I have cautioned you before against investing in rumors, regardless of the source. But I recently bought into one myself. Before you call me a hypocrite, let me explain.

The stock in question is Office Depot (ODP). A local small-business owner who dabbles in the market told me he’d heard a rumor about ODP being the target of a hostile takeover. As I always do with any stock of interest, I checked three things:

  • ODP’s chart (It looks like it has put in a double-bottom at the $10.80 level.)
  • the sentiment indicators (Analysts don’t think very highly of this stock. All 10 are rating it as a “hold.”)
  • its fundamental stats (The fundamentals don’t look very good at this point, but it appears that all the company’s troubles may be out and on the table.)

So what did I do? I bought some long-term calls on ODP that don’t expire until January 2010. I only bought a few, but if the company is going to turn around it should be within the next 12 to 18 months. If they do get a hostile takeover bid, the stock could shoot up from $11.70 to $17 real quick.

So there you go. If you’re going to listen to a rumor, this is how you should play it.

ODP was brought to my attention by a takeover rumor. That’s what made me look at it twice. But that’s not what made me buy. In the end, I made a bullish play on the stock because of the same three things I always look at: technicals, sentiment, and fundamentals. I encourage you to do the same. Don’t buy into rumors. But if the stock happens to fit your investing criteria, go ahead and make the trade.

[Ed. Note: Rick Pendergraft is a professional trader and market analyst. In Rick’s new investment service, he gives easy-to-follow, step-by-step advice that you can use to create a consistent, automated income. Learn more about how he can help you produce explosive gains – no matter which way the market is trading – here]

Inspired by his high school economics teacher, Rick Pendergraft fell in love with the markets at an early age. He entered his first investing competition at 17, and opened his first brokerage account before he finished college. At the age of 23, on the third options trade he had ever placed, Rick turned $1,800 into $22,000 in less than a week, when the company he bought became the target of a takeover. He admits it was a stroke of luck, but it was a memorable education as to the leverage that options can provide. After a ten year career in banking, Rick decided to pursue trading full-time. To get his foot in the door, he started out in the sales department at Schaeffer's Investment Research. It was not long before his talent was recognized and he was invited to apprentice under Bernie Schaeffer, one of the top options traders in the world. Rick thrived in his new position and twice received the award for "Top Trader."Rick has developed a loyal following of readers who are grateful for his timely warnings and profitable advice. He is widely recognized as a market expert and has been frequently quoted by Reuters, BusinessWeek, Forbes, USA Today, the New York Times, and the Washington Post. Rick's primary focus is on identifying short and intermediate term rising and falling trends in the major market sectors. His analysis is based on technical factors along with indicators of market sentimentRick lives near Delray Beach, FL with his wife and three children.