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3/9/05
MAYBE HE’S HUMAN AFTER ALL

March 09, 2005

Next time you are kicking yourself for underperforming the S&P 500, keep in mind that the man whom many call the greatest investor of this century, Warren Buffett, did exactly that in 2004. In exact terms, the net worth of Mr. Buffett's stock, Berkshire Hathaway, rose by $8.3 billion, increasing the per-share book value of both its Class A and Class B stock by 10.5% -- short of the 10.9% return by Standard & Poor's 500-stock index in 2004. In his own words, Mr. Buffett said, "My hope was to make several multibillion-dollar acquisitions that would add new and significant streams of earnings to the many we already have. But I struck out. Additionally, I found very few attractive securities to buy."

Before any of you fire off an e-mail to me for bashing the Oracle of Omaha, please understand that I am a big fan. However, I do think that with $43 billion in cash, Mr. B. could send a little distribution to the complete strangers like me who own his stock! When I cite Microsoft's massive 2004 payout ($33 billion!), true believers in Mr. Buffett's magic touch state that he can do better (i.e., create bigger returns) than they can. While that may be true, last year's returns indicate that both Mr. Buffett and his second, Charlie Munger, Berkshire Hathaway's vice chairman, set the bar low enough for mere mortals to take a stab at besting their results.

WHAT THE OPTIONS MARKETS ARE TELLING ME

Last week, Cell Therapeutics (CTIC) hit the highest reading I have ever recorded for any option class! Just days ahead of the results for its late-stage trial of its experimental lung cancer drug, CTIC option volatility hit 420%. And on Monday, the company released the harsh fact that its drug did not meet its main goal of showing that it worked better than standard chemotherapy. CTIC shares fell 48% on upward of 15 million shares in the first 30 minutes! The now at-the-money CTIC March 5 Calls traded down to 95% volatility -- a loss of more than 87% of their previous value. In early trade Monday, the CTIC March 5 Calls were trading for 65 cents, down $4.65, with CTIC shares down $4.72 to $5.28.




CATCHING THE CHANGEWAVE -- GIVING ENERGY A RUN FOR ITS MONEY

Crude oil marches higher nearly every session. Last week's trade in Valero (VLO) moved so quickly that we had to offer two trades in an attempt to give everyone a fighting chance to get in! In fact, when I was writing the copy for the VLO trade, shares were below $66, but they jumped to $68 just prior to publication. And, literally moments after we sent the trade out to all of you, VLO traded up above $70 and went up another $4 from there!

As I said on Neil Cavuto's show this past Saturday, one of the biggest reasons we have a shortage of supply is that oil companies used to average 75% reinvestment of cash flow back into exploration, but now they average just below 50%. Discovering companies that are successfully finding and bringing new wells online is difficult, but again, our ChangeWave Alliance has put us in the sweet spot for yet another hot stock: XTO Energy (XTO).

XTO Energy and its subsidiaries are engaged in the acquisition, development, exploitation and exploration of producing oil and gas properties, as well as in the production, processing, marketing and transportation of oil and natural gas. Its production and exploration activities are concentrated in Texas, Oklahoma, Arkansas, Kansas, New Mexico, Colorado, Wyoming, Alaska and Louisiana. It also gathers, processes and markets gas, transports and markets oil and conducts other activities directly related to its oil and gas producing activities.

When Toby Smith wrote about XTO on Feb. 25, he had two big ChangeWave catalysts:

1. Potential for production growth doubling in gas in their Barnett fields.

2. Some kind of play on their long-lived assets (i.e., royalty trust roll-out or other monetization play).

Toby expects XTO to move from $47 with a $70 target! Well, here it is still just under $47, with tons of upside and potential to be another home run for Options Investor subscribers.






Here's how we play XTO: Let's buy the XTO May 45 Calls (XTOEI) and sell a like number of XTO May 50 Calls (XTOEJ) for a net debit of $2.15.

