The Option Investor Newsletter Wednesday 12-05-2001 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/6716_1.asp Posted online for subscribers at http://www.OptionInvestor.com ******************************************************************* MARKET WRAP (view in courier font for table alignment) ******************************************************************* 12-05-2001 High Low Volume Advance/Decline DJIA 10114.29 +220.45 10142.32 9891.35 1.75 bln 2063/1098 NASDAQ 2046.84 + 83.74 2056.81 1980.30 2.72 bln 2420/1272 S&P 100 597.70 + 12.07 599.38 585.63 Totals 4483/2370 S&P 500 1170.35 + 25.55 1173.62 1143.77 RUS 2000 479.42 + 11.58 480.43 467.84 DJ TRANS 2612.49 + 77.64 2618.47 2531.40 VIX 24.79 - 0.54 24.79 23.62 VXN 47.44 - 0.60 48.90 46.57 TRIN 0.34 Put/Call 0.44 ******************************************************************* Special K, Special Day The Dow Jones Industrial Average (INDU) closed above the 10K mark for the first time since September 5. Meanwhile, the tech-laden Nasdaq Composite (COMPX) closed above the 2K mark for the first time since August 7. WHOA, what a day! The Catalysts: There was a confluence of catalysts that emerged Wednesday morning, which would carry stocks higher throughout the day. Salomon Smith Barney raised its earnings per share estimates for the S&P 500. Salmon upped its earnings estimates for this year and next. The National Association of Purchasing Managers (NAPM) reported its non-manufacturing index of business activity rose to 51.3 percent during the month of November, which was a big jump over October's reading of 40.6 percent. Economists had predicted the November NAPM number to rise to 42.2. In other words, the actual number was a big upside surprise. A reading above 50 percent in the NAPM index suggests growth. Late Tuesday, Larry Ellison of Oracle (NASDAQ:ORCL) said his company's businesses were stabilizing. Ellison upped margin estimates and reaffirmed revenue opportunities in the company's new application server product. Shares of Oracle finished over eleven percent higher Wednesday. The stock's gain added fuel to the momentum in the Software Sector Index (GSO), which finished 6 percent higher. Other notable advancers in the GSO included Rational (NASDAQ:RATL), PeopleSoft (NASDAQ:PSFT), Siebel (NASDAQ:SEBL) -- an OI put play no more -- Check Point (NASDAQ:CHKP), and Veritas (NASDAQ:VRTS). I of course have to mention Microsoft (NASDAQ:MSFT) when writing about the GSO; the stock finished $2.10 higher. Micron (NYSE:MU) boosted the chip sector. Talk spread of consolidation within the DRAM market. The aim of consolidation is to clear the excess inventory among DRAM manufacturers in an attempt to firm up prices. Shares of Micron added $2.57 on the news. The Semiconductor Sector Index (SOX) finished over seven percent higher Tuesday. The Short Covering Impact: The two positive developments in the technology sector caught the bears off guard in a big way. Traders shorted into last week's rally and again during Tuesday's rally. I highlighted that fact in Tuesday's Market Sentiment piece, noting the excessive number of puts traded in the QQQs -- the tracking stock of the Nasdaq-100 (NDX) -- which is a barometer for big cap technology stocks. I wrote that "I [didn't] expect another 4.25 percent day in the NDX [Wednesday]," which was obviously wrong. But the revelation of continued short selling into the rally Tuesday proved to be a costly mistake for the bears. Without the necessary supply to cover their shorts, the bears were forced to chase stocks higher Wednesday, especially technology stocks. Big Breakouts: Big Blue (NYSE:IBM) and Intel (NASDAQ:INTC) broke out to the upside Wednesday. In addition to only a few others, the two stocks are the most important in technology. Fortunately, both IBM and Intel are current call plays on Option Investor. In IBM, we've been writing about entering near support at $112. The stock dipped down to that level last Thursday and provided yet another entry opportunity near support, where risk could've easily been managed. Five days and nine points later, you're a genius if you entered on the weakness. The breakout in Big Blue bodes well for the health of the technology sector. And then there's Intel. Our play on Intel was written in a simple fashion: enter on a breakout above $33. Amazingly, the stock opened Wednesday morning at $33.04, which was a rare gift from the market makers. More than $1.50 later, you're a genius if you entered on the breakout. Intel's advance above $33 is a positive development for the SOX. Know Your Debt: Away from stocks, Treasuries were whacked Wednesday. But that made sense, right? If bonds were sold heavily, wouldn't it make sense for the proceeds of those sales to move into stocks? Especially if bond market participants think the