Option Investor

Daily Newsletter, Monday, 11/27/2000

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The Option Investor Newsletter                   Monday 11-27-2000
Copyright 2000, All rights reserved.                        1 of 1
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MARKET WRAP  (view in courier font for table alignment)
        11-27-2000        High      Low     Volume Advance/Decline
DJIA    10546.10 + 75.90 10626.80 10479.30  929 mln   1555/1288
NASDAQ   2880.49 - 23.89  2998.75  2874.71 1.71 bln   1790/2260
S&P 100   714.78 +  3.62   724.84   711.16   totals   3345/3548
S&P 500  1348.97 +  7.20  1362.50  1341.77           48.5%/51.5%
RUS 2000  471.70 -  0.17   478.72   471.65
DJ TRANS 2824.76 - 25.13  2852.81  2820.27
VIX        29.02 -  0.56    29.09    27.97
Put/Call Ratio      0.48

After A Big Friday, The Markets Are Split

Kinda like the Election, right?  Not anymore.  Bush was certified
the winner of Florida's electoral votes last night, but it is not
etched in stone just yet.  As promised, Gore and Lieberman are
contesting the results in three Florida counties by filing legal
documents in state court.  So the battle continues.  Did the
markets pay much attention?  Not really, the word "valuation"
seems to be the driver on the Street.  The INDU rallied quite
nicely while the NASDAQ shied away from 3000 and sold off.

It feels like the Election snafu has been front and center for so
long that market watchers have become numb to it.  In fact, it
seems like a non-event these days.  The selling on the NASDAQ
after Friday's impressive gains was a product of the technical
health of the tech index and valuations.  Just as 3000 represented
a critical support level, it now represents a critical resistance
level which will be formidable.  But the NASDAQ only gave up 23.89
points today, hanging onto a large portion of Friday's advance.
Not bad.  The problem with today's trading was that traders sold
into strength once again after this morning's gap up.  As a result,
on the chart, 3000 represents another failed rally attempt and a
lower high in the downtrend.  Quite honestly, I do not put much
merit in gaps.  There is no real volume to support the move
besides negligible pre-market activity.  Real volume is not buying
the index to that level, or selling it down to that level.  It is
merely a perception of where the market should be valued at the
open based on information priced into the futures contracts.
NASDAQ futures were up 71 points this morning.  S&P futures were
up about 13.50.

Today's gap up can be attributed to the Florida certification,
topped off with the Abbey Factor.  CNBC reported before the market
open this morning that Abbey Joseph Cohen of Goldman Sachs
forecasted a 234 point rally for the S&P 500 year-end.  That's a
target of 1575, and the S&P 500 closed today at 1349.  Essentially,
this was a reiteration of her previous predictions last month and
her list of tech favorites.  It includes CSCO, SUNW, VRTS, GLW,
ITWO, EMC, SLR, and DOX.  Obviously, when she speaks, the markets
get excited.  But that was the pre-market, hence, the futures.
The gap up brought the market near 3000 where traders took
advantage of the artificial strength and sold.  It has been the
trend that the NASDAQ has been giving us, and another great
opportunity to trade it.  Put entries abound.

Adding to the negative sentiment was selling in the Semiconductor
sector.  ALTR and XLNX got whacked after Lehman Bros. lowered its
earnings projections on them, citing slower demand in November.
Both companies manufacture programmable logic device(PDL) chips.
Of course, there's always someone on Wall Street that begs to
differ.  Bear Stearns analyst Charles Boucher, while agreeing that
there is a slowdown, doesn't think it is very dramatic, calling
the Lehman call "overstated."  ALTR lost $3.88 to $27.31, and
XLNX closed at $46.50, down $10.31.

BRCM felt the selling heat today after Salomon Smith Barney reduced
its price target from $300 to $200, citing signs of flattening
orders.  BRCM lost 16.7%, almost $20 to $97.56.  Some positive news
for the Semis came from Ashok Kumar of US Bancorp Piper Jaffray on
INTC.  He sees modest upside to Intel's quarter-to-quarter revenue
growth guidance and noted that the stock looks attractive at
current valuations.  WOW!  Someone actually said it!  Let's not
forget that Ashok is the one who called the Semi slowdown in the
summer and was almost chased off Wall Street.  Not a bad call in
retrospect, huh?

