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Daily Newsletter, Tuesday, 08/20/2002

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The Option Investor Newsletter                 Tuesday 08-20-2002
Copyright 2002, All rights reserved.                       1 of 3
Redistribution in any form strictly prohibited.

In Section One:

Wrap: Pause to Reload
Index Trader Wrap: CORRECTION TIME
Market Sentiment: Majority Rules
Weekly Fund Screen: Best Taxable Bond Funds Now
Index Trader Gameplans: THE SECTOR BEAT - 8/20

Updated on the site tonight:
Swing Trader Game Plan: Orderly Selling


Posted online for subscribers at http://www.OptionInvestor.com
************************************************************
MARKET WRAP  (view in courier font for table alignment)
************************************************************ 
      08-20-2002           High     Low     Volume Advance/Decline
DJIA     8872.07 -118.70  8986.50  8822.02 1.54 bln   1235/1932
NASDAQ   1376.57 - 18.00  1389.84  1370.98 1.45 bln   1370/2024
S&P 100   474.03 -  6.81   480.84   471.24   Totals   2605/3956
S&P 500   937.43 - 13.27   950.70   931.86 
RUS 2000  397.84 -  3.45   401.29   396.95 
DJ TRANS 2347.72 - 16.30  2367.10  2332.78   
VIX        32.56 +  0.99    34.01    32.05   
VXN        47.71 +  0.69    48.96    46.61
Total Vol   3,174M
Total UpVol 1,120M
Total DnVol 2,000M
52wk Highs    96
52wk Lows    220
TRIN        1.24
PUT/CALL     .74
*************************************************************  

Pause to Reload

The bulls phoned home today for more cash to increase their 
long positions. Bears took advantage of the buying lull to 
press the advantage but without conviction. The volume was
anemic with barely three billion total shares trading. This
was by far not a rush to short or a change in directional 
trend. It was simply a pause in the buying. The key is 
whether it is permanent or just temporary. 

Chart of the Dow


 

Nasdaq Chart


 

The morning began with a blow for tech stocks. Chip equipment
maker Kulicke & Soffa (Nasdaq:KLIC) warned during a mid-quarter
update that it had hit a pothole on the road to a recovery. 
The company makes tools to build and test microchips and said
the last quarter has been a roller coaster ride. They said 
companies were deferring orders and recent capital expenditure
cutbacks were hampering sales. They also said customers were
unwilling to pay for higher performance products and were
content to keep their current equipment until demand returns.
They are now forecasting a steeper downturn than expected.
CSFB dropped estimates for 2002 results to -$1.41 a share
and 2003 estimates to a loss of -$.50 a share. KLIC had been
expected to be at or above breakeven in 2003. The very negative
comments from KLIC tanked AMAT, NVLS, DPMI and most of the 
semiconductor sector.

Dell Computer added to the negativity when they announced a
decision to sell unlabeled computers to retailers at a discount.
They had previously said they would not sell "white box" computers
because it would cut into its own retail market. The current
slow down in PC sales has Dell going back on its promise and
has them courting dealers they cut off back in the early 1990s
to go consumer direct. They are targeting dealers who sell to
small businesses with 100 employees or less. Analysts think 
Dell will be less than successful selling their $499 base
system without a monitor because most competitors sell for 
less than that. They will not pre-make the computers but only
build to order and even with their quoted 5-day lead time this
means time between customer order and customer delivery could
be as much as 10-14 days. When you can go down to CompUsa and 
get one built today this is a strong disadvantage. The current
independent builders offer 24-48 hr turnaround. Many feel Dell
has just raised the red flag for the PC sector if they are 
stooping to this low margin attempt to keep assembly lines 
running. This may also indicate back to school sales did not
appear. 

Agilent (Nyse:A) said it posted a wider than expected loss
today at -$.31 compared to previous estimates of a -$.10 to
-$.20 per share loss. They blamed overall market weakness and
problems with some software installations. The software was
responsible for a nickel of that loss according to Agilent. 

News after the bell today will weigh on the tech sector as 
well. The book-to-bill ratio for July dropped to 1.16 from 
1.26 and was the lowest number in the last four months. After
peaking at 1.27 in May the decline is picking up speed but
still showed an apparent expansion in progress. The number 
indicates the chip industry is receiving $116 in orders for 
every $100 in product shipped. The challenge, as you can see 
in the KLIC news above are that the orders are being cancelled 
and deferred at very high rates. It does not do any good to 
get a million dollar order if it gets delayed indefinitely or 
cancelled completely a month later. The BTB number is also a 
three month moving average so the current number for July is 
using the high months of May (1.27) and June (1.26) as two 
components of the current July number of 1.16. Using some 
quick math and multiplying 1.16 by 3 = 3.48. Subtracting 
1.27 and 1.26 leaves you with .95 for July. Suddenly there 
was a contraction and they really shipped more than they 
booked for July. This calculation is not precise since the 
numbers for May and June were also three month averages 
including the prior months. Since February was .90 and March 
1.05 that means May/June actual numbers were higher than the 
average quoted. This means the actual number for July was 
even lower than the .95 above. I doubt many media reporters 
will think this through and the "headline" 1.16 number is 
what will be reported. Astute investors and our readers will 
see the truth and be forewarned. 

Contrary to the published "soft recovery in progress" VLSI
Research reported that chip fab utilization rates will drop
in August to 81.9% from 86.5% in June. They reported that
activity at global chip factories was slowing significantly. 
This does not bode well for the anticipated 4Q holiday sales.
Many analysts are now beginning to predict a slower 2003 in
consumer chips, like chips used in DVD players, as well as PC
chips. Should be interesting to see how the bulls spin these
reports on Wednesday. 

Consumers have been on a car-buying spree driven by zero
interest and high rebates. These discounts cost the auto
companies between $3,500 and $7,500 per car. You didn't 
think the car companies were going to eat this expense did
you? Chrysler announced today they were going to raise prices
on 2003 models between +4.5% and +12.8% depending on the models.
That is about $3,600 for their best selling $28,000 minivan.
There is no free lunch!

Oil prices continue to rise and topped $30 a barrel today on
fears that an Iraq attack will disrupt not only supplies but
fragile supply channels as well. If Saudi Arabia suddenly 
decided to not supply oil to coalition partners then other
suppliers would have to take up the slack. Oil would continue
to flow but from whom and to whom would be in question. In
1990 oil prices correctly predicted the Iraq invasion of 
Kuwait as knowledgeable traders read between the lines. Oil
rose to $40 a bbl when the conflict started. The same is true
today as it becomes increasingly apparent there will be another
war. Oil over $30 depresses the stock market and raises prices
on manufactured goods. This energy inflation has been seen
many times in the past. I had a dozen all electric homes in
Texas during the big oil crisis in the 70s. They were fully
rented when it began but all vacant within a year when the
electric bills exceeded the rent. The creation of the energy
surcharge sent renters back to apartments which were not
individually metered at the time. An Arab controlled OPEC, 
angry at an Iraq attack, could cause another crisis like 
this at any time. OPEC is scheduled to meet on Sept 18th
to discuss quotas and production caps. 

The KLIC event today was also a warning that we are moving 
into the earnings warning cycle for the third quarter. The
mid quarter updates will start hitting the wires in greater
frequency as we near the end of August. With the numerous
instances of slowing demand it would be silly not to think
there will not be a wave of lowered guidance as we get closer
to September. This is not a rare cycle. September is not known
as the worst month of the year for nothing. It is historically
when companies warn of a sluggish summer sales for the 3Q and 
after nine months of history lower guidance for the year as
well. Products for holiday selling have already been manufactured
and are being shipped. They have a pretty good handle on what 
the full year will be by September and that is when they break 
the bad news.

With no major economic reports tomorrow and earnings over for
97% of the S&P companies, there is nothing left for the bulls
to feed on. They have not needed much lately with bad news
being ignored or spun to their own uses. The bears have plenty
of ammo but have been plagued with a rash of misfires. With
the bulls needing no good news to buy and bears unable to 
capitalize on bad news it appears we are at a stalemate. There
is not enough volume on either side to win the battle. This 
makes it more likely we will move sideways until the tug of
war is won by the side with the most staying power. 

