Option Investor

Daily Newsletter, Monday, 08/20/2001

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The Option Investor Newsletter                 Monday 08-20-2001
Copyright 2001, All rights reserved.                      1 of 1
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MARKET WRAP  (view in courier font for table alignment)
        08-20-2001        High      Low     Volume Advance/Decline
DJIA    10320.07 + 79.29 10320.07 10210.48  890 mln   1768/1336
NASDAQ   1881.30 + 14.30  1881.62  1854.96 1.15 bln   1881/1809
S&P 100   599.00 +  5.13   599.00   593.00   totals   3674/3094
S&P 500  1171.41 +  9.44  1171.41  1160.94           
RUS 2000  478.87 +  3.22   478.88   473.74
DJ TRANS 2840.42 + 15.77  2840.72  2818.37
VIX        25.14 -  1.60    27.78    24.99
Put/Call Ratio      0.45

Is This Deja vu or Vuja De?

As expected, the broad markets saw rather light volume on
Monday, with traders hesitant to place their bets ahead of
tomorrow's FOMC meeting.  With economic weakness continuing to
intensify everywhere, Uncle Alan Greenspan looks likely to
continue the recent pattern of cutting short term rates.  But it
looks like the old boy is being relegated to a position of
impotence, at least where the markets are concerned.

Ahead of the Fed report, all the major indices managed decent
gains on light volume, but it sure wasn't anything to get
excited about.  The DJIA pulled ahead by 79 points, regaining
the 10,300 level, but 10,400 is looming overhead, a mere 80
points away.  The S&P500 managed to regain the 1165 level,
closing at 1171 and change, but the NASDAQ Composite is just
snoozing along between the 1865 support level and formidable
resistance at the 1950 level.


Consensus is calling for the Fed to drop rates by 25 basis
points tomorrow, but after a total of 275 basis points since
the first of the year and no real signs of economic recovery,
how much of a difference is the marginal 25 points really going
to have?  And in my opinion, 25 points is the BEST thing he can
do.  He has to cut or investors are likely to revolt over not
getting their expected candy, but cutting by 50 basis points
again would put the Fed in a more aggressive stance again.
Investors could very well view this as Greenspan seeing a new
monster under the bed, and run for the exits.  25 points, 50
points or no cut.  Those are the choices for investors to
contemplate prior to the Fed's announcement at 2:15pm ET

Of course rampant bullishness is still a highly contagious
disease, as evidenced by the parade of talking heads on CNBC.
Even though all the indices were in the green today, I actually
heard one of the guys on the NYSE trading floor say that no
matter what Greenspan does, it will provide a catalyst for a
sustained bullish move, due to the overwhelming negative
sentiment in the market.  I actually heard, "the only bad thing
that could happen is if he were to raise rates".  Excuse me??
If sentiment is so negative, then why is the VIX lurking around
at a mere 25-27?  Seems to me that it was rocketing north of 40
back in late March and early April.  And if not for the
intervention of the Fed back then to provide an inter-meeting
rate cut and stem the bleeding, I see no reason why the Fear
Index couldn't have topped the 50-55 range as it did back in
late 1998.

Whether the VIX will revisit those peak levels is not really
what I'm concerned with.  It's the basic trend that is making
me nervous.  Over the past 3 weeks, the broad market indices
have continued to deteriorate, falling to or even through
significant support levels, while the VIX is refusing to head
higher.  Sure it is off of its lows near 22 early in August, but
look at the VIX action today.  After starting just below 28,
the VIX fell to just above 25!  And that was on a low volume,
weak rally.  A look at the chart below really highlights my
concerns for the market as a whole.


If the broad markets are threatening to test the spring lows
and investors are not showing their fear, what will happen with
the next event that drives up their fear (Mid-East tensions,
Argentina, worsening earnings picture, declining consumer
spending, weakness in housing, etc.)?  It seems like that could
give us a pretty ugly drop in the markets in short order.

