2006 Year Of The Dragon

CAUTION: The following post contains extraordinary graphical representations of incredibly ridiculous, extremely exponentially, jet-like propulsionary pie-in-the-sky stock charts that could create mild to severe delusions of greedy grandeur.

What do you get when you add "China" to a stock? Definitely not hari kari (I think that's Japanese which is close to China). Rather, you get small float stocks with incredible growth potential and short squeezes all the way up to atmospheric proportions.

Let me just say that these charts below tell what the China growth story can do to a stock.

Now here comes the always infamous "hindsight is 20/20" what if scenario.
We'll use China Life Insurance (LFC) for this whatif.

What if instead of buying the stock, you got an idea to buy the Dec06 or Jan07 Calls in August 06. And let's say that instead of buying 100 shares at around $25 per share (split-adjusted) at that time, you bought 1 Jan07 25 Call contract for $5.00/contract.

Let's do the math together just so everyone is on the same page:
Stock purchase= 100 shares x $25.00 = $2,500 total capital outlay (plus commission)
Option purchase= 1 contract = 100 shares x $5.00 (premium)= $500 (plus commission)

Theoretical Stock Proceeds if sold December 29th, 2006 (last day of trading for the year) = $50.00

100 shares x 50.00 = 5,000 (less commission) Total p/l = $2,500 (+100%)

Theoretical Option Proceeds if sold 12/29/06 = Jan07 25 Call Premium = 25.00/contract

1 contract = 100 shares x 25.00 = $2,500 (less commission) Total p/l = $2,000 (+400%)

Now what if you weren't so bullish on LFC and you instead bought puts. Then you're options would have been worthless had you held them for this long costing you your initial capital outlay of $500. Had you shorted the stock and did not cover you'd have incurred many margin calls and lost a lot more than your original investment.

I point this out to illustrate the benefit of longer term option plays in lieu of buying the stock. This can also be said for the reverse king of trade; that of buying puts. Keep in mind that this is an extreme example but nonetheless possible. One could have used trading Microsoft as well which is a large cap stock with less growth potential and performed almost as well.

Well, I warned you about the delusions that these charts and scenarios would cause you. It's up to you whether or not you want to entertain or eradicate them. Whatever you do, the million dollar question is what will 2007 hold for the dragon? Will it be a "gong" (sorry about that pun), or will it be an eragon (have not seen the movie but it seems to be popular)?

To be continued....
Happy New Years!!!

Boring Old USG Sheetrock Play

I know, I know. You're probably thinking what kind of option trader even considers an old Berkshire Hathaway Buffett holding like USG? Well here are my reasons and as always in the Jungle, you're welcome to dispute these and/or wave them all off (that's the fun about optionocracy).

Ok here's my take:

1. Fundamentals (Fundies)-take a look at Seeking Alpha's A Closer Look at USG Corporation review of USG's recent action. I wanted to make sure that the whole Asbesto thing is behind USG, which it seems to be.

I know that Buffett's cost basis is around the $40s but he still could add to his position later. USG seems to have a buffer for a weak housing market with commercial construction continuing strong and of course, like Buffett, I think the brand "sheetrock" is strong like "coke".

2. Technicals-for longer term option plays I like solid companies (ie Microsoft in July 06) that get beat up once in a while. The chart below validates that USG seems to have found strong support in the mid-40 range.

The chart also shows some accumulation going on once it broke above the 50 level. A breakout above 58.50 with strong volume would definitely confirm a new uptrend beginning. Also, for you technicians out there, we are seeing the beginning of the famous "rounded bottom" recently. That tends to be bullish.

3. Option pricing-I'm looking at the Aug07 50 Calls that are currently priced at $9.80. Why the 50's? Because we have some plenty of intrinsic value and that is where I'd like the stock not to drop below.

A premium caveat is needed here however. The theoretical value for the Aug07 50 Calls is currently around $9.00. I'd like to see the premiums there if possible for entry.

The delta is currently 0.75 which gives you a nice .75 increase to your cost basis for every $1.00 increase in the underlying USG security (all things being equal).

4. Implied Volatility-the IV for the Aug07 50 Calls is currently around 35%. That is moderately above the 52 wk IV lows of 31%. That means that if we get an IV hike (usually around earnings or any anticipated event where there is an uncertain outcome) we'll get extra "juice" poured into the premiums (this could be a chance to insert an Option Jungle pun from now on-let's call any increase in IV "jungle juice").

5. Risks-the housing sector gets worse and the demand for sheetrock could decrease. Buffett decreases his holding in USG. Some sort of Asbesto claim rearises. The stock drops below $50 for a shorter term concern and then $46 for a longer term technical concern. The volume and open interest for these options is light but the spread between the bid and the ask is still reasonable.

6. Entry-I'd like to review the prices after the new year and look for an entry where the premiums start getting closer to fair theoretical value.

Grab a "vine" and swing by to post your comments as always welcomed.

Happy New Year and I'm still debating on my other healthcare stock that I wanted to discuss.

Has The UNH Scandal Been Priced In To The Stock?