The Dow traded in a range between 8800-9000 and stubbornly 
refused to break 8800. The Nasdaq traded in a very narrow
range between 1370-1390. Despite the negative chip news from
KLIC and the news from Dell it also stubbornly refused to 
break the 1370 barrier. This tells me there is still a bid
under the market despite the low volume. There is not enough
buying pressure to push it higher but it was successful in 
holding it up on Tuesday. With total market volume only 
slightly over 3 bil shares it is evident the end of summer 
vacation session is in full swing. I still see no reason to 
buy stocks but we have seen that shorting a dull market is 
not working either. Vacation anyone?   

Enter Very Passively, Exit Very Aggressively!

Jim Brown
Editor




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

CORRECTION TIME
By Leigh Stevens

[NOTE: I'll be out of the office Wed. My next update will be Thurs.] 

TRADING ACTIVITY AND OUTLOOK - 
A correction always come and its only surprising how long this 
one took. It looks to me like it will be longer than a 1-day 
affair but it doesn't have to be a steep pullback. We'll look at 
the levels and possibilities with the charts. Time to take the 
call profits and RUN! And, short rallies if you must stay indoors 
trading and not go to the beach.     

A dose of reality seemed to set in today.  Market observers are 
noticing that there is only light volume coming in after the 
initial rebound, as both individuals and institutions pause in 
their exchange of paper with pictures of dead presidents on them 
for stock certificates. You can see this on the QQQ chart below. 

I noticed one lead sentence to a market summary that said that 
Dow dropped "steeply" Tuesday - journalists, if they weren't so 
dumb you would probably be mad at them. Sure, with the Dow down 
1.3% this is a BIG drop after a 17% rise into yesterday in 18 
trading days! Well, they have to have something to write about - 
no story, no job. Me too actually. 

Losses in semiconductors, oil services and financials were key 
sectors under the selling pressure. Chip stocks were bogged down 
by deep losses in Micron Technology following a downgrade. Its 
always one of those bloody pesky analysts crunching their numbers 
and finding something not to like.  And, they don't all get 32 
million dollar severance packages even! 

Positive earnings news from Dow component Home Depot buoyed the  
retail sector and buyers did find something to like in Telecoms, 
Biotech, Airlines (even), Networking and Gold - although absent 
the 1.25% gain in telecom, none of the others were up more than a 
fraction of a percent.   

As the floor sees it, 9000 on the upside is about as far as we go 
without a "good" news catalyst - oh, an earnings pick up would be 
nice and Q3 earnings reports are a ways off yet; and how good 
could they be anyway when they include the summer. I sometimes 
think the French have a great idea in just taking August off.  
You know, the whole country - leave Paris to the tourists and 
flee for wine country and the shore. 

Also, the talk is starting about the dread September-October 
ogres that waylay the market so often on a seasonal basis.  9/11 
is coming and we're getting more aware of it in the "dog days" of 
summer.  

These last two weeks of August often see many key market 
participants out at the Hamptons or wherever they go in the rest 
of the big cities where there is a concentration of money 
managers. 

S&P 500 Index (SPX) - Hourly chart:


 
 
Pivotal technical resistance is 960 - as long as SPX doesn't 
climb above this level, look to short rallies or just come out of 
calls and wait for the next good buying opportunity and for 
oversold oscillator readings again. 

A KEY resistance has not been pierced in the S&P on a daily chart 
basis - the September low at 945 was exceeded only once on a 
closing basis. In one way, you could say that the dominant trend 
of the market is down until the broader market indices can get 
back above the post 9/11 lows. Only the Dow is well above its 
September low (at 8064).  
   
Near technical support is in the 910 area, where the S&P 500 
maintains itself in its uptrend channel. I think this lower 
trendline will get tested and is a "minimum" downside technical 
objective. The near-term trend remains up as long as the 876 
prior low is not exceeded. 
 
I suggested taking call profits on the first day of weakness - 
not necessarily the first weak opening, but the first day that 
closes weak this week - the bell rang today.  

S&P 100 Index (OEX) - Daily/Hourly charts: 


 

Since you are all experts on "flag" patterns :- (see my 8/15 
Trader's Corner article) you will "naturally" (maybe?) spot the 
minor bear flag on the OEX hourly chart (even clearer on the DJX 
hourly chart below), suggesting another downswing ahead.   

While the OEX has stopped shy of reaching its implied daily chart 
flag objective up near 500, at least in the near-term, its still 
possibility if 460 is not exceeded on a pullback here.  460 is 
the key support on the hourly chart, at the lower channel line.  

Flag patterns are not as reliable on the index charts as on 
individual stocks anyway, but they do at least suggest a further 
up move once the top of the flag type consolidation is pierced.  
The higher objective based on the "pole" measurement are not as 
often realized in the indices - or, not until well after the 
first strong upswing. Jury is still out on the outcome here.       

Near support is 472, then 462-464. A move under 472 in the OEX is 
the first indication of a technical breakdown. OEX remains in its 
uptrend channel as long as it doesn't fall under 462 currently - 
462 is also the prior swing high - what was resistance should now 
be support if the uptrend is going to remain in a strongly 
bullish pattern.  

DJ Industrial Index (1/100 of INDU) - $DJX - Daily/Hourly charts: 


 


DJX is faltering at the pivotal 50-day moving average and 
momentum oscillators like stochastics have or are starting to 
roll over to the downside. 87.6-87.9 is the area to watch for 
support and a technical break - 89.9-90 is the key near 
resistance.  

I estimate we'll see a move into the 87-86 area in DJX, with 86 
being hourly up trendline support. Below trendlines, I look at 
the prior swing low as a possible next target - certainly a 
pivotal price area to keep watch on - in this case, at 83.7.  

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


 
 
Suggested shorting taking long profits and shorting QQQ at 25.25 
or higher - the intraday high was 24.43. On any short positions, 
where I suggested an initial 26.00 buy stop, I would now move 
this down to 25.70 - 25.50 is probably enough "leeway", but let's 
allow for a rally try back up to at or near the 25.6 high of 
yesterday.   

Near support is in the 24.5-24.7 area; then, if exceeded, down in 
the 23.7-23.9 area. 

If you want to focus on a stock, Nasdaq bellwether Cisco Systems 
(CSCO) is the one to watch. Right now it may be forming a double 
top at 15.  All the other key Nasdaq stocks look like they are 
turning down again and correcting.    

Leigh Stevens
Chief Market Strategist
lstevens@OptionInvestor.com    


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****************
MARKET SENTIMENT
****************

Majority Rules
by Steven Price

The Dow experienced a triple-digit drop today, losing 118.72 to 
close at 8872.07.  This drop was accompanied by similar drops of 
13.27 points in the S&P 500, which finished the day at 937.43, 
and 17.95 points in the Nasdaq Composite, which finished at 
1376.59.  The Nasdaq 100 fell 17.93 to close at 1008.02.  While 
it may seem that I'm just reporting numbers, the reason for 
commenting on all four of these in the sentiment section of the 
newsletter, is that they all held above significant levels.

All four indices crossed their 50 day moving averages yesterday, 
not entirely a coincidence, as the market tends to rise and fall 
as a whole.  A strong rising tide will lift all boats, however 
the fact that they all broke a barrier that hadn't been reached 
since the spring, and all did it on the same day, is significant.  
While all of the indices gave back some ground today, they have 
all found support at the 50-dma.  If this level continues to 
hold, we may see a new base from which to begin the next leg up.  

The Dow had the Great Wall of 9000 staring it in the face, and 
retreated.  However, after a gain of over 1400 points since the 
morning low of 7532.66 on July 24, we were bound to see the index 
pause for a breath before getting over this next significant 
hump.  Today's pullback to just above the 50-dmas could be viewed 
by bulls as evidence of strength on the way up.  The bears will 
focus on the inability to get over 9000.  

A look at the bullish percentage figures now shows 56% of the 
Nasdaq 100 stocks giving point and figure buy signals, along with 
52.8% of the S&P 500 stocks and 50% of the Dow stocks.  While the 
Dow bullish percentage gave up 2% from yesterday's reading, this 
amounts to 1 stock out of 30 reversing its buy signal, while the 
0.8% gain in the S&P 500 translates to 4 stocks switching from 
sell signals to buy signals. The Nasdaq 100 remained unchanged.  
The point is that in spite of today's pullback, a majority of 
stocks are still giving buy signals in these indices.  This 
majority was established at Monday's close, and has held up.

