The Option Investor Newsletter Monday 06-11-2001 Copyright 2001, All rights reserved. 1 of 1 Redistribution in any form strictly prohibited. To view this email newsletter in HTML format with embedded charts and graphs, click here: http://www.OptionInvestor.com/htmlemail/3740_1.asp Posted online for subscribers at http://www.OptionInvestor.com ****************************************************************** MARKET WRAP (view in courier font for table alignment) ****************************************************************** 06-11-2001 High Low Volume Advance/Decline DJIA 10922.09 - 54.91 10975.44 10871.34 856 mln 1238/1811 NASDAQ 2170.78 - 44.32 2205.41 2150.75 1.39 bln 1462/2322 S&P 100 646.59 - 5.33 651.92 543.42 totals 2700/4133 S&P 500 1254.39 - 10.57 1264.96 1249.23 39.5%/60.5% RUS 2000 506.93 - 4.71 511.64 505.71 DJ TRANS 2828.94 - 53.15 2882.43 2826.41 VIX 22.74 + 1.33 23.78 22.56 Put/Call Ratio 0.63 ****************************************************************** Moot Monday Continued worriers over the economy and corporate profits kept the bulls at bay Monday. In fact, the conviction amongst the bears was less than inspiring noting the lackluster volume. Monday's session marked the third lightest trading day of the year on the Nasdaq market. Trading totaled roughly 1.4 billion shares on the Nasdaq market, while only 856 million shares exchanged on the New York Stock Exchange (NYSE). The 50-day average volume figures for the Nasdaq and NYSE are 1.8 and 1.09 billion, respectively. The light volume we're observing across the broader market is very indicative of this time of year. And it makes forming a thesis or bias all the more difficult because the ebbs and flows of the market lack conviction. Absent the volume and conviction, we can refer to price action in the major market averages in an attempt to find profitable trades while we wait (Hold our collective breath) for more guidance on the corporate and economic fronts. Last week, we made several observations concerning the bearish head-and-shoulders (H&S) pattern in the Nasdaq Composite (COMPX). Over the weekend, Jeff Bailey and I spent some time discussing the H&S pattern in the COMPX. Jeff is less convinced about the pattern due to the lack of volume near the right shoulder and due to the height of the right shoulder. While I argued that the pattern is ascending, hence the higher level of the right shoulder. Either way, Jeff and I both agree that 2100 is an important level for the COMPX to hold. That level is significant because it marks the 61.8 percent retracement of the COMPX's advance in early April and it is also the current site of H&S' ascending neckline. In addition, 2100 is a relatively significant level of demand on the point & figure charts. If the COMPX does break below that level, the H&S pattern we've been addressing may become a self-fulfilling prophecy, which would leave the COMPX with a bearish price objective in the low 1800s. However, as the chart above illustrates, dip buyers have shown up around the 2100 level on a regular basis in the recent past. So traders predisposed to buying dips might look to get long relatively strong Nasdaq stocks if the COMPX approaches 2100, but doesn't breakdown below that level. Conversely, a break and subsequent settlement below 2100 may embolden the shorts, who are likely to pressure tech shares, so try to keep those stops tight if you buy any further dip. As far as resistance for the COMPX, short-term traders might focus on the 2200 level, while those with a longer view should keep focused on 2250. Interestingly, the broader market, as measured by the S&P 500 (SPX.X) also exhibits an eerily similar head-and-shoulders (H&S) pattern. As I've illustrated on the chart below, the S&P has traced an ascending H&S, although I concede it is an imperfect pattern. Nonetheless, the S&P did bounce right off its ascending neckline this afternoon, which does give some credence to the pattern. Currently, that neckline lies at roughly 1250. Below that level, the S&P doesn't have much meaningful support until the 1225 level, which is reinforced by the index's 38.2 percent retracement level. Insofar as resistance concerns the S&P, I see congestion in the near-term at the 1270 level. The Dow Jones Industrial Average (INDU) has a somewhat similar ascending price pattern compared to the S&P and COMPX, but I think the INDU traded high enough last week to reject any suggestion