This Out-of-Favor Stock Could Make You 50%

CIENA Corp. (NASDAQ: CIEN) is a stock that has fallen out of favor stock with investors during the past few years. In 2007, it traded up around $50, and it was at almost $30 just last year. Cheap is a relative term, but with shares now at about $12.60, prices are close to 75% below their peak.

During the past five years, $10 has remained a key support price for the stock. A solid quadruple-bottom held in 2009, 2010, 2011 and 2012.

The recent profit-taking pullback has CIEN sharply lower from the 52-week high made in August above $18 per share. And the bullish divergence in the stock, with new lower lows in price but volatility not posting new highs, is often the sign of a significant price base.

CIEN Chart

The initial upside objective is the $15 gap. The next target is the $19 halfway retracement bounce of the 2011 highs to 2012 lows. Only a weekly close below the $11 level would negate the basing pattern.

While the initial $15 target is almost 20% above the current stock price, you could potentially make close to 50% profits on the same price move with a stock substitution strategy.

One major advantage of using long call options rather than buying shares is putting up much less to control 100 shares — that’s the power of leverage. But with all of the potential strike and expiration combinations, choosing an option can be a daunting task.

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Simply put, you want to buy a high-probability option that has enough time to be right, so there are two rules traders should follow:

Rule One: Choose an option with 70%-plus probability.

Delta is a measurement of how well an option follows the movement in the underlying security. It is important to buy options that pay off from a modest price move in the stock or ETF rather than those that only make money on the infrequent price explosion.

Any trade has a 50/50 chance of success. Buying in-the-money options increases that probability. Delta also approximates the odds that the option will be in the money at expiration. In-the-money options are more expensive, but they’re worth it, as your chances of success are mathematically superior to buying cheap, out-of-the-money options that rarely pay off.

For example, with CIEN trading around $12.60at the time of this writing, an in-the-money $10 strike call currently has $2.60 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 do not buy enough time for the trade to achieve profitable results. Nothing is more frustrating than being right about a move only after the option has expired.

I recommend the CIEN April 10 Calls at $3.75 or less.

CIEN Options Chart

The $10 option strike gives you the right to buy below the yearly lows with absolutely limited risk. A close below $11 in the stock on a weekly basis or the loss of half of the options premium would trigger an exit. If you do not use a stop, the maximum loss is still limited to the $375 or less paid per option contract. The upside, on the other hand, is unlimited. And the April option has six months for the desired move to develop.

This trade breaks even at $13.75 ($10 strike plus $3.75 options premium). That is a little more than $1 above CIEN’s current price. If shares hit the conservative $15 price target, the option would produce a nearly 50% return.

Recommended Trade Setup:

— Buy CIEN April 10 Calls at $3.75 or less
— Set stop-loss at $1.88
— Set initial price target at $5.50 for a potential 47%-plus gain in six months