I am fascinated by, but lack the courage to participate in, extreme activities, whether physical, mental or monetary. I'll admit I have gambling and debating proclivities, but there's no way you'd find me in an arm-wrestling competition, unless it's for money and I'm already in the hole.
With stock valuations soaring and every day delivering another bunch of 52-week highs, shorting seems like an extreme sport, given the current momentum and the tendency of liquidity-driven markets to render short-term valuations meaningless. But active traders always need to be looking for ideas.
It might be a good time to revisit the concept of selling a
naked call, whose time and volatility premium can provide the cushion necessary to short highflying stocks. Identifying a price level that offers an acceptable risk/reward is much easier than trying to pick an exact top, especially when dealing with stocks that have momentum.
Remember, selling a call naked short exposes you to the same unlimited risk as selling the underlying stock short, but the profit potential is limited to the amount of premium sold. The tradeoff is that the short call effectively raises your sales price, and a profit can be realized through time decay, even if the price of the underlying remains unchanged.
You Shan't See Infinity
Screens are one of the best tools for creating a pool of potential trading candidates. Using the concept that nothing goes straight up, my first filter was to identify stocks that have gained more than 40% over the past six months. The other simple criteria were daily trading volume of more than 500,000 shares a day, a stock price greater than $20 and a minimum market capitalization of at least $500 million. This rudimentary screen returned 187 names, which should provide a large enough pool to pull one or two good ideas.
It should come as no surprise that the most eye-popping valuations and percentage gains reside in the technology set. But what really caught my eye has been the tremendous performance of the travel and leisure set.
Upgrades to Nowhere
After a tough two years, partly the result of a ratcheting back of boom-time business-account spending levels and the immeasurable negative impact of the Sept. 11, 2001, terrorist attacks, hotel and cruise and casino stocks are back to multiyear highs and sporting aggressive growth valuations.
Summer travel proved better than expected, and with little new construction hitting the market, hotels are finally getting a little pricing power back. "We expect to see improved margins heading into the fall. Travelers may be surprised that the rooms they look to book are no longer discounted by default," said David Richter, a lodging analyst with Smith Barney.
The recent performance of some issues such as
(up some 60% in six months to $49),
Carnival Cruise Lines
(up over 45% to a new two-year high of $35.50) and
(up over 50% in six months to a new 52-week high) explain why analysts are beginning to take notice.
Recently upgraded names include
But similar to last week's
postulation that many retailers, while doing well, may be fully priced, I fear there is also little upside surprise for hotels over the next three months. Couple their stretched valuations with Wall Street's new penchant for profit-taking (witness the 5% decline suffered by
on Tuesday due to the J.P. Morgan downgrade, as an example), a strategy of naked call selling isn't too extreme. I think that as fall travel moves further into season, we'll see fewer upgrades and an increased risk of disappointments. Here are three candidates offering a good opportunity to sell short some near-dated calls.
Cruising for a Losing?
The recent run in Carnival Cruise has pushed its forward price-to-earnings ratio above 22 and its price/sales ratio above 4.51, both at the high end for the industry.
Carnival Cruise (CCL: NYSE)
Carnival has recently broken a six-month uptrend and is in danger of failing to hold above the two-year high. New resistance is now in place at $36. With the shares currently trading at $34, you can sell the October 34 call for $2.50. This gives you a maximum profit of $250 a contract, 7.3% over the next six weeks. The break-even level is $36.50, which coincides with a new high and with where a stop-loss should be placed.
Everyone has been a winner with Mandalay, but will the streak continue?
Mandalay Bay (MBG: NYSE)
On Tuesday, it failed to finish positively following an upgrade from Jefferies & Co. After touching the 52-week intraday high of $39.90, the stock settled 20 cents lower at $38.88, creating a minor reversal day. Momentum may be momentarily sapped, and $40 now represents reasonable resistance. Currently, the October 40 call can be sold for $1.
Not so HOT?
Starwood (HOT: NYSE)
Starwood may be a good candidate for selling. The stock has put on a good run and is now trading at nearly 65 times 2003 earnings. Analysts have been increasing estimates to keep valuations reasonable, but I think the best-case scenario is already built in for an expected 25% EPS growth in 2003. The stock seems to be running out of buyers at the $35 level. Use that level for a stop-loss to cover shorts.
Steven Smith writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He invites you to send your feedback to