economy is going to recover next year, right? Wouldn't you rather own a stock during an expansion than a bond? The positive reading in the non-manufacturing NAPM number added credence to the argument that the Fed is nearing the end of its easing cycle. The Fed Funds predicted about an 85 percent chance of an easing next week, but no more cuts thereafter. If the economy rebounds and the Fed is near its easing cycle, which way do interest rates move next? Chances are higher, which is what was reflected in the sell-off in Treasuries Wednesday. (Remember that bond prices move inverse to yields. Lower prices equate to selling equates to higher yields.) The recent action in the 5-year Note (FVX) was the one thorn in the side of stocks. The 5-year Note saw buying recently as indicated by its falling yield. But that all changed Wednesday in the wake of the NAPM report. The yield of the 5-year sharply reversed as bond market participants discounted a stronger economy. The yield finished 6.87 percent higher, which was a massive, massive move. From a technical standpoint, the 5-year yield recently turned lower at the 44.65 (4.46%) level. The advance Wednesday carried the yield to as high as 43.06 (4.30%), just above a key retracement level at 42.80 (4.28%). Readers can monitor the progress of the yield through the levels of the retracement bracket. (I've anchored the bracket at May's high and September's low.) The Business Cycle: The recent economic reports and action in stocks and bonds discounted a recovery next year. How do you play the recovery? There are many, many ways to play an economic recovery, but one you might not have thought of is through cyclicals -- the companies closely tied to the business cycle. There are several sub-sectors within the cyclical group, one of which is chemicals. The S&P Chemical Index (CEX) hit a peak in late 1999 up around the 550 level and traded all the way down to 315 in September of this year. The rising price of energy during that time pressured the group and so did the economic slowdown. But those two trends have recently reversed. Despite Russia's agreement to cut production Wednesday, the price of crude oil remains relatively low around the $20 per barrel mark. Energy is a chief cost of the chemical companies. In addition, a recovery in the economy will spur economic activity and a greater demand for chemical products. As long as the price of energy remains relatively low, the CEX could be a good place to look for ideas for playing an economic recovery. Among the more attractive CEX components include: FMC (NYSE:FMC), Praxair (NYSE:PX), International Flavors & Fragrances (NYSE:IFF), Dow Chemical (NYSE:DOW), and Engelhard (NYSE:EC). Although not a component of the CEX, Neogen (NASDAQ:NEOG) might be another stock worth a look. No, the chemicals aren't sexy. But they're something different and worth a try at this point in the cycle. Don't you get tired of reading only about tech? What To Do Next: The last two days have been most bullish. But I've received a lot of e-mails from readers who've experienced a great deal of frustration because they missed the move. I've been told by my mentors: opportunities are easier to make up than losses. Write that down! If you missed this move, don't worry about. There will be more. The only thing a trader can do is stick to his/her strategy, discipline, and methodology. If the recent rally didn't offer a suitable entry point for YOU, then wait until it does. For those who captured this move, now may be a good time to consider taking defensive steps in order to preserve gains. That could include setting trailing stops, selling covered calls, or scaling out of partial positions on further strength. Just have a plan in place and stick with it. Cisco Systems (NASDAQ:CSCO) is reporting to analysts this evening and Intel will do the same after the bell Thursday. Remember that the market is a forward-looking mechanism, so bullish guidance by either of the aforementioned tech bellwethers may actually be met with selling, in a typical "buy the rumor, sell on the news" event. Now, I'm not suggesting that either stock will go lower. Rather, the good news may have been discounted in the last two days. The jobless claims Thursday morning and non-farm payrolls number Friday morning are two big forthcoming economic reports. Each could influence the Fed's decision on interest rates next week and consequently impact trading in the bond market. The Dow and S&P 500 (SPX) kissed their 200-dmas Wednesday, while the Nasdaq measures closed well above their 200-dmas. That was a significant development in tech, which may prompt institutional buyers to step in again Thursday. The Nasdaq-100, for example, hasn't traded above its 200-dma in more than a year. Yep, it sure feels like a new bull market. Eric