The Option Investor Newsletter Monday 5-15-2000 Copyright 2000, All rights reserved. Redistribution in any form strictly prohibited. Posted online for subscribers at http://www.OptionInvestor.com ****************************************************************** MARKET WRAP (view in courier font for table alignment) ****************************************************************** 5-15-2000 High Low Volume Advance Decline DOW 10807.80 + 198.40 10811.50 10605.30 851,159k 1,753 1,143 Nasdaq 3,607.65 + 78.59 3607.77 3445.13 1,155,352k 2,148 1,883 S&P-100 776.53 + 14.86 776.54 756.17 Totals 3,901 3,026 S&P-500 1452.36 + 31.40 1452.39 1416.54 56.3% 43.7% $RUT 497.81 + 6.87 497.81 483.73 $TRAN 2838.04 - 35.98 2891.29 2837.44 VIX 27.45 - 2.50 30.14 27.14 Put/Call Ratio .53 ****************************************************************** The Rally Before the Rally With investors expecting a rally following the FOMC meeting tomorrow, the very act of taking an early position sent the Dow and the NASDAQ markets ahead today. Does that limit the upside tomorrow once the announcement of higher rates (foregone conclusion) hits the airwaves at 2:15 ET? Not in our opinion. Today's rally came on extremely low volume indicating more a lack of sellers than "bucket-o-buyers". In fact, based on the last three days of gains, sellers have all but evaporated leaving only a few active but brave soles in charge of buying. It's the same old story - nobody is willing to lead the bullish herd out of the current trading range until Cowboy Al (Alan Greenspan) pulls the trigger on interest rates. Here's the deal. It's a foregone conclusion that rates are going to rise with the consensus of investors expecting a 50 bp (basis point) hike. That expectation is already priced into the market. Most have lined up behind that notion leaving a scant few thinking that a 25 bp hike is the maximum increase now, followed by another in June. The latter group is being treated as though they are the last of the believers from "Church of the Flat Earth". Their reasoning is that the Fed generally operates in 25 bp increments and hasn't done a 50 bp hike since 1994. Unfortunately, there are signs of inflation in housing prices, wage increases and energy costs, which pretty much assures a 50 bp rate hike. Figuring this is nearly the Fed's last chance to hike rates prior to the November election, the consensus expects the Fed to make it count this time since the Fed will not want to take the blame for cratering the economy by meddling with rates later on. We fall into 50-bp hike camp too. Enough about the background. What about tomorrow going forward? It really won't matter if the hike is 25 or 50 bp. Huh? Wouldn't a 25 bp hike create more uncertainty by leaving the door open for another hike on June 27, the next FOMC meeting, and crater the market tomorrow? That's one possible outcome. But in the bigger picture, what really matters is how the Fed views inflation GOING FORWARD. No matter what the value of the rate hike, Investor's reaction to the hike is really predicated how good a job the Fed does at minimizing interest rate fear and inflation uncertainty for the future. If Alphonso the Great, in addition to a 50 bp hike says something like "today's action may not eliminate the need for future rate hikes" or "we are prepared to act decisively to keep the destructive forces of inflation in check, blah, blah, blah. . .", we may not see as much of a rally as we hoped for since that would mean that more hikes are not only possible, but likely. While we aren't predicting it, it is also possible that that kind of language could induce disappointed sellers back into the fray, sparking another decline, despite the 50-bp hike. We don't want to think too much about that scenario. On the other hand, if the Fed's outlook is that "wages are rising, but under control, energy prices appear stable, and productivity gains are exceeding our wildest expectations", then another rate hike in June is less likely to occur and would give the markets the green flag to rally. In this more likely scenario, we'd expect the see the greatest interest in high quality issues, like chips, chip equipment, networking/telecom equipment, and the biggest cap B2B infrastructure/commerce issues. This action would likely attract momentum players back into some tier-two issues. Not many have mentioned the wild card, the CPI numbers, which come out tomorrow morning at 8:30 ET. The expectation is for a 0.1% increase in the CPI, with a core rate increase of 0.2%. If it gets much beyond that to the upside, the rally most traders are looking for will