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A Rational Speculation

BMC looks ready to break out, and the P/E isn't up in the clouds.

The stocks that can break your heart -- if not your trading account -- are those with price-to-earnings ratios that not only far exceed their growth rate, but also defy value and reality. You'll find some examples of those heartbreaker stocks in the "cloud" business of the computer world. Stocks in that sector have P/E ratios from 50 to 200! Those levels are historically not justified -- future expectations tend not be realized as companies mature in their industry and business cycle. Competition can enter the sector too, bringing down those lofty expectations.

Now that I've ripped my favorite group to watch in shock and awe, there is a stock somewhat related to that "pie-in-the-sky" cloud computing sector that does offer a rational speculation -- BMC Software ( (BMC) ; $40.66). The software sector is hot right now and might be getting even hotter over the next few weeks to months.

BMC has landed on my market radar screen because of its breakout potential chart pattern and the relatively benign volatility pricing of its options (mid-30s for the November series). In addition, BMC is puffed in this week's Barron's, mentioned as a possible takeover candidate. BMC has a quality balance sheet and trades at a price-to-earnings multiple not up in those "clouds" -- the trailing P/E ratio is 18 (not 180!) and the forward P/E ratio is 14 (not 140!).

A stock that has upside breakout potential is a stock that options speculators want to play with long calls. You should give yourself a reasonable amount of time for the breakout to possibly occur, so use longer-dated options. BMC has excellent short-term breakout potential that can take the stock up into the mid-$40s or higher. Consider buying the BMC November 40 calls for $2.50. The risk, of course, is the entire premium paid for the calls.

The trade: Buy BMC November 40 calls for $2.50.

At the time of publication, Skip Rashcke held no positions in the stocks or issues mentioned.

Skip is a former registered options trader and member of the Philadelphia Stock Exchange. He was an equity options analyst and broker with Paine Webber and a proprietary trader for Van Der Moolen. He served in the USMC, as well as played minor league baseball with the N.Y. Yankees organization. He is an independent stock and options market consultant.

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