Utley Option Investor ************************Advertisement************************* GREAT TECHNOLOGY, LOW RATES * EASY screens for covered calls, spreads, and straddles * FREE REAL-TIME quotes and custom option chains * $1.50 Per Contract (10+ contracts) or $14.95 Minimum. No Hidden Fees. * ZERO minimum deposit required to open an account Visit: http://www.optionsxpress.com/marketing.asp?source=optinv1 Note: Options involve risk. Risk disclosure: http://www.optionsxpress.com/welcome_risk_index.htm ************************************************************** ***************** STOP-LOSS UPDATES ***************** SPW - call Adjust from $118.50 up to $122 PMCS - call Adjust from $21 up to $25 PDLI - call Adjust from $35 up to $36 CNXT - call Adjust from $13 up to $14 MCDT - call Adjust from $22 up to $25 INTC - call Adjust from $30 up to $32 MLNM - call Adjust from $31 up to $32 IBM - call Adjust from $112 up to $115 IMCL - call Adjust from $67 up to $69 ************* DROPPED CALLS ************* No Dropped Calls for Wednesday. ************ DROPPED PUTS ************ SEBL $24.80 +1.82 (+2.45) SEBL charged higher out of the gates this morning in the wake of the positive ORCL comments. The stock bolted above its 10-dma and closed above our stop which was at the $24.50 level. Traders with open positions might look for a pullback early tomorrow to cut losses. ***** LEAPS ***** Due To Overwhelming Demand - Let's Look At EBAY Again By Mark Phillips Contact Support The past 2 days' action in the broad markets have left me with no choice but to embrace the idea that the bull is back in town. Do I think it is here to stay? Not a chance! The Fed has done a remarkable job of flooding the market with liquidity, and market participants are taking the gift as an excuse to re-inflate the tech bubble. Investors don't seem to need any proof that profits are going to surge next year; just the slightest hint that things are not getting worse is sufficient to drive the momentum stocks of yore to 5-10% daily gains. It feels just like late 1999 again. Except for one thing...we aren't in an expanding economy. Even the most die-hard bull would only describe the current economic condition as "possibly bottoming". In my never-to-be-humble opinion, valuations (particularly in the technology arena) are rapidly approaching ridiculous levels once again. Judging by some of the email I've received this week, I'm not alone. I've had a long list of emails requesting a revisit of the eBay (NASDAQ:EBAY) LEAP Put play that we dropped from the Portfolio last weekend, asking if it might be ripe for an even more attractive entry. I had intended to talk about my bearish slant over the long term on stocks such as Intel (NASDAQ:INTC) and Home Depot (NYSE:HD) after receiving several requests since the weekend for elaboration on my expectations. But the number of requests for further discussion of EBAY far outnumbered them. So let's start with just one of the emails I received this week, which I think is representative of the group. "Wondered if you've been watching (actually I know you have given your comments from last Sunday) EBAY and it's ascension to what looks like a very significant price of $70 (june/july high). I was wondering if you felt this price point could be an even more attractive entry than those you have previously discussed. It would seem if 70 could hold up as resistance, there is plenty of room to move to the downside on any sort downturn. In addition, it seems pretty low risk if one sets their stop just above $70. To borrow the theme from your Sunday article - this $70 level may have been worth the wait. Thoughts on this subject? Curious and I thought I'd comment. Alan" Thanks, Alan! Many others echoed the same point, but I believe it gives us a starting point for today's discussion. Let's start by looking at the weekly/daily chart we used at the end of October. With weekly Stochastics starting to weaken, all we had to do was wait for the daily oscillator to get back to overbought, more than likely in the $58-60 area, and we'd have a high-odds LEAP Put entry. Well, sure enough, the Portfolio took that entry a couple weeks later, and last week got stopped out, as the bulls rallied right through the long-term descending trendline. So with the stock now trading nearly $13 higher than in the chart shown above, the big question is whether this is an even better entry point into the play. With the fundamental picture materially unchanged in the past 6 weeks, we have nothing else to rely on than the almighty charts. So let's see how the weekly/daily montage has changed since we last discussed EBAY. With the breakout over both the $62-63 resistance level and the long-term descending trendline, a lot of damage has been done to the bearish picture that we painted back in