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Why do you need high-risk stocks when trading $INTC is as easy as this? (see chart)

6/12/2014

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All too often, I receive emails asking about short-term trading strategies for extremely risky companies (see MedBox post below)... but what about blue-chip companies such as Intel?  Earlier this year I advocated buying Intel stock for a few different reasons:
  1. It is one of the great technology companies that grew with the popularity of the personal computer, but has since been hurt by "The Death of the Personal Computer"-type statements from prominent investors and analysts
  2. The Windows XP OS, released in 2001 has been an extremely popular platform for personal users, universities, retail banks, government institutions, and ATM operators.  This is due to its ease of use, security, and stability.  However, security support for Windows XP ended this April.  While most personal users and small/medium businesses have moved on to newer systems, about 90% of ATMs still use XP.  As ATM operators begin to upgrade to newer software (mostly Windows 7), they will also need to upgrade their hardware to the 2010s-era, not the 2000s-era hardware they currently run on with XP.  This is where Intel comes in.  According to Retail Banking Research in London, there are approximately 200,000 ATMs in the United States that still use XP.
  3. Although many banks have started to make the shift towards newer Windows systems, many have elected to pay Microsoft to continue producing security updates (most contracts are for 1 year).  In other words, the opportunity to ride the wave of hardware system updates is not over.
  4. Why Intel and not AMD or Microsoft?  Microsoft, while a great company, derives only 10% of its revenue from the Windows Operating system.  Most revenue comes from Microsoft Office and Windows Server.  Simply put, you need a big % change in OS revenue to make a significant dent in the overall price of Intel stock.  Furthermore, this news is most likely already built into the stock price.  Why Intel over AMD?  This comes down to company valuation and preference for ATM operators to go the Intel route.  AMD is already trading at a P/E ratio of 89.38 with a 1y forward P/E estimate of 18.65.  Intel's same numbers are 14.94 and 13.96, respectively.  As you can see, investors aren't expecting much growth from Intel.
  5. It has been easy to trade since late last year.  Barring regular company events such as dividend announcements and quarterly reports, Intel has been following a nearly perfect technical pattern since its 52-week low last August (see chart below).  Traders who buy near the bottom of the regression channel and sell near the top will have made a significant profit.  The regression channel runs from the August 2013 low to March 4th, 2014 (the first time I made the study) and haven't changed it yet.
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CLICK TO ENLARGE IMAGE
  6.    While the trend described in (5.) will certainly not go on forever, traders should find comfort            in knowing that Intel is a stable company and long-term prospects are encouraging.


So with a YTD return of over 8% versus less than 4% for the NASDAQ composite, is Intel still a great buy?  Yes.  With a low P/E ratio for the industry and reassuring growth prospects over the next 12- to 18-months, the price certainly doesn't match the potential.  Oh, and for all of you dividend buffs out there, it pays a hefty 3.30% yield.

Trader's Thoughts

Start buying around $27, but save some cash for if and when it drops below $26.50.
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Medbox - The Vending Machine Drug Dealer

1/7/2014

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"Medbox stock has skyrocketed into the New Year and I was hoping you could give me insight on to why that is and if it is a viable long-term investment holding.  Because it is a "marijuana" stock, I would assume most of its success its attributed to Colorado's new recreational use law.  What are your thoughts?"
Introduction

The Marijuana debate has officially tipped in favor of its users.  Starting on January 1st, 2014, Colorado residents were officially allowed to purchase up to one ounce of marijuana for recreational purposes.  And possibly most importantly – between the long lines at dispensaries, product shortages, and cold temperatures – the transition was incident free.  I, for one, have no interest in smoking the drug regardless of its legal status, but think it will be a fantastic source of tax revenue for the government (25%+ in Colorado) and great source of legal profits (which will be taken from violent drug cartels and gangs).  For the first time, Americans favor legalizing marijuana.  58% now say the drug should be legalized, with 39% saying it should remain illegal.  As long as this trend continues, public opinion will push the government to continue its acceptance of the drug, resulting in massive profits for dispensaries, growers, accessory-makers, and others involved in the industry.  From a “macro” perspective – marijuana is a high growth industry with lots of potential for massive returns over the next 5 to 7 years.

Volatility Concerns

The first thing that needs to be mentioned regarding Medbox, Inc. is that it is HUGELY volatile.  Over the last 18 months, the stock has been trading as high as $205 and as low as $2.  If the stock follows a trend similar to that of January 2013, it will pop then drop again.  In December 2012, the stock went from the low $20 range to a high of $98 on January 11th, only to return to the $20 to $30 for the rest of the year.  Recently, the stock continued its December 2012-like climb in December 2013, only to continue into the New Year.

