The Option Investor Newsletter Wednesday 03-28-2001 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/032801_1.asp Posted online for subscribers at http://www.OptionInvestor.com ****************************************************************** MARKET WRAP (view in courier font for table alignment) ****************************************************************** 03-28-2001 High Low Volume Advance/Decline DJIA 9785.35 -162.19 9941.20 9695.81 1.30 bln 1083/1980 NASDAQ 1854.13 -118.13 1925.30 1852.96 2.07 bln 1098/2606 S&P 100 588.31 - 17.27 605.58 584.87 totals 2181/4586 S&P 500 1153.29 - 28.88 1182.17 1147.83 32.2%/67.8% RUS 2000 442.20 - 10.68 452.88 442.20 DJ TRANS 2765.08 - 37.41 2805.59 2746.99 VIX 33.22 + 2.53 33.95 32.30 Put/Call Ratio 0.86 ****************************************************************** Everybody Down The catalyst for this latest round of bloodletting was two former year 2000 high-flyers (which could be nearly anyone these days). Electronic organizer king Palm (Nasdaq:PALM) got the rivulets forming when it announced after the close on Tuesday that it expects fourth-quarter earnings to fall short of estimates. According to the company, it now expects to post a fourth-quarter loss of $0.08 a share vs. the First Call estimate of a $0.03 per share profit. Palm's confession may have been good for the soul; unfortunately, it wasn't very good for the stock price. For the day, Palm shed $7.44, or 48 percent, to close at $8.06. Nor was Palm's confession very good for the competition. Fellow handheld contraption peddler Handspring (Nasdaq:HAND) got whacked for $5.31 to $10.88 while Research in Motion (Nasdaq:RIMM) got nicked $4.43 to $20.25. Still, the handheld market's woes were small potatoes compared to the outright despair displayed in the networking sector. This morning Canadian telecom equipment supplier Nortel (NYSE:NT) reported that it expects a per-share loss wider than it forecast in February. The company also reported that its 2001 projections are unreliable (hey, who should know better?) and that it will dismiss 5,000 employees by mid-year. For the day, Nortel tumbled $2.76 to $14.00, which, of course, was a new 52-week low. Nortel's mea culpa quickly reverberated throughout the entire networking sector. Cisco Systems (Nasdaq:CSCO), which was the most active stock on the Nasdaq, skidded $2.38 to $15.75. Meanwhile, Juniper Networks (Nasdaq:JNPR) crumbled $8.85 to $43.89 and Corning (NYSE:GLW) slumped $3.49 to $21.50. Another notable telecom loser was Lucent Technologies (NYSE:LU), which had the misfortune of tapping the equities markets for its Agere Systems (NYSE:AGRa) today. Agere is a seller of microelectronics and optical components used on communications equipment and networks. Agere was priced at $6.00 a share, a considerable discount to the $15 to $20 share price Lucent had anticipated as recently as last month. Despite the lousy climate for tech stocks in general, and optical component makers in particular, Lucent had no choice but to proceed with the offering. The company trashed its balance sheet last year, causing its debt to balloon to unhealthy levels (over $8 billion), and the spin-off will help clean up some of this mess. For the day, Lucent finished off $1.43 to $10.27 while Agere finished up $0.02 to $6.02. The seemingly never-ending tech sell-off was fully manifest in most major market indices today, but nowhere more than the Nasdaq Composite Index (COMPX). The tech-heavy index was routed for 118.13 points, or 5.99 percent, to close at 1,854.13, putting it smack-dab on its intermediate downtrend line. I see a possible silver lining here. While everyone is carrying on about COMPX 1,750 or COMPX 1,500, there is an ever-so-slight argument that it could hold 1,800. Of course, for the COMPX to have any chance of standing firm, it must get some help from the Triplets, meaning Microsoft (Nasdaq:MSFT), Intel (Nasdaq:INTC) and Cisco Systems (Nasdaq:CSCO). All three finished off more than $2.00 today. Meanwhile, in the Old Economy, traders and investors were once again thinking bear market. The Dow Jones Industrial Average (INDU) lost 162.19 points, or 1.63 percent, to close at 9,785.35. Of the INDU 30 components, only three finished the session up. Johnson & Johnson (NYSE:JNJ) was the notable winner, closing up $3.03 to $86.28 thanks to an upgrade from Morgan Stanley. As for the INDU losers, the most notable was Disney (NYSE:DIS), which lost $0.84 to $28.36. In a surprising announcement, the company said it will eliminate about 4,000 jobs, or 3 percent of its worldwide workforce, to reduce annual operating expenses by $350 million to $400 million. If anything, the notion of folks who used to earn a living masquerading as rats, dogs, birds and dwarves having to seek employment elsewhere proves beyond a doubt that no one is immune from a slowing economy. Despite today's attrition, the INDU looks as if it will stay out of bear-market territory (officially recognized by a close below 9,377) for the remainder of the week. Technically, the INDU appears to have support 9,650, if not more immediate support near a weak uptrend line at 9,750. In all honesty, though, predicting support levels in this market has been as easy as picking Powerball numbers. In other stock news on Wednesday, ADC Telecommunications (Nasdaq:ADCT) lost $2.25 to $8.31 after reporting that it expects a second-quarter loss. Like Disney, ADC expects to slash up to 4,000 jobs. Yahoo! (Nasdaq:YHOO) also made news again today. The king of the Internet portals fell $0.63 to $14.94 despite being upgraded by UBS Warburg. However, the upgrade could be considered left- handed at best. Warburg upgraded Yahoo to a "hold" from a "reduce." Not that the rest of the Internet sector fared much better than Yahoo, because it didn't. Selling was widespread in the Internet issues, as the AMEX Internet Index (IIX) tumbled 11 percent today. Still, there is one sector of the capital markets thriving in this contracting economic environment, and that's the treasury sector. The 10-year Treasury note was up 7/32 to yield 4.98 