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3/30/05
RAISING THE ROOF

March 30, 2005

Calling the housing market hot is like saying the iPod has been modestly successful for Apple! Even six straight weeks of rising interest rates haven't reigned in buying enthusiasm, as evidenced by last week's astonishing 9.4% jump in new-home sales. When you put it in context -- this latest reading didn't arrive on the heels of soft comps year-over-year but, rather, red-hot sales last year -- you get a better understanding of just how significant these numbers really are.

Like many of you, I expect rising mortgage rates will cool but won't cancel buyer's demand. I don't think 6% mortgage rates are pushing any serious buyers out of the market. I think the sign that the housing market is indeed rolling over will be when we see a big switch from new-home sales to existing-home sales -- as, to me, existing homes are the indicator that the buyers are compromising and shopping for used, rather than new, as a way to still afford a home. It's the same thing I observe when consumers go for used rather than new cars, and my postulate is that this will be our sign that the four straight years (2001 to 2004) of record-breaking sales are finally done. Please keep in mind that I have yet to see that switch, so I'm not saying we're done yet.

For those of you who don't track such statistics, sales of previously owned homes account for roughly 85% of total home sales. Most of those buyers are in that portion of the market because they are willing to live with or fix someone else's problems to get either the school district or size of home they want. I believe we'll either need a red-hot stock market to draw money away from real estate or a surge in rates for 30-year mortgages above 7% to see any significant fall in demand.

CATCHING THE CHANGEWAVE -- PLAYING HOLLYWOOD'S GOOD GUYS

If you're a longtime subscriber, then you've heard me frequently state the fact that the video game industry is bigger than Hollywood. That's an indisputable fact -- it has had nearly $1 billion more in sales than the motion pictures developed by Disney, Fox and Sony combined. But, rather than going with "Grand Theft Auto III," I'm going with a Tinseltown twist -- IMAX Corp. (IMAX).

IMAX is a pioneer in sound and projection for giant screens, and we've seen "The Matrix" and, more recently, "Robots" drive HUGE numbers to IMAX. And, with the latest "Star Wars" prequel, "Revenge of the Sith," projected to be the first blockbuster of 2005, I think IMAX is ready to build on the strength of its 2004 move from $4.50 to above $12.

I've seen a rapid rise in the number of theaters signing up for the IMAX format, and you have to keep in mind that there are currently only about 240 IMAX formats in place in 35 countries, so there is significant room for growth. Lastly, IMAX put itself on the auction block before (back in 2000) and may do so again. Potential buyers could include Sony, Disney and Time Warner.






Here's how we turn this into a blockbuster for our portfolios:

Lets buy the IMAX June 10 Calls (IMQFB) and sell the IMAX June 12.50 Calls (IMQFV) for a net debit of 50 cents. Prices that fit for you do-it-yourselfers are paying 75 cents for the 10s and selling the 12.50s for 25 cents, for a net of 50 cents. On a 10-lot spread, we're investing $500 with potential reward of $2,000 if IMAX is above $12.50 on June expiration.

To make a limited-risk investment in IMAX Corp., I recommend buying the IMAX June 10-12.50 bull-call spread for a net debit of 50 cents.

TRADE DETAILS
All information is based on prices as of 11:30 a.m. Eastern on Wednesday, March 30, 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 50 cents for the IMAX June 10-12.50 bull-call spread through Wednesday, April 6, as long as IMAX shares trade for $8.75 or higher.

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

Underlying Stock: IMAX Corp. (IMAX)

Current Stock Price: $9.05

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	IMAX June 10 Call	$10	IMQFB	-$0.75
Sell	1	IMAX June 12.50 Call	$12.50	IMQFV	+$0.25
		Net Cost			-$0.50

*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 50 cents, 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 50 cents, or $50 for each spread. (For those of you who are do-it-yourselfers and making the trade online, an order to buy the IMAX June 10 Calls (IMQFB) for 75 cents while simultaneously selling the IMAX June 12.50 Calls (IMQFV) for 25 cents puts you in the trade with a net debit of 50 cents.)

Our loss is limited to that 50 cents we are paying for the spread. If, on the other hand, IMAX rises above $12.50 on June expiration, then we make $2 on our 50-cent investment!

SUMMARY

With IMAX trading for $9.05, a 1,000-share position would tie up $9,050. However, with our trade you'll be able to put just $500 at risk and have a potential gain of $2,000 if IMAX rises to $12.50 or higher.

