Chasing Value: Shocked By Toxic Stock and Still Finding Deals

Does that mean that a lot of people agree but they are timing the market waiting to jump back in sometime soon, but not now? Could it mean that they think I'm probably correct but their conviction is not enough to cause them to invest? Otherwise, you might conclude that this level of support would also be more accurately reflected in the stock market, which has been trending down for 7 out of the last 8 weeks.

I find it very strange that the polling was so lopsidedly positive, but the market is so negative. Perhaps it is telling of the preponderance of readers that follow Chasing Value. Perhaps I have started to attract a disproportionate amount of fellow contrarian investors?

Yesterday, Bank of America, BP p.l.c., Goldman Sachs, and Transocean continued to slide down, while Citigroup and General Electric managed to move higher with the market.

Today the market is down, which is no surprise with powerhouses like International Business Machines (IBM) feeling blue, Johnson and Johnson (JNJ) lowering guidance; and Goldman Sach's reporting disappointing quarters.

What should we make of today's market? So far the earnings season has brought mixed results. My polling contradicts the recent market trend. Blue chips stocks are tepid at best, and from my perspective I have to maintain that the fear and confusion create opportunities. For those that trade options in stock futures, that is where there may be opportunity.

Some examples from my own activity today. I bought to close put options I had sold within the last month (naked puts) taking profits in six different positions. They included BP contracts for August with strike prices at $20.00, $22.50, $25.00 and $30.00. I also closed out GE August $14.00 puts and Ebix (EBIX) $15.00 puts.

All of them were advantaged by high levels of fear and volatility. At yesterday's close BP was $35.75, GE was $14.62 and EBIX was $15.66.

Looking at the futures market and put options now what do I see as great opportunities. Here are a few examples for both conservative options traders and the gunslingers among you. All of them are naked puts so not everyone is qualified to make these trades, however, you can still examine similar put and call positions if you are familiar with options.

Johnson and Johnson, January 2011 $60.00 puts are paying $4.70 per share. That offers you a break-even point of $55.30 for a 17% annualized return. ($4.70 / $55.30 x 2). To me this is a sweet deal. You either get a good return on investment or you own one of the great companies in the world at a bargain price.

A little more risk but a great return is offered for General Electric, January 2011 $16.00 puts paying $2.42 per share. That offers you a break-even point of $13.58 (a buck under today's price) or a 35.6% annualized return.

I have been trading Citigroup options for the past year and there has been a lot of money to be made. January $4.00 puts offer $0.51 per share for a break-even of $3.49, far less than today's price. The return is 29.22%. For myself I prefer the $5 puts offering $1.18 per share. Your break-even is now higher, and closer to today's price at $3.82, however, your annualized return is about 60%.

Obviously I am ecstatic that the market has so much uncertainty that these opportunities are there by the hundreds. Looking at the risk versus return for any of these trades you can see that you are either going to make a lot of money or own the underlying stock at a bargain price.

There is a down side to these options although that is in the eye of the beholder. If you would not be happy to own the stocks I have used in this example, than you should not pursue these options and look for similar deals in stocks you would like to own.


Sheldon Liber is the CEO of a small private investment company and the principal for design and research at an architecture and planning firm. He writes the columns Chasing Value and Serious Money. Disclosure: At the time of this post he owned shares and/or options in all of the stocks mentioned with the exception of IBM.