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Daily Newsletter, Monday, 05/06/2002

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The Option Investor Newsletter                   Monday 05-06-2002
Copyright 2001, All rights reserved.                        1 of 2
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)
******************************************************************
      05-06-2002          High     Low     Volume Advance/Decline
DJIA     9808.04 -198.59 10023.86  9807.69  1.12 bln   1038/2130
NASDAQ   1578.48 - 34.56  1622.83  1577.93  1.77 bln   1178/2373
S&P 100   519.48 - 11.04   531.88   519.27   Totals    2216/4503
S&P 500  1052.67 - 20.76  1075.96  1052.65             
RUS 2000  502.91 -  9.41   513.07   502.51
DJ TRANS 2703.94 - 40.15  2749.21  2702.48
VIX        24.88 +  1.65    24.92    22.75
VXN        49.12 +  2.86    49.12    46.02
TRIN        2.38
PUT/CALL    0.77
******************************************************************

Bears and Dead Fish
By Buzz Lynn
buzz@OptionInvestor.com

I don't always agree with him, but I like Richard Russell.  Who is 
he?  A guy that has been in the newsletter and Wall Street 
investment business since 1958.  He knows his way around the 
Street and possesses this thing we call, "wisdom".  He may not 
always be right, as most of us aren't.  But he has wisdom, plus 
he's entertaining, which makes for an interesting read. 

On occasion, I get a forwarded e-mail with some of his tidbits and 
this weekend was one of those "on occasion" occurrences.  Here's 
an observation I just love, which would have taken me this 40+ 
years to figure out for myself.  

"Bull markets die in exhaustion. Bear market's die in exhaustion. 
Is this bear market exhausted?  Has the housing market collapsed? 
Has CNBC been pulled off the air?  Are secondary stocks 
collapsing? Are people asking, "What's the dividend?" when their 
broker calls with a new stock to buy?  Does anyone believe that 
the bear market has a long way to go?"

Bulls are not only out to pasture.  They appear to be "feasting" 
on Nevada rangeland, which is to say, "limited greens".  Just as 
in the real-life world of ranching, it's no wonder there are fewer 
of them per acre.  The countryside - the market in this case – 
can't support them.

So what do we look at without cows for entertainment?  How about 
fish?  Dead Fish, that is, as Austin calls the desk-pounding, buy-
side analyst crowd.  You know, the ones that swim upstream against 
the market currents only to die on their last can't miss, hot buy, 
one-pick, focus list, sure winner stocks.  How doe they die?  In 
the jaws of patient bears.  'Nuff said.

I won't long dwell on this.  We all know that underwriters and 
analysts are not separated at all.  Nor are their co-conspirators, 
the auditors and consultants at accounting houses.  Both are 
incentified to fluff the numbers.  A naked King can only fool the 
townsfolk for so long until someone with more common sense than 
imagination blurts out that the King is naked or that stocks are 
overpriced based on their earnings.  That's what it all boils down 
to.  

But unlike a naked King exposed, no single event causes the market 
to fall.  Accountants are investigated.  Brokerage firms are 
investigated.  ENE collapses as brokers issue, "compelling value" 
ratings.  Oil prices are falling again now that Iraq wants to sell 
oil after all to the West.  Semiconductors don't sell well.  
Federal Reserve meets tomorrow and will likely conclude that 
economic conditions remain week and that it sees no need to raise 
rates or change bias.  The budget surplus expected through 2008 is 
vaporize within weeks necessitating a raising of the debt ceiling.  

Each by itself is a non-event.  But together they are symptoms of 
a bear market born of slowing economy, lack of corporate earnings, 
and an investing [public coming to grips with the idea of a 
reverse wealth effect.  We can see the sentiment in the charts of 
the major indexes.  The long-term direction of the market is 
sideways to down.  We should get use to it.  

Take heart and remember that businesses will not shut down 
tomorrow; unemployment even at 10% means that 9 of 10 who want to 
work are working; Safeway, Home Depot and Wal-Mart will pretty 
much have more than everything we need; and that most importantly, 
through turmoil and hardship comes opportunity.  It's not as bad 
as it sounds unless you own overpriced stocks that produce no 
income.  Never forget that.

