The Option Investor Newsletter Monday 01-22-2001 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/012201_1.asp Posted online for subscribers at http://www.OptionInvestor.com ****************************************************************** MARKET WRAP (view in courier font for table alignment) ****************************************************************** 01-22-2001 High Low Volume Advance/Decline DJIA 10578.20 - 9.35 10634.40 10509.90 1.13 bln 1610/1241 NASDAQ 2757.91 - 12.47 2789.63 2722.96 2.04 bln 1992/1813 S&P 100 703.17 - 2.06 710.35 698.39 totals 3602/3054 S&P 500 1342.90 + 0.35 1353.59 1333.84 54.1%/45.9% RUS 2000 490.15 + 2.06 490.69 485.99 DJ TRANS 2969.85 + 16.56 2983.01 2933.37 VIX 25.94 - 0.35 27.38 25.83 Put/Call Ratio 0.46 ****************************************************************** Another Warning Digested The broader market averages spent the day in consolidation mode despite another earnings warning from the tech sector. The action felt as if the majority of market participants were on the sidelines, waiting for this week's round of earnings reports and guidance from Mr. Greenspan. Dell Computer (NASDAQ:DELL) warned this morning that its fourth quarter profits would miss estimates by as much as 30 percent. The direct seller of PCs blamed its shortfall on the economic slowdown and the company's strategy to cut prices in an attempt to gain market share. The news from Dell was not all that surprising, and many market participants had already discounted the earnings miss into Dell's share price. We can conclude this much because Dell's stock didn't blowup this morning in the wake of the warning. In fact, shares of Dell finished just -0.13 cents lower at $25.50. Over the last several weeks, it's been interesting to witness the market's reception to earnings warnings and the distinct shift in sentiment. It was not too long ago that the Intels (NASDAQ:INTC) and Dells of the world would blowup after warning of lower profits. However, the shift in market psychology, thanks in part to the Fed's cut earlier this month, has allowed for the market to digest bad news fairly regularly and easily. Nevertheless, Dell's earnings miss does reinforce the fact that risk remains in certain areas of the tech sector. Although its stock didn't get taken apart by the bears, Dell's warning can serve traders as a reference point when forming their top-down or macro views and opinions. Although Dell's warning didn't inflict widespread damage in the tech sector, it did help to spur a rotation back into the defensive sectors of the market including drug, insurance and energy names. That rotation back into the blue chip, defensive names helped to support the Dow Jones Industrial Average (INDU) despite a poor forecast from American Express (NYSE:AXP). The financial services firm met Wall Street's consensus estimates when it announced profits this afternoon, during normal trading hours, but guided analysts to expect earnings growth at the lower end of its estimates for 2001. As a component of the INDU, AXP did add extra volatility to the blue chip index this afternoon, but its losses were offset by gains in energy and cyclical components. The near-term resistance level to be cognizant of for the INDU is 10,800. Bullish earnings reports from the drug companies and energy firms would help drive the INDU past that level this week. If the INDU does break above 10,800, we're likely to see an advance to 11,000. On the flip side, if the INDU sags, we're likely to see a retest of support near the 10,300 - 10,400 range. The buyers have been showing up around those levels, and barring any major blowup, should continue to do so. If the buying-near- support-levels pattern continues, traders can use any pullbacks in their favorite INDU components to add bullish exposure. The ongoing rotation in the broader market is causing the INDU to churn, and churn. The blue chip index continues to find its way back to the 10,500 level, which is becoming an extremely efficient area. What that means is it's difficult for traders to game the INDU's direction because of all the time and volume that has been working around the 10,500 level. Think about this: the INDU has been rotating around 10,500 for almost two years. That's a very, very long time to spend consolidating. One might speculate that once the INDU is ready to breakout it's going to BIG! But the question remains when exactly that breakout finally materializes. As I previously wrote, Dell's warning did cause a bit of trepidation among tech investors and traders. However, the Nasdaq Composite (COMPX) finished lower by only -12.47 points on very light volume. The bulls will argue that today's session served the purpose of consolidation. After all, the COMPX has rallied over 10% thus far in 2001. And as every steer knows, pullbacks on light volume are a natural part of every bull market. The bears, on the other hand, will continue to point to the deteriorating fundamentals in the tech sector as seen in none other than Dell. However, the Fed is on the side of the bulls, which is why I feel the path of least resistance for the COMPX is to the upside. And if the COMPX can close above the 2,800 level in the coming days, then I feel 3,000 will be reached in short order. The Conference Board, a business research network, released its Leading Economic Indicators