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Daily Newsletter, Monday, 08/06/2001

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The Option Investor Newsletter                   Monday 08-06-2001
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******************************************************************
MARKET WRAP  (view in courier font for table alignment)
******************************************************************
        08-06-2001        High      Low     Volume Advance/Decline
DJIA    10401.30 -111.50 10504.10 10374.90  817 mln   1200/1869	
NASDAQ   2034.20 - 32.10  2053.60  2032.51 1.08 bln   1393/2286
S&P 100   615.21 -  8.44   623.65   613.16   totals   2593/4155
S&P 500  1200.48 - 13.87  1214.35  1197.35           
RUS 2000  480.96 -  6.19   487.14   480.95
DJ TRANS 2908.27 -  5.75  2934.27  2905.50
VIX        23.74 +  1.35    24.20    22.85
Put/Call Ratio      0.56
******************************************************************
 
The Weekly Chip Flip-Flop Continues

The seemingly never-ending chip saga continues with negative
comments on the Semiconductor industry issued this morning to
combat Merrill Lynch's bullish remarks last week.  Salomon Smith
Barney fired the opening volley before the opening bell this
morning, trimming their estimates on Intel (NASDAQ:INTC) for Q3
from 11 cents down to 8 cents, for 2001 from $0.54 to $0.47, and
from $0.75 to $0.70 for 2002.  Lehman Brothers chimed in, saying
the company is planning to cut prices by up to 50% in an effort
to halt a growing market share loss to rival Advanced Micro
Devices (NYSE:AMD).

Other analysts stepped in to defend INTC, saying the price cuts
are not a surprise.  Bear Stearns reiterated their Buy rating,
saying that bookings are strong.  Clearly, the bullish case on
INTC is predicated on strengthening back-to-school and seasonal
demand driving strong order flow for the chip giant's ubiquitous
Pentium processors.  But there's a fly in that ointment.  Radio
Shack (NYSE:RSH) reported disappointing July same-store sales
this morning, and investors responded by shaving 8.5% from the
stock's price.  Other electronics retailers like Best Buy
(NYSE:BBY) and Circuit City (NYSE:CC) fell in sympathy.

It's hard to make a bullish case for chip stocks when demand
seems to be softening at the end market and major price
reductions tend to cut into margins.  Hmmmm...Lower sales
volume and less profit on each sale don't seem to be a good
recipe for earnings growth and that seems to have been the
conclusion many investors arrived at today.  The Semiconductor
index (SOX.X) gapped lower and fell all the way to its 200-dma
near $625 on the bearish sentiment.  But what's this?  The SOX
actually bounced at the 200-dma and managed a steady, if tepid
recovery throughout the day.  The daily chart below shows the
mixed technical picture that is facing traders right now.


 

Bulls see the bounce at significant support and the fact that
the SOX has broken out of the descending channel.  Bears see
the reversal at the 61% retracement level (near $644) and daily
stochastics just lining up to give a strong sell signal as the
fast line drops out of overbought territory.  A renewed move
through the 61% retracement level will embolden the bulls as
they take aim on major resistance at $700.  The other side of
the coin has bears focused on the 50% retracement level, as a
drop through that point would open the door for a retest of the
38% level ($605) as support.  Semiconductor bulls don't want to
think about a violation of that level, as it would drop the SOX
back into the descending channel.

And what's this?  CDW Computer Centers (NASDAQ:CDWC) is out
after the close with an earnings warning, confessing flat
same-store sales and a lack of confidence that it could meet its
August and September sales targets.  After closing on Friday at
$47.62, the stock had already lost nearly 4% to $45.82 by the
closing bell.  The extended session saw plentiful sellers drive
the price down as low as $40.10, and there could be more
collateral damage in the consumer electronics sector tomorrow.

Why have I focused so heavily on the Semiconductor sector
tonight?  It is widely accepted that any sustainable recovery
in Technology stocks will have to be led by growth in chip
stocks, so the outcome of this bull-bear debate will be pivotal
to the near-term direction of the NASDAQ.  And simply put, the
broader market averages are stuck in a rut, stuck in a rut,
stuck in a rut...SLAP!  Thanks, I needed that!

