The Option Investor Newsletter Wednesday 01-03-2001 Copyright 2001, All rights reserved. 1 of 1 Redistribution in any form strictly prohibited. To view this email newsletter in HTML format with embedded charts and graphs, click here: http://www.OptionInvestor.com/htmlemail/010301_1.asp Posted online for subscribers at http://www.OptionInvestor.com ****************************************************************** MARKET WRAP (view in courier font for table alignment) ****************************************************************** 01-03-2001 High Low Volume Advance/Decline DJIA 10945.80 +299.70 11019.00 10581.10 1.87 bln 2294/ 782 NASDAQ 2616.69 +324.83 2618.03 2251.71 3.18 bln 3062/ 986 S&P 100 703.97 + 36.84 704.58 664.56 totals 5356/1768 S&P 500 1347.56 + 64.29 1347.76 1274.62 75.2%/24.8% RUS 2000 484.39 + 21.90 484.39 459.28 DJ TRANS 3015.07 +140.96 3016.53 2853.39 VIX 28.67 - 5.53 34.04 28.47 Put/Call Ratio 0.48 ****************************************************************** The Dynamic Has Changed Around 1:15 EST, during a rare inter-meeting gathering, the FOMC cut the Fed funds rate by a full 50 basis points - from 6.50 percent to 6 percent. The results from the FOMC's actions were of historic proportions. The Nasdaq Composite (COMPX) enjoyed its largest percentage gain EVER on the most active trading EVER. When the bullish buying had finished, the COMPX gained over 14 percent on over 3 billions shares traded. The action in the Dow Jones Industrial Average (INDU) was equally impressive. The blue chip index gained roughly 300 points and at its peak advanced measurably above 11,000 to levels not seen since late September. The price action and trading volume in the major indices gave much credence to the Fed's actions and may portend an end to the bear that ravished so many investors during 2000. The action by Greenspan and his cohorts this afternoon marks a brief moment in financial history. Greenspan is well known to be a gradualist - he moves interest rates slowly but surely. The cut by 50 basis points in Fed funds, along with the 25 basis point cut in the discount rate is a rare event, indeed. As many market watchers know, Greenspan has historically moved rates in 25 basis point increments. In fact, Greenspan has lowered rates by a full 50 basis points on only one other occasion, which was in 1991. The Fed backed its move this afternoon with the following statement: "These actions were taken in light of further weakening of sales and production, and in the context of lower consumer confidence, tight conditions in some segments of the financial markets, and high energy prices sapping household and business purchasing power." Going forward, the market will be listening and watching for further indications of rate cuts to follow the one we received today. There's a 90 percent chance, according to the Fed funds futures, that the FOMC will cut by another 25 basis points at its January meeting at the end of the month. On top of that rate cut, the same futures are predicting another 50 basis points by June. If the futures are a sign of things to come, the Fed will be cutting rates aggressively in 2001. And that means good news for equities. Now that we know Greenspan and his gang are back on our team, what do we do now? As I have written before, the immediate beneficiaries of a rate cut are the most sensitive to the cost of capital and the business cycle. The sectors to look in are the old economy blue chip names in such spaces as papers, financials, retailers, capital goods makers and industrials, among many others. The financials are worth examining closely at this juncture. Some specific names to watch over the next 48 hours (and nine months) include: J.P. Morgan (JPM), Charles Schwab (SCH), Bank One (ONE), Merrill Lynch (MER), Citigroup (C), Goldman Sachs (GS) and General Electric (GE) - a very interest rate sensitive company. Of course, the preceding names are simply a starting place to look for opportunities in light of the friendlier interest rate environment we were given today. But lower interest rates will immediately benefit those very types of companies and should send their respective share prices higher. And if you're looking for more interest rate sensitive names, look no further than the good old Dow Jones Industrial Average (INDU). If you don't believe that the INDU likes lower rates, take a look at the chart below. The INDU gained over 350 points in the space of the fifteen minutes following the Fed's announcement. Now that's what I call confirming price action! And although the INDU enjoyed a monstrous gain today, it was still unable to close above the psychologically significant 11,000 level. However, the INDU was able to pierce that level during its peak, as I previously wrote. Going forward, the 11,000 resistance level will be the key hurdle for the INDU to clear. A strong move above that level may allow for traders to gain entry into some of the blue chip names that comprise the INDU, such as the aforementioned General Electric. If the bulls have truly gained control of the battle, we could see the INDU clear the 11,000 level early tomorrow. Watch it closely! While the pictures in the INDU and the more interest rate sensitive sectors are becoming very clear, the picture in the Nasdaq Composite is a little more clouded. And the reason for that is the debate whether or not today's interest rate cut will immediately benefit the tech sector. Some market watchers argue today's move by the Fed, in effect, formed a bottom for the tech sector. And while the Nasdaq may have found bottom, others argue that the tech sector needs time to repair and consolidate its heavy losses from 2000. Furthermore, the bears argue that today's rate cut won't prevent any shortfalls of tech bellwethers during the first half of 2001. Many market watchers are still speculating that several big cap tech stocks have yet to warn, and they feel those warnings are looming in the shadows of today's rate cut. Case in point was this evening's warning from fallen Internet star, Inktomi. The Internet software developer said its first quarter earnings and sales would fall short of expectations. And while Inktomi is no Cisco Systems or Sun Microsystems, its warning does serve as an example of the risks that remain in the tech sector. Shares of Inktomi gave up all of their post-Fed announcement gains following the warning. The stock settled at $18 11/16 during the regular session and was last trading around $14 in the after hours session follow the warning. But if your specialty is the Nasdaq, and you must trade tech from the long side, let me offer the following. While I feel a trader can aggressively pursue the financial and other interest rate sensitive names following the Fed cut today, I do believe the names in the tech sector will require much more discretion and careful selection. Along with increased selectivity in the tech sector, I feel that it's imperative to trade with extreme discipline while the Nasdaq tries to digest today's actions from the Fed. I think there will be increased volatility as the bulls and bears duke it out in