The Option Investor Newsletter Sunday 05-13-2001 Copyright 2001, All rights reserved. 1 of 5 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/051301_1.asp Entire newsletter best viewed in COURIER 10 font for alignment ****************************************************************** MARKET STATS FOR LAST WEEK AND PRIOR WEEKS ****************************************************************** WE 5-11 WE 5-4 WE 4-27 WE 4-20 DOW 10821.31 -129.93 10951.24 +141.19 10810.05 +230.20 +452.91 Nasdaq 2107.43 - 84.10 2191.53 +115.85 2075.68 - 87.73 +201.98 S&P-100 645.43 - 13.31 658.74 + 9.63 649.11 + 5.45 + 35.89 S&P-500 1245.67 - 20.94 1266.61 + 13.56 1253.05 - 10.07 + 60.41 W5000 11491.34 -195.93 11687.27 +178.43 11508.84 + 99.07 +557.12 RUT 487.36 - 5.53 492.89 + 8.92 483.97 + 17.26 + 11.69 TRAN 2879.56 + 10.37 2869.19 + 6.82 2862.37 + 1.07 + 94.71 VIX 27.48 - .24 27.72 - .05 27.77 - 1.24 - 1.27 Put/Call .63 .67 .48 .91 ****************************************************************** Is The Fed Still Our Friend? This week was not nearly as pleasant as the prior week with the Dow losing -129 and the Nasdaq -84. We came so close to a potential breakout but the cards were stacked against us. With each economic report our hand of stud poker just got worse. You know how that works. It is like starting out with a pair of jacks and thinking alright, full house here we come. Instead every remaining card drawn is not even remotely related. The economic cards we drew this week have left traders wondering if the Fed will even cut at all, much less by 50 basis points. With 50 points already priced into the markets there was nothing left for traders to do but take profits and hope for a wild card on Tuesday. The trio of economic reports on Friday painted a picture that was economically positive but two were Fed negative. Starting with the Retail Sales report which followed the same path as the Chain Store Sales on Thursday. Sales increased +.8% which was substantially better than the 0.1% estimates. Auto sales were up a full percent. The consumer is still buying and showing no signs of recessionary caution or worry about their jobs. The PPI was benign at 0.3% vs estimates of 0.4%. Prices rose only moderately and showed that inflationary pressures were still absent from the economy. The entire last year has had very little indication of any inflation. About the only increases were in the energy prices and in products impacted by high energy. This was good for the Fed because they do not have to worry about inflation. The preliminary reading of the Michigan consumer sentiment index for May came in at 92.6 compared to April's 88.4 level. Optimism about the economy appears to have rebounded and that is in marked conflict with expectations. With signs that maybe the economy has turned the corner and is recovering nicely the reasons for the Fed to cut rates aggressively have evaporated. The rebound in the stock market may have spurred the recovery in consumer confidence just at the wrong time. The Fed had said they were very concerned in the falling consumer confidence and it was obvious that Greenspan timed the last inter-meeting rate cut to juice the market as much as possible. Maybe his technique was too successful and now he is going to find himself back behind the curve of having cut too much too fast and he may need to take some back quickly. He just can't seem to get the right interest rate at the right time. Traders were almost in shock at the abrupt change in events in just one week. Earlier in the week Fed funds futures indicated an over 90% chance of a 50 point cut next Tuesday. Out of nowhere a combination of events evolved to show that the Fed was ahead of the recession curve and had maybe acted too aggressively. As the chances for a big cut fell with each passing tick traders who had profited from the rate cut rally headed for the exits. The saving grace was it all occurred on VERY light volume. The Nasdaq posted only 1.4 billion shares and was the lightest volume day of the year. The NYSE only managed 896 million shares and it was also the lightest day of the year. It was simply a buyers strike more than a sellers rout. This produces a serious question of what will happen when the summer doldrums actually appear. Still with no volume we can draw no real conclusions from the trading day other than everyone is holding their breath until the FOMC decision. The worst thing we could see next week would be an increase in volume with the markets still trending down. The stock news did nothing to increase the desire to buy stocks. Deutsche Banc said the Gartner Group is going to release a highly negative report on the E-procurement software industry. It was widely reported and began with questions about Oracle's pricing power. There are several rumors that ORCL is under pressure to severely discount their software or lose sales. This goes along with rumors that ORCL will release an earnings warning soon. The report said the stand alone E-procurement business in this sector will not exist in three years. The entire sector sold off with ARBA leading the list including ITWO, CMRC, EPNY, FMKT and PPRO. Ironically ORCL may benefit from the demise of the smaller companies as CEO Ellison says customers want an entire suite of software from one company instead of buying pieces from multiple providers. PSFT and SAP were cited with ORCL as the possible winners of the sector shakeup. This news caused a drop in the Internet sector in general even though the report was specific. Merger news was about the only other stock specific news of note. American International Group agreed to acquire American General for $23 billion in stock. This creates a huge company since AIG is already the largest underwriter of commercial and industrial insurance in the U.S. and one of the worlds largest. Merck said it was acquiring RSTA, a leading genomics research company for $620 million in stock. That was not the biggest news for MRK. They are also rumored to be considering another offer for Schering Plough (SGP). SGP was up almost +10% on the news but sold off later in the day as analysts talked down the deal. Canadian Imperial Bank is reported to be in talks to acquire Ameritrade for up to $10. Considering the gains in AMTD lately it appears to be true. AMTD has risen from $5.27 to $8.56 in the last three weeks in almost a vertical climb. CIBC is the third largest bank in Canada and their rival, Toronto Dominion bought TD Waterhouse. Last month AMTD chairman Joe Rickets, who with his family owns 60% of the company said he was not against selling the company, for $20 a share. Looks like CIBC was listening but somebody folded on the price. Bond yields have spiked in the last two days to levels not seen since last November. When the Fed comes to an end of a cutting cycle, yields tend to rise in advance and telegraph the event. You don't need much telegraphing after the Fed fund futures dropped to only a 42% chance of a 50 point rate cut next Tuesday. The real market illness today was simply a realization that the free rate cut ride may have drawn to a close. With analysts now predicting only a 25 point cut on Tuesday and, are you ready, possibly the next move after that a rate increase, the climate for stocks has changed completely. We all know the rules that say a rate change is not really felt in the economy until six months after it is enacted. We have several rate cuts that have not yet filtered through the economy and those cuts should help the economy over the next several months. The second guessers are saying now that Greenspan should stop now and wait for evidence of direction before changing rates again. However, not everyone has fallen off the 50 point wagon. 23 of 24 bond dealers surveyed on Friday said they still expected one more 50 point cut. Were they just uninformed of the day's events or just trying to put pressure on Greenspan to follow through on the expected cut to avoid a market massacre? Who knows but you can bet the discussions at the FOMC meeting on Tuesday will not be casual. The Fed normally telegraphs their intentions the three weeks prior to the meeting and the fedspeak over the last three weeks has been minimal at best. They have given no direction and with the market expecting 50 points they are definitely aware of how consumer confidence could be broken by a plunging market if they do not cut. But, they may be convinced that a 25 point cut will keep the major carnage from occurring and a minor dip worth the risk. Either way the markets are not going to be testing new upward resistance on Monday and Tuesday. Even if we do get another 50 point cut the market knows it is probably the last. The guidance the Fed gives with their decision will be critical to market direction over the summer. If traders feel the cuts are over and priced in then they have to depend on improved earnings to increase stock prices. That news is simply not here yet. Even the IBM pep talk on Wednesday was ignored by the markets and analysts even talked down their comments significantly causing IBM to gap down at the open. Has the ignore bad news and celebrate good sentiment from last week disappeared? If it has then next week could be rocky. The semiconductor sector will brace for another blow when AMAT announces results on Tuesday. With the dueling chip analysts split over the fate of chip stocks this release could fuel the rally or douse the fires completely. Also on Tuesday Dell, BRCD and NTAP announce results. Dell has already said it would meet the lowered target but further guidance will be critical. They announced they were cutting more jobs this week and analysts will want to see what they say about future visibility. Both the Dow and Nasdaq rallied into the close on short covering but no real buying interest. Traders enjoying the warmer weather called in "well" and took an early vacation day. The Dow fell at 10:AM when the consumer confidence was released but then traded in a very narrow 50 point range the rest of the day. 10800 was weak support but without volume you have no directional confirmation. The Nasdaq continued the slide from Thursday but the rate of descent slowed as it approached 2100. The broader markets as evidenced by the S&P stopped on support at 1240 dating back to mid-April. Again, there are no conclusions to be drawn here without volume and a Fed decision. Waiting to exhale. Traders should be wary of Monday/Tuesday. The Fed decision at 2:PM on Tuesday will be guessed and second guessed hundreds of times before and after it is announced. All this information will be sifted by traders and it will boil down to whether investors feel there is substantial risk at this level. If they decide the risk is minimal then they will continue to scale into the market and provide a base to build from. The key is the prior Fed rate cuts. As the economy improves due to those cuts, earnings will improve. The market will normally anticipate that event by about six months. Ding! That was the starting bell because we are at that point now. Don't jump in just yet however! Could there be another retest of the April lows? Sure, anything is possible but I don't think it is probable. We are more likely going to be range bound once the post Fed volatility passes. If there is going to be a dip it should be soon and I would look at it as a buying opportunity for fall. The concept of buying the dip for fall is as alien to me as ET and I think most of our readers feel the same. We want action now, not later. Our task will be to find the leaders early. Find the stocks that funds are trying to sneak into for the fall and ride their coat tails for the short term. The best possible scenario would be a significant drop immediately. We could track the stocks that drop the least and they will likely be the leaders when money starts flowing again. So if the market crumbles after the Fed announcement we should all be cheering from the sidelines. Investing in the market is still the new national pastime and unlike the XFL it will still be here next year! Technically the markets look terrible and ripe for that drop. The Nasdaq, S&P and Dow have all bounced off significant overhead resistance for two weeks with no breakthrough. The S&P-500 has clearly rolled over. The Nasdaq barely clung to weak support at 2100 at the close and should that fail, 2000 is almost a given. The Dow is now almost -200 points below its highs from early in the week and not showing any signs of life. If the markets get any bad Fed news this week it is a good possibility the shorts will come out in force again and we could easily get the retest the technicians have been missing since April 4th. Like I said earlier, I doubt we will retest the lows again but we could easily see 1800-1900 on the Nasdaq and 10300-10500 on the Dow. It all depends on the Fed and the guidance they give with their decision. The "Capturing Stock Appreciation With Leap Puts" seminar for this Sunday was rescheduled to Sunday May-20th due to the Mothers Day conflict. We had numerous complaints that we would schedule this without thinking about the family strife it would cause. SORRY GUYS!!! We apologize! Click here for current info: http://www.premierinvestorseminars.com/ Trade smart, enter passively, exit aggressively! Jim Brown Editor ******************************************** Capturing Stock Appreciation With Leap Puts ******************************************** If you are interested in attending an online seminar on my strategy of capturing stock appreciation by selling Leap Puts it will be next Sunday, May 20th at 8:PM ET and I will repeat it at 8:PM PT as well. It will last 90 minutes and will be interactive. You will be able to ask questions and I will answer your questions in real time with charts and diagrams. You do not need any special software to view the seminar but you must have a 56K Internet connection or faster for best results. If you are interested in this seminar, please click here for more information: http://www.premierinvestorseminars.com/ ************** EDITOR'S PLAYS ************** Expiration Week Straddles/Strangles With expiration week upone us and the market confused about direction the safest plays, IF you have to play, are straddles/strangles. This time of month the time premiums are very low and many plays can be entered for just a couple bucks. Straddle = buying a put and a call for the same strike price Strangle = buying a put and a call for different strike prices. QQQ - Strangle $46 Call/$44 Put - Net Debit = $2.25 The QQQ, which represents the Nasdaq 100 has come to a dead stop at $45 and with the Fed meeting on Tuesday and several big Nasdaq companies announcing earnings, DELL, AMAT, and NTAP, it is entirely possible the QQQ could move several dollars in either or both directions. ********************** Dow - strangle $109 Call/108 Put - Net Debit $2.15 The odds of the Dow making a 300-400 point move this week are huge. Any negative Fed news could send us to 10500 or below and positive Fed news could have us retesting 11000 again. The strangle listed above only needs a small move in either direction to be profitable. ********************** GE - May $50 straddle - net debit $2.20 GE is a proxy for the Dow and has been making positive statements lately. If we get bad news we could see $45 again but any positive news could break them out over $50 and that would create a buy signal for many funds. ********************* These are just several of the many possibilities available in expiration week. Do your own research and I am sure you will find many other "safe" plays for a volatile week. Jim **************** MARKET SENTIMENT **************** Falling Down By Matt Russ Friday's light volume dragged the major indices lower. We all know what we're waiting for now. The Fed Funds Futures contract has priced in a 100% chance of a 25 bp rate cut. It would seem that the markets will be greedy and want a 50 bp cut. With the markets having reacted to bad news rather well recently, there's no telling what they could do in the face of only a 25 bp cut. But, we have a good risk-to-reward scenario this coming week with cheap May premiums and a volatility storm on the horizon. Man, I love it when major market-moving events are scheduled for Expiration Week. NASDAQ & QQQ The Nasdaq selling continued on Friday without even mustering an attempt at 2150, now overhead resistance. 2100 was briefly breached with a low of 2097 late in the session. Our critical support level at 2089 has not yet been tested, but the Nasdaq is not far off. I highlighted this level last week and today's chart below confirms support with the new retracement. In addition to the previous retracement spanning from April 4th to the recent highs, I added one from April 25th as well. This was the day that the Nasdaq tested 2000. The new retracement reveals support at 2089 as the 68.2% level. Support here is very important. A break would lead to 2050 and then, 2000. Resistance at 2117 was established on Friday afternoon, also the 50% level from the new bracket. If the Nasdaq bounces higher, watch this level for sellers as well as 2144 - 2150 further up. On the QQQs, support at $45.30 held up until late on Friday when supply broke it. Key support now is $45, $44, and 43.43. Resistance at $46.42 and $47.11. SPX & OEX We saw the first sign of a breaking down in the S&P 500 on Friday as the broad market index gave up key support at 1253 and 1247. The wedge that was coiling and narrowing near 1270 has broken down its recent trendline. Support at 1240 was the saving grace late in the session as the markets just drifted lower on light volume. A breakdown below 1240 would be bearish confirmation that the bullish wedge has failed. Now we must look for the next level of support. Using a retracement from April 25th's lows to recent resistance at 1270, we can see how retracement levels provide support, if only temporarily. 