The Company

Medbox essentially produces highly secure “vending machines” for the “alternative medicine industry”.  What makes the company’s core product (the “Medbox Machine”) confusing is that it is only intended to be used by the clinic employee/pharmacy/nurse as opposed to directly to the end-consumer.  I suppose I was expecting more of a Redbox-style user interaction than asking an employee to interact with the machine for me.  The company does not directly hold any patents (according to the website), but holds rights to 5 patents through an “affiliate entity” – a euphemism meaning they bought the licensing rights for these patents from a different company.  I think the company has potential in the long-term, but marijuana dispensaries that start up in recently legalized states will most likely focus their expenditures on building inventory – not high-cost vending machines.

How to Invest

This is a very thinly traded stock only available in the OTC markets (if you’re not familiar – OTC is everything that doesn’t trade on a major exchange – including penny stocks).  This means that it may be hard to buy or sell a large position in one day.  Based on the current share price and average 3-month trading volume, less than $1.7 million worth of shares change hands every day.  Compare that to over $6 billion for Apple and over $43 million for AutoNation (one of the smallest companies in the S&P 500).

Recommendation

In my opinion, this is a pure momentum play.  The money to be made here is in the very short-term (holding time should be measured in hours, not days).  This is a buy high, sell higher scenario.  If that’s your style, this is the opportunity for you.  I would recommend choosing a dollar amount that represents the maximum you could fathom losing.  Then invest twice that amount.  Don’t pay more than $50 a share for the company, and set a limit sell order around $75 to automatically sell your position at that price or higher.  I do not recommend holding onto it for more than a week, and definitely sell before they report earnings at the end of the month.

One Final Thought

An interview with the CEO of a company can either make or break my opinion of the stock.  There are many great companies with great CEOs that have performed extremely well in the market last year – Boeing’s McNerney, Berkshire’s Buffett, P&G’s Lafley, Goldman’s Blankfein, and Sprint’s Hesse to name a few.  I have seen all 5 of these CEOs speak and have been nothing but impressed with each: a clear vision for the company, implementing meaningful changes, a clear understanding of their business and where it is headed, etc.  I watched a few YouTube videos of Medbox’s CEO speak, and while he appears to know what he’s talking about, when he was questioned on the performance of Medbox, he appeared uneasy and began stuttering and started looking off the screen.  I suppose it’s important to note that OTC companies have much more laid-back reporting requirements than NASDAQ or NYSE components.  Maybe it’s just me, but I don’t trust the guy – especially when he tries to make it sound like they developed the patents when they simply license them from a different company.  However, the dependability and trustworthiness of a CEO is not really a factor when it comes to short-term momentum trading, so take this with a grain of salt.

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Covered calls are dead, or are they?

11/8/2013

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"I was recently introduced to the concept of the covered call strategy, and it seems to make a lot of sense.  However, after researching the strategy more in-depth, it appears that it doesn't generally work well.  Why is this?  And what can I do to earn income on my current holdings?"
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Covered call payoff chart
The covered call option strategy is one that certainly doesn’t get the respect it deserves.  It essentially works like this: you agree to sell your stock in XYZ company to another party within a specified period of time at a specified price (“strike price”).  In return, you receive a premium from the buyer of this option.  Sounds like a pretty simple concept, right?  So first, let’s review the benefits of writing covered call options:

1. You earn money on your holdings even when the stock price is flat over a period of time

2. The value of your holdings (underlying stock and call option together) will be much less volatile: when the price of the stock drops, the value of the call option also drops – meaning you can buy the call option back at a lower price, should you choose

3. For value-oriented investors, the covered call strategy forces you to sell when the price gets above a certain threshold, generally minimizing future losses

4. You can sustain a certain level of losses on the underlying stock and still break even due to the premium paid to you for the option

So if this is such a great concept, why doesn’t everyone use it?

The covered call strategy has been ill-employed in the past, causing poor performance, followed by a general disinterest in selling covered calls.  This is most likely because, in the past, the strategy was to sell options with a strike price x% higher than the current market value of the stock.  Unfortunately, this strategy does not take into account the volatility of the stock.  For example, selling a monthly call option for Coca-Cola (low volatility stock) that is 5% higher than the market price will most likely net next to nothing since the chances of Coca-Cola growing 5% in one month are extremely low.  Conversely, selling a monthly call option 5% higher than the market price for high volatility stocks such as Tesla or Questcor Pharmaceuticals isn’t unreasonable.

