The Alpha Hunter: Profiting from Option LEAPS (GENERAL FINANCE & INVESTING) - Hardcover

Schwarz, Jason

Hardcover

ISBN 10: 0071634088 ISBN 13: 9780071634083

Publisher: McGraw Hill, 2010

Synopsis

Earn triple-digit returns with option LEAPS!

“Investing on the new Wall Street requires a strategic gameplan for all types of economic conditions. The information in this book can helpprepare your portfolio for the coming cycles.”
―Randy Reid, Senior Vice President, Private Banking & Investment Group, Merrill Lynch

“Jason Schwarz has written an investment book that will both inform and entertain. I have rarely come across investment wisdom that is dispensed with a combination of such humor and insight.”
―William Hesterly, author of Strategic Management and Competitive Advantage and associate dean, Faculty and Research, David Eccles School of Business, University of Utah

“In The Alpha Hunter, Jason Schwarz marries together two veryimportant and complex aspects of investing. Namely, extraction ofnondiversifiable risk returns, or alpha, through utilization of optionsstrategies called LEAPS. He achieves these objectives througha very down-to-earth and sensible approach to investing.”
―Scott Rothbort, president and founder, LakeView Asset Management, LLC, andterm professor of finance, Stillman School of Business, Seton Hall University

When the price of oil surged to an all-timehigh in summer 2008, optionsstrategist Jason Schwarz was among the fewexperts predicting imminent drops. Then, inMarch 2009, his was the lone voice tellinginvestors to return to financial stocks. Thoseintrepid “alpha hunters” who heeded his callsenjoyed huge returns. Now, Schwarz unveilsthe investment strategy of the future that willguide your efforts to outperform on the newWall Street.

The Alpha Hunter provides the economicknowledge perfectly suited to conquer thenew-found volatility of the global enviroment.Schwarz examines the “four winds” of thestock market―online trading, hedge funds,bubbles, and the unintended consequences ofgovernment regulation―and explains how touse them to your benefit. His method beginsand ends with option LEAPS (Long-termEquity Anticipation Securities). Purchaseoption LEAPS headed in the right direction,and returns can reach triple digits.

LEAPS allow you to carry a longer positionon the option, which is advantageous in threekey ways. They function as:

• An alternative to stocks: LEAPS callsenable you to benefit from stock price riseswhile placing less capital at risk than isrequired to purchase stock.
• A means of diversification: Helping youcapitalize on market overreactions, they getyou out of the market for the next downturnand get you in for the next growth phase.
• A tool for hedging: With a LEAPS putpurchase you can boldly take risks on wellresearchedtrades.

In order to build a solid portfolio, you mustabandon the old buy-and-hold model. TheAlpha Hunter provides you with a methodologybuilt for the times we are living in. Explorehow the latest innovations coming out ofApple, China, and the White House will affectthe investment climate of tomorrow.

About this title

About the Author

Jason Schwarz is the options strategist for Lone Peak Asset Management (LPAM), a registered investment advisory firm located in Westlake Village, CA. Specializing in option LEAPS, he played a key role in helping LPAM’s clients manage their way through the 2008 downturn. His articles have appeared on the Web sites Seeking Alpha, Yahoo! Finance, Stock House, and Mac Daily News, and his expertise has earned him multiple appearances on the Fox Business News Network and Business News Network in Canada.

Excerpt. © Reprinted by permission. All rights reserved.

THE ALPHA HUNTER

Profiting from Option LEAPSBy JASON SCHWARZ

The McGraw-Hill Companies, Inc.

Copyright © 2010 Jason Schwarz
All right reserved.
ISBN: 978-0-07-163408-3

Contents

Chapter One

THE NEW WALL STREET

In August 2008, the global spotlight was shining on the New Wall Street as never before, not least because the price of a barrel of oil was galloping up to its peak of $147. At the time, I wrote an article for the Seeking Alpha Web site in which I predicted that not only would this commodity run not last but also that oil was in for a gigantic drop in price: it would return not to $100 a barrel, but to its historic norm of $30 to $50 a barrel, and it would get there within a year.

That was a forecast that got people talking. My article was the most popular on Seeking Alpha for at least three weeks, and soon it was circulating through China, Russia, and the Middle East. The major television networks took notice, and they invited me on for interviews in which I discussed my thesis. In an age when it's increasingly hard to make one's voice heard above the collective, daily roar of the mass media, I'd had a breakthrough.

But as I did my tour of the television studios, it was obvious that my newfound popularity wasn't based on respect for my prediction; if anything, it was considered so outrageous as to provide good entertainment. I could see that my interviewers didn't agree with me and perhaps didn't even take me seriously.