for the month of December. The leading indicators are designed to forecast economic activity about six months out. The index of leading indicators fell by 0.6 percent during December, while estimates called for a lower 0.3 percent decline. Yet another data point for the Fed to examine at its meeting next week. Before the Fed decides on the size of its rate cut, it will need to digest the Employment Cost Index (ECI) report scheduled for release Thursday morning. The estimates call for a 1.1 percent rise. Remember, the Fed's reason for raising interest rates last year was to prevent inflation, and the ECI is the best measurement of inflation in the labor market. A stronger-than-expected ECI number could lead to the Fed dropping rates by only 25 basis points, instead of the full 50 basis point cut which has already been factored into the Fed Funds Futures. Greenspan will be testifying to the House Budget Committee this Thursday but is unlikely to hint ahead of next week's meeting. Nonetheless, traders should be aware of the Doc's testimony Thursday and its implications on Bush's proposed tax cut along with future Fed policy. To come full circle, it seems appropriate to end with dismal earnings news, but not from Dell. After the bell, Texas Instruments (NYSE:TXN) reported fourth-quarter profits that missed estimates by two pennies and the chip maker warned of lower revenues in the first quarter of 2001. Shares of Texas Instrument dipped almost three dollars in the after hours session and weighed on the Nasdaq futures, which were down -23 points at time of writing. However, many analysts felt estimates for the chip maker were too high and expected Texas to report near the low-end of the range. That said, tomorrow morning's open in Texas, the broader chip sector and the Nasdaq will depend upon how much discounting the market had already done. The way we filter out the noise is to pay heed to price action, regardless of the news. Trade smart and manage risk! Eric Utley Assistant Editor ************************************ Spring Options Workshop and Bootcamp April 5th-9th, Denver Colorado ************************************ OptionInvestor is proud to announce our third annual Spring option workshop in Denver Colorado. This power packed five-day event is structured to fully educate you on advanced option strategies and will make you a better and more profitable trader. If you attended the March Denver Expo last year and thought it was the best function you had ever attended..... You haven't seen anything yet! Great food, entertainment, education and just plain fun in sunny Denver. The biggest complaint in March was the massive weight gain experienced by the attendees from the gourmet menu. We know how to put on a function. Ask anyone who came last March! We guarantee the speaker lineup to be second to none. In the October seminar not only did we have Jim Brown and over 15 of the OIN staff but Steve Nison, the father of modern candlestick charting. Also, Dick Arms, creator of the Arms Index or the Trin Indicator, Gregory Spear, author of the Spear Report, Stan Kim, founder of the Snail Trader System and Jim Crimmins, president of TradersAcounting.com. We promise the lineup this April will exceed your expectations again! This is not a beginner seminar but if you feel the need to brush up on the basic trading strategies then we have an optional boot camp the day before the four day seminar begins. If you have traded options before and you are comfortable with the basic strategies then this seminar will take you to a new trading level. If you have been trading options for sometime and are ready to broaden your knowledge and improve your trading results in all kinds of markets then this is for you. Meet and interact in a small group setting with the writers you have seen in OptionInvestor for the last four years. We are starting the seminar with an optional one day boot camp which will cover all the basic strategies, calls, puts, leaps, covered calls, naked puts, spreads, straddles, etc. This will help investors not familiar with all the basic strategies get up to speed before the intensive education and the advanced material in the main seminar. The boot camp will be 8 hrs of personal instruction by the OIN staff. The main seminar will begin with a reception, dinner and entertainment on Thursday night and continue non-stop until noon on Monday. We mean non-stop. We don't quit until you do and many optional sessions last until 10:PM or later. The detailed schedule will be posted in about two weeks. There will not be individual breakout sessions during the day. Each topic will be covered in 1-2 hr general sessions taught by one or more OptionInvestor staff and presented on three giant screens. In the evening we will offer five of our popular chalk talk sessions for that personal question and answer interaction. The list of instructors is led by Jim Brown and will include many OIN staff with outstanding guest speakers during lunch and dinner each day. The Spring Denver Expo seminars fill up fast and seating is limited! SIGN UP NOW or risk missing out on this opportunity. Unlike other seminars with only two or three instructors, you will get in-depth knowledge from many different instructors who are experts in their field. The cost for the four-day workshop, April 6th to 9th is only $2995 (spouse only $1495). This includes breakfast, lunch and supper each day. All course materials, a CD of all the presentations and a professional video package of the entire seminar so you can review the material at home in the comfort of your living room. There is also a $500 discount if you have attended a prior OIN seminar. This is not a prepackaged presentation that gets repeated over and over with stale information. This is a one-time production and everything is fresh, live and as current as we can make it. The videos will have your real time questions and answers and not some from a prior class. Where else can you get intensive yet personalized options education like this? Do not delay as seating is very limited. We guarantee you will not be disappointed! You can pay for your education one bad trade at a time or you can invest less money one time to learn how to do it right. Click here for more info https://secure.sungrp.com/workshop/april01/index.asp If you have not been to one of our Denver Expo seminars before here are some comments from previous attendees: The words herein are totally inadequate to express what I am feeling about you and all the OptionInvestor organization. But this medium is all I have. Thank you more than these few simple words can say. Wow, what a seminar! In my 25 years of investing I have attended many instructional conferences, but I have never, never experienced one like your Options Expo. The instructors were absolutely tops. Subjects, generally were on target. Especially for me, the Skybox, index funds/options and the early morning strategies and trading were particularly great. The attention to the many details and nuances were especially evident, and I guess most of the credit that area goes to your great support team. Now, the real challenge is to apply and implement the powerful knowledge I was exposed to. Sincerely and warmly, Kevin Hughes, Denver ************ Jim & Staff, I am sitting in the hotel room after a great 3 days in your seminar. I can't tell you how pleased I am and want to thank each of you for a job well done. Having been responsible for events like this, albeit on a much smaller scale, I can recognize all the hard work that went into the seminar. Each member of the staff is to be congratulated!! The seminar confirmed my belief that the OIN staff really cares about the success of their subscribers. Jim, you all should be proud of the work you do to enrich the lives of so many people. It is one thing to amass a personal wealth. It is a much higher calling to help others meet their goals in life. I was very impressed that you were emotional in your closing remarks. You have so much to be proud of -- helping people fish all over the world! Thanks again and I look forward to attending another seminar in the future. My best reagrds, Jim Boettcher Austin, Texas ************** I must say, that your seminar was outstanding!!! Sign me up for next year. It is rare that a person of your position would share so generously your knowledge of his trade. I hope that I will be able to put into place much of what you taught. Every aspect of the seminar was first class, from the hotel, to the food, the instructors and the luncheon speakers. One of the biggest surprises was your generosity in handing out material, and gifts. Two weeks ago I attended a competing option seminar in Chicago and all I got from the was coffee at the morning break, No handouts, no food and half of the final day was promoting their web site and additional classes. I must say your seminar far exceeds what I got from them. Sincerely yours, Mike Lillis *************** Please pass on my thanks to the entire OIN group for a fabulous EXPO. The seminar far surpassed any expectation that I would have fathomed, had I attempted to! OIN has the right attitude and the obvious ability to be a leader and I look forward to many years of positive experiences with you folks. Kind regards, Gwen Richardson **************** GREAT JOB TO EVERYONE! I described this event to my friends as a life changing event! (options aside) ,the quality of people, dedication, sacrifice of their time (the second 40+ hours a week they don't have to work but do) they do this because they care, wanting to help others change their life dramatically (My wife thinks I was oxygen deprived up there !) I came back a different person for those who know me that says a lot. Now for the options side I have to admit there was so much info to absorb, most of it came to me on the 2000+- mile ride home it all started to fall into place I feel Very confident (yes Jim this can be bad but I know this now!) Notice the patience here guys! that's one change I have a plan to stick to ! THANK YOU !!! Allan O'Neill ************** Need we say more? If you want to learn how to be a better trader, making more and losing less then you should come to this seminar. We guarantee you will not be disappointed! For more info: https://secure.sungrp.com/workshop/april01/index.asp #!!!AD23!!!