Option Investor
Market Wrap

1998 is now history and 1999 will go down in history.

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       WE 12-31         WE 12-25         WE 12-18         WE 12-11
DOW     9183.43 - 36.56  9217.99 +342.17  8875.82 + 85.22  -194.38  
Nasdaq  2192.60 + 29.52  2163.03 +119.15  2043.88 + 34.52  - 26.15  
S&P-100  604.03 -  3.91   608.91 + 25.30   583.61 +  8.49  -  5.47  
S&P-500 1229.23 +  4.15  1226.27 + 46.31  1179.96 + 18.02  - 10.28  
RUT      421.96 + 16.42   405.56 + 11.78   393.78 +  3.93  -  3.96  
TRAN    3149.31 +108.48  3044.08 + 73.44  2970.64 +100.82  -119.89
VIX       25.41            22.04            28.07            28.46
Put/Call    .55              .52              .47              .66

1998 is now history and 1999 will go down in history.

1998 finished with a whimper for the Dow but the underlying market was smoking at the close. Even though the Dow was down -93.21 the Nasdaq overcame a host of Internet problems and set a new closing high.

AOL gave us the mother of all spikes at the close on Thursday as some index fund bought 20 million shares at the close and the price jumped from $144 to $160 after the bell. Shorts and limit sellers are now in serious trouble without any opportunity to cover. Some estimates for the open on Monday are $170-180 as other funds and shorts scramble to cover after the surprise spike. Other rumors flying fast this weekend include AOL announcing a split Tue/Wed next week. Congratulations to everyone that held on for the expected bump at the close Thursday. You got way more than you bargained for!

New statistics just came out for AOL. They passed 15 million customers this week. Up from 1 million Christmas week of 1994. The current rate of new Internet users is 68,000 every day. AOL is signing up 23,000 every day. ONE THIRD OF ALL NEW INTERNET USERS!! This puts AOL on track for 25 million users by next Christmas. Since AOL is already profitable what will 10 million new users do for them?? Internet blue chip anyone?

The highlight of Thursday was the very bullish closing ticks, over +1000 and the broad breadth. The advancers led decliners 2307 to 780 on the NYSE and 3094 to 1331 on the NASDAQ. The totals of 5401 advancers and only 2111 decliners showed how strong the coming rally might be. Traders have been waiting for volume to reassert a direction. This should give them the proof they need.

The eight day streak came to a close with a -140 drop in the Dow but the positive market breadth on Friday looks like a good start for a new year. Sure, we have some blue chips that people think are now overvalued but the broader market is racing to catch up. The Russell turned in an incredible performance on Thursday as it jumped +10.07 and +16.42 for the week. This was a +4% gain for the week!! The Russell was expected to outperform the blue chips in the post holiday rally and is still expected to be strong again next week.

The choppy market, caused mostly by profit taking and year end portfolio restructuring, only put a little fear back into investors. The put/call ratio only came up from .51 to .55, hardly noticeable. The VIX did rise some from 22 early in the week to 25.41 at the close Friday. Without some volatility, as evidenced by the VIX the option premiums will go flat. That means time premium will decay rapidly without "expectation" built into the market. If everybody expects the market to move in one direction then there is no speculation. No speculation equals no inflated premium prices. This is good if you are buying but bad if you are selling.

On Monday European financial markets will start trading in the new Euro currency. Analysts are not expecting too much disruption for U.S. equity markets but we will keep our fingers crossed.

Now that the parties are over and the decorations are coming down Wall Street will be faced with an impeachment trial, the Euro and earnings projections that are falling daily.

The week ahead will produce a large amount of economic data that is likely to show a split in the U.S. economy. Manufacturing will be sluggish but the techs and service sector will be strong. The December unemployment report on Jan-8th is expected to show an increase in the jobless rate to 4.5% from 4.4% in November. Traders will also look at the Monday NAPM index for the manufacturing sectors health in December.

With blue chips lacking momentum from Wed/Thr there may be some further consolidation in the Dow but the broader market should continue to move upward without any market killing bad news. This should be a good week to buy the dips and look for the longer trend for the month to be upward.

Several people have asked recently what "buying the dip" meant and how to know when it was a dip and not a crash. Obviously if anyone could accurately call the "dips" they would not share this holy grail info with anyone else. This is a tough call. You have to be in tune with the broader market and current market trends. When you see the market moving up strongly for some period of time you can expect a dip for profit taking ever 5-7 days. Experienced traders wait for these dips to take positions. The correct way to play the dips is to wait for the dip to be over. For example, I would call the -140 drop on Wed/Thr a dip. The broader market has already started the rebound but then the broader market was dipping before the Dow finally dropped last week. When the major stocks you are watching start back up along with the rising market then it is time to buy. A rule of thumb could be 25%. Since the Dow dropped -140 then a +35 point or greater gain with positive ticks would look like a rebound beginning. Individual stocks may lead before the Dow moves upward. Stocks like MRK, LU, MSFT, BA, C, may start up early and then ignite a Dow rally. The key here is patience and observation. You can't look at some stocks prices once a day and expect to be "in tune" with the market. I have some traders that I correspond with by email daily and even several times a day and we have trouble agreeing on when the market will turn. You just have to wait and watch everything and look for positive signs in more than one place. Just watching one or two stocks or one or two indexes will not work.

I had several readers ask this week about open interest and its relevance to us. One reader asked about certain strikes on CSCO which had 10,000, 12,408 and 14,852 open interest. The questions I get are something like "the stock is $100 and the Jan-120 strike has 15,000 open interest. Why are you not recommending that strike? With that large an open interest isn't that a great play?" Our quick answer is Open Interest(OI) DOES NOT MAKE A GREAT PLAY. Lack of open interest can make a play more risky but high OI has no relevance to us as traders. These far out of the money strikes got this high OI because the stock was close to the strike at one time. This stock may have been tacking on $2 a day for a week until it got to $118 and every option player alive may have been betting on the $120 as a sure thing. One morning they woke up to see a downgrade or earnings warning had taken -$5 off their sure thing and denial set in. It will come back up!! It was up +$15 the last three weeks, it will recover! Famous last words. Nothing is ever a sure thing and nothing ever has to come back up. The stock can lose $2 a day for weeks as expectation slowly drains away. Traders who did not want to sell their $5 option for $3 the day of the announcement just watch the value drop another $1 a day until it is $.50 and "not worth selling" in their eyes. Many traders still in denial will then "load up" on these bargain options to wait for the eventual return to glory. (good money after bad) This is how a strike that is far out of the money gets a huge OI. This is also why OI does not matter or make a good trade.

Low OI however can mean you are at the mercy of the market maker when you try to sell your option. If you are deep in the money then this is not a problem. If you are out of the money and the stock does not move then the market maker will "mark down" the price of the option drastically as the expiration date closes in. Be cautious when buying any option with OI less than 500 and be ready to pull the trigger quickly if the trade goes against you. Higher OI strikes will hold value longer as the "denial" factor will erode a bit slower.

In summary we think the market will rebound from the dip on Wed/Thr and move up. There is some uncertainty from the conflicting signals but the broader market looks ready to run. The only minefield ahead would be missed earnings but that is a week or two away. Remember, a noted analyst (RA) said he could see a Dow 11,500 this year. Same guy can also see 8,500. That gives him a 3,000 point margin of error but at least gives us a great upper target to shoot for. Lets hope we only break one of his predictions!

Good Luck

Jim Brown
Editor

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