of a head-and-shoulders. On the daily chart below, it looks like the Dow might settle into a trading range between support at 10,800 and resistance at the almighty 11,000 level. However, a breakdown in the Dow below 10,800, in my mind, would be most disconcerting because I don't see any REAL significant support until roughly 10,500. Along with the price action in the big three (COMPX, S&P and Dow) I think it makes sense to monitor the CBOE Market Volatility Index (VIX.X) as we work through the summer months. The current low level of the VIX is indicative of the lack of commitment in the market - the VIX traced a new yearly low last week at 21.11. To review, the VIX measures the level of fear in the market. The less fear in the market, the lower the level of the VIX. In 1999, the VIX bottomed on the week ended July 11th, at the 17.70 level, which coincided with a significant relative high in the COMPX. In 2000, the VIX bottomed on the week ended August 27th, at the 18.13 level, which, of course, coincided with the COMPX's post-Labor Day slide. Keep these historical lows in mind if the VIX continues to work lower, as it could spell trouble for the COMPX if the last two year's of history repeat. Perhaps the weakness in the Nasdaq Monday can be mostly blamed on the carryover of Juniper Network's (NASDAQ:JNPR) big warning last Friday. In fact, the company was the target of many downgrades Monday warning, which adversely impacted those tech stocks levered to the telecom industry. In addition to the Juniper-related weakness, two warnings before the bell Monday morning impacted trading. DuPont Photomasks (NASDAQ:DPMI) and Powerwave Technologies (NASDAQ:PWAV) both issued warnings. After the bell Monday, there weren't any warnings as big as Juniper's last week. But the warnings are certain to color trading in several sectors Tuesday. Affymetrix (NASDAQ:AFFX), which provides biotechnology research products and services, warned of a revenue short-fall Monday evening. The broader biotech sector, as measured by the Biotechnology Sector Index (BTK.X), has been a source of strength recently and Affymetrix's warning is likely to pressure shares within this space. Another recent "hot" sector of the market has been alternative energy stocks. But, after the bell Monday, General Motors (NYSE:GM) pre-announced that it was going to make two separate announcements in the coming days concerning fuel cell technology. It wasn't indicated is the announcements by General Motors were going to be good or bad, but judging by the price action in shares of FuelCell Energy (NASDAQ:FCEL) in the after hours session, the news isn't good. Shares of FuelCell lost about $7 in the after hours session before being halted. I'd like to thank everyone who attended my online seminar over the weekend and would encourage those who haven't already to check out our line-up this week. Our all-star analyst, and my good friend, Jeff Bailey, is scheduled to present an online seminar on Point & Figure Charts Tuesday evening. In addition, Jim Brown with be presenting on Basic Options Strategies and an excellent technician, Jon Farnlof, will be presenting a seminar on how to read Candlestick Charts. Check out the schedule below and simply follow the link provided to sign up. Eric Utley Editor ================================================================== June Online Seminar Calendar ================================================================== You can take the following seminars without leaving the comfort of your home or office. They are interactive and allow you to question the presenter during the presentation. You do not need any special software to take the seminar but you must have a 56K Internet connection or faster for best results and a separate phone for the audio portion. If you are interested in these seminars please click here for more information. http://www.premierinvestorseminars.com/seminarcalendar.asp Tue Jun-12 Starting with Point & Figure Charts - Jeff Bailey Wed Jun-13 Ask the Analyst - Eric Utley Wed Jun-13 Basic Option Strategies - Jim Brown Thr Jun-14 Using Volatility to Pick Stocks - John Seckinger Thr Jun-14 Basic Candlesticks - Jon Farnlof Sun Jun-17 7 Steps to Play Picking - Eric Utley Mon Jun-18 Zero Cost Leaps - Mark Wnetrzak, Ray Cummins Tue Jun-19 Profiting From Failed Technical Patterns - John Seckinger Wed Jun-20 Chart Patterns, Flags, Pennants, Wedges - Derek Baltimore Wed Jun-20 Entry