schaeffer’s options advisor may 2012

7/26/2019 Schaeffer’s Options Advisor May 2012

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STOCK RE-CAP OPTION RE-CAP

www.SchaeffersResearch.com

Serving option investors worldwide since 1981 Bernie Schaeffer Senior Editor

A publication of schaeffer’s investment research

*MINIMUM ENTRYMAXIMUM STRADDLE/STRANGLE PRICE.

B e r n i e S c h a e f f e r’ s

THE

MARKET

May 2012 Volume 32, Issue 5

(Continued on page 6

Citigroup 33.88 B C June 38 P 4.40 4.90 100% 5/30

Dunkin’ Brands 32.57 B DNKN June 30 C 2.90 3.30 100% 5/30

Garmin 47.28 B GRMN June 41 C 6.80 7.50 100% 5/30

Lennar 27.38 B LEN June 23 C 4.80 5.20 100% 5/30

SPDR Gold Trust 161.03 B GLD June 166 P 6.75 7.10 100% 5/30

VeriFone Systems 53.86 B PAY July 50 C 6.50 7.00 100% 6/26

PUT SELL

Citrix Systems 86.76 S CTXS May 82.50 P 1.05 0.90* 6.4% 5/18 1

Ryland Group 21.62 S RYL June 20 P 0.65 0.50* 15.6% 6/15 1

United Rentals 44.95 S URI May 43 P 0.90 0.75* 9.6% 5/18 1

PAIRS TRADE

Continental Resources 89.79 B CLR June 80 C 11.50 12.60 50% 6/12 6

Petroleo Brasileiro 23.63 B PBR June 27 P 3.75 4.35 50% 6/12 6

B e r n i e S c h a e f f e r

THESE RECOMMENDATIONS WERE MADE AVAILABLE ON THE THURSDAY EVENING PRIOR TO PUBLICATION AND SHOULD BE ENTERED NO LATER THANMAY 4, 2012. CONSULT OUR SUBSCRIBER-ONLY HOTLINE FOR THE LATEST INFORMATION REGARDING CLOSEOUT CHANGES, EXIT INSTRUCTIONS, AND

NEW RECOMMENDATIONS. SEE TABLE ON PAGE 6 FOR COMPLETE HOTLINE INFORMATION.CURRENT ALLOCATIONS: AGGRESSIVE (92.0% CASH; 8.0% OPEN), PUT SELLING (100.0% CASH; 0.0% OPEN).

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In my commentary last month in thisspace, I discussed what I described asthe “feeding frenzy” in the openinterest for the two major volatility-

based option products -- the CBOE Market VolatilityIndex (VIX) and the iPath S&P 500 VIX Short-TermFutures ETN (VXX). My conclusion was that the manictrading in these volatility-based instruments -- despiterelatively low market volatility and a slow, steady rally in

the major stock indices -- was a symptom of fear-basednvestor behavior, and that, in contrast, market tops occuralmost by definition when the sentiment environment isgreed-based.

The S&P 500 Index (SPX) was trading at about 1,402 atthat time, and it closed today at 1,399, resulting inessentially zero market movement over the past fourweeks. In addition, the S&P closed today with a year-to-date gain of 11.3%, and all of the closing price action othis period has been compressed between +8% and +12% on a year-to-date basis.** Yet, despite this snooze-wormarket action, the VIX managed to soar from a low of about 14 at last month’s press time to a peak of about before settling at its current level near 16.

From my perspective, there is more than undue bearishness involved in this apparent dissonance betwextremely well-contained U.S. stock price behavior and the tendency for option implied volatility levels to surghair-trigger fashion on minor pullbacks. Specifically, concerns (serious at times) about the

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A g g r e s s i v e PORTFOLIO

2 • Bernie Schaeffer’s

DAILY CHART OF C SINCE MAY 2011

WITH 320-DAY MOVING AVERAGE

CITIGROUP - EXPECTATIONAL ANALYSIS®: C has struggled on the

charts over the previous 12 months, with the stock losing roughly 25% of itsvalue in that time. The security recently rallied up to its 320-day movingaverage, and was rejected. This trendline has effectively kept C at bay sinceMay 2011. Despite this poor technical showing, bullish sentiment is on the rise.For starters, 67% of analysts maintain a “buy” or better rating toward C. Plus,in the most recent Barron’s Big Money poll, 31% of investors believe financialswill be the best-performing sector in the next six to 12 months, up sharply from9% in the October poll. What’s more, the consensus 12-month price target of$44.08 represents an area not reached by C on a daily closing basis in nearly ayear. Such lofty levels of optimism may have negative consequences for thestock in the short term. A capitulation from the bullish brokerage bunch could bring a fresh round of selling pressure, exacerbating the stock’s slide.RECOMMENDATION: Buy the June 16, 2012 38-strike put.

