The Option Investor Newsletter Monday 05-22-2000 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) ****************************************************************** 5-22-2000 High Low Volume Advance Decline DOW 10542.50 - 84.30 10664.50 10369.50 869,030k 1,164 1,775 Nasdaq 3364.21 - 26.19 3390.95 3172.65 1,615,462k 1,227 2,839 S&P-100 748.04 - 4.91 754.29 730.01 Totals 2,391 4,614 S&P-500 1400.72 - 6.23 1410.55 1368.73 34.1% 65.9% $RUT 471.67 - 8.03 480.59 458.21 $TRAN 2720.16 - 21.84 2761.90 2703.11 VIX 28.83 + 0.06 32.12 28.24 Put/Call Ratio .60 ****************************************************************** Ugly Selling Turns to Technical Rebound For those just tuning in to see the NASDAQ down 26 points and the Dow down 84 points at today's close, you missed the fireworks. Investors continue to exercise caution stemming from the belief that the Fed will act to raise rates again in June, and belief that valuations are still too "high". Just what is "high"? We don't know for sure. But apparently the lows hit today convinced more than a few bargain hunters to step back to the plate for a swing at some of the beaten down former kingpins in the market. In short, after testing new lows, the rebound was impressive. So just what happened? Let's start with the most dramatic first - the NASDAQ. At the opening bell, the index sat at 3390. Within slightly more than one hour, it fell through technical, psychological and historical support at 3227, its intraday low set on April 17. That was a big deal. It didn't stop there and instead continued south below 3200 all the way to 3172, its low so far this year. Weak attempts to rally back to the 3227 were met with selling pressure, again testing the sub-3200 level. Things did not look good with 3227 failing to hold on three intraday tests. However, with plenty of cash on the sidelines (but still in their pockets) investors waited for deals too good to pass up and couldn't resist the buying opportunities presented. CSCO for instance was down to $50 before springing back on twice the normal volume to close at $55, a gain of almost $2 on the day. Similar patterns could be found in the top 10 most active issues. ORCL dipped to $62.75, but closed at $67.75 on volume 50% greater than the ADV. SUNW dropped to $70, nailing its 200-dma before moving back to close at $79 on volume 70% greater than the ADV. JDSU rebounded nearly $9 from its low of $76.50 on 50% greater volume than average. QCOM close up $11 from its low of $77.75, also on 50% greater volume. AMAT closed up nearly $8 from its low on twice the ADV. The only laggard was MSFT, whose volume was 20% shy of average. Nonetheless, it too closed up $1.50 from its low of $62.44. Most of these issues are at or near their 200-dma and represent buying opportunities in a bull market. The point of conveying this to you is to show that a perceived bottom was hit on many big issues and many investors were willing to step back into the market with conviction, sensing that those levels were a buying opportunity. Volume confirms that. However, many analysts believe that the market cannot advance further without the big caps caving in as the final sign of capitulation. While we saw some of that today on the stocks noted above, there are still others which remain far above their 200-dma and may have further to fall before they find a trading bottom. Note that biotechs were missing from the tech recovery. What's it all mean? Don't dive in the pool yet without first checking the water temperature. Internally, things weren't so hot. Declining issues outpaced advancers by a 7 to 3 margin. 276 new lows (yow!) beat just 19 new highs, while declining volume was nearly twice advancing volume. In the final two hours though, the NASDAQ tacked on 189 points to overcome its 220 point decline, and closed down just 26 at 3364, well above important support at 3227. We like that and look for a trading rally to continue. We've talked a bunch about volume lately. While today's figure of 1.6 bln shares traded is a bigger number than what we've seen of late, it's still well below the 1.8 to 2.0 bln we'd like to see to convince us that the worst is over. We still think the NASDAQ will remain rangebound between 3300 and 3800, until we get a breakout to the upside over 3800 (and more convincingly, 4000). Nonetheless, we think today's overall action gave us many tradable entries for the week. We would expect to see the rebound continue tomorrow and perhaps through Wednesday afternoon when investors will likely pare back holdings pending the outcome of the GDP deflator figure, initial jobless claims, and existing home sales on Thursday morning. Don't expect the market to rock and roll to new highs; just look for it to snap out of its sourpuss mood for a couple of days before getting grumpy again. In all the excitement, you probably thought we forgot about the Dow. Nope. But it too mirrored the action of the NASDAQ opening at 10,624 then sinking to 10,369 (an intraday loss of 255 points) before recovering 173 of those lost points to close at 10,542, a loss of just 84 points. However, volume was a dull 871 mln shares. Decliners beat advancers 3 to 2, while down volume exceeded up volume by 80%. 