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  • DARK HORSE HEDGE - What I Like About You, VECO 12 comments
    Oct 11, 2010 1:59 AM | about stocks: VECO

    DARK HORSE HEDGE - What I Like About You, VECO

    By Scott Brown at Sabrient, and Ilene, at Phil’s Stock World

    Dancing Scotsmen waving money
    What I like about you, you really know how to dance
    When you go up, down, jump around,
    think about true romance, yeah

    That's what I like about you
    What I like about you, you keep me warm at night
    Never wanna' let you go, know you make me feel alright, yeah

    Veeco Instruments Inc. (Veeco) (VECO) designs, manufactures, markets and services enabling solutions for customers in the high brightness light emitting diode (HB LED), solar, data storage, scientific research, semiconductor and industrial markets. In its LED and Solar segment, Veeco designs and manufactures metal organic chemical vapor deposition systems that are used to make HB LEDs or solar cells made of III-V compound semiconductors. In its Data Storage segment, Veeco designs and manufactures equipment used in the production of thin film magnetic heads that read and write data on hard disk drives. In its Metrology segment, the Company designs and manufactures atomic force microscopes, scanning probe microscopes, stylus profilers and fast three-dimensional (3D) optical microscopes... (Sabrient's Ratings Report)

    Sabrient rates VECO a Strong Buy for its superior value and growth profiles, which indicates a stock that should outperform the market.  

    Read Sabrient's full report here.

    We liked a lot about VECO when we added it to the Dark Horse Hedge virtual portfolio at $31.93 on August 25, 2010. Using Phil Davis's Buy/Write strategy, we bought half a position in the stock and sold October $32 calls and puts against it (1 put and 1 call per 100 shares of stock).  

    With option expirations on Friday, October 15, it's time to decide if we "never wanna let you go," for now, or if we want to close the trade and take profits.  

    VECO closed at $36.51 yesteday. We could keep the $6.20 option premium and let VECO get called away for $32. But why do that when there is so much to like about VECO?  We learned Friday that Bruce Kovner's Hedge Fund has been buying VECO shares too:

    Due to portfolio activity on September 28th, 2010, Caxton Associates has disclosed a 5.3% ownership stake in VECO with 2,168,800 shares. This is a brand new position for the hedge fund as they did not own it as of June 3oth. Kovner of course has graced the pages of Forbes' billionaire list due to his success as a hedge fund manager. (See http://seekingalpha.com/article/229118-bruce-kovner-s-hedge-fund-starts-new-veeco-instruments-stake?source=yahoo)  

    And on Tuesday, October 5 Daniel Amir, Lazard Capital Analyst wrote: 

    [recent checks from China] “suggest that tool orders continue to accelerate.” He adds that “not a month goes by without new players popping up in China that order LED tools.” He says the situation at some point could overheat in terms tool orders, but that for the near-term, the strong demand is good news for Veeco, which he says has about 60% of the market for LED manufacturing tools in China. (See http://blogs.barrons.com/techtraderdaily/2010/10/05/veeco-seeing-strong-led-tool-orders-in-china-lazard-says/?mod=yahoobarrons)

    Monday, October 25, 2010 the quarterly financials for VECO will be released. VECO is trading at a P/E of 8 on a $4.18/share estimate for 2010 and $4.67/share for 2011.  

    We believe VECO is undervalued and we're optimistic about it's future performance. Therefore, Dark Horse Hedge will hold its VECO shares, while repeating the Buy/Write Strategy used when entering the position in August.

    DHH is already long VECO (half our normal position size). We will continue to hold our shares while BUYING back the calls and puts we sold in August.  

    The Oct $32 puts we sold for $3.20 on August 25 will expire worthless on Friday if VECO stays above $32 this week, and the Oct $32 calls we sold for $3.00 closed at $4.40 yesterday.  Therefore, we can close both sides of our option positions on Monday for approximately $4.50 which puts $1.70 in our pockets:  ($3.20 (put) + $3.00 (call) - $.10 (put repurchase) - $4.40 (call repurchase) = $1.70) .

    After buying back the options we sold, we will SELL one VECO Jan $32 2011 Put (approximately $3.40) and SELL one VECO Jan $32 2011 Call (approximately $6.60) for each 100 shares of VECO held.  The net effect of "rolling" these options is to lower our cost basis (see below).  Rolling to the January 21, 2011 $32 Call for approximately $6.60 and the Jan $32 Put for approximately $3.40 gives us an additional $10 in premium. The same scenarios from our October VECO options apply to our new positions, except that our expiration date has moved out to January 21, 2011.

    Lastly, we entered the VECO trade in August using Phil Davis's Buy/Write Strategy which gave us a 15-20% discount on our VECO shares. In less than two months, we lowered our cost basis from $31.93 to $20.33.  We can continue rolling this trade forward earning 15-20% per quarter if the stock performs as we anticipate.

    Cost Basis:
    $31.93      Original purchase on 8/25
    -$3.20       Oct $32 put premium
    -$3.00       Oct $32 call premium
    +$.10       Close Oct $32 put
    +$4.40     Close Oct $32 call
    -$6.60       Jan $32 call premium
    -$3.40       Jan $32 put premium
    ----------
    $20.33 cost basis on VECO

    Roll the options positions in VECO on Monday, October 11, 2010.

