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How to Pick 100% Winners Using Call Debit Spreads

By Jim Fink on May 16, 2016

In the stock market, everyone dreams of investing in a “two-bagger” – a stock that at least doubles in value, which is also known as rising 100% or more in a single year.

Truth be told, finding these two-baggers is extremely difficult and more luck than science. In fact, the two-bagger is only a little less elusive than a unicorn sighting or finding a needle in a haystack.

Over the past nine years, for example, the S&P 500 has averaged only 11 two-baggers per year, ranging from zero in 2008, one in 2011, two in 2015, up to 17 in 2007 and 49 in 2009.

Simple math tells you that the chance of randomly selecting a two-bagger stock from the S&P 500 universe is only two percent – a 1-in-50 longshot.

That’s no way to invest your hard-earned money successfully.

Fortunately, I have discovered a two-bagger system that uncovers these gems much more frequently – it involves the use of stock options, which is my investment vehicle of choice.

When I launched my two-bagger options service called Velocity Trader, I made the seemingly ridiculous promise of recommending at least 24 two-baggers in a single year – which averages out to almost one new 100% winner every other week!  So far, my first group of subscribers has received 14 two-baggers in less than six months, so we’re ahead of that promised pace.

How have we been able to do it?

The Magic of Options

You see, options enable traders to achieve huge percentage gains based on very small price moves in the underlying stock.

For example, purchasing a $90 stock would require a huge price move of $90 to achieve a 100% return, but options can achieve the same return for a price move of only $1!

The magical attribute of options is that you choose the “starting point” of a trade, which can be much higher than zero. When you buy a stock directly, you must use a “starting point” of zero, meaning that you pay the entire price of the stock. For a stock trading at $90, you must pay $90 per share.

In contrast, with options you can choose a “starting point” of $90 and avoid paying the entire price of the stock, leaving only a tiny cost called time value (i.e., the speculative value based on expected future price volatility of the stock).

For example, buying a $90 call option on a $90 stock could cost only $1.75 and yet generate the same return from any upward movement in the stock price equal purchasing the stock itself for $90.

Which would you prefer paying — $1.75 or $90?

What about even less?

When you come to appreciate a technique we use inside Velocity Trader called an options spread, you open yourself up to a new world of investing.

That’s because you can pay such a low amount for exposure to a stock, that the price move necessary to obtain a two-bagger is next to nothing. Of course, the key to success still rests in the ability to predict the direction of future price accurately a high frequency of the time. 

There are several analytical indicators I use to help us predict short-term price direction, but four are primary: 

  1. Seasonality
  2. Max-pain analysis of a stock’s option open interest for a given expiration
  3. Technical analysis using moving average convergence divergence (MACD) and the stochastic oscillator; and
  4. Important upcoming corporate events.

Every week, I scan the entire stock market for those few stocks that pass one or more of these four indications because filtering for such stocks has proven to help predict the direction of future stock prices with uncanny consistency.

Below, I discuss four stocks that are on our Velocity Trader radar based on at least one of the four indicators. These are all prime candidates for trade recommendations aimed at 100%-plus rates of return. I’ll be releasing my final instructions to Velocity Trader members tomorrow morning.

Velocity Trader Candidate #1: Apple

Apple (Nasdaq: AAPL) may have recently lost its title to Alphabet (Nasdaq: GOOG) as the largest publicly-traded company by market capitalization, but its dominance in consumer communications devices, primarily the iPhone smartphone, ensures that its stock price will rebound from its 14% year-to-date swoon sooner rather than later. Apple’s family of devices, which also includes the iPad tablet, the Mac personal computer, the Watch smartwatch, and the iPod music player, all operate on the proprietary iOS mobile operating system that offers services such as iCloud, Apple Music, and Apple Pay. This mobile communications ecosystem of hardware and software benefits from a network effect of almost 600 million unique users.

The stock sold off severely following its second-quarter financial report, which disappointed investors because the company experienced its first quarterly sales decline in 13 years, led by the first quarterly decline in iPhone sales in history. Bearish sentiment in the options market appears to be overdone, however, and contrarians are looking for at least a short-term dead-cat bounce. Longer term, Apple still has tremendous growth opportunities in China and India that have yet to be tapped.

Bullish Indicator: Max-pain analysis.

According to options market data, the volume of “bearish” options trades dwarfs the number of “bullish” trades, suggesting that trader sentiment has gotten excessively negative.  Several academic studies have demonstrated that stocks have the tendency to get “pinned” at the strike price that generates “maximum pain” for purchasers of options. In this case, many options buyers are betting on a downward move in Apple shares. That means the option market makers that sell options have an incentive to push the stock in the direction that causes their inventory of short option positions to expire worthless so that they are not required to pay out much to the owners.

Conclusion: An upside move this week is likely and a call debit spread expiring on May 20th looks good.

 

AAPL Chart

 

Velocity Trader Candidate #2: Cisco

Cisco Systems (Nasdaq: CSCO) is the world leader in computer networking equipment–the equipment that runs the Internet. Cisco’s market share in switches, which are the backbone of corporate local area networks (LAN), is 70 percent and Cisco commands a 50 percent market share in routers, which are the backbone of telecommunication carriers’ wide area networks (WAN).

That’s an attractive position for Cisco to be in when you consider that internet traffic is expected to triple between 2015 and 2020. That’s a 26 percent compounded annual growth rate, a heck of a lot stronger than the anemic 3 percent annual growth forecast for the global economy. Plus, the Federal Communications Commission has adopted a “national broadband plan” that will allocate hundreds of millions of dollars to upgrade America’s Internet infrastructure in the coming years.

Bearish Indicator: MACD and stochastic oscillator.