Here’s why:

* Our net investment on that bull-call spread is the difference between what we paid for the IMAX June 10 Calls (75 cents) and our credit on the IMAX June 12.50 Calls (25 cents), or a net debit of $50 per contract.

* With IMAX trading at $9.05, a 1,000-share position would cost us $9,050.

* Instead, if we buy 10 of the IMAX June 10 Calls (IMQFB) for 75 cents per contract (75 cents each times 100 shares = $75 per contract), or $750 and ...

* Against that purchase, we sell 10 of the out-the-money IMAX June 12.50 Calls (IMQFV) for 25 cents per contract (25 cents each times 100 shares = $25 per contract), or $250.

* Thus, on a 10-contract spread we have only $500 invested, so that's all we can lose!

* If you follow these guidelines, this means your broker can pay no more than 50 cents 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 $50 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 50 cents for this spread trade through Wednesday, April 6, as long as IMAX shares trade for $8.75 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 IMAX shares, you can see that the trade becomes profitable (green area) when the underlying stock crosses the $10.50 level. Likewise, while the stock is under $10.50, 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, 50 cents.

Breakeven: $10.50

The breakeven is $10.50 because, as in any bull-call spread, the breakeven is determined by adding the net cost of the spread (50 cents in this case) to the strike price of the call you are buying. Again, because we paid 75 cents for the IMAX June 10 Calls and took in 25 cents for the sale of the IMAX June 12.50 Calls, our net out-of-pocket is 50 cents. You add that net to the strike price we’ve purchased ($10) and you get your breakeven of $10.50.

Max Profit: $200 per spread ($2 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 $2.50 ($12.50 – $10 = $2.50) and subtracting the amount we paid for the spread (50 cents) and is therefore $2. Thus, if IMAX is $12.50 or higher on expiration, the spread will achieve that $2.50 max and, since we paid 50 cents for the spread, that would leave us with a $2 profit, or 400%. On a 10-contract spread, that would translate to a profit of $2,000!

*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 IMAX Corp., you’d buy 10 of the IMAX June 10 Calls and sell 10 of the IMAX June 12.50 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.

ABOUT OUR RECENT BULL-PUT SPREAD TRADES

We've recently done two bull-put spread trades -- Valero Energy (VLO) and Companhia Vale do Rio Doce (RIO), and we've gotten a lot of positive feedback on this new way to make options trading work for us.

Even though we're doing a bull-call spread this week, I wanted to answer some questions you might have about the bull-put spreads we've recommended:

Q: When do we decide to use a bull-put spread instead of a bull-call spread? How is the price action different?

A: Selling a put spread has the exact same risk profile as buying a call spread of the same strikes. Here is an example:

If we buy a 60-65 bull-call spread for $2.70, then our breakeven is $62.70 (the price of the long 60 strike plus the premium we paid). The risk is that $2.70 we paid if the stock finishes below $60. We can make $2.30 if the stock is $65 or higher on expiration.

If we sell the 65-60 bull-put spread for $2.30, then our breakeven is $62.70 (the price of the long strike minus the premium we paid). Our risk is $2.70, which is the difference between the $2.30 we collected for selling the spread, subtracted from the $5 spread difference between the two strikes. We can make $2.30 if the stock is $65 or higher on expiration.

You will note that the risk and reward are the same for both spreads. We choose one over the other based solely on liquidity. If the calls are more liquid, we do the bull-call. But, if the puts are more active and tightly traded, then we choose the sale of the put spread.

Q: How do I open this kind of spread? How do I close it?

A: You direct your broker to sell the put spread for a net credit and, when you do so, your broker has the same obligation to only fill your order at that price or better.

Q: What happens on expiration?

A: At expiration, the put spread either finishes above $65 and we keep our credit, or one or both sides of the puts finish in the money. If just our short $65 put is in the money, then we will have stock "put to us" and, thus, we'd need to sell that stock to zero out our position. If both our short $65 puts and long $60 puts are in the money, then we need do nothing, as the short $65 put will "put stock to us" but our long $60 puts allow us to "put that stock" to someone else, thus zeroing out the position.

Q: What do I do with the money in my account (the net credit)? Can I use it?

A: The credit you generate can help offset other long positions you are paying for, or will simply generate a small amount of cash by the interest your broker pays.