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6/22/05
TOIL AND TROUBLE
June 22, 2005
For those of you who didn't catch me on Fox News Channel's "Cavuto on Business" on Saturday, I was, and am, one of the panelists who think stocks will outperform real estate during the next 12 months. My thesis is based on two observations:
STOCK PERFORMANCE SINCE 1980
According to my friend Dr. John Rutledge (who was also on Neil's show this past weekend), if you owned the S&P 500 back in January 1980 and held through the first quarter of this year, then you'd have a total return of 1,651% (12.5% annually)! Nearly half of this spectacular return (46.6%) was in the form of capital gains; 53.4% was in re-invested dividends.
But in this what-have-you-done-for-me-lately world we live in, everyone is grousing about the stock market! Next time you hear this at a cocktail party or on the golf course, you might want to inform these folks that stocks are up 26.3% just in the past two years since the dividend tax cut!
REAL ESTATE
Meanwhile, the Wall Street Journal reported on Monday (June 20) that the 22 major metropolitan markets with the fastest-growing house prices account for 35% of the value of the nation's residential real estate -- yet just a fifth of its population. Nearly five years ago, the 22 markets accounted for 27% of all U.S. residential real estate, and in 1995 the figure was just 24%.
If you purse your lips and push a few hard breaths through them, the sound might be similar to what's going on in the housing space! That said, and other bubble references aside, you can't short real estate, so it's far more difficult to profit from a negative outlook. Not to mention the fact that local bubbles might burst without negatively impacting the national scene.
Fed Chairman Greenspan said virtually the same thing last week when he said he sees "signs of froth in some local markets" but nothing out of the ordinary nationwide.
CATCHING THE CHANGEWAVE -- BACK IN THE CHIPS
As Intel's and Texas Instruments' mid-quarter updates proved, chip stocks are back in the chips!
Our latest ChangeWave Alliance quarterly survey shows an uptick in semiconductors as well, and yesterday, an influential analyst (Lehman Bros.' Arnab Chanda) increased his outlook on communication chip companies to positive from neutral.
One reason he cited -- and our survey results yielded as well -- is that improving utilization rates are indeed yielding gross margin expansion, and with that expansion comes the potential for higher stock prices!
One stock that fits the profile and has several catalysts on the horizon is Broadcom Corp. (BRCM). Using my "distant thunder" program to track accumulations of call or put options, I've seen a very unusual acceleration of call-buying in Broadcom. To wit: Yesterday (Tuesday, June 21) my computers tracked nearly 6,000 July 37.50 Calls changing hands, and 94% of these trades came from aggressive buyers paying the offer price.
The fact that they were buying near-term options and were eager enough to jump up to the offer suggests to me that the buyers expect a fast move higher.
Here's how we coattail this fast-money trade:
I recommend buying the BRCM Nov 37.50 Calls (RCQKT) and selling a like number of BRCM Nov 42.50 Calls (RCQKS) for a net debit of $1.70. As BRCM is below our long call strike, this is an out-the-money call spread, but one that will be worth $5 if BRCM is $42.50 or higher on November expiration. That would yield a $3.30 profit on our $1.70 investment!
To make a limited-risk investment in Broadcom Corp., I recommend buying the BRCM Nov 37.50-42.50 bull-call spread for a net debit of $1.70.
TRADE DETAILS
All information is based on prices as of 11:30 a.m. Eastern on Wednesday, June 22, 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 $1.70 for the BRCM Nov 37.50-42.50 bull-call spread through Wednesday, June 29, as long as BRCM shares trade for $36 or higher.
Here is the information you need to know to buy our Broadcom bull-call spread for profits:
Underlying Stock: Broadcom Corp. (BRCM)
Current Stock Price: $36.27
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 | BRCM Nov 37.50 Call | $37.50 | RCQKT | -$2.75 | |
| Sell | 1 | BRCM Nov 42.50 Call | $42.50 | RCQKS | +$1.05 | |
| Net Cost | -$1.70 |
*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 $1.70, 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 $1.70, or $170 for each spread.