percent while the 30-year government bond shed 11/32 to yield 5.465 percent. As for economic news, we were once again reminded that we are in the midst of an economic downturn. The Commerce Department reported that new orders for durable goods fell 0.2 percent in February, while new orders for capital goods - which tell us how much companies are spending on new equipment and software - dropped 4 percent. Needless to say, every time the market gets slapped with a negative economic data set, its eyes instinctively turn to the Federal Reserve for comfort, which at this point may be a waste of time and energy. At this point, I think the Fed has done just about all it can do. After all, liquidity isn't the end all to our economic downturn. Clearly, the technology sector has serious inventory overhang and pricing issues, which won't be washed away by more market liquidity. With that said, I wouldn't be surprised if the economy turns by mid-summer, which means that the market will turn before then. The fact is, the market is a discounting mechanism and I think that most of the bad economic and earnings news is already reflected in current stock prices. Finally, I think that market pessimism has grown to levels that probably necessities some sort of rally. According to Bloomberg and Investors Intelligence, pessimism about U.S. stocks surged to its highest level in more than 16 months last week. Keep in mind, long before the economy and investor sentiment turns positive, the market will probably be half way to reaching new highs. S.P. Brown Contributing Editor ************************************ TOPICS and SPEAKERS 3rd Annual Trading Expo 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. ------------------------------------------------------------------ Jeff Bailey, Editor, PremierBriefing.com Learn the basics of Point and Figure Charting while analyzing how supply and demand on an institutional level affects the markets and the stocks you want to trade. Mark Skousen, Ph.D., Editor, FORECASTS & STRATEGIES The Global Economy and its Impact on Us. Learn from a professional economist who turns his understanding of economics into highly valuable investing advice. Harry Browne, Author of Fail-Safe Investing Sixteen Golden Rules of Failsafe Investing. A powerful session that translates the essence of the book into guiding principles. Jim Brown, Founder, OptionInvestor.com Austin Passamonte, Editor, IndexSkybox.com Jeff Bailey, Editor, PremierBriefing.com Preparing for Battle. This is a very popular session where multiple speakers team together offering insights on: planning your trades and the combination of research, market factors, and choosing your hot list. Tom DeMark, Author of three books on DayTrading Options Day Trading Options. An extremely popular subject taught by one of the world's foremost authorities on chart analysis. Tom wrote the book on day trading options, literally. Steve Nison, Author, Japanese Candlestick Charting Techniques Candlestick Charting. Is that a doji or an evening star formation? How can this benefit your trading success? Candlestick chart analysis is another hot topic that traders are always eager to learn. Nison is internationally recognized as the "Father of Candlesticks" and has written two books on the subject. Austin Passamonte, Editor, IndexSkybox.com Buzz Lynn, Contributing Editor, IndexSkybox.com Beating the Market with Indexes. This is another tag team event where you'll hear from two of our staff from IndexSkybox.com as they discuss topics like: Don't Pick Stocks, Pick Markets; and Market Timing Equals Sector Profits. Rance Masheck, President, SpreadTrader.com Calendar Spreads & Bull Call Spreads. Some of the first strategies a beginner will encounter in spread trading are these two spreads. Both simple and effective they continue to draw experienced traders over and over again. Mark Skousen, Ph.D., Editor, FORECASTS & STRATEGIES Scrooge Investing - The Best Bargains in Beaten Down Stocks for 2001. This is a great topic and Mark's background as an economist really offers some new insight into the challenge of choosing your investments. Jeff Bailey, Editor, PremierBriefing.com Calculating the Bullish Percent. Applying your new knowledge in Point and Figure charting to decipher how many stocks in a sector are showing buy signals. Jim Brown, Founder, OptionInvestor.com Austin Passamonte, Editor, IndexSkybox.com Pre-Market Analysis. A very popular session where multiple speakers team together offering insights on: Pulling the Trigger, Amateur Hour, and Market Hype. Dick Arms, Inventor of the Arms Index, Founder, ArmsInsider.com Increase your profit potential with Equivolume Charting, volume adjusted moving averages and the TRIN Derek Baltimore, Co-Editor, IntradayTrader.com Risk Management in a declining Market Buzz Lynn, Contributing Editor, IndexSkybox.com Sector Trading with IShares. You may know of DIAMONDS for the Dow Jones, SPDRs for the S&P 500, and the QQQs for the NASDAQ but there is a growing list of IShares and HOLDRS that offer great trading potential. Jon Najarian, Founder, Mercury Trading, Floor-Trader CBOE Successful Option Trading. "Doctor J" is the name and options is the game. Jon has twenty years of experience as a professional option trader. His firm makes markets in over 90 high-tech and biotech stocks and trades up to 40,000 options per day. Matt Russ, Editor, OptionInvestor.com How to Profit from Option Pricing, Market Making and Volatility Rance Masheck, President, SpreadTrader.com Straddles. An excellent strategy for today's markets. Traders should be very familiar with the proper execution of a straddle to benefit from expected volatility. Jeff Wright, Preferred Trade Understanding Option Basics and the roll of an options floor trader. Buzz Lynn, Contributing Editor, IndexSkybox.com Slump Busting. Are you on a losing streak? Learn what you need to do to BUST out and break the pattern. Jim Brown, Founder, OptionInvestor.com Big Cap Strategies, Naked Puts, Zero Risk Trading, Making Dollars not Dimes. Jim Crimmins, President, TraderAccounting.com