The Option Investor Newsletter Monday 07-16-2001 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/8038_1.asp Posted online for subscribers at http://www.OptionInvestor.com ****************************************************************** MARKET WRAP (view in courier font for table alignment) ****************************************************************** 07-16-2001 High Low Volume Advance/Decline DJIA 10472.12 - 66.94 10568.69 10446.60 1.03 bln 1184/1877 NASDAQ 2029.12 - 55.67 2091.68 2025.41 1.48 bln 1466/2234 S&P 100 620.60 - 6.25 629.69 618.61 totals 2650/4111 S&P 500 1202.45 - 13.23 1219.63 1200.05 RUS 2000 483.80 - 6.91 491.40 483.77 DJ TRANS 2962.79 + 22.44 2975.35 3937.45 VIX 25.31 + 1.44 25.66 23.70 Put/Call Ratio 0.58 ****************************************************************** Buckle Up, Baby The week ahead is going to be a wild one. Second-quarter earnings are in full effect, Greenspan appears mid-week and option contracts expire Friday. Whoa, welcome volatility. The earnings picture Monday morning was painted with a lot of colors and viewed with mixed perceptions. Citigroup (NYSE:C) reported profits that beat consensus estimates by one penny, and although its shares ended modestly higher, they lost the majority of earlier gains as the day wore on. Bank of America (NYSE:BAC) also reported earnings that beat expectations, but its shares weakened throughout the day, similar to the trading in shares of Citi. The late day weakness in the aforementioned banking shares was perhaps partially a product of the earnings shortfall of Bank of New York (NYSE:BK). The company missed consensus estimates by one penny, and provided cautious guidance for the remainder of the year due to the global economic weakness. Its shares shed 13 percent. The KBW Bank Sector Index (BKX.X) finished rather poorly Monday, which may be indicative of further downside in the bank sector, thus the broader market as measured by the S&P 500 (SPX.X) In fact, a few of us in the office this morning were mulling the probabilities of shorting some weak bank stocks...To digress, I can't emphasize enough that the bank/finance sector is ultra critical to the broader market, and should serve as a leading indicator. In fact, a trader might do well to monitor the BKX in conjunction with bond yields to get a feel for the supply and demand dynamic in the market. The BKX settled near its day lows Monday and meaningful support now lies around the 870 level, while the 900 level on the upside should serve as resistance. What the bank sector is to the broader market, the Philadelphia Semiconductor Sector (SOX.X) is to the Nasdaq. The SOX steadily declined throughout Monday's session in the wake of cautious comments from Merrill Lynch chip analyst Joe Osha. The selling of semi stocks was perpetuated by cautious guidance delivered by an Applied Materials (NASDAQ:AMAT) executive out west at the Semicon West Conference, which is a large gathering of chip businesses. The conference should continue to produce guidance, in one form another, as the week progresses. After the bell, Novellus Systems (NASDAQ:NVLS) - a chip equipment maker akin to AMAT - reported earnings that beat previously lowered estimates, but delivered guidance that was less than positive. In essence, Novellus stated that they weren't sure whether or not the bottom had been reached in their business and remained cautious going forward. The stock dropped another $1.50 in the after hours session, and dragged alike chip shares lower. The SOX should gap lower Tuesday morning off of Novellus' guidance, depending upon how the sell-side of Wall Street paints the picture. The SOX is below most meaningful support levels, but does have some minor support between the 540 - 550 range. Of course a convincing breakdown below that level could offer bearish traders the green light to get short weak chip stocks and should portend further weakness in the Nasdaq Composite (COMPX). But keep in mind that Intel (NASDAQ:INTC) - the mother of all chip companies and about 6 percent of the Nasdaq-100 (NDX.X) - reports after the bell Tuesday. The weakness in the SOX dragged the COMPX back towards the psychological 2000 level. The COMPX remains a bit of a conundrum in its recent range, unless you've been shorting strength and buying weakness. With the COMPX, keep in mind that it has an unfilled gap down to the technically significant 1975 support level, which looks like it's going to get filled this week without some help from corporate America. The S&P 500 is also approaching a key support level at 1200. Actually, it's already there. The S&P has traced a pattern of lower highs and lows since late May, like the rest of the major market averages, and could be setting up to take out its lows between the 1170 - 1180 range. In terms of overbought versus oversold, the S&P is in neutral territory. Therefore, it's certainly possible that it could take out its relative lows, giving traders opportunities for profits on the short side in weak sectors. Also worth noting, as it pertains to the broader market, is the continued slide in bond yields. On balance, yields continue to fall