This is the dilemma of todays Blue Collar Investor. These are unique and historical economic times. Experts can’t agree on when the economy will recover. We hear everything from late 2009 to early to late 2010 to 2012 to Thursday (but they won’t say which Thursday). Pundits are always giving their opinions and in the end, some will be right and the others wrong. We just don’t know who fits into which category.

In March, the stock market had a significant rally and many felt that this was a sign of economic recovery for the long run. To come to such a major conclusion would be emotional investing, something not permitted in the Blue Collar Investment System. A factor that is gnawing at me is something I’ve alluded to several times in the past few weeks: Historically, recessions show three definitive bottoms (on the price chart) and we’ve only had two so far. Perhaps, the circumstances are so unique this time that we will, in fact, only have the two. That would be welcome. But to ignore history and invest in an all-out bullish manner would be elevating risk to uncomfortable levels. If only we could be a fly on the wall in the chief executive’s office of the world’s largest stock exchange and get his take on the March rally and predictions of the future.

Well folks, if that’s what you want, you’ve come to the right place. On April 15, 2009, Duncan Niederauer, the chief executive of NYSE Euronext was interviewed by the Financial Times. These remarks are rare so I thought it important to share them with you. He stated that the March rally was deceptive because “real money” investors (not us, but the institutional big boys) remained on the sidelines. He felt that this rally was driven by short-term traders who were taking advantage of market volatility without any true conviction of an economic turnaround.

Furthermore, he noted that increased volumes were concentrated in just a handful of stocks, further minimizing the significance of the rally. He called today’s market a “traders market” while “real money investors are still waiting….once they are convinced you will know it. The market will have a different tone to it.”

He also said that trading volume, although healthy, was below levels which would be indicative that investors are confident in market fundamentals. “I think we’re waiting for another rally, in my opinion, in around June and July,” he said.

He predicted that a summer rally would be a six to nine month leading indicator of economic recovery and that by April 2010 the global economy would look a lot healthier. Because of his position and perspective, in addition to the information he has access to, I felt that this interview would be of interest and asistance to my fellow Blue Collar Inverstors. 

So which personality should we adopt, bullish or bearish? How about cautious? There is a middle ground to consider. Many investors have their assets in fixed-income securities or cash. Some (few) are fully invested in the stock market. The approach I am persuing is to take half of the cash I normally have in the market and invest those funds with extreme caution. I have written about favoring in-the-money strikes during these volatile economic times. Although the year is still young, I will always reflect on 2009 as the year I brough the in-the-money strike to the attention of so many Blue Collar Investors all over the world. More than ever, preparation for possible exit strategy execution is essential. This approach has been working well for me over the past few months. Many of you are just beginning to invest with stock options and probably should remain on the sidelines a little longer. Only you know your comfort level for risk tolerance.

For those of you not investing at this time I would make this suggestion: Paper trade as if you are risking your hard-earned money. What a wonderful learning experience this can be for all of us. If you can navigate through these current market conditions, you will kick financial butt when things calm down.

Stocks with the greatest fundamentals:

I ran a screen, independent  of the IBD screens, to get a list of the companies with the top earnings, sales and cash flow growth. I then took the top 25 stocks from this list and ran them through our system criteria as described in Cashing in on Covered Calls.. Here are the stocks that passed ALL screens:

AAPL
CTSH
LKQX
CTRP
RIMM
NTES
ICE
QSII
NFLX

My hope is that some of these equities are familiar to you and may already be on your watchlists. Check them out and see if they have a place on your watchlist.

Market Tone:

 We have significant signs of market stabilization. The concern is for a possible retesting of market lows before a real return to a bull market. Let’s look at the uptrending charts of the Housing, Banking/Financial Industries and the calming Volatility Index (VIX). The lower the number, the better for the VIX and this chart shows a decline from October highs of 90 to a current mark of 35:

Building/Housing Industry as of 5-1-09

Banking Industry as of 5-1-09

Volatility Index (VIX) as of 5-1-09

Exit Strategies for Covered Call Writing/ Making the Most Money Selling Stock Options:

My publisher just informed me that my newest book will be available to the public in mid-June. I will be placing an order form on this site a few weeks prior to the first shipments so we can expedite your books to meet the demand. For a sneak preview of the book exterior, use the following link:

Exit Strategies for Covered Call Writing- Covers

Economic News of the Week:

Real GDP had a steeper than expected decline in the first quarter which when added to the decline in the last quarter of 2008 became the worst 6-month decline in 50 years. This was offset with some bright spots like an increase in consumer spending which was attributed to lower energy prices and tax cuts. The Federal reserve noted that “the economic outlook has improved modestly” since the March meeting. Consumer confidence also rose for the second straight month. For the week, the S&P 500 was up 1.3% for a year-to-date return of -2.0%.