And why should they? The experts in the field—billionaire oilman T. Boone Pickens, the legendary Goldman Sachs investment firm, to name a couple—were predicting that oil was going to keep going up, perhaps to $200 a barrel. History had become an unreliable guideline; high oil was the new norm. Who was I to suggest otherwise?

Well, I was an analyst coming from another perspective, an outsider's perspective. Most analysts, such as Pickens and Goldman Sachs, have conflicts of interest. Much of Pickens' vast fortune was invested in oil and alternative energy.

Goldman Sachs was generating huge returns in its commodity trading department. These were players positioned to clean up should the price of oil continue its upward march. How did that affect their judgment?

Months later, in January 2009, hedge fund manager Michael Masters commented on the unusual oil speculation activity in a 60 Minutes Special Report. "So you had the largest price increase in history during a time when actual demand was going down and actual supply was going up during the same period," he said. He concluded that the only sensible explanation for the jump in price "was investor demand."

Masters believed that investor demand for commodities, and oil futures in particular, was created on Wall Street by hedge funds and the big investment banks, such as Morgan Stanley, Goldman Sachs, Barclays, and J.P. Morgan, which made billions investing their clients' money. "The investment banks facilitated it," Masters said. "You know, they found folks to write papers espousing the benefits of investing in commodities. And then they promoted commodities as a, quote-unquote, 'asset class.' Like, you could invest in commodities just like you could in stocks or bonds or anything else, like they were suitable for long-term investment."

In the summer of 2008, contagious momentum had infected the commodities market and created an overreaction that reached bubble proportions and spread across the spectrum of analysts and commentators. Once you're inside a bubble, it is easy to lose sight of the big picture. That's why no one in the financial media agreed with me. And it wasn't just them; even my own family and friends thought that my oil call was crazy.

But you know how the story ends. Within a few short, wild months, crude was at $30 a barrel.

That was my first chance to play out a David and Goliath scenario with traditional Wall Street. Then, in March 2009, I spelled out a thesis on TheStreet.com in which I argued that financial stocks were ready to rally off of the bottom. The primary article, titled "Bank of America Is Going Back to $20," was published the day Bank of America hit its low of $2.53.

Again, it was the right time to make the prediction, as long as I didn't mind being told I was wrong, at best, or judged a fool, at worst. After all, this was the trough of the financial crisis, and the action in the market had never felt more chaotic. But once more I was confident that my investment methods allowed me to see the bigger picture.

Meanwhile, Goldman Sachs issued a research note among investors that explained why they still didn't have any faith in a rally for the financial sector. Banking guru Meredith Whitney, who had become an overnight sensation for correctly forecasting the financial crisis, came out against my call on CNBC; she was also skeptical of the initial relief rally. Back on TheStreet.com, Rev Shark made it a little more personal by describing my bullishness as "damn dangerous."

Lo and behold, that rally wasn't just real; it was a once-in-a-lifetime opportunity that conventional wisdom just couldn't detect. My Bank of America call was subject to as much mockery as the oil call had been six months earlier, but in both cases, Alpha Hunter's David got a notch on his belt, and the traditional Wall Street Goliath took a nice black eye.

We've just discussed two of the most important investment plays of the 2007 to 2009 recession, two that very few got right. This book is going to explain the macroeconomic methodology that will help you identify future golden opportunities and position yourself to see the big picture as the market roils.

Life Outside the Box

Investment conditions on the street have undergone a paradigm shift, yet I don't think the traditionalists have noticed. They're stuck inside a box that was hammered together in the last century, and they are unwilling and unable to accept the new reality. This is especially true as you move up the ranks and into the elite analysts inside the financial institutions and among the media that keep an eye on them; they're used to dominating market perception and being applauded for their insights.

I don't trust anything I hear coming out of that old box. Investment philosophy is in critical need of a comprehensive update, even a total rewrite, and any investor who counts on his or her returns had better get up to speed, with speed. Most books you read won't put it that starkly, but I believe your financial future depends on recognizing that we are at a turning point in history. The courses of global markets are undergoing transformations on a scale that hasn't been seen in 100 years.

Where is the big change? It concerns the variable that was—and remains—the real market mover: confidence. The stock market acts as if the future happened yesterday; its inference of confidence in future fundamentals drives the investment strategies of the present moment.

In the twenty-first century, as digital technology pounds the world flatter and flatter, and makes us ever more dependent upon its lightning speed, we are much more susceptible to the contagious consequences of confidence or the lack of it. Worry spreads quicker than it ever did before. Momentum builds up much faster. News flow that is distributed instantaneously around the globe has dramatically enhanced the volatility of confidence.