as bonds are bought, which could translate into less demand for equities. The 30-year Treasury Bond YIELD (TYX.X) is approaching a key support level, so bullish and bearish traders alike may want to monitor its action this week as it relates to equities. The Dow Jones Industrial Average (INDU) may also be having trouble due to bond yields. It has stalled around the 10,550 level in the past two trading days, and on balance is having difficulty around the 10,500. That much is not surprising given the fact that 10,500 provided substantial support on the way down. Should the Dow continue to act heavy around the 10,500, it is likely to roll back down towards 10,250 in the short-term. Conversely, the 'right' catalyst could propel the index above the 10,550 range and catch some shorts off guard. Aside from corporate earnings this week, perhaps Greenspan's appearance Wednesday could serve as a positive catalyst. The Fed Chairman is scheduled to give his semi-annual state of the economy testimony before Congress Wednesday morning. Market participants will be listening for guidance from the Doc on the current state of the U.S. economy, the Fed's forecasts on growth and inflation and, perhaps most importantly, the Fed's future actions on interest rates. Therein lies possible catalysts, but whether Greenspan remains mum or not remains to be heard. The list of companies reporting earnings Tuesday is a long one, but here are several companies worth mentioning that are slated to report, either before or after the bell: Apple Computer (NASDAQ:AAPL), Bank One (NYSE:ONE), Biogen (NASDAQ:BGEN), Caterpillar (NYSE:CAT), General Motors (NYSE:GM), Intel, International Paper (NYSE:IP), Johnson & Johnson (NYSE:JNJ), Pfizer (NYSE:PFE), Veritas (NASDAQ:VRTS) and Wells Fargo (NYSE:WFC). Again, within that list lies the possibility of a catalyst either in one direction of another for respective sectors. Add to the mix that Friday marks July expiration which, in and of itself, should produce some rather wild gyrations. My best advice for those who can't watch the market actively this week is to be very selective when putting on trades. But for those with the ability to monitor price action closely, there are sure to be several big profit opportunities available this week. Just take a look at two of the Biotech short plays we had on the list over the weekend in Myriad Genetics (NASDAQ:MYGN) and Human Genome Sciences (NASDAQ:HGSI), whose shares lost 15 and 10 percent, respectively. Fear can be a wonderful thing if you're on the 'other' side. Eric Utley Editor www.OptionInvestor.com **************** MARKET SENTIMENT **************** FUNdamentals By Jeffrey Canavan As a dyed-in-the-wool technician, I must yield to fundamentals this week. Technical indicators will still their impact, but they could easily be trumped by positive or negative earnings surprises. As technicians, one thing we can watch is how the markets react to the upcoming earnings announcements. Take the Banking Index for example. Citigroup and Bank of American reported better than expected earnings, yet gave up most of their profits by the end of the day. Citigroup was up $1.85 at one point in the day, but only finished up $0.29. By the end of the day, the Banking Index was in negative territory. An argument could be made that a future profit warning from Bank of New York hurt the index, but positive earnings from the No. 1 and No. 3 banks should have had a bigger impact. Overall this sector looks susceptible. Then again, most sectors are stuck in a downtrend and look susceptible. The Internet Index had a chance to break its downtrend today, but failed. Tomorrow could be the Retail Index's turn, but the way it retreated today doesn't bode well. The only sectors that come close to resembling an up trend are transports and its cousin airlines. Biotechnology and oil services are oversold, but have fun trying to catch that falling knife. Overall shorting looks like the best policy, and it's going to take a lot of positive earnings to change that. Luckily we have a plethora of earnings to choose from this week. The main focus will be on what IBM and Intel have to say, and we should then focus on how the market reacts to that. If IBM and Intel meet or beat estimates and the market still sells off, something could be amiss. *************************Sector Watch**************************** Weekly Daily Overbought Support Resistance Trend Trend Oversold DJIA Bearish Bearish Neutral 10,200 10,600 NASD Bearish Bearish Neutral 1,940 2,125 S&P 500 Bearish Bearish Neutral 1,170 1,240 Rus 2000 Neutral Bearish Neutral 465 500 Semis Bearish Bearish Neutral 525 585 Biotech Bearish Bearish Oversold 490 550 Internet Neutral Bearish Neutral 160 186 Networking Bearish Bearish Neutral 300 365 Software Bearish Bearish Neutral 188 210 Banking Neutral Neutral Neutral 625 670 Retail Neutral Bearish Neutral 850 900 Drugs Bearish Bearish Neutral 365 390 Percent Change Last Last Last Relative Strength 5 Days 10 Days 30 Days vs S&P 500 DJIA 2.8% (0.3%) (3.4%) Positive NASD 0.1% (6.2%) (5.6%) Neutral S&P 500 0.3% (1.8%) (4.6%) N/A Rus 2000 (0.4%) (5.6%) (3.6%) Neutral