First, let me say this: Most people lose money trading options.
It’s a very difficult game. But if you can find an edge, the returns can be huge. One of the best option-trading hedge funds in the business, Cornwall Capital, has averaged 51% annualized over the past 10 years. That turns a mere $20,000 investment into $1.2 million, in less than 10 years.
Two of the best option strategists that have ever worked on Wall Street are Keith Miller, formerly of Citigroup, and John Marshall, of Goldman Sachs. Both Miller and Marshall happen to be Blue Jays (i.e., Johns Hopkins University grads), like me. If you can ever find any of their research studies, print them out and examine them closely. They are excellent — and will give you an edge.
Below are the rules the best hedge funds use when trading options:
Rule #1
Options are like a coin toss; you’ll be lucky if half your option trades are profitable. That is why you have to make sure you get paid for the risk you take.
Only trade an option if your projected return is a triple or better. To do this you will have to buy an out-of-the-money option. And you should go out at least two months, preferably longer. Now, here’s the math:
Let’s say you make 40 option trades a year. Odds are at best you will only make money on 50% or half of these trades. Therefore, if you had 40 options trades and 20 of those trades expired as worthless, and the other 20 option trades averaged a triple or more, you would still make 50% a year. For example, on a $40,000 account taking 40 trades a year, if 20 option trades lose everything and the other 20 trades give you an average return of 200%, your account would be worth $60,000, giving you a 50% return.
So $20,000 would go to zero on the option trades that expired worthless. The other $20,000 would go to $60,000 on a 200% return.
Rule #2
Price predicts a stock’s earnings and fundamentals 90% of the time. According to Keith Miller of Citigroup, a stock will start to move one to two months ahead of its earnings date, in the direction of the earnings report. This means if a stock starts trending higher or breaks out higher before the company reports earnings, the earnings report will be positive 90% of the time.
Rule #3
When you are buying options on a stock, make sure the stock is owned by an influential investor or activist. These investors, such Carl Icahn, Barry Rosenstein of Jana Partners and the rest, are always working behind the scenes to push the companies to unlock value; this can come in the form of incremental positive change or big one-time catalysts. This positive announcement or catalyst usually emerges after the stock has moved up in price. So when you see an activist-owned stock breaking out, or trending higher, there is usually a good chance change is coming. Thus, you’ll want to buy calls on this stock immediately.
Rule #4
Only trade an option if there is an event or catalyst that will reprice the stock. This could be an earnings announcement, a company’s Investor Day or an annual meeting.
Rule #5
Only buy options when both implied volatility and historical volatility are cheap. Be a value buyer of options. Watch volatility. Buy volatility only when it’s cheap.
A perfect example of an option trade that fits all of the above criteria is Walgreens ($WAG).
> Jana Partners, run by billionaire Barry Rosenstein — one of the top 5 activist hedge funds on the planet — owns more than $1 billion of Walgreen’s stock. That’s more than 10% of the fund’s overall assets invested in Walgreen’s (Jana has $10 billion under management). Even better, they just added to their position last week, buying $77 million more during the market correction.
> Walgreen (WAG) just broke out of a consolidation pattern, and it looks like it is ready to make a big run (see chart below).
> Walgreen reports earnings on December 22nd. So whichever way the stock moves over the next month or two will predict whether the company’s earnings are positive or negative. Based on the stock’s current price momentum, the report will be positive.
> The Walgreen $65 calls are cheap, especially since they expire only two days before the company reports earnings. You can buy the Walgreen December $65 calls for just $1.10. That means, at $66.10 or higher, you will make money on this option. My price target for Walgreen, based on its recent breakout, is $69. That also happens to be where Walgreen gapped previously.
> If Walgreen stock trades just 10% higher to $69 by December 20th, you will more than triple your money on this option in less than two months. This is the risk-reward profile you want when trading options. Your goal should be to make 50% a year.
Momentum investing, or buying stocks with the largest six-month and one-year price gains, works well when volatility is low, with the VIX below 25. But when the VIX closes above 25, all bets are off. This is when mean reversion kicks in, and the sectors and asset classes that have performed the worst tend to turn into the market leaders.
What would that shift mean today? It would mean: Go long energy, long small caps, and short momentum-driven tech stocks (YELP, TSLA, FB, NFLX, TWTR), while trimming healthcare and scaling into retail.
The simplest play would be to buy energy stocks and small-cap stocks (or the Russell ETF), and short momentum tech stocks or the QQQ’s.
If Carl Icahn is going to push Apple to buy one of his holdings, it has to be Nuance (NUAN). Here’s why:
Icahn owns 19.2% of Nuance, or $1.14 billion worth, and his son Brett is on the board. That’s big.
