Option Investor

Daily Newsletter, Monday, 11/26/2001

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The Option Investor Newsletter                   Monday 11-26-2001
Copyright 2001, All rights reserved.                        1 of 1
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MARKET WRAP  (view in courier font for table alignment)
        11-26-2001        High      Low     Volume Advance/Decline
DJIA     9982.80 + 23.10  9992.80  9903.80 1.08 bln   1666/1508	
NASDAQ   1941.20 + 38.00  1941.31  1906.89 1.72 bln   2106/1561
S&P 100   596.24 +  2.97   596.85   590.82   totals   3772/3069
S&P 500  1157.42 +  7.08  1157.88  1146.17
RUS 2000  461.22 +  2.80   461.44   456.97
DJ TRANS 2525.85 -  9.05  2550.67  2506.57
VIX        25.24 +  0.46    26.20    24.94
Put/Call Ratio      0.45

Send In The Clones!

Re-igniting the cloning controversy, a small biotechnology firm
announced over the weekend that it had successfully cloned a
human embryo.  Advanced Cell Technology Inc. announced that it
had cloned three human embryos as a potential means of extracting
stem cells from embryos as treatments for disease.  Day-traders
jumped into stem-cell related issues such as Geron Corp.
(NASDAQ:GERN) and Aastrom Biosciences (NASDAQ:ASTM), driving
these stocks higher at the open.

All three embryos died before growing beyond the puny size
of 6 cells, but that didn't stop the debate about the ethics
of pursuing either cloning or stem-cell research.  President
Bush denounced the practice of human embryo cloning, saying "We
should not, as a society, grow life to destroy it".  The Vatican
chimed in with their condemnation of the embryo cloning, saying
that the scientists tampered with life, not just cells.  This
debate began with the cloning of the sheep "Dolly" and it won't
end anytime soon.  But the stocks involved in the Biotech sector
should continue to provide profitable trading opportunities long
after the ethical debate is resolved.

Despite comments from noted Biotech analysts that this was not
a significant development, the Biotechnology sector surged more
than 3% during Monday's trading session, led by the likes of
Millennium Pharmaceuticals (NASDAQ:MLNM), +7.3% and Protein
Design Labs (NASDAQ:PDLI), +7.1%.  Note that PDLI is currently
on the OIN Call list.  The moves in these more established
Biotechnology stocks likely had less to do with the cloning
news, and more to do with the fact that the Biotechnology index
(BTK.X) has been one of the leading sectors for the past 2
months, now up more than 50% from the September 21st low.
More importantly, the BTK broke above its long-term descending
trendline (currently $590) last week and continued that breakout
today, as it advanced through resistance at $613 for the first
time since late June.

I don't care what angle you choose, that is an impressive
uptrend, with a consistent pattern of higher-highs and
higher-lows, without so much as a single oversold Stochastics
reading since the last week of September.  With the move through
the descending trendline, I wouldn't be a bit surprised to see
it continue, as the bulls continue working through overhead
resistance.  For the record, the next likely levels of
congestion will be at the conveniently round numbers $650 and

On the news front, the recession is official! According to the
National Bureau of Economic Research, it began in March 2001.
Does that mean it is over?  Historical patterns point out that
by the time a recession is officially acknowledged, that the
economy is already on the path to recovery.  Judging by the
market action, it seems like that may be the case, as we edged
ever closer to Dow 10,000.  Historical patterns also suggest
that the recession should end by July 2002, and investors are
jockeying for position so they won't miss out on the profit
train that surely is leaving the station, even as I write this.

The September 11th attacks deepened the recession, but it is
widely believed that the combination of an aggressive Federal
Reserve and the pending economic stimulus plan currently being
bandied about Washington will serve to keep the economic
downturn short-lived.  While the signs of actual economic
improvement are slight, at best, we must keep in mind that they
always are at these turning points.  The stock market is a
forward-looking mechanism and is clearly focused on the
certainty that the economy will be looking much better by next
summer.  Whether or not that actually comes to pass really
isn't important.  If enough other market participants believe
the story, the market will behave as though it is true,
creating the trend from which we can profitably trade.

To that end, let's look at the important developments that took
place today.  Intel (NASDAQ:INTC) and Taiwan Semiconductor
(NYSE:TSM) kicked the Semiconductor sector back into rally mode
this morning, each with positive news.  TSM is the world's
largest chip foundry and rocked the newswires this morning by
raising its pre-tax profit estimate by 55%.  In addition, the
company ratcheted up its sales forecast and the market responded
by handing TSM a 5.7% gain.