Splitting the market was the INDU which managed to muster up a
75 point gain on the day, following through from Friday's move.
Investors piled into issues like WMT(+4.13), MMM(+3.44), MRK(+2.19),
JNJ(+2.31), HD(+1.25), JPM(+1.94), and AXP(+1.63).  That's what I
call a well-rounded rally.  Retails, Drugs, and Financials all
attracted buyers.  The holiday shopping season began with a bang on
Friday.  Drugs stocks held strong as usual, anticipating a Bush
victory.  And beaten down Financials had buyers step in at what
appears to be attractive levels.  Put it all together and the INDU
looks really good.  Friday's gains broke through the most recent
downtrend since running into 11000, and today's trading showed
some consolidation.  Contrary to the NASDAQ, the INDU has been
making higher highs and higher lows since bottoming at 9654.  It
would follow that the retested support at 10369 must hold for the
INDU continue rolling higher.  10600 is the next level of
resistance in the near term.  Then, 11000 must be broken in order
to establish a higher high.  If this occurs, the INDU will be
looking very strong.

Market bellwether and INDU component GE didn't add to the index's
gains today but they did unveil the much-anticipated successor to
CEO Jack Welch.  Jeffrey Immelt, the head of GE Medical Systems,
will succeed Jack Welch, who retires next year after two decades
of leading a pillar of Corporate America.  Analysts are pleased
and confident with the choice.  If GE gets the kick start in its
stock price as predicted, the INDU could be off to the races.
Watch this bellwether into year-end.

Looking ahead, pessimism on tech stocks continues to grow, which
may indicate that we are nearing the end.  The NASDAQ continues to
be oversold.  In fact, the NASDAQ generals are holding up relatively
well:  MSFT, INTC, and SUNW.  The INDU is looking good.  There is a
ton of cash sitting on the sidelines.  Money managers must be
salivating at some of these current valuations.  When the buying
begins, it should be explosive.  Once the Election results can be
put behind us for good, the one catalyst that could set this market
free is the Fed.  They meet on December 19th and change to a
neutral stance could be just what the doctor ordered.  Until then,
we must trade what the market gives us.

Matt Russ


NEWP - put play
Adjust from $75 down to $71

VRSN - put play
Adjust from $103 down to $101


RATL $38.50 +2.88 (+2.88)  It appears that the buying that began
last Wednesday when the stock dipped below $32 was real.  Friday's
light volume buying never cleared $36, and we held the play to see
if the buying was legitimate.  Today's gap up over our stop at $38
should have discouraged any further entries into this put play.
The close over our stop, not to mention the newfound buying, has
led to dropping RATL.

ARTG $39.75 +3.00 (+3.00)  We got one good down day on Wednesday
with this put play, but ARTG reversed course after bouncing from
the $30 level.  When we added this play, we put a tight stop of
$38 in case ARTG did indeed reverse.  The stock gapped up over
$38 this morning never trade below it.  While ARTG may roll over
at its 10-dma at $42, we are dropping the play tonight with a
close over our stop.


Methodical Account Management II
By Austin Passamonte

Last week we portrayed examples of managing our trading account
by percentage of gains and drawdown versus merely buying options
at whim. Let's finish up that thought with some specific rules to
this approach.

Can you see from last week's examples how managing your trade
size to fit profit/loss percentage can make all the difference
between good and poor results? Both account sizes were identical
and so was trade execution. We managed our risk/reward strictly
by percentages and our trading model design favors us over Trader
#2's whimsical approach.

Trader #2 never bothered to figure this stuff out and blindly
bought ten contracts each time because that's what most option
traders buy out of habit or false reasoning. One of the main
reasons for this being the limit for instant electronic execution
of ten-contract "market order" trades. This appears to be an
advantage versus filling bigger lots or "buy-limit" orders on the

Believe it or not, traders feel that instant execution at
prevailing market prices equates to overall profit or loss
percentage of their account. I believe this stems from a lack of
discussion on this topic. I can't find widespread coverage on
different money management approaches in the option world,
although it is a common feature in trading commodities.

Trader #2 in last week's examples bought too few contracts on the
winning plays and too many in the losing plays while disregarding
dollar-cost risk/return management. A desire to delve deeper into
account management optimization can return big rewards.

My trading approach is to target percentages of profit from
option trades rather than buy & wait to see where they end up.
That approach works during long-term trends without major
correction but those days are far behind and likely just as far
ahead. Meanwhile, volatile markets with big swings up and down
are a trader's euphoria if handled right.

