Market Report for Friday, July 20, 2007

By Adam Lass and Bryan Bottarelli

Market Report: "Don't hate the playa, hate the game"

Yes, I know: there is nothing sadder than a middle-aged man trying to adopt “hip” lingo. But it happens to be appropriate, at least just this once. So let me see if I can find an “old fogey” way to tell this tale.

Once upon a time, back in the dark old days before the Sarbanes Oxley Act made companies fill out an awful lot of paperwork, a bunch of Western energy companies went stark-raving mad. Got involved in all sorts of weird trades. Lied a lot about their assets and debts. Tried to bankrupt the very large state to their left.

You’ve probably heard of one of them. Little outfit out of Houston called Enron? In the end, vengeance was called down upon them, and what assets it had that were real were scattered on the far winds. Oh except for that huge mansion Ken Lay owned, you know, the one with its own zip code? Because he died before they could convict him, his wife got to keep the joint.

Anyone who was reading more than just the headlines knows that Enron was not alone in its slightly dotty bookkeeping habits. Rightly or wrongly, aspersions were cast upon fellow oil-patch “playas” like Dynegy (DYN:NYSE) and El Paso (EP:NYSE). Those who survived the ensuing prosecutorial pogroms promised to keep their noses very, very clean moving forward, and have mostly done so.

With that pledge in mind, I recently held my nose and allowed El Paso into the WOW portfolio. And so it was that I found myself reading in absolute cringing trepidation the headline off Wednesday’s AP feed that EP has received a “Wells” notice from the Feds warning that its reserve claims were being investigated.

A quick glance at the ticker, and sure as heck, share price was dropping faster than a rapper with half a bottle of Dom -- and three .45 slugs in him. That’s the bad news.

The good news is in the details. It appears that this notice is a leftover from the bad ole days of 2003 when EP was in “da game” as it were and perhaps overstating its reserves a bit. The folks at EP are cooperating fully, shipping forklift loads of paper to the bureaucrats in D.C., and I’m pretty sure that no one is talking arrest warrants or the like here.

And EP’s share price? By Thursday, it was back up to a fresh 52-week high today, and pushing WOW readers’ calls back to their max gain of 127.59%.

Today’s earnings announcements are becoming more and more perplexing to trade. Take Google (GOOG:NASDAQ) for example. The company reported a 28% gain in earnings for the June quarter -- and witnessed a revenue jump of 57% from the same period last year. But these results disappointed Wall Street and the stock is down over $30.

Now let’s look at SanDisk (SNDK:NASDAQ). The company reported that Q2 profit fell 70% from last year, as deteriorating flash memory prices ate away at profits. But since the company “sounded bullish” about prices and demand looking ahead, the stock rose 4% in early trading.

So what you have is a company like GOOG exceeding last quarter’s numbers (but falling short of expectations) -- which leads to GOOG shares getting pummeled.

At the same time, you also have a company like SNDK falling well short of last quarter’s numbers (but exceeding expectations) -- which leads to SNDK shares rocking.

Confused yet?

It just goes to show you, there is no logical way to play earnings -- and this is a clear illustration of why I like to play stocks leading up to their earnings release.

After all, the one thing that was consistent with GOOG and SNDK in the weeks leading up to their earnings dates was that each stock was moving higher in anticipation of the numbers. So in my view, the best tactic is to play these moves via options leading up to the announcements -- and then take profits a day or two prior to the actual announcement. That way, you mitigate the directional risk and walk away safe with a nice profit in hand.

This is what Adam and I recommended doing in our WOW service on our Cisco (CSCO: NASDAQ) call play a few weeks back. CSCO was moving higher leading up to its earnings release, and the call options we were holding were showing a strong gain. So we said (in not so uncertain terms) to take the profits to reduce the risk of holding CSCO into its earnings announcement. And this proved to be strong advice -- as anyone who heeded our guidance sold their CSCO calls for the best prices of the week.

Until further notice, this should be the trading tactic you implement in any of your positions leading into earnings day.