Nasdaq Set to Splat

I am going to start a new series where I occasionally share actionable picks related to my subscription-based newsletter Wall St. Cheat Sheet. Recently, I have been watching Nasdaq OMX Group Inc. (NDAQ). Sellers have become more aggressive since October. However, buyers have been protecting the ~$18.10 area since the start of 2009. When this happens, it sets the stage for a potential breakdown if the line of defense breaks. Psychologically, many who were buying at $18.10 and remaining calm will decide to cut losses if we head lower. Additionally, those who are profitable from the lows ($14.96) will look to lock in profits as they fear a disappearing act. When this fear-fueled supply hits the market, we are presented with a low risk trade.

In this case, the first price target is $16.57,the second is $15.65, and the third is $14.96. So, if you enter a short or put position at a break below $18.10, you will look to take profits at these targets. Of course, you should take profits whenever you want. These are just suggestions and change in real-time depending on how the market behaves (you must make those determinations because I will not be there to tell you when to sell). You can set your stop-loss at $20.50 or $21 depending on your risk tolerance and outlook for the market. Once your trade is firmly profitable, you can always lock in profits by lowering your stop-loss to first break-even and then other profit levels that make you smile.

The risk-reward for this trade is not the ideal 2-to-1, but the setup is strong. Remember, NDAQ will only breakdown if the market continues lower. In the event the rally resumes (which is possible during volatile earnings season), all bets are off for now.

I am not recommending you make this trade. I am simply sharing a trade setup that I plan to take if the market conditions dictate an edge. For example, if you got short NDAQ today in the last 5 minutes of trading, there is a reasonable chance we could open higher tomorrow. Thus, it was a high risk trade (i.e., not my style). However, if we break below the entry tomorrow morning and the markets confirm weakness, the odds are much more favorable — and this game is all about trading with the odds, and watching when they are not on your side.

If you find this type of information valuable, please follow me on Twitter and consider subscribing to Wall St. Cheat Sheet for many more money-making ideas.

Water ETFs are Correlated to Market Tide

• Sell PHO and PIO around 22 and 24 respectively

Eleven months ago I recommended the water ETFs PowerShares Water Resources (PHO) and PowerShares Global Water Portfolio (PIO). I was specifically seeking an asset class uncorrelated to the broader stock market. However, I think too many traders and funds are buying and selling these assets based on the same signals as broader market indicators. Therefore, the investments have not met my thesis and need to be sold.

This is a good lesson for investing. We have many prospective investments, yet only enough cash to buy a tiny fraction of assets. As a result, we must consider our opportunity costs when holding investments that under-perform. Moreover, we want to cut our losses when a thesis has been proven incorrect. If for some reason these water ETFs start trading as if water is a scarce commodity, then I will happily jump back in the pool.

SmartGuyDH no longer owns shares of PHO or PIO

Game Over for Nintendo’s Risk-Reward Ratio

• Sell NTDOY around 71.15

Avid readers of SmartGuyStocks know that Nintendo (NTDOY.PK) has been one of our favorite stocks over the past year. NTDOY is the only stock I have recommended twice. The company has delivered two of the most exciting products in the world: Wii and DS. However, I believe price appreciation is limited for the following reasons: skyrocketing shipping costs, the weak dollar, and the current point in the console cycle.

First, let me preface my comments by saying NTDOY is still one of the best companies in one of the hottest sectors in the world. If the global economy was steamrolling, I would hang on to NTDOY through the coming holiday season. Unfortunately, my wish is not the economy’s command. Rather than fight reality and stubbornly hold my shares, I am willing to take my extraordinary gains and accept that my risk-reward ratio has diminished.

Although many shareholders will focus on the positives at Nintendo, headwinds are gaining strength. As oil costs levitate, shipping costs perform the same miracle. These costs eat into NTDOY margins for both manufacturing and distribution. Moreover, the dollar continues its celebrity makeover as toilet paper. This will continue to diminish the value of building in yen and selling in dollars.

Thus, the great irony of globalization (i.e., foreign production is cheaper) begins to mature. The forces in the global oil and currency markets are stronger than those in the growing video game space. And until something changes, these costs will limit upside in NTDOY.

Lastly, the easy money has been made in the current console cycle. Those who remain in shares are playing chicken with the inflection point of the cycle. Some time in the next 12-18 months I expect Microsoft (MSFT) and Sony (SNE) to start introducing exciting concepts for their next generation consoles. These glossy press releases will create signs that the current cycle is in the latter stages. Once that happens, analysts and investors will start to look ahead. And once that happens, doubt will arise as to whether NTDOY will repeat their success in the future. If you are still holding shares at that point, you will be very disappointed to see Nintendo the company still minting money while NTDOY the stock discounts for the great unknown of the next console cycle.