Semis (1.0%) (10.6%) (9.6%) Negative Biotech (11.9%) (18.7%) (20.0%) Negative Internet (1.6%) (7.9%) (18.8%) Neutral Networking 0.5% (7.3%) (21.8%) Neutral Software (3.5%) (12.1%) (10.6%) Neutral Banking (0.4%) (1.6%) (2.0%) Neutral Retail 6.1 3.3% (0.6%) Positive Drugs (2.5%) (0.6%) (7.1%) Neutral ************** TRADERS CORNER ************** Analyzing Those Amazing Analysts by Mark Phillips If you are like me, you grew up hearing of the experts on Wall Street and mentally assigning a rather high status to their ability to analyze a company and determine whether a given stock was over-valued or under-valued. As a matter of fact, it wasn't that long ago that I began to question the vaunted wisdom of analysts at the major Brokerage houses. Conventional wisdom says that if the leading Semiconductor analysts at Merrill Lynch, Robertson Stephens, Goldman Sachs and Bear Stearns all rate INTC a Strong Buy, with a 12-month price target of $70, while the stock is trading below $30, we should all run out and buy the stock, right? Not so fast, Sparky! We know that mass psychology moves the markets, but most people assume that applies only to investors. Analysts are people too, driven by the same hopes and dreams as individual investors. Why is it that 9 different analysts come out on the same day to downgrade a stock when the company issues a negative press release or earnings warning? You think they all arrived at the same conclusion independently? No way, Jose! They are each motivated by staying with the crowd and not being out of step. Afterall, that could make the tardy or contrarian analyst unpopular with investors if they deem him to be out of touch with the stock/sector/market, and will take their investment business down the road to another firm that is more "in touch" with the market. My question is, "Where were they BEFORE the warning came out?" If with all their research resources, they can't see the bomb before it hits, then what good are they? If you think that is a harsh statement, let me propose that it is the kindest face I can put on the behavior of analysts, as it presupposes that they are moved by simple mass psychology. Nothing more, nothing less. Unfortunately the water gets a lot muddier. First there is the problem of trying to interpret what the various ratings mean. It can be a daunting task with a list of ratings that includes Aggressive Buy, Strong Buy, Buy, Hold, Sell, Market Perform, Market Outperform, Market Underperform, Attractive, Neutral, Accumulate, Trading Buy, Maintain, Avoid, Recommended List and Top Pick. Could somebody please point me to a roadmap for this confusing list of ratings. Why can't we just have Buy, Sell and Hold? I think it is deliberately confusing to further propagate the illusion that analysts have some great secret knowledge, which they are willing to dole out in limited quantities to their loyal (read that, high net worth) clients. And don't even get me started on the issue of conflict of interest. With the large percentage of the revenue of large brokerage houses coming from their investment banking arms, analysts are frequently pressured to not make negative comments about companies that provide substantial revenue to the investment banking side of the business. We need to understand this relationship, as it makes it clear that following analyst ratings is not necessarily in the best interest of individual investors. The analysts do not issue their ratings for us. They do it to keep the investment banking revenue stream flowing. I'd be willing to bet the analyst in question is motivated by the fact that his year-end bonus is tied to performance. And that performance has NOTHING to do with the accuracy of his prognostications in the stock market; but it has everything to do with the amount of revenue the analyst brings into the firm, either directly or indirectly. The translation is that for the most part, analysts seem to move as a crowd, you know, lemmings. Well, let's be fair - maybe analysts really are a cut above, possessing some great hidden wisdom, and we should pay attention. Let's grab a random example, say AMZN, and look at the upgrade/downgrade history over the past 21 months for three different, big-name firms (Prudential, Banc of America, and Merrill Lynch). That takes us back to early September, 1999. Let's look at Prudential first. On 9/23/99, Prudential initiates coverage of the stock with a Strong Buy rating when AMZN is trading for $67. Just over a month later, on 10/28/99, the firm drops their rating to a Hold with the stock now trading at $69 (after dropping back from the early October high of $90). Then after the Technology market finished with its blowoff top in early 2000, Prudential was back on the Strong Buy bandwagon on April 27th. With the stock trading near $50 at this point, it must have looked like a bargain; doubly so when AMZN dropped to $33 in late June, prompting a reiteration of the firm's Strong Buy rating. Thinking it over a month later, the call must not have looked so smart, as it was dropped back to a Hold on July 27th with the stock trading near $30. Now here's a quick aside. The strict