Sponsored By:
| Dow | 10,465.94 | -1.22 |
| NASDAQ | 2,254.70 | 3.01 |
| S&P | 1,101.60 | 0.07 |
- Events & Appearances
- Special Reports
- Getting Started
- FAQ
- Modify Your Account
- Glossary
- Renew Subscription
- About the Adviser
August 1, 2010
- Subscriptions:
7/20/05
JUSTIFIED WISDOM
July 20, 2005
First, I'd like to thank all of you who joined us at the Chicago Traders Expo last week in the Windy City. I was flattered that you packed the room so full that we had to bring in additional chairs and still had a standing-room-only crowd!
It was great to meet and greet so many of you, and if you missed the Chicago show, please mark the August Money Show in Washington, D.C., on your calendar. (See the note at the bottom of this newsletter for details.)
As for this week's news, I saw that Alan Greenspan responded to written questions from a congressional committee, and the Fed chairman indicated that the U.S. had fared well against high oil prices. Some reported that this was a sign that Mr. G wouldn't let up on his steady (measured in "Fedspeak") increase of interest rates, but I think that those reporters' translations are only half-right.
The headline writers have picked up on a fair portion of what Mr. Greenspan said but failed to put it in context. To wit, I offer the full quote: "Aside from these 'headwinds,' the U.S. economy seems to be coping pretty well with the run-up in crude oil prices."
Now you tell me, dear ChangeWave Options Investing subscriber and friend, does this sound like the chairman is indicating there are more increases in the offing?
The Fed chairman also said that last year, rising crude oil prices cut U.S. growth by half a percentage point, but that the rise in the price of "Texas T" this year would likely reduce growth by three-quarters of a percentage point. Last year, the economy grew at a 4.4% rate, but this year economists are projecting 3.5%.
I think the three-quarters of a percentage point is huge and not something Mr. Greenspan and the rest of the Fed governors are likely to dismiss. It all depends on what "spin" you want to put on it.
As one of my favorite passages in the Bible says, "Wisdom is justified by all her children."
CATCHING THE CHANGEWAVE -- IF IT'S GOOD ENOUGH FOR LANCE ARMSTRONG
Every time I see Lance Armstrong beating the competition like a rented mule in the Tour de France, I shake my head and remind myself that this guy had terminal cancer less than a decade ago.
If any of us drew what was used to be an immediate death sentence (cancer), we could take some comfort in the fact that Lance was saved not only by his incredible will, but also by Taxol -- a cancer treatment that is part of the huge potential that is American Pharmaceutical Partners (APPX).
American Pharmaceutical Partners, one of the worlds largest manufacturers of generic cancer and critical-care injectables, is on my radar because my models suggest that its shares -- trading for $39.68 -- are $15 undervalued.
Why? Because the company has nearly 150 generics in the oncology, anti-infective and critical-care injectable space. American Pharmaceutical Partners also enjoys operating margins of roughly 54%, substantially above average for the generics industry.
Its key drug is Abraxane, a treatment for late-stage, metastatic breast cancer built around paclitaxel, the treatment form of Taxol that was the Lance Armstrong drug. As we watch Lance cruise to his seventh-consecutive Tour title on Sunday in Paris, keep in mind that drugs like Abraxane are why cancer patients like Lance are not just surviving -- they are also thriving.
To make profits like a champion, I recommend buying the APPX Oct 40 Calls (AQOJH) and selling a like number of APPX Oct 45 Calls (AQOJI) for a net debit of $1.85. Prices that work for do-it-yourselfers are paying $3.30 for the Oct 40 Calls and selling a like number of Oct 45 Calls for $1.45.
As always, that $1.85 is all the risk we bear by buying into this $5 spread, and because it's a $5 spread and we're paying $1.85, our profit potential is $3.15, or 170.3%.
To make a limited-risk investment in American Pharmaceutical Partners, I recommend buying the APPX Oct 40-45 bull-call spread for a net debit of $1.85.
TRADE DETAILS
All information is based on prices as of 1:30 p.m. Eastern on Wednesday, July 20, 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 $1.85 for the APPX Oct 40-45 bull-call spread through Wednesday, July 27, as long as APPX shares trade for $39.50 or higher.
