The Option Investor Newsletter Tuesday 08-13-2002 Copyright 2002, All rights reserved. 1 of 3 Redistribution in any form strictly prohibited. In Section One: Wrap: Okay, Now What? Index Trader Wrap: Fed Bust Market Sentiment: Now What? Weekly Fund Screen: Special Situation and Recovery Funds Index Trader Game Plan: THE SECTOR BEAT - 8/13 Swing Trade Game Plan: Okay, Now What? Posted online for subscribers at http://www.OptionInvestor.com ************************************************************ MARKET WRAP (view in courier font for table alignment) ************************************************************ 08-13-2002 High Low Volume Advance/Decline DJIA 8482.46 -206.40 8745.52 8473.32 1.52 bln 1014/2184 NASDAQ 1269.28 - 37.60 1324.43 1268.99 1.45 bln 1101/2294 S&P 100 445.30 - 10.85 460.13 444.89 Totals 2115/4478 S&P 500 884.21 - 19.59 911.71 883.62 RUS 2000 377.76 - 10.80 389.57 377.75 DJ TRANS 2264.23 - 44.40 2326.27 2261.59 VIX 39.80 - 0.66 41.35 37.94 VXN 57.68 + 1.39 58.61 54.72 Total UpVol 464M Total DnVol 2,757M 52wk Highs 65 52wk Lows 353 TRIN 2.06 PUT/CALL .71 ************************************************************* Okay, Now What? The Fed has come and gone leaving disaster in their wake and the corporate certification day has arrived. 344 companies due tomorrow have not yet certified their statements and traders left with an empty feeling from the Fed are now wondering if there is another shoe about to drop. Chart of the Dow Chart of the Nasdaq Today was ugly. It was like watching a train wreck in slow motion. Standing on a mountain top (OIN) you see the washed out bridge ahead (Fed announcement) of the speeding train (the bullish market bounce). You grab the person next to you and point, shout, wave and scream but the market keeps moving toward the abyss, ignoring your warnings. Sure enough the Fed does not cut, just like OIN predicted, and the market plunges off the cliff. Surprise, surprise! The media is all-aghast over the unexplained drop and spends hours of valuable air time trying to explain it away. Why, traders got what they wanted, right? Wrong! Traders were jerked out of their dismal outlook back on August 6th when three brokers went public on the same day with a call for the Fed to cut rates by as much as 50 basis points at this meeting. Here Alan, here boy, cut rates, cut rates, nice Alan. Anybody with half a brain knows Alan Greenspan is nobody's lap dog and several people have said he would go against anyone to prove it. Still the markets rallied out of the depths of despair and analysts were calling market bottoms at record rates. Suddenly this week many were retracting those bottom calls and warning of new weakness ahead. Bulls ignored them and rallied the markets right back to resistance again while waiting for Alan's blessing. The blessing turned into a curse and shorts popped champagne and piled back into the markets in droves. The problem it appears is that according to the Fed the "risks to the economy remain weighted to weakness due to weakness in the financial markets and fears over corporate governance." Yes, the Fed feels the economy could be headed back into a second recession but did nothing about it. Ouch! The Fed did adopt an easing bias but in the carefully worded Fed speak but the key words were missing. Those words were "closely monitor economic and financial conditions". These words are required to indicate they are considering or open to an inter-meeting rate cut. Also, wording of the statement contained the kiss of death clause. "The current accommodative stance of monetary policy, coupled with still-robust underlying growth in productivity, ""should"" be sufficient to foster an improving business climate over time." In English, "we already cut eleven times and we are not cutting again anytime soon." Put that in your rally and smoke it. Yes, Alan, thank you sir. There is no doubt the Fed is worried. Not about the current conditions but about the possibility of more severe problems in the future. They know Brazil is going to meltdown eventually. They probably know more about which companies are really in financial trouble than anyone. They know there could be another terrorist attack at any time. They know they are at risk of a war with Iraq soon. They have to keep their remaining options open and conserve as much ammo as possible. They tried to throw a bone to the markets in the bias change but traders had already blown their rate cut hopes out of proportion. This chapter of the Fed story is now complete and there has already been a reduction in the odds of a rate cut in September according to the futures. Bond traders see the writing on the wall and are already moving to erase that option. Stock traders are sitting around tonight wondering what hit them. We wanted a cut, the brokers said so! We got a bias change, which the media said we wanted but it was really a warning in disguise. Now what? Earnings and guidance is what really matters in the end and AMAT joined the ranks of beat and warn tonight. They beat the street by two cents but then lowered industry projections only three months after raising them. "It is now apparent that the economic environment from last quarter has moderated" said their CFO. Customers are becoming more cautious and we now expect overall capital expenditures to decline by -25% instead of the -20% we first projected. Orders are expected to decline -5% to -15% sequentially. AMAT traded down in after hours. An even more telling piece of evidence for the current economic decline was the announcement by IBM that they were laying off -15,613 workers due to over capacity and lack of sales. This news came from an SEC filing made public today. IBM tried to defer criticism saying they had mentioned previously in the 2Q they were going to layoff these people. Kings X! They refused to give any details in their past comments. There is a difference in saying we will cut some workers and we will cut 15,613 workers! Add this to the 7,000 workers American Airlines is laying off and they will create their own wave of unemployment. Goldman Sachs and CSFB both went on record today as saying IT spending estimates for 2003 were too high. Goldman said software would probably not grow more than +3% to +5%. CSFB said 2002 estimates were now for zero growth in the chip sector and the 12% growth estimates for 2003 were too high. Finally somebody is catching on to the facts. With 344 companies still uncertified with a deadline of tomorrow there is a good chance there will be some more surprises. There were three today. Suddenly IPG, CBUK and ADRX "found" some accounting irregularities today, one day before certification, and have asked for extensions. How many more we will have tomorrow is anybody's guess. IPG "found" $68.5 million in missed costs and is going to restate earnings all the way back to 1997. Seems they "overlooked" these expenses and accidentally overstated earnings but they have taken steps to prevent it from happening again. Without beating a dead horse, the economy still has challenges ahead. Rate cut hopes are dead and we are left to focus on stock news during the two worst months of the year. The bulls are not dead and they will probably try to buy this dip but the underlying bid from the last week was pulled this afternoon. Without that bid the next week will be significantly different. I am not predicting a crash or rally but the volatility will definitely be back. 466 of the 500 stocks in the S&P have posted earnings for last quarter which leaves us with very little positive motivation. Dell will be the big earnings news this week when they post on Thursday after the close. They have already pre- announced so there should be no surprises. The only worry is their guidance going forward. The rest of this week could be very choppy as bulls and bears battle for control. I would be really cautious about opening any large positions unless you are very confident of the prevailing trend. Enter Very Passively, Exit Very Aggressively! Jim Brown Editor ******************** INDEX TRADER SUMMARY ******************** FED BUST By Leigh Stevens TRADING ACTIVITY AND OUTLOOK - The Fed decided not to lower so the market lowered prices instead! The Fed did just as expected, indicating a bias now toward "ease" later due to an expressed concern about a weak economy. Bonds rallied sharply however on this signal that rates will be coming down - from low to lower. Never failing to amaze us, the market sold off on the news - the shorts having lost their fear to sell and those with some recent gains, cashing in. Day traders had something to do again! Airlines fell again as UAL took it on the chin again - this time the stocks had company, as aerospace/defense stocks like Boeing were weak. Someone figured out that if they can't fill all their planes, there are not going to be as many new ones ordered. WalMart reported and turned in its usual good results, but biotech tumbled - traders looked around and saw they could cash in on some gains other than in Dow stocks. Guess what folks? - while we may be in a bottoming process, SIDEWAYS is a big part of this process. We have to get past September-October and it has turned out that we're still in August, as much as we may want to have Thanksgiving already. And, of course, lets not forget the CEO's and the accounting certifications are largely delayed until the final day - that would be tomorrow. I have worked with some top executives and whenever their necks are on the line that involves money and numbers, they have a tendency to have their people check and RECHECK the figures. Hey, these people didn't get to where they are by being reckless, but by being smart. So, no surprises here in terms of why most of these reports are going to come in AT the deadline. S&P 100 Index (OEX) - Daily/Hourly charts: The 460 area was the stopper in the S&P 100 - 3 strikes and it was out! The OEX hit this same resistance zone again and from there, with a little help from the Fed, it was finally down toward the support again. 