It is hard to view the failure at 9000 as a turning point in the 
market, as long as a majority of stocks have broken above recent 
highs.  The Dow could give up 700 points from Monday's high and 
still have only retraced 50% of its recent gains. This is not to 
say we haven't simply experienced a bear market rally, which is a 
bump in the road on the way down.  However, with many positive 
signals, and the 50-dmas currently holding, I'm not yet slipping 
back into hibernation with the rest of the bears.


-----------------------------------------------------------------

Market Averages

DJIA ($INDU)

52-week High: 10679
52-week Low :  7702
Current     :  8872

Moving Averages:
(Simple)

 10-dma: 8728
 50-dma: 8835
200-dma: 9730



S&P 500 ($SPX)

52-week High: 1226
52-week Low :  797
Current     :  937

Moving Averages:
(Simple)

 10-dma:  914
 50-dma:  930
200-dma: 1072



Nasdaq-100 ($NDX)

52-week High: 1782
52-week Low :  892
Current     : 1008

Moving Averages:
(Simple)

 10-dma:  963
 50-dma:  996
200-dma: 1340



-----------------------------------------------------------------



The Semiconductor Index (SOX.X): The Semiconductor Index has 
enjoyed a meteoric rise the last two weeks.  It rebounded from 
its August 5 close of 283.91 to close yesterday at 363.06, just 
under its 50-dma.  This rise is significant for the bulls, while 
the fact that it could not hold above the 50-dma is significant 
for the bears.  While the NDX, Dow and S&P 500 all managed to get 
above their 50-dmas - and hold there in spite of today's 
pullback, the SOX was turned away and landed just above 
yesterday's low of the day.  What may be significant in terms of 
support though, is that today's low of 343.24, was approximately 
the same as yesterday's low of 343.96.  This will be the next 
level to watch for this group.  While it was not able to hold the 
50-dma, it may have found support just a bit lower.

52-week High: 657
52-week Low : 282
Current     : 345

Moving Averages:
(Simple)

 10-dma: 326
 50-dma: 361
200-dma: 497


-----------------------------------------------------------------

Market Volatility

The VIX has dropped precipitously in the last two weeks, from a 
high of just under 50 on August 5, to the low 30s.  While this 
may seem like an enormous show of faith in the health of the 
overall market, remember that this past spring it was trading 
around 19.  Summer is generally a period of very low volatility, 
and this year has been the extreme exception, not the rule.  If 
the market can hold these levels, or slowly creep forward, we 
would normally see a VIX closer to 20 at the end of August.  This 
year, however, with September 11 around the corner, we may not 
see a reading below 30 before then.

CBOE Market Volatility Index (VIX) = 32.56 +0.99
Nasdaq-100 Volatility Index  (VXN) = 47.71 +0.69

-----------------------------------------------------------------

          Put/Call Ratio  Call Volume   Put Volume

Total          0.74        509,438       376,768
Equity Only    0.62        420,722       260,655
OEX            0.78         19,942        15,609
QQQ            0.19         30,598         5,805

-----------------------------------------------------------------

Bullish Percent Data

           Current   Change   Status
NYSE          41      + 3     Bull Confirmed
NASDAQ-100    56      + 10    Bull Confirmed
DOW           50      + 0     Bull Confirmed
S&P 500       53      + 5     Bull Alert
S&P 100       53      + 2     Bull Alert

Bullish percent measures the number of stocks in an index 
currently trading on a buy signal on their point and figure 
chart.  Readings above 70 are considered overbought, and readings 
below 30 are considered oversold.

Bull Confirmed  - Aggressively long
Bull Alert      - Cautiously long
Bull Correction - Pause or pullback in upward trend
Bear Alert      - Take defensive action if long
Bear Confirmed  - High risk if long, good conditions for shorting
Bear Correction - Pause or rebound in downtrend

-----------------------------------------------------------------

 5-Day Arms Index  0.80
10-Day Arms Index  1.01
21-Day Arms Index  1.13
55-Day Arms Index  1.31

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       1043          1698
NASDAQ     1299          1955

        New Highs      New Lows
NYSE         35              58
NASDAQ       28             115

        Volume (in millions)
NYSE     1,539
NASDAQ   1,494

-----------------------------------------------------------------

Commitments Of Traders Report: 08/13/02

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

Commercials have reduced positions on both sides of the coin, 
resulting in a net change of 700 short contracts.  Small Traders 
have reduced long positions by 3700 more contracts than shorts.


Commercials   Long      Short      Net     % Of OI 
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%)
08/13/02      427,618   475,536   (47,918)   (5.3%)

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
07/23/02      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%
08/13/02      155,040    66,546    88,494     39.9%

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 have added to long positions by 1300 contracts, while 
short contracts increased slightly.  Small traders also added to 
long contracts, increasing positions by 1200 contracts, while 
leaving shorts virtually unchanged.


Commercials   Long      Short      Net     % of OI 
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%)
08/13/02       42,303     50,354    (8,051) ( 8.7%)

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
07/23/02       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%
08/13/02       12,797     8,933     3,864    17.8%

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 have maintained the status quo, subtracting 600 
contracts from the long side and 400 from their shorts.  Small 
traders got decidedly shorter, dumping almost 3,000 long 
contracts and only 900 shorts.


Commercials   Long      Short      Net     % of OI
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%
08/13/02       22,837    13,833    9,004      24.6%
 
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
07/23/02        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%)
08/13/02        5,050     8,349    (3,299)   (24.6%)

Most bearish reading of the year:  (8,777) - 10/12/01
Most bullish reading of the year:   1,909  -  1/16/01

-----------------------------------------------------------------


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******************
WEEKLY FUND SCREEN
******************

Best Taxable Bond Funds Now

This week, we use Morningstar's basic fund selector and scoring 
tool to isolate taxable bond funds that meet our desired levels 
of total return, risk and cost relative to their category peers.  
As you will see shortly, our selection criterion is designed to 
weed out funds that may have excessive risk or cost relative to 
their relative category.  Our criteria also specifies a desired 
average credit quality and duration level to minimize bond risk.  

Typically, we limit our screens to funds that are independently 
rated as the equivalent of 4 stars (above average) or 5 (high).  
That controls the universe of potential candidates to top-rated 
funds on a risk-adjusted return basis compared to similar funds.  
Within that group, we normally look for the funds with the best 
overall package, considering return, risk and cost of each fund, 
and other factors, such as management team and investment style. 

We'll show you the process we go through to screen and evaluate 
the taxable bond fund group.  First, we'll narrow the bond fund 
universe to 25 candidates using Morningstar's basic fund screen 
tool.  Second, we manipulate the results data further using the 
Morningstar score tool.  Based on the two views, we'll tell you 
which funds we like for their historical performance, and their 
future total return potential. 

Screening and Evaluation Process

We have purposely skewed the screen this week to quickly narrow 
the field of taxable bond funds to potential best bets.  We use 
the following screen criteria to find funds in this broad class:

 Fund Group = Taxable Bond 
 Manager Tenure > or = Category Average 
 Minimum Initial Purchase < or = $3,000 
 Expense Ratio < = Category Average 
 Star Rating = 4 Stars or 5 Stars
 Morningstar Risk > or = Average
 Average YTD Return > or = Universe Category 
 1-Year Return > or = Category Average 
 3-Year Return > or = Category Average 
 Average Credit Quality = A or Higher 
 Average Duration < or = 5 years

This screen quickly isolated funds because it is stringent with 
regard to manager tenure, expense ratio, star rating, risk, and 
relative performance.  To make our fund results, a taxable bond 
fund had to outperform its category peers on multiple standards, 
not just one measure.

Our stringent criterion quickly identified 25 top bond funds for 
further consideration.  Twenty-four of them have no load charges, 
with the one exception being FPA New Income (FPNIX), which has a 
3.50% front-end load.