GARMIN - EXPECTATIONAL ANALYSIS®: GRMN has sprinted up thecharts, adding nearly 19% on a year-to-date basis. The stock’s technical prowess has been highlighted by its rising 80-day moving average. GRMNrecently pulled back to this supportive trendline and bounced. However,skepticism toward the electronic map maker is steep. GRMN’s Schaeffer’s put/call open interest ratio (SOIR) of 1.47 shows that near-term put open interesteasily outweighs call open interest. This bearish bias has spilled outside of theoptions arena, where short interest accounts for a hefty 10.2% of the security’sfloat. Elsewhere, no fewer than eight out of 11 analysts maintain a “hold” or“sell” suggestion toward GRMN. Plus, the consensus 12-month price target of

$50.55 is just a stone’s throw from the equity’s April 26 closing price of $47.28.Any upgrades and/or price-target hikes could prompt some of the weaker bearish hands to call it a day, providing GRMN with a fresh wave of buying pressure.RECOMMENDATION: Buy the June 16, 2012 41-strike call.

DUNKIN’ BRANDS - EXPECTATIONAL ANALYSIS®: DNKN has been astandout on the charts recently, tacking on roughly 30% since the beginning of theyear. In fact, the stock notched a new all-time best of $33.54 on April 26, eclipsingits previous highs in the $32-$32.50 area. Short interest hit a post-IPO peak lastmonth, but bears are now rushing to cover. Despite falling 39.7% over the pasttwo reporting periods, short interest still accounts for a healthy 5.7% of theequity’s float, and continued short covering could translate into a contrarian boonfor the stock. Unimpressed by DNKN’s technical prowess, analysts following thedoughnut chain are split. There are six “buy” or better endorsements, comparedto six lukewarm “holds.” Additionally, the stock is trading just below itsconsensus 12-month price target of $32.64. Going forward, this configurationleaves DNKN susceptible to a fresh bout of upgrades and/or price-target hikes,

should the shares prolong their quest for new highs.RECOMMENDATION: Buy the June 16, 2012 30-strike call.

DAILY CHART OF GRMN SINCE OCT. 2011


DAILY CHART OF DNKN SINCE JULY 2011

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A g g r e s s i v e PORTFOLIO


LENNAR - EXPECTATIONAL ANALYSIS®: LEN has flexed some technical

muscle recently, getting a boost from an unexpected upturn in pending home salesfor March. The shares have turned in a 39% year-to-date jump, and an equallyimpressive 42.6% 52-week gain. In fact, the stock has outpaced the broader S&P500 Index (SPX) by nearly 14% over the past three months. Short interest dropped11% during the past two reporting periods, but still makes up 18.6% of thesecurity’s float. At LEN’s average pace of trading, these pessimistic positionswould take over four sessions to unwind, pointing to a healthy supply of sidelinecash. In the options arena, there is huge open interest at the May 26 put, whichcould provide a layer of options-related support over the near term. LEN could alsocatch a lift from a capitulation among the bearish brokerage holdouts. The average12-month price target sits at $28.08, which is a fractional premium to the April 26close of $27.38. What’s more, just 53% of analysts consider the homebuilderworthy of a “buy” or better rating.RECOMMENDATION: Buy the June 16, 2012 23-strike call.

SPDR GOLD TRUST - EXPECTATIONAL ANALYSIS®: In recentmonths, gold has lost some of its safe-haven allure amid improving economictrends. As a result, GLD has drifted steadily lower since mid-September, withthe shares currently down about 13% from their all-time high of $185.85Recent rally attempts have been consistently thwarted by the trust’s declining140-day moving average. This trendline previously served as key support fromDecember 2008 through December 2011, but now appears to be acting assimilarly staunch resistance. From a sentiment perspective, cumulative buy-to-open option volume on GLD has been notably weak of late. Historicallyspeaking, previous such downturns in option-buying activity have coincidedwith periods of negative price action for the shares. Meanwhile, an uptick inshort selling has provided yet another headwind for GLD, with short interest

jumping by 23.8% over the past two reporting periods. Given the deteriorating price trend, continued shorting could weigh heavily on the trust.RECOMMENDATION: Buy the June 16, 2012 166-strike put.