# ************* NEW CALL PLAY ************* AETH - Aether Systems $51.94 +2.88 (+2.88 this week) Positioned to profit from the proliferation of handheld computing devices, AETH provides wireless data services, systems and software enabling people to use their handheld devices for mobile data communications and real-time transactions. Current services include TradeRunner, a real-time wireless trading and financial information service offered to the online customers of Morgan Stanley Dean Witter Online, and the Reuters MarketClip service for financial market price quotes, alerts and information. Through recent acquisitions, the company has expanded its services into the healthcare, sales force automation and transportation logistics and delivery industries. The past 7 months have been painful for AETH investors as they have watched their beloved stock decline from its lofty heights, north of $200, all the way to the pedestrian sub-$30 level in late December. As the NASDAQ has begun to firm and actually put on a good impression of a rally, our new play has emerged from its month-long consolidation between $33-42. Helping to motivate the bulls has been a recent string of product and service enhancements, but the real kicker was the positive analyst comments last Tuesday. Banc of America Securities upgraded the stock from Buy to Strong Buy. Finally breaking above the $42 level late last week, AETH rode the upper Bollinger band and broke above the long-term descending trendline (currently resting at $46). Continuing to distance itself from this level in today's trading, the stock looked strong, trading nearly 150% of the ADV, despite the fact that the NASDAQ couldn't put together another positive close. Finding resistance today near $54, our new play will likely need the help of a positive market in order to scale this level. AETH has only broken above this trendline once since last summer, and then it rolled over at the 50-dma. Since patterns tend to repeat, the 50-dma ($59.25) looks like it will be the next serious resistance as the bulls attempt to maintain the rally into the FOMC meeting on January 31st, and then the company's earnings report on February 7th. While a little bit of profit taking could be looming on the horizon (due to the tightly stretched Bollinger band), any pullback should be contained by the intraday resistance at $48, and then $46. Since we are looking to jump into the play and enjoy the upward momentum while it lasts, we are placing our stop just below, at $45. Aggressive players can target shoot intraday dips to support, so long as it is followed by strong buying action, while the more conservative approach will be to wait for AETH to break free of the $54 resistance level before playing. BUY CALL FEB-50 HIZ-BJ OI=435 at $ 8.50 SL= 6.00 BUY CALL FEB-55*HIZ-BK OI=149 at $ 6.38 SL= 4.25 BUY CALL FEB-60 HIZ-BL OI=393 at $ 4.75 SL= 3.00 BUY CALL MAY-55 HIZ-EK OI= 72 at $13.50 SL=10.25 BUY CALL MAY-60 HIZ-EL OI= 79 at $11.88 SL= 8.00 BUY CALL MAY-65 HIZ-EM OI= 42 at $10.38 SL= 7.50 SELL PUT FEB-45 HIZ-NI OI= 70 at $ 3.50 SL= 5.50 (See risks of selling puts in play legend) http://www.premierinvestor.com/oi/profile.asp?ticker=AETH ************ NEW PUT PLAY ************ CCU - Clear Channel Communications $59.38 -2.38 (-2.38 this week) Clear Channel Communications, Inc., is a global leader in the out-of-home advertising industry with radio and television stations and outdoor displays in 40 countries around the world. The Company began its operations in 1972, and became a publicly traded company in 1984. Including announced transactions, Clear Channel operates 900 radio and 19 television stations in the United States and has equity interests in over 240 radio stations internationally. Clear Channel also operates more than 700,000 outdoor advertising displays, including billboards, street furniture and transit panels across the world. The Company is headquartered in San Antonio, Texas. Fears over declining advertising revenue played a significant role in CCU's downturn last year. Businesses faced with rate hikes and a slowing economy in 1999 had to lower costs and one of the first things to go was ad spending. The surprise 50 basis point rate cut by the Fed early this year gave the stock a boost but ever since failing to break above its 200-dma (currently sitting at $64.80) last week, traders have been tuning out the bullishness on shares of CCU. While the stock has enjoyed a nice rally so far this year, it appears that the upward momentum that had driven the stock up over 35 percent in two weeks is now waning. Connecting the lows since the beginning of this year reveals an upward trending channel, one which was broken to the downside with today's close. In doing so, CCU also put itself below support at $60. Look for this level to provide resistance going forward, allowing aggressive traders to enter on failed rallies. Moving average resistance from the 5-dma at $62.13 and the 200-dma could also provide target entry points but make sure that the stock closes below our protective stop price of $64, and confirm a rollover with selling volume before taking a position. For a more conservative play, look for downward momentum to take CCU below its 10-dma (now at $59.15) on volume before jumping in, but only if competitors INF and VIA confirm negative sector sentiment. From keep an eye on support at $58, the 100-dma at $55.23 and the 50-dma at $52.71. BUY PUT FEB-60*CCU-NL OI=197 at $4.00 SL=2.50 BUY PUT FEB-55 CCU-NK OI=125 at $1.75 SL=1.00 http://www.premierinvestor.com/oi/profile.asp?ticker=CCU ***************** STOP-LOSS UPDATES ***************** No stop-loss updates today ************* DROPPED CALLS ************* BRCM $128.81 -1.25 (-1.25) Broadcom