Morningstar's basic fund selector give you four views of results: 
a snapshot view, a performance view, a portfolio view, and a nuts 
and bolts view.  In the snapshot view, we observe that 20 results 
are categorized by Morningstar as intermediate-term government or 
general bond funds, with the other five categorized as short-term 
government or general bond funds.  Ten of the funds have a 5-star 
Morningstar overall rating for risk-adjusted returns within their 
respective category peer group, as follows:

 Morningstar 5-Star Rated Funds:
 American Century Ginnie Mae (BGNMX) Intermediate Government
 CMC Short Term Bond (COTBX) Short-Term Bond
 Dodge & Cox Income (DODIX) Intermediate-Term Bond
 Fidelity Advisor Mortgage (FMSFX) Intermediate Government
 Harbor Bond (HABDX) Intermediate-Term Bond
 Scudder Fixed Income (MFISX) Intermediate-Term Bond
 Strong Government Securities (STVSX) Intermediate Government
 TIAA-CREF Bond Plus (TIPBX) Intermediate-Term Bond
 Vanguard GNMA (VFIIX) Intermediate Government
 Vanguard Short-Term Federal (VSGBX) Short Government

It came as no surprise to see that many top-rated funds have low 
expense ratios compared to the average taxable bond fund (1.11%).  
Seven of the above 5-star funds have expense ratios below 0.60% 
currently, contributing positively to relative fund performance.

In the performance view, we saw that American Century Ginnie Mae 
(BGNMX) and Fidelity Advisor Mortgage (FMSFX) have "low" risk in 
comparison to other intermediate-term government bond funds, per 
Morningstar.  Vanguard GNMA (VFIIX) is scored as "below average" 
risk relative to intermediate government category peers.  All of 
the other Morningstar 5-star rated fund results had an "average" 
risk level compared to their respective categories.  We observed 
trailing 1-year, 3-year and 5-year average annual returns, which 
in most cases outperformed the average taxable bond fund by wide 
margins.

The portfolio view showed that all ten 5-star funds had average 
credit qualities of "AA" or better (high-grade, what we wanted) 
and had short-to-intermediate average durations of near 2 years 
to about 4.7 years.  If you are concerned that rates might rise 
in the next year, then you may prefer to have a shorter average 
duration, since short-term funds are less sensitive to interest 
rate movements than funds with intermediate/long-term durations.  

We note that Vanguard GNMA (VFIIX) has the lowest turnover (8%) 
of the 5-star fund results.  Two funds, Harbor Bond (HABDX) and 
Strong Government Securities (STVSX), have turnover ratios that 
are in excess of 500% yet their annual expense ratios are below 
that of the average fund in its category.  The "nuts and bolts" 
view indicates the range of expense ratios.  At the low end is 
Vanguard GNMA (VFIIX) and CMC Short Term Bond (COTBX), both at 
0.25%.  The highest expense ratio among out list of Morningstar 
5-star rated funds is Strong Government Securities (0.90%).

Rather than score these results, we opted to see which of them 
were also top-rated by other independent funds trackers.  Data 
from Lipper Analytical Services indicates that eight of the 10 
potential candidates hold Lipper's top preservation score of 1, 
while four sport Lipper's highest consistent return score of 1.  
Three funds were "Lipper Leaders" for both measures as follows:

 Lipper Leaders for Return and Preservation:
 TIAA-CREF Bond Plus (TIPBX)
 Vanguard GNMA (VFIIX)
 Vanguard Short-Term Federal (VSGBX)

Strong Government Securities (STVSX) is a Lipper Leader (a "1") 
for consistent strong returns and carries an above average "2" 
preservation score.  Accordingly, if you seek a bond fund that 
has excelled at producing strong and consistent returns versus 
similar funds, these four Lipper Leaders for returns provide a 
terrific starting place in your search process.

Our Favorite Funds

At this point, we opt to stop here and provide profiles of the 
three Morningstar 5-star rated funds that are also Lipper top-
rated ("Lipper Leaders") for both consistent strong return and 
preservation.  You may find that another fund better suits you 
based on your individual situation and preferences.  These are 
three of the best taxable bond funds today for income-oriented 
investors.  

The $2.2 billion Vanguard Short-Term Federal Fund (VSGBX) seeks 
current income consistent with the maintenance of principal and 
liquidity.  It invests primarily in short-term U.S. government-
agency securities (high-grade paper) and keeps the fund average 
weighted maturity between one and three years.  The fund's very 
low expense ratio of 0.31% means portfolio manager John Hollyer 
doesn't have to take excessive risk with assets to overcome its 
cost burden.


 
 
The Vanguard cost advantage is evident in this fund's relative 
return performance.  According to Morningstar, the fund's 7.6% 
return over the past 12 months ranks in the 15th percentile of 
the short government category.  Trailing 3-year, 5-year and 10-
year annualized returns rank in the category's top decile, per 
Morningstar.  

Vanguard Short-Term Federal Fund's 6.3% average return for the 
10-year period through July 31, 2002, was just 1.0% shy of the 
Lehman Brothers Aggregate Bond Index (measuring the total U.S. 
bond market).  The fund's consistently "high" returns combined 
with its "average" risk profile relative to its category peers 
earns its Morningstar's highest 5-star rating over all periods 
tracked.  Income investors in search of a short-term bond fund 
with low cost and a fine track record have an excellent choice 
here.

The $18.7 billion Vanguard GNMA Fund (VFIIX) seeks high income 
consistent with maintenance of principal and liquidity.  It'll 
usually invest 80% or more of assets in intermediate-term GNMA 
securities, and may invest the balance of assets in other U.S. 
government debt securities. The fund's ultra low expense ratio 
(0.25%) means manager Paul Kaplan does not have to incur undue 
portfolio risk to overcome the fund's cost hurdle.    




 

 
In the last three years, the fund's risk level has been average 
relative to its intermediate government bond fund peers, higher 
than its historical "below average" risk rating by Morningstar.  
Overall, Morningstar rates the fund's risk as below average vs. 
category peers.

Over the past year through August 19, 2002, Vanguard GNMA Fund 
produced a total return of 8.3%, ranking in the category's top 
quintile.  Like its short government sibling, Vanguard GNMA is 
top decile ranked over the trailing 3-year, 5-year and 10-year 
periods per Morningstar.  The fund's average 10-year return of 
7.2% as of July 31, 2002 matched the return of Lehman Brothers 
Aggregate Bond Index.

Vanguard GNMA Fund may not be flashy but it gets the job done.  
Investors seeking an intermediate-term government fund with no 
load charges, low expenses and a below average risk level have 
another suitable investment option here.  

The $327 million TIAA-CREF Bond Plus Fund (TIPBX) seeks income 
consistent with preservation of capital by typically investing 
more than 80% of assets in bonds, principally investment-grade.  
To enhance the fund's total return potential, it may invest no 
more than 25% of assets in high-yielding instruments (of which 
15% of assets may be illiquid securities).



 

Compared to other intermediate-term bond funds (ones that invest 
both in government and corporate bonds), TIAA-CREF Bond Plus has 
produced "average" risk and "high" return.  However, Morningstar 
ratings reflect only three years of performance since the fund's 
5th anniversary is not until September 1, 2002.  We expect it'll 
still be rated 5 stars overall in a few weeks, considering TIAA-
CREF's low-cost leader stature, similar to Vanguard's.

For the trailing 3-year period through August 19, 2002, the fund 
returned an average of 8.9% a year, ranking in the top decile of 
the intermediate-term bond fund category, per Morningstar.  That 
average compares to 9.0% for the Vanguard GNMA Fund and 8.2% for 
the Vanguard Short-Term Federal Fund.  Accordingly, all three of 
the funds profiled this week have produced returns over the past 
three years that are in between the historical norm for equities 
(10%) and the historical norm for bonds (6%) - roughly speaking.

Summary

While low expenses do not guarantee a bond fund's success, they 
give the fund a cost advantage that often results in top return 
performance.  Low expenses also permit the fund manager to keep 
fund risk at bay.  Funds with higher operating expenses need to 
produce more gross return in order to match or beat their index 
benchmark and category peers.  Therefore, higher expense ratios 
can lead to fund managers incurring more risk to overcome their 
expense burdens.  

For more information of the two Vanguard funds, their home page 
is located at www.vanguard.com.  TIAA-CREF fund information may 
be found at www.tiaa-cref.com.


       
Steve Wagner
Editor, Mutual Investor
Steve@mutualinvestor.com


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

THE SECTOR BEAT - 8/20
by Leigh Stevens

[NOTE: I'll be out of the office Wed. My next update will be 
Thurs.]