440 looms as a key level again, this time as potential support - below here, we're looking at the 420 area again. Judging by the relative position of the daily stochastic, OEX has to either go down substantially or go sideways for a few days to see this market get oversold again. It will probably be a combination of both sideways and lower - 440 in fact, seems unlikely to contain the decline now that the "fear of the fed" is gone. The question may be - will a move back to 420 or about a one half (50%) give back, be enough correction to find willing buyers a again - stay tuned! One other technical note is about "divergence" - I talked about this in my Trader's Corner article on oscillators. Bearish price/oscillator divergence is where a stock or index goes to a new high OR goes sideways, but the oscillator does not and makes a LOWER low. (The reverse is true in a bullish divergence - prices go to a new low, but not the oscillator.) Divergences like this are usually best seen with the RSI, but sometimes it's seen on the stochastic indicator as it is above and all the others indices, including QQQ. Today's price action made it apparent. Something for the future for when you see this divergent pattern set up. S&P 500 Index (SPX) - Hourly chart: The 855 prior hourly low looks a downside target on the S&P 500 now that its hourly trendline has been pierced decisively. Below here a next lower potential support area is the 833 downswing bottom. Key resistance is at 493-495 and this would be an area to sell if there was a bounce tomorrow - don't hold your breath waiting for this happen however - looks like its back to two-sided trading swings and they usually slide faster and easier than they glide. DJ Industrial Index (1/100 of INDU) - $DJX - Daily/Hourly charts: 86 is near resistance, 84 is near support. Sell at resistance, but hold off trying to catch any falling knives. Looks to me that the 82 area is a possible target now, maybe back to Dow 8000 again. Whatever the ultimate target, I look for downside follow through tomorrow. Nasdaq 100 Trust Stock (QQQ) Daily/Hourly charts: I was looking to short QQQ in the 24.7 area at the prior price peak. I also figured that we had no "confirmed" up trend until this level was cleared. Now it looks like the Q's are heading toward 22 again, maybe to the 21.5 area. A trendline through the first two hourly highs - a minimum two points to draw a trendline - defined the final reversal point for this rally at 23.9. A higher high accompanied by a lower low in the 21-hour stochastic model - a "classic" divergent sell signal. However, it also should be noted that this is only clear cut AFTER the fact usually. Someone asked me about a bullish rising "wedge" on the intraday QQQ chart and this person was quite right in that assessment, although I wasn't certain that the pattern was a wedge. But, it fulfilled the conditions - there was this pie-shaped formation outlined by higher highs and higher lows that NARROWED as you got closed to the "apex" or narrowest point. What the wedge is showing is what I call "compression" - this is where buyers and sellers get more and more in balance or in equilibrium. When there is a break, the buyers who were purchasing on a scale up basis at higher and higher prices (as the price dips were slight), BAIL out in a hurry. They realize that they have bought high instead of buying LOW - as in "buy low, sell high!" There was another divergence that shaped up in QQQ - my answer to those who say why don't I just follow the Nas 100 Index itself and not the "derivative"; i.e., the QQQ tracking stock. Well, one reason is that you have daily volume information with the Q's. Perhaps if I had made more of the DECLINING volume trend - a definite NON-confirmation of the last rally - I might have suggested selling at 23.70 as a starter to get in on the short side - with the intent to sell more if 24.70 was reached. So it goes on the Street of Dreams. Leigh Stevens Chief Market Strategist lstevens@OptionInvestor.com ------------------------------------------------------------ WINNER of Forbes Best of the Web Award optionsXpress voted Favorite Options Site by Forbes Easy screens for spreads, collars, or covered calls Free streaming quotes Real-time option chains, charts + calculators Go to http://www.optionsxpress.com/marketing.asp?source=oetics21 Note: Options involve risk. Risk disclosure: http://www.optionsxpress.com/welcome_risk_index.htm ------------------------------------------------------------ **************** MARKET SENTIMENT **************** Now What? by Steve Price Day umpteen of the Fed watch is finally over. Now we can begin the countdown to September 24, when the FOMC next gets together for tea and crumpets. The Fed did exactly as OI predicted and kept rates steady, while issuing an easing bias. Also, as OI predicted, we experienced a major sell off. Makes one wonder why they don't invite the OI staff to their meetings. The FOMC finished their meeting by issuing a statement that they still saw economic weakness as the greatest risk. This basically means that there is still a danger of recession, but that they are holding on to their ammunition, as there is only so much further that they can lower rates. With a 1.75% Fed Funds rate, they may need several more decreases to deal with a faltering economy, and the specter of a September 11 anniversary attack still looms. Historically speaking, we have now been warned about the possibility of a surprise cut between now and the next meeting. The Airline industry got more bad news just two days after U.S. Airways filed bankruptcy. American Airlines revealed its plans to cut 7,000 jobs, or 6% of its workforce. They will also reduce their fleet and defer current aircraft deliveries. In total American will cut capacity by 9% in an attempt to save about $1.1 billion per year. The resulting sell off in the airlines also bled into the aerospace and defense stocks. The tech sector, which has been reeling from lack of IT spending got more bad news, as well. IBM announced that they are in the process of cutting over 15,000 jobs, due to a recent decline in corporate spending on tech services. They reported cutting about 14,000 workers from their Global Services Unit, and another 1400 from the Microelectronics division. Consumer spending appeared to show a healthy trend this morning, as retail giant Wal-Mart reported a 26% gain in net profit and raised guidance for next quarter, igniting a rally during the early part of the day. The Commerce Department reported that retail sales were up 1.2% for the month of July, although most of the spending was focused on new cars and trucks, as consumers took advantage of low financing offers. This rally was tempered in the afternoon by the Fed's comments about dangers to the economy. Now that the anticipation of a rate cut is over, we can expect to give back more of the Dow's recent gains. Now trading at 8482.39, the possibility of re-testing the 8000 level seems realistic. With a break back under 1300 in the Nasdaq Composite, which finished the day at 1269.28, we will be looking toward support at 1200 to see if it can hold once again. Bulls can focus on the Fed's easing bias as an indication that rates will be lowered in the near future. Investors eyeing September 11 will most likely want to avoid holding long positions toward the end of this month. A surprise rate cut just before the anniversary is not out of the question, as a preliminary strike toward preventing an anticipatory nosedive in the markets. Short of that, there is a slew of economic data due at the end of this week. On Wednesday, we will see business inventories. Thursday brings initial unemployment claims, industrial production and the Philadelphia Fed. Friday is CPI, housing starts and preliminary consumer sentiment. Although the big number may be behind us temporarily, there are a lot of rungs to climb this week. Watch for continued volatility in the market, as the market Volatility Index (VIX) maintained itself over 40, in spite of the rate news fading in the rear view mirror. Tomorrow, August 14, is the day that hundreds of companies are required to certify their accounting results. We could be in for some surprises, as we find out who signs off and who does not. Not all companies are required to report tomorrow, but keep an eye on the ones that are, and the ones that have their dates coming up. For those that don't report on time, remember that puts serve a purpose. ----------------------------------------------------------------- Market Averages DJIA ($INDU) 52-week High: 10679 52-week Low : 7702 Current : 8482 Moving Averages: (Simple) 10-dma: 8495 50-dma: 8918 200-dma: 9740 S&P 500 ($SPX) 52-week High: 1226 52-week Low : 797 Current : 884 Moving Averages: (Simple) 10-dma: 883 50-dma: 940 200-dma: 1075 Nasdaq-100 ($NDX) 52-week High: 1782 52-week Low : 892 Current : 907 Moving Averages: (Simple) 10-dma: 917 50-dma: 1013 200-dma: 1350 ----------------------------------------------------------------- The Semiconductor Index (SOX.X): The Semiconductor Index returns to Market Sentiment on a sour note. The index had staged a valiant rally above 300, but has lost its footing and fallen back below this key support level. IBM announced they are cutting over 15,000 jobs, as a result of a slowdown in IT spending. This does not bode well for the stocks in this sector. The index has rolled over once again at its downward sloping trend line, beginning in the middle of June. The next level to look out for is the 282.75 support level from August 5th, just before the sector began its failed rebound. A break below this level will demonstrate the lack of a new floor, and a move down to 250 would not be out of the question. 