Dow Industrial chart  - INDU (weekly/daily/60):


 

Comments:  weekly stochastic in a nose dive on both time frames – 
bearish.  Daily stochastic has rolled over on 5-period lookback – 
not looking strong either.  To boot, the Dow is well below its 20-
dma (gray line) of 9921.  Yet the fact remains that the Dow is 
nearing support at the 9700-9750 range on both the weekly and 
daily chart.  Will it hold again or fall through?  Who knows?  The 
60 minute chart is stochastically buried at support, which might 
give the bulls a pop on calls.  But I wouldn't be take a call 
position on any more than a daytrade.  Even then, I'd be bucking 
the bigger trend that is pretty strong right now.  Yes, the Dow is 
currently the strongest of the major indexes, but a sinking tides 
lowers all boats, even those with fat pontoons.

NASDAQ chart - COMPX (weekly/daily/60):


 

A few ants short of a picnic?  The NASDAQ IS the weakest link.  
Good Bye!  That's how it went when the COMPX broker under 1600 
today.  Everything else fell with it.  No surprise given the lack 
of earnings and current over value on many issues.  While 1600 
will likely become a formidable point of resistance, the stretched 
lower Bollinger band, the significant decline under the 50 and 200 
dmas, and the buried stochastics on all time frames are stretching 
the NASDAQ hard to the downside.  There likely will be a swing 
trade call play emerge in the not-so distant future, if nothing 
else, for a bit of respite from the bulls in pain.


S&P 500 chart - SPX (weekly/daily/60):


 

SPX too suffered as the NASDAQ went south.  Again, while the SPX is near 
support at 1048-1050, the stochastics are still pointed down, which 
makes me believe there is no relief in sight, especially since a rising 
support line and a horizontal support line were violated in the process.  
Still the 60 min chart offers the possibility of technical bounce given 
the big oversold condition.

Minor mention:  VIX is just under 25.  Nobody appears scared of a 
meltdown, nor do they think equities will shoot to the moon either.

For tomorrow?  The Fed watch will likely be the big news of the day, but 
in the end will mean nothing since the outcome is pretty well known 
(barring any stray, offhand comments).  Rate should remain the same, as 
should the bias to tighten when the time is right.

To boot, we'll see Productivity and Wholesale Inventory reports tomorrow 
morning followed by the FOMC meting at 2:30 ET, and then Consumer Credit 
at 3:00.  The latter may actually spook some people in the bond market 
if it comes in reflecting that Americans are again borrowing themselves 
rich.

In short, this is still a rangebound market.  Remember what we noted 
last Wednesday:  What appears to be tradable bullish run will ultimately 
end up a short opportunity for those who recognize the underlying and 
patient bear.  If support gets broken, I would take that as a cue to 
consider exiting calls, the reason being that the bear will have likely 
head-faked us again, which is not all that surprising.

Think of this as the dawn of Spring.  Those cute little green 
sprigs popping up on brown branches will be toast with one night 
of frost.  The green needs some seasoning before it can withstand 
the unexpected cold.  It's too early to start counting the cash 
from the crop that has yet to mature.

Frost happens, buds die, bears do headfakes.  If you take calls on a 
bounce, they won't be safe for long following today's breakdown below or 
to support.  Market wobbles will persist and except for days like today 
where the range is huge, it's tough to make money on the range.

See you at the bell.


********************
INDEX TRADER SUMMARY
********************

CAPITULATION?
by Leigh Stevens

TRADING ACTIVITY AND OUTLOOK - 
In Wall Street parlance, they talk about "capitulation", when the 
bulls or just those hanging on and hiding out, give it up on 
stocks; "it" here being the hope or expectation that stocks are 
going to do better/come back/recover. All of those things.  

The concept of capitulation goes back to the observations that 
Charles Dow made over 100 years ago. He noted that near the end 
of bear markets and at market bottoms, participants, especially 
the public investors, are and have become VERY pessimistic about 
the prospects for stocks and an earnings recovery. This leads to 
a final wave of bearishness and selling.  

The bulls or patient long-term holders of stocks, "capitulate" to 
the prevailing market view.  This capitulation leads to a final 
spurt in prices lower, where buying interest finally surfaces by 
some knowledgeable investing groups that can foresee an economic 
recovery ahead and improving corporate profits along with it.