INTC announced a breakthrough in transistor design, which could
lead to microprocessors that run at blazing speeds, while
consuming far less power and therefore generating less heat than
conventional ones.  Named the TeraHertz transistor because it
cycles on and off a trillion times per second, the new advances
could ultimately lead to new applications such as real-time
voice and face recognition, computing without keyboards, and
(dare we hope?), improved battery life.

Dan Hutchison of market research firm VLSI Research said "The
real significance of this is that they've basically invented a
new transistor technology that's fundamentally different and
it's manufacturable.  They've completely re-engineered the
transistor as we know it."  If you think that's impressive,
take a look at INTC's price chart -- the stock is now trading
just below $32, a major level of support since April.

We have talked about the Semiconductor sector (SOX.X) over the
past 2 weeks, pointing out the fact that it has been one of the
leading sectors in the recent NASDAQ advance.  Last week it was
looking a bit top-heavy, as it had rolled over right at the
descending trendline.  Well, don't look now, but the SOX is
right back at that trendline this week (currently $532) after
bouncing from the ascending 2-month support line last Wednesday.
The dip to support relieved the overbought condition and the SOX
is now poised to take a serious run at the $540-550 resistance
area.  This was a consistent level of support from December 2000
through August of this year, and now that it has been converted
to resistance, it will likely be the site of a hard-fought
battle between the bulls and the bears.

Our discussion of leading sectors wouldn't be complete without a
visit to the Internet index (INX.X), which was the top gainer on
Monday with a 5.4% advance.  The catalyst here was the 34% gain
in shares of Amazon (NASDAQ:AMZN) after the online book (and
everything else under the sun) vendor reported that holiday
sales may be running modestly ahead of expectations.  Internet
portal Yahoo! (NASDAQ:YHOO) made similar comments about its
online sales and was rewarded with a nearly 15% increase in price.

While the price moves on Monday may be exaggerated, we can draw
an important conclusion from the recent strength in leading
Technology sectors such as Biotechs, Internets, Networkers and
Software is that money is finding its way off the sidelines into
the riskier areas of the market.  As this process continues, we
can expect to see the broad market averages continue to work
through overhead resistance.

Speaking of the broad market averages, I deliberately stayed
away from discussing them tonight.  The scorecard at the top of
the Wrap contains the details, but in a nutshell, they are all
working towards their 62% retracement levels, and that will be
the next major obstacle for the bulls.  For the record those
levels are 10,153 for the DJIA, 1178 for the S&P500 and 1963
for the NASDAQ Composite.  Rather than just watching the
movement in these indices, I think the real place to watch for
market direction is in the sectors that are leading the advance.
If they remain healthy, then it looks like victory (at least
over the near-term) will go to the bulls.

Stay long while the pattern of higher lows continues, and
protect yourself with trailing stops.  Remember that the music
will stop eventually, and we want to make sure there is a seat
available for us to relax in while the profit-taking occurs.
The only thing worse than having to take a large loss on a
position after failing to set a stop is taking a large loss
on a position that at one time was showing a large profit.
Remember that markets and their underlying stocks oscillate
over time.  If we are entering a new bull market, there will
be plenty of dips for us to buy as we work through the technical
damage inflicted over the past 20 months.

So, until next time, protect your profits!

Mark Phillips
Research Analyst



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More Corrections and a Kickoff for Butterfly Spreads
By Mark Phillips
Contact Support

As the saying goes, "Haste makes waste" and last week's article
provided yet another reminder of that fact, as I neglected to
proofread my discussion on the math involved in the OEX Call
ratio backspread.  Rather than try to describe the error and
the appropriate correction, here is the erroneous paragraph,
followed by the same paragraph with highlighted corrections.
My apologies for any confusion this may have created.

Well, that starts out a bit better, as we pocket a little cash
when we put on the trade.  But we need to keep in mind that if
the OEX closes anywhere near where we initiated the trade, we'll
be racking up a significant loss.  Worst case, with the OEX
closing right at $600, we would realize a net loss of $7570.
Our long call would expire worthless, and the 2 long calls would
each have an intrinsic loss of $4000.  Subtract out the paltry
$430 net credit, and it would make for an unpleasant experience,
now wouldn't it?  We need that big upward move in order to
profit, but the question is (and we need to have this answer
before initiating the trade) how far does it have to move?