Index options work better for this than most equity options do
for numerous reasons. I focus on the QQQ, OEX and SPX for 90% of
my trades. If I had to pick only one it would be the SPX due to a
blend of old and new economy, volatility and liquidity. This is
NOT a market for new traders! It takes precise entry, careful
stop placement and a good familiarity of its normal behavior for
continual trading success.

The QQQ (NASDAQ 100 HOLDR) would be my choice for new traders.
Premium prices are very low compared to others, volume is high
and the bid/ask spread is tight. Heck, these parameters make it a
favorite of big players too!

All three indexes have good movement more sessions than not. This
gives us plenty of chances to play both market sides frequently.
Lastly, OEX and SPX options (and all true index options) are
taxed on a 60% long-term/40% short-term capital gains basis. This
allows you to keep more of your after-tax profits than equity
options yield on an equal dollar basis.

I try to set up trades on a 2/1 - risk/return ratio. That allows
me to reach sell targets only half the time (or slightly less)
and still profit over the long term if I manage them well.
Whether my stop loss is set at -25% of cost and sell target is
+50% or -50%/+100% the end result is still the same. Win half the
trades, make big money OVER TIME.

The way you manage profit & loss means everything. Let's explore
a generic example to explain:

We have an account balance of $100,000 and are willing to risk 5%
of that to loss. We buy twenty options on the ABC underlying
instrument for $10 each and set stops at $2.5 each. Our sell
target if $15 for each. This trade fits our risk/reward

We win that trade as option prices reach our sell target and
close at $15 each.

$100,000 balance (Trade #1)
  20,000 option cost - 5,000 risked on stop-loss
+ 10,000 trade profit (+5 x 20 contracts hit sell target)
$110,000 new balance

We take the exact same setup once more with similar results:
$110,000 balance (Trade #2)
  20,000 option cost - 5,000 risked on stop-loss
+ 10,000 trade profit (+5 x 20 contracts hit sell target)
$120,000 new balance

We take the exact same setup once again and lose:
$120,000 balance (Trade #3)
  20,000 option cost - 5,000 risked on stop-loss
 - 5,000 trade loss (-2.5 x 20 contracts stopped out)
$115,000 new balance

We take the exact same setup once again and lose:
$115,000 balance (Trade #4)
  20,000 option cost - 5,000 risked on stop-loss
 - 5,000 trade loss (-2.5 x 20 contracts stopped out)
$110,000 new balance

In this simple equation we show how cutting losses at 25% while
taking profits at 50% of contract cost builds methodical gains in
a trading model that wins/loses a 1/1 ratio or thereabouts.

The only difference we make when option prices change is to
adjust how many we buy in order to fit the $5,000 loss/$10,000
win basis.

Of course we actually risk a bit less than 5% total after each
win and a bit more than 5% after some drawdowns. That's why we
strive to keep our excess capital in reserve to pad losses and
continue maintaining our business model.

We must always adjust our option purchases by specific dollar
amounts and let the option's current price dictate how many we
buy in order to make this work.

An easy way to internalize this is not to think about how many
option contracts you want. Think about how much of your capital
you are willing to risk versus what you expect in return. Then
choose your trade vehicle and how many from contracts from there.

The trade vehicle happens to be options on the market of your
choice. The amount you buy rests solely on how much money you
allot to work with. How many you allot to work with rests solely
on how many contracts your risk balance allows you to afford!

As long as you trade the number of contracts your maximum loss
amount can handle dictated by the stop-loss order, you'll make
more money than you lose with the following in mind:

Your system should avoid long strings of losing trades. It should
have strings of wins and losses mixed among average results. Five
or six wins or losses in a row can happen to most any system from
the natural law of probability. That should be the exception
instead of norm when it comes to losses.

The system must have a higher average percentage of gain to loss.
This makes sense, but most traders think you have to win most
trades in order to profit. While that is certainly desired, too
many times new traders will take strings of small winners and get
wiped out by one or two big losses.

By the same token you can win only 40% of the time is winning
trades are much bigger than losing trades in dollar percentage.

If more than half of trades win this is great and adds to overall
success. Utilizing moving stops also reduces the number and/or
size of overall losses as well. If you carefully manage advanced
stop strategies to lock in unrealized gains it will prevent small
temporary wins from becoming significant loss. Any plays that
fail to reach maximum profit targets will offset maximum loss
trades to lower the overall losing trade percent average.

