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2/2/05
GOOD RIDDANCE!

February 02, 2005

I think the only ones who will miss January are the bears, as we close the books on a hideous start to the new year. My back-of-the-envelope calculations show that the Dow lost 2.7%, the Nasdaq nearly doubled that, shedding 5.2%, and the S&P 500 dropped 2.6%. That's pretty ugly, my friends, but I am happy to say that we do have one of the best performers of the year so far in our portfolio: Apple (AAPL) ! I show Apple up nearly 20% in January, and our spread has moved up right along with that, giving some hope in a terrible month!

Other than the bears, the guys and gals who had the best month were the investment bankers, as deals came together fast and furious during January with Procter & Gamble buying Gillette, SBC buying AT&T, and MetLife buying Travelers. When you figure that 7% of those hefty price tags went to the I-bankers, you'll discover that's a lot of scratch! Just the deals mentioned above totaled $83 billion, leaving nearly $6 billion to Goldman, UBS, Merrill and Morgan. Kinda makes the payrolls of both the New England Patriots and the Philadelphia Eagles pale by comparison, doesn't it?

While I hope we don't see a continuation of January's sell-offs, it does appear we will see more deals, with financial services giant American Express planning to spin off its financial advisory business to their shareholders to focus on its charge and credit card, payments processing and travel businesses. American Express officials indicated that they expect the spin-off to be completed in the third quarter.


WHAT THE OPTIONS MARKETS ARE TELLING ME

Chinese online media company SOHU.com (SOHU) will release its fourth-quarter and 2004 fiscal year results on Monday (Feb. 7). Investors are very uncertain about whether the news will be good or bad, and their uncertainty is causing SOHU's option-implied volatility to surge to 80%. As SOHU is near its 52-week low ($13.56), I'm thinking there's more upside than downside in this one. Right now the Feb. 15 calls are trading for $1.50 which, despite the volatility, seems quite cheap given the moves we've seen from eBay and Overstock.com recently. Also, W.R. Grace & Co.'s quarterly loss widened sharply as higher sales were offset by a big charge for asbestos liabilities and other claims under its Chapter 11 reorganization. That larger-than-expected loss pushed volatilities up to 64% as investors factor in that continuing asbestos liability.



CATCHING THE CHANGEWAVE -- GOING ONCE … GOING TWICE

During the past year I've made money on both the bullish and, more recently, the bearish side of eBay (EBAY).

Most recently, I had the 100-90 put spread on, and eBay rewarded me handsomely by slamming down from $100 to $81 in a single session (Jan. 20, 2005) after posting a Q4 profit that missed forecasts and guidance that was under Street estimates as well. While I think the news was indeed very bad for eBay, I don't think the future looks as dark as some of the analysts are predicting.

In fact, while some cite the fee increase as driving business away from eBay and to competitors like Overstock.com, I think the vast majority of sellers will stay put, not liking but still paying the $6 increase and, thus, increasing eBay 's profits dramatically. Why am I so confident that eBay will recover and the fees will ultimately be accepted? Because it takes two to tango -- a buyer and a seller.

Right now everyone's focused on the eBay stores (sellers), but it's the buyers who also make eBay run. As long as eBay brings them, the sellers will be there to offer product.

Here's how we play the rebound in eBay: Let's buy the EBAY July 85 Calls (XBAGQ) and sell a like number of EBAY July 95 Calls (XBAGS) for a net debit of $2.65. Do-it-yourselfers can leg into this one by paying $5.20 for the July 85 Calls and selling the July 95 Calls for $2.55.






To make a limited-risk investment in eBay, I recommend buying the EBAY July 85-95 bull-call spread for a net debit of $2.65.


TRADE DETAILS

All information is based on prices as of 12:10 p.m. Eastern on Wednesday, Feb. 2, 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 $2.85 for the EBAY July 85-95 bull-call spread through Wednesday, Feb. 9, as long as eBay shares trade for $77.50 or higher.

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

Underlying Stock: eBay (EBAY)

Current Stock Price: $78.19

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	EBAY July 85 Call	$85	XBAGQ	-$5.20
Sell	1	EBAY July 95 Call	$95	XBAGS	+$2.55
		Net Cost			-$2.65

*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 $2.65, 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 $2.65, or $265 for each spread. (For those of you who are do-it-yourselfers and make the trade online, an order to buy the EBAY July 85 Calls (XBAGQ) for $5.20 while simultaneously selling the EBAY July 95 Calls (XBAGS) for $2.55 puts you in the trade with a net debit of $2.65 to you.)

SUMMARY

With eBay trading for $78.19, a 1,000-share position would tie up $78,190. However, with our trade you'll be able to put just $2,650 at risk and have a potential gain of $7,350 if EBAY rises to $95 or higher.

Here's why:

* Our net investment on that bull-call spread is the difference between what we paid for the EBAY July 85 Calls ($5.20) and our credit on the EBAY July 95 Calls ($2.55), or a net debit of $265 per contract.

* With EBAY trading at $78.19, a 1,000-share position would cost us $78,190.

* Instead, if we buy 10 of the in-the-money EBAY July 85 Calls (XBAGQ) for $5.20 per contract ($5.20 each times 100 shares = $520 per contract), or $5,200 and ...

* Against that purchase, we sell 10 of the out-the-money EBAY July 95 Calls (XBAGS) for $2.55 per contract ($2.55 each times 100 shares = $255 per contract), or $2,550.

* Thus, on a 10-contract spread we have only $2,650 invested, so that's all we can lose!

* If you follow these guidelines, this means your broker can pay no more than $2.65 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 $265 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 $2.85 for this spread trade through Wednesday, Feb. 9, as long as EBAY shares trade for $77.50 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 eBay shares, you can see that the trade becomes profitable (green area) when the underlying stock crosses the $87.65 level. Likewise, while the stock is under $87.65, 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 $2.65.

Breakeven: $87.65

The breakeven is $87.65 because, as in any bull-call spread, the breakeven is determined by adding the net cost of the spread ($2.65 in this case) to the strike price of the call you are buying. Again, because we paid $5.20 for the EBAY July 85 Calls and took in $2.55 for the sale of the EBAY July 95 Calls, our net out-of-pocket is $2.65. You add that net to the strike price we've purchased ($85) and you get your breakeven of $87.65.

Max Profit: $735 per spread ($7.35 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 $10 ($95 – $85 = $10) and subtracting the amount we paid for the spread ($2.65) and is therefore $7.35. Thus, if eBay is $95 or higher on expiration, the spread will achieve that $10 max and, since we paid $2.65 for the spread, that would leave us with a $7.35 profit, or 277%. On a 10-contract spread, that would translate to a profit of $7,350!

*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 eBay, you'd buy 10 of the EBAY July 85 Calls and sell 10 of the EBAY July 95 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.