Rebound Stocks

by: David Jonas

In college I couldn't meet girls to save my life.

Part of my problem was physical, as I wasn't much to look at. With a dab of pomade, couple squirts of Clearasil, and my good-luck all-season earmuffs, though, I could generally pull together a good enough game face. My real problem -- and one that resisted all of my efforts at concealment -- was a crushing congenital personality defect. Girls just didn't go for me. When I'd strike up a conversation with a girl, she would indulge me up to about 30 seconds of her time -- that seemed to be the breaking point -- before urgently taking flight, as if a discourse on the history of cabbage had issued forth from my lips rather than the enchanting shtick that I had intended. I was my own deal-breaker.

(The cabbage reference is not arbitrary. The first reported instance of the family curse dates to the early 1800's, when an Estonian milkmaid terminated the romantic overtures of my great-great-great Uncle Shmuel by plunging a stuffed cabbage into his mouth in mid-sentence.)

To improve my odds, I decided to focus my attentions on girls whose boyfriends had recently broken up with them -- so-called "rebound" girls. I reasoned that these girls would have their guard down and be less particular about the male company they kept, thereby presenting me a fleeting window of opportunity. If I could simply listen sympathetically and keep my mouth shut I figured I might have a chance.

These encounters usually started well enough: Offering a sympathetic ear to a jilted girl, I discovered, was like offering mother's milk to a newborn. I'd spot my target, sidle up to her and gently ask, "Is there anything wrong?" She would then go off passionately about the scoundrel who had dumped her, her ranting interrupted only by the compassionate-sounding grunts that I would occasionally interject. Inevitably, though, after about 3 hours or so, the girl would notice my presence, and prompt me to contribute meaningfully to the conversation. Very soon thereafter the cabbage face would flare and she would be gone.

Eventually I found my way, married the girl of my dreams, and forgot all about my rebound theory, until recently, when stocks started crashing and burning all around me, causing me to wonder: Could I strike gold in rebound stocks, even though I had struck out with rebound girls? Could I find high yield in broken-down stocks, even though I couldn't find true love in broken-hearted girls? Of course I can! Fallen stocks offer outsize rewards, as long as you buy when the stock has found a floor, rather than taken a breather on its way to lower lows.

Spotting a girl who is ripe for a rebound is easy, provided you can get close enough to pass judgment. She's smart, witty, charming, smells OK, has good credit, and her car says she brakes for whales. Yet, in spite of these fetching fundamentals, she spends Friday evenings in the libraries (or, like poor Joan in Maxwell's Silver Hammer, spends late nights alone with a test tube.)

Identifying a potential stock rebounder is a much trickier business.

Investors turn to all sorts of indicators to gauge a stock's future price movement: Analyst targets, short interest ratios, Jim Cramer's spittle, insider transactions, moving averages, Bollinger bands, and the like. (little known fact: Cramer's spittle is one of the most bullish signals on this planet. If, in the midst of one his rapturous, talking-in-tongues rants about the sure-fire next big thing, a Cramer spittle bomblet tags the lens of the Mad Money studio camera, back up the truck and buy buy buy. Make sure you do this, though, before Cramer changes his mind, meaning you have about 7 minutes.)

Because I am a self-disclosed Covered Call Junkie, a key indicator that I employ to seek out rebounders is: Annualized covered call yield. A down stock with a high call yield suggests that call option buyers anticipate recovery of the share price. To be sure, option buyers represent only one small corner of the investor universe, but it's one to which I pay close attention.

Here are the key tenets of my overall investment strategy: (For more information please click madly on my previous Seeking Alpha articles.)

I only invest in optionable companies. If I can't sell a call, then I don't buy the shares.

  • My goal in establishing a covered call is assignment, i.e. I want the shares to be called away at option expiration. I therefore sell either ITM or just OTM front-month or next-month calls.
  • I avoid Chinese and biotech companies, and stocks that meet any of the following criteria:
  1. Short interest greater than 10%
  2. Market cap under $300 million
  3. Stock price under $15
  4. Less than moderate option liquidity

In evaluating covered call rebound candidates I look for companies that:

1. Are trading at 30% or more below their 200-day simple moving averages; and

2. Offer an average annualized yield of at least 70%, where:

  • Yield includes income from share appreciation, option premium, and (if applicable) dividends combined.
  • Average annualized yield refers to the average of:
  • Yield if the shares are assigned; and
  • Yield if the shares are not assigned.

Here are the top 10 covered call rebound candidates, sorted in descending sequence by average annualized yield:

  • Research in Motion (RIMM): 127% yield if assigned, 105% yield if not assigned
  • Forest Oil (NYSE:FST): 127%, 90%
  • Walter Energy (NYSE:WLT): 100%, 95%
  • Alpha Natural Resources (ANR): 107%, 87%
  • G-III Apparel Group (NASDAQ:GIII): 151%, 37%
  • Silver Standard Resources (NASDAQ:SSRI): 88%, 97%
  • Arch Coal (ACI): 83%, 89%
  • Computer Sciences Corporation (NYSE:CSC): 102%, 65%
  • Arcelor Mittal (NYSE:MT): 93%, 71%
  • Dolby Laboratories (NYSE:DLB): 99%, 58%

Here are more details on these companies:

(Click to enlarge)

Notes & Caveats:

The yield calculations:

  • Reflect pricing data as of close of business Friday, November 11, 2011;
  • Assume purchasing 200 shares and selling two call contracts on November 14, with the options expiring December 17, 2011.
  • Incorporate the following fee schedule:
  • Commission $6.99
  • Option contract fee .50
  • Assignment fee $19.95

For each company I selected the first OTM strike price.

The yields are for one month only. Do not expect to repeat these yields month-over-month.

I'm an inveterate Research In Motion hater, but the numbers speak for themselves and RIMM finished first. I beg you, though, invest elsewhere.

I rarely sell calls going into earnings, as a poor earnings report can thrash a share price. Three of the companies listed -- RIMM, GIII, and DLB -- all report earnings prior to option expiration.

Two of the companies -- ACI and MT -- go ex-div prior to option expiration.

Consider this list of companies as a starting point for your own due diligence. Each of these companies has warts -- RIMM's condition verges on leprosy -- else they wouldn't have sunk deeply below their 200 day SMA's. Proceed with extreme caution.

Comments welcome!

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in RIMM, DLB, MT, CSC, ACI, SSRI, GIII, ANR, WLT, FST over the next 72 hours.