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Daily Newsletter, Monday, 11/20/2000

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The Option Investor Newsletter                   Monday 11-20-2000
Copyright 2000, All rights reserved.                        1 of 1
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MARKET WRAP  (view in courier font for table alignment)
        11-20-2000        High      Low     Volume Advance/Decline
DJIA    10462.60 -167.30 10624.30 10449.30  953 mln    976/1848
NASDAQ   2875.64 -151.55  2949.50  2860.49 1.72 bln    972/2998
S&P 100   710.04 - 15.05   719.55   709.16   totals   1948/4846
S&P 500  1342.62 - 25.10  1360.31  1341.67           28.7%/71.3%
RUS 2000  470.24 - 12.37   482.69   469.41
DJ TRANS 2795.86 - 21.44  2818.20  2785.28
VIX        30.33 +  2.48    30.99    29.26
Put/Call Ratio      0.76

Another Day, Another Downgrade

Today it was the Networkers who got bad-mouthed and the effect
rippled throughout the tech sector.  Telecoms, telecom equipment
providers, and fiber stocks felt the heat, bringing the NASDAQ
back down to painful levels.  The longer this investor "fear
factor" continues, the harder it becomes for the markets to
snap out of the trance.  Yet, the concern about earnings growth
is warranted:  the economy is slowing.  No doubt about that.
Throw in the volatility, courtesy of the Presidential battle, and
this market leaves something to be desired.

Valuation still is, and always will be, the determining factor in
the markets.  If a stock is perceived to be overvalued, investors
sell it.  If it seems undervalued, investors buy it.  It is as
simple as that.  We are currently in a market environment where
everyone is asking the question:  can the market sustain these
valuations?  This is directly related to the earnings outlook.
With the economy slowing and every other company revising there
future earnings growth figures to the downside, one only needs to
look at the NASDAQ to see the effect.  Those high-dollar, high
fliers have come down from their lofty valuations:  BRCD, BRCM,
JNPR, VRSN, and SDLI to name a few.  Investors, especially
institutions, are reassessing whether those stocks are good values
in relation to projected earnings growth.  Most of the analysts
that I hear on CNBC preach "lightening up on positions" in the
rallies.  Then, I hear the fund managers calling the same stocks
"good values."  So which is it?  For the latter, considering the
size of their positions and available cash, they can afford to
take that capital risk.  They buy on the way down and sell on
the way up.  But for us individual traders, you have got to go
with the trend.

Each rally we have seen recently has created a bull trap, sucking
in those longs thinking that the last spike down was it.  These
moves are entirely tradable however.  Just make sure you keep your
eyes on the screen, along with a short term time horizon.  As much
as we all want to put in the bottom on the NASDAQ, it hasn't
happened.  Characteristics of a downtrend are lower highs.  That's
what we've got.  In the chart below, when the bottom was thought
to be in place at 3000, buyers couldn't take the index over 3550,
conceding to the sellers and establishing a major failure.  The
bounce from 2859 was merely a bounce:  a lower low, another
characteristic of a downtrend.  That second rally topped out at
3200, establishing the lower high, and another bull trap.  It
is important to realize this so that we can take advantage of
this short term trading moves.  It doesn't have to be a total
market reversal to make money.  It takes discipline.  Today's
failure to sustain the late-day rally resulted in another dead
cat bounce.

Yet, just because the NASDAQ is trending lower doesn't mean we
can't make money.  As option traders, the put plays can be our
best friends, making money on the intrinsic side and on the
expanding volatility in the put as the underlying goes lower.  The
best of both worlds.  Have you taken a look at our put list lately?

Rally failures at key resistance levels have provided ideal entries
into put plays.  Think about it.  The failure on the NASDAQ at 3200
was only four trading sessions and 325 points ago.  That's big
money to be made on puts.  It has been very tough psychologically
to watch this market day in and day out when everyone has grow so
accustomed to astronomical bullish moves.  We need to remember
that each day the NASDAQ becomes more and more oversold.  It will
come back eventually.  In the meantime, like the old adage, the
trend is your friend.  Same as when the trend was going towards
5000.  Don't be afraid to play what the market gives you.

The major catalyst to the downside was a downgrade of the entire
Networking sector by Morgan Stanley Dean Witter.  They cut their
rating on CSCO, RBAK, JNPR, and EXTR to an Outperform from a
Strong Buy.  Morgan Stanley cited current valuations, the economic
slowdown, moderating telecom growth, and seasonally weak demand
as its reasons for the call.  This put pressure on many other
telecom related issues.  SG Cowen stepped up to defend CSCO and
RBAK by reiterating their Strong Buy recommendation on the two.
On a different sector note, Lehman Internet analyst Holly Becker
downgraded EBAY to a Neutral from a Buy, concerned that the
company's core collectible business is slowing.

