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Dykstra: McDermott Calls Traders to Action

The options on this energy play can reward investors. Plus, Lenny shares some reader email.

Many analysts have predicted a correction in the equities markets for some time now. While the overall magnitude of the correction remains unclear, it is clear that money is leaving equities for the time being.

In these times I often reflect on my favorite bit of investment advice, from none other than Warren Buffett: "Be fearful when others are greedy and greedy when others are fearful."

While there are obviously problems for lenders in our economy, the problems have not spread throughout the entire economy. Unemployment and inflation remain historically low while retail expenditures remain high. The "operators on Wall Street" are getting exactly what they want: public fear, which leads to selling. Why? So they can buy all the great companies that are now on sale. And this isn't a normal sale, this is a clearance sale!

My pick today is getting cheap enough to become a possible takeover target:

McDermott International

(MDR) - Get McDermott International, Inc. Report

closed Thursday at $73. McDermott is one of those companies that define fundamental strength; its balance sheet is about as good as it gets. Its second-quarter earnings tripled from the same period a year ago, with net income increasing to $149.4 million, from $47 million. The result easily surpassed estimates on Wall Street, as revenue rose to $1.42 billion from $1.05 billion last year, beating analysts' forecast of $1.39 billion.

McDermott's customers are utility companies, oil companies and the U.S. government. The U.S. Energy Department recently renewed its contract with them to maintain the nation's strategic crude oil reserve. The $600 million contract will provide needed protection against disruptions in the oil market. The Strategic Petroleum Reserve has a capacity of 727 million barrels of oil, and the Bush administration has proposed doubling the size of the strategic oil stockpile to 1.5 billion barrels by 2027.

In April I raved about the company's strong return on equity. That ROE provides a great measure of how well a company generates profits. McDermott's ROE continues to be outstanding, currently at an amazing 117%. This means that for each $1 of equity, McDermott generates $1.17 of profit. Additionally, it has booked $5.21 billion in revenue and $1.12 billion in cash, and it has

zero

debt.

Today, I am going to place a $12 limit order for 10 November 60s (MDRKL), so that I get about four months until expiration. Bottom line: Instead of paying $73,000 for 1,000 shares; I will pay $12,000 for the right to control 1,000 shares of MDR common stock. With a market all over the map, be patient and let the stock come in.

Money will ultimately return to equities, making for potentially lucrative investment opportunities. With that in mind, we must be diligent and make only the most prudent of choices.

Fielding Reader Email

Now, as we do every Friday, it is time to take a look at your emails.

TheStreet Recommends

You occasionally show your portfolioscorecard in your postings. One ofthe columns shows an "Average Cost." Iam assuming that this means youoccasionally do some dollar-costaveraging on your positions by addingmore capital if the call pricedecreases. If I am interpreting thiscolumn correctly, do you have a rule ofthumb for how low before you add to theposition and/or how many times you'lladd to a position before cutting baitand taking a loss/rolling out further?

An important feature of the Stat Book that is published each Wednesday is the "Next Buy" column. This shows where I would add to open positions when the common stock drops to the next buy level. Adding to the position at this time would result in a reduction of the overall cost basis of the position. As long as I adjust the good-till-canceled sell price too, the stock will not have to move as far back up to ensure a win. Therefore, positions are added to each time the technical indicators are met.

The only times to consider taking a loss are when the expiration date is approaching or if any news comes to light that would cause an unavoidable and unfavorable outcome. For example, on July 12, I wrote about

Amgen

(AMGN) - Get Amgen Inc. Report

, but some news came out, and the order to buy the option was canceled before the open order was filled. Had the position opened, it would have been prudent to sell it for a small loss, in order to preserve as much of the capital as possible.

It is interesting to note that when trading deep-in-the-money calls, the decision to move into a position needs to be based on the merits of the company. As long as the technical strengths of the company remain stable, I can relax -- the strategy works. However, most decisions thereafter are based on market conditions. As market conditions change, we make adjustments to the strategy to account for them.

After you've already bought calls, andthe stock then goes down afterward,and you buy more at a lower price, doyou adjust your sell price down?

When the stock goes down and I add to the position, I will automatically adjust the good-till-canceled sell price as well to $1 higher than the new cost basis. Remember, the purpose of adding to a position is to lower the average price so that it won't be necessary for the stock to make up all the lost ground. This is a very important component of my deep-in-the-money calls strategy, because it allows us to improve our position, and at the same time it moves the finish line, making it easier to score a win.

Why are you looking for a 30% gain onPfizer (PFE) - Get Pfizer Inc. Report but only a 13% gain on Lowe's (LOW) - Get Lowe's Companies, Inc. (LOW) Report?

It is interesting to note that not many people ask this question, but it is important to know the answer. I set the good-till-canceled selling price when I open a position. As you know, this locks in a percentage gain right then, unless it is adjusted later. However, this is only half of the picture. The length of time I hold on to a position in conjunction with this percentage yield will determine the ultimate return of investment.

How fast I can make our 30% or 13% gain is the unknown. If I can turn the 13% play quicker than the 30% play, it can actually be the better of the two trades. I cannot know the future, so going in I can't know which play will be the better one to have. Therefore, looking for quality companies that are strong candidates for the DITM calls strategy is the basis of our purchases.

Always remember: Life is a journey; enjoy the ride!

At the time of publication, Dykstra had no positions in stocks mentioned.

Nicknamed 'Nails' for his tough style of play, Lenny is a former Major League Baseball player for the 1986 World Champions, New York Mets and the 1993 National League Champions, Philadelphia Phillies. A three time All-Star as a ballplayer, Lenny now serves as president for several privately held businesses in Southern California. He is the founder of The Players Club; it has been his desire to give back to the sport that gave him early successes in life by teaching athletes how to invest and protect their incomes. He currently manages his own portfolio and writes an investment strategy column for TheStreet.com, and is featured regularly on CNBC and other cable news shows. Lenny was selected as OverTime Magazine's 2006-2007 "Entrepreneur of the Year."