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10/19/05
STATISTICS, LIES AND INFLATION

October 19, 2005

First, let me thank all our friends in San Francisco who packed both talks I gave this past Saturday at the Money Show!

It was a great crowd with great questions -- plus, it was wonderful to get together with Phillips and ChangeWave analysts Louis Navellier, Bryan Perry, Michael Shulman and, of course, Toby Smith! If you missed us at that show, make sure to come on out to Las Vegas Dec. 13-16 for the Traders Expo.

I came home energized by the enthusiasm from the trading and investing community. Unfortunately, that spirit was tested when, on Tuesday morning, the headline on nearly every financial site read, "Inflation highest in 15 years."

As Benjamin Disraeli, a former British prime minister, once said, "There are lies, damn lies and statistics." Nothing says that better than this abuse of the recent Labor Department report. Yes, wholesale prices jumped 1.9% in September because of the increases in gasoline, natural gas and home heating oil prices.

Sure enough, that is noteworthy. However, the core rate of inflation at the consumer level was well-behaved, rising by a tiny 0.1%. Energy prices rose 7.1% in the month, while food prices rose 1.4%, reversing a string of five straight months that food prices declined on the wholesale level.

Now, I know some will choose to look at the glass as half-full, and some will see that same glass as half-empty. If you choose to go the Chicken Little route and scream that the sky is falling or that inflation is everywhere (a la the Dallas Fed's Richard Fisher), then I think you missed the point of Delphi Corp. last week.

The thing is, businesses will take advantage of cheaper labor in places like Poland, China and Guatemala to address wage inflation. Consumers have demonstrated how quickly they will ditch Whirlpool and Maytag appliances for cheaper Korean manufacturers like LG.

In short, yes there is inflation, but the Fed can't address energy inflation by raising rates and, if they try, they risk tossing us into a recession.

CATCHING THE CHANGEWAVE -- NOWHERE TO GO BUT UP

Hurricanes Katrina and Rita both forced Apache Corp. (APA) to substantially cut back on its oil and natural gas production. Prior to that bad news, though, the company had reported six straight quarters of record earnings!

Apache shares traded around $78.15 less than a month ago, but they corrected all the way down to $60.50 this morning. Credit Suisse started the exploration and production industry at "Market Weight," estimating that the oil-heavy group is trading at a 12% net asset value discount.

Couple that upgrade with the sell-off (a 22% correction), and you see why Apache is in our crosshairs!






To invest in Apache, I recommend buying the APA April 65 Calls (APADM) and selling a like number of April 70 Calls (APADN) for a net debit of $1.70. Prices that work with shares trading $62.23 were paying $6.20 for the April 65 Calls and selling the April 70 Calls for $4.50.

To make a limited-risk investment in Apache, I recommend buying the APA April 65-70 bull-call spread for a net debit of $1.70.

TRADE DETAILS
All information is based on prices as of 3:15 p.m. Eastern on Wednesday, Oct. 19, 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 $1.70 for the APA April 65-70 bull-call spread through Wednesday, Oct. 26, as long as APA shares trade for $61.50 or higher.

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

Underlying Stock: Apache Corp. (APA)

Current Stock Price: $62.23

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	APA April 65 Call	$65	APADM	-$6.20
Sell	1	APA April 70 Call	$70	APADN	+$4.50
		Net Cost			-$1.70

*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 $1.70, 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 $1.70, or $170 for each spread.

For those of you who are do-it-yourselfers and are making the trade online, an order to buy the APA April 65 Calls (APADM) for $6.20 while simultaneously selling the APA April 70 Calls (APADN) for $4.50 puts you in the trade with a net debit of $1.70.

Our loss is limited to the $1.70 that we are paying for the spread. If, on the other hand, Apache rises above $70 on or before April expiration, then we make $3.30 on our $1.70 investment!

SUMMARY

With Apache trading for $62.23, a 1,000-share position would tie up $62,230. However, with our trade you'll be able to put just $1,700 at risk and have a potential gain of $3,300 if APA 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 APA April 65 Calls ($6.20) and our credit on the APA April 70 Calls ($4.50), or a net debit of $170 per contract.

* With APA trading at $62.23, a 1,000-share position would cost us $62,230.

* Instead, if we buy 10 of the APA April 65 Calls (APADM) for $6.20 ($6.20 each times 100 shares = $620 per contract), or $6,200 and ...

* Against that purchase, we sell 10 of the APA April 70 Calls (APADN) for $4.50 ($4.50 each times 100 shares = $450 per contract), or $4,500.

* Thus, on a 10-contract spread we have only $1,700 invested, so that's all we can lose!

* If you follow these guidelines, this means your broker can pay no more than $1.70 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 $170 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 $1.70 for this spread trade through Wednesday, Oct. 26, as long as APA shares trade for $61.50 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 APA shares, you can see that the trade becomes profitable (green area) when the underlying stock crosses the $66.70 level. Likewise, while the stock is under $66.70, 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, $1.70.

Breakeven: $66.70

The breakeven is $66.70 because, as in any bull-call spread, the breakeven is determined by adding the net cost of the spread ($1.70 in this case) to the strike price of the call you are buying. Again, because we paid $6.20 for the APA April 65 Calls and took in $4.50 for the sale of the APA April 70 Calls, our net out-of-pocket is $1.70. You add that net to the strike price we've purchased ($65) and you get your breakeven of $66.70.

Max Profit: $330 per spread ($3.30 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 ($1.70) and is therefore $3.30. Thus, if Apache is $70 or higher on expiration, then the spread will achieve that $5 max and, because we paid $1.70 for the spread, that would leave us with a $3.30 profit, or 194.1%. On a 10-contract spread, that would translate to a profit of $3,300!

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

BUY LIST UPDATE

It's October expiration week, which means our October spreads are about to cash out on Friday after the close. That's both good and bad, as Starbucks and FedEx are winners, but FuelCell, Medicis and Lexmark are losers.

We've written off the latter three, but we're excited that Starbucks will cash out for its full $2.50 spread value.

As for FedEx, it's trading around $88, so our $2.50 spread is currently worth $3 and has the potential to expand all the way to its full potential value of $5 -- which would be a profit of $3.40.

In all likelihood, though, we will trade out prior to such a move -- in fact, we are going to keep an eye on the trades for a little while longer and will issue an alert with closing instructions before expiration.

The profits in these two winners just about equal the losses from the other three trades, and FedEx may just make this a winning expiration all around!