Point, Exit Point - Jim Brown Thr Jun-21 Day-Trading for People WIth Day Jobs - Jon Farnlof Sun Jun-24 Determining Support and Resistance - Derek Baltimore Sun Jun-24 Ask The Analyst - Eric Utley Tue Jun-26 Assessing Risk with Point & Figure - Jeff Bailey Tue Jun-26 Charting, Stage Analysis - Mark Wnetrzak, Ray Cummins Wed Jun-27 Big Cap Strategies - Jim Brown Wed Jun-27 Conservative CC/NP - Mark Wnetrzak, Ray Cummins Click here for a detailed explanation of each: http://www.premierinvestorseminars.com/seminarcalendar.asp ************* NEW CALL PLAY ************* MSFT - Microsoft Corp $72.12 -1.07 (-1.07 this week) Microsoft is the #1 software company in the world. They develop, manufacture, license, and support a broad range of software products including Windows operating systems, server applications, the popular MS Office suite, and a Web Browser. CEO and co-founder, Bill Gates still owns 15% of Microsoft. Following a consistent pattern of lower-highs, the ascending wedge formation compressed and shares of MSFT "popped the lid off" its $72 resistance. The NASDAQ's bolt through 2200 was also an obvious catalyst that advanced MSFT upward to $73.75 last week amid the notable return in trading volume. Today's mild pullback and soundness at the $71.60 support offers us the opportunity to begin coverage in preparation for another upswing. Until we see a visible breakout through $74, it may be to your advantage to target shoot for an entry at the lower end of the Bollinger Band, near $71. The technical indicator suggests MSFT may be overbought as it approaches $74. In other words, playing the current spread in a volatile environment could be profitable for those with the risk portfolio and interest for quick in-and-out plays. Otherwise, it'll be a game of wait-and-see before committing your capital to MSFT. We have a bullish expectation that the NASDAQ may rally off its support mid-week; and hence, the #1 software maker would be first in line to lead the tech gains. Wait for the market confirmation and look for additional guidance from Goldman Sach's Software Index (GSO.X). Convincing moves through the 240 resistance would be awesome collaboration. And from a totally different viewpoint, there's the true-blue bulls who won't balk at taking positions down near May's $67 break point, perhaps even anticipating an earnings run. The company is confirmed to report its 3Q earnings on July 19th, after the market. We have a protective stop set at the above-mentioned $67 and will drop coverage if MSFT fails to close above this level. BUY CALL JUL-65 MSQ-GM OI=20504 at $8.90 SL=6.25 BUY CALL JUL-70*MSQ-GN OI=47460 at $5.30 SL=3.25 BUY CALL JUL-75 MSQ-GO OI=40644 at $2.65 SL=1.25 BUY CALL JUL-80 MSQ-GP OI=41508 at $1.15 SL=0.00 Average Daily Volume = 43.9 mln http://www.premierinvestor.com/oi/profile.asp?ticker=MSFT ************ NEW PUT PLAY ************ EBAY - eBay, Inc. $62.79 -0.76 (-0.76 this week) After developing a Web-based community in which buyers and sellers are brought together in an efficient format, EBAY has emerged as the dominant online auction site. The eBay dynamic pricing format permits sellers to list items for sale, buyers to bid on items of interest and all eBay users to browse through listed items. Items listed on eBay include collectibles, automobiles, art objects, jewelry, consumer electronics and a host of practical and miscellaneous items. Although based in the United States, through its subsidiaries, EBAY also operates trading platforms in Germany, the United Kingdom, Australia, Japan, Canada, France, Austria, Italy and South Korea. There's no arguing with the fact that eBay has become the dominant online auction site and that the EBAY has emerged as an anomaly in the world of Internet stocks -- they've become profitable, and it looks like they will stay that way. Investors have been rewarding the stock for this performance lately and the price has traced a nice uptrend for the past 2 months. So why is it on the put list, you ask? Well, don't look now, but in the past 3 weeks, EBAY has traced a nice double top near the $66 level. A quick look at a 2-year chart reveals that this is a pretty formidable resistance level. With the CBOE Internet index (INX.X) posting a Head & Shoulders top and the overall Technology sector being pressured by the bears, it doesn't take a rocket scientist to see that in the near term, EBAY has a lot more downside risk than upside potential. The