VERIFONE SYSTEMS - EXPECTATIONAL ANALYSIS®: Electronic payment provider PAY’s performance on the charts has been nothing short ofimpressive, with the stock sitting on a 51.6% year-to-date gain. After tagginga new annual high of $55.89 on April 19, the equity pulled back to its 40-daymoving average, only to immediately bounce higher. Despite PAY’s feats oftechnical strength, options players remain unconvinced. Over the past 20sessions, traders on the International Securities Exchange (ISE), ChicagoBoard Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) have bought to open 2.05 puts for every call. In the front-month series, peak putopen interest rests at the 50 strike. As the hedges related to these bearish bets

begin to unwind, it could provide a tailwind for the shares. The security couldalso benefit from a round of price-target hikes, with the average 12-month price target of $54.50 sitting just a hair’s breadth from PAY’s April 26 closing price of $53.86.RECOMMENDATION: Buy the July 21, 2012 50-strike call.

DAILY CHART OF LEN SINCE OCT. 2011

DAILY CHART OF PAY SINCE JAN. 2012


DAILY CHART OF GLD SINCE SEPT. 2011


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P u t S e l l i n g PORTFOLIOCITRIX SYSTEMS - EXPECTATIONAL ANALYSIS®: Shares of CTXS

gapped sharply higher on April 26, as the company’s first-quarter earningscrushed analysts’ expectations -- which inspired a flood of upgrades and price-target hikes from various brokerage firms. This high-volume rallyeffectively pushed the stock through short-term congestion in the $80neighborhood, bringing its year-to-date gain to an impressive 43%. Bearish bettors were caught off-guard by the post-earnings breakout, as the 50-day buy-to-open put/call volume ratio for CTXS checked in at 1.05 ahead of theevent. The shares are now trading well north of several significantaccumulations of put open interest in the front-month series, and theunwinding of the hedges related to these bearish bets could bode well forCTXS over the coming weeks.RECOMMENDATION: Sell the May 19, 2012 82.50-strike put.

RYLAND GROUP - EXPECTATIONAL ANALYSIS®: Homebuilder RYLrallied to its highest price in nearly two years on April 26, as traders cheereda narrower-than-forecast quarterly loss, as well as a stronger-than-expectedrise in pending home sales. The stock notched a convincing daily close aboverecent resistance in the $20-$21 area, which could switch roles to serve assupport going forward. With RYL exploring multi-year highs, the shortscould be left scrambling to limit their losses. Currently, short interest accountsfor 21.2% of the equity’s float, or 5.2 times its average daily trading volume.A bout of short-covering activity could serve as a steady tailwind for RYLgoing forward. Plus, the builder could benefit from options-related support,with its gamma-weighted SOIR of 5.36 revealing a glut of put open interest atnear-the-money strikes.RECOMMENDATION: Sell the June 16, 2012 20-strike put.

UNITED RENTALS - EXPECTATIONAL ANALYSIS®: A positiveearnings surprise in mid-April sent URI gapping above the $44 level -- aformer layer of resistance that has since proven its mettle as support, having provided a reliable floor for the equity’s post-earnings consolidation. Theshares are trading just a chip shot away from their all-time highs in the $48neighborhood, which could ignite some anxiety among the bears. No less than31.6% of URI’s float is dedicated to short interest, representing a formidablesupply of potential future buying pressure. In fact, at the stock’s average dailytrading volume, it would take more than eight days for all of these shortedshares to be repurchased. As URI cements its footing above newfoundtechnical support, a short-covering trend could keep the wind at its back.RECOMMENDATION: Sell the May 19, 2012 43-strike put.

