Sponsored By:

01/12/05
APPLE OF THE MARKETS' EYE?

January 12, 2005

The leading question this week, at least here on the trading floor, was what is Apple going to introduce at MacWorld in San Francisco?

The reason for the interest was that people like me talk incessantly about the fact that Mr. Steven Jobs, chairman of Apple, shrewdly uses this platform to introduce new products. As you may have seen me hypothesize on CNBC, I believed Mr. Jobs would announce a flash memory iPod, thus pushing his company to an expanded audience as this should help Apple break the $150 level for its digital music monster. That plays to their strategy of using the popularity of the iPod to bring PC users over to the Mac and other Apple offerings. Sure enough, Mr. Jobs did exactly what I predicted and introduced a new version of its popular iPod music player dubbed the "Shuffle," priced at just $99 or $149!

Now as much as I do love patting myself on the back when I'm right, I am willing to take the heat when it's deserved and the only thing falling faster than seats at the New York Stock Exchange was Advanced Micro Devices. Yesterday the shares cratered down to $15.43, a loss of almost $5 per share. AMD traded 70 million shares by noon after the chipmaker announced sales for the fourth quarter are now expected to only be up slightly from the $1.239 billion reported in the third quarter. I must apologize to each of you for that miscue.

Investors hit the exits fast and furious after this warning, but even though I picked AMD for our trade last week, I think it points out the reason for a ChangeWave Option Investor newsletter. That reason is to participate in the good side of stock market activity, without the risk associated with outright ownership of stock.

Think about it. Last week our subscribers could buy the AMD April 22.50 – 25 bull-call spread for 60 cents. On a 10-lot spread you invested $600, but that was all you could lose if AMD did indeed fall out of bed. Now if another stock investor bought 1,000 shares at $19.66, they experienced a loss of over $4,000, which again points to why our controlled risk option investing should yield superior results! Please understand that I'm not pleased about the timing or performance of my pick, but I am happy that we limited our exposure and thereby have cash to invest in other opportunities rather than waiting for AMD to claw its way back to $19.66!


WHAT THE OPTIONS MARKETS ARE TELLING ME

For those of you who traded, as I did, on the unusually high (200%) volatility in American Pharmaceutical Partners (APPX) last week, you were richly rewarded as the stock ran $23 in two sessions from Friday, Jan. 7 to Monday, Jan. 10. The catalyst was that FDA approval of their treatment for breast cancer, Abraxane.

This week I'm showing unusually high volatility in Hovnanian (HOV) and eBay (EBAY) options. eBay was trading down 2% Tuesday, while HOV -- which just last month reported that earnings rose 47% to $133.8 million -- was struggling to stay in positive territory. The California mudslides may be part of the reason Hovnanian is getting such a rapid appreciation of its volatility, but keep your eyes peeled for a pre-announcement, as this activity in the options is typical of same.




CATCHING THE CHANGEWAVE

With the so called "granddaddy" of biotechnology conferences (23rd annual J.P. Morgan Healthcare Conference) shining the spotlight on a host of biotech stocks, I thought we'd go after Biogen Idec (BIIB). They have enjoyed a great conference and have several exciting drugs out there helping people improve their health.

Biogen Idec isn't just an Avonex play on multiple sclerosis. They also have two cancer fighters in Rituxan and Zevalin, as well as their joint venture with Elan Pharmaceuticals (ELN) and their latest winner, Tysabri, another multiple sclerosis drug.






To invest in Biogen Idec with limited risk, I recommend buying the BIIB April 65-70 bull-call spread for a net debit of $2.45.

With BIIB trading for $66.65, that spread is worth $1.65, so we're paying just 80 cents of extrinsic premium. In addition to taking significantly less risk with this option spread, we're putting 1/20th of the money of owning BIIB on the table! Think about that. A 1,000-share position would set you back $66,650, but a 10-lot trade is yours for just $2,450! Heck, you could put the other $64,200 into a 2.35% account at ING.com and pay for half the option spread with the interest you'd earn!


TRADE DETAILS
All information is based on prices as of 11:45 a.m. Eastern on Wednesday, Jan. 12, 2005.

NOTE: This example follows the most current prices available to us at the time of publication. You can still enter the trade at up to $2.55 for the BIIB April 65-70 bull-call spread through Wednesday, Jan. 19, as long as BIIB shares trade for $66 or higher.

Here is the information you need to know to buy our Biogen Idec bull-call spread for profits:

Underlying Stock: Biogen Idec (BIIB)

Current Stock Price: $66.65

Trade Type: Bull-call spread

Options to Trade: The specific trades to make are in the table below...

Action	Quantity	Option	Strike Price	Ticker	Investment
Buy	1	BIIB April 65 Call	$65	IHDDM	-$5.40
Sell	1	BIIB April 70 Call	$70	IHDDN	+$2.95
		Net Cost			-$2.45

A minus sign (-) indicates an amount you pay; a plus sign (+) indicates an amount you receive.

Making The Trade:

If you give this trade to your broker at a net debit of $2.45, then it doesn't matter which prices your broker pays for the individual parts of the bull-call spread. Thus, our net debit would be $2.45, or $245 for each spread. (For those of you who are do-it-yourselfers and making the trade online, an order to buy the BIIB April 65 Calls (IHDDM) for $5.40 while simultaneously selling the BIIB April 70 Calls (IHDDN) for $2.95 puts you in the trade with a net debit of $2.45 to you.)