the tech sector and that battle will require traders to use tight stops - clearly defining any risk to the downside. I want to write that the Nasdaq is going to keep trading higher and that readers can buy calls on any four-letter stock, but I just don't think that's the case, not yet anyway. The Nasdaq was a complete disaster last year and that type of damage requires a lot of time to repair. And while the Fed's actions clearly shifted the psychology in the tech sector today, whether the bulls are free to run remains to be seen. Don't get me wrong. I'm not bearish on the Nasdaq by any means. I just want to make it clear that risks still exist in the tech sector and if you do wade into that group of stocks, be careful! While today's rally erased much of the damage done over the past two weeks, let us not forget about the overwhelmingly negative trend the Nasdaq has been battling since September. And let me reiterate that I'm not bearish on the Nasdaq, but the path of least resistance is not yet clearly to the upside. Only the Nasdaq will tell us when it's ready to roll higher and we must pay heed to its clues. And at the risk of boring our readers, I must reiterate again that if you're trading four-letter names from the long side use tight stops that will clearly define downside risk. Now that I've begged for caution among the Nasdaq traders, let's cover how today's interest rate cut adds a little ammunition to the tech bulls' case. The lowered interest rates today, and additional cuts expected, will allow for higher price-to-earnings multiples among the tech high-flyers. The reasons for that is the obvious up-tick in the business cycle along with the lower cost of capital. The bulls might also argue that there still exist a large number of shorts in the Nasdaq, along with the S&P 500. I know a few professional shorts, and I know they don't like lower interest rates. The historically high levels of shorts in the S&P 500, along with the bears in the Nasdaq, will be bringing in some of their shorts over the next few days and I bet the bulls will try to squeeze them out of their positions. It will take some time to cover all of the short interest that is currently residing in the equities, options and futures markets. That said, an extension of the Nasdaq's rally over the next two days might not be out of the question if those big shorts start bringing stock in. And those shorts may have enjoyed 2000, but their fun may soon come to an end. Today's move by the Fed may very well bring an end to the bear that tortured the better part of U.S. equity markets for the last nine months. The Fed IS more powerful than any bear. The threat of a nasty recession has been looming in the shadows for some time now, and the Fed just erased the lion's share of those fears today. While we may still witness a mild contraction in GDP, the worst fears are gone. Isn't it amazing how much can change in one day? Although the Fed is now on our team, it doesn't mean we can go out with reckless abandon and buy everything in sight. Our usual rules of discipline and risk management remain in the toolbox, but the tape might become a lot easier to read as the market foreshadows a pickup in the U.S. economy. It's been a historic day on many fronts and it's only going to get better for those who stay the course and trade with discipline. Good luck in 2001 and stay tuned to OptionInvestor to help guide you through the game we call the stock market! Eric Utley Assistant Editor ************************Advertisement************************* Tired of waiting on trades to execute? Does your broker offer Stop Losses on Options? Trade instantly with Stop Losses at PreferredTrade Inc. Stop Losses based on the option price or the stock price. Move your trading into the next millennium with PreferredTrade. Anything else is too slow! http://www.sungrp.com/tracking.asp?campaignid=1290 ************************************************************** ************* NEW CALL PLAY ************* ONE - Bank One $39.56 +2.44 (+2.94 this week) Headquartered in Chicago, Illinois, Bank One is the #4 bank in the U.S., (after Bank of America, Chase Manhattan, and Citigroup). ONE operates some 1800 banking offices in 14 mostly Midwestern and Wouthwestern states, providing domestic retail banking, finance and credit card services. Its other business activities, which span the U.S. and more than 10 other countries, include commercial, corporate, and institutional banking, as well as loan and leasing services, and investment, brokerage, and insurance services. Greenspan kicked the Financials into rally mode today, giving investors an early 50 basis point decrease in interest rates. Traders were clearly thrilled with the news as the broader markets took off, led higher by the Financials. Not wanting to be left behind, our new play, ONE, managed to tack on a respectable gain of more than 6.5%. There was no shortage of volume to support the move, as ONE traded 7.6 million shares, well over twice the ADV. Now here is the dilemma; with today's gain, ONE is now at its upper Bollinger band, the $39-40 resistance level that has been in place for over a year, and Stochastics are deep in overbought territory. It seems the prudent approach will be to wait for some profit taking before initiating new positions. As long as the current rally has legs, we would look for support to hold near $36-37 on any profit taking. A bounce near this level would make for a great entry as ONE gets set to rally into its earnings announcement. That's right, the company is set to release its quarterly numbers on January 17th before the opening bell, giving us just 2 weeks in which to play. While the combination of the changing interest rate environment and the approach of earnings could propel ONE higher without a pullback, it seems unlikely, given the barrier imposed by the upper Bollinger band. If you do buy the breakout over $40, monitor the position closely and keep your stop in place. We expect some profit taking first, and have placed our stop at $35, just below the near-term support. Regardless of your entry strategy, use the strength of the broader markets and the Financial sector (The Banking Index, BKX.X, will work fine) to keep you on the right side of the trade. BUY CALL JAN-35 ONE-AG OI=12401 at $4.88 SL=3.00 BUY CALL JAN-37.5*ONE-AU OI= 8717 at $2.75 SL=1.50 BUY CALL JAN-40 ONE-AH OI=14701 at $1.31 SL=0.50 BUY CALL FEB-37.5 ONE-BU OI= 2936 at $3.75 SL=2.25 BUY CALL FEB-40 ONE-BH OI= 4252 at $2.13 SL=1.00 BUY CALL FEB-42.5 ONE-DV OI= 649 at $1.25 SL=0.50 http://www.premierinvestor.com/oi/profile.asp?ticker=ONE MER - Merrill Lynch & Co., Inc. $73.44 +7.69 (+5.25 this week) Merrill Lynch & Co., Inc. has a strong client focus with a goal to deliver superior returns to their shareholders. They are determined to create value for their clients by providing wisdom and high quality services that meet their needs. Merrill Lynch has a track record of delivering strong returns to their shareholders, and has aligned employee and shareholder interests through a high level of employee stock ownership. They are leveraging the