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Dykstra: Ride Forest Labs' Confidence

Lenny Dykstra

Clearly, significant amounts of money have left the markets over the past few weeks. It remains to be seen whether that money will return to equities, so we need to keep our focus on strategic investments in very specific and strong sectors of the economy.

Today's selection, Forest Laboratories (FRX), recently announced an expanded share-repurchase program. Forest focuses on developing and producing branded and generic forms of pharmaceutical products.

At its close Friday of $37.91, it is trading just above its 52-week low. However, the share-buyback program makes this an opportune time for using deep in-the-money options with Forest Laboratories.

Share-buyback programs indicate management's confidence in the company, providing a ready buyer of the company's shares should demand dry up. Furthermore, buybacks protect against a further devalued share price. When a company's management buys more shares, it indicates a high level of confidence in the direction of the share price.

Management buys more shares when it believes the stock's price is too cheap. Considering the position of management to assess the corporation's strengths, buyback programs should always indicate an opportunity for investors.

Forest's management is buying an additional 35 million of the company's shares, because at its present value, Forest is a great investment.

Forest's key asset is its sales force. As a marketing-focused company, Forest solicits research-oriented firms for opportunities to in-license potential best-in-class new products within Forest's therapeutic focus areas, such as the central nervous system and cardiovascular categories.

Each new product increases the productivity of Forest's existing sales force. The company has historically in-licensed late-stage products, but it is migrating to more early-stage opportunities.

In July, Forest posted a 34% quarterly increase in profits, but the performance failed to satisfy more optimistic expectations. Its leading product, Lexapro, fell short of analyst expectations, and since that time the company's stock price has taken a beating. Falling back on a common theme of mine, it's clear that the beating in this case was too severe.

Management reiterated its fiscal-year projections, indicating future strength. Furthermore, the company possesses nearly $1 billion in free cash flow to go along with zero debt. In the pharmaceutical business, a healthy balance sheet generally leads to a healthy and promising future.

Research and development, along with the ability to invest in new products, allow pharmaceutical companies to succeed.

With that in mind, I will place a limit order to buy 10 contracts of the January $30 DITM calls (FRXAF) for $8.90 or better.

Now, let's take a look at what the readers had to say in our regular Friday feature.

First, thank you for teaching me so much about this kind of investment strategy. Of course I also do my own homework and investigating, but your picks are the initial triggers that get me interested in a particular stock.

I've also made several of my own selections using the same criteria I've learned from reading your articles.

Second, I was very interested in your column on Morgan Stanley(MS), but when I went to check on the pricing, I found that MSAK opened at $11.00 and never dropped below that price. Your article says you planned to purchase 10 options at $10.30 so I'm curious to know how you buy so much below the market. Am I missing something, or am I just confused about the date or price?

-- Stephen

Thank you for your very kind email; it is very rewarding to know that my DITM calls strategy columns have been a useful learning tool for you.

The question you ask is a common reader misconception -- I am not able to purchase DITM calls below market costs. I must wait for the option order to fill, just like everyone else.

You mention Morgan Stanley: On Aug. 24, I placed my order for 10 contracts of the January $55s with a limit order of $10.30 or better. This order was not filled until Aug. 28. Waiting for orders to open is a lot like waiting for the right pitch, or "working the count." If you play smart and remain patient, you can get on base, on your own terms, and put yourself in scoring position.

Hi Lenny:

I have followed you column since you started writing over a year ago. I have not tried any of your strategies yet though, because I am still getting behind the idea. Mostly I read your column to learn about new companies out there; I am trying to learn as many as possible for my investing.

You really don't give the readers much of a reason to buy; basically you find blue chips, and throw out that they have no debt and huge revenue. Also, most other reporters and analysts on TheStreet.com have at least a chart to back up their research, so the readers can see the moving averages, since basically you are a technician.

Do you have any idea about the math behind options? It is very complex. I have never read you talk about any Greek terms that are involved in the pricing of these options.

Also, your Stat Book shows you have made money, but you have thrown a huge amount of capital at your strategy to make this happen. Very few readers have this kind of capital. Then again, I could go half of what you say and get half the profit, but by the time I double down, I have no capital left, and am left undiversified. It also seems your strategy doesn't work, because you basically double and triple down on every stock. So your 9k cost about doubles for one trade.

On another note, all of your emails on Fridays always give you praise -- why not include some bad emails? Most other writers do this, especially on sports Web site-related mailbags.

I'm also curious how much knowledge you have? How much of the work is by your broker?

My last request is, please stop talking about the Players Club; you put it in at the end of about every column. You don't give updates of what is going on with the Players Club, who is a member, how much money is in it, how it is investing -- some more details would be nice.

This email seems kind of harsh, but I think of it as my constructive criticism. I am a fan and read every column you put out and usually enjoy them. I think your column could be better, and isn't that the goal in life, to get better?

-- Lucas

Lucas,

All my reader responses are important to me, the good, the bad and the ugly. Emails for the column are selected each week solely on the basis of whether they can be used as a tool to teach my readers more about my DITM calls strategy. On to the points raised in your email.

1.) My DITM calls strategy gives readers many solid reasons to buy; it should be enough that the success rate to date on my column picks is irrefutable and unprecedented. What more do you require?

2.) I have found a simple strategy within the complex market of options trading. I fully understand the Greek terms. However, teaching math and confusing the average investor is unnecessary, as the strategy is simple enough to understand without them -- and it works beautifully.

3.) As a technical trader, I do rely on charts and moving averages when making a selection. However, I also believe in due diligence and encourage my readers to do their own homework before making a trade. There are so many online sites where readers can look up a chart. I feel it is in their best interest to expend a little effort and confirm my selections with outside sources. It protects them against inadvertent errors and omissions on my part, as I am only human.

4.) Investing in a trading strategy requires capital. You have to spend money to make money. A tremendous amount of research and time is spent each and every day in order maintain the level of success my DITM picks have yielded to date. Investors who cannot afford 10 contracts at a time can still produce the same exact return by proportionally scaling back their purchases to match their personal resources.

5.) It has been several years since I was taught the ins and outs of the stock market and the benefits of trading DITM calls, and I am proud to say I am still learning. In order stay at the top of my game, I will continue to learn and expand my knowledge base.

6.) The broker I use is like a base coach. He doesn't bat for me, but he contributes to my success, and I am thankful for his coaching skills.

7.) I have no plans to stop talking about the Players Club. As a former Major League Baseball player, it is very important to me that professional athletes have access to educational tools and resources needed to protect their wealth. It's the one thing that doesn't automatically come with the uniform, and it is my goal to change it. Everyone should have the opportunity to be set for life.

If you can't get behind my strategy, I encourage you to find one that works for you. P/> Lenny,

What does this statement at the end of your column mean: "At the time of publication, Dykstra had no positions in stocks mentioned."

-- George

George,

Every investment columnist is required to disclose the positions they hold at the time of publication. When TheStreet.com posts the message that I have no positions in the stocks mentioned, it means that my column is published "before" I place my trade.

However, new rules now make me wait 24 hours before I can buy or sell all recommendations in case my mention moves the stock in question. Please understand, I write these columns to help my readers "get in the game" and make some money. I have no problem with the rules; in fact, the rules are the single most important thing.