likely turn to dust since a large CPI number would put investors on notice to expect further hikes. That's just a "what if", and another minefield to dodge. If it's a non- event, look for CPI news to quickly fade from the radar screen. Let's take a look at the action in today's market to gauge the sentiment. Can you say "low volume"? Sure, after 30 days of it, we knew you could. While we like to see gains on the indices, this low volume stuff does not inspire confidence for any breakout of the trading ranges anytime soon. All that may change tomorrow if the Fed provides some future visibility. But we've learned not to count on Greenspan for clarity. The point is that trading volume is going to be the key for reversing the trend. Volume aside, the Dow had a great day tacking on 198 points to close at 10,801. After the open at 10,606, the ascent was steady thanks to strength in a few key issues. MO got a big boost (+3.06, 27.38) from Goldman's and Morgan Stanley's favorable comments this morning that MO is undervalued. Financials like GE (+1.75, 54.00), AXP (+1.94, 52.19), JPM (+1.50, 132.00), and C (+2.69, 62.88) led the charge for the advance, while surprisingly, HWP (-2.19, 129.38) provided the biggest drag. Manufacturers including AA (+2.66, 67.88), GM (+1.43, 86.44), and MMM (+1.06, 85.94) all did heavy pulling too. Internals were decidedly positive with 1757 advancers beating out 1140 decliners, while up volume trumped down volume by more than 3 to 1. While this all looks good, not enough believers are putting their money where their mouths are as evidenced by the scrawny 851 mln shares traded. We won't be convinced the market is ready for a leg up until we see the volume return. Does the market cause you to have trouble sleeping? NASDAQ was so quiet, Sprint could have done a "pin-drop" commercial today. Only 1.16 bln shares traded hands today, the lowest volume this year. Nonetheless, internals were good with advancers leading decliners here too, 7 to 6. Up volume led down volume by a factor of 2.5. In the end, NASDAQ gained 78 points to close at 3607, slightly above historical support of 3600 and mercifully back over the 200-dma of 3594, which should also provide support going forward as long as there are no CPI or Fed surprises. The next resistance is at 3750, so there's room to run. Before we wrap it up, let's touch on a few of news items. First, there's a food fight breaking out over Nabisco (NGH), 80% owner of Nabisco Foods (NA). NGH is the deal, but carries tobacco liability, while NA trades at a higher multiple but has no potential tobacco liability. Carl Ichan already owns 10% of NGH, but "significant" interest is coming from a French food conglomerate. MO and RJR (Nabisco's former sister company) are also reported to be interested. No numbers available yet. On the tech front, CA (Computer Associates) put to rest the negative speculation of an earnings miss by announcing earnings today of $1.13, in-line with estimates. Recall that their earnings postponement last week sparked talk and a price hit based on fear of an earnings miss. Not so, they just need more time, thanks to changing auditors. Ciena (CIEN), who reports earnings on May 18th was added to DLJ's focus list, replacing Young and Rubicam (YNR). CIEN was up $4.19 on the news. Next, Wit Capital (WITC) will acquire E*Trade's E*OFFERING unit. EGRP shareholders will get 25% of WITC equity and Wit's retail brokerage business, while Wit will become the exclusive source of IPO's, secondaries, and other investment banking services. Both were up over $1 today. One tidbit we found interesting was a news item this morning that according to DLJ, DRAM prices in the Asian spot market fell $0.10 to $6.20. They cited that demand was weak, and dealers are looking to turn over inventory at cost. Perhaps that's why we saw the semiconductors gasping for air throughout most of the trading day until a nearly 50 point spurt in the last hour and a half of trading today. Finally, just when you thought "old world" stocks were again losing their luster, especially metal stocks, fourteen of the world's largest mining and metal stocks including AL, NEM, ABX, N, AA, and PD are creating a B2B exchange of their own to cut the industries estimated $200 bln procurement bill. At 10% savings, that's $20 bln of newfound profits. Gold stock fever anyone? OK, let's wrap it up. While we appreciate a good rally as much as the next guy (or gal), without volume it doesn't mean much and won't get us out of the trading range. We're at support on the NASDAQ and have another 100 points to go on the Dow until it hits resistance at 