October. Looking at the daily chart above, you can see that the past month has seen a series of higher highs and higher lows. And what about that bearish reversal on the Weekly Stochastics? It too has been negated with the strong bullish reversal and is now deep in overbought territory. So we could definitely make the case that a fresh put entry is rapidly approaching on EBAY. Both the daily and weekly Stochastics are overbought, and we got a big 'doji' reversal today on huge volume (nearly double the ADV). Let's take a closer look at the daily chart and see where our targets of opportunity may lie. The bulls were rebuffed at the $71 level on Wednesday, although they made an impressive push higher in the early going. They'll need a bit more conviction to clear the June/July highs, but judging from the current momentum in the market, I will be surprised if they don't manage to break through this level over the near term. In fact, the stock will more than likely challenge the $76 level of resistance, which was last seen way back in September of 2000. Sure it's silly, but bullish enthusiasm is breaking out all over. Given the relatively strong performance of EBAY over the past year, I would be surprised to see much downward pressure on the stock until the broad market runs out of steam. Even with some sustained selling pressure, I now see the downside as limited to the $60-62 level, as this resistance will more than likely act as support going forward. All the leading Technology sectors (including the Internets) are seeing strong buying pressure and taking out important resistance levels (seemingly on a daily basis lately). Trying to game the downside in that environment is going to be rough. As much as it goes against my own rationality, it looks to me like the bull may be here for awhile -- possibly until March/April of next year. One final bullish factor to add to the mix is the evidence offered by the monthly chart. Unfortunately, I can't seem to get my charting program to respond this late in the day, so I'll have to go from memory, and you'll have to use your imagination. What I noticed is that since the September lows, the monthly Stochastics has been charging towards overbought territory and could be entering that zone in the next couple months. Not only that, but the stock broke above the very long-term descending trendline near $67 on the monthly chart with its breakout move last week. With both the monthly and weekly charts exhibiting strong bullish trends and the descending trendlines broken in both timeframes, it is hard to make a case for a bearish play. While I still believe EBAY could prove to be a profitable play to the downside, the time for that sort of play is definitely not now. I'll be first in line to buy long-term puts when monthly/weekly/daily charts align in overbought territory and the daily begins to roll over. I expect that convergence to occur at price levels considerably higher than right now due to the irrational enthusiasm currently fueling the market's rally. I don't want to stand in the way of that rally, as I would be likely to get trampled. From my peek at the various charts tonight, I'm inclined to think there may be some money to be made to the upside before the music stops. I may just have to see if I can harvest part of that rise for myself. Of course, for those of you that have learned to treat my advice as the ultimate contrarian indicator, maybe my venturing into the long side on EBAY will be just the key to pulling the rug out from under the bulls. (big grin) Remember, that this is only one man's opinion. Is EBAY overpriced? Yes. Can it continue higher? Yes. Could the stock sell of from here, making it a great put play? Yes. I just can't make a technical argument to play puts at this point in time. My strongest ally is the picture painted by the charts, and right now they are telling me there is no bearish play to be had. I wish I had been right with my put play last month, but given the choice between being right and making money, I'll pick making money every time. And right now, the money is being made by the bulls. I hope this helps. ************************Advertisement************************* Tired of waiting on trades to execute? Does your broker offer Stop Losses on Options? Trade instantly with Stop Losses at PreferredTrade Inc. Stop Losses based on the option price or the stock price. Move your trading into the next millennium with PreferredTrade. Anything else is too slow! http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ********************* PLAY OF THE DAY - PUT ********************* LH - Laboratory Corp. of America $78.25 +0.75 (+1.35 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 Update The positive market environment this week has helped to buoy shares of even poorly performing