119 new lows beat out just 30 new highs in similar fashion. While starting out negative, by the close, IBM, T, KO, MCD, JPM, C, WMT, INTC, and XOM were the only issues to struggle back into the green, though investors exhibited no tremendous buying pressure on any of them. GM, however, noting that its tender to convert GM shares to GMH shares (the satellite division GM and owner of Dish Network) was oversubscribed, dropped almost $9 to $78 on four times its ADV. In similar fashion, GE lost nearly $2 to close at $50 on twice its ADV. HWP also kicked in for a loss of $3.44 bringing these three up for the ball and chain award today in contributing to 70 of the Dow's 84-point loss. One more time on the volume - as long it remains consistently under about 900 mln shares, the Dow will likely continue trading within the support and resistance ranges of 10,500 to 10,800. How'd we figure that? We merely drew a line connecting the lower highs and another line connecting the higher lows to get a pennant formation, then estimated the figures if the trend continues to hold. 10,800 is also the 200-dma for the index and has lately provided resistance. Thus, don't look for a positive breakout anytime soon. In case you are interested (don't hang your hat on this either), the convergence of the lines, which would represent the date and level of a breakout is in roughly the last week of June at about the 10,500 level. If you trade 100% technical, you've undoubtedly noted that the pennant is descending, which generally portends a breakout to the downside. While it isn't good news, we think there is still trading opportunity in the bounce off today's low until the Dow gets back to the 10,750 to 10,800 level. Like the NASDAQ, we'd expect the trend to continue until Wednesday afternoon prior to the release of Thursday's economic figures before caution possibly overtakes greed. Yes, there was news today, but the big story is really today's market rebound. So we'll skip the news tonight and move on to our fearless forecast for Tuesday and possibly beyond. While we think today's rebound is a big plus despite the drubbing both indexes took most of the day, we're going to be watching for further rebounds in the big cap tech issues, which are generally less interest rate sensitive. On the NASDAQ, we'll look for support at 3300 if there is any amateur hour profit taking from today's recovery - about 10,450+/- on the Dow. Then we'll make our move on individual issues as long as the overall market cooperates. We don't want to be a helium balloon stuck in a downward moving elevator, so we'll make sure the market and our stocks are moving up. We'll also be watching for big caps that that have bounced off of or near their 200-dma. Overall, we expect a tradable rally for the next couple of days. Pay particular attention to the sectors. By symbol, we've listed some sector issues to watch (the Merrill Lynch HOLDRS in particular). While most of them are not yet optionable, they can show you strength of various sectors - use them as a tool. BBH Biotech PPH Pharmaceuticals TTH Telecom IAH Internet Architecture IIH Internet Infrastructure BBH B2B BDH Broadband SMH Semiconductors If the sector doesn't look good, we suggest staying out in favor of one that does. As always, sell too soon (because this isn't a major change of market direction) and don't buy too soon either. It's a tradable market, but trade where the trading is good. Buzz Lynn Research Analyst *********** IN THE NEWS *********** Vignette Acquires OnDisplay in $1.7 Billion Stock Deal By Cindy Christ E-business application provider Vignette Corp. said Monday it would acquire rival OnDisplay in an all-stock deal valued at $1.7 billion based on Friday's closing prices. The deal is aimed at helping Vignette, which got its start helping companies launch business-to-consumer Web sites, strengthen its position in the market for business-to-business transactions. Under terms of the merger, shareholders will receive 1.58 shares of Vignette for each OnDisplay share, an exchange ratio valuing OnDisplay at $69.22, a 30 percent premium over Friday's closing price of $52.31. But after the agreement was announced, shares in Austin, Texas-based Vignette plunged more than 