Once again, the Presidential-Elect litigation has caused minor
gyrations in the market, and major volatility.  When the Florida
Supreme Justices took there seats for the hearings today, the
market perked up and rallied.  Yet, it was just another
short-lived rally attempt.  The result of today's hearing was
that the Supreme Court will rule quickly in the fate of the
1.6 mln manually counted ballots.  Until then, the volatility will
continue as the markets hang onto each press conference.

As for the INDU, it sold off along with the tech index.  Dragging
the INDU down were two of the old economy companies, GM and KO.
KO sold off on news that it would acquire Quaker Oats(OAT) in
what is expected to be a $16 bln deal.  KO will get its hands on
the Gatorade brand name and improve its position in the Beverage
arena.  This talk comes just weeks after OAT spurned a $13.7 bln
offer from rival Pepsi(PEP).  KO was down $4.88 to $56.56, while
OAT closed at $95, up $4.69.  GM fell today $4.31 and JPM lost
$4.06, accounting for a large portion of the INDU's losses.

Technically, the INDU is in better shape than the NASDAQ in that
it has put in a bottom at the sub-10000 level.  The support at
10369 will likely be retested.  Yet, tomorrow will probably have
a relief rally given the oversold conditions.  Watch to see if
any rally can be sustained or if it turns into another bull trap.

Looking ahead, the markets are very oversold.  Look for a relief
rally tomorrow.  Let's not forget that tomorrow will probably be
the last day of decent volume, and therefore liquidity, before the
Thanksgiving holiday.  Traders will probably take off on Wednesday.
This will take us clear until next week since Friday will only be a
half day of trading.  Hopefully by that time we will have a
Presidential-Elect.  Remember that trading opportunities lie on
both the up and the downside, so any failure of a relief rally could
very well provide put entries.  At the same time, with the markets
being closed for a day and a half this week, there will be some
additional time decay.  Use prudence when trading and be sure that
you have stops in place if you're not glued to the monitor.
Have a Happy Thanksgiving!

Matt Russ


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HUM $11.94 -2.63 (-2.63)  HMO stocks took a hit today after
Prudential Securities downgraded the entire sector on valuation.
Analyst David Shove lowered his rating on HUM to a Hold from a
Strong Buy.  In analyst terms, that means sell.  And that's what
they did.  HUM blew through our stop of $13 and closed near the
low of day in a very ugly session all around.  As a result, we
are dropping this low volatility call play.

SGI $4.06 -0.19 (-0.19)  This lottery ticket has expired.  If it
doesn't move, we can't make money.  Quite simple.  Even though
SGI has not violated our $4 stop level, we will be dropping it
tonight and start searching for our next lottery play.

CIEN $89.94 -14.50 (-14.50)  With the downgrade of many networkers
today by Morgan Stanley Dean Witter, related stocks fell in
sympathy.  CIEN, which provides fiber-optic components for the
networker, sold off over 10%.  This very well could be over done,
and relief might be waiting in the wings, but with CIEN closing at
the day low, it broke our stop loss at $90.  In after-hours, the
stock was trading down at $89.  Traders seem to like this stock so
a bounce may be likely, turning CIEN around once again.  However,
we must drop CIEN tonight.

SUNW $81.63 -7.69 (-7.69)  We placed a tight stop on SUNW for this
exact reason.  With the NASDAQ opening down almost 90 points, it
should have deterred anyone from entering this play.  Only an hour
into the session, SUNW was breaking our stop and should have
screamed "stay away!"  The technical health of NASDAQ continues to
look weak and is keeping the cash on the sidelines.  It is clear
that they don't even want to buy SUNW and other NASDAQ generals
at this time.  Therefore, we are cutting SUNW loose tonight.


ARBA - put play
Adjust from $84 down to $75

RATL - put play
Adjust from $44 down to $38


TLAB - Tellabs Inc $57.06 +1.19 (+1.19 this week)

Tellabs is an optical networking firm.  Its equipment is used
throughout the world to manage and transmit data, voice, and
voice signals.  Customers include telecommunication companies,
cable operators, corporations and government agencies.  Baby
Bells account for nearly one-third of sales with another third
generated outside the U.S.

