Which Stocks to Love Tomorrow and Today

by: Dark Horse Traders' Hedge

Once again we find ourselves at option expiration week which means we decide, in the spirit of "Love Me Two Times Baby" by the Doors, which stocks we want to “love (me) two times” and which will be “goin’ away."

First up is Gannet Communications Inc. (GCI) which we have already loved two times and deserves “One for tomorrow” too, which will make three. The original premise on July 26, 2010 was to get exposure to GCI because it was a value buy at $14.52 with very limited downside risk. The Dark Horse Traders’ Hedge [DHTH] virtual portfolio entered the position with Phil Davis’ Buy/Write Strategy, so we could earn the option premium while holding onto the stock.

Phil’s basic idea is to continue rolling the buy/write as long as we can until we reach a point where our cost basis is at or near zero, and then turn the position into a yield play by selling covered calls. GCI is trading $0.11 higher than the date we added it on July 26, which wouldn’t excite many people if they had held the stock 9 months to make $0.11/share. However, by selling the Jan $15 call ($1.75) and Jan $15 put ($2.25) we were able to net $3.51 (after buying back the Jan $15 put on January 21, 2011, for $0.49); and by rolling to the Apr $15 call ($0.95) and Apr $15 put ($1.35) for another $2.30, we have pocketed $5.81 in 9 months on a stock that moved $0.11.

In order to roll the buy/write into July $15 call and July $15 put, we will buy back the put or call on or before Friday, April 15, for approximately $0.37. Once we have closed the April positions we can sell the July $15 call (approximately $1.15) and the July $15 put (approximately $1.50) for another $2.65 in premium.

In summary, the DHTH virtual portfolio bought GCI at $14.52 on July 26, 2010, and by selling January, April and now July buy/writes, we have reduced our cost basis to $6.43 — and today (April 12) GCI is trading at $14.63. That is one for yesterday, “one for tomorrow” and “one just for today.”

Our second consideration will sound much like the first. MEMC Electronic Materials Inc. (WFR) captured the attention of Dark Horse Traders’ Hedge back on August 11, 2010, while trading at $10.31. We recommended the same entry strategy as GCI utilizing Phil Davis’ Buy/Write Strategy with Jan $11 strike prices.

WFR closed (April 12) at $11.90, or $1.61 higher in 8 months. Not terrible, if we had just bought and held the stock, but as with GCI we were able to return a much higher percentage using the buy/write strategy. On January 21, 2011, we spent $0.36 to close out the Jan $11 call, and the Jan $11 puts expired worthless, netting the virtual portfolio a $2.33 reduction in cost basis.

DHTH rolled into the Apr $11 call for $1.08 and the Apr $11 put for $0.71, or another $1.79. It will cost approximately $0.90 to buy back the Apr $11 call between now and Friday, allowing us to roll into the July $12 buy/write (notice that we have moved the strike price up $1).

This leaves us holding WFR with a $12 strike price and a cost basis of $4.85 ($10.31 purchase price minus $2.33 Jan buy/write minus$0.89 Apr buy/write minus $2.24 July buy/write). We see no reason not to love WFR a third time as well.

Batting third in our option expiration slot is China Petroleum and Chemical Corp. (SNP). DHTH liked SNP the first time on October 17, 2010 at $96.54. We used a slightly different approach with a simple covered call strategy to earn premium while we held SNP. We elected to use the Jan $100 call for $4.40 when we added the position in October. With the backdrop of Joan Jett’s “I Love Rock n’ Roll,” we recommended rolling the Jan $100 call to Apr $100 call for $6.30 (net $4.35 additional premium after buying the Jan $100 call back for $1.95).

SNP closed (April 12) at $103.35, so we face a decision between now and Friday regarding rolling the option again. I continue to like everything about SNP going forward, as they anticipate earnings of $14.19/share for 2011. The July $100 call can be sold for approximately $7; we can close the Apr $100 call for approx. $3.35, which leaves us having earned $3 on the call, so I am inclined to stay exposed to SNP and roll the covered call.

Once again, we have taken a stock which we bought for $96.54 and lowered our cost basis to approx $84.14 ($96.54 purchase price minus $2.45 earned on Jan $100 call minus $2.95 earned on Apr $100 call minus $7 premium on July $100 call).

In the clean-up spot is GameStop Corp. (GME) which, honestly, I wish I had handled a little differently. As you will see, I can’t complain about the return we earned on the stock, but given the covered call strategy it is falling into the “I’m goin’ away” category even though I still like the stock.

GME was added to the virtual portfolio on July 23, 2010 at $19.92. At the time, I attempted to guess the market direction to be flat (mistake #1), so we used a covered call that was thinly traded and didn’t offer much premium. In retrospect, I would have been happier simply owning the stock, but we recommended earning some premium while holding the stock.

I started with the Sept $20 call for $1.31, which we closed on expiration for $.31, netting $1. At that time I recommended rolling to the Jan $20 call for $1.19, knowing that we were heading into the holiday season (mistake #2). When GME did well (which I should have anticipated), we recommended covering the call at expiration for $0.99 and only netting $0.20.

For my third and final blunder on GME, we rolled into the Apr $20 call for $1.96, and the stock closed (April 12) at $23.80. Following on the baseball season and theme of “batting third” and “clean-up spot,” I am going to call 3 strikes and am out on GME, for now.

So, in summary, we bought into GME at $19.92, and it will be called for $20. In the meantime, we earned $3.16 in premiums which underperformed the stock itself.

One last housekeeping measure is to recommend closing the short position in School Specialty Inc. (NASDAQ:SCHS) recommended on February 19, 2011 at $16.18. SCHS closed today at $13.87 providing DHTH virtual portfolio a quick 14%+ profit.

The final score is that we will “Love (GCI, WFR and SNP) two times more” and to GME and SCHS “I’m goin’ away,” for now.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: This newsletter is published solely for informational purposes and is not to be construed as advice or a recommendation to specific individuals. Individuals should take into account their personal financial circumstances in acting on any rankings or stock selections provided by Sabrient. Sabrient makes no representations that the techniques used in its rankings or selections will result in or guarantee profits in trading. Trading involves risk, including possible loss of principal and other losses, and past performance is no indication of future results.