Despite its strong long-term business prospects, the short term looks negative for this stock. The weekly MACD histogram turned red (i.e., negative) at the May 13th close last week for the first time since December 2015. The weekly stochastic oscillator has dropped materially below the 80% bullish line to the 70% level, thus creating a “double-barrel” sell signal that we look for.

Weekly charts take time to play out, however, so I wouldn’t trade this week’s option series expiring May 20th. Rather, a put debit spread that expires the fourth week of May on the 27th should allow the bearish thesis to be fully realized. The company reports earnings on Wednesday May 18th after the market close, so it may be beneficial to wait until after earnings to place a put debit spread in order to take advantage of any short-lived price pop caused by the quarterly earnings release.

Conclusion: a downside move over the next two weeks is likely and a put debit spread expiring on May 27th looks promising.

 

CSCO Chart

 

Velocity Trader Candidate #3: ConocoPhillips

ConocoPhillips (NYSE: COP) is the world’s largest independent exploration and production company, based on proved reserves and production of liquids and natural gas. It has been a pure upstream oil company ever since it spun off its Phillips 66 refining business in May 2012. The result is that the oil-price crash that started in the summer of 2014 has hurt ConocoPhillips much worse than the integrated energy companies such as ExxonMobil and Chevron.

When crude oil traded at $26 in February 2016, it had dropped 82% below its all-time high of $145 per barrel in July 2008. Until it finally crossed over on May 9th, oil’s 50-day moving average was beneath its 200-day moving for 422 days, which is the longest in recorded history (i.e., since 1983), surpassing the previous record of 367 days in 1993/1994.

There have only been three times that oil went more than 300 days with the 50-day moving average under the 200-day moving average, and all three saw positive gains one year after a crossover finally occurred, averaging a 26% up-move. Given that pure-play upstream ConocoPhillips got hurt the worst of all major energy companies on the downdraft of oil prices, it should benefit the most from a resurgence in oil prices.

Bullish Indicator: Seasonality. Using Velocity Trader’s proprietary Seasonal Velocity Scanner, we quickly discover that ConocoPhillips has risen 90% of the time (i.e., nine of the past 10 years) between May 15th and May fourth-week options expiration, which ends this year on Friday, May 27th:

May 15th Close to May (4th week) Close

9 out of 10 Years Positive (90%)

Year

Stock Return %

2015

0.1

2014

1.3

2013

1.2

2012

0.5

2011

2.6

2010

-6.2

2009

2.1

2008

2.9

2007

8.7

2006

0.5

 

Conclusion: an upside move over the next two weeks is likely and a call debit spread expiring on Friday, May 27th is the ticket.

 

COP Chart

 

Velocity Trader Candidate #4: Intercept Pharmaceuticals

Intercept Pharmaceuticals (Nasdaq: ICPT) first made national headlines on January 9, 2014, when its stock skyrocketed around 300% higher on news that it was prematurely stopping the clinical trial of its liver drug obeticholic acid (OCA), which treats nonalcoholic steatohepatitis (NASH). NASH is an increasingly common chronic liver disease closely associated with diabetes that causes liver inflammation due to a buildup of fat in the liver.

OCA showed “highly significant” effectiveness, and a drug approval for the treatment of NASH would open up a multi-billion dollar market opportunity. The stock rose as high as $497 on that day, but has gradually drifted down to its current price of $131 as final FDA approval of OCA (brand name is Ocaliva) for the treatment of NASH has proved elusive. That’s primarily because of negative findings that OCA can cause dangerous increases in a person’s “bad” LDL cholesterol levels. Plus, it was also discovered that the drug doesn’t work as well in NASH patients who aren’t also diabetic.  

While FDA approval for OCA in the treatment of NASH languishes, OCA has shown tremendous results treating another liver condition called primary biliary cirrhosis (PBC), an autoimmune disease that causes bile acids to build up and destroy the liver. Even better, PBC patients taking OCA at the prescribed lower dosage do not show the increased bad LDL cholesterol levels NASH patients experienced.

PBC is a much smaller market opportunity than NASH because fewer people suffer from PBC. Whereas an approved drug for PBC could generate annual sales of $200 million, an approved drug for NASH could generate annual sales of $6.5 billion. Nevertheless, FDA approval of OCA for PBC would be a very positive step toward eventual approval of OCA for NASH.

On April 7, 2016, an FDA advisory panel voted 17-0 to approve OCA for PBC as there have been no new treatments in nearly 20 years for patients with this progressive liver disease.  The FDA is scheduled to make a final decision on May 29th and, although not bound to follow the recommendations of an advisory panel, normally agrees with the panel especially when the vote is unanimously in favor. If OCA is approved for PBC, Intercept plans to launch the drug in the U.S. market starting in June.

Bullish Indicator: FDA drug approval date on May 29th.

Conclusion: an upside move following the FDA decision whether to approve OCA for the treatment of PBC is likely if approval is granted. Since the FDA’s decision is expected on May 29th, the first option series that expires after this important date is June first-week expiration, which ends this year on June 3rd. Although approval is already anticipated and move higher by the stock is likely to be modest, call debit spreads don’t require big stock-price moves to be big winners themselves. A small stock-price move up would be enough to make this trade very profitable.

ICPT Chart

Editors Note: As Jim mentioned earlier, he’ll be releasing final trading instructions to members of his Velocity Trader service tomorrow morning. To make sure you’re on the list to know which of these 4 trades makes the cut, click here to learn more about Velocity Trader and the extreme performance guarantee Jim’s making for the next few days.

 


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  1. avatar
    David Mackenzie Reply May 17, 2016 at 5:34 AM EDT

    what is the diff between Velocity Trader and Profit Multiplayer … ? does the one subscription entitle you to the other …? What is the price of each …?