Videos currently playing on the homepage:

1- Selecting the best strike price

2- Education is power- lists many of the topics covered in my books, DVDs and CDs

Here is the link:

http://www.thebluecollarinvestor.com/

My best to all,

Alan (alan@thebluecollarinvestor.com)

Definition of a protective put:

A put option purchased for a stock that is already owned by the owner of the option. A protective put defends against a decrease in the share price of the underlying security. When a protective put is used in conjunction with covered call writing, the strategy is referred to as a collar strategy. A collar in options trading is the owning of the underlying shares while simultaneously selling the call options and buying protective puts. In a true collar strategy the puts and calls are both out-of-the-money having the same expiration dates and equal number of contracts. So we sell an O-T-M call and protect the downside by purchasing a put.

Example of a Protective Put/Collar Strategy:

• Buy 100 x Company XYZ @ $48
• Sell 1 x $50 call for $2
• Buy 1 x $45 put for $1
• Net gain on the option buy and sale is + $100 (200 – 100)
• This brings our cost basis down to $4700 (4800 – 100)

Outcome if stock prices surpasses the $50 strike price:

• Shares are sold for $5000 (50 strike x 100 shares)
• Results in a profit of $300 (5000 – 4700)
• ROO = 300/4700 = 6.4%

Outcome if stock prices falls below the $45 strike price:

• Shares are sold for $4500  (not $4300) because of the protective put
• Net loss is $200 (4700 – 4500) = 4.3%

Outcome if stock price remains @ $48:

• ROO = $100 (100/4800) = 2.1%

Chart of possible outcomes:

The profit potential is slightly muted due to the cost of the protective put but the downside risk is protected at the strike of the put.

Tax treatment of Protective Puts:

When the protective put is purchased on the same day as the stock, it is referred to as a married put for tax purposes. To calculate capital gains or losses, the investor adds the premium paid for the option to the purchase price of the stock to calculate the tax basis of the stock. For example, you buy 200 x ABC @ $30. On the same day, you purchase 2 x $25 puts @ 2. The tax basis of the stock is $6400 (6000 + 400).

The case against protective puts:

Let me premise these remarks by saying that there is nothing wrong with purchasing protective puts. I feel, however, that we can get our insurance for free by educated, well-calculated and common sense investing. Here is what the Blue Collar Investor System  does to alleviate risk without spending cash for insurance (protective puts):

• Select only the greatest performing stocks.
• Select equities in the best performing industries.
• Avoid earnings reports, the most likely cause of a radical share downturn.
• Avoid companies that report same store retail sales.
• Sell I-T-M strikes when market tone and/or stock technicals are compromised. In this case, the option buyer is paying our insurance.
• Use technical analysis to determine buy-sell points.
• Implement exit strategies when needed.
• Sell predominently 1-month contracts for better control.

The only time a protective put will benefit us over and above our system’s inherent protection, is when a stock drops precipitously in a short period of time. This can occur after an earnings report but we are already avoiding these reports. Otherwise, such events are few and far between. Therefore, in my judgement, it doesn’t pay to purchase a put every time you sell a call option. You’re just not getting enough bang for your buck as long as you do your due diligence and follow all the system criteria.

Technical Analysis of Recessions:

How frustrating is it to listen to the experts disagree with each other on the recovery of the economy in general and the stock market in particular? We are in a unique and historical time and so our financial futures cannot be predicted with the same degree of clarity we would see in normal market conditions. One concept this site has brought to focus recently is the fact that historically recessions show three distinct bottoms on their chart patterns. If history will repeat itself, then we are due for one more. Here is the chart of the S&P 500 during the recession of 1982. Note the three bottoms in September of 1981, March of 1982 and August of 1982:

Recession of 1981-1982

Now let’s look at the current recession which began in December of 2007. Note the bottoms that occured in November of 2008 and in March of 2009:

Recession 2007 to ?