UP on Tuesday -


 


DOWN on Tuesday - 


 


SECTOR NEWS - 

Telecom stocks (XTC) were higher as Qwest Communications (Q), the 
Western telecom under financial pressure rallying some 32% after 
the sale of one of its yellow pages business unit - $7 billion 
dollars was the sale price!  Wow, 7 billion, with a "b" - hard to 
believe that a monster book that makes such a good doorstop is 
worth that kind of money!  AT&T also rallied after an analyst 
upgrade. But SBC, BellSouth and Verizon were down following an 
analyst downgrade - oh those analysts in green eyeshades 
crunching their numbers - the gnomes of Wall Street. 

Semiconductor stocks (SOX) were off nearly 5% after a steep 
decline in Micron Technology (MU) following a downgrade - a 
"weaker" second half outlook for PX sales was blamed. Earnings, 
earnings, earnings - nothing else to say. 

Some networking stocks fell early, but the Networking Index (NWX) 
closed slightly higher after Nasdaq bellwether Cisco Systems 
(CSCO) announced the acquisition of storage switching product 
maker Andiamo in a deal worth $2.5 billion - more competition for 
networkers like Sonus (SONS), RSTN and TLAB, all down by 4% or 
more today. 

CSCO ended up slightly but is having trouble surmounting its 
prior $15 high and looks like it could be forming a double top. 

Retail stocks were active, but mixed as the Retail Index (RLX) 
closed down slightly (-.6%) - Home Depot (HD) ran up $% after 
reporting Q2 profits of a 50 cents a share, beating consensus 
estimates by 3 cents. Lowe's (LOW) ran up nearly two & a half 
percent, adding to its Monday gain on better than expected 
profits.  Guess those booming home sales are having a strong 
effect!  

Staples (SPLS) fell nearly 7% after registering a Q2 profit that 
was above Q2 of a year ago and above Street expectations but they 
lower guidance for the coming quarter and the rest of the year. 
B.J's Wholesale Club (BJ) fell some 2% after reporting its Q2 
profit - in line with estimates I saw, but some investors sold 
anyway, perhaps anticipating they would do better than consensus. 

SECTOR TRADE RECOMMENDATIONS -

NEW/OPEN TRADE RECOMMENDATIONS -

Bought SMH at 27.90 on a 27.90 buy stop
(Semiconductor HOLDR)
RAISE Sell stop to 26.90 
** SEE SECTOR HIGHLIGHT BELOW **

 
TRADE LIQUIDATIONS -

NONE


SECTOR HIGHLIGHT - 

Semiconductor Sector Index ($SOX.X)
STOCKS: AMAT; AMD; CMOS; CREE; IDTI; INTC; KLAC; LLTC; LSCC; 
LSI; MOT; MU; NSM; NVDA; NVLS; PMCS; RMBS; TER; TXN; XLNX


 

I thought that the SOX and the HOLDR's would clear the upper end 
of the their downtrend channels and make to the next resistance 
level at their prior highs. And, of course, just after my 
recommendation to get back into SMH. 

If the Chip stocks turn further south (lower) tomorrow, I suggest 
exiting the SMH holding stock, especially if SOX cannot stay 
above its September low at 344. 

If this happens, the SOX Index could be headed back down to at 
least the middle of the well-defined downtrend channel that has 
defined the bear trend for some months. Downside potential then 
would be to the 315-320 area, perhaps back to 300 if active 
selling comes into the sector again.  


Leigh Stevens
Chief Market Strategist
lstevens@OptionInvestor.com


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***********************
SWING TRADER GAME PLANS
***********************

Orderly Selling

Into every market a little profit taking must fall. All the 
indexes pulled back on steady selling but many stocks formed a 
bottom early and tried to rally into the close. It was 
predominately the ones with the higher relative strength. The big 
Dow gainers like IBM, MSFT and MO held their ground and did not 
show the profit taking you would have expected. The bulls are 
fighting to hold their gains and the light selling today was 
actually a pretty good showing.

To read the rest of the Swing Trader Game Plan Click here:
http://www.OptionInvestor.com/itrader/indexes/swing.asp


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The Option Investor Newsletter                  Tuesday 08-20-2002
Copyright 2002, All rights reserved.                        2 of 3
Redistribution in any form strictly prohibited.


In Section Two:

Dropped Calls: NOC, JNJ
Dropped Puts: None
Daily Results
Call Play Updates: IBM, ATK, ADBE, EDS, TEVA
New Calls Plays: PII
Put Play Updates: BAX, ESRX, GS
New Put Plays: POT, MXIM

****************
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:
*****

NOC $114.80 -2.45 (-2.35 for the week) NOC - Northrop Grumman has had a 
wild week, trading as low as 109.60, and as high as $119.12.  The stock 
first saw resistance at the 50-dma, currently $115.45. This level then 
served as support after the stock broke through to the upside.  The 
stock has now broken below support at that level, and the extreme 
volatility does not lend itself to a definable trend. We are therefore 
dropping this play.

JNJ  $54.90 -1.00 (-0.42 for the week) Johnson and Johnson has 
established a pattern of higher highs and higher lows.  Today's 
pullback, however, broke back below recent support at $55.  While the 
stock may eventually trade higher once again, it appears to have turned 
downward from its latest consolidation and may have a fight in front of 
it to get back above the recent high of $56.49. In addition to this 
breakdown, we see risk of a continued pullback in the Dow, and feel 
this would take JNJ with it.  We are closing this play, and will put 
our eggs in another basket.


PUTS:
*****

None


***********************************************************
DAILY RESULTS
***********************************************************

Please view this in COURIER 10 font for alignment
*************************************************

CALLS              Mon    

ADBE     20.16    0.79  -0.72  Support at $20
ATK      67.00    0.98  -1.35  Still in rising channel
EDS      39.79    1.80  -0.96  Inside day after steady rise
IBM      81.27    3.14  -1.22  Consolidation after $10 gain
JNJ      54.90    0.38  -1.00  Drop, break in recent support
NOC     114.80   -0.35  -2.45  Drop, Volatility breaks trend
PII      72.80    1.00   0.85  New, Recreational play
TEVA     68.17    0.89  -0.61  Still in range


PUTS               


BAX      34.87    1.19  -0.27  Still in descending channel
BCC      27.26    1.05  -0.28  Relative weakness
ESRX     44.86    2.02   0.10  Stalled and rolled back
GS       80.51    0.97  -0.99  Failed at 200-dma
POT      60.03    1.06  -1.95  New, overextended and done
MXIM     35.99    0.90  -1.91  New, rolled over from trendline


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********************
PLAY UPDATES - CALLS
********************

IBM $81.27 –1.22 (+1.92 for the week) has achieved our initial 
target of $82, trading as high as $82.85 on Monday before giving 
a little back on Tuesday.  After a $10 gain in four days, this 
consolidation is not unexpected.  Big Blue broke out of an $8 
wide rectangle and the minimum measuring objective of $8 gave a 
target of $82.  This objective was reached faster than we could 
have predicted and we recommended on Monday's Market Monitor that 
conservative traders take at least partial profits at that level.  
We are maintaining our long position with a new target of $85, 
which is the PnF bullish vertical count.  Today's pullback, with 
the broader markets, has set up as an inside day, which is a 
consolidation pattern.  The hold above $80 looks as though the 
stock has established a new level of support, from which to 
extend its rally.  We have raised our stop loss to $79, just 
below Monday's low, in order to lock in profits if this new 
support does not hold. Look for a trade back over $82, today's 
high, to initiate new positions with a target of $85.

---

ATK $67.00 -1.35 (-0.37 for the week) ATK gave back some of its 
recent gains today, however a look at the tightly defined rising 
channel begun at the end of July shows the stock simply rolling 
back to the bottom of this channel.  The stock experienced 
consolidation last week, which also put it at the bottom of the 
channel.  The stock received a boost at that time, as it has on 
each of the 9 occasions it has touched this lower trendline.  
Talk of an Iraqi invasion continues to flow from the White House, 
and this should keep investors interested in defense stocks.  If 
there is an invasion, or even a buildup in anticipation of one, 
ATK should see a revenue boost from demand for its ammunition and 
parts for rocket propulsion systems.  Earlier this week, the U.S. 
army awarded a $27 million contract to ATK to assist the 
government of Egypt in production of 120 mm tank training 
ammunition.  While the dollar amount is not significant, the new 
relationship with Egypt demonstrates the U.S. government's 
commitment to ATK. Te trade down to $67 did not disrupt the PnF 
buy signal established on Aug 16, and the bullish vertical count 
remains $80.  While this is an eventual count, it leaves plenty 
of room to the upside.