1240 is 50% and held back on May 3rd. This leads us down to 1232, established on the 4th. And we wonder if prices just stop at arbitrary levels. Institutions are watching and the more I learn about retracement levels, the more informed trader I am. It has been a tremendous trading tool. So we will likely see support at 1240 and 1232, with overhead in the 1248 - 1250 area. On the OEX, support was lost at 650, given the close at 645. Next OEX support 638 - 640, with overhead resistance at 648 - 650. DOW 30 The Cyclical Index (CYC.X) did not break out over the downtrend line on the weekly chart from Thursday. That index sold off slightly and the Dow slid even further, weakened by techs like Intel (NASDAQ:INTC), Microsoft (NASDAQ:MSFT), and IBM (NYSE:IBM). 10900 gave way early, plummeting 110 points in 20 minutes after the Michigan Sentiment-Prem. for May came in stronger-than-expected, 92.6 vs. est 88.5. After that, new resistance at 10835 provided supply into the close. During the session, the Dow spent some time below 10800. The same April 25th retracement to recent highs as in the previous indices shows the key levels for the INDU. Ahead of the Fed meeting on Tuesday, we will be watching roughly the 10780 area for support, followed by 10720. The latter support has been tested numerous times and represents strong demand. Well, we're playing the waiting game again here. 25 bp is pretty much expected. Looking at the New COT report below, positions have changed very little, indicating that most of the Fed bets have been placed. Most notable is Small Specs increasing their Net-Long position by 6.19% in the S&P 500 Futures. They also decreased their Net-Long positions on the Nasdaq by 8.47%. Commercials remained relatively unchanged. It certainly will be an interesting week with Tuesday's reaction and Expiration on Friday. Keep an eye on the VIX.X, which spiked toward 29 on Friday, but settled back down at 27.48. Trade Smart, Matt Russ ********************** CBOT Commitment Of Traders Report: Friday 05/11 Weekly COT report discloses positions held by small specs and commercial traders of index futures contracts on the Chicago Board Of Trade(CBOT). Small specs are the general trading public with commercials being financial institutions. Commercials are historically on the correct side of future trend changes while small specs are not. Extreme divergence between each signals a possible market turn in favor of the commercial trader's direction. Small Specs Commercials (Current) (Previous) (Current) (Previous) S&P 500 Open Interest Net Value +47090 +36513 -49689 -41144 Total Open Interest % (+21.09%) (+14.90%) (-7.33%) (-6.05%) net-long net-long net-short net-short DJIA Futures Open Interest Net Value -7572 -6592 +7468 +7488 Total Open Interest % (-62.11%) (-57.98%) (+21.83%) (+25.09%) net-short net-short net-long net-long NASDAQ 100 Open Interest Net Value +2657 +4288 -9986 -10972 Total Open Interest % (+13.59%) (+22.06%) (-17.20%) (-17.02%) net-long net-long net-short net-short What COT Data Tells Us ********************** Indices: Divergence increased on the S&P 500 with the Commercials adding to their net-short positions by 1.28 percent while the Small Specs enhanced their net-longs by 6.19 percent. From here were are in limbo until %values actually switch to flat or net-long sometime in the future. We could see fluctuation of positions oscillate up and down for weeks or even months to follow. A major market hurdle will be the S&P 500 commercial traders moving to net-long in accumulation stage and that is still undetermined from here. Data compiled as of Tuesday 05/08 by the CFTC. ************** MARKET POSTURE ************** Please visit this link for Market Posture: http://www.OptionInvestor.com/marketposture/051301_1.asp *************** ASK THE ANALYST *************** Mother Should I Trust Greenspan? By Eric Utley After a couple of weeks of painfully slow trading, I welcome the return of volatility next week with three key events. Of course, the big one we'll be watching is the FOMC's official announcement on interest rates Tuesday. I'm in the camp that the Fed cuts by another 50 basis points. If they don't, I'll be looking to short tech stocks with weak fundamentals (Read: PMC-Sierra). Following the Fed announcement Tuesday, capital equipment giant Applied Materials (NASDAQ:AMAT) will announce its quarterly number. I think the AMAT release this time around will be interesting in the wake of the Morgan Stanley upgrade last week. Did they know something that we don't? AMAT is expected to earn 33 cents. A favorite of this column, CIENA (NASDAQ:CIEN), will report Thursday. Here again, I think the CIENA number will be very interesting because the company raised guidance the last time it reported, but had its estimates reduced recently. The company is expected to earn 16 cents per share, and I'll be listening for guidance on capital spending by the telecom carriers and will elaborate upon that very topic below. Finally, I'd like to wish all of those great people who make this world a wonderful place a very, very Happy Mothers Day. Love ya' mom! Send your stock requests to Contact Support. Please put the symbol of your requests in the subject line of the e-mail. ---------------------------- JDS Uniphase - JDSU As many others can attest this past 12 mo's have been painful for holders of [JDSU]. Although I have trimmed my losses with written calls and averaging down with incremental purchases I remain 30% from even. Can you give me your opinion for the Fiber sector and JDSU specifically? Thank you and keep up the good work. - Bill Thanks for the question and compliment, Bill. To be succinct, I think it's too late to sell shares of JDS Uniphase (NASDAQ:JDSU), but too early to buy. To review quickly, JDS Uniphase is a supplier of fiber optic components to original equipment manufacturers of telecom systems and subsystems. These manufacturers, in turn, sell their subsystems to telecommunications carriers, such as WorldCom (NASDAQ:WCOM), Verizon (NYSE:VZ), Qwest (NYSE:Q), AT&T (NYSE:T), SBC Communications (NYSE:SBC), XO Communications (NASDAQ:XOXO), Bellsouth (NYSE:SBC), Sprint (NYSE:FON), Global Crossing (NYSE:GX), Level 3 (NASDAQ:LVLT) and Nextel (NASDAQ:NXTL), among others. The reason I gave such a lengthy list of carriers is to reinforce the fact that the JDS Uniphases of the world are totally dependent upon the spending of the aforementioned companies. Also known as capital expenditures, or Cap-ex, these telecom companies have cut back on the build out of their networks due to an initial over expansion, decrease in revenues from long-distance service, the economic slowdown, tight capital markets and competition from emerging service providers, among other reasons. But, to make it perfectly clear, JDS Uniphase is levered to the spending habits of the above list of carriers. There's a fairly intense debate concerning cap-ex going forward. As we heard on the Cisco Systems (NASDAQ:CSCO) conference call last week, Chambers & Co. have yet to see an improvement in spending from the telecom carriers. Those remarks fueled the bears' argument that spending will continue to decline in 2002, amid continued defaults among the emerging carriers. However, the telecom bulls might argue that the big carriers, such as WorldCom and Sprint will soon ramp spending as capital markets ease up (Read: WorldCom's HUGE debt offering) and the emerging carriers, while they may continue to experience defaults, are a much smaller segment of the bigger telecom picture now. Getting back to JDS Uniphase, I think it would be worth while to monitor the news and guidance coming from the big carriers such as WorldCom, Spring, AT&T, Qwest and SBC. Look for signs that these companies are increasing their spending. When that begins, I think it would be time to buy. In the meantime, I think the most prudent strategy would be to continue to try to lower your cost basis, Bill. I don't know when spending will begin to significantly increase and impact JDS Uniphase's growth, and I would expect the stock to trade sideways until we see an improvement. I don't think that there's much downside left in the stock. After all, there were around 25 downward revisions in EPS estimates in the just the last month. And I would call that capitulation on the part of analysts. In terms of a trading range, maybe look for shares to trade between $18.50 to $23.50. ---------------------------- Laboratory Corp. - LH Could you please check LH. I have been watching this stock for while and it look like that this is a good short stock. I know the bear season is over but hey it is May and as the saying goes sell in May and go away. That is why I wonder should short this. - Ahmad I can feel your thinking, Ahmad. Sell in May and go away...to the river for a summer filled with fly fishing! After first glancing at the chart of Laboratory Corp. (NYSE:LH), I can understand why you might want to short the stock. However, the company is EXTREMELY strong in terms of financials and despite its triple digit share price, sells at a modest valuation relative to earnings. Having said that, I think it's most prudent to ONLY short shares of a company whose business is deteriorating. And from what I can tell, Lab's business is just fine. The only real catalyst that I can think of to back up a bearish stance on Lab is that the market will begin to rotate out of defensive issues into those companies that are more likely to benefit from lower rates. And that may be enough. As previously mentioned, the chart of Lab is conducive to gaming the stock from the short side. Shares have been rolling lower since the beginning of the year, tracing a pattern of lower highs and lower lows. At this point, I think the best way to trade the stock from the short side is to wait for a rollover from the clearly visible trend line of Lab's chart. And by "best," I'm obviously referring to the risk/reward dynamic. ---------------------------- DISCLAIMER: This column is an information service only. The information provided herein is not to be construed as an offer to buy or sell securities of any kind. The Ask the Analyst picks are not to be considered a recommendation of any stock or option but an information resource to aid the investor in making an informed decision regarding trading in options. It is possible at this or some subsequent date, the editor and staff of The Option Investor Newsletter may own, buy or sell securities presented. All investors should consult a qualified professional before trading in any security. The information provided has been obtained from sources deemed reliable, but is not guaranteed as to its accuracy. ************* COMING EVENTS ************* For the week of May 14th, 2001 Monday ====== Business Inventories Mar Forecast: -0.20% Previous: -0.20% Industrial Production Apr Forecast: -0.20% Previous: 0.40% Capacity Utilization Apr Forecast: 79.10% Previous: 79.40% Kansas City Fed Mfg. Q2 Forecast: NA Previous: -6.0 Tuesday ======= FOMC Meeting Forecast: NA Previous: NA NAHB Housing Idx May Forecast: NA Previous: 56 Wednesday ========= CPI Apr Forecast: 0.40% Previous: 0.10% Core CPI Apr Forecast: 0.20% Previous: 0.20% Housing Starts Apr Forecast: 1.605M Previous: 1.613M Building Permits Apr Forecast: NA Previous: 1.615M Internet Sales Q1 Forecast: NA Previous: $8.7B MBA Mortage App 11-May Forecast: NA Previous: 558.9 Oil and Gas inventory 11-May Forecast: NA Previous:318.8MB Thursday ======== Initial Claims 12-May Forecast: NA Previous: 384K Philadelphia Fed May Forecast: -10 Previous: -7.2 Leading Indicators Apr Forecast: 0.10% Previous: -0.30% FOMC Minutes Forecast: NA Previous: NA Friday ====== Trade Balance Mar Forecast:-$29.0B Previous:-$27.0B Treasury Budget Apr Forecast:$180.0B Previous:$159.5B ECRI Wkly Leading Idx 11-May Forecast: NA Previous: 123.2 Week of May 21st ================= May 24 Initial Claims May 24 New Home Sales May 25 Durable Orders May 25 GDP-Prel. May 25 Chain Deflator-Prel. May 25 Existing Home Sales May 25 Mich Sentiment-Rev. 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. 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The Option Investor Newsletter Sunday 05-13-2001 Sunday 2 of 5 To view this email newsletter in HTML format with embedded charts and graphs, click here: http://www.OptionInvestor.com/htmlemail/051301_2.asp ************** TRADERS CORNER ************** Post-Party Lull: A Favorite Play Strategy Returns By Renee White The overall strength in the markets is clearly different from recent months, noted by traders holding on to their profits longer. Mixed economic signs are now swinging the opposite direction from last year, when we hung onto each one waiting to hear if the booming economy was continuing or soon to stall. The mixed economic signs stopped the Fed from raising rates further back then, and soon we may find a Fed reluctant to aggressively drop rates further. This week's meeting should not be of concern. One more cut is surely warranted. Nevertheless, the June meeting should keep us alert to economic news from here forward. The more strength that starts peaking through the covers of darkness, the less likely we will see another 50-basis point cut. Personally, I would prefer to see only a 25 basis point cut this week with another down the road. But I would not be surprised to get one more 50 bp cut. After that though, our rate cutting days may soon be over for a while, with economic strength smoldering here and there. With the European Central Bank joining the fight against the bears, confidence is building, at least internally. The market told us this week it is indeed feeling better. All traders should be able to feel this change. Markets tell you the most when they are quiet, not during massive over-reactive rallies or sell-offs. Even though fundamentally the bull may be awakening, it is still weak and subject to quick reversals. Don't be lulled into thinking all is safe sailing from here. Only a fool would take their eyes off of the market in this environment. Feeling better or not, reversal can occur in the blink of an eye. The markets were clearly on hold last week, waiting on the upcoming Fed meeting. Did you notice that we returned to the "wait on the Fed" mentality? We have not seen that for some time. During the last 9 months of the last bull market, I made good money by playing that lull period. Time and time again, the markets would contract before the meeting, volume would dry up, option premiums would contract and life would be boring. Then BAM! The announcement, followed by explosive volatility. If you were on the right side of the trade, it was very rewarding. If you didn't know which side to be on, a straddle would work beautifully, allowing a quick exit of the wrong leg on the announcement. I don't know if we are creeping back into this pattern again, but I sure will be looking for it. Had I caught it early enough this week, I would have entered some bi-directional positions myself. The markets are feeling some aspects of economic recovery brewing, and the stagnation in volume is telling us that a continuation of an aggressive Fed is started to feel uncertain. I suspect we will see this reaction again in June. I'd love to see the good old' days of market uncertainty before the Fed meeting, followed by a relief rally. The play is simple. Usually a week or so before the next Fed meeting, volume will start to drop off. When countdown to the meeting begins and volume decreases, one should take any option profits off the table. The flat volume and dull market environment will hurt any profits by deflating implied volatility. Then, I found it best to wait a few days for implied volatility to shrink. Let the markets reach boredom, usually with a slight dull drift down, even a minor sell-off going into the meeting if there had been a recent rally. When the Ballinger Bands contract visibly, preferably for a few days, this became my signal to enter cheap option trades on fast moving techs. Sometimes I entered 2-3 days before the fed announcement and other times, only a few hours before. I held until the relief rally that followed showed signs of slowing and while the volatility was high, so option premiums would not deflate. Again, that may have been a few hours after the announcement, or a few days. In 1999 and early 2000, I capitalized on this strategy. I had forgotten about this pattern until this week, when flashbacks of the past surfaced. Actually, my first reaction to the flat market this week was to enter bearish trades, expecting profit taking from the recent run-up. As I mentioned last week, all signals appeared to be pointing to a correction, a natural expectation after such a great rally. But with few wanting to take their profits off the table, and few buyers wanting to jump in until after it corrects, nothing much happened until the end of the week. By Friday, I realized the return of this set-up, as markets quietly drifted down. Business meetings will keep me away from the markets on Tuesday, but my radar is officially "on" for the return of this favorite play of mine in the future. Of course, anything you love so much can always come back to hurt you. A word to the wise: My faith in this play had grown overly optimistic due to its success