The Option Investor Newsletter Wednesday 12-8-99 Copyright 1998, All rights reserved. Redistribution in an/;'y form strictly prohibited. Posted online for subscribers at http://www.OptionInvestor.com Also provided as a service to The Online Investor Advantage Published three times weekly, Sunday, Tuesday, Thursday evenings ************************************************************ MARKET WRAP (view in courier font for table alignment) ************************************************************ 12-8-99 High Low Volume Advances Decline DOW 11068.10 - 38.50 11171.80 11068.10 957,040k 1,138 1,937 Nasdaq 3586.08 - 0.84 3625.47 3579.51 1,671,042k 1,929 2,223 S&P-100 754.11 - 1.99 760.29 754.11 Totals 3,067 4,160 S&P-500 1403.88 - 5.29 1415.66 1403.88 42.4% 57.6% $RUT 468.84 + 3.14 468.84 465.16 $TRAN 2881.67 - 4.49 2937.50 2879.42 VIX 22.62 + 1.24 22.79 21.51 Put/Call Ratio .51 ************************************************************* Euphoria: An Intense Feeling of Well-Being That is the definition of euphoria but it could easy be applied to many of the tech stocks that have been running wild lately. Today was another day in which you would have needed a double- digit gain to just make the top thirty in Nasdaq gainers. To list in the top 5, you needed a plus +40 move! Individual issues with a positive story to tell are being over-run with momentum money and daytraders looking for the quick kill. That is where the euphoria is and it isn't necessarily bad if you use some degree of caution to protect against yourself. Small fortunes are being won in stocks like CMGI, YHOO, ICGE and SFE, but others are being lost in LE, VISX, CC and YHOO (notice on YHOO it can work both ways). Right now investors are acting extremely care-free in moving back and forth from the momentum plays. Take a look at some of the returns in the largest point movers today. ISLD +45.31, ICGE +43.31, BOBJ +28.38, BFRE +23.00, ASWX +22.75, VERT +22.00, EXDS +21.06, SFE +20.00 and JNPR +18.13. Unfortunately, this is typical of the action before the end of the short-term cycle. We will get into this more before this article is done, but let's get to the markets. The Dow Industrials were down 38.53 to 11068.12, continuing the meltdown since mid-day last Friday. The S&P 500 turned in a loss of 5.29 to close at 1403.88. The NASDAQ held in positive territory for most of the day before dipping just under the unchanged line. It finished at 3586.07, -0.85 for the session. The volume was heavy, which is a continuing theme for the past two months. The NYSE recorded 948 million shares and for those of you looking for some kind of NASDAQ record, you got it in volume. The NASDAQ did 1.67 billion shares. The decliners beat advancers once again by a 7-to-4 margin. The one bright spot was the Russell 2000 which hit a new 52-week high today at 468.84, up 3.14. But we are still aways from its all-time high at 491. Notice the continuing slow death of the Industrials in the chart. We won't likely hit support until at 11,050, which is also the 10-dma, followed by more support at 11,000. This is the level that will need to hold for investor confidence to remain in tact heading towards the end of the year. You may also notice the divergence continues between these two major averages. The rally is narrowing! Today's economic numbers from the Beige book report were a lot like the color of the book...dull. It showed that relatively little had changed in the past six weeks. Growth remained moderate to strong, labor is still tight, a possible slowdown in spending and prices that were steady. This is the same scenario we have been facing for months now. The bond traders seemed to agree as the yield held in a tight range. The bond was down 11/32 today, forcing the yield up to 6.23%. The Dow Jones Utility average fell to a 15-month low today. This is just another sign of the euphoria. This group that is typically bought for dividend yield, has suffered from a lack of buyers as investors are going after the tech sector. This is also common at the end of the year as tax loss selling takes precedence. Investors ditch some of there losers to offset their gains for tax purposes. The Internet group was the place to be once again. The AMEX Internet index rose by 1.3% and featured some of the big winners listed above. EXDS was up $21.06 after bullish comments from Merrill Lynch analyst Henry Blodgett. The big story in the news this morning was on ISLD. The new deal for Digital Island brought a smile to the faces of investors. They announced a pact with SUNW and INKT which