52-week High: 657 52-week Low : 282 Current : 298 Moving Averages: (Simple) 10-dma: 308 50-dma: 372 200-dma: 500 ----------------------------------------------------------------- Market Volatility In spite of the FOMC announcement on interest rates being behind us, the VIX has maintained itself over 40. This foreshadows continuing volatility as the market searches out a bottom after today's 206-point drop. We may see the Dow approach 8000 once again, which would probably translate into a VIX level back near 50 again. CBOE Market Volatility Index (VIX) = 40.09 –0.37 Nasdaq-100 Volatility Index (VXN) = 57.68 1.39 ----------------------------------------------------------------- Put/Call Ratio Call Volume Put Volume Total 0.71 616,365 436,169 Equity Only 0.52 496,394 257,843 OEX 1.23 32,207 39,752 QQQ 0.25 121,082 30,186 ----------------------------------------------------------------- Bullish Percent Data Current Change Status NYSE 33 + 1 Bull Confirmed NASDAQ-100 29 + 1 Bull Correction DOW 40 + 3 Bull Confirmed S&P 500 35 + 2 Bull Alert S&P 100 36 + 2 Bull Alert Bullish percent measures the number of stocks in an index currently trading on a buy signal on their point and figure chart. Readings above 70 are considered overbought, and readings below 30 are considered oversold. Bull Confirmed - Aggressively long Bull Alert - Cautiously long Bull Correction - Pause or pullback in upward trend Bear Alert - Take defensive action if long Bear Confirmed - High risk if long, good conditions for shorting Bear Correction - Pause or rebound in downtrend ----------------------------------------------------------------- 5-Day Arms Index 1.23 10-Day Arms Index 1.41 21-Day Arms Index 1.32 55-Day Arms Index 1.40 Extreme readings above 1.5 are bullish, and readings below .85 are bearish. These signals don't occur often and tend be early, but when the do, they can signal significant market turning points. ----------------------------------------------------------------- Market Internals Advancers Decliners NYSE 808 1939 NASDAQ 1054 2222 New Highs New Lows NYSE 19 97 NASDAQ 30 146 Volume (in millions) NYSE 1,493 NASDAQ 1,560 ----------------------------------------------------------------- Commitments Of Traders Report: 08/06/02 Weekly COT report discloses positions held by small specs and commercial traders of index futures contracts at the Chicago Mercantile Exchange and Chicago Board of Trade. COT data can be found at www.cftc.gov. Small specs are the general trading public with commercials being financial institutions. Commercials are historically on the correct side of future trend changes while small specs tend to be wrong. S&P 500 The commercials reduced their short contracts position by 4,000, while increasing their long contracts slightly. Small traders, increased their long contracts by nearly 6,000, while leaving their short positions virtually unchanged. Commercials Long Short Net % Of OI 07/16/02 388,943 464,162 (75,219) (8.8%) 07/23/02 405,969 471,704 (65,735) (7.5%) 07/30/02 430,833 482,957 (52,124) (5.7%) 08/06/02 431,590 478,879 (47,289) (5.2%) Most bearish reading of the year: (111,956) - 3/6/02 Most bullish reading of the year: ( 36,481) - 10/16/01 Small Traders Long Short Net % of OI 07/16/02 157,370 67,247 90,123 40.1% 07/23/02 166,713 73,778 92,935 38.6% 07/30/02 153,858 67,451 86,407 39.0% 08/06/02 159,561 67,434 92,127 40.5% Most bearish reading of the year: 36,513 - 5/01/01 Most bullish reading of the year: 114,510 - 3/26/02 NASDAQ-100 Commercials increased both long and short contract positions equally, by just less than 3,000 contracts on each side. Small traders reduced both positions, taking 1600 contracts from the long side, and 450 from their shorts. Commercials Long Short Net % of OI 07/16/02 33,152 39,866 (6,714) ( 9.2%) 07/23/02 37,204 43,601 (6,397) ( 8.0%) 07/30/02 38,163 47,343 (9,180) (10.7%) 08/06/02 41,014 50,025 (9,011) ( 9.9%) Most bearish reading of the year: (15,521) - 3/13/02 Most bullish reading of the year: 9,068 - 06/11/02 Small Traders Long Short Net % of OI 07/16/02 12,816 10,774 2,042 8.7% 07/23/02 12,756 11,152 1,604 6.7% 07/30/02 13,159 9,237 3,922 17.5% 08/06/02 11,547 8,782 2,765 13.6% Most bearish reading of the year: (10,769) - 06/11/02 Most bullish reading of the year: 8,460 - 3/13/02 DOW JONES INDUSTRIAL Commercials added to both long and short contract totals. They added 1,000 long contracts and about 1400 shorts. Small Traders also added to both sides, increasing their long contracts by 1200, while adding 250 to the short side. Commercials Long Short Net % of OI 07/16/02 20,357 14,074 6,283 18.2% 07/23/02 22,369 14,745 7,624 20.5% 07/30/02 22,429 12,811 9,618 27.3% 08/06/02 23,491 14,290 9,201 24.4% Most bearish reading of the year: (8,322) - 1/16/01 Most bullish reading of the year: 15,135 - 10/16/01 Small Traders Long Short Net % of OI 07/16/02 8,524 10,133 (1,609) (8.62%) 07/23/02 9,101 12,604 (3,503) (16.1%) 07/30/02 6,778 8,999 (2,221) (14.1%) 08/06/02 7,981 9,258 (1,277) ( 7.4%) Most bearish reading of the year: (8,777) - 10/12/01 Most bullish reading of the year: 1,909 - 1/16/01 ----------------------------------------------------------------- ------------------------------------------------------------ VOTED one of "Best Online Brokers" (4 stars)--Barron's optionsXpress's "order-entry screens...go far beyond... other online broker sites"--Barron's 8 different online tools for options pricing, strategy, and charting Access to options specialists via email, phone or live chat online Real-Time Buying Power, Account Balances or Cancels Go to http://www.optionsxpress.com/marketing.asp?source=oetics22 Note: Options involve risk. Risk disclosure: http://www.optionsxpress.com/welcome_risk_index.htm ------------------------------------------------------------ ****************** WEEKLY FUND SCREEN ****************** Special Situation and Recovery Funds This week, we use Standard & Poor's online power search tool to isolate the best special situation and recovery funds. The S&P power search tool we will use allows you to screen and evaluate funds using factors you believe are most important in measuring and analyzing fund performance. S&P's fund website, located at www.funds-sp.com, touts a comprehensive mutual fund database of more than 50,000 funds. S&P's power search tool is unique from other screen tools we've seen in that it classifies mutual funds by their main sector or category, their specialist sector, their general sector and the geographic area in which they invest. Considering the state of the economy and financial markets, I thought it would make some sense to revisit the specialty category known by S&P as special situation and recovery funds. Special situation stocks are defined as undervalued stocks that should soon rise in value because of an imminent favorable turn of events. A special situation stock may be about to introduce an exciting new product or service, or may be undergoing needed management change. Many security analysts focus on looking for and analyzing special situations. Stocks that fluctuate widely in daily trading because of a particular news development, such as the announcement of a takeover bid, would also be considered special situation. In our comparison and evaluation process, we may use other fund ratings (Lipper, Morningstar, etc.) to validate the S&P results. By the end of this exercise, we hope to isolate one or two good funds in this specialized category. Because of their specialty nature, they should represent the explore portion, not the core portion, of an equity portfolio. Screen and Evaluation Process S&P's power search tool utilizes their proprietary database of over 50,000 funds worldwide. To get to their database of "USA Mutuals" you need to select that database from the list of all databases on the main page (www.funds-sp.com). Once you enter the USA Mutuals database, you can click the "Power Search" tab and that will take you to the S&P advanced fund screener. We skipped to the Classification section, and then clicked the button next to the "Specialist Categories" field to reveal all the different investment niches. We highlighted the specialty category we want "Special Situations and Recovery" and clicked the Go Search button at the bottom of the screen. That simple all-inclusive screen returned 17 results. Some of the results are load funds with more than one share class, thus in reality there are only 10 funds in this specialized category using the Standard and Poor's USA Mutuals database. Next, we identified which funds on the list had S&P ratings of three stars or above (with 5 stars highest, and 1 star lowest). That yielded six special situation and recovery funds rated at least three stars by Standard & Poor's as follows: Credit Suisse Global Post Venture (CPVAX, CPVBX, CPVCX) Excelsior Value and Restructuring (UMBIX) Janus Special Situations (JASSX) Legg Mason Special Investment Trust (LMASX) Midas Special Equities (MISEX) Value Special Situations (VALSX) The Standard & Poor's power search results can be viewed based upon different criteria. We clicked the "Quantitative" tab to view each fund's quantitative risk measures in relation to all funds in its general sector peer group. Below is a summary of the quantitative measures for the six funds against the General Sector Peer Group (over 4 years and up to August 2, 2002). Credit Suisse Global Post Venture: R Squared: 0.88 Beta: 1.50 Alpha: -0.06 Excelsior Value and Restructuring: R Squared: 0.80 Beta: 1.28 Alpha: 0.52 Janus Special Situations: R Squared: 0.83 Beta: 1.09 Alpha: 0.25 Legg Mason Special Investment Trust R Squared: 0.69 Beta: 1.07 Alpha: 0.65 Midas Special Equities: R Squared: 0.65 Beta: 0.93 Alpha: -0.48 Value Line Special Situations: R Squared: 0.95 Beta: 0.85 Alpha: 0.35 Of the six funds on the list, Value Line Special Situations has the highest correlation to the market (0.95) as measured by the S&P 500 index. It is also the least volatile fund relative to the market as measured by its beta coefficient (0.85). A 1.00 would be equal to the market (S&P 500 index). Two of the fund offerings have negative alpha scores, indicating they have not been successful in "adding value" relative to the market index considering their risk (beta) level. Next, we compared the six special situation and recovery funds using Morningstar's Fund Compare tool (at www.morningstar.com). That exercise resulted in the elimination of the Credit Suisse Global Post Venture Capital Fund, since it lacks assets and is not rated by Morningstar nor does it match the profile of fund where looking for this week. Of the five remaining funds, two fall into the large-cap blend style box, two land in the mid-cap blend style box, and one is classified as having a mid-cap growth style. We make a mental note of the funds' investment style and look to other decision criteria, such as expenses. There, we find that one fund, the Midas Special Equities Fund, has a 3.80% current expense ratio and it is effectively removed from consideration. That leaves four funds with three mid-cap investment styles as follows: Excelsior Value and Restructuring (UMBIX) Mid-Cap Value Janus Special Situations (JASSX) Mid-Cap Blend Legg Mason Special Investment Trust (LMASX) Mid-Cap Blend Value Line Special Situations (VALSX) Mid-Cap Growth In terms of assets, Legg Mason's Special Investment Trust has been the group's most successful retail fund, with current net assets of $2.6 billion today. Excelsior Value & Restructuring has $1.8 billion in net assets today according to Morningstar. Janus Special Situations is third with assets of $679 million, while Value Line's Special Situations Fund has assets of $234 million. Each of the funds is