So, like one of the kids saying, constantly, "are we there yet?", 
are we at this final stage? Well, it FEELS a lot like it. Except 
that prices look they will go lower still.  While we have not 
seen huge volume on these recent big down days, a so-called 
"volume climax" is less common in bear market.  

What IS common, approaching the bottom of a bear market is that 
declining (down) volume (selling on downticks) overwhelms 
advancing (up) volume -- and this has been happening big time.  
We had a day in Nasdaq last week when down volume ran 6 times 
that of up volume. Today, Nasdaq down volume ran 4 times ahead of 
up volume. 

In terms of oversold measures of the market, we are oversold in 
terms of advance-decline measures and volume measures, however in 
terms of the most important element, price, we are NOT at 
oversold readings on weekly advance/decline oscillators like the 
MACD, as shown on the charts in my weekly summary piece from 
yesterday (5/5).   

Moreover, I think it unrealistic to think that we have come this 
close to the fall lows in the Nasdaq and not challenge these 
levels, and perhaps exceed them for awhile.  

In the S&P, however, with the areas of market strength in some of 
the big consumer and "defensive" type stocks, mid cap stocks and 
some of the strong sectors like healthcare and oils, it seems 
more likely that the S&P 500 will hold 1000-1030, between the 62% 
retracement (1030)level and a major psychological level, 1000. 

The Dow Industrial Average has even more of an edge in relative 
strength, given its composition with many big cap stocks with 
strong earnings momentum. In the Dow, at most we may be looking 
at a re-test of the Feb. bottom around 9625.  

Also, it is usually the case at market bottoms that every sector 
gets somewhat hit by profit-taking and short-selling.  At 
important bottoms we would not normally have some sectors sailing 
merrily away to the moon, while everything else is in the 
basement.  Not impossible that this would happen, just unusual.  
Usually at major market bottoms, fear and loathing (of stocks) 
extends, to some extent, to even the pet stocks and groups. 

So, for example, we see oil stocks (e.g., $OSX.X) correcting 
today. Healthcare stocks (e.g., $HMO.X) have been correcting by a 
sideways to lower move over the past 4 sessions. Even the poster 
child of the small cap high flyers, the Russell 2000 ($RUT.X), 
has faltered in the last 4 weeks. The Amex Composite index 
($XAX.X) has been an exception but it's stalling at resistance in 
the 960 area.     

And, I don't think it realistic that we will see a bottom until 
we can measure a couple of elements of market "sentiment" that 
suggest more bearish pessimism, or less complacency, then we are 
seeing to date.  The two indicators are the CBOE Volatility Index 
($VIX.X), which more typically has a day or days in the 28-30 
area at important bottoms.  Today's close was 24.88. The peak 
intraday high in the past weeks was 26.6 and peak close was 26.1.  
We have some ways to go.  

We didn't even get close in terms of option trading put to call 
ratios -- at a major low, expect to see as much put volume as 
call volume, particularly in the CBOE equities daily volume 
ratio. Today, equities call volume was 1.5 times put volume. This 
ratio is showing LESS bearishness than Friday.  A bullish 
"favorable" trend would have just the opposite development. 

So, how low is low and where to next?  Of course, we got the Fed 
meeting tomorrow - no surprises expected - and Cisco's 
(CSCO)earnings, which should not be a surprise but could be. 
The Chart and technical picture follows -       
 
S&P 500 (SPX) Daily/Hourly Charts: 


 


I had to go back to the drawing board and re-draw the hourly 
downtrend downtrend channel to take in one spike low that I had 
drawn through, bisecting it to achieve the best fit through the 
most number of point; i.e., an internal trendline. The chart 
above has an external trendline as the outer line which may help 
define an area(s) of short-term support. 

Looks like 1044-1042 is the low end of my revised hourly 
downtrend channel. 1065 is trendline resistance -- a move through 
there may get something going on the upside, especially due to 
the near-term oversold.  However, don't expect rallies to carry 
far, due to the strong dominant downside momentum. 

Sell rallies to the 1065 area, if that should develop, taking the 
risk that that rallies will continue to be too feeble to take out 
even minor resistance.  Conversely, the nimble and brave could 
take a shot at buying the 1040-1043 area (risk to 1037), looking 
for a 20 point rebound.         