makes frequent appearances on our play list, and for good reason. As a fundamentally strong company that makes volatile moves in both directions, we have been successful in capturing substantial gains in the numerous forays we have made into its stock. Our most recent call play is no exception. Capturing over $35 of its upside move these past two weeks, BRCM has been nicely consolidating its gains in a tradable range of over 15 points. It appears that a major move is coming and with earnings tomorrow after the close, it could go either way. As per our policy, we are selling too soon ahead of the report but rest assured, we will be watching this one closely for future plays. LRCX $21.75 -1.00 (-1.00) Despite the recent trend of stocks rising post-earnings, we are sticking to our principles and taking profits on our call play in Lam Research ahead of its report after tomorrow's close. As options traders, part of a successful strategy is to seek out plays with high odds of a high return while minimizing chances for loss. The potential for a large gain in LRCX following its announcement could result if a strong rally ensues but with that increased potential for gain comes an even greater potential for loss. With the risk profile now greater due to that uncertainty, we are dropping coverage of this play. MER $75.13 +1.25 (+1.25) With the next Fed meeting rapidly approaching, and the bond market pricing in a high degree of probability that we could receive another 50 basis point rate cut at that time, shares of Merrill Lynch rallied, gaining 1.69 percent. Volume was lower than average, about 80% of ADV. This is not surprising considering that the company will be announcing its earnings tomorrow after the closing bell. Those who know our Top 10 Rules for Option Trading know that Rule #2 is, "Never hold a position over an earnings report." True to our word, we are taking our money off the table before that time arrives. ORCL $31.81 -2.75 (-2.75) It appears that we will be dropping our call recommendation on B2B Gorilla Oracle a little earlier than expected. Having initiated coverage this past weekend, we had designed an entry strategy with confirmed bounces off the 5 and 10-dma and a stop price of $32. Gapping down at the open, the stock fell on high volume right through moving average support, ending the day below our stop price. Rumors of the company restating earnings were being circulated, leading to today's price action. Whether or not they are true, they have had a material effect on the stock's technicals, so with our conditions for entry unmet, we are closing out this play. ATHM $8.59 -0.09 (-0.09) After breaking above the 50-dma near $7.31 early last week, the bulls are starting to look tired, and ATHM is rolling over. Stochastics are weakening, volume is dropping off, and it looks like the enthusiasm that was driving Internet and Telecom stocks has waned. Although our stop is still intact, with earnings coming up on Thursday unable to motivate buyers, we'll take our leave of ATHM while the getting is good. C $53.88 -0.50 (-0.50) It's hard to get excited about C's performance over the past 2 weeks, as it continues to trade in an ever narrower range. Although it looked like it might be getting close to breaking out of its neutral wedge to the upside, bearish guidance from AXP today seems to have given the bears the upper hand. Despite a slight gain for banking stocks today, C posted a fractional loss and even though our stop is still intact, it looks vulnerable. Rather than wait for it to be violated we will take our leave of C tonight. COMS $10.06 -0.06 (-0.06) What started off as a promising rally has fizzled into a boring decline in shares of COMS. After pulling back from the upper Bollinger band early last week, the bears have been whittling away at the stock, taking back the bulls' hard won gains a little bit each day. With Networking stocks beginning to show signs of weakness, and the NASDAQ following suit, it seems foolish to keep our COMS play open, even though it has yet to violate our stop. Stochastics are rolling over from the overbought zone, and volume is drying up; not exactly the ingredients we want to see in a call play. Q $43.31 -3.19 (-3.19) Weakness across the Telecom sector today accelerated the rollover on Q, and dragged the price below the $44 stop, spelling a premature end to the play. While we were hoping that the move through the 200-dma last week, would spell an end to the months-long downtrend, the bears had other ideas, whacking the stock for a nearly 7% loss today and keeping the downtrend intact. There's no sense in bucking the trend, and with the oscillators all rolling over, that trend is now clearly to the downside. ************ DROPPED PUTS ************ No dropped puts today ************** TRADERS CORNER ************** Proper Account Management (Through Good Times & Bad) By Austin Passamonte Each of us at one point or another have or soon will take a trading account and grow it large. Favorable market conditions, blind luck or some combination of the two eventually prevails. How we manage to deal with the other side of that coin makes all the difference in career longevity. The financial world is littered with carcasses of dead accounts that once sported five, six, seven, eight and nine-digits to the left side of any comma. From the greenest of dumb to a number of famous, revered gurus there lays a trail of fortunes lost and dreams broken. Mathematicians and statisticians are quick to tell any who listen that total loss is inevitable. Trading is no more than playing odds and odds always prevail. The game is rigged against us with bid/ask spreads, commissions and other costs that inevitably sends us to ruin. I've seen, read and been told countless times that anything other than selling option premium is a road to financial failure. My reply: HOGWASH! First of all, there are traders in this world who've profited over time buying option premium. That proves it is possible beyond shadow of doubt. Naysayers would be quick to point out that given enough time these traders will bust out too. Really? And how long would that take? 50 years? 