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8/10/05
THUNDER BRINGS LIGHTNING

August 10, 2005

Things are strange and keep getting stranger!

Last week was one for the books. Not because of moves that the stock market made, but rather thanks to one takeover -- that being Adidas-Salomon's bid for rival Reebok.

As we cited here last week, my Distant Thunder program (that tracks unusual activity in calls and puts) found very unusual activity going on just ahead of Adidas' bid, which sent shares of Reebok up $15 in a single session.

Without boring you with the details of the algorithms and data collection that go into this program, I will say that, in a nutshell, our computers look for activity that is above the daily, weekly and monthly averages for each and every option class in every series that is traded on every U.S. options exchange.

When volumes reach a certain threshold, they are sorted and ranked for further review. Such was the case in Reebok, where the monthly average in June was 176 call contracts per day. Suddenly, on Aug. 1 and Aug. 2, we saw more volume printing on the Chicago Board Options Exchange, Philadelphia Stock Exchange and Pacific Exchange than we saw trading during the entire month of June!

That got my attention, and you can say that you heard it here first. Stories began appearing in the media -- Doris Frankel of Reuters wrote the first news article about our observation, and then Adam Shell of USA Today ran a story that appeared in the newspaper's Money section on Thursday.

Word was on the street -- and, subsequently, Wall Street -- that what we saw was textbook insider trading and, thankfully, authorities jumped on the trail while it was still warm.

I must say that in all my years of tracking unusual options activity, I have never seen regulators jump into action so quickly and aggressively. My hat is off to them for doing such a great job.

By midday Friday, Aug. 5, authorities had found and charged a Croatian national with insider trading. Everything seemed like a typical tip-off of a relative or friend to a deal in which "material non-public information" was used to make an illegal profit. That was until Monday of this week, when -- as Paul Harvey has said countless times -- we got "the rest of the story!"

A 63-year-old retired Croatian woman, suspected of using insider information to gain millions on the Adidas/Reebok deal, said Monday that she has never bought any stock and has no clue about how the stock exchange functions! In other words, this woman charged in the insider trading (into whose account the options cleared), says she has no computer, occasionally works as a cleaning lady and receives a pension of just $263 per month!

That hardly sounds like someone who would have the $130,000 that authorities said was used to buy call options on Reebok that turned into $2 million in profit in less than 24 hours! The Associated Press, however, reported on Monday (Aug. 8) that she has a 25-year-old nephew who works as a broker in New York.

Alas, the plot continues to thicken. ...

CATCHING THE CHANGEWAVE -- SHARING IN EMC'S SUCCESS

Our Distant Thunder program has picked data storage giant EMC Corp. (EMC) as the options trade of the day because they've had strong buying of at- and out-of-the-money calls for the past week. There were rumors on trading desks that EMC might get a buyout offer at the $20 per share level, and the options activity certainly jumped on those rumors.

Here are a few more reasons to own EMC: The company will continue its aggressive share buyback this year, and it expects revenue in 2006 to grow by a brisk 14%. EMC recently reaffirmed guidance for 2005, saying it expects to earn 50 cents or 51 cents a share on sales of $9.6 billion.

Last year, EMC posted a profit of 36 cents a share on sales of $8.23 billion. Additionally, Goldman Sachs has had some positive notes on the data giant. I say we should take note of this company ourselves and make profits of our own right alongside it.






Here's how we can invest in EMC's bright future: I recommend buying the EMC Jan 12.50 Calls (EMCAV) and selling a like number of EMC Jan 15 Calls (EMCAC) for a net debit of $1.35. Sample prices that work are buying the Jan 12.50 Calls for $1.95 and selling the Jan 15 Calls for 60 cents.

Paying $1.35 for this $2.50 bull-call spread means we make $1.15 if EMC is $15 or higher on January expiration. If EMC is unchanged, this spread is worth $1.28, as EMC is trading for $13.78 and our ownership of the Jan 12.50s means we have the right to buy the stock for $15. As always, if EMC tanks and finishes below $15 in January, we could only lose that $1.35 that we paid for this bull-call spread.

