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Daily Newsletter, Monday, 12/31/2001

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The Option Investor Newsletter                   Monday 12-31-2001
Copyright 2001, All rights reserved.                        1 of 1
Redistribution in any form strictly prohibited.


Posted online for subscribers at http://www.OptionInvestor.com


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MARKET WRAP  (view in courier font for table alignment)
******************************************************************
        12-31-2001        High      Low     Volume Advance/Decline
DJIA    10021.60 -115.40 10137.60 10019.10  954 mln   1615/1558	
NASDAQ   1950.40 - 36.80  1989.17  1950.40 1.39 bln   1945/1846
S&P 100   584.28 -  7.47   591.75   584.17   totals   3560/3404
S&P 500  1148.08 - 12.94  1161.16  1148.04           
RUS 2000  488.50 -  5.12   494.20   488.41
DJ TRANS 2639.99 -  3.06  2658.97  2636.63
VIX        23.29 +  0.79    23.41    22.27
Put/Call Ratio      0.63
******************************************************************

2001 Goes Out With a Whimper

It was looking like another light volume, narrow-range trading
session for most of the day on Monday, as the traders that
bothered to show up today finished squaring their positions
ahead of turning the calendar over to a new year.

Showing the quiet nature of the broad market, the internals were
fairly balanced, with a nearly dead heat between up and down
volume and advancers and decliners on both exchanges for most of
the day.  But the final hour was decidedly bearish.  The DJIA
had been bouncing around between 10,080-10,115 until the final
hour, when the index gave up 60 points to close just above the
10,000 level.  Up and down volume had been running nearly even
all day, but in the final hour, almost all of the volume was on
the sell side, with the closing ratio coming in at nearly 2:1
in favor of the bears.  

The picture wasn't much different over on the NASDAQ, with the
quiet and fairly even session seeing a surge of selling in the
final hour (and continuing into the close).  By the time the
dust settled, down volume had swamped up volume by more than a
2:1 ratio as well, with heavy volume seen in the afterhours
session in some of the big-cap Techs.  There was unexpectedly
heavy trade in the likes of Intel (NASDAQ:INTC), Cisco Systems
(NASDAQ:CSCO), Oracle (NASDAQ:ORCL) and Sun Microsystems
(NASDAQ:SUNW).  All of these stocks sold off in the final half
hour of the regular session, ending at the lows of the day.
And that was followed by after-hours trading measured in the
millions of shares for each of the above-mentioned stocks.  It
may mean nothing, but it could be a hint of further weakness
in the Technology sector when we return in 2002.

Despite the lack of scheduled events today, that didn't mean
that there wasn't some significant news for investors to deal
with.  The ongoing buzz about whether the FDA would approve
Imclone's (NASDAQ:IMCL) application for cancer drug, Erbitux
finally came to some sort of resolution on Monday.  Much of
the stock's recent rally from the mid-$40s to $75 was due to
the anticipated approval of the company's new colorectal
cancer drug, which was anticipated to be a blockbuster for the
company.  That enthusiasm began to get tempered earlier this
month when rumors began to surface that there might be some
problems with the FDA approval.  Those concerns turned out to
be well founded when the government rejected the application
this morning, stating "Clearly , the submission didn't comply
with the expectations of the agency."

Ouch!  That isn't what IMCL wanted to hear, and IMCL investors
were similarly displeased, knocking the stock back to close at
$46.46 (-15.9%) after trading as low as $43.35 earlier in the
day.  This is a big setback for both the company and the stock,
which has now given up all its gains accrued since July.  The
news sent the Biotechnology sector (BTK.X) reeling right from
the opening bell, and the midday bounce had no legs, rolling
over with the rest of the broad markets in the final hour to
close more than 3.5% lower.

The weakness in the BTK is indicative of what I saw on many
sectors this evening -- they are either sitting right on
critical support or rolled over from meaningful resistance.
The bulls are going to have their work cut out for them as we
head into a new year.  Trading volume will be picking up and
earnings season is just around the corner.  If the bears are
right, those earnings (and the attendant forward-looking
guidance) won't be enough to sustain the 3-month bull run.

It seems the government never learns its lessons.  The past 2
decades have been a stark demonstration that the government
doesn't handle private business concerns well.  The focus of my
ire for this evening is the ailing Amtrak concern and its
connection to the latest government bailout.  The government
can't seem to run trains on time and show a profit, so rather
than acknowledge that private industry does that sort of thing
best, they are setting themselves up to play in the airline
industry.  Oh joy!  In the wake of the 9/11 attacks, there are
many carriers in financial trouble, and America West Airlines
(NYSE:AWA) is the first to garner a direct government subsidy.