greatly expands the Digital Island server network. Under the agreement, Digital Island will deploy up to 5,000 Sun Microsystems' servers equipped with Inktomi's Traffic server platform and content distribution suite. That was all traders need to here as they bid ISLD up $45.31 to $114.94 which is a new all-time high. The Internet group was the place to be with the exception of Yahoo, of course. The day after an addition to the S&P 500 can wreak havoc on your stock price. This is from the big moves that happen the day before, as index funds pile into the stock. That is why we dropped YHOO from the call list last night after the pronounced move. The stock opened down over $20. If you weren't aware of the "day after" phenomenon (very similar to earnings and stock splits), it is a tough lessen for your account to learn but hopefully we all know not to buy a stock that is up over $40 on the day. It all comes back to "sell too soon". Microsoft and Ericsson announced today that they will form a joint company to market and deliver mobile e-mail solutions to network operators. Ericsson will be a majority shareholder in the new company. ERICY added $5.44 to $64.13 and MSFT went lower by $1.25 to $91.75. Circuit City, Best Buy and Tandy got hammered today after CNET said they found electronic products to be cheaper online. The survey, released today, compared prices of 24 items such as DVD players, portable televisions and digital cameras between online retailers such as Amazon.com and MySimon.com, and real-world stores like Circuit City and Sears. Some of the items were noticeably cheaper too. Now we know where to do our Christmas shopping. On the session, CC -13.2%, BBY -6.3% and TAN -5.0%. So is there more euphoria ahead? Well, there is a reason you won't find the name NASDAQ anywhere in the dictionary under the definition for euphoria. That is because the market cycles. How many times over the past 4 years have we seen 2-4 months up, only to be followed by 2-4 months sideways to down. Granted the volatility has seemingly increased but this cycling pattern is not likely to end anytime soon. So what is the opposite of Euphoria? Maybe lugubrious, which portends to doleful, mournful, and dismal. All feelings that you will have if you are the one left without a chair when the music stops. With Y2K right on the doorstep, look for the volatility to increase even more than current levels. The trick is to not get sucked in by visions of dollar signs dancing in your head. There are still good solid technical and fundamental plays that will produce trends and returns that you are used to seeing. You will have better success by trading in an environment in which you are familiar then by chasing a stock that is up $20 on the day. There are still plays with catalysts such as an earnings run, stock split or analyst upgrade that historically prove more reliable than rolling out of bed and seeing what is at the top of the biggest point-gainers list. YHOO was in the $220s when announced that they would join the S&P 500. GMST traded down to $102 twice in the few days after the stock split announcement before closing at $133 today. It also pulled back to $110 for a couple days just last week! The plays are there and they carry a nice reward. Just don't get caught in a stock that doesn't belong in your portfolio. I know I sound like a scrooge but I am not ready to give back any of profits that were earned in this incredible year for the NASDAQ. So make the most of the volatility in the stocks that you know and love and, as always, sell too soon. Especially if a stock is up $68 on the day it enters the S&P 500 after the close! Ryan Nelson Asst. Editor *********** STOCK NEWS *********** The S&P 500 Index Explained By S.P. Brown The S&P 500 Index has garnered a good deal of attention over the past few days after the index's sponsor, Standard & Poor's, announced on November 30 that Internet portal Yahoo! (YHOO) was joining the 500's ranks. Making room for the portal powerhouse was staid business services company Laidlaw, Inc. (LDW). The S&P 500 Index has a long, storied history. It dates back to 1926, and in its present form, with 500 stocks, back to 1957. It was designed by its founders to measure performance of the broad domestic economy through changes in the aggregate market value of 500 US-based stocks (and a handful of "grandfathered" foreign stocks that have been in the index for decades) representing all major industries. And unlike another popular market yardstick, the Dow Jones Industrial Average, the S&P 500 Index is