On a 10-lot spread, you'd be putting $2,150 on the table, versus a 1,000-share stock purchase that would tie up $46,500. Think about that -- you're investing approximately 5% of the money the stock investor has to plunk down and, yet, a move above $50 for May expiration means you make $2,850 or better than 132.56% in about 100 days! As always, with a bull-call spread like this, the risk is limited to the $2.15 per contract that you invest.

To make a limited-risk investment in XTO Energy, I recommend buying the XTO May 45-50 bull-call spread for a net debit of $2.15.

TRADE DETAILS
All information is based on prices as of 11:30 a.m. Eastern on Wednesday, March 9, 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 $2.15 for the XTO May 45-50 bull-call spread through Wednesday, March 16, as long as XTO Energy shares trade for $45.50 or higher.

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

Underlying Stock: XTO Energy (XTO)

Current Stock Price: $46.50

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	XTO May 45 Call	$45	XTOEI	-$3.60
Sell	1	XTO May 50 Call	$50	XTOEJ	+1.45
		Net Cost			-2.15

*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 $2.15, 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 $2.15, or $215 for each spread. (For those of you who are do-it-yourselfers and make the trade online, an order to buy the XTO May 45 Calls (XTOEI) for $3.60 while simultaneously selling the XTO May 50 Calls (XTOEJ) for $1.45 puts you in the trade with a net debit of $2.15.)

As always, if something bad happens to XTO (e.g., if OPEC increases production dramatically), then our loss is limited to that $2.15 we are paying for the spread. If on the other hand, XTO rises above $50 on May expiration, we make $2.85 on our $2.15 investment! Cha-Ching!

SUMMARY

With XTO Energy trading for $46.50, a 1,000-share position would tie up $46,500. However, with our trade you'll be able to put just $2,150 at risk and have a potential gain of $2,850 if XTO rises to $50 or higher.

Here’s why:

* Our net investment on that bull-call spread is the difference between what we paid for the XTO May 45 Calls ($3.60) and our credit on the XTO May 50 Calls ($1.45), or a net debit of $215 per contract.

* With XTO trading at $46.50, a 1,000-share position would cost us $46,500.

* Instead, if we buy 10 of the in-the-money XTO May 45 Calls (XTOEI) for $3.60 per contract ($3.60 each times 100 shares = $360 per contract), or $3,600 and ...

* Against that purchase, we sell 10 of the out-the-money XTO May 50 Calls (XTOEJ) for $1.45 per contract ($1.45 each times 100 shares = $145 per contract), or $1,450.

* Thus, on a 10-contract spread we have only $2,150 invested, so that's all we can lose!

* If you follow these guidelines, this means your broker can pay no more than $2.15 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 $2.15 for this spread trade through Wednesday, March 16, as long as XTO shares trade for $45.50 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 XTO Energy shares, you can see that the trade becomes profitable (green area) when the underlying stock crosses the $47.15 level. Likewise, while the stock is under $47.15, 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, $2.15.

Breakeven: $47.15

The breakeven is $47.15 because, as in any bull-call spread, the breakeven is determined by adding the net cost of the spread ($2.15 in this case) to the strike price of the call you are buying. Again, because we paid $3.60 for the XTO May 45 Calls and took in $1.45 for the sale of the XTO May 50 Calls, our net out-of-pocket is $2.15. You add that net to the strike price we’ve purchased ($45) and you get your breakeven of $47.15.

Max Profit: $285 per spread ($2.85 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 ($50 – $45 = $5) and subtracting the amount we paid for the spread ($2.15) and is therefore $2.85. Thus, if XTO is $50 or higher on expiration, the spread will achieve that $5 max and, since we paid $2.15 for the spread, that would leave us with a $2.85 profit, or 132.56%. On a 10-contract spread, that would translate to a profit of $2,850!

*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 XTO Energy, you’d buy 10 of the XTO May 45 Calls and sell 10 of the XTO May 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.