The LEAPS Option Trader
105 W. Monument Street
Baltimore, MD 21201
Wednesday, February 1, 2006
#300
** The Tip of the Iceberg?
Google’s earnings yesterday were stellar. Earnings and revenues grew faster than any company in the same market capitalization space. Yet, the shares sold off. Two weeks ago, Intel reported great numbers, but future guidance dampened share price. Weeks before, Dell reported numbers – again, they disappointed. The list goes on: Yahoo, Sandisk, eBay – all of these companies reported great news, but when share prices are priced for perfection, bad things happen to good companies.
Now, there are a lot of positive reports as well – companies like AMD and Microsoft are doing well; Texas Instruments is doing well – but the tone of this earnings season is definitely negative. And, for many tech companies, this past quarter is usually the strongest quarter of the year.
Add to this a general market malaise after a strong run-up last year (which we took full advantage off last month by lightening up on several positions), higher rates, a potential for a housing-led consumer meltdown, the usual political issues, and earnings slowdowns, and you have the perfect mix for a potential hiccup in the market.
However, the thing about the market is that it is a market. And it is unpredictable. So, I would rather take a position that can make me money if it goes my way, and also limit my risk if it goes against me. You guessed it. We will be doing another spread trade – this time on the Nasdaq (Nasdaq: QQQQ) index.
Our bet is that this index will fall by 10% over some point in the coming year. It has fallen that much in a week before. We may exit the position at any time, but our intent is to hold ’til the end, if necessary. Right now, sentiment is changing. We have seen intense volatility return to market in the past few weeks. This bodes well for a strong move… in either direction. Right now, the trend is pointing down.
In a spread trade, in this case a bear spread, we are buying one put option and selling another put option against it – both are at different strikes. Our cost is the difference between what we paid for the first option and what we received for selling the second option. Our profit potential is the spread between the two prices. We closed out five profitable spreads in the past couple of months, ending several of them very early.
Here’s what you need to do (keep in mind, the price will be different when you see this, but with a spread that should not matter as both sides of the trade will change):
Buy the Nasdaq 100 Trust (Nasdaq: QQQQ) January 2007 $42 PUT LEAP (VCQ MP) currently trading for $2.45. And against this position, sell the January 2007 $38 PUT LEAP (VCQ ML) currently trading for $1.15. Your net debit (cost) on this trade is $1.30 (2.45 minus 1.15) with the potential to make $4 (42 minus 38) or more than a double in a year. And, your risk is $1.30 per contract. Use a net debit of $1.40 as the maximum you are willing to risk for this spread.
Regards,
Karim Rahemtulla
Current Portfolio:
Company / Symbol: American Airlines (NYSE: AMR)
Option / Symbol: Jan. 08 $17.50 put (WAR-MW)
Date Purchased: 1/10/05
Current Price: $4.30
Comment: Hold.
Company / Symbol: Target (NYSE: TGT)
Option / Symbol: Jan. 08 $50 put (WDH-MJ)
Date Purchased: 10/20/05
Current Price: $4.40
Comment: Hold.
Company / Symbol: Microsoft (Nasdaq: MSFT)
Option / Symbol: Jan. 08 $30 call (WMF-AF)
Date Purchased: 8/8/05
Current Price: $2.75
Comment: Hold.
Company / Symbol: Doral Financial (NYSE: DRL)
Option / Symbol: Jan. 07 $20 call (OVL-AD)
Date Purchased: 5/6/05
Current Price: $0.55
Comment: Hold.
Company / Symbol: S&P 500 MITT (AMEX: MCP)
Date Purchased: 7/18/03
Current Price: $11.42
Comment: Hold.
Bull & Bear Spreads
Company / Symbol: Nasdaq 100 Trust (Nasdaq: QQQQ)
Option / Symbol: Jan. 07 $42 put (VCQ MP)
Date Purchased: New
Current Price: $2.45
Comment: Buy
Company / Symbol: Nasdaq 100 Trust (Nasdaq: QQQQ)
Option / Symbol: Sell Jan. 07 $38 put (VCQ ML)
Date Purchased: New
Current Price: $1.15
Comment: Sell January 07 $38 put against January 07 $42 position.
Company / Symbol: Energy Select SPDR (AMEX: XLE)
Option / Symbol: Jan. 07 $39 put (ORJ-MM)
Date Purchased: 3/1/05
Current Price: $0.75
Comment: Hold.
Company / Symbol: Energy Select SPDR (AMEX: XLE)
Option / Symbol: Sell Jan. 07 $37 put (ORJ-MK)
Date Sold: 3/30/05
Current Price: $0.45
Comment: Hold. Sold put against Jan. 07 $39 position.
Bio:
Karim Rahemtulla is the former Investment Director of The Oxford Club. The editor of The Smart Options E-Report, The Income Trader – A Covered Call Strategy and The LEAPS Option Trader, Karim is also a regular contributor to The Oxford Club Communiqué. His highly successful trading systems use covered calls and LEAPS to boost returns on blue chip stocks, and during the bear markets of 2000 and 2001, his picks outperformed the major market averages. Educated in England, Canada and the U.S. and fluent in several languages, Karim travels the world to find the best investment opportunities for our members.
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