The Option Investor Newsletter Tuesday 08-29-2002 Copyright 2002, All rights reserved. 1 of 3 Redistribution in any form strictly prohibited. In Section One: Market Wrap: What Bad News? Index Trader Wrap: NAS UP, DOW DOWN Market Sentiment: Lack of Confidence Weekly Manager Microscope: Ken Kam: Marketocracy Masters 100 Fund (MOFQX) Index Trader Game Plans: THE SECTOR BEAT - 8/29 Updated on the site tonight: Swing Trader Game Plan: Chalk One Up For The Bulls Posted online for subscribers at http://www.OptionInvestor.com ************************************************************ MARKET WRAP (view in courier font for table alignment) ************************************************************ 08-29-2002 High Low Volume Advance/Decline DJIA 8669.74 - 23.10 8742.01 8558.02 1.39 bln 1796/1376 NASDAQ 1334.75 + 21.39 1345.37 1295.79 1.38 bln 1914/1416 S&P 100 461.81 - 0.53 465.69 454.89 Totals 3710/2792 S&P 500 917.77 - 0.07 924.59 903.33 RUS 2000 394.50 + 5.02 396.10 387.23 DJ TRANS 2246.30 - 67.10 2312.80 2211.57 VIX 36.32 + 0.09 39.14 35.84 VXN 55.05 + 1.53 57.63 54.20 Total Vol 2,975M Total UpVol 1,874M Total DnVol 1,032M 52wk Highs 84 52wk Lows 209 TRIN 1.34 PUT/CALL .93 ************************************************************ What Bad News? Multiple tech downgrades, European markets down strongly, GDP lower than expected and higher jobless claims all failed to hold the markets down after a triple digit opening drop. Short covering, index fund markups or bargain hunting were given as reasons for the rebound but the bottom line was a draw as the Dow closed down about as much as the Nasdaq gained closing the markets in a tie. The morning started out just like any other August day. Multiple downgrades of the chip sector along with a scattering of downgrades on non tech companies. Morgan Stanley cut estimates on Micron, ASML and Triquint Semi. UBS Warburg cut NVLS, LGVN, LRCX, NEWP based on valuation and earnings. Soundview cut KLAC and TER on worries that orders were down more than 10% below estimates. Unbelievably the SOX rallied back to positive territory after gapping down significantly at the open. Traders simply ignored bad news again and bought tech stocks. The Nasdaq was the leader all day but was held back by the broader averages. Also hurting the markets was another downgrade on the transportation sector. Goldman cut the airlines with downgrades on CAL, DAL, AMR, UAL, ALK, NWAC, LUV and AWA. The said business travel not returned and families were not using the airlines for vacations. Did Goldman just come back from the twilight zone? This has been the wet blanket on the sector for months. Roadway (ROAD) led the shippers down with a warning that the economy was recovering much slower than expected with business slowing even more in July and August. ROAD was seeing more bugs on the windshield than expected with less than full load bookings slowing instead of increasing as fall approached. Downgrades were flying with even GE being dropped for a loss after Lehman lowered estimates on GE by a nickel. Lehman thought that lowered expectations for pension income and the cost of expensing stock options would cut net income for the giant. Other analysts also commented on the weak aircraft engine business as a possible drag on GE which lost nearly $1 in light trading. The economic news started with a larger than expected rise in jobless claims to 403,000. The +8,000 gain was the third consecutive week for gains and raised the continuing claims to 3.588 million jobless. The GDP for the second quarter remained unchanged at +1.1% growth, which was substantially down from the +5.0% first quarter rate. Analysts were hoping for an upward revision to show a stronger recovery but were also relieved to not see a downward revision. Business inventories rocketed to +$7.3 billion from only a +$1 billion rate when the number was first reported. Consumer spending fell from +3.1% in Q1 to +1.9% in Q2. Corporate profits were revised down to +1.7% growth from +2.0% earlier forecasted. In news after the bell SUNW CFO Steven McGowan said earnings would come in at the very low end of guidance probably in the -15% decrease range from last quarter. Instead of gaining ground he said the overall market for business IT spending may be worsening. SUNW guided analysts lower for the current quarter and could be setting the stage for Intel to do the same next Thursday. Following the bad news from SUNW was NVLS who said it would miss earnings estimates for the quarter. The outlook is "very, very murky and the feeling is negative" CEO Richard hill said. They said they were experiencing significant order delay from major customers as capex spending continues to shrink. They said they expected to break even this quarter, down from the +11 cents analysts had expected. Sales were expected to be -10% to -15% less than previously expected. They said they were seeing a very small uptick in business spending but drastic drops in consumer spending was more than offsetting the minor gains in business spending. Let's review. Roadway says that shipments are down. Morgan Stanley said back to school PC sales have been weak at best and inventories of computers and memory are rising drastically. Initial jobless claims are up three weeks in a row and the GDP was barely positive. SUNW says the economy could be worsening and Novellus said major customers are delaying orders due to capex spending cuts. This same song with different verses has been repeated daily for a month. Does this sound like