global investments they have made to sustain profitable growth. Financial stocks for the most part had been moving tentatively higher in December on hopes that the New Year would bring forth a friendlier Fed and a more favorable fundamental backdrop. Nonetheless, the uncertainty has kept MER in a trading range but today, with the Fed coming out with an unexpected but much-needed rate cut, traders celebrated on the news. With the cost of borrowing money now 50 basis points lower, this has a direct positive effect on the core business of the Financial sector, and with the Fed funds futures expecting a series of rate cuts ahead, this can only be good news for MER. Which is why shares of MER closed up almost 12 percent on well over twice the ADV. An environment in which the cost of doing business becomes progressively lower will give MER's bottom line a lift, meaning that earnings estimates will most likely be raised. Factoring that into the Price-Earnings (PE) equation, more E means a higher P, which is what traders are expecting. After such a big day, a pullback is quite possible, so exercise patience and discipline when targeting an entry. Support can be found at $72, $70, the 5-dma at $68.42 and our protective stop placed at the $68 level. There is also support from the 10 and 100-dma, converged at $66.15, and the 50-dma at $65.18 but in buying a bounce off these levels, make sure that MER closes above our stop price. As well, when taking a position, confirm bounces with buying volume and confirm direction with that of peers such as GS and LEH. BUY CALL JAN-65 MER-AM OI=11572 at $9.38 SL=6.50 BUY CALL JAN-70 MER-AN OI=46272 at $5.25 SL=3.25 BUY CALL JAN-75*JMR-AO OI= 9402 at $2.06 SL=1.00 BUY CALL FEB-70 MER-BN OI= 620 at $7.38 SL=5.25 BUY CALL FEB-75 JMR-BO OI= 417 at $4.50 SL=2.75 http://www.premierinvestor.com/oi/profile.asp?ticker=MER ************ NEW PUT PLAY ************ CELG - Celgene Corpation $30.00 -2.38 (-2.50 this week) Celgene specializes in immunotherapy medications, focusing on small-molecule compounds that suppress the body's overproduction of tumor necrosis factor alpha, which has been linked to several inflammatory diseases. Not one to shy away from the controversial, CELG makes leprosy treatment THALOMID (a form of thalidomide, which was blamed for thousands of birth defects when used as a sedative in Europe in the 1950s and 60s). The company is exploring the use of THALOMID for brain tumors and other cancers. CELG is also developing its own version of Ritalin, which is used to treat children with Attention Deficit Disorder. Even with the pain inflicted on Biotechnology stocks in February and March of last year, CELG managed to keep from losing its way. The stock spent much of the year 2000 posting higher highs and higher lows, using the 200-dma as solid support on the recoveries. This pattern began to fall apart last October, when the bulls were unable to push through the $75 resistance level. Early December sealed the deal, as the stock posted another lower high, followed by a quick violation of the 200-dma as it entered free-fall mode. The wimpy bounce seen in the past week is not the kind of solace the bulls are looking for, and the stock's inability to participate in today's interest rate rally paints a dim picture. Even a modest rally in the Biotech sector wasn't enough to float this sinking boat. Earnings are currently scheduled to be released on January 25th, but it is unlikely to help with the ailing stock price. Although the company is gradually approaching profitability, the revenue growth has been slowing over the past several quarters. That is clearly not the kind of financial pattern that investors like to see. So where to from here? The bulls are desperately trying to hold the line at the $30 support level, but it appears the bears are gaining the upper hand, as evidenced by today's loss, which came on volume that nearly tripled the ADV. A break below current levels should provide a decent entry point, although more aggressive players may want to wait for a bounce and rollover near resistance of $34-35 before taking the plunge. The stock is likely to be volatile, so we have given ourselves some room by placing a fairly loose stop at $37. Although today's drop came with a gain in the Biotech Index (BTK.X), your odds of success will be greater if both the BTK and CELG are heading south when you initiate your position. BUY PUT JAN-35 LQH-MG OI=104 at $7.50 SL=5.25 BUY PUT JAN-30*LQH-MF OI=187 at $4.13 SL=2.50 BUY PUT JAN-25 LQH-ME OI= 39 at $2.13 SL=1.00 http://www.premierinvestor.com/oi/profile.asp?ticker=CELG FRX - Forest Laboratories Inc. $121.50 -6.69 (-11.38 this week) Forest Laboratories develops, manufactures and sells both branded and generic ethical drug products that require a physician's prescription, as well as non-prescription pharmaceutical products sold over the counter. Forest's most important United States products consist of branded ethical drug specialties marketed directly, or detailed, to physicians by Forest Pharmaceuticals, Forest Therapeutics and Forest Specialty Sales forces. The year 2000 was a golden time for FRX, gaining over 125 percent on a steady uptrend on higher lows and higher highs. Most investors were reaching for the Prozac but finding it a little too rich for their lighter wallets, went for FRX's less expensive anti-depressant Celexa. While most Tech stocks were well below all their major moving averages, dips to the 50 and 100-dma for FRX were rare buying opportunities that were bought up with enthusiasm, as traders huddled to this defensive stalwart. But ever since hitting the $140 level in late October, the stock has struggled, unable to break what appears now to be formidable resistance. Having recently fallen below its 50-dma (now at $132.54), the stock appears now to be perched perilously above its 100-dma at $119.93, threatening to drop further, thereby completing a rounded top formation. Today's close marks the second time in less than two weeks that FRX has tested its 100-dma. The last bounce, while dramatic, lacked the volume necessary to count as conviction so upon hitting a brick wall at $140 yet again, FRX sold off. But this time around, the selling volume has been gaining strength, suggesting that there may be further downside ahead. Today's drop of 5.22 percent on well over twice the ADV in a rallying market suggests that traders may not be in as defensive a mood any longer. While there is a 2-for-1 stock split ahead on January 11th, FRX could be much lower by then on its own. For a conservative entry, the signal to buy would be a break below the 100-dma on strong volume, confirming sentiment with other Drug stocks such as LLY and MRK. For aggressive traders, failed rallies off resistance at $124, the 5 and 10-dma (converged at $129) and our stop price of $130 could allow for possible entries. BUY PUT JAN-125 FRX-ME OI=22 at $7.25 SL=5.00 BUY PUT JAN-120*FRX-MD OI=66 at $4.63 SL=2.75 BUY PUT JAN-115 FRX-MC OI=75 at $2.88 SL=1.50 http://www.premierinvestor.com/oi/profile.asp?ticker=FRX ***************** STOP-LOSS UPDATES ***************** No stop-loss