The Option Investor Newsletter Thursday 08-15-2002 Copyright 2002, All rights reserved. 1 of 3 Redistribution in any form strictly prohibited. In Section One: Wrap: Highest Close In A Month Index Trader Wrap: Buoyant Market Sentiment: Coming Up Roses Weekly Manager Microscope: Warren Isabelle: ICM/Isabelle Small Cap Value Index Trader Gameplans: The Sector Beat – 8/15 Updated on the site tonight: Swing Trader Game Plan: Ping Pong Markets Posted online for subscribers at http://www.OptionInvestor.com ************************************************************ MARKET WRAP (view in courier font for table alignment) ************************************************************ 08-15-2002 High Low Volume Advance/Decline DJIA 8818.14 + 74.80 8854.21 8687.92 1.72 bln 1921/1234 NASDAQ 1345.01 + 10.70 1350.92 1322.11 1.71 bln 1732/1621 S&P 100 469.78 + 5.34 471.64 463.76 Totals 3653/2855 S&P 500 930.25 + 10.63 933.29 918.17 RUS 2000 390.73 + 1.32 392.37 388.65 DJ TRANS 2319.97 + 13.90 2328.77 2278.28 VIX 33.07 - 3.29 36.57 33.07 VXN 51.24 - 2.04 54.24 51.10 Total Vol 3,665M Total UpVol 2,376M Total DnVol 1,230M 52wk Highs 99 52wk Lows 277 TRIN 0.62 PUT/CALL .63 ************************************************************ Highest Close In A Month The Dow rallied back from a severely negative Philadelphia Fed Survey to close positive for the second day in a row and the highest close since July 10th. Could it be the trend have been broken? It may be too soon to tell but the outlook is promising. Whenever markets rise on bad news the future is definitely looking up. Chart of the Dow Chart of the Nasdaq The Philadelphia Fed Survey fell to a dramatic low and a continuation of a six month slide. The -3.1 headline number was the first negative number since December and down from a high of 22 as recently as June. The August estimate was +7.6. This is the first real evidence of a contraction of the manufacturing sector while most other indicators have been hovering just on the brink of turning negative. New orders fell from 6.6 to -2.7 in August and the labor component fell to -13.4 from 6.8 in July. Both new orders and shipments fell as demand weakened. The six month outlook also worsened and capital expenditures for that period dropped to 5.1 from 24.4. This was by far the worst economic report yet and although it is region specific it is assumed the other regions are seeing the same results. Contrasting the Fed survey was the Industrial Production number which came in slightly better than expected at +0.2%. Growth was weaker than June but still growth! It does indicate that the drop in July was not as severe as previously thought. Jobless claims rose slightly to 388,000 but well within the current trend. The number from last week was revised upward from a drop of -15,000 to only -9,000. Continuing claims did rise +73,000 from the prior week. When you factor in the 16,000 job cuts at IBM, 7,000 at AMR, 1,700 at PLAB among dozens of layoffs announced this week you can see that the longer term picture is not improving. The earnings after the close were positive with Dell announcing inline with estimates, beating revenue estimates and predicting a 5% increase in sales for this quarter. They bordered on raising guidance saying they were looking for $.20 to $.21 cents for next quarter when analysts were only looking for $.20. They claimed their business was good despite the down sector and they were gaining share from competitors. Their inventory depth was only four days when HPQ is sitting on 49 days of inventory. They said they were seeing an increase in server sales although they did not see business spending increasing on the whole. They attributed this to gaining share in a flat market. Dell was trading up in after hours. Retailer Kohls is exploding if you can believe their earnings. They beat the street by two cents and increased sales +27%, earnings +44% and same store sales +10%. While this may be incredible performance it was less than they had originally projected and they said if back to school buying doesn't appear soon they may have to lower guidance. This was the same story from Target who said earnings for the quarter could be at risk if slowing sales trends continue. They said it was still too soon to make the earnings call but the trend was definitely slowing. Other retailers posting strong gains included Nordstrom which beat the street by +5 cents and ANN posted $.38 cents from estimates of 29 cents. This followed wins by FD and WMT yesterday. Federated also warned that estimates for this and next quarter are too high compared to current slowing sales. Are you noticing a trend here? The certification period passed its initial hurdle with barely a whimper. There were a few last minute restatements but mostly from companies that were under suspicion already. There was no smoking gun or major corporation going down in flames. This no doubt contributed to the bullish sentiment we saw in the last two days. The passing of this date does not in any way win us a get out of jail free card. The problems still abound and the largest of which is the coming 9/11 anniversary. Everyone in the travel, lodging, retail and even the restaurant business has started warning of slower sales and we are still three weeks away from the 11th. The struggling economy has to weather this storm for another four weeks and then we should start ramping into the holiday season using all that pent up cash. This cloud has been overhanging the back to school sales and restricting business and vacation travel over the next three weeks. I don't expect anything to happen because the terrorists only want to strike when we least expect it. They will not try to overcome substantially increased security and risk an increased chance of failure. Still the public will see this as a potential disaster of unknown scale and stay home until the anniversary passes. The other continuing problem is still Brazil. The questionable candidates are still in the lead in the presidential election for October and the wrong winner would be a sure disaster. Add in the increasing likelihood that we will go after Saddam on our own and risk having our oil cutoff from other Arab countries and you can see why the Fed was not eager to spend its remaining rate cuts frivolously. Friday is a toss up. We finished the day over 8800 but well off the highs. The Dell news is a positive but probably already priced in with today's gains. The retail earnings announcements were excellent but almost all warned of slower sales trends. Trading at new relative highs after a big decline puts us at risk of hitting new sell programs with every +25 point gain. Until the majority of traders turn bullish the remaining bears will continue to make our life miserable with every up tick. The bright side is every bear becomes a panic buyer if the markets continue to trend up. Tomorrow we have the CPI report, Housing starts and the Consumer Sentiment. Sentiment should have remained flat for the first two weeks of August since the market has been trending up. This is the number one cause of its decline. The housing starts should rise slightly due to the good weather and continued lower interest rates. The key for tomorrow is for the Dow to remain over 8750 and close over 8850. This will keep the current short term up trend in place and keep pressure on the shorts. The Nasdaq needs to close over 1354 for the same reasons. Ralph Acompora came out into the sunlight today and said the close over 8796 today indicated we could rally to 10,060. He has not been right for a long time but he said the July-24th low was the bottom and he expects +1000 to +1200 point gains from here. Let's hope his luck has changed. Enter Very Passively, Exit Very Aggressively! Jim Brown Editor ******************** INDEX TRADER SUMMARY ******************** BUOYANT By Leigh Stevens TRADING ACTIVITY AND OUTLOOK - Like a buoyant cork, the market keeps bobbing back up after being sold down and today was another example. This won't last either - we'll go back to more two-sided trading swings again, but for now we have a shift in professional sentiment - a willingness to buy at least "old economy" stocks. Tech of course is another story as the economy has to "catch up" to their still- high valuations. As for the public - FURGETTABOUTIT! I'm not talking about you dear readers, the more sophisticated trader types, but the investor who will get in only when the barber, baker and candlestick maker are talking about the market. Or, even more so when cocktail party conversations turn to the new bull market and charts are drawn on cocktail napkins. These folks are not buying although they may have some mutual/pension funds where the managers are doing some buying. Contrast price action this week with the past months of this year when the indexes kept falling after any minor rallies. How the worn has turned! Well this price action matches what the bullish S&P chart patterns have been suggesting - this rally has "legs" and bullish upside potential to as high as 500 on the OEX, 1000 in SPX and 9200 in the Dow are possibilities. I'm not saying these kind of targets will be realized on this current move or even on this up leg. But, this kind of price action is typical of market shifts. There are not so many people on board yet. By now, bears are not able to suddenly become bulls - its too big of a transformation to make psychologically. Actually, when these unexpected countertrend moves start and keep going and going and going like that crazy bunny - well, what actually happens is that things kind of go quiet. I'm getting fewer e-mail than ever. People don't know what to do. I myself find it hard to buy into an overbought market for example but this is where "momentum" type traders will do OK, although they will tend to be too quick to jump out also. Anyway, the type trader that jumps on board index trades anytime there is MO - will the day traders be back next!? - right now they have plenty of space in those trading rooms. Fundamentally, I think the shift we are seeing in due in large measure to asset allocation movement of relatively small percentage amounts from fixed income to equities. There is an emerging perception that equities have at this juncture limited downside risk - we don't have serious money managers talking about Dow 5,000. Perhaps maybe 7,500 as the downside risk. And bonds, well THEY have limited upside potential in terms of appreciation - bonds yields are not going to go to zero or close to it like Japan. With the 10-year note yielding around 4%, MAYBE this could fall to 3% but that's a stretch. Investors are not used to lending their money to the government for a decade