definition of a Hold rating is to maintain your current position in the stock. Don't sell it, but don't add more money into the position at this time. Due to their desire to maintain investment banking business with publicly traded companies, brokerage firms very rarely issue an actual sell rating. That leaves it up to us, the investing public to decipher the analyst code and deduce that a Hold rating actually means Sell. And if they ever issue a Sell rating, it means "Get out fast, run for your lives, the world is going to end, yadda, yadda, yadda". So back to the trail of ratings left by Prudential. After the Hold on July 27th, they reiterated that rating 5 times by the end of January 2001, as the stock continued to fall. Then finally on February 15th, Prudential threw in the towel and issued a Sell rating with AMZN trading near $14. Since that time we have watched the stock come under additional selling pressure, declining as low as $8.37 in early April. But the burning question is, what is the point of issuing the Sell rating at that point? Investors that followed the advice of Prudential would have purchased the stock between $35-55 and held it all the way down to a price of $14, before finally cutting their losses and avoiding the final $6 loss. Adding insult to injury, AMZN has since recovered significantly. While it hasn't shot to the moon, it has several times topped the $17 level, most recently on Friday. Prudential is still sitting on their Sell rating, while AMZN is now trading much better than at any time over the past 18 months when the brokerage held Buy and Strong Buy ratings. Lest you get the idea that I'm picking on Prudential, let's look briefly at the performance of our other two brokerage firms. First let's look at Merrill Lynch. Starting with a downgrade from Buy to Accumulate on October 28th, 1999, with AMZN trading at $69, the firm had no less than 11 revisions to its ratings up through November, 2000. Bouncing back and forth between Buy and Accumulate (which I think means Buy more slowly), with numerous reiterations, Merrill Lynch looks like their goal is to have their clients dollar-cost-average all the way to zero. Despite the fact that their rating on the stock (Near-Term Accumulate/Long-Term Buy) hasn't changed since November of 2000, the price of the stock is down another 60%. That's not exactly what I would call stellar guidance! Not to belabor the point, but let's take a quick look at our third brokerage firm, Banc of America Securities. Starting with a Buy rating on October 28th, 1999, the firm quickly dropped its rating to Market Perform, helping their clients to miss out on the run above $100. Not to miss out again, the firm joined the orgy of upgrades on February 1st and 3rd, 2000, quickly moving AMZN up to Buy and then to Strong Buy. That highest recommendation was maintained all the way until July 27th, when the stock had declined back to the $32-33 range (down from north of $80). After quickly ratcheting their rating back down to Market Perform on July 28th, Banc of America has been fairly quiet, with their latest statement on the matter coming with a reiteration of their rating on January 9th. So what's the point of all this analyst bashing? It is two-fold. First I want you to be aware that analysts are not any smarter than you or I - they look at the same data and draw their own conclusions, which are handed down like so much pablum for consumption by the masses (you and I). Mass psychology, greed, fear, and hysteria are just as dominant in their decision-making process as it is in ours. But we are responsible for our own investing success, and need to do our own research. All the information we need for making well informed investing decisions is available online - all we need to do is buckle down, go find it, and then draw our own conclusions. The results are bound to be at least as good as the kind of 'advice' we get from the analyst community. But here's the second way we can learn from the behavior of analysts. If they behave like a crowd, can't we use them as a contrarian indicator? If our analysis says that a stock may be approaching a point where all the good news is priced in and it could be due for some weakness, could it be that most of the analysts will be lined up on the Buy/Strong Buy side? If so, it would seem to be a good contrarian indicator that will confirm our own analysis. Or better yet, find an analyst or group of analysts that seem to defy the 'madness of crowds' and actually arrive at their own conclusions. If they can demonstrate a good-track record, maybe you have found a reliable analyst that you can listen to as one of your inputs for analyzing various investments. The bottom line is, "Trust Yourself"! Nobody else will be as serious about looking out for your financial interests as you will, and you are just as capable of assimilating the information necessary to make informed investment decisions as the Grand Wizards of Wall Street. ************* NEW CALL PLAY ************* No new calls tonight ************ NEW PUT PLAY ************ SRNA - Serena Software $23.13 -2.81 (-2.81 this week) Serena Software is