CONTINENTAL RESOURCES and PETROLEO BRASILEIRO -EXPECTATIONAL ANALYSIS®: Oil-and-gas issue CLR has powered itsway to a gain of more than 34% in 2012, with the stock recently findingsupport at the $80 level and its 20-week moving average. With a short-to-floatratio of 15.7%, and 67% of analysts maintaining a middling “hold” rating,CLR could benefit from an unwinding of negative sentiment. Conversely,Brazilian energy giant PBR is locked in a downtrend, having shed 38% of itsvalue over the past year. Bears are only just beginning to catch on, as shortinterest rose by 11.2% in the first half of April. With only 0.3% of PBR’s floatsold short, a continuation of this shorting activity could keep the stock under pressure.RECOMMENDATION: Buy the Continental Resources June 16, 2012

80-strike call and the Petroleo Brasileiro June 16, 2012 27-strike put.

DAILY CHART OF CTXS SINCE DEC. 2011

DAILY CHART OF RYL SINCE OCT. 2011

DAILY CHART OF URI SINCE OCT. 2011WITH 80-DAY MOVING AVERAGE

WEEKLY CHART OF CLR SINCE OCT. 2011WITH 20-WEEK MOVING AVERAGE



O p t i o nS t r a t e g i e s &

CONCEPTS

P r i o rRECOMMENDATIONS


Sometimes, the right pair assumes a certain synergy, making the duo much more desirablethan the mere sum of its parts. The same concept can be applied to one’s investments; ina “pair trade” approach, two can truly be better than one. As its name implies, a pair-

trading approach is a dual-pronged strategy, where two seemingly disparate option positionsare opened simultaneously. The strategy can offer somewhat of a safety net to guard against

an unanticipated move in a specific sector, while capitalizing on a particularequity’s relative-strength backdrop.

The so-called “pair trade” involves being long a security or index in a particular sector and being short a different security or index from the samesector. This strategy has proven to be a moneymaker when there’s volatilityin any of the major sectors.

We’ve taken this strategy and thrown options into the mix to create atrading approach available to the everyday trader. How? In a paired option trade, a trader opens a position purchasing a call on a bullish stock pick within a sector, while simultaneously buying a put on another stockexchange-traded fund (ETF) within that same sector. Or, he might purchase a put on a bearish stock pick, and hedthis trade by buying a call on another stock or ETF within the same sector. While the position consists of being loa call and long a put on separate underlying assets, it is typically managed as one trade. Also, the trader should papproximately equal dollars into the call and the put. So, if the call is up 100% and the put is down 60%, the positi

is net positive by 20% [(100-60)/2 = 20].The appeal of the strategy is that it can improve your option-buying win rate by reducing your vulnerability

adverse sector-wide moves. And since you have a hedge in place, the average loss tends to be smaller relative simply buying a call or put in a directional trade. The fact that your win rate improves and your average loss declinallows you to maintain an overall profit, even though you’re booking smaller wins.

We apply this theory in Schaeffer’s Hedge Hunter, an alert service that combines a proven hedge-like strate-- pairs trading -- with the power and flexibility offered by options, which involve less capital at risk and leveragreturns compared to playing the underlying equities. Because of our success with this trading strategy, we alinclude paired picks within our Option Advisor newsletter.

Using our Expectational Analysis® approach, we can identify which components of a sector are likely to eithoutperform or underperform the overall group. This increases our chances for being correct on one or both ends the trade, and at the same time leverages this advantage via the sector’s volatility.

The end result is that subscribers can now profit from a hedging technique employed by many long/short hedfunds, even though they don’t have the resources to participate in an actual hedge fund.

OPEN AGGRESSIVE POSITIONS

Limited Brands - May 44Ca

CLOSED AGGRESSIVE POSITIONSComcast - May 26C b, Equinix - May 135C b, Fastenal - May 50Cc, Ford Motor - May 14P b

iShares Barclays 20+ Yr. Treas. Bond Fund - April 106Cd, Questcor Pharmaceuticals - April 30Ce

Time Warner Cable - April 72.50Cd,f

PUT SELLING

Dillard’s - April 60Pg, Fastenal - April 50Ph, Garmin - April 44Pg, LinkedIn - April 92.50Pg, Whole Foods Market - April 77.50

