options players. Covered calls in this market environment may be a rewarding strategy.

How to play this sector
Nobody really knows when the credit crisis will be over. From all of the articles I've read on the subject, many feel that further pain is yet to come. With this in mind, I certainly wouldn't be jumping into this group with both feet; perhaps taking quarter or half positions on market pull-backs. Speaking of pull-backs, the topping tails seen today on many of the above charts indicate that a breather is in order meaning we should see lower prices in the next few days.

In this case, patience will be rewarded.

Friday, September 5, 2008

No More 99 Cents Store

I love the 99 Cents Only Store (symbol NDN). I buy most of my produce and all of my canned tomatoes there where the big 28 oz. size is still only 99 cents. But apparently not for long, according to recent rumblings in the media made official by today's press release. According to the company who operates out of 277 western retail stores located mostly in California, a buck just ain't what it used to be. In fact, it takes over $2 today to purchase what 99 cents did back when the company was formed over 25 years ago. No wonder they've had to downsize a lot of their products. I've watched as the 25 square foot roll of aluminum foil was trimmed by 5 square feet and eggs that used to be sold by the dozen are now being sold by the half-dozen. Not only has quantity been reduced but quality has suffered along with it. They just can't afford to stock the nicer items any longer, like the occasional Lu cookie hidden among the other so-called baked goods made of sealing wax and cardboard. It used to be that one could find some great bargains but not any more which makes me and many other veteran 99 Cent Store shoppers yearning for the good ol' days.

And the company knows this. They have to raise prices; it's the how that's been the problem. They fear that a complete price restructuring might be too much of a shock for their core customers; it's how to ease into it that poses the problem. Apparently, they've come up with a solution that will be unveiled at their highest volume store near Beverly Hills this coming Monday (1pm PDT).

So, is there some money to be made from this event? I think there might be. From the daily chart shown below, the company has been moving steadily upward rising 50% since putting in a ten year low on July 15th at $6. Just last week the founder and chairman purchased over $900,000 shares of company stock. Guess he must have some faith in the new price restructuring model.

More importantly, will this restructuring plan excite the public or turn them off? We won't know until we hear the details. For me, I'm keeping my fingers crossed that this will be the boost the company is looking for in order to increase their margins which they need to do if they have plans on expanding into the rest of the country. Hopefully, we'll have more than 99 reasons to shop at the 99 Cents stores along with another good reason to buy the stock. The question that really interests me is will they change the company's name and if so, what are they going to call it? The Not-Only 99 Cents Stores?

MANDA Fund Update: Tumbleweed Communications (TMWD) Merger Announced Today

For all of you following the MANDA Fund (see Portfolios under Blog Resources), the Sopra Group earlier today announced today that they acquired Tumbleweed Communications (TMWD) for $2.70 per share in cash. Apparently the deal passed the Exon-Florio review process. This stock was added to the portfolio on August 15th at a price of $2.52 per share, giving us a 7% return on the transaction for an annualized return of around 130%. Not bad for our first completed trade!

Note: If you own this stock, it may take anywhere from a few days to a couple of weeks for the transaction to be settled and the cash to be deposited into your brokerage account. Contact your broker for further details.

Thursday, September 4, 2008

The Georgia Gulf Triangle

While doing my morning stock perusal, I stumbled upon the chart of Georgia Gulf (GGC). The company is involved in making vinyl products for the building sector and aromatics such as acetone (used in nail polish remover among other things). Certainly this company doesn't fall into the "sexy" category, but many great companies don't. Not that GGC could be called a great company, especially not by long-term shareholders who have seen their stock lose 95% of its value in the last few years. I'm positive the word "great" hasn't been uttered in those camps in a while...but the tide may be turning.