Providing further proof that the NASDAQ has been relegated to
almost-irrelevant status, First Union Securities came out today
stating that the tech index is once again overvalued, based on
the current rate of earnings deterioration.  Accordingly, the
firm lowered their "Fair Value" for the NASDAQ from 1850 to
1550.  Just for the record, that's where the Composite was
finding support in 1997-1998.  We may grouse that the DJIA has
been rangebound for the past 2 years, but at least it isn't
trading back in the 7500-8500 level (its 1997-1998 trading
range).  Until capital spending comes out of its suspended
animation, it's going to be hard to make money in Techs.  Just
my opinion...take it for what it's worth.


Is it any wonder I look at the NASDAQ as a secondary market
right now?  On its most recent "rally", bulls couldn't even push
it through the 2300 level.  Another way of putting it is that
NASDAQ bulls couldn't trade their way out of a wet paper bag!
Although I haven't shown it, I did put a very long-term weekly
chart of the NASDAQ composite up and drew a trendline through
all the lows since late 1995 through the March 2001 lows.  If
that trend is going to hold, then the COMPX should find support
in the vicinity of 1775.  My concern with this trendline is the
fact that all the prior lows occurred in the midst of a record
bull market.  We're now in a protracted bear market (in my
never-to-be humble opinion) and I question whether there is any
fundamental reason for the long-term bullish trend to prevail.
Make no mistake...I'm hoping it does, but preparing for the
possibility that it doesn't.

If the Fed doesn't matter (as I happen to believe, right now)
then what does?  That's right, it's still the economy and more
importantly to us, earnings.  Sad to say, there just isn't any
great news to point to on that front and General Motors
(NYSE:GM) vaulted to the head of that watch list this morning.
On the heels of Ford's layoff announcement last week, Goldman
Sachs cut their outlook for GM for 2001 and 2002 and the stock
fell to $56 today on very heavy volume, negating all the gains
the stock accrued since mid-May.  Does the recent weakness in
the Auto sector indicate that the almighty U.S. consumer is
reeling in their wallets?  If so, does that mean the capital
spending recession is preparing to drag the rest of the economy
into a full-blown recession.

This all brings me to the title of the Wrap tonight.  It seems
like we've been here before doesn't it?  The markets are
struggling under concerns about earnings continuing to weaken.
All the major indices are resting above tenuous support levels
that if broken, will open the door for a retest of the April
lows.  On one hand we have Alan Greenspan promising to "act
aggressively" when necessary, while on the other hand we have
corporate profits continue to atrophy, leading us closer and
closer to the official definition of a recession.

But what if the markets are about to begin another downward
leg?  Then the situation we find ourselves is more akin to what
comedian Robin Williams calls Vuja De, "The strange,
unexplainable feeling that somehow none of this has happened
before".  Sure, similar market conditions have probably occurred
in past market downturns.  But for those of us that entered
the investing world in the past decade, we truly are in
unexplored territory.  When venturing into unknown and possibly
hostile territory, caution is the watchword.

Every pundit that can fog a mirror is busy telling us how the
economy is going to rebound in the second half (ok, they've
moved it to the first half of 2002, but the mantra is the same)
and that investors should be buying stocks now.  Does everything
really look the darkest before the dawn?  Yes, it probably does,
but just because it is dark doesn't necessarily mean that the
sun is about to rise.  I wouldn't be a big fan of chasing these
markets up with calls.  until the DJIA clears 10,600 again and
the NASDAQ clears 2100 ON STRONG VOLUME, the profitable trades
are in Put plays.  Just ask someone who has been trading the
downside.  I'll bet they will tell you they're making money.
The time to trade calls and bet on the bulls will come
again...hopefully soon.  But that time is not now.  Either take
advantage of the opportunities to the downside (shorting the
rallies) or sit on your hands.  In the long run, your trading
account will thank you.