and be willing to accept only 3% normally, which hardly keeps pace with inflation. Bond holders usually demand more of an inflation premium. One has to look at the capital markets in terms of two choices - fixed income and the variable return of equities. At some point, the risk in stocks starts to look attractive relative to the alternative. Well, there is real estate of course, but most people are only buying one home, and maybe one vacation place. They're not buying rental properties for the most part. So there you have it, the Steven primer on the investing. S&P 100 Index (OEX) - Daily/Hourly charts: A broad uptrend channel is starting to emerge on the hourly chart as the S&P 100 index appears to be consolidating in what may be the approximate midpoint of a range. Double that range and you are at the top end of the hourly uptrend channel. What gives good initial definition to a trend channel is when you have 3 points to define one trendline - the lower one in this case. Then the tentative upper end of that channel is a line parallel to the first one that "touches" the highest high or highs - we have 2 or 3 here although they are part of a cluster around 458. The other pattern we see is possible bullish flag type formations on both the daily and hourly charts. As it happens, I have written my Trader's Corner column tonight on (chart) "pattern recognition", beginning with "continuation" type patterns like flags and triangles that are usually just back and forth price moves that are "pauses" in a trend that will continue. Often these pauses are about midpoint or midway in a move. A bull flag pattern is also more likely to "fall apart" in an index than they are in an individual stock - an index being infinitely more complex so to speak. That said they often do work out - the key is that we usually see a move that KEEPS going AFTER prices break out above the top (in this case) of the narrow range consolidation that "forms" the flag. A "negation" of this bullish pattern is signaled by a decisive downside penetration of the LOW end of the flag pattern. In the case of the hourly OEX chart, a move below 464 suggests is bearish and an exit of calls - especially if there was an hourly close below this level or an intraday break of 460. The 460 area was the key "line" of resistance formed by repeat hour price peaks - resistance, once broken, "becomes" support or should if a rally is going to have a next leg up. Key resistance implied by the top end of the aforementioned hourly flag is 470-471 - this is the "breakout" point if penetrated. If pierced, a next upside objective is 480 initially, but the flag objective is higher, closer to 500. I am giving the most bullish scenario or possibilities. A break of 464, then 460 gives a downside target to the low 450s. The hourly up trendline intersects at 450 - below here, key support is in the 440 area around the prior downswing low. I won't spend as much time on SPX and DJX as the patterns are similar - only the upside and downside numbers are different. S&P 500 Index (SPX) - Hourly chart: While the upper channel line intersects close to the 1000 area, the upside implied by a measured move objective whereby the first up leg was at least equal to a second up leg is closer to 980. There is room on the upside - as Jim said today on our Market Monitor, nothing but "blue sky" overhead. Given the overbought condition on a near-term basis the risk of taking on new call positions is also high. If long, exit on a decisive downside penetration or move below the "line" of prior highs (912-914). Or, at 980 if reached - why fight for the last 20 points if there is that kind of upside potential on this current move. Support below 912-914 in SPX is 890. A break of 890 would also break the up trendline and suggest that the prior low might be retested in the 875 area. DJ Industrial Index (1/100 of INDU) - $DJX - Daily/Hourly charts: I'm bullish as long at DJX can stay above the 87.6-87.9 area, especially on a closing basis both in terms of the hourly and daily closes. Support under this area is 86, then some ways below - at the 84-83.7 area. Upside potential, and probably resistance is at 90 in DJX - 9000 in the Dow is not only a number talked about on the floor, but is resistance implied by lows formed in late-June/early-July. Above 90, my upside target is 92. I would be a seller in the 92-93 price zone, if reached. Nasdaq 100 Trust Stock (QQQ) Daily/Hourly charts: We almost at resistance in QQQ - the technical picture is quite different than the S&P indices which have broken out above their prior recent highs. I don't know how this will be resolved. I find it hard to imagine that the S&P soars and the Nasdaq is deflected right near closing levels. The Composite chart looks a bit more bullish with upside potential to the 1380 area, maybe to 1400 over the next 2-3 days. The 24.7-25.25 is my expected upside for QQQ - not much more until there is another pullback. Of course a new high above 24.7 AND the ability to hold a new high does "confirm" an uptrend - and, the double bottom low for that matter. The Nasdaq chart/technical picture keeps me more cautious on the market here, the S&P more bullish. At some point tech will likely be somewhat of a "drag" on the NYSE market. Whereas, there is a limit to how much the S&P will pull UP the Nasdaq 100 and Composite - stay tuned! 23.7-23.9-24.0 is the key line of prior resistance in the Q's and should now act as support. A break of this area suggests further downside, with support looking like 23.5 then 23, which is a key support currently in terms of the emerging hourly uptrend line, with the prior swing low at 22.5 as the last ditch support to keep the emerging uptrend intact. 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 **************** Coming Up Roses by Steven Price Green lights everywhere! That's how the screen looked today, with even the Semiconductors posting a healthy gain. Brocade released positive numbers yesterday after the bell, and the techs took off. This was in spite of Goldman Sachs lowering estimates on four of the major hardware makers. Goldman's targets were storage equipment maker EMC, business computer maker Sun Microsystems and Hewlett-Packard, which recently took over Compaq. Today's action seems to indicate that after the SEC deadline for CEOs to certify financial results passed without any major surprises, investors felt comfortable jumping back into the market. A look at the Dow shows a confirmed PnF buy signal, after trading over 8800 to finish the day at 8818.14, up 74.83. This coincides with the buy signal established yesterday by the S&P 500, with its trade of 920. The S&P finished today's trading session at 930.25, up 10.63. These buy signals seem to confirm what has been developing in the bullish percentage charts since late July. A look at the bullish percentage for the S&P 500 shows a meteoric rise from a low of 12%, to a current reading of 44%, indicating the percentage of stocks in the index now generating buy signals. The Dow bullish percentage rebounded from an even more oversold condition of only 4% of stocks generating buy signals, to a healthy 42% as of today's close. The Nasdaq 100, which has been leading the market for the last several years, reflects a bullish percent of 38%, and a breakout to the upside from a bullish flag pattern. The combination of turnarounds in all of these indicators is almost enough to convince this market skeptic that a precipitous fall may not be around the corner after all. The fall I have been expecting at the end of August and beginning of September, as investors dump their long positions ahead of the 9/11 anniversary, may in fact take place from a much higher level than originally anticipated. A release of the minutes from the FOMC's June meeting showed that they were comfortable keeping rates low, as long as inflation co-operated. According to the minutes, "Given their anticipation of strong productivity growth and continuing slack in labor and other markets, members expected inflation to remain low over the next several quarters." In fact, instead of discussing further rate cuts, the members of the committee discussed how long they could keep rates at these 40 year lows before returning them to a more normal level. This attitude may have changed between the June and August meetings, as reflected in the easing bias stated this past Tuesday. After the bell, Dell released earnings which met expectations, and reported a double digit increase in shipments. the company posted earnings of $0.19, on revenue of $8.5 billion. This revenue beat the company's own estimates by $200 million. CEO Michael Dell stated that the company would also likely enter the PDA and printer markets, however would remain focused on its computer systems. This news is bullish for the techs and should lead to continued strength in tomorrow's session. Jack Grubman, the lead Salomon Smith Barney telecom analyst, who is being investigated for his role with World Com, resigned today, stating that he could no longer work under the pressure of the investigations and negative statements about his work. he will have to somehow find contentment in a $32 million severance package, which includes forgiveness of a $19 million loan he received from the company 4 years ago. The NASD fined and suspended the licenses of 2 Credit Suisse First Boston executives who were charging excessive commissions to buyers of initial public offerings. J. Anthony Ehinger, global head of equity sales, and George Coleman, head of institutional listed sales, were fined $200,000.00 each and suspended for 60 days. The pall over the market seems to be lifting, and the Dow's series of three higher lows, followed by higher highs, seems to indicate we may not be in for a re-test of the 7500 low from last month. The Nasdaq 100 has also broken out of its short-term descending channel, begun in late May (although the descending channel from the beginning of the year remains in tact ). Look for continuing strength tomorrow, after Dell's revenue surprise. The basic fundamentals of a lack of IT spending and very slow growing economy have not changed, however. We are not yet out of the woods, and a re-tracement of recent gains is still possible. However, let's stop and smell the roses for the moment, as things appear to be turning positive for the short term. One note of warning, however. Tomorrow is expiration, and I can't seem to remember many boring expirations. ----------------------------------------------------------------- Market Averages DJIA ($INDU) 52-week High: 10679 52-week Low : 7702 Current : 8818 Moving Averages: (Simple) 10-dma: 8528 50-dma: 8880 200-dma: 9735 S&P 500 ($SPX) 52-week High: 1226 52-week Low : 797 Current : 930 Moving Averages: (Simple) 10-dma: 889 50-dma: 936 200-dma: 1074 Nasdaq-100 ($NDX) 52-week High: 1782 52-week Low : 892 Current : 981 Moving Averages: (Simple) 10-dma: 925 50-dma: 1005 200-dma: 1346 ----------------------------------------------------------------- The Semiconductor Index (SOX.X): The Semiconductors have enjoyed a revival the last couple of days. Dell released earnings after the bell that met expectations. The real surprise, however, was in the revenue, which beat Dell's own forecasts by $200 million. The index has popped out of its descending channel from the middle of May, and may have finally found a bottom after these stocks have been repeatedly crushed over a lack of IT spending. 