A 34% gain in seven days

As promised, SmallCapInvestor PRO readers took their gains on Arena Pharmaceuticals (Nasdaq:ARNA) on Wednesday. The final haul was 34%. Not bad for holding a stock for seven days. I expect we’ll re-buy Arena if it drops to $4.50 over the next few days. 

I hope Daily Profit readers were able to lock in some gains on the stocks we recently recommended here.

*****The next few days should be interesting for the stock market. I’m a bit surprised that the major indices finished in the green on Wednesday. I’ll be more surprised if they finish with gains today.  

Congress will be discussing mark-to-market rules today. It’s a safe bet that some kind of easing of these rules will happen. That would essentially buy the banks some time that could be better spent than writing down assets and taking losses. And it could extend the rally. No decision is expected until April. 

I also think it’s safe to say that there are entities out there that would like banks to continue to be squeezed. Eventually, they will be forced to puke up impaired assets and even more impaired prices, which would almost certainly to a windfall for those with ready cash. It’s a dog eat dog world ? 

*****It’s getting a little scary in Japan. Fourth-quarter GDP fell an annualized 12.7% after exports fell an amazing 45%. Some economists think the current quarter could be even worse. It’s so bad that Japan’s blue chips are having cash flow problems and are turning to state-sponsored Japan Bank of International Cooperation (JBIC) for loans. The $40 billion in loan requests so far this year is four times the bank’s annual budget.  

*****Jobless claims and retail sales numbers are out. Yes, they are not good. But not disastrous, either.  

*****Last week, I promised you a look at what other newsletter gurus buying. However, due to a communication breakdown, we failed to run the piece. So we’re doing that today. Here’s an interview with two top options traders from Big Money Options. Enjoy ? 

Andrew Houghton and Nick Atkeson work together to identify options trading opportunities on the institutional level and, now, for OptionsZone.com readers. They are the editors of Big Money Options, an options trading service that provides one to two new opportunities each week based on their findings. 

Nick and Andrew: As experienced options traders, how have you kept your head above water in the past year? 

Staying above water for the past year was generally not a problem until the market crash of the fourth quarter of 2008 and its aftereffects coming into 2009.  

For options traders, we have had to manage a situation where the Chicago Board Options Exchange’s Volatility Index (VIX) ran from 20 to a high of 89 and has remained persistently in the high-40s near "panic" levels for the past several months. (The VIX is a measure that shows investors’ expectations for the market in the coming 30 days. Also known as the "fear index," it is calculated using options on the S&P 500.) 

In practical terms, this means it has been hard to make much money by just going straight long calls and puts, as the volatility has been priced at very high levels. Despite the record moves in the overall indices, many individual stocks are showing less actual volatility than what has been accounted for in the options pricing.

Although there is still plenty of profit to be made by following what the "big money" players are doing, we have had to adjust our style somewhat by looking for opportunities that include selling volatility. That is, we are directly shorting options to collect a premium upfront and buying them back at a much-lower price or letting them expire worthless (while we keep our premium). 

We have also been using spread, risk-reversal and naked short-selling of puts to collect premium that is priced too high. In cases where we are selling options, we look to do so only in situations where, if we end up taking ownership of the underlying stock, it is a position that we believe is fundamentally sound, attractively valued and a money winner over time. 

What type of investor (and or knowledge) would one need in order to follow your advice? Would you recommend they go it alone? 

Our Big Money Options trading service works well for investors who range in experience from beginner to expert so that, not only are they not "going it alone," we can meet them where they are and help them to take their next steps toward becoming better, more profitable options traders.  

For the novice, our service allows them to dip a toe into the options market while we stand by their side. For the most experienced option traders, we are identifying the most-significant tradable opportunities in the market and suggesting effective trade structures to take advantage of these opportunities.  

All subscribers benefit from having two very experienced institutional options guys scanning the market full-time with state-of-the-art technology. For the price of a cup of cappuccino per day, you are made aware of trade ideas that could easily buy you all the coffee you might want for the rest of your life. 

As a way of background, we began our careers in the world of finance in the small- and mid-cap equities area, where our focus was on company fundamentals. After several years, we moved into options trading with the largest options trading firm in the world and successfully mated a fundamental stock approach with the more-quantitative methodologies of the options world.  

