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Market Wrap

Triple Witch Puts Spell on Markets

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        WE 12-17         WE 12-10         WE 12-03        WE 11-26
DOW     11257.43 + 32.73 11224.70 - 61.48 11286.18 +297.27 - 14.98
Nasdaq   3753.06 +132.82  3620.24 + 99.61  3520.63 + 72.82 + 78.56
S&P-100   773.93 + 10.44   763.49 -  3.99   767.48 + 13.91 +  4.27
S&P-500  1421.05 +  4.01  1417.04 - 16.26  1433.30 + 16.68 -  5.38
RUT       466.21 -   .50   466.71 +  2.13   464.58 +  5.64 -  2.33
TRAN     2918.42 + 43.48  2874.94 - 53.86  2928.80 + 19.64 - 67.34
VIX        23.01 +  2.09    20.92 +   .10    20.82 -  2.13 +  3.32
Put/Call     .43              .45              .49             .42

Triple Witch Puts Spell on Markets

The triple witch options expiration on Friday was credited with putting a volatility spell on the markets. After gapping open over +80 points to almost 3800 the Nasdaq ran in place until the Dow caught up after lunch. About 1:30 the Dow started climbing on the strength of a financial upgrade to JPM and soared to a new intraday high of 11383 dragging the Nasdaq along for the ride. About 2:30 both indexes topped out and support started thinning. The advance/decline line turned negative on the Nasdaq and the race to the exits began. What had been euphoria at new highs for both indexes turned to worry as each bled points faster the closer we got to the closing bell. Not only could the Dow not hold the intraday highs but fell back under its previous record closing high as well. A sure double record close evaporated in an avalanche of volume. The NYSE set two volume records today. The heaviest volume day ever with 1.3 bln shares and four days in a row with volume over 1 bln shares. After being up +100 at 2:45 the Dow barely managed to close positive +12 points. The Nasdaq lost over half of its gains to close +38. Friday was expected to be the last major volume trading day of the year as many funds went into lock down for Y2K. With options expiring volume was high as traders squared positions and moved to the sidelines, some for the year.

The fear of the Fed meeting on Tuesday has prompted many traders to simply step aside for the next week and await a possible Santa Claus rally the following week. Will they or won't they, change the bias, not the rates. The debate is not over a possible rate hike but on how the Fed will move on the bias. With many analysts complaining about how the Fed handles the bias statements and the different views of what they mean, the Fed may change the way they express their views. However they say it the outcome is still the same. Traders will worry and volatility will reign. This uncertainty was seen with the run for the exits on Friday. The bonds held their ground Friday with 6.38% yields.

You would think with four one-billion+ share days in one week the Dow would have made some significant gains. This was not the case as the index only managed to add +32 points for the week. The broader market attempted to rally but the sellers were out in force. The very big caps were the only NYSE stocks to post gains. The same is true on the Nasdaq as the big caps continued to rise but the smaller stocks lagged. Liquidity is the key. With billions continuing to flow into funds there is just no safe small caps in which to put the money to work before Y2K. Smaller companies are deemed to be risks and big caps are assumed to have the problem under control. If things go wrong, funds cannot move out of the small caps fast enough without impacting the price substantially. This flight to the very large caps is likely to continue until Y2K. Adding to this trend is the year end window dressing as funds want to show the big safe names in their portfolio in the year end statements.

The Nasdaq has now exceeded 70% gains for the year and ranks as the largest gain ever. Previous high years were 1991 +56.84%, 1995 +30.9% and 1998 +39.6%. Tech valuations are now the highest since 1983 and are likely to adjust in January.

The housing starts came in much lower than expected this morning with a -2.3% drop. Analysts expected a +1.4% gain. This shows the Fed interest rate hikes in action as increased costs of home ownership slow the demand. This was the lowest level since August. The housing permits however rose more than expected which point to a future increase in housing starts. The economy is still cooking along at a +5% rate and that is more than the Fed will tolerate.

The big turnaround today came from JP Morgan. Earlier in the day a Merrill Lynch analyst cut their earnings estimates for JP Morgan and JPM dropped over -$5. Later in the day after speaking with JPM again the same analyst retracted her comments and JPM rebounded to positive territory taking the Dow with it. Another Dow component, GE, made several high profile announcements including a 3:1 stock split, an increase of +17% in their dividend and an increase in their share buyback program of $5 billion. The triple witch of the three announcements launched the Dow into record territory. Another Dow component, MSFT, finished the week up +$23 or almost +100 Dow points. Remember, the Dow was only up +32 for the week yet MSFT contributed over +100. Yes, the Dow was technically up for the week, but was it really? It looks like MSFT was up helped by INTC +$10 (+50 Dow), HD +10 (+50 Dow) and DD +10 (+50 Dow). After checking there were only eight Dow stocks up for the week, 2 flat and 20 down. Four Dow stocks MSFT, INTC, HD and DD accounted for almost +250 points. If it were not for three of the four new stocks the Dow would have been down substantially. Think about it. Was the market up or just four stocks?