A dramatic gap-move against you can cause greater loss than the
5% range of your stop protection. This is why we must maintain a
separate account balance for high-risk methods versus other less
volatile option investment strategies. If we use 20% of our total
high-risk balance on option purchases, much or most of this is
vulnerable to actual loss, especially with equity options.

I'm willing to risk 20% of my total high-risk account balance on
index option purchases because large gap moves are the exception.
I would likely think twice about that trading equity options as
we've recently seen what can happen to MSFT, INTC and a host of
other "blue chip" stalwarts.

Can you see how designing your account management approach to fit
the win/loss ratio and average percent of wins to loss heightens
the odds of probability in your favor? This is by far the most
critical part of successful trading, as demonstrated by the
scenario of us versus Trader #2 in the exact same situations. We
profited, he lost and the only difference was proper account

Think it's easy? I'm here to tell you it's not. We must ALWAYS
honor our stops even when we know for sure "the market will come
back to us" if we just pull them this one time. One time leads to
many and the markets will cunningly wait for our biggest play to
be left unguarded before racing right through us never to look
back. Trust me on that one!

This is how we manage an account based on profit/loss percentage
as our trading models are designed. Simply buying a static number
of contracts won't work; you will more likely lose money than
profit with that approach.

Next week will complete this exploration as we compare several
management scenarios with the same account balance and trades. I
bet we'll all be surprised at the results one can achieve over
time just by tweaking what we risk and settle for as returns!

Contact Support


VRSN - VeriSign, Inc. $87.19 -6.06 (-6.06 this week)

VeriSign is the leading provider of Internet trust services
and digital certificate solutions needed by Web sites,
enterprises and individuals in order to conduct secure
electronic commerce and communications over IP networks.  VRSN
has used its secure online infrastructure to issue over 100,000
of its Website digital certificates and over 3.5 million of its
digital certificates for individuals.  The company also offers
the VeriSign Onsite service, which allows an organization to
leverage the company's trusted service infrastructure to develop
and deploy customized digital certificate services for use by an
organization's employees, customers and business partners.

Most Recent Write-Up

The bears had a field day with VRSN last week as the NASDAQ
dropped to post 3 new consecutive 52-week lows.  With bearish
comments hitting the Internet sector in the form of earnings
concerns leveled at YHOO and EBAY, selling volume in the
Internet security stock increased, dropping our play to $78.31
on Wednesday, another lower low in the 8-week downtrend.  The
severity of the selloff this past week steepened the descending
trendline, and even Friday's relief rally couldn't put much of
a dent in the stock's losses.  After gapping above $90 at the
open on Friday, VRSN ran out of momentum before reaching $95,
despite the fact that the NASDAQ continued to move up into the
early close.  This looks like a classic sucker's rally, and
barring a continuation of the NASDAQ recovery on Monday, VRSN
should head lower again as the bears reassert their control.
Above current levels, VRSN has resistance between $100-102, so
we moved our stop down to $103 to insure that we keep the lion's
share of our profits.  Nothing has really changed, with election
and economic concerns sure to add further downside pressure in
the week ahead.  Use any failed rally as an opportunity to
initiate new positions with a better entry point.  Target shoot
to your level of risk tolerance as the stock rolls over and
heads back towards the lows seen last week.  More conservative
players will want to stand on the sidelines until the bears can
poke a hole in Friday's weak intraday support at $90 before
adding new positions.  Once the selling begins in earnest again,
VRSN should have little trouble challenging its lows from last


VRSN opened today near $100 and simply cratered.  What an entry!
The selling momentum is there and VRSN could very well go back
for a retest of the $78 level.  To play this put, look for failed
rallies near resistance at $95 or $92.  A challenge of these
levels along with a rollover would provide entry.  Further breaking
down below $85 would warrant entry as well.  Watch for the
direction of the NASDAQ and the sector when placing a trade.  Also
note that we have lowered the stop to $101, today's high.

BUY PUT DEC-95 XVR-XS OI=239 at $15.63 SL=12.25
BUY PUT DEC-90*XVR-XR OI=493 at $12.75 SL=10.50
BUY PUT DEC-85 XVR-XQ OI=499 at $10.13 SL= 7.50



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