While we've seen some substantial daily moves both to the upside
and the downside over the past week, we are awfully close to
unchanged for the past 5 sessions.  As I was filling in the
table above, I was astounded by the miniscule week-over-week
changes.  The DJIA is down a whopping 0.4 points since last
Monday, the S&P500 is down just over 4 points and the NASDAQ
Composite is actually leading this parade with a gain of 16.40.

So the NASDAQ did the best of the 3 major indices over the past
week, but a quick look at the chart shows the bears flexing
their muscles again.  Daily Stochastics have rolled and dropped
out of overbought, and the descending trendline (now at 2085) is
still capping the upward moves.  Whether you pick 2000 or 1960
as your support level, the COMPX is locked in a bearish
descending wedge, and with earnings winding down, there are few
catalysts on the horizon that might motivate buyers.  Earnings
from CSCO tomorrow evening are one possible exception, but I'm
not holding my breath.


 

Looking at the DJIA and S&P500 doesn't present a rosier picture
either as you can see from the montage below.  Simply put
Dorothy, we're not in Kansas anymore!  We're in the summer
doldrums, with anemic volume to boot.  For the record, this was
the lightest full trading day on the NASDAQ for 2001, with a
measly 1.08 billion shares trading hands.  The NYSE didn't do
much better, barely topping 800 million shares.  The set of
charts below show the effect this lack of interest is having
on the other two broad market averages.


 

Market internals weren't rosy either with decliners solidly
outpacing advancers on both the NYSE and NASDAQ, but with the
light volume, it is hard to draw solid, reliable conclusions.
There is a reason for the old trading advice about never
shorting a dull market.  Ken Fisher, the initiator of the
"Great Humiliator" theory, says the market endeavors to
humiliate the greatest number of investors.  One of the easiest
victims for the market is freshly-minted and complacent bears.
Trade the downside as long as it lasts, but keep those
protective stops in place.

Heading up the news parade on Tuesday will be Cisco Systems
(NASDAQ:CSCO), announcing their earnings after the close.
Investors are waiting to hear what the company says, hoping for
some sort of bullish forward-looking comments.  If you're
dipping your toes in the Tech market, the smart move will be to
wait for CSCO's report and more importantly, investor response
to the company's conference call.  As Jim has been mentioning
for the past month, the prudent approach for bullish Tech
positions is to wait for the Composite to move back through the
2100 level.  If the charts above are any indication, we may have
to wait until volume comes to more robust levels after Labor Day
in order to have this condition met.

Trade only when the reward/risk ratio is in your favor.


Mark Phillips
Research Analyst


****************
MARKET SENTIMENT
****************

Meandering Monday
Jeffrey Canavan

Monday's haven't been the most bullish days this summer, and 
today was no different.  The Dow lost 111 points, and spent the 
day trying to stay above last weeks low.  The S&P 500 lost 13.87, 
but managed to close right at 1,200.  On a percentage basis the 
Nasdaq was today's worst performer, losing 1.55 percent.

But then we have the Nasdaq-100.  The triple Qs closed down 68 
cents, but managed to close above Friday's low.  While only 22 
Nasdaq-100 stocks closed in positive territory, biotechs, 
specifically Amgen and Biogen, did what they could to minimize 
losses.  The Biotechnology Index has been consolidating for the 
past five days, and will need to continue to limit its losses if 
wants to play the role of leader.

That brings us to last week's leader, semiconductors.  After 
receiving some positive news last week from Merrill Lynch, 
semiconductor stocks came under fire today, losing 1.48 percent.  
Salomon Smith Barney and Lehman Brothers sparked the sell off, 
citing concerns about Intel's pending price war with AMD.

Retail stocks also came under pressure today after RadioShack 
posted worse than expected July sales.  With July retail sales 
numbers due out this Thursday, investors are starting to worry 
that consumer spending may be breaking down.

Adding to the concern over consumer confidence was a record 
number of job cuts in July.  Outplacement firm Challenger, Gray 
and Christmas reported that there were 205,975 job cuts in July, 
up 65% from June, and the most in eight years.