rate in 1999 and early 2000. Greed was lurking and I did not notice its smiling face. In March 1999, I was forced to be away from the markets for 10 days, the week before and of the Fed announcement. Because I felt like I knew this play so well, the week before the announcement I entered a huge basket of options with limit orders that were at incredibly cheap prices. In other words, I was expecting a sell-off, and I let orders sit on the books, hoping to catch some high-flying techs that sold off on the pre-announcement dip. That proved to be a VERY painful and stupid mistake of mine. Not only was I completely away from all news and my accounts, I did not know until the weekend that the first leg of the bear market had come knocking at the door. By the weekend, I saw that every single order had filled and within 2 days, they were all 60-70% underwater. The Fed announcement was the following Tuesday and again I would be out of touch. If I remember correctly, our fatal 50 basis point rate increase occurred, the markets imploded immediately and violently, for the next several weeks. I gambled on a dip and got a crash. Ashes to ashes...options to dust. My loss was large, and my greedy game plan was stupid. If you can't watch the markets, then at least hedge your positions. Remember, during times when the overall market is changing directions, the unexpected can happen. I will use the next major correction as an entry point for my long-term IRA accounts with some lazy LEAPS and possibly non-techs that happen to pullback with the correction. With buyers lurking in the background, bearish plays may become a bit more challenging after this next period of profit taking. If you continue to play the downside of the market, make sure you have a clear understanding of support levels, for those levels may find buyers ready to gobble you up. renee@OptionInvestor.com ******************** THE PLAYS OF THE DAY ******************** Call Play of the Day: ********************* GPS - The Gap, Inc. $33.20 (+5.10 last week) See details in sector list Put Play of the Day: ******************** JNPR - Juniper Networks $54.26 (-6.87 last week) See details in sector list ************************** PICKS WE DROPPED THIS WEEK ************************** Remember that historically, when we drop a pick it will go up 10 to 15% the very next week. It is part of Murphy's Law. Just because we drop a stock as a pick does not mean we are advocating a "sell" on any position you have. We are simply dropping our recommendation as a new play. Existing plays can and do continue on and are usually profitable. CALLS STOR $19.27 (+3.87) What a nice play! We caught the trend just at the right time! Following the crucial break above the $13.50 neckline, it was off to the races. The lucrative action lined many traders pockets with gains; especially if you were holding positions going into Friday's session. STOR bolted from the gate and lit the track on fire, well surpassing our $20 target. STOR peaked at $21.13 before settling in for a bullish day of trading primarily between $19.50 and $20. While it can be argued whether the upside close or the selling in late afternoon dictates next week's potential trading scenario, we're simply choosing not to be greedy - or put our handsome gains at risk! Coverage is hereby terminated. MER $64.99 (-2.56) Simply put, the play on MER just didn't pan out. We added the stock to our call list speculating its strong stance above the 200-dma coupled with its blue-chip reputation would support bullish moves as the DOW advanced. Unfortunately, the precarious financials are blowing in the wind. Not only did the sideways trading cost us time, but the divergence from the narrow trading channel signals trouble. MER's break to the downside in Friday's session violated our $65 protective stop; and therefore, we're dropping coverage immediately. LLY $83.90 (-2.14) Slowly losing steam with the rest of the market throughout the week, LLY found itself unable to break through the $87 ceiling and by mid-week was losing altitude. As it became clear that the major indices were not going to clear their formidable resistance levels, the Pharmaceutical index (DRG.X) rolled over as well. Just as it fell through it's ascending trendline on Friday, LLY fell back into its channel, and dropped solidly through our $85 stop. While the bulls may be back next week in anticipation of the Fed, we are more than happy to book our gains on LLY and go hunting for another winner. PUTS GMST $37.10 (-2.70) As always, it's a pleasure to take profits on a successful play. Despite good news this week of customer wins and upgrades from analysts, shares of the digital media provider have continued to drift lower, taking our put play deeper into profitable territory. While we would have liked to hold this play a little longer, the company is set to report on Monday after the closing bell. True to our sell rules, we are cutting this play loose. *********** DEFINITIONS *********** SL = Suggested stop loss. Sell if bid breaks this price. OI = Open Interest - the number of open contracts outstanding. ITM = In the money ATM = At the money OTM = Out of the money ADV = Average Daily Volume The options with a "*" by the strike price are our choices from the group. If the stock moves as expected we feel they have the best chance to substantially increase or double in price with the best risk/reward ratio compared to the other options for the same stock. You must determine if they fit your risk profile for time and price. Analysts ratings: 1-2-3-4-5 Analysts who follow each stock rate it and these rating are accumulated and displayed as follows; Position 1 = number of analysts recommending "strong buy" Position 2 = number of analysts recommending "moderate buy" Position 3 = number of analysts recommending "hold" or "neutral" Position 4 = number of analysts recommending "moderate sell" Position 5 = number of analysts recommending "strong sell" Example rating 5-3-1-0-0 would be 5 "strong buys", 3 "moderate buys", 1 "hold" recommendation. RISKS of SELLING PUTS: The risk of selling naked puts is always the possibility of a catastrophic event that drops the stock below the strike price and could result in the stock being PUT to you. Always protect yourself with a "buy to cover" limit order to take you out before this can happen. ************* NEW CALL PLAY ************* TGT - Target Corporation $39.93 (+1.33 last week) Target Corporation operates large-store general merchandise formats, including discount stores, moderate-priced promotional and traditional department stores, as well as a direct mail and on-line business called target.direct. At month-end, the company operated 1,321 stores in 46 states. This included 991 Target stores, 266 Mervyn's stores and 64 Marshall Field's stores. TGT has been on a strong upward trend for the last six months, and a renewed interest in the retail sector, combined with good news and an upcoming earnings run might act as catalysts to set a fire under this retail stalwart. On Friday, two economic reports were released which indicated that the American consumer has not lost interest in one of our favorite pastimes: shopping. Retail spending rose a stronger than expected 0.8 percent in April, and consumer confidence rose to 92.6, from the previous month's 88.4 reading. This follows a strong retail sales report on Thursday, which lifted the retail sector; RLX.X was up over 3.4% for the day. While the rest of the market worried about the implications of these reports on Federal Reserve policy, certain select retailers continued to ride up on the waves of strong momentum which started earlier in the month. On Thursday, TGT reported an admirable increase of 6.9% in its net retail sales from the year ago quarter, and the stock surged up past its converged 5-dma and 10-dma of $38.98 on impressive volume. On Thursday, the momentum carried TGT to a new 52-week high of $40.38, before the stock retreated to strong support at $39.50, which could be an entry point going forward. TGT is scheduled to report earnings on May 22nd before the opening, which leaves all of next week for this play. Stronger than anticipated earnings and good news from others in the retail sector like AEOS and GPS are likely to bid up shares of TGT in anticipation of its earnings report, market conditions permitting. Next week will be tricky with the Fed meeting coming up on Tuesday, and conservative traders might want to wait for the market to settle down after this meeting before taking positions. A conservative trader could wait for TGT to close above $40.40 with heavy volume before moving in. Be sure to monitor the RLX.X, as well as others like AEOS, and WMT. We are setting closing stops at $38, so end the position if TGT closes below this level. ***May contracts expire next week*** BUY CALL MAY-35 TGT-EG OI= 440 at $5.10 SL=3.00 BUY CALL MAY-40 TGT-EH OI=1919 at $1.30 SL=0.75 BUY CALL JUN-35 TGT-FG OI= 194 at $5.70 SL=3.50 BUY CALL JUN-40*TGT-FH OI= 911 at $2.25 SL=1.25 http://www.premierinvestor.net/oi/profile.asp?ticker=TGT ********** 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: Contact Support
The Option Investor Newsletter Sunday 05-13-2001 Sunday 3 of 5 To view this email newsletter in HTML format with embedded charts and graphs, click here: http://www.OptionInvestor.com/htmlemail/051301_3.asp ****************** CURRENT CALL PLAYS ****************** BA - The Boeing Company $66.01 (+1.51 last week) The Boeing Company, an aerospace company, operates, together with its subsidiaries, in three principal segments: Commercial Airlines Operations, Military Aircraft and Missiles, and Space and Communications. Commercial Airplanes Operations is involved in the development, production and marketing of commercial jet aircraft. The segment also provides related support services, principally to the commercial airline industry worldwide. The Military Aircraft and Missiles segment is involved in the research, development, production, modification and support of military aircraft, including fighter, transport and attack aircraft; helicopters; and missiles. The Space and Communications segment is involved in the research, development, production, modification and support of space systems, missile defense systems, satellites and satellite-launching vehicles, rocket engines and information and battle management systems. An entry point occurred Friday morning, as BA rebounded from a dip to its 5-dma at $65.29, probably riding on the momentum brought on by good news and reassuring guidance from the company management. On Friday morning, Virgin Atlantic announced that they are talking to Boeing regarding ordering their new Sonic Cruiser airplane, which can fly up to 20 percent faster than current passenger airplanes. In addition, BA announced that they had demonstrated their ability to meet a key demand in a project that both BA and LMT are bidding on for the U.S. military, which could be worth up to $500 million. Boeing has stated that their computer program can predict the performance of a plane, although they do not have an identical prototype. This reassurance follows an announcement by the company management that they do not foresee cancellations of aircraft orders, despite the slowing economy. With all of this good news, and a little strength in the Dow, BA might be able to rally up to its next major level of resistance at $70. Positions could be taken upon a bounce from the $65.50 level, if others in the sector are strong. Alternatively, traders could take positions at the current level, or at a break above resistance at $66.50 with strong volume. We are keeping closing stops at $64, as a drop below this level could signify an end to the current upward trend. ***May contracts expire next week*** BUY CALL MAY-65 BA-EM OI=8475 at $1.75 SL=1.00 BUY CALL JUN-60 BA-FL OI= 256 at $7.10 SL=5.50 BUY CALL JUN-65*BA-FM OI=1538 at $3.40 SL=1.75 BUY CALL JUN-70 BA-FN OI=3440 at $1.05 SL=0.25 http://www.premierinvestor.net/oi/profile.asp?ticker=BA GDW - Golden West Financial Corporation $61.25 (+2.50 last week) Headquartered in Oakland, California, Golden West Financial Corporation is a savings and loan holding company with assets of $57 billion as of March 31, 2001. Currently operating 423 savings and lending offices under the World name, the company has one of the largest thrift branch systems in the country. Golden West's stock is listed on the Pacific and New York Stock exchanges under the symbol GDW. In a continuation of the momentum GDW has demonstrated after popping up out the neutral wedge GDW had developed during April, GDW made a high of $62.96 on Friday morning before pulling back to consolidate at the first support level of $62.50. Despite the fact that GDW pulled back to $61.25 later in the day, the stock held onto most of its weekly gains in an impressive demonstration of strength, despite persistent rumors that we could see a smaller than previously anticipated rate cut next week. Upward moves have been accompanied by substantial volume, as GDW's new current level of $61.22 may turn out to be a good entry point for aggressive traders. A glut of consolidation continues in the financial service industry, and has been stimulating interest in smaller, niche financial service companies, as investors and analysts speculate on the next possible takeover targets. Next week, trading is likely to be very volatile, especially for financial stocks, as analysts continue to debate over the chances of a 25 or a 50 basis point rate cut on Tuesday. Very aggressive traders might want to take a position if GDW pulls back to its 5-dma of $60.43, if the overall indexes and banking sector are strong. Alternatively, wait for another surge up past $62.50 with heavy volume. Traders must use their own judgement and risk tolerance when deciding whether to hold over the Fed meeting, which could be highly risky. Remember to monitor other S & Ls like RSLN and WM, and set a closing stop at $60. ***May contracts expire next week*** BUY CALL MAY-60 GDW-EL OI=126 at $2.00 SL=1.00 BUY CALL JUN-60*GDW-FL OI=164 at $3.80 SL=1.75 BUY CALL JUN-65 GDW-FM OI= 15 at $1.40 SL=0.75 http://www.premierinvestor.net/oi/profile.asp?ticker=GDW YHOO - Yahoo! Inc. $17.72 (-2.30 last week) Yahoo! Inc. is a global internet Internet communications, commerce and media company that offers a comprehensive branded network of services. The company's principal offering is an online navigational guide to the web. The company also provides online business and enterprise services designed to enhance the productivity and Web presence of Yahoo!'s clients. Yahoo! has offices in Europe, Asia Pacific, Latin America, Canada, and the United States. Under the Yahoo! brand the company provides broadcast media, communications, business, enterprise and commerce services. Bold traders who took YHOO positions at $17.50 were rewarded on Friday, as the stock rallied from this strong support level to intra day resistance at $18.03. A key sign here which has been a common theme with many technology stocks is volume. Very low volume was exhibited as YHOO drifted down on Friday, as selling interest has been dwindling, and buying has had a dramatic impact on this oversold Internet bellwether. The Nasdaq rebound from 2000 which occurred during April started YHOO moving on a new upward channel to a high of $23.70 on May 1st. This pattern could possibly begin anew next week if we have some cooperation from the Internet sector (INX.X) as well as the broad indexes. While INX.X dipped below its 5-dma of 209, and its 10-dma of 205 last week, the sector remains well above its 50-dma of 170.86, so look for a possible rebound of INX.X above 210 as a potential catalyst to move YHOO over its own 5-dma of $18.90, which could be a good entry point for conservative traders. More daring types can continue to take positions from pullbacks to $17.50, if others like AOL and AMZN are strong. We are setting stops right at the 50-dma of $17.50, so close positions if YHOO closes below this critical support level. ***May contracts expire next week*** BUY CALL MAY-17.5 YHZ-EW OI= 9489 at $3.10 SL=1.50 BUY CALL MAY-20 YHZ-ED OI=11182 at $1.50 SL=0.75 BUY CALL JUN-17.5*YHZ-FW OI= 187 at $4.00 SL=2.50 BUY CALL JUN-20 YHZ-FD OI= 548 at $2.65 SL=1.25 http://www.premierinvestor.net/oi/profile.asp?ticker=YHOO MO - Philip Morris Companies Inc. $51.75 (-1.00 last week) With 2000 underlying operating revenues of $80.3 billion, ($88.3 billion assuming Philip Morris owned Nabisco for all of 2000) the Philip Morris family of companies is the world's largest producer and marketer of consumer packaged goods. Philip Morris Companies Inc. has five principal operating companies : Kraft Foods Inc., Miller Brewing Company, Philip Morris International Inc., Philip Morris Incorporated, and Philip Morris Capital Corporation. After reaching a new 52-week high of $53.88 on Monday, MO spent most of the week consolidating between the converged 5-dma and 10-dma of $51.60, and resistance at $52.50, as the markets await the Federal Reserve’s verdict next Tuesday. Considering the substantial gains MO has made in the last several weeks, consolidation can be a healthy sign, and the stock remains firmly positioned above its 50-dma of $48.28. This week, Moody’s and Standard and Poor’s reaffirmed that MO’s credit rating will not be impacted by a Florida statute which required the company to post a bond in an ongoing litigation. In addition, MO’s famous Oreo cookie (which fans claim is their most addictive product) will have a new chocolate filled variation launched in