The Money Tree

Safely Generating Income in Retirement

Deep OTM NP Strategy – MAY Week 5

Posted by mounddweller on April 16, 2011

Fellow Traders,

Below is the list of the trades meeting our Week 5 criteria.   We haven’t had a “Week 5” for quite some time so let me refamiliarize you with how this occurs and the criteria we use for the Week 5 selections.  First, a “Week 5” occurs only a couple times a year.  It occurs when there are literally 5 weeks between expiration dates on the options calendar.  Given the extra week to expiration (hence, an additional week of exposure to market and stock risk) we increase our requisite DSP to 20%.  The put factor (PF) remains the same at 2.0. 

As you can see we have 24 selections meeting our Week 5 criteria.  I have highlighted four that I found to be interesting and worth doing some DD on.  The two highlighted in green, AMSC and RMBS, are my best bets.  LFT and ANW, highlighted in orange, are in my mind much riskier but also worth a look.

American Superconductor (AMSC) had a precipitous fall earlier this week when its largest customer (70% of revenue) stopped taking delivery on any more AMSC product.  There’s nothing wrong with AMSC’s product, it appears their customer’s business is slowing down and they have too much AMSC product in inventory. 

Here’s why I like this AMSC trade.

(1) At a strike price of $10 you have over 23% of additional DSP on a stock that has already fallen 49% in the past week.

(2) The bad news is already priced into the stock.  While it could fall further, I have a hard time believing it will fall another 23% in 5 weeks.

(3) The book value of the stock is $9.86.  If you have the stock put to you at $10, you’ll own it at book value.

(4) Almost half of the $9.86 book value is cold, hard cash in the bank; not intangible or illiquid assets.

(5) After the big drop in price this week an insider stepped up to the plate and increased his holdings in AMSC by $50M.  I don’t think he would do that unless he thought it was a great buy at the current price.

Next up is Rambus (RMBS).  I’m not going to say much about it since it was in our selections last month as well and I wrote about it then.  The stock is up about 4% from where it was back in March.  Here’s why I like it:

(1) The ROIC at 2.83% is fantastic given the over 22% DSP.  However, this is due to RMBS announcing earnings next week.  Despite the impending earnings release I still like this trade. 

(2) The stock has not seen $16 since November of 2009.  Also, it has strong support at $16 as it bounced off of this level 4 times between August and November 2009.

(3) RMBS has a strong balance sheet with almost $4/share in net cash.

A quick note or two about the riskier plays I mentioned.  LFT is a Chinese mid-cap stock.  It sells software to financial services companies.  It has sold off hard due to fear of what could happen to its business should the Chinese real estate market falter.  That isn’t an insignificant risk given the government’s rise in interest rates to keep inflation at bay.

The other risky play is ANW.  It provides marine fuel logistics services.  What caught my eye about it is that it is trading at 0.8x book value.  While that doesn’t mean it can’t fall further it does tell me it is more likely to tread water at this level than fall much further to the selected $7.50 strike price.

Best of luck to all of you in the coming month. 

Regards,

Troy

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