So if you are a chartist and believe that history will repeat itself, your investments should be cautious and conservative. Most of you following this site have read my posts (ad nauseam) about utilizing I-T-M strikes when concerned about market tone and stock technicals. This site will continue to monitor the chart pattern of the S&P 500 (among other market indicators) to see how this ultimately plays out.

Last Weeks Economic News:

Housing sales disappointed in March after surging in February. The Conference Board’s Index of Leading Indicators fell a worse-than-expected 0.3%. On a positive note, it is no longer dropping precipitously. Demand for durable goods also disappointed by dropping by 0.8%. For the week, The S&P 500 was down 0.4% for a year-to-date return of – 3.3%.

Best in investing,

Alan

alan@thebluecollarinvestor.com

For the past several years, I have directed you to the Stock Checkup page of this site and set up the following criteria:

• Overall Diagnosis: A minus or better
• Stock Technical Rating: B or better
• Stock Fundamental Rating: B or better
• Stock Attractiveness Rating: B or better
• Group (industry) Technical Rating: C or better

For the past several months I have been discussing the fact that IBD was planning an upgrade to this site and changes would occur. The improved site went “live” this past week.

Reasons for the change:

I have been told by the IBD technical and educational staff that the change was made mostly because of the differences in terminology used in the newspaper versus the website. They wanted to make the two medias more consistent. They also wanted to expand the database and provide more information. This can be both a positive and a negative as more information is great as long as it is not at the expense of time efficiency and accuracy. In other words, we wouldn’t want it to complicate a system that has been working so well for us for so long.

My approach to these changes:

My goal was a simple one: Always set yourself up for success. If the new screen took too much time and effort or if the accuracy was adversely effected, our system and profits would be negatively impacted. That would be unacceptable!

With the assistance of my wife Linda, I set up a  comparison study of the new screen (in beta testing) versus the older (or current at that time) one. The original screen had letter grades only; the new one both letter and numerical. The stock checkup page now has many more categories as additional information was added. We tried a myriad of combinations until we struck gold (perseverance always pays off). These are the findings I will share with you in this article. Amazingly, our screening process will be even easier than before without sacrificing one bit of accuracy. I will be giving you a link to print out all the updated information later in this article.

The new screen: Green Alert Scan using the SmartSelect Ratings:

One area in the enhanced site is entitled SmartSelect Ratings. These ratings measure a company’s key characteristics, like earnings growth, profit margins, share price performance and other traits. They also show you how the stock compares to others in the market.  These ratings were tested in many different combinations and compared to the original stock checkup screen. Over 1000 stocks were tested and I was actually making my personal stock buy/sell decisions based on this new screen for the past few months.

My findings:

The new screen, which I will be describing below, had better than an 85% accuracy compared to the original one. In other words, 85% of the stocks that passed the new screen would also have passed the older one. Of the remaining 15%, the difference in many cases was 1/2 grade. For example, a stock that passes the new screen may have failed the older one becuase it ranked B minus and thus missed by 1/2 grade. The new screen also has a stricter requirement for the group technical rating, now closer to a “B” as opposed to the older “C” requirement.

How to use the Green Alert Screen:

After logging in to the IBD site, type in the ticker of the stock you are screening. Then proceed to the quote page. Under the stock chart you will see the SmartSelect ratings. There are six ratings, some numerical, some in letter format. To the right of these letters and numbers are colored circles:

• Red: poor
• Yellow: neutral
• Green: Positive

A stock will pass this screen if all six circles are colored green, hence the title Green Alert. Now how easy is that! Should you see a “NR” next to a particular category, that means that there is not enough information to provide a ranking. A stock will FAIL our screen if there is even one “NR”. We only will settle for six green circles. Here is an example of what the quote page looks like:

Green Alert Scan-Stock Quote Page

• Composite Rating is similiar to the Overall Diagnosis
• EPS Rating and SMR Rating are similiar to the Stock Fundamental Rating
• RS Rating and Acc/Dis Rating are similiar to the Stock Technical rating
• Group RS Rating is similiar to the Group Technical Rating
• All SmartSelect Ratings incorporate elements of the Stock Attractiveness Rating

Definitions of the SmartSelect Ratings:

1- Composite Rating:The IBD SmartSelect Composite Rating combines all 5 SmartSelect Ratings into one easy-to-use rating. More weight is placed on EPS and RS Rating, and the stock’s percent off its 52-week high is also included in the formula. Results are then compared to all other companies, and each company is assigned a rating from 1-99 with 99 being the best. A 90 rating means that the stock has outperformed 90% of all other stocks in terms of its combined SmartSelect Ratings.

2- EPS Rating: Exclusive rating found in Investor’s Business Daily’s SmartSelect® Corporate Ratings. Stocks are rated on a 1 to 99 scale (with 99 being best) comparing a company’s earnings per share growth on both a current and annual basis with all other publicly traded companies in the William O’Neil + Co database. Stocks with EPS Ratings of 80 or above have outperformed 80% of all publicly traded companies in earnings. The EPS Rating combines each company’s most recent two quarters of earnings-per-share growth with its three- to five-year annual growth rate.

3- RS Rating: This IBD SmartSelect® Corporate Rating is a measure of a stock’s price performance over the last twelve months, compared to all stocks in its database. The scale ranges from a low of 1 to a high of 99.

4- Group RS Rating: A percentile-based version of Industry Group Rank, a proprietary number obtained by calculating the least-squares curve fit of summed prices on certain stocks within that industry. Another calculation is then done using all companies in the group. Separate weightings are used for different time periods. Industry groups are ranked in value from 99 (highest) to 1 (lowest).

5- SMR Rating: A proprietary rating pioneered by Investor’s Business Daily to help investors identify companies with superior Sales Growth, Profit Margins, and Return on Equity ratios. Parameters are combined into one simple A through E ranking system.

6- Acc/Dis Rating: Exclusive rating in Investor’s Business Daily. One of the IBD SmartSelect® Corporate Ratings, it tracks the relative degree of institutional buying (accumulation) and selling (distribution) in a particular stock over the last 13 weeks. Updated daily, stocks are rated on an A+ to E scale.

Conclusion:

By using the enhanced Green Alert Scan from the stock quote page, our system of locating the greatest performing stocks in the greatest performing industries just got more time efficient without sacrificing one iota of accuracy. For your convenience, I have provided a link to download and print out this entire package of information to insert into your Cashing in on Covered Calls books:

http://www.thebluecollarinvestor.com/pdfs/IBD_greenalertpackage.pdf

The information in this package replaces pages 48 – 50 in the first and second printing of Cashing in on Covered Calls. The third printing (see below) will have this information as part of the book interior.

Note: Thanks to your incredible support, my first book, Cashing in on Covered Calls, will be coming out in its third printing this coming week. The updated information on this enhanced screening process will be reflected in these new books. To those of you who have been inquiring about my upcoming book on exit strategies, I can tell you we are getting closer to publication. I have approved the book interior and I’m just waiting for changes on the book covers. I appreciate your interest in this book and will keep you posted.

Last Weeks Economic News:

In the minutes of ther last Federal Reserve meeting, officials lowered economic growth estimates for 2009 and 2010, lowered their inflation estimates and raised the unemployment estimates. The minutes state: “In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability.” In other news, the U.S. trade deficit continued to shrink, now at its lowest level since 1999, and U.S. consumers continued to reduce debt. For the week, the S&P 500 rose 1.67% for a year-to-date return of -4.4%.

Happy Holidays to all,

Alan (alan@thebluecollarinvestor.com)

Definition:

An exchange-traded fund is a security that tracks an index, a commodity, or a basket of assets like an index fund, but trades like a stock on an exchange, thus experiencing price changes throughout the day as it is bought and sold. These securities provide the diversification of an index fund.