updates today ************* DROPPED CALLS ************* IVGN $74.00 -7.06 (-12.38) While the selling volume in shares of IVGN was light yesterday, today, traders continued to head for the exits, this time on strong volume, on a day when most stocks were being bid up on a record day for the NASDAQ. Having already closed below its 5-dma ($81.83) the previous day, IVGN opened today below its 10-dma ($80.45) and from there, proceeded to drop further. Like most of the market, the stock got a lift after the Fed announcement but it was not enough, as IVGN closed down 8.71% on over twice the ADV. High volume drops on high volume up days for the market is not a good sign, nor is the close below the 50-dma ($75.17) and our stop price of $79. As a result, we are closing out this play. MO $42.25 -3.94 (-1.75) An unexpected rate cut midday today has changed the sentiment on the Street. While MO had been a strong performer on our call list, the reversal of sentiment in the market as a whole was evident in the rotation of money today. After some morning consolidation of yesterday's gains, news of the rate cut resulted in selling of many perceived safe havens: drugs, tobacco, and energy. With our stop at $42.50, we must drop this play and book our profits. MO very well may maintain its uptrend yet it remains to be seen if this rotation back into big cap techs continues. ENE $75.06 -4.81 (-8.13) Profit takers stepped in early this morning and ENE drifted lower. Initially after the Fed rate cut at about 1:10pm ET, ENE surged almost $4. But as investors began rotating back into the beaten down techs, many energy stocks fell by the wayside as profits were booked to raise cash. Our stop of $79 was nearly violated yesterday and it was the point at which ENE bounced. However, today that level was quickly violated and should have signaled a red flag to stay away. With this violation of our stop and the major shift in monetary policy, we will be closing this call position tonight. JNJ $98.75 -3.25 (-6.31) JNJ finished out the year at a 52-week high last Friday. It has been an incredible performer for OI's call list. Two factors of 2001 contributed to the selling this week: tax-gain selling on Monday and a 50 basis point rate cut today, both fairly unpredictable. After the investors locked in some gains on Monday, JNJ looked poised to continue its strong uptrend, offering a nice entry point. Yet, the second factor hit the market like a ton of bricks, entirely by surprise. As a result, many of the drug and healthcare stocks were sold and cash was thrown at the tech sector. Our stop of $102 was violated intraday and JNJ closed well below it, therefore we are dropping this call play. ************ DROPPED PUTS ************ VSTR $112.88 +11.88 (+12.25) Our first hint of trouble was VSTR's refusal to break below the critical $100 support level. This is the real trigger we were looking for before initiating playing. The fact that this event never came to pass kept us out of the play, and out of hot water this morning when Greenspan finally acquiesced and handed the markets a surprise interest rate decrease. The entire Telecom sector rallied on the news, and it was clear from the start that the bulls were going to trample the bears today. After the news broke, VSTR quickly traded through our $106 stop and proceeded up the charts by another $7 before slowing down. If you took the aggressive entry when VSTR rolled over near $105 yesterday morning, you should be congratulating yourself on your disciplined use of stop loss orders, which took you out of the trade today before the damage got out of hand. Needless to say, VSTR is a drop tonight, as it held onto a nearly 12% gain, closing right at the high of the day. QCOM $84.06 +13.19 (+1.88) It appears that the Fed is mightier than the head and shoulders reversal pattern, as a surprise rate cut today helped QCOM to rally almost 19 percent on over 145% of ADV. Breaking through the neckline of the head and shoulders formation yesterday made this an attractive put play but today's turn of events have in one fell swoop put QCOM back above all its major moving averages. This was an impressive move indeed, and the close well above out stop price of $78 more than suggests a break in QCOM's downtrend. With our entry objectives not forthcoming, we are reversing our recommendation. JNPR $132.00 +29.44 (+5.94) When we started this put play yesterday, we mentioned two possible ways to enter this play. The conservative entry called for a break below support at $98. Opening right at that level, support held up and the stock moved higher. Fast forward to the more aggressive entry points we mentioned and once again, there was no signal to buy, as dips were on light volume while buying pressure was on high volume. For the day, JNPR closed up almost 29 percent on over twice the ADV. With the stock now out of range of our trading plan, we are taking this play off the table with no harm done. SFA $38.69 +8.69 (+6.13) SFA was performing quite nicely and maintaining its dominant trend until the FOMC made their midday announcement of a rate cut. While this was good news for the economy and the market, it was not for our put play. This interest rate shift simply launched SFA from $31 to a high of $40 where the sellers stepped in. Technically, for both SFA and tech stocks, this is a major reversal of sentiment. On the SFA chart, a bullish engulfing pattern on high volume indicates that this recent downtrend may be temporarily over for SFA. Intraday, SFA paused at our stop level of $36 to consolidate the post-announcement gain and then used that previous resistance as support to move higher. Today's close stopped us out of this put play that performed well until this unexpected rate cut. EXDS $22.13 +5.56 (+2.19) This was a short-lived put play that was foiled by the FOMC. EXDS gapped down this morning and then rallied to the $18 level and offered a very nice entry point. From there, EXDS rolled over and dropped almost $2, which would have been an very nice intraday trade. The stock stabilized at the $16.50 level just before the rate cut announcement. After that, there was no looking back. These kind of beaten down tech stocks found bids as the euphoria of a 50 basis point rate cut took hold of the market. Our tight stop of $19 was blown out and results in a drop this evening. SEBL $69.88 +15.88 (+2.13) After yesterday's technical breakdown to a new relative low taking out 12/21's low, SEBL looked technically weak. But the extraordinary circumstances of today changed everything for SEBL and the market as a whole. Prior to the rate cut news, SEBL rolled over from $55 and appeared to be heading for a retest of support at $50. Yet, the rate cut fueled SEBL and high volume accumulation continued until the very last tick, as SEBL closed on the high of the day. Technically, SEBL has a bullish engulfing candlestick as today's trading spanned below yesterday's low and above yesterday's high. A move of this type typically indicates a reversal. In the heat of the buying, SEBL surpassed our stop loss level of $64 and never looked back. We are dropping