Tax Strategies for the Active Trader. It's that time of year again and Uncle Sam wants a cut of your trading profits. Let Jim offer some advice on how traders should handle such taxing issues. Molly Evans, Writer/Trader, IndexSkybox & OptionInvestor.com The Organized Trader. Rance Masheck, President, SpreadTrader.com Five Point Star Trader System. Learn what you need to know about a stock before making a decision to trade. Austin Passamonte, Editor, IndexSkybox.com Swing Trading & Day Trading Index Options. Many consider Index option trading to be the pinnacle of equity options. Learn more about the do's and don'ts for Index Option trading. Eric Utley, OptionInvestor.com & IntradayTrader.com Psychology of trading and the Importance of the top down approach to trading. Buzz Lynn, Contributing Editor, IndexSkybox.com Trading with Qcharts. Learn how to properly set up, use, and deploy the best features and techniques. Derek Baltimore, Co-Editor, IntradayTrader.com Exit Strategies, knowing when to quit Tim Taylor - Preferred Trade Using Direct Access Trading Platforms 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. 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 ************* NEW CALL PLAY ************* FDC - First Data Corporation $60.53 +0.83 (+1.93 this week) Atlanta-based First Data Corp. helps move the world's money. As the leader in electronic commerce and payment services, First Data serves more than two million merchant locations, 1400 card issuers, and millions of customers, making it easier, faster, and more secure for people and businesses to buy goods and services using virtually any form of payment. Its money agent transfer network includes approximately 101,000 locations in more than 185 countries and territories. After making an almost uninterrupted move from $19 to $50 during 1998 to 1999, FDC has been trading in a range from $36.94 last September to resistance at the $57 level which was penetrated once on February 16th. This week's trading pattern indicates that FDC may have broken out of its 18-month trading range after clearing resistance at the 50-dma of $59.19. While FDC is considered a defensive stock with steady, consistent earnings, it has not lost strength during previous technology sector rallies, which often occurs with other defensive sectors, like health care. Over the last few weeks, several excellent news items have been released confirming the solid growth in demand for FDC's services. For example, on March 19th, Western Union (a subsidiary of FDC) signed an agreement with China's national postal service, dramatically expanding the company's presence in Asia, with 1000 locations expected to be added the first year. JP Morgan upgraded FDC last week, stating that their new deal with China Post should continue to expand their money transfer system, which constitutes 50% of FDC's growth. UBS Paine Webber and US Bancorp Piper Jaffray also upgraded FDC, and US Bancorp Piper Jaffray gave the company a year end price target of $72. During last week's severe sell off in the Dow, FDC found strong support at $55, and has since rebounded to higher support at $58.36. On Monday and Tuesday, FDC had difficulty clearing strong resistance at $60, but on Wednesday the stock powered through $60, and closed with a surge of buying on strong volume. Traders could consider taking positions on another pullback to $60. The next light resistance level is $62, and a break above this level could be an entry point for conservative traders. Watch others in the sector like ADP and PAYX. We are setting stops at $58.50, so close positions if FDC closes below this level. BUY CALL APR-55 FDC-DK OI= 10 at $6.40 SL=4.50 BUY CALL APR-60*FDC-DL OI= 473 at $2.80 SL=1.50 BUY CALL MAY-55 FDC-EK OI=2385 at $7.40 SL=5.25 BUY CALL MAY-60 FDC-EL OI=2890 at $4.20 SL=2.50 http://www.premierinvestor.com/oi/profile.asp?ticker=FDC ************* NEW PUT PLAYS ************* ADBE - Adobe Systems $33.97 -2.63 (-1.72 this week) A long-time leader in desktop publishing software, ADBE provides graphic design, publishing, and imaging software for Web and print production. Offering a line of application software products for creating, distributing, and managing information of all types, the company generates nearly 75% of sales through publishing software products such as Photoshop, Illustrator, and PageMaker. In addition, ADBE licenses its Industry standard technologies to major hardware manufacturers, software developers, and service providers, as well as offering integrated software solutions to businesses of all sizes. Those of you that joined us earlier in the month as we rode ADBE down to its recent lows near $25, are likely licking their chops in anticipation of a repeat performance. Moving up ahead of the recent bounce in the broader Technology market, the software company ran out of gas late last week near the $36-37 resistance level. Pulling back from the upper Bollinger band (currently at $37.44) the stock is showing definite signs of weakness. The descending trendline (now at $37) turned the bulls back with barely a whimper of protest, and if the $33.50 level fails to provide support, we could see the bears drive the stock back down for a retest of its lows. Adding to the bearish picture is the daily Stochastics oscillator, rolling down out of the overbought zone, and completing a solid pattern of bearish divergence with respect to the price action between the mid-January highs and the highs last week. Earnings warning season is upon us, and we saw the first installment last night from the likes of NT, PALM and BGEN. The result was a hobbling of the Biotechs, and absolute carnage in the Semiconductor and Networking sectors today, leading the NASDAQ back to test its lows from last week. Imagine what will happen if we get a warning from a company in the Software sector. It would likely wreak havoc on the Computer Software index (GSO.X), which gave up almost 10% today anyways. Conservative entries will materialize as selling volume pushes our play below the $33 level, while more aggressive traders may want to