But overall it was another listless summer day.  Volume was 
especially light as investors were hesitant to take a stand ahead 
of Cisco's announcement after the bell tomorrow. That could lead 
to another lackadaisical day tomorrow, with a slight advantage 
going to the downside.

*************************Sector Watch****************************

            Weekly   Daily     Overbought    Support  Resistance 
            Trend    Trend      Oversold                         

DJIA        Bearish  Neutral    Overbought   10,200   10,600
NASD        Bearish  Neutral    Overbought    1,940    2,125
S&P 500     Bearish  Neutral    Overbought    1,170    1,240
Rus 2000    Neutral  Neutral    Overbought      465      495

Semis       Neutral  Neutral    Overbought      600      660
Biotech     Bearish  Neutral    Overbought      490      550
Internet    Bearish  Neutral    Overbought      140      170
Networking  Bearish  Neutral    Overbought      300      365
Software    Bearish  Neutral    Overbought      180      200
Banking     Bullish  Neutral    Overbought      640      675
Retail      Bullish  Neutral    Overbought      875      920
Drugs       Neutral  Neutral    Overbought      380      410


               Percent Change
            Last    Last    Last    Rel Strength   Point and 
           5 Days  10 Days 30 Days   vs S&P 500   Figure Signal
DJIA        0.9%    (0.6%)  (1.9%)    Neutral         Buy
NASD        1.8%     1.8%    0.4%     Neutral         Sell
S&P 500     0.7%     0.3%   (1.8%)      N/A           Sell
Rus 2000    0.4%    (0.2%)  (2.1%)    Neutral         Sell

Semis       6.5%    11.6%    9.8%     Positive        Buy
Biotech    (2.9%)   (0.7%) (15.0%)    Neutral         Sell
Internet    1.3%    (8.5%) (13.8%)    Negative        Sell
Networking  2.9%     5.1%    4.1%     Neutral         Buy
Software   (0.1%)    4.5%  (12.1%)    Neutral         Sell
Banking     1.6%     2.9%    0.8%     Positive        Buy
Retail      0.8%     0.2%    0.7%     Neutral         Sell
Drugs       1.9%    (0.3%)  (3.7%)    Neutral         Buy

*****************************************************************


**************
TRADERS CORNER
**************

Stochastics - A Primer

The unintended consequence of my frequent use of the Stochastics
oscillator has unleashed a flood of questions on its origin, use
and interpretation in recent weeks.  With apologies to those who
will find my description here redundant and repetitive, I felt
it would be beneficial if we went back to the beginning with
this ubiquitous technical indicator, putting everyone on an even
footing.

Developed by George Lane in the late 1950s, the Stochastic
oscillator is based on the theory that prices tend to close near
the upper end of a trading range during an uptrend.  As the
trend matures, the tendency for prices to close away from the
higher end of the trading range becomes more pronounced,
allowing for the emergence of a downward trending market where
prices tend to close near the lower end of the trading range.
Simply put, the Stochastic oscillator measures a market's
momentum by determining the relative position of closing prices
within the high-low range of a specified number of days.

The purpose of the Stochastic oscillator is to alert traders to
the failure of the bulls to close prices near the highs of an
uptrend or the inability of the bears to close prices near the
lows of a downtrend.

The Stochastic oscillator consists of two lines, %K and %D.  The
formula for %K is 100*[(Close-Low(n))/(High(n)-Low(n))], where
Close is the current close, Low(n) is the low of the n-day
period and High(n) is the high of the n-day period.  The formula
for %D is 100*(H(m)/L(m)), where H(m) is the m-day sum of
(Close-Low(n)) and L(m) is the m-day sum of (High(n)-Low(n)).

Hang on, we're almost there.  We have a bit more jargon to go
through and then I'll bring it all together at the end into a
coherent picture.  The %K and %D lines produce what is typically
referred to as the "fast stochastics", which is generally
considered too sensitive and erratic to be used as a reliable
indicator.  We can take the "fast stochastic" and subject it to
a further smoothing (typically 3 days), producing the "slow
stochastic" that most technicians prefer.  In the smoothed
version of stochastics, the fast %D line becomes the slow %K,
and a 3-day moving average of the fast %D becomes the slow %D.