The liquidity driven market is about to get another boost. Year end bonuses for most people in the financial sector typically go directly into the market. With the hundreds of thousands of newly rich from the Internet boom their big year end bonuses are also going back into the market. The funds are faced with receiving millions of dollars every day and nothing to do with it. The cash buildup over the next two weeks will be unprecedented and the end of year retirement contributions will be the largest ever. The cash flood will make it impossible for the market to mount a serious pull back anytime soon.

The coming week should be a week for family, shopping, parties and friends. It should not be looked on as a great trading opportunity. The Fed meeting on Tuesday will impact trading on Monday and Tuesday. Wednesday is a tossup and low volume on Thursday will make it a yawner. If you are going to open new positions the best targets should be the very big caps. Historically the market is up the week after Christmas but the Y2K event could blunt that rally depending on the negative hype in the news. This would be a good week to wait for the bus. Bus? If you want to go somewhere on the bus you probably would not simply hop on the first bus that came along. You would wait for the one with your route on the header. Would you get on a bus going to a different stop simply because you were impatient or tired of waiting? Of course not! You would wait as long as necessary for the right bus to come along. This week would be a good week to wait for the right bus. Trading just because the market is open is a good way to lose money. There are literally hundreds of good plays setting up for a post Christmas run. Spend your time analyzing the prospects and narrowing your targets to only three or four. Decide what your entry point will be and how you are going to scale into the position. I am going to place some ridiculous target shooting orders on several stocks I would like to play the week after Christmas. If I get filled this week, great! If not, I did not lose any money and I can still buy them after Christmas. We are probably going to get one more good rally into January and then some instability as we see how Y2K impacted fourth quarter profits. Plan your trades to capitalize on this rally and then be ready to take profits.

Have a safe week in the market. Don't buy the first dip. Plan for the January rally and execute your plan.

Jim Brown
Editor

Reminder for our male readers: There are only three days left before you have to shop for Christmas. I have heard that some stores will actually take money from males, without a spouse or girlfriend present, before Christmas Eve but I have yet to prove this theory.


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JIM'S PLAYS
QCOM - DEC-390 Calls, Naked Dec-400 Puts

Last week the chart on top was predicting a blowout soon. I was long the Dec-390 calls @ $13 and short the Dec-400 Puts @ $54.50. As you can see by the second chart is was a very profitable play. I covered the naked puts on Tuesday for $4.00 for a profit of a little over $50 per share. When the drop started just before the close I was afraid they would spike up again and closed the position. They eventually expired worthless but who can complain about a $50 a share profit? I closed the Dec-390 calls on Monday at $30 which was WAY!!!! too soon but again, who can complain about a $17 profit when the Nasdaq can connect at any minute? I took advantage of the Wednesday drop to buy the Dec-420 calls at an average of $22 and sold them on the open Thursday for $32.75. On Friday I felt the market and QCOM would tank by the end of the day and I sold Dec-440 calls naked at the open for $10.00 and covered them just before the close for $5.00. Just barely!!

This is a one minute chart of QCOM for late afternoon. I had been nursing the $440 calls as they hovered around $10-11.00 all afternoon. When the sell off finally came I was sitting on the trigger. When it bounced on $444 the first time I covered 10 contracts @ $5.00 and put in a limit buy to cover 10 more at $4.00. When it bounced at 15:45 I was afraid it was going back up. By the time I decided to change my limit price it started back down again but I was already nervous. I changed it to $6.00 and got a fill at $5.63. I was also riding some OEX puts and as soon as I got the fill I switched screens to watch the OEX. You can imagine my surprise when I checked back just before the close. I was thinking about buying some Jan calls but when I saw the spike I was in such shock I decided to wait. If I had only held off covering those naked calls five more minutes I would have been burnt toast. Never fail to take a profit when offered. Especially when there is only 15 minutes until expiration!

JDSU - DEC-240 Calls

Good plan, bad entry. I had entered the DEC-240 calls UQD-LH for $8.00 on the previous Fridays drop. I tried to catch the falling knife and got stabbed. It continued on down and I got stopped out at $6.00. Hindsight is 20:20 and Wednesday morning I could have bought the same calls for $2.00 with a high on Friday of $25. I had removed JDSU from my watch screen and missed the rebound completely until the gap open on Thursday.

ARBA - $240 Calls

This play suffered from December decay. I had a nice profit going into the weekend on the Dec-240 calls bought at $9.25. After the dip at the open on Monday they never recovered the premium from the previous week. I closed at a profit for $12.00 but remained disappointed. The bounce off resistance took all the expectation out of the premiums and it never came back.

INKT - $150 calls

Luck never hurts. Sometimes your luck is all bad and sometimes you can do no wrong. The gap open on Monday offered too much of a profit to pass up and after looking at the chart for Tue/Wed I am very glad I sold for $30. I wish I could be lucky like this for a $15 profit on every play! This is not normal and you should not expect this kind of return.

