Market Shadows'  Instablog

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

But every day there's a new thing comin'
The way of an oriental view
The sherriff and his buddies
With their samari swords
You can even hear the music at night

And though its a part of the lone star state
People don't seem to care
They just keep on lookin' to the east

We're talking 'bout your China Grove
Wo ho ho! (Wo oh!)
Oh, China Grove

Doobie Brothers 

There was a time when we looked to the lone star state for our energy investments but it is time to look to the east. China Petroleum and Chemical Corp (SNP) has done things the right way building $18.09 Billion in operating cash flow.  This is the type energy stock Dark Horse Hedge likes for many reasons.  SNP is trading at a P/E of 8.5 while the sector trades at an average P/E of 13.5, the industry at 15.2, and the benchmark S&P 500 at 17.2. SNP projects finishing 2010 with $11.29/share in profit, and $12.81 in 2012.  The five year growth expectation for SNP is 38% per annum, and given its history, those are numbers we can get excited about.  SNP has all the things our bearish energy positions don't have--operating cash flow, earnings growth, and a p/e below sector and industry averages. Unlike our bearish virtual positions in IOC and HUSA, we believe SNP's earnings and growth prospects justify its price. 

Adding SNP to the virtual DHH portfolio gives us a balanced pairs trade against our HUSA short.  SNP is #8 in Sabrient's VCU ranking system as one of the best value stocks available.  VCU (Value Change Up) is Sabrient’s proprietary forward-looking outlook score which ranks a universe of stocks into quintiles that have proven to be very predictive of performance.  DHH has already recommended positions in three stocks ahead of SNP in VCU ratings, and those stocks have performed well (XRTX, TEO and AXS).

So, we are "lookin' to the east" and adding SNP as a long position replacing AEO, which had a brief and profitable stay in the virtual DHH portfolio. In addition to adding 100 shares of stock, we are also selling one January 2011, 100 Call against this position in our virtual DHH portfolio.  This will bring the cost basis down from approximately $96-$97 to approximately $92. As we have stated before, 65% of options expire worthless and therefore we prefer to sell time premium than to pay it. SNP has a 2%+ dividend yield and, in addition, this strategy allows us to earn option premium while holding the stock. 

Covered Call Strategy for Monday, October 18, 2010:

BUY SNP (9% of Portfolio) on Monday. 

SELL SNP 100 Jan. 2011 Call (SNP110122C00100000) on Monday. 

Note: In order to buy 100 shares of SNP and sell one call, we have to allocate approximately 9% of our initially 100K portfolio to this position. Normally our position size is 7.5% of our 100k portfolio but we need 100 shares of stock to sell one call against.