52-week High: 657 52-week Low : 282 Current : 327 Moving Averages: (Simple) 10-dma: 309 50-dma: 367 200-dma: 498 ----------------------------------------------------------------- Market Volatility The VIX is back in territory it hasn't seen since the end of July, during the market rebound between July 24 and July 31. the Fed meeting is behind us, the CEO certification deadline has passed, and the New York financial community is vacationing in the Hamptons. Somehow I get the feeling we may be getting lulled into a false sense of security. Of course the other explanation is that all of the high premium option holders are getting out as quickly as possible, as time decay is eroding their positions, and buyers are nowhere to be found. They are most likely racing each other to hit bids, as the drop in volatility can be just as expensive as being short the explosion. Traditionally, on the first day of a new expiration cycle, front month options tend to be sold en masse. So expect Monday's VIX to be even lower if there is no major event in the next 72 hours. CBOE Market Volatility Index (VIX) = 33.07 –3.29 Nasdaq-100 Volatility Index (VXN) = 51.24 –2.04 ----------------------------------------------------------------- Put/Call Ratio Call Volume Put Volume Total 0.63 1,003,642 634,444 Equity Only 0.42 728,145 307,451 OEX 0.87 59,105 51,659 QQQ 0.31 144,743 44,379 ----------------------------------------------------------------- Bullish Percent Data Current Change Status NYSE 36 + 3 Bull Confirmed NASDAQ-100 39 + 10 Bull Confirmed DOW 43 + 3 Bull Confirmed S&P 500 44 + 9 Bull Alert S&P 100 46 + 10 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 1.15 10-Day Arms Index 1.18 21-Day Arms Index 1.25 55-Day Arms Index 1.36 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 1713 1010 NASDAQ 1658 1573 New Highs New Lows NYSE 22 51 NASDAQ 30 96 Volume (in millions) NYSE 1,745 NASDAQ 1,632 ----------------------------------------------------------------- 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 MANAGER MICROSCOPE ************************* Warren Isabelle: ICM/Isabelle Small Cap Value This week, we put Warren Isabelle, president and chief investment officer of Ironwood Capital Management LLC ("ICM"), and portfolio manager of the ICM/Isabelle Small Cap Value Fund under the scope. Isabelle's independent investment management firm specializes in investing in undervalued small cap stocks. ICM seeks to combine the risk-adverse nature of value investing with the greater long- term appreciation potential of small company stocks. Warren Isabelle is perhaps best known for his years with Pioneer Management Corporation (13 years), where he was head of domestic equities and portfolio manager of the successful Pioneer Mid-Cap Value Fund (originally called Pioneer Capital Growth Fund) which he managed from July 1990 inception through January 1997. While with Pioneer, Isabelle also managed another small cap value fund, Pioneer Small Company Fund, from November 1995 inception through January 1997. At the time of his departure, the combined assets totaled nearly $3 billion, per company sources. His performance at Pioneer garnered him national attention, the website states. He has since appeared on Louis Rukeyser's Wall Street Week and been featured in articles in Barron's, Business Week, Individual Investor, Money, Smart Money, and USA Today. Our primary focus this week is on Warren Isabelle's latest fund, the ICM/Isabelle Small Cap Value Fund (IZZYX). Note that we'll be using the Investment Class shares of the fund for comparison and evaluation purposes. The Investment Class Shares impose no front-end or back-end sales loads, and require a $1,000 minimum initial investment for both regular and IRA accounts. Complete information on ICM's Isabelle Small Cap Value Fund is available by calling the ICM Series Trust at 1-800-472-6114 or by logging on to www.icmfunds.com. The ICM website says this fund will close to new investors once assets equal or exceed $500 million. Right now, there's plenty of room, with current net assets at $87 million per Morningstar. Additional Background Warren Isabelle named his Portland (Maine) based firm after the Ironwood tree, described as a small hardy tree that yields very useful and solid wood. The ICM website states that these trees remain under the forest canopy until taller neighbors fall, and once given the opportunity to grow, they grow quickly, reaching their full potential. This imagery ICM says is appropriate for their firm, as well as their investment style. We'll talk more about Isabelle's style/strategy shortly. Prior to founding ICM in August 1997, Isabelle had a brief stint as chief investment officer and portfolio manager at Keystone Investment Management Company. From June 1984 until his departure in January 1997, he was head of U.S. equities at Pioneer Management Company, one of the nation's leading money managers. Prior to joining Pioneer in 1984, he worked as an analyst at Hartford Insurance and Travelers Corporation. Isabelle is a Chartered Financial Analyst (CFA). He holds a MS Degree in Polymer Science and Engineering from the University of Massachusetts (1980) and a MBA Degree, Finance from Wharton Graduate School, University of Pennsylvania (1981). Warren Isabelle has 19 years of investment industry experience. Investment Style/Strategy The ICM website states that Isabelle has been committed through the years to delivering a consistent and disciplined investment style. He takes a long-term horizon when choosing equities for the small-cap portfolio, selecting stocks utilizing an approach that combines proprietary research with a "fundamentals-driven" philosophy for determining what is described as "the real world economic value of each underlying business." The website notes that Isabelle buys businesses, not the stock. The ICM/Isabelle Small Cap Value Fund employs this time-tested management style. If you go to the ICM Funds website, you can find out more about the fund's investment philosophy, approach, and portfolio characteristics. We will cover what we feel are the highlights here. The fund's investment philosophy is founded in the belief that investment potential is identified by ascertaining a company's long-term economic value (existing assets and future cash flow potential). It follows a disciplined investment strategy that focuses on companies whose market value is substantially below their intrinsic business value at time of purchase. Isabelle favors companies that have a strategically focused management team, potential to improve fundamentals and are positioned to benefit from internal or external catalysts. When performing fundamental analysis on companies, ICM/Isabelle considers both qualitative and quantitative factors and takes a long-term investment view. A clearly defined sell discipline is another important ingredient of Isabelle's disciplined approach. In terms of portfolio characteristics, equity holdings include four types of stocks: turnaround situations, cyclical companies, transition situations, and emerging companies. The site states that the fund will take large stakes in companies where there's extremely compelling fundamental valuation, great confidence in management, and conviction to the business strategy. The result is a fairly concentrated portfolio of 40 to 50 small cap stocks. According to the website, the Small Cap Value Fund had 45 holdings as June 30, 2002 with the top 10 stock holdings representing 37.8% of total portfolio assets. The fund was 97% invested in stocks ("fully invested") at midyear for a weighted average market capitalization of $436 million. The average P/E ratio of the fund at June 30, 2002 was 12.7x, while the average P/B ratio stood at 2.4x. According to Morningstar's style history, Isabelle maintained a small-cap value style bias in 1999 and 2000. In 2001 and 2002, however, this fund has landed in the small-cap blend style box, although Morningstar still has it categorized as "small-value." The fund is categorized as "small-cap core" in Lipper's system. Whether you call it small-value, small-blend or small-core, the fund normally stays somewhere left of center (value bias versus growth tilt). In the next section, we'll see how well Isabelle has performed compared to his category peers, using Morningstar data through August 14, 2002. And we'll look at the fund's risk and return ratings to see how well Isabelle has performed after adjusting for risk (downside volatility) relative to similar funds. Fund Risk and Performance This fund got off to a terrific start, with Isabelle returning 49.5% in 1999 while the average small-cap value fund picked up only 5.4% that year. In 2000 and 2001, the fund returned 7.7% and 8.8%, respectively, but ranked in the last quartile of the small-value category. On a 2002 YTD basis as of Aug. 14, 2002, the fund has a negative 7.6% return, ranking in the category's second quartile. Below is a 3-year chart of the Investment Class shares of ICM Isabelle Small Cap Value Fund (IZZYX), where you can see fund volatility graphically displayed. According to Morningstar, the fund's risk has been "high" in comparison to the average small-cap value fund. Morningstar dings managers heavily for downside volatility (risk) in its ratings system. Despite having produced above average total returns compared to other small-cap value funds, Morningstar rates Isabelle's overall performance just 3 stars or average, after adjusting for risk. If you have the stomach for high fluctuations in share price, then you may want to focus more on Isabelle's longer results, such as trailing 3-year performance. There, you'll find that over the last three years, Isabelle produced an average total return of 10.8% (as of August 14, 2002) outpacing the average small-cap value fund by 3.1% a year and the average small-cap blend fund by 6.8% a year on average. The S&P 500 index lost 10.4% on an annualized basis