But that subsidy comes at a steep price (possibly for travelers
as well as AWA investors).  In exchange for a $380 million loan
guarantee, the federal government gets the option to buy as
much as 33 percent of the company's stock.  That provision
would ostensibly allow the government to profit if AWA regains
its financial footing.  If this scheme sounds familiar, it
should.  It is very similar to the government bailout of
Chrysler in 1979.  AWA isn't the only airline that is counting
on Uncle Sam to provide an infusion of cash/loan guarantees to
keep the friendly skies flying.  What happens if this scenario
is repeated at other carriers over the months ahead, the federal
government could find itself embedded deeply in the airline
industry.  I sure hope they do a better job than they have done
with Amtrak!

Back to the markets.  The net result of the day's late weakness
was that all of the major indices closed at their lows of the
day, near major levels of support.  The bulls' conviction will
likely be tested on Wednesday, as the professionals will be back
from their vacations and volume should return to normal levels.
After 2 weeks of essentially directionless trade, it will be
refreshing to get back to normal market action again.  So let's
see what the charts might be telling us to expect.



 

The DJIA has now failed to penetrate the 62% retracement of its
decline since the May highs (10,153), and once again fell below
the 200-dma (now at 10,091).  With the daily Stochastics once
again rolling over, I would not be surprised to see another test
of the 50% retracement level near 9800 before the bulls are
sufficiently energized to take another run at breaking out over
recent highs.



 

We've got a similar picture here with the SPX, although I've
drawn a different retracement.  This one began with the
September 2000 highs, and you can see that the bulls haven't
been able to manage a breakout over this level.  Of course, the
200-dma at 1167 is making that resistance level that much
harder to crack.  An interesting side note is what happens if
you draw a retracement from the May highs to September lows.  I
haven't shown it here, but the 62% retracement lies at 1170,
near recent resistance.  So we have two separate retracements
from different timeframes that reside within a 2-point range.
My bet says the bulls had better build up a head of steam if
they hope to plow through this level over the near term.

Earnings should start to trickle in next week, and I expect this
process to be the dominant factor contributing to market action
for the next couple weeks.  Make sure to check earnings dates on
any stock that you happen to be playing, so that you don't get
caught off guard.  With that being said, the bullish trend is
still intact across the broader market.  Play it as long as it
lasts, but be ready to move to the sidelines or even the short
side as market conditions change.

Now turn off your computer, and ring in the New Year with friends
and family!

I'll see you next year!

Mark Phillips
Research Analyst


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

Spreads - The Final Installment (The Short Butterfly)
By Mark Phillips
Contact Support

Over the past couple of months, we've talked about numerous
types of spreads and the market conditions that are conducive
to their profitable use.  But we keep getting pulled this way
and that into other topics of conversation.  So, with this
being the final issue of the newsletter for the year, I want
to also finish our wandering discussion of spreads with the
Short Butterfly spread.  And don't you worry your pretty little
heads, if there is sufficient interest in other spread topics,
I'll be more than willing to revisit this arena in the future.

Recall that the last time we talked, we were covering the Long
Butterfly trade, which has the Risk/Reward curve shown below.



 

The Long Butterfly consists of selling 2 calls (or puts) at the
'B' strike and buying a call (or put) at 'A' and a call (or put)
at 'C'.  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.  Recall that 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.

While the Long Butterfly consists of buying the wings and
selling the body to profit from a stock that stays rangebound,
the Short Butterfly is slightly different.  In this trade, we
sell the wings and buy the body in expectation that the stock
will move out of its recent range over the near term, letting
us keep the credit received when we initiated the spread.



 

This trade must be done for a net credit, as premiums of
the options sold at strikes 'A' and 'C' are used to finance
the purchase of the two options purchased at strike 'B', while
taking in a net credit.  In fact, that credit is the maximum
possible gain on the position, as we would ideally like to see
the stock close above 'A' or below 'C' at expiration, resulting
in all the options expiring in the money or all the options
expiring out of the money.

Looking at the out of the money case, clearly if all options
expire worthless, then we get to keep the credit as our profit.
So how does it work if all the options are in the money?  I'm
glad you asked.  Let's assume we did the initial trade with
calls, so the 'C' strike is the least in the money.  If the 'C'
strike is $1.00 in the money at expiration, that means the 'B'
strike is $6 in the money and the 'A' strike is $11 in the money
(assuming $5 strike increments).

