Option Investor
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Daily Newsletter, Wednesday, 05/24/2000

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The Option Investor Newsletter             Wednesday  5-24-2000
Copyright 2000, All rights reserved.
Redistribution in any form strictly prohibited.

Posted online for subscribers at http://www.OptionInvestor.com
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MARKET WRAP  (view in courier font for table alignment)
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       5-24-2000           High     Low     Volume Advance Decline
DOW    10535.30 + 113.00 10554.90 10364.00 1,142,336k 1,405  1,483
Nasdaq  3270.61 + 106.06  3276.19  3042.66 2,086,635k 1,612  2,488
S&P-100  747.10 +  14.55   749.14   724.75    Totals  3,017  3,971
S&P-500 1399.05 +  25.19  1401.75  1361.09            43.2%  56.8%
$RUT     461.74 +   2.73   461.74   443.99
$TRAN   2829.07 +  74.80  2867.06  2746.49
VIX       27.87 -   1.43    31.20    27.59
Put/Call Ratio       .50
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Airline Deal Helps Markets Soar Past Costco Fiasco

Costco had investors scared early when there was a mysterious 
delay to their earnings, but cooler heads prevailed.  It was a 
strange story this morning when investors were waiting for news 
of COST's earnings report before the bell, but to no avail.  
In some sort of strange mix up, the press release didn't hit 
the wire in a timely fashion.  This caused some degree of panic 
and the stock was halted before the opening.  The word was that 
Costco had provided some sort of earnings warning, but facts 
were hard to come by.  This set the stage for more fear on Wall 
Street during the morning hours.  

But the Bears eventually had to give up and go home because 
this market was ready for a relief rally.  Quite frankly, if 
it wasn't for relief rallies, we wouldn't have any rallies at 
all.  The Nasdaq sunk to 3042.66 to the year's low before 
bouncing back, and this bounce had legs behind it.  The rally 
that ensued took the Composite up 200 points off that low to 
settle out at 3270.58, just a touch off the day high.  How was 
volume you ask?  Great question, as we all know that is the 
one missing ingredient that everyone is waiting for.  It did 
come in much better than expected at over 2 billion shares.  
It had been a long time since we've seen this kind of volume.  
Some may say that the incredible volume in COST at 144 mln 
shares traded inflated the total volume, but even without the
extra 100 mln, the Nasdaq would have still been pushing 2 bln.  
Advancers still beat the decliners 24 to 16 though.  

Take a look at the technical picture on the Nasdaq chart for 
the week and it's easy to see why we need a relief rally.  At 
today's low, we were off 15% in less than a week.  It is my 
feeling that the NASDAQ will have a tough time going below the
2900 level, but I won't be surprised to see it try once this 
relief rally subsides.  Note the downtrend is still in tact. 


 

The DJIA also had a strong day, thanks to the strength in the 
Transports.  This typically forgotten sector of late decided 
to shine on news that UAL, parent of United Airlines, would be
acquiring US Airways (U).  The full story is listed below, but 
it was definitely welcome news to the ailing markets.  The DJIA 
closed up 113 to 10535, up just over one percent.  The volume 
was good here too at over 1 billion shares.  The Transports 
gained 74.80, or 2.71%.  Advancers and Decliners were even at 
14-14.  The technical picture on the DJIA isn't stellar, but 
you can make a case for support at 10,400.  The  problem is, 
what is the real upside?  A move over 10,600 could be clear 
sailing back to 10,800.


 

The moves on some individual stocks were amazing.  Let's run 
through a couple to give you an idea.  RMBS opened at $150, 
fell to $144, before rattling off 24 points to the upside to 
close at $168.38.  SDLI opened at $168, dropped to $147.50, 
and rallied to close at $175.31.  A $28 intraday swing.  It 
was a similar story in AETH, ISSX, SEBL, INKT and EBAY.  Money 
was rushing in at a rapid clip in the final two hours.  The 
VIX was all over the map too.  As high as 31.20, before tanking 
to the low at 27.64.

So the disappoint of the day was Costco (COST) earnings.  They
missed analysts' estimates of $0.27 by a penny and warned that 
fourth quarter earnings will be sub-par.  Yet, what was really
disappointing and confusing for investors was the early release.  
At 5AM EDT, the earnings report was faxed to about 300 investors 
and analysts, resulting in pre-market selling.  It wasn't until 
9:30AM EDT that the report came across BusinessWire.  Needless to 
say, COST may find itself in a heap of legal trouble with the SEC 
if these reports of selective disclosure prove to be true.  This 
controversy certainly will be heated as disgruntled investors 
seek recourse.  COST was down 21%, or $8.63, in regular trading 
to close at $32.