I have to admit that I'm no fan whatsoever of health insurers especially giant and unethical ones. Having said my purely subjective and baseless comments, I paradoxically give you my objective viewpoints about how I might possibly play UNH on another longer term option play.

1. Fundamentals (Jim Cramer of "Mad Money" calls these the fundies-which I like). Their founder has recently resigned and according to this report SEC Inquiry of UnitedHealth Becomes Formal Investigation he's adjusted his options to reflect the highest stock price during the 1997-2002 period (what a charitable guy-always looking out for the stockholder's value).

UNH has already told investors that they will take greater charges than previously predicted. I think that given all of these events, investors can now look forward to more price gauging and exploiting the human need for healthcare (sorry about the extra editorial but I had to throw that in there to remind you all that I don't fall in love with stocks or companies I trade).

2. Technicals. The chart below shows that the stock has endured plenty of selling pressure and is starting to find an uptrend. It seems to be consolidating here between the $52-54 range.

3. Option Pricing-Since UNH is not what a trader would consider a "fast mover", the Jun 07 50 or 55 Calls should give us plenty of time for it to make its gradual move higher. If you are a little more bullish on 07 for UNH and think that the breakout above the 54 level will occur soon than the 55 Calls would be your flavor.

4. Premium-Right now the Jun 07 50 Calls are trading at a fair theoretical value and the Jun 07 55 Calls are actually trading a little under FTV. Current premiums are $6.60 and $3.50 respectively.

5. Implied Volatility (IV)- IV on the above referenced calls are about 25 and 23% respectively which in accordance with the Ivolatility chart below is near 52 week lows and has potential of rising.

6. Risks-Given that the markets have had a phenomenal run and appear to finish strong for the year, UNH has also participated in this run since November even after the Democrats took control of the Congress. Shorter term downside risk would be a drop below $50 with intermediate to long term damage being done below $46.

7. Entry point-I'm planning on waiting after the new year to see what the first week of regular volume level trading will bring to the overall markets. Again, I'd like to see a breakout above 54 with above average volume before I pull the trigger but I'll post my entry decision at any rate.

Alright. That's my take on this play, grab a "vine" and feel free to tell me I'm "bananas" (excuse the Jungle puns but it makes life a little more interesting) or if you can vouch for my idea or if you have any questions.

"Swing" on by and post a comment.

Look for my other healthcare play coming next.

Is FDC As A LBO Candidate A Good Play?

I want to preface this post by saying that I've done my fair share of chasing for the next buyout target and let me tell you, the odds have typically been against me. Having said that, I do like a couple of things from a trader's standpoint that make FDC an interesting longer term play regardless.

1. The fundamentals seem to support what Reuters posted
US CREDIT-First Data spread weakness to persist on LBO fear
(Thu, Dec 21) that "First Data has excellent cash flow and some high margin business", said Dave Novosel, analyst at New York-based Gimme Credit. The company also has different business segments that could be spun off or sold, he said.

2. A lot of technical support at the $24 level going on since late Oct as evidenced by the chart below:


3. The August ATM Call option IV levels are close to 52 wk lows of 22% which after a nice collaspe of IV due to a recent earnings annoucement makes for a potential IV hike if and when a LBO announcement is made:

4. The August options would make sense here to offset any time decay against any strike premium we choose.

5. The Aug 07 25 Call Option premiums are slightly below theoretical value which gives us a nice comfort level with regards to IV and premium cost.

6. The delta for the Aug 07 25 Calls is currently at .60.

Those are some of my reasons for possibly justifying a longer term position in FDC call options. I'd would prefer a breakout above the recent consolidated range high of about 25.50 to 26 with above average volume on the stock to confirm a move higher. The problem then would be a probable increase in IV.

The risk/reward ratio would be based on an exit out of the option if the stock closes below the 22.00 level which would more than likely put premium at about $1.00-1.20 level based on current price of $2.40-2.50.

So there you have my first possible play for those of you who might like a little longer term play that includes a possible LBO factor.

I certainly welcome your feedback on this idea. Grab a "vine". I'll certainly keep all abrest of any entry points that I may plan to make on this play in future posts.

Disclaimer

This is a personal web site, reflecting the opinions of its author and commentators. The information on this site is provided for discussion purposes only, and are not investing recommendations. Under no circumstances does this information represent a recommendation to buy or sell securities. All participants may have positions in some or all of the names that are mentioned.

About Option Jungle

Option trading can be likened to a "jungle out there". Option Jungle Blog is designed to enable all option traders or anyone interested in options alike to share option trade ideas and give and get feedback.

It is not a site to push a product or service or any particular strategy. It is to provide a path for all traders to be enlightened and empowered in using options as an investment strategy.

I am a self-taught option and stock trader since 1998.

I co-operated a small daytrading franchise in 1999 and later mentored self-directed investors in option trading. I use Interactive Brokers for my trade execution and I use prophet real-time java charts for my technical analysis.

My option trading focuses primarily on three approaches: short term momentum directional trading, credit spreads, and longer term "undervalued" or "overvalued" plays.

I hope that everyone will feel comfortable in participating in getting through the "jungle". Feel free to send me a "vine" anytime via email at tmk0427@gmail.com.

Terence

The Real Me