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5/4/05
LIKE A TON OF BRICKS

May 04, 2005

Stock market analysts have repeatedly said that the market is running against the wind. And, while that analogy paints a picture of the struggle the market has had, I think running with an armload of bricks more accurately depicts the market that's been challenging us so far in 2005!

The Fed and crude oil have contributed the bulk of those bricks, and after this week's Federal Open Market Committee meeting and the breakdown in crude below $50, it seems we're more likely to be hauling far fewer bricks. This should contribute to a more supportive environment for the bulls.

Interest rates -- while rising -- are still at the low end of levels we've experienced in the past 50 years. That tells me that, if the Fed stays "measured" and perhaps even steps to the sidelines, then the markets will switch from wind in their faces to wind at their backs.

For all the folks who said it would be a nonevent when the Fed did exactly what the market thought it would do, I have two words: think again! That’s right -- even when the FOMC did what was universally expected, they had to tweak us a little, just to show us who’s boss.

For those of you that weren’t glued to your trading screens like I was, the markets were down, up and then down -- in 40- to 80-point chunks -- as traders digested the minutes of the FOMC meeting. But then, with just minutes left in the regular session, the FOMC released a statement that said they had mistakenly left out a line about inflation!

LEFT OUT A LINE!! Are you kidding me?!? The pits erupted and traders scrambled to grab S&P futures to cover, pushing the market back up into positive territory as short-covering neared panic proportions. The following chart illustrates the activity on the Dow upon the announcement of the omission:




When the runaway sentence was corralled, it turned out to be relatively benign: “Longer-term inflation expectations remain well-contained.” That statement was hardly the stuff 1,000-point rallies are made of, but it might be just enough to keep both bulls and bears at bay.

CATCHING THE CHANGEWAVE -- GETTING IN ON INTERACTIVE'S ACTION

InterActiveCorp (IACI) -- the e-commerce company whose brands include the Home Shopping Network, Lending Tree, Expedia, Match.com and Ticketmaster -- has been hit along with eBay, Amazon and the rest of the Internet retailers, but I think Barry Diller's company deserves a little more respect.

First of all, with all these sites to cross-sell (market or advertise) his other properties, IACI will not be as adversely affected by the increasing costs of Internet advertising. Second, their announcement of the acquisition of AskJeeves.com (on March 21) was also responsible for some of this selling pressure, but shares have bounced nicely off $21 and stand just $3 off the 52-week low of $19.16.

InterActive just reported today that its Q1 earnings rose 80%, helped by growth at its travel and electronic retailing units. Shares are moving up but are still at very attractive levels. My updated target is now $27.






Here's how we play IACI:

Let's buy the IACI July 22.50 Calls (QTHGX) and sell the IACI July 25 Calls (QTHGE) for a net debit of $1. With IACI trading for $23.10, our July 22.50 Calls are intrinsically worth 60 cents, so this spread is a mere 40 cents of out-the-money premium! Do-it-yourselfers can pay $1.65 for the July 22.50 Calls and sell the July 25 Calls for 65 cents for that same net debit of $1.

To make a limited-risk investment in InterActiveCorp, I recommend buying the IACI July 22.50-25 bull-call spread for a net debit of $1.

TRADE DETAILS
All information is based on prices as of 11:52 a.m. Eastern on Wednesday, May 4, 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 $1.05 for the IACI July 22.50-25 bull-call spread through Wednesday, May 11, as long as IACI shares trade for $22.25 or higher.

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

Underlying Stock: InterActiveCorp (IACI)

Current Stock Price: $23.10

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	IACI July 22.50 Call	$22.50	QTHGX	-$1.65
Sell	1	IACI July 25 Call	$25	QTHGE	+$0.65
		Net Cost			-$1.00

*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 debit of $1, 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, or $100 for each spread. (For those of you who are do-it-yourselfers and are making the trade online, an order to buy the IACI July 22.50 Calls (QTHGX) for $1.65 while simultaneously selling the IACI July 25 Calls (QTHGE) for 65 cents puts you in the trade with a net debit of $1.)

Our loss is limited to the $1 that we are paying for the spread. If, on the other hand, InterActiveCorp rises above $25 on July expiration, then we make $1.50 on our $1 investment!

SUMMARY

With InterActiveCorp trading for $23.10, a 1,000-share position would tie up $23,100. However, with our trade you'll be able to put just $1,000 at risk and have a potential gain of $1,500 if InterActiveCorp 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 IACI July 22.50 Calls ($1.65) and our credit on the IACI July 25 Calls (65 cents), or a net debit of $100 per contract.

* With IACI trading at $23.10, a 1,000-share position would cost us $23,100.

* Instead, if we buy 10 of the IACI July 22.50 Calls (QTHGX) for $1.65 ($1.65 each times 100 shares = $165 per contract), or $1,650 and ...

* Against that purchase, we sell 10 of the IACI July 25 Calls (QTHGE) for 65 cents (65 cents each times 100 shares = $65 per contract), or $650.

* Thus, on a 10-contract spread we have only $1,000 invested, so that's all we can lose!

* If you follow these guidelines, this means your broker can pay no more than $1 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 $100 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 $1.05 for this spread trade through Wednesday, May 11, as long as IACI shares trade for $22.25 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 IACI shares, you can see that the trade becomes profitable (green area) when the underlying stock crosses the $23.50 level. Likewise, while the stock is under $23.50, 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.

Breakeven: $23.50

The breakeven is $23.50 because, as in any bull-call spread, the breakeven is determined by adding the net cost of the spread ($1 in this case) to the strike price of the call you are buying. Again, because we paid $1.65 for the IACI July 22.50 Calls and took in 65 cents for the sale of the IACI July 25 Calls, our net out-of-pocket is $1. You add that net to the strike price we’ve purchased ($22.50) and you get your breakeven of $23.50.

Max Profit: $150 per spread ($1.50 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) and is therefore $1.50. Thus, if IACI is $25 or higher on expiration, then the spread will achieve that $2.50 max and, because we paid $1 for the spread, that would leave us with a $1.50 profit, or 150%. On a 10-contract spread, that would translate to a profit of $1,500!

*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 InterActiveCorp, you’d buy 10 of the IACI July 22.50 Calls and sell 10 of the IACI July 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.