Well, that starts out a bit better, as we pocket a little cash
when we put on the trade.  But we need to keep in mind that if
the OEX closes anywhere near where we initiated the trade, we'll
be racking up a significant loss.  Worst case, with the OEX
closing right at $600, we would realize a net loss of $7570.
Our 2 long calls would expire worthless, and the 1 short call
would have an intrinsic loss of $4000.  Subtract out the paltry
$430 net credit, and it would make for an unpleasant experience,
now wouldn't it?  We need that big upward move in order to
profit, but the question is (and we need to have this answer
before initiating the trade) how far does it have to move?

Re-calculating the break even points for the trade shows that we
would need the OEX to move above $635.70 or back below $564.30
for our trade to be above break even.  Let's start with the case
to the upside.  By the time the OEX reaches the $630 level, all
of the options (both long and short) will be deep in the money,
with deltas close to 1.0.  Simple math tells us that the break
even will occur at OEX=640 (2 long contracts with intrinsic
value of $40 minus 1 short contract with intrinsic value of $80)
minus the initial credit of $430, which yields an actual break
even of $635.70.  Any movement above that point yields profits
from a position that will now move point-for-point with the
movement of the underlying index.

On the downside, if the trade were done for zero cost, or no net
credit, it is easy to see that the position will incur a maximum
loss at $600, decaying to zero at $560, at which point all the
options would expire worthless.  Since we took in a credit of
$430 when we initiated the trade, the break even point moves up
by that amount, so that the actual break even point on the
downside is $564.30.

Given such a wide range of values for the OEX ($564.30-635.70)
where the trade would incur a loss, and in an already extended
market, I think you can see why I stated that this is clearly
not the right time to initiate such a strategy, at least not on
the OEX.  Hopefully these comments will help to clarify any
lingering questions about the Ratio Backspreads we have been
discussing recently.

Now let's move on to a strategy I've been referring to lately
that can serve us well in a rangebound market, namely the
Butterfly spread.  This trade can be implemented with either
puts or calls, depending on which gives the most favorable
pricing.  For the sake of discussion, I'm going to focus on
utilizing calls to initiate our hypothetical trade.

The basic Butterfly Spread consists of purchasing two calls and
selling two calls, and the relative position of the strikes
involved determines whether we are buying or selling the spread.
If we see a stock that is trading sideways and our bias is that
we expect the stock in question to continue to do so, we might
consider purchasing a Butterfly spread by buying 2 ATM calls and
selling 1 ITM call and one OTM call, each equidistant from the
long call strike.  Here's what the risk-reward graph looks like.

Clearly, this is a limited risk, limited reward trade, where we
are betting on the stock trading near 'B' at expiration.
Maximum reward (B-A-cost to initiate the trade) would occur
at 'B', while maximum loss (defined as the cost to initiate the
trade) would occur either at 'A' plus the cost of the spread or
'C' minus the cost of the spread.  In these trades, most of the
profit develops in the month prior to expiration, so we prefer
to initiate the position with front month contracts in the first
two weeks of the expiration cycle and next-month contracts in
the last two weeks of the expiration cycle.

Let's walk through a simple example to hopefully make things
clear.  Assume XYZ is currently trading at $100 and we want to
buy a butterfly spread to profit from our expectation that the
stock will remain near $100 at expiration.  Since we are
currently in the second week of the December option cycle, we
would opt to use DEC strikes.

Buying the butterfly will consist of selling 2 $100 calls (the
Body), buying 1 $95 call (Left Wing) and buying 1 $105 call
(Right Wing).  Let's assume that it costs $1.00 to initiate the
trade.  That gives us a maximum reward of $4 ($100-95-1) if XYZ
closes exactly at $100 on expiration Friday.  The worst case
loss of $1 (the cost to initiate the spread) would occur if XYZ
were trading below $95 or above $105 at expiration with break
even at $96 (A plus cost of spread) or $104 (C minus cost of

At 4:1, that looks like a pretty decent risk-reward to me,
especially for a conservative spread strategy.  Of course, we
need to pick the right time to initiate such a trade, and we'll
look at some possible candidates next week.  On the other side
of this discussion, we can use the Butterfly spread to initiate
a position for a net credit that will profit if the underlying
stock moves strongly in either direction.  In that case, we buy
the ATM contracts (Buy the Body) and sell one each of the OTM
and ITM contracts (Sell the Wings), pocketing a net credit.