a recipe for a new bull market? Not to me but considering the markets have been eating bad news for breakfast and rebounding this should be good for a couple hundred points! (grin) I feel like a bear crying wolf when the market rebounds on news like we had this morning. No less than five different brokerages cutting estimates on more than a dozen chip stocks but the SOX rose from a -10 point opening dip to close positive for the day. Goldman Sachs was the only broker to call chip stocks attractive with a 12-18 month time horizon. I would agree for 18 months from now but why buy before 9/11 and the typical October bottom? The answer of course is that chip stocks at $10 don't offer much risk to a long term trader. Still I continue to stare in disbelief to rallies on bad news. They get another chance for the breakfast of champions tomorrow with Personal Income/Spending, Chicago PMI and Consumer Sentiment reports. These should not be market movers but who can tell anymore what will provide the spark for the implosion/explosion. Historically this week produces negative results and leads into a Tue/Wed rally after Labor Day. So far this week the Dow is only down -200 points. This is definitely not a major move in this day and age. With expectations of a rally next week I expected traders to close short positions Friday afternoon and start bargain hunting before the weekend. Also, the end of the month is when Mutual Funds try to "mark up" their biggest holdings by using recent cash inflows to aggressively buy those stocks all at once. This raises the stock prices and makes them look better on their month end statements. This used to be a quarter end scenario but with competition among funds at a fever pitch for the few meager deposits available it has broadened to a monthly cycle. The question here is "do they have any cash" and is it worth spending that cash if we are going to see new lows soon? My two cents for tomorrow looks like this. I would look for a possible drop at the open followed by an afternoon bounce. I would look to close any short positions on the morning drop and look to go flat or long by the close. The problem with going long is the low ceiling overhead. With the Dow likely to top around 9000 again and the Nasdaq around 1400 there is minimum upside potential. As long as you realize what the possibilities are that is still a decent trade. Just don't expect Dow 10,000 anytime soon. After any post Labor Day bounce I still expect the markets to drift back to levels around Dow 8400 or lower before 9/11. The Put/Call ratio closed at .93 which would normally be positive. Volume is expected to be very light tomorrow which means the morning volatility could be extreme. Enter Very Passively, Exit Very Aggressively! Jim Brown Update on the Editors Play from last Sunday: You should be fully invested on the DJX puts and depending on how you executed the trades you should have an average cost of around $1.40 per contract. The closing price today was $1.95 and the high was $2.40. The initial exit point was profiled at Dow 8100 over the next couple weeks. We are facing the prospect of a bounce on Friday afternoon from a higher level than I expected. I had projected 8400 for Friday with the plan on riding out any post Labor Day bounce and waiting for the lower levels before 9/11. At this point I would want you to be aware that any bounce from our close at 8669 could put us back near 9000 again and make that eventual drop to 8100 less likely. Two things to consider, the bounce may not occur or it may be less than I expect. I am not suggesting that you close the position but I am suggesting that it may decrease in value before we see the next dip. Should we get a decent drop at the open on Friday it might be prudent to close for a profit and reenter on a failed rally on Tue/Wed. Be proactive as a trader and don't let profits slip away if the markets don't follow the plan. ******************** INDEX TRADER SUMMARY ******************** NAS UP, DOW DOWN By Leigh Stevens TRADING ACTIVITY AND OUTLOOK - Everyone seemed to be surprised that the Nasdaq rebounded and the S&P and the Dow were down on the day - well, not by much, as the Dow came back from a triple digit loss. Big deal. Guess there is not much to focus on today as trader's thoughts turned not to possible Boeing or Baseball strikes but those last days at the beach, lake or just outdoors. In techland, Networking and Internet sector strength led the recovery - Net stocks were helped by strong gains in Yahoo (YHOO). The rally was not before the Nasdaq 100 tracking stock, QQQ, met a downside technical objective (to 23) based on the Head & Shoulder's top pattern that formed recently on its hourly chart. Gold stocks rallied, continuing to track the investor anxiety level related to Iraq and the uncertainties related to the ftermath of a U.S. invasion (I almost said a U.S. LED invasion - we wish) and its effect on oil supplies and prices. Volume continued to decline and only totaled 1.16 billion NYSE shares and 1.38 billion on the Nasdaq. Volume should slow even more tomorrow (Friday). The favorite game of the media talking heads is whether this recent rally was a BEAR market rally or a rally that marked the end of the bear market and the beginning of a new BULL market. Hey, who cares as long as there are trading opportunities! I'll just repeat my view that I "trust" an uptrend more once the prior lows have been retested or a correction retraces a half to 2/3rds of the first run up. Technically, we could