Remember to trade only when the reward/risk ratio is in your

Mark Phillips
Research Analyst 

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Nobody Home

It was a simple plan, really it was.  I was going to step into 
the 80's and purchase a cell phone, and dump my home phone.  My 
first call was to Qwest to see if I could get DSL service if I 
didn't have a home phone.  The answer was a resounding no, and 
even if I had a phone line, I still couldn't get it in my area.  
Not a problem, I'll just get an @Home cable Internet connection.  
Not available in my area.  The plan was starting to fall apart 
when I remembered Sprint ION.  Right there on the website was the 
answer to my problem, fixed wireless technology, no phone line or 
cable connection needed.  Of course I found out that I live in 
some bizarre telcom Bermuda triangle where I can't pick up the 
signal unless I put a 20-foot pole on my roof.  If these telcom 
companies racked up $600 billion in debt to make the world 
Internet ready, why the $@#! can't I get a high-speed internet 

I'm not one to revel in the misery of others, but when it was 
reported today that ExciteAtHome (ATHM) currently does not have 
enough cash on hand to operate for the rest of the year, a slight 
grin crossed my face.  Most of ExcitAtHom's problems stem from 
declining ad revenues from their Internet content site and a 
mountain of debt that has been downgraded to triple C.  Throw in 
the prospect of their stock being delisted from the Nasdaq, and 
there is "substantial doubt" about their ability to continue.

North American Telecommunications Index


I'm trying to follow Eric Utley's advice from last Thursday's 
traders corner, and not let my consumer opinions spill over into 
my trading, but the upside for the Telecommunications Index 
(XTC.X) looks limited.  If the index is able to follow through on 
today's 1.05 percent gain, perhaps a 30-point bounce to test the 
base of the double top and 50-day moving average could happen.  
Maybe even a test of four-month downtrend could be in the cards, 
but I'm doubtful of any further advances based on the groups 
relative strength compared to the S&P 500.

Next up we had Lehman Brothers downgrading shares of Ciena to a 
market perform.  Analyst Steve Levy not only questioned the 
stocks ability to provide a "reasonable" return over the next six 
months, but even suggested that further downside was possible.  I 
guess in the networking sector, falling less than the other guys 
is a market perform.

Networking Sector Daily Chart


I thought the Networking Index (NWX.X) had a chance when it fell 
into a two-month base, but by closing below 298 for two straight 
days, I'm starting to agree with Mr. Levy's outlook for 
networking stocks - better returns than the S&P 500 are doubtful 
over the next few months, but tradable bounces should occur.  
Climbing back above 298 would be the first step in the bounce 

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

            Support                Close              Resistance
DJIA       |10,200  |      |10320 |      |      |      |  10,600|
NASD       | 1,710  |      |      | 1881 |      |      |   2,125|
S&P 500    | 1,150  |      | 1171 |      |      |      |   1,240|
Rus 2000   |   465  |      |      |  479 |      |      |     495|
Semis      |   535  |      |  561 |      |      |      |     660|
Biotech    |   473  |      |  489 |      |      |      |     550|
Internet   |   121  |      |  127 |      |      |      |     160|
Networking |   300  |      |  292 |      |      |      |     365|
Software   |   166  |      |  167 |      |      |      |     200|
Banking    |   650  |      |      |  675 |      |      |     685|
Retail     |   858  |      |      |  884 |      |      |     920|
Drugs      |   380  |      |      |  396 |      |      |     410|

Support Alerts: Nasdaq, S&P 500, Networking Software
Resistance Alerts:
           |   Long    |   Short   |   Strength    | Relative   |
           |   Term    |   Term    |     of        | Strength   |
           |   Trend   |   Trend   |    Trend      | vs S&P 500 |
DJIA       |  Bearish  |  Bearish  |     Weak      |  Positive  |
NASD       |  Bearish  |  Bearish  | Strengthening |  Negative  |
S&P 500    |  Bearish  |  Bearish  | Strengthening |    --      |
Rus 2000   |  Bearish  |  Bearish  |     Weak      |  Neutral   |
Semis      |  Bearish  |  Bearish  |     Weak      |  Neutral   |
Biotech    |  Bearish  |  Bearish  | Strengthening |  Neutral   |
Internet   |  Bearish  |  Bearish  |    Strong     |  Negative  |
Networking |  Bearish  |  Bearish  | Strengthening |  Negative  |
Software   |  Bearish  |  Bearish  |    Strong     |  Negative  |
Banking    |  Bullish  |  Bullish  |   Weakening   |  Positive  |
Retail     |  Neutral  |  Bearish  |     Weak      |  Neutral   |
Drugs      |  Neutral  |  Neutral  |     Weak      |  Positive  |

