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5/11/05
THE MORE THINGS CHANGE, THE MORE THEY STAY THE SAME

May 11, 2005

Last Friday, just as I was enjoying the Labor Department's April employment numbers, my computers started ringing like my friend's bookie's cell phone during the Kentucky Derby! Now, while my friend claims to have "beat his book like a rented mule," my computers were kicking like a mule about what was going on in Ameritrade (AMTD) options!

In sleepy Ameritrade options that traded a mere 315 calls on the previous session (May 5), I was tracking more than 15,000 calls changing hands by mid-session! Now I'm sure you've heard, oh, maybe a couple of hundred times the Wall Street adage that only two things move markets, fear and greed -- and a massive accumulation of calls is usually the latter!

Yes, dear Options Investor, bad people still get information that the rest of us aren't privy to, but paying attention to what's going on and looking for the telltale signs of that greed manifesting itself can help me to coattail insiders. Such was the case last Friday, and I posted the information on my Weblog at InsideOptions.com and sent out the same information to the usual news services.

The reason this is interesting isn't just that the action in Ameritrade helped some folks to make a few bucks, but also because it is amazing to see how people used the information. Sure, traders bought calls for 25 cents that turned into $1.50 on Monday when E*Trade announced its intentions for Ameritrade and the stock jumped from $11.50 to $14. But more interesting to me -- and more telling about the state of the information flow to the general public -- was the fact that, armed with this time-critical information, the various news outlets didn't run the story about how this action could foretell a takeover, but instead spent their space writing about why such a deal wouldn't happen!

Does that sound as bizarre to you as it does to me? I was dumbfounded! I mean, I literally wrote the story for them, and the journalists spit it back in my face and instead relied on folks "who would know," citing all the reasons why this wasn't a takeover I was following! I kid you not! Off-the-charts volume and exploding volatility, and they write the story about this as just active speculation?

I've spared the journalists the embarrassment of publishing their names or the publications they write for, but I thought you should know just how the information tap gets turned off, next time you’re wondering why you didn’t get a crack at the stock that opens up 20%. Makes you wonder, doesn’t it?




CATCHING THE CHANGEWAVE -- POCKET-SIZED HYBRIDS

In a recent ChangeWave Alliance report from April, we took a look at a different type of hybrid -- not autos, but PDAs. According to our Alliance members who participated in the survey, the crossover, multi-function PDA phones such as the Treo or BlackBerry are the must-have items for both corporate clients and individuals. And while Research in Motion's ubiquitous "CrackBerries" are still the 800-pound gorillas of this space, our survey found that those looking to buy a hybrid PDA during the next 90 days are picking palmOne's Treo over the BlackBerry by 27% to 15%.






Here's how we play the great upside for palmOne (PLMO): Let's buy the PLMO Aug 22.50 Calls (UPYHX) and sell a like number of PLMO Aug 25 Calls (UPYHE) for a net debit of $1.40. With PLMO trading for $24.81, this spread is already $2.31 in the money, and if PLMO is $25 or higher on August expiration, we make $1.10 on our $1.40 investment! Breakeven is our long strike, 22.50 plus that $1.40 debit, or $23.90. Our total risk is the debit of $1.40, or $1,400 on a 10-contract spread.

To make a limited-risk investment in palmOne, I recommend buying the PLMO Aug 22.50-25 bull-call spread for a net debit of $1.40.

TRADE DETAILS
All information is based on prices as of 11:55 a.m. Eastern on Wednesday, May 11, 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 $1.40 for the PLMO Aug 22.50-25 bull-call spread through Wednesday, May 18, as long as PLMO shares trade for $24.40 or higher.

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

Underlying Stock: palmOne (PLMO)

Current Stock Price: $24.81

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	PLMO Aug 22.50 Call	$22.50	UPYHX	-$4.40
Sell	1	PLMO Aug 25 Call	$25	UPYHE	+$3.00
		Net Cost			-$1.40

*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 $1.40, 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 $1.40, or $140 for each spread. (For those of you who are do-it-yourselfers and are making the trade online, an order to buy the PLMO Aug 22.50 Calls (UPYHX) for $4.40 while simultaneously selling the PLMO Aug 25 Calls (UPYHE) for $3 puts you in the trade with a net debit of $1.40.)

Our loss is limited to the $1.40 that we are paying for the spread. If, on the other hand, palmOne rises above $25 on August expiration, then we make $1.10 on our $1.40 investment!

SUMMARY

With palmOne trading for $24.81, a 1,000-share position would tie up $24,810. However, with our trade you'll be able to put just $1,400 at risk and have a potential gain of $1,100 if palmOne rises to $25 or higher.

Here’s why:

* Our net investment on that bull-call spread is the difference between what we paid for the PLMO Aug 22.50 Calls ($4.40) and our credit on the PLMO Aug 25 Calls ($3), or a net debit of $140 per contract.

* With PLMO trading at $24.81, a 1,000-share position would cost us $24,810.

* Instead, if we buy 10 of the PLMO Aug 22.50 Calls (UPYHX) for $4.40 ($4.40 each times 100 shares = $440 per contract), or $4,400 and ...

* Against that purchase, we sell 10 of the PLMO Aug 25 Calls (UPYHE) for $3 ($3 each times 100 shares = $300 per contract), or $3,000.

* Thus, on a 10-contract spread we have only $1,400 invested, so that's all we can lose!

* If you follow these guidelines, this means your broker can pay no more than $1.40 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 $140 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 make it as small, as you’d like.

* Remember, you can pay up to $1.40 for this spread trade through Wednesday, May 18, as long as PLMO shares trade for $24.40 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 chart 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 PLMO shares, you can see that the trade becomes profitable (green area) when the underlying stock crosses the $23.90 level. Likewise, while the stock is under $23.90, we are below the axis (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, $1.40.

Breakeven: $23.90

The breakeven is $23.90 because, as in any bull-call spread, the breakeven is determined by adding the net cost of the spread ($1.40 in this case) to the strike price of the call you are buying. Again, because we paid $4.40 for the PLMO Aug 22.50 Calls and took in $3 for the sale of the PLMO Aug 25 Calls, our net out-of-pocket is $1.40. You add that net to the strike price we’ve purchased ($22.50) and you get your breakeven of $23.90.

Max Profit: $110 per spread ($1.10 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 ($25 – $22.50 = $2.50) and subtracting the amount we paid for the spread ($1.40) and is therefore $1.10. Thus, if PLMO is $25 or higher on expiration, then the spread will achieve that $2.50 max and, because we paid $1.40 for the spread, that would leave us with a $1.10 profit, or 78.57%. On a 10-contract spread, that would translate to a profit of $1,100!

*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 the elimination of that minimum.

If you wanted to simulate a 1,000-share position in palmOne, you’d buy 10 of the PLMO Aug 22.50 Calls and sell 10 of the PLMO Aug 25 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.