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Dark Horse Hedge’s Balancing Act II

DARK HORSE HEDGE’S BALANCING ACT II

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

Close-up of a discount coupon

How do we explain our shift towards Long/Short balance when the economic news appears so discouraging?  There’s an interesting article in TIME discussing why multinational companies may be doing well their worldly operations, even though our U.S. economic appears terminally ill.  As Zachary Karabell writes in "With Stocks, It’s Not the Economy:

Stocks are no longer mirrors of national economies; they are not — as is so commonly said — magical forecasting mechanisms. They are small slices of ownership in specific companies, and today, those companies have less connection to any one national economy than ever before.

As a result, stocks are not proxies for the U.S. economy, or that of the European Union or China, and markets are deeply unreliable gauges of anything but the underlying strength of the companies they represent and the schizophrenic mind-set of the traders who buy and sell the shares. There has always been a question about just how much of a forecasting mechanism markets are. Hence the saying that stocks have correctly predicted 15 of the past nine recessions. At times, stocks soar as the economy sours (in 1975, for instance) or sour when the economy soars (as with China’s stock market, the Shanghai stock exchange, in the past year).

Decoupling, of course is a matter of degree.  In the long run, the world economy is affected by the economies of all the nations that make up the world, and businesses do not conduct themselves in a vacuum.  Some special cases may thrive in the worst of conditions, but most companies probably will not, and eventually the world’s economies will have some impact on the multinational corporations.  Thus, we have not changed our tepid view of the U.S. economy and the stock market’s prospects for the longer term. As David Rosenberg writes in his market thoughts earlier today, at Zero Hedge, "Ever Wondered How You Know You Are In A Depression?":  

Everyone seems to be basing their view on the economic outlook from what the stock market is telling them – so one week it is a return to recession, and now that the market is surging, we must be in some sort of boom. Coincident indicators out of Europe has everyone convinced that the backdrop is solid and yet the massive fiscal tourniquet has to be applied. Investors are caught in bouts of monthly euphoria and depression – it is amazing that we have all this joy for a market that has made its way back to the middle of the range and a market that is basically flat for the year.

Program trading, algorithms, momentum trading, technicals – all are at play. Meanwhile, the Treasury market has steadfastly refused to budge from a double-dip view, with real rates still under downward pressure, and while the breadth of the market has been decent, this rally has continued to lack volume – down a further 2% on Friday on the NYSE. Meanwhile, we are at another key technical juncture – the Dow and Nasdaq have retaken their 200-day moving averages while the S&P 500 and the Nasdaq are caught between the 50-day and 200-day m.a.’s.

With that said, we are adding another two Long positions to complete the balancing of the DHH virtual portfolio.  We are going to use Phil’s Buy/Write Strategy to enter the positions in our virtual portfolio using a combination of stock and options. You may also simply buy the stock, or buy the stock and sell the calls, but we will describe Phil’s Buy/Write method which includes buying the stock, and selling both calls and puts in proportion to the number of shares of stock purchased.  For each 100 shares of stock, we will sell one call and one put.  The result of this strategy is to buy the stock at a 10% to 20% discount. 

Add LONG Gannet Co., Inc (GCI) at the market Monday July 26.

Gannett Co., Inc. operates as a media and marketing solutions company in the United States and internationally. It operates in three segments: Publishing, Digital, and Broadcasting.  

Gannet Co. Inc (GCI), like our other additions this week, is coming off positive second quarter results. Analysts’ had forecast a +$.53 result but GCI delivered a profit of +$.61. The three analysts are looking for +$.51 and +$.79 the next 2 quarters which have been upgraded in the last 7 days. Again, we are picking up a company trading at a P/E of 6.03 versus the industry average of 16.04. Sabrient has GCI rated a STRONGBUY with a VALUE score of 66 and a FUNDAMENTALS score of 96.8. The Fundamentals score is a broad measure of the company’s financial health, including balance sheet, cash flow, revenue and earnings quality. 

GCI’s strong fundamentals make it a good candidate to use with Phil’s Buy/Write Strategy of purchasing value stocks at 10-20% discount to their current price.  We are going to use Phil’s Buy/Write Strategy to establish our full GCI position in our virtual DHH virtual portfolio, though you can also simply buy the stock, or buy the stock and sell the calls without also selling the puts. (The puts sold will contribute to the size of the long position, decreasing the number of shares we will buy accordingly.)

To enter our position on GCI, we start by purchasing ½ of the shares we are happy to own, or 200 shares.

Using the current price of about $14.50 we purchase the 200 shares (using our allocation method we would want to own 400 shares total) and we sell two JAN 15 2011 CALLS (GCI110122C00015000) for $1.75 per contract and two JAN 15 2011 PUTS for $2.25 (GCI110122P00015000), each contract representing 100 shares. This allows DHH to purchase 200 shares of GCI at $14.50 but bring in +$4 in option premium giving us a cost basis on the 200 shares of $10.50. If on the 3rd Friday in January 2011 GCI is trading above $15 our 200 shares will be “called” away/purchased for $15 putting another +$.50 in our pocket. If GCI is trading below $15 on the 3rd Friday of January 2011 we will acquire the second 200 shares we wanted to own for $15 while keeping the $4/share taken in from the options giving us a purchase price for 400 shares at $12.83. Thus, using Phil’s Buy/Write Strategy we are able to gain control of the 400 shares we would like to add to DHH at a 10-20% discount to the current market price.

Add LONG Ingram Micro (IM) at the market Monday July 26. 

Ingram Micro Inc. and its subsidiaries distribute information technology (IT) products and supply chain solutions worldwide. The company offers various IT products, including peripherals, systems, software, networking, and others.

We like IM leading into its earnings announcement on July 29, 2010.  The 10 analysts covering IM forecast a profit of +$.37 versus year ago profit of +$.20, giving a narrow range of +$.35-+$.39. IM has beaten estimates the last three quarters by an average of +$.067. 

We are adding IM to our virtual portfolio using Phil’s Buy/Write Strategy by purchasing ½ of the shares we wish to own, or 200 shares.  Using the current price of $16.65, we will purchase the 200 shares (using our allocation method we would want to own 400 shares) and sell two Dec 17.5 2010 CALLS (IM101218C00017500) for $.90 per contract and two Dec 17.5 2010 PUTS for $1.60 (IM101218P00017500), each contract representing 100 shares. This allows DHH to purchase 200 shares of IM at $16.65 but bring in +$2.50 in option premium giving us a cost basis on the 200 shares of $14.15.  If on the 3rd Friday in December 2010, IM is trading above $17.50 our 200 shares will be “called” away/purchased for $17.50 putting another +$.85 in our pocket. If IM is trading below $17.50 on the 3rd Friday of December, we will acquire the second 200 shares we wanted to own for $17.50 while keeping the $2.50/share taken in from the options giving us a purchase price for 400 shares at $15.82.  Using Phil’s Buy/Write Strategy, we gain control of the 400 shares we would like to add to DHH at a 15% discount to the current market price. (DARK HORSE HEDGE’S BALANCING ACT II)


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