The merger market continues to heat up as United Airlines (UAL)
made a surprise $11.6 bln bid for rival U.S. Airways (U).  This 
move raises the question of whether there will be a realignment 
in the airline industry.  Government scrutiny is certain as the 
merger raises anti-trust questions as well.  Analyst speculate 
that this announcement is just the beginning of airline wheeling 
and dealing.  American Airlines (AMR) is expected to made a 
competing bid for U.  Under the terms of the merger, UAL would 
pay $60 per share of U.S. Airways, which is a 128% premium to 
yesterday's closing price.  DLJ analyst James Higgins cut his 
rating on UAL from a Buy to Underperform as he believes this 
move could put pressure on UAL's future earnings.  He also 
downgraded AMR to a Market Perform from a Buy in expectation of 
their competing bid.  AMR fell $2.56 to $30.06.  UAL slid $7.19, 
or 12%, to $53.19.  U shares benefited from the news soaring 85%, 
or $22.44, to close at $48.75.

Once again, MSFT has its hands full with the government as a 
federal judge rejected MSFT's request for more time to examine
the breakup proposal.  Questioning the effectiveness of a two-way
breakup of MSFT, U.S. District Court Judge Jackson entertained 
the suggestion to divide MSFT into three companies rather than 
two.  He also put the remedy phase of this case on a fast track 
by ordering the government to submit a revised plan by Friday.  
Jackson only granted MSFT 48 hours to examine that plan before
it becomes court record.  This is a severe blow to the MSFT legal
effort which was requesting an additional six months to depose
witnesses and prepare for more extensive hearings.  It is expected
that Judge Jackson may issue a final judgment within two months.
MSFT shares rallied today with the NASDAQ, closing up $2.38 to 
$65.56.

This market has been a tough one to play if you learned to 
trade options in the past year.  You are probably used to the 
bulls returning at each dip, right?  I have found way to the 
sidelines and have been staying there for the most part.  I 
love to trade, but hate trying to fight the trend.  One bullish 
note though, typically when we have as many puts as calls in 
the plays section, we are nearing a bottom.  This morning I 
looked at all of our puts plays to see most of the stocks down 
another 10-12%, taking them to absurdly low levels.  They 
have been great plays, but when the puts start looking that 
attractive, I use it as the contrarion.  When it looks too 
good to be true, well...you know.  Besides, I have been waiting 
for the return of volume to the 2 billion level and we got that 
today.  I will really be excited if we can do that tomorrow in 
front of a three-day weekend.  Not likely, but that would have 
my online broker back up in my browser in a heartbeat.  

There is one economic report due out Thursday.  It is the 
revision to first quarter GDP.  Analysts expect a 5.4% number 
and anything less should lift the markets.  A good number, 
with good market volume will bode well for the up coming week.  
To reiterate Jim's thought yesterday, it is always darkest 
before the dawn.

Ryan Nelson
Asst. Editor



***********
IN THE NEWS 
***********

Costco Misses Estimates
By Matt Paolucci

Costco Wholesale Corp. (COST), the nation's top warehouse club
retailer, said its third-quarter profits rose 14 percent to
$120.3 million, but missed Wall Street expectations.

Costco operates membership warehouses, which offer its members
very low prices on a limited selection of nationally branded
and selected private label products in a wide range of
merchandise categories.

The 305-warehouse chain also cut earnings expectations for the
fourth quarter by one or two cents below the consensus
estimate of 45 cents a share and said it expects earnings-per-
share growth in the range of 11 to 13 percent for fiscal 2001.

Shares of Costco, after being delayed for several minutes,
finally began trading, with a first trade at $28.50, down
$12.125 from Tuesday's close of $40.625.

Costco earned 26 cents per share in the third quarter, versus
the 27 cents expected by analysts at First Call/Thomson
Financial. In last year's third quarter, Costco earned 23
cents per diluted share.

Net sales for the third quarter increased 14 per cent to $6.77
billion from $5.94 billion a year ago.

Costco said it plans to open 10 to 12 new warehouses including
two or three relocations of existing warehouses before the end
of its fiscal year 2000 on Sept. 3.

Several brokerage firms chimed in with downgrades. Lazard
Freres lowered its rating on Costco shares to Hold from
Outperform, Morgan Stanley lowered COST to Neutral from Strong
Buy, and Legg Mason reduced its rating from an Outperform
rating to Market Perform.

Yesterday, PaineWebber analyst Jeffrey Edelman said he was
expecting 15 percent plus earnings growth. Robert Toomey of
Dain Rauscher added, "We remain very confident in the
company's business model and the company's aggressive new
store expansion." Toomey rated the stock a "strong buy" with a
12-month price target of $59 a share.

Earnings estimates, before today's announcement, for fiscal
2000 and 2001 were $1.38 and $1.60 per share, respectively.

Costco said it is budgeting for 8-9 percent growth in fourth
quarter same store sales.

