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Is the Fed Resolving to Take a Breather This Year?

January 06, 2006

Dear Fellow Options Investor,

I have said it for most of the past month on my CBS radio show ("Jocks and Stocks: Taking Care of Business with Dr. J" on WSCR-AM 670 in Chicago), but to put it as plainly as I can, the Fed is nearly done!

The release of the December minutes of the Federal Open Market Committee (FOMC) meeting confirmed this, and market reaction was immediate and forceful. The Dow, Nasdaq and S&P 500 all put in strong opening performances, especially when you look at the crude oil contract, which surged to more than $64 per barrel this week.

The key phrase that so many of us noted was that Fed officials said, "Although future action would depend on the incoming data, this characterization of the outlook for policy was seen by most members as indicating that, given the information now in hand, the number of additional firming steps required probably would not be large."

That, my friends, is as black-and-white as we'll ever get from the FOMC. Thus, after 18 months and 13 straight hikes, we can indeed see light at the end of the tunnel!

On Jan. 31, Fed Chairman Alan Greenspan steps down and, as always, I watch the Fed Funds futures at the Chicago Board of Trade for indications of the likelihood of a hike or drop in interest rates. Right now, those futures are telling us that the FOMC is more than 93% likely to hoist rates at Mr. Greenspan's going-away party, but that future hikes are much less likely!

So, based on what I've seen, here is my prediction for interest rate moves and non-moves in 2006:

I think the Fed will move just once more, pause for two meetings, and then offer us two cuts -- that's right, CUTS -- by the end of '06. I expect that this week's report on U.S. manufacturing growth -- which showed a slowing in December -- gives a glimmer of hope that Mr. Greenspan's last meeting could go out with a pause. However, I stress that this is a long shot, but we can definitely hope!

CATCHING THE CHANGEWAVE -- GETTING GOOGLY-EYED OVER GOOGLE

All right, this week's pick isn't for everyone. Sure, everyone wants a piece of Google (GOOG), as it has been a darling long before it was a listed stock. But with shares now trading for $460, a 1,000-share position isn't a stock investment -- it's a new house!

The great news is that situations like Google are precisely why options and our option spreads are such powerful investment tools. Right now, you can invest with me in Google for not $460, not $225 -- no, not even one-tenth of that. Get this: If you follow my recommendation, you can control shares of Google (trading between $470 and $480) for just 1.6% of what it would cost you to buy 100 shares of GOOG!

You already know that Piper Jaffray made headlines this week, moving their target up to $600, and they were followed by Bear Stearns, which raised its price target to $550. What you may not know is that our proprietary Distant Thunder program (which tracks unusual buying activity) caused us to raise our target to $500 back in December. To these catalysts, throw in the any-day-now inclusion into the S&P 500, and you have some very compelling reasons to own the king of Internet search engines.




Here's how we invest in the future of this fantastic stock, with very limited risk.

I recommend buying the GOOG March 470 Calls (GOPCG) and selling a like number of GOOG March 480 Calls (GOPCI) for a net debit of $3.40. If you did this spread 10 times, you'd be investing $3,400, but as always, that is the entire exposure you have! If GOOG gets an inclusion to the S&P and shares are $480 or higher, this spread will expand to $10, a profit of $6.60, or $6,600!

I will pay $3.40 for this spread with GOOG trading $450 or better until Wednesday, Jan. 13.

To make a limited-risk investment in Google, I recommend buying the GOOG March 470-480 bull-call spread for a net debit of $3.40.

TRADE DETAILS
All information is based on prices as of 11:30 a.m. Eastern on Friday, Jan. 6, 2006.

* 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 $3.40 for the GOOG March 470-480 bull-call spread through Wednesday, Jan. 11, as long as GOOG shares trade for $450 or higher.

Due to the volatility of GOOG shares, we are unable to provide an example with a $3.40 spread. For the purpose of this broadcast, we are using $4 for today's sample spread trade. However, the recommendation remains at $3.40.

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

Underlying Stock: Google (GOOG)

Current Stock Price: $461.33

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	GOOG March 470 Call	$470	GOPCG	-$28.10
Sell	1	GOOG March 480 Call	$480	GOPCI	+$24.10
		Net Cost			-$4.00

*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 $4, 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 $4, or $400 for each spread.

For those of you who are do-it-yourselfers and are making the trade online, an order to buy the GOOG March 470 Calls (GOPCG) for $28.10 while simultaneously selling the GOOG March 480 Calls (GOPCI) for $24.10 puts you in the trade with a net debit of $4.

Our loss is limited to the $4 that we are paying for the spread. If, on the other hand, GOOG rises above $480 on or before March expiration, then we make $6 on our $4 investment!

SUMMARY

With GOOG trading for $461.33, a 1,000-share position would tie up $461,330. However, with our trade you'll be able to put just $4,000 at risk and have a potential gain of $6,000 if GOOG rises to $480 or higher.

Here's why:

* Our net investment on that bull-call spread is the difference between what we paid for the GOOG March 470 Calls ($28.10) and our credit on the GOOG March 480 Calls ($24.10), or a net debit of $400 per contract.

* With GOOG trading at $461.33, a 1,000-share position would cost us $461,330.

* Instead, if we buy 10 of the GOOG March 470 Calls (GOPCG) for $28.10 ($28.10 each times 100 shares = $2,810 per contract), or $28,100 and ...

* Against that purchase, we sell 10 of the GOOG March 480 Calls (GOPCI) for $24.10 ($24.10 each times 100 shares = $2,410 per contract), or $24,100.

* Thus, on a 10-contract spread we have only $4,000 invested, so that's all we can lose!

* If you follow these guidelines, this means your broker can pay no more than $4 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 $75 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 $3.40 for this spread trade through Wednesday, Jan. 11 as long as GOOG shares trade for $450 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 GOOG shares, you can see that the trade becomes profitable (green area) when the underlying stock crosses the $474 level. Likewise, while the stock is under $474, 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, $4.

Breakeven: $474

The breakeven is $474 because, as in any bull-call spread, the breakeven is determined by adding the net cost of the spread ($4 in this case) to the strike price of the call you are buying. Again, because we paid $28.10 for the GOOG March 470 Calls and took in $24.10 for the sale of the GOOG March 480 Calls, our net out-of-pocket is $4. You add that net to the strike price we've purchased ($470) and you get your breakeven of $474.

Max Profit: $600 per spread ($6 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 $10 ($480 - $470 = $10) and subtracting the amount we paid for the spread ($4) and is therefore $6. Thus, if GOOG is $480 or higher on expiration, then the spread will achieve that $10 max and, because we paid $4 for the spread, that would leave us with a $6 profit, or 150%. On a 10-contract spread, that would translate to a profit of $6,000!

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

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

P.S. If you'd like to know more about how I routinely turn the odds in my favor when trading options by using simple, easy-to-learn techniques, I will be hosting a FREE 60-minute teleseminar in January.

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Finally, I'll give you an opportunity to instantly put into practice what you learned by issuing an option trade that you can make immediately after the FREE teleseminar is done.

I don't know what this trade is yet, but I can promise you that something fresh will catch my eye that day and I'll pass it directly along to you.

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