A critical requirement of my system is to be properly diversified both by industry and by cash allocation. No one industry should represent more than 20% of your portfolio holdings. Owning five different stocks in five different industries would require you to own at least 500 shares since each options contract represents 100 shares. This may require a cash allotment of $25,00 to $50,000 or more. By writing calls on ETFs, each share represents a basket of stocks and therefore, instant diversification.

There is also a benefit of a lesser time requirement. With individual equities, we are constantly changing our portfolio mix and factoring in earnings reports, technical and fundamental analysis. With ETFs, we are basically tracking just one security. Now if you are asking yourself why use stocks at all, the answer lies in the greater returns you will garner by writing calls on individual equities. In normal market conditions, a return of 2-4% is achievable compared to the 1-2% for selling options on ETFs.

Who should use ETFs?:

Investors with limited income, with low risk tolerance or with time retrictions should consider writing calls on ETFs.

Advantages of ETFs:

1- Broad diversification- by definition an ETF inherintly provides diversification across an entire index.

2- Lower costs- Most ETFs are not actively managed therefore decreasing marketing, distribution and accounting expenses and most do not have 12b-1 (advertising) fees.

3- Tax efficiency- ETFs have low capital gains because of the low turnover in their portfolios.

4- No need for a financial advisor- Why pay 11/2-2% a year to do something you could manage yourself?

5- Buying and selling flexibility- These securities maintain all the features of a stock, such as limit orders, short selling, stop orders and options.

Types of ETFs- Most ETFs are index funds and those are the ones I will focus on. For informational purposes, there are also leveraged (short), commodity, currency, actively managed ETFs and more. Here are three of the more popular ETFs for writing calls on heavily traded indexes:

1- QQQQ- follows a basket of 100 of the largest non-financial equities on the Nasdaq exchange.

2- VTI- Vanguards security that tracks the total stock market.

3- VV- Vanguards security that tracks the large cap universe.

Major issuers of ETFs:

1- Barclays Global Investors issues iShares.

2- State Street Global Advisors issues street Tracks and SPDRs

3- Vanguard issues Vanguard ETFs, formerly known as VIPERs.

4- Merrill Lynch issues HOLDRs.

5- PowerShares issuers ETFs and BLDRS (based on American Depository Recepts).

Did you know that there are ETFs based on Covered Call Writing?: 

There are several relatively new ETFs that use cc writing in at least 50% of its portfolio. Here are a few:

LCM, BEO, DPD, FFA, MCN, and BEP. These funds haven’t proven themselves over time plus we aren’t sure what’s going on in the other portion of the portfolio. My gut tells me that if I was going with an investment vehicle that was actively managed, I’d prefer to manage it myself, thank you.

The CBOE S&P 500 BuyWrite Index (BXM):

This is a benchmark index designed to track the hypothetical performance of a covered call strategy on the S&P 500 Index.

It is based on buying the index and selling a 1-month O-T-M call, similiar to the Blue Collar System although we consider all strikes. A study done by Ibbotson Associates in 2004 came to the conclusion that a 16-year history showed the BXM to have a 12.30% return compared to the S&P 500 with a 12.20% return but with two-thirds the volatility of the S&P 500. This means that by using the BXM an investor can get similiar returns to the S&P index but with less aggravation. I created the chart below to show the comparison of the BXM Index (black line) compared to the S&P 500 (blue line) over the past year:

BXM vs. the S&P 500- 1 year chart

VIX as of 4-3-09

Banking Industry 4-3-09

S&P 500 4-3-09

_____________________________________________________________________________________________

Last weeks economic news:

The one big negative this past week was the increase in the unemployment rate to 8.5%, the highest in 26 years. Several positives included an increase in consumer confidence, construction spending beat expectations, factory orders rose for the first time in six months, and the manufacturing indusrty continued its modest recovery. For the week, the S&P 500 was up 3.3% for a year-to-date return of -6.0%.

_____________________________________________________________________________________

Replay of radio interview:

For those who missed it, WNB Radio Network is replaying an interview I did several weeks ago. It will play all weekend:

• WnbRadioNetwork.com
• Click on the “MInd Your Bizness Program”.