Shares of Costco (COST) closed at $31.875, down $8.75 per share.



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ASK THE ANALYST
***************

State of the Market
By Eric Utley

My fellow investors and traders, we are in a bear market.  While
the pundits on CNBC debate whether or not we are in a bear market
let me present to you a few interesting items.  First, there is
the obvious, the NASDAQ is down roughly 36% from its peak in
early March.  And have you noticed the action in the stale
sectors such as Food, Gold, and Tobacco?  If not, pull up a chart
on ABS, KBL, NEM, and MO.  The preceding stocks are clearly
defensive plays, and their respective rises signal a bear market.
The advance/decline line looks terrible, and new lows are far
outpacing new highs.  And we all know what has happened to the
once beloved market leaders such as AMAT, CSCO, SUNW, and YHOO.
Additionally, and a little more concerning, we are starting to
see a few isolated cases of companies falling short of earnings
estimates, today it was COST.  I've also heard a few traders on
CNBC mumble something about layoffs on Wall Street.  You know
the bear has arrived when Wall Street starts talking job cuts.

While each bear market is unique, they all have one thing in
common.  Eventually, every bear morphs into a bull.  So how do we
know when the new bull has emerged?  I'll turn to William O'Neil
for the answers.  In a recent interview O'Neil explained that the
market will find real support once almost every stock has broken
down, all the bad news is digested, and enough time passes.
Eventually, the market will rally, and one of the major indices
will have what O'Neil calls a "follow-through" day, when either
the DOW, S&P, or the NASDAQ will rally over 1% combined with an
increase in volume from the initial rally day.  The "follow-
through" day will usually occur four to seven days after the
initial attempted rally.  Clearly, two of O'Neil's criteria have
been met; broken down stocks and a lot of bad news.  I think the
only variable is if enough time has passed.  This bear market is
approaching its third month of existence, in our times of instant
information maybe the worst is over.  If you would like a more
complete explanation of O'Neil's hypothesis, read Chapter 7 in
his book titled, HOW TO MAKE MONEY IN STOCKS.  By the way, you
can purchase that title in the OIN bookstore under the resource
tab.

I've received requests from several astute readers that have
found stocks that have bucked the bear.  If you have a winning
stock that you would like discussed, please send your request to
asktheanalyst@OptionInvestor.com.  Please put the symbol in the
subject line of the e-mail.

----------------------------

NASDAQ Composite Index - COMPX

While we're on the topic of bear markets, I thought it
appropriate to examine the long-term trend of the NASDAQ and the
current conditions of the US economy.  Unlike the famous markets
of 1929 and 1973-74, this bear is much different.  In 1929,
capitalism was feared to fail, and the US economy was facing many
uncertainties, most notably the collapse of American banks.  The
1973-74 bear market foreshadowed super-inflation and high
unemployment.  Unlike those famous crashes of the past, our New
Millennium Bear is not faced with a collapsing financial system,
nor hyper-inflation, nor high unemployment.  And, although Alan
Greenspan hasn't helped the cause for bulls recently, he is on
our side.  The bottom line here is that the economy is in great
shape, inflation is still low, and employment is high.  

I think the New Millennium Bear was caused simply by excesses in
the market.  I know that is not a profound statement filled with
insight and vision.  But, if you think back seven months ago when
the NASDAQ really took off, not a lot has fundamentally changed
with the US economy since then.  Okay, the Fed is in tightening
mode, but from a historical perspective, interest rates remain
relatively low.  And prosperity reigns supreme!  Biotech
concerns are increasing our life expectancy and curing diseases.
Tech companies are making life easier, and the Internet is
connecting the world.  Don't let the bear get you down, we are
living in the greatest time mankind has ever known.  Eventually
a new bull will emerge, but until it does, we must practice
patience.  I've provided a weekly chart for the NASDAQ below.
As you can see, the long-term upward trend-line remains intact.
I think the critical support level going forward is 2950.  If
that level holds in the coming weeks, I think we'll be just
fine.  You can also see on the chart, the bullish hammer formed
during Wednesday's trading.  Is this the bottom?  Maybe.  As
O'Neil might suggest, wait for a "follow-through" day to confirm
the rally.


 

----------------------------

Echelon Corp. - ELON

Thanks for your articles.  I read them every week and continue
to learn from them.  Would you please evaluate Echelon (ELON)?
Thank you. - Michael

Well thank you Michael, your comments are much appreciated, I
try hard to write articles that are useful for our readers.  I'd
love to take a look at ELON, as you well know, it's a very
interesting company.  ELON makes hardware and software that
connects everyday devices such as light switches, washing
machines, and gas pumps to the Internet.  ELON helps original
equipment manufacturers cut costs by linking electrical devices
to a control network, thus cutting costs through centralized
control and increasing service efficiency.  ELON is expected
to report its first quarter of profitability in its next
earnings report.  And the story gets better.  ELON is estimated
to grow earnings 30% annually over the next five years.  And get
this, ELON is expected to earn 19 cents per share during fiscal
2001, an 1800% increase over fiscal 2000!  If the analysts are
correct, ELON looks attractive for the long-term.

