Wiser Trader Stocks and Options Newsletter

Issue No. 3 – December 6, 2004

http://www.WiserTrader.com

Systems@WiserTrader.com

James A. Andrews

1.0 Penny Stocks, Options, Investors and Traders

      Penny stocks and options attract both the trader and the long term investor because of the small amount of capital required to make substantial gains as compared with large cap stocks.  The long term investor may buy a penny stock believing that a company’s value will increase over a substantial time period and the stock price along with it.  When he buys an option it is usually to reduce the risks in owning an underlying stock.  The short term trader looks at things a little differently.  Typically a trader looks for large percentage price movement over a shorter period of time.  Large percentage short term price movements can be found both in penny stocks and options.

      Penny Stocks are often defined as stocks that are priced below $5.  It is often implied, but not necessarily the case, that penny stocks are also micro caps with capitalizations of less than about $250 million.  For example, Sun Microsystems (NASDAQ: SUNW), until recently, met the definition of a penny stock, trading between $4 and $5.  Now trading still at only approximately $5.50 per share, it has a capitalization of over $18 billion.  The largest percentage daily price gainers, of say 50% or more in one day, are typically stocks that started from $5 or less.   But they are truly micro caps.  A large cap stock like SUNW would never be expected to move by a large amount over a short period of time.  As a group, micro cap penny stocks are avoided by large funds because prices are too easily affected by sizeable buy and sell orders and capitalizations are too small to affect a large fund’s bottom line.  Buying more than 10% of a publicly held company carries with it certain insider responsibilities.  Large funds must wait until stock prices rise typically above $10 to $20 before they can become seriously involved without moving the price and yet have price movement impact their financial results.  The small investor has a distinct advantage over large funds when he takes an early position in a good micro cap penny stock.   If you would like to read more about penny stocks, refer to “The Penny Stock Trading System” on the Resources page at the web site.

      Short term options are best suited for when the underlying stock has a higher price, say above $50.  While it is more likely that a micro cap penny stock will gain 50% in a single day than it is for a higher priced stock, the typical 5 or 10 to one leverage that options provide makes it only necessary for a higher priced stock to move 5% to see a 50% gain in a corresponding option price.  When chosen properly, options for higher priced stocks provide the same large daily price movements of penny stocks.  Lower priced stocks need to move by a larger percentage in order to see a similar percentage in the corresponding option.  They are only likely to do so if they are also micro caps.  There are several additional considerations involved in choosing an option.  Not the least of these is the market environment, as described in last week’s newsletter in the Archives page at the site.   Option selection is described in the Resources page.

2.0 Analysis

      The market rose this week as oil prices pulled back.  The dollar fell slightly.  Holiday sales are indeterminate at this point. The coming OPEC meeting promises to be interesting.  OPEC may very well cut production due to the price pullback.  In any case, its current rate of production is nearly maxed out.  Although there is speculation that oil will continue to fall, it appears that oil prices have no where to go but up.  Energy stocks should follow.  If past performance is any indication, the rest of the market will pull back as a result.  The market focus will probably remain on oil, the dollar, and whether or not holiday sales are strong. 

  Week ending 12/05/04:

  Gold for past 30 days:

  USD   +5.65%

  CAD   +2.65%

  CHF   +0.14%

  GBP   +1.35%

  EUR   +1.43%

  JPY   +2.30%

  Indices for the week:

  Dow Jones    +0.7%

  NASDAQ 100   +2.2%

  S&P500 Index  +0.7%

  Russel 2000  +1.8%

  Leaders for the week:

  Sector:   Tech/Telecom

  Industry: Pipelines

  Laggards for the week:

  Sector:   Energy

  Industry: Utilities

3.0 Procedure

      The screen being used looks for optionable stocks whose percentage relative strength over the past 6 months is greater than 95%, EPS Growth over the past 12 months is greater than 80% and are within 5% of their 52 week high. Maximum P/E’s for these momentum stocks are less than 30.  If such stocks can be found that fall within a leading or emerging sector and industry, that is considered a plus.   

      TXU and UBRN were in the options portfolio briefly and quickly returned to the watch list after their sudden pull back.  Otherwise, the watch list is little changed from last week.  See Table 1.   

Table 1

Watch List as of 12/05/04

4.0 Results

      The portfolio took a hit this week as energy pulled back from its leading position in the previous week.  Current thinking is that the oil pullback will not endure because of global demand.  TXU got hammered after it completed a stock buy back.  URBN fell more gradually as retail sales figures were lower than expected.  

Table 2

Stock Trades as of 12/05/04

Table 3

Options Trades as of 12/05/04

Option

 Buy Date

  Buy Price

  Last

 Action

 P/L(%)

 TXU APR 55.00 CALL

  11/23/04

  $11.30

  $6.30

   Sold 12/2

     -44.2

 URBN JUN 35.00 CALL

  11/23/04

  $11.50

  $9.00

   Sold 11/30

     -21.7

 USG MAY 25.00 CALL

  11/23/04

  $ 8.40

$11.40

   long

     +31.0

5.0 Conclusion

      The average portfolio P/L is -3.7%, with +1.0% for stocks and -11% for options.