In other words, we began our careers in this business understanding the importance of knowing an investment opportunity from as many sides as possible, and our trading philosophy involves explaining trades with a fundamental approach. As "stock guys," we learned to get the story behind the trades, and as "options guys," we tend to talk about options in ways stock investors find easy-to-understand. 

We make every effort to provide comprehensive advice in terms of opening and, more importantly, closing the position.  

We do recommend that an investor have a basic understanding of puts and calls and that they visit the Options Clearing Corp.’s website (OptionsClearing.com) and read the "Characteristics and Risks of Standardized Options" document. The OCC site also has a link to a document entitled "Understanding Equity Options" if you are looking for a review of option mechanics. 

Name your two most successful trades thus far in 2009. 

Many great companies have depreciated to very attractive valuations during this bear market. One of our most successful trades this year involved taking advantage of the depressed valuation of Wal-Mart (NYSE:WMT) after the company disappointed investors with weak earnings and guidance in early January.  

With the stock trading down 8% on Jan. 8 and the company clearly being one of the few beneficiaries of consumers "trading down," we recommended that our members sell (i.e., "sell to open," to establish a short position) the February $47.50 Puts for $1.45. Selling puts is a bullish strategy that allows us to immediately pocket money and keep that money when the stock goes up and the puts lose their value as options expiration nears. 

It was also clear that for the past decade, the mid-$40 range was the low end of WMT’s trading range. The stock performed well, surprising investors several times with better-than-expected sales and earnings announcements and closed well above the $47.50 strike price on expiration, leaving us with a 100% profit in a little over a month. 

Another successful trade occurred during the December/January time frame. In late November 2008, Shaw Group (NYSE:SGR) was trading at about $16 per share. We saw very bullish option signals on this high-quality engineering, technology and construction company that made us take a hard look at the options.  

After some analysis, we recommended buying the SGR April 15-25 bull-call spread (i.e., buying the calls at the $15 strike price and selling the $25-strike calls against them in a single transaction) and also selling the SGR April 12.50 Puts.  

It may sound complicated on the surface, but it was a fairly low-risk way to gain upside exposure to a great company that had been oversold.  

It was also a very profitable play. 

On Jan. 8, we closed the bull-call spread for an 83% win. And then on Jan. 26, we closed half of the $12.50 put position for an 87.5% win. We are letting the other half of the put position ride, as we fully expect to have a 100% win come expiration. 

Although we are seeing a broad economic slowdown, there are some very robust growth trends emerging under the surface. One such trend is the continued migration of economic activity from bricks and motor to the Internet.  

The most recent powerful evidence of this was Amazon.com’s strong outperformance on its most recent quarter. Companies that are exposed to this trend include Amazon.com (Nasdaq:AMZN), Google (Nasdaq:GOOG), Cisco (Nasdaq:CSCO) and United Parcel Service (NYSE:UPS).

China has not disappeared. Their developing focus on capitalism will drive increased amounts of wealth-creation for years to come. You can gain exposure to this market as well as find attractive value in Baidu (Nasdaq:BIDU) and BHP Billiton (NYSE:BHP). BIDU is a Chinese Internet play, and BHP is the largest supplier of many of the raw commodities that are used as the factors of production and growth in China. 

Although energy prices are down on falling demand, oil demand-and-supply conditions look attractive over the longer-term. ExxonMobil Corp. (NYSE:XOM) has been earning record profits and is globally positioned to take advantage of this trend. 

With the domestic indexes down to the lows of 1997, what trading/investment advice would you give individuals as we move through? 

We will address this from an options perspective. The overriding question of the day is whether we are entering a depression and will the market go substantially lower, or whether the worst is behind us.  

Without knowing the answer to the question, there are options trading strategies that have a high probability of winning, whatever the answer may be. The tug-of-war between these two opposing views is keeping the VIX at very elevated levels. 

Uncertainty is making options premiums expensive. We have already discussed selling puts in high-quality companies that you would not mind owning at lower prices. You may also want to sell calls on many of the stocks you own in your portfolio to provide some income enhancement. 