PAIRS TRADING

Aetna - May 43Ci and MetLife - May 41Pi

Limited Brands - April 42C j and Abercrombie & Fitch - April 52.50P j

SAP AG - May 62.50Cd and Oracle - May 31Pd

KEY TO COMMENTS

a-Time stop extended per 4/23 hotline, b-Closed per 4/23 hotline, c-Closed per 4/10 hotline, d-Closed per 4/9 hotline, e-Closed per 3/26 hotlineTime-stop extended per 3/26 hotline, g-Achieved maximum profit upon 4/21 expiration, h-Closed per 4/11 hotline, i-Closed per 4/2 hotline, j-Closed per 4/16 h




Bernie Schaeffer’s Option Advisor is published monthly (plus Special Bulletins) by Schaeffer’s Investment Research, 5151Pfeiffer Rd., Blue Ash, OH 45242. E-mail: [email protected]. Bernie Schaeffer, Senior Editor; Todd Salamone, SeniorAnalyst; Elizabeth Harrow, Editor. Subscription rate: $149 per year. To subscribe, call 1-800-327-8833 or visit our websitewww.SchaeffersResearch.com. Schaeffer’s Investment Research also publishes a variety of real-time investment services,available via e-mail and the Internet. This newsletter may not be reproduced in whole or in part without explicit permissionfrom a duly authorized officer of Schaeffer’s Investment Research, except by established newspapers that wish to quote brief passages for purpose of review. We advise all readers to recognize that they should not assume that future recommendationswill be profitable or will equal the performance of any of the recommendations in this issue. The information presented hereinhas been obtained from sources believed to be reliable, but there is no guarantee of accuracy. This publication should beused only by sophisticated investors who are aware of the risks in forecasting and in options trading. It is recommended thatsubscribers carefully read the brochure prepared by the The Options Clearing Corporation and restrict commitments to fundsthat can be lost without undue financial hardship. The security portfolio of our employees, officers andaffiliated companies may, in some instances, include securities mentioned in this issue. Member: TheNewsletter & Electronic Publishers Association and The Market Technicians Association, Inc. Founding Member:Financial Newsletters International. Any enclosed third-party promotional materials should be considered a paid advertisement and do not constitute an endorsement of these products or services by Schaeffer’s

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economic situation in Europe as expressed through volatile European stock markets has been exerting amajor pull on U.S. stock market volatility. And these European markets are -- right here and now -- atcritical levels, the action around which may well determine the course of their behavior for the remainder

of the year. And I believe the sentiment backdrop on the U.S. stock market is such that, should theseEuropean markets post even modest gains for the remainder of 2012, U.S. stocks could soar.

As of today’s close, the Euro Stoxx 50 Index, for all its volatility, has been essentially flat in 2012 -- postinga year-to-date gain of about 0.4%. On the upside this year, with the exception of a 10-day period in mid-March, all Euro Stoxx rallies have been capped at a 10% gain on a closing basis. On the downside, Monday’sbottom registered at -3% year-to-date, and prior to Monday’s nadir the year-to-date low weighed in at-1.4% on Jan. 9. The punch line here is that the European markets have been very respectful of round-number levels, which renders encouraging (but by no means definitively bullish) the fact that we have nowre-taken a positive year-to-date return.

The major reason, from my perspective, that stabilization and, better yet, a rally in the European marketscould have such explosive potential for U.S. stocks emanates from the fact that we have been “importing”

a level of fear and anxiety far out of line with the price action in our own market, and this in turn hasengendered a huge degree of protective behavior by U.S. investors in terms of index put buying, hedgedbets on a surge in volatility, and an ongoing flow of funds that strongly favors bonds over equities. To theextent stocks rally in Europe and investor confidence increases to the point that these fear-based activitiesdiminish, the resulting “unwind” of this fear trade, which has created ongoing headwinds for U.S. stocks,could produce tailwinds of immense proportions.

** I consider 1,400 on the S&P, as well as a 10% year-to-date gain (or, for that matter, a 10% year-over-year gain),to be “round-number levels.” While it may seem trite and simplistic, it is very important to pay attention to suchlevels in order to gauge the health of the market (or of a stock), as well as help project where the market isheaded. For a discussion of the seriously underappreciated significance of round-number levels and how tobridge this gap in most investors’ toolboxes, see my article entitled “Trading on the Level” from the summer

2011 issue of our SENTIMENT magazine.

(Continued from THE MARKET on page 1...)

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schaeffer’s options advisor may 2012

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