Here is one we can work for a long time, I think.

TBT, which is a blend of Treasuries that produce a 20 year maturity, moves higher with interest rates. It is the “ultra short” version of the bond price, but seems to be a good proxy for 10 times the interest rate. Today it is at 48.50, which is almost exactly 10 times the 4.8% interest rate of a 20 year bond. It was 70 in early 2008 (when it was created) which was similar to 10x the interest rate for a 20 year note at that time. It is not really pegged to that rate, but should move proportionately.

I think we can all agree that interest rates move higher from here. So, I suggest buying the 38 June call and selling the 58 June call. This gives a 20% upside between now and June on a $9.70 investment, which means a better than 100% return if interest rates move over 5% by that time. I just got done discussing using a put to protect the downside, creating a collar, but there is no point in this case. The price never got below 38 in the crisis and it is hard to see lower interest rates than what we just had….forever.

I like using options for any of the “Ultra” or amplified short ETFs because they all use Swaps and the futures market to build their positions. Trading costs and other futures market ineffiiciencies cause the price of such ETFs to deteriorate over time. Using options forces a repricing of the underlying as the traded options expire. This manages (does not eliminate) the problem with short ETFs.

Here are the tickers:

Buy June 38 TBTFL Call for 11.00
Sell June 58 TVTFF Call for 1.30

Net Cost = $9.70 / contract

I think we will be able to keep this trade on, rolling forward and upward, for the next 2-3 years as interest rates climb back into “normal” territory with the 20 year maturity average getting back to 7%. If inflation explodes because the Fed screws up, this is an even better trade and those levels, and beyond, come much faster.

Great Earnings this morning (Tuesday, October 20) from CAT, UTX, PFE and KO. CAT guidance was the economy is improving much faster than expected and the risk of a double dip recession is now ”very low” in 2010. CAT (a proxy for the export driven, industrial equipment market) beat earnings estimates by 85% and had higher revenues than forecast (which is supposedly what the market is begging for). So, what happened to its stock price? Sold off.

This earnings season has become the typical denial event by the Bears. The hardcore bear traders try and sell down every rally and discount any good news as either lies or misinterpretation. They first criticize the weakness of economic growth and unemployment levels, and then turn around and criticize the Fed for using accomodative policy to ramp back up the economy.  (Earth to Bears: you can’t have it both ways, unless Armageddon is your objective, in which case, tight policy will deliver the economic disaster you are awaiting)

This market is still climbing a huge “wall of worry” and so it will continue climbing higher (until all the Bears throw in the towel). When I stop seeing Michael Pento, David Rosenberg , Peter Schiff, Joe Battapaglia, etc on CNBC blasting the Fed and the market, that is when I will Sell.  There is no Euphoria.  There are no “rose-colored glasses.  There are only Bears (likely still short since SP500 of 666) begging for their wishes to be fulfilled.  Please keep ripping the market and economy.  It is making me wealthy.

Today, I was able to roll my October FLRs that were exercised on Friday to November sold puts, and picked up another 0.50 per contract in the process. I also flipped my BHP for a 2.47 gain the past 12 days (closed my Nov 70 puts at 1.75 and opened same number of Nov 75 puts at 4.50 a few minutes later) during the morning sell off. I am now waiting to get back into EWZ as Brazil sold off big today (down to 70 from 76). I will wait for $67 to get back in with some DITM calls on Mar 2010.

I also doubled down on my GE Mar 2010 Calls ($10s) at $5.80. They had been almost $7 a few days ago. Now I have 10 contracts (1000 shares) plus another 500 shares of GE.

Fluor Engineering has many positive attributes.  FLR has a P/E of 12 and an almost guaranteed profit for the next 12 months due to the contractual backlog that is inherent to engineering construction companies.  Its Revenue / backlog is $23B while its Market Cap is only $8.6B for a very low P/S ratio of 0.37. This while the ROE is 26.71%.  Engineering construction is a high margin business. (all numbers as of October 2, 2009)

The long term outlook for engineering construction is very good globally with infrastructure and natural resource processing required in Emerging Markets and as a form of stimulus in developed markets. FLR was at 100 in June 2008 and tracks very close with energy and materials stocks as that is where FLR does most of its projects. Its five year low was 28.60 on Nov 20 during the panic. I can’t imagine prices getting back to that level again:

Take a look at this ITM call spread. Underlying: FLR at $47.60 (Friday close)

Buy APR ‘10 $40 CALL (FLRDH) for $10.50

Sell APR ‘10 $65 CALL (FLRDM) for $1.10

Net Cost = $9.40 per contract (100 shares

Upside is 166% Return in 6.5 months (note that the time premium degrades closer to expiration which causes return to decrease)

Downside is 40 – 1.10 = 38.90; return = zero;

Any close above $49.40 at April expiration will be profitable

A $9400 investment would buy 10 contracts and allow the possibility of a $15,600 return

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To provide a little better downside protection in return for giving up some upside, go deeper in the money to the $35 CALL:

Buy APR ‘10 $35 CALL (FEMDG) for $14.60

Sell APR ‘10 $60 CALL (FLRDL) for $1.90

Net Cost = $12.70 per contract (100 shares)

Upside is 97% Return in 6.5 months (note that the time premium degrades closer to expiration which causes return to decrease)

Downside is 35 – 1.90 = 33.10; return = zero;

Any close above $47.70 at April expiration will be profitable (basically, just above the current price)

A $13,970 investment would buy 10 contracts and allow the possibility of a $13,530 return

Another possibility is to just buy the shares outright and then sell a $60 April Call against them for $1.90. But that reduces the return and really doesn’t provide much benefit in reduced risk. Chances are the time premium on option 1 of $2 between now and April will be rewarded. It is not much to pay for the chance at a 100% return in 6 months

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I attribute recent price weakness (past two weeks) to profit taking.  The past nine months had seen an almost 100% price rally from the November low.  But fundamentally, FLR is very sound.  If you believe as I do, that global growth will continue, especially in the Emerging Markets, FLR is very well positioned regardless of problems in the American economy.