I'm out of space for today, but will pick up where we left off
next week, profiling a couple of examples of attractive long
Butterfly Spreads.  Then we'll further detail the Short
Butterfly spread, along with the characteristics of an
attractive candidate for that type of strategy.  If you have a
candidate for either strategy, send it along.  Who knows?  Maybe
one of your suggestions will prove to be even better than the
examples I'll dig up.  Making the discussion more interactive
should prove profitable to all involved.

Have a great week!

Mark Phillips
Contact Support


No new calls tonight


No new puts tonight


BRCM - call
Adjust from $42.75 up to $46

JNPR - call
Adjust from $23.25 up to $24

NOK - call
Adjust from $22.50 up to $23

PDLI - call
Adjust from $33.50 up to $35

PMCS - call
Adjust from $20.50 up to $21

SPW - call
Adjust from $114 up to $117


No Dropped Calls tonight


MXIM $55.13 +2.90 (+2.90) Weakness in the Semiconductor sector
last week gave us a nice gain in our MXIM play, but warning
signals began to go off on Friday, as the stock traced a higher
low and closed near the high of the day.  With positive news
from INTC this morning, the SOX took off from the opening bell,
and our MXIM play quickly vaulted through our $54 stop, bringing
the play to an end as the chip bulls are clearly back in charge.

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BRCM – Broadcom Corporation $49.99 +3.54 (+3.54 this week)

Sitting in the sweet spot between the Broadband and
Semiconductor sectors, BRCM is a provider of highly integrated
silicon solutions that enable broadband digital transmission
of voice, video and data to and throughout the home and within
the business enterprise.  These integrated circuits permit the
cost-effective delivery of high-speed, high-bandwidth networking
using existing communications infrastructures that were not
originally designed for the transmission of broadband digital
content.  Using proprietary technologies, the company designs,
develops and supplies integrated circuits for several markets
including digital cable set top boxes, cable modems, high-speed
office networks, home networking, and digital subscriber lines.

Most Recent Write-Up

The dip last week was quick, but hopefully it allowed traders
to gain an entry into this super strong play.  SPW climbed
back towards its relative highs last Friday after briefly
pulling back to the $115.40 level the day before the holiday.
The stock looks poised to breakout above its relative high at
$119, but keep in mind that resistance lurks just above at
$120.  Although, SPW hasn't paid much attention to resistance
levels in the last two months.  The stock is clearly a momentum
favorite among traders and could continue its out performance
to the upside if the market continues advancing.  However, as
we've been writing in the past, with as extended as SPW currently
is, the risk in chasing the stock higher on a breakout may be
more than waiting for a pullback.  The big problem we've had has
been waiting for a pullback: it hasn't materialized.  With that
said, readers should consider their trading styles and risk
tolerances before entering new plays.  Let your discipline
dictate trading SPW.  Those with open positions might look for
strength above $119 to book gains.  Our coverage stop has been
raised to $114, which is very liberal; readers with open
positions should consider a tighter stop.


The Semiconductor sector (SOX.X) got a serious shot in the arm
this morning in the form of good news from INTC and TSM.  While
the new technology announced by the chip giant won't find its
way into products anytime soon, the improved guidance from TSM
was enough to invigorate the bulls and push the SOX up for a 4%
gain.  Our BRCM play was looking rather healthy all last week
and outdistanced the broad sector by tacking on more than 7.5%,
clearing long-term resistance near $49.  The stock hasn't traded
this high since early March, and the above-average volume
confirms the bulls are serious.  There's no question that BRCM
is getting extended here, so we'd prefer to grab it on a
pullback, perhaps to the $47 level, near the top of this
morning's gap.  Of course, if the SOX breaks through its $550
resistance level, it wouldn't be out of the question for BRCM
to continue rallying from current levels.  Momentum traders can
buy further strength above $50, but need to carefully manage
their risk.  We're raising our stop tonight to $46.

BUY CALL DEC-50*RCQ-LJ OI=10452 at $4.00 SL=2.50
BUY CALL DEC-55 RDZ-LK OI= 8565 at $1.85 SL=1.00
BUY CALL JAN-50 RCQ-AJ OI= 2062 at $6.50 SL=4.50
BUY CALL JAN-52 RDZ-AX OI=  426 at $5.10 SL=3.00
BUY CALL JAN-55 RDZ-AK OI= 2507 at $4.10 SL=2.50
BUY CALL JAN-57 RDZ-AY OI= 1467 at $3.20 SL=1.50

Average Daily Volume = 13.3 mln

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