weighted by market capitalization, meaning the larger cap stocks have more influence on the index's price movements than the smaller cap issues. In other words, if General Electric (GE) has a one point price movement, that will have a greater effect on the overall movement of the index than if a smaller cap stock like Emerson Electric (EMR) has a one point movement. Calculation of the index is relatively straight-forward. It's done by using a base-weighted aggregate methodology, meaning the level of the index reflects the total market value of all 500 component stocks relative to a particular base period, which was set at a level of 10 back in the early 1940s. Total market value is determined by multiplying the price of a stock by the number of shares outstanding. Arguably, the S&P 500 is the most widely quoted index among professional investors. The index is often used as a market proxy for the Capital Asset Pricing Model (CAPM) along with many proprietary stock valuation algorithms. It's also a universally recognized benchmark that's used by 97 percent of US money managers and pension plan sponsors. And it's a difficult benchmark to beat at that. How difficult? A search of Standard & Poor's mutual fund data turned up only 14 diversified equity funds that beat the index's annual return of 22.98 percent for the past five years. The S&P 500 Index is constantly evolving, too. This year alone 42 companies were removed and 42 companies were added to the index. This constant reshuffling of the deck can lead to potentially lucrative arbitrage opportunities for the more astute investor. The reason for this opportunity is the way the S&P Index Committee, the group responsible for the composition of the index, goes about adding and deleting member companies. On average, the committee announces the addition of a stock five trading days before it actually joins the index. Following the announcement, a rise of 3 to 6 percent in price usually occurs over the next few days. The price rise is fueled by index funds buying the stock and by arbitrageurs trying to create a market squeeze to profit from it. These arbitrage profits are even higher, though, for technology stocks. According to Murali Ramaswami, Lehman Brothers' (LEH) global head of equity derivatives research, returns for technology stocks added to the S&P 500 average 10 percent. The potential for this extra return from the "index effect" has many money mangers and investors working overtime trying to figure out which companies will be added to the index in the future. Besides collecting a few bonus points, a correct call on an S&P 500 index addition can produce a windfall, as witnessed by YHOO's 126 point price rise over the past few days. Unfortunately for the prognosticators, picking a company for possible inclusion is no easy feat, for it's often not the largest or even the best company around that gets picked. The Index Committee usually requires that a stock under consideration be easy to trade because investment portfolios that mimic the performance of the index must be able to buy the shares. That generally excludes stocks that don't trade actively, or stocks that are controlled by small groups. For example, Berkshire Hathaway (BRKA), the largest company that's not in the index, is an insurance and holding company that's 36 percent owned by its chairman and chief executive, Warren Buffett. The Index Committee is also partial to companies with a publicly-traded track record and a stable financial history. Highly profitable Goldman Sachs (GS) is the fifth biggest US securities firm with a market value of $36 billion, yet it has only been publicly traded since May, meaning the company would likely be excluded from consideration in the index for the near future. Other companies that probably wouldn't make the grade include Internet heavyweights such as Amazon.com (AMZN) and eBay (EBAY). Both have made a big splash in US equity markets, but both are relatively new companies with untested business models. An additional pox-mark on AMZN is that it isn't making any money. The choice of YHOO was something of an anomaly for the Index Committee, who previously had chosen only one other Internet stock - America Online (AOL) - for the S&P 500. Many money managers and investors are expecting the committee to return to character and head for its usual stomping grounds for new additions - the S&P MidCap 400 Index. This year alone 83 percent of the additions to the S&P 500 have come from the MidCap 400, up from 52 percent in 1998. This has focused investors squarely