during the same trailing period. Considering Isabelle's strong showing in 1999, his ability to produce positive results in 2000 and 2001, and his long track record at Pioneer Funds employing a similar investment style, potential investors can be optimistic about the fund's longer term appreciation potential. Summary The fund's low turnover rate, consistent with Isabelle's long term investment perspective, adds to its appeal, and makes it appropriate for use in both taxable and tax-deferred accounts. Because of its concentrated sector weightings, small-cap value bias, and large stock stakes, the ICM/Isabelle Small Cap Value Fund should not serve as the core component of your portfolio. If the ICM Series Trust can get the fund's expense ratio down (currently 1.74%), it'll help the fund's relative performance. At 1.74%, it's a little high, but the Investment Class shares have no sales loads, and may be purchased with no transaction fees through leading fund networks, such as Schwab OneSource. All things considered, Isabelle's track record at Pioneer and Ironwood Capital Management (ICM) suggests that, in this case, the fund's potential benefits are worth the greater risks and costs of ownership. With the number of small-cap value funds declining in 2002, this is one offering that has some room to grow before it'll shut its doors. For more information, or a fund prospectus, log on to www.icmfunds.com. Steve Wagner Editor, Mutual Investor firstname.lastname@example.org *********************** INDEX TRADER GAME PLANS *********************** THE SECTOR BEAT - 8/15 by Leigh Stevens More upside in some the favorite sectors of late and very few sectors in the red today, but Healthcare (HMO & RXH), Fiber Optics (FOP), Defense (DFI) and the Networking (NWX) indices did not manage to get plus on the day. Well believe or not the Airline index (XAL) eked out a 2+% gain today. Guess my call to start flying again did some good or maybe or maybe it was the beginning of a trend, started by American, to start imitating the smaller profitable carriers to some extent - a radical idea! - that is, thinking you can learn from the upstarts just cause they make money. American, headquartered only 30 miles from Southwest, wanted to come over and check out what they do and how they do it. Not sure SW extended an invitation - southern hospitality only extends so far when it comes to big brother breathing down your neck! Biotech (BTK) still moving higher, broke out above recent resistance. Also continuing strong were the Amex Composite Index (XAX), the Bank index (BKX), Brokers (XBD), Computer Boxmakers (BMX). Cyclicals (CYC) had a decent rally after languishing in recent days - don't want to be left behind as the economy may be perking a tiny bit according the latest industrial production figure (up slightly & not expected to be) and a pick up in Dell earnings. Gold stocks rallied - XAU advancing 4% on the ongoing tension around the Iraqi question and the oil price rise. The sector had a new high close for the current rebound. I continue to think that XAU is heading to the 70 area. And Retail stocks (RLX) were on a tear to the upside with a strong move today - the sector benefited from some good news on Target (TGT), which rallied over 9% after reporting a better- than-expected Q2 profit. Also, Nordstrom (JWN) ran up almost 12% after reporting late-Wednesday an operating profit well above analysts' expectations. The Oil Index (OIX) & Oil Services (OSX) rallied as the stocks responded to crude futures (Sept) climbed 91 cents to $29.06 Home builders (DJUSHB) had a strong rebound today, with the index going from the 310 area at yesterday's close to 328 today. UP on Thursday - DOWN on Thursday - SECTOR TRADE RECOMMENDATIONS - NEW/OPEN TRADE RECOMMENDATIONS - NONE TRADE LIQUIDATIONS - NONE SECTOR HIGHLIGHT(S) - NONE 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 *********************** Ping Pong Markets Some days you watch from the sidelines and others you get to participate in the action. I was very involved in today's market action as I was the ball in the ping-pong game between the bulls and bears. Fortunately the markets made it two in a row and the Dow posted the highest close since July 10th at 8818. 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 08-15-2002 Copyright 2002, All rights reserved. 2 of 3 Redistribution in any form strictly prohibited. In Section Two: Dropped Calls: None Dropped Puts: BA, AZO, QLGC, TMX Daily Results Call Play Updates: JNJ, NOC, TEVA New Calls Plays: IBM, ADBE Put Play Updates: HD, AIG, NKE, PHTN New Put Plays: BAX **************** 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: ***** None PUTS: ***** BA $37.49 +1.14 (-3.51 for the week) Boeing has made up some of its recent losses from the last couple of days. Bad news from American Airlines and United weighed heavily on this stock and the prospect of more airlines heading for Chapter 11 does not look good either. After today's bell, however, Boeing staged somewhat of a return from the dead, announcing it had landed a $9.7 billion contract with the U.S. Air Force for 60 C-17 aircraft. This should help it weather the coming storm, and we are closing the play with this new infusion of cash from a source with little chance of defaulting on its payments. --- AZO $72.20 +2.95 (+4.92 for the week) The recent run in the overall market and strong retail numbers, has lifted AZO through our stop loss of $70. Although the economic data released regarding retail sales showed that much of the sales increase was in NEW cars and trucks, which is bearish for AZO, investors seem to have scooped this stock with the rest of the sector. The trade above the 200-dma of $70.60 has broken resistance and we will close the position as we look for better opportunities. --- QLGC $35.72 +1.50 (-0.18) Negating the negative sentiment in the Storage sector, BRCD reported positive earnings after the close last night. That, along with some decent follow-through to yesterday's stellar afternoon rally in the Technology sector pushed QLGC up through our $35 stop at the open this morning. After meandering both north and south of that level throughout the day, the bulls finally won the tug of war, enabling the stock to end near its high of the day. We're dropping QLGC tonight, due to our violated stop. Use any early weakness tomorrow morning to exit any remaining open positions. --- TMX $29.61 +0.73 (+1.21) The continued positive tone in the Technology market on Thursday lent a bid to TMX at the open, but with the fade of the early rally it looked like we might get a rollover. Such was not the case though, as TMX found support right at the bottom of the morning's gap and powered higher into the close with the rest of the market. While our $30 stop wasn't violated, the fact that the stock went out right at the high of the day on strong buying volume leads us to believe that stop will be taken out on Friday. If you have open positions, consider closing them at the open, or else honor your stop, whichever fits your risk profile. *********************************************************** DAILY RESULTS *********************************************************** Please view this in COURIER 10 font for alignment ************************************************* CALLS Mon Tue Wed Thu ADBE 19.94 0.54 -0.16 1.57 0.67 New, filling gap IBM 76.50 0.72 0.35 2.97 1.58 New, breakout JNJ 53.37 0.68 -1.21 2.01 0.47 Higher ground NOC 111.56 -2.21 -2.55 3.71 0.14 Bounce off 200-dma TEVA 68.55 1.47 0.64 -0.14 0.35 Relative strength PUTS AIG 62.31 -0.49 -3.20 1.79 1.15 Not strong enough AZO 66.15 -1.35 0.90 3.10 2.95 Drop, stopped BA 37.23 0.35 -3.27 -0.48 1.14 Drop, Air Force Rescue BAX 35.45 -0.40 -0.91 -1.20 0.05 New, Bad medicine HD 26.49 -0.32 -0.21 1.38 0.65 Lagging behind NKE 43.00 -0.63 0.23 1.15 1.05 Order Slowdown PHTN 18.85 -1.83 -1.02 0.91 0.84 lack of Demand QLGC 32.14 0.05 -3.15 1.57 1.50 Drop, stopped TMX 27.65 0.05 -0.40 0.98 0.73 Drop, pattern break ------------------------------------------------------------ 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 ******************** JNJ $55.97 +0.47 (+1.46 for the week) Johnson and Johnson has continued its rise, trading over resistance at both $55 and $56. After being turned back from $55 on four consecutive days, JNJ broke through yesterday with a close of $55.50. This also took the stock above resistance of $55.30 from June 25. Today, it traded as high as $56.49, before settling at $55.97. This trade placed it on its bearish resistance line of $56 on the point and figure chart, and a trade of $57 would put it through, establishing a new bullish support line. The stock has been establishing higher consolidation levels since hitting $50 at the end of July. The first consolidation was between $50 and $52, during the end of July and beginning of August. This was followed by support just over $53. After JNJ's recent move, the new support level looks to be $55, as this served as resistance on several occasions. The series of higher highs and higher lows continues on the stock's way toward its bullish vertical PnF count of $76. JNJ is also one of the health stocks that Bill Gates has invested heavily in during the second quarter, as Cascade Investments, Gates' investment arm, purchased 600,000 shares. We will maintain $60 as our initial target on this play. However, given recent increasing support levels, this goal may be conservative. --- NOC $115.51 +0.14 (-1.06 for the week) Northrop Grumman pulled back, according to the OI master plan, although the pullback was below our target of $113. The stock's drop to 109.60 made a strong case for support at the 200-dma of 109.44. The bad news for the airlines bled into the aerospace sector as well, which took NOC down with it. NOC, however, has a percentage of its business tied up in government contracts, and includes a large shipbuilding component. While commercial air travel may be taking a hit, the diversity of NOC's business should be able to weather the storm. NOC delivered its 17th Aegis guided missile destroyer to the Navy on Tuesday. The stock experienced a 4-box reversal down on the point and figure chart yesterday, but has rebounded with another 3-box reversal up today, finding support on both PnF and daily charts at the 200-dma. Today's close of 115.51 looks bullish back above yesterday's high. The 50-dma of 115.61, which provided resistance yesterday, was also crossed intraday. The stock's previous trade of $118 on August 9 broke through the bearish resistance line and the bullish vertical count of $150 remains in tact, however our initial target remains $130. --- TEVA $68.28 +0.35 (+0.69) While the past 2 days