Dykstra: Growth in Store

EMC presents today's call opportunity, and Lenny fields more reader email.
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In the modern age, everyone needs more storage space, whether it is physical or digital. Today's deep-in-the-money (DITM) call pick is one of the world's leading storage providers: EMC (EMC) .

On Thursday, EMC reported record revenue, $2.98 billion for the first quarter, claiming its 15th consecutive quarter of double-digit revenue growth, yet the stock went down, closing at $15.57, down 1% on the day.

Growth was particularly strong in the Asia-Pacific region and Japan, checking in at nearly 30%. With the dollar relatively low in value internationally, growth and increased profits abroad provide enhanced value to earnings reports back home. With accelerating growth abroad, EMC's stock price is in a great position to benefit.

VMware, EMC's virtual infrastructure business, saw its net income rise 30% from a year ago to $86.95 million on strong demand, and yesterday VMware filed for an initial public offering of up to $100 million. Many analysts believe that this could be one of the most sought-after IPOS of the year.

In February, EMC announced that it would sell off a 10% stake in VMware. At that rate, EMC values VMware as a $1 billion company. With VMware's strong performance this quarter and positive outlook for the future, the IPO should provide a nice increase in value for EMC stock as well.

The ascent of EMC's stock preceding earnings may have been the reason for a slight selloff after the great earnings report; however, that should only be a hiccup on this stock's path higher. With its strong earnings, impressive growth overseas and impending spinoff of VMware, EMC provides a great DITM play. I am going to use the October 12 calls (EMCJN), placing a limit order to buy 10 contracts at $3.90 or better.

I always like to have an idea of who else is invested in the stocks I buy. On

Stockpickr

I can see exactly which funds and pros choose particular stocks, as well as who has purchased the stock recently. I can see that EMC is owned by several large funds, and I can also look at which other stocks investors in EMC own, which often include

Cisco

(CSCO) - Get Report

and

Comcast

(CMCSA) - Get Report

.

Speaking of Comcast, the company reported very strong earnings Thursday, yet the stock declined. This also may have had some to do with its steady rise throughout April. The stock received a nice premarket pop after the announcement early yesterday, but it opened lower and then proceeded to decline throughout the day. Look for Comcast to regain its traction and once again continue to rise.

Fielding Reader Email

Hello, Mr. Dykstra, congratulations on your huge Amgen (AMGN) - Get Report win! I remember watching you play ball, and you were great. Even though I am a die-hard Twins fan, I have to give you your due. But as an investor (and a teacher) you have found something that your excel in even more than baseball! Thank you. Now for my question: How do you decide what to pay for the contract? I understand (and agree with) your strategy and have followed you daily since you started writing again. But I cannot figure out how you decide on the entry price.

Thank you for your kind remarks, Amgen was a very exciting win. I have been fortunate enough to enjoy success as an investor and baseball player but cannot declare one better than another. There's something about the rush of a very successful trade that puts me right back on the diamond. In buying an option, I choose to buy the calls when the underlying stock price reaches a certain buy level. There is no exact formula for exactly what price I will place my GTC buy. However, I generally base my price off of the previous day's close and make my maximum limit order equal to the closing bid.

I'm struggling through how to do DITM calls. Looking at the Yahoo! (YHOO) options for October '07, it looks like you chose the 22.50s for $6.40 because the ones having strike prices below that add up to approximately the same total (option price plus strike price) as the ones you chose but cost more per contract, and the ones with strike prices above that, like the next one which is the 25.00/4.40s, represent a bit more jump up in the total. Is that how to pick an approximate level to go for? Thanks for your time.

You have basically figured out the approach. The options that have a higher strike price are not deep in-the-money, they are near-the-money. Near-the-money options present a much higher level of risk, because if the underlying stock decreases in value, the near-the-money calls will become out-of-the-money, while DITM calls have more leeway to implement an effective trading strategy, whether it be dollar-cost averaging or simply hold and wait.

If I were to buy calls with a lower strike price, that would only increase my exposure and my potential risk in each trade. Provided I can find a premium in the $1 range and the options are DITM, then the strategy can be implemented effectively. As a result, I find the right balance between a low premium and a DITM level.

First off, thanks for the excellent columns. I am enjoying them very much, learning along with you, and recently opened my first DITM position. I wonder if you might address in a future column how you go about determining the next DITM buy level, as listed on your weekly scorecard. This is the only column on the chart that I'm not clear on after having read your columns for a while now.

Just to clarify, several readers have inquired about the next DITM buy level. This column is there to provide readers with an idea of the technical levels I look for in a stock. These buy levels are the relevant moving averages that provide the next level of support for each of the DITM calls and, as a result, will provide a boost to a declining stock price. Using a dollar-cost average strategy, DITM traders can use these buy levels in order to increase their profit potential.

Your investing style is interesting and very similar to one that I use, which involves buying very beat-up stocks, but not with options. It is the only style of investing that I have found to work based on extensive back-testing and real-time trading. One question that I have, however, is, how much capital have you allocated, or do you allocate to the options trading that appears in your columns so that you have sufficient capital to buy all of your picks and also be able to average down? Are you allocating or assuming an account size of $150,000, $200,000 or some amount that is far in excess of what would be required? Thank you for your insightful columns.

I write the column with a selection for each day knowing full well that my readers will not be able to invest in all of my selections. There's no right amount of capital to have available for the strategy; however, I urge all my readers to

never

trade using margin and to use capital that they can afford to lose. My selections provide an idea for my readers who I hope will then use their own due diligence and select what they believe to be the best selections I offer.

Lenny, my wife grew up in Flushing, and I grew up in Westchester, so we're big fans of the Mets and yourself. Congrats on your ongoing success! Question about your strategy of buying options that expire six months out that are DITM. I see you are picking only "quality" companies. This reduces risk. Why not reduce risk further by using LEAPs long-term equity anticipation securities? Take Komag (KOMG) for example. Why not use the Jan 19, 2009, calls with strike price of $30 or $35 for $7.10 or $5.10, respectively? It seems that the prices are not much different than the six-month call options you are using, and it reduces risk considerably. Just curious. Thanks for your columns -- they are very interesting.

With the long-awaited and finally budding rivalry between the Mets and Phillies, it's great to hear that Mets fans still hold a special place for me. You pose an interesting question about the DITM strategy. I generally avoid LEAPs as they typically trade with a higher premium than DITM calls four to six months down the road. For what I am looking for, four to six months provides plenty of time for corrections in the market and the underlying equity to sort themselves out and implement the necessary strategies to succeed. There will be occasions where leaps provide the most effective DITM play; however, since my return to

TheStreet.com

, no such occasion has come up.

Always remember: Life is a journey; enjoy the ride!

At the time of publication, Dykstra was long EMC, KOMG, YHOO and CMCSA.

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.