100 years? I expect they'll be retired before then. In actuality, sellers of naked premium play with statistical fire. Natural laws of random chance and chaos order will see to that. Even those who sell premium on the "blue chip" stocks (Nasdaq:MSFT, Nasdaq:INTC, Nasdaq:CSCO, NYSE:NT) can wake up to disaster one not-so-fine day. Does that mean option trading is no more than a fool's game? No. Not at all. The secret to survival is quantifying risk and managing it in efficient manner. There are various ways to do this and most of them work, but we'll continue from where I left off before the last three of four holiday Mondays squeezed our space. I can tell you with 100% certainty no matter how bad a losing streak I'm in, my trading account can never go to zero. That's real good news for me this month as I've been mired in one of the worst personal performances in my career! Oh, I have all kind of excuses; markets didn't favor my approach, a move across country took its toll, etc., etc. Bottom line is my account doesn't care. It doesn't measure excuses, it measures performance. Thank heavens the yard-stick can be kept short! A methodology using stops AND smaller trade sizes after each losing trade keeps us alive to play another day. If we happen to start with a string of losing trades, at least our account won’t be decimated. First, let’s look at the performance of Swing Trade plays after these past few weeks. For detailed statistics on each of the indexes from September through December as well as the specifics of this analysis, see previous articles in the Trader's Corner archive section. We begin with the following assumptions: Account Value $100,000 Risk Level 5% Stop/Sell Amount ---------------- Week 1 25%/35% Week 2 25%/35% Week 3 30%/50% Week 4 50%/100% Here is the performance through most of January's expiration cycle for QQQ, OEX and SPX: Initial Value $100,000 Ending Value QQQ SPX OEX Value %Chg Value %Chg Value %Chg September 121,800 22% 112,600 13% 121,650 22% October 133,879 9% 147,491 24% 168,738 28% November 171,692 22% 175,270 16% 188,062 10% December 235,506 27% 256,745 32% 258,132 27% January 229,259 -3% 266,580 4% 208,882 -24% ----------------------------------------------------------- Overall Growth 129% 167% 109% Win % January 33% 36% 29% Win % Overall 52% 58% 51% Two very important lessons can be drawn from this information. First, managing trades based on percentage of account rather than number of contracts protects the downside. Secondly, religious use of stop losses keeps losses at bay. Let’s take a look at some details to see what happens. First the Qs. Below is the detailed accounting of the trades: We'll restate these trades based on the same $100K initial account and compare results to typical trading methods using a static number of contracts every trade. Here’s the same trades entering with $100,000: The account beginning at the first part of January expiration cycle has a net value of $97,386. That’s a loss of -3%. This is important. It does not matter what size account, loss level is the same. Now let’s look at the same trades using 50 contracts every time: As you can see we’ve lost a net of -7% instead of -3%. Scale up the numbers and it gets worse. For example, run these trades at 100 contracts. The net value would be $86,800 or a net loss of over -13%. This is the reason we manage trades by percentage of account instead of an arbitrary number of contracts. As the account grows its value grows IN PROPORTION to its size. As the account shrinks its shrinks IN PROPORTION to its size. Next stop: the SPX trades. It really underscores the benefits of this approach and highlights both stop loss management and trade size management. Here are the trades: Things to note in this table: 1 - Cutting losses through standard stops and active use of trailing stops keeps loss percentage small (SXY-AJ, last trade). Even a couple of opening gaps or after closing bell traps can’t keep a good account down. 2 - A string of several losses in a row (last three in the table) did not wipe out the progress thus far in the month. Once a model is found that consistently produces profits under proper conditions for that model AND provides good downside protection during adverse conditions we have an approach that should allow us to consistently profit over time. In my opinion it is impossible to trade financials in any form or fashion over time without experiencing a string of losses. Even credit spreads or some variation of selling premium with downside risk defined and odds of probability for success