If you would rather just go long options, we would recommend buying longer dated calls in companies that you believe are at or near the extreme end of an oversold range. See below for an example with our recommendation to buy the NOVL 2010 leaps. 

Name three trades/stocks you would recommend today. 

B/E Aerospace (Nasdaq:BEAV) is the world’s leading provider of interior products and solutions, and the world’s leading distributor of aerospace fasteners and consumables for the commercial, business jet and military markets. 

The airline industry isn’t immune to the serious economic downturn. Airline traffic was down 4% in November and December and the International Air Transport Association forecasts that international passenger traffic will fall by an additional 3% in 2009.

The airline downturn may offer a clue as to why airplane fasteners and interiors are selling well. Rather than buying new jets, it appears airlines are maintaining and upgrading the old jets with BEAV manufactured parts. 

On Feb. 2, B/E Aerospace reported a record year in 2008 for the company in terms of sales, operating earnings, net income, earnings per share, bookings and backlogs. More surprisingly, management raised its forward-year EPS guidance to $2. The consensus analyst estimate was $1.89. The company is generating cash and has more than ample liquidity and no debt maturities until 2014. 

We like collecting premium while we are exposed to a possible market bounce, so the way we’re playing this is via "buying to open" the BEAV April 10 Calls (BQVDB), and "selling to open" the BEAV April 7.50 Puts (BQVPU) against them. This trade currently offers a net credit of $0.40. 

Research In Motion (Nasdaq:RIMM) and Apple own the PDA market. Consumers around the world are steadily moving from simple cell phones to full-featured smartphones that can surf the Web and manage e-mail. This is a secular change that will continue for the foreseeable future. 

RIMM is down on the announcement that its gross margins and Q4 earnings per share will be at the low end of the range. Current analyst estimates for fiscal year 2009 ending in February is $3.38. The company has $3 per share of cash. 

Cisco (Nasdaq:CSCO) just completed a $4 billion bond offering for the purposes of "aggressively" investing in the United States, India and China. We have seen this before. The great companies invest during the downturns and emerge stronger and more dominant on the other side of the recession. CSCO is a company built in large part through acquisitions. 

We recommend selling the RIMM June 25 Puts (RUPRE) for $1.85 cents or higher. We believe that if RIMM approaches a $25-per-share valuation, there is a good chance it will be acquired.

Assuming analyst earnings estimates are about $3 in June and RIMM is trading at $25, the P/E would be about seven times if you subtract the cash. Even if you cut the earnings in half, the stock at $25 per share would be inexpensive given its market position and long-term growth prospects. 

Novell Inc. (Nasdaq:NOVL) is an infrastructure software company that offers software to integrate mixed technologies so they operate as one.  

In the past, the company has struggled against Microsoft. Now, the company has a new management team that has been in place for about a year, $3 per share of cash, positive cash flow and no debt. The stock is currently trading at about $3.45.  

Analyst estimates for this fiscal year and next are $0.26 and $0.30 respectively. That translates into a P/E multiple of less than two times earnings, if you account for the cash on the balance sheet. 

Our background checks indicate that the company’s solid financial condition shouldn’t change materially during the next six to 12 months. And we may not be the only people who recognize how silly the low valuation has become on this stock.  

We like the position of the stock, the price of the options and the duration of them. We’ve joined the smart options buyers by recommending that our members "buy to open" the NOVL Jan 5 Calls (WNNAA) and "sell to open" the NOVL Jan 2.50 Puts (WNNMZ). This position can be executed today for a net debit of $0.10. 

We’ve got plenty more option trade recommendations where those came from, as we work around the clock to spot under-the-radar opportunities to pass along to our Big Money Options members. A typical week can bring anywhere from one to three new trades, along with intraday alerts to take profits and otherwise help our subscribers to manage their positions.  

We’d like to share with you a deeper understanding of the money flows that drive the options market, timely market intelligence that gives you the confidence to pull the trigger, and an opportunity to receive specific, easy-to-execute options trades that will give you profits regularly throughout the year.  Please accept a  free copy of The Secret Formula to Doubling Your Money Twice a Month by going here now.