Buying Options on Companies' Survival

03/24/2009 11:35 am EST


John Bollinger

President and Founder, Bollinger Capital Management

John Bollinger, editor of Capital Growth Letter, says some stocks are so low they're acting as options on the companies' survival-and might be worth betting on.

In the midst of the panic last November, Ford (NYSE: F) traded for a dollar a share. [So,] the price of the stock was less than what a reasonable person might have been willing to pay for a bet as to whether Ford was going to make it as a company.

As I look around today, there are many companies whose stock prices are so depressed that they are trading more like long-term options on the survival of the enterprises.

The very simplest form of an option is a winner-take-all bet. For example, a wager on Ford's continued existence that cost a dollar and paid two dollars if Ford survived, or nothing if Ford failed over some given horizon (say, two years) is an option on Ford. In fact there are binary options, which behave in exactly that manner.

Some stocks are trading at prices so depressed that they appear like options on the survival of the enterprise. If one were to assemble a package of them-maybe ten or 20-and wait a couple of years, one would no doubt find that some of them had failed and gone to zero. But I am fairly certain that the stock prices of the survivors would much more than compensate for the losses.

There is no magic bullet here, no formula that will reveal the stocks trading like options, sorting the wheat from the chaff. So, we decided to do a couple of simple technical screens to get us into the right ball park, a short list of some candidates worth thinking about.

The first pass was a screen to select stocks more than 90% off their two-year high. The two-year window includes the 2007 highs, when things looked pretty good to most stock buyers. The first quarter of 2007 is far enough back to capture meaningful high water marks for most stocks.

There are 4,545 common stocks in the Quotes Plus database, and an amazing 927 stocks were down more than 90% from their two-year highs as of March 6th. That's almost exactly 20% of the universe, or one in five stocks currently down more than 90% in this bear market.

I knew that there had been huge damage done in the stock market, but this result seems extraordinary, especially when you consider that it doesn't include those stocks that went to zero.

That makes our job of identifying stocks trading for their option value or less very, very hard, simply because there is so much merchandise to choose from. I have put a list of stocks down more than 90% from the two-year highs here.

I suggest that you scan it for stocks that you know and understand. That way you'll have an edge putting your package together. A few stocks that caught my eye are: Sprint Nextel (NYSE: S), Ford, General Electric (NYSE: GE), and Bank of America (NYSE: BAC).

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