this put play as the NASDAQ puts in a record day with a 14% gain on over 3 bln shares. ************** TRADERS CORNER ************** Was I Hallucinating? By Mary Redmond That was the thought which first crossed my mind when I looked away from the market when it was down 30 and looked back when it was up over 250. Without any warning or indication, the Federal Reserve cut rates by 50 basis points, the answer to a (long) trader's dream. While we may still have a few earnings warnings left, at least we know that the Fed is not in a coma. This type of occurrence may only happen once in a lifetime, and it can result in certain market irregularities. For example, the market popped as soon as the decision was announced, and about twenty minutes later, there were so many crossed and locked markets on Nasdaq securities that order execution reports were delayed, due to extraordinarily heavy trading. This is also one reason why it can be dangerous to short an oversold market. We are not necessarily out of the woods, and rate cut may not be a panacea, but it can be the first catalyst to a major turning point. While we were being bombarded by downgrades and warnings over the last few weeks, it is interesting to remember what was occurring last year around this time. We were in such a strong bull market for the Nasdaq that one analyst upgrade could send a stock and its sector soaring 20 points in one day. Yesterday, one analyst downgraded several internet software and infrastructure stocks, and these stocks, as well as others in the sectors lost double digits. Are either of these extremes rational? Last year, there were a number of analysts who predicted a bear market in 2000, and practically no one believed it. They were considered the same grumpy party spoilers who had been calling a bear market since 1994. Bear market analysts were contrarians last year. In contrast, bull market analysts are the contrarians at this point, that is, up until today's rate cut. For the last few weeks, everyone ignored the bulls and concentrated on the bad news. No analyst can ever predict the market 100% of the time, but most of the time, investors believe what they want to believe. Last year around this time, most people were overjoyed that their appliances still worked, and that Y2K induced Armageddon had been postponed. While it is unclear whether the billions spent on Y2K preparation were wasted, the actions taken by the Federal Reserve to prepare the banking system for Y2K may have impacted the market. Last fall, the Fed pumped the banking system with approximately $500 billion in excess cash, in case we had a panic-induced run on the banks. While their actions may have been prudent, considering the public's anxiety, the liquidity had to be drained from the market during 2000, and some analysts have speculated that this factor may have contributed to liquidity problems. Around the end of March, the liquidity crisis reached a peak, and, combined with the inflationary indictors, which led the Fed to increase rates by 50 bp, contributed to the market decline. When the Fed raises rates, it draws liquidity out of the market. When rates are lowered, liquidity is added. Analysts may speculate for years about whether the Fed raised rates excessively in 2000. While the liquidity issue seems almost certain to improve from last year, no one can control the levels of volatility. Certainly last year was the most volatile in market history, and it is entirely possible that Y2K01 may be even more volatile. During 2000, it was common to see the Dow move 1000 points in a month, and 20-40% monthly moves in the Nasdaq were the norm. Volatility in the market can result from traders perceptions about market actions, the speed with which information travels, and the number of market participants. None of these factors contributing to market volatility are likely to decrease, in fact, we are likely to see even more volatility in the years ahead. While the VIX.X is a broad gauge of OEX option volatility, traders also want to assess the volatility of the other market indexes, sectors, and individual stocks. For example, the QQQ currently has an implied volatility of 71.5, nearly double the VIX.X. The QQQ's implied volatility and the VIX.X generally move in tandem, however, the QQQ IV is almost always considerably higher, since this index moves faster than the OEX. Implied volatility is a measure of the market's perception of how much the option will move over the life of the option. For example, the implied volatility of the QQQ was under 30 In September, and rose as the Nasdaq declined, reaching 60 in November. The highest level of volatility the last year was over 80, and occurred during the market sell off last April. Many investors are currently thinking that this may be an historic buying opportunity, particularly for stocks which fared poorly this year, like technology and telecom. Option investors may be making the same plans. There are so many high quality tech stocks which have been battered beyond belief that the shopping opportunities seem unlimited. However, it may be a good idea to check the historic volatility and implied volatility of the options before buying. If a call option has a very high implied volatility, compared to the historic volatility of the stock, it may be harder to profit from an increase in the stock price. For example, the implied volatility of the options of many high tech stocks tends to rise considerably after a market correction. Volatility basically measures speed of movement. The velocity of market corrections is almost always higher than that of rallies. If put options are priced very high, the call options will be price high also, since there is a put/call ratio which exists for every stock such that the stock price plus the at the money put price minus the at the money call price is always less than or equal to the cost of borrowing money for the particular time period. Look at the iv of NT, SUNW, and ORCL, three stocks which have made very rapid corrections in the last several months. NT has a six month average historic volatility of 73, and the current implied volatility of the options is 94.5. ORCL's historic volatility doubled from 57 in September to the current level of 118, and the implied volatility of the options is 93. SUNW's historic volatility also doubled in the correction, from 48 to 99.47, and the implied volatility of SUNW's calls is 116.7. While these stocks are very cheap, the options are relatively high priced. It is not necessarily a bad idea to buy high volatility call options, as this can be an aggressive strategy which could work well if the stock makes a significant rise. However, high volatility options are expensive and therefore riskier. A move in the wrong direction could result in a very large, fast loss. These are options which should be monitored very carefully. Some bullish option traders may also consider covered calls for stocks with high volatilities, as the premiums sold can yield substantial profits. ************************Advertisement************************* Get 10 FREE Issues of Investor's