S&P 100 (OEX) Daily/Hourly Charts: 


 

Traders could take some profits in puts, plus nimble, brave and 
quick short-term termers reversing to calls in the 510 area for a 
rebound of 12-15 points (risk to 505).  Sell rallies to 526.  
Otherwise stay put.   

Dow Industrials 1/100 Index ($DJX.X) Daily/Hourly Charts: 


 

DJX -
Sell in the 99.30 area, exit if there starts to be hourly closes 
above 101. Downside objectives are apparent in the 96 area where 
there would likely be some profit-taking on put positions - I 
wish I could say I knew that bears would get another good-sized 
rally to buy em back again.  Tempting, as the Dow is been holding 
up pretty well on the declines and goes down the least. 

Nasdaq Composite ($COMPX) Daily/Hourly Charts:


 

Well, there comes a time, when a trendline stops "working" in the 
sense of defining the boundaries of a trend.  We are either at 
that juncture or there is a rally coming at the opening. 

I have a new, steeper, trend channel going to the downside, 
reflecting the accelerated selling pressure and downside 
momentum.    

Best guess on a stopping place or a further downside target if 
the rout continues -- 1540.  Possible, not the most likely. More 
likely that we are at or near a short-term low in the area 
suggested -- 1575-1576 could be that area, with potential of a 
quick dip to 1570. A rally should find resistance developing in 
the 1615-1620 area, which is suggested as an area to sell into. 
 

Depends on Cisco's earnings I suppose. Even a slightly bearish 
surprise in a market that is discounting all possible bearish 
scenarios may not keep prices down for long given a short-term 
oversold condition.         


Nasdaq 100 ($NDX.X) Daily/Hourly Charts: 


 

The 1140 area looks like a place to look for at least a temporary 
bottom -- 1138 is the intersection of my the downtrend channel.  
Near resistance comes in at the hourly down trendline and is an 
area from which the index could get knocked down again.  

Nasdaq 100 Trust Stock (QQQ) Daily/Hourly Charts: 


 

Yes, QQQ is now quite oversold on a 14-day basis, but not yet as 
oversold as it can get, on a weekly chart basis.  Moreover, the 
Q's are not yet at 27, a next major downside objective, offering 
a retest of the September low. 

29.5 is the first area to look at new put plays, with 32.2 as the 
major area. Support may come in around 28.5 - I have the lower 
channel intersecting at 28.4.  We may see a rebound from this 
area, but upside seems pretty limited in terms of playing such a 
rally. 28, risking to 27.5 for a bounce to 29.5 is an OK risk to 
reward ratio.      


Index Trade Recommendations 

- Informal trade guidance offered recently only 


Long/Call Positions:

Date: 
Bought; Stop or risk parameters;  
Trade Objective: 
Comments: 

Short/Put Positions: 

Date: 
Bought; Stop or risk parameters;     
Trade Objective: 
Comments:


Leigh Stevens
Chief Market Strategist 
lstevens@OptionInvestor.com 


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***********************
INDEX TRADER GAME PLANS
***********************

THE SECTOR BEAT - 5/6
by Leigh Stevens


SECTOR ACTIVITY/OUTLOOK - 
As I was discussing in my Index commentary, most all areas of the 
market, most all sectors were correcting today.  Only gold, the 
ultimate doomsday hedge, was up more than a percentage point 
today.  The Health Provider Index ($RXH.X), which has lagged the 
Payors Index ($HMO.X) was slightly higher on the day, by .6 
percent. The Forest and Paper products index ($FPP.X), a 
seemingly ever green/ever strong group, was the only other  
popular sector that was slightly plus on the day.   

One of the characteristics of most major market bottoms, is that 
most stocks and stock groups will undergo selling pressure. With 
the strong groups, they will likely continue to be leaders after 
the market bottoms, but from a corrected level. I want to be 
positioned for those corrections.  
     


SECTOR TRENDS AND TRADING IDEAS - 

Healthcare Payors Index ($HMO.X): 


 

I continue to suggest purchase of Oxford Health Plans (OHP) on a 
pullback into the zone outlined above. Buy the stock 
or deferred OTM calls in the 40-41.00 area. In terms of the 
sector, am looking for a correction of the HMO Index back to the 
lower end of its daily uptrend 
channel around 570.  


 
A POSSIBLE GOLD PLAY - 


 

When I come to the bullish case on gold, it may be the kiss of 
death for the move, but let's suppose I am not jinxing it.  