So let's do the math real quickly.  We sold 1 of the 'A' strikes
and one of the 'C' strikes, so we have a liability of $11+$1 for
a total of $12.  The 2 calls at 'B' though have a value of $6
each, giving us a total asset value of $12.  $12 minus $12 leaves
us with zero.  So there is no net value to the position at
expiration, so long as the stock expires above strike 'C' or
below strike 'A'.  And that leaves us with the net credit as
profit in our pocket.

Calculation of breakeven and maximum possible loss is very
similar to the Long Butterfly as well.  Maximum loss on the
position would occur if the stock closes on expiration Friday
right at strike B.  That would mean that our long options would
expire worthless, but the 'A' strike option would have intrinsic
value.  The amount of that maximum loss would be B-A-credit
received when initiating the position.  Breakeven for the
position can be calculated as 'A' plus the initial credit
received and 'C' minus that initial credit.

So let's review what we've learned about each of these spreads
and when and how to apply them.

Long Butterfly
     How Constructed: Buy Wings, Sell Body
     When to Use: Rangebound stock, expect to remain that way
     Maximum Profit: Options expire with stock trading at 'B'
         Amount: 'B' - 'A' - cost of spread
     Maximum Loss: Cost of Spread
     Break Even at: 'A' plus spread cost/'C' minus spread cost


Short Butterfly
     How Constructed: Buy Body, Sell Wings
     When to Use: Rangebound stock, expect breakout or breakdown
     Maximum Profit: Credit received when initiating spread
     Maximum Loss: Options expire with stock trading at 'B'
          Amount: 'B' - 'A' - credit received 
     Break Even at: 'A' plus spread credit/'C' minus spread credit

Now that we've finished with this series on spreads, we can begin
the new year with a clean slate of topics.  And I've got a long
list to work from.  I hope you found this series useful and look
forward to sharing with you over the next year.

Have a safe and happy New Year!

Mark Phillips
Contact Support


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

EMMS - call
Adjust from $20.50 up to $21.75

MDT  - call
Adjust from $49.75 up to $50

WEBX - put
Adjust from $27.25 down to $27

CORR - put
Adjust from $27.65 down to $26

FLIR - put
Adjust from $41.25 down to $40.25


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

No Dropped Calls for Monday.


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

No Dropped Calls for Monday.


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


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

XMSR - XM Satellite Radio $18.36 +0.41 (+0.41 this week)

XM Satellite Radio is a development stage company that seeks to
become a premier nationwide provider of audio entertainment and
information programming.  The company owns one of two FCC licenses
to provide a satellite digital radio service in the United States.
It plans to transmit its XM Radio service by satellites to
vehicle, home and portable radios.

Most Recent Update

XMSR spent the latter-half of last week consolidating its recent
and very big rally.  The pullback through Friday was routine in
terms of price action, although volume remained active late last
week.  The stock bounced from its 10-dma last Thursday, and spent
Friday's session gyrating above the very same short-term moving
average.  The 10-dma, currently at $17.53, may be a good spot to
target short-term entry points early next week.  The longer XMSR
can spend holding above its 10-dma, the more likely it is to
resume its rally above the $20 level.  Those who prefer entering
call plays into strength may wait for a strong advance back above
the $19 level.  The stock has a tendency to ignore the price
action of the broader market as was evident last week.  With no
sector index to reference and the independent nature of this
stock, it may be best to monitor its closest competitor in SIRI
when gaming entry points.

Comments

The satellite plays were in focus again Monday after a Barron's
article over the weekend highlighted Gilat Satellite
(NASDAQ:GILTF) as a beneficiary of the satellite radio services.
Both XMSR and its competitor SIRI were higher on the news,
bucking the overwhelming weakness across the broader market.
The article may serve as the catalyst to get XMSR moving higher
again.  Watch for another bounce from the 10-dma or look for
XMSR to advance past the $19 level in Wednesday's session.

BUY CALL JAN-15 QSY-AC OI=1791 at $3.90 SL=2.00
BUY CALL JAN-17*QSY-AW OI=3012 at $1.85 SL=1.25
BUY CALL JAN-20 QSY-AD OI=4397 at $1.00 SL=0.50 
BUY CALL APR-17 QSY-DW OI= 136 at $4.90 SL=3.25

Average Daily Volume = 1.93 mln



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


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