10,900, which we expect to hold unless volume picks up for a breakout. The only way that will happen is if Greenspan provides forward visibility after the rate hike. Some of that speculation could be removed on lack of surprise in the CPI numbers tomorrow before the open. But the Fed meeting outlook is the focus. The amount, 25 or 50 bp almost doesn't matter. Our job is to listen for how the Fed views the future. That will be the key. If the status quo is met, expect a trading rally at a minimum. If it's better than that, and volume picks up substantially (like over 2 bln shares on the NASDAQ), we would have much more confidence in a sustained rally. Helping matters, but overlooked is that this is also options expiration week, which could offer some upward bias. Dust off your running shoes and get prepared to find new cheese (see January 24th, 2000 Market Wrap). Confirm the market direction, and as Jim says, don't buy too soon. Buzz Lynn Research Analyst *********** IN THE NEWS *********** Pioneer Sold to Italy's UniCredito Group By Matt Paolucci UniCredito Italiano Group, Italy's second largest banking group, said it would buy U.S. investment management firm Pioneer Group Inc (PIOG) for $43.50 per share in cash, or a total of about $1.2 billion. Unicredito plans to merge its own EuroPlus asset management unit, which has roughly $80 billion of assets under management, with Pioneer's asset management operations, which has $24 billion of assets. The newly created Pioneer Global Asset Management would be the holding company for all Unicredito's global investment management business and would operate under the Pioneer name from Milan, Dublin and Boston. Completion of the acquisition is subject to approval by Pioneer's shareholders, Pioneer's mutual fund board of trustees and fund shareholders, and various regulatory agencies. The transaction is expected to close in the third quarter of 2000. Pioneer will distribute to shareholders all of the company's interests in non-funds management assets, which include its Russian financial services operation, its natural resource businesses and its interests in venture capital and real estate. John F. Cogan, Jr., President and CEO of The Pioneer Group, Inc. said, "We are very pleased to be joining an organization with the reputation and breadth of UniCredito. UniCredito's EuroPlus division has approximately $80 billion of assets under management. This transaction provides Pioneer shareholders with a premium on their investment and positions the combined company to play a leadership role in asset management throughout Europe and within the United States." Pioneer's other assets will be spun-off into a new limited duration company called Harbor Global Company Ltd. Pioneer shareholders will receive certificates of ownership in the new company, which will operate the businesses with the purpose of liquidating the assets and distributing the proceeds within five years. Pioneer CEO John F. Cogan Jr. would become Pioneer Global Asset Management non-executive Deputy Chairman, while EuroPlus CEO Fabio Innocenzi would become the new group's CEO. News of the deal spurred gains in several other publicly traded money management companies, including T.Rowe Price (TROW), State Street Corp. (STT), Franklin Resources (BEN), Gabelli Asset Management Inc. (GBL), and Kansas City Southern Industries (KSU, owner of Janus Funds). Mr. Pietro Modiano, Head of Treasury, Investment Banking and Asset Management of UniCredito Italiano Group said, "The combination of Pioneer and EuroPlus will create one of the few asset management groups with strong bases in both the U.S. and Europe, and a presence in eight countries. We see significant opportunity to leverage Pioneer's and EuroPlus's product and distribution capabilities in Europe and the U.S. Pioneer will benefit from a strong commitment of UniCredito to realize fully what we perceive to be enormous potential of our combined asset management businesses both in the U.S. market and globally." Shares of Pioneer Group were up $11.19 at $42.19 in afternoon trading. ********************** PLAY OF THE DAY - CALL ********************** DNA - Genentech $131.38 +2.38 (+2.38 this week) Genentech, is a leading biotechnology company that discovers, develops, manufactures and markets human pharmaceuticals for significant unmet medical needs. Thirteen of the approved products for biotechnology stem from Genentech science. Genentech markets seven products directly in the United States. The company has headquarters in South San Francisco, California. Most Recent Write-Up Their stock has been under the weather lately, but