Let’s hope for more good news this week,

Alan (alan@thebluecollarinvestor.com)

What is a reverse stock split?:

It is a reduction in the number of a corporation’s outstanding shares and a corresponding increase in the value of those shares. For example, if you own 200 shares of company XYZ @ $5 per share, a 1-for2 reverse stock split would result in your owning 100 shares @ $10 per share. The value of your holding remains the same:

200 x $5 = $1000

100 x $10 = $1000

Reasons why reverse stock splits are done:

1-It makes corporate shares look more valuable although there has been absolutely no change in real worth.

2- Many institutional investors have rules against purchasing a stock whose price is below a certain minimum level, $5 perhaps. Citigroup now falls into that category.

3- Fear of being delisted is another possible reason. If a stock falls below a certain price, it may no longer meet the exchange requirements and face delisting or being removed from trading rights on that particular exchange.

4- Reduce the number of shareholders is a rare but possible explanation for a reverse split. If the split results in a shareholder owning less than a minimum required number of shares, they would receive a cash payment and no shares of stock. This may be benficial to a company seeking to be put in a different regulatory category such as an S-Corp which is required to have less than 100 shareholders.

Typically, a stock will temporarily add a “D” to the end of its ticker symbol during a reverse stock split.

Citigroup situation:

Let’s take a look at a chart of Citigroup as of 3-24-09:

You can see that Citigroup went from a $50 per share stock to a $3 per share equity. To get this to a somewhat cosmetically acceptable scenario, a 1-for-10 split would be necessary. This would elevate the share price to $30 per share. If you owned 1000 shares @ $3 before the split, you would own 100 shares @ $30 after the split. 

What does a reverse split signal? :

In 2008, Jim Rosenfeld, an associate professor of finance at Emory University’s Goizueta Business School in Atlanta, did a study involving 1600 companies that did reverse stock splits. He found that the typical stock in his study underperformed the market by 50% on a risk-adjusted basis during the three year period after the action. His conclusion:

“Reverse stock splits are a strong indicator the company is going to be a significant underperformer during the near future.”

What if I sold covered call options on such a stock? :

Perhaps you were out partying the night before and had a bit too much to drink. You woke up the next morning and omitted your first cup of high-octane coffee that might have brought you out of your fog. Through no fault of your own, this drug-induced state causes you to ignore all the fundamental and technical requirements of our system. Common sense is also tossed out the window as you rationalize that Citigroup cannot possibly go any lower than $30!  Okay, that’s all water under the bridge. Here’s an example that is simple to follow:

• You sold 10 contracts of the $5 call.
• After a 1-for-10 split that would change to having sold 1 contract of the $50 call.
• Ticker symbols would change but the expiration date remains the same as does the premium initially collected.

When the numbers don’t break down as perfectly as these, it is much more complicated. The best way to handle these scenarios is to contact your broker or the CBOE Exchange. The split information can be obtained online as follows:

www.cboe.com/contractadjustments

You can also call the CBOE (Chicago Board Options Exchange) for free information:

1-888-678-4667

For more information on conventional stock splits, here is a link to an article I published a year ago:

 http://www.thebluecollarinvestor.com/blog/stock-splits-and-their-effect-on-our-option-contracts/

I also devoted a full chapter in my book, Cashing in on Covered Calls, to the subject of stock splits.

* The Blue Collar System will force you to avoid all stocks that are forced to resort to reverse splits. They simply will never meet our fundamental and technical criteria.

 Industry in the Spotlight:

Great performing stocks can oftentimes be located by first identifying those industries that have been favorites of the institutional investors. One such group in the Chemical Manufacturing-Fertilizer Group. Here is a chart showing a definite reversal of a downtrend for the last several months:

Chemical Manufacturing-Fertilizer Industry 3-09

Three stocks that are performing well within this industry are TRA, SQM and CF. Check them out and see if they belong on your watchlist.

Last weks economic news:

The final revision of the 4th quarter 2008 GDP was down 6.3%, the worst since 1982. However, there was good news on the economic front last week. February exisitng home sales rose 5.1% from January and new home sales were up 4.7%. Consumer spending was up for the second straight month along with an increase in prices, allaying fears of deflation. February durable goods orders were also up for the first time in seven months. For the week, the S&P 500 was up 6.1% for a year-to-date return of – 9.0%.

My best to all,

Alan (alan@thebluecollarinvestor.com)