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7/6/05
OPPORTUNITY COSTS
July 06, 2005
"Opportunity is missed by most because it is dressed in overalls and looks like work."
-- Thomas Alva Edison
My friends, I am an optimist but also a realist and, proudly, a capitalist! While I applaud Sir Bob Geldof for his fight to put African aid and global poverty front and center at this week's G-8 meeting in Scotland, I think Sir Bob blew a great opportunity to make Live 8 a much bigger success.
My realist side wonders why the front man for the Boomtown Rats elected not to sell tickets but, rather, to make a very minor amount of money by raffling off tickets to one of the biggest concert events of our lifetime. Yes, I know there will be CDs and DVDs of the event, but how many times do you have the chance to use a live gate of 3 million people to help the less fortunate? What an opportunity lost!
Imagine, ladies and gentlemen, what they could have sold tickets for with U2, Madonna, Coldplay, Elton John, Paul McCartney and nearly 100 other artists on the bill. Had Geldof decided to sell the tickets to these must-see events, I believe he could have brought in $200 million to $300 million. Instead, he picked up pennies by raffling tickets via text messages from cell phones at a buck a throw.
If Geldof would have auctioned the tickets on eBay a la Warren Buffett (who raised upward of $310,000 from the lucky winner of the annual lunch with the "Oracle of Omaha"), Geldof might have pushed nearly $500 million to help meet his declared goal of "making poverty history."
Instead, he railed against selling tickets that were won as "profiteering on the backs of the impoverished." Hmmm, that’s an interesting take on it, is it not? EBay had even offered to donate revenues to charity from the listing fees that the sellers paid.
Again, I'll happily tip my hat to Sir Bob for having the connections and chutzpah to pull this off. However, for Live 8 to be more than just a catchy slogan that captured our attention for a week or two in mid-2005, citizens like us and luminaries like Sir Bob need to focus attention on programs that will help the poor to help themselves.
CATCHING THE CHANGEWAVE -- ADDING 'BEAS' TO OUR BONNET
On Thursday, June 30, our Distant Thunder program started picking up unusual activity in the BEA Systems (BEAS) Aug 10 Calls. The stock was unchanged, but those calls were up 50% on heavy turnover of 8,706 contracts! My computers said that more than 70% of those calls traded on the offer, meaning that the buyers wanted to own them in a hurry!
Now ladies and gents, BEA Systems options traded just 5,828 contracts on June 29, so the action in just those BEAS Aug 10s was nearly double the trading in every other BEA Systems call during the previous trading session! The BEAS Dec 10 Calls have also seen increased activity, and as neither of these are short-term (July) bets, I am focusing my attention on the September options.
In case you're not familiar with BEA Systems, it is the world's leading application infrastructure software company. Even Oracle CEO Larry Ellison said in federal court last June that potential takeover candidates on his short list included BEAS.
His testimony stated that Oracle was actively considering "three or four" acquisitions in addition to its hostile bid for PeopleSoft. From the looks of things, BEAS might be moving to the top of Ellison's short list.
To get in on the action, I recommend buying the BEAS Sept 7.50 Calls (BUCIU) and selling a like number of BEAS Sept 10 Calls (BUCIB) for a net debit of $1.25.
Because we are paying $1.25 for a $2.50 bull call spread, our profit potential is $1.25. This is an in-the-money spread because our longs (Sept 7.50 Calls) are beneath the price BEAS is trading ($8.81). This means we are paying $1.25 for a spread that is intrinsically worth $1.31, so if BEAS is unchanged by September expiration, we'd have made a whopping 6 cents ($1.31 - $1.25).
If BEAS falls below $7.50 on September expiration, we could lose our entire investment of $1.25. A 10-lot spread in BEAS would cost us $1,250 versus $8,810 that a stock buyer would pay for a similar investment.
To make a limited-risk investment in BEA Systems, I recommend buying the BEAS Sept 7.50-10 bull-call spread for a net debit of $1.25.
TRADE DETAILS
All information is based on prices as of 11 a.m. Eastern on Wednesday, July 6, 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 $1.35 for the BEAS Sept 7.50-10 bull-call spread through Wednesday, July 13, as long as BEAS shares trade for $8.70 or higher.
Here is the information you need to know to buy our BEA Systems bull-call spread for profits:
Underlying Stock: BEA Systems (BEAS)
Current Stock Price: $8.81
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 | BEAS Sept 7.50 Call | $7.50 | BUCIU | -$1.60 | |
| Sell | 1 | BEAS Sept 10 Call | $10 | BUCIB | +$0.35 | |
| Net Cost | -$1.25 |
*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 $1.25, 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 $1.25, or $125 for each spread.
For those of you who are do-it-yourselfers and are making the trade online, an order to buy the BEAS Sept 7.50 Calls (BUCIU) for $1.60 while simultaneously selling the BEAS Sept 10 Calls (BUCIB) for 35 cents puts you in the trade with a net debit of $1.25.
Our loss is limited to the $1.25 that we are paying for the spread. If, on the other hand, BEA Systems rises above $10 on September expiration, then we make $1.25 on our $1.25 investment!
SUMMARY
With BEA Systems trading for $8.81, a 1,000-share position would tie up $8,810. However, with our trade you'll be able to put just $1,250 at risk and have a potential gain of $1,250 if BEA Systems rises to $10 or higher.
Here’s why:
* Our net investment on that bull-call spread is the difference between what we paid for the BEAS Sept 7.50 Calls ($1.60) and our credit on the BEAS Sept 10 Calls (35 cents), or a net debit of $125 per contract.
* With BEAS trading at $8.81, a 1,000-share position would cost us $8,810.
* Instead, if we buy 10 of the BEAS Sept 7.50 Calls (BUCIU) for $1.60 ($1.60 each times 100 shares = $160 per contract), or $1,600 and ...
* Against that purchase, we sell 10 of the BEAS Sept 10 Calls (BUCIB) for 35 cents (35 cents each times 100 shares = $35 per contract), or $350.
* Thus, on a 10-contract spread we have only $1,250 invested, so that's all we can lose!
* If you follow these guidelines, this means your broker can pay no more than $1.25 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 $125 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 $1.35 for this spread trade through Wednesday, July 13, as long as BEAS shares trade for $8.70 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 BEAS shares, you can see that the trade becomes profitable (green area) when the underlying stock crosses the $8.75 level. Likewise, while the stock is under $8.75, 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, $1.25.
Breakeven: $8.75
The breakeven is $8.75 because, as in any bull-call spread, the breakeven is determined by adding the net cost of the spread ($1.25 in this case) to the strike price of the call you are buying. Again, because we paid $1.60 for the BEAS Sept 7.50 Calls and took in 35 cents for the sale of the BEAS Sept 10 Calls, our net out-of-pocket is $1.25. You add that net to the strike price we’ve purchased ($7.50) and you get your breakeven of $8.75.
Max Profit: $125 per spread ($1.25 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 ($10 – $7.50 = $2.50) and subtracting the amount we paid for the spread ($1.25) and is therefore $1.25. Thus, if BEAS is $10 or higher on expiration, then the spread will achieve that $2.50 max and, because we paid $1.25 for the spread, that would leave us with a $1.25 profit, or 100%. On a 10-contract spread, that would translate to a profit of $1,250!
*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:
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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