20 percent, slashing the total value of the deal and erasing the hefty premium for OnDisplay shares. Analysts said investors were turned off by the high price Vignette paid for OnDisplay, whose early stage technology is far from turning a profit. The merger also is expected to delay Vignette's first quarterly profit by about six months. The companies said the combination of Vignette's V/5 suite of applications software and OnDisplay's XML-based products will create the industry's most comprehensive offering for building businesses online. XML, or Extensible Markup Language, is an easy-to-use set of codes put into documents and programs that can help speed up Internet commerce. Based in San Ramon, Calif., OnDisplay makes software allowing sellers, buyers and vendors to access and exchange in real time critical information such as purchase orders, inventory status checks, invoices and product catalog data. "Our eMarektplace customers have told us how important a complete and integrated solution is -- one that both reaches out to customers and back to suppliers, vendors and the back- office. Together with Vignette we now provide the industry's only true end-to-end solution," said Mark Pine, OnDisplay chairman and CEO. The combined company will have about 2,000 employees, 870 customers and global operations in the U.S., South America, Europe, Asia and Australia. Vignette said it would account for the transaction, which is expected to close in third quarter 2000, using purchase accounting. Shares in Vignette (VIGN) closed down $8.94, or 20.4 percent, at $34.88 after trading as low as $30.75 intraday. OnDisplay (ONDS) rose $0.88, or 1.6 percent, to $54.12. Over the last 52 weeks, OnDisplay, which went public in December 1999 at $28 per share, has traded as high as $132.50 and as low as $20.50. ********************** PLAY OF THE DAY - CALL ********************** SDLI - SDL Incorporated $192.00 -4.00 (-4.00 this week) SDL's products power the transmission of data, voice and Internet information over fiber optic networks to meet the needs of telecommunications, DWDM, cable television and satellite communications applications. They enable customers to meet the bandwidth needs of increasing Internet, data, video and voice traffic by expanding their fiber optic communications networks more quickly and efficiently than would be possible using conventional electronic and optical technologies. SDL's optical products also serve a variety of non- communications applications, including materials processing and printing. Most Recent Write-Up The long and short-term reasons that make SDLI attractive are certainly in place. The market has had on ongoing love affair with SDLI and many of its peers in the fiber-optics industry. Until Friday, SDL had faired pretty well for the week. Even then it managed a gain of 12.6%. The strong move up the ladder on Wednesday came with over 6.1 million shares traded. So what makes SDL so special? They are fast becoming a leader in their industry, which includes the likes of JDS Uniphase, E-Tek Dynamics and Corning. None of these stocks are cheap by most investors standards. The ever increasing need for bandwidth expansion, along with continued consolidation in the industry seems to have kept SDLI and others at the top of investors lists. Speaking of consolidation, last week SDLI announced it was buying Photonic Integration Research for $1.8 billion in cash and stock. Company Chairman and CEO Don Scifres said, "We view it as a strategic acquisition in a very rapidly growing market, and very complimentary to our present business." SDL plans to use a silicon chip made by Photonic that allows for information to be channeled through a single fiber. The chip would replace several components inside SDL products. The following day no less than six brokerages firms came out with Buy and Strong Buy recommendations or reiterations on SDLI. Since that time SDLI has climbed from the $155 area to a high last Tuesday at $217. Although some technical indicators suggest a continued pullback or consolidation for our new play, we believe this one's worth keeping an eye on. If the sell button continues to be the one most frequently pushed early next week, and SDLI moves lower, support can be found at $190, $185 and $171. We realize that sounds like a broad range for support, however this one can obviously be a bit volatile. A move back through the $200 level with better than average volume could indicate the up trend has resumed. If we do get a bounce early in the week, be prepared to take a profit. Going into a holiday weekend the liquidity will only get worse as the week progresses. Comments Today was a rocky day on the NASDAQ. SDLI traded as low as $169 and it