I've been using this oscillator for years, and that description
still makes my head spin.  I don't want to get buried in the
math here, especially because most books on technical analysis
do a much more thorough job than I can in the limited space I
have available here.  The full version of the Stochastics
indicator when we strip away the math is Stochastics(n(s),m),
where n is the period used for calculating %K, m is the period
used for calculating %D, and s is the period used for smoothing
(or slowing) the %K line.  A typical setting for Stochastics
that provides a 10-day %K, a 5-day %D and 3-day smoothing of
the %K line is shown below.

Stochastics(10(3),5)

Most charting programs provide a Stochastic oscillator for users
to apply to charts, but they all seem to be a little different.
The charting application I use allows me to modify all three of
the settings for Stochastics, and I prefer to use the setting
(5(3),3) for long-term (weekly and daily) charts, while I have
found (10(3),5) provides better results for shorter-term
(intraday) charts.

Many other charting applications provide the ability to display
either a Fast Stochastic or a Slow Stochastic, each of which have
only two parameters for users to modify.  The smoothing factor is
kept at a fixed 3 days, so we only have the ability to modify the
'n' parameter for %K and the 'm' parameter for %D.  As you can
see from the settings I listed above, I have kept the setting
for smoothing fixed at 3 days, so these abbreviated indicators
with only 2 parameters should serve the purposes of most
traders.  Another point is that we really only want to use the
Slow Stochastics, due to the choppy nature of the un-smoothed
fast Stochastics.

I try not to get wrapped up in the actual math involved, and
instead focus on how to use the stochastics in the real world.
There are two important observations to make from the above set
of equations.  First, we have at our disposal the necessary
parameters to adjust the sensitivity of the oscillator.  As we
lower the numbers used in the calculation of %K and %D, the
stochastics will become more responsive, but at the expense of
a choppier and more erratic indicator.  The second observation
we can make is that because the %K and %D formulas are ratio
calculations that will always be less than one, we can see that
both lines will vary between 0-100.

I refer to the %K line as the 'Fast line' and the %D as the
'Slow line', as that description gives us a simple terminology
that we can use for interpreting the motion of the Stochastics
oscillator.  These references shouldn't be confused with the
Slow Stochastics and Fast Stochastics that we have described
above.  When I speak of Stochastics, I am referring to the Fast
and Slow line of the Slow Stochastics.  I hope that makes sense.

When the two lines cross, they behave similarly to a dual Moving
Average system, but with some important differences.  Because of
the range limitations, (neither line can exceed 100 or fall
below 0), we can define levels at which we consider the
Stochastics oscillator to be giving overbought and oversold
readings.  The traditional levels are 80 for overbought and 20
for oversold, although adventurous traders can certainly
fine-tune these levels for their own purposes.  I use the
default 80 and 20 levels.

The simplest buy signals come from having both lines in oversold
territory and then watching the fast line cross up through the
slow line as it (fast line) moves above 20.  Similarly, sell
signals are generated when both lines are in overbought
territory and the fast line crosses down through the slow line
as it (fast line) drops below 80.  Stochastics crossovers that
occur outside the overbought/oversold region can be used as
trading signals as well, but they are not as strong, unless they
are a part of a larger pattern like divergence.  Unfortunately,
we don't have time to go into that fine point today.

I realize this has been a rather dry article, with a bunch of
equations and none of the illustrative charts I normally use.
This week I needed to lay the groundwork, and next week we'll
be back to the charts, looking at examples of the Stochastics
oscillator showing how different settings produce different
results.  More importantly, we'll also cover how to interpret
the signals generated by the Stochastics oscillator to make
better trading decisions.  

