Options Strategies for 7 Diversified and Balanced Investments

by: Hedgephone

Lately, I have been receiving a ton of flack for my "terrible" calls on certain articles I have written for Seeking Alpha. Nothing helps me as an investor more than someone from the other side of the tape telling me how wrong I am and why; these comments make me a better investor and a better analyst.

To be clear, I am usually a non-directional investor and analyst by nature. I am currently bearish on the overall small cap stock indices, bullish on commodities, neutral on large caps, and bearish on momentum stocks.

The reason for all of these decisions are largely based on bottoms up fundamental research. P/E ratios, price to cash flows, discounted future free cash flow analysis, and growth models. These are the tools I use to evaluate individual investments.

Many traders and investors argue that analyzing balance sheets and cash flow statements are a waste of time, that markets are efficient, and that you should simply buy what is fashionable and what Wall Street likes at any given time. Growth investing is a great strategy, however we have all witnessed times when last year's best investment ideas become this year's biggest losers.

Here are 7 investments I like on a relative basis right now from a fundamental, bottoms-up perspective. These investments will help long/short investors stay diversified and balanced within their given exposure parameters.

RSX -- The Russian stock market is obviously volatile and fraught with political and corporate governance risk, yet the index is trading at just 7X trailing earnings and the country is host to some of the largest oil and gas reserves in the world. My favorite way to participate in the RSX is to buy the August $37 calls for $2.90 and to sell the September $41 calls for $.90 per contract. While this spread seems a little backwards from my usual calendar spread approach, in essence you are getting long the RSX for almost zero premium and have lowered your maximum downside risk to just $2 per contract.

Your maximum gain is $2.20 a contract, which is nearly a 75% return on your investment in two months, or as a "covered call replacement" strategy, yields a max gain of 5.6% in just two months time without risking more than 5.3% or so on your investment. I like this position as a "long hedge" for short positions in the IWM and QQQ here which appear overvalued to me at current levels.

FXI -- The FXI is a basket of China's largest stocks and trades for around 10X earnings. China has underperformed recently, but the country is growing much faster than the United States and their central bank has been snapping up gold, silver, and other commodities as a hedge against weaker currencies globally and massive sovereign deficits around the globe.

Like the RSX, I believe a call spread approach makes a great deal of sense as a "long hedge" versus a short in the IWM index. Investors can buy the August $40 calls for $2.70 a contract and can sell the September $44 calls for $.88 cents a share for another "reverse" calendar spread trade in FXI. This trade gives investors a maximum risk of 4.5% versus owning the stock directly and a maximum potential gain of 5.2%. Keep in mind, once the August call option expires, you will either be long the stock if FXI is over $40 or will be naked short the call option and will either have to exit the position or buy another call on the stock.

This is a slightly more bullish strategy than a traditional calendar spread, but carries lower risk than a covered call strategy with roughly the same potential upside. Keep in mind that the FXI looks weak technically with a "death cross" in place after the 50 day crossed below the 200 day earlier this year.

RJI-- The Rogers Raw Materials Index is a simple choice. If the central banks continue their policy of competitive currency devaluation, the RJI is one of the only investments that can make you money without having to speculate on overvalued equity markets. The Rogers Index has outperformed equity markets for the past twelve years, and I don't see this trend ending until governments decide that printing their way toward new stock market highs is not the answer to our economic difficulties.

What needs to change is inequity, and without a new economic framework besides mis-understood Keynesian ideals, the RJI will simply continue its march ever higher while economists continue saying that more money should be printed to create jobs. The Phillips curve can't describe what's going on today, because pushing on a string has real consequences to the poor and middle class who have to pay ever higher prices for raw materials. This failed model simply can't account for finite resources or automation.