considered to have high risk compared to their relative category peer group, except for the Value Line Special Situations Fund, considered to have less than average risk relative to other mid-cap growth funds. Only one of the funds is 5-star rated, Morningstar's highest rating. That is Excelsior Value and Restructuring Fund (UMBIX). Value Line's Special Situations Fund is 4-star rated by Morningstar. Legg Mason Special Investment Fund is 3-star rated while the Janus Special Situations Fund is only 2-star rated by Morningstar. Considering Legg Mason's long-term track record in this area, Legg Mason Special Investment Trust may have the better risk- reward profile in the mid-cap blend style box (versus Janus). That leaves three special situation and recovery funds, with three different mid-cap equity styles. Each fund is further discussed in the following sections. Excelsior Value and Restructuring (UMBIX) This high risk-high return fund may be our favorite of the three special situation funds. It seeks long-term growth of capital by normally investing at least 65% of assets in common and preferred stock, and convertibles issued by companies management expects to benefit from restructuring or redeployment of assets. These may include companies involved in mergers, consolidations, spin-offs, liquidations, financial restructurings and reorganizations. The fund may also invest in investment-grade debt, although it tends to remain fully invested in equity securities. Historical returns haven't always been consistent but they have been strong relative to the market (S&P 500 index) and category peers over the past five years. According to Morningstar, this fund has a 5.8% annualized total return for the trailing 5-year period through August 12, 4.9% better than the market (S&P 500) and ranking it in the top 3% of the mid-cap value category, per Morningstar. David Williams, a senior vice president and department manager with U.S. Trust Company of New York, has managed the Excelsior Value and Restructuring Fund since December 31, 1992 (10 years almost). Previously, he served as a senior investment officer with Horizon Trust Co. and as a portfolio manager with T. Rowe Price Associates. The Excelsior Value and Restructuring Fund has a below average expense ratio of 0.94% and a no-load cost structure, adding to its appeal. The fund's minimum initial investment requirement stands at only $500 for regular accounts ($250 for IRAs). For more information or a prospectus, you can call Excelsior Funds (800-446-1012) or logon to www.excelsiorfunds.com. Legg Mason Special Investment Trust (LMASX) Legg Mason Special Investment Trust pursues capital growth by investing mainly in equity securities issued by companies with market capitalizations of below $2.5 billion. It buys equity securities that appear to be undervalued in relation to their long-term earning power or asset values. The fund also seeks firms involved in special situations that may prompt a price increase in their securities. It may invest up to 20% of net assets in companies that are involved in actual or anticipated reorganizations or restructurings. According to Morningstar, LMASX has a 5-year annualized total return of 5.5% through August 12, 4.7% better than the market (using the S&P 500 index as the market proxy) and ranking the fund in the top 27% of the mid-cap blend category (almost top quartile). Over the trailing 5-year period, the fund has had high risk and above average returns relative to its category. Portfolio manager Lisa Rapuano is relatively new, starting on January 1, 2000, but her tenure with Legg Mason dates back to 1994. Before joining Legg Mason, Rapuano was an analyst with Franklin Street Partners. Cautious investors may want to wait until Rapuano has 3 years investment history to compare and evaluate. Considering this fund's long-term track record and Legg Mason's reputation, it shouldn't be ruled out. For more information or a prospectus, call the Legg Mason Funds at 800-577-8589. Value Line Special Situations (VALSX) Value Line Special Situations Fund seeks long-term growth of capital by investing mostly in equity securities, putting at least 80% of assets in special situations (again, companies involved in reorganizations, mergers, technological advances, liquidations, or distributions of cash. This fund relies on Value Line's ranking system for timeliness in its investment decisions. According to Morningstar, the fund's trailing 5-year/10-year annual average returns rank in the top decile of the mid-cap growth category. Its 5-year average return of 8.8% was 7.9% better than the S&P 500 index and good enough to rank in the category's 5th percentile. The fund's 10-year return of 1.9% (annualized basis) lagged the S&P 500 index considerably, but ranked it in the category's 7th percentile for performance. This may have been the first mutual fund to invest in special situations. It began operations on May 30, 1956 and today is managed by a team of Value Line investment professionals. If experience is important to you, then you may want to consider Value Line's approach to special situation investing. In the last decade, the fund has generated "high" return with "below average" risk, per Morningstar, in comparison to its category peer group (i.e. mid-cap growth). For more information, call Value Line Mutual Funds at 800-223-0818. Summary This week, we identified three special situation and recovery funds that offer investors long-term capital growth potential. All three invest primarily in the mid-cap sector, or multiple capital sectors as the Excelsior Value and Restructuring Fund does (Morningstar calls it mid-cap value, while Lipper says it has a multi-cap value style). Depending on your equity style orientation, we have shown one fund with a value style bias, one fund with a pro-growth tilt, and one that blends value and growth characteristics. You may find that one style suits you better than another may. Steve Wagner Editor, Mutual Investor email@example.com *********************** INDEX TRADER GAME PLANS *********************** THE SECTOR BEAT - 8/13 by Leigh Stevens Lots of red ink today - many sectors looked like they could extend their recent rallies - WRONG! How quickly they turn - on a dime! The Airline sector (XAL) was not off more than 2%, but this is another loss tacked on to many and to a very steep decline in recent weeks - this group was in the news again as United Airlines (UAL) fell again the day after US Air filed for bankruptcy protection. Selling also spread to the defense/aerospace sectors, with Dow stocks Boeing and United Technologies (UTX) getting hit with selling. American (AMR) was up however, after announcing a major restructuring. Biotech (BTK) got hit on profit taking after a strong run in recent days. Financial stocks like the Banks (BKX), Brokers (XBD) and the financially sensitive Utilities (UTIL) sector fell under their recent consolidation patterns after the Fed did not ease the key Fed funds rate and on a bout of profit-taking selling. The Defense sector (DFI) index reversed its recent uptrend, as did the Healthcare (HMO) and Pharmaceuticals (DRG) sectors. Technology and the Internet stocks (INX) were weak across the board. Only Gold & Silver stocks (XAU) and the Retail sector (RLX) bucked the downtrend today. Retail got a boost from Wal-Mart's positive earnings report. XAU looks like it can work it's way back up toward 70. UP on Tuesday - DOWN on Tuesday - SECTOR TRADE RECOMMENDATIONS - NEW/OPEN TRADE RECOMMENDATIONS - Short BBH on break of 83.00 (Biotech HOLDR's) Stop: 84.70 Objective: ** See Sector Highlight below - ** TRADE LIQUIDATIONS - NONE SECTOR HIGHLIGHT(S) - Biotechnology Index ($BTK.X) STOCKS: ABGX; ADRX; AFFX; AMGN; BGEN; CELG; CEPH; CHIR; CRA; DNA; ENZN; GENZ; GILD; HGSI; ICOS; IDPH; IMCL; IMNX; INCY; MEDI; MLNM; MYGN; PDLI; TARO; TEVA; VRTX; XOMA The Biotech Index is close to breaking below its recent uptrend and giving back a portion of its recent gains after rallying up to resistance implied by its May low - prior support (once broken) "becomes" resistance. If BTK gave back half of its recent run up by retracing 50% of the recent advance - a very "normal" correction - it could drop back to the 330 area. In the case of the Biotech HOLDR's (BBH), a 50% retracement would be to 77, but believe that a downside objective in BBH may be to the 73 area, or back to its recent upside chart gap - this would a bit more than a 62% retracement. Leigh Stevens Chief Market Strategist lstevens@OptionInvestor.com ------------------------------------------------------------ We got trailing stops! Trade online with trailing stops at optionsXpress, at no extra cost Trailing stops based on the option price or the stock price Also place Contingent, Stop Loss, and "One Cancels Other" orders $1.50 /contract (10+ contracts) or $14.95 Minimum--NO Hidden Fees! Go to http://www.optionsxpress.com/marketing.asp?source=oetics23 Note: Options involve risk. Risk disclosure: http://www.optionsxpress.com/welcome_risk_index.htm ------------------------------------------------------------ *********************** SWING TRADER GAME PLANS *********************** Okay, Now What? The Fed gave traders some good news if you believe what the media is saying. Is it good that the economy is shrinking and the "futures risks are weighted toward weakness"? I don't think so! Sure there may be another Fed rate cut in our future but that is like saying "I hope I am sick so I can get another shot from my Doctor." This is not something I expect most traders are looking forward to. To read the rest of the Swing Trader Game Plan Click here: http://www.OptionInvestor.com/itrader/indexes/swing.asp FREE TRIAL READERS ****************** If you like the results you have been receiving we would welcome you as a permanent subscriber. The monthly subscription price is 39.95. The quarterly price is 99.95 which is $20 off the monthly rate. We would like to have you as a subscriber. You may subscribe at any time but your subscription will not start until your free trial is over. 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The Option Investor Newsletter Tuesday 08-13-2002 Copyright 2002, All rights reserved. 