Have a great week!
Mark
 

*************
NEW CALL PLAY
*************

No new calls tonight 


************
NEW PUT PLAY
************

No new puts tonight 


*****************
STOP-LOSS UPDATES
*****************

JEC - put
Adjust from $58 down to $55


*************
DROPPED CALLS
*************

AHAA $34.93 -4.82 (-4.82) All good things must come to an end
and our call play on AHAA did that in a big way today, losing
more than 12% on nearly triple the average daily volume and
shattering the upward trend in one swift move.  Concerns about
some significant profit taking is why we cinched up our stop to
$38, and those that followed suit still managed to harvest a
profit from the play, even though it shattered support today.

CDWC $45.82 -1.80 (-1.80) Looking at the CDWC chart, there
really seems to be no reason to issue a drop tonight.  In fact,
the late-day bounce from $44.50 looked pretty encouraging for
new entries.  But that was before the company issued a warning
for the third quarter, citing flat July sales and lack of
confidence in sales targets for August and September.  Investors
whacked the stock in the afterhours session, driving the price
as low as $40.  The prudent move is to exit the play now before
the damage gets worse.  Those with open positions will want to
use any bounce in the morning as an opportunity to exit the play
at a more favorable level.


************
DROPPED PUTS
************

MEDI $38.04 +0.55 (+0.55) Bucking the broader market trend on
Monday, shares of MEDI managed another gain, just clawing their
way above our $38 stop at the close.  While volume continued to
fall, and the chart definitely doesn't look strong, we'll honor
our stop and move on to more favorable plays.  Those that took
our advice and exited near the lows last Thursday managed to
harvest a nice gain from the play.

PDII $61.71 +4.06 (+4.06) Forgive us from tooting our own horn
on this one, but it looks like we really picked the bottom on
PDII.  Recall that we recommended taking profits last Thursday
as the stock closed just above $57.  Sure enough, the stock
rebounded on Monday, taking out our $61 stop and bringing the
play to a successful close.  Even after today's strong rise,
PDII is more than $8 below the level we picked it, and it
provided numerous profit opportunities over the past 2 weeks.


*********************
PLAY OF THE DAY - PUT
*********************

JEC - Jacobs Engineering $50.88 -4.01 (-4.01 this week)

Jacobs Engineering provides a broad range of project services;
process, scientific and systems consulting services; operations
and maintenance services; and construction services. For the 6
months ended 3/31/01, revenues rose 15% to $1.94B. Net income
totaled $41.7M, up from $12.3M. Revenues reflect the growth of
consulting services. Earnings also benefited from the absence of
a FY 1999 litigation settlement provision.

Most Recent Write-Up

Shares of JEC fell about -13% back on July 24th after a downgrade
took the share price through the 100 DMA.  Today's declines came
on better than average volume, suggesting that conviction for
further declines might be in the mind of traders.  The dip under
the 200 DMA- a break in support not seen in nearly 2 years, tells
us that investors have decided to cash in after a long, very
impressive run by the stock.  The first level of support presents
itself at right about tonight's close, say $50.00.  The lack of
liquidity could come to haunt the stock should sellers step up to
the plate on Monday.  Downside resistance will present itself at
$50.00 and this short-term volatility could spell big gains for
those on the short side of the trade.  It is at this price that
short-term holders should look to exit the trade.  The exit price
for the longer-term trader is a bit less discernible, but another
level of minor downside resistance exists at $46.00 and that would
likely be the best area to exit.  As mentioned before JEC is not a
heavily traded stock and can be prone to volatility.  Make sure to
cover your trade with a stop at $58.00.

Comments

In the midst of light volume in the broad markets, JEC broke
down on heavy volume Monday, cementing the violation of the
200-dma and knocking on the door of support at the March lows
just above $50.  A continuing breakdown could take the stock to
significant support near $45 in a hurry, and would still look at
that level as a good place to harvest some profits.  A drop
under $50 will provide for fresh entry opportunities as this
momentum play unfolds.  We are lowering our stop to $55 (near
the 200-dma) and we may be fortunate enough to gain entry on a
failed rally near this level if the stock bounces later this
week.  Note that we have only listed October strikes due to
limited strike availability in the earlier months.

BUY PUT OCT-50*JEC-VJ OI=705 at $3.40 SL=1.75
BUY PUT OCT-45 JEC-VI OI=450 at $1.70 SL=1.00

Average Daily Volume = 317 K



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