stocks and LH has certainly been a beneficiary of this effect over the past couple days. Finding support near the 200-dma ($75.92) and recovering back towards the descending trendline (currently $78.50). With historical resistance at this level and the declining 10-dma ($78.85) looming overhead, a rollover in price near $78.50 looks attractive for initiating new positions. The longer-term ascending trendline is currently resting at $72, and we would look to harvest profits on a dip near that level. Comments LH rolled over at the $80 level today, which is currently the site of our stop. The failure to trade above $80 in such a strong market may portend a reversal over the short-term. Look for weakness in the Healthcare Sector (HCX.X) early tomorrow. A breakdown below $77.40 may offer favorable entries into weakness. BUY PUT DEC-80 LH-XP OI=551 at $4.00 SL=3.25 BUY PUT DEC-75*LH-XO OI=271 at $1.80 SL=1.25 Average Daily Volume = 762 K ***************************************** BIG CAP COVERED CALLS & NAKED PUT SECTION ***************************************** Global Finance 101: Zurich - The Money Center! By Ray Cummins Most traders will agree, "Money makes the world go round" and in Zurich, Switzerland, the popular adage has never been more accurate. Switzerland was once described as a combination of the "colossal and the well ordered" and similar to the country's reputation for precision timepieces, Zurich runs like an atomic clock. Indeed, much of Switzerland's architectural beauty and complex works of civil engineering, as well as the core of its ultra- reliable public transportation system are showcased in this grand city. Of course, that doesn't mean it is predictable, despite rumors to the contrary, and the Swiss financial capital definitely offers something for everyone. In contrast to its banking background, Zurich presents a unique blend of many of the world's oldest cultures with an uncommonly diverse range of urban lifestyles. Switzerland's largest city boasts a population of over 350,000 and it houses the country's most famous landmarks and cultural offerings including one of the world's best operas. Visitors are drawn to the city's well known historical repositories such as the National Museum and the Zurich Museum of Fine Arts. In addition, tourists enjoy lovely walks through the narrow streets of old town, which is inundated with cozy restaurants and chic art galleries, and they also come to Lake Zurich for fun and frolic on the historic paddleboats. Geographically, Zurich is located in the northern region of Switzerland and its name comes from the large body of water at the city's center. The ancient community started life as a Roman outpost called Turicum. It grew slowly with time, as textiles merchants gradually increased the wealth of the area and in 1812, Zurich became a free city in the Holy Roman Empire. During the following century, merchants and artisans formed a group of powerful guilds that eventually took control of the local government and in 1351, they elected to join the Swiss Confederation. The decision was an important one as it marked the starting point for the cultural and intellectual growth of the region and Zurich's unique reputation, as well as its rich tradition, has blossomed ever since. From a financial viewpoint, Zurich's status as a global industrial and business center is thanks in no small part to the efforts of the railway magnate Alfred Escher; a strong force in government and politics during the mid-1800s. In 1877, Zurich's stock exchange was founded, and it is still the most important facility of its kind in the country. Today Zurich offers one of the world's best blends of new age affluence and traditional culture and it is the only place where chocolate bars battle with gold bars for your attention. Those of you who are long-time readers know I consider both of those items to be valuable commodities and only with great resolve was I able to focus on the more relevant subject during my brief visit. Indeed, a tour of the Zurich Exchange and banking center was the main purpose of my journey to Europe and in the next segment of Global Finance 101, we will explore the innermost workings of the highly developed financial mechanism that is the "World's Money Center." Summary of Current Positions (as of 12/4/01): Covered Calls: (Margin not used in calculations) Stock Strike Strike Cost Current Gain Potential Symbol Month Price Basis Price (Loss) Mon. Yield INTU DEC 45 40.85 43.73 2.88 4.8% TMPW DEC 35 33.20 41.90 1.80 4.5% ELBO DEC 35 33.50 41.15 1.50 3.7% Naked Puts: Stock Strike Strike Cost Current Gain Potential Symbol Month Price Basis Price (Loss) Mon. Yield SMTC DEC 30 29.50 39.93 0.50 7.9% EBAY DEC 50 48.85 69.99 1.15 6.8% PCSA DEC 45 44.05 53.05 0.95 6.0% TMPW DEC 30 29.40 41.90 0.60 6.0% INTU