may now be on the road to recovery. Since early March, Genentech has suffered like many of the biotech issues, dropping 60% from its recent highs. Besides profit taking and a change of investor sentiment, DNA has attempted to fight off some bad press. Late last week concerns hit the trading floors over the safety of a drug called Herceptin, which is used in the treatment of breast cancer. Genentech warned U.S. doctors about 15 deaths from allergic reactions linked to Herceptin. They went on to say there had been 62 serious reactions reported among the 25,000 patients who had been given the drug. Analysts at SG Cowen rushed to the aid of DNA saying that the Herceptin news was not new, noting that adverse events have occurred in less than 1% of those treated. Besides the obvious, why all the fuss? Herceptin's sales rose 72% in the first quarter helping Genentech achieve better than expected earnings. On Wednesday, DNA got another dose of bad news. A U.S. Appeals Court denied Genentech's motion for an injunction against Bio-Technology General Corp., pending the outcome of its appeal of a court decision earlier this year. It's more in-depth than we will go here, but could be viewed as another stumbling block for the company. Amazingly, with all its had to face in the past six sessions, DNA has managed to gain about 13%. So how do we approach our new play? After putting in a bottom at $97, Genentech has formed good support between its 200-dma at $116.33 and $118. In the midst of recent negative sentiment, DNA has continued to find buyers. Intraday support is also found near $121. With the renewed interest seen in Genetech and the biotech sector, we would view further advances as an opportunity to buy calls. Comments Genetech managed to break out above $130 and held a nice trend into the close. This looks like a good opportunity to pick up some calls. Watch the sector for bullish signs tomorrow to confirm the move and don't forget about the Fed either. The rate decision will be coming at 2:15pm EST. BUY CALL JUN-120 DNA-FD OI= 50 at $18.13 SL=13.50 BUY CALL JUN-125 DNA-FE OI=237 at $15.25 SL=11.25 BUY CALL JUN-130*DNA-FF OI=336 at $13.00 SL= 9.75 BUY CALL JUN-135 DNA-FG OI= 33 at $11.75 SL= 8.25 BUY CALL SEP-125 DNA-IG OI=116 at $22.88 SL=16.50 SELL PUT JUN-120 DNA-RD OI=700 at $ 7.63 SL=10.00 (See risks of selling puts in play legend) Picked on May 14th at $129.00 PE = N/A Change since picked +2.38 52 week high=$245.00 Analysts Ratings 4-6-4-0-0 52 week low =$ 58.25 Last earnings 04/00 est= 0.26 actual= 0.28 Next earnings 07-12 est= 0.29 versus= 0.28 Average daily volume = 1.37 mln /charts/charts.asp?symbol=DNA ************** TRADERS CORNER ************** Learning Is A Process, Not An Event Austin Passamonte Why do new traders often expect instant success and riches? Is the allure of wild claims we sometimes read about really that strong? They sure are... I'm tempted to buy the newest "hot method" every time one of those junk mail flyers hit my PO box. Wendy just rolls her eyes when I open one up and share those testimonials with her. "Look here Wen, this guy drives a milk truck for a living and made six figures last month trading options". "Oh really," she replies. "Maybe you should apply for a job driving milk trucks, it sure couldn't hurt your six-figure monthly success"! Very funny... just the type of spousal support a trader needs these days. Are you tired of hearing about traders who ran accounts to literal fortunes during the gravy days of straight-up bull markets only to give too much back recently? Well, it's happened since the markets' inception. History repeats itself with amazing accuracy when it comes to human behavior. How about new traders trying their very best to put methods and tactics learned in books, videos and internet chatrooms to work? Are they sometimes discovering with real money that there is more to this game than pundits proclaim? I will politely suggest that many from these two groups of traders have yet to learn the profession. How can this be? Some from the first group made zillions of profits in a short period of time. So what? What's done during times when one simply bought high and sold much higher isn't a complete example of market success. Sadly, gravy days are not when we learn life's lessons... it's the challenging times when knowledge and wisdom become ingrained. We all need to remain flexible, open, willing to learn. Learning only comes from mistakes. Want proof? What do you recall clearer, 99 answers you had right on that test in school or one mistake which kept you from perfection? I thought so. Mistakes are an inevitable