    • Buy to Close VECO Oct $32 put at the market (approximately $.10)
    • Buy to Close VECO Oct $32 call at the market (approximately $4.40)
    • Sell VECO Jan $32 2011 put at the market (approximately $3.40)
    • Sell VECO Jan $32 2011 call at the market (approximately $6.60)

    Note to Newcomers:

    Phil's Buy/Write strategy can be initiated by buying half of your desired VECO position and then for each 100 shares of VECO, SELL one Jan $36 2011 put and SELL one Jan $36 2011 call on Monday:

    • Buy 1/2 position in VECO Long at open Monday (approximately $36.50)
    • Sell 1 Jan. $36 Call per 100 shares of VECO (approximately $4.40)
    • Sell 1 Jan.$ 36 Put per 100 shares of VECO (approximately $5.20)

    The options being sold have higher strike prices reflecting the higher current price of the stock. 



    Disclosure: none
    Themes: options trade Stocks: VECO
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Comments (12)
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  • ChaChing - Nice way to create, if my math is right, about 15% every few months. I like it.
    11 Oct 2010, 02:38 PM Reply Like
  • Author’s reply » Yes, I think the biggest risk is if the market really falls apart, due to the put being sold.
    11 Oct 2010, 08:46 PM Reply Like
  • And what do you think the biggest risk is to your HUSA short?
    12 Oct 2010, 10:39 AM Reply Like
  • Obviously the biggest risk is that somehow HUSA hits on enough of the deals that are hyped to justify or bring the forward P/E down from 132. That is a bet a lot of people are willing to make. They will have to create a lot of profits to continue to justify the P/E they have and history doesn't appear to be on their side. HUSA isn't the only energy stock with the ridiculously high valuation and clearly not all are going to be successful so putting a small % of a well hedged portfolio into one of these seems to makes sense to me Brett. What do you think?
    13 Oct 2010, 01:55 PM Reply Like
  • Thanks for asking Mr Absolute. Here are my thoughts. Every day I look at my long and short positions and ask myself would I buy or short the stock today based on fundamentals, technicals and new information that I have. Most important is to not let small losses become big ones – That historically has been what has ruined investors and speculators. The problem I see with this “portfolio’ is that they seem to take quick profits and let the losses run, and they do not seem to have any protection in place for when things turn against them or any willingness to admit that they made a mistake. It’s not only HUSA, but look at SGEN, TEX and SCOR (just to name a few!) Nonetheless, HUSA just released an independent report on the 3D seismic of their acreage by a very respected Petro Engineering firm which shows that they are in fact sitting on top of an enormous amount of oil. In my experience, this could drive the stock straight higher from here and there are some who think it could double or more from these levels – So, looking at the fundamentals, technicals and new information, what do you suggest?
    14 Oct 2010, 09:54 AM Reply Like
  • brett farvrrrrrrrrrrre she is talking about veco here which clipped over $40 today. other post is about St blow Joe and it was clipped down by 10% today. Your husa is a dog with fleas and it was clipped today too so crawl back into the whole you came out of and go back to sending pictures to the jets while you learn how to spell your name.
    14 Oct 2010, 05:24 PM Reply Like
  • Well, I believe you have analyzed the information and convinced yourself to own the stock. These people seem to have analyzed information and decided to be short the stock. That is what makes our market system work. Personally I don't care for the stock. When they start making money that justifies the valuation or the price reflects the current profits and proven growth then I might change my mind. The company has a slim $10 million in cash and haven't shown a history of ROE that gets anywhere near the current value. So you like it and I don't. No big deal.
    14 Oct 2010, 06:22 PM Reply Like
  • Well put. I have consulted all my technical signals and am convinced that Brett is throwing an interception on this one. Dude, you got cracked one too many times in the skull if you are buying this fools gold. Follow your buddy John Elway and just put it in a good ponzi scheme.
    14 Oct 2010, 07:30 PM Reply Like
  • Farvre is spelled "FAVRE".
    13 Oct 2010, 02:11 PM Reply Like
  • Author’s reply » BF,

     

    Dark Horse Hedge is predicated on the basis that a) you are never correct 100% of the time b) nobody can predict market direction in the short term with any accuracy. So to manage beta down to a minimum level we use a Long/Short approach and manage the overall portfolio from a sector weighting, industry neutral methodology and seek to enhance the alpha by tilting based on lagging market trend indicators and option yield enhancement. The idea of hanging on to losers or not being willing to admit a mistake doesn’t come into play. Each position is evaluated weekly and in most cases, without new developments, a short becomes more attractive as it goes against us because it is simply getting more and more overvalued. Because of the leverage in the account started July 1, 2010 which assumed $100,000 cash, $200K buying power and 10% uninvested for margin activity, etc. we don’t have to concern ourselves with margin calls as they don’t occur. The S&P 500 is +13% during this same period and so it makes perfect sense that in managing a L/S portfolio the Longs would be outperforming the Shorts at this point (however DHH has recongnized profits on SHORTS HUSA (3 times), STI, AMAG (actually covered too soon as stock dropped another 13 points after cover), BOOM, RAIL and SGEN gave us an opportunity for the quick profit when it dropped under $12 during the week of Sept. 20 when SGEN announced the discontinuance of leukemia drug trials after they failed. The company quickly rebounded with a positive result on Lymphoma trials. This drug likely won’t make it to market until 2012, if at all. Many cancer drugs that have been approved early by the FDA due to Special Protocol Assessments like the one for Seattle Genetics often end up being yanked from the market after they've shown that they're not effective in real-world settings. Take a look at PFE’s Mylotarg and IMGN’s stock which fell 40% in a similar situation. So does the potential for this one drug in 2012 justify a $1.7 BILLION market cap? In our opinion, no and so we remain and reiterate being SHORT SGEN.