bearish divergence on the daily Stochastics oscillator is just icing on the cake, further stacking the deck in favor of the bears. The only obstacle in our way is the 2-month ascending trendline, currently resting at $62. Conservative players will target new entries on a drop through that level, ideally with increasing volume and further weakness on the INX index. Aggressive traders can target shoot new entries near the $64 or $65 intraday resistance levels or our stop which rests at $66. Our first downside target is the $58 level, followed by $55. BUY PUT JUL-65 QXB-SM OI= 897 at $6.80 SL=4.75 BUY PUT JUL-60*QXB-SL OI=2553 at $4.50 SL=2.75 BUY PUT JUL-55 QXB-SK OI=2699 at $2.80 SL=1.50 Average Daily Volume = 5.93 mln http://www.premierinvestor.com/oi/profile.asp?ticker=EBAY ***************** STOP-LOSS UPDATES ***************** NETE - put Adjust from $44 down to $40 NEWP - put Adjust from $35 down to $34 RIMM - put Adjust from $37 down to $35 TLAB - put Adjust from $34 down to $32 ************* DROPPED CALLS ************* IMCL $49.50 -3.80 (-3.80) As feared, Biotechs continued to deteriorate on Monday and IMCL never stood a chance as traders lined up to the sell side. After the BTK index fell through the $640 level on Friday, the odds were stacked against the bulls and the result can be seen in IMCL's chart, as it opened today just above our $53 stop and promptly fell through it on its way to posting a 7% loss on heavy volume. We got to ride IMCL for a nice gain over the past couple weeks and we're happy to move on to the next winning play. PDLI $80.15 -4.54 (-4.54) It's hard to believe that PDLI posted a 9% gain just a week ago. What a difference a week makes. The $90.50 resistance level turned out to be too much of an obstacle for the bulls to scale, and simple profit taking gave way to a more serious correction today. Our $84 stop got taken out at the open, as PDLI continued to be pressured by weakness in the Biotechnology sector. Fortunately, we began coverage of the stock just before last week's 2-day 15% surge, and those that came along with us managed to book an impressive gain. With the Biotechs in retreat, it is time to find the next high-odds play. QCOM $59.78 -1.46 (-1.46) Sometimes it seems there is no justice. Just when QCOM looked like it was ready to run, JNPR warned and tanked the fledgling Technology rally. QCOM has done nothing but move down since we began our coverage, and with performance like that, it was no great surprise this morning to see the stock slice right through our $60 stop without even slowing. Although we did get a decent bounce in the afternoon, the fact that buyers couldn't hold the $60 level is a good sign that we don't want to chase this play for an entry. *********** DROPPED PUT *********** EPG $59.20 +2.20 (+2.20) A bullish day for the energy stocks killed any hopes of EPG setting another relative low. Rallying oil futures incited by Iraq's halt on oil imports and reported production problems related to the effects of Tropical Storm Allison in Texas were the culprits. A strong wave of buyers set EPG's share price on fire, fueling a fast run through $58 and $59. Stabilization above our $59 stop occurred throughout the afternoon. The likelihood that EPG will hold the gains going into tomorrow coupled with the fractional violation of our closing stop compels us to drop coverage tonight. ************** TRADERS CORNER ************** Calendar Spreads By Robert Ogilvie Last weekend, I wrote about Diagonal Spreads as an alternative to covered calls. Many of you must be thinking I am completely crazy writing about buying calls in the current market. All the market psychology gauges are getting close to previously over bought levels (VIX, VXN, and Investor Sentiment Polls) and earnings warning season is approaching. I often write about contrarian indicators and live by "when the VIX is low it's time to go." But the optimist sees that volatility levels are low which translates into lower premiums for many securities. Being carefully selective, I am looking for some stocks with strong fundamentals that are either uptrending or at lower levels just basing. For the purpose of this article, I am going to discuss debit call calendar spreads. A calendar spread is defined as an option strategy that generally involves the purchase of a farther-term option (call or put) and the writing of an equal number of nearer-term options of the same type and strike