THE STRIKING PRICE
Battle of the Beasts
By STEVEN M. SEARS
How to cash out equities but still stay in the game.
A BULL AND BEAR SIT ON THE SHOULDERS of every investor. The bull whispers optimism in one ear. The bear is a different animal.
With training, investors can synthesize the two to make risk-adjusted decisions that lead to longevity in the markets. But sometimes, unusual events intensify the battle between bulls and bears to such a pitch that even the most disciplined investors don't know what to do. Now is such a time.
As the Standard & Poor's 500 Index extends its historic advance that began in March, many investors are weighing the unspoken words of both beasts.
The bull says: "Man up, sissy. The meek will not inherit."
And the bear: "Use your brain, idiot. Take profits. Now."
ENTER THE OPTIONS TRADER, who effectively can do both, by hedging against a continued rally -- and protecting against a market decline.
We recently detailed how options-trading volume is surging as more investors try to have it both ways. Jefferies & Co.'s derivatives strategists put a finer point on this. They're telling clients to protect stock gains by selling shares and buying calls before third-quarter earnings season starts.
Revenue generally was weak in the second quarter of 2009, and many companies boosted their profits (or posted profits) by cutting costs. "As this appears unsustainable over a long period, there remains meaningful risk in companies reaching the increasing earnings expectations for Q3," Pat Neal, Jefferies strategy chief, says.
Indeed, many analysts played catch-up this past earnings season. They often were too negative, and had to increase estimates and ratings to match results and corporate guidance. The bar remains high for third-quarter earnings.
Stock-replacement strategies, which is what Jefferies advocates, work best when a stock price is high, and options volatility low. This lets you sell high in one market, and buy low in another.
Jefferies identified 20 stocks with the largest outperformance relative to the market since the March low. Three-month options on these also are inexpensive.
The list includes General Electric (ticker: GE), American International Group (AIG), BJ Services (BJ), Fortune Brands (FO), Dow Chemical (DOW), Constellation Energy (CEG), Ciena (CIEN), Genworth Financial (GNW), Citigroup (C), Advanced Micro Devices (AMD), Comerica (CMA), BB&T (BBT), Adobe Systems (ADBE), Caterpillar (CAT), Chesapeake Energy (CHK), Allegheny Technologies (ATI), Disney (DIS), FedEx (FDX) Autodesk (ADSK), and Eastman Kodak (EK).
Buying cheap calls on such high-beta names are often good trades.
Onward goes the battle of the bull and the bear.
Copyright 2009 Dow Jones & Company, Inc. All Rights Reserved
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