I do not aim to find the absolute high and low of a cycle. Rather, I seek to capture the easier money when companies are in stride during their climb or descent. That’s why I have not made many picks since the market has traded in a choppier manner. I prefer shorts and puts when things are falling hard, and buys and calls when they are rising in a healthy environment. Occasionally I will offer a short-term trade that contradicts the macro environment, but those who follow my picks will make most of their money in the sweet spot of each cycle. My one-year track record on SmartGuyStocks validates this strategy.

On a technical note, NTDOY peaked in the high 70’s and has not been able to push back. This is more evidence that the macro environment has great control over NTDOY shares. I held my shares during the decline from the peak because I believed the stock had a chance to bounce back and charge ahead for another leg up. Despite excellent growth and earnings, the stock has not made new highs. Therefore, I believe we may be witnessing the best price for NTDOY we will get as the hype for Mario Kart and Wii Fit bring optimistic buyers back to the trading floor.

Of course, the economy could improve later this year, but I do not take my economic analysis from the White House. From where I sit, it’s game over for Nintendo’s risk-reward ratio.

Arbitraging Activision

• Sold ATVI calls at 9.60

I just want to let everyone know that I sold my ATVI calls this week when ATVI was trading at $27. I have since bought and sold some more calls as an arbitrage play when the broad market sold off strongly and dragged ATVI down. Although SGS is closing our ATVI position, we will watch post-merger to see whether this excellent company deserves another investment.

Selling MCD Options to Lock in Profits

• Sell MCD March ‘08 45 Calls around $14

Although I still like McDonald’s (NYSE: MCD) the business, I am concerned about the stock in the current market environment. Given that options are much riskier than equities, I recommend selling the MCD March ‘08 45 Calls into strength around $14.

MCD’s rich valuation (Forward PE 19 v. S&P Forward PE 16) is predicated on the successful rollout of premium coffee and smoothies. I believe the objective will be successful, but I am afraid the expectations have ignored the possibility of any kinks during the rollout. I have heard that franchisees have challenged the initiative because they will be asked to invest $100,000-200,000 in new equipment. If the challenge lasts longer than anticipated, we may be able to buy more options at a better price in the future. Either way, I like locking in gains when faced with a very dark macro environment. Now let’s go grab a coffee at McDonald’s …

Disclosure: SmartGuyDH no longer owns MCD options

Update: Selling CVA on US Energy Bill Issue

• Sell CVA around 26.60

This morning I was informed that Senate Majority Leader Harry Reid and House Majority Leader Nancy Pelosi have reportedly decided to remove the federal renewable portfolio standard (RPS), as well as all tax provisions benefiting renewables from the proposed US Energy Bill. Thus, I recommend selling Covanta Holding Corp. (CVA) and locking in gains until the issue has been decided.

The issue matters because if the federal tax credits for renewable energy are gutted from the bill, no projects will receive financing until tax credits are guaranteed. Thus, the entire industry will come to a halt (like it did a few years ago when the credits were allowed to expire before being renewed).

Legislators say they will deal with the tax credits and RPS next year, but the simple act of creating an unknown will have the practical effect of destroying the sprouting renewable energy companies in solar, wind, biomass, and more. Moreover, nothing gets done in an election year, so financiers will be even more skeptical about funding clean energy projects.

I hope the Democrats do not sell out the entire renewable energy industry, but I cannot afford to bet on politicians. I will keep you updated as things proceed.

For more information on the issue, check out the detailed report at Renewable Energy Focus.

Update: Closing BBI Puts Position

•  Sell BBI Jan ‘08 7.50 Puts around 3.40

After eight trading days, I recommend closing your position of BBI puts at $3.40 to lock in a 36% gain. I still believe BBI is in major trouble. Therefore, if your risk tolerance permits, feel free to ride your puts longer. Personally, after watching the stock’s price action since their earnings announcement on November 1st, I would rather lock in my gains and trade the puts on daily pops and drops.

If you are raising cash, do not rush to jump back in this schizophrenic market. Better to see whether the bulls or bears will control Q1 …

Activate Activision

• Buy ATVI Jan ’08 17.50 calls around 6.10

Blue chip video game publisher Activision Inc. (Nasdaq: ATVI) will announce earnings this Monday, November 5^th. Given recent market turbulence, shares are trading lower than they should given Activision’s complete domination in the publishing space and their recent launch of blockbuster Guitar Hero III. Like Microsoft’s (Nasdaq: MSFT) stock pop following the successful launch of Halo 3, ATVI should experience a similar pop when they announce better-than-expected earnings, awesome initial sales numbers for GHIII, and exciting forecasts for other holiday blockbuster releases.

ATVI shares have also seen resistance as a result of Electronic Arts’ (Nasdaq: ERTS) distribution deal for a new music game called Rockband. Near-term concerns about Rockband are overdone for the following reasons:

1) ATVI beat EA to the punch by releasing GHIII much earlier than Rockband (release Nov. 20). I believe most gamers have been impatiently awaiting a new music game, and ATVI has captured such demand.

2) GHIII is more than 50% cheaper than the $199 Rockband. Given that parents already complain about video game prices like businesses complain about rising energy costs, I think Rockband has the wrong price point for mass sales. I think the more expensive game will appeal to music aficionados, while GHIII will maintain its phenomenal mass appeal.