on the MidCap 400 for the next addition, and on one company in particular, Veritas Software (VRTS), a maker of data-storage management software. VRTS is the largest company in the MidCap index, and with a market value of more than $27 billion, it's almost twice the size of the next biggest MidCap issue. VRTS also is a top pick of the derivatives strategists at LEH. LEH looks for industries that are under-exposed in the S&P 500 relative to their weighting in the Russell 3000 Index, and then picks the biggest companies in those industries. According to LEH, technology, financial and industrial stocks are underexposed, and the biggest stocks in those areas are VRTS, online stockbroker E*Trade (EGRP), and Maxim Integrated Products (MXIM). Other possible MidCap 400 members that are rumored to be considered for upgrade to the 500 include Harley-Davidson (HDI), the largest U.S. motorcycle maker; Telephone & Data Systems (TDS), a provider of cellular and local phone services; and Biogen (BGEN), one of the world's biggest biotechnology companies. None of these companies is a sure thing to get bumped up to the big leagues because of S&P's strict guidelines for membership, especially VRTS, which is over 30 percent owned by disk-drive maker Seagate Technology (SEG). But the guidelines may loosen in the future as pressure mounts for the Index Committee to construct an index that truly is representative of today's economy. After all, which companies are more representative of the US economy today, S&P 500 has- beens Foster Wheeler (FW), Polaroid (PRD), and Bethlehem Steel (BS) or AMZN, CMGI, and EBAY? It doesn't take a stock market genius to figure out which three stocks will trump the other three going into the next millennium. So there it is, the nuts-and-bolts of the S&P 500 Index. It's sometimes shrouded in mystery, often created by frustrated money managers who haven't been able to beat the index in recent years. In reality, though, there's really not much to it. And for the sagacious investor, it can be a tool to generate additional profits. **************** PLAY OF THE DAY **************** USWB - USWeb Corp. $51.75 +1.69 (+5.56 this week) USWeb seeks to transform businesses in the digital economy and create sustainable market leadership for its clients. As the leading Internet professional services firm, USWeb has created a new standard for success in the digital economy-Time-to-Value. Time-to-Value means USWeb applies extensive insight, experience and scale to deliver break through results quickly. Tuesday's Write Up Coverage was initiated by Legg Mason on USWB with an Outperform rating on Monday. This was on the back of Friday's news that USWB would be offering a new service for customers looking to outsource there Internet setup and management needs. Customers will pay a monthly fee from $25,000 to $75,000 dollars to have USWB design, host, or operate there Internet applications. This will help company's to avoid paying the start up cost of building there own system. The shares of USWB have been on a steady climb this month reaching a 52-week high today of $50.13 backed by strong volume. Looking ahead, we like the stock at current levels. The technical picture for the stock is very strong with prices, volume, and the moneystream converging in a hot sector-Internet software and services. Look for the uptrend to remain steady as long as the Nasdaq continues to break records. The volatility in the shares should allow traders to target shoot there way in above current levels or on a pullback to support levels near $48. Internet advertising and services firms should be in play, as Agency.com in the space is due to go public this week. That could put other cyber-advertisers like Razorfish and USWB in the spotlight. BUY CALL DEC-45 QWB-LI OI= 892 at $ 7.50 SL=5.75 BUY CALL DEC-50*QWB-LJ OI=1341 at $ 3.88 SL=1.75 BUY CALL JAN-45 QWB-AI OI= 537 at $10.13 SL=7.50 BUY CALL JAN-50 QWB-AJ OI=1199 at $ 7.25 SL=5.25 Picked on Dec 7th at $50.06 P/E = N/A Change since picked +1.69 52-week high=$52.25 Analyst Ratings 10-6-1-0-0 52-week low =$17.00 Last earnings 11/27 est= 0.13 actual= 0.15 Next earnings 01-24 est= 0.16 versus= 0.07 Average daily volume =2.67 mln Chart = http://quote.yahoo.com/q?s=USWB&d=3m ************************************************************* Tired of waiting on trades to execute? Does your broker offer Stop Losses on Options? Trade instantly with Stop Losses at Preferred Capital Markets Stop Losses based on the option price or the stock price. 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