2 of 3 Redistribution in any form strictly prohibited. In Section Two: Dropped Calls: ABGX, AMGN, CHIR, IDPH Dropped Puts: QCOM Daily Results Call Play Updates: New Calls Plays: Put Play Updates: New Put Plays: **************** PICKS WE DROPPED **************** When we drop a pick it doesn't mean we are recommending a sell on that play. Many dropped picks go on to be very profitable. We drop a pick because something happened to change its profile. News, price, direction, etc. We drop it because we don't want anyone else starting a new play at that time. We have hundreds of new readers with each issue who are unfamiliar with the previous history for that pick and we want them to look at any current pick as a valid play. CALLS: ***** ABGX $9.16 -1.05 (-0.88) Biotechnology stocks began cracking around the edges at the open on Tuesday, as investors looked to take profits on the recent run ahead of the Fed's decision on interest rates. ABGX slid at the open, but managed to find some support near the $8.75 level. That came to an end after the FOMC results were announced, as the broad markets tumbled and the BTK index shed more than 5.5%. That brings the bullish run to an end, at least for now. While our stop hasn't been violated yet, we want to get out now, as it looks like the trend in the sector has turned. Use any sort of oversold bounce tomorrow morning to exit gain a more favorable exit from open positions. --- AMGN $45.64 -2.34 (-2.09) Big or small, Biotech stocks were among the favorites on the sell side on Tuesday and that selling picked up after the Fed's announcement that interest rates would remain unchanged. With the BTK index sliding back under the center line of its ascending channel, the trend in this sector appears to have shifted back in favor of the bears. AMGN did better than the BTK index, but still shed 4.87%, settling below $46 for the first time since last Wednesday. Even though our $45 stop hasn't yet been violated, it appears the prudent course of action is to close any open positions before our stop is triggered. With an apparent change in the trend (daily Stochastics rolling down out of overbought), use any morning strength as an opportunity to liquidate open positions. --- CHIR $37.18 -1.71 (-0.72) Despite its relative strength over the past week, CHIR couldn't dodge the meltdown in the Biotechnology sector (BTK.X) on Tuesday. While the weakness was fairly mild in the morning, it gathered momentum to the downside after the Fed's announcement on interest rates. Up until that time, CHIR had been holding near the unchanged level. But the bulls couldn't hold up in the face of the heavy selling that came in during the final 2 hours of the day. By the closing bell, CHIR had given up more than 4% -- outperforming the BTK index, but still notably weak. Rather than wait for our stop to be triggered, we want to close the play here, using any strength tomorrow as a selling opportunity. --- IDPH $43.89 -2.39 (-1.89) Variations on a theme, IDPH got caught in the Biotech downdraft that intensified in the wake of the Fed's decision to leave interest rates unchanged. After meandering around the $46 level early in the day, the stock tumbled through support at $45 before coming to rest just below $44. That slide amounted to nearly a 5% loss on the day, and the acute loss of relative strength is prompting us to close the play before stop is triggered. The tide in the Biotech sector appears to be turning in favor of the bears. Use an oversold bounce to exit open positions tomorrow before the decline continues. PUTS: ***** QCOM $26.32 +0.50 (+0.40 for the week) QCOM has experienced a bounce since trading down to $23.36 the day after OI initiated the Put Play. After being turned back from the $26 level several times, the stock experienced a breakout today, trading as high as $27.35. Our stop was violated intraday, but more importantly, QCOM has broken its short-term downtrend from the middle of July. While the stock was turned back below our end of day stop loss once again, we are closing this play and will look for better opportunities. *********************************************************** DAILY RESULTS *********************************************************** Please view this in COURIER 10 font for alignment ************************************************* CALLS Mon Tue ABGX 9.16 0.37 -1.05 Drop, broke formation AMGN 45.64 0.97 -2.33 Drop, biotech pullback CHIR 37.18 1.03 -1.7 Drop, profit taking IDPH 43.89 0.86 -2.39 Drop, gift horse JNJ 53.37 0.68 -1.21 new support still there NOC 111.56 -2.21 -2.55 Pullback, look for support TEVA 68.55 1.47 0.64 New, taking off on down day PUTS AIG 62.31 -0.49 -3.20 New, Run done AZO 66.15 -1.35 0.90 Money spent in wrong place BA 37.23 0.35 -3.27 New, Fewer planes, fewer dollars DIA 84.95 0.61 -2.04 Suspense over, crutch gone HD 26.49 -0.32 -0.21 Technical breakdown NKE 43.00 -0.63 0.23 Running in place PHTN 18.85 -1.83 -1.02 New, Off the cliff QCOM 26.32 0.58 0.50 Drop, going nowhere QLGC 32.14 0.05 -3.15 New, Look out below TMX 27.65 0.05 -0.40 Government is a tough foe ------------------------------------------------------------ Quit paying fees for limit orders or minimum equity No hidden fees for limit orders or balances $1.50 /contract (10+ contracts) or $14.95 minimum. Zero minimum deposit required to open an account Free streaming quotes Go to http://www.optionsxpress.com/marketing.asp?source=oetics24 Note: Options involve risk. Risk disclosure: http://www.optionsxpress.com/welcome_risk_index.htm ------------------------------------------------------------ ******************** PLAY UPDATES - CALLS ******************** NOC $111.56 -2.55 (-5.01 for the week) Northrop Grumman pulled back below our original target for new entries around $113. The stock dropped with the rest of the market this afternoon, after disappointment from the FOMC's rate decision set in. The key level to watch, however, is our stop loss of $110. NOC's 200-dma of 109.31 should provide a level of support from which the stock could experience a big bounce. A look at the chart shows NOC repeating its pattern from the end of July, when it dropped from $110 to $103, before beginning its rise back up to $115. The rising channel from the end of July remains in tact, as a high priced stock will experience high dollar swings within this channel. The bottom of the channel coincides with the stop loss of $110, so today's drop was not so great as to change our stance on NOC. The trade of $112 created a 3-box reversal on the PnF chart, however most rising stocks experience several of these on the way up. In addition to finding support from the 200-dma, there is also PnF support at $110. We will continue to hold our long position in NOC, as the PnF bullish objective remains $150. Tomorrow's action following the rate disappointment sell-off could test support. A bounce should indicate a good point for new long entries. Our target remains $130, just below recent resistance from the middle of June. --- JNJ $53.37 +1.37 (-1.14 for the week) JNJ has continued to test new support above $53 the last few days. It has rebounded each time from approximately the same area, around $53.40. The stock's sideways movement is further evidence of consolidation at a higher level than the last. There is currently support at the 10-dma of $52.73 and 50-dma of $52.82, just below the aforementioned $53. On a day the market plummeted as a result of disappointment in the FOMC's reluctance to lower interest rates, JNJ held up well. This stock has had quite a run, and today's drop shook out many stocks that had risen on air. JNJ, however, held its ground. The pipeline of new products, several of which are scheduled to be reviewed before the FDA in the next couple of months, has kept the sellers at bay, as the prospects look promising for JNJ. JNJ remains on a PnF buy signal with a bullish price objective of $65. We are maintaining our long position with a target of $60. ************** NEW CALL PLAYS ************** TEVA – Teva Pharmaceutical Inds. $68.55 +0.64 (+1.82 this week) Company Summary: Producing drugs in all major therapeutic categories, TEVA is a fully integrated global pharmaceutical company. In the area of proprietary drugs, TEVA has focused on products for the central nervous system disorders, primarily the development of Copaxone, a treatment for relapsing-remitting multiple sclerosis. Through its U.S.-based subsidiary, the company manufactures 137 generic products in 210 generic forms, which are distributed and sold in the United States. TEVA also manufactures over 270 generic products, which are sold primarily in the Netherlands, the United Kingdom and Hungary. Why We Like It: The Biotechnology sector (BTK.X) has been one of the strongest performers in recent weeks, marching steadily upwards in its ascending channel. That strength ran into a serious roadblock on Tuesday, as profit taking intensified in the wake of the Fed's announcement on interest rates. Unlike virtually every other stock in the sector, shares of TEVA bucked the trend and advanced 6th consecutive day. While today's gain was only fractional, it is important for two reasons. First the stock is clearly outperforming the BTK index, and secondly, TEVA is now on the cusp of completing a breakout over resistance dating back to last October. TEVA has tested the $68 resistance level several times over the past few months, and today's close above that level (the first since last October) in the face of sector-wide profit-taking is quite encouraging. Breaking above the $65 level a couple weeks ago generated a fresh double-top Buy signal on the PnF chart, with a very bullish price target of $89. After pulling back to post a double-bottom near $58 on July 24th, TEVA has been working higher along an aggressive ascending trendline, currently at $67.75. Along with resistance near the $68 level, this ascending trendline describes an ascending wedge, and TEVA is tantalizingly close to completing a bullish breakout from that pattern. A near-term pullback to support near $68 or even $67 would make for a solid entry into the play. With the weakness in the BTK today, we want to keep TEVA on a short leash, hence our tight stop at $66. Momentum traders can consider new positions on a volume-backed move through the $69 level, but only if the BTK is pushing higher again. BUY CALL SEP-65 TVQ-IM OI=1534 at $5.00 SL=3.00 BUY CALL SEP-70*TVQ-IN OI=2733 at $2.00 SL=1.00 BUY CALL DEC-70 TVQ-LN OI=1062 at $4.90 SL=3.00 BUY CALL DEC-75 TVQ-LO OI= 698 at $2.75 SL=1.25 Average Daily Volume = 964 K ------------------------------------------------------------ optionsXpress has "...a lot of bang for the buck."