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Daily Newsletter, Monday, 08/27/2001

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The Option Investor Newsletter                Wednesday 08-27-2001
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******************************************************************
MARKET WRAP  (view in courier font for table alignment)
******************************************************************
        08-27-2001        High      Low     Volume Advance/Decline
DJIA    10382.30 - 40.82 10441.40 10382.30  849 mln   1355/1752	
NASDAQ   1912.41 -  4.39  1933.94  1897.63 1.18 bln   1604/2020
S&P 100   604.22 -  2.49   608.48   603.53   totals   2959/3772
S&P 500  1179.21 -  5.72  1186.85  1178.07           
RUS 2000  478.93 -  1.88   481.81   478.93
DJ TRANS 2831.91 - 22.48  2855.83  2821.68
VIX        22.44 +  0.15    23.29    21.94
Put/Call Ratio      0.50
******************************************************************


So Much For Follow-Through?

Remember the explosive rally from Friday?  After spending the
day snoozing in front of my computer, the contrast between
today's quiet range-bound trade and Friday's explosive moves at
the open and then again at the close was striking.  Once again
we were back to light volume, drifting markets and stubborn
resistance levels.

As Jim Brown so correctly pointed out in the weekend Market
Wrap, Friday's action had all the earmarks of simple
short-covering with no true buying to continue the move.  Proof
of that dynamic came at the open this morning as the broader
markets fell quickly on scattered bearish news.  There was
nothing stunning, but it was enough to reign in the bulls.



 

There's nothing bullish to point at here, as the DJIA reversed
right at the descending trendline, right in the middle of the
recent trading range.  And daily Stochastics hasn't been able
to get into overbought territory for over a month.  Will this
time be any different?  Maybe, but a strong push through
resistance will likely have to wait for increased volume,
which hopefully will arrive after the Labor Day holiday.



 

The NASDAQ Composite finally found support near 1817 last week,
but the index has been unable to reclaim the high side of the
1934 level (previous support) due to a lack of buying
enthusiasm.  Look at that rate of ascent on the daily
Stochastics.  It has now exceeded the highs from 2 weeks ago.
If price can't top the 2000 level before the Stochastics
oscillator begins to roll over, we'll have bearish divergence
pressuring the index towards new recent lows.  Despite spending
much of the day in slightly positive territory, the weakness
over on the DJIA was too much for the Tech bulls and they gave
up near the close, settling for a -4.39 loss on the day.  We
need volume in this market if we're going to head higher.

The high points for the day started with Existing Home Sales,
which came in at 5.17 million, weaker than the consensus
expectation of 5.30 million.  This just added to investor
nervousness when combined with the continued rumors of job cuts
at JP Morgan (NYSE:JPM).  These rumors have been swirling around
for weeks, and the firm isn't commenting on the issue.  But
other firms have been more forthcoming, with announced job cuts
from the likes of Citigroup (NYSE:C), Goldman Sachs (NYSE:GS),
Morgan Stanley (NYSE:MWD) and Merrill Lynch (NYSE:MER).  It
seems a pretty easy conclusion that we'll get the same from
JPM...the only questions are when and how much?

And the significance of the cuts at major brokerages was spelled
out in a piece on Briefing.com this morning by Patrick J.
O'Hare.  Mr. O'Hare boiled it down to the basics with the
following statement. "...when those who conduct the business
that makes the stock market go round are cutting staff in an
effort to bolster their bottom-line, investors should not be
fooled into believing it is a sign of strength.  On the
contrary, in the current environment, it is a sign of
continuing weakness."  I couldn't have said it any better,
myself.

Microsoft (NASDAQ:MSFT) delaying the release of its Xbox system
in Japan so that they can focus on the upcoming holiday season
in the good old US of A.  Reiterating their target of 1.5
million units sold by the end of the year helped to keep the
stock afloat, but it spent the bulk of the session trading in
a narrow range.  Buyers seemed to have gained the upper hand
just before 2pm ET as the stock rallied through the intraday
highs on increasing volume.  But there was nothing to support
the stock in the final 30 minutes and along with the broad
market averages, MSFT came crashing back into the middle of its
intraday range, closing with a gain of $0.26.

Barron's took a swipe at the Housing sector over the weekend,
stating that Home Depot (NYSE:HD) has run up too far, based on
excessive optimism over housing and consumer spending.  Shares
of HD pulled back at the open on heavy volume, but managed to
claw their way back or a loss of only $0.95 at the close.  Once
again the descending trendline at $49.50 held sway, threatening
to abort the stock's fledgling recovery.  HD is not that
important, except when you consider that numerous stocks (many
in the Retail and Housing sectors) are moving in a similar
fashion.