will suffer occasional series of loss. Using methods that allow us to quantify downside risk and sensible account management make these experiences irksome, frustrating but never financially lethal. To recap, regardless of our trading method or approach we will always buy (or sell short) the number of option contracts our stopped-out loss would result in a 5% or similar fixed percent draw down of our account. The second part of this equation is adjusting the stop-loss percentage according to its underlying play risk/reward. Volatile trades demand wider stops and less volatile ones permit tighter stops. Here's what we mean: High-Volatility Plays I'll repeat the stop loss figures we use for very short-term trading the QQQ, OEX and SPX markets. Other more volatile equity options might require wider stops and stodgy, slow-moving equity options could use tighter as we discuss later. Risk Level: 5% of total account balance Stop/Sell Amount ---------------- Week 1 25%/35% Week 2 25%/35% Week 3 30%/50% Week 4 50%/100% During the first two weeks of an expiration cycle, time premium is high and it takes larger index move to push those percentages than the last two weeks of expiration. Therefore, using our sliding scale of capital at risk we would have more exposed to catastrophe early on than later. Trade target: QQQ 60 Put @5.00 ------------------------------ Week #1: stop loss @3.75 (25%) Week #2: stop loss @3.75 (25%) Week #3: stop loss @3.30 (30%) Week #4: stop loss @2.50 (50%) Trading a $10,000 account, we are prepared to risk 5% or $500 on a stopped out trade. With $500 representing 25% of the trade's cost, we would spend $2,000 on five of the above QQQ 60 put option contracts. That is actually risking far more than 5% overall if things go wrong in a hurry. Open put options during an unexpected interest- rate reduction about 1:15pm EST comes to mind. What then? Well, drastic as that would be (was) to those holding open puts, time value will not go to zero this far from expiration. It might go from 5.00 to 1.50 in a flash, but not zero. The net result is an actual loss of $1,750 instead of $500. We may be shocked but not destroyed. That's about as extreme a move against us as any I can imagine. We still have $8,250 left to work with in normal market conditions. Should that happen during week #4, we would only have five of those contracts but the price would be much less due to lack of time premium. More like 2.00 instead of 5.00. Total cost would be $1,000 of which we would risk 50% (our $500 limit). A gap-move up like we saw in the same scenario would shrivel them from 2.00 to 0.06 "bid" in the blink of an eye. We lose our entire $1,000 in one sharp move. Now what? Now we trade! We still have $9,000 or 90% of our account balance left after the worst calamity possible. If lightning strikes again the next day, so be it. We'll lose another $1,000 and go from there. How often can these disasters occur? Not counting overnight gap moves I cannot remember one worse than that since late fall in 1998. Those are odds I can live with. Low Volatility Plays It gets better. Traders who forego front-month options and buy more time-premium could stick with a 25%/35+% risk-reward combo or something similar as familiarity with those targets proves best. Stock or share traders could opt for a strict 5%/10+% stop/sell ratio or likewise also. Again, getting to know your target's average daily range is critical for fine-tuning stop usage. Key Points To Remember This simple system works for a few reasons. It ensures we are always using near-optimum amount of our capital to work while immune from devastating loss. Our balance is always scaling up at greater multiples after the first win and scaling down in lesser multiples after the first loss. Random chance dictates wins and losses happen in strings over time instead of win, loss, win, loss, win, loss. By asking for greater gain than total amount risked, we are always levering higher & faster to the upside and lower, slower to the downside. Use of disciplined stops and risking no more than 5% of total account balance on any similar play is paramount for success over time. Larger accounts can certainly take more heat, but it is impossible to trade any account down to absolute zero in this fashion. At some point it could no longer afford to buy any options at all, but the balance would be greater than zero. Small accounts always have less staying power than bigger ones, but I believe this is among the best ways to protect downside and permit upside to prevail when time takes over. If you've been immune to streaks of losing trades and draw down in your career, keep up the excellent work! For the rest of us, a method of capital defense is objective #1 before offense has a chance to take over. Modifying this or a similar approach to suit your style of trading can surely help you on the path to success over time. My personal thanks and great appreciation for Bill Kadlec at IndexSkybox for compiling the charts & data within for our use. Best Trading Wishes, austinp@OptionInvestor.com #!!!AD24!!!