Examination of the weekly XAU chart suggests we may be in a 
resistance area and will get a correction that would take this 
index back into the middle of the uptrend channel. If so, the 
stocks in the group would be correcting to. 

As a way to play this sector, rather than buying the XAU calls, I 
suggest buying Newmont Mining (NEM) under 28.50, choosing the 
stock or deferred OTM calls.  I'd prefer to buy on a price 
correction to near the 25 level support, in terms of call 
purchases. 


>> DRG, the Pharmaceutical sector index ($DRG.X). 

The drug sector, DRG, which was looking like it was stabilizing 
at the low end of multimonth trading range, is slipping under it.

I thought this sector was playable for a rebound, by the purchase 
of the May 60 Merck(MRK EL)calls, a prominent stock in this 
sector.  While MRK has been rallying over the past 4 sessions, 
bucking the market and sector trends, am reluctant to trust this 
stock play until DRG appears to have bottomed.  Bullish action 
would occur if MRK rallied to above 58 or the down trendline as 
noted by the "R" for resistance.  



 



LONG/CALL TRADES, PREVIOUSLY RECOMMENDED:

>> Cyclical sector ($CYC.X) - 4/15 suggestion:
1.) iShares Cyclical Trust (IYC)  - 4/16 open: 56.95
Objective: new high above 63.00
2.) OPTION play: CYC Sector stock, - Alcoa (AA) 
May 40 calls (AA EH) - 4/16 open: .60  

UPDATE: AA is rebounding some - sell any options or stock on 
rallies to 35.00 OR on a break of 33. 

CYC broke technical support recently and AA fell to low end of 
its trading range at $33.30, but is off these lows. HOLD only.   


>> Airline sector ($XAL.X) - 4/15 Sector Trader suggestion:
OPTION PLAY: XAL sector stock Southwest Airlines (LUV) 
Sept. 20 (LUV ID) call suggested at 1.25 or less.  
OBJECTIVE: $22 based on a rebound back toward the high end of the 
current uptrend channel.

UPDATE: Exit if stock closes under 17.25. 


>> Utilities Index - Holders trust shares (AMEX: UTH) 
Long at 95.25 
Stop: 91.00



OPEN SHORTS/PUT PLAYS:

>> RTH (AMEX: Retail sector trust stock)
SHORT at 99.00 
Stop: 100 


LIQUIDATIONS:

>> Internet Sector index ($INX.X) - Option play on INX sector 
stock Juniper Networks (JNPR); Long May 15 Calls (JUX EC). May 
12.5's (JUX EV) Calls were also suggested. 

Stock did not perform - EXITED as stock dropped below 9.00. 
 

NOTE: RISK to REWARD guidelines -  
Determining an objective is important, even if it is a moving 
target, as this is the reward potential.   Determining reward 
potential is critical to establishing whether a stop that makes 
“sense” (e.g., a sell stop that was placed under a key support 
level) would, if triggered, result in a dollar loss that is in 
proportion to profit potential; e.g., 1/3 of it.  (On occasion, 
when the purchase price of call or put is equal to 1/3 or less of 
the estimated reward potential, there may not be a specific exit 
suggestion, as the cost of the option is equal to the amount that 
is being risked.)   


Leigh Stevens
Chief Market Strategist
lstevens@OptionInvestor.com


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The Option Investor Newsletter                   Monday 05-06-2002
Copyright 2001, All rights reserved.                        2 of 2
Redistribution in any form strictly prohibited.


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

SRCL - call
Adjust from $65 up to $69

THC - call
Adjust from $71 up to $72

GS - put
Adjust from $83 down to $80

IDPH - put
Adjust from $55 down to $52.50

LRCX - put
Adjust from $26.75 down to $26

SEBL - put
Adjust from $24 down to $22.50

VRTS - put
Adjust from $28.50 down to $27


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

None


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

MU $22.78 +0.17 (+0.17) We've had a nice downhill slide in shares
of MU as the Semiconductor index has melted down over the past
couple weeks, but there are hints of a bottom starting to form.
While there is definitely the potential for further downside,
with solid gains in the play, we think the best course of action
is to harvest those gains prior to an oversold bounce in the
Semiconductor index (SOX.X).