DEC 35 34.20 43.73 0.80 5.6% CVTX DEC 42.5 41.90 55.85 0.60 5.1% BBY DEC 55 54.00 72.37 1.00 5.1% ELBO DEC 30 29.50 41.15 0.50 5.0% IGEN DEC 30 24.65 35.50 0.35 4.5% Naked Calls: Stock Strike Strike Cost Current Gain Potential Symbol Month Price Basis Price (Loss) Mon. Yield CCMP DEC 80 80.65 72.98 0.65 5.4% CHIR DEC 50 50.45 43.33 0.45 5.3% IDPH DEC 75 75.70 69.43 0.70 5.2% EASI DEC 55 55.50 42.12 0.50 4.5% Sell Strangles: Stock Strike Strike Cost Current Gain Potential Symbol Month Price Basis Price (Loss) Mon. Yield AZN DEC 50-C 51.30 45.37 1.30 4.9% AZN DEC 45-P 43.60 45.37 1.40 5.3% ERTS DEC 50-P 48.45 64.44 1.55 7.9% The (short) call position in Electronic Arts (NASDAQ:ERTS) should have been closed last week when the stock moved up to the sold strike price. The issue remained near $60 for two sessions before moving higher, providing ample exit (or adjustment) opportunities. Credit Spreads: Stock Pick Last Position Credit C/B G/L Status PCAR 62.59 63.27 DEC50P/55P 0.70 54.30 0.70 Open AHP 56.47 60.10 DEC65C/60C 0.65 60.65 0.55 Open CSC 45.09 48.95 DEC35P/40P 0.60 39.40 0.60 Open PEP 50.28 48.47 DEC45P/47P 0.35 47.15 0.35 Open NKE 51.56 52.97 DEC45P/47P 0.40 47.10 0.40 Open AGN 76.10 74.74 DEC65P/70P 0.60 69.30 0.60 Open LLY 83.33 82.79 DEC75P/80P 0.80 79.20 0.80 Open CHIR 45.59 43.33 DEC55C/50C 0.60 50.60 0.60 Open IGEN 35.44 35.50 DEC25P/30P 0.85 29.15 0.85 Open ENZN 57.00 57.80 DEC70C/65C 0.60 65.60 0.60 Open *************** Strategy and Play Selection: Part II *************** Sunday's discussion of spread and combination strategies generated some interesting E-mails, all of which I will answer when I return from Europe. However, since many of the questions referred to the methods I use in play selection and portfolio management, it seems appropriate to review the fundamental goals of the Spreads/Combos section, as well as the techniques used to produce the candidates and establish the entry and exit prices for each position. Spreads and Combination Plays: A Conservative Approach The Spreads/Combos section is produced for a target audience: novice traders that need simple strategies. To generate the majority of plays, I search through lists of candidates and evaluate the positions and their potential returns based on the technical outlook of the underlying issue, its sector and the overall market. If I feel the chart fits the strategy and there is an acceptable risk/reward ratio, the position is placed on a list of final candidates. After I have all of the possible plays for a specific day, I simply choose those which, in my opinion, appear most favorable. On some days, I also list positions on candidates (stocks or indexes) that readers have requested or submitted, so they can see what type of play a more experienced trader might utilize, based on their outlook for the underlying issue, industry or market segment. These plays are always listed with the heading "Reader's Request" to differentiate between my picks and those coming from subscribers. One of the first skills new market participants must learn is to identify and execute a favorable opening trade. A good technique for initiating a combination position is to place the order as a "spread." That's why I always list a suggested "net-credit" or "net-debit" target to help traders open the play. This is simply a recommended entry point; just my opinion of what a trader might use as an initial "limit" for the spread order, and it should be a reasonable price to initiate the play even with small changes in the stock and option quotes. The target is always less than the straight BID/ASK numbers (we don't pay "market" for spread orders) and generally, you can expect to shave a minimum of $0.10-$0.20 off the BID/ASK price when opening or closing even the smallest spread order. The margin can be more or less, depending on the price of the options, whether they are ITM or OTM, the time value remaining, the volatility of the stock, etc. I simply try to give the beginning trader an idea of the value of the position because the option prices are always different the next day. Of course, you may need to adjust this target based on the activity of the underlying issue, the trading volume of its options or the Implied Volatility of the series being traded. In closing the plays, I generally suggest a target return of 10-20% per month on most of the basic spread strategies and that is how the target profit or "return on investment" numbers are derived. I try to construct positions to reflect that goal, but not every play is a winner so the main objective is to limit losses and close losing positions before they become very costly, preserving trading capital for the next success. Portfolio Tracking: I follow the portfolio "real-time" with Interquote and paste all the prices for each position