So what is the best way to take implied volatility into account when selling call options?  Instead of setting the strike price as a percentage of the market price, choose a percentage return you would like to receive on your option sales (say 1% for monthly options).  Then find the call option with a “bid” price closest to this number.  For example, if XYZ stock is trading at $100 and you want to earn 1% on this monthly option sale, choose the strike that has a “bid” value of $1 ($100x1%=$1).

Once you decide what strike price you would like to sell against your holdings, take a look at the MACD and Bollinger Band charts of the underlying stock.  The best time to sell a call option is when the price is approaching the upper band of the Bollinger Band and the MACD line is decreasing (momentum slowing, possible reversal coming).  This will allow you to get paid the highest premium for your stock holding, with the greatest possibility that it will drop in value in the near future (remember: drop in option value = gain for you).
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Buying HollyFrontier (or any company) before an earnings report

11/5/2013

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"I'm thinking of making a big play on HollyFrontier Corporation before their Q3 2013 earnings report on November 6th.  More than 5,700 November 48 call options were purchased on Friday, showing traders turning bullish on the company.  What are your thoughts?"
HollyFrontier vs. Peers

Two things I would like to point out before I get too in-depth with this analysis.  First of all, one of the most important inputs in the profitability of oil refiners is the price of oil.  As you can see from Figure 1, the price of oil during July 2013 to September 2013 (the quarter the company is reporting for) is the highest it has been all year.  This is certainly a good sign for HollyFrontier, as its profitability has fallen behind its peers in recent quarters.  Companies with shrinking margins tend to trade at higher price-to-sales ratios and lower price-to-earnings ratios than those of their peers.  This is reflected in the PE ratio of oil refiners, where HollyFrontier has the lowest ratio versus its peers (showing an underpricing in the company’s stock – see Figure 2), and is also reflected in the PS ratio, where HollyFrontier has the highest PS ratio versus its peers (showing an overpricing in the company’s stock – see Figure 3).  The downside to the company is that investors take into account the present value of all future cash flows when pricing a stock, and the price of crude oil has fell from over $110 per barrel in September to $93.39 today – not a good sign for the company’s bottom line for the 4Q2013 reporting.

Do Not Let Speculative Option Traders Deceive You

The second perspective that is important to mention is, historically, high option volume (whether it is puts or calls) does not indicate direction of a stock following its earnings report.  Two recent examples were Apple, Inc.’s quarterly earnings released last week that were preceded by high call option volume.  Before the report, the stock was trading at $529.88 versus $526.85 (keep in mind that the actual EPS of $8.26 was higher than analyst estimates of $7.96 – it was the outlook that was less than promising).  I have a feeling that HollyFrontier may follow this same trend – great returns for 3Q2013, but negative forward-looking prospects.  The second example is stock in Sprint Corporation.  The earnings report came in worse than expected based on subscriber losses throughout 3Q2013, but a positive outlook going forward.  This has propelled the stock from $6.70 before its 3Q3013 earnings release on October 30th to $7.20 today (a 7.24% increase).  It’s also important to note that put option volume in the week before its earnings release was over 3 times call option volume.

Summary

I certainly wouldn’t rule out HollyFrontier as a long-term acquisition, but I definitely wouldn’t use high call option volume as a core reasoning for purchasing stock in the company ahead of an earnings report.  The stock has seen virtually no net price change from the beginning of the year (-0.11%), while its PE and PS ratios have stayed mostly stable as well.  Two of HollyFrontier’s competitors underperformed analyst EPS estimates for 3Q2013 (Phillips 66 was 7.4% lower than expected and Western Refining, Inc. was 35.3% lower than expected).  None of the companies mentioned in the charts below increased more than 4% since the earnings release (Valero Energy Corporation increased less than 1% after its EPS for 3Q2013 came in 39% higher than analysts’ expectations.

Recommendation

I cannot make a recommendation on the short-term trading prospects of HollyFrontier.  There are multiple analysts who follow these stocks on a daily basis and are still only right 50% of the time on quarterly earnings.  However, with an impressive earnings yield (18.8%), FCF yield (19.32%), book to market ratio (0.7321), dividend yield (2.58%), and reasonable PS ratio (0.4204), this is a reasonable value pick that will perform as a long-term holding.

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Figure 1 – YTD Crude Oil Spot Price
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Figure 2 – YTD PE Ratio of Comparable Oil Refiners
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Figure 3 – YTD PS Ratio of Comparable Oil Refiners
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    Spencer Sargent

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