Shares of the nation's leading thrifts continued to be sold
wholesale on Monday and the Housing/Thrift sector is at a
critical juncture here as the Fed approaches the end of the
current rate cutting cycle.  Either the weakness in the Thrift
sector is going to sink the last bastion of strength in our
economy - the Housing sector - or the Housing sector will prop
up the ailing thrifts.  Eric Utley did an excellent presentation
of the dynamics of these two sectors in his 12:00pm ET Intraday
Update today.  If you're looking for fertile ground for fresh
trades, I would highly recommend reviewing his update.  My bet
is that the Thrifts are going to win this tug-of-war, and we are
going to get a valuable piece of evidence tomorrow morning.
Remember the Existing Home Sales report this morning?  It wasn't
a big miss, but it could be the first chink in the armor of a
sector that has been keeping the US economy intact.

Consumers have continued to spend (at least according to the
official government reports), providing much-needed support
to our economy and supposedly keeping us out of recession.
Tomorrow's Consumer Confidence numbers have the potential to be
either a non-event or a barn-burner, depending on how they come
in relative to expectations.  Expectations are for a number of
117.5 and anything close to that will likely give new life to
the bulls.  But a significant miss would have the ability to
devastate both the Retail and Housing sectors.  Investors do not
want to hear that Consumer Confidence is falling.

The major indices bounced back and forth between positive and
negative territory as buyers and sellers jockeyed for the upper
hand throughout the day.  Volume on both the NASDAQ and the
NYSE was very light, coming in at 1.18 billion and 849 million
shares respectively.  Internals were neither stellar or
disastrous, with decliners outpacing advancers by a modest
margin on both exchanges.  Very little movement and very little
to get excited about.

The real problem is that we are still in the month of August,
and trading volume is exceptionally light, just as it is every
year at this time.  The negative market is keeping that volume
lighter still and as Jim pointed out over the weekend, the smart
move may be to just wait on the sidelines until volume
(hopefully) comes back after Labor Day.

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


Mark Phillips
Research Analyst


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

Shhhh

Be very quiet, the market's sleeping.  At least that's the way it 
felt today.  This week was expected to be a little slow ahead of 
the Labor Day holiday, but that doesn't make it any better.  At 
least the Semiconductor Index provided some excitement.

Semiconductor Index Daily Chart



 

After Friday's move that pushed the Semiconductor Index (SOX.X) 
through the 50-day moving average, the SOX took a crack at the 
200-day moving average today.  It came up a little short, but was 
still today's best performing sector.  So how much higher can the 
SOX go?  That's a day-by-day question, and tomorrow's question is 
can the SOX crack the 200-dma at 615?  If that happens, perhaps a 
test of 650 can happen.  Since the April run up, the SOX has 
managed "rallies" ranging anywhere from 4 days to 8 days.  
Tomorrow is day five, so time is running out.

Bank Sector Index Daily Chart



 

While semiconductor companies should eventually benefit from all 
of the Fed's rate cuts, the party may be coming to an end for 
banks.  Bank bears believe that the rate cutting cycle is coming 
to an end, and banks, especially savings and loans, will no 
longer benefit from people refinancing their debt.  Bank bulls 
believe that further rate cuts are likely, and it will take banks 
a year before they exhaust the benefits of recent cuts.  I 
believe the Bank Index is below both the 50 and 200-day moving 
average, and a close below 870 means there are more bank bears 
than bank bulls.

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

            Support                Close              Resistance
DJIA       |10,200  |      |      |10382 |      |      |  10,600|
NASD       | 1,710  |      |      | 1912 |      |      |   2,125|
S&P 500    | 1,150  |      | 1179 |      |      |      |   1,240|
Rus 2000   |   465  |      |      |  479 |      |      |     495|
Semis      |   535  |      |      |  606 |      |      |     660|
Biotech    |   473  |      |      |      |  551 |      |     575|
Internet   |   121  |  124 |      |      |      |      |     160|
Networking |   300  |      |      |  309 |      |      |     365|
Software   |   158  |      |  171 |      |      |      |     200|
Banking    |   650  |      |  660 |      |      |      |     685|
Retail     |   858  |  868 |      |      |      |      |     920|
Drugs      |   380  |      |      |  396 |      |      |     410|