And more good news, Thomas Weisel Partners initiated coverage on
ELON Tuesday with a Strong Buy rating and set a 12-month price
target of $80 per share.  The analyst action helped ELON to buck
the decline Tuesday, and edge higher.  What's even more
interesting is the chart pattern formed over the past two
months.  ELON has developed a classic cup-and-handle formation,
which by the way, O'Neil believes is the most telling trading
pattern in the technical analysis universe.  Although the stock
retraced much of its gains from earlier in the year, the chart
formation looks strong.  The stock consolidated its gains in
the cup portion of the chart through much of April, it has since
rallied on heavy volume to form the handle.  A breakout around
$72 would provide a good entry to go long.  Notice the
resemblance of a cup-and-handle formed earlier in the year.
Look at what happened when ELON broke away from the handle.


 

----------------------------

Silicone Storage Technology - SSTI

Wassup with these stocks in this bearish market?  AMD, NVDA,
SSTI, ELON. - Surya & Sheela

Most of the stocks you mentioned above had held up relatively
well until recently.  SSTI had been holding steadily above $100,
but the bear mauled it down over the past five trading sessions.
As you well know, the semiconductor sector is extremely
cyclical.  And the memory chip market, in which SSTI operates,
is even more volatile.  Going back to 1998, SSTI was trading
below $2.  The stock has since rocketed higher in the past two
years along with the boom in the semi business.  If you take a
look at SSTI's financials, you'll see why the stock has risen
over 1700% in two years.  The company reported sales of $62.3
mln for in its first quarter of fiscal 2000, and blew away
analysts' estimates by 48%.  And analysts estimate that SSTI
will grow earnings by nearly 100% next year.

So what has led to the recent decline in SSTI?  Most notably,
concerns over a slowdown in the chip sector.  The chip equipment
companies recently reported a slowdown in orders for their semi
manufacturing products.  The book-to-bill ratio for April was
lower than the record number of orders in March.  Also, there is
the uncertainty over the long-running litigation against ATML.
SSTI is challenging ATML over a patent infringement.  If the
analysts are right and SSTI grows earnings 37% over the next
five years, this might be a good buying opportunity.  But,
further signs of slowdown in the chip sector will send the stock
tumbling.  Turning to the chart, despite the sharp sell-off
recently, SSTI's upward trend is intact.  However, like many
other leading tech stocks, it is hovering above key support
levels.  On a bullish note, the stock did form a hammer pattern
Wednesday.  You can see the spike in volume which may signal a
capitulation by sellers.  If the sellers lost their power
Wednesday, the stock could rebound quickly as there is very
little resistance above $80.  Also of note, you'll notice a
similar hammer pattern in early April, where after SSTI enjoyed
a quick, but brief rally.  The big difference is that
Wednesday's hammer came on much higher volume.


 

----------------------------

DISCLAIMER:
This column is an information service only.  The information
provided herein is not to be construed as an offer to buy or
sell securities of any kind.  The Ask the Analyst picks are not
to be considered a recommendation of any stock or option but an
information resource to aid the investor in making an informed
decision regarding trading in options.  It is possible at this
or some subsequent date, the editor and staff of The Option
Investor Newsletter may own, buy or sell securities presented.
All investors should consult a qualified professional before
trading in any security.  The information provided has been
obtained from sources deemed reliable, but is not guaranteed
as to its accuracy.



***********
OPTIONS 101
***********

Discipline
By David Popper

Is it not amazing that in America today there are more books on 
how to lose weight, and yet, we have more overweight people than 
ever.  It is not the lack of knowledge that causes people to be
overweight, rather it may be a medical problem or more commonly, 
a lack of discipline.  

So to, in the markets, many people have very workable trading 
systems but simply lack the discipline to make that system work.
Howard Abell, in his book "The Day Trader's Advantage," stated
"technical analysis is very important.  It is not, however, in my
opinion, as important as working through the psychological and
attitudinal issues of trading in general and day trading in 
particular."  In other words, a discipline to execute your plan 
is of paramount importance.