# ********************** PLAY OF THE DAY - CALL ********************** CIEN - CIENA Corporation $100.88 -3.94 (-3.94 this week) Helping to satisfy our insatiable demand for bandwidth, CIEN makes dense-wavelength division multiplexing (DWDM) systems for use with long-distance fiber-optic communications networks. CIEN offers optical transport, intelligent switching and multi- service delivery systems that enable service providers to deliver and manage high-bandwidth services to their customers. The company’s MultiWave DWDM systems allow optical fiber to carry up to 40 times more data and voice information without requiring more lines. CIEN's customers include long-distance carrier, competitive local exchange carriers (CLECs), Internet service providers and wholesale carriers. Most Recent Write-Up Positive earnings reports this past week have kicked the Networking sector (NWX.X) into a sustained rally that has helped CIEN to finally clear its descending trendline. Resting at $99 now, the fact that the bulls were able to scale this level on Thursday and then hold onto those gains, marks an important step in our new play's move out of its 12-week downtrend. The first sign that things were on the mend was on Wednesday, when the stock cleared its 50-dma (then at $89.63), and the icing on the cake was the additional $7 gain in the last two days of the week. Closing near the high of the day on Friday, CIEN has now climbed 46% in the past 6 trading sessions. Can you say profit taking? Sure you can, and it could be lurking just around the corner, now that CIEN is resting right up against its upper Bollinger band and stochastics have moved into overbought. It wouldn't surprise us to see some profits come off the table early next week, but this will likely give us just the entry point we are looking for. With resistance looming near $106, the overbought condition of the stock could open the door for a quick drop to support near $100 or even the level of our stop at $94. But with the returning strength of the Optical stocks, prompted by strong earnings from the likes of NT and AMCC, and the Fed likely to drop rates again by the end of the month, any such drop is likely to be short-lived. Aggressive traders can target shoot any such dip, so long as the bulls step in to support the price above our stop. Continuing strength in Networking stocks could even give us a decent entry if it produces a volume-backed move above Friday's high of $106. For you stock split hounds out there, CIEN announced on Friday that there will be a special shareholder meeting on March 14th. On the agenda will be a proposal to increase the number of authorized shares from 460 million to 980 million. Comments CIEN's action Monday exemplifies the meaning of consolidation. The high-flying Nasdaq superstar traded in a narrow range on light volume and a return of the tech bulls Tuesday could lead to profits for call traders. As for execution, pullbacks to support levels at $100 or lower near $95 would provide solid entries. Conversely, a breakout over resistance at $105 on heavy volume would provide another entry possibility. Either way, confirm direction in the Nasdaq before entering new plays. BUY CALL FEB-100 UEE-BT OI=2496 at $12.75 SL=11.25 BUY CALL FEB-105*UEE-BA OI=1119 at $10.38 SL=10.25 BUY CALL FEB-110 UEE-BB OI=2364 at $ 8.63 SL= 8.25 BUY CALL FEB-115 UEE-BC OI= 723 at $ 7.00 SL= 6.25 BUY CALL APR-110 UEE-DB OI=1736 at $16.25 SL=13.75 BUY CALL APR-115 UEE-DC OI=1401 at $14.75 SL=12.50 http://www.premierinvestor.com/oi/profile.asp?ticker=CIEN #!!!AD25!!!# ******************* FREE TRIAL READERS ******************* If you like the results you have been receiving we would welcome you as a permanent subscriber. The monthly subscription price is 39.95. The quarterly price is 99.95 which is $20 off the monthly rate. We would like to have you as a subscriber. You may subscribe at any time but your subscription will not start until your free trial is over. To subscribe you may go to our website at www.OptionInvestor.com and click on "subscribe" to use our secure credit card server or you may simply send an email to "Contact Support" with your credit card information,(number, exp date, name) or you may call us at 303-797-0200 and give us the information over the phone. You may also fax the information to: 303-797-1333 ********** DISCLAIMER ********** Please read our disclaimer at: http://www.OptionInvestor.com/page/oin/aboutus/disclaimer.html
Option Investor Inc is neither a registered Investment Advisor nor a Broker/Dealer. Readers are advised that all information is issued solely for informational purposes and is not to be construed as an offer to sell or the solicitation of an offer to buy, nor is it to be construed as a recommendation to buy, hold or sell (short or otherwise) any security. All opinions, analyses and information included herein are based on sources believed to be reliable and written in good faith, but no representation or warranty of any kind, expressed or implied, is made including but not limited to any representation or warranty concerning accuracy, completeness, correctness, timeliness or appropriateness. In addition, we do not necessarily update such opinions, analysis or information. Owners, employees and writers may have long or short positions in the securities that are discussed.
Readers are urged to consult with their own independent financial advisors with respect to any investment. All information contained in this report and website should be independently verified.
To ensure you continue to receive email from Option Investor please add "email@example.com"
Option Investor Inc