June, which is expected to be received with much fanfare. While MO consolidates, traders should be able to carefully pick entry points for the rally which is likely to occur in anticipation of the upcoming Kraft IPO. On Friday, MO announced that they had narrowed the price range of the offering to $27 to $30 per share, and that an offering at the high end of the price range could result in an $8.4 billion IPO. At this point, the offering is tentatively scheduled for mid June, depending on market conditions. A possible strategy could be to take positions at the current price, if the broad indexes exhibit a benign reaction to the Fed meeting. Conservative traders might want to wait for a break and close above $54 with heavy volume before jumping in. Continue to monitor others in the sector like LTR and RJR, and set closing stops at $50. ***May contracts expire next week*** BUY CALL MAY-50 MO-EJ OI=16528 at $2.15 SL=1.00 BUY CALL JUN-50*MO-FJ OI=26314 at $3.50 SL=1.75 BUY CALL JUN-55 MO-FK OI=16571 at $1.15 SL=0.25 http://www.premierinvestor.net/oi/profile.asp?ticker=MO CAT - Caterpillar Inc $53.20 (+2.65 last week) Caterpillar is a Fortune 50 industrial company and the world's leading manufacturer of construction and mining equipment, diesel and natural gas engines, and industrial gas turbines. Caterpillar also offers innovative financing options through its Financial Products Division. Caterpillar is dedicated to both sustaining and improving the quality of life. The company is guided by its Code of Worldwide Business Conduct in meeting or exceeding local environmental regulations, developing solutions to customers' environmental challenges, in advocating free trade and in taking the lead in the business community on important issues. This Caterpillar has acted more like a butterfly for shareholders who have been long shares of leading earth-moving equipment maker this past week, as the stock continues to fly higher on increased trading volume. In doing so, CAT continues to make new 52-week highs. All of this has happened in spite of a flat to down week for most Old Economy issues. There were two news items of note this week for the company. First of all, CAT took advantage of the recently lowered interest rates, by raising $1.1 billion in the corporate bond market. An easing Fed has traditionally worked in the favor of deep cyclicals such as CAT and so far, this appears to be the case once again. What's more, a well-received earnings report from Finning International, who is a major distributor of Caterpillar products, noted strong new equipment sales numbers, a good sign indeed for CAT. Technically, the stock has displayed remarkable relative strength. Breaking above resistance at $51 on Monday, the stock spent the next couple of days in consolidation mode before basting off again on Thursday, this time taking out the $53 level. Pullbacks to support at $53, the 5-dma at $52.39, the 10-dma at $51.38 and $51 may allow aggressive players to take a position. Just make sure that the stock continues to close above our stop price of $51.75. Continued buying pressure leading to a break above $54 with conviction may allow conservative traders to enter. In both cases, keep an eye on sector peers DE and DOV. ***May contracts expire next week*** BUY CALL MAY-50 CAT-EJ OI=4156 at $3.60 SL=1.75 BUY CALL MAY-55 CAT-EK OI= 910 at $0.45 SL=0.00 BUY CALL JUN-50*CAT-FJ OI= 586 at $4.50 SL=2.75 BUY CALL JUN-55 CAT-FK OI=2094 at $1.85 SL=1.00 BUY CALL AUG-50 CAT-HJ OI=2823 at $6.00 SL=4.00 BUY CALL AUG-55 CAT-HK OI=1884 at $3.40 SL=1.75 BUY CALL NOV-55 CAT-KK OI= 787 at $5.00 SL=3.00 http://www.premierinvestor.net/oi/profile.asp?ticker=CAT GPS - The Gap, Inc. $33.20 (+5.10 last week) Gap Inc. is a global company with three distinct brands - Gap, Banana Republic and Old Navy - and revenues topping $11.6 billion. The company has its headquarters in the San Francisco Bay area, product design offices in New York City and Distribution Centers and offices coordinating sourcing, store operations and supply activities around the world. At the heart of the company are more than 140,000 people world-wide supporting their catalog and Web site operations, in addition to more than 3,000 stores in the United States, Canada, France, Germany, Japan and the United Kingdom. The Gap has certainly lived up to its name this past week. When we initiated coverage on this call play on Wednesday, we cited a number of factors both fundamental and technical. Low interest rates, analyst upgrades, and a strong stock chart were compelling reasons for GPS to rise. The next day, the stock gapped up at the open on news of another upgrade, along with positive comments for the retail apparel industry and the company itself. Stronger than expected retail numbers for the apparel industry due to warmer than anticipated weather helped to lift the entire sector. The company also came out to say that that first quarter numbers (due this coming Thursday) would be higher than Street estimates. By the end of the session, GPS closed up over 12.5 percent on 3.7 times the average daily volume. This bullish sentiment carried over into Friday, on the heels of strong retail figures from the Commerce Department. The stock closed at the highs of the day, up 2.44 percent on 1.65 times the ADV. At this point, resistance at $34 may be formidable, but if GPS can surpass this level on volume, this may allow conservative traders to make a play. For entries on pullbacks, support may be found at $33, $32 and our closing stop price of $31.50. Correlate entries with movement in rivals AEOS and ANF. Please note that we will be dropping coverage this week ahead of earnings on May 17th. ***May contracts expire next week*** BUY CALL MAY-30 GPS-EF OI=3689 at $3.30 SL=1.75 BUY CALL JUN-30*GPS-FF OI=8749 at $4.20 SL=2.50 BUY CALL JUN-35 GPS-FG OI=2301 at $1.35 SL=0.75 BUY CALL SEP-35 GPS-IG OI= 673 at $3.20 SL=1.75 BUY CALL SEP-40 GPS-IH OI= 681 at $1.75 SL=1.00 http://www.premierinvestor.net/oi/profile.asp?ticker=GPS AOL - AOL Time Warner Inc $51.64 (-0.56 last week) AOL Time Warner is the result of a 2001 gargantuan merger that married the world's largest online company with a media giant. America Online brings its flagship online service, CompuServe, Netscape, and several interactive online services whilst Time Warner's contributions span films and TV, music, cable networks and systems, publishing, and professional sports. AOL Time Warner's brands include Time Warner Cable, Warner Brothers, Warner Music, HBO, Turner, America Online, CNN, New Line Cinema, and Time Inc. The lackluster activity of the media stocks failed to generate an action-packed week of trading. AOL's narrow channel, although at the higher levels, is also frustrating. The break through the $52 resistance on Thursday does however, offer some comfort that AOL is capable of a major run. We continue to maintain a CLOSING stop at the $51 near-term support level. OI will exit if AOL cannot hang tough above this mark. A solid bounce off the 10-dma ($51.70) followed by a clean break of $52.98, Thursday's relative high, should incite momentum traders to take notice of AOL. Be patient for a successful synergy of an advancing marketplace to ignite the technology stocks before considering additional positions in AOL. If AOL does make the big breakout, it's likely to challenge the $60 level as it did in previous months. Take a look at a six to nine-month chart for visual confirmation. ***May contracts expire next week*** BUY CALL MAY-50 AOO-EJ OI=24678 at $2.40 SL=1.25 BUY CALL JUN-45 AOE-FI OI= 766 at $7.80 SL=5.50 BUY CALL JUN-50*AOO-FJ OI= 3693 at $4.00 SL=2.50 BUY CALL JUN-55 AOO-FK OI=21826 at $1.45 SL=0.75 BUY CALL JUL-50 AOO-GJ OI=33533 at $5.20 SL=3.25 BUY CALL JUL-55 AOO-GK OI=42760 at $2.65 SL=1.25 http://www.premierinvestor.net/oi/profile.asp?ticker=AOL ********** 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: Contact Support
The Option Investor Newsletter Sunday 05-13-2001 Sunday 4 of 5 To view this email newsletter in HTML format with embedded charts and graphs, click here: http://www.OptionInvestor.com/htmlemail/051301_4.asp ************* NEW PUT PLAYS ************* RIMM - Research In Motion Ltd. $28.37 (-6.81 last week) Based in Waterloo, Ontario, Canada, Research In Motion Limited is a leading designer, manufacturer and marketer of innovative wireless solutions for the mobile communications market. Through development and integration of hardware, software and services, RIMM provides solutions for seamless access to time-sensitive information including email, messaging, Internet and intranet-based applications. RIMM technology also enables a broad array of third party developers and manufacturers in North America and around the world to enhance their products and services with wireless connectivity. Despite the strong growth prospects in the wireless computing market, the sector has not been immune to the economic woes, which have affected Tech stocks across the board. IBM came out this week and noted that they see the future trending towards wireless networking via handheld computing devices, choosing to focus heavily on that aspect of the Technology market. However, at the present, excess inventory problems are weighing heavily on RIMM. News that one of the company's major distributors, Aether Systems, has an overstock of Blackberry devices to last the next several quarters, was not looked well upon by shareholders of RIMM. This announcement struck a note of uncertainty in the tune sung by analysts. Now no longer as sure of their revenue estimates for the upcoming quarters, the market has been in the process of pricing in this news. At this point, the stock appears technically weak. The past three of trading sessions have been marked by declines on large selling volume. Friday's drop of 5.72 percent resulted in yet another close below resistance at the 50-dma (now at $31.65). Aggressive traders may look for that moving average along with the 5 and 10-dma (at $31.65 and $33.02) as potential targets for entry. As well, $29.50, $30 and our closing stop price of $32 may provide horizontal resistance. For an entry on weakness, wait for the stock to fall below $28 on volume before making a play, but only if other handheld computer makers such as HAND and PALM are also moving lower. ***May contracts expire next week*** BUY PUT MAY-30 RUL-QF OI=4559 at $2.95 SL=1.50 BUY PUT MAY-25 RUL-QE OI=2186 at $0.70 SL=0.00 BUY PUT JUN-30*RUL-RF OI=4134 at $5.00 SL=3.00 BUY PUT JUN-25 RUL-RE OI=4518 at $2.60 SL=1.25 http://www.premierinvestor.net/oi/profile.asp?ticker=RIMM EMLX - Emulex Corporation $38.80 (-4.50 last week) A leading networking company, EMLX designs, builds and distributes three types of connectivity products: network access servers, printer servers, and high-speed fibre channel products. It's fibre channel products, which are based on internally developed ASIC technology, are deployable across a variety of network configurations and operating systems to support increasing volumes of stored data. EMLX sells its products directly throughout the world to OEMs and end users, as well as through system integrators and industrial distributors. After running up more than 250% in less than a month, EMLX ran into a brick wall near $46 and over the past 2 days it is clear that the bulls are starting to lose their resolve. Following a series of economic reports that have lessened investor's conviction that the Fed would cut interest rates by the expected 50 basis points on Tuesday, all of the major indices have pulled back from testing recent resistance levels. The last 2 days have seen volume on the rise again, while price has been falling. To the tune of 15%. That was enough to get the daily Stochastics oscillator heading south out of overbought territory. Next week is going to be a busy one for EMLX executives. Starting on Tuesday, President and CEO Paul Folino will present at the CSFB Communications Technology 2001 Conference. Wednesday and Thursday will find Ron Quagliara, president of the company's IP Storage Networking Group, and VP Mike Rockenbach presenting at the Salomon Smith Barney Data Storage Infrastructure Conference. Combined with the Fed's interest rate announcement on Tuesday, there should be plenty of potential catalysts to move the stock next week. Closing out last week below the $39 support level, EMLX bears are now setting their sights on support at $35. Intraday resistance at $41 and $43 will likely provide for aggressive entry points on failed rallies. More conservative players will find entry points materializing as the bears push the price below the $37 level, preferably on solid volume and weakness in other fibre-channel stocks like BRCD and QLGC. Speaking of QLGC, the company will release its earnings report after the close on Tuesday and cautious investors may want to close any open positions in EMLX ahead of this report to avoid an adverse gap move. We are initially placing our stop at $43, and a close above this level will spell a premature end to our play. ***May contracts expire next week*** BUY PUT MAY-40 UMQ-QH OI=1367 at $3.60 SL=1.75 BUY PUT MAY-35 UMQ-QG OI=1518 at $1.40 SL=0.75 BUY PUT JUN-40*UMQ-RH OI= 363 at $6.70 SL=4.75 BUY PUT JUN-35 UMQ-RG OI= 604 at $4.10 SL=2.50 BUY PUT JUN-30 UMQ-RF OI= 378 at $2.30 SL=1.25 http://www.premierinvestor.net/oi/profile.asp?ticker=EMLX ***************** CURRENT PUT PLAYS ***************** BRCM - Broadcom Corporation $38.49 (-4.50 last week) Broadcom Inc. is the leading provider of highly integrated silicon solutions that enable broadband communication and networking of voice, video and data services. Using proprietary technologies and advanced design methodologies, Broadcom designs develops and supplies complete system on a chip solutions and related applications for digital cable set top boxes and cable modems, high speed local and metropolitan optical networks, carrier access, satellite, DSL, and network processing. Earnings from Cisco on Tuesday took center stage this past week, as the widely followed report was to serve as a barometer of health for the entire Tech sector. CSCO's numbers were especially meaningful to Broadcom, since the communications chipmaker is a major supplier to the networking giant. With that in mind, Cisco beat lowered Street estimates by a penny. But what traders were more interested in was the outlook going forward. During the conference call, CEO John Chambers stated that visibility was still uncertain. Analysts did not see this as good news, as Merrill Lynch's Michael Ching re-iterated his Neutral rating on communication chipmakers who provide components to CSCO, such as AMCC, CNXT, PMCS and VTSS. With that, BRCM has headed lower, since failing to break above psychological resistance at $50 earlier in the month. Connecting the highs and lows since that time, we can see the downtrend channel that the stock has been caught in. A break below $37 on volume may allow conservative traders to jump in, but only if the Philadelphia Semiconductor Index (SOX) confirms downward momentum. From there, BRCM will most likely test 50-dma support at $35.55. Resistance overhead is formidable, with the 5 and 10-dma at $40.78 and $42.25 respectively. Horizontal resistance may also be found at our new closing stop price of $40. ***May contracts expire next week*** BUY PUT MAY-40 RCQ-QH OI=8932 at $3.80 SL=2.50 BUY PUT MAY-35 RCQ-QG OI=6134 at $1.65 SL=0.75 BUY PUT JUN-40*RCQ-RH OI= 513 at $6.70 SL=5.00 BUY PUT JUN-35 RCQ-RG OI= 472 at $4.00 SL=2.50 http://www.premierinvesor.com/oi/profile.asp?ticker=BRCM AMAT - Applied Materials $51.71 (+0.18 last week) Applied Materials develops, manufactures, markets and services semiconductor wafer fabrication equipment and related spare parts for the worldwide semiconductor industry. Many of AMAT's products are single-wafer systems designed with two or more process chambers attached to a base platform. The platform feeds a wafer to each chamber, allowing the simultaneous processing of several wafers to enable high manufacturing productivity and precise control of the process. These platforms support chemical vapor deposition, physical vapor deposition, etch and rapid thermal processing technologies. While the weekly change numbers above paint a less-than-exciting picture for our AMAT play, judicious entry and exit points have made AMAT a successful, if slow-moving venture. As Semiconductor stocks have continued to pull back from their recent highs, our play has consistently pulled back each time it has ventured up to the long-term descending trendline. The 200-dma has regained the upper hand this week, winning out against the bulls every day. The range has been small though, as sellers have been unable to break the $50 support level either. While easier to see on a chart, you should recognize this pattern as a descending or bearish wedge, and it looks like it will break one way or the other within the next week. Alas, we don't have that much time as AMAT is set to release earnings Tuesday after the close, so we'll want to have all positions closed before then. But gun-slinging, aggressive traders may be able to make one more swipe at profits early this week. The little spat between Morgan Stanley and virtually every other analyst (Merrill Lynch, Goldman Sachs, CSFB, etc.) about the near-term future for Semiconductor Equipment stocks Thursday morning provided fertile ground for new short positions in AMAT as the gap open quickly fell apart, driving the stock down to close more than $3 below the open, but a mere 3 cents below Wednesday's closing price. So you