The operative question is, how do I develop a plan and how do I 
develop a mind set for successful trading.  How can I develop a 
winning edge?  Below I would like to explore some aspects of these
questions:

Understand your motive for trading:  Most traders are in a 
constant state of conflict.  They turn on CNBC in the morning and 
are depressed when a stock they were considering but had not yet
purchased, has gapped up.  They wish they were in total cash when 
the market goes down and somehow feel guilty that they were not
clairvoyant enough to take preventative action.  They feel equally
as foolish when the market goes up and they are not fully 
invested.  These type of concerns are unrealistic and detrimental.
Instead of worrying about all of the could haves, should haves and 
would haves, a disciplined trader must be able to take the trades 
that are consistent with his methodology.  His goal is not to 
maximize every trade, rather his goal is to achieve consistent 
positive results.  Remember singles are more consistent than home
runs and can easily help you achieve your overall goal. 

Develop a personal strategy that works for you and fits your 
personality.  If the system does not feel right, then you are 
going to lose before you even start.  You must trade a system that
feels comfortable even if it is less profitable than other 
systems.  Confidence and consistency are key.  Experiment with 
different systems and pick the one that's most comfortable.  If it
works, stick to it.

The system should be enjoyable.  The whole purpose of trading is 
to either provide a living or extras for you and your family.  If 
your trading creates needless anxiety and actually causes you to 
lose money on a consistent basis, then that system simply is not 
for you.

Hard work is essential.  You simply must put in the time.  Despite 
the myriad of self-help trading books, there is no substitute for 
the hard work of reading charts, knowing your stocks, fine tuning 
your system and implementing your buy and sell rules.

Confidence.  You must believe in your analysis, your trading system 
and your execution of trades, whether you win or lose.  

During a bull market, very little discipline is required to make 
money.  People could almost throw a dart at the Wall Street Journal
and find a winner.  Times are changing.  Bear markets will expose
weaknesses in your discipline, weaknesses in your system and 
weaknesses in your execution.  If you find that you are having too 
much difficulty at this point, sit it out.  A good market will 
return.  If you must trade at this point, it is critical that you
ratchet up your focus and discipline.  It is simply hard to win 
today.

Nevertheless, most experts will tell you to find one system that 
you are comfortable with.  Find several stocks that you know well.
Trade only those stocks and trade them only in your one system.  
Do not use margin in sideways markets, but instead maintain a
comfortable amount of cash.  This cash reserve may lead to 
explosive gains later when a bottom is finally reached and a rally
ensues.  

Contact Support



**********************
PLAY OF THE DAY - CALL
**********************

SDLI - SDL Incorporated $175.56 +5.06 (-20.69 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

SDLI was added this past weekend, and we would hope you have let
patience be your guide.  Remember our place is not to try and 
convince anyone that they should jump into a play, just because 
it showed up on our list.  Entry points are the key to success.  
The fact is this one is down 13% so far this week and a bottom may 
or may not be in place yet.  The volume on the decline the first 
two days of the week has exceeded 13 million which is fairly 
substantial indicating their may be more room to move to go.  Long 
and short term fundamentals have not changed.  Unfortunately at 
this point SDLI is just like many of the tech issue that have 
suffered from Fed fears, and a lack of buying interest.  There is
economic data and a speech by Alan Greenspan in the next few days,
which could help bring a few buyers back to the market.  No company 
news so far this week to help prop up the stock, although in these 
markets it would have to be darn good news to make a difference.  
SDLI closed on support at $170.  The next levels show up between 
$155 and $160.  If we do get a move up, be ready to take profits 
at a moments notice.  If we see further weakness, continue to be 
patient.
 
Comments

Impressive volume on the NASDAQ and an impressive rally today.
Finally.  On an intraday chart, you can see how this increased
volume pushed SDLI higher in the latter half of the session.  
Quite a beautiful climb.  This upward surge brought SDLI above 
100-dma of $169.63, which represents a short-term support.  As
you can see from today's tail on the candlestick, SDLI can really
sell-off before finding support.  Today's low was $147.50.  Yet,
the strong volume today is very positive.  Resistance	will be
found at $180 and $183, its 50-dma.  Targetshoot on the intraday
dips and confirm any upside moves with volume.

BUY CALL JUN-170 YAL-FN OI= 46 at $22.75 SL=17.75
BUY CALL JUN-180*QZL-FP OI=317 at $18.25 SL=14.25
BUY CALL JUN-190 QZL-FR OI=415 at $14.38 SL=11.25
BUY CALL JUL-190 QZL-GR OI=421 at $25.50 SL=20.00

Picked on May 21st at   $196.00    P/E = 390
Change since picked      -20.69    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



*****************************************
BIG CAP COVERED CALLS & NAKED PUT SECTION
*****************************************

Conservative strategies are looking more attractive every day!

******************************************************************
Today the assistant editor for this section is attending a very
important family event, a graduation ceremony.  Without this key
member of the research team, it is difficult to produce a viable
group of candidates.  With that in mind, I have decided to review
some of the techniques and guidelines that we use to profit from
this strategy.
******************************************************************

Success with Covered-Calls...

