Stock Trading Techniques

When Wall Street’s darling growth stocks start reversing course, they become beaten-up value stocks.  Growth-stock investors have no patience for companies that fail to meet inflated earnings expectations and value investors are too timid to step up and buy for fear of getting into a declining situation too soon.

When the former stars of Wall Street crash and burn it creates a buying opportunity. Right now we have that opportunity with Crocs (Nasdaq: CROX), the former highflying maker of brightly colored plastic shoes. This stock, which once traded north of 100 times earnings, is now a value stock.

Crocs recently reaffirmed 2008 earnings guidance of $1.50 to $1.70 per share. So, at its Friday closing price of $11.01 per share, CROX trades somewhere between 6.5 and eight times forecasted earnings. The company also has no debt and trades at just one times revenue.

Here’s the deal. CROX is CHEAP! Growth-stock investors have tossed the shares out the window and the chart has all the looks of a selling capitulation:

You can see the peak last October at nearly $75, followed by a dramatic falling-star decline that pushed the shares below $10 last month. This is an amazing buying opportunity for value investors.

Here’s how I’d play it. I’d buy CROX for about $11.00 per share (I actually did buy it and got it for $10.88) and I’d sell the CROX September 12.50 covered calls (CZLIV) for about $1.40 (I actually got $1.35).

So, with this trade, I bought CROX for $10.88, giving someone else the right to buy it from me any time between now and option-expiration day in September for $12.50. I collected a $1.35 premium up front, so I’m really getting into this trade for $9.53 per share ($10.88 for the stock minus the $1.35 received from selling the call).

As long as CROX is trading for more than $9.53 on option-expiration day in September, I’ll make money on this trade. In other words, the only way I’ll lose money here is if CROX declines another 12% from its already depressed price. Even then, I can simply sell another series of calls and  receive an additional premium to offset any loss.

On the other hand, I’ll do quite well if the stock stays the same, and I’ll do even better if it rallies a bit (which is what I expect to happen).

If CROX stays at $11.00 per share by option-expiration day in September, then the calls will expire worthless and I’ll record the entire premium as a gain. So, I’ll make $1.35 off of a net investment  of $9.53. That’s a 15% gain in a little more than four months on a stock that goes nowhere.

If the stock goes up, then I can earn an extra $1.62 per share if it gets called away from me at $12.50. That’s a gain of $2.97 per share, or just more than 27% of the net amount invested.

To recap, here’s what I did. I bought 500 shares of Crocs (CROX) at $10.88 and did a Sell to Open of 5 contracts of the CROX September 12.50 calls (CZLIV), covered, for $1.35.

You can do this trade in an IRA, but you must first be apporved for COVERED CALL writing. You MUST own the stock in even 100-share lots for each COVERED CALL contract you sell (each contract  represents 100 shares). You cannot sell any shares of the stock unless you buy back the equivalent number of contracts.

To profit from this type of trade, the trick is to buy hugely under-valued stocks and sell the calls (when you sell something you receive the cash so your portfolio immediately increases by the value of the contracts - minus commissions - you sold) then if the options you sold expire worthless (80% of the time they do), you can sell them again. I know of a fellow in Sun City, Arizona, who makes over $100,000/year doing this.

This trade is still viable as of Friday’s close.

Please note that the author is not an investment advisor nor a broker-dealer. Any actions you take as a result of this the information posted on thi web site is strictly your responsibility.