For those of you who are do-it-yourselfers and are making the trade online, an order to buy the BRCM Nov 37.50 Calls (RCQKT) for $2.75 while simultaneously selling the BRCM Nov 42.50 Calls (RCQKS) for $1.05 puts you in the trade with a net debit of $1.70.
Our loss is limited to the $1.70 that we are paying for the spread. If, on the other hand, Broadcom rises above $42.50 on November expiration, then we make $3.30 on our $1.70 investment!
SUMMARY
With Broadcom Corp. trading for $36.27, a 1,000-share position would tie up $36,270. However, with our trade you'll be able to put just $1,700 at risk and have a potential gain of $3,300 if Broadcom Corp. rises to $42.50 or higher.
Here’s why:
* Our net investment on that bull-call spread is the difference between what we paid for the BRCM Nov 37.50 Calls ($2.75) and our credit on the BRCM Nov 42.50 Calls ($1.05), or a net debit of $170 per contract.
* With BRCM trading at $36.27, a 1,000-share position would cost us $36,270.
* Instead, if we buy 10 of the BRCM Nov 37.50 Calls (RCQKT) for $2.75 ($2.75 each times 100 shares = $275 per contract), or $2,750 and ...
* Against that purchase, we sell 10 of the BRCM Nov 42.50 Calls (RCQKS) for $1.05 ($1.05 each times 100 shares = $105 per contract), or $1,050.
* Thus, on a 10-contract spread we have only $1,700 invested, so that's all we can lose!
* If you follow these guidelines, this means your broker can pay no more than $1.70 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 $170 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 $1.70 for this spread trade through Wednesday, June 29, as long as BRCM shares trade for $36 or higher.
TRADE PROFITABILITY ANALYSIS
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 BRCM shares, you can see that the trade becomes profitable (green area) when the underlying stock crosses the $39.20 level. Likewise, while the stock is under $39.20, 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, $1.70.
Breakeven: $39.20
The breakeven is $39.20 because, as in any bull-call spread, the breakeven is determined by adding the net cost of the spread ($1.70 in this case) to the strike price of the call you are buying. Again, because we paid $2.75 for the BRCM Nov 37.50 Calls and took in $1.05 for the sale of the BRCM Nov 42.50 Calls, our net out-of-pocket is $1.70. You add that net to the strike price we’ve purchased ($37.50) and you get your breakeven of $39.20.
Max Profit: $330 per spread ($3.30 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 ($42.50 – $37.50 = $5) and subtracting the amount we paid for the spread ($1.70) and is therefore $3.30. Thus, if BRCM is $42.50 or higher on expiration, then the spread will achieve that $5 max and, because we paid $1.70 for the spread, that would leave us with a $3.30 profit, or 194.12%. On a 10-contract spread, that would translate to a profit of $3,300!
*This analysis does NOT include the cost of commissions while executing your trades.
JOIN ME AND THE CHANGEWAVE TEAM IN THE NATION'S CAPITAL, WASHINGTON, D.C.
I want you to be my guest at The Money Show in Washington, D.C., on Aug. 11-13, 2005, at the Wardman Park Marriott in Washington, D.C.
Plus, you and your companion are entitled to FREE admission when you click below:
www.dcmoneyshow.com/ms/dcms/main.asp?scode=004074
Or, call 800-970-4355 and mention priority code 004074.
The ChangeWave gang will be on hand, including Toby Smith and Bryan Perry, and we will talk about stocks and trading with you throughout the show.
Here is the ChangeWave adviser schedule:
THURSDAY, AUG. 11, 2005
FRIDAY, AUG. 12, 2005
SATURDAY, AUG. 13, 2005
The Money Show in Washington, D.C., WILL book up quickly, so call 800-970-4355 now and don’t forget to mention priority code 004074.
Or visit the Web page below to make your reservations online today:
www.dcmoneyshow.com/ms/dcms/main.asp?scode=004074
Good luck trading and remember -- pigs get fat, but hogs get slaughtered, so don't be a hog!
Jon “Dr. J” Najarian
Editor
ChangeWave Options Investor
