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3/2/05
IN LIKE LIONS ...

March 02, 2005

Conventional wisdom claims that if March comes in like a lion, then it goes out like a lamb. As we kicked off the first day of March, J.P. Morgan Chase upgraded the king of all tech stocks, Intel Corp., to overweight and, just for good measure, threw in positive comments on the entire chip sector. The world's largest chipmaker's shares gained more than 2% and traded up to a three-month high of $24.72. That, and a 50-cent dip in crude oil prices, helped March indeed come in like a lion. But, as most of you know, it’s not how you start but, rather, how you finish that counts, and that verdict will have to wait another 30 days!

Other than sky-high crude oil prices, the market has also been running against the wind in the form of two of the world's largest automakers, General Motors and Ford. Ford, the nation's second-biggest automaker, just announced that February sales of its domestic cars and trucks fell 3%, dragged down by the vehicles that provide Ford with its highest profits: pickups and large SUVs. That marked the ninth-straight monthly sales decline for Ford and came just one day after GM was downgraded by Bank of America. Now, I'm not saying we need to hold a bake sale for either company, but with both trading at or near multi-year lows, I think it will be tough for them to exert much more bearish influence than they already have.

WHY WE PREFER OPTIONS SPREAD TRADES

As bad as Monday's fiasco that hit both Biogen Idec (BIIB) and Elan Corp. (ELN) was for our bull-call spread, it is a great example of why our form of investing, through spread trading, is superior to stock investing.

In real terms, a stock investor in BIIB lost $31 a share Monday as Biogen tumbled from $67 to $36. A 1,000-share investor would have incurred a loss of $31,000. Our bull-call spread lost virtually all of its value -- certainly not a good thing, to flip the domestic diva Martha Stewart’s famous phrase – but our loss of $2.60 per spread (or $2,600 for a 10-lot investor) is a far cry from that loss suffered by the stock investor. I'm sick about the outcome, but I'll take our loss and keep the other $28,000 in my pocket any day.

CATCHING THE CHANGEWAVE -- GETTING ENERGY OUT OF ENERGY STOCKS

I searched through the energy patch and found Valero Energy (VLO), an independent refining and marketing company. They own and operate 15 refineries, having a combined throughput capacity of approximately 2.4 million barrels per day. Valero produces premium, environmentally clean products, such as reformulated gasoline, gasoline meeting the specifications of the California Air Resources Board (CARB), CARB diesel fuel and low-sulfur diesel fuel and oxygenates (liquid hydrocarbon compounds containing oxygen), as well as a substantial slate of conventional gasoline, distillates, jet fuel, asphalt and petrochemicals.






The way we play this one is to buy the VLO June 65 Calls (VLOFM) and sell the VLO June 70 Calls (VLOFN) for a net debit of $2.40. On a 10-lot spread, you'd be putting $2,400 on the table, versus a 1,000-share stock purchase that would tie up $24,000. Think about that -- you're investing less than 2% of the money the stock investor has to plunk down and, yet, a move above $70 for June expiration means you make $2,600 or better than 108.3% in about 100 days! As always, with a bull-call spread like this, the risk is limited to the $2.40 per contract that you invest.

This is a great example of why options are such a great tool. Those VLO June 65 Calls carry more than $5 in premium above their intrinsic value! Imagine just buying those calls and watching the premium seep out.

To make a limited-risk investment in Valero, I recommend buying the VLO June 65-70 bull-call spread for a net debit of $2.40.

TRADE DETAILS
All information is based on prices as of 11 a.m. Eastern on Wednesday, March 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 $2.50 for the VLO June 65-70 bull-call spread through Wednesday, March 9, as long as Valero shares trade for $67.50 or higher.

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

Underlying Stock: Valero (VLO)

Current Stock Price: $68.46

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	VLO June 65 Call	$65	VLOFM	-$8.60
Sell	1	VLO June 70 Call	$70	VLOFN	+6.20
		Net Cost			-2.40

*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 $2.40, 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 $2.40, or $240 for each spread. (For those of you who are do-it-yourselfers and make the trade online, an order to buy the VLO June 65 Calls (VLOFM) for $8.60 while simultaneously selling the VLO June 70 Calls (VLOFN) for $6.20 puts you in the trade with a net debit of $2.40.)

SUMMARY

With Valero trading for $68.46, a 1,000-share position would tie up $68,460. However, with our trade you'll be able to put just $2,400 at risk and have a potential gain of $2,600 if VLO 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 VLO June 65 Calls ($8.60) and our credit on the VLO June 70 Calls ($6.20), or a net debit of $240 per contract.

* With VLO trading at $68.46, a 1,000-share position would cost us $68,460.

* Instead, if we buy 10 of the in-the-money VLO June 65 Calls (VLOFM) for $8.60 per contract ($8.60 each times 100 shares = $860 per contract), or $8,600 and ...

* Against that purchase, we sell 10 of the out-the-money VLO June 70 Calls (VLOFN) for $6.20 per contract ($6.20 each times 100 shares = $620 per contract), or $6,200.

* Thus, on a 10-contract spread we have only $2,400 invested, so that's all we can lose!

* If you follow these guidelines, this means your broker can pay no more than $2.40 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 $70 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 $2.50 for this spread trade through Wednesday, March 9, as long as VLO shares trade for $67.50 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 Valero 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, $2.40.

Breakeven: $67.40

The breakeven is $67.40 because, as in any bull-call spread, the breakeven is determined by adding the net cost of the spread ($2.40 in this case) to the strike price of the call you are buying. Again, because we paid $8.60 for the VLO June 65 Calls and took in $6.20 for the sale of the VLO June 70 Calls, our net out-of-pocket is $2.40. You add that net to the strike price we’ve purchased ($65) and you get your breakeven of $67.40.

Max Profit: $260 per spread ($2.60 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 ($2.40) and is therefore $2.60. Thus, if VLO is $70 or higher on expiration, the spread will achieve that $5 max and, since we paid $2.40 for the spread, that would leave us with a $2.60 profit, or 108.3%. On a 10-contract spread, that would translate to a profit of $2,600!

*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 Valero, you’d buy 10 of the VLO June 65 Calls and sell 10 of the VLO June 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.