survey on Feb. 4 showed that 55% of financial advisers were bullish, 19% were bearish and 26% were expecting a correction. But it's that last group, defined by
Editor John Gray as "those that are still optimistic on the markets but are waiting to buy at lower levels on a pullback," that gets my attention.
The 26% reading was the highest level since October 2002, which, not coincidentally, marked a major market bottom as the
S&P 500 Index
sank below 800. Since that time, the S&P has gained about 42%.
As we know, most sentiment indicators are predicated on the belief that the majority is often wrong. If the
survey, which is considered a contrary indicator, is looked at as a Venn diagram, you'll see that the overlapping portion representing the correction camp is actually approaching a majority of the pie.
However, in hunting for trading ideas, it makes sense to stop looking for a big, broad market correction; that strategy has produced slim profit and is overgrazed at this point. The broad market is trending higher, and there are plenty of fresh opportunities in individual issues.
There Was a Correction?
Underneath the broad uptrend in the market indices, some sector rotation has caused some people to overlook the number of recent corrections in individual stocks. Here are a few quality names that racked up substantial gains over the past 52 weeks but have recently suffered double-digit-percentage declines:
- Cisco Systems (CSCO) - Get Report has declined 17% in the past two weeks.
Amkor Technology (AMKR) - Get Report is down 19% in the last two weeks.
Beazer Homes (BZH) - Get Report has given back 13% over the past month.
Caterpillar (CAT) - Get Report has pulled back 11% in the last two weeks.
Yellow Corp. (YELL) has been knocked down by 23% in the last two weeks.
These are just five names, yet they still represent a nice cross-section of the market -- representing the tech sector, housing, cyclical industrials and transportation -- that could make solid core holdings of a well-balanced portfolio.
One way to take advantage of the declines in these stocks is to purchase at-the-money call options with at least six months remaining until expiration. This is a simple way to buy the dips that have already occurred. By using call options rather than the underlying shares, you reduce the total dollar value risk but still get unlimited upside potential. This
earlier article (actually, my first for this Web site) discusses the virtues of buying call options instead of actual shares.
Creating Your Own Correction
On the other side of the coin are stocks that never seem to dip, giving you no chance to get in at anything but a new high. In fact, many of the stocks I mentioned above were prior occupants of this never-ending uptrending category.
For this group of stocks, I'd suggest selling puts. As I described in an earlier column,
selling puts lets you create a moderately bullish position where profit potential is limited to the amount of the premium sold. But it also establishes a "purchase price" for getting outright long the stock at a level below where the shares are currently priced. That purchase price would equal the strike price minus the sale price of the put option.
For example, let's use
, which has gained 11% over the last four weeks alone.
No End to AXP's Uptrend
With this stock trading at $53, you can sell the April $55 put for $3.20. This gives you a break-even, or purchase price, of $51.80. While a move of 2.3% might not qualify as a correction, it certainly is a nice discount from the current market price. More importantly, selling the put gets you a long position on a stock that you might have been hesitant to buy. If American Express keeps moving higher, or is just above the $55 strike by the April expiration, you can capture the $3.20 profit (6%) over the next 10 weeks. That translates into 33% on an annualized basis.
However, unlike the calls, where we wanted to purchase options with at least six months until expiration, I'd suggest selling puts that have no more than three months remaining in the life of the contract. This allows you to take better advantage of time decay, and should the stock price keep moving higher, you can roll up and sell a higher strike put.
Some other candidates I might suggest selling puts on include:
- Nike (NKE) - Get Report, which has gained 12% over the last four weeks.
Countrywide Financial (CFC) , which is up about 29% in the past four weeks.
IBM (IBM) - Get Report, up 11% over the last four weeks.
Papa John's Pizza (PZZA) - Get Report, up 20% in the last four weeks.
All of these candidates are just a few suggestions. Your shopping list might -- and should -- look quite different, but it should only contain stocks you feel comfortable owning. For stocks that have already corrected, buying calls instead of actual shares will cut your risk and help you get in without trying to pick a bottom.
For stocks that are still moving higher, selling puts lets you overcome your fear of buying the top. But names from the first list can quickly turn into names on the second list, and vice versa, so remember to use stops and take profit.
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