certainly looked bleak. Selling volume was strong as traders took the stock to its 200-dma. The bounce that followed on the NASDAQ and SDLI was quite impressive. SDLI's $22 rise from the ashes was also on strong volume. This appears to have been a capitulation in this particular stock and may be poised to go higher. Watch the NASDAQ for direction tomorrow before entering as another round of NASDAQ selling could be an overall drag on techs. A little help from NASDAQ buyers could take SDLI higher. Targetshoot at your own risk levels and look for support at the 50-dma of $184. BUY CALL JUN-180 QZL-FP OI=196 at $28.75 SL=22.50 BUY CALL JUN-190*QZL-FR OI=270 at $23.88 SL=18.50 BUY CALL JUN-200 QZL-FT OI=531 at $19.63 SL=15.25 BUY CALL JUN-210 QZL-FB OI=302 at $15.75 SL=12.25 Picked on May 21st at $196.00 P/E = 390 Change since picked -4.00 52 week high=$244.75 Analysts Ratings 14-9-0-0-0 52 week low =$ 21.63 Last earnings 04/00 est= 0.16 actual= 0.22 Next earnings 07-19 est= 0.22 versus= 0.09 Average daily volume = 2.39 mln /charts/charts.asp?symbol=SDLI ************** TRADERS CORNER ************** Debit Spreads & The OEX: Is It For You? By Austin Passamonte When it comes to spread trading options, thoughts usually run to long-term, watching grass grow type of action. That's partially true, but profits from 50% to 500% return on capital within days is possible as well. Are you interested in hearing more? Before I begin, let me mention that some of the terms and actual market examples we'll discuss here may not be 100% familiar to everyone. Fortunately, OIN has an archive full of spread trading articles by real experts. You can also learn a great deal from most of the books listed in the OIN library section as well. One I highly recommend is a copy of "Trade Options Online" by George Fontanills. Between the archives and this book all of the basics and many advanced techniques are explained in great detail. Trust me, I will keep my part very simple in here! Much of this article will discuss ideas and facts before we lay the groundwork. Don't worry if it all doesn't make sense right off. I want to share some thoughts before we hit the meat & potatoes where it will all come together nicely. By the time we're through kicking some math around over the next couple sessions the market will only then start to ripen for our strategy anyway. Why even bother trading spreads? What advantages do they offer? Very good questions if you were about to ask, and I often wondered the same things myself. Spread trading gives a trader several key advantages over straight calls and puts during certain times and specific conditions. We will stick to debit spreads and the OEX for awhile, and there are certainly times when these tactics blow away linear plays. One main feature spread trading offers us is staying power. If you haven't noticed, OEX option premiums have a burn rate just below lit kerosene. It's hard to take a directional position on the index and wait longer than a few days for it to happen. With front-month options it can be impossible to hold beyond one week and have any hope for profit at all. This is fine for intraday traders, but many don't enjoy that luxury. How many times has your market analysis suggested to you a substantial move was about to take place? Have you ever bought the OEX and been painfully stopped out only to watch the market reverse course and speed off in the direction you knew it wanted to go? We may have a cure for that! The second feature spread trading has is the ability to buy options when they are overpriced without getting burned by volatility. I use the Skybox price suggestion as an important tool in my arsenal, and many times options are priced heavily to the seller's advantage. Usually this happens when the market is enjoying a big day of 25 - 40 point range. Wouldn't it be nice to tag along for the ride? We can often buy & sell overpriced options within the same day and capture the fleeting volatility but too many times I've bought in after a swift move in one direction only to have the action stall moments after my fill confirm hits the screen. I swear those market makers know I'm in! Do my 5 - 20 contract plays really stall the market? There are times when I'd be easy to convince of that. You should see the bid/ask spread melt a point or two below where I just bought when the action dies. On second thought, no you shouldn't! The good news is that buying one option while selling another at the same point in time limits the volatility effect regardless of the relative value these options are fetching on the market. Isn't that nice? Without complicating things or getting ahead of ourselves, this means if the ASK price of an option we want is a bit