Transaction Alert: Exelon LEAPS Part 2

I just bought 10 contracts for EXC January 2012 $50 Calls at $2.00. I previously purchased 10 identical contracts earlier in the month, the only difference being that I paid $2.10. So, now I have a total of 20 contracts for EXC January 2012 $50 Calls.

Transaction Alert: FAF Call Options

On Friday I purchased 2 sets of call options in FAF for a combined outlay of about $2,000. The first was 10 contracts of FAF October 2010 $40 Calls at $1.10 and the second was 20 contracts of FAF June 2010 $37.50 Calls at $0.50. The price of FAF is currently around $35 a share, so both these call options are currently "out of the money."

This bet falls a little outside the realm of normal value investing. FAF is splitting into 2 companies on June 1st, one that focuses on title insurance and another that focuses on information services. My current thinking is that FAF has a fair value of about $50 a share, and my hope is the spinoff will act as a catalyst for FAF shares to appreciate.

The danger with this investment is that it's very short term - so if there's a broad market selloff these options could easily expire worthless. On the flip side, if the market rallies in the near term these options could be worth a lot of money.

In conclusion, this "investment" is 1/3 special situation, 1/3 value investing, and 1/3 luck - my guess is there's a 50% it'll make money and a 50% chance it won't. HOWEVER, if it does make money it'll be 3x to 4x my initial investment, which is why I felt comfortable making the bet in the first place.

Transaction Alert: Exelon LEAPS

I just purchased my first option - 10 contracts of "EXC January 2012 $50 Calls at $2.10." In other words, anytime between now and January 2012 I have the right to buy shares in Exelon for $50. Each contract includes 100 shares, and I bought 10 contracts, so my sunk cost in this investment was $2,100 (plus a small commission of ~$11).

Since the contract price was $2.10, I make a profit if the share price exceeds $52.10 (50+2.10). Due to the leveraged nature of LEAPS, for each incremental $1 above this price I make a $1,000 profit! My hope is the economy continues to rebound and both power prices and energy consumption rise along with it. If this happens my guess is EXC could be worth $60 to $80 a share, which would generate a profit of $7,900 to $27,900, respectively - not bad for a $2,100 investment.

On the other hand, there is a decent chance my investment thesis could be flat-out wrong. If this is the case and EXC never gets above the $52.10 threshold then I only stand to lose $2,100.

Time to lever up?

LEAPS, or Long-term Equity AnticiPation Securities, have recently grabbed my attention. LEAPS are simply a long-term call option, or in other words the right (but not obligation) to buy a stock at some point in the future at a predetermined price.

Here's an example: let's say stock XYZ is being investigated for some alleged wrongdoing. Currently the stock is trading at $100 a share, but it's worth $200 assuming they're innocent. However, if they're guilty the stock is probably only worth $50. If I were to purchase XYZ common stock, based on my current portfolio size, I'd probably buy $10,000 - and I'd either lose $5,000 or gain $10,000.

However, let's say I could buy XYZ LEAPS (expiring 1/2012) with the following terms: a strike price of $150 and a contract price of $5. In other words, for $5 I reserve the right to buy one share of XYZ for $150 anytime between now and 1/2012. If I were to invest $5,000 in XYZ LEAPS I could potentially lose it all if the stock never gets to $150 (which is the same amount I'd lose with the common stock).

But what happens if the stock goes to $200? Well, since I invested $5,000 I have the right to buy 1,000 shares at $150. Since I could immediately sell them for $200, I'd realize a $50,000 profit! So, with LEAPS I'd either lose $5,000 or gain $45,000 (50K profit less the initial investment of 5K).

Obviously this is a very simplistic example - the real world is much murkier. However, the economics of buying LEAPS can be extremely attractive, and in some cases it just makes more sense. I'm specifically looking at Jan. 2012 LEAPS for EXC and MON and as always I'll post about anything I decide to do.

Transaction Alert: Sold USG

Knowing when to sell is definitely more tricky than knowing when to buy, and selling can be especially difficult if the stock has been on a run. Nonetheless, today I sold my 800 shares of USG at $21.83 (I purchased the shares in March of 2009 at an average price of $4.91). This position resulted in a return of approximately 345% in just over 13 months.