PLCM $20.25 -0.13 (-0.13) We're starting to get concerned about
our PLCM play, as it isn't participating in the broad market
decline.  With all the major averages cratering again on Monday,
PLCM gave up a paltry 13-cents, and appears more likely to bounce,
rather than fall.  We'll take advantage of the current market
weakness to get out ahead of a potential bounce.  Use
follow-through weakness in the morning to negotiate a more
favorable exit from the play.

QLGC $42.00 +0.44 (+0.44) Expectations that QLGC would fall apart
with the broader market ahead of their earnings report tomorrow
never were fulfilled, as the stock bucked the bearish market
trend throughout the day on Monday.  A rollover tomorrow is
still playable, but with the company set to report earnings after
the closing bell on Tuesday, we're dumping this short-lived play
to avoid the uncertainty that normally surrounds earnings


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

THC– Tenet Healthcare Corp. $74.78 +1.18 (+1.18 this week)

THC is the second largest investor-owned healthcare services
company in the United States.  As of the end of May, 2001, the
company's subsidiaries and affiliates owned or operated 111
general hospitals with more than 27,000 licensed beds and
related healthcare facilities serving urban and rural
communities in 17 states.  The related healthcare facilities
included a small number of rehabilitation hospitals, specialty
hospitals, long-term care facilities, and numerous medical
office buildings located nearby its general hospitals and
physician practices.

Most Recent Write-Up

Momentum traders had some serious fun with the Health Care
stocks over the past 2 months, with the HMO index running
almost vertically up the charts for a 38% gain.  Given that sort
of run, it should come as no surprise to see a bit of profit
taking over the past 2 days, with the index giving back a paltry
3.4%.  Shares of THC participated nicely with the rest of the
sector since the beginning of March, but the past 2 weeks have
the look of some necessary consolidation.  After the sharp selloff
early in the week, the stock has been building a new ascending
trend with a series of higher lows as the bulls continue to chip
away at the $74 resistance level.  Each move to that level has met
with selling in the past several days, but each round of selling
is meeting with buying interest at a higher levels.  This is
notable because the stock has essentially remained flat over the
past 3 days (gathering its strength), while the HMO index has been
dropping.  That indicates an increase in Relative Strength.  And
despite the weakness over the past 2 days, the HMO index is strong
relative to the broader market and looks like it still has
significant upside left.  Use the near-term weakness to enter
new positions near support (first at $72.75-73.00 and then down
at $71.50-72.00).  Traders looking to play the next breakout will
want to wait for THC to crest the $74.75 with the support of
bullish action in the HMO index before playing.  Keep stops set
at $71.

Comments

You had to look long and hard to find breakouts on Monday, with
the carnage found throughout the broad markets, but THC delivered
again.  The Health Care stock broke out above the $74.75 intraday
highs from just over a week ago, after gradually recovering from
the most recent bout of profit taking.  Even with the HMO index
posting its 3rd straight loss, THC bucked the trend and ended the
day with a 1.6% advance.  The persistent weakness in the broad
market did have its effect though, pulling the stock back from
its best level of the day ($75.40) to end just above intraday
support.  Look for another dip and bounce in the $73.50-74.00
area to provide entries before the stock takes off with the HMO
index later this week.  Raise stops to $72.

*** May contracts expire in less than 2 weeks ***

BUY CALL MAY-75*THC-EO OI=1319 at $1.20 SL=0.50
BUY CALL JUN-75 THC-FO OI= 641 at $2.60 SL=1.25
BUY CALL JUN-80 THC-FP OI= 379 at $0.75 SL=0.25

Average Daily Volume = 2.02 mln



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Anatomy of a Trade
by Mark Phillips
mphillips@OptionInvestor.com

We've had some educational fun in recent weeks, learning about
various Candlestick patterns and how to interpret them.  Rest
assured that we'll cover some more of those in due time, but
this week I want to change gears a little bit.  It is no secret
that I've been viewing this market, particularly the Technology
arena through bearish glasses for awhile now.  I thought it
might be instructional if I were to highlight a stock that I've
been trading recently to give you an idea of how I put together
these various Technical tools that we've been talking about,
mixing in some fundamental data to give it some additional spice.