3) GHIII is available on all three game consoles, while Rockband is not available on the most popular console, Nintendo’s (OTC: NTDOY.PK) Wii.

Although I think Rockband has potential to compete with GHIII in the long-term, I do not think the new competitor will hurt GHIII sales this holiday. That is why I am recommending the January ’08 call options for a short-term trade, and we will reevaluate ATVI sometime in late January once industry holiday sales are tallied. If you want to buy stocks in this sector, see my previous article about Nintendo at SmartGuyStocks.com.

Disclosure: SmartGuyDH owns Jan ’08 17.50 calls

BBI: Trick? Or, Treating Shareholders & Customers like Busters?

• Buy BBI Jan ‘08 7.50 Puts around 2.50

Blockbuster Inc. (NYSE: BBI) reported a 30% increase in losses yoy to $0.15 a share. The video rental company also saw revenues drop 5% to $1.24 billion, missing analyst expectations of $1.28 billion. The major blemish with Blockbuster’s frightful post-Halloween announcement was the scary drop in online subscribers to 3.1 million from 3.6 million only one quarter earlier.

Bulls and bears have been battling over whether incumbent BBI or newer online video rental company Netflix Inc. (Nasdaq: NFLX) will win the video rental war. Today’s subscriber numbers show that BBI may be fatally falling behind. Management has continued failing experiments with their Blockbuster Total Access online plan. As a current member who plans on canceling next month and joining Netflix, I know every reason why Blockbuster continues to fail.

First, Blockbuster’s online service is like a high school student’s final project for an ‘Intro to E-commerce’ class. During the first three months, my wife and I have sent customer service six complaints regarding failures for our next movies to ship when others were returned, the unbelievable 3-4 days it takes for a movie to arrive after it supposedly shipped (Cf. Netflix arrives in 1-2 days), and failures for our movies to be registered online as ‘returned’ when they were scanned at the store days earlier. When I complain at the in-store locations they blame the “online people,” and when I spoke to a customer service rep from Blockbuster Total Access, she blamed the store employees. The only buster in this scenario was me!

Second, I recently upgraded my plan to receive an extra DVD in the mail at the expense of my unlimited free in-store exchange rentals (which reminds me of another NFLX advantage: cheap unlimited online downloads). I made this choice because the online selection is better than in-store (although still far inferior to the availability of titles on Netflix – by the way Blockbuster, “Long Wait Time” does not count as an available title). To my great dismay, for more money a month I now receive less rentals because BBI takes forever to send my next rentals. I do not want to declare a conspiracy theory, but since Blockbuster Total Access has been bleeding money like a victim in Friday the 13^th, I would not be surprised if internal strategy involves delaying shipments just long enough to make the business more profitable. Should the customer receive crappy service because a business started selling first and thinking second? I, like 500,000 other subscribers, seem to think not.

My favorite moron analyst comment of the day goes to Sterne, Agee & Leach analyst Arvind Bhatia who said Blockbuster is shifting the focus away from its online service because the company believes their first quarterly loss of subscribers is a sign that online DVD rentals may be peaking and facing a slowdown. If this is true, why is Netflix growing? I’ll give you a hint Arvind: they are taking business from BBI. Yet another example that BBI management and their crony I-bankers have no idea where they are steering the ship.

But we should feel safe as a babe in mother’s arms because Arvind said “Blockbuster is going to be improving the profitability of its business rather than focusing on online subscriber growth … That’s a good thing.” Really? Losing market share and decreasing revenue is good? Did you learn that in college or at your Sterne, Agee & Leach training? Seems like BBI thinks both shareholders and customers are busters for the taking.

Disclosure: SmartGuyDH owns Jan ‘08 7.50 Puts

MCD: Juicing Gains with Options

• Buy MCD March ‘08 45 Calls around 13

McDonald’s Corp (NYSE: MCD) is continuing its bullish turnaround. Following last week’s earnings, I believe the company has at least an additional 12-24 months of superior returns ahead. The new coffee offerings will surely keep the positive PR coming as McDonald’s starts throwing that hefty marketing budget behind their java. Moreover, international expansion and sales are benefiting nicely from increasing demand and a weaker dollar. Lastly, as the US consumer looks for ways to prune spending, say goodbye to Applebee’s (Nasdaq: APPB) and hello to McDonald’s dollar menu (you don’t think people will actually cook, do you?).

However, the easy money has been made. Thus, to juice returns I recommend snapping up deep in-the-money calls. Options are a risky way to bet on equities, but I believe a fairly conservative strategy is purchasing deep in the money calls for blue chip stocks that are doing well. For example, you can purchase the March 08 45 MCD calls for a 20-30 cent premium. So long as MCD can get to 60 by the strike date, you will have a 15+% return versus a 3.5% return. Not a bad way to beat the market over the next 5 months.

Disclosure: SmartGuyDH owns MCD call options