What's Next for This $200 Stock?

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This is yet another article about that one stock trading around $200 per share that was a fairly recent IPO. The price has gone up so fast that I find myself mesmerized by the way it trades. I am, of course, talking about Chicago Mercantile Exchange Holdings (NYSE: CME). Were you expecting some other stock?

Actually, Chicago Merc is not that recent of an IPO; it debuted in December 2002 at about $43 per share and has almost quintupled to $209. Wow!

I was quite proud of myself when I bought it at $48 and got stopped out at $84 in the summer of 2003. Er, uhm, I only left 125 points on the table. I wildly underestimated the stock's potential: my loss.

In trying to pick apart the numbers, most Fools should like the 30% return on equity, the 27% profit margin, and a history of excellent earnings growth. But -- and you knew there was a but or two coming -- Chicago Merc trades at nine times its book value and 10 times sales, and the PEG ratio is above two.

It is logical to think that a stock that has gone up so much would have very high valuations. So what to do now? I believe the reason the stock has done so well is because there has been more demand among professional investors for the type of derivative products traded on the Merc. Hedge funds are one source of order flow, and some reports have hedge fund assets at almost $1 trillion and growing. Another source of demand is from retail brokerage firms, as more products are created to offer clients alternative investments such as managed futures.

One simple way to think about buying a stock is to try to gauge the demand for its product. I wrote about this in June regarding Taser (Nasdaq: TASR). I see a lot of parallels to the stock action between Taser and Chicago Merc, except that Taser has significantly outperformed. Both stocks have high valuations, but there is clearly demand for the product that's easy to understand.

Even though there is demand for derivative products traded at the Merc, you should be mindful that the stock has gone parabolic. The risk is obviously high, and this type of stock is not for the faint of heart.

Fool contributor Roger Nusbaum is an investment manager and wildland firefighter in Prescott, Ariz. At press time, neither he nor his clients owned any of the stocks mentioned .