can see the importance of good entry and exit points. Use any strength early next week to initiate new positions on a rollover near the descending trendline and our stop (currently $53). Keep a tight reign on the position as it approaches support at $50, and don't be afraid to take a profit when it is offered. More conservative players can enter new positions on a drop through support, but need to make sure that all positions are closed by the end of trading on Tuesday. ***May contracts expire next week*** BUY PUT MAY-55 ANQ-QK OI=7670 at $4.50 SL=2.75 BUY PUT MAY-50 ANQ-QJ OI=7080 at $1.75 SL=0.75 BUY PUT JUN-50*ANQ-RJ OI=2398 at $3.90 SL=2.50 BUY PUT JUN-45 ANQ-RI OI=2259 at $2.30 SL=1.25 http://www.premierinvestor.net/oi/profile.asp?ticker=AMAT HGSI - Human Genome Sciences $57.88 (-3.89 last week) Possessing one of the largest human and microbial genetic databases, HGSI licenses its database of knowledge to pharmaceutical heavyweights like GlaxoSmithKline and Merck. Management has chosen to forgo the race to decode the entire human genome, and has instead focused on finding and patenting genes involved in developing gene-based therapeutics. Its four compounds currently in clinical trials are intended to limit the toxic effects of chemotherapy, promote the repair of damaged cells, stimulate antibody production, and spur regrowth of blood vessels. Going the way of several other sectors, the Biotechnology index (BTK.X) ran into impenetrable resistance at $580 2 weeks ago and no amount of pushing and straining could give the bulls a victory. After several attempts, the bulls seem to have given up and the BTK is now rolling over. Sure enough, HGSI is following the broader index lower and with the daily Stochastic oscillator now in a steep descent, the stock is at a critical point. UBS Warburg initiated coverage of the stock with a Buy rating on Friday, but amidst all the market weakness, HGSI continued to decline, ending just above the $57 support level. A drop below this level will provide new entry points for conservative traders although they will want to be on the lookout for a bounce near the $54-55 support level, which coincides with the 30-dma (currently $54.40). Due to the recent weakness, we are ratcheting our stop down to $61, just above Friday's high. More aggressive players can use failed rallies near this level as an opportunity to open new positions in anticipation of further weakness. Confirm the health of the play by watching for more weakness in the BTK index (preferably a drop through the $535 level) and increasing selling volume on HGSI. ***May contracts expire next week*** BUY PUT MAY-60 HHA-QL OI=914 at $4.50 SL=2.75 BUY PUT MAY-55 HHA-QK OI=752 at $2.05 SL=1.00 BUY PUT JUN-60*HHA-RL OI= 47 at $8.20 SL=5.75 BUY PUT JUN-55 HHA-RK OI=105 at $5.60 SL=3.50 BUY PUT JUN-50 HHA-RJ OI=189 at $3.50 SL=1.75 http://www.premierinvestor.net/oi/profile.asp?ticker=HGSI JNPR - Juniper Networks $54.26 (-6.87 last week) As a provider of Internet infrastructure solutions, JNPR serves Internet service providers and other telecommunications service providers, helping them to meet the demands resulting from the rapid growth of the Internet. The company delivers next generation Internet backbone routers that are specifically designed for service provider networks. The routers provided by the company combine the features of the JUNOS Internet Software, high performance ASIC-based packet forwarding technology and Internet-optimized architecture into a purpose-built solution for service providers. Our aggressive stance was clearly rewarded last week as JNPR took a tumble, first on a less than glowing earnings report from Networking giant CSCO Tuesday night and then a poorly received conference call Thursday afternoon. It seems the fact that company management provided no additional guidance for the current quarter didn't set well with investors as they continued to punish the stock right up to the closing bell with only a mild (less than $1) recovery on Friday. In the midst of this, the Networking index (NWX.X) has fallen back to support near the $450 level and looks to be in danger of further downside. What should really be disconcerting to the bulls at this point is the fact that the NWX has now broken below its 6-week ascending trendline (currently at $470), and this level should provide significant resistance in the near future. What about JNPR? Same pattern, only it broke the ascending trendline (then at $61) Monday morning. Selling the rallies seems to be back in vogue as the broader markets weaken ahead of Tuesday's FOMC meeting in which the outcome has become uncertain due to recent stronger than expected economic reports. If the bears are successful at breaching the $450 support level on the NWX, then new positions in JNPR look attractive as the stock falls through its corresponding $51-52 support level, right at the merging 30-dma ($51.01) and 50-dma ($52.45). More aggressive traders can use intraday rallies as an opportunity to get onboard at a better price, target shooting a rollover from resistance at $56, $58 or $60, depending on your risk tolerance. Keep stops set at $60. ***May contracts expire next week*** BUY PUT MAY-55 JUX-QK OI=11708 at $3.90 SL=2.50 BUY PUT MAY-50 JUX-QJ OI=10636 at $1.95 SL=1.00 BUY PUT JUN-55*JUX-RK OI= 5518 at $7.40 SL=5.25 BUY PUT JUN-50 JUX-RJ OI= 7567 at $5.30 SL=3.25 BUY PUT JUN-45 JUX-RI OI= 896 at $3.50 SL=1.75 http://www.premierinvestor.net/oi/profile.asp?ticker=JNPR NVLS - Novellus Systems $49.09 (-1.86 last week) Providing equipment for advanced Semiconductor manufacturing, NVLS focuses on advanced, high-productivity thin film deposition systems and surface preparation systems used in the fabrication of integrated circuits. Utilizing Chemical Vapor Deposition (CVD), Physical Vapor Deposition, electroplating, photoresist strip and residue removal systems, the company's products provide high film quality while attaining the high levels of productivity required to meet the semiconductor industry's need for high-volume, low-cost wafer production. Semiconductor bulls had another frustrating week, thrice failing to push the Semiconductor index (SOX.X) back above the critical $650 resistance level. Although it certainly couldn't make any upward progress, NVLS managed to keep from losing too much ground on a weekly basis. While there were scattered negative reports from various chip companies, the real excitement of the week transpired in the first hour of trading on Thursday. Morgan Stanley upgraded the whole stable of chip equipment stocks (including NVLS) before the open, giving both the SOX and all the affected stocks a nice pop at the open. It took less than 30 minutes after the open before dissenting opinions from the likes of Merrill Lynch, Goldman Sachs and CSFB hit the newswires, bringing the early rally to an abrupt end. Traders that jumped into new positions as the rally fizzled got a nice ride down on Thursday and the stock's losses widened fractionally Friday. NVLS has now filled the gap left on April 18th and could be finding support near $49. Daily Stochastics have now reached oversold, volume has dropped off to just over half the ADV and the Fed's decision on interest rates is less than 2 trading days away. Adding one more hazard to the mix for bearish positions, CE Unterberg Towbin initiated coverage of the stock at a Strong Buy on Friday. So here's the approach. Conservative entries still make sense, but only if NVLS falls through the $48 level on increasing volume. Intraday bounces will provide opportunities for more aggressive types, letting them into the play near the $51 resistance level (also the location of our stop). The real key to more weakness is for the SOX to fail to hold above the $600 level, opening the door to a possible retest of $540. Another item to keep on your radar screen is earnings from AMAT. They will be released Tuesday after the close, so cautious investors may want to go flat before the announcement, just in case the company releases good news with the numbers. ***May contracts expire next week*** BUY PUT MAY-50 NLQ-QJ OI=2034 at $2.90 SL=1.50 BUY PUT MAY-45 NLQ-QI OI=1821 at $0.90 SL=0.00 BUY PUT JUN-50*NLQ-RJ OI=1178 at $5.80 SL=3.75 BUY PUT JUN-45 NLQ-RI OI=3433 at $3.30 SL=1.75 BUY PUT JUN-40 NLQ-RH OI=1127 at $1.75 SL=1.00 http://www.premierinvestor.net/oi/profile.asp?ticker=NVLS QLGC - QLogic Corp $44.11 (-5.18 last week) QLogic Corporation is the leading manufacturer of fibre channel bus adaptors. The company is also a designer and supplier of semiconductor and board level input/output (I/O) components They've been designing and marketing SCSI-based (small computer system interface) products for over 12 years and sells its products to server, workstation, and date peripheral makers. Blue-chip clients include Compaq, Dell, Hitachi, IBM, and Quantum Corporation. QLGC's initial instability and critical break of the $46 support on Thursday forecasted downside trading as the company approached it earnings' release this coming Tuesday, after the market. On the basis of a technical meltdown and investor caution, we added QLGC that evening. As it turned out, we were rewarded with a viable rollover entry from the 5-dma line early in Friday's session. The slide to $43.13 then offered a profitable exit, if you were quick to the keyboard. At this point, we essentially have only two trading days to play QLGC. Remember, OI never holds over an announcement despite the earnings' projection. For example, while it's expected that they'll come in at $0.28 p/s in comparison to last year's same quarter of $0.24, there's simply no telling what other interesting tidbits the company may render. The Semiconductor Index (SOX.X) can play a vital role in QLGC's trading, so keep an eye on the index levels. Currently the SOX.X is dawdling in the lower trading zone of 610 and 620, with 605 marking very dangerous bear territory. A breakdown through 600 signals a superb trading opportunity, assuming QLGC is tracing the broader sector. If your strategy is to buy into subsequent weakness, consider locking in gains as QLGC converges upon the $40 level; especially in light of the tight time frame. ***May contracts expire next week*** BUY PUT MAY-45 QLC-QI OI=549 at $3.70 SL=2.00 BUY PUT JUN-50 QLC-RJ OI= 52 at $9.60 SL=6.75 BUY PUT JUN-45*QLC-RI OI=163 at $6.60 SL=4.50 BUY PUT JUN-40 QLC-RH OI=228 at $4.10 SL=2.50 http://www.premierinvestor.net/oi/profile.asp?ticker=QLGC ***** LEAPS ***** Waiting On The Fed By Mark Phillips Contact Support With less than 2 full trading days to go before we receive Alan Greenspan's august delivery of the latest interest rate move by the Federal Reserve, investors' hopes of another fat 50 basis point cut are fading fast. Just a couple short days ago, half a point was almost a certainty according to the Fed Futures contract. And along with that expectation, all the major averages were knocking on the door of major resistance. Not so, any more. So what happened? In the upside-down topsy-turvy world of the stock market, good news is sometimes bad and bad news is sometimes good. In this case, the worse the economic news got, the more investors expected to receive their monthly dose of 50 basis point cuts from their friendly neighborhood Fed Chairman. That's all fine until the economic news is no longer abysmal. With stronger than expected Initial Jobless Claims on Thursday and robust Retail Sales on Friday, there were hints of economic healing on the horizon. Then University of Michigan Consumer Sentiment came out Friday morning, throwing more cold water on the bulls' excitement. The index ticked up to 92.6 in early May, up significantly from 88.4 and fooling economists who had expected another slight drop. That's right, Uncle Alan's unsung hero, the mighty consumer, looks like he/she will continue to spend with abandon until the economy has shed all vestiges of recession. Don't bet on it! The reaction in the market was just what one might expect, with bond yields exploding to the upside (if you read Jeff & Jeff's intraday updates, then you already knew that), and the Fed Fund Futures are now only giving the 50 basis point cut a 50-50 shot. The equity markets didn't like the news either, as early losses continued to widen and every major index I looked at continued to bleed red. I know what you're thinking. "Thanks Mark, but what does any of this have to do with LEAPS?" I'm glad you asked! Entry Points! Despite hints of economic improvement, I think these are largely anomalous, and expect the Fed to continue its interest rate-cutting spree. Unless Easy Al cuts rates by 100 points on Tuesday, I expect a selloff on the news. Earnings are all but over and catalysts for an upward move in the markets are waning faster than California power supplies as summer approaches. Sure we have Dell Computer (NASDAQ:DELL) and Oracle Corp. (NASDAQ:ORCL) later in the week, but I don't expect any earth-shaking positive comments from either of these previous high-flyers. While I think we are likely to see some weakness in the days and possibly weeks following the Fed's action on Tuesday, I don't expect to get anywhere near a retest of the March lows in the markets. If I am right, the post-Fed dip (when it stabilizes) should provide the attractive entry points we've been waiting for. This isn't an excuse for trying to catch falling knives, but I would look for support to hold at higher levels on this trip down. Major index support that is likely to hold firm, in my opinion, would be DJIA=10,300; S&P500=1200; NASDAQ Composite=1900. Will we get there? I really don't know, but I think our current list of Watch List (and Portfolio) plays would look very attractive for new long-term positions on a return to those levels. The Fed has been good to us so far this year (despite their unadmitted culpability in none-too-gently bringing an end to the historic economic expansion), and when the economy does show definitive signs of recovery, those plays should appreciate nicely. That is, so long as the Fed doesn't wake the sleeping inflation monster with their easy money policies. Look at the entry targets for our current Watch List plays. Note that I have raised those for Texas Instruments (NYSE:TXN), EMC Corp. (NYSE:EMC), and Verisign (NASDAQ:VRSN) due to their good relative strength over the past couple weeks. All of our entry targets have been placed at what I expect to be significant support levels and I'm looking to get filled on several of these in the next few weeks. At those levels, I perceive our plays to be providing attractive values, and limited downside risk. There is one caveat to this approach. I would be hesitant to initiate new long-term positions with 2002 LEAPS. These will soon cease to be treated as LEAPS as the 2004 LEAPS are released. The consequence is that time decay will soon start to be a significant factor in the 2002 expiration cycle LEAPS and the expected recovery could take a few months to really get moving. You don't want to have time decay shrinking the gains from your plays just as the recovery gets going. Refer to the link at the bottom of the Strategy section for a full explanation of how and when the 2004 LEAPS are released to the trading public. As soon as the 2004 LEAPS are available, our recommended strikes will be added to the Watch List. Just like the rest of our indicators, the VIX has been rather directionless lately. Maybe it is waiting for the Fed as well? In fact, it looks like there is support forming between 26-27 that should support one more launch over the venerable 30 level before all is said and done. That move upwards should coincide with drops on the major indices near the support levels mentioned above, providing us with another confirming tool that says "Attractive risk/reward ratio". It has been difficult sitting on the sidelines during this recent rally without chasing some of our Watch List plays higher, but I think our patience is going to be rewarded soon. For the record, the VIX closed out the week at 27.48. As you can tell by my commentary, I expect some near-term weakness, which should provide entries for us on several of our Watch List plays. But at the same time, we have moved up nicely on many of our Portfolio plays. Most of our stops are remaining in place this week with the exception of Clorox (NYSE:CLX) and Wal-Mart (NYSE:WMT). Over the past 2 months CLX refused to close below $30 and I think that level bodes well for support going forward. WMT benefited from the recent run in Retail stocks, and we have booked some decent gains since we added the play in late March. I'm not convinced it will continue much higher without some consolidation however. Rather than let those profits melt away, I have moved the stop up to $51, and any serious profit taking will close that play out with a modest gain. Those of you with itchy trigger fingers have already paged down to see the new Watch List plays, Brocade Communications (NASDAQ:BRCD) and Nextel Communications (NASDAQ:NXTL). You'll quickly notice that we are looking for significant pullbacks before we are willing to take a position. As I have stressed recently, I think patience and following a predetermined game plan (logical entry points and ruthless money management) are the keys to success over the long run. I know it sounds like a broken record, but chasing stocks higher at this point could give you the dubious distinction of buying near the highs. Remember to stick to your plan and let those entry points come to you. Mark Phillips Contact Support Current Playlist (Old Format) SYMBOL SINCE LEAPS SYMBOL