A Potential 200% Gain from an Unlikely Stock
Technology shares have been the undisputed sector leader in 2012. Apple’s gain of more than 75% since last fall carries much of the load with its heavy weighting in the NASDAQ index.
New decade plus highs not seen since the 2000 record tech boom levels has highlighted innovation and efficiency in an era of global cost cutting.
The widely followed Powershares QQQ (Nasdaq: QQQ) had appreciated 25% in three short months before an expected pause. The current pullback has held the end of February congestion support area that led to the latest leg up to the $68 area.
Shares of YHOO bottomed out at $9 in 2008 after a decline from $34 just a year earlier. The recovery has shares now near the $15.50 level with the stock also an attractive takeover target to unlock potential technology goodwill.
The six-month trading channel between $14 and $17 sets up for an YHOO price breakout. A rally run above the resistance top projects a $3 move, the width of the channel, to $20. The upside objective is 30% above the current stock price.
Only a weekly close below $13.50 and the $14 support bullish base would negate the technical technology pattern.
The Options Way: Unlimited Upside Potential with Limited Risk
#-ad_banner-#A YHOO long call option can provide the staying power in a potential larger trend extension. More importantly, the maximum risk is the premium paid.
One major advantage of using long options instead of buying or selling shares is putting up much less money to control 100 shares — that’s the power of leverage.
Choosing an option can sometimes be a daunting task with all of the choices and expirations. Simply put, traders want to buy a high probability option that has enough time to be right.
The option strike price is the level at which you have the right to buy without any obligation to do so. In reality, you rarely convert the option into shares. Simply sell the option you bought to exit the trade.
There are two rules options traders need to follow to be successful.
Rule One: Choose an option with 70%-plus probability. The Delta is a measurement of how well the option reacts to movement in the underlying security. It is important to buy options that payoff from only a modest price move. There is no need to ONLY make money on the all but infrequent price explosion.
Any trade has a fifty/fifty chance of success. Buying options ITM options increase that probability. That Delta also approximates the odds that the option will be In The Money at expiration. Buying better options are more expensive, but they are worth it — the chances of success are mathematically superior to buying cheap, long shot Out Of The Money lottery tickets that rarely ever pay off.
With YHOO trading at $15.35, for example, an In The Money $12.50 strike option currently has $2.85 in real or intrinsic value. The remainder of any premium is the time value of the option.
Rule Two: Buy more time until expiration than you may need — at least three to six months for the trade to develop. Time is an investor’s greatest asset when you have completely limited the exposure risks.
Traders often buy too little time for the trade to develop. Nothing is more frustrating than being right but only after the option has expired premature to the market move.
Trade Setup: I recommend the January 2013 YHOO $12.50 Call at $3.75 or less. A close below $13.50 on a weekly basis or the loss of half of the option premium would trigger an exit.
Looking at the YHOO chart above, the $12.50 level coincides with September support lows that confirmed the price bottom. This option strike gives you the right to buy near the lowest point for the year with absolutely limited risk. The January 2013 option gives the bull trend over eight months for development.
The maximum loss is limited to the $375 or less paid per option contract. The upside, on the other hand, is unlimited.
The YHOO option trade break is $16.25 at expiration ($12.50 strike plus $3.75 option premium). That is just a little more than dollar above Yahoo’s current price. If shares hit my $20 price target, the option investment would double, a gain of at least 200%.