Wednesday, March 18, 2009

Volume 3, Issue #20

For today's issue of TopStockAnalysts Digest guest contributor Karim Rahemtulla, investment director of The Smart Profits Report, will reveal how you can buy bank stocks with low risk and high return potential.  (Full Story Below)

Also in Today's Issue...

Recently, Global Finance published its list of the World's 50 Safest Banks - a list that the publication has run for 17 years.

In the past, investing in the banking sector was a no-brainer. Just buy a strong bank like JP Morgan (NYSE: JPM) or US Bancorp (NYSE: USB), sit back, and collect the healthy dividends they dished out.

Not any more. Few banks on the Top 50 list currently pay dividends worth noting. Worse still, most are actually cutting their dividends to pennies per year or eliminating them altogether.

And with the sector responsible for much of today's current crisis, the incentive to buy bank shares is gone, too.

So, why buy a bank stock?

Could "Zombie Banks" Actually Be Profitable?

Cast your eye across the banking sector carnage and the list of the dead is impressive: Washington Mutual, Wachovia and IndyMac are among the biggest.

The list of walking dead is equally remarkable: Citigroup (NYSE: C) and Bank of America (NYSE: BAC) - two banks that once graced the Top 50. Not any more.

The main reason to consider buying bank stocks is in anticipation of a significant turnaround.

Many banks will recover from current levels and having been oversold, will provide stupendous returns in the months ahead, as the bounces will be as sharp to the upside.

But there is risk.

Last month, for example, shares of Wells Fargo (NYSE: WFC) - one of the top banks on Global Finance's list crashed by more than 50%. The company then slashed its dividend by more than 80%. Not exactly a compelling reason to dip your toes into this sector, right?

Well, not so fast. Here's how you can play bank stocks with low risk and very high return potential...

The LEAPS Trifectaf: Time, Returns, Less Risk

One of the best ways to invest in a volatile sector like banking is by using a strategy that allows you to risk just 10% to 20% of the capital that you'd use to buy the shares.

That way, if the shares move lower, the amount of money you have at risk is less than you would have risked had you placed a 20% stop-loss. But if they move higher, you're looking at substantial returns. So what is this strategy and how does it work?

LEAP options.

The beauty of these options is that they expire in one to two years, thus allowing you to participate in the upside of a stock (or the downside if you're buying puts) without risking the capital you'd need if you bought the shares outright. It also works well for sectors that are struggling, as it gives you more time to be correct with your call as the stocks recover.

Let's take JP Morgan as an example...

How Buy JP Morgan For Five Times Less Risk

If you wanted to buy 1,000 shares of JPM today, with a target price of $40 in two years, it would set you back a hefty $18,000. The company has the earnings power to make $4 per share in 2010 if the economy normalizes and a ten times multiple is not out of the question.

But instead of spending $18,000 to make $22,000 - a heck of a return if you can make it - you could buy the JPM $30 LEAPS for $3.50 per contract (expensive because of the volatility). So it would cost about $3,500 to control 1,000 shares.

If JPM hits $40, you stand to make about $6,500 for each $3,500 you invested. Sure, $6,500 isn't as much as $22,000, but it's still a heck of a return. And throughout the process, you gain one crucial peace of mind benefit: A lot less risk.

To have $18,000 at risk through simply buying the shares is five times more than the money at risk if you bought the LEAP options. And if you set a 20% stop-loss, you're committed to losing $3,600 on the JPM stock trade- more dollars than you'd risk by buying the LEAP option.

In the past, this trade would have made less sense because while in it, you'd also be receiving a couple of dollars per share each year in the form of dividends. But with no dividend to speak of any more, why put so much capital at risk?

If you'd like to find out more about LEAPS options, plus many more investing strategies and techniques - direct from the pros - feel free to take advantage of our free content at the Smart Profits Report. And if you'd like to get specific investment recommendations from our team of high-level experts, who'll show you how to accelerate your profits from today's hottest trends in a variety of low-risk ways, check out our premium content service here.


 

Karim Rahemtulla
Investment Director
The Smart Profits Report
 

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