target a rollover following an oversold bounce to the $36-37 resistance area. Monitor the GSO.X to confirm continued bearish sentiment in the sector before playing and place stops at $37, just in case the bulls decide to attempt another rally. BUY PUT APR-40 AEQ-PH OI=3317 at $7.10 SL=5.00 BUY PUT APR-35*AEQ-PG OI=1767 at $3.60 SL=1.75 BUY PUT APR-30 AEQ-PF OI=1509 at $1.50 SL=0.75 BUY PUT APR-25 AEQ-PE OI=3749 at $0.65 SL=0.00 http://www.premierinvestor.com/oi/profile.asp?ticker=ADBE NSM - National Semiconductor $26.00 -2.90 (-3.65 this week) National Semiconductor is a leading technology provider of analog solutions and related semiconductor products. The company promotes its system-on-a-chip (SOC) components, which combine microprocessors with logic, memory, and other functions on a single chip. Its Geode SOC products serve a variety of markets; particularly wireless communications and power management. Customers include Compaq, Nortel Networks and Samsung. Ironically enough, chip stocks were strong in the down markets of late. Some investors felt the sector, which has been in a perpetual downtrend for some time now, was the best candidate to yield positive results. But it now looks like they could fall back to the wayside; especially given the tough business market ahead. The downturn in tech spending, which translates to high inventories and low demand, is a critical issue that isn't going to disappear any time soon, despite the oversold conditions. The influential brokerage firm, Lehman Brothers, recently started coverage on NSM and rivals Analog Devices (ADI), Linear Technology (LLTC), Maxim Integrated Products (MXIM) with a measly Market Perform due to the heavy downside risk. Today Goldman Sachs and Banc of America came forward with similar Market Perform ratings on NSM. This coverage combined with the major sell-off across the broad markets brought NSM down a notch, to say the least. On the day, NSM was cut down $2.90, or 10% on 2.4 times the ADV. That's some serious selling! Currently, NSM is perched just a smidgen below the 10-dma ($26.49). More downside action from this level or a distinct rollover off the 5-dma ($28.35) offer traders a variety of entry points in a declining environment. Better confirmation of a true breakdown would be for NSM to slide under the immediate support at the converged 30 & 50 DMAs, tracing $24 and $25, on heavy volume. If there's a major slide, expect buyers to start nibbling as NSM approaches the $20 level. Lock in gains early! If our expectations don't come to fruition, we'll exit the play on a close above the $29 mark. BUY PUT APR-35 NSM-PG OI= 34 at $9.20 SL=6.25 BUY PUT APR-30*NSM-PF OI=596 at $4.70 SL=2.75 BUY PUT APR-25 NSM-PE OI=699 at $1.50 SL=0.75 http://www.premierinvestor.com/oi/profile.asp?ticker=NSM ***************** STOP-LOSS UPDATES ***************** ERTS - call play Adjust from $51 up to $52 OPWV - put play Adjust from $25 down to $22 AETH - put play Adjust from $17 down to $15 VRTS - put play Adjust from $55 down to $53 ENE - put play Adjust from $62 down to $60 DPMI - put play Adjust from $51 down to $48 ************* DROPPED CALLS ************* ELNT $26.94 -3.00 (-4.75) There was no doubt that traders were taking profits today. The sell-off was hard and fast across the broad markets. After a failed attempt to break $32 during amateur hour, ELNT went into sell mode. The $29 support managed to keep the share price afloat during the doldrums of lunch, but the bears returned in force. Our $29 closing stop and notably, the 10-dma ($27.65) were violated; hence, we're exiting the play this evening. QCOM $54.81 -5.06 (-4.06) QCOM had built a very nice ascending wedge into the $60 level and was poised to make a move. Unfortunately, PALM and NT played the spoilers with warnings in after hours. Right out of the gates, QCOM slipped below our closing stop level of $57 and began settling along the $56 line. With the NASDAQ accelerating to the downside throughout the session, entry into this call play should have been avoided entirely. As went the brief relief rally of last week goes our QCOM play after it closed under our stop level. VRSN $33.06 -4.56 (-0.31) VRSN had been hammering out a support level at $32 throughout last week. Monday's move from that consolidation level and through $35 caught our eye. The action on Tuesday was picture perfect as VRSN opened slightly lower, then exploded toward $39. It appeared that VRSN, along with the NASDAQ, was making a short-term rally attempt. But, PALM and NT's warnings were all it took to crush this fragile market's uncertain hope. This is a good example of how sentiment can change on a dime and the importance of stops. VRSN closed below our stop of $34 and we are disappointed to drop it this evening. *********** DROPPED PUT *********** MDT $46.55 +1.11 (+1.55) While the market initially gave MDT a lukewarm response to the company's reiteration of their earnings expectations, the trend was defined today. On Tuesday, First Union Securities, US Bancorp Piper Jaffray, and Prudential Securities all upgraded MDT, which helped to give the stock a temporary lift in the morning. However, the news released by Nortel and Palm last night devastated the tech sector today, which helped the defensive sectors like health care attract money. MDT closed above our stop level with a bullish candlestick pattern, and as such, we are dropping it this evening. ************** TRADERS CORNER ************** Broad Market Indicators To Watch By Mary Redmond No one knows if last week marked the beginning of the end of the downfall in the indexes, although many analysts have been trying to pinpoint a particular level which is "the bottom." Instead of trying to decide which analyst is right, traders might want to watch for several key indicators which contributed to the decline, and are starting to turn around. In addition, it is a very good idea to take fast profits and use as many technical indicators in tandem as possible. One of the most important indicators of future market action is the action of bond yields. We want to see money coming