Also, Nuance has a market cap of $4.7 billion and an enterprise value of $6.2 billion; Apple has around $37.7 billion in cash, so they could easily buy the company for a significant premium.
In Netflix (NFLX), not only has Icahn reduced his stake and sold some of his shares this year, but he only owns $777 million and does not have the same type of board representation as he does at Nuance. Netflix also has a $28 billion market cap, so it would cost Apple $30 billion-plus (with a buyout premium) to buy Netflix. That’s too rich.
William Meade
President of The Billionaire’s Portfolio
Yesterday GT Advanced Technologies (GTAT) declared bankruptcy, sending the stock down more than 90% in one day. It’s likely that 99% of everyone who read this news went on with their day thinking to themselves, “Thank goodness I didn’t own this stock.”
But the 1%, the smartest hedge funds, were getting ready to pull the trigger on one of the oldest and most powerful quantitative trading strategies around: buying a stock the day after it declares bankruptcy, then selling it at the close.
This strategy has been known by almost every hedge fund on the Street, including the billion-dollar-plus hedge fund I worked for back in 2002, when WorldCom filed one of the largest bankruptcies in history. The next day our fund loaded up on WorldCom stock, which was selling for pennies on the dollar, and we made over 120% in one day.
This bankruptcy trade works for two main reasons:
1) Short sellers buy their stock back (or cover immediately after a bankruptcy filing)
2) Distressed traders-hedge funds will buy bankrupt stocks because there is a possibility they can squeeze some money out of them during the bankruptcy process, especially if they own 5% or more (a controlling stake).
This powerful combination of huge buying with virtually little selling (because no one really sells a stock after it has declared bankruptcy and dropped 90%) usually pops the stock more than 100% the day after a company declares bankruptcy.
That is why GT Advanced Technologies is up 150% today on huge volume, and why many hedge fund traders are smiling while the rest of the public is left scratching their heads.
To find out more about what hedge funds are buying and the sophisticated strategies they use to make 100% or more returns go to Billionairesportfolio.com
When I first heard about this, I thought it was a joke: There is a start-up company, of course in San Francisco, that connects maids with people who need their home cleaned. Ok, I considered Merry Maids, which a lot of people use. But when I found out the company had received $38 million in venture capital financing and that the founder was in her 20s, with zero experience in the house-cleaning industry, I knew the apocalypse had come and the tech bubble had burst.
The company is called Homejoy, and it was founded by Adora Cheung, who has an undergraduate degree from Clemson University and a Masters from The University of Rochester; she started Homejoy right after graduate school.
Even more amazing, it seems Adora Cheung had no previous experience in the industry before she started Homejoy. However, in today’s world, where venture capitalists will throw money at any and every idea, this is not a huge surprise. Yet when a woman in her 20s without any real experience in her industry gets 38 million, you have to wonder what they are smoking in the Valley.
Even more bizarre, Adora admits she didn’t know how to clean a house before she started the company, so she went to a “maid boot camp.” And it gets even stranger: According to recent articles in The Washington Post, New York Magazine and International Business Times, Homejoy has used homeless people to clean houses. Imagine you come back from a hard day at work, and the poor guy whom you’ve been giving money to on the corner of your street is not only in your house, but he is cleaning your house. Wow!
But perhaps I am too cynical and should really be moving out to San Francisco to pitch venture capitalists on an online pest control company. I mean, if a 20something woman with zero experience in her industry can get $38 million from venture capitalists to hire homeless people to clean houses, maybe I am the fool for not grabbing the money while it’s hot.
But in reality, this is Pets.com, this is the end — sayonara, Silicon Valley. I only wish you could short privately held firms.
Will Meade
President of The Billionaires Portfolio
When high-quality stocks sell off for non-fundamental reasons, billionaire investors lick their chops.
As you probably know, Warren Buffett has made his fortune being “greedy when others are fearful.” Billionaire Jeffrey Ubben, of ValueAct Capital Management, has been quoted as saying, “As soon as a company falls out of bed, for whatever reason, we can go right to our old notes.” Ubben bought a $1 billion stake in 21st Century Fox when the stock fell last July, in reaction to Fox’s bid for Time Warner (TWX).
Billionaire Bill Ackman recently said in an investment letter that “minority stakes in high-quality businesses can be purchased in the public markets at a discount. These discounts principally arise because of two factors: shareholder disaffection with management, and the short-term nature of large amounts of retail and institutional investor capital which can overreact to negative short-term corporate or macro factors.”
Legendary billionaire activist Carl Icahn is another investor who likes to add to his positions after a correction or dip. He has added to his positions in both Nuance Communications and Navistar International over the past year.
Some investors take macro and news-driven dips as an opportunity to take companies private.