PICKED CURRENT CHANGE CPN 01/21/01 JAN-2002 $ 40 YLN-AH $10.50 $17.50 66.67% JAN-2003 $ 40 OLB-AH $15.38 $22.80 48.29% LEAPS Portfolio Current Open Plays SYMBOL OPENED LEAPS SYMBOL ENTRY CURRENT CHANGE STOP CLX 03/13/01 '02 $ 35 WUT-AG $ 3.50 $ 3.70 5.71% $ 30 '03 $ 35 VUT-AG $ 6.10 $ 6.30 3.28% $ 30 GENZ 03/23/01 '02 $ 85 YGZ-AQ $24.50 $32.50 32.65% $ 99 '03 $ 90 OZG-AR $27.75 $40.30 45.23% $ 99 SWS 03/22/01 '02 $ 18 YWF-AT $ 4.10 $ 7.10 73.17% $ 20 '03 $ 20 VWZ-AD $ 5.00 $ 7.80 56.00% $ 20 WM 03/22/01 '02 $ 50 WWI-AJ $ 6.00 $ 8.40 40.00% $ 48 '03 $ 50 VWI-AJ $ 9.20 $12.00 30.43% $ 48 WMT 03/23/01 '02 $ 50 WWT-AJ $ 7.00 $10.00 42.86% $ 51 '03 $ 50 VWT-AJ $11.00 $14.00 27.27% $ 51 JWN 03/30/01 '02 $ 20 WNZ-AD $ 1.65 $ 2.05 24.24% $17.50 '03 $ 20 VNZ-AD $ 3.30 $ 3.60 9.09% $17.50 GS 04/05/01 '02 $ 90 WSD-AR $14.00 $18.70 33.57% $ 89 '03 $ 90 VSD-AR $20.50 $26.80 30.73% $ 89 MU 04/05/01 '02 $ 40 WGY-AH $10.60 $10.60 0.00% $ 38 '03 $ 40 VGY-AH $14.80 $15.80 6.76% $ 38 NSM 04/05/01 '02 $ 25 WUN-AE $ 5.50 $ 6.10 10.91% $ 24 '03 $ 30 VSN-AF $ 7.20 $ 8.20 13.89% $ 24 NOK 04/06/01 '02 $ 25 WIK-AE $ 4.70 $ 9.70 106.38% $ 29 '03 $ 25 VOK-AE $ 7.00 $12.30 75.71% $ 29 FON 04/09/01 '02 $ 25 WO -AE $ 2.80 $ 3.00 7.14% $ 19 '03 $ 25 VN -AE $ 4.40 $ 4.90 11.36% $ 19 QQQ 04/25/01 '02 $ 40 WD -AN $11.10 $10.70 - 3.60% $ 41 '03 $ 45 VZQ-AS $12.30 $12.10 - 1.63% $ 41 DELL 04/27/01 '02 $ 25 WDQ-AE $ 6.20 $ 4.90 -20.97% $ 23 '03 $ 25 VDL-AE $ 9.00 $ 7.70 -14.44% $ 23 LEAPS Watchlist Current Possibles SYMBOL SINCE TARGET PRICE TARGETED LEAP SYMBOL CPN 03/18/01 $46-47 JAN-2002 $ 45 YLN-AI JAN-2003 $ 50 OLB-AJ GE 03/25/01 $45-46 JAN-2002 $ 50 WGE-AJ JAN-2003 $ 50 VGE-AJ TXN 03/25/01 $34-35 JAN-2002 $ 35 WTN-AG JAN-2003 $ 40 VXT-AH EMC 04/22/01 $36 JAN-2002 $ 40 WUE-AH JAN-2003 $ 40 VUE-AH SEBL 04/22/01 $38 JAN-2002 $ 40 YDS-AH JAN-2003 $ 40 OIE-AH VRSN 04/29/01 $45-47 JAN-2002 $ 50 YXO-AJ JAN-2003 $ 50 OVX-AJ LRCX 04/29/01 $25 JAN-2002 $ 30 WMJ-AF JAN-2003 $ 30 VPC-AF ADBE 05/06/01 $36-37 JAN-2002 $ 40 WAE-AH JAN-2003 $ 40 VAE-AH AOL 05/06/01 $49-50 JAN-2002 $ 55 WAN-AK JAN-2003 $ 55 VAN-AK BRCD 05/13/01 $30-32 JAN-2002 $ 35 YNU-AG JAN-2003 $ 35 OMW-AG NXTL 05/13/01 $14-15 JAN-2002 $ 15 WFU-AC JAN-2003 $ 20 VFU-AD New Portfolio Plays None New Watchlist Plays BRCD - Brocade Communications $40.18 Stocks in the Storage arena were among the last to undergo valuation compression, but as the ferocity of the bear increased, even BRCD fell sharply over the past few months. The company is a leader in the storage area networking infrastructure arena, and recent comments from other leaders in the Storage sector are indicating a slight increase in demand. CSFB initiated coverage with a Buy rating on Friday, adding just one more reason to put BRCD on our radar screen. The bottom line is that the demand for storage isn't going to diminish for the foreseeable future, and companies like BRCD are poised to profit handsomely as the bear heads back into hibernation. Trading as low as $16.75 just over a month ago, the stock has really had quite a run and it is good to see it coming back to earth a little. The combined effect of the FOMC meeting and BRCD's earnings announcement on Tuesday could be the catalyst to provide an attractive entry point. We don't want to chase this stock as the valuation is already rich (with a PE ratio north of 100), but we want to be ready when it comes back to solid support. Look for a pullback to the $30-32 level, also the site of the converged 30-dma and 50-dma, to provide entry, as we attempt to position ourselves for what we expect to be a stellar performing Portfolio play. BUY LEAP JAN-2002 $35.00 YNU-AG BUY LEAP JAN-2003 $35.00 OMW-AG NXTL - Nextel Communications $17.89 Nextel provides a wide array of digital wireless communications services throughout the United States, primarily to business users. Wireless stocks haven't exactly been popular of late (with the notable exception of Nokia, which is already in our Portfolio), due to concerns about growth in the industry and profitability. Despite increasing revenues, many of these companies (including NXTL) are still unprofitable, and that is not an attractive characteristic in the current marketplace. But Goldman Sachs was out priming the pump a week ago, recommending the likes of NXTL, AWE and PCS. Their recommendation for NXTL came complete with a price target of $27. By no means do we expect the stock to go stratospheric any time soon. Rather this is our opportunity to go fishing for an attractive entry point, and the expected market consolidation over the next couple weeks may be just the ticket. We are looking for the stock to come back to the $14-15 level before finding support from which to launch its recovery into the end of the year. Providing Goldman is accurate in their estimates of the stock's potential over the next year, then we should be able to book a tidy gain in the months ahead. BUY LEAP JAN-2002 $15.00 WFU-AC BUY LEAP JAN-2003 $20.00 VFU-AD Drops None ********** 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: Contact Support
The Option Investor Newsletter Sunday 05-13-2001 Sunday 5 of 5 To view this email newsletter in HTML format with embedded charts and graphs, click here: http://www.OptionInvestor.com/htmlemail/051301_5.asp ************* COVERED CALLS ************* Covered-Call Basics: The "Total Return" Concept By Mark Wnetrzak This week, the Covered-calls editor is on a brief hiatus so we decided to publish one of his most popular narratives on conservative option trading techniques. There are many types of investors and no single strategy can work for all of them however, a position with moderate profit potential and relatively low risk can be very appealing. The technique we use to achieve this outlook is the "in-the-money" covered-call. All covered-calls involve selling a call against stock that is owned. If the stock declines, the covered writer will offset part of his loss by the amount of the option premium. The two most common approaches are the "out-of-the-money" covered-call and the "in-the-money" covered-call. Some investors prefer to strive for higher potential returns with an aggressive outlook, writing out-of-the-money calls on stocks in their portfolios. These (OTM) positions offer greater rewards but also have less downside protection. The maximum potential profit of an OTM position, while generally greater than that of an in-the-money (ITM) position, will always require an increase in price by the underlying stock. Thus, by using an OTM option, the success of the overall position depends more on the movement of the stock price and less on the benefits of writing the call. Since the premium generated from the sale of the call is much smaller, the overall position will be more susceptible to loss if the stock's price declines. ITM plays are more defensive, offering less risk but also smaller reward potential. These conservative positions appeal to those investors who are attempting to earn a relatively consistent return while striving for preservation of capital. In spite of having a smaller profit potential, the "in-the-money" approach can be attractive on a percentage return basis, especially when the stock is held in a margin account. The cost basis in the underlying issue is substantially reduced and even if the stock declines, the position can still return a profit. Traders who utilize this conservative approach consider both downside protection and potential profit. The combined position (both stock and options) is viewed as a single entity and the trader is not overly concerned with long-term ownership of the underlying issue. This "total return" concept represents the true focus of most successful covered call writers. The ideal investment offers limited risk and a good probability of making a profit. Our primary goal is to provide plays that make acceptable returns while still receiving an above-average amount of downside protection. Investors who plan to sell OTM calls should concentrate on the "return not called." This is the return on investment that one would achieve even if the stock price were unchanged when the sold option expires. One can also compare potential positions more fairly using this approach since no assumption is made about the price movement in the underlying issue. In our conservative option-writing strategy, we search for plays that return a minimum of 3-5% per month with downside protection of at least 10% (of the current stock price). The overall position that is constructed using these guidelines will be a relatively low risk play, regardless of the volatility of the underlying stock, since the levels of protection will be large and there is still the expectation of a reasonable return. Since the primary objective of covered-call writing for most investors is increased income though stock ownership, the amount of downside protection and the return on investment are both very important considerations in determining which position to choose. Of course, the technical and fundamental outlook of the underlying stock must also be favorable. While a minimally acceptable return is a matter of personal preference, it would appear that with the current market volatility, the advantages of the in-the-money position; consistent profits and lower risk, are more attractive to the majority of investors. Good Luck! SUMMARY OF PREVIOUS CANDIDATES ***** Note: Margin not used in calculations. Stock Price Last Call Strike Price Gain Potential Symbol Picked Price Month Sold Picked /Loss Mon. Yield LMNE 5.22 4.65 MAY 5.00 1.30 $ 0.73 20.2% MFNX 5.25 5.36 MAY 5.00 0.95 *$ 0.70 17.7% MRVC 8.80 8.23 MAY 7.50 2.15 *$ 0.85 13.9% STOR 15.40 19.27 MAY 12.50 3.40 *$ 0.50 9.1% BORL 7.99 10.50 MAY 7.50 1.05 *$ 0.56 8.8% ENMD 20.26 19.25 MAY 17.50 3.70 *$ 0.94 8.2% ASTE 16.05 18.60 MAY 15.00 2.10 *$ 1.05 8.2% SRNA 18.81 20.85 MAY 15.00 4.50 *$ 0.69 7.0% NFLD 11.55 13.50 MAY 10.00 1.85 *$ 0.30 6.7% JBL 26.00 30.79 MAY 22.50 5.00 *$ 1.50 6.2% EXAR 30.15 27.15 MAY 25.00 6.50 *$ 1.35 6.2% EXFO 31.95 34.14 MAY 25.00 8.60 *$ 1.65 6.1% SBYN 13.75 13.10 MAY 10.00 4.40 *$ 0.65 6.0% TWAV 17.70 17.90 MAY 15.00 3.10 *$ 0.40 6.0% AHAA 21.21 27.37 MAY 17.50 4.80 *$ 1.09 5.8% MU 44.07 40.32 MAY 37.50 8.00 *$ 1.43 5.7% EMIS 18.20 15.63 MAY 15.00 4.10 *$ 0.90 5.5% FDRY 13.35 17.24 MAY 10.00 3.70 *$ 0.35 5.3% ILUM 29.13 29.38 MAY 25.00 5.00 *$ 0.87 5.2% ISIL 31.74 30.98 MAY 25.00 7.60 *$ 0.86 5.2% SMTC 31.67 29.80 MAY 27.50 4.80 *$ 0.63 5.1% ZIGO 24.74 34.32 MAY 17.50 8.20 *$ 0.96 5.0% PVTL 24.13 22.55 MAY 20.00 4.80 *$ 0.67 5.0% ULCM 28.00 26.05 MAY 22.50 6.00 *$ 0.50 4.9% ITWO 23.85 19.63 MAY 20.00 4.40 $ 0.18 2.0% NXCD 11.35 9.66 MAY 10.00 1.85 $ 0.16 1.8% PIOS 13.37 12.05 MAY 12.50 1.25 $ -0.07 0.0% *$ = Stock price is above the sold striking price. Comments: I may be gone but I am still here! I am enjoying the HOT Vancouver weather while my son attends a hockey camp! Well, at least it's hot compared to Anchorage. Next week should be very interesting as it appears everyone is waiting on the FED (not to mention it is also expiration week). Emisphere Tech (NASDAQ:EMIS) held at support and is enjoying a bit of a rally. The April high is near-term resistance and a move higher would improve the bullish outlook. Keep a close eye on Illuminet (NASDAQ:ILUM) as Friday's action is a worrisome. Pivotal (NASDAQ:PVTL) has again failed to move above its 150 dma. Monitor closely as it now appears ready to test support at $20. i2 Technologies (NASDAQ:ITWO) has reversed direction and is also testing support at $20. Evaluate your long term outlook on Nextcard (NASDAQ:NXCD) and also Pioneer Standard (NASDAQ:PIOS) as they continue to act technically weak. NEW CANDIDATES ********* Sequenced by Company ***** Stock Last Call Strike Option Last Open Cost Days Target Symbol Price Mon. Price Symbol Bid Int. Basis Exp. Yield AFCI 17.70 JUN 15.00 AQF FC 3.40 161 14.30 35 4.3% AREM 18.81 JUN 15.00 UKM FC 4.60 106 14.21 35 4.8% FNSR 20.98 JUN 15.00 FQY-FC 7.00 323 13.98 35 6.3% NEM 20.98 JUN 20.00 NEM FD 2.00 8226 18.98 35 4.7% NPIX 10.00 JUN 10.00 XMQ FB 1.15 122 8.85 35 11.3% STOR 19.27 JUN 15.00 OSU FC 5.40 347 13.87 35 7.1% VOXX 10.09 JUN 10.00 UXX FB 0.95 111 9.14 35 8.2% Sequenced by Target Yield (monthly basis) ***** Stock Last Call Strike Option Last Open Cost Days Target Symbol Price Mon. Price Symbol Bid Int. Basis Exp. Yield NPIX 10.00 JUN 10.00 XMQ FB 1.15 122 8.85 35 11.3% VOXX 10.09 JUN 10.00 UXX FB 0.95 111 9.14 35 8.2% STOR 19.27 JUN 15.00 OSU FC 5.40 347 13.87 35 7.1% FNSR 20.98 JUN 15.00 FQY-FC 7.00 323 13.98 35 6.3% AREM 18.81 JUN 15.00 UKM FC 4.60 106 14.21 35 4.8% NEM 20.98 JUN 20.00 NEM FD 2.00 8226 18.98 35 4.7% AFCI 17.70 JUN 15.00 AQF FC 3.40 161 14.30 35 4.3% Company Descriptions LB-Last Bid price, OI-Open Interest, CB-Cost Basis or break-even point, DE-Days to Expiry, TY-Target Yield (monthly basis). ***** AFCI - Advanced Fibre $17.70 *** Technicals Only! *** Advanced Fibre Communications (NASDAQ:AFCI) develops, makes and supports telecommunications access products and services that enable telecommunications companies and other service providers to connect their central office switches to end users for voice and high-speed data communications. The company's products are integrated multi-service access platforms and devices, network management systems, indoor and outdoor cabinets for the portion of the telecom network between the service provider and their customers, often referred to as the local loop. Not much news on this once-dominant player in the telecom hardware sector but the technical indications suggest that investors are willing to support the issue at the current price. Use a net-debit order to target a better cost basis (and monthly yield) in the issue. JUN 15.00 AQF FC LB=3.40 OI=161 CB=14.30 DE=35 TY=4.3% http://www.OptionInvestor.com/charts/may01/charts.asp?symbol=AFCI ***** AREM - Aremissoft $18.81 *** Solid Earnings! *** Aremissoft (NASDAQ:AREM) develops, markets, installs and supports enterprise-wide software applications, primarily for mid-sized organizations in the manufacturing, hospitality, healthcare and construction industries. The company's suite of Internet-enabled products is designed to allow customers to manage and execute mission-critical functions within their organization, including accounting, purchasing, manufacturing, customer service, and sales and marketing. The modular design of its products enables AREM to provide customers with a cost-effective scalable solution that can be easily implemented. AremisSoft reported record results in late April with revenue of $39.2 million, an 82% increase for the first quarter of 2000. On a pro forma basis, net income for the first quarter increased 140% year-over-year and EPS increased 108% from the year-ago quarter. The company's business remains solid and has not been negatively affected by the current market conditions. JUN 15.00 UKM FC LB=4.60 OI=106 CB=14.21 DE=35 TY=4.8% http://www.OptionInvestor.com/charts/may01/charts.asp?symbol=AREM ***** FNSR - Finisar $20.98 *** Options Activity! *** Finisar (NASDAQ:FNSR) provides fiber optic subsystems and network performance test systems that offer high-speed data communications over local area networks and storage area networks. Additionally, the company has developed products for digitizing the return path of a cable television network and for aggregating data traffic in extended networks. Finisar also offers optical subsystems, which convert electrical signals into optical signals, for networking and storage equipment manufacturers that develop systems based on Gigabit Ethernet and Fibre Channel. The company's line of optical subsystems supports a wide range of applications and Finisar also provides network performance test systems. Options in FNSR have been active in recent sessions on speculation of a recovery in the networking sector and news of an upgrade by FAC/Eqts First Albany. Now the issue is trying to consolidate recent gains and investors who think the company is a good long-term holding can establish a reasonable cost basis in the stock with this position. JUN 15.00 FQY-FC LB=7.00 OI=323 CB=13.98 DE=35 TY=6.3% http://www.OptionInvestor.com/charts/may01/charts.asp?symbol=FNSR ***** NEM - Newmont Gold $20.98 *** Gold Sector Hedge *** Newmont Mining (NYSE:NEM) is engaged in the production of gold, the exploration for gold and the acquisition and development of gold properties worldwide. The company currently produces gold from mines in Nevada and California, and outside of the U.S. from operations in Peru, Indonesia, Mexico and Uzbekistan. The company also produces copper concentrates from a copper/gold deposit at a second location in Indonesia. The company's subsidiary, Battle Mountain Gold has operations in Ontario, Canada and Bolivia, as well as interests in mines in Australia and Papua New Guinea, became a wholly-owned subsidiary of Newmont. Gold stocks are HOT and investors who want to diversify their growth portfolio with a broad-market hedge should consider owning this issue. Target a slightly lower cost basis in the stock initially, to allow for a brief consolidation after the recent rally. JUN 20.00 NEM FD LB=2.00 OI=8226 CB=18.98 DE=35 TY=4.7% http://www.OptionInvestor.com/charts/may01/charts.asp?symbol=NEM ***** NPIX - Network Peripherals $10.00 *** Reverse Merger *** Network Peripherals (NASDAQ:NOIX) designs and markets scalable, cost-effective Gigabit Ethernet switching solutions designed for local area networks. All of its switches are based on its highly flexible NuWaveArchitecture, which combines its advanced design and its proprietary