Most Recent Write-Up

News events, company announcements, and a jittery marketplace
all contributed to the mixed trading TLAB experienced last week.
The climax was TLAB's decisive break out of the narrow trading
range during Wednesday's session.  After a relatively long
period of consolidation between $52 and $56, TLAB shot up to
$57.06 and closed strong at $56.69.  The 2pm explosion
corresponded with the start of USB Warburg's 5th Annual Global
Telcom Conference, which Tellabs was a participant.  The bullish
move through the $56 resistance also came ahead of the company's
announcement that it had signed a multi-year agreement with
Beijing Bell Telecommunications Equipment Manufacturing to sell
its latest switching technology in China.  The deal was well
received by the Street on Thursday.  Gains immediately extended
and TLAB pushed through the $58 level on robust volume.
Although the break through the 200-dma ($57.48) was a technical
achievement, it was short-lived.  The uncertainty hanging over
the broader markets dragged TLAB backed down to shorter-term
support at the $54 level and the 10-dma line ($54.46).  More bad
news continued to hit the industry as Nortel (NT) set another
52-week low when Bank of America implied that it could lose
market share to rivals in the optical networking arena.
Overall, TLAB faired well throughout the week and presented a
variety of entry points, depending on your risk portfolio.
Currently, the $53 mark is serving as a safety net on the deeper
intraday dips, but consider taking a more conservative approach.
Cautious types might wait for momentum traders to take TLAB back
through the $56 and $58 levels on strong volume before beginning
new plays.  While the prospects for additional gains look good,
nevertheless, keep stops tight.  A close at $52 and we'll exit
the play for better opportunities.


The stock opened near the day low and bucked the NASDAQ trend,
trading higher throughout the session.  Even as other telecom
component providers felt the heat of the networker downgrade,
TLAB proved strong.  It bounced from the 10-dma currently at $55
and never looked back.  To play this call, look for bounces from
$56, or lower at the 10-dma.  Overhead, resistance will be at $58
which is in the vicinity of the 200-dma at $57.46.

BUY CALL DEC-50 TEQ-LJ OI= 764 at $8.50 SL=6.50
BUY CALL DEC-55*TEQ-LK OI=1675 at $5.00 SL=3.25
BUY CALL DEC-60 TEQ-LL OI=4304 at $2.63 SL=1.25
BUY CALL JAN-55 TEQ-AK OI=2499 at $7.00 SL=5.25
BUY CALL JAN-60 TEQ-AL OI=3136 at $4.88 SL=3.25


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Methodical Account Management
By Austin Passamonte

Whenever I ask fellow traders about account-management strategies
to maximize profits I'm usually met with indifference, confusion
or both. Far more important than choosing a good trade is being
profitable over time by managing both wins and losses.

Before I get started, let me address any questions about the
series of articles I began covering credit-spreads. At first I
really thought this subject could be covered in three sections.
The more I wrote, the more "little things" popped into my head
that aren't in print anywhere I've read so far. Things I had to
learn the hard way, most of the time at direct expense to my
account in the process.

Questions still continue to flow in from the very basic to
advanced. This has now become a mini-series instead! For those
who remain interested in learning more about credit spreads from
A to Z, please visit us in OIN's sister site: www.IndexSkybox.com

You will find four articles there now and many more to go. We
also have a trading section just for credit spreads that may be
of value to your education as well.

I apologize in advance if this causes inconvenience but at this
rate our credit-spread series would take until January to finish.
For brevity's sake and with great respect to those interested in
varied topics, I have tons more I'd like to share than time &
space permits. I look forward to continuing this topic at length
and much more with you in IS.


I know beyond a shadow of a doubt most new traders and many
others believe picking winners is all that matters. This is
certainly far from true!

Reality is any trader can profit, break even or take an overall
loss depending entirely on account management with the exact same
trades, entries and exits. How can this be? Let's break it down.

When I began trading options, my first account for $5,000 became
$32,000 in two months mostly trading the OEX. The third month saw
it turned to -$19,000 as I bet bigger, didn't use stops right (or
at all) and chased everything under the sun. Ever hear any other
stories like that? Ever been one of those stories yourself?

I worked really, really hard for 1/4 a year out of my life only
to lose $51,000 net. This was lesson enough to instill the fact
that long-term fiscal success includes more than simply wins and
losses. Not to mention similar previous painful lessons trading
futures and stocks but let's not pile it on here!

One of many mistakes I made at the time was mismanagement
of trade sizes according to my account balance and win/loss
strategy. During the great recent bull-run we could get away with
all kinds of mistakes and still come on top. Heck, just buy some
calls and hang on; market action will take care of the rest! That
hasn't been the case for a long time and may be awhile before
returning again.

Today we need a discipline, systematic approach to consistently
succeed during normal market conditions that have returned.

In the past I merely bought option contracts on a whim, no cause
to dictate results other than hoping to win. That's a very poor
approach at best.

My profit/loss parameters on any trading models are now based
upon percentage of wins being larger than loss (of course) with a
target of more overall wins than losses. Not all profitable
models win more than they lose. It is common for systems to win
only 3 or 4 trades out of 10 but earn big profits on the wins
while keeping losses small.

It's my opinion systems that win half or more of their trades are
the best choice for most. Therefore, we must also base our trade
purchases on a static dollar figure rather than number of
contracts in order to match these results in actual performance.