into an archive at regular intervals throughout the day. I trade the "paper" portfolio just as I would trade (or adjust) my personal account and I post the target entry prices for each position (the suggested NET CREDIT or NET DEBIT numbers) whenever they are achieved or fall within a small margin. That margin is generally $0.10-$0.20 for spreads under $3-$4 and slightly more for higher priced positions. Occasionally, I will allow additional latitude on unique plays if it is realistic that the target price could have been attained and I have knowledge of the market-maker that handles that issue or can document other trades in that series at that price. I usually don't "leg" into combination plays as far as the newsletter portfolio is concerned (unless specifically stated) but I try to utilize the volatility at the open and close of the session to improve the entry prices. Some of the positions may be priced better than the "target" while others are worse. I do not simply take the best price of day; I try to trade just as I would in my own portfolio. In addition, I have the benefit of real-time (and historical) option quotes and a link to one of the top market-makers in the industry, to help price the positions without actually trading them. In most cases, the published prices are a fairly accurate record of the potential entry opportunities and keep in mind, I rarely show positions as "not-traded" even though I personally might have avoided them, based on new information that became available after the play was initially offered. New readers occasionally complain when they are unable to achieve the entry targets, even after trades are posted at those prices. As with most experienced traders, I have the benefit of a floor specialist working on my behalf to get the best entries. Most orders will not get filled at our target with discount brokerages unless the options actually trade at those prices. The potential for success with an online broker such as Preferred Trade (which has direct access to the exchange but does not allow simultaneous orders for multiple positions) is based strictly on the trader's skills and the market's volatility. Most of our advanced readers use the Spreads/Combos section as a candidate list and they trade their own positions at different prices. I correspond with many of them daily (lots of candidates that way!) and they are quick to report when an entry price has been posted in error or could not have been achieved. Some of them open and close new positions using the method I previously referred to: "legging" in or out-of a spread. Basically, you just try to utilize the daily movement of the underlying stock to your advantage, buying a long position when it is cheaper and selling a short position when it is more expensive. This tactic becomes easier after you are familiar with the daily stock, sector, and market trends and use the appropriate trading tools. The Weekly Summary (Portfolio Activity): I try to monitor all the plays in the Spreads/Combos section on a regular basis and as time permits, I will make suggestions as to when they might be closed or adjusted. However, my primary job is to provide candidates for your careful scrutiny and to identify positions that have a favorable risk/reward outlook. In the end, the determination to trade is solely yours. I will also try to identify those occasions when a play offers a favorable early-exit profit, or when I notice an issue has reversed direction and may require closure or adjustment of the associated position. Keep in mind that I generally have over 100 positions in three sections to track on a daily basis and I may not always observe the crucial turning point or change in character of a specific issue. The portfolio narrative is a service I provide to help novice traders understand how various positions might be opened and closed. In most cases, actions taken based on the commentary would be far too late to be effective, thus it is not intended as a substitute for personal trade management nor does it replace your duty to monitor the positions in your portfolio. In years past, we published a monthly summary of combination positions, and it was a reasonable representation of the plays offered during the month. However, because there are so many ways in which each play can be opened , closed and adjusted, the summary eventually became a journal of my personal management of the positions and it became obvious that it might not be completely representative of the manner in which the average trader would react. Now I create an Excel-based summary for daily play tracking and the ongoing summary, which is part of the week-end Spreads/Combos section, and is in a narrative format. Position Management: One of the questions I receive frequently concerns the correct timing