Application-Specific Integrated Circuits. This architecture is designed to enable the Company to deliver standards-based switches that can work seamlessly with a variety of existing LAN infrastructures and technologies. It is the only wire-speed, non-blocking performance capability on all ports in a stackable configuration and facilitates the creation of multiple configurations of Fast Ethernet and Gigabit Ethernet switches. Network Peripherals is involved in a unique reverse merger with privately held storage software maker FalconStor. The all-stock deal is valued at about $300 million and NPIX will issue shares of its common stock for FalconStor shares, which will be listed on the NASDAQ under the stock symbol FNST. Investors appear to favor the new deal and after some extensive due diligence, you may as well. JUN 10.00 XMQ FB LB=1.15 OI=122 CB=8.85 DE=35 TY=11.3% http://www.OptionInvestor.com/charts/may01/charts.asp?symbol=NPIX ***** STOR - Storagenetworks $19.27 *** On The Move! *** Storagenetworks (NASDAQ:STOR) is the world's leading provider of data storage management services, and an innovator of storage management software. Their technology, software and services enable enterprises to easily and cost-effectively store rapidly growing volumes of business-critical information. The rally in Storagenetworks began in early May after the company said Ford Motors (NYSE:F) had signed up for two of its storage packages. Storagenetworks also surprised investors by announcing it can reduce storage costs for its clients by 25% to 30% and analysts say the company's services also improve utilization. The recent bullish trend in this niche sector is favorable and the heavy volume breakout in STOR suggests the issue is poised for future upside activity. JUN 15.00 OSU FC LB=5.40 OI=347 CB=13.87 DE=35 TY=7.1% http://www.OptionInvestor.com/charts/may01/charts.asp?symbol=STOR ***** VOXX - Audiovox $10.09 *** Solid Fundamentals *** Audiovox (NASDAQ:VOXX) designs and markets a diverse line of communications products, and provides related services around the globe. These products and services include handsets and accessories for wireless communications, fulfillment services for wireless carriers, automotive entertainment and security products and automotive electronic accessories. Audiovox operates in the Wireless Group and the Electronics Group and among these segments, it is one of the most fundamentally sound companies with an excellent price-to-earnings ratio and a book value well above the current share price. Investors who are looking for a long-term holding in this industry should consider this conservative entry position. JUN 10.00 UXX FB LB=0.95 OI=111 CB=9.14 DE=35 TY=8.2% http://www.OptionInvestor.com/charts/may01/charts.asp?symbol=VOXX ***** ***************** SUPPLEMENTAL COVERED CALL CANDIDATES ***************** The following group of issues is a list of additional candidates to supplement your search for profitable trading positions. As with any investment, you must decide if the selections meet your criteria for potential plays. Only you can know what strategies and positions are suitable for your experience level, risk-reward tolerance and portfolio outlook. They will not be included in the weekly portfolio summary. Sequenced by Target Yield (monthly basis) ***** Stock Last Call Strike Option Last Open Cost Days Target Symbol Price Mon. Price Symbol Bid Int. Basis Exp. Yield VITR 5.00 JUN 5.00 TKU FA 0.85 145 4.15 35 17.8% IMNR 4.90 JUN 5.00 IMQ FA 0.80 426 4.10 35 17.0% PCG 9.97 JUN 10.00 PCG FB 1.25 679 8.72 35 12.5% NFLD 13.50 JUN 12.50 DHQ FV 2.20 16 11.30 35 9.2% BTGC 10.64 JUN 10.00 QTG FB 1.30 256 9.34 35 6.1% ACPW 26.85 JUN 25.00 ACQ FE 3.10 491 23.75 35 4.6% #!!!AD13!!!# *********************** CONSERVATIVE NAKED PUTS *********************** Option Trading Basics: Q&A with the Editor By Ray Cummins This week's questions concern institutional option trading and liquidity, hedge funds and the difference between the Trade Date and Settlement Date. One of our readers asked how institutional traders affect the retail options market. What strategies do they use and how does their influence affect retail players? Also, what is a "Hedge Fund" and which trading strategies do they use to profit in the financial markets. Institutional investors use futures, options and other financial instruments to help control risk and maximize the value of their portfolios. In the equity-options market, portfolio managers are often option sellers as well as buyers, writing both put and call options to improve the income of their stock holdings and provide a margin for downside movement in volatile markets. The strategy of Covered-call writing has become a popular technique for pension funds and other specialized investment vehicles, who use this method to outperform the major indices. Since pension funds have few alternatives to holding a major portion of their assets in common stocks, covered-writing also provides a form of risk management with no additional cash outlays or expenditures. Another common strategy among institutional option traders is the protective put. Fund managers who want to eliminate the risk of a downward price movement can simply purchase a block of puts to "protect" the value of a specific holding. This method is more common because it allows the buyer to "lock-in" a realized profit at specific cost basis and also participate in any future upside activity in the underlying. Institutions are almost always in the market for put options and they are willing to pay a premium for the insurance against a drop in the price of the held asset. This is the main reason that put options have enjoyed relatively high premiums over the past few months and the trend is likely to continue for some time. Indeed, institutional traders do have a significant impact on the stock-options market and even more so in index options, which are used to insure portions of, or entire equity portfolios. This activity adds liquidity to the market and allows retail traders to enter and exit their positions much more efficiently and with better prices. Hedge funds are simply private pools of capital usually limited to a small number of "qualified" investors and administered by a fund manager (who may also have his/her own money in the fund). Hedge funds profit through the use of many unique strategies including everything from sophisticated arbitrage techniques to speculation in high growth issues and structured products. Some funds invest only in ordinary stocks and bonds while others focus on intricate risk management systems and complex derivatives. Almost all of them use high leverage instruments and "short" positions in their portfolios but most of these funds don't actually "hedge" as the title suggests. The concept of "hedging" refers to the practice among traders of buying or selling opposing futures contracts or other derivatives to limit or reduce exposure to unwanted price movements. Most hedge funds simply use a variety of strategies to reduce their overall exposure to the market in which they trade. The most important fact about hedge funds is they are unregulated and qualified (very wealthy) investors are simply limited partners in the fund with no input on its management or objectives and very little recourse if it should go bankrupt. Another reader requested an explanation of the differences between the Trade Date and the Settlement Date, with regard to stock and option trading. In simple terms, the Trade Date is the day you actually enter an order and have it executed. When you buy or sell a stock (or an option), that day is reported as the trade date. The Settlement Date is when cash or securities must be in place in your account to settle a trade. The current settlement period is 3 business days after the trade date for stocks and 1 business date after the trade date for options transactions. In Wall Street lingo, the settlement date for stocks is T + 3 (the trade date plus three business days). These dates are important because when you sell a stock, you need to know how long you've held it for tax purposes. For example, if you want to sell a stock within a certain period such as the end of the calendar year (to take a loss in an issue), you need to know which date is important to the Internal Revenue Service. In most cases, records for tax purposes are based on the trade date of a transaction, not the settlement date. By using the trade date, you can sell a stock on the last day of the year, as long as the market is open. Even though the transaction won't settle until three business days later, you are able to recognize the loss for the current year, as long as you record the day you bought the stock as the trade date. Good Luck! *** WARNING!!! *** Occasionally a company will experience catastrophic news causing a severe drop in the stock price. This may cause a devastatingly large loss which may wipe out all of your smaller gains. There is one very important rule; Don't sell naked puts on stocks that you don't want to own! It is also important that you consider using trading STOPS on naked option positions to help limit losses when the stock price drops. Many professional traders suggest closing the position when the stock price falls below the sold strike or using a buy-to-close STOP at a price that is no more than twice the original premium from the sold option. SUMMARY OF PREVIOUS CANDIDATES ***** Stock Price Last Call Strike Price Gain Potential Symbol Picked Price Month Sold Picked /Loss Mon. Yield AVCI 14.98 13.59 MAY 10.00 0.30 *$ 0.30 19.8% AHAA 27.20 27.37 MAY 22.50 0.50 *$ 0.50 16.3% SRA 23.60 23.36 MAY 20.00 0.45 *$ 0.45 15.5% PPD 20.86 21.35 MAY 15.00 0.45 *$ 0.45 14.1% PPD 17.25 21.35 MAY 10.00 0.50 *$ 0.50 13.8% UCOMA 15.39 15.69 MAY 10.00 0.30 *$ 0.30 12.9% CTLM 32.73 26.55 MAY 25.00 0.40 *$ 0.40 12.5% ISIL 33.10 30.98 MAY 25.00 0.40 *$ 0.40 12.4% FNSR 16.00 20.98 MAY 10.00 0.40 *$ 0.40 12.1% SNWL 16.60 17.63 MAY 12.50 0.40 *$ 0.40 11.7% MCDT 25.99 32.31 MAY 17.50 0.45 *$ 0.45 11.5% MANU 34.40 31.31 MAY 22.50 0.75 *$ 0.75 10.7% NTAP 23.55 24.25 MAY 15.00 0.50 *$ 0.50 10.4% PSFT 35.87 36.09 MAY 27.50 0.55 *$ 0.55 10.3% EBAY 41.63 53.25 MAY 30.00 1.10 *$ 1.10 10.1% RFMD 17.85 28.71 MAY 12.50 0.45 *$ 0.45 9.7% EMLX 34.96 38.80 MAY 22.50 0.50 *$ 0.50 9.7% SEBL 45.70 41.44 MAY 32.50 0.65 *$ 0.65 9.6% AMD 30.00 27.68 MAY 22.50 0.35 *$ 0.35 8.0% SCI 22.99 25.20 MAY 17.50 0.45 *$ 0.45 7.7% VSEA 39.35 38.72 MAY 30.00 0.70 *$ 0.70 7.1% BRCD 36.78 40.18 MAY 22.50 0.50 *$ 0.50 6.9% MUSE 48.83 39.41 MAY 25.00 0.65 *$ 0.65 6.8% EXFO 31.95 34.14 MAY 17.50 0.45 *$ 0.45 5.7% GOTO 21.92 17.10 MAY 17.50 0.35 $ -0.05 0.0% *$ = Stock price is above the sold striking price. Comments: Funny, this week we have some "good" news about the economy which of course was "bad" news for the Markets. Of course, everyone is really wondering how Alan and the FED interpret the news; just some added ingredients to the expiration week stew. A little Nortel (NYSE:NT) scare for Centillium Comm. (NASDAQ:CTLM) was put to rest after the company confirmed its previous revenue and earnings guidance. We shall see if the rally continues into next week. Carreker (NASDAQ:CANI) was the victim of an unexpected downgrade by Robertson Stephens before the opening bell on Monday. The comments were quite negative and changed the outlook for the issue significantly. The stock opened lowed and never looked back, dropping 30% in two sessions. That's a good example of why it's so important to check the news after the weekend and monitor each issue on a daily basis. Based on the bearish recommendation, we did not initiate the position. Goto.com (NASDAQ:GOTO) retreated sharply this week on heavy volume and we decided to close the play for a small loss. NEW CANDIDATES ********* Sequenced by Company ***** Stock Last Call Strike Option Last Open Cost Days Target Symbol Price Mon. Price Symbol Bid Int. Basis Exp. Yield APCC 16.83 JUN 15.00 PWQ RC 0.45 749 14.55 35 7.3% AVCI 13.59 JUN 7.50 QYV RU 0.30 10 7.20 35 8.6% EXEL 15.97 JUN 12.50 XQT RV 0.70 0 11.80 35 15.6% GLGC 21.05 JUN 17.50 CYV RW 0.70 34 16.80 35 10.9% GNSS 20.45 JUN 15.00 QFE RC 0.35 132 14.65 35 6.9% NFLD 13.50 JUN 10.00 DHQ RB 0.30 3 9.70 35 8.7% PDG 11.05 JUN 10.00 PDG RB 0.30 4695 9.70 35 7.1% TSAI 12.03 JUN 10.00 TQR RB 0.30 20 9.70 35 8.5% Sequenced by Target Yield (monthly basis) ****** Stock Last Call Strike Option Last Open Cost Days Target Symbol Price Mon. Price Symbol Bid Int. Basis Exp. Yield EXEL 15.97 JUN 12.50 XQT RV 0.70 0 11.80 35 15.6% GLGC 21.05 JUN 17.50 CYV RW 0.70 34 16.80 35 10.9% NFLD 13.50 JUN 10.00 DHQ RB 0.30 3 9.70 35 8.7% AVCI 13.59 JUN 7.50 QYV RU 0.30 10 7.20 35 8.6% TSAI 12.03 JUN 10.00 TQR RB 0.30 20 9.70 35 8.5% APCC 16.83 JUN 15.00 PWQ RC 0.45 749 14.55 35 7.3% PDG 11.05 JUN 10.00 PDG RB 0.30 4695 9.70 35 7.1% GNSS 20.45 JUN 15.00 QFE RC 0.35 132 14.65 35 6.9% Company Descriptions LB-Last Bid price, OI-Open Interest, CB-Cost Basis or break-even point, DE-Days to Expiry, TY-Target Yield (monthly basis). ***** APCC - American Power Conversion $16.83 *** Power Monger! *** American Power Conversion designs, develops, manufactures, and markets power protection and management solutions for computer and electronic applications worldwide. The company's solutions include uninterruptible power supply products, electrical surge protection devices, power conditioning products, and associated software, services, and accessories. These solutions are used with sensitive electronic devices, which rely on electric utility power including, home electronics, personal computers, servers, networking and telecommunications equipment, data-centers and other electronic facilities. Despite an ongoing slowdown in the technology industry, the battery backup giant improved on last year's sales and announced better-than-expected results in its most recent quarterly report. The bullish trend has resumed and traders who favor the outlook for the company can own the issue at a discounted price with this position. JUN 15.00 PWQ RC LB=0.45 OI=749 CB=14.55 DE=35 TY=7.3% http://www.OptionInvestor.com/charts/may01/charts.asp?symbol=APCC ***** AVCI - Avici Systems $13.59 *** Cheap Speculation! *** Avici (NASDAQ:AVCI) develops and sells high-speed data networking equipment that allows communications service providers to transmit high volumes of information across fiber optic networks. Their high-performance solution is being marketed to telecommunications companies and Internet service providers that are creating new optical networks to address the increasing data traffic on the Internet. The Avici Terabit Switch Router product is designed to address the critical needs of carriers by: managing high volumes of network traffic at high speeds; providing the ability to add capacity to the network without disrupting network performance; with high levels of availability and redundancy; prioritizing traffic types for new revenue-generating services, such as video streaming and the transmission of telephone calls over the web; and operating with existing carrier equipment. We like the recent basing pattern and the low-risk cost basis that can be established with this position. JUN 7.50 QYV RU LB=0.30 OI=10 CB=7.20 DE=35 TY=8.6% http://www.OptionInvestor.com/charts/may01/charts.asp?symbol=AVCI ***** EXEL - Exelixis $15.97 *** Earnings Speculation! *** Exelixis (NASDAQ:EXEL) is a biotechnology company focused on the discovery and validation of novel targets for several major human diseases, and on the discovery of potential new drug therapies, specifically for cancer and other proliferating diseases. The company is focused on the life sciences industries and development of proprietary drugs, through its unique experience in comparative genomics and model system genetics. The company also develops proprietary genetic, biochemical and cell-based assays for use in screening for potential targets, proteins and products. Exelixis shares have rallied in recent sessions amid optimism in the gene sequencing segment and with quarterly earnings due Monday, this position qualifies as "conservative speculation." JUN 12.50 XQT RV LB=0.70 OI=0 CB=11.80 DE=35 TY=15.6% http://www.OptionInvestor.com/charts/may01/charts.asp?symbol=EXEL ***** GLGC - Gene Logic $21.05 *** A Big Day! *** Gene Logic (NASDAQ:GLGC) provides a wide variety of products and services in the areas of gene expression information, genomic data management and bioinformatic software as well as pharmacogenomics. These products and services all designed to improve the efficiency and effectiveness of the drug discovery and development process. They may also be useful in research and development in diagnostics, animal health and agriculture. The company's information products enable scientists to produce biological knowledge by integrating the company's proprietary expression information with a growing array of biological information available on the Internet. GLGC has become a merger target, due to Merck's acquisition of genetic research company Rosetta Inpharmatics (NASDAQ:RSTA) and analysts say that Gene Logic is now the leading provider of disease-related gene expression information. If this is a company you want to own, the sale of an OTM Put can help you establish a discounted cost basis in the issue. JUN 17.50 CYV RW LB=0.70 OI=34 CB=16.80 DE=35 TY=10.9% http://www.OptionInvestor.com/charts/may01/charts.asp?symbol=GLGC ***** GNSS - Genesis Microchip $20.45 *** Chip Sector! *** Genesis Microchip (NASDAQ:GNSS) designs, develops and markets integrated circuits that manipulate and process digital video and graphic