part of our natural learning curve no matter what endeavor we try. Why should trading be any different? Have you caught on by now that there's just a little more to option trading than what we read about or saw on video? I mean, those tools do an excellent job of teaching us all they can but there's no substitute for live fire. The problem is that every new lesson learned comes at a price costing real dollars to learn when money is risked. How many new lessons can any of us afford before we get them right? Here's my point: if you're new at the trading game, terrific! Welcome to the party. Keep in mind that you & I are tossing our money in the ring out there with experts and veterans of the game who're thrilled to usher us a seat at the table. We need to be nimble and learn fast when our money is on the line in order to survive long enough to win. May I share my thoughts with you on what steps new traders might take in order to keep their bankroll intact long enough to prosper and thrive? First off, don't be in a great hurry to learn everything with your money in real-time trading. Even after years of experience trading futures and stocks I knew options would be a bit different. Now there's one thing I've been very accurate about, for sure. I compiled a collection of books and videos when squeezed together eat up three rows of a wide bookshelf in my office. I've scoured them all repeatedly to boot, but there were plenty of things never written about I've learned on my own since! You aren't even close to prepared for tossing your hat in the options ring until you can pick up most any book at random, read through it and say, "I didn't learn a whole lot of fundamentals from there". Until that point arrives for you, most of your time should be spent devouring such books. Don't like to read? Watch videos. No time for either? Rest assured your free time won't be spent trading profitably for long, either. Once you are comfortably competent about option trading, it's time to begin following the markets - on paper. Not green money paper, I'm talking notebook paper. You have no idea how many $1,000s of Wendy's hard-earned dollars I didn't lose while getting started trading options. I began paper trading and held myself honest to the results. Naked puts, credit spreads, LEAPS, calls & puts - try 'em all in virtual trading and be very honest with your results. I can tell you truthfully that I crashed and I mean flat-bottom crashed my first few tries on paper because I didn't know what I didn't know. The markets taught me quickly and if I had used real money instead of Mead Composition notepads we wouldn't be sharing this time together now. Do you think there might be others who should have begun the way I didn't but are too impatient to miss out on hitting it big? I don't understand why everyone doesn't begin testing themselves on paper first. Even today I continue to try new theories and methods on paper myself. Currently I'm working on the use of trailing stops trading the OEX to greatly reduce losses. Also another method of position-trading the OEX and SPX to give part-time traders staying power to catch imminent moves without the risk of massive draw downs. If either or both prove unfavorable it cost me nothing to find out. Should they profit wildly on paper from day one, the results will give me the confidence needed to work them effectively. Once I began live trading it was with one or two option contracts at a time. Loading up on big plays may seem macho, but it's much easier to learn the nuances of hitting entry points, splitting bids and taking small losses instead of monstrous ones when only a fraction of your risk capital is at stake. A great many traders who jump in with both feet quickly have them cut off at the knees or worse in short order. Think about it... trading financials is a zero-sum game for the most part. Every time a trader profits, someone else sits on the other side of that trade. Which do you think has the better chance of winning, a prepared student of option trading or the one who's sure they can simply "wing it" to success. Your choice in either case, but rest assured you can only be one or the other. I completely understand the impatience everyone has to get started. Option trading is fun, thrilling and can be as lucrative as we all hoped it would be. Still, the markets moved before we arrived, they're moving now and will continue to for eons down the road. They will be ready when you are... the key question is, are you ready for them? Trade the right direction when well-prepared. 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