BVSN - $90 calls

I had bought the Dec-90 calls BDV-LR for $14.50 the previous week on the strength of the saucer bottom formation. They looked ready to breakout over $110 again and the chart above shows the perfect follow through. I jumped at the chance to sell at the open on Monday for an average of $28 for another double. I was kicking myself at the close when they were trading for $45 but +100% gain is still 100%!!.

MSTR - Stock and Jan-170 calls

This is the painful part. I owned 1000 shares of MSTR in another account that I had bought the prior week. Options on MSTR are very expensive due to the strong price swings in the stock. Note that the chart lines are $40 graduations. When some stocks correct they can really correct. MSTR had gone from $100 to $230+ in about three weeks. When the Nasdaq corrected last week MSTR fell off the cliff. I first noticed it when it took the first drop to the $210 range. I was concerned but a -$25 drop and a solid hold, surely it was over. Wrong!

When the bottom fell out it really fell out. The long red line at the close on Tuesday was literally about ten ticks. I was holding at -$20 and I looked away for a minute or two and now I am -$35 for the day. OUCH! Then it gapped down the next morning. I finally sold in disbelief at $180 for a serious hit. The good news was extremely high option premiums were dropping like a rock. I queued up the Jan $180, 170, 160 calls on Interquote and waited for the bounce. When MSTR hit $160 and started rebounding I bought 20 contracts of the $170 calls for an average of $20. My rationale was with 20 contracts MSTR would only have to go back up half as much to recover my loss on 1000 shares since I now controlled 2000 through options. Everything was looking real good midmorning on Friday but it eased off its highs before the close. I calculated I need a recovery to $200 to recover my loss on the stock.

CLS - Jan-75 calls

CLS got killed on the Solectron news. CLS is the third largest electronics manufacturer in the world. CLS was on a split run and would probably have been $110 by now without the SLR news. When It dropped to $84 on Monday on the news I thought it would be a quick entry point. I bought the Jan-75 calls for $12.75. Wrong again! The next day the bottom fell out and it lost another -$8. The drop was temporary and with the split coming next week and the numerous upgrades on the sector as a whole I elected to not sell. That was a good decision as you can see. The ex-date on the split is 12/22 and I plan to sell on Mon/Tue depending on the market. The calls closed at $19 Friday.

OEX - Puts

After the big recovery in the Nasdaq since Wednesday and the possibility of a sell off at the close on Friday, which was the last day of business this year for many funds, I decided to play OEX puts on Friday. The huge gap open setup the OEX for some profit taking but the JPM downgrade/upgrade at midday stopped it dead. I was stopped out with a dollar loss at midday but the mid-afternoon run just put me in a stronger position. I could not believe it. The OEX was sitting right on 780 at 3:15 and the DEC-780 puts were only $1.06x1.13. When the market stalled at the highs of the day I bought 50 contracts for $1.13 to $1.25 (what a bargin!) and within ten minutes the sell off started. I closed them just before the bell for an average price of $5.50. The play only took 30 min to run but all day to wait the entry point.

Strategy:

I had some incredibly lucky plays this week. Actually I like to think of them as being in the right place at the right time. By researching and planning carefully you can help these accidents happen more often.

The downside was my failure to bail out on the two big losers soon enough. I did not have stops set on the MSTR stock because I was not planning to sell it any time soon. This just reinforces the fallacy of this type of thinking. You should always plan for the worst and hope for the best. A trailing stop would have taken me out well over $200 and I would be spending my time finding new plays instead of trying to nurse that one back to health. The JDSU play was simply a bad pick. Good stock, bad entry. These happen to everybody all the time. The key is to run quickly for the exits and minimize your losses. Stocks gap down just as much as they gap up. Stocks trending down tend to gap down and those trending up tend to gap up. If you are already nursing a losing position and the stock is showing signs of weakness then which way do you think the next gap will go?

I am not planning to "trade" next week. I am planning to target shoot some options on several stocks using the contingent order feature on Preferred. (Place an order to buy options based on the stock price not the option price) This way I don't have to worry about what the option price will be if/when the stock drops intraday.

I would like to get back into some January options on QCOM, YHOO, JDSU, INKT, CMGI. Some of these stocks are splitting and should have a decent split run. (market permitting) I am not going to chase them but if I have not filled I may consider opening some positions on Thursday afternoon.

Something you should consider for your stock only accounts.

The HHH is a basket of the 20 largest Internet stocks by market cap and was started by Merrill Lynch. It trades like stock on the AMEX. I bought some when it hiccuped at $162 and sold it when it rolled over last week at $180. I was expecting it to drop more on Wednesday and missed the $163 dip. If we get any weakness in the Internet market this week we could see a pullback to $163-165 again. I would be a buyer here. I think the Internets will be strong the two weeks after Christmas and we could see $190 easy. There are no options on it yet but it does let you profit from the top 20 stocks without having to pick one or two to play. We all know the trend is up overall. We just do not know which ones are going up this week. This is very safe and with proper stops very easy to trade because of the low volatility.

Remember, my trading plan is to trade "only when profitable" and yours should be also.

Good Luck

Jim

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