can't be labeled as bullish for TEVA on the basis of price gains, you certainly can't fault the bulls for their resilience. They keep pressing on the $69 resistance level, trying to gain a breakout. Although they haven't yet been successful, it is certainly encouraging that they haven't given up any ground either. TEVA has spent the past 2 days in a fairly narrow $2 range, as support has been building near the $67.50 level. With the intraday highs moving ever higher and squeezing the price action up against the $69 resistance level, it looks like a breakout is just around the corner. Use another rebound from support in the $67.50-68.00 area to initiate new positions or else wait for a volume-backed breakout above $69.25 (today's intraday high). Don't forget to keep an eye on the Biotechnology index (BTK.X) to confirm bullish action in the overall sector. ************** NEW CALL PLAYS ************** IBM - International Business Machines $76.50 +1.58 (+4.67 for the week) Company Summary: IBM is the world's largest information technology company, with 80 years of leadership in helping businesses to innovate. IBM is a leading provider of e-business solutions and is dedicated to helping customers, IBM Business Partners, and developers leverage the potential of the Internet and network computing across a wide range of businesses and industries. The company offers a host of cross-industry and industry specific solutions designed to meet the needs of growing companies. (source: company press release) Why We Like It: IBM has been stuck in a consolidation rectangle pattern since the last week of June. It has traded in a range between $66 and $74, venturing barely out of the range on only four occasions. On Wednesday ,the stock posted a decisive breakout to close at $74.92, after trading as high as $75.02 intraday. With the $75 psychological barrier out of the way, Big Blue continued its rise with a close of $76.50 on Thursday. The general rule on consolidation patterns is that the longer the pattern takes to form, the more significant the breakout. A look at the daily chart shows IBM approaching the top of this rectangle ($74) on 12 different occasions (including 4 in the last week), before finally breaking through. The measuring objective of an $8 wide rectangle would be $82 to the upside in this case. Although IBM had referred to employee layoffs in its most recent earnings report, last night's revelation that the amount would total more than 15,000 workers, or 5% of its workforce, showed a commitment to cost cutting that investors found encouraging. A look at the point and figure chart shows a decisive buy signal. The trade of $75 created a spread triple top breakout, followed by a break in bearish resistance with the trade of $76. IBM's bullish vertical count now sits at $85, and given the pent up pressure that has been building in the stock over the last 7 weeks, this level does not seem unrealistic. This will be our initial target on the play, although conservative traders may want to take some profits at the measuring objective of $82. The congestion around $74 on the PnF chart goes all the way back to the triple bottom break down at that level in June. This should now provide support on a pullback in the stock. We will use a stop loss of 71.25, as this level is below Wednesday's low of $71.35 and below IBM's 50-dma of $71.38. BUY CALL SEP-75*IBM-IO OI= 14007 at $4.30 SL=2.50 BUY CALL SEP-80 IBM-IP OI= 8350 at $1.80 SL=1.00 BUY CALL OCT-75 IBM-J0 OI= 15483 at $5.80 SL=3.00 BUY CALL OCT-80 IBM-JP OI= 19762 at $3.20 SL=1.60 Average Daily Volume = 8.95 mil --- ADBE – Adobe Systems $19.94 +0.67 (+2.23 this week) Company Summary: A long-time leader in desktop publishing software, ADBE provides graphic design, publishing, and imaging software for Web and print production. Offering a line of application software products for creating, distributing, and managing information of all types, the company generates nearly 75% of sales through publishing software products such as Photoshop, Illustrator, and PageMaker. Its Acrobat Reader, which uses portable document format (PDF) is popping up all over the Internet, as businesses shift from print to digital communications. In addition, ADBE licenses its industry standard technologies to major hardware manufacturers, software developers, and service providers, as well as offering integrated software solutions to businesses of all sizes. Why We Like It: Remember the Software sector? This had been one of the weakest sectors in the market as it fell to new lows last month, but since then, we're starting to see some encouraging signs. After bottoming near the $84 level in late July, the GSO index has been clawing its way back and we have the potential of a Head & Shoulders bottom in the making with its impressive rally through the $91 level yesterday. Shares of ADBE have been one of the hardest hit Software stocks, but even it is showing some strong bullish signs. After falling to the $16.50 level in the wake of its earnings warning on July 31st, the stock has been marking time, unable to move up or down. Up until this week that is. Helped along by the strong broad market recovery yesterday afternoon, ADBE rallied through the $18.50 level, moving into the gap left behind when the company warned. Now that it has moved into the gap, and with the improving technical condition of the GSO index, it appears that the stock wants to close that gap. With the top of that gap up at the $24 level, there is plenty of room to profit from the move. Clearly we're looking for the overall market to continue its current rally, so we're going to play this one with a tight stop set at $18. The best case for new entries will come with a dip and bounce at recent support near $19, or possibly as low as $18.50, the site of the previous upswing high. If the rally continues without pause, aggressive traders can look to enter the play on a breakout through the $20.25 level, just above Thursday's high. Monitor the GSO index for signs of continued strength before playing, ensuring that it doesn't fall back below $90 before rebounding. BUY CALL SEP-17 AEQ-IW OI=368 at $3.50 SL=1.75 BUY CALL SEP-20*AEQ-ID OI=502 at $1.95 SL=1.00 BUY CALL SEP-22 AEQ-IX OI=136 at $1.00 SL=0.50 BUY CALL OCT-20 AEQ-JD OI=255 at $2.75 SL=1.25 BUY CALL OCT-22 AEQ-JX OI=247 at $1.65 SL=0.75 Average Daily Volume = 5.04 mln ------------------------------------------------------------ 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 $28.93 +0.65 (+0.64 for the week) Home Depot has continued its struggle under $30. Despite a recent surge for the retailers, with Wal-Mart up $7 in the last 2 days, Target up $4 in the last 2 days, and Lowe's up $3.75 in the same period, Home Depot has managed a gain of just over $2.00, and remains in a sideways pattern. The recent revelation that Bill Gates has bought 1 million shares was figured into that rally, which makes it look paltry by comparison. Home Depot is going to have to post decent sales and revenue numbers before finding buyers en masse again. If the retail surge and endorsement from the Microsoft Chairman can't help HD out of its funk, things do not look promising in the near term. Tomorrow's preliminary consumer sentiment number could be bearish for this stock if it comes in below expectations of 89.0. Keep an eye on building permits and housing starts as well. While new home purchases don't necessarily mean new business for Home Depot from homeowners, signs of weakness in the housing sector could drag it down, as those working on the new homes would not be shopping as heavily for supplies. A pullback in the Dow could put this stock into the low 20's, as the recent strength has no doubt propped up this component. We will maintain our short position in HD, with a stop loss of $30. --- AIG $65.00 +1.15 (-1.95) Well, our AIG play certainly isn't playing out the way we envisioned. Yesterday's drop at the open is the only bearish action we've seen since we initiated coverage, with yesterday's afternoon ramp pushing shares of the insurer back up to the $64 level on strong volume. As was the case in the broad markets, AIG had a rather directionless day on Thursday after the opening gap, but after meandering in a fairly tight range, managed to hold onto another 1.8% gain at the close. With heavy open interest at the $65 strike it is entirely possible that the pros will attempt to keep it pinned there on Friday, in the absence of any other over-riding news developments. Note that our stop remains in place at $65.50 and following the bullish action of the past couple days, we don't want to initiate new positions unless the bears can prove they are serious by driving AIG back under the $64 level. If the broad market continues in rally mode on Friday, it will more than likely propel AIG through our stop, meaning we'll have to drop it over the weekend. --- NKE $45.30 +1.05 (+1.38) The mind-numbing rally off the lows Wednesday afternoon gave a hint that the certification event might be a non-event, and indeed it was. Shares of NKE went along for the ride into the close, helped in part by the improving sentiment in the Retail sector, created by WMT's solid earnings report. NKE ramped higher into the close, but promptly reversed course at the open this morning on news of a significant decline in the future orders from Foot Locker, NKE's largest customer. After trading briefly down to the $41 level, the dip was over almost before it began, as NKE spent the remainder of the day marching higher, capping it off with a strong spurt of buying into the close. Can you say volatility? Such is the character of expiration week. If you're wondering if this is the end of the decline in NKE, you aren't alone. NKE saw heavy trading volume throughout the day, both on the early decline and on the subsequent rebound. It should come as no surprise, that the stock came to rest right at its high of the day, and at solid resistance near $45.40. A continuation of this afternoon's rally will likely take out our $46 stop, while a rollover could have the stock testing its recent lows. Stick to your stops on further strength, and wait for a decline under the $44 support level before initiating new positions. --- PHTN $20.81 +0.84 (-1.63) Despite the recent bearish news in the Semiconductor sector (SOX.X) buyers showed up in droves to buy even this beaten-down sector when the broad markets reversed yesterday afternoon. PHTN's advance of its lows was rather tepid yesterday, but the bulls followed through today, tacking on more than 4%. PHTN is now nearing significant overhead resistance near the $21 level, backed up by the bottom of Monday's gap at $21.70. We can use