ADBE $20.16 -0.72 (+0.02) Following its solid breakout over the
$18.50 resistance level last week, ADBE was due for a bit of
profit taking, and the pullback in the broader markets on Tuesday
seemed as good a time as any.  The 20-dma at $20.30 pressure the
Software stock back near the $20 level, although the decline came
on notably light volume of just over half the ADV.  At its low of
the day, ADBE had retraced just about a third of the recent price
rise, so at this juncture, it looks like simple profit taking,
and is likely setting us up for a fresh entry into the play.  The
Software index (GSO.X) pulled back a bit as well in Tuesday's
session, but is still holding on to the lion's share of its gains
of the past week.  Look to initiate new positions on a rebound
from the $20 level, or perhaps as low as intraday support at
$19.50.  Alternatively, entries on renewed strength can be
considered on a breakout over the $21 level.  Recall that our
initial target is the $23.50-24.00 level, the top of the August
1st gap.  Keep stops set at $19.

---

EDS $39.79 -0.96 (+0.87) Once the Day of Reckoning for Corporate
America passed last week, investors have been gobbling up shares
of some of the large conglomerate companies.  That boost helped
to propel shares of EDS as high as $41 yesterday, as all the
major indices bested their 50-dmas.  After such a strong bullish
performance, a bit of give-back was due, and EDS did as was
expected, pulling back in a bit of consolidation.  Inside Day
aficionados will notice that EDS gave us just such a setup on
Tuesday, with its narrow-range trading today.  Traders still
looking to enter the play can use either a rebound from the site
of Monday's low (near $38.70) or a breakout over Monday's high
($41.05) to initiate new positions.  Should EDS fall below
Monday's lows, we'll need to look to the $37 level (the site of
the 3-week ascending trendline) for support and a possible entry
into the play.  Our stop remains at $36.50, as a close below that
level would indicate the bulls have lost traction.

---

TEVA $68.17 -0.61 (-0.22) Can you say rangebound?  Our TEVA play
has frustratingly gone nowhere over the past week, as it continues
to meander between $67.50-$69.25.  In light of the weakness in
the Biotechnology sector (BTK.X), the stock's resilience is
encouraging, although it was a bit disappointing to see TEVA lose
ground on Tuesday, with the BTK actually posting a small gain.
Over the past 2 weeks, the stock has been posting a series of
higher lows, defining an ascending trendline, that currently
rests at $68, just below where the stock went out today.  On the
upside, the $69.25 level is presenting formidable resistance to
the bulls.  That gives us a couple of easily definable entry
points into the play.  Dip-buyers can target a rebound off of
the $68 level, while momentum traders will want to see a
volume-backed rally through the $69.50 level before taking a
position.  Of course, in the latter case, we'd prefer to see the
BTK index advancing strongly as well, ideally moving north of
resistance in the $383-387 area.


**************
NEW CALL PLAYS
**************

PII – Polaris Industries - $72.80 +0.85 (+1.62 for the week)

Company Summary:
Polaris designs, engineers, manufactures and markets snowmobiles, 
all-terrain vehicles, personal watercraft, Victory motorcycles, 
and the Polaris RANGER for recreational and utility use with 
annual 2001 sales of $1.5 billion. Polaris is the largest 
snowmobile manufacturer in the world, and one of the largest U.S. 
manufacturers of ATVs and personal watercraft. Polaris markets a 
complete line of Pure Polaris(TM) apparel, accessories, and parts 
available at Polaris dealerships. Consumers can also purchase 
apparel and accessories around the clock online at 
www.purepolaris.com. The Polaris Professional Series, a line of 
heavy duty Workmobiles(TM) targeted at lawn and landscape 
companies, equipment rental companies and construction 
operations, marks Polaris' expansion into the commercial 
equipment marketplace. Polaris Industries Inc. trades on the New 
York Stock Exchange and Pacific Stock Exchange under the symbol 
"PII," and the company is included in the S&P SmallCap 600 stock 
price index. (source: company release)

Why We Like It:
Polaris demonstrated good relative strength as the market receded 
today, after recent gains.  PII just kept going on its ascending, 
uninterrupted path. The stock found resistance just over $70 in late 
July, but has plowed through that level and continues to add green 
candles as it closes higher than each day's open.  This sign of 
bullishness in a choppy market is very encouraging.  The company 
recently announced a plethora of new products, which include an 
environmentally friendly personal water-craft, a new all terrain 
vehicle line built specifically for racing, the new custom cruiser 
Victory Motorcycle and a new Professional Series utility vehicle.  If 
one thing in a slow economy is now apparent, it is that people still 
like their toys.

This company released record earnings on July 16th, 
which reflected a 15% increase from the previous quarter.  This was the 
17th consecutive quarter with increased earnings.  Polaris is one 
company that did not experience the same recession in 2001 as the rest 
of the market.  July's record earnings were also accompanied by record 
sales of $362.6 million, a 2% increase from the year ago period.

Monday's trade of $72 established a new buy signal on the PnF chart, 
resulting from a double-top breakout.  The new bullish vertical count, 
which the stock is in the process of building, is $87.  Each $1 box 
advance now adds $3 to this count.  The stock had been consolidating in 
a PnF flag pattern prior to the current breakout.  Based on the 
principle that flags fly half-mast, the breakout to the upside is 
another bullish indication for the stock.  The stock could see some 
resistance at $75, which is a level of PnF resistance and a possible 
psychological mark. Once it gets above that level, there does not 
appear to be any significant roadblocks in its way.  OI sees the 
current level as an opportunity to initiate long positions.

BUY CALL SEP-70*PII-IN OI=  86 at $4.80 SL=2.50
BUY CALL SEP-75 PII-IO OI= 151 at $2.25 SL=1.20
BUY CALL OCT-70 PII-JN OI= N/A at $6.40 SL=3.20
BUY CALL OCT-75 PII-JO OI= N/A at $3.70 SL=2.00

Average Daily Volume = 244.8 K



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*******************
PLAY UPDATES - PUTS
*******************

BAX $34.87 -0.27 (+0.87) After breaking below the important $35
support level last Friday, shares of BAX rebounded sharply Monday
morning with the rest of the market.  Rising as high as $36 in
the early going, BAX provided an attractive entry into the play,
as the stock promptly reversed from that level and headed lower
into the close.  Although the decline was fairly tepid on Tuesday,
the stock continued to slide lower on Tuesday, closing once again
under the important $35 level.  The big question is whether the
stock is trying to build a new base or preparing for another leg
down.  Given the fact that it is still on our Put list, we're
clearly leaning towards a fresh breakdown, due in part to its
relative underperformance yesterday afternoon.  Note that the
descending trendline (now at $35.60) continues to keep a lid on
any rally attempts, and another failed rally could present new
entry opportunities on the rollover.  Alternatively, momentum
traders will want to wait for the $33.75 support level (just
below Monday's intraday low) to be broken before entering new
positions. We are lowering our stop to $36.50, which is just
above the recent upswing highs.

---

ESRX $44.86 +0.10 (+2.17) After digesting the latest round of
bad news, shares of the PBMs (Pharmacy Benefit Managers) such as
ESRX have been trying to claw their way back into an uptrend.
ESRX's intraday chart presents an interesting picture, showing a
series of lower highs over the past week.  In fact, Tuesday's
continuation of the stock's recovery had our play right on the
cusp of being dropped tonight.  But the negative pressure of the
broad market kept the stock under pressure and it closed under
the $45 level (the location of our stop), keeping the play alive.
The longer-term trend is more telling with respect to ESRX's
near-term direction, as the trendline (currently $45.65)
connecting the lower highs over the past 3 weeks seems to have
come into play near the close, keeping the bulls at bay.  So the
action play is easy to lay out tonight.  Look to fade a failed
rally below that trendline with new positions, so long as our $45
stop isn't violated on a closing basis, or else wait to enter the
play until after ESRX violates its shorter-term ascending
trendline (currently at $44), which also happens to be the site
of intraday support.