Investors usually write covered-calls to generate monthly income,
collecting the premium for the sale of an option against a stock 
position in his or her portfolio.  This conservative strategy can
be used effectively on all type of stocks as long as the outlook
(fundamental or technical) for the issue is favorable.  One of the
advantages to this approach is that it allows new investors to
learn successful trend-trading techniques with a small margin of
safety while managing the combined position for upside profit and
downside risk.  This underlying basis for this strategy is a high
probability of limited profit.  The major advantage to a novice
trader is the technique is easy to use and the resultant position
is more conservative than outright stock ownership.  In writing an
option on the stock, the investor has insured the issue against a
future drop in value.  Regrettably, the downside risk in ownership
is not eliminated, only reduced.  In addition, the actual cost of
opportunity loss or potential upside movement can be substantial.
There are other, more subtle benefits and disadvantages but these
are the most common reasons that investors choose (or avoid) this
strategy.

Each week we receive a number of questions regarding the various
approaches to the investment strategy of selling covered-calls.
In our personal portfolios, we utilize the "in-the-money" covered
write as a primary technique for consistent profits.  This method
is easy to master and works in harmony with a low maintenance, low
risk investing style.  The underlying theory behind our success is
to be "aggressively conservative."  This tactic is in contrast to
the more popular "conservatively aggressive" outlook used by many
traders, where the underlying position is bullish, (based on OTM
calls) and requires an upward movement from the stock for profit.
In general we are conservative, long-term investors with contempt
for excessive risk and the potential for large losses.  Studies
suggest (and our results confirm) that the average investor will
make substantially greater returns through the consistent profits
from "in-the-money" covered writing than he would using the high
risk, high reward approach of more aggressive positions.

You may think that this technique is far too conservative to yield
favorable returns however, the "magic" ingredient of the strategy
is the power of compound interest.  Covered call writing allows
investors to potentially compound their returns on stock ownership
each month of the year.  Unfortunately, while most investors begin
writing covered calls with the goal of compounding their money on
a monthly basis, many lose focus of the fundamental outlook of the
technique (consistent, low risk profits) and start to concentrate
on higher, single transaction returns.  This is a common mistake
and it can substantially increase risk and the probability of loss.
The market historically offers a 2-4% monthly (annualized) return
for this conservative strategy but with diligent research and
analysis, and proper money management, the margin of profit can be
increased.  In our personal portfolios, we attempt to establish
positions that offer on average, a 4-6% (8-12% on margin) monthly
return on investment.  Even with this meager profit, the long-term
portfolio growth is excellent, based on the simple mathematics of
compounding.  Earning just 3% per month in a personal portfolio,
without compounding or margin trading, equates to a 36% yearly
return.  We haven't found a bank or CD that matches that rate (but
Mr. Greenspan is working on the issue).  Obviously, most retail
option traders regard a 3% monthly return as far too low.  In fact,
why would anyone want such a paltry reward when the market offers
such great potential for wealth.  There is answer is quite simple:
RISK.  Any strategy that yields 10% will be riskier (on a purely
theoretical basis) than one offering a 3% return.  You know the
old adage, "The greater the risk, the greater the reward."  Some
of you will learn the hard way, as we did.  After getting hammered
on the majority of aggressive positions, we made the transition to
ITM covered writes with lower returns.  Now our portfolios grow on
a consistent monthly basis.

The goal of the covered-call writer is to have a good selection of
favorable positions with adequate downside protection.  With this
approach, an investor reduces risk by entering several stock and
option plays with a predetermined conservative profit target for
each one.  We strive for a 5%-8% monthly return in the newsletter
but again with a lower profit target, the higher the probability
of a favorable outcome and the lower the risk.  To further reduce
the potential for catastrophic loss, a trader should diversify his
market exposure through a wide variety of covered-call positions.
The stocks you purchase should generally represent companies of
different types in a variety of industries.  Most novice investors
ignore this principle and consequently, their portfolio losses are
substantial when a heavily weighted sector falls "out of favor."
Many experts suggest you should limit each investment to no more
than 10% of your overall portfolio.  This is very important to the
success of the covered call strategy as you do not want one issue
to have a significant impact on your overall gains or losses.  The
fact is, no one really knows what a particular stock is going to
do in the future.  History suggests that the most prolific traders
are correct in only slightly more than 50% of their directional
forecasts and that statistic reinforces our basis for choosing to
hedge poor selections with "in-the-money" covered writes.

Before you open any position, it is important to understand the
strategy that you are using and identify the specific goals for
that particular trade.  You can't make good decisions without
knowing the mechanics of a specific technique.  Don't use complex
or advanced methods simply because they are intriguing.  The best
strategy is usually the simplest one that accomplishes your goals.
Prior to executing a transaction, you should know exactly what the
break-even (cost basis) point is, and be prepared to take action
if the underlying issue reaches that price range.  Once you have
a candidate in mind, do your homework!  Know the company and the
calendar; upcoming events, earnings dates and scheduled reports.
When you have a superior knowledge of a stock and its industry,
you are way ahead of the investor that trades simply on intuition
or outside advice.

