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Bull Spreads: Option Experts Only!

09/23/2005 12:00 am EST


Jon Najarian

Co-Founder and Managing Partner,

Jon Najarian is a leading expert in the complex world of options. But we emphasize that the ideas featured here are not meant for the inexperienced. For those familiar with option strategies-in this case, bull-call spreads-we offer his latest plays on steel and energy.

"Let's invest in the rebuilding of New Orleans and the Gulf Coast, one of the largest public works projects in our time. The stock that I love and am focusing on is Steel Dynamics (STLD NASDAQ), which makes and sells steel products. Unlike its huge competitors, Steel Dynamics primarily uses steel scrap to produce its products, and I think that a great deal of this material will come out of the Gulf region during the cleanup efforts. It's a good effort when we recycle and return the debris from Katrina to the people who will need the new structures.

"We are investing in Steel Dynamics by using a bull-call spread. I recommend buying the STLD Jan 35 Calls for $2.50 and selling the STLD Jan 40 Calls for $1, for a net debit of $1.50. In so doing, the breakeven will be the long $35 strike plus that $1.50 debit, or $36.50. Our maximum profit will be achieved when STLD trades above $40 on that third Friday in January, if not sooner. That's when the spread goes to $5, leaving us with a profit of $3.50. As always, our risk is that $1.50 we paid for the spread.

"If you give this trade to your broker at a net debit of $1.50, then it doesn't matter which prices your broker pays for the individual parts of the bull-call spread. Thus, our net debit would be $1.50, or $150 for each spread. Our loss is limited to the $1.50 that we are paying for the spread. If, on the other hand, Steel Dynamics rises above $40 on or before January expiration, then we make $3.50 on our $1.50 investment."

"KFx Inc. (KFX ASE) is a Denver-based energy company that is one of the most highly shorted on Wall Street. The company's K-Fuel technology is a coal-drying process that it claims improves the energy content of Western coal, reduces levels of harmful pollutants, and lowers its weight, thus making coal cheaper to transport. KFx uses heat and pressure to physically and chemically transform coal with a lower heat value into coal with a higher heat value, and its K-Fuel process also removes certain impurities, including mercury, sulfur dioxide and emissions of oxides of nitrogen.

"The shares have fallen to $15 since a mid-August high of $18.50. One month ago, Barron's cited KFx for developing something quite close to alchemy, as the company can transform low-grade Western coal into the equivalent of a superior Eastern variety- which costs five times as much. As you might imagine, K-Fuel would indeed be a huge deal, especially with natural gas prices hitting record highs. That's the rub and also the reason for last month's sell-off.

"Because of this make-or-break, all-or-nothing technology, our option spread is the only prudent way to invest in the unbelievable upside of KFx with limited risk. I recommend buying the KFX March 15 Calls and selling a like number of KFX March 20 Calls for a net debit of $1.75. Prices that work are paying $3.10 for the March 15 Calls and selling the March 20 Calls for $1.35. In paying $1.75 for this $5 bull-call spread, we have a potential profit of $3.25 and, as always, our risk is isolated to that $1.75 debit we paid for this spread."

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