Betting on the Downside

01/31/2003 12:00 am EST


Bernie Schaeffer

Chairman and CEO, Schaeffer's Investment Research

We caution readers that there are risks associated with betting on the downside. However, for those seeking to bet on a market decline, several leading advisors offer a variety of options. Bernie Schaeffer suggests buying puts on several vulnerable issues. Elliott Gue suggests selling stocks short. And Doug Fabian offers a variety of bear market funds.

Bernie Schaeffer, editor of The Option Advisor, has added several "put" recommendations to his aggressive portfolio. "Defense contractor Northrop Grumman (NOC NYSE) has failed to live up to its title of ‘Company of the Year’ for 2003. In late October, NOC broke below previous support in the 100 area. This level, which has acted as resistance ever since, is also the site of peak February call open interest with more than 14,000 contracts. Sentiment toward the security is at optimistic extremes. This optimism is further reflected in the heavy call open interest at deep out-of-the-money strikes in the February series compared to relatively light open interest at out-of-the-money put strikes. This overwhelming desire for NOC calls is a contrarian's delight. We recommend the Northrop Grumman May 100 put. Meanwhile, America's motorcycle magnate, Harley Davidson (HDI NYSE) hasn't been hitting on all cylinders recently. The company recently beat fourth-quarter earnings estimates but failed to raise its production schedule for 2003. This news sent HDI skidding lower to the tune of 12%. The sell-off coincided with resistance at the stock's declining 10-week moving average, which recently suffered a bearish cross below its 20-week trendline for the first time since May. It also pushed the shares below previous support at the 44 level. Despite these problems, the equity remains a favorite of Wall Street. According to Zacks, 12 of the 16 analysts following HDI rate it a ‘buy’ or better. As these high expectations begin to unwind, we look for additional selling pressure to ‘rev up’ on HDI. That spells further downside in the near future. We suggest the Harley Davidson August 50 put."

Elliott Gue, editor of The Wall Street Winners , says, "We suggest shorting Best Buy (BBY NYSE) at prices above 27, with a stop loss order at 31. The stock has acted well of late, but the sector has been very shaky, as retailers are breaking down with the rest of the market. We think the little rally in Best Buy is overdone and that it will trade lower during the next month or so. We shorted Herman Miller (MLHR NASDAQ) around 18.78 a little more than a month ago. Since then, the stock first rallied a bit then gradually sold off in a downtrend channel. Part of this was in response to the company’s dismal earnings report last month. Those who aren’t already shorting Herman Miller can take short position above 17.00. Use a stop-loss at 19.50. We also recommend that traders short Kookmin Bank (KB NYSE) at prices above 35. The company is in trouble. One of the biggest Korean banks, Kookmin is having problems with rising delinquencies in its consumer lending division. Kookmin has already broken key support levels and is already in the process of a pretty good breakdown."

"With most averages retracing 50% of their recent rally gains, we have generated a ‘bear fund buy’," says Doug Fabian, editor of Successful Investing. "To position your portfolio at this time, use the funds and allocation guidelines recommended below for your risk tolerance level. For conservative investors, we suggest a 25% position in the Prudent Bear Fund (BEARX). Moderate investors can allocate 50% of your portfolio to indexed bear market funds. I recommend a 25% allocation to an S&P bear fund, and 25% to a Nasdaq 100 bear fund. For the S&P bear fund, choose from ProFunds Bear (BRPIX), Potomac US Short (PSPSX) or Rydex Ursa (RYURX). For the NASDAQ 100 bear funds, choose from Potomac OTC Short (POTSX), ProFunds Short OTC (SOPIX) or Rydex Arktos (RYAIX). Aggressive investors can take a 50% position in leveraged bear funds. Of that, 25% should be allocated to a leveraged S&P bear fund and 25% to a leveraged Nasdaq 100 bear fund. For a leveraged S&P bear fund, use either ProFunds UltraBear (URPIX) or Rydex Tempest 500 (RYTPX). For a leveraged NASDAQ 100 bear fund, use either ProFunds UltraShort OTC (USPIX) or Rydex Venture 100 (RYVNX ). Note that leveraged bear funds will double your loss when we get stopped out. If you're uncomfortable with that fact, use the moderate-risk recommendations.For all in these positions, we suggest tight stop-loss sell points to cut our losses if a new uptrend develops. For the Prudent Bear fund and the S&P short fund positions, use a 5% trailing stop-loss. For NASDAQ 100 short position, we suggest a 7% trailing stop-loss."

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