Portfolio management is critical to the success of any trading
system.  After you take a position in a particular issue, stay
informed by monitoring all the news and announcements affecting
that play.  Observe the daily progress of the your stocks and
realize that you have the ability and control to adjust or close
the position at any time.  Obviously you do not need to check the
prices on an hourly basis, but we do recommend that you review
each day's closing quotes.  News and public opinion can have a
significant impact on a stock's price and unfortunately, it is
impossible to research "future" events before you buy an issue.
The most painful lesson comes when you close a losing trade.  It
is very difficult to learn to exit unsuccessful plays in a timely
manner but the simple fact is, there is no reason to hang on to a
losing position when there are so many other profitable plays that
deserve your time and money.  Accept your losses, learn from your
mistakes (evaluate each one critically), and move on!  With any
strategy losses are inevitable.  Instead of being surprised, we
anticipate them.  We know that a percentage of the covered write
positions we select will be unprofitable therefore, when the
situation arises, it is not regarded as a failure but rather an
integral part of the trading system.  Our portfolio is evaluated
based on the sum of its positions, rather than each transaction.
In this manner, success is gauged by growth in portfolio value
and the losses become less significant.  That is the fundamental
reason for entering several positions.  It becomes much easier to
identify and act on a potentially negative play when it doesn't
have a substantial effect on your overall success.

The concepts of most exit and adjustment strategies are relatively
simple but there is no way to develop a specific guide for proper
position management.  With stock and option combinations, the key
is to evaluate the risk-reward outlook of each possible scenario
and construct a position that fits your trading plan and technical
outlook for the underlying issue.  Remember, success with this
strategy lies in one objective; a consistent flow of monthly
income with limited portfolio risk.  The focus of play selection
and management should be to continually generate an acceptable
level of option premium while protecting against the potential
for downside losses.  Positions that become unfavorable due to
changes in the fundamental or technical characteristics of the
underlying issue must be removed from the portfolio before they
can generate significant deficits.  Catastrophic failures are not
unavoidable but they can be sufficiently managed to reduce the
effects of the shortfall.  Obviously, each situation will require
a different solution but in general, we try to limit individual
position losses to 20%.  Unfortunately, there are occasions when
issues fail without warning, leaving no opportunity for exit or
adjustment.  Unexpected events simply occur; earnings warnings,
shareholder lawsuits, negative news in the industry or sector and
changes in public sentiment.  All of these activities can affect
the success of an individual position but with a diversified
portfolio, the long-term effects are minimal.

Our approach to "in-the-money" covered calls is designed to lock
in profits whenever possible and reduce the inevitable losses to
a minimum.  A rise in share value is the ultimate goal of stock
ownership and with this strategy, a significant short-term move
can provide additional opportunities for profit.  When the share
value rises substantially after the initial position has been
established, you have several choices.  You can do nothing, get
"called-out" and accept the original return that was established
when the play was opened.  If the option is priced near parity,
you can close the play early or, you may also choose to adjust
the position to match the new outlook for the underlying issue,
"rolling" the call up and forward to a higher strike price.  When
you roll up (buy-back the current sold call and sell a higher
strike call), the profit potential of the position is increased.
Unfortunately, the downside break-even point is also increased by
the amount of debit required to complete the transaction.  That
is the main reason most traders transition to a future expiration
date; it reduces the debit required for the new position.

While it is not our preferred investment approach, there are a
number of benefits and advantages to long-term stock ownership.
If that is your intention, additional measures are necessary when
utilizing "in the money" covered-writes.  As expiration nears and
the "time value" premium disappears from the written option, you
should consider rolling forward to reduce the likelihood of early
assignment.  The overall profit potential of the position will be
increased and the outlook for the stock/option combination can be
adjusted, consistent with your forecast for the movement of the
underlying issue.  With "deep-in-the-money calls," most of the
time value premium vanishes long before expiration.  However, as
long as (time) premium remains in the call option, there is little
risk of early assignment.  As the option price (bid) falls to
parity or a discount, there is a considerable probability of
exercise by arbitrageurs; floor traders who do not pay commissions
for trading.  When this situation occurs, you should endeavor to
roll-forward or adjust the position in some manner that prevents a
monetary loss through unexpected assignment of the short option.

One last opinion, Larry McMillan's book, "Options: As a Strategic
Investment," is an excellent resource that completely explains the
various aspects of the covered write strategy.  It is available in
the OIN bookstore

Good Luck!