Former Federal Reserve Chairman Alan Greenspan offered up his own insight into the new Wall Street when he said:

After 9/11, I knew ... that we are living in a new world—the world of a global capitalist economy—that is vastly more flexible, resilient, open, self-correcting, and fast changing than it was even a quarter century earlier.

People have always been enthralled by the notion that it is possible to peer into the future. To what extent can we anticipate what lies ahead? Fortunately for policymakers, there is a degree of historical continuity in the way democratic societies and market economies function. This enables us to reach back into the past to infer inherently persistent stabilities that, while not having the certainty we attach to physical laws, nonetheless offer a window on the future that is more certain than the random outcome of a coin toss."

Greenspan was far ahead of me, and most everyone else, in noticing that we have entered a new era of investing. For me, this knowledge kicked in during a holiday conversation with Paps, just as the debacle of 2008 was coming to a close.

I start every morning the same way, by picking up the phone and calling Paps. We discuss the day's market-moving news and decide how to adjust our portfolios accordingly. None of my investment ideas pass muster until they've been hashed out during one of those morning check-ins.

Paps is my dad. He just happens to have more skepticism and common sense than any critic or advisor I've ever known. He's the man who took me under his professional wing and taught me everything he has learned in 30-plus years working as an investment advisor. He's prescient: he was investing in option LEAPS before they were known as LEAPS (you'll read about LEAPS in detail in Chapter 4). He's spent his adult life on the front lines of the market and has seen it all. So you're probably imagining his old-guy reaction when I argued that we're living on a new Wall Street. The old guys don't believe any of that rubbish. Or do they?

Me:

You ready for the question of the day?

Paps:

Bring it on.

Me:

We all know this recessionary sell-off in 2008 has brought too many investors to their knees. How could we have helped mainstream, individual investors avoid the carnage? It didn't have to happen the way it did. So many advisors kept telling their clients to hang on and be patient through the downturn, but it kept getting worse.

Paps:

I honestly think they didn't know what else to do. If you didn't get out early enough, the damage became so bad that you probably got paralyzed into inaction. The only way to crawl out of the deep hole was to stay invested at 20 percent down, then 30 percent down, and on and on.

Me:

Their clients' eyes looked like deer in the headlights. Advisors love to preach the doctrine of "buy and hold," don't they? It's the only strategy most of them know. It's easy to implement, and history says it works. Buy and hold reminds me of Jerry Sloan coaching the Utah Jazz; the guy never makes adjustments, just sticks with his system no matter what. Every night he plays the same guys who run the same plays no matter who the opponent may be. Coaches like Greg Popovich and Phil Jackson love playing against the Jazz because they can make one simple adjustment and get a victory. It's inexcusable that it's been over 10 years since the Jazz won in San Antonio. In 20 years, Sloan still hasn't beaten Phil in a playoff series. Don't get me wrong, I'm a big fan of having a system, but there are times when you need to adapt.

Paps:

Hey, watch it boy! Jerry Sloan has had a great run in Utah. Don't be so hard on him, and don't be so hard on these buy-and-holders. Until this point, the results have been in their favor. The advice they've given their clients worked in the old days, but I'll admit, in all my years in the business, I've never seen this amount of fear and volatility in the market. Many of my clients are really having a hard time with it. You've got to wonder if something has changed.

Me:

You can't have an advisor like Jerry Sloan running your portfolio. Not in today's world. Buy and hold may have been the strategy of the twentieth century, but it just hasn't worked in the twenty-first century. Since 2000, investors have lived through two of the worst stock market sell-offs in history. The chase of momentum is at an extreme level. Investors need smarts. They need the ability to adapt. They can't rely on one rigid system anymore.

Paps:

These two big sell-offs remind me of the saying "Fool me once, shame on you; fool me twice, shame on me."

Me:

Which brings me back to my initial question. What could have been done to help out individual investors? Can you imagine what's going to happen the next time the economic cycle turns down? Investors have been burned twice in eight years. Fool me once, shame on you; fool me twice, shame on me—there won't be a third time. The next time the economic cycle turns negative, we'll see a rush to the exits. They won't let it happen a third time.

Paps:

What did you just say?

Me:

I said, they won't let it happen a third time.

Paps:

No, before that. You said the next time the economic cycle turns.

Me:

Absolutely.

Paps:

Son, that's it. That is the message that individual investors need to hear. Trying to time the markets with technical analysis has never worked, which is why investors always revert back to buy and hold. But what if we can do a better job of timing the economy? Maybe a strategy built on economic timing would give investors the risk management that they're looking for.