a failure of the current rally below that gap as a confirmation of our bearish stance and consider initiating new positions on that rollover. If PHTN moves into that gap though, it is highly likely that it will push through our $22 stop. So while aggressive traders can enter on the failed rally, those with a more conservative bent will want to see the stock fall back under the $20 level before entering. Regardless of your strategy, make sure the SOX is showing signs of weakness before playing. ************* NEW PUT PLAYS ************* BAX – Baxter International $35.45 -0.05 (-2.44 this week) Company Summary: Baxter engages in the worldwide development, manufacture and distribution of a diversified line of products, systems and services used primarily in the healthcare field. BAX's products are used by hospitals, clinical and medical research laboratories, blood and blood dialysis centers, rehabilitation centers, nursing homes, doctor's offices and by patients at home, under physician supervision. The company manufactures products in over 28 countries and sells them in over 100 countries. Why We Like It: Despite the improving tone in the broader markets, Pharmaceutical stocks (as denoted by the DRG index), just can't seem to make any headway. Perhaps it has something to do with the fact that the DRG index is back to the point of its major breakdown at $308-315, now the site of multi-year resistance (broken support). Whatever the cause, the DRG index has run into a veritable brick wall near $308 for the last 5 days. That's a marked divergence from the broader market, which has broken out to new highs for this rally. We featured shares of BAX on the call list last month, as it was recovering from its lows near the $30 level. It now looks like that rally attempt has run its course, with the stock showing significant weakness, even in contrast to the DRG index. Sliding lower throughout the week, BAX is back to the $35 level. Note that after drifting below the July 29th gap this week, that gap came into play again today, with the bottom of the gap (near $36.50) acting as resistance. The pattern of lower highs and lower lows over the past 2 weeks is pointing to another breakdown in the stock. Use a failed rally below the descending trendline (currently $37) or a breakdown under $34.75 to initiate new positions, and set stops at $37.50. Monitor the DRG index to confirm bearish action in BAX before playing. BUY PUT SEP-40 BAX-UH OI= 64 at $5.40 SL=3.25 BUY PUT SEP-35*BAX-UG OI=916 at $2.25 SL=1.00 BUY PUT SEP-30 BAX-UF OI=280 at $0.80 SL=0.25 Average Daily Volume = 4.03 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 08-15-2002 Copyright 2002, All rights reserved. 3 of 3 Redistribution in any form strictly prohibited. In Section Three: Play of the Day: CALL - IBM Traders Corner: Pattern recognition - Continuation patterns: Flags Additional Traders Corner: Bond Basics, and then some Options 101: Bull Confirmed?; Betting Against the Prince; Option Expense Perils ********************** PLAY OF THE DAY - CALL ********************** IBM - International Business Machines $76.50 +1.58 (+4.67 for the week) Company Summary: IBM is the world's largest information technology company, with 80 years of leadership in helping businesses to innovate. IBM is a leading provider of e-business solutions and is dedicated to helping customers, IBM Business Partners, and developers leverage the potential of the Internet and network computing across a wide range of businesses and industries. The company offers a host of cross-industry and industry specific solutions designed to meet the needs of growing companies. (source: company press release) Why We Like It: IBM has been stuck in a consolidation rectangle pattern since the last week of June. It has traded in a range between $66 and $74, venturing barely out of the range on only four occasions. On Wednesday ,the stock posted a decisive breakout to close at $74.92, after trading as high as $75.02 intraday. With the $75 psychological barrier out of the way, Big Blue continued its rise with a close of $76.50 on Thursday. The general rule on consolidation patterns is that the longer the pattern takes to form, the more significant the breakout. A look at the daily chart shows IBM approaching the top of this rectangle ($74) on 12 different occasions (including 4 in the last week), before finally breaking through. The measuring objective of an $8 wide rectangle would be $82 to the upside in this case. Although IBM had referred to employee layoffs in its most recent earnings report, last night's revelation that the amount would total more than 15,000 workers, or 5% of its workforce, showed a commitment to cost cutting that investors found encouraging. A look at the point and figure chart shows a decisive buy signal. The trade of $75 created a spread triple top breakout, followed by a break in bearish resistance with the trade of $76. IBM's bullish vertical count now sits at $85, and given the pent up pressure that has been building in the stock over the last 7 weeks, this level does not seem unrealistic. This will be our initial target on the play, although conservative traders may want to take some profits at the measuring objective of $82. The congestion around $74 on the PnF chart goes all the way back to the triple bottom break down at that level in June. This should now provide support on a pullback in the stock. We will use a stop loss of 71.25, as this level is below Wednesday's low of $71.35 and below IBM's 50-dma of $71.38. BUY CALL SEP-75*IBM-IO OI= 14007 at $4.30 SL=2.50 BUY CALL SEP-80 IBM-IP OI= 8350 at $1.80 SL=1.00 BUY CALL OCT-75 IBM-J0 OI= 15483 at $5.80 SL=3.00 BUY CALL OCT-80 IBM-JP OI= 19762 at $3.20 SL=1.60 Average Daily Volume = 8.95 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 ************** Pattern recognition - Continuation patterns: Flags By Leigh Stevens lstevens@OptionInvestor.com CONTINUTATION PATTERNS - The word continuation comes of course from the verb "to continue" – in technical analysis continuation patterns "consolidate" the prior movement within the dominant price trend. After an initial strong move up or down, there is typically a countertrend or sideways price movement before the trend renews itself and continues in the same direction as before the consolidation. After buying interest or selling interest has been satisfied, some participants with profits exit part or all their positions. Hence the idea of "profit-taking" that the financial press likes to say is something that goes on all the time - we wish there was as many profits taken as they say there is! The investors and traders on the losing side, who bought high and sold low, are trying to also help themselves – but in their case it’s to reduce their losses. For example, in a decline, those long have decided to get out if they can sell on a rally at a higher price than the recent lows and will use future rallies to exit. In an advancing trend, those short will use price pullbacks or dips to exit or cover their short positions. This back and forth movement, after the initial strong surge of a trend, is what creates a consolidation pattern. The common types of consolidations are: - flags - triangles - rectangles In this first of a series on continuation patterns, I will focus on bulls and bear FLAG formations. FLAG PATTERNS - Flag patterns are very common continuation patterns and are considered bullish in an uptrend and bearish in a downtrend. Flags, and a variety of flag called a pennant – although I find it easier to just label them all "flags" -- are relatively short- term sideways consolidations of or after a prior sharp move in prices. We need to think of duration in terms of the number of trading periods we're looking at (i.e., bars or candles) for the time- frame we are looking at. So, a flag is formed over a duration of only 3-6, up to perhaps 20, periods. This could be 3-6 hours, days or weeks. A flag pattern’s outline is formed by a series of relatively narrow price range sessions AFTER a sharp, but relatively short, price spurt – the more or less "straight up" or "straight down" nature of this spurt resembles a "flagpole": long and narrow. These consolidations occur near the top or bottom of the first price spurt (pole). The narrow ranges that form the narrow price swings of the "flag" have tops and bottoms that allow drawing trendlines across the highs and lows – the two resulting trendlines will usually if not always slope in the opposite direction from the trend. Some examples can be seen in the following charts - as usual with technical or classical chart analysis a picture is worth a thousand words. A flag formation composed of two sloping trendlines set rather close together, will generally slope against or opposite to the dominant trend. Slope is not relevant to the "pennant" variation as it makes a triangular shape, but is usually of significantly shorter duration than a "triangle" pattern - which I will describe and discuss in my next week's Trader's Corner column. In an uptrend the slope of a flag will be down and in a downtrend, the slope of the flag will be up. I find this rule less true in the commodities markets but quite true in stocks. So generally we could say that when the thrust creating the "flagpole" is up and a subsequent flag slopes down, this pattern is a bull flag. When the thrust is downward and a subsequent flag formation slopes up, this pattern is called a bear flag. When a market is in a rapid price move and forms a series of flags, one after the other, there may not be a well-defined "pole" pattern as you can see below: There is a measurement implication for the height of a further move after the breakout – this minimum upside or downside objective is equal to the height of the "flagpole" added or subtracted to the breakout point – see the charts below. A more recent example is provided in the QQQ chart - at first it seemed that the upside objective implied by its bullish flag would NOT be met. I find the measuring method for a flag price objective to be quite accurate usually and flag patterns are among my favorite finds when I run across them - AND I’m in time to buy/sell the breakout and take a quick profit hopefully on the next run up. The stop out point, if the pattern fails, is just the other side of the breakout point -- which should be quite near the entry point if you buy only if prices exceed the breakout line (across the top or bottom of the "flag"). My favorite trade is when the risk to reward ratio can be estimated at 3-4 to 1; i.e., for every dollar risked you can project a minimum upside profit of 3-4 times this based on the flag "breakout" objective. A series of