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Option Tip – Thursday, October 20, 2011
EMC Calls



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The Option Tip is to Buy EMC Corporation Calls: An Even Stronger Buy After Earnings



EMC

EMC’s Q3 Earnings Rise; Stock Should Follow - Collect call premium now as the shares go higher.

With earnings season upon us, so traders and investors need to be careful when picking stocks to buy and, in turn, to sell calls against for income. A bad report can cause the stock to drop more in value than anticipated.

But what if the stock just had a favorable announcement? This might set up a scenario where the stock may continue to slowly rise or at least not become bearish – excellent conditions for entering a covered call position.

A quick explanation of the covered call strategy is when a trader buys stock (or already owns shares) and, at the same time, sells a call as part of the same trade. Generally, covered calls generate additional income for a stock position – the market pays you just for owning them!

The universal approach for finding good covered call candidates is to identify a stock that is stagnant but, overall, slightly bullish. This week, for the option tip, it’s equally important to find a candidate whose earnings have already hit the tape, so that there are no short-term surprises in store.

With that in mind, EMC Corp. (NYSE: EMC) looks like a viable candidate this week. The company just reported earnings on Tuesday morning. This provider of corporate data-storage systems reported that its third quarter net income rose 28%. Earnings were 37 cents a share, which was a penny ahead of most analysts’ estimates.

computer cloud

Description of EMC Corp. (EMC)

EMC Corporation (EMC) develops, delivers and supports the information technology (IT) industry’s range of information infrastructure and virtual infrastructure technologies, solutions and services. EMC provides information storage, back-up and protection, management, security, information intelligence, data computing and virtualization technologies, services and solutions.

EMC operates in two business categories:

• EMC Information Infrastructure provides a foundation for organizations to store, manage, protect, analyze and secure information and enhance their advantage within traditional data centers, virtual data centers and cloud-based IT infrastructures.

• VMware Virtual Infrastructure, which is represented by EMC’s interest in VMware, Inc. (VMware), is a provider of virtualization and cloud infrastructure software solutions.

In April 2011, the Company acquired NetWitness Corporation.

The Reasoning for the Option Tip

The option tip requires that the right stocks are selected for the covered call strategy, and EMC definitely fits that category with a positive year-end outlook.

The stock has been trading basically sideways between $20 and $23 since the beginning of August. After the earnings announcement, the stock gapped over the $23 resistance area, triggering a possible bullish move to the upside.

EMC-102011-graph



EMC Earnings Report to Support the Option Tip

EMC reported a profit of $605.6 million, or 27 cents a share, up from $472.5 million, or 22 cents, a year earlier. Excluding restructuring-related charges and other items, per-share earnings rose to 37 cents from 30 cents, topping analysts' expectations for 36 cents a share, according to Thomson Reuters.

Revenue jumped 18% to $4.98 billion, compared with the Street forecast for $4.91 billion.

Gross margin rose to 61.6% from 59%. Research-and-development costs rose 13%.

Revenue from the U.S. rose 17% to $2.7 billion. Sales in the Europe, Middle East and Africa region jumped 15%, while Asia-Pacific revenue climbed 37% and Latin America saw 8% growth.

VMware Inc.

Along with its strength in traditional data-storage business, EMC has been benefiting from its majority ownership of VMware Inc. which is great for the option tip.

This company dominates the market for virtualization software, which allows users to run multiple computers' operations on a single machine. On Monday, VMware reported its third-quarter earnings more than doubled and revenue rose 32%.

VMware reported that third-quarter net income more than doubled to $177.5 million from $84.6 million. Sales rose 32 percent to $941.9 million.

Option Tip Support in Brief

Highlights from EMC’s earnings report:

• Earnings at VMWare (VMW) (Which EMC owns 80% of) doubled.

• EMC is seeing none of the weakness in corporate spending that NetApp (NTAP) and Dell (DELL) have warned recently on and improved its gross margin to 61.6% from 59%.

• Revenues grew 18% overall surpassing analysts’ estimates as it gained market share.

• In the U.S. market which is experiencing slow overall GDP growth, EMC grew sales 17%.

• Despite some negative headlines in the last few months, its RSA information security division’s revenues improved 16%.

Reasons EMC is still a strong buy at $24 a share:

1. Between VMWare (Server virtualization) and its storage products, EMC is the leader in some of the key pieces of data center consolidation, cloud computing and ever increasing needs to manage data. These trends should provide growth opportunities well into the foreseeable future.

2. With this earnings report, EMC has now met or beat earnings estimates for 13 straight quarters. It also sells at a reasonable 15.5 times this year’s earnings.

3. It has a five year projected PEG of just .9 which is at a 30% discount to its five year average.

4. EMC is selling below analysts’ price targets, which will probably be revised up as a result of this earnings report’s robust growth. The median analysts’ price target is currently $31 on EMC.

Stock Performance and Statistics Impact on Option Tip

• EMC percentage change grew 5.78%, to close at $23.99 and its overall traded volume was 52.34M shares in the last trading session.

• EMC opened the day at $23.61, it made an intraday low of $23.22 and an intraday high of $24.26.

• The stock has a 52 week range of $19.84 – $28.73.

• At current market price, the market capitalization of the company stands at $49.54B and it has 2.06B outstanding shares.

The $23 area should now act as support for the stock. The way the erratic market has been trading, a conservative estimate for the stock is about $25 for November expiration, which is just below the horizontal 200-day moving average.

The Option Tip

Here’s how you can make the EMC Covered Call Trade for instant income generation:

With EMC currently trading at $24.....

Example:

Buy 100 shares of EMC @ $24 and sell the Nov 25 Call @ $0.44

Cost of the stock: 100 X $24 = $2,400 debit

Premium received: 100 X $0.44 = $44 credit

Maximum profit: $144 — that’s $100 ($25 stock target – $24 current price X 100) from the stock and $44 from the option premium received if EMC finishes at or above $25 @ November expiration.

Breakeven: If EMC finishes at $23.56 ($24 – $0.44) @ November expiration.

Maximum loss: $2,356, which occurs in the unlikely event that EMC goes to $0 @ November expiration.

Managing the Option Tip

The main objective for a covered call strategy is for the stock to just rise up to the sold call’s strike price, which in this case is $25. The stock moves up the maximum amount without being called away, gains are enjoyed on the shares and the sold call expires worthless.

Because of a solid earnings report, EMC has a chance to go above $25 way before November expiration. If the stock looks like it’s going to go much higher, then the call that was previously sold (the Nov 25 Call) can be bought back and a higher strike can be sold against the position to avoid assignment. This will allow the stock to remain in the portfolio and also give the position a chance to increase its return.

If the stock drops in price more than was anticipated, it might make sense to close out the entire trade (stock and short call) to avoid further losses.

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