When the stock market is as volatile as it is now, it is prudent to limit your risks both on the long and short side. It's anybody's guess if we've seen the full magnitude of this correction. A good way to stay exposed to the market yet control your risks is through options, wherein your risk is limited to the amount you pay for your premium. On the other hand, if you place the right bet, either on the long or short side, you still get to make your money. Betting on "out-of-the-money" calls or puts might also be a good idea, since you get to buy more contracts and the upside are much bigger.
I would like to present some options ideas, both on the long and short side.
Call Options: EMC
Everybody knows why EMC is selling a 10% stake in VMware (NYSE:VMW) to the public. It plans to give its own stock price a boost as it unlocks the value trapped in this high growth company it purchased three years ago. In fact, EMC's plan seems to have worked. Its stock price has soared from $13.64 pre-announcement of planned IPO to above $18 most recently. That's an additional $10.22 Bil in marketcap for EMC. So it looks like the public are already factoring in a $27.25 price for VMW ($10.22 Bil divided by 375 Mil shares after the IPO). So the question will be: Will VMW be worth more than $27.25 per share for us to bet call options on EMC?
VMW provides revolutionary virtualization software for enterprises, and has virtually no competitors. It allows varoius applications to run simultaneously on different underutilized servers, as if these servers were one entity, boosting efficiency of these servers. This saves corporations a lot of maintenance, hardware, as well as energy costs. It has set its price range at $23-$25 per share, but the final offer price may be much higher depending on demand. Revenues last year came in at $704 Mil, up 82% over the previous year, with healthy operating profits of $120 Mil. Revenues this year are on track to reach $1.3 Bil.
Assuming net profit margins of 12%, EPS for 2007 should come out to $0.42. At $27.25, this gives VMW a trailing PE of 65x. I this at this price VMW still has ample room to rise given its growth potential and the "Google-like" hype its been getting pre-IPO.
Put Options: ACAS, AINV, BX, FIG
Heed this: the private equity boom is over. Due to the credit crunch caused by the deteriorating collateralized debt obligation (CDO) market, it will be hard for these private equity funds to fund their asset growth and give out their hefty dividends. Costs will rise, and deals will be harder to make as corporations have second thoughts about being bought out at lower prices due to the recent slump in the market.
The more heavily leveraged of these issues are ACAS and FIG. This is more of a sector call than a company specific call (ACAS just announced good earnings for Q2). Technically all these issues have shown breakdowns from their major area patterns. I would buy put options on these issues on any rally.