out of bonds and into the stock market. Since last fall, the ten year bond yield(TNX.X) has been on a strong downward trend. The TNX.X made a big move up on Tuesday of this week, and has so far held on to most of its gains. If the TNX.X drops precipitously again, this could indicate additional downward momentum for the major indexes. In addition to simply watching bond yields, the spread between high grade corporate bonds and medium grade corporate bonds is key to recovery. We have not yet seen enough of a tightening in credit spreads to stimulate the corporate debt market. Bank lending is still very tight, in fact, worse than it was during the 1990 recession. One way to monitor the spread between AAA and medium grade corporates is through the Barron's confidence index. This measures the high grade corporate yield divided by the intermediate grade corporate yield. A rise in the confidence index can imply that the financing window may be opening again for corporations. The confidence index is currently 88.2 compared to the year ago level of 93.2. This comes from a best grade yield of 6.8% divided by an intermediate yield of 7.4%. In comparison, last year's yields were 7.71% vs. 7.94%. Another important factor is liquidity entering the market. It took a long time for the massive flood of cash which entered the market last year to dwindle to a trickle, and it may take even longer for this trickle to become a tidal wave again. While money market funds have already taken in over $200 billion this year, the weekly moving average of cash to equity funds has been varying between negative levels and $1 or $2 billion per week. It is also important that companies start giving optimistic projections for the second half of 2001. Some companies may be reluctant to state overly optimistic projections for a number of reasons. In addition to Reg FD, many companies have been bombarded with class action law suits over the last few months. It has been a field day for lawyers. If you look at the news released by companies which gave optimistic guidance for the coming quarters and then warned, you will often see five or six law firms lined up waiting to suck the blood out of the wounded beast. Most shareholder class action suits amount to a settlement in which the lawyers benefit and the shareholders get zero, nonetheless, it is an added expense companies don't want. So, at this point, many companies feel it is safer to give no guidance going forward than to face additional lawsuits. While we are waiting for a strong upward trend, there have been a few profitable trades for traders who are able to pinpoint key entry and exit points, as well as those who have a solid reading of the technical indicators. One of the best ways to trade is to look at the market first, then the sector, then the stock's pattern, then the TNX, TYX, VIX, QQV and VXN, as well as the stochastics and other indicators. As an example, take a look at one of the one of our successful call plays from this week. PMI is a mortgage insurance company which was bucking the downward trend by trading in a range from approximately $55 to $59 since the end of January. The stock fell sharply after the initial Fed rate cut, and pivoted at the $48 level. Since that point, it traded in a strong upward channel. You can see the upward channel which started around March 13th, at which point the Dow was over 10,400. While the Dow proceeded to tumble, PMI demonstrated excellent technical strength, especially considering the fact that the IUX.X was performing poorly. This can be partly attributed to the fact that the stock is a small cap($2.6 billion) value stock with a low beta of .69, which indicates that it has a low sensitivity of response to overall market moves. When viewed on a 30 minute chart, you can see how the stochastics are indicating a very strong upward move. In addition, look at the series of higher lows the stock formed over the last week. An article which appeared in the Wall Street Journal last week discussed how PMI and other mortgage insurers might likely benefit from reductions in interest rates, as the increase in mortgage applications would over shadow the decrease in mortgage insurance. You see how there is heavy resistance at $60? The longer the stock has been trying to penetrate resistance without success, the stronger the resistance is. If there is very strong resistance, then a breakout above this level is likely to have real momentum. So, we are going to consider where our entry points would be. There are different ways to play it. For example, last week was a tumultuous week with a very dramatic turnaround in the Dow. On the 22nd, the VIX reached a very high level of over 40. There have only been four times in the last several years when the VIX reached this level, and each was a turning point. At this point PMI was at support at $58. When the Dow started to turn around, traders could have taken positions in PMI, which would have been an aggressive entry point. At this point, the IUX also started to turn around. Traders could also have waited for the 23rd, and a confirmation of the rally. At this point, the 10 year treasury bond yield(TNX.X) had made a significant move upward of 10 basis points. Alternatively, take a look at what happened on Monday. The stock broke above $61 with strong volume and a very bullish candlestick pattern. A trader who bought at $62 could have sold at $64 for a quick profit. In conclusion, this is probably one of the most difficult trading environments in many years. Traders who can hone their skills at this point might find themselves more able to prosper in easier times. ********************* PLAY OF THE DAY - PUT ********************* OPWV - Openwave Systems Inc. $18.71 -4.30 (-4.84 this week) Openwave Systems Inc., the combination of Phone.com and Software.com, is the worldwide leader of open Internet-based communication infrastructure software and applications. Openwave's customers are communication service providers worldwide, including wireless network operators, wireline carriers, internet service providers, portals, and