---

GS $80.51 -0.99 (+0.98) Highlighting our skepticism about the
recent rally in the Brokerage sector (XBD.X), we decided to put
our money where our mouth is, with a bearish play on shares of GS
last weekend, following their meteoric rise off their lows of just
a few short weeks ago.  Needless to say, we were quite pleased to
see the stock continue to rise with the broad market yesterday, as
it seemed to be setting us up for a better entry point.  Monday's
advance came to a halt just below $82, as the bulls deferred to
the looming 200-dma at $82.43.  Profit taking arrived on Tuesday,
with GS promptly falling back to the $80 level, but recovering
late in the day to close above that important level.  That
presents a picture of Tuesday's decline being no more than profit
taking.  Clearly we'll need more weakness than that if our bearish
thesis about GS and the broader Brokerage sector is to prove
fruitful.  Resistance at $82 is now defined by yesterday's highs
and another failed rally below that level can be used for
initiating new positions.  But those with a more cautious stance
will want to wait for a close back under the $80 level, preferably
Friday's consolidation zone near $79.50 before jumping into new
positions.  If trading the breakdown, make sure to confirm sector
weakness, looking for the XBD to decline back under the $408
level.  We're keeping our stop in place at $82.50 tonight.

---

BCC $27.26 -0.28 (+0.79 for the week) Boise Cascade has been in 
consolidation the past couple of days, in a similar pattern to 
that of the Forest and Paper Product Index (FPP).  However, a 
look at BCC's relative strength, as compared to the rest of the 
stocks in the group, looks extremely negative.  A negative 
breakout from consolidation for the group, which has been 
downgraded numerous times, should be led by BCC.  A look at the 
daily chart shows BCC being turned away once again from a 
descending trendline begun on July 30, as the rest of the market 
was rebounding.  The stock remains on a double bottom PnF 
breakdown, with a bearish vertical count of $16.  This count is 
an eventual target, not a short term one, but shows the lack of 
support below for the stock.  BCC is already predicting rising 
expenses for 2003, and there does not appear to be any impetus 
for a reversal from the downward trend that both this stock and 
the FPP have been in.  We will maintain our short position in 
BCC, with an initial target in the low 20s.  Conservative traders 
may want to look for a trade below $26.50, the stock's recent 
low, to initiate new short positions.  We will continue to hold 
our short position in BCC, as long as the descending trendline 
remains in tact.


*************
NEW PUT PLAYS
*************

POT – Potash Corporation $60.03 –1.95 (-0.88 this week)

Company Summary:
Potash Corporation of Saskatchewan Inc. is the world's largest 
fertilizer enterprise producing the three primary nutrients and is a 
leading supplier to three distinct market categories: agriculture, as 
the world's largest fertilizer producer; animal nutrition, with the 
world's largest capacity in phosphate feed ingredients; and industrial 
chemicals, as the world's largest producer of industrial nitrogen 
products and one of only three North American suppliers of industrial 
phosphates.

Why We like It:
Potash has experienced a 20% increase since August 5th.  The news that 
farmers may be using more fertilizer next year, as a result of this 
year's drought, appears to have brought the buyer's out of the 
woodwork.  This stock looks to have been dramatically overbought, and 
has failed at its 200-dma on 5 separate occasions.  Although it has 
traded above this level intraday, the sellers have piled on to make 
sure it was turned back by the close of business.  It now looks to have 
rolled over, and is quickly approaching a support break of $60 and the 
50-dma of $59.25 directly below. 

The company came out with disappointing results earlier in the summer.  
POT reduced earnings guidance by 60% for the second quarter and 30% for 
the full year. The stock began a plunge into the deep end shortly 
thereafter, and has attempted to recover.  The recovery, however, has 
run out of steam. The stock had a weak spring, as it had approximately 
1 million fewer corn acres planted than the USDA predicted. There had 
predictions of an increase in their volumes, but those predictions were 
reduced. The company's reduced DAP production continues to increase its 
fixed cost per ton on phosphate products.  Any increase in second-half 
nitrogen products is dependent on low season-ending inventories and 
higher natural gas costs leading to stronger nitrogen pricing. 

A look at the point and figure chart shows that the stock attempted to 
get through bearish resistance of $63, with a trade of $63.02 on August 
15th.  The buyers, however, could not manage enough strength to get 
through the barrier, and the stock has now experienced a three-box 
reversal down to $60.  The next level of PnF support could be $56, 
which served as resistance on the way up.  Below $56, $50 is the next 
solid support level.  OI will look for a trade below $60 as our trigger 
to initiate a short position.  More conservative traders may want to 
wait for the stock to break through the 50-dma of $59.25.  We will use 
a stop loss of $63.25, just above its recent high, to signal renewed 
strength and a negation of the rollover. 

BUY PUT SEP-60*POT-UL OI= 902 at $2.20 SL=1.10
BUY PUT OCT-60 POT-VL OI= N/A at $3.10 SL=1.75

Average Daily Volume = 188.5 K


---

MXIM – Maxim Integrated Products $36.05 -1.85 (-1.14 this week)

Company Summary:
MXIM designs, develops, manufactures and markets a broad range
of linear and mixed-signal integrated circuits, commonly
referred to as analog circuits.  The company also provides a
range of high-frequency design processes and capabilities that
can be used in custom design.  MXIM's objective is to develop
and market both proprietary and industry-standard analog
integrated circuits that meet the increasingly stringent
quality standards demanded by customers.

Why We Like It:
Quick!  With the broad markets all advancing through their
50-dmas yesterday, can you name the popular momentum sector that
failed to scale its own 50-dma?  If you guessed the Semiconductors
(SOX.X), you win the prize.  Not only did the SOX fail to advance
through that level on Monday, but it appeared to find resistance
at its 50-dma (currently $361.64) on Tuesday.  Dialing up a few
daily charts brought MXIM to our attention.  Yesterday's continued
strength in the SOX propelled shares of MXIM right to the
descending trendline ($38) that has been giving the bulls
heartburn since April.  Turning to the PnF chart, we can see that
the stock is on a Buy signal after trading through the $34 level.
But it is also bucking up against the bearish resistance line at
$39, which has been the site of significant historical resistance.
The first test of bearish resistance is usually painful for the
bulls, and today's nearly 5% decline certainly bears (pun
intended) that out.  We're still waiting for the oscillators to
turn in favor of the bears, but in the meantime, fading the
rallies (so long as they continue to fail below resistance) looks
like a good risk-reward proposition.  Look to initiate new
positions on a rollover either from the $37 intraday resistance
or up near $38.50, the site of Monday's high.  We can manage risk
quite effectively with our stop set at $39.  Momentum traders may
want to try entries on a breakdown under $35.25 (just below
Tuesday's intraday low), but only if the SOX falls under its
significant $343 support level.

BUY PUT SEP-40 XIQ-UH OI= 655 at $5.00 SL=3.00
BUY PUT SEP-35*XIQ-UG OI=1852 at $2.25 SL=1.00
BUY PUT SEP-30 XIQ-UF OI=2525 at $0.85 SL=0.50

Average Daily Volume = 8.61 mln



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The Option Investor Newsletter                  Tuesday 08-20-2002
Copyright 2002, All rights reserved.                        3 of 3
Redistribution in any form strictly prohibited.