SIVR -- Silver is another uncorrelated asset which has simply outperformed stocks with the printing of more money. Silver is up over 100% since last summer and has clearly performed much better than equities over that time period. Because of scarcity and Keynesian mis-interpretation, I expect silver prices to continue their near vertical climb in the years ahead. Silver is rising based on supply and demand -- for one, the supply of dollars has increased by 200% or more since the 2008 financial crisis, so because their are less ounces of silver per dollars in circulation, the metal should rise to reflect additional monetary easing.

In addition to the supply of dollars rising, the supply of silver is decreasing because of investment demand. Silver registered on the COMEX has seen a sharp decline recently, and shortages of the metal could continue the metal's meteoric rise from here. The metal is already up 26% this year, but I view this as just the start of the third inning of the silver bull market. If the only answer Bernanke has for unemployment is printing money, expect unemployment to get worse and for commodities to skyrocket even further, creating more unemployment and thus more money printing, which creates more money printing and this more money printing.

FCX -- Freeport holds some of the most valuable copper, silver, and gold reserves in the world. The stock is trading at only 10X trailing earnings and 8X forward earnings. Freeport is a volatile stock, so investors need to have a longer term buy and hold approach and add to the position on large dips. FCX is dependent on copper prices, but the stock is cheap enough that longer term investors have to stop looking at the headlines and other risk factors and simply buy and hold the name through thick and thin.

One way to play FCX is to sell the January 2012 $55 put options for $6 a contract. This gives investors a large margin of safety to compensate the risks that America will suddenly move towards a "strong dollar" policy in a meaningful way. I'm not holding my breath.

MOS -- Mosaic is now trading at around 10X forward earnings, and the fact of the matter is that phosphorous and potash are two resource items facing long term supply shortages. Investors can also look at Potash (NYSE:POT) for a way to invest in this long term bull market, but I prefer MOS because of the stock's more reasonable P/E ratio.

Mosaic shares are down substantially from their YTD highs, and this offers investors a strong opportunity to buy on relative weakness. Investors can look to sell the January 2012 $72.50 put options for $7.3 per contract and buy the January $60 put options for $2.7 or so per contract for a bull put spread. While this spread "only" yields a 6.4% or so return over this time period, the long put option can be sold for a gain if the position moves lower in the shorter term, which will lower your cost basis even further.

Maximum risk is around $7.9 and is only triggered if MOS is trading below $60 or so on expiration. If MOS trades at $30 for some reason, you will be fully protected and will still only lose the maximum $7.90 per contract.

AIG -- AIG is a controversial stock and has been punished this year quite badly. That said, the government has realized it can't really exit this illiquid position without stepping on its own feet and the stock is trading at a large discount to book value. I like this name, but would be very cautious in how I purchase the stock. I like selling the January $29 put options here for around $2.7 or so per contract, while possibly selling a DB bear call spread for a pairs trade.

I don't think AIG has as much PIIG exposure as DB, but with the derivatives mess so hard to figure out, I am skeptical of most of the largest bank and financial stocks at the moment. Their is "blood in the streets" again here, so any up-tick in these could represent a real bottom for financial names in general, though personally it's still too tough to evaluate.

Fairholme's large position in AIG is extremely bullish, however, and I don't think their long term track record is a fluke. Banks are obviously risky and while financials such as AIG are not for widows and orphans, this stock looks a lot better than others in the sector, however.

While I am not ready to completely abandon stocks here, my level of skepticism and bearishness has never been higher. That said, Washington is clearly more obsessed with the stock market's weekly and daily gyrations than they are on actual governance. In today's world, the stock market IS the economy to the powers that make policy, so short selling has its own set of fundamental difficulties.

While I am a Democrat and I believed that President Bush made a ton of bad decisions, I must say that I have never witnessed a political system more obsessed with the rich and with higher stock prices than the American political class is today with the stock market averages. From Ben Bernanke touting his successful manipulation of the Russell 2000 to this weekend's drive to solve a debt deal so that markets don't sell off on Monday morning, Americans are obsessed with higher equity prices and will throw many a poor person under the bus to get there.

Disclosure: I am long MOS, FCX, FXI, RSX, SIVR, RJI.