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Derivative trading without a solid hedging strategy can be a double edged sword. The dangers of trading with or against Wall St is something traders should consider strongly before pouring their hard earned money into options. With the slightest of errors or manipulation, losses can be tremendous.

The only way us individual traders can really make a killing is when we find plays that are inaccurately priced before the institutional managers have a chance to exploit it. I am experimenting with a new method of playing the game which might give me just a slight opportunity to catch a wave before it gets on the radar of the big boys.

In a nutshell, I’m looking to target specific equities that have recently hit their 52 week highs on days with significantly increased volume and have limited exposure to the marketplace due the fact that they are small or mid cap stocks without the same coverage as others larger companies.

Most see that as a great buying opportunity for a short term pop in price, but what I’m looking for is a stock that is trading this way AND is newly issuing options.

The two plays I’ve found thus far that fit the above mentioned criteria are my previously recommended Ceragon Networks (NASDAQ:CRNT) and Amtrust Financial Services (NASDAQ:AFSI).

CRNT has increasingly strong fundamentals, and an attractive chart. It also had a tremendous run up in price from the mid 9 dollar rage to the current 13 and a half range. What’s best is they were just approved for options on the CBOE. The December 10 dollar strike price is trading at a 4.40 premium. When considering the favorable run up in price, and continued strengthening of its fundamentals, its looking rather cheap. What’s an even more attractive play for those who have a bit more of an appetite for risk is the August 2007 calls with strike price of 12.50. Those traded at 1.50 today with a volume of 300. It looks as though market sentiment is bullish on CRNT, especially hitting the 14 dollar mark in the near future, which is precisely why I'd want to get in the further out calls at an in the money strike price.

CRNT 1-yr chart

CRNT 1-yr chart

AFSI also has had a wonderful run up in price. Though I haven’t done the same amount of research on this insurance company, I do know one thing. If we see a mild hurricane season or limited natural disasters this year, insurance carriers should have a lot more cash flow. This is why, in my personal opinion, the insurance industry doesn’t look half bad. Granted that wasn’t the most astute analysis you will find, it’s definitely something to consider.

For AFSI, look at the August calls with strike price of 17.50 and 20. The 17.50 traded at a premium of 2.9 whereas the 20 traded at a 1.25 premium. So when considering the premiums you are looking at August calls of either at 20.4 or 21.25 depending on what calls you buy. This is exactly what I mean by mispriced. Of course there are other factors you need to take into consideration other than purely what the prices are trading at, but I think it’s pretty clear that there is a great potential of opportunity here – though I’d recommend more due diligence done before diving into the play.

AFSI 8-mo chart

AFSI 8-mo chart

I will write some follow up to this in the weeks to come to see how this strategy turns out. If you have any experience trading options please feel free to critique and add some valuable commentary.

Disclosure: none

Source: Ceragon Networks, Amtrust Financial Services: New Options, New Plays