price. While fishing in Florida, where there are constant isolated storms throughout the summer, it is necessary to have a back up plan if a storm does kick up. The sees get rough and the boat's bilge fills up with water. I have been out on the Gulf of Mexico and had storm clouds surrounding the boat. Sometimes it rains and sometimes it stays clear. If it does rain, the boat has a bilge pump that pumps the water out so we don't sink. The bigger the boat, the better it can handle the rough water. This is true with longer-term options. The other common trait is the bigger the boat (longer-term option) the more it costs. The reason I sell the calls is the same reason bilge pumps are installed in boats; to bail us out a little when times get stormy. Assuming I have found a few candidates that meet my parameters, I begin shopping around for the best value on the longer term options (3 - 9 months until expiration) or the LEAPS. I am looking at the amount of premium I am buying as well as the delta and gamma figures. Open interest is important to a point, especially if I am doing a lot of contracts. I need liquidity without getting my head chopped off when I go to sell. For instance, the underlying is priced at 47.5. The Jan 2002 40 Calls trade at 11.40 per contract with a delta of 75. The Jan 2002 45 Calls trade at 8.30 with a delta of 67. The 40's have 7.5 of intrinsic value (in the money) and 3.90 of premium. The 45's have 2.5 of intrinsic value and 5.8 of premium. In my experience, the deltas are close enough to be a non-issue unless doing a large number of contracts for a short-term trade. The choice is yours. I prefer buying less premium in these market conditions. If the security goes down, the higher delta causes the premium to go down faster than on the lower delta option. In addition, there is the loss of intrinsic value. The more you have the more you can lose. For this example, let's buy the Jan 2002 45 call. O.K., I have my long position. Now I wait. Doesn't that sound stupid? A smart investor waits until there is some indication that the security may rise in price. But we are in a peculiar market where it may go up or down. Assume I think this is a good time to buy. However, just in case I am wrong, I want to sell the near term calls that are out of the money. If there is any premium in the June strike prices; I may try to lock in a little premium for a week. Most likely, I will sell the July calls. The June 50's are only bidding $0.25 per contract. I might do this. The reason I may not is because the July calls may lose an equal amount of premium. If I sell the June and July calls, there are two commissions. As a broker, one might think I would push the June and July's. But the best thing may be to wait to sell the calls. If the stock starts to move up, I'll wait until it becomes extended to sell the out of the money calls. I may choose to sell the long calls. But I have entered this for a longer uptrend and will probably hold the leaps and use the premium on the short calls to offset any market volatility. If the stock starts to drop after I've bought the calls, I will sell the out of the money calls. There is one problem with lower volatility. This translates into less premium on the out of money calls. The July 50 calls are trading for $1.85/contract while the July 55 calls are bidding $0.60/contract. Which call do I sell? I look for the next resistance level to help decide. I want to sell the next strike price above the resistance. For instance, if the resistance is at 52, I will sell the 55's. If the resistance is at 48.5, I will sell the 50's. Lower priced and recently split securities allow more flexibility because of the $2.5 strike price increments. But these stocks are low priced because the all-knowing market has deemed them low price. The argument could go either way. The lower priced stocks have less to fall and/or might not be over inflated. This above example is actually a diagonal (combination & price) spread. If I wanted a true calendar spread I would buy the Jan 2002 50's and sell the June 50's. The long position's premium is low enough, but the delta is lower and I am paying all premium. I would rather have my mutated example. The most important ingredient is to buy the option strike that makes the most sense to you and your analysis. If you buy the long-term option because of technical analysis, then sell it based on technical analysis. The reason