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10/12/05
A TIME TO PROFIT?

October 12, 2005

I love Wall Street adages, even those that have little evidence that they truly work. One such chestnut actually made me a bit of cash last week, and that's "sell Rosh Hashanah and buy Yom Kippur."

Given the 300-plus points that the Dow fell, I'd like to say thanks to the trading gods, although I suspect they had little to do with my good fortune!

In all seriousness, though, this adage is iffy at best -- as a quick look at the past 30 years of trading around Rosh Hashanah showed no better than a 50/50 breakdown of sell-offs then rallies, versus rallies then sell-offs.

In other words, the fact that Jewish investors and traders were doing a 25-hour fast meant almost nothing to the overall performance of the stock market, regardless of which index we looked at.

CATCHING THE CHANGEWAVE -- THERAPY FOR THE PORTFOLIO

Genentech is the granddaddy of biotech companies and the stock has been on a monster run. That's why it's NOT our trade of the week -- it's simply too close to a fully valued level.

However, the company's clinical success gives us an indication of valuation for its peers, if indeed they could get it together. One candidate that fits that bill is Biogen Idec (BIIB), which engages in the development, manufacture and commercialization of novel therapies worldwide.

Genentech commands a $90 billion market cap and has an EPS of 95 cents. Biogen, on the other hand, has fallen from $70 in February to just $3 above its 52-week low of $33.18, which it hit back in June.

As Biogen's shares took that hit, its market cap was halved -- falling to just above $12 billion. And while its P/E comparison is favorable against its larger competitor (Biogen's P/E is 88, while Genentech's is 89), its earnings per share is half of Genentech's, coming in at 41 cents.

I'm sure you remember the catalyst for Biogen's disastrous fall in late February, but as a quick-and-ugly reminder, the company and its joint venture partner Elan Corp. had to pull their injectable drug (Tysabri) for the treatment of multiple sclerosis when it was linked to several cases of a fatal brain disorder.

Yes, that was very bad news, but after exhaustive examination of the potential problems, the drugmakers asked the U.S. Food and Drug Administration to review the new safety data on Tysabri within the next six months. And that, my friends, is the catalyst!






Here's how we should play BIIB:

Our bull-call spread strategy is perfect for such a volatile issue as Biogen and, thus, I recommend buying the BIIB Jan 35 Calls (IDKAG) and selling a like number of BIIB Jan 40 Calls (IDKAH) for a net debit of $2.15. Prices that work are paying $3.50 for the Jan 35 Calls and selling the Jan 40 Calls for $1.35.

To make a limited-risk investment in Biogen, I recommend buying the BIIB Jan 35-40 bull-call spread for a net debit of $2.15.

TRADE DETAILS
All information is based on prices as of 4 p.m. Eastern on Wednesday, Oct. 12, 2005.

* NOTE: This example follows the most current prices available to us at the time of publication. You can still enter the trade for up to $2.15 for the BIIB Jan 35-40 bull-call spread through Wednesday, Oct. 19, as long as BIIB shares trade for $35.25 or higher.

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

Underlying Stock: Biogen Idec (BIIB)

Current Stock Price: $35.94

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 Jan 35 Call	$35	IDKAG	-$3.50
Sell	1	BIIB Jan 40 Call	$40	IDKAH	+$1.35
		Net Cost			-$2.15

*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 $2.15, 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 $2.15, or $215 for each spread.

For those of you who are do-it-yourselfers and are making the trade online, an order to buy the BIIB Jan 35 Calls (IDKAG) for $3.50 while simultaneously selling the BIIB Jan 40 Calls (IDKAH) for $1.35 puts you in the trade with a net debit of $2.15.

Our loss is limited to the $2.15 that we are paying for the spread. If, on the other hand, Biogen rises above $40 on or before January expiration, then we make $2.85 on our $2.15 investment!

SUMMARY

With Biogen trading for $35.94, a 1,000-share position would tie up $35,940. However, with our trade you'll be able to put just $2,150 at risk and have a potential gain of $2,850 if BIIB rises to $40 or higher.

Here's why:

* Our net investment on that bull-call spread is the difference between what we paid for the BIIB Jan 35 Calls ($3.50) and our credit on the BIIB Jan 40 Calls ($1.35), or a net debit of $215 per contract.

* With BIIB trading at $35.94, a 1,000-share position would cost us $35,940.

* Instead, if we buy 10 of the BIIB Jan 35 Calls (IDKAG) for $3.50 ($3.50 each times 100 shares = $350 per contract), or $3,500 and ...

* Against that purchase, we sell 10 of the BIIB Jan 40 Calls (IDKAH) for $1.35 ($1.35 each times 100 shares = $135 per contract), or $1,350.

* Thus, on a 10-contract spread we have only $2,150 invested, so that's all we can lose!

* If you follow these guidelines, this means your broker can pay no more than $2.15 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 $215 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 make it as small, as you'd like.

* Remember, you can pay up to $2.15 for this spread trade through Wednesday, Oct. 19, as long as BIIB shares trade for $35.25 or higher.

TRADE PROFITABILITY ANALYSIS

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 chart 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 BIIB shares, you can see that the trade becomes profitable (green area) when the underlying stock crosses the $37.15 level. Likewise, while the stock is under $37.15, we are below the axis (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, $2.15.

Breakeven: $37.15

The breakeven is $37.15 because, as in any bull-call spread, the breakeven is determined by adding the net cost of the spread ($2.15 in this case) to the strike price of the call you are buying. Again, because we paid $3.50 for the BIIB Jan 35 Calls and took in $1.35 for the sale of the BIIB Jan 40 Calls, our net out-of-pocket is $2.15. You add that net to the strike price we've purchased ($35) and you get your breakeven of $37.15.

Max Profit: $285 per spread ($2.85 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 ($40 – $35 = $5) and subtracting the amount we paid for the spread ($2.15) and is therefore $2.85. Thus, if Biogen is $40 or higher on expiration, then the spread will achieve that $5 max and, because we paid $2.15 for the spread, that would leave us with a $2.85 profit, or 132.6%. On a 10-contract spread, that would translate to a profit of $2,850!

*This analysis does NOT include the cost of commissions while executing your trades.