broadband network providers. Openwave was formed in November of 2000 following the merger of Phone.com Inc. and Software.com Inc. Most Recent Write-Up OPWV bucked the trend on one of the strongest market rallies we have had in weeks. While OPWV moved in a vary narrow range between $24.56 and $25.49 on Monday, OPWV experienced a sharp drop to $21.15 on Tuesday morning, and a subsequent rally to a lower high consistent with the two week pattern. Tuesday's selling occurred on heavy volume of over 7 million shares, nearly 15% higher than the average daily volume, which sets OPWV in a precarious position going forward. If the markets experience a pullback or any profit taking in the next couple of days, OPWV is likely to roll over from the $23 level to the next support level at $21. The near term outlook for OPWV seems particularly bleak, considering the fact that Robertson Stephens downgraded the stock from a strong buy to a buy on Monday. While analyst Marianne Wolk states that OPWV has a $300 mln backlog of business, the company is experiencing some near term weakness in messaging due to the difficult macro environment. Aggressive traders could take positions at current levels, particularly if others in the sector such as CMVT are weak. Conservative traders could wait for a break below $22.62 on strong volume, particularly if accompanied by weakness in the broad indexes. We are keeping stops at $26, so close the position if OPWV closes below this level. Comments Massive volume poured into OPWV, taking the stock firmly below the $20 level. There's blood and the shorts are circling! This type of violation of $20 has been providing large profits to the shorts, AETH being one of them on our put list. To play OPWV puts, look for a rollover from overhead resistance at $20 or on a high volume breakdown below $18, the low today. Use the NASDAQ direction to aid in entering this position. If it's weak, these types of tech stocks will fall prey to the shorts. BUY PUT APR-25 UGE-PE OI=998 at $7.30 SL=5.75 BUY PUT APR-20*UGE-PD OI=834 at $3.50 SL=1.75 http://www.premierinvestor.com/oi/profile.asp?ticker=OPWV ***************************************** BIG CAP COVERED CALLS & NAKED PUT SECTION ***************************************** They're Back! Tech Warnings Draw out the Bears... The Markets fell today, sending technology and blue chip stocks down sharply in reaction to another round of earnings warnings and job cuts. Nortel (NYSE:NT) warned after the close Tuesday, saying that revenue would miss previously lowered estimates in the first quarter. The company now anticipates a first-quarter loss of 10 to 12 cents a share vs. previous estimates of a loss of 4 cents. Nortel also said it would cut another 5,000 jobs in 2001 on top of the 10,000 job cuts previously announced. Nortel fell $2.76 to $14.00 and pulled down all of the fiber-optic and networking stocks. Cisco Systems (NASDAQ:CSCO) fell to a new 52-week low of $15.75 and Corning (NYSE:GLW) lost $3.52, finally stopping at $21.47. Palm (NASDAQ: PALM) warned after the close Tuesday of a shortfall in its fourth quarter and announced that it would cut 250 jobs. The DOW wasn't exempt, as Walt Disney (NYSE:DIS) announced that it's slashing 4,000 jobs worldwide, or 3.7% of its work force, due to the softening economic environment. Profit taking was in vogue as investors worried on the potential for further Tech warnings and the lack of forward visibility. The Drug sector was one of the few areas of safety as Merck (NYSE:MRK), Johnson & Johnson (NYSE:JNJ), and Eli Lilly & Co. (NYSE:LLY) all advanced. Summary of Previous Candidates: Covered Calls: (Margin not used in calculations) Stock Strike Strike Cost Current Gain Potential Symbol Month Price Basis Price (Loss) Mon. Yield NVLS APR 40 37.56 44.38 $2.44 5.3% NVDA APR 45 42.81 68.11 $2.19 4.2% ERTS APR 45 43.00 55.88 $2.00 3.2% Positions closed: SNPS Naked Puts: Stock Strike Strike Cost Current Gain Potential Symbol Month Price Basis Price (Loss) Mon. Yield ERTS APR 45 42.81 55.88 $2.19 10.5% NVLS APR 35 33.81 44.38 $1.19 9.3% NVDA APR 40 38.75 68.11 $1.25 8.1% NVDA APR 40 38.94 68.11 $1.06 8.1% MU APR 30 29.38 44.25 $0.62 5.5% Positions closed: SNPS Sell Strangles: Stock Strike Strike Cost Current Gain Potential Symbol Month Price Basis Price (Loss) Mon. Yield GMST APR 30 29.19 29.69 $0.50 4.4% Close or Cover? GMST APR 60 60.69 29.69 $0.69 6.2% JNPR APR 30 29.06 43.89 $0.94 8.3% JNPR APR 80 80.88 43.89 $0.88 7.8% VECO APR 30 28.75 43.75 $1.25 13.3% VECO APR 55 56.00 43.75 $1.00 11.0% Naked Calls: Stock Strike Strike Cost Current Gain Potential Symbol Month Price Basis Price (Loss) Mon. Yield WWCA APR 50 50.62 42.13 $0.62 6.0% GENZ APR 95 95.94 89.79 $0.94 5.9% At Resistance CHKP APR 110 111.25 50.50 $1.25 5.7% PDII APR 85 85.62 60.88 $0.62 5.6% Credit Spreads: Stock Pick Last Position Credit C/B G/L Status EMR $66.31 $61.06 APR80c/75c $0.75 $80.75 $0.75 Open SII $74.80 $71.29 APR90c/85c $0.80 $90.80 $0.80 Open LEN $39.04 $43.30 APR30p/35p $0.80 $34.20 $0.80 Open MMM $103.63 $104.83 APR120c/115c $0.80 $115.80 $0.80 Open Positions closed: HAL, NBL New Candidates: There will be no new candidates this week as Ray is travelling abroad on a visit to one of the most popular European trading venues; The London International Financial Futures and Options Exchange (LIFFE). In the interim, readers who participate in writing covered calls may benefit from a review of this common option-trading strategy. *************************************************************** Selling Covered-Calls: A Conservative Approach With the recent indications of a potential market bottom in the technology group, it's a great time to review the fundamentals of one of the most common stock-option strategies. Investors usually write covered-calls to generate monthly income, collecting the premium for the sale of an option against a stock position in his or her portfolio. This conservative strategy can be used effectively on all type of stocks as long as the outlook (fundamental or technical) for the issue is favorable. One of the advantages