Cyberonics

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Jul 16, 2005 10:08 am

When somebody tells me they made $350,000 in a single stock in a single

year I never believe it, but it does pique my interest regarding what

they were talking about.



I had never heard of Cyberonics--I know, I know it's probably the

hotest thing on Nadaq, but I don't care about it. One of the

basics about investing is to attempt to understand a few things very

well rather than a lot of things not so well. Ever been to one of

those restaurants that has a Chinese, Italian, Mexican menu? One

thing's for sure, you're not going be having a good meal.



Anyway, I decided to take a look at CYBX. It's a company that

sells some sort of electrical thing that jolts the brain--yep, just

like that woman who talks like the Aflac duck in the commercials.

Mad scientist type stuff--but apparently they have FDA approval.

Anyway, it's really techie.



The stock has been as low as in the 12s in the last year and is

currently 44 to 45. Good run--nothing seriously stunning but a

good run.



What caught my interest was the value of the options--Imagine that, a Put Trader looks at the options.



They are exceptionally--or should I say EXCEPTIONALLY--pricey. I

don't have the screen up--and the bids and offers have been spread

because the market it closed--but late last night, I was looking at

them and was surprised at the opportunities I was seeing. Of

course I have to wait till Monday to actually price them out but what I

was seeing is very interesting.



The stock is at 44.50 let's say--in that area. An January

2006--like August, September, October, November, December, January--40

straddle last traded at about 19--12 for the call and 7 for the put.



What that means is there are professional traders who think the stock

might be below 33 by January--they also think it might be above 52.



This provides OPPORTUNITY to add Alpha.



If you were to write the straddle at 18 (give up a buck to bid ask

differentials and commissions) twnety times you would collect

$36,000. The margin call on such a trade varies from firm to firm

but it would be approximately 25% of the value of the stock.

Two-thousand shares at 45 is $90,000--25% of that is $22,500.



You do not have to have cash--you could do the trade if you have on

deposit securities with a loan value of $45,000. Generally that

would be $90,000 worth of something--as a rule of thumb if you're going

to use securities in lieu of cash the securities on deposit must have

market value equal to the securities you're going to play with.



So, you sell the twenty straddles and collect the $36,000. Then

you wait. July becomes August, August becomes September--you

know, time passes. Eventually it will be January. If you're

a child such as SaySo, or have the IQ of a child like Roger, it will

seem like forever--but if you're an adult you know what it means when

they say "time flys."



Anyway you wait. Now in January the stock will be

somewhere--remember it's 44 or so now. Let's suppose it loses 10%

of its value between now and then and is trading at 40.



The $40 calls that you sold in July for $24,000 (2,000 x 12) will be

worthless--nobody will force you to sell them 2,000 shares of CYBX at

$40 when it's available at $40 on Nasdaq.



Similarly, the $40 puts which you sold for $12,000 (2,000 x 6) will

also be worthless--nobody is going to force you to buy 2,000 shares at

$40 when they can be sold for $40 on Nasdaq.



Let's see what that is as a percentage. $36,000 divided by

$22,500 is, why it's a number that begins with 1. Don't see that

when you're doing your mutual funds and annuities do you boys and

girls. And you know what else-that return is generated in half a

year--you really should double it.



The downside is you have to declare a $36,000 short term capital gain,

you still have your mutual funds, and you still have the income those

funds generated. Just please don't throw me in the briar patch.



Ah, I can hear it now. The nimrod in the back of the room is

raising his hand and say, "But Professor Trader, there has to be

risk. Right?"



Yes, boys and girls there is risk. Lots and lots of it. You may have heard about the Risk/Reward Ratio.



If the stock should collapse you're going to have to buy 2,000 shares

for a total of $80,000. You do get to keep the $36,000 you

collected in July so your net investment will be $44,000 or $22 per

share. In other words you will lose if the stock loses 50% of its

value between now and January.



Yes Nimrod, another question? You want to know what happens if it goes up? OK lets see.



If the stock goes up you will have to sell 2,000 shares for

$80,000. Again you get to keep the $36,000 so you're going to

have a cash balance of $116,000 to spend on the shares. That's

$58 per share.



The stock is now at 44 so if it rises by $14 points you'll begin to

lose. $14 is just a bit shy of 32% of $44. January is only

six months from now so the 32% is really 64% on an annual basis.



Is the stock going to be cut in half by January? Is it going to rally at a 64% annualized clip by January?



That's the pay your dime and take your chances.



When I read things like Cyberonics delays analysts meeting it makes me

a little nervous. When I read the story about how the company was

all but certain that they were going to be acquired by St Jude and had

no ongoing plan beyond that it makes me very nervous.



As for Putnam. I may stick my toe in the water, but if I do I'll be

writing calls naked and staying away from the puts--no way to I want to

buy this puppy at $40, even if I do get to keep the put premium.



I can hear it now. Roger will come along and say that he's

not impressed with a strategy that returns only $36,000--why that will

hardly buy fuel for his Cobalt. You know, failed planner

money...well maybe piker money, but certainly not top gun producer type

stuff.



Fine, don't do it twenty times do it forty, fifty or one hundred

times. You're only limited by how big your balls are and how many

dollars in mutual funds you can leave on deposit till January.



Jul 16, 2005 10:15 am


You do not have to have cash--you could do the trade if you have on
deposit securities with a loan value of $45,000.  Generally that
would be $90,000 worth of something--as a rule of thumb if you're going
to use securities in lieu of cash the securities on deposit must have
market value equal to the securities you're going to play with.



Just damn, I'm off on that.  The $22,500 cash requirement can be
met by depositing securities worth only $45,000 not $90,000.  That
makes it even more within the reach of the schlubs.



Ah, wait a question from Nimrod at the back.  What's that?  Oh, right the minimum equity issue.



That's true at most firms you're going to have to have an account with equity upwards of $50,000 to even be allowed to do this.

Jul 16, 2005 10:47 am

Well, private mail questions have started.



1.  You will find it very difficult to engage in strategies like this if you don't work for a real brokerage house.



2.  Of course you can do things to try to protect yourself. 
Options are liquid contracts, so assuming the market is open and the
stock is freely trading you can engage in transactions to get you out
of the market.



They are joked about as, "You can keep the cheese, just let me out of the trap."



Suppose CYBX starts to run--opposite of crash.  Remember, your
break even point is at 58.  Good options traders react rather than
"fight the tape."  You can sit there all day long screaming, "It
shouldn't be this high, it's going to go down I know it's going to go
down" and end up even more wrong.



So react.  I could write pages about how you get out, let's just say you can get out.



Ditto for it it crashes.  You don't lose unless it goes under $22
but assuming that it's not my nightmare for this stock--they stop
trading it one day when it's (say) $30 and it simply never opens again
because it's really just a house of cards or they're into creative
accounting.



One wonders why an almost certain merger fell apart at the altar, and
why they cancel and delay meetings with analysts.  One also
wonders about the class action law suit working its way through the
Illinois courts--no big deal, just something about securities fraud.

Jul 16, 2005 2:55 pm

Just so everybody knows, puttndacrack is copying and pasting these examples from other sources on the net. He doesn't have the scratch, he just wishes he could food us into believing he does.