Implementing Fundamental Analysis Strategies

Discussion in 'Options' started by rrisch, Jun 29, 2003.

  1. rrisch


    One way to try to use fundamental analysis in stock buying to built up a portfolio of long positions in undervalued stocks and short positions in overvalued stocks. It is very hard to get this to work because, even though reversion to the mean eventually happens, it is very hard to predict when. You probably will be stopped out of your positions before they become profitable.

    Thus it seems that a way to possibly implement such a strategy successfully, one might buy longer term (4 month to leaps) calls for the undervalued and longer term puts for the overvalued. I have no idea on the best way to pick strikes if you have such a goal.

    Is there any analysis of such a portfolio approach available? TIA.
  2. 4 month should be a MINIMUM. Reversion to the mean might take years if ever.

  3. ktm


    I am one of the few here who uses serious fundamentals as part of the process.

    First I'd like to say I don't really use stops. If an undervalued stock declines and I have properly assessed the business, the value should be that much better and warrant adding to the position. The same applies for shorts.

    Having said that, I prefer buying/shorting the underlying and writing short maturity options (2 months or less generally) around the position to lower the basis and increase the return.

    This shoud be an even better strategy with the further deployment of $1 strikes.
  4. Banjo


    How do you determine over/under valued?
  5. rrisch


    I've used various criteria. One that seems to work better than others is: P/E < Earnings Growth Rate = Undervalued. P/E >>> Earning Growth Rate = Overvalued. I've tried both using trailing and forward looking numbers and am not sure which is better.

    Now back to my original question. I am getting the impression that the strategy that I outlined is an unknown. At least I can't find any reference to it anywhere. Certainly though, there are people who trade leaps.
  6. ktm


    For undervalued equities, I use several Discounted Cash Flow models, historical PEs vs. current using conservative figures and assuming misses of numbers by 15 - 20%. The biggest measure is Free Cash Flow. There is a huge laundry list after this, from options outstanding and being issued to insiders, product placement among competitors, niche sustainability, prospects for continued expansion.

    On the overvalued side, I look for high burn rates with low/no prospects for Free Cash Flow, sloppy accounting and pretty much the exact opposite of everything else above.