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March 11, 2010
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3/23/05
HEALTH IN A HANDBASKET
March 23, 2005
The skyrocketing cost of healthcare was one of the reasons I sold my 55-employee firm to a large hedge fund last year. Providing $500 deductible insurance for our traders -- along with their wives or husbands and kids -- was running north of $1,200 per month, with the usual 12% cost increase coming just as regularly as the Cubbies losing in September!
I'm not intending this to be a rant about folks on either side of the aisle, but something had to give, and that something was me! It just made no financial sense to keep shouldering such heavy costs for traders when I could go the way of so many other firms and take the humans out of the equation. That -- and a last-minute bidding war -- and my firm and healthcare problems were gone!
Now I'm reading that the United Auto Workers union members over at General Motors -- who, other than our elected officials, have the best and costliest healthcare in the U.S. -- are coming to the realization that the cost of their benefits is breaking the company. I can't imagine the cost per worker of non-deductible, no-monthly-fee insurance. This so-called "First Dollar" insurance for their present and past workers has been a noose around the necks of the big three automakers, and the fact that their workers are now saying they are willing to switch to PPOs is a sign to me that the industry may indeed be ready for some positive change.
CATCHING THE CHANGEWAVE -- MINING FOR PROFITS
In an alert to his ChangeWave Investing subscribers last week, Tobin Smith recommended Companhia Vale do Rio Doce (RIO) to take advantage of growth in the basic materials sector. RIO is a large global diversified mining company, and just last week, RIO said exports jumped 30% last year to $5.2 billion. Output of iron ore reached about 210 million tons last year, nearly 15% higher than in 2003, and RIO is also Brazil's biggest net exporter.
I show RIO trading just a dollar above its 50-day moving average, down at $31.45. We like RIO to trade up to and through its 52-week high, around $36, and here's how we take advantage of such a move with a different strategy this week, using a bull-put spread:
We're selling the June 35 Puts (RIORG) for $4.90 and buying the June 30 Puts (RIORF) for $1.90. If entered as a $3 credit spread, you needn't worry about what prices make this one work, as your broker would have to execute the spread at $3 or better, not worse!
THE TRADE -- RIO BULL-PUT SPREAD
To make a limited-risk investment in RIO, I recommend buying the RIO June 35-30 bull-put spread for a net credit of $3.
TRADE DETAILS
All information is based on prices as of 11:30 a.m. Eastern on Wednesday, March 23, 2005.
* NOTE: This example follows the most current prices available to us at the time of publication. You can still enter the trade at $2.45 or higher for the RIO June 35-30 bull-put spread through Wednesday, March 30, as long as RIO shares trade for $30 or above.
Here is the information you need to know to buy our RIO bull-put spread for profits:
Underlying Stock: Companhia Vale do Rio Doce (RIO)
Current Stock Price: $31.45
Trade Type: Bull-put spread
Options to Trade: The specific trades to make are in the table below...
| Action | Quantity | Option | Strike Price | Ticker | Investment | |
| Sell | 1 | RIO June 35 Put | $35 | RIORG | +$4.90 | |
| Buy | 1 | RIO June 30 Put | $30 | RIORF | -$1.90 | |
| Net Credit | +$3.00 |
*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 credit of $3, then it doesn't matter which prices your broker pays for the individual parts of the bull-put spread. Thus, our net credit would be $3, or $300 for each spread. (For those of you who are do-it-yourselfers and make the trade online, an order to buy the RIO June 30 Puts (RIORF) for $1.90 while simultaneously selling the RIO June 35 Puts (RIORG) for $4.90 puts you in the trade with a net credit of $3.)
You keep all $3 if RIO is above $35 on June expiration, and your risk is limited to the difference between the $3 you collected and the full $5 to which the spread could expand if RIO is at $30 or lower on June expiration.
SUMMARY
With RIO trading for $31.45, a 1,000-share position would tie up $31,450. However, with our trade you'll be able to put $3,000 in your pocket and keep it if RIO rises to $35 or higher upon expiration.
Here’s why:
* Our net investment on that bull-put spread is the difference between what we paid for the RIO June 30 Puts ($1.90) and our credit on the RIO June 35 Puts ($4.90), or a net credit of $300 per contract.
* With RIO trading at $31.45, a 1,000-share position would cost us $31,450.
* Instead, if we buy 10 of the out-the-money RIO June 30 Puts (RIORF) for $1.90 per contract ($1.90 each times 100 shares = $190 per contract), or $1,900 and ...
* Against that purchase, we sell 10 of the in-the-money RIO June 35 Puts (RIORG) for $4.90 per contract ($4.90 each times 100 shares = $490 per contract), or $4,900.
* Thus, on a 10-contract spread we have already earned $3,000!
* If you follow these guidelines, this means your broker can pay no more than $3 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-put spread in this example will give you $300 before commissions are taken out. 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 $2.45 or higher for this spread trade through Wednesday, March 30, as long as RIO shares trade for $30 or above.
