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8/4/05
'WORKING' IT

August 04, 2005

When I'm looking for indicators that haven't already been addressed as potential catalysts for the market to continue its upside move, I turn to fresh data rather than just rehashing the same tired, old issues.

This week, I unearthed something from a nonprofit human-resources trade group named WorldatWork.org that deserves our attention, as it could be (or might become) one of those significant catalysts.

WorldatWork found that a greater number of employers expect to administer pay raises this year. Their survey of 2,400 firms (collectively employing approximately 14 million workers) found that the employers will give raises to 92% of their workers this year -- up from 87% last year. Even though the latest reading is below the 94% number they registered in 2001, it is nonetheless the highest reading since that time.

The average raise is expected to be 3.7% of an employee's salary this year, and these same employers expect the average to inch up to 3.8% next year. Mr. Greenspan and his fellow members of the Federal Open Market Committee should like these figures, as inflation averaged 3.3% in 2004 and seems on track for a similar reading this year.

In other words, employers aren't facing anything like the 1980s, when inflation was running about 10.3%, and employers had to increase salaries by 10.6%. These figures are also considerably better than the 1990s, when pay hikes averaged about 5.6% while inflation ran at about 5.4%.

WHAT THE OPTIONS MARKETS ARE TELLING ME

When the news broke yesterday that Adidas-Salomon AG was buying rival Reebok (RBK) for $3.78 billion, shares of RBK exploded -- trading as high as $57.45 yesterday, up $13.50 from Tuesday's closing price. That's a fantastic move, but from where I sit, I'd say some folks got wind of this a little earlier than the rest of us!

Twice in the past three weeks, I've seen massive call-buying in Reebok. The buying was so huge that it dwarfed the normal trading volumes, and this action is explainable as trading related to either a known event (such as earnings) or to the darker possibility that someone had access to (and acted upon) nonpublic information.

In June, the average daily volume for Reebok options was 176 contracts per day, with a monthly total of 3,879 contracts. The options had a high-volume day on June 22, when 895 contracts changed hands.





Our computers -- which track every print on every exchange of every call or put -- show that on Tuesday (Aug. 2), Reebok traded 5,131 contracts, with 3,674 contracts traded in the previous session (Aug. 1).

Previous volumes in July are more rationally explained. On July 21, there were 3,179 contracts traded; 3,358 traded on July 20 and 1,069 contracts changed hands on July 19. This volume on these three days was almost certainly earnings-related, as Reebok posted an impressive 70% jump in profits on July 21.

The Aug. 1 and Aug. 2 volumes are not easily explained and have resulted in massive gains for the buyers. For instance, the RBK Aug 42.50 Calls were $1.60 Tuesday night, but they traded as high as $16.10 yesterday! The RBK Aug 45 Calls were 55 cents Tuesday night, and those traded as high as $12.50 yesterday.

Also, the RBK Aug 47.50 Calls were one thin dime Tuesday night, yet they traded as high as $11.20 yesterday.

This sort of activity can hardly be attributed to really good luck for the call-buyers. Rather, this looks like a case of textbook, insider-buying activity.

CATCHING THE CHANGEWAVE -- THE MONEY-MAKER OF THE MILLENNIUM

Last week, fellow ChangeWave analyst Bryan Perry put out a buy on Millennium Pharmaceuticals (MLNM). In his ChangeWave Tactical Trader newsletter, Bryan cited such recent, positive developments as the naming of a new CEO who ran the North American Oncology Operations for Novartis as well as positive Phase II clinical trial results in patients with multiple sclerosis as reasons for his bullish outlook.

Late last week and early this week, our proprietary tracking software began to pick up very positive money flow into MLNM call options. Yesterday (Wednesday, Aug. 3), our Distant Thunder program found an astonishing imbalance of buying of the MLNM Sept 10 Calls for 95 cents.

The buyers have consumed upward of 7,500 call options, and that represented 98% bullish activity, as these trades were going on the offer!