Support Alerts:
Resistance Alerts: Biotech
            ____________________________________________________
           |   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  |  Neutral  |     Weak      |  Neutral   |
Biotech    |  Bearish  |  Neutral  |     Weak      |  Neutral   |
Internet   |  Bearish  |  Bearish  |    Strong     |  Negative  |
Networking |  Bearish  |  Bearish  | Strengthening |  Negative  |
Software   |  Bearish  |  Bearish  |    Strong     |  Negative  |
Banking    |  Bullish  |  Neutral  |   Weakening   |  Positive  |
Retail     |  Neutral  |  Bearish  |     Weak      |  Neutral   |
Drugs      |  Neutral  |  Neutral  |     Weak      |  Positive  |

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

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


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

Bollinger Bands - Beyond the Basics

We left our discussion last week after laying out the basic
construction of the Bollinger Band indicator and how to use it
in the most basic sense.  To recap that visit, we set our moving
average to the default of 20 days and the width of the outer
bands to 2 standard deviations.  In the interest of brevity,
I'll refer to Bollinger Bands with the shorthand notation BB
for the remainder of our discussion on the topic.  

The most basic application of the BB indicator is to buy the
security in question when price drops to the lower band and
bounces, and then sell when price exceeds the upper band and
then pulls back.  Fine-tuning our application just a bit, we
saw last week that the center line (20-dma) often acts as
support/resistance and we can use the price action around this
level to generate entry and exit triggers.  When the price rises
to the 20-dma and then rolls over, it is a pretty good bet that
the stock is headed back to visit the lower Band.  Conversely,
when the price drops to the 20-dma and then bounces north, we
may have an attractive setup for trading the long side until
price once again reaches the upper band.  Momentum traders can
also find valuable information from the BB and its median line.
As price rallies through the 20-dma, it gives a clue that the
bulls are likely to continue their ascent, while a drop through
the 20-dma shows bearish momentum is likely to continue in the
near term.

So now that we have covered the basics, let's get to the fun
and interesting --not to mention-- profitable nuances of the BB.
The slope of the outer bands can provide valuable clues to the
future price action of the stock or market in question, allowing
us to determine in advance, whether the prudent course of action
is to continue to ride the prevailing trend or go against it.
Doesn't that sound like it might be useful in the current market?

I'll get to the charts shortly, but here are the basic
slope-related rules that we will be focusing on:

1. If the angle of the upper band rises in response to
   approaching price, then we can expect the upward trend to
   continue, riding higher along the top band.
2. Rising price that strikes a horizontal or declining upper
   band foretells of resistance and a pending reversal.
3. If the angle of the lower band falls in response to
   approaching price, we can expect a series of declining
   candles, each pushing lower along the bottom band.
4. Declining price that strikes a horizontal lower band predicts
   support and a reversal to the upside in the near future.

So let's take a look at some charts and see if these rules can
be used to make prudent investing decisions.  Due to the fact
that it presents some great examples, I'm going to continue
focusing on the S&P 500 or SPX index for our examples today.
First, let's look at the SPX index from mid-February through the
end of May.



 

At the left-hand side of the chart, we can see a precipitous
drop in price and the lower Bollinger Band responds by falling
away.  Using rule #3 above, we have a good indication that the
price and lower band will continue to decline.  This patter
continues through the end of March with each bounce finding
resistance and falling back sharply from the 20-dma (red line).
Finally, conditions seem to be changing in early April as the
dip near the lower band finds the slope of the band turning
positive.  According to rule #4, we can expect a significant
price rise to follow.  And did it ever!

Our next inflection point comes in the third week of April, and
the pullback from the upper band appears unlikely to create a
strong decline because the slope of the band is still strongly
positive.  Sure enough, the SPX rebounded after a 3-day decline
and spent the next month moving sideways.  The mid-May rally
pushed the upper band higher again, bringing the SPX above 1300
for the first time since late February.  And that was as far as
she could go.  As the upper band flattened out, price pulled
back and began the long downward slide that is still in force
as of this writing.  Paying attention to the slope of the
Bollinger band could have given a clue as to the probable next
direction for the SPX index.

Just to demonstrate that this example isn't a fluke, let's grab
the same index when the market was still clearly in bullish
mode.  I've selected January-April of 1998, and while we see a
market with a decidedly different nature, the rules defined
above still give us a valuable insight into market action.



 

Starting with the strong rebound in early January (another
example of rule #4), the SPX launches into a 3-month momentum
run.  The BB indicator gives us a hint that this will be the
case in late January, as the upper band begins to increase its
positive slope in response to approaching price.

