Dykstra: Riding the Headwaters

This energy and construction materials firm is perfect for deep-in-the-money calls.
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The baseball season is not yet 20 games old, but interesting patterns are already beginning to emerge.

The Mets continue to occupy the top perch in the NL East, with their off-season acquisitions -- Carlos Delgado, Paul LoDuca and Billy Wagner -- all making significant contributions. The Yankees remain entrenched in the pack, behind the Red Sox, who sit atop the AL East.

The playoff teams from last year -- the Astros, Braves, Cardinals, Giants, Angels and White Sox -- are at or near the top of their respective divisions. Certainly, it's still too early to be late, but the Royals and Marlins are off to inauspicious starts. Nonetheless, I am mindful of the Yogi-ism, "It got late early."

From the standpoint of individual accomplishments, Albert Pujols, Andruw Jones, Vladimir Guerrero and Alex Rodriguez are all off to good starts. The biggest surprise of the early season is Chris Shelton of the Tigers, who is sporting Triple Crown numbers.

Elsewhere, my good friend Curt Schilling is 4-0 with an era of 1.61. Tom Glavine continues to lead the NL in strikeouts and sports a microscopic ERA of 1.38. Again, I realize it is early in the season; therefore, attaching any real significance to the aforementioned numbers is difficult.

However, with the exception of Shelton, all the other players and the teams that I mentioned have consistently shown an ability to sustain success over time. Hence, they are representative of the companies that would be good candidates for deep-in-the-money calls.

Shelton, on the other hand, who lacks the pedigree of the others, presents an interesting, albeit somewhat riskier opportunity. His relative anonymity, coupled with the significant potential upside, may justify deep-in-the-money calls in this situation.

Therein lies the flexibility of my options strategy: Established companies with blue-chip status, as well as relative no-names having a breakout year, can be attractively lucrative. Moreover, you get three to six months to gauge progress so as to minimize any losses and maximize profits. With that in mind, here is my deep-in-the-money call for this week.

Headwaters

(HW)

, a relatively unknown company, has been on my radar screen for quite some time.

The stock closed Monday at $34.34, a price that represents what I would call a bargain -- it's too damn cheap!

The operators on Wall Street are at it again -- they want you to sell this great company, which operates in three segments: construction materials, coal combustion products and alternative energy. The stock is trading below its 50-day and 200-day moving averages, a negative technical situation. But with earnings less than a week away and Headwaters' strong track record of growth, I smell an opportunity.

In the past four years, Headwaters has been able to generate an average compounded revenue growth rate of 120%, operating income growth of 86%, earnings-per-share growth of 34% and a return on equity of 24%. Market capitalization grew from $67 million at the end of fiscal 2000 to almost $1.6 billion at the end of fiscal 2005. Are we starting to get the picture?

It's the same old game those operators on Wall Street have been playing for years: Run 'em up so that the public says "it's time to buy"

while the operators sell

. Then, when the stocks get cheap enough -- because the public sold on fear -- guess what happens? You got it, the operators start buying again.

That is why we use deep-in-the-money calls to make profits. This is the safest way to participate in the stock market, period! We buy quality stocks that are priced at a discount and

on sale

, while giving ourselves three to six months, just to be safe.

Then all we need is for the stock to make one move up, because we already have our good-till-canceled (GTC) standing sell order in, to yield a $1,000 profit. Everyone is different; you can set your GTC higher or lower. I use $1,000 because that's a nice win!

My patience has, or will, pay off for all of us. Headwaters closed Monday at $34.34. This stock has no business trading down at this level. So let's capitalize!

We are going to buy the August $25 deep-in-the-money calls for $10 or better (i.e., cheaper). The reason we have to go a little deeper in the money, meaning the $25 strike, is because of the premium we would have had to pay if we bought the August $30. By buying the August $25 strike for $10, our total cost is $35 (the strike price plus the cost of the call).

Now, to get to the real cost of our premium, we take the stock, which closed Monday at $34.34, and then subtract it from the $35 total cost (the August $25 strike price plus $10), and we come up with a cost of 66 cents that we pay in premium.

So to have to the right to control 1,000 shares of Headwaters all the way until the third Friday of August, the premium will be 66 cents.

The bottom line is this: instead of having to come up with $34,340 for 1,000 shares of Headwaters common stock, by using our deep-in-the-money calls we will only have to come up with $10,000.

Recall that we went deep in-the-money because we wanted to keep the cost of our premium down -- and we paid only 66 cents in premium. In reality, we are controlling 1,000 shares of Headwaters, a $34.34 stock, for $10,000. Lock and load!

Remember:

Life is a journey, enjoy the ride!

At the time of publication, Dykstra was long Headwaters calls, although holdings can change at any time.

Nicknamed "Nails" for his tough style of play during his Major League Baseball career, Lenny Dykstra was an integral member of the powerful Mets of the mid-1980s, including the world champion 1986 squad, and the Phillies in the early 1990s.

Today, Dykstra manages his own stock portfolio and serves as president of several of his privately held companies, including car washes; a partnership with Castrol in "Team Dykstra" Quick Lube Centers; a state-of-the-art ConocoPhillips fueling facility; a real estate development company; and a new venture to develop several "I Sold It on eBay" stores throughout high-demographic areas of Southern California.