           | Short-Term  |          | Point and |
           | Overbought/ | Momentum |   Figure  |
           | Oversold    |          |   Signal  |
DJIA       | Neutral     |  Flat    |   Sell    |
NASD       | Oversold    |  Flat    |   Sell    |
S&P 500    | Neutral     |  Flat    |   Sell    |
Rus 2000   | AP OB       |  Flat    |   Sell    |
Semis      | Oversold    |  Flat    |   Sell    |
Biotech    | Neutral     |  Rising  |   Sell    |
Internet   | Oversold    |  Falling |   Sell    |
Networking | Oversold    |  Flat    |   Sell    |
Software   | Oversold    |  Falling |   Sell    |
Banking    | Neutral     |  Rising  |   Buy     |
Retail     | Oversold    |  Falling |   Sell    |
Drugs      | Neutral     |  Rising  |   Buy     |
             AP OB = Approaching Overbought
             AP OS = Approaching Oversold



Who the Heck is This Guy Bollinger?

And what kind of music does his band play?  In all seriousness,
the Bollinger Bands are another ubiquitous technical indicator
that most traders have heard of and probably seen on charts.
But what is its basis, where did it come from and more
importantly, how can we use it?  These are the kinds of
questions that periodically show up in my Inbox, so join me as
I attempt to shed some light on the subject in the next
installment of our continuing journey of discovery in the land
of Technical Analysis.

John Bollinger created the indicator in 1982 as a variation of
a moving average envelope.  Bollinger theorized that the band
width of an envelope should be determined by the market rather
than by the assumptions of the analyst, as is done with percent
envelopes.  He focused on the principle that an envelope's
distance from the mean should be a function of market
volatility.  Intuitively, this makes sense because a volatile
market does have wider swings from its average, despite the fact
that a distinct trend may be in effect.  The bands should expand
to account for this, rather than remaining excessively tight and
giving false reversal signals at the boundaries of the envelope.

The first step in constructing Bollinger Bands is to select a
central moving average; Bollinger recommends a 20-day moving
average, and I have yet to find a reason to deviate from this
default setting.  According to Mr. Bollinger, 10 days can be
used for shorter-term trading and 30 days for longer-term
trading, but I have found that a 20 period moving average
applied to any time timeframe (from weekly down to 10-minute
charts) delivers consistently good results.

Now that we have constructed the central line of the Bollinger
Band indicator, we need to paint the upper and lower bounds of
the envelope.  This is done through the application of some
simple statistics, creating a line above and a line below the
20-dma that represents a number of standard deviations above
and below the central line.  Bollinger recommends using 2
standard deviations from the median line, which yields an
envelope that statistically should encompass 97.5% of all the
trading action in the particular equity or market.  

I don't want to go into any of the math behind the Bollinger
bands as the equations for the standard deviation lines can be
found in any basic statistics textbook.  But more to the point,
we don't need to create the indicator, as most charting
programs provide it as a standard study that we can apply to
our price charts.  What we need to know is how to modify the
Bollinger Band indicator to suit our trading needs.  I would
recommend becoming acquainted with the indicator using the
default settings of a 20-dma for the central line and 2 standard
deviations for the envelope bands.  As you become familiar with
the indicator's behavior, then you can modify these settings
and experiment to your heart's content.

Look at the chart below of the S&P500 during the period of
March-August of 2000 and you can see that price is prone to
significant reversals whenever it pulls back from a penetration
of either the upper or lower Bollinger band.


Not only that, but notice that the bands expand during periods
of higher volatility and contract during periods of reduced
volatility.  The sharp drop in price in early April caused the
bands to expand dramatically reaching a maximum spread of 173
points by late April.  Contrast this to the relatively small
spread of only 51 points in early July as volatility continued
to contract during the normally slow summer months.  As
mentioned above, the bands expand or contract with volatility so
that they encompass the majority (97.5%) of the trading action.
This gives us a starting point for watching a given stock for
potential reversals.