Me:

I like it. Market timing is as phony as palm reading. But economic timing—that feels more legit. I was just talking with a doctor who told me that he had wanted to get his money out of the market last year but was persuaded by his advisor to stay in. That was in February when the Dow was near 12,500. There was no reason to stay invested down to 6,600.

Paps:

It's interesting that usually the average Joe recognizes we're in a recession before the financial analysts do. Every cab driver in New York City knew we were in for a rough year.

Me:

We need to develop of system of economic timing that captures Main Street observations but can be proved correct by sophisticated financial analysis. It really bothers me that so many investors got duped by Wall Street when they knew exactly what was happening on Main Street.

I hung up the phone and realized that I was shocked. How could Paps be so ready to ditch buy and hold after touting its principles for his entire career? It was inconceivable that he'd join me in such a fast shift in philosophy. But the more I thought about it, the more I could see that fast or not, this was a shift brimming with common sense.

You can pull an old tradition up by its deep roots only if you have something to replace it. And whatever that something is, it needs to be better. Economic timing is better. That conversation was a game changer.

So over the next few weeks, I threw myself into creating an investment model to exploit an economic timing strategy. Paps and I extracted the best elements of market timing and combined them with the proven principles of buy-and-hold investing. We developed a Web site, the Economic Weather Station, to help investors get a feel for the new strategy. It's remarkable what two normal guys can come up with when they put their minds together. Paps and I are a poor man's Warren Buffett and his business partner, Charlie Munger. Creating a tag team that isn't afraid to talk openly and honestly about the market is a decent recipe for success and then some.

Cling to the Past at Your Peril

You can be sure that I was on my own learning curve at the time. That game changer conversation with Paps helped me identify a huge and very public mistake I'd made in the middle of the crisis, in October 2008. CNBC's Jim Cramer had appeared on NBC's The Today Show, and I believed that he had compounded the severe market panic by advising investors to pull out. As an adherent to the doctrine of buy and hold, I was convinced that Cramer had been reckless, not bold, and I said so on the Seeking Alpha Web site. It's worthwhile for you to read the article in full, because it's a good primer for the conventional arguments used by buy-and-holders.

Pretty persuasive, don't you think? Now I'll use the rest of this book to explain why and how that strategy became totally outdated and unreliable.

Why was I so off the mark? At the time, I hadn't noticed the increasing frequency of large sell-offs, and I didn't comprehend the reasons underlying them. It simply hadn't registered yet that history is no longer on the side of buy-and-holders. I think that article makes a credible case for the buy-and-hold strategy of the twentieth century, but the events of the last decade require more safety and flexibility in your portfolio. The hard facts show that the Nasdaq sold off from its high of 5,048 on March 10, 2000, to a low of 1,172 in October 2002, a 77 percent sell-off. If that wasn't jarring enough, we also watched the Dow drop from 14,279 on October 11, 2007, to a low of 6,440 in March 2009, good for a 55 percent sell-off. Two deep sell-offs in eight years defies any historical precedent.

So I'm sorry I came on so strong, Jim. I'll beg your forgiveness for as long as I live. I'm a passionate guy, and I'm willing to admit when I was wrong; well, that whole article was wrong.

Still Trying to Figure out a New Strategy? Catch a Wave

I grew up on the beaches of Southern California, so perhaps it's inevitable that I'll use a surfing analogy to explain buy and hold and its limitations in today's markets. Focus for a moment on Kelly Slater, who is pretty much accepted as the best surfer in his sport's history. He's a nine-time world champion as of 2009, having taken his first title at 20 and his latest at 36, quite a dominating record.

You won't see much of Slater if you hang around just one beach. According to Wikipedia, he travels all over the world to time the weather's cyclical patterns. Depending on the time of year, his favorite waves might be found at beaches in Hawaii, Florida, Barbados, South Africa, Australia, Argentina, or, of course, SoCal. He moves to where the action is best.

Now if Slater applied the buy-and-hold investment mentality to surfing, he'd sit in the water 24 hours and day, seven days a week, to be 100 percent sure he wouldn't miss the good waves. Depending on the beach he was parked at, he might have to sit in the water for a few weeks before the waves return. It's not too exciting to be sure, but it's also dangerous because the "surfer" has become a sitting duck for myriad hazards: dehydration, unmanageable swells, sharks—you name it.

(Continues...)

Excerpted from THE ALPHA HUNTERby JASON SCHWARZ Copyright © 2010 by Jason Schwarz. Excerpted by permission of The McGraw-Hill Companies, Inc.. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

Edition details

• Publisher: McGraw Hill
• Publication date: 2010
• Language: English
• ISBN 10: 0071634088
• ISBN 13: 9780071634083
• Binding: Hardcover
• Number of pages: 288