Jeff Smith’s $2.5 billion Starboard Value fund owns RealD (RLD) at an average cost of around $10.50. After this week’s broad market decline, he offered to take the company private at $12, a 28% premium for shareholders from yesterday’s share price.
Given the recent slide in broader stocks, I think we’ll find that the world’s best billionaire investors and hedge funds are using this opportunity to add to their losers. Here are four stocks that would fit the bill:
Hertz (HTZ) – Carl Icahn owns almost 9% of Hertz at an average cost of $28.50. The stock is selling at $24.00 today. That’s a 17% discount to what Icahn paid for his shares.
MeadWestvaco (MWV) – Starboard Value’s average cost in Mead is $43.50 a share. The stock is currently selling for around $40. According to their 13D filing, Starboard believes the stock could be worth $69 a share if MeadWestvaco management follows through with their restructuring plan. That would be a 72% return from Mead’s share price today.
Armstrong World Industries, Inc. (AWI): ValueAct Capital owns nearly 17% of this stock, though it’s down 10% in the past month. According to Barron’s, ValueAct has averaged a 59% return on stocks when they own a controlling stake. That compares to 9% for the S&P 500 over the same time period.
Apache Corp (APA) – Billionaire Barry Rosenstein of the activist hedge fund Jana Partners reported a $1 billion stake in Apache in July. The stock has dropped from $104 to under $90.
To learn more about the stocks owned by the world’s best billionaire investors, follow me at BillionairesPortfolio.com.
When the news broke on Friday that activist hedge fund Starboard Value had taken a position in Yahoo (YHOO) and was pushing for a Yahoo-AOL merger, many people were probably asking, “Who is Starboard Value?”
As I told Bloomberg on Friday, Starboard Value has one of the best track records of any hedge fund out there; they have been profitable on 85% of their activist campaigns since 2002.
Starboard also has produced some of the best risk-adjusted returns of any hedge fund in the industry, and they do the most exhaustive and comprehensive research of any activist investor I have ever followed.
Here is the entire Bloomberg article on Starboard Value, including my quotes about Starboard to Bloomberg’s top activist-investing reporter, Beth Jinks.
Will Meade
President of The Billionaires Portfolio
[Our post on Bill Ackman, below, was one of our most widely read stories on Forbes and Yahoo Finance.]
Billionaire investor Bill Ackman has one of the best investing track records in the world. When you add back fees, Ackman has returned 1,199% since starting his fund in 2004. That compares to 119% in the S&P 500 for the same period.
Of course, if you invested in his fund back in 2004, you had to pony up a huge initial amount, likely $5 million or more. You had to agree to remain invested in the fund for a specific period of time, likely three years at minimum. And you had to pay Mr. Ackman a big cut of that handsome cumulative return. With that, after Ackman has taken his cut throughout the past decade, investors who have been in his fund since day one sit with a cumulative return of 627%. They put all the money up, but they share in just a little more than half of the total profits generated on their cash during the past 10 years. Still, no one would argue with a seven-fold return over a decade. It’s outstanding.
In his recent letter to investors, Ackman explained that there is no need to pay him fees. He admits that following his portfolio is easy. He says “free riders” can follow him “with none of the costs or the illiquidity, and with all of the upside.” In plain English, this means you can piggyback his investments without paying him fees, without putting up a multi-million dollar minimum investment in his fund and without having your money locked up for three years.
How is this possible, you might ask? When Ackman’s fund, Pershing Square Capital Management, takes a stake of 5% or more in a company, he is required to notify the SEC within 10 days, through a public disclosure filing called a Schedule 13D. And then, on a quarterly basis, Ackman is required to file form 13F with the SEC. This filing discloses all his fund’s positions. Ackman says, looking back, in 87% of the activist campaigns they’ve launched, the public could have bought the stocks at a “bargain price” even the day after he made his public filing.
While Ackman is one of the best-performing investors on the planet, his portfolio might be one of the easiest to replicate. His fund holds just six positions.
Here’s a look at the holdings of Ackman’s $12 billion Pershing Square fund as of its last filing:
Allergan AGN +0.33% (AGN) – AGN represents 39% of his portfolio. He has a nearly $5 billion stake in the company.
Air Products & Chemicals APD +0.89% (APD) – APD represents 21% of his portfolio. He has a $2.6 billion stake.
Canadian Pacific Rail (CP) – CP represents 20% of his portfolio. He has a $2.5 billion stake.
Burger King Worldwide (BKW) – BKW represents 8% of his portfolio. He has a stake worth $1 billion.
Platform Specialty Products Corp (PAH) – PAH represents 7% of his portfolio. He has a stake worth nearly $1 billion.
The Howard Hughes Corporation (HHC) – HHC represents 4% of his portfolio. He has a stake of $563 million.