reliable sell signals was provided by the series of flag formations seen on the chart below. The measuring implication for the flag pattern is really a variation of the measured move concept – this is the rule of thumb that says that a next price swing will at least equal the extent the prior move. Remember too that the measurement is a minimum objective only - but one that, if achieved, would make the next price swing at least equal to the prior swing. And, the subsequent price swing may be far greater than this minimum objective as we know, but having a minimum is valuable in order to establish some parameters as to price potential. If a minimum move that I can somewhat reliably project is $30, I can see that a maximum could easily be $90. A flag that forms near either extreme in a trading range will usually be significant. If a bull flag forms at the top end of recent price swing, it suggests there may be enough new buying coming in to kick off a second up "leg". The reverse would be true at the low end of a trading range – a bear flag there would suggest that another secondary downswing could be starting. ************************* ADDITIONAL TRADERS CORNER ************************* Bond Basics, and then some By John Seckinger Have you ever wondered about the relationship between fixed-income securities and equities? Curious on how bonds are priced? Struggled with the concept of price, yield, and interest rates? Left puzzled why traders follow bond futures? Lost entirely on the concept of a yield curve? If so, this article is for you. When somebody says “bonds”, what could they be talking about? In the general sense, A certificate of debt issued by a government or corporation guaranteeing payment of the original investment plus interest by a specified future date. When I say “bonds”, I am only referring to United States Treasury Bonds, unless otherwise noted. So, what is the definition of a U.S. Treasury Bond? A negotiable, coupon-bearing debt obligation issued by the U.S. government and backed by its full faith and credit, having a maturity of more than 7 years (if less than 7 years, the correct term is Treasury Notes). Interest on Government Bonds is paid semi-annually and exempt from state and local taxes. How does one calculate Yield? For bonds and notes, it is the coupon rate divided by the market price. 30-year yield at 4.91, equal to 5.375/107-02. Remember 2/32 is 0.06 So, are YIELDS and interest rates the same? No. A good practice is to watch the relationship between what the FOMC was doing and how YIELDS reacted. A bond’s YIELD does not have to fall with interest rates, seen in practice as the Fed has raised rates while YIELDS actually fell. YIELDS can have a life of their own, representing investor psychology and reflecting a perception of risk used to “grade the Fed” on how their monetary policy is working. Remember, in late 1999-early 2000, it sure didn't make sense that an investor would pass up stocks that were generating 30% annual gains for a small 30-year YIELD of 6.5%, then 6%, then 5.75%, especially when the Fed was RAISING interest rates. Only in the past year do we find out "why" the MARKET was buying the higher YIELDS. This was one example of Treasury YIELDS being a leading indicator to equity valuations. The chart below should give a good illustration of how YIELDS and Rates differ: As shown, the 30-year YIELD does not always track interest rates. Please keep this in mind down the road. Some Intermediate Concepts: 1. Bonds with longer maturities fall or rise more than bonds with shorter maturities. If, for example, interest rates fall 1%, the price on a 20-year bond will rise more than a 5-year bond. 2. Bonds with lower coupon rates will also move more in price than bonds with higher coupon rates. The coupon rate is the contractual interest obligation that a bond pays, usually semi-annually. If interest rates rise, for example, a 9% bond will not fall in price as much as a 4% bond 3. Credit risk is the fourth determinant of all bond prices. Credit risk is primarily the ability of the bond's issuer to maintain interest or coupon payments on time and to repay principal amounts on schedule. Credit risk can be gauged by a reputable bond rating agency such as Standard and Poors. A ratings change from, say AA to BB, can seriously hurt the price of the bond being downgraded. BBB and higher are referred to as Investment Grade. A chart of the different maturities will produce a yield curve: A situation in which long-term debt instruments have higher yields than short-term debt instruments is referred to as a positive yield curve. This is common. If, however, long-term interest rates have lower yields than short-term interest rates, this is called a negative yield curve. When the curve gets more positive, the term is “steepening”. This can be done a variety of ways, but usually I look for buying of shorter-term maturities (lowering yields) and selling of longer- term maturities (raising yields). This could be analogous to lowering your left hand and raising your right. The opposite is called “flattening”. Unfortunately, curves steepen and flatten for a variety of reasons and there is no cookie-cutter reason. Currently, it seems as though investors are risk averse, preferring shorter-dated maturities and lowering long term exposure to either a depreciation of the U.S. dollar or lowering confidence. To get a yield curve number, use the formula below: Using cash quotes (see above), five-year is quoted at 100-08 (110.25) ten-year quoted at 102-11 (102.34) I then multiply the 110.25 by 6, resulting in 661.50. The ten-year quote (102.34) is multiplied by 4, resulting in 409.36 Subtracting the two (661.50 – 409.36) we get 252.14. I encourage “bond followers” to calculate such a curve daily, eventually getting a sense of what numbers are psychologically important. Unfortunately, I do not have a chart available. So, what can a trader do with such information then? Look for patterns, and make mental notes such as: From the 252.14 calculation, how does the stock market react if the number falls or rises? Is the number rising by traders buying five-years, or is it longer-maturities that are coming under selling pressure? Does the number get lower when trading is quiet? Can I use this number for longer time periods? What happens to the yield curve when the Fed does a refunding? (Ok, that was unfair for me to throw an advanced concept in – grin). How are bonds priced? By textbook definition, the value of a bond equals the present value of its expected cash flows. What is the definition of present value? The current value of one or more future cash payments, discounted at some appropriate interest rate. The buzzword I hope you picked up on was “appropriate interest rate”, since this rate fluctuation influences Present value. This is what is called Time Value of Money. When pricing bonds in the secondary market (remember from Finance 101, the Primary market is when a company goes public – IPO, while the secondary market is when an investor purchases a security from another investor rather than the issuer), the variables to consider are: current market price of bond, number of years to maturity, annual coupon payments (remember: coupon payments do not change), Yield to Maturity, and par value. Ready for an example? The Present Value of a Bond = The Present Value of the Coupon Payments (an annuity) + The Present Value of the Par Value (time value of money) Example Par Value = $ 1,000 Maturity Date is in 5 years Annual Coupon Payments of $100, which is 10% (100/1,000) Market Interest rate of 8% - The Key Variable. The Present Value of the Coupon Payments (an annuity) = $399.27 The Present Value of the Par Value (time value of money) =$680.58 The Present Value of a Bond = $ 399.27 + $ 680.58 = $1,079.86 Unfortunately, there is not a simpler way to calculate the price, and I did spare the reader from looking at Present Value charts. Looking at the inverse relationship between interest rates and price Let’s say that you buy some OI bonds at 8%. Then, say PI issues a bond that pays 8%. The bonds will be the same cost since equally as attractive. Now suppose that the economy deteriorates and interest rates fall to 6%. Remember, the OI and PI bonds still pay 8% while the overall market can now only offer 6%. OI and PI Bonds will then demand more than what they did before (called a premium). However, investors that pay more to get the 8% (or 8 dollars per bond if par is 100) will still get a 6 percent return. Why? Let’s say the OI and PI bonds went from par of 100 to 133 dollars. Then take the $8 (coupon) and divide by 133. Then multiply by 100. This equals 6 percent. Of course, the OI and PI holders have a 33% capital gain they have to contend with. Note: I would re-read this paragraph a few times to get a solid grasp of the concept. So, what are bond futures? The September Bond (USU2) is a standardized futures instrument traded in Chicago as a hedging instrument for cash traders. A futures account allows you to buy/sell a contract for much less than the 111-05 (111,050), with margin roughly 3,000 per bond contract. Every tick (1/32) takes or adds 31.25 into your account. There are no dividends paid, and very few traders hold the bond until delivery. Futures, by definition, gives traders an idea where yields might be down the road. The “U” stands for September. The other main months are: Z for December, M for June, and H for March What about the relationship to equities? Usually, periods of lower interest rates occur in parallel with rising stock. Why? Under normal conditions, rising bond prices are a net positive to the stock market. Complex reason: The present value of a company's future cash flow becomes greater as interest rates fall. When the bond market and stocks move in opposite directions, usually we are in either (a) a deflationary period, or (b) experiencing a credit bubble. Looking at the following two charts (the dates should line up), the correlation may not be perfect; however, there is reason to believe that, in general, lower interest rates spell out higher equity prices. ------------------------------------------------------------ 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 ------------------------------------------------------------ *********** OPTIONS 101 *********** Bull Confirmed?; Betting Against the Prince; Option Expense Perils Buzz Lynn buzz@OptionInvestor.com . . .And other tails of mystery and imagination. Well, not really. Originally, I'd planned to do a stream of consciousness tonight. But upon reflection I figured that a more meaty, concise, and focused effort would be more useful. After all, at the end of a stream