     

    TEX is a horse of a different color. Here you have a large company ($2.61B Market Cap) on negative return on Assets and Equity, losing money quarter after quarter worse than expectations all while having a particularly low corporate governance score. The fact that this hasn’t played out in the stock price yet is not a concern in the overall scope of the portfolio. TEX provides us with appropriate SHORT exposure to the construction industry on a poor performing company with some overvaluation issues possibly exposed through its aggressive accounting measures. We maintain and reiterate the SHORT position of TEX at these levels.

     

    SCOR continues to rank as the #8 (from the worst) in the Sabrient ranking system. A P/E of 368 is certainly something to consider when selecting SHORT candidates for a L/S strategy. Recalling the internet days of 2000 it should be obvious why SCOR would be a candidate as nothing about its performance to date would lead a savvy investor to want to pay 368 times their earnings when S&P 500 stocks trade at multiples of 15-17. Nothing fundamentally has changed about the company since we added it as a short and the P/E has grown even further out of range so we maintain and reiterate the SHORT position on SCOR.

     

    HUSA, fundamentally it is the same overvalued company we thought it was 3 times at $10 per share. They sold an asset for $1.65 million and retained a small royalty, clearly not enough to justify the current $400 million valuation with a forward P/E of 127.9. Technical’s, well we don’t use technical’s on individual stocks so nothing has changed there. The new information I suppose is the “independent report” that you say “could” drive the stock straight higher. Well, if it does then I suppose we were wrong this time but we maintain and reiterate a SHORT position on HUSA.

     

    Hope this helps you understand better.

     

    - Scott
    14 Oct 2010, 07:54 PM Reply Like
  • Thank you for your response Scott. I just have a few more questions. Could you tell me about your track record? Do you post performance results of this portfolio? And what has your experience been running portfolios? You keep referring to P/E, but historically it’s been pretty dangerous to value Internet, E& P and Biotech on P/E as most of the pros who invest in those sectors look at other metrics such as revenue growth or free cash flow. And w/ SCOR, why would you want to compare it to the S&P 500 when they are in the S&P 600 SmallCap and the S&P 1500 SuperComp? By the way, from what I’ve read, the street is looking out to SCORs earnings in 2011/12 which they are pegging at > $1.00 and which could crush your whole p/e argument if they have that kind of growth – But you do bring back some memories when you bring up the “internet days” as that was when I learned the importance of stop losses on short positions because even if you are right on the fundamentals, that doesn’t mean that the stock can’t go MUCH higher on the basis of nothing other than momentum…
    15 Oct 2010, 11:14 AM Reply Like
  • Author’s reply » Thanks for the follow-up. Sabrient track records are published online for strategies (sabrient.com/performan... ) and indexes which are licensed by Guggenheim as ETFs (sabrient.com/performan... ). I'm including a copy of the 10 year performance for VCU www.sabrient.com/pub/S... which has a 10 year annualized return of +29.9% with a beta of -.12 and Sharpe Ratio of 1.54 and no losing years, including 2008. There are also published track records for the retail portfolio’s Investors’ Hedge +35.85% since inception, Select Opportunity +34.03% and newer services MESA-Sabrient Trading Alerts, Rock Solid Yield, ALPHA-Sabrient Reversal Alerts and Dark Horse Hedge. Performance results are available on anything Sabrient publishes down to the 4 weekly ideas on What The Market Wants.

     

    Here is the report we published on SCOR and perhaps it will help you understand the reasons we believe it is overvalued sabrient.com/clientare... . I was merely using the S&P 500 P/E as a quick reference in my reply yesterday but in fact you can see on the ratings report that Sabrient compares SCOR to the S&P 600 when determining its STRONGSELL rating. The 5 analysts are projecting 2011 to be $.28 and a 5 year growth rate of 49.9% which would be impressive and is the reason behind the current valuation. The Value score and Fundamentals Scores are worrisome and makes me comfortable feeling that it is less, rather than more, likely that SCOR can meet the growth expectations and the stock will adjust accordingly.

     

    Obviously any stock can be carried on momentum on non-fundamentals driven noise. This is the reason Sabrient always measures beta in sectors, groups, et al and implores a Long/Short approach to most portfolio methodology.

     

    I hope this helps you understand our approach better and am always open to discussion. - Scott
    17 Oct 2010, 06:20 PM Reply Like
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