Another observation we can make from the Bollinger Band
indicator is that the 20-dma frequently acts as a level of
support or resistance, giving trading signals near the middle
of the range, allowing us to pick attractive entry and exit
points without having to wait for price to reach the upper or
lower bands.  Fast forward to May-July of 2001 and we can see
that the SPX provides a great example of this behavior as well.


In mid-April, the SPX found resistance at the 20-dma before
powering through that level.  The breakout through the 20-dma
gave a signal that the bulls were back in charge, and the
subsequent rally showed us just how strong that breakout signal
was.  In keeping with this improved sentiment, we can see that
price fell back to the 20-dma and bounced in mid-May before
shooting above the 1300 level.  Since then the center line of
the Bollinger Band indicator has been providing resistance;
early June and then 3 times in the month of July.  The bulls
managed to clear this level in late July, but the last candle
indicates a breakdown (denoted by "BD" on the chart) below the
20-dma and would seem to indicate further price weakness.  How
did it play out?  Pull up a current chart of the SPX and see
for yourself.  Looks like the Bollinger Band median line
highlighted another pretty good trade to the downside!

As with everything in the Technical Analysis world, we can't
use Bollinger Bands by themselves.  While they can give us some
good signals, their real utility isn't realized until they are
combined with oscillators (MACD, RSI, Stochastics) and analysis
of price/volume relationships.  What we've done here is lay out
the basics of the indicator and how to interpret it.  But with
every indicator, there are many fine points in its application
and it should never be used alone.

Tune in next week and we'll continue our discussion, moving on
to some of these fine points in the interpretation of Bollinger
Bands.  Then we'll move on to combining Bollinger Bands with
other indicators in an attempt to show how they can be an
important ingredient in your trading decisions.

Have a great week!


No new calls tonight


No new puts tonight


AIG - put
Adjust from $81 down to $80

CLS - put
Adjust from $44 down to $42

CPN - put
Adjust from $32 down to $30


No dropped calls tonight


No dropped puts tonight


AIG – American International Grp. $78.14 -1.07 (-1.07 this week)

Engaged in a broad range of insurance and insurance-related
activities through its subsidiaries, AIG's primary focus is on
its general and life insurance businesses.  Additionally, the
company is growing its presence in financial services and asset
management.  Other operations include auto insurance, mortgage
guaranty, annuities, and aircraft leasing.  With operations in
130 countries, AIG generates more than half of its revenues
outside the United States.

Most Recent Write-Up

It took a lot of patience to wait this one out, but on Friday
AIG finally gave us the breakdown we have been waiting for.
With the Insurance index (IUX.X) breaking below its $726 support
level, AIG had no choice but to follow suit.  Selling volume was
heavy (nearly 50% above the ADV) as the stock fell as low as
$78.50 before a late-day recovery.  It looks like the stock may
have now fallen into a lower trading range, and we'll look for
the $80-81 level (previous support) to act as resistance.  Lower
stops to $81 and target any failed rallies below this level
(possibly at $80.25) for new entries.  Should the breakdown
continue on Monday, look to step into the play on a volume-backed
drop below $78.50.  Below that, support lies first at $77 and
then $76.  The daily Stochastics still has plenty of room to
fall, so it wouldn't be surprising to see AIG test the $74 level
before the bulls get interested again.


Somebody forgot to tell AIG investors that the broad market was
trying to mount a recovery on Monday, as shares of the insurance
company continued to plunge on heavy volume.  Now well under the
$80 support level, which should now act as resistance, AIG looks
like it is moving into a lower trading range.  The floor is
likely to form near $74-75, and this would be a good level to
consider taking profits in the days ahead.  Any weak bounce to
the $80 level should provide for fresh entries, so long as the
bulls can't push through that level on a closing basis.  Move
stops down to $80 to protect your profits.

BUY PUT SEP-80 AIG-UP OI= 6453 at $3.50 SL=1.75
BUY PUT SEP-75 AIG-UO OI=16045 at $1.50 SL=0.75

Average Daily Volume = 4.47 mln

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