anticipate a correction developing due to the lackluster volume on the later part of the rally and by the bearish rising wedge chart patterns on the indexes, which forms when there is a narrowing of the difference between succeeding rally highs and downswing lows. Rallies with better technical underpinnings don't tend to do this. S&P 100 Index (OEX) - Daily/Hourly charts: OEX slipped under its 50-day moving average today on the close. Intraday, it also dipped under the pivotal 21-day average but came back by the close. Pivotal resistance, as I've been saying on the Market Monitor today is at the previously broken "neckline" - in at 466 currently. Unless there is a close above this level and further confirmed by a move above 468-470, the chart and technical patterns continue to suggest that the S&P is headed lower, with an objective to the 450 area in OEX based on my Head & Shoulder's (H&S) top objective. I suggest staying short or in puts. S&P 500 Index (SPX) - Hourly chart: As with the 100 stock index, the S&P 500 (SPX) has pivotal resistance at 930, or back to the neckline of its H&S top formation. Absent a close back above 930, I also anticipate the downside objective suggested by the H&S will be met, at a minimum - this implies that SPX will work its way down to the 900 area. The pattern traced out today looks like a bear flag - this is a rebound within a trend that is still pointed LOWER. DJ Industrial Index (1/100 of INDU) - $DJX - Daily/Hourly charts: DJX's downside technical objective is to 85. Objectives based on a Head & Shoulder's (H&S) top are "minimum" suggested targets - this rule of thumb measurement does not imply that the trend, once in motion, will not carry still lower. Sometimes the H&S target is met sometimes it is exceeded. But, when a index or stock traces out the triple dome shaped outline like the charts above, its usually an excellent indication that the buyers have taken prices as high as they are able to given the current fundamentals. On the upside, a close above 87.6 would suggest covering short stock and long DJX put positions - if so, then resistance at the trendline comes in at 89.5, for a bearish re-entry play. Nasdaq 100 Trust Stock (QQQ) Daily/Hourly charts: My projected "minimum" downside objective of 23.00 based on the Head & Shoulder's top was met on the decline within a couple of ticks. Usually, in a situation like this, I will have an order in to buy at 23.05-23.10. My thinking is "situational" - the market is oversold on a short- term basis and on a next even number level like 23.00, the sellers may step away and not look to press the thing further. The buying from short-covering is my competition so to speak. If I am in the index for a trade, I am not going to necessarily wait for my objective to be exactly met, or exceeded. In this case, I think the Q's are going lower than we saw today but I am not looking for more than my approximate trading objective. Note that today's rally reversed at and right after the downside chart gap was "filled in". A downside chart gap being the distance between one day's low and the next day's high. Such spaces or "gaps" often then act as resistance as sellers did not PREVIOUSLY have a chance to sell as high as this area. When they get the chance by a price return to this area, it tends to bring in renewed selling interest. Pivotal resistance is at 24.60, doubly implied by the prior low and by the intersection of the previously broken trendline connecting prior lows - this also being the "neckline" of a Head & Shoulder top formation. A move above 24.6 would suggest that a rally could carry still higher and I would not suggest staying short/long puts in this situation, as I would rather step aside given the risk that a significant rally was developing. Leigh Stevens Chief Market Strategist lstevens@OptionInvestor.com ************************Advertisement************************* Tired of waiting on trades to execute? Does your broker offer Stop Losses on Options? Trade instantly with Stop Losses at PreferredTrade Inc. Stop Losses based on the option price or the stock price. Move your trading into the next millennium with PreferredTrade. Anything else is too slow! http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** **************** MARKET SENTIMENT **************** Lack of Confidence by Steven Price This morning started out with a downgrade of several chip equipment makers. This development seemed to simply pile on the recent slew of IT spending warnings, as UBS Warburg warned that semiconductor production equipment order momentum has gone from slowing to declining. This accompanied an earnings estimate cut for General Electric by Lehman Bros. Lehman cut its 2003 earning's estimate for GE from $1.81 to $1.76. It cited pension income problems, expensing stock options and the negative impact of the firm's aircraft engines and power systems forecast. Another triple digit down day was under way for the Dow. Before we knew it, though, the rally caps were on and we had bounced strongly. The Dow posted a rally of 183.99 from its lows, before finishing down just 23.10 points for the day. The Nasdaq, on the other hand, posted a 50-point turnaround, before settling up 21.39 on the day. The one sector to lag, however, was the semiconductors. The Semiconductor Index (SOX.X), which broke support of 300, trading as low as 293.17, also experienced a rebound, but ended with an increase of only 0.53 on the day, at 304.33. After the bell, Novellus warned that third quarter revenue