of consciousness, the reader is usually unconscious, maybe even comatose with eyes glazed over. Besides, nobody likes a writer-induced nap, especially the writer with a deadline! Anyway, three items have grabbed my attention lately. Today's confirmation of a Baby Bull is the most recent. But I've also been stewing a bit since last week on a Richard Russell (Dow Theory Letters) snippet I received from a trading buddy, and a longer-lasting topic of expensing options. On the latter, my focus has been in trying to answer the question as to why INTC and MSFT have declined to expense options in their income statement. None of this is rocket science, which we'll get to in a minute. But first. . . Bull Confirmed? We touched on this topic last week in the article about Baby Bull taunting Big Bear. If you missed it last week, t can be found here: http://members.OptionInvestor.com/options101/080802_1.asp. Anyway, strange as it may seem since I've been leading the secular bears' chorus for the last year and a half, today I can sing with the bulls. So how is that Fundamentals Guy drew this conclusion while building the ark for rough seas ahead? Remember from last week, we know that cyclical bull markets can occur for weeks or even months within a larger bear market, and vice-versa (see 1997 and 1998). While cyclical markets do not reverse the bigger market trend, they can certainly trick a number of unsuspecting investors into believing that happy days are here again. Don't bet on it. As earlier noted, consider this a potential day of sunshine between storm fronts. Now, about that sunshine - how do we know? Like last week, let's go the Dow chart. Dow Industrial chart - INDU (weekly/daily/60): First, with the weekly chart, we can see the continuation of green candles and continuation of the rising stochastic on both the 5 and 10 period lookbacks - bullish. Aside from that, we see the breakout of today's green candle on the daily chart - bullish. While the daily stochastic is bobbling a bit around overbought, doesn't that look promising? Careful. The 60-min chart shows an ascending wedge, usually considered bearish. But the 60-min chart deserves even more examination. Is it really bearish? Let's see by expanding it a bit. Dow Industrial chart - INDU (60-min): Hmmm. . .interesting. On the 60 min chart, the Dow is at a crossroads. We can't tell if the ascending pennant will drive the index temporarily bearish, or if the ascending wedge will drive the Dow bullish. Though we don't see it on this particular chart, the 50-dma is just under 9000 and could act as strong resistance. Should the Dow clear 9000, I would say the bull is confirmed. Furthermore, the ascending lows tell us that the trend is back up, though one more decline to 8400 might signal the next bullish buying opportunity. What else for evidence? Point and figure chart tells the same story with a triple top breakout. For traders, this isn't a daytrade event. But as a measure of risk and reward, the risk is now much reduced with the reward much higher thanks to the column of "X's". The math: 9 "X's" times a 50 point box times 3 equals 1350 points, plus 8450 equals 9800 price objective - bullish. That doesn't mean it will get there and if it does, it won't do so in a straight line. But it is nonetheless bullish for the short- term investor. For the day or position trader, wait for the 3-box of "O's" pullback to line up with a stochastic oversold pullback to support. Woops! This just in, Ralph Acampora has called a bottom to the market! For those who don't know Ralph, he was wrong at almost every turn over the last three years and quit making CNBC appearances because his prognostications became such a joke in the marketplace. He made a great contrarian indicator. Oh, well, maybe I should stay bearish %^) Betting Against the Prince What Prince? Prince Alwaleed bin Talal bin Abdulaziz al Saud, etc. of course. He's the Saudi Prince, who in most un-princely fashion bucked royalty to hustle large mid-east construction projects to earn his first billion dollars. From there he branched out into passive investing large dollars in U.S. companies, most notably Citicorp, Disney, and AOL, and in the not so notable Teledisic and Priceline.com. His wins in the first three make up for the losses on the latter two, though he would argue, ala Warren Buffet, that it isn't a loss until sold. He has been very successful in the real estate development business too. Anyway, I can't argue with a $10 bln (give or take a few) net worth. He has done well. But I fear that his U.S. stock fortunes may be in danger, as may anyone's who also has a stake in C, DIS, or AOL. Here's the deal. There has been innuendo and scuttlebutt - the U.S. government has not done a good job of keeping this a secret - that we could freeze Saudi Assets in the U.S. as a penalty on the Saudi's (mostly royalty, but who's discriminating?) for "harboring and sponsoring" terrorist acts against the U.S. As a prince who earned his fortune the hard way, Alwaleed won't get any favorable treatment. I might add that 600 families of 9/11 victims filed suit against the Saudi government today seeking $1 trillion in damages. It's clearly heating up. That said, if I were a prince, or any Saudi royalty for that matter, with assets about to be frozen in the U.S., would I sit idly by? I don’t think so, Tim! I'd be getting those shares off shore or sold and taking the cash off shore, or partially sold and taking the cash off shore. Common element? Getting the holdings out of the U.S. Richard Russell brought this up last week, and it could amount to hundreds of billions of dollars or even $1 trillion. That is clearly not good for stocks in general just because of the sheer volume, but it might be particularly tough on C, DIS, and AOL (as if they didn't have enough troubles of their own) if word got out that the prince was selling. It won't matter why. When word gets out that a huge holder is liquidating shares, the twitchy are prone to sell now and ask questions later. . . something to think about if you own any of these three or others in which the prince is involved. Caveat Emptor. Option Expense Perils Here's something else that's been bugging me for weeks. That is, the failure of supposedly respectable companies failing to implement a policy of reporting employee stock options as an expense. While Coke and General Electric have taken the high road and announced their intent to expense options, Microsoft and Intel, most notably have stated their intent NOT to do so. Funny, this comes from respected tech companies who's earnings have taken a hit in the last 28 months. Oh wait, did we just swerve into something noteworthy? Their earnings have taken a hit in the last 28 months without expensing options? By definition, wouldn't their earnings be lower than already announced, along with their guidance in coming quarters? Yes, is the correct answer. Now here's something else I learned from John Mauldin in his August 1st letter (www.2000wave.com - a free read and worth infinitely more than every penny!): "We did a simple spreadsheet. We analyzed the 15 largest NASDAQ companies, which represent about 37%, give or take, of the $2 trillion NASDAQ index. We input their 2001 pro forma profits, their real profits, the fair value of the options expense and then let the computer tell us what affect this would have on their Price to Earnings ratio (P/E). (I rely upon the Bear Stearns report for the pro forma earnings and options expenses. The rest is from Yahoo/Finance, or company reports.)" "But as an example, Microsoft had pro forma (operating) earnings of $11 billion, and real bottom line earnings of $7.3 billion. They also had $3.3 billion of option expense. At today's price, they have a P/E of 34. Option expenses reduced their income by 46%. This would increase the P/E to 63, based upon 2001 earnings." "For the group of 15 firms, total 2001 pro forma earnings added up to $25 billion. Real earnings were about half, or $13 billion. But total option expenses for the 15 firms were $12.5 billion. That means pro forma income was cut in half, and real, Honest-to-Pete profits were a mere $423 million, give or take a few million." "These 15 firms have a total market cap of roughly $750 billion (the total value of their stock). That means the combined P/E ratio based upon 2001 earnings which deduct option expenses, and using their stock price today, is a little north of 1,789!" "I should note that Comcast and Cisco do bring the average down. If you take away their $4.8 billion losses (after option expenses), the P/E after options expenses is a far more reasonable 142." "I should also note that if you take away Microsoft, the combined earnings of the remaining 14 is a NEGATIVE $3.5 billion. That means 14 of the largest NASDAQ firms could not combine to make a profit, if you deduct the expense of their options. Seven of these firms had negative earnings once options were deducted." There you have it folks; data to match your hunch. Collectively, these companies made no money even during their heyday. They are worse off now, and to expense options is to admit much lower (MSFT) or no (nearly all others) profitability. That, in my opinion is why we will not see tech companies expensing options anytime soon. Caveat emptor here too. Tales of Mystery and Imagination Just for fun, I have to share this e-mail I got from a good friend of mine who works in a publicly traded company that supplies industry, from high tech to low tech, with raw materials. Apparently they just got some new software! This is the Mission Statement: "The Enterprise Design is an evolving sum of SAP functionality, configured for the processes that are intended to be globally consistent. We will use versions of the Enterprise Design to designate the addition of functionality as we build on to the design. Each version will have a defined scope, and eventually the Enterprise Design version "n" will be equal to the functionality envisioned in the Global Blueprint (the definition of Company X's intended end state scope of functionality for the entire business)." Anybody get that? Me either. But it reminds me of a maxim noted by John Rutledge (money manager, economist, Forbes columnist) many years ago. "Every new buzzword introduced and used in the boardroom is good for a 10% decrease in earnings." Umm, lets see...Enterprise Design, functionality, global consistency, version "n", envisioned, Global Blueprint...look for earnings to fall by more than half! ;^) That's it for now. Make a great weekend for yourselves! Buzz ********** 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
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