Continuing

last week's mission of looking at upcoming earnings to establish option positions, here is another attractive opportunity.

CheckFree

(CKFR)

, the electronic payment company, is scheduled to report earnings after the close on Thursday. It is expected to earn 31 cents per share on $182 million in sales for its fiscal second quarter of 2005. That would represent a 21% increase over the year-ago period.

The stock's price-to-earnings ratio has contracted along with its growth rate in recent years; at $37, the stock is trading around 28 times this year's earnings, down from the Internet-like multiple of 50 it was sporting back in 2000. The earnings growth rate has slowed from 80% per year during the prior five years, and is expected to drop to the midteens over the next few years.

Stabilizing

But the plus side to this slowdown, which should be expected as a company matures from its initial hyper year-over-year growth rate, is that CheckFree is now on solid ground and appears poised to settle in as a reliable and steady performer. After a few somewhat erratic years, the company has now been very consistent in delivering on-target results and guidance. It has beaten estimates by an average of 6% in five of the last six quarters.

I expect the company to meet its numbers Thursday, and another solid quarter should supply the base for the stock to work higher in coming weeks. With the stock at $37, a purchase of the February $35/$40 call spread looks attractive here. The spread can be bought for a net debit of $2.30 (pay $3 for the $35 call, receive 70 cents for the sale of the $40 call), providing a reasonable risk/reward. The maximum loss is equal to $2.30, or the net debit; the maximum profit is $2.70, or the cost minus the differential between the strike prices. The maximum profit is achieved if CheckFree is above $40 at the February expiration.

One thing I like here is that the long-call portion of the spread is currently $2 in the money, giving the position intrinsic value, which I believe improves the risk/reward ratio. Even if the stock stands still, the position will retain its $2 of intrinsic value, letting you recoup a large portion of the spread's initial cost.

This contrasts with buying an out-of-the money spread. Although an out-of-the-money spread has higher profit potential, it's subject to greater time decay, requires a larger gain to realize a profit, and has a much higher probability of expiring totally worthless. After a nice price gain Tuesday, CheckFree's chart shows good support at $36, which gives me some degree of confidence that the $35 call will be at least $1 in the money.

I'm also choosing to use relatively short-dated options. As I've mentioned before, it can be difficult to realize the full value of a vertical spread, even if it is in the money, if there is a long time remaining until expiration. That's because the two strikes still will have significant time value and essentially the same theta, which causes relatively flat pricing across the strikes until the options are deep in the money.

For example, CheckFree's February $30/$35 call spread, which is fully in the money, is currently trading around $4.20, or 80 cents below its intrinsic value. But a $30/$35 call spread with a May expiration is trading around $3.50, or $1.50 below its intrinsic value.

By using the shorter-dated options, you not only take advantage of the more rapid time decay of the further out-of-the-money call you've sold short, but the spread's full value can be realized sooner if this bullish thesis plays out. And if the quarter is a disaster and the stock drops, it's nice to know the risk is limited.

Steven Smith writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He invites you to send your feedback to

steve.smith@thestreet.com.