Conditions begin to change in early April as the upper band is
no longer being propelled higher by the approach of the daily
candles and we get 2 examples (warning signals that the trend
may be  to an end), with the second one resulting in an abrupt
drop to the lower band.  This is the first time that price has
touched the lower band and tells us that the nature of the
market has once again changed.  We must then wait for
additional trading action to tell us what to expect next.

As I mentioned last week, the Bollinger band indicator should
not be used alone.  We have used it in a vacuum here in our
discussions for the sake of clarity and education, but we're
really going to have some fun next week.  We'll begin adding
some additional indicators that will incorporate additional
price and volume information.  Since we will want to focus on
volume-related indicators, we'll have to move away from the
SPX index, since the exchange does not report volume
information for the SPX.

In the meantime, stick some Bollinger bands on your favorite
equity chart and see how many examples you can find of the four
rules I listed above.  When you can pick the signals out on your
own and combine them with other technical indicators, you will
be well on your way to directing your own investment decisions.
And that my friends is my definition of Financial Independence;
knowing that you can trade profitably without needing any help
interpreting what you see on the charts in front of you.

Happy Hunting!
Mark


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

No new calls tonight


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

No new puts tonight


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

CNXT - call
Adjust from $9.50 up to $10.50

LH - call
Adjust from $81 up to $84

EBAY - put
Adjust from $61 down to $59


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

No dropped calls tonight


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

No dropped puts tonight


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**********************
PLAY OF THE DAY - CALL
**********************

CNXT - Conexant Systems $12.46 +0.85 (+0.85 last week)

Conexant provides semiconductor products and system solutions for
a wide variety of communications electronics.  Conexant delivers
semiconductor integrated circuit products and system-level
solutions for a broad range of communications applications.  These
products facilitate communications worldwide through wireline voice
and data communications networks, cordless and cellular wireless
telephony systems.

Most Recent Write-Up

WOW!  CNXT's advance up to the $12 level came a little earlier
than we had expected.  The stock continues to out perform both
the Nasdaq Composite (COMPX) and the Philly Semi Index (SOX.X) on
up and down days.  That being the case, the stock should continue
to perform exceptionally well IF the SOX and COMPX rally into
next week's trading.  Bullish, momentum traders can use any
future advance above the $12 level to gain new entry into call
positions.  But be warned that the stock's next major level of
resistance lies at the $12.50 level, which doesn't give much room
for mistakes from current levels.  Therefore, we maintain that
"better" entries will come on weakness from current levels.  If
the stock's pattern of higher lows is going to continue, buyers
should emerge between $10 and $11 on any future weakness.  A
bounce in between that range could offer a favorable entry for
new positions, as long as light volume accompanies any weakness.
To switch gears, those traders who picked up some cheap calls
last week should definitely be thinking about booking some
gains around current levels; after all, the SEP 10's doubled
last week.  An advance up to $12.50 would offer a solid exit
point early next week for those in at lower prices.  For the
longer term, above $12.50, there's not much congestion until
the $14 level.  So be patient for a good entry point, as CNXT
could continue working for some time to come.  Insofar as its
options are concerned, we continue to prefer the higher delta
contracts not only because they're more sensitive to the
movement in the underlying, but because they're also still
pretty cheap.

Comments

The broad markets couldn't rally their way out of a wet paper
bag on Monday, but that didn't stop investors from driving CNXT
through Friday's intraday high to close just below $12.50.
Better yet, volume came in at a brisk 5.8 million shares vs. the
daily average of just over 3.2 million.  Looks like a good
old-fashioned momentum run, doesn't it?  After clearing several
resistance levels in recent days, the stock is on the cusp of
breaking out to new 5-month highs.  We're moving our stop up to
$10.50 tonight, and would look at any dip into the $11.00-11.50
range as an attractive dip-buying opportunity.  Momentum players
will want to wait for a strong push through $12.50 before adding
to current positions.

BUY CALL SEP-10.0 QXN-IB OI=5876 at $2.70 SL=1.25
BUY CALL SEP-12.5*QXN-IV OI=1783 at $0.85 SL=0.25
BUY CALL OCT-10.0 QXN-JB OI=8939 at $3.10 SL=1.50
BUY CALL OCT-12.5 QXN-JV OI=1899 at $1.55 SL=0.75
BUY CALL OCT-15.0 QXN-JY OI= 876 at $0.65 SL=0.25

Average Daily Volume = 3.22 mln



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