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1/26/05
TRUMPING THE MARKETS

January 26, 2005

I must confess that I was jealous of Tobin Smith being on the guest list for "The Donald's" big wedding in Palm Beach last weekend. That is, until I heard that he had to sit next to Don King, the fright-wigged boxing promoter, who summed up the nuptials by stating, "There was a spontaneous combustion of love when The Donald saw Melania!" Having had the good fortune to have seen the Slovenian model up-close, I must say that it's probably a very apt description of just what happened when Mr. Trump met Melania, and a pretty good depiction of what happened to the stock market last week. Spontaneous combustion indeed!

I'm sure most of you were wondering two things as you read this. One, how did I manage to weave Trump's wedding into this, and, two, what the heck does this have to do with the stock market?

Well, for starters, "The Donald's" ceremony at that little Episcopal church lasted about 30 minutes, which was almost exactly how long each attempted rally lasted last week! And secondly, I figured anything that took me away from describing the carnage on the trading floor would provide some welcome relief to those of us who share even the slightest bullish feelings. In fact, given the hit I took for carrying International Game Technology (IGT) into the final days of expiration, I daresay it'll be some time before I can look at a slot machine without gagging.

WHAT THE OPTIONS MARKETS ARE TELLING ME

After nearly putting in another 52-week low, the Chicago Board Option Exchange's Volatility Index (VIX) made a dramatic rebound from mid-week last week through Monday's trading session (Jan. 24). The mild panic that gripped traders carried the VIX from 12.25% up to 14.75%. That's just more than a 20% increase in three sessions, but as soon as the market stabilized around 10,400 in the Dow, the premium sellers went back to work as you can see from the far right-hand side of our graphic below, up to and through 51% on Friday.


Stocks that are on my watch list this week include Autodesk (ADSK), which has tumbled from $37 to $27 since the beginning of the year. Volatilities were up substantially in Autodesk options as were those for UNM Provident (UNM), which has an earnings call scheduled for Feb. 3. Cyberonics (CYBX) is still on my list, but I'm trying to be patient and wait another week before jumping into this one with both feet.


CATCHING THE CHANGEWAVE -- GETTING TO THE CORE OF APPLE

I have been in love with Apple since they introduced the iPod and have gratefully and enthusiastically ridden the wave along with a host of you. It's been a great ride, but there are two reasons I don't believe the ride is over.

First, the glowing reports of how the "iPodization" of America (and the world) is driving PC buyers to Apple. Second, our most recent ChangeWave Alliance survey found that Windows- and Linux-using professionals are hooked on the iPod and are planning to purchase Macs for their homes at a faster rate than they plan to buy PCs. (EDITOR’S NOTE: The survey indicated that 13% of consumers planning to buy a desktop computer in the next 90 days plan to buy a Mac, placing Apple in second place among all manufacturers.) In other words, as compelling a driver as the iPod is for the conversion of PC users, our Alliance members cited viruses and the ease of integrating media, not just iPods, as the main reasons they would consider the switch from PC to Mac.

Both cases are compelling and while I'm in the camp that says it's the iPod that's the primary driver, I think both will serve this stock well. As of today, Piper Jaffray analyst Gene Munster has a $100 target price for Apple, but Bear Stearns is right behind that with a $97 target. The rest of the field offering coverage of Apple has price targets in the $75-$85 range. Call me kooky, but as long as they continue to sell 1.25 million songs per day on their iTunes Web site, I'd say the demand for their products can only go one way: UP!

Here's how we use options to make a limited-risk investment in Apple: Let's buy the AAPL April 75 Calls (AAQDO) and sell a like number of AAPL April 80 Calls (AAQDP) for a net debit of $1.60. If you're a do-it-yourselfer, prices that work as we write this would be buying the AAPL April 75 Calls (AAQDO) for $5.00 and selling the AAPL April 80 Calls (AAQDP) for $3.40, again for a net debit of $1.60.






To make a limited-risk investment in Apple, I recommend buying the AAPL April 75-80 bull-call spread for a net debit of $1.60.

On a 10-contract trade representing 1,000 shares of Apple, we're paying just $1,600 versus the stock investor who has to invest $72,170. That means we're putting up less than 2.5% of the amount the stock investor has to invest from his or her account (or on margin), and that's the sum total of our commitment -- even if Apple turns south! Moving the odds in our favor is always my goal, and I believe this trade does just that.

TRADE DETAILS
All information is based on prices as of 12:05 p.m. Eastern on Wednesday, Jan. 26, 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 $1.60 for the AAPL April 75-80 bull-call spread through Wednesday, Feb. 2, as long as Apple shares trade for $71 or higher.

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

Underlying Stock: Apple (AAPL)

Current Stock Price: $72.17

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	AAPL April 75 Call	$75	AAQDO	-$5.00
Sell	1	AAPL April 80 Call	$80	AAQDP	+$3.40
		Net Cost			-$1.60

*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 $1.60, 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 $1.60, or $160 for each spread. (For those of you who are do-it-yourselfers and make the trade online, an order to buy the AAPL April 75 Calls (AAQDO) for $5.00 while simultaneously selling the AAPL April 80 Calls (AAQDP) for $3.40 puts you in the trade with a net debit of $1.60 to you.)

SUMMARY

With Apple trading for $72.17, a 1,000-share position would tie up $72,170. However, with our trade you'll be able to put just $1,600 at risk and have a potential gain of $3,400 if AAPL rises to $80 or higher.

Here's why:

* Our net investment on that bull-call spread is the difference between what we paid for the AAPL April 75 Calls ($5.00) and our credit on the AAPL April 80 Calls ($3.40), or a net debit of $160 per contract.

* With AAPL trading at $72.17, a 1,000-share position would cost us $72,170.

* Instead, if we buy 10 of the in-the-money AAPL April 75 Calls (AAQDO) for $5.00 per contract ($5.00 each times 100 shares = $500 per contract), or $5,000 and ...

* Against that purchase, we sell 10 of the out-the-money AAPL April 80 Calls (AAQDP) for $3.40 per contract ($3.40 each times 100 shares = $340 per contract), or $3,400.

* Thus, on a 10-contract spread we have only $1,600 invested, so that's all we can lose!

* If you follow these guidelines, this means your broker can pay no more than $1.60 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 $160 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 $160 for this spread trade through Wednesday, Feb. 2, as long as AAPL shares trade for $71 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 Apple shares, you can see that the trade becomes profitable (green area) when the underlying stock crosses the $76.60 level. Likewise, while the stock is under $76.60, 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 $1.60.

Breakeven: $76.60
The breakeven is $76.60 because, as in any bull-call spread, the breakeven is determined by adding the net cost of the spread ($1.60 in this case) to the strike price of the call you are buying. Again, because we paid $5.00 for the AAPL April 75 Calls and took in $3.40 for the sale of the AAPL April 80 Calls, our net out-of-pocket is $1.60. You add that net to the strike price we've purchased ($75) and you get your breakeven of $76.60.

Max Profit: $340 per spread ($3.40 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 ($80 – $75 = $5) and subtracting the amount we paid for the spread ($1.60) and is therefore $3.40. Thus, if Apple is $80 or higher on expiration, the spread will achieve that $5 max and, since we paid $1.60 for the spread, that would leave us with a $3.40 profit, or 212%. On a 10-contract spread, that would translate to a profit of $3,400!

*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 its 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 Apple, you'd buy 10 of the AAPL April 75 Calls and sell 10 of the AAPL April 80 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.

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 of 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!