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 RIO shares, you can see that the trade becomes less profitable when the underlying stock moves downward and crosses the $32 level as expiration approaches. Likewise, while the stock is under $32, we are below the section (red area) and lose some of the credit we collected from the bull-put spread.
As with any 1-to-1 bull-put spread, our risk is limited to what we collected for the spread -- in this case, $3 -- minus the price change in the calls.
Breakeven: $32
The breakeven is $32 because, as in any bull-put spread, the breakeven is determined by subtracting the net credit of the spread ($3 in this case) from the strike price of the put you are selling. Again, because we paid $1.90 for the RIO June 30 Puts and took in $4.90 for the sale of the RIO June 35 Puts, our net credit is $3. You subtract that net from the strike price we’ve sold ($35) and you get your breakeven of $32.
Below $32, the spread becomes more expensive (this becomes a loss because you are short it), but the loss is limited. The maximum spread value is $5. If the stock closes below $30, then the put we are long at 30 will be in-the-money, and you will want to exercise it. This will make you short stock at 30 and will cover the long position you will have at 35, because the put you are short will be assigned to you. Thus, buying stock at 35 and selling it at 30 is a 5 loss to you. If we subtract the premium we gained when we first put on the spread, we have a net loss of $1.90 ($4.90 - $3) -- this is the most we can lose on this spread.
With the bull-put spread, the reward potential is reduced, but so is the risk profile. With this spread, we aspire to see the stock close above $35upon expiration. This would result in the options expiring worthless and allow us to collect the total cash flow generated when the position was initiated.
Max Profit: $300 per spread ($3 x 100 shares)
The max profit is determined by taking the difference between the two strikes of the bull-put spread, which in this case is $5 ($35 – $30 = $5) and remembering that the amount we earned from the spread is $3. Thus, if RIO is $35 or higher on expiration, the spread will achieve that $5 max and, since we already earned $3 for the spread, the options would expire worthless and we keep all of our credit. On a 10-contract spread, that would translate to a profit of $3,000!
The risk is determined by taking the difference between the two strikes of the bull-put spread, which in this case is $5 ($35 – $30 = $5) and subtracting the amount we earned from the spread ($3) and is therefore $2, if RIO is $30 or lower on expiration.
*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 RIO, you’d buy 10 of the RIO June 30 Puts and sell 10 of the RIO June 35 Puts. This 10 x 10 bull-put 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.
BUY LIST UPDATES
AMYLIN PHARMACEUTICALS
Amylin Pharmaceuticals (AMLN) just got approval last week for Symlin -- its injectable diabetes drug that will complement the use of insulin in patients with two major types of the disease. With 18 million Americans with diabetes who stand to benefit from Symlin and analysts predicting that annual sales of the drug, which is slated to go on sale in 90 days, will reach $200 million --watch for a possible Cha-Ching later!
XTO ENERGY
XTO Energy (XTO), which we recommended on March 9, completed a 4-for-3 stock split last week, and our options have been adjusted. Our XTO May 45 Calls (XTOEI) are now XTO May 33.75 Calls (XTAEY), and our XTO May 50 Calls (XTOEJ) become XTO May 37.50 Calls (XTAEU). Investors who purchased the stock have 1.33 shares for each one held before the split on March 17.
BE OUR GUEST AT THE LAS VEGAS MONEY SHOW
It’s money show time again.
I want you to be my guest at the 17th Annual Las Vegas Money Show, May 9-12, 2005 at the Paris/Bally’s Resort in Las Vegas. You are entitled to free admission when you mention ChangeWave and priority code #004074.
Your free admission will give you access to more than 200 educational workshops featuring the world’s best financial advisers, policy-makers, commentators and educators. You’ll also be able to comparison-shop the investor’s mega-marketplace on the exhibition floor, which will feature nearly 225 of the world’s leading financial product and service providers plus representatives from world-class public companies.
Best of all, there are a number of workshops where you can find me and the ChangeWave team of advisers -- Tobin Smith and Bryan Perry. We just received the schedule, and there will be plenty of time for us to get together during and after the sessions -- and plenty of chances to go hear Toby and Bryan.
Here is the full schedule of your favorite ChangeWave speakers:
MONDAY, MAY 9, 2005
TUESDAY, MAY 10, 2005
WEDNESDAY, MAY 11, 2005
THURSDAY, MAY 12, 2005
I’ll provide more details on these events as the show draws closer.
The Las Vegas Money Show WILL book up quickly, so call 800-970-4355 and mention #004074 to get your free registration or visit the Web page below to make your free reservations online today. I look forward to seeing you there. -- Jon.
www.lasvegasmoneyshow.com/lvms/main.asp?sCode=004074
Be sure to mention ChangeWave, and priority code #004074 for your free admission.
Hope to see you there!