What caught my eye today about GGC's chart was the absolutely perfect right-angle triangle pattern that the stock has been putting in. But before we look at that, I'd like to briefly review the weekly chart to show you how it clearly indicated that the stock was breaking down. Investors who had obeyed those tell-tale signs could have gotten out much earlier and not have had to suffer the ego-bruising nor the investment loss.
GGC breakdown indications
You can see from the weekly chart that GGC put in a double-top formation at the end of 2004 and early 2005. Major support was broken in early April affording astute investors the opportunity to take some money off the table. The symmetrical triangle formed a few months later was a continuation pattern indicating further decline on the horizon. From there, the stock oscillated in price, but always bouncing off of the $23 level--that is, until it didn't. In the middle of October, it busted through that level on heavy volume (not shown in the chart) where it fell like an angry meteor before landing at its all-time low of just under $2 on July 17th of this year. This was a major Maalox moment for GGC investors, and had they understood what the chart was telling them, they could have avoided this disaster.

This was the bad news.
Is there hope?
The good news is that the company may be shaping up because the chart is in a good shape. Yes, you read that correctly. The chart is in good shape because it's in a good shape, and that shape is a right-angle triangle. A right-angle triangle is a more powerful variation of the symmetric triangle pattern and is formed when one of the edges is parallel to the x-axis. This edge represents a support or resistance level and breaking through that level is meaningful, especially if accompanied by stronger than normal volume. This is exactly what happened to GGC today as you can from the daily chart below.
Price target
So, assuming that the price is indeed breaking out, how far can we expect it to rise? Good question. The answer, according to the tenets of chartology, is to plot a line through the first peak of the triangle that is parallel to the base line. (Line A-A' on the above chart.) This line represents the price objective which prices may be expected to meet or exceed. The caveat here is the resistance level at $5. If the stock makes it through that, then there doesn't seem to be any other major technical barriers standing in its way.

How to play it?
The stock is so cheap right now you might as well buy it, but if you want more bang for your buck I'd go with the 2010 January 5 call options. Since its call options are fairly liquid, you could write covered calls against the stock or the option to generate some income (paper trade this strategy for a few months first).

I know we haven't discussed triangle formations or their close relatives--pennants, flags, and wedges--but I was so excited about seeing such an obvious one today I just had to discuss it. Either tomorrow or in the next few days we'll take an in-depth look at these basic chart formations to see what information they hold so we can add them to our arsenal of cooking tools.

Wednesday, September 3, 2008

MANDA Fund Holdings as of 9/3/08

(Click on image to enlarge in new window.)

Another MANDA Addition: Lincoln Bancorp (LNCB)

Our fifth addition to our M&A portfolio is Lincoln Bancorp (LNCB) which agreed today to be acquired by rival First Merchants Corp (FRME). Lincoln shareholders have the option to receive about $15.76 in cash per share or they can choose to swap their shares for 0.7004 shares of First Merchant common stock. The deal is expected to close in the fourth quarter of this year.

If you want to buy this stock for yourself, be careful! The average daily volume is less than 5,000 shares. Floor traders are taking advantage of this illiquidity by expanding the spread between the bid and the ask prices, so if you want to own this stock, you might have better luck placing smaller limit orders (less than 200 shares or so) some place between the bid and the ask. I managed to get my order executed at $13.97/share which represents over a 12% gain on the transaction. Plus, the company has been regularly paying quarterly dividends of 0.14 cents/share. If we only manage to snag the September dividend, our total gain will be almost 14%, and if we're extra lucky, we might get the late December dividend thus increasing our gain to 15%!

Now the press releases don't say when shareholders need to choose between cash or stock, but if First Merchants is trading above $22.50 at that time, we'll make even more money. And with many bank stocks on the upswing, there's a good chance it'll get there in the not too distant future. Yippee!

To see the MANDA Fund's current holdings, click on the Portfolio link on the right under Blog Resources.

In more MANDA news:

Rohm & Haas (ROH) paid a $0.41/share dividend on Sept. 1st.

Community Bankshares (SCB) will be paying a $0.12/share dividend on Sept. 30th to shareholders on record as of Sept. 15th.

Tumbleweed Communications (TMWD) is closing today at $2.41, one of the lowest prices since the takeover was announced on August 8th. There's no new news on the company, but the most important hurdle to this deal is the Exon-Florio process which is a government review of foreign companies to ensure that national security is not breached. (The takeover company is the Sopra Group, a European IT consulting and services company.) Being unfamiliar with the process, I can't give an opinion on the outcome, but if you want to take the risk and are able to pick up the company at this price, you'll wind up with a nice 12% return. Since I've already bought the maximum number of shares allowed by the Fund at $2.52, I can't buy any more, alas.