Here is the information you need to know to buy our American Pharmaceutical Partners bull-call spread for profits:
Underlying Stock: American Pharmaceutical Partners (APPX)
Current Stock Price: $39.68
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 | APPX Oct 40 Call | $40 | AQOJH | -$3.30 | |
| Sell | 1 | APPX Oct 45 Call | $45 | AQOJI | +$1.45 | |
| Net Cost | -$1.85 |
*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 $1.85, 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 $1.85, or $185 for each spread.
For those of you who are do-it-yourselfers and are making the trade online, an order to buy the APPX Oct 40 Calls (AQOJH) for $3.30 while simultaneously selling the APPX Oct 45 Calls (AQOJI) for $1.45 puts you in the trade with a net debit of $1.85.
Our loss is limited to the $1.85 that we are paying for the spread. If, on the other hand, American Pharmaceutical Partners rises above $45 on October expiration, then we make $3.15 on our $1.85 investment!
SUMMARY
With American Pharmaceutical Partners trading for $39.68, a 1,000-share position would tie up $39,680. However, with our trade you'll be able to put just $1,850 at risk and have a potential gain of $3,150 if American Pharmaceutical Partners rises to $45 or higher.
Here's why:
* Our net investment on that bull-call spread is the difference between what we paid for the APPX Oct 40 Calls ($3.30) and our credit on the APPX Oct 45 Calls ($1.45), or a net debit of $185 per contract.
* With APPX trading at $39.68, a 1,000-share position would cost us $39,680.
* Instead, if we buy 10 of the APPX Oct 40 Calls (AQOJH) for $3.30 ($3.30 each times 100 shares = $330 per contract), or $3,300 and ...
* Against that purchase, we sell 10 of the APPX Oct 45 Calls (AQOJI) for $1.45 ($1.45 each times 100 shares = $145 per contract), or $1,450.
* Thus, on a 10-contract spread we have only $1,850 invested, so that's all we can lose!
* If you follow these guidelines, this means your broker can pay no more than $1.85 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 $185 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 $1.85 for this spread trade through Wednesday, July 27, as long as APPX shares trade for $39.50 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 APPX shares, you can see that the trade becomes profitable (green area) when the underlying stock crosses the $41.85 level. Likewise, while the stock is under $41.85, 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, $1.85.
Breakeven: $41.85
The breakeven is $41.85 because, as in any bull-call spread, the breakeven is determined by adding the net cost of the spread ($1.85 in this case) to the strike price of the call you are buying. Again, because we paid $3.30 for the APPX Oct 40 Calls and took in $1.45 for the sale of the APPX Oct 45 Calls, our net out-of-pocket is $1.85. You add that net to the strike price we've purchased ($40) and you get your breakeven of $41.85.
Max Profit: $315 per spread ($3.15 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 ($45 $40 = $5) and subtracting the amount we paid for the spread ($1.85) and is therefore $3.15. Thus, if APPX is $45 or higher on expiration, then the spread will achieve that $5 max and, because we paid $1.85 for the spread, that would leave us with a $3.15 profit, or 170.3%. On a 10-contract spread, that would translate to a profit of $3,150!
*This analysis does NOT include the cost of commissions while executing your trades.
BUY LIST UPDATE
NORFOLK SOUTHERN
On Friday, we decided to try something a little bit different from our weekly spread trades. I sent you a single, short-term option trade based on our proprietary search engines for unusual volumes and buy-or-sell action.
As you recall, I recommended buying the Norfolk Southern Sept 35 Calls (NCSIG) up to 85 cents to coattail on the "smart money" that bought in big.
How big? Well, 17,840 calls traded Friday against an average daily volume for the month of June of just 713 calls. The volume dipped back to 4,704 calls on Monday and just 1,400 calls yesterday.
Does this mean the speculation is over in Norfolk Southern? Hardly -- I'm still holding, even though the calls are trading for $1.05 - $1.10. I think we will get another surge later this week ahead of the earnings report on July 27, so hang tough and we'll wait until news breaks next week to ring the register on this one.
In the meantime, you can track activity on this trade online at www.changewave.com/options/opencalls.html
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., is just three weeks away, 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