images. The company also supplies reference boards and designs that incorporate its proprietary integrated circuits. The company is focused on developing and marketing image processing solutions and is currently targeting the flat panel monitor market. In addition to product sales, the company derives revenues from providing design services which help its customers to develop products that include its chips in their designs or to accelerate the development of its products to meet customer demand. Genesis recently posted fourth quarter earnings that topped expectations, and forecast current quarter revenue would grow to $20 million, above the analysts' consensus estimates for the upcoming period. Investors applauded the news and it appears GNSS is once again a favorable small-cap issue in the semiconductor sector. JUN 15.00 QFE RC LB=0.35 OI=132 CB=14.65 DE=35 TY=6.9% http://www.OptionInvestor.com/charts/may01/charts.asp?symbol=GNSS ***** NFLD - Northfield Labs $13.50 *** Blood Substitute *** Northfield Laboratories (NASDAQ:NFLD) is primarily engaged in the development of a safe and effective alternative to transfused blood for use in the treatment of acute blood loss. Its PolyHeme blood substitute product is a solution of chemically modified hemoglobin derived from human blood. The company is devoting substantially all of their efforts and resources to the research, development and clinical testing of PolyHeme and NFLD officials recently announced at the Deutsche Banc Alex. Brown Healthcare Conference that they were confident and optimistic about bringing the company's blood substitute product through the regulatory review process. Traders who like drug stock speculation can use this position to establish a favorable cost basis in the issue. JUN 10.00 DHQ RB LB=0.30 OI=3 CB=9.70 DE=35 TY=8.7% http://www.OptionInvestor.com/charts/may01/charts.asp?symbol=NFLD ***** PDG - Placer Dome $11.05 *** Precious Metals Hedge *** Placer Dome (NYSE:PDG) and its subsidiaries, joint ventures and associated companies (collectively, Placer Dome) are principally engaged in the exploration for, and the acquisition, development and operation of gold mineral properties, although significant quantities of silver and copper are also produced. The company's share of gold production in 1999 was derived from mines in Canada, the United States, Australia, Papua New Guinea, South Africa and Chile. The La Coipa Mine in Chile contributes the majority of the company's share of silver production, with the balance from the Misima Mine in Papua New Guinea. The Zaldivar Mine in Chile and Osborne Mine in Australia are responsible for the company's share of copper production. Here's a favorable position in the Precious Metals sector for investors who want to diversify their portfolio. JUN 10.00 PDG RB LB=0.30 OI=4695 CB=9.70 DE=35 TY=7.1% http://www.OptionInvestor.com/charts/may01/charts.asp?symbol=PDG ***** TSAI - Transaction Systems $12.03 *** On The Move! *** Transaction Systems Architects (NASDAQ:TSAI) develops, markets, installs and supports software products and services primarily focused on facilitating electronic payments and other electronic commerce. In addition to its own products, TSA distributes or acts as a sales agent for software developed by third parties. The products and services are used mostly by banks and financial institutions, retailers and e-payment processors in domestic and international markets. Transaction Systems recently posted a quarterly profit of $0.06, matching consensus estimates and said it expects third quarter earnings in the range of $0.12-$0.18 per share with revenues of $79-$84 million. Apparently investors are pleased with the news as the company's share value has rallied since the announcement. JUN 10.00 TQR RB LB=0.30 OI=20 CB=9.70 DE=35 TY=8.5% http://www.OptionInvestor.com/charts/may01/charts.asp?symbol=TSAI ***** ***************** SUPPLEMENTAL NAKED PUT CANDIDATES ***************** The following group of issues is a list of additional candidates to supplement your search for profitable trading positions. As with any investment, you must decide if the selections meet your criteria for potential plays. Only you can know what strategies and positions are suitable for your experience level, risk-reward tolerance and portfolio outlook. They will not be included in the weekly portfolio summary. Sequenced by Target Yield (monthly basis) ****** Stock Last Call Strike Option Last Open Cost Days Target Symbol Price Mon. Price Symbol Bid Int. Basis Exp. Yield CMLS 12.84 JUN 10.00 UUC RB 0.35 0 9.65 35 10.4% ACPW 26.66 JUN 22.50 ACQ RX 0.75 0 21.75 35 9.0% PGNX 13.61 JUN 10.00 GUB RB 0.30 20 9.70 35 8.6% FNSR 20.98 JUN 12.50 FQY RV 0.30 179 12.20 35 5.8% EMLX 38.80 JUN 20.00 UML RD 0.45 226 19.55 35 4.8% VECO 49.85 MAY 45.00 QVC QI 0.70 283 44.30 35 27.0% #!!!AD14!!!# ************************ SPREADS/STRADDLES/COMBOS ************************ The Market Approaches A Key Moment... Stocks slumped today as renewed strength in retail spending and rising consumer confidence fueled concerns the Fed would be less aggressive with interest rate reductions in the coming months. Friday, May 11 Stocks slumped today as renewed strength in retail spending and rising consumer confidence fueled concerns the Fed would be less aggressive with interest rate reductions in the coming months. The Dow was down 89 points at 10,821 and the NASDAQ finished 21 points lower at 2,107. The broader S&P 500 index also retreated, down 9 points to 1,245. Trading volume on the NYSE was light at 896 million shares, with declines beating advances 16 to 13. On the technology exchange, volume reached just 1.41 billion shares with losers outpacing winners 21 to 16. In the bond market, the 30-year Treasury fell 1 9/32, pushing its yield up to 5.85%. Thursday's new plays (positions/opening prices/strategy): Pepsi (NYSE:PEP) JUL50C/42P $0.10 credit synthetic Pepsi (NYSE:PEP) JUN42P/45P $0.70 credit bull-put Novellus (NASDAQ:NVLS) JUN65C/35P $1.55 credit strangle Alliance (NYSE:AC) JUL50C/50P $5.40 debit straddle Norfolk (NYSE:NSC) JUN22C/22P $2.35 debit straddle Today's bearish activity provided some great entry opportunities in the PEP positions. We chose the bullish synthetic play with a downside break-even near $42.40. The conservative straddles in AC and NSC were also available at acceptable prices and the NVLS credit strangle offered a reasonable opening credit. Portfolio Plays: The major averages closed lower today with industrial stocks deep in the red on weakness in financial and defensive issues. Shares of technology bellwethers also weighed heavily on the market with the greatest selling pressure seen in computer hardware companies, software vendors, chip-makers, and telecom equipment stocks. The bullish economic data regarding consumer confidence and spending did little to assuage widespread concerns that corporate earnings will continue to decline over the next few quarters. In addition, some analysts suggested that today's optimistic reports reduced the potential for future rate cuts and investors began to question how much longer the Fed would pursue its aggressive interest rate management in view of the new data. Experts say a half-point cut is expected next week but the changing economic conditions may not warrant another reduction in rates during 2001. Some of the more optimistic traders expect the Federal funds rate to fall to 3.75% by mid-summer and yet there is little confidence that an economic recovery will begin in earnest before the first quarter of 2002. Investors echoed that outlook as they retreated to the sidelines with little interest in opening new positions before the weekend. The obvious anxiety over the current reporting period has started to fade but already there are rumors of upcoming sales and profit warnings, when companies confess they are likely to miss earnings estimates amid the slowing economy. Unless your are still waiting for an entry point, it's not a pretty picture in the near-term. Fortunately, there were a few positive moves in the Spreads/Combos section today. While most technology shares traded lower, select wireless telecom stocks posted small gains and AT&T (NYSE:T) and Nextel (NASDAQ:NXTL) were among those issues. In the chip sector, PMC Sierra (NASDAQ:PMCS) rebounded almost $3 to remain in a recent trading range near $40 and the retail group also advanced with Liz Claiborne (NYSE:LIZ) and Lowe's (NYSE:LOW) enjoying limited upside activity after analysts at Merrill Lynch analysts said they expect a strong performance from the sector. In the industrial segment, Active Power (NASDAQ:ACPW) continued its recent rally and both of the bullish plays in that issue are expected to finish at maximum profit. Among the bearish positions, Minnesota Mining (NYSE:MMM), Dynegy (NYSE:DYN) and Total Fina Elf (NYSE:TOT) all retreated and in the premium selling category, Lincare (NYSE:LNCR), Shire Pharma (NASDAQ:SHPGY), Chiron (NASDAQ:CHIR) and Veeco (NASDAQ:VECO) are profitable. One of the surprises of the session occurred in that category as Western Wireless (NASDAQ:WWCA), a provider of cellular service in mostly rural areas, posted a first-quarter loss amid a sequential decline in sales. The company said its losses totaled $17.3 million, or $0.22 a share, well below the consensus earnings estimate of $0.02 a share. Sales rose 35% from one year earlier but revenue actually declined slightly and the company gained only 37,000 new customers, far short of the 54,000 added in the fourth quarter, when sales tend to be strongest. Investors were shocked by the news and they dumped the stock for a $3 loss to $40. Since there was no real explanation for the shortfall, it may be best to take the current profit of $0.75 in the neutral credit strangle, closing the position before any other surprises become public. Questions & comments on spreads/combos to Contact Support ****************************************************************** - TRADING STRATEGIES - ****************************************************************** There are no "New Plays" today as I will be assisting with other sections of the newsletter. However, the market is once again entering a favorable period for option buying and since (debit) Straddles are a popular strategy, now is a great time to review some of the fundamental concepts in this technique. Debit Straddles - Volatility and Time Value A Straddle is an appropriate strategy for situations in which one suspects that a stock's price will move substantially but does not know in which direction it will go. A straddle can work very well in situations where important news is about to be released and it is expected that it will be either very favorable or extremely unfavorable. Corporate earnings announcements, new drug approvals, merger or takeover speculation and annual board meetings (where splits and spin-offs are announced) are examples of situations in which unexpected information can significantly affect stock prices. The most important thing to remember when evaluating a straddle of this nature is that the greater uncertainty associated with the current situation is known by everyone. The options may already be priced according to a higher future volatility, making the play unfavorable. The most attractive straddles will be those in which the trader is confident that the stock will be more volatile than everyone else and for that kind of evaluation, you need a solid understanding of Implied Volatility and Time Value. If you do not have a basic knowledge of volatility, please review that concept before you participate in these types of positions. It is very important that you understand what it is and how it behaves before you devote portfolio capital to strategies that profit from its effects. Assuming you have an fundamental understanding of volatility, we can discuss another important component of option pricing: Time Value. Option premium consists of two components: Intrinsic Value and Time Value. Assume that the current stock price is equal to the strike price. In this case, an option's premium for the call and put does not have any intrinsic value, only time value. The main factors that influence Time Value include: 1) The number of days until expiration 2) Implied Volatility 3) How far the option is in- or out-of-the-money. At-the-money options have the highest time value. As the option starts moving in- or out-of-the-money, the time premium begins to lose value. The closer an option is to expiration, the more an option's premium will shrink (per day), due to time decay. This gives us a guideline in selecting straddles. We have to pick an expiration month so that the price of the straddle will not be too high (not too far from expiration). However, it should still provide enough time for the stock to perform as expected, before we have to exit the trade to preserve capital. One important fact to remember; the highest increase in time decay for at-the-money options occurs in the last 30 days before expiration. That means one should rarely hold a straddle position to expiration. When you understand that time decay is working against the trade, you can begin to choose positions in which the other beneficial components such as intrinsic value and implied volatility, will boost the potential for profit, even as time passes. Now that you know time decay is working against the straddle, what other factors can help you achieve your goal of selling at a higher price in the future? Two components: Implied Volatility and Intrinsic Value. Implied volatility is a characteristic of an option's time value. The higher the implied volatility, the higher the option's time value. When you find a situation where implied volatility is statistically low (probability dictates that it should start to move higher), you can make a profit by selling your straddle at a higher price, even if the underlying stock price doesn't trade in a large range. Obviously, any increase in implied volatility will boost the time value of your position and move your position closer to a profitable outcome. Another basic component that can help us profit in a straddle is Intrinsic Value. Once again, assume that the underlying price is equal to the strike price; this means that our straddle does not have any intrinsic value. When the stock starts moving in either direction, one of our options will become in-the-money. This will cause the intrinsic value to grow in that option. In contrast, the time value of both of our positions begins to decrease as the underlying moves away from the at-the-money strike. Remember, the further the option is in- or out-of-the-money, the less time value it contains. The rate of change for both of these values is very important. Intrinsic value has a rate of change equal to one; if the stock price moves one point into the money, intrinsic value increases by one point. Time value is much more complex; the rate of change depends on how far away the option is from the strike price. The further the option is in or out-of-the-money, the smaller the rate of change on a one point move in the underlying issue. With that concept in mind, it is easy to see that when the stock price moves away from the strike price, we gain more in intrinsic value than we lose in time value and that's one way a straddle profits. The measurement of the underlying move is statistical volatility and we look for straddles on issues where we expect that component to increase. To construct profitable straddle positions, it is important to be aware of the effects of all these components. A theoretical edge in one or two of these factors can make a position favorable but it is better to have the majority of them on your side. The most common mistake among new traders is the purchase of short-term straddles. You can profit from these positions but usually that occurs only when the underlying starts moving immediately after the play is opened. Of course, it appears attractive because the straddle does not have a large amount of time value and the small movement required for profit seems very probable. The problem is, if the underlying doesn't move right away, time decay will start to increase rapidly and the option premiums will fall regardless of the potential for future stock price movement. Many traders believe that 2 to 3 months should be the minimum time frame for a debit straddle. If you have a choice between two or more series of expirations and the implied volatility for the longer-term options are lower, then you should probably go with the greater time value because those options are theoretically cheaper. In addition, you must always look for volatility that is low with respect to its historic levels. The reason is the tendency for volatility to return to its historical trend or median. This is sometimes called the "Rubber Band" effect and it basically means there is a high probability that when it's pulled too far in one direction, it will eventually reverse and start moving the other way. This pattern of behavior is the main reason why experienced traders use volatility based positions to make money. They will construct plays that take advantage of the future volatility of an issue, when the current value is high or low compared to its recent history. Volatility is a predictable and powerful concept for option traders and understanding this unique component is a must for achieving consistent profits in the derivatives market. Good Luck! #!!!AD15!!!# ********** 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: Contact Support
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