So let's start with the top-down approach.  If I'm bearish on
Technology as a whole, then it seems the NASDAQ Composite would
be a good place to start, don't you think.  Following the
inability of the bulls to hold the uptrend in the COMPX in
January, the index went on to post its first lower high in early
March.  That was the first meaningful attempt by the bulls to
break out of the developing bearish trend and it got my
attention.  Take a look at the chart below, and I think you can
see why.



 

Beginning in early March, I started really watching the action
in the broader Technology market, as it was starting to smell
like a big rollover was in the works.  Price action was having
a hard time advancing off the lows near the 50% retracement of
the fall rally and the daily Stochastics very quickly ran from
oversold to overbought.  I wasn't trying to catch the absolute
top of the market, as risk is more difficult to manage.  But
once I could identify a solid bearish trend in place, then I
had a trade that was much more to my liking.  So that rollover
in early March (2) gave me a lower high with which I could draw
that descending trendline.  

Recall also that in early March, both the VIX.X and VXN.X were
trading very near the lower ends of their historical ranges,
indicating a lack of fear or excess of complacency in the market.
And at the same time, numerous individuals and media pundits
were postulating that the behavior of the VIX would be different
this time.  History is a far better guide than uninformed opinion
and by mid-March, I was well on my way to accumulating a sizable
position in back month QQQ puts.  With the QQQ trading in the
$36-38 range at the time, you might wonder what strike I
selected.  Well, a quick look at the PnF chart at the time showed
me that the bearish price objective was $25, actually below the
September lows.  Wanting to take advantage of both Gamma and
Delta (as well as Vega, as volatility inevitably increased on
the decline), I started picking up January $30 QQQ Puts -- at
the time, seemingly far out of the money.

By the way, my apologies for mixing the discussion between the
NASDAQ Composite and the QQQ, which is really tied to the
NASDAQ-100 (NDX.X).  For whatever reason, I couldn't get charts
of either QQQ or the NDX to display properly this afternoon.  It
isn't critical to our discussion here, but I did want to clarify
it for any that might have questioned my logic.

A part of my rationale was that I wanted to profit from Gamma
as my options approached ATM status, and then increasing Delta as
they became ITM options.  Take a look at the chart above and see
how each time the COMPX approached the descending trendline, it
was another opportunity to add to the position.  I actually had
to wait a bit longer than I expected at the time (but that's why
I bought plenty of time), but you can see that with the QQQ now
below $30, my puts are now ITM and appreciating nicely as fear is
coming back into the market.

This wasn't a home-run trade by any stretch of the imagination,
but risk was very easy to manage with a stop just above the
descending trendline.  A break of that trendline would tell me
that my bearish thesis was decidedly flawed and provided my
entries were timed on rollovers near that trendline, I would be
able to exit any open positions for par or even a slight gain
(depending on how much time had passed).  What I like about this
trade is that it is a very simple application of nothing more
than trendlines and overbought readings on an oscillator, in this
case Stochastics.

Will my objective of $25 on the QQQ be achieved?  I really don't
know, but judging by the recent market action and the expanding
volatility as measured by the VXN, I think it is a distinct
possibility.  Needless to say, the stop on my position is now
well below the descending trendline, as I exercise my trading
discipline to retain the lion's share of my gains once the
NASDAQ finally begins to find a bottom.

One other point that is worth making on this QQQ/COMPX trade that
is worth noting.  See how the important retracement levels (38%,
50%, 62%) served as points of support/resistance as the QQQ has
proceeded to retrace the euphoric fall rally?  If you are new to
retracement levels, let me just say that it is an invaluable tool
for gauging potential inflection points on the price charts.  I
haven't always used them, but I rarely trade without them now.

There's another trade that has been a favorite of mine in recent
months, also to the downside.  Unlike many other areas of the
Technology market, those companies involved in Storage for the
IT market haven't been beaten up nearly as badly as other areas,
such as Software.  But the fundamental picture is absolutely
awful, as investors are just beginning to realize with the poor
results out of the likes of IBM, SUNW and EMC.  The stocks that
fall into this Storage group that I like to watch are EMLX, BRCD
and QLGC.  Just applying some basic logic, my thinking went like
this, "If the customers of these Storage companies are having a
rough time, it would seem to make sense that they aren't buying
much of what QLGC, BRCD and EMLX are selling".  Doesn't that
make sense?  Of the three, BRCD has the best chart, at least if
you're a bear.



