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LEAP Options
The Smart Profits Report: Issue #177
Thursday, January 20, 2005
LEAP Options: The Intel Bargain & A Potential 566% Return
By Karim Rahemtulla
Chairman, Mt. Vernon Research
Some people feel nothing but pain when the market falls. But I have often made the most money in down markets - more money than in ones that are moving higher or sideways.
Down markets are a dream for LEAP options or long-term options. Here’s the simple reason: Would your rather want to own a two- or three-year call option on a company like Intel when the market is valuing it at 10 times sales or at 3 times sales? When a lousy market has pulled a popular (and good) company down that far, you have a good long-term opportunity, and sometimes a genuine bargain on your hands.
A few years back Intel was trading at $70 per share. The Nasdaq 100 index was trading at 5,000. Intel LEAPS calls were around, and some people were even trading them then. The thinking was that momentum has no bounds and the company would continue to grow year after year at double-digit rates… you know the story.
Today Intel is at $23, about 3.5 times sales, a low for the company. It just announced a record quarter and forecast an excellent year ahead. Yet, now people are treating the company as a pariah. Instead of buying on a bullish forecast for better times ahead, investors are willing to sit on their hands or put their faith in less proven companies. Meanwhile, Intel is poised to produce a very nice return for us that could easily reach high triple-digits.
Let me explain…
An Intel LEAP Play That Could Return 566%
It is precisely at times like this that you should look over your holdings for the real companies with real earnings… and put aside the fads.
Fads usually end badly - see TASR and Krispy Kreme if you want to watch how fad stocks work.
Real companies cycle from good earnings to great earnings. Intel is now on track for great earnings.
Of course, it would have been a good time to invest in Intel a few weeks ago, before it announced its projections and its earnings. And in fact, I had bought Intel LEAPS options a couple of months back.
Not only did we take profits, we also entered into a bull spread, controlling shares of Intel for pennies.
We bought Intel options that had a $22.50 strike price when Intel was around $21. Within a couple of weeks, Intel announced that it would have a better-than-expected quarter.
The shares surged to $23 and it was clear we had made a good choice.
Now we could either take some super-sized profits or engage a bull-spread.
We Chose Both: Bull Spreads & LEAP Options
We took profits (for those who don’t like spreads) and we sold the $25 calls as the second part of our spread. By selling the $25 calls, we took a good chunk of our original investment off the table to re-deploy elsewhere.
We also set ourselves up for a huge return on our money at risk. If Intel closes at $25 or higher by January 2006, we stand to make something like $2,000 on a $300 investment - or approximately 566%.
Not bad for a down market.
I strongly believe that buying good companies cheap is a good strategy. What makes it even better is to buy the same company for 10% of what its shares are selling for and have years on my side to find out if I was right.
Great trading,
Karim
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Today’s Smart Profits Cribsheet
- Can’t fool you! Last week’s Smart Profits #175, Limit Prices: Tip the Odds on Options Trades In Your Favor contained an error… I made mention of each nickel in an option trade being worth $50. In actuality, that should have been $5. The reason I said $50 is because I am always under the assumption of using 10 contracts for purposes of example since it is easier to work with round numbers. Please forgive the oversight.
- Check out the Smart Profits Glossary for defintions of words like “LEAP” or “bull spread” found in today’s article.
Related Articles:
- Using LEAPS: These Options Are Set to Run Full Tilt
- LEAPS As Proxies: Making 30% While Others Make 3% - On the SAME Stock
- Timing Your Trades: Two Ways to Expand Your Thinking And Your Profits
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