In Section Three: 

Play of the Day: Call - PII
Traders Corner: Failure to Fortune

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

PII – Polaris Industries - $72.80 +0.85 (+1.62 for the week)

Company Summary:
Polaris designs, engineers, manufactures and markets snowmobiles, all-
terrain vehicles, personal watercraft, Victory motorcycles, and the 
Polaris RANGER for recreational and utility use with annual 2001 sales 
of $1.5 billion. Polaris is the largest snowmobile manufacturer in the 
world, and one of the largest U.S. manufacturers of ATVs and personal 
watercraft. Polaris markets a complete line of Pure Polaris(TM) 
apparel, accessories, and parts available at Polaris dealerships. 
Consumers can also purchase apparel and accessories around the clock 
online at www.purepolaris.com. The Polaris Professional Series, a line 
of heavy duty Workmobiles(TM) targeted at lawn and landscape companies, 
equipment rental companies and construction operations, marks Polaris' 
expansion into the commercial equipment marketplace. Polaris Industries 
Inc. trades on the New York Stock Exchange and Pacific Stock Exchange 
under the symbol "PII," and the company is included in the S&P SmallCap 
600 stock price index. (source: company release)

Why We Like It:
Polaris demonstrated good relative strength as the market receded 
today, after recent gains.  PII just kept going on its ascending, 
uninterrupted path. The stock found resistance just over $70 in late 
July, but has plowed through that level and continues to add green 
candles as it closes higher than each day's open.  This sign of 
bullishness in a choppy market is very encouraging.  The company 
recently announced a plethora of new products, which include an 
environmentally friendly personal water-craft, a new all terrain 
vehicle line built specifically for racing, the new custom cruiser 
Victory Motorcycle and a new Professional Series utility vehicle.  If 
one thing in a slow economy is now apparent, it is that people still 
like their toys.  This company released record earnings on July 16th, 
which reflected a 15% increase from the previous quarter.  This was the 
17th consecutive quarter with increased earnings.  Polaris is one 
company that did not experience the same recession in 2001 as the rest 
of the market.  July's record earnings were also accompanied by record 
sales of $362.6 million, a 2% increase from the year ago period.

Monday's trade of $72 established a new buy signal on the PnF chart, 
resulting from a double-top breakout.  The new bullish vertical count, 
which the stock is in the process of building, is $87.  Each $1 box 
advance now adds $3 to this count.  The stock had been consolidating in 
a PnF flag pattern prior to the current breakout.  Based on the 
principle that flags fly half-mast, the breakout to the upside is 
another bullish indication for the stock.  The stock could see some 
resistance at $75, which is a level of PnF resistance and a possible 
psychological mark. Once it gets above that level, there does not 
appear to be any significant roadblocks in its way.  OI sees the 
current level as an opportunity to initiate long positions.

BUY CALL SEP-70*PII-IN OI=  86 at $4.80 SL=2.50
BUY CALL SEP-75 PII-IO OI= 151 at $2.25 SL=1.20
BUY CALL OCT-70 PII-JN OI= N/A at $6.40 SL=3.20
BUY CALL OCT-75 PII-JO OI= N/A at $3.70 SL=2.00

Average Daily Volume = 244.8 K



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

Failure to Fortune
By John Seckinger
JSeckinger@OptionInvestor.com

Every time I look at a chart, this question comes to mind:  Is 
there a bullish or bearish chart pattern institutional traders 
want me to see?  If I answer “yes”, most likely I will be 
thinking about putting on the exact opposite strategy.

Yes, this article is somewhat cynical in nature; however, it is 
my opinion that institutional traders force a retail investor to 
see one thing (example, “screaming buy”), only to use the extra 
liquidity to do something completely different (sell) and have 
these retail traders holding the bag.  

Is there one thing a trader can do to “control possible damage” 
if caught on the other side of a failed technical pattern?  Yes, 
use stop-loss orders.  In fact, the correct strategy is to 
actually sell the initial long and take a new short position – 
since smart money is selling and it makes sense to follow the 
momentum.  Remember:  Do not force trying to see these patterns; 
it will simply be a losing proposition.  Also, you have to 
condition yourself to become comfortable “flipping” out and in to 
another trade extremely fast.  Selling the long for a small loss 
is good, but to make money it really does make sense to ride the 
trend lower.  Most traders, including myself at times, gets “gun 
shy” and wants to take a breath instead of entering another 
trade.  Do not make that mistake.     

Believe me, there is no coincidence when a chart pattern is 
“barely broken.”  Market makers love to use a small amount of 
capital to get out a new low/high, trigger stops, and then take 
the opposite position as stops are finished being filled.  
Example:  ABC trading 99 with intra-day high at 99.50.  A market 
maker then starts buying up to 100.50 and all-of-a-sudden shares 
go vertical as stops are triggered and retail investors jump in, 
afraid to miss the move.  Shortly thereafter, the market maker 
and institutional traders realize all stops are out, demand is 
relatively weak, and pushes shares back down until these same 
retail traders bail out, afraid that they bought the high.  Of 
course, this market maker would also know that an extremely 
bullish chart pattern would be seen in shares of ABC as soon as 
shares trade 100.5.  After seeing this occur at the CBOT many 
times, I have begun to approach charting with a different slant 
at times.    

Ok, time for some illustrations.  

Chart of American Express Inc, Daily 


 

How hard would it be to sell shares of American Express at 44.87?  
Actually, it wouldn’t make any sense to sell at 44.87; however, 
shares should not falter one cent since any weakness should be a 
“red flag” for traders holding a long position.  Shares have just 
completed an outside day higher, set a new high, formed a 
catapult formation, given a possible “runaway gap” pattern; all 
signs that point to one thing – higher share prices.  So, in all 
actuality, being long is fine here.  But, if the chart pattern 
fails, it will most likely fail big.  Therefore, as noted above, 
tight stop with the intention of going short as well.  Of course, 
we know that shares peaked on that day and almost went straight 
to 26.92.  

Chart of International Business Machines, Daily 


 

Shares of IBM formed the “b” long liquidation pattern after 
setting a key relative low near 66.  Interestingly enough, shares 
formed a relative high, pulled back, and then traded to 75 and 
gave a false buy signal.  Since there was no apex (pivot) yet, 
most likely all it did was give shorts more ammunition in case 
the key relative low was ever broken.  Then, when shares did in 
fact gap lower to 65, shorts most likely expected an accelerated 
move lower and tried to go for the jugular.  

With shares rallying back to the apex before consolidating and 
then heading lower, shorts might have been wondering if 65 would 
be tested again.  Once shares of IBM rallied back above the old 
key relative low, the pattern is then considered failed and 
thoughts of selling should turn to those of buying opportunities.  
The weakness near the apex should not waiver thoughts of buying.  
Also noteworthy is the RSI Bullish Divergence – defined as prices 
making a new low while the indicator does not.  Moreover, the 
explosiveness just reinforces both short and long traders getting 
“caught” in a failed technical pattern and realizing going long 
most likely is the proper action.   

Chart of Intel Corporation, Daily 


 

Shares of INTC is highlighted because of volatility seen in just 
six trading session, with the third of six giving a false sell 
signal and most likely trapping bears in the process.  Similar to 
IBM, shares of INTC rose above the first relative high, formed an 
apex, showed a Bullish Divergence within the RSI Indicator, 
traded underneath the key relative low, and then rallied strongly 
as shorts covered and longs took on new positions.  

Here is a twist.  What if INTC is simply forming a bear flag 
formation and is actually not a failed technical pattern?  Well, 
as any trader can testify, stick with what works and what allows 
for a solid risk/reward scenario.  With INTC, the term “false 
sell signal” would be given during the following day’s open, 
since shares were higher than the key relative low set a number 
of weeks back.  Remember, once this key relative low is 
penetrated, shares should not then go back into the previously 
defined range.  Once back into the range, a long position would 
have risk back to 16.  The reward would be for a move back to 
where the selling started – roughly current prices at 18.75.  If 
a trader stayed long at current levels, a stop would have to be 
placed at the apex of 17.50 with an objective of 20 in the near 
term.  Stops would also have to be tightened as shares approached 
20.  If shares of INTC fall from current levels, aggressive 
traders could sell shares with a stop near 19.  Objective is only 
17 in near term, since there is a pattern of higher relative 
lows.  Nevertheless, the point of this chart was to illustrate 
how “extreme bearishness” can, one day later, be viewed as a 
buying opportunity.  

A similar analogy would be shares of ABC spending months trading 
between 20 and 30, only to close one day at 31 and spark interest 
from NY to LA.  Well, what should a trader do?  Buying is fine, 
as long a stop is put in at 29.25 to exit long positions and 
actually go short.  In fact, if 29.25 is hit, there are good odds 
20 comes into view much faster than normal.  Once again, traders 
would blame the “randomness of the market” and the “difficulty of 
making money when competing against institutions.”  Key point:  
Try to forget all fundamental analysis before and during the 
trade.  In my opinion, all fundamental research should be done 
prior to trading.


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