SUMMARY

With Biogen Idec trading for $66.65, a 1,000-share position would tie up $66,650. However, with our trade you'll be able to put just $2,450 at risk and have a potential gain of $2,550 if BIIB rises to $70 or higher.

Here's why:

Our net investment on that bull-call spread is the difference between what we paid for the BIIB April 65 Calls ($5.40) and our credit on the BIIB April 70 Calls ($2.95), or a net debit of $245 per contract.

With BIIB trading at $66.65, a 1,000-share position would cost us $66,650.

Instead, if we buy 10 of the in-the-money BIIB April 65 Calls (IHDDM) for $5.40 per contract ($5.40 each times 100 shares = $540 per contract), or $5,400 and ...

Against that purchase, we sell 10 of the out-the-money BIIB April 70 Calls (IHDDN) for $2.95 per contract ($2.95 each times 100 shares = $295 per contract), or $2,950.

Thus, on a 10-contract spread we have only $2,450 invested, so that's all we can lose!

If you follow these guidelines, this means your broker can pay no more than $2.45 and you avoid the risk of “legging the spread” -- that is buying one side and waiting to sell the other.

NOTE: Keep in mind that nobody knows your risk tolerance or financial situation better than you. A single bull-call spread in this example will cost you $245 plus commissions. As long as you maintain the ratio of one contract purchased against one contract sold, you can ramp up this strategy as big, or as small, as you'd like.

Remember, you can pay up to $2.55 for this spread trade through Wednesday, Jan. 19, as long as BIIB shares trade for $66 or higher.


TRADE PROFITABILITY ANALYSIS

Here's how we figure out how much money we can make on this trade:

To illustrate how and where you will make money on this trade, I have included a payoff diagram at the start of this section. You can use this to follow along with my explanation below:


If you look at the shaded areas as they compare to the horizontal axis that tracks the price of Biogen Idec shares, you can see that the trade becomes profitable (green area) when the underlying stock crosses the $67.40 level. Likewise, while the stock is under $67.40, we are below the section (red area) where the bull-call spread registers a profit.

As with any 1-to-1 bull-call spread, our risk is limited to what we pay for the spread -- in this case $2.45.

Breakeven: $67.45

The breakeven is $67.45 because, as in any bull-call spread, the breakeven is determined by adding the net cost of the spread ($2.45 in this case) to the strike price of the call you are buying. Again, since we paid $5.40 for the BIIB April 65 Calls and took in $2.95 for the sale of the BIIB April 70 Calls, our net out-of-pocket is $2.45. You add that net to the strike price we've purchased ($65) and you get your breakeven of $67.45.

Max Profit: $255 per spread ($2.55 x 100 shares)

The max profit is determined by taking the difference between the two strikes of the bull-call spread, which in this case is $5 ($70 – $65 = $5) and subtracting the amount we paid for the spread ($2.45) and is therefore, $2.55. Thus, if Biogen Idec is $70 or higher on expiration, the spread will achieve that $5 max, and, since we paid $2.45 for the spread, that would leave us with a $2.55 profit, or 104%. On a 10-contract spread, that would translate to a profit of $2,550!

This analysis does NOT include the cost of commissions while executing your trades. Please see the note below about commissions.

OPTION COMMISSIONS

If you use a full-service broker, you may pay as much as $8 per contract with a 10-contract minimum. The broker uses a minimum to cover their cost of mailing the statement out to you. If you've agreed to electronic notification via e-mail, then you may negotiate both lower commissions and elimination of that minimum.

If you wanted to simulate a 1,000-share position in Biogen Idec, you'd buy 10 of the BIIB April 65 Calls and sell 10 of the BIIB April 70 Calls. This 10 x 10 bull-call spread could run you as much as $160 ($8 x 20 contracts). On the other hand if you trade online through a discount broker, you could pay less than $50.

Good luck trading and remember -- pigs get fat, but hogs get slaughtered, so don't be a hog!

BE MY GUEST AT THE NEW YORK TRADERS EXPO FEB. 12-15

The entire ChangeWave team including Tobin Smith and Bryan Perry will be in New York next month for the Traders Expo, and we'd like you to be our guest. You can sign up now for free using the link below and meet each of us at the beautiful Marriott Marquis Hotel in New York City, Feb. 12-15.

I will be speaking at several workshops during the show and giving presentations at the ChangeWave booth (5804-5806) with Toby and Bryan. Here's one of the hot topics I know a lot of you are interested in that I'll cover at my session:

How to Trade the New Gold and Oil Options: We all know gold and oil are the two busiest markets in the world, but until recently, the only way to trade them was through a futures account. Now the securitized contracts similar to the QQQ and SPY are out on both gold and oil, you can trade these through your securities account! I'll detail the strategies for trading these volatile contracts! Bullish, bearish, you name it -- I will outline prudent strategies to profit with limited risk. Don't miss it! We'll look at some the key indicators for a good “short” trade as well as the stocks I think are due for a fall.

In addition to meeting and discussing trading strategies with me, the Traders Expo offers free classes in both the exhibit hall and in various meeting rooms that are just a few steps away from the action.

More than 30,000 traders and investors have attended the Traders Expo over the past two years, many of whom never miss a show! Come join the ChangeWave gang -- Toby, Bryan and myself -- and discover why the New York Traders Expo is one of the top traders events of the year.

For complete details on how you and a companion can gain FREE admission to the New York Traders Expo, call 800-970-4355 and mention priority code 003929 or click on the link below:

changewave.com/rdr

Don't forget to mention ChangeWave when you sign up. See you at the Expo!