Ackman has 80% of his fund’s money in just three stocks. That shows extraordinary conviction, and it also means he can’t afford to lose. That conviction and confidence is present only because he has the ability to gain control of, and influence on, the companies he invests in.
Buffett’s Berkshire Hathaway (BRK-A, BRK-B) is back on top again; it has has returned 18.2% year to date in 2014, double the return of the S&P 500, and better than 99% of all domestic equity mutual funds on the planet.
What’s even more amazing is that, between 1980 and 2003, Buffett returned an incredible 40% a year.
That turns $10,000 into an incredible $32.1 million, and $100,000 into $320 million.
Buffett achieved this using a technique recently divulged in two academic papers. One came out of a major Ivy League university. Another was authored by two professors from a top public business school. In both papers, the researchers analyzed all of Warren Buffett’s holdings over the past 35 years.
These academic papers are very long, 50 pages each. But I have summarized the key points from each in simple enough terms that anyone, even a novice, could understand it.
Buffett, due to his incredible size now, will never be able to put up 40% years again. But an individual investor can, and should. Warren Buffett has said it himself. In an interview with BusinessWeek he said: “If I was running $1 million today, or $10 million for that matter….. I could make you 50% a year… No, I know I could. I guarantee that.”
The secret of the hedge fund industry is that the best-performing funds are nearly always the newest — and usually the smallest. These are great funds to piggyback, as they are structured to perform in any market condition, and they tend to put up big numbers.
Sure, everyone these days has heard of Carl Icahn, George Soros, even folks such as David Einhorn. But how many people have heard of Joseph Edelman? You may be surprised to hear he runs the best-performing hedge fund in the world today: Perceptive Advisors.
Perceptive has returned an incredible 42% annualized since 1999. That means $10,000 invested in this hedge fund at its inception would be worth an incredible $1.3 million dollars today.
You’re probably saying, “Sign me up!” Well, unfortunately, the SEC has made hedge funds such as this available only to the super rich. To invest in a fund such as Perceptive Advisors, you have to meet accredited investor criteria, which means you must have at least $1 million in investable assets or an earned income of more than $200,000 ($300,000 with a spouse) over the past two years. Even if you fit the profile of an accredited investor, funds like Perceptive tend to have very high minimums ($5 million or more). Furthermore, Perceptive charges a hefty 2% management fee and 25% performance fee to investors.
So what do you do?
This has been an issue facing the broad investing public for a long time. The deck is stacked squarely against the average investor. Rich investors have access to good strategies; average investors get stuck with dog-meat mutual funds and stock-tip hype perpetuated through the media.
But don’t worry: If you’re reading this note, you have an alternative. We are filling this void. We are pioneering a change to the one-sided model that has driven Wall Street forever. They’ve given you big losses in bad years, and only a fraction of the returns in good years. In short, the Wall Street model is set up to give you all the risk, and they get the lion’s share of the return.
Wealthy, sophisticated investors don’t accept that treatment. Nor should you.
That’s why my partner and I have used the power of the Internet to design a new model; we give average investors across the world access to sophisticated hedge fund strategies and analysis. Our Billionaire’s Portfolio is the only service in the world that gives the average person an opportunity to co-invest with the world’s greatest billionaire investors and hedge funds including Perceptive Advisors. It’s a concept we call piggyback investing. This has proven so groundbreaking that Barron’s recently ran a feature piece about us in their Electronic Investor Column.
Furthermore, we know this system works; in 2013 we piggybacked three different top-performing hedge funds to gains of 260%, 220% and 110%. Already this year we have piggybacked one of the best-performing hedge funds to a 72% gain, 10 times more than what the S&P has returned this year. Furthermore, this stock was the top-performing stock in all of the S&P 500 this year.
Perceptive Advisors is the perfect hedge fund to use our groundbreaking piggybacking concept on. Perceptive specializes in taking big positions in small-cap biotech stocks, which can double, triple or even go up 1,000% in a year. Joseph Edelman is one of the most seasoned biotech investors on the planet. He employs numerous analysts, all with life-science backgrounds and many with PhDs, from the world’s top schools, including Princeton and Harvard.
Perceptive is essentially a biotech “think tank,” and they spend millions of dollars on research before they make an investment in a stock. That is why they are so good, and why so many of the stocks they have owned in the history of their fund have returned 200%, 300%, even 1000% in less than a year.
Last year Perceptive returned 65%, doubling the S&P 500’s return; they owned four stocks in their portfolio that went up more than 500%.
Biotech stocks are event driven, meaning they move up or down on news, such as clinical trial data and FDA approvals. They have little correlation to the overall stock market or the economy, and that is why funds such as Perceptive made money in 2002 and 2011, when the stock market was down double digits.
After the recent biotech selloff, there may be no better time to piggyback one of Perceptive’s small-cap biotech stocks.