Business Daily. No obligation. Nothing to cancel. http://www.sungrp.com/tracking.asp?campaignid=1280 ************************************************************** ********************** PLAY OF THE DAY - CALL ********************** NOK - Nokia $44.69 +3.81 (+1.19 this week) Nokia is the world leader in mobile communications. Backed by its experience, innovation, user-friendliness and secure solutions, the company has become the leading supplier of mobile phones, and a leading supplier of mobile, fixed and IP networks. By adding mobility to the Internet, Nokia creates new opportunities for companies, and further enriches the daily lives of people. Most Recent Write-Up Considering the widespread carnage in the tech sector Tuesday, Nokia held up fairly well. The stock actually moved to $44.81 in morning trade, however, the weak NAPM report, and several analyst downgrades of technology stocks proved to be too much for even Nokia to handle. Strong support at $40 has held since mid-November, faltering only once on November 13th, which brought Nokia to $37.56. A possible entry point would be a move above $43, which would position Nokia to move above the major moving averages to the next resistance at $45. Watch the telecom sector for strength, and keep stops at $40. Comments If there's a tech stock that could continue advancing in the wake of Wednesday's massive rally it's NOK. Shares of the cell phone giant have held up well recently and are poised to breakout above a key resistance level. New positions can be added on a strong move above the key $45 level. Make sure to confirm volume with any advance along with direction in the broader tech sector and peers ERICY and QCOM. Light volume pullbacks to support at $44 or lower near $43 might also provide entry points if the buyers step in on any dip. BUY CALL JAN-40 NAY-AH OI=19057 at $5.75 SL=4.00 BUY CALL JAN-45*NZY-AI OI=22531 at $2.63 SL=1.25 BUY CALL FEB-45 NZY-BI OI= 2304 at $4.38 SL=2.75 BUY CALL FEB-50 NZY-BJ OI= 2151 at $2.38 SL=1.25 http://www.premierinvestor.com/oi/profile.asp?ticker=NOK ***************************************** BIG CAP COVERED CALLS & NAKED PUT SECTION ***************************************** The Fed comes to the rescue! The stock market soared today after news that the Federal Reserve cut key interest rates by half a percentage point. Normally the FOMC raises or lowers interest rates at regularly scheduled policy meetings and the central bank's next engagement is not until late January. The last time the Fed cut rates between regular meetings occurred in mid-October 1998 as the market contended with a global financial crisis, which included Russia's loan payment default. The decision to reduce the overnight lending rate and the discount rate was a pleasant surprise but it was not entirely unexpected, given the recent outlook for the economy. Earlier this week, data indicated that outlays for U.S. construction activity moved lower in November along with spending on government projects. This news and other recent reports suggesting the economy would grow at a relatively sluggish pace this year, prompted the Fed to act early. The FOMC said that, "These actions were taken in light of further weakening of sales and production, and in the context of lower consumer confidence, tight conditions in some segments of financial markets, and high energy prices sapping household and business purchasing power." Now investors will look to Friday's employment report for more indications about the economy and hints of whether to expect another interest-rate cut from the Federal Reserve in the coming weeks. With today's flurry of buying pressure, it will be difficult to determine which issues have simply rebounded from substantially oversold conditions on "short-covering" and those that are truly engaged in a significant change in character. With that fact in mind, we will limit the number of selections until the underlying market trend is positively reestablished and focus only on those positions that offer conservative entry points in favorable issues and a high probability of a reasonable profit with low risk and limited potential for loss. Summary of Previous Picks: Covered Calls: (Margin would double the listed Monthly Return) Stock Strike Strike Cost Current Profit Monthly Symbol Month Price Basis Price (Loss) Return IMPH JAN 45 42.69 65.63 $2.31 5.5% Naked Puts: Stock Strike Strike Cost Current Profit Monthly Symbol Month Price Basis Price (Loss) Return QCOM JAN 70 68.50 84.06 $1.50 10.2% AFFX JAN 55 53.81 68.94 $1.19 9.6% IMPH JAN 40 38.87 65.63 $1.13 9.2% LEH JAN 55 54.12 76.13 $0.88 7.8% IVGN JAN 60 58.50 75.00 $1.50 7.0% DCTM JAN 40 38.94 45.88 $1.06 6.8% IDPH JAN 120 117.50 186.31 $2.50 6.4% 3-1 split 01/18 EMLX JAN 45 43.69 81.00 $1.32 6.3% Adj 2-1 Split BGEN JAN 50 49.37 58.00 $0.63 6.3% NOK JAN 40 39.25 44.69 $0.75 4.7% Sell Strangles: Stock Strike Strike Cost Current Profit Monthly Symbol Month Price Basis Price (Loss) Return IMPH JAN 35 33.25 65.63 $1.75 11.7% IMPH JAN 80 82.75 65.63 $2.75 17.0% CEPH JAN 40 39.06 60.50 $0.94 8.2% CEPH JAN 70 71.19 60.50 $1.19 10.1% RIMM JAN 50 48.44 70.00 $1.56 12.1% RIMM JAN 115 115.94 70.00 $0.94 7.6% BRCM JAN 45 43.75 106.94 $1.25 8.6% BRCM JAN 160 161.06 106.94 $1.06 7.4% GMST JAN 25 24.37 46.56 $0.63 5.8% GMST JAN 65 65.75 46.56 $0.75 6.8% Naked Calls: Stock Strike Strike Cost Current Profit Monthly Symbol Month Price Basis Price (Loss) Return QLGC JAN 130 131.50 86.94 $1.50 10.1% BEAS JAN 85 86.25 67.88 $1.25 10.1% ADBE JAN 80 81.00 57.94 $1.00 8.1% VRTS JAN 160 161.69 86.38 $1.69 6.1% Credit Spreads: Stock Pick Last Position Credit C/B G/L Status ESRX $88.88 $92.44 JAN65p/70p $0.50 $69.50 $0.50 Open AFFX $63.63 $68.94 JAN40p/45p $0.69 $44.31 $0.69 Open VAR $62.00 $61.38 JAN50p/55p $0.50 $54.50 $0.50 Open FCEL $72.25 $60.88 JAN45p/55p $0.56 $49.44 $0.56 Alert New Candidates: This following group of plays is simply a list of candidates to supplement your search for profitable trading positions. As with any investment, you must decide if the selections meet your criteria for potential plays. Only you can know what strategies are suitable for your skill level, risk-reward tolerance and portfolio outlook. In addition, we recommend that you avoid any strategy or technique in which you are not completely comfortable with the potential loss, the necessary adjustments and the common entry-exit strategies. (We monitor the positions marked with ***). *************** BULLISH PLAYS - Covered Calls, Naked Puts, & Combinations *************** JNPR - Juniper Networks $132.00 *** A Big Day! *** Juniper Networks is a global provider of Internet infrastructure solutions that enable Internet service providers and other telecommunications service providers, to meet the new demands resulting from the rapid growth of the Internet. The company delivers next generation Internet backbone routers that are specifically designed, or purpose-built, for service provider networks. The company's flagship product is the M40 Internet backbone router, and it recently introduced the M20, an Internet backbone router purpose-built for emerging service providers. The