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Pairing Up for Profit

Buy calls and buy puts: Obviously this will have a lower cost and reduced risk compared to the all-stock position. The main disadvantage is the time decay. You will need the value spread between the two issues to move substantially in your predicted direction to overcome the erosion of the options' premium. If both stocks stand still, the position will lose money. In this case, it definitely makes sense to use long-term and somewhat deep-in-the-money calls.

Sell calls and sell puts: The initial capital requirements will be nearly equal and the risk is just as great as the stock-only position. But the potential profit is limited to the amount of premium sold. The main attraction of employing this strategy would be to take advantage of time decay and rich premiums. In this case, it definitely makes sense to use short-dated options and not go too far into the money. Even if both stocks remain unchanged, this position can make money.

Some Candidates

When Dell (DELL - Get Report) lowered revenue and profit forecasts last week, investors were trying to determine if the issues were specific to Dell or a sign of trouble for the whole PC industry. It seems that the shortfall was the result of a shift in Dell's marketing from low end to higher margin products and is therefore a Dell-specific issue.

While I'm not pounding the table or wildly bullish on the PC sector in general, I do believe this provides a small window for some of the also-rans to gain back a little market share. I think going long Gateway (GTW) and short Dell could prove profitable over the next eight to 12 months. I'd look to buy calls in Gateway and buy put options on Dell.

With Gateway currently trading around $3.10 and Dell near $29 per share, one could buy the Gateway January 07 $2.50 calls for around $1.10 per contract and buy the Dell January $30 puts for around $3.50 per contract.

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