of early exits and adjustments for spread positions. While there is no perfect answer (or solution) to this dilemma, one of the most practical closing strategies is based on the target ROI (return on investment) for the position. For example, if a play originates with a 15% monthly return target and a slightly smaller but reasonable profit becomes available at an earlier date (based on a lower yield and shorter time period), the position is indeed a candidate for early closure. Of course, most positions that meet that criteria will appear to be so successful they can't possibly lose at expiration. This aspect, along with commission considerations and the effects of human nature - which urges you to simply hold the play and hope for maximum profit - will prevent most traders from closing the play early. As you know, even when the issue moves in the predicted direction, the position is always at risk from a variety of changes in the market. These effects are reduced with hedged positions but the end result can still be unfavorable. There are a number of examples in past portfolio plays including some which might have been our most profitable positions, except that they were closed in the interest of sound money management. As far how to place STOPS and closing orders; some traders suggest closing a position when it meets a specific price while others use technical analysis to determine the correct placement of potential exit orders. The limited-risk techniques discussed in the Spreads/Combos section are not with out their disadvantages and obviously, the more advanced strategies are not immune to the market's corrections. Spreads and combinations, as well as all option trading techniques, need to have some type of exit point in case the market/stock/sector turns in the opposite direction from that which is expected, and position management is an important part of being a successful trader. In addition, the success of a limited risk strategy such as OTM credit spreads is limiting loss to a minimum. There are never any big winners to offset the big losers, so there simply can't be any big losers. Obviously, a gapping issue will occasionally wipe out a portion of previous gains and there is nothing you can do about it. But, at the same time, you must manage the remaining positions effectively or there will be no profits to offset the rare catastrophic losers. Additional Information: As far as trading strategies, I have written a number of narratives for the techniques used in my sections and those are still listed in the web-site archives (Options 101 etc). Of course, there are also a plethora of great articles by other OIN writers, covering just about every imaginable option trading strategy commonly used by retail investors. Unfortunately, there is no way to produce a list of specific guidelines or step-by-step techniques on entering and exiting combination plays. The methods I use are much the same as those that Jim and the other writers discuss in daily strategy narratives and each is based on simple, proven money-management techniques; the most important of which is "keep the losses small!" The older articles in Options 101 (by broker Robert Ogilvie) cover the basic spread strategies and their possible outcomes (good and bad) and many of Jim's recent trading lessons describe the use of position trading adjustments (rolling into spreads for example) to minimize losses in straight option positions (buy call/sell call). The most important entry/exit information for spreads comes from the knowledge of option pricing, time-value erosion, volatility and probability. Those subjects have been covered at length in past educational series on the web-site. Contrary to what you might believe, there are no simple and easy answers. Option trading is not free money in any way -- lots of hard work and research -- and success comes only after failure and experience. The key is to find something you do well and stick to it. Don't use complex strategies just because they are unique or intriguing. Often the best course of action is the simplest. The key to remember is most sections of the newsletter are really just a list of candidates to significantly limit your search for profitable trading positions. You still have to decide what you are looking for, and if the positions meet your personal criteria for potential plays. Only you can know what type of strategies are suitable for your portfolio outlook, skill level, and risk tolerance. Good Luck! *************** SEE DISCLAIMER ***************************** ************************Advertisement************************* Tired of waiting on trades to execute? Does your broker offer Stop Losses on Options? Trade instantly with Stop Losses at PreferredTrade Inc. 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