This alert was originally sent to subscribers of TheStreet.com Options Alerts on July 26 at 1:56 p.m. EDT.

As I mentioned in Monday's Weekly Outlook, the drug firm

Abgenix

(ABGX)

is slated to report earnings after the close July 26, and trading volume and volatility have been moving higher prior to the report. This is setting up a trading opportunity.

The

implied volatility

(I.V.) of Abgenix's front-month

options

have risen to the 75% level, from around 65% two weeks ago. The stock's real, or

historical volatility

(H.V.) has been running at just 40% over the past 30 days, suggesting the options are pricing in a move far in excess of their historical statistics. Abgenix's relatively stable stock price combined with a rich option makes this a good candidate for establishing a

covered call

to reap some short-term gains. There are no known, impending drug-test results or court rulings that could unhinge the stock in the next few days. With the stock currently trading around $10.40 a share, one should be able to sell the August $10

call option

at $1.00.

This

buy-write

offers nearly 9.7% of downside protection. Based on ABGX's past six months of historical price-volatility data, I calculate the likelihood of the shares breaking below the

break-even point

of $9.40 within the next five trading days as less than 6%. To boot, the stock's daily chart shows good support at $10 a share. I expect the buy-write should take advantage of contraction in the implied volatility following the release of the earnings, barring a surprise announcement, such as a major disappointment or revelation of a new lawsuit or investigation. I anticipate I.V. to retreat back below 60% by the end of the week.

Suggested Trade:

-- Buy 500 shares of ABGX at $10.40;

-- Sell five August $10 calls (AZGHB) at $1.00.

The maximum profit of 60 cents per

contract

, or $300 for the five contract buy-write, is achieved if ABGX remains above $10 a share. This would represent a 12.7% return on investment (ROI is based on this position's initial

margin

of $2,350) for a three-week trade. I doubt I will try to wring out the final pennies in the final days, but I would look to close the position at a price that offers a 10% return at the soonest available date.

One suggestion concerning the order entry for this or any multileg positions: Enter them as a spread.

For example, the above order should be entered as a buy-write with a single price of $9.40; this, of course, represents the effective purchase price, or break-even point, of the position regardless of the size of the order. A 100-share/one-call position has the same break-even and maximum profit points of $9.40 and $10, respectively. So, for example, enter the order as a buy-write with a net price of $9.40. That will allow you to execute the trade at multiple prices, such as buying stock at $10.10 and selling calls at 70 cents rather than being limited to using two specific entry prices. In both scenarios, the net debit is $9.40 and the risk-reward remains the same.

Update on Cemex

(CX) - Get Report

: I was able to execute one adjustment I proposed Monday to this existing position. I had been looking to turn this long position in the January 2006 $40 calls into a diagonal calendar spread. By shorting an equal number of calls with a higher

strike price

but shorter

expiration

period (this creates the diagonal calendar spread), I have reduced the overall cost (and risk) of the position and hope to benefit from the accelerated time decay of the shorter-dated options I have sold short. On Monday, the September $45 calls traded as high as $2.15, allowing an entry to sell at the $2.00 per contract that I stipulated:

-- Sold five September $45 calls (CXII) at $2.05.

The Cemex position is now:

-- Long five January 2006 $40 calls;

-- Short five September $45 calls.

The position's new net cost, or total risk, is $4.50, or $2,250, for the five-contract spread. An important point to make clear is that this reduction in cost comes with a commensurate limiting of near-term potential gains. If Cemex trades above $45 by the September expiration, the position's profit is limited to just 50 cents per contract spread.

But that said -- and noting that one should not be making constant adjustments -- I anticipate that a move lower in Cemex would prompt me to cover the September short calls at a price below $1. If Cemex shares rise above $49, I will likely look to roll the diagonal up and out into the October $50 calls. But we can talk about that later, should it come to pass.

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 appreciates your feedback;

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