An ideal conservative approach is to choose a working capital
amount and then take trades based upon that total figure dictated
by stop loss amount at risk. Let accrued profits buffer total
principle to insulate against drawdown. Examples follow:

If we have a very modest $5,000 trading account dedicated to high
risk/high reward trading, let's first decide how much drawdown to
risk on each individual trade. That will in turn dictate our
trade position size as well.

Let's say we won't risk more than 5% of that account or $250 on
any single trade. Terrific. This means we can play one option
that has a stop-loss risk of 2.5 regardless what the actual cost
is. All we care about is managing loss and it's capped near the
$250 range by placing our stop there. If the model we follow
doesn't suffer large consecutive strings of losses we might
choose to risk $250 on each play for quite some time.

If the sell-target is 4 points profit and odds of success are in
your favor we then wind up with an account balance of $5,400 on a
successful play. Perhaps the next win will yield 4.5 points and
we now hold a balance of $5,850. A loss of 2.5 points draws us
down to $5,600 and the next loss is on a trailed stop for 0.5
that takes us to $5,550.

Two more wins of 3.5 now ratchet us to $6,250. Can you see how a
methodical and conservative management system allows us to turn
frequent small profits into much bigger accounts?

The absolute lifeblood of this success is keeping losses at a
smaller percentage. That includes initial stop-loss targets hit
and plays that exit on advanced trailing stops as well. Keeping
our overall loss percentage low as possible makes long term
success automatic.

Let's say you followed a system that always bought 10 contracts
regardless of price. If the stop loss and sell-target dollar
amount is different every time you might win on two small gains
and lose on two larger losses to lose overall.

Example: The QQQ plays we target are at 1.5 "ask" and we look to
risk 50% for a return of 100%. That means our stop is set at 0.75
to protect with no guarantee we won't suffer slippage with a sell
target of 3. How do we approach this trade?

With a $5,000 account and a $250 risk balance I would personally
buy four of these QQQ options for $600 total cost and risk $300
total loss on a stop to make $600 profit at the sell target. You
would do fine to only buy three but the extra $50 over the $250
target is not much versus the possible gain. A win gives you a
new account balance of $5,600 just like that.

The next trade comes during the first week of a new cycle and
premiums are high. Now the QQQ play we target is at 4 "ask" and
we have a 25% risk/50% profit target. Then what?

Again, our 5% of balance to risk is $250 on this trade. We can
afford two of these options based on risk of a 1-point stop @ 3.
Our sell target is 2-points gain @ 6. We buy two contracts, get
stopped out and lose $200 from our new balance of $5,600, taking
us to $5,400.

If we had simply bought four QQQ contracts again with no
forethought to leveraging percentages, our loss would be $400 and
our new balance would in this case be only $5,200 instead.

Let's go to our next example. We have a $100,000 account and are
trading a model that has a 25% risk stop and a 50% profit target.
Again, using our 5% per trade risk level we have $5,000 to work
with. The OEX options we target are 10 points each. We buy twenty
of them, place our stop loss at 7.5, sell-target at 15 and let the
trade execute from there. Our risk is having 20 contracts stopped
at 2.5 each for a total of $5,000 loss.

Trader #2 also has the same account size and always buys ten
option contracts per play no matter what out of habit or lack of
better money management.

This trade wins and we are up $10,000 with a new balance of
$110,000. The same trade presents itself next session and we
repeat the process for another $10,000 win. Total account balance
is now $120,000.

Trader #2 bought his static ten contracts, hit the same targets
we did but his net return was only $5,000 on each of the two
winning trades. He is up $10,000 for a total of $110,000 with the
only difference being account management. If you think this
approach is more prudent, read on!

The third trade has option contracts at 24 "ask" in the new
cycle. We have our $5,000 of account balance risk per trade and
can afford 8 of these more expensive contracts. That is $4,800
risked on 8 options with 6 point stop-losses. Our stop is set at
18 and sell target at 36.

Trader #2 bought ten of these contracts out of habit and uses the
same stop loss at 18 and sell target at 36. This is great if one
never loses but you know what's coming next.

The market moves against us and we are both stopped out at the 18
mark. Our account is down $4800 but Trader #2 is out $6,000. The
same setup occurs next session and we each take the trade. Same
result, stopped out again. Now what?

Well, we lost $4,800 + $4,800 for a total of $9,600 on our total
account balance. We are still at $110,400 in one week.

Trader #2 lost $6,000 + $6,000 for a total of $12,000 on the very
same trades. He stands at $98,000 total balance to our $110,400
in one week.

Same exact trades, very different results. Can you see a method
to the madness here?

Next Monday will complete this topic with more examples and exact
approaches to apply in your personal trading style as well. See
you then!

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