News Analysis date published New: 
Tuesday, October 2, 2012 - 16:00
New Date created: 
Tuesday, October 2, 2012 - 16:00
New Date last updated: 
Tuesday, October 2, 2012 - 16:00

Why Make 15% on This Stock When You Could Make 100%?

Tuesday, October 02, 2012 4:00 PM

Tech shares have led the market resurgence with the Nasdaq hitting new decade-long-plus highs in recent weeks.

As you can see in the chart below, the year-to-date gains in the Nasdaq closely mirror those of Oracle (Nasdaq: ORCL). The benchmark index is up a little more than 18% since Jan. 1, while the enterprise software giant is up 23%.

But if you look at the price action for the last one-year period, it shows that Oracle has underperformed with only about one-third of the tech rise. However, when looking at five and ten year periods, this stock has done much better by more than doubling the index's returns.

In the next chart, you can see that during the past two years, $30 has remained a key pivot price for this stock.

A solid triple-bottom has formed at the $25 support level. The recent profit-taking pullback has found support once again at the $30 level. A breakout rally above the September highs at $33 targets $36 and the 2011 resistance top. Only a weekly close below the $26 base would negate the technical pattern.

The initial upside objective of $36 is 14% above the current stock price, but there is a way you could potentially double your money 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.

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 Oracle trading around $31.50 at the time of this writing, an in-the-money $29 strike call currently has $2.50 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 Oracle March 2013 29 Calls at $4 or less.

This option strike gives you the right to buy below the $30 pivot point with absolutely limited risk. A close below $26 in the stock on a weekly basis or the loss of half of the option premium would trigger an exit. If you don't use a stop, the maximum loss is still limited to the $400 or less paid per option contract. The upside, on the other hand, is unlimited. And the March 2013 option has more than five months for the desired move to develop.

This trade breaks even at $33 ($29 strike plus $4 option premium). That is just a little more than $1 above Oracle's current price. If shares hit my conservative initial price target of $36, the option should double.

Action to Take --> Buy Oracle March 2013 29 Calls at $4 or less. Set stop-loss at $2. Set price target at $8 for a potential 100% gain by March 2013 expiration.



This article originally appeared on TradingAuthority.com:

Why Make 15% on this Stock When You Could Make 100%?

Alan Knuckman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.