To make a limited-risk investment in EMC Corp., I recommend buying the EMC Jan 12.50-15 bull-call spread for a net debit of $1.35.

TRADE DETAILS
All information is based on prices as of 11:45 a.m. Eastern on Wednesday, Aug. 10, 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 EMC Jan 12.50-15 bull-call spread through Wednesday, Aug. 17, as long as EMC shares trade for $13.60 or higher.

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

Underlying Stock: EMC Corp. (EMC)

Current Stock Price: $13.78

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	EMC Jan 12.50 Call	$12.50	EMCAV	-$1.95
Sell	1	EMC Jan 15 Call	$15	EMCAC	+$0.60
		Net Cost			-$1.35

*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 $1.35, 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 $1.35, or $135 for each spread.

For those of you who are do-it-yourselfers and are making the trade online, an order to buy the EMC Jan 12.50 Calls (EMCAV) for $1.95 while simultaneously selling the EMC Jan 15 Calls (EMCAC) for 60 cents puts you in the trade with a net debit of $1.35.

Our loss is limited to the $1.35 that we are paying for the spread. If, on the other hand, EMC Corp. rises above $15 on January expiration, then we make $1.15 on our $1.35 investment!

SUMMARY

With EMC Corp. trading for $13.78, a 1,000-share position would tie up $13,780. However, with our trade you'll be able to put just $1,350 at risk and have a potential gain of $1,150 if EMC rises to $15 or higher.

Here's why:

* Our net investment on that bull-call spread is the difference between what we paid for the EMC Jan 12.50 Calls ($1.95) and our credit on the EMC Jan 15 Calls (60 cents), or a net debit of $135 per contract.

* With EMC trading at $13.78, a 1,000-share position would cost us $13,780.

* Instead, if we buy 10 of the EMC Jan 12.50 Calls (EMCAV) for $1.95 ($1.95 each times 100 shares = $195 per contract), or $1,950 and ...

* Against that purchase, we sell 10 of the EMC Jan 15 Calls (EMCAC) for 60 cents (60 cents each times 100 shares = $60 per contract), or $600.

* Thus, on a 10-contract spread we have only $1,350 invested, so that's all we can lose!

* If you follow these guidelines, this means your broker can pay no more than $1.35 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 $135 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, Aug. 17, as long as EMC shares trade for $13.60 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 EMC shares, you can see that the trade becomes profitable (green area) when the underlying stock crosses the $13.85 level. Likewise, while the stock is under $13.85, 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, $1.35.

Breakeven: $13.85

The breakeven is $13.85 because, as in any bull-call spread, the breakeven is determined by adding the net cost of the spread ($1.35 in this case) to the strike price of the call you are buying. Again, because we paid $1.95 for the EMC Jan 12.50 Calls and took in 60 cents for the sale of the EMC Jan 15 Calls, our net out-of-pocket is $1.35. You add that net to the strike price we've purchased ($12.50) and you get your breakeven of $13.85.

Max Profit: $115 per spread ($1.15 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 $2.50 ($15 – $12.50 = $2.50) and subtracting the amount we paid for the spread ($1.35) and is therefore $1.15. Thus, if EMC Corp. is $15 or higher on expiration, then the spread will achieve that $2.50 max and, because we paid $1.35 for the spread, that would leave us with a $1.15 profit, or 85.2%. On a 10-contract spread, that would translate to a profit of $1,150!

*This analysis does NOT include the cost of commissions while executing your trades.

BUY LIST UPDATE

Shares of Qualcomm (QCOM) were up more than 3.5% to $40 after the wireless-technology company was upgraded to Equal Weight from Underweight at Morgan Stanley.

The Morgan Stanley analyst believes that the risks he saw in 2005 have already been played out, given the relative underperformance of the stock since October of last year. On July 28, we recommended the QCOM Oct 40-45 bull-call spread, which is positioned right in the driver's seat and ready to take off!