--Barron's $1.50 /contract (10+ contracts) or $14.95 Min. No hidden fees Easy screens for spreads, collars, or covered calls! Contingent, Stop Loss, Trailing stop, or OCO 8 different online tools for options pricing, strategy, and charting Go to http://www.optionsxpress.com/marketing.asp?source=oetics25 Note: Options involve risk. Risk disclosure: http://www.optionsxpress.com/welcome_risk_index.htm ------------------------------------------------------------ ******************* PLAY UPDATES - PUTS ******************* HD $26.49 -0.21 (-1.80 for the week) Home Depot got a bit of a boost today when Wal-Mart raised guidance for the third quarter, and the broader markets staged a rally leading up to the Fed's interest rate announcement. The stock staged a mild rebound, reaching a high of $28.08. After the FOMC announcement left rates unchanged, HD fell back into its previous descending trend line. Yesterday's trade of $27 established a triple bottom breakdown for HD on the PnF chart, which is a very bearish formation. Additionally HD appears to have been forming a bearish flag on the PnF, from which it has now broken down. The lack of a rate cut also means a delay in further cuts to re- financing rates, which may have helped Home Depot recover as homeowners may have further financed home improvements with home equity loans. The stock is currently trading at a level not seen since October 1998. We will continue to hold our short position with a target in the low 20s. There may be some psychological and round number support at $25, however there is no fundamental or technical basis for that level. --- AZO $66.15 +1.37 (-1.13 for the week) Autozone enjoyed a run-up to start the day after retail sales numbers indicated a 1.2% increase in July. Wal-Mart also raised guidance, a further indication of spending consumers. However, a closer look at the retail numbers indicates a not so rosy picture for AZO. Most of the increase was due to people taking advantage of free financing offers and other incentives to purchase new cars and trucks. Excluding auto sales, retail sales were up only 0.2%. When the majority of money being spent in the economy is spent on new cars and trucks, there is not much increase in the need for parts. The do-it-yourselfers that AZO targets are being lured away with financing plans that makes new automobile ownership more accessible. The stock finished up on the day, but well off its high of $68.32. The 200-dma of $70.47 still looms above, and should serve as a cap on any more bounces. More importantly, a look at the daily chart shows the downward trend line since August 7 to be in tact. The stock has found some recent support around $65 and new entries may want for a break below this level to go short. We are maintaining our short position in AZO from this level with a price target of $60. --- DIA $84.95 -2.04 (-3.79 for the week) The market behaved pretty much according to the OI plan, outlined on the Market Monitor and in our original DIA play. The FOMC held rates steady and changed their bias to an easing stance, indicating that they could be lowering rates in the near future. The key wording in the Fed's statement was that economic weakness was still the greatest risk. This basically told the market that the Fed sees a risk of recession, yet is not going to lower rates right now. Huh? With September 11 around the corner, the FOMC is hording its bullets to deal with any market reaction from possible anniversary terrorist attacks. The market Volatility Index remained high, even after the Fed announcement, reflecting fear of a continued drop tomorrow. There are also hundreds of companies whose CEOs must sign off on their accounting statements beginning tomorrow, August 14. Expect daily reports on which companies have missed their individual deadlines, and which companies will be reporting any "irregularities" ahead of time. In addition, we have a slew of economic data later this week. Wednesday brings Business Inventories for June. On Thursday we see Initial Unemployment Claims, Industrial Production, Capacity Utilization and the Philadelphia Fed. Friday is CPI for July, as well as Building Permits and Housing Starts. Friday also brings preliminary Consumer Sentiment numbers for August. This week's roller coaster may continue, and the big drop may not be over. We are lowering our stop loss on this play to $86.50, in order to lock in profits on a rebound. --- NKE $43.00 +0.23 (-0.92) Positive earnings from WalMart this morning gave a lift to the Retail sector (RLX.X) in the early going, but that positive momentum was only able to push the index up to the $277 level. Investor optimism turned to disappointment after the Fed left interest rates unchanged and the RLX fell back to near the unchanged level by the closing bell. The rise in the RLX lent a bid to shares of NKE early in the day, allowing the stock to rise to the $44.50 level before the bottom fell out in the final 2 hours of trade. Traders that took advantage of the artificial rise got a great entry into the play as NKE rolled over and are sitting on a decent gain tonight, with NKE primed to break down under yesterday's low at $42.70. Today's reversal from the highs solidified resistance near $44.50-45.00, so we can continue to fade rallies near that level. If looking to initiate momentum-based trades, use a breakdown under $42.50 to enter, but watch out for a possible bounce from the $41 area, near the September lows. Keep stops set at $46. --- TMX $27.65 -0.40 (-0.75) In typical volatile fashion ahead of an FOMC announcement, the broad markets rose early in the day and then went flat ahead of the 2:15pm ET announcement. That action helped lift shares of TMX to just below the $29 level (the site of the 20-dma) by early afternoon. That provided an attractive entry point into the play as the stock began to drift lower ahead of the FOMC statement. Late-comers got another entry point off the initial post-announcement lift, which began to roll over from a slightly lower high. The $29 level is solidifying as overhead resistance, increasing our confidence in entering the play on subsequent failed rallies below this level. Alternatively, a continued decline under the $27.80 level can be used for momentum-based entries. The next significant level of support after that will be $26.50-27.00, the site of the lows from last Monday. For now, we're keeping our stop in place at $30. ************* NEW PUT PLAYS ************* BA - Boeing Company - $37.23 -3.27 (-3.77 for the week) Company Summary: The Boeing Company is the largest aerospace company in the world and the United States' leading exporter. It is NASA's largest contractor and the largest manufacturer of commercial jetliners and military aircraft. The company's capabilities in aerospace also include rotorcraft, electronic and defense systems, missiles, rocket engines, launch vehicles, satellites, and advanced information and communication systems. The company has an extensive global reach with customers in 145 countries. Why We Like It: Bad news for Boeing. A day after U.S. Airways filed for bankruptcy, and a few days after Vanguard grounded itself, American Airlines announced a streamlining of operations. American will cut 7,000 jobs, which amounts to 6% of its workforce, but more importantly to Boeing, the airline is reducing its fleet and deferring aircraft deliveries as it copes with the loss of full-fare customers in an industry wide recession. American says it will focus on efficiency and cost cutting, rather than revenues. This means fewer planes, not more. This is not good news coming from the world's largest carrier. Boeing's biggest client, United Airlines, is facing enormous financial problems, losing $1 million per day, and faces a debt payment of over $900 million in December. United is currently up to date on payments to Boeing's financing group, but any interruption in those payments could have a material adverse effect on Boeing. There has been talk of United following U.S. Air into bankruptcy if they do not obtain a $1.8 billion bailout loan from the government. If the airline files bankruptcy, this will affect its obligations to creditors, including Boeing. The dominoes have begun to fall among major airlines, and with the September 11 anniversary around the corner, a lack of passengers may push more of the airlines over the Chapter 11 brink. In addition to problems with its customers, Being now faces problems from one of its biggest competitors. Total orders for the first six months of 2002 were just over half of what they were last year for Boeing and Airbus combined. Boeing now claims that Airbus is selling aircraft at cut rate prices in an attempt to steal market share, relying on heavy subsidization from European governments to make up the losses. A look at Boeing's chart shows that today's low of $37.10 came within a dime of creating a triple bottom breakdown on the PnF chart, which is a very bearish formation. The stock's current bearish vertical count is $32, which will be our initial target on this play. In addition, today's low matched that of the morning of July 24, before the Dow took off on its massive rally. A trade below this $37.10 would be Boeing's lowest level since December of last year, as it recovered from the post September 11 drop. OI sees the current price level as a short entry, with a stop loss of $40, just above today's high. BUY PUT SEP-40.OO*BA-UH OI= 508 at $4.10 SL=2.50 BUY PUT SEP-37.50 BA-UU OI= 233 at $2.70 SL=1.35 Average Daily Volume = 3.34 mil --- AIG – American International Grp. $62.31 -3.20 (-4.64 this week) Company Summary: Engaged in a broad range of insurance and insurance-related activities through its subsidiaries, AIG's primary focus is on its general and life insurance businesses. Additionally, the company is growing its presence in financial services and asset management. Other operations include auto insurance, mortgage guaranty, annuities, and aircraft leasing. With operations in 130 countries, AIG generates more than half of its revenues outside the United States. Why We Like It: Insurance stocks have been under consistent selling pressure for the past several months, so it came as a relief that they managed to participate in the broad market rebound that commenced on July 24th. Not because we want to buy them, but because we needed a bit of a lift to give us an attractive entry point. Shares of AIG have been mired in a persistent downtrend since topping out near $86 last October. That selling reached a climax in the last week of July, with the stock trading