company's Internet backbone routers combine the features of the JUNOS Internet Software, high performance ASIC-based packet forwarding technology and Internet-optimized architecture into a purpose-built solution for service providers. The stock market came back to life Wednesday, with the Nasdaq posting its biggest gain ever, after the Federal Reserve surprised investors with an unexpected interest-rate cut to keep the world's largest economy from slowing too much. The technology composite was bolstered by a surge in the price of leaders in the Internet Equipment group and Juniper Networks was one of the big movers. Investors who "shorted" stocks with the aim of buying them back later at lower prices, rushed to cover positions on the Fed move and that boosted prices even higher. Now the question is whether the recovery rally will continue and traders who are bullish on the technology sector can speculate on that outcome with these conservative positions. JNPR - Juniper Networks $132.00 Action Month & Option Open Closing Cost Monthly Req'd Strike Symbol Interest Price Basis Return Sell Put JAN 70 JUX MN 415 1.06 68.94 7.3% *** Sell Put JAN 75 JUX MO 542 1.50 73.50 10.2% Sell Put JAN 80 JUX MP 1516 2.00 78.00 13.4% /charts/jan01/charts.asp?symbol=JNPR ******* MWD - Morgan Stanley Dean Witter $83.69 *** Hot Sector! *** Morgan Stanley Dean Witter is a global financial services company that maintains leading market positions in each of its primary businesses: securities; asset management; and credit services. The company combines global strength in investment banking and institutional sales and trading with strength in providing full service and on-line brokerage services, investment and global asset management services and, primarily through its Discover Card brand, quality consumer credit-card products. The company also provides its products and services to a large, diversified group of clients, including corporations, governments, financial institutions and individuals. In recent weeks, the performance of the financial sector has been improving and today Bank and brokerage shares rallied amid a wider market surge spurred by news that the FOMC had cut interest rates. The surprise announcement by the Fed to reduce a key short term interest rate and the signal that the Fed was prepared to decrease borrowing costs further was viewed favorably by investors because lower rates reduce lending costs and also spurs demand for loans. In addition, the rate cut helps banks that assist companies with new bond and stock offerings, a business that was hurt by recent rate hikes and the subsequent U.S. economic slowdown. With the recent bullish activity in the issue, it's obvious that investors believe the Financial Services group is "back on track" and we favor the recent technical support near the target cost basis. MWD - Morgan Stanley Dean Witter $83.69 Action Month & Option Open Closing Cost Monthly Req'd Strike Symbol Interest Price Basis Return Sell Put JAN 65 MWD MM 7042 0.56 64.44 6.2% *** Sell Put JAN 70 MFZ MN 6095 0.94 69.06 8.6% Sell Put JAN 75 MFZ MO 7967 1.63 73.37 11.7% /charts/jan01/charts.asp?symbol=MWD ******* NEWP - Newport $90.31 *** Own This One! *** Newport Corporation is a global supplier of high-precision test, measurement and automation systems and subsystems that enable manufacturers of fiber optic components, semiconductor capital equipment, industrial metrology, aerospace and high-precision products to automate their manufacturing processes, enhance new product performance, and improve manufacturing efficiencies and yields. Their high precision products enhance productivity and capabilities of test and measurement and automated assembly for precision manufacturing, engineering and research applications. Newport has been a favorite of the OIN over the past year and with the recent slump in technology issues, there are some excellent premiums available for traders who wish to initiate new portfolio positions through the use of (ITM) Covered-calls or the sale of (OTM) Naked puts. Based on today's activity, the issue has demonstrated excellent upside potential and those who favor the bullish technical outlook for the company can use the inflated premiums to establish an acceptable cost basis in the underlying issue. NEWP - Newport $90.31 Action Month & Option Open Closing Cost Monthly Req'd Strike Symbol Interest Price Basis Return Sell Call JAN 65 NZZ AM 25 27.75 62.56 7.4% *** Sell Call JAN 70 NZZ AN 65 24.25 66.06 11.3% Sell Put JAN 55 NZZ MK 166 1.13 53.88 11.1% *** Sell Put JAN 60 NZZ ML 109 1.88 58.13 17.9% Sell Put JAN 65 NZZ MM 67 2.88 62.13 26.1% /charts/jan01/charts.asp?symbol=NEWP *************** Neutral Plays - Straddles & Strangles The issues are excellent candidates in the "premium-selling" category of options trading. Based on analysis of statistical option pricing and the underlying stock's technical history, these positions meet our fundamental criteria for profitable Credit Strangles. Each issue has robust option premiums, a well defined trading range and a high probability of remaining between the target strike prices. However, current news and market sentiment will have an effect on these issues and, as with any recommendations, these positions should be carefully evaluated for portfolio suitability and reviewed with regard to your strategic approach and personal trading style. Some traders may favor a more aggressive approach, selling options that are closer to the current price of the issue, to produce a higher initial return. While that technique may be more attractive, it also increases the theoretical risk of loss. Only you can know what plays are suitable for your risk-reward tolerance and portfolio outlook. *************** MERQ - Mercury Interactive $94.31 *** Trading Range? *** Mercury Interactive is a provider of integrated performance management solutions that enable businesses to test and monitor their Internet applications. The company's software products and hosted services help e-businesses enhance the user experience by improving the performance, availability, reliability and scalability of their Web sites. By using its solutions to help identify and assess performance problems, e-businesses can increase their ability to attract and retain customers, and improve their competitive advantage. The company's customers represent a range of industries including Internet companies such as Amazon.com, America Online, Ameritrade, E*Trade, Healtheon, HomeGrocer.com, Jobs.com, ShopLink.com and WingspanBank.com; Internet infrastructure providers such as Ariba, Broadbase, Broadvision, i2 Technologies and Oracle; and Fortune 1000 enterprises such as Apple Computer, Caterpillar, Cisco Systems, Ford Motors and Wal-Mart. With regard to the near-term outlook for Technical and System Software issues and the relatively well-established trading range for MERQ, these positions offer excellent speculation for traders who participate in premium-selling strategies. Review the companies' earnings outlook as a quarterly report is due on or about January 17. MERQ - Mercury Interactive $94.31 PLAY (aggressive - neutral/credit strangle): Action Month & Option Open Closing Cost Monthly Req'd Strike Symbol Interest Price Basis Return Sell Put JAN 60 RQB ML 496 0.69 59.31 6.7% *** Sell Call JAN 140 RBF AH 143 1.00 141.00 9.6% *** - or - Sell Put JAN 65 RQB MM 157 1.31 63.69 12.3% Sell Call JAN 135 RBF AG 260 1.38 136.38 13.0% /charts/jan01/charts.asp?symbol=MERQ *************** BEARISH PLAYS - Naked Calls The issues are excellent candidates in the "premium-selling" category of options trading. Based on analysis of statistical option pricing and the underlying stock's technical history, these positions meet our fundamental criteria for profitable naked-calls. Each issue has robust option premiums, a well defined resistance area and a high probability of remaining below the target strike prices. However, current news and market sentiment will have an effect on these issues and, as with any recommendations, these positions should be carefully evaluated for portfolio suitability and reviewed with regard to your strategic approach and personal trading style. Some traders may favor a more aggressive approach, selling options that are closer to the current price of the issue, to produce a higher initial return. While that technique may be more attractive, it also increases the theoretical risk of loss. Only you can know what plays are suitable for your risk-reward tolerance and portfolio outlook. *************** IVGN - Invitrogen $75.00 *** Biotech Bubble? *** Invitrogen develops, manufactures, and markets research tools in kit form and provides other research products and services to corporate, academic and government entities. The company's research kits simplify and improve gene cloning, gene expression and gene analysis techniques as well as other molecular biology activities. These techniques and activities are used to study how cells are regulated by genetic material, known as functional genomics, and to search for drugs that can treat diseases. The company currently offers approximately 700 gene-identification, cloning, expression and analysis services. Since the merger with Life Technologies and Dexter Corporation, Invitrogen announced that it intends to reorganize the company into two primary lines of business, a Molecular Biology division and a Cell Culture division. With today's rally in hi-tech shares, rumors of a biotechnology "bubble" began to make the daily commentaries. While we believe that Invitrogen is one of the top companies in its industry, its share value may not be able to overcome the near-term selling pressure that will likely occur if technology stocks continue to recover. Technically, the IVGN price trend remains bullish but the recent failed rally at $85 suggests the possibility of a new downtrend is very high. In addition, today's decline came on increasing selling pressure and heavy volume. With substantial resistance near $85, it appears the stock has little chance of reaching our sold positions in two weeks. IVGN - Invitrogen $75.00 Action Month & Option Open Closing Cost Monthly Req'd Strike Symbol Interest Price Basis Return Sell Call JAN 90 IUV AR 675 1.81 91.81 20.5% Sell Call JAN 95 IUV AS 44 1.13 96.13 13.3% Sell Call JAN 100 IUV AT 403 0.63 100.63 7.7% *** /charts/jan01/charts.asp?symbol=IVGN ******* RIMM - Research In Motion $70.00 *** Downtrend Intact! *** Research In Motion is a designer, manufacturer and marketer of wireless solutions for the mobile communications market. With the development and integration of hardware, software and other ervices, RIM provides solutions for seamless access to valuable information including e-mail, messaging, Internet and Intranet applications. RIMM's technology also enables an array of third party developers and manufacturers in North America and around the world to enhance their products and services with wireless connectivity. RIMM's portfolio of products includes the RIM Wireless Handheld product line, the BlackBerry wireless email solution, wireless personal computer card adapters, embedded radio modems and software development tools. This play is simply based on the current price or trading range of the underlying stock and its recent technical history. The recent downward movement in RIMM's share value was halted near $50 in late November and after an ensuing recovery rally, the second sell-off found support near $65; a bullish indication. However, the issue has also achieved lower lows in each of its three attempts to reverse the bearish trend; a negative trait that will affect its upward movement in the near-future. Even today's record rally failed to bring the issue to a test of its short-term (30-day) moving average and with the heavy overhead supply from $85-$95, the issue has little chance of reaching our target strikes in the next two weeks. RIMM - Research In Motion $70.00 Action Month & Option Open Closing Cost Monthly Req'd Strike Symbol Interest Price Basis Return Sell Call JAN 100 RUL AT 475 1.88 101.88 22.5% Sell Call JAN 105 RUL AA 670 1.44 106.44 17.7% Sell Call JAN 110 RUL AB 298 1.06 111.06 13.4% *** /charts/jan01/charts.asp?symbol=RIMM *************** BEARISH PLAYS - Combinations *************** MRK - Merck $89.13 *** Drug Sector Sell-off! *** Merck is a global research-driven pharmaceutical company that discovers, develops, manufactures and markets a broad range of human and animal health products, directly and through its joint ventures, and provides pharmaceutical benefit services through Merck-Medco Managed Care, L.L.C. (Merck-Medco). The company's operations are principally managed on a products and services basis and are comprised of two reportable segments: Merck Pharmaceutical and Merck-Medco. Merck Pharmaceutical products consist of therapeutic agents, sold by prescription, for the treatment of human disorders. Merck-Medco revenues are derived from the filling and management of prescriptions and health management programs. This position was discovered with one of our primary scan/sort techniques; identifying potentially failed rallies on issues with bullish options activity. In this case, the premiums for the (OTM) call options are slightly inflated and the potential for a successful (technical) recovery is significantly affected by the resistance at the sold strike price; a perfect condition for a bearish credit spread. MRK - Merck $89.13 PLAY (conservative - bearish/credit spread): BUY CALL JAN-100 MRK-AT OI=14128 A=$0.25 SELL CALL JAN-95 MRK-AS OI=13672 B=$0.68 INITIAL NET CREDIT TARGET=$0.50-$0.62 ROI(max)=14% B/E=$95.50 /charts/jan01/charts.asp?symbol=MRK *************************ADVERTISEMENT********************* Why put all your risk into one stock when you can play the index instead? Learn how to invest in the OEX, QQQ, and SPX. Get intraday market updates, plays, education and daily commentaries by those who know. Sign up for a two week free trial and see for yourself at IndexSkybox.com: http://www.sungrp.com/tracking.asp?campaignid=1311 ************************************************************ ******************* 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. 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