to this approach is that it allows new investors to learn successful trend-trading techniques with a small margin of safety while managing the combined position for upside profit and downside risk. The underlying basis for this strategy is a high probability of limited profit. The primary advantage to a novice trader is the technique is easy to use and the resultant position is more conservative than outright stock ownership. In writing an option on the stock, the investor has insured the issue against a future drop in value. Of course, the downside risk in ownership is not eliminated, only reduced. In addition, the actual cost of opportunity loss or potential upside movement can be substantial. There are other, more subtle benefits and disadvantages but these are the most common reasons that investors choose (or avoid) this strategy. Each week we receive a number of questions regarding the various approaches to the investment strategy of selling covered-calls. In our personal portfolios, we utilize the "in-the-money" covered write as a primary technique for consistent profits. This method is easy to master and works in harmony with a low maintenance, low risk investing style. The theory behind this approach is to be "aggressively conservative." This tactic is in contrast to the a popular "conservatively aggressive" outlook used by many traders, where the underlying position is bullish, (based on OTM calls) and requires an upward movement from the stock for profit. In general we are traditional, long-term investors with contempt for excessive risk and the potential for large losses. Studies suggest (and our results confirm) that the average investor will make substantially greater returns through the consistent profits from "in-the-money" covered writing than he/she would using the high risk, high reward approach of more aggressive positions. You may think that this technique is far too conservative to yield favorable returns however, the "magic" ingredient of the strategy is the power of compound interest. Covered call writing allows investors to potentially compound their returns on stock ownership each month of the year. Unfortunately, while most investors begin writing covered calls with the goal of compounding their money on a monthly basis, many lose focus of the fundamental outlook of the technique (consistent, low risk profits) and begin to concentrate on higher, single transaction returns. This is a common mistake and it can substantially increase risk and the probability of loss. The market historically offers a 2-4% monthly (annualized) return for this strategy but with diligent research and analysis, and proper money management, the margin of profit can be increased. In our personal portfolios, we attempt to establish positions that offer on average, a 4-6% (8-12% on margin) monthly return on investment. Even with this meager profit, the long-term portfolio growth is excellent, due to the unique mathematics of compounding. Earning 3% per month in a personal portfolio, without compounding or margin trading, equates to a 36% yearly return. We have yet to find a bank or CD that matches that rate. Obviously, most retail option traders regard a 3% monthly return as far too low. In fact, why would anyone want such a paltry reward when the market offers such great potential for wealth. There is answer is quite simple: RISK. Any strategy that yields 10% will be riskier (on a purely theoretical basis) than one offering a 3% return. The old adage, "The greater the risk, the greater the reward" is quite accurate. Regardless, some of you will learn the hard way, just as we did. After getting hammered on the majority of aggressive positions, we made the transition to ITM covered-writes with lower yields. Now our portfolio value grows (most of the time) on a consistent basis. The goal of the covered-call writer is to have a good selection of favorable positions with adequate downside protection. With this approach, an investor reduces risk by entering several stock and option plays with a predetermined conservative profit target for each one. We strive for a 5-8% monthly yield in the newsletter but again with a lower profit target, the higher the probability of a favorable outcome and the lower the risk. To further reduce the potential for catastrophic loss, a trader should diversify his market exposure through a wide variety of covered-call positions. The stocks you purchase should generally represent companies of different types in a variety of favorable industries. Most novice investors ignore this principle and consequently, their portfolio losses are substantial when a heavily weighted sector falls "out of favor." Many experts suggest you should limit each investment to no more than 10% of your overall portfolio value. This is very important to the success of the covered call strategy as you don't want one issue to have a significant impact on your overall gains or losses. The fact is, no one really knows what a specific stock is going to do in the future. History suggests that even the most prolific traders are correct in only slightly more than one-half of their directional forecasts and that statistic reinforces our basis for choosing to hedge poor selections with "in-the-money" covered writes. Before you open any position, it is important to understand the strategy that you are using and identify the specific goals for that particular trade. You can't make good decisions without knowing the mechanics of a specific technique. In addition, don't use complex or advanced methods simply because they are intriguing. The best strategy is usually the simplest one that accomplishes your goals. Prior to executing a transaction, you should know exactly what the break-even (cost basis) point is, and be prepared to take action if the underlying issue reaches that price range. Once you have a candidate in mind, do your homework! Study the company and the calendar; upcoming events, earnings dates and any other scheduled reports. When you have a superior knowledge of a stock and its industry, you are way ahead