Tuesday's Hot Stocks: Ride the Rovi Rave

With the U.S. markets selling off sharply Tuesday, there were 10 stocks fighting the trend and on higher than usual volume. If this is your first time reading one of my breakout reports you'll want to read the section below, however if you are familiar with my daily breakout report you should skip ahead to the list of stocks and option strategy below it.

To reiterate previous blog posts like this, the first thing I do is scan the list for familiar names, such as stocks I am quite familiar with or ones which have appeared on similar scans multiple times in the past week or two (most of these names are unfamiliar so it saves a lot of time). This indicates there may be some real momentum behind the stock, and that it could trade higher in following sessions as well. Then (if and when any of the stocks I find are familiar to me), I make sure the stock has options available to trade, and then take a look at the chart(s) to see if I can structure a potential option trade. The list in this post includes 10 stocks, all of which traded higher on heavier volume Tuesday February 23, 2010. However I will only be writing about one stock in detail which I'll be adding to my watch list, and outline an option trade I may look at opening in the near future.

This method is just one of the ways I use to find stocks for potential option trades. The first part of this post will show the list of stocks which traded higher on above average volume. The second part of this post requires the knowledge of stock options. To learn more about the option strategies outlined in this post, risks, pricing, calculations, other strategies, and options in general, click heres..

The table below shows the company, ticker, per share % increase, and volume increase (% increased compared to 50 day average). For your convenience I have ranked the stocks in order from greatest to least volume % change.

Rovi Corporation (ROVI) appeared on a similar list Monday which makes it the stock I will be writing about today. As always, I will give a company profile from Google (GOOG) Finance below.

Rovi Corp, formerly Macrovision Solutions Corporation, provides a set of solutions that are embedded in its customers’ products and services and used by end consumers. The Company’s offerings include interactive program guides [IPGs]; embedded licensing technologies (such as recommendations and search capability), standards based media connectivity middleware, media recognition technologies, licensing of its database of descriptive information about television [TV], movie, music, books, and game content, and content protection technologies and services. The Company sells its products into the market verticals, such as service providers (cable, satellite, telecommunications, mobile and Internet service providers), consumer electronics [CE] manufacturers and others. In January 2009, the Company sold its TVG Network business and, in February 2009, it sold TV Guide Network and TV Guide Online businesses.

From the chart below we can see that Rovi is approaching its 52 week high and closing high set back in October (34.50 per share and next level of resistance). As volume is increasing going into this resistance, I believe we have a good chance of breaking above and even higher in the following days/weeks. Before I enter into this trade I would like to see ROVI close two days higher than 34.50. Following the chart, I will outline an option position I am looking at opening and why.

Click to enlarge
Rovi Corporation Option Strategy: With volume on shares of ROVI increasing Tuesday, near-the-money call options also had some bullish action. The March and April 35 strike call options were both getting action as shares traded higher. The March 35 call options traded 260 contracts on an open interest of 40, and the April 35 Call options traded volume of 1,081 on open interest of 597. I am looking to follow the money here and open a Synthetic Stock like option strategy for the March options expiration. This is similar to the Synthetic Stock option strategy but slightly different as I will explain shortly. First of all I would like to sell March in-the-money vertical put spreads on ROVI. Using current market data, I would look to sell the March 35/30 Vertical put spread for a net credit of $140 per spread. With the credit received I would then choose to purchase March 35 strike call options for $60 per contract. This strategy is slightly different from a synthetic stock option strategy because I will be purchasing the 30 strike put option, this will limit my downside risk in case ROVI sells off significantly. This is a very bullish option strategy and I'll look to be trading out of it on continued strength in the stock.

Profit & Loss: Although I rarely wait until expiration to get out of my positions, I will outline the maximum profit and losses associated with this trade if I waited until March options expiration to close or get exercised on this position. Assuming I could open this option position for the prices outlined above, my maximum risk is limited to $420 per position, this will occur if ROVI sells off and expires on March options expiration at or below 30 per share. This position will become more and more profitable with each penny ROVI trades above the break even point of 34.20 per share (less any commissions).

This is a very bullish strategy and should not be considered if you think the stock will sell off in the near future. However if you feel the stock could move higher in the near future, this strategy could yield a nice gain. To get a better understanding of stock options and different option strategies please check out my Simplified Stock Option Trading E-Books.

These are just examples and are not recommendations to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly.

The reason option volumes have surged in the last five years is because they are a great way to hedge your portfolio as well as create income off of your shares (see chart here). Keep in mind when using this strategy it is essential that broker commissions are low enough to profit from the position.

Disclosure: Long SIRI