briefly below the $48 level. Since then, AIG has rebounded nearly $20, topping out last Friday near $67. Helping to put the near-term top in the stock was the news that broke over the weekend, high-lighting the exposure of insurance firms (including AIG) to failed or failing companies like Enron, Worldcom and Global Crossing. With all eyes on the FOMC meeting today, the negative impact of that news was somewhat muted yesterday, but the sellers got a boost of confidence when the Fed left rates unchanged. Even after the company claimed that it had already taken the Enron and Worldcom writeoffs and announced that it will begin expensing stock options in 2003, the sellers really smacked the stock on Tuesday. AIG dropped at the open and declined all day, with the drop accelerating after the Fed announcement. Not only has this dragged the daily Stochastics into decline, but it is presenting us with an even more bearish setup, that of bearish Stochastics divergence, which is created when higher price highs fail to be confirmed by higher Stochastic highs. With the still unsettled market, this is still an aggressive play, so we're going to set a fairly tight stop at $65.50, just above the bottom of this morning's negative gap. A failed rally below this level can be used to initiate new positions, ideally in the $64.50-65.00 area. Alternatively, consider momentum-based entries as AIG falls under the $61.50 level on its way to closing the July 29th gap down near the $57 level. BUY PUT SEP-65 AIG-UM OI=4702 at $5.00 SL=3.00 BUY PUT SEP-60*AIG-UL OI=8275 at $2.75 SL=1.25 Average Daily Volume = 7.42 mln --- PHTN – Photon Dynamics, Inc. $18.85 -1.02 (-3.59 this week) Company Summary: Photon Dynamics is a provider of yield management solutions to the flat panel display industry. The company also offers yield management solutions for the printed circuit board assembly, advanced semiconductor packaging and cathode ray tube (CRT) industries. The company's test, repair and inspection systems are used by manufacturers to collect data, analyze product quality and identify and repair product defects at critical steps in the manufacturing process. Why We Like It: The realization that there isn't going to be any near-term recovery in the PC sector is starting to take hold, as demonstrated by the heavy selling that has been hitting companies involved in the manufacture of flat panel displays. GNSS (a supplier to the flat panel industry) was one of the few remaining high-flyers in the Technology arena through the end of 2001, but since then the stock has lost more than 90% of its value. That's quite a comeuppance, and now we're starting to see the selling pressure intensify in other stocks involved in the industry. A quick look at a chart of our new play, PHTN, shows that there isn't much interest in the stock (at least to the long side), as selling volume has been on the rise again this week. In just the past 2 days, PHTN has slid more than 16%, and Tuesday's drop broke the $20 support level that had been holding for more than a year. There's no question that the stock is getting oversold in the near-term, but that doesn't mean it can't become more so, especially with the weak fundamentals, and the extreme weakness still being exhibited in the Semiconductor space. While the Semiconductor index (SOX.X) managed to rebound off its recent lows last week, the index rolled over again at another lower high over the past two days and appears to be headed back to test those lows in the near term. That sector weakness is just going to exacerbate the weakness in shares of PHTN, which are already reeling from the lack of demand for its products and services. After the sharp drop of the past 2 days, it would be natural to expect a bit of an oversold bounce. Take advantage of that bounce (if it develops) to enter new positions on the next rollover below our $22 stop, ideally in the vicinity of intraday resistance near $21. Failing that, look to enter the play as the stock falls under the $18.50 level, just below today's intraday low. BUY PUT SEP-20 PDU-UD OI=33 at $2.90 SL=1.50 BUY PUT SEP-17*PDU-UT OI=40 at $1.60 SL=0.75 Average Daily Volume = 761 K --- QLGC – QLogic Corporation $32.14 -3.15 (-3.76 this week) Company Summary: Somebody has to make the equipment that lets your computer talk to all its peripheral equipment, and QLGC does it well. A leading designer and supplier of semiconductor and board-level input/output (I/O) management products, QLGC has been providing SCSI-based connectivity solutions to this market sector for over 12 years. QLGC's I/O products provide a high performance interface between computer systems and their attached data storage peripherals, such as hard disk and tape drives, removable disk drives and RAID (redundant array of independent disks) subsystems. The company is also the market share leader in Fibre Channel host bus adapters, a market segment that is receiving tremendous attention from investors. Why We Like It: In the wake of Emulex's severe warning last Thursday night, shares of Storage stocks have been under heavy selling pressure. Hope for an interest rate cut from the Federal reserve seemed to keep stocks in this sector afloat over the past couple days, but that artificial prop was brutally removed on Tuesday. Shares of QLGC have stubbornly refused to undergo the valuation compression that has been seen in the likes of ELX and BRCD in recent months, with even the broad market decline that culminated on July 24th failing to take the stock to new yearly lows. But it seems that the combined effect of the ELX warning and a lack of a rate cut is going to get the job done this time. QLGC shed nearly 9% on Tuesday on volume 75% above the ADV. That decline pushed the stock below the 62% retracement of the fall rally, resulting in its lowest close since October 11th. With a fresh double-bottom breakdown on the PnF chart and a bearish price target of $27, there is clearly still some room to fall for this storage stock. The $35 level had been providing strong support over the past couple months and now that it has been broken, it should act as resistance. An oversold bounce would likely set us up for an entry on the failure of that bounce, so long as it fails below $35, the level of our stop. Momentum traders will want to initiate new positions on a continued volume-backed decline below the $31.75 level, the site of Tuesday's low. BUY PUT SEP-35 QLC-UG OI=1553 at $5.30 SL=3.25 BUY PUT SEP-30*QLC-UF OI=1437 at $2.80 SL=1.50 Average Daily Volume = 12.4 mln ------------------------------------------------------------ WINNER of Forbes Best of the Web Award optionsXpress voted Favorite Options Site by Forbes Easy screens for spreads, collars, or covered calls Free streaming quotes Real-time option chains, charts + calculators Go to http://www.optionsxpress.com/marketing.asp?source=oetics21 Note: Options involve risk. Risk disclosure: http://www.optionsxpress.com/welcome_risk_index.htm ------------------------------------------------------------ ********** DISCLAIMER ********** Please read our disclaimer at: http://www.OptionInvestor.com/page/oin/aboutus/disclaimer.html ************************************************************** ADVERTISING INFORMATION For more information on advertising in OptionInvestor Newsletter, or any Premier Investor Network newsletter please contact: Contact Support
The Option Investor Newsletter Tuesday 08-13-2002 Copyright 2002, All rights reserved. 3 of 3 Redistribution in any form strictly prohibited. In Section Three: Play of the Day: PUT - BA Traders Corner: From b to P ********************* PLAY OF THE DAY - PUT ********************* BA - Boeing Company - $37.23 -3.27 (-3.77 for the week) Company Summary: The Boeing Company is the largest aerospace company in the world and the United States' leading exporter. It is NASA's largest contractor and the largest manufacturer of commercial jetliners and military aircraft. The company's capabilities in aerospace also include rotorcraft, electronic and defense systems, missiles, rocket engines, launch vehicles, satellites, and advanced information and communication systems. The company has an extensive global reach with customers in 145 countries. Why We Like It: Bad news for Boeing. A day after U.S. Airways filed for bankruptcy, and a few days after Vanguard grounded itself, American Airlines announced a streamlining of operations. American will cut 7,000 jobs, which amounts to 6% of its workforce, but more importantly to Boeing, the airline is reducing its fleet and deferring aircraft deliveries as it copes with the loss of full-fare customers in an industry wide recession. American says it will focus on efficiency and cost cutting, rather than revenues. This means fewer planes, not more. This is not good news coming from the world's largest carrier. Boeing's biggest client, United Airlines, is facing enormous financial problems, losing $1 million per day, and faces a debt payment of over $900 million in December. United is currently up to date on payments to Boeing's financing group, but any interruption in those payments could have a material adverse effect on Boeing. There has been talk of United following U.S. Air into bankruptcy if they do not obtain a $1.8 billion bailout loan from the government. If the airline files bankruptcy, this will affect its obligations to creditors, including Boeing. The dominoes have begun to fall among major airlines, and with the September 11 anniversary around the corner, a lack of passengers may push more of the airlines over the Chapter 11 brink. In addition to problems with its customers, Being now faces problems from one of its biggest competitors. Total orders for the first six months of 2002 were just over half of what they were last year for Boeing and Airbus combined. Boeing now claims that Airbus is selling aircraft at cut rate prices in an attempt to steal market share, relying on heavy subsidization from European governments to make up the losses. A look at Boeing's chart shows that today's low of $37.10 came within a dime of creating a triple bottom breakdown on the PnF chart, which is a very bearish formation. The stock's current bearish vertical count is $32, which will be our initial target on this play. In addition, today's low matched that of the morning of July 24, before the Dow took off on its massive rally. A trade below this $37.10 would be Boeing's lowest level since December of last year, as it recovered from the post September 