to buy long-term options is based on leverage. If the premium paid is near the cash required to buy the underlying security, maybe you should buy the stock. I usually sell the long position if it drops below its support or if it becomes overbought or if the stock price breaks through the short option's strike price. Here is another example to drive it home. XYZA is trading at $17. It has support at $15 and resistance at $18 and has been trading in a range for months. It is also a leader in its sector and may be showing signs of future strength. The Jan 2002 17.5 calls cost 3.60/contract while the Jan 2003 17.5 calls cost 5.90/contract. I buy the 2003's and sell the June 17.5 calls for $0.35/contract. The initial return isn't bad. Then next week I can decide whether to sell the July 17.5 or 20 strike price. As with all strategies, there are various actions that may be done that I my not have considered. If you have any questions, please contact me. If there are strategies or topics that you feel need coverage, please let me know. Robert John Ogilvie email@example.com Neither Cutter & Company, Inc. nor Robert J. Ogilvie makes any representation as to the accuracy, reliability or completeness of any charts, formulas, and /or research opinions presented herein. This article is intended solely for educational purposes. Nothing herein should be construed as an offer or solicitation to buy or sell any securities. Cutter and Company is a Member of the NASD, MSRB, and SIPC. Please read the OptionInvestor.com's Disclaimer: http://www.OptionInvestor.com/page/oin/aboutus/disclaimer.html ********************** PLAY OF THE DAY - CALL ********************** BRCD - Brocade Communications $46.07 +0.98 (+0.98 this week) Brocade Communications is a provider of Fibre Channel switching solutions for Storage Area Networks (SANs), which apply the benefits of a networked approach to the connection of computer storage systems and servers. The company's family of SilkWorm switches enables companies to cost-effectively manage growth in their storage capacity requirements and improve the performance between their servers and storage systems. This provides the ability of increasing the size and scope of a company's SAN, while allowing them to operate data-intensive applications, such as data backup and restore, and disaster recovery on the SAN. Most Recent Write-Up Despite the JNPR-induced weakness on Friday, BRCD had a pretty decent week, tacking on a respectable 16% gain. While volume is still waffling below the ADV, it is encouraging to see higher volume on the rally days than on those days where the stock is giving back a little ground. Since Memorial day, BRCD has established a new, if tenuous uptrend line, which currently rests just above our $42 stop. Investors desperately want to believe that the worst is behind for Storage stocks (as well as the overall Technology sector) and ignored a good bit of bad news sprinkled throughout the week (mainly in the Semiconductor sector), to push our play as high as the $48 resistance level before pulling back on Friday. With the price currently above the 30-dma ($44.00) and the 10-dma ($41.98), both of which have offered support in the past few days, BRCD looks like it is headed higher. Even the daily Stochastics is cooperating, halfway between its extremes, but still pointing towards the sky. Aggressive entries still await on a bounce from the ascending trendline, or possibly from intraday support at $44. More conservative traders will let BRCD prove itself by surging through the $48 level before taking the plunge. Either way, keep a sharp eye out for profit taking as our play approaches the $51-52 level, and then again near $54. Comments Shares of Brocade staged an incredible rebound Monday, off of our stop at the $41 level. The stock finished the day strongly and its momentum may carry over into Tuesday's session. Look for a breakout above $48 resistance or a pullback into the $44 area for entry points. BUY CALL JUL-45*UBF-GI OI=11908 at $6.40 SL=4.50 BUY CALL JUL-50 UBF-GJ OI= 2868 at $4.10 SL=2.50 BUY CALL JUL-55 UBZ-GK OI= 4886 at $2.60 SL=1.25 BUY CALL OCT-50 UBF-JJ OI= 1523 at $8.20 SL=5.75 BUY CALL OCT-55 UBZ-JK OI= 213 at $6.70 SL=4.50 Average Daily Volume = 14.4 mln http://www.premierinvestor.com/oi/profile.asp?ticker=BRCD ******************* 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. 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