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HGSI Trade Made Worthwhile with Options

|Includes:GlaxoSmithKline (GSK)

As you may know, Human Genome Sciences has been in the new lately as a subject of merger speculation. On Wednesday, the stock surged after the Wall Street Journal reported that options traders were speculating on a takeover by GlaxoSmithKline. The companies said that they don't comment on merger speculation, but they didn't deny the rumor.

The next day, though, a report crossed that a takeover was unlikely in the short term, and the stock dropped. The drop in the stock allowed Buy and Hold Plus to stake out a position in the stock. The stock was purchased at $19.23, which was about a dollar lower than the price where it traded on when the Journal released its article on merger talk. On top of that, Buy and Hold Plus sold the September $20 call for $1.41.

Think about that. Someone was willing to give Buy and Hold Plus $1.41 for the right to buy the stock at $0.77 higher than it was available for on the open market at the September options expiration date. They are betting on a merger, and a surge in the stock price to close to the merger price. The income from the call represents 7.3 percent. If the stock remains unchanged until options expiration date, which is 22 days away, the income alone will provide Buy and Hold Plus with an annualized return of 122.7 percent. If the stock appreciates, the gain will only add to the return. And, if the stock price declines, then the call provides protection to $17.82.

Obviously, with a trade involving merger speculation, it is important to monitor the position and close it out accordingly. A probability analysis shows that there is a 58 percent chance this trade will be profitable, and with the kind of gains possible, it's a trade worth making. But stop orders will be put in place to prevent the trade from going bad.

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Stocks: GSK