 

After the gap below $30 in mid-February, BRCD has been tracing
out a nice little ascending wedge.  The trade at $22 in late
February brought the prior sell signal to a successful
conclusion, as that was the bearish price target from the PnF
chart.  The rollover from the descending trendline in early April
was a solid bearish entry and made for a nice gain on the drop
right back down to the $22 support level.  What was really
interesting here was the pattern that developed on the PnF chart.
We got a fresh sell signal as the neutral wedge became a bearish
wedge with the print at $22 on April 10th.  That gave us a fresh
bearish price target of $15.

Something I've learned about using PnF charts is that the initial
sell signal that is generated there is not usually the best entry
point into the play.  No, the best way to play is to then look
for a rally back to resistance and then fade the rally as it
fails.  So the bulk of my effort on this play has been focused
on accumulating puts on BRCD each time the stock tests the
descending trendline and rolls over.  Those labeled (3) and (4)
were both high-odds entry points and I took them both.  Now I
view this as a shorter term play than the QQQ play I listed above
and I base this on the angle of the trendline, with respect to
support near $22.  Extending these trendlines out into the future
gives me a resolution to the wedge no later than the 3rd week in
June.  Since the oscillations between support and resistance are
rather quick (1-3 weeks), I've been content to use the June $22
contracts up until this point.

So here's how it works.  Enter June $22 puts on a rollover from
the trendline, with stops placed just above the trendline.  If
the stock gets a solid bounce from support, harvest gains and
wait for a fresh entry near the descending trendline.  My
expectation is that the $22 support level will eventually fail
(each test weakens that level of support) and I want to be
onboard for what I expect to be a rather sharp drop.  My target
is $15 and if that price level is achieved, then I will close out
all open positions, no questions asked.  And if this test of
support produces another rally, I'll roll right out of my
profitable position and look to re-enter on another failed rally.
The only difference is that with May expiration approaching, I'll
move out to the July expiration cycle to insulate myself from
Theta decay.  Note that I selected the $22 strike for this trade
as that will put my open contracts ATM (maximum time value
component of the option premium) should I need to roll out of
the play on a bounce from support.

Now here's where the fundamentals come into play.  Recall my
comments about IBM, SUNW and EMC.  None of them have had anything
good to say in their earnings reports and they are the principal
customers for the likes of QLGC and BRCD.  QLGC is set to report
earnings tomorrow night after the closing bell, and I expect that
even if they meet estimates, the guidance will be cautious.  Then
BRCD is scheduled to report next Wednesday and if the QLGC numbers
are less than inspiring, I'm looking for a breakdown ahead of
their earnings report.  Taking a look at the BRCD price chart
above, you can see that the stock is either on the cusp of another
rebound or the breakdown I have been waiting for.

The prudent course of action is to harvest partial gains prior to
the QLGC report, leaving a partial position in place to benefit
on a price breakdown, without taking the risk of giving back all
the gains if QLGC surprises to the upside.

See how we combine our bearish picture for the Technology market
with our expectations of bearish fundamentals in a specific area
of that market to arrive at a bearish posture on a specific
stock?  Then we take our rudimentary technical analysis tools to
time our entries and exits on the play while we await the big
move that we "know" is coming, all the while managing our risk
according to our money management plan.  

My intention here, as always is to educate.  Please don't take
my rambling discussion here as a recommendation to short (or buy
puts on) the QQQ or BRCD tomorrow morning.  That's not why I went
through this discussion.  If you like the sort of trades I've
highlighted here, then by all means go looking for other
candidates that look similar.  I think you'll find that in a bear
market, these chart patterns are not uncommon.  Another one that
gave a similar chart pattern to BRCD in recent months was VRSN
before it finally collapsed below $10 last month.  BRCD might do
the same thing and it might not.  But I'd be willing to bet there
are other Technology stocks that will break down in dramatic
fashion in the months ahead.  Hopefully my discussion here will
help you to find them and profit handsomely.

As you can see, successful trading does not need to be complex
or terribly involved.  We can apply a very simple set of rules
and trade in a very methodical manner.  For those that don't have
the luxury of watching the intraday market action, perhaps this
discussion of a couple of my recent trades can illuminate how
simple the process really can be.


Mark


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