11 drop. OI sees the current price level as a short entry, with a stop loss of $40, just above today's high. BUY PUT SEP-40.OO*BA-UH OI= 508 at $4.10 SL=2.50 BUY PUT SEP-37.50 BA-UU OI= 233 at $2.70 SL=1.35 Average Daily Volume = 3.34 mil ------------------------------------------------------------ VOTED one of "Best Online Brokers" (4 stars)--Barron's optionsXpress's "order-entry screens...go far beyond... other online broker sites"--Barron's 8 different online tools for options pricing, strategy, and charting Access to options specialists via email, phone or live chat online Real-Time Buying Power, Account Balances or Cancels Go to http://www.optionsxpress.com/marketing.asp?source=oetics22 Note: Options involve risk. Risk disclosure: http://www.optionsxpress.com/welcome_risk_index.htm ------------------------------------------------------------ ************** TRADERS CORNER ************** From b to P By John Seckinger jseckinger@OptionInvestor.com Market dynamics consist of prices either trading in a horizontal (range bound) or vertical (explosive) manner. The former is considered efficient, while the latter is the market violently searching for that efficient area, or inefficient. When used together, traders can begin to recognize important market patterns and improve the likelihood for successful trading. These vertical and horizontal patterns first began with J. Peter Steidlmayer, a Chicago trader/author who understood the idea of looking for a “pivotal” or efficient area within the marketplace. Mr. Steidlmayer first joined the Chicago Board of Trade in 1963 as an independent trader, serving on the Board of Directors from 1981 to 1983. Getting back to the nomenclature, this word “pivot” can be used synonymously with either “high volume area”, “efficiency”, “apex”, or “horizontalness”, and is the widest part of the “b” or “P” formation. The lowercase “b” is considered long liquidation, with “l” representing massive selling and the lower part of the “b” (the hump) representing a lull in trading as prices consolidate. On the other hand, the capital letter (P) is short covering, with traders all rushing to cover until a lull takes over as demand begins to equal supply. Before we look at an example, there are a few disclaimers that must be made. First, there are times when a trader will not be able to find either the “b” or “P” pattern. That is ok. In fact, these patterns do not happen all the time anyhow. Trying to force a “b” or “P” pattern is the same thing as forcing a trade. It doesn’t have to be done. Secondly, once a trader determines that a relative bottom in place (explained later), it is important to give the market TIME to consolidate and produce an apex. Thirdly, do not be mad if the next vertical move is missed, since there is usually a significant portion left to capture. Lastly, it is important to go back and judge exactly where the pivot area was. While the consolidation is in process, we will make an educated guess on where the pivot is; however, we may find out later we were a few points off. Fortunately, the market will make it clear where the pivot resides. Ok, now it is time to look at an illustration. Looking at a 60- minute chart of the Dow, we will start with an “inefficient” (explosive) move lower. Note: If the lack of price levels on the right hand side becomes annoying, please look at the final chart for the proper price levels. However, both the “b” and “P” patterns do not have exact price objectives anyhow. As the charts note, I wait until two green (or red) candles before thinking about a relative low (or high), and it could be 20 or 500 points until finding such a level. This is analogous to “letting the profits ride.” Looking at the chart above, I hope the “b” pattern looks somewhat obvious. If a trader was short before the inefficient (vertical) move lower, it would make sense to either cover during the second green candle (say, a few minutes before the candle ended so the chances of it closing green is 99.9%) or wait until the pivot is formed and then use a tight stop right on the other side of the pivot. A few important points to notice here: The relative low was not re-tested after the two green candles, allowing us to begin thinking of a “b” formation. If this low was taken out, the pattern would then be nullified. This is why TIME becomes important. Another important note: It is fine if the pivot is not easily recognized; letting the market tell you later where the pivot was is an acceptable strategy. The “perceived value” (or pivot) is simply an “educated guess” on where the market spent most of its time. The horizontal line above was chosen because it bisected three candles in the middle of their open/close area. Ok, we have our first pivot. Now what? Wait for a move and then jump on board, OR put on a trade and then use a stop right on the other side of the pivot. As the second chart shows below, the market did proceed to go lower (the bold P is the pivot level we determined from our first chart). Even if we missed recognizing the pivot, there was plenty move to catch on the downside. Ok, what should traders be noting now? Well, since the relative low in our first example was taken out, is now has to be put deep in the back of our minds with only the pivot on our minds. Now that we know the pivot, it is time to wait for another relative low to take hold (2 green candles). Once that happens, the cycle continues: a trader can either cover or wait until yet another pivot takes form. Looking at the chart below, this second “b” formation isn’t very clean looking; however, it still has to be considered a “b” since the relative low was not re-tested and prices clearly went into a consolidation fashion. So, let’s say that this time we hold on to our short. Remember, we still have a stop in just above the first pivot (which has not been tested), and we could also put in a stop just above the perceived pivot within the larger “b” formation. So, what ended up happening? Well, the market did in fact go lower (see chart below) and neither stop would have been hit. Now we have two pivots that have not been re-tested. The thinking is, these pivots are where sizable shorts started, and these short traders will defend their profits with authority. Moreover, it would be psychologically harmful if demand brought prices back through the pivot – changing sentiment and allowing technicians to now look for prices to continue the upswing. A change in power, if you will. Looking more at the chart above, it is fine that there was not a “b” pattern at the bottom. As stated before, b’s and P’s will not always be present. As seen on the right side of the chart, there is then an explosive move higher (six out of seven green candles – next to two arrows), followed by a consolidation, and then, not surprisingly, another explosive move (far right side of chart). This breakout began at 8244 in the Dow – changing our focus from b’s to P’s. What should we be looking at now? The same as before: Will the old pivots be tested on the upside, and then will this new P-pivot be tested on the downside? Remember what shorts are thinking; Sell the market as prices get close to the pivot!! The pivot(s) can not fail!! Well, let’s see what happened. Prices did manage to rise above the second b-pivot, but not the first! Very important to recognize that at least one pivot held. We will now give critical importance to that pivot. As we can see in the chart, prices consolidated between those two pivots; however, they didn’t form a nice “P” formation. Not a problem, since we are now only worried about the first pivot holding. As time progressed, prices did dramatically fall, giving shorts even more credibility going forward. Looking at the far right side of the chart, prices are currently at the first “P” pivot at 8244. That could have been used as a place to cover shorts during the free-fall (sure, you would have missed a part of the move); nevertheless, 8244 now seems to be in play. What do we do at 8244? Well, it seems as though another “P” formation is taking shape, since we have two green candles in a row acting explosive (vertical). Also interesting is prices coming back to test previous pivot. Since it is a pivot, we will use the definition of a pivot: if above, buy; if below, sell. Therefore, it makes sense to take a long position at 8244 and look for the “P” to form. If the “P” doesn’t form and a trader went long, make sure to put a stop underneath the new relative low. Ok, let’s see what happens. Well, the market did in fact rise from 8244 (bottom blue line); however, we didn’t get a nice “P” distribution with a clear cut apex. That is ok; our reasoning seemed to make sense going into the trade because of a possible “P” pattern and we had our support and stop. As you probably already see, it was once again amazing how prices rocketed to the very first pivot, just below 8800. In fact, the reason I guessed the Dow at 8775 was based on this type of research. Of course, the Dow did close at 8745. Not too far off. So, now what? Well, on Monday the pivot held once again and shorts gained control. During market hours, should all traders use only a 60-minute chart? Of course not, please use whatever works. From a 5- minute chart to a yearly illustration, traders should be able to find either “b” or “P” with little problem. For trading purposes, which timeframe works better? It is my opinion that a shorter timeframe can work better than a longer one. Why? The psychological aspect is more current; thus at times more powerful and fresh in traders’ minds. Fortunately, we can make note of both. When the market is closed, look at all timeframes, then during market hours turn to the 60, 30, and 5-minute chart for more practical purposes. Remember, even if after this article you still find yourself visualizing “wedges”, “consolidation patterns”, etc. instead of the “b” or “P” formations – that is fine; please stick with what works. The “b” and “P” formation is a tool I use to help understand when the market is “asleep” and when it is time to jump on board. Moreover, once the move is captured, I use these patterns for finding a relative low (or high) and help maximize profits. For the rest of the week, please spend some time looking for “b” and “P” patterns and send me an email on how things turned out. I am here to help. John ------------------------------------------------------------ We got trailing stops! 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