higher than suggested entry, all of the other strike prices should be more or less equally overpriced as well. This only matters when the bid/ask spread isn't too wide, but let's shelve that for now and revisit such talk later. The third important feature spread trading offers us is an ability to play the index with small amounts of capital while offering returns of 25%, 50%, 100% - even 500% or more is possible and I've got actual market data to prove it! We can buy spreads at certain times for 1.25 to 4.50 points each with the possibility of a 10 point maximum profit if the market moves in our favor. Of course, the smaller our premium paid the bigger a move has to occur but have you kept track of the OEX weekly range over the past five months? I've watched and taken trades like this since last November and I'm sure they ain't done yet. Let's talk about risk/reward first. I like to buy spreads in the 2.50 - 3 point purchase range that have a 10 point potential profit. That means I have to be correct 1 out of 3 or 1 out of every 4 trades to at least break even except for commissions. Folks, even I can at least hope to do that. In mathematical theory if we managed our account properly and stuck around long enough, just playing one direction or the other each month would eventually win 50% of the time. With 3 to 1 odds on a 50 - 50 actuarial, it is impossible to lose over time. I'm not saying the drawdowns couldn't get ugly or boredom wouldn't be enough to die from, this is just an example of how nice the risk/reward ratio can be trading spreads. Remember, math doesn't lie - it's an exact science. Sadly, these trades aren't possible every day. As a matter of fact they aren't available most days. Only the last two weeks before option expiration do the markets stage themselves for pricing skews in our favor. Prior to this period options carry too much extrinsic value for us to buy spreads near the action cheaply enough. I personally never want to pay more than 3.50 points for any OEX spread 10 points wide. Why bother? If I pay too much four weeks away from expiration and the market doesn't move deep in our direction the spread value will melt to 3.50 or less anyway. Remember Jim Brown's mantra - patience & entry points are everything! The good news is we have two weeks every month, especially the week of expiration to really swell our accounts. The bad news is we have two or three weeks where such won't work. Let me say this about that: if you were able to trade one week per month with 25% of your capital and hit a 400% return on that, what would your new account balance be? My math says double if I'm right. If you could do that one out of every two or three months at least, what would your balance tally by year's end? Something to be said for less is more. By now I bet you're wondering when I'm just going to shut up and dive into the heart of things. Ding - ding - ding...I've hit the maximum space allotment for today. I promise we'll open up tomorrow's visit and lay it all out in one fell swoop. See you then! Trade the right direction with staying power! Contact Support P.S. For those learning the Skybox methodology, did you follow its winning trade from May 18th - 19th? The OEX index opened near 774 and traded up to 778 when the bearish trigger was hit as the market MOVED UP! For those who had the guts to take that trade (not me L) the June 770 puts were bought @ 15.50 and the market eroded all day from there. The play was sold at gap-down open next day @ 27.50. See the method to madness of buying at the trigger opposite current market direction if price conditions are met? I sure wish I'd pulled the trigger on that $1,200 per option trade! ************************Advertisement************************* 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. Move your trading into the next millennium with Preferred Capital Anything else is too slow! http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ******************* FREE TRIAL READERS ******************* If you like the results you have been receiving we would welcome you as a permanent subscriber. The monthly subscription price is 39.95. The quarterly price is 99.95 which is $20 off the monthly rate. We would like to have you as a subscriber. You may subscribe at any time but your subscription will not start until your free trial is over. To subscribe you may go to our website at www.OptionInvestor.com and click on "subscribe" to use our secure credit card server or you may simply send an email to "Contact Support" with your credit card information,(number, exp date, name) or you may call us at 303-797-0200 and give us the information over the phone. 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