This kind of action is something we shouldn't miss. Here's how we play this compelling stock:

I recommend buying the MLNM Nov 10 Calls (QMNKB) and selling a like number of MLNM Nov 12.50 calls (QMNKV) for a net debit of 80 cents. With Millennium Pharmaceuticals trading for $10.20, the MLNM Nov 10 Calls are in-the-money by 20 cents, so we are paying 60 cents of extrinsic premium for this spread.

If Millennium shares trade for $12.50 or higher, then this spread expands to its full potential of $2.50, and because we are paying 80 cents for it, we will make $1.70, or more than 112.5%. If MLNM falls below $10 on November expiration, we would lose our 80-cent investment.

To make a limited-risk investment in Millennium Pharmaceuticals, I recommend buying the MLNM Nov 10-12.50 bull-call spread for a net debit of 80 cents.

TRADE DETAILS
All information is based on prices as of 11:05 a.m. Eastern on Thursday, Aug. 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 80 cents for the MLNM Nov 10-12.50 bull-call spread through Wednesday, Aug. 10, as long as MLNM shares trade for $9.80 or higher.

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

Underlying Stock: Millennium Pharmaceuticals (MLNM)

Current Stock Price: $10.20

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	MLNM Nov 10 Call	$10	QMNKB	-$1.20
Sell	1	MLNM Nov 12.50 Call	$12.50	QMNKV	+$0.40
		Net Cost			-$0.80

*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 80 cents, 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 80 cents, or $80 for each spread.

For those of you who are do-it-yourselfers and are making the trade online, an order to buy the MLNM Nov 10 Calls (QMNKB) for $1.20 while simultaneously selling the MLNM Nov 12.50 Calls (QMNKV) for 40 cents puts you in the trade with a net debit of 80 cents.

Our loss is limited to the 80 cents that we are paying for the spread. If, on the other hand, Millennium Pharmaceuticals rises above $12.50 on November expiration, then we make $1.70 on our 80-cent investment!

SUMMARY

With Millennium Pharmaceuticals trading for $10.20, a 1,000-share position would tie up $10,200. However, with our trade you'll be able to put just $800 at risk and have a potential gain of $1,700 if MLNM rises to $12.50 or higher.

Here's why:

* Our net investment on that bull-call spread is the difference between what we paid for the MLNM Nov 10 Calls ($1.20) and our credit on the MLNM Nov 12.50 Calls (40 cents), or a net debit of $80 per contract.

* With MLNM trading at $10.20, a 1,000-share position would cost us $10,200.

* Instead, if we buy 10 of the MLNM Nov 10 Calls (QMNKB) for $1.20 ($1.20 each times 100 shares = $120 per contract), or $1,200 and ...

* Against that purchase, we sell 10 of the MLNM Nov 12.50 Calls (QMNKV) for 40 cents (40 cents each times 100 shares = $40 per contract), or $400.

* Thus, on a 10-contract spread we have only $800 invested, so that's all we can lose!

* If you follow these guidelines, this means your broker can pay no more than 80 cents 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 $80 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 80 cents for this spread trade through Wednesday, Aug. 10, as long as MLNM shares trade for $9.80 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 MLNM shares, you can see that the trade becomes profitable (green area) when the underlying stock crosses the $10.80 level. Likewise, while the stock is under $10.80, 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, 80 cents.

Breakeven: $10.80

The breakeven is $10.80 because, as in any bull-call spread, the breakeven is determined by adding the net cost of the spread (80 cents in this case) to the strike price of the call you are buying. Again, because we paid $1.20 for the MLNM Nov 10 Calls and took in 40 cents for the sale of the MLNM Nov 12.50 Calls, our net out-of-pocket is 80 cents. You add that net to the strike price we've purchased ($10) and you get your breakeven of $10.80.

Max Profit: $170 per spread ($1.70 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 ($12.50 – $10 = $2.50) and subtracting the amount we paid for the spread (80 cents) and is therefore $1.70. Thus, if Millennium is $12.50 or higher on expiration, then the spread will achieve that $2.50 max and, because we paid 80 cents for the spread, that would leave us with a $1.70 profit, or 112.5%. On a 10-contract spread, that would translate to a profit of $1,700!

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