a provider of eBusiness software change management (SCM) solutions. The company's products and services are used to manage and control software change for organizations whose business operations are dependent on managing information technology (IT). SRNA's product offerings support the industry standard IBM mainframe platforms, including MVS, and are marketed under the brand name Full Cycle mainframe. This product suite automates the software application life cycle and creates an IT environment that facilitates concurrent development efforts by separate programming teams, improves process consistency, enhances software integrity and protects valuable software assets. Following the broader Software index (GSO.X) lower, SRNA is having its own problems, which commenced with a sharp decline earlier this month. Despite a strong bounce last Thursday, the index is rolling over again ahead of major earnings reports due out this week, beginning with SEBL on Wednesday and MSFT on Thursday. Failing to break through the $37 resistance level, SRNA quickly fell back through the $31 support level, then the 200-dma (currently $29.05), before today's technical failure, where SRNA dropped through the $25.50 support level. This completed a triple-bottom breakdown on the Point and Figure chart, which is now giving a tentative bearish price target of $15. Volume the past 2 days has been very heavy, adding to the bearish picture. With earnings still a month away, the stock is likely to be subject to the whims of the broader Software sector. Watch for the GSO index to continue its decline, pushing SRNA towards a test of the $20 support level. If the GSO index falls through the $190 support level, look for SRNA to break that important support level and take aim on the next level of support near $16. Target failed intraday rallies below $27.50 for new entry points, as this is also the site of major resistance and the 50-dma. Alternatively, wait for SRNA to fall through the $22.50 level before taking a position in the ongoing decline. We are initially placing our stop at $27.50. BUY PUT AUG-25.0 NHU-TE OI=120 at $4.00 SL=2.50 BUY PUT AUG-22.5*NHU-TX OI=188 at $2.75 SL=1.50 BUY PUT AUG-20.0 NHU-TD OI=225 at $1.40 SL=0.75 Average Daily Volume = 697 K ***************** STOP-LOSS UPDATES ***************** BBY - call Adjust from $64 up to $65 JCI - call Adjust from $76 up to $78 AT - call Adjust from $61 up to $62 LEA - call Adjust from $37 up to $38 LH - call Adjust from $79 up to $80 MYGN - put Adjust from $53 down to $45 AMGN - put Adjust from $57 down to $56 HGSI - put Adjust from $49 down to $46 AES - put Adjust from $42 down to $40 ************* DROPPED CALLS ************* No dropped calls tonight *********** DROPPED PUT *********** No dropped puts tonight ********************** PLAY OF THE DAY - CALL ********************** LH - Laboratory Corp. of America $85.20 +1.22 (+1.22 this week) Laboratory Corporation of America Holdings (LabCorp) is the #2 clinical laboratory service in the world, behind Quest Diagnostics. LH performs 2000 types of tests for more than 100,000 clients, including health care providers, pharmaceutical firms, physicians, government agencies and employers. With 25 major laboratories and some 1200 service sites nationwide, the company emphasizes specialty and niche testing such as allergy tests, HIV tests, blood analyses, and substance abuse screenings. Most Recent Write-Up It took some time to build a new base after the sharp decline in shares of LH that commenced in early January, but the price action over the past 4 months has done a good job of establishing a new uptrend. The ascending trendline is now resting near $79, giving us a reasonable location for our stop. Breaking above the top of the long-term bullish wedge at $82 on strong volume Friday is what really got our attention though, as it opens the door for LH to move up and retest its January highs near $90. Chiming in with an ascending triple-top breakout on Friday, the Point and Figure chart casts its vote in favor of the bulls as well. CS First Boston helped to get the stock moving up last week by reiterating their Strong Buy rating and with earnings scheduled for the afternoon of July 23rd, it looks like a momentum run is in the making. We'll target intraday pullbacks to the $82 or $80 level for new entries, although a volume-backed move through $84 looks attractive as well. Comments LH bucked the broad market weakness Monday, and actually closed on its day high. We're looking for the buying to follow through into Tuesday's trading as the stock faces little in the way of near-term resistance. Bullish traders can enter new positions at current levels early Tuesday if others in the sector such as DGX and PPDI are advancing. Otherwise, wait for a pullback on light volume down to $83. BUY CALL AUG-80 LH-HP OI=731 at $7.80 SL=5.50 BUY CALL AUG-85*LH-HQ OI=408 at $4.80 SL=3.00 BUY CALL AUG-90 LH-HR OI=123 at $2.65 SL=1.75 BUY CALL NOV-85 LH-KQ OI= 32 at $9.20 SL=6.50 Average Daily Volume = 486 K ******************* 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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