Tuesday, September 2, 2008

Welcome back the Greenback

Now that summer is officially over, the kidlets are thankfully the teachers' problems, our white clothes have been dutifully folded into the cedar chest (Mom's Fashion Rule: “Never wear white after Labor Day, dear.”), and UCLA miraculously pulled out the first major upset of the college football season last night on national television (take that Trojan scum!), we can now return to our regularly scheduled routines, for better or for worse. I, for one, usually have a difficult time getting out of bed after a long holiday, but today was less brutal since the markets opened up strongly on news that hurricane Gustav left the Gulf oil rigs and refineries alone. At last, a ray of sunshine! Maybe this September won't be the downer like most of them have been in the past, but alas. The bluebird of happiness quickly flew the coop as financials and energy stocks continued their slide sending the market into a tailspin. With little more than one hour before close at the time of this writing, the S&P has fallen more than 2%, down 28 points from it's 1303 high put in right after the open. The volatility index, the VIX, shot up over 8%. Could this relatively large move signal the end of the late summer rally?

I don't know, and honestly, I wouldn't put all my eggs in either Papa bull's or Mama bear's basket until we get some sort of confirmation in the direction of the trend. If history is any indication, the bulls usually get skewered in September, but who knows if history will repeat itself this time. So, if the prognosis for the broader market is unclear is there any other market that is in a discernible trend?

You betcha.

Short foreign currencies; go long the US dollar
All of Wall Street has been hailing the return of the US dollar for the past several weeks, yours truly included. On August 14th, we looked at shorting the British pound via the currency ETF, the FXB. At that time, the pound had already fallen precipitously, roughly 7% from recent highs. Since then, it's fallen another 4.6%, with half of that drop happening today. (If, instead, you had gone long the US Dollar ETF, the UUP, you would have been up only 2%.)

All of the other foreign currency ETFs have declined since the rise of the dollar starting July 15th. Another significant decline in the price of oil today probably accounts for the breakout in the US Dollar and the breakdown in foreign currencies. All of them with one exception were down today, with the Australian dollar and the British pound leading the losers (-2.8% and -2.5% respectively.) The exception is the Japanese Yen which posted a very modest gain. Does this mean you should buy it? No. A look at the chart of its currency ETF, the FXY, shows that today's action is forming a higher low within an established down-trend--exactly the time one wants to go short.

Are there other ways to play this market?
As I said previously, you can short any of the foreign currency ETFs or go long the UUP. Just so you're not relying on the chart of the currency ETF alone, check out my August 18th blog for tips on the country ETF action. (A list of both country and currency ETFs are given there.) While you're checking those out, compare them with their short and ultra-short counterparts. Here's a few of them with their short ETF listed first followed by their Ultra-short:

Emerging Markets: EUM, EEV
EAFE Markets (Europe, Australia, Far East): EFZ, EFU
China: FXP (Ultrashort)
Japan: EWV (Ultrashort)

If you check out the above charts, you'll see a long run-up in the prices. Does that mean you shouldn't buy them? No, both the DUG (Ultrashort Oil & Gas), the GLD (a gold ETF), and the UUP made significant moves today, all indicating further upside to the dollar. That doesn't mean, however, that you should charge right in all at once. The best plan of attack is buy on pull-backs if going long the short ETFs, and sell into rallies if going short the long ETFs as in the case of the Japanese yen today. Soon would be a good time to buy the UUP.

This blog just touched on some of the ways to play a rising dollar. Since the greenback is sensitive to commodities, you can also go long the airlines--a good play if oil continues to drop. (All of the airlines did well today. JetBlue (JBLU), US Airways (LCC), and United (UAUA) are the best of the birds.) Aggressive investors can buy options on the currency ETFs (but note many are thinly traded) or play the currency market outright. Risk adverse investors should probably avoid options and the ultrashort ETFs. Perhaps for now, putting your money under your mattress isn't such a bad idea.