Transaction Alert: Bought Sandridge (SD)

Today I purchased 1700 shares of SD at $7.06. I've previously discussed my interest in this stock on my blog and on Gurufocus at http://www.gurufocus.com/news.php?id=89642.

In conjunction with this trade I'll probably also sell GMXR. I will discuss my rationale as time permits...

Updated Returns

I last posted about my portfolio returns at the end of Q1, but due to the recent runup I thought I'd recalculate (see "My Returns So Far..." to the right). Over the past 4 years and 3+ months my annual rate of return is 21.4%. Over this same time period the "S&P parallel portfolio" would've returned 3.5%.

I realize that 4+ years is not long enough to know if my results are simply dumb luck, so I'm keeping my fingers crossed and hoping the streek continues!

Feeling Fearful

It's been quite a ride over the last year! I remember in March 2009 the fear in the market was almost palpable. Now, 13 months later, all the major indexes continue to soar, seemingly defying gravity. IMO the market, in aggregate, has turned greedy - so is it time for the individual investor to turn fearful? I think so...

These days I find myself asking, "Where is the opportunity, where is the value, and most importantly where is the risk?" I've been struggling to find individual stocks that offer an acceptable margin of safety and potential return. Additionally, several portfolio holdings of mine are approaching my guess of their intrinsic value. As a result, my portfolio's cash position has grown to about 30% and I'm very seriously considering selling several more holdings. Specifically, these are USG, WTM, and COV. However, this is only half the story. I have found a small handful of stocks that seem attractively priced. Among these are GENZ, EXC, SD, MON, ISCA, APOL, and FNF.

My sense of it is that a lot of investors spend a great deal of time picking stocks at the expense of portfolio management. David Swensen is the master of this - in his excellent book, "Unconventional Success," he lays out a fairly simple but powerful plan based primarily on portfolio management. Additionally, I'd argue that one of the main reasons the Magic Formula works so well is because there is a defined, rigorous plan around portfolio management (although everyone seems to focus on the stock picking aspect).

I have to admit, holding on to USG is tempting because it has the potential to be my first 10-bagger. And it was difficult for me to sell SHLD because I kept thinking it might be the next Berkshire. But the fact of the matter is "hope" isn't an investment strategy. SHLD hit my estimate of its intrinsic value and USG is quickly approaching it. IF I can find stocks that are priced at a greater discount to my estimate of their intrinsic value then, by definition, they have a better margin of safety and better potential return. Of course I could turn out to be wrong for any given stocks I buy/sell, but I think the process I've laid out is right.

As always I'll post about any stocks I buy or sell.

Opportunity in Natural Gas?

I wrote an article for the awesome website http://www.gurufocus.com/ called "EMT, 'Ick' Investing, and Natural Gas." Readers can access the article here: http://www.gurufocus.com/news.php?id=89642#89677

This article basically outlines my thoughts on efficient market theory, why I'd be considered a "contrarian" investor, and why I think there are currently opportunities in natural gas exploration and production companies.

I specifically discussed SandRidge, which is one of the top stocks on my watch list. Other stocks high on my watch list that weren't discussed are MIR and EXC, and obviously I already own GMXR. I'll keep you posted if I decide to make any purchases...

My Returns as of Q1 2010

At the end of every quarter I will write a quick post that details my returns. I started 2010 with $107,514 in my portfolio and finished the quarter with $114,624. I didn't make any deposits or withdrawls, so the increase in value is straight appreciation.

• On an absolute basis, my portfolio appreciated 6.6% during the quarter. Annualized, this rate of return is 29.7% (this is slightly better than the S&P).
• I've been tracking my returns for 4 years and 3 months, during which time my annual rate of return is 19.4%. Over the same period the S&P returned 2.3% annually.

Following are my portfolio details and a summary of transactions for the year:

• I started my blog in the beginning of March 2010. Between then and now I've sold my stakes in SHLD and MDZ.
• Prior to starting my blog but during fiscal 2010 I sold my stakes in PFE and WSC.
• The only new position I've initiated during 2010 is GMXR.
• Currently I only own 6 stocks and about 30% of my portfolio is in cash, as shown in the picture below (and on the "My Current Holdings" link to the right).