of the investor that trades simply on intuition or outside advice. Portfolio management is critical to the success of any portfolio. After you take a position in a particular issue, stay informed by monitoring all the news and announcements affecting that issue. Observe the daily progress of the your stocks and realize that you have the ability and control to adjust or close the position at any time. Obviously you do not need to check the prices on an hourly basis, but we do recommend that you review each session's closing quotes. News and public opinion can have a significant impact on a stock's price and unfortunately, it is impossible to research "future" events before you buy an issue. The key is to be fully prepared for any outcome because the most difficult lesson comes when you close a losing trade. Indeed, it is very hard to learn to exit unsuccessful plays in a timely manner but the simple fact is, there is no reason to hang on to a losing position when there are so many other profitable plays that deserve your time and money. Accept your losses, learn from your mistakes (evaluate each one critically) and move on! With any strategy losses are inevitable and instead of being surprised, you must anticipate them. History has proven that a percentage of the covered write positions selected will be unprofitable thus, when the situation arises, it is not regarded as a failure but rather an integral part of the trading system. Your personal portfolio should be evaluated based on the sum of its positions, rather than each transaction. In this manner, success is gauged by growth in portfolio value and the losses become less significant. That is one of the principal reasons for entering several positions; it becomes much easier to identify and act on a potentially negative play when it doesn't have a substantial effect on your overall success. The concepts of most exit and adjustment strategies are relatively simple but there is no way to develop a specific guide for proper position management. With stock and option combinations, the key is to evaluate the risk-reward outlook of each possible scenario and construct a position that fits your trading plan and technical outlook for the underlying issue. Success with this strategy lies in one objective; a consistent flow of monthly income with limited portfolio risk. The focus of play selection and management should be to continually generate an acceptable level of option premium while protecting against the potential for downside losses. Any positions that become unfavorable due to changes in the fundamental or technical characteristics of the underlying issue should be removed from the portfolio before they can generate significant deficits. Catastrophic failures are not unavoidable but they can be sufficiently managed to reduce the effects of the shortfall. Obviously, each situation will require a different solution but in general, a trader should try to limit individual position losses to 20%. Unfortunately, there are some occasions when issues fail without warning, leaving no opportunity for exit or adjustment. Unexpected events simply occur; earnings warnings, shareholder lawsuits, negative news in the industry or sector and changes in public sentiment. All of these activities can affect the success of an individual position but with a diversified portfolio, the long-term effects are minimal. Our approach to "in-the-money" covered calls is designed to lock in profits whenever possible and reduce the inevitable losses to a minimum. A rise in share value is the ultimate goal of stock ownership and with this strategy, a significant short-term move can provide additional opportunities for profit. When the share value rises substantially after the initial position has been established, you have several choices. You can do nothing, get "called-out" and accept the original return that was established when the play was opened. If the option is priced near parity, you can close the play early or, you may also choose to adjust the position to match the new outlook for the underlying issue, "rolling" the call up and forward to a higher strike price. When you roll up (repurchase the current sold call and sell a higher strike call), the profit potential of the position is increased. Unfortunately, the downside break-even point is also increased by the amount of debit required to complete the transaction. That is the main reason most traders transition to a future expiration date; it reduces the debit required for the new position. While it is not always compatible with our weekly candidates, there are a number of benefits and advantages to long-term stock ownership. If that is your intention, additional measures are necessary when utilizing "in the money" covered-writes. As expiration nears and the time-value premium disappears from the written option, you should consider rolling forward to reduce the likelihood of early assignment. The overall profit potential of the position will be increased and the risk versus reward outlook for the combination can be adjusted, consistent with your forecast for the movement of the underlying issue. With deep-in-the-money calls, most of the time premium vanishes long before expiration. However, as long as time value remains in the call option, there is little risk of early assignment. When the option price (bid) falls to parity or a discount, there is a considerable probability of exercise by arbitrageurs; specialists and floor traders who do not pay commissions for trading. When this situation occurs, you should endeavor to roll-forward or adjust the position in some manner that prevents a monetary loss through unexpected assignment of the short option. Good Luck! ******************* 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 ************************************************************** ADVERTISING INFORMATION For more information on advertising in OptionInvestor Newsletter, or any Premier Investor Network newsletter please contact: advertising@OptionInvestor.com
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