Summary of Previous Picks: (May Strikes based on Friday's close)

Covered Calls: (Margin would double the listed Monthly Return)

Stock  Strike Strike Cost   Current Profit  Monthly
Symbol Month  Price  Basis  Price   (Loss)  Return

TIN     MAY    50    48.88   54.06   $1.12   7.7%
CY      MAY    45    42.06   46.25   $2.94   7.1%
PLXS    MAY    70    68.75   80.50   $1.25   6.1%
SEPR    MAY    75    70.75   99.75   $4.25   6.1%
AMD     MAY    60    55.25   83.81   $4.75   5.9%
TQNT    MAY    80    76.65   83.75   $3.35   5.8%
PDLI    MAY    85    82.71  132.63   $2.29   5.3%
TER     MAY    85    81.56   84.75   $3.19   5.2%
PLXS    MAY    65    62.56   80.50   $2.44   5.2%
PVN     MAY    85    80.38   89.50   $4.63   4.7%
AHP     MAY    55    52.75   59.50   $2.25   4.3%
BBRC    MAY    60    57.56   58.63   $1.07   3.5%
INSUA   MAY    35    32.19   33.06   $0.87   2.2%
NVLS    MAY    50    48.06   46.94  -$1.12   0.0%
CGNX    MAY    55    51.34   49.56  -$1.78   0.0%
BRKS    MAY    70    66.88   61.50  -$5.38   0.0%

NEWP    JUN   110   104.44  130.38   $5.56   5.4%
NVDA    JUN    90    85.50  106.50   $4.50   5.3%
RFMD    JUN    95    90.50   96.38   $4.50   5.0% Key moment
ARBA    JUN    55    51.63   53.19   $1.56   2.5% Nearing support

IMNX (MAY) - Closed
CSCO (MAY) - Closed: Broke 150 dma on Thursday 5/18


Naked Puts:

Stock  Strike Strike Cost   Current Profit  Monthly
Symbol Month  Price  Basis  Price   (Loss)  Return

PLXS    MAY    70    68.50   80.50   $1.50  20.8%
TIN     MAY    50    48.94   54.06   $1.06  18.4%
YHOO    MAY   100    98.75  120.31   $1.25  14.1%
CIEN    MAY   100    99.00  116.50   $1.00  12.6%
CY      MAY    40    38.56   46.25   $1.44  12.6%
SEBL    MAY   105   103.88  123.25   $1.13  12.4%
BBRC    MAY    55    54.06   58.63   $0.94  10.8%
PLXS    MAY    60    58.75   80.50   $1.25  10.1%
NVLS    MAY    45    44.06   46.94   $0.94   9.7%
TER     MAY    75    73.50   84.75   $1.50   9.0%
SEPR    MAY    65    63.25   99.75   $1.75   8.8%
INSUA   MAY    30    29.06   33.06   $0.94   8.7%
TQNT    MAY    70    68.87   83.75   $1.13   7.5%
PDLI    MAY    70    69.19  132.63   $0.81   6.9%
STT     MAY    85    84.31  113.13   $0.69   6.0%
BRKS    MAY    60    58.94   61.50   $1.06   5.9%
AHP     MAY    50    49.12   59.50   $0.88   5.8%
PVN     MAY    70    68.75   89.50   $1.25   5.2%
CGNX    MAY    45    44.25   49.56   $0.75   4.8%

ARBA    JUN    50    48.00   53.19   $2.00  10.6%
NEWP    JUN    95    92.00  130.38   $3.00   9.5%
NVDA    JUN    80    77.87  106.50   $2.13   8.9%
RFMD    JUN    85    82.94   96.38   $2.06   8.3%
SDLI    JUN   140   136.75  175.31   $3.25   7.3%
YHOO    JUN   115   112.75  122.75   $2.25   6.6%
AFFX    JUN   105   102.94  128.81   $2.06   6.1%


Naked Calls:

Stock  Strike Strike Cost   Current Profit  Monthly
Symbol Month  Price  Basis  Price   (Loss)  Return

PWAV    MAY    80    81.46   64.06   $1.46  21.0% Adj for 3-1 split
CMTN    MAY   115   117.19   76.00   $2.19  12.4%
JNPR    MAY   260   262.25  163.00   $2.25  10.4%
BRCM    MAY   220   222.00  139.63   $2.00  10.2%
TDS     MAY   120   121.13  102.63   $1.13  10.1%
ITWO    MAY   185   187.25   98.06   $2.25   9.5%
CHKP    MAY   270   273.25  161.38   $3.25   9.3%
AAPL    MAY   145   146.56   94.00   $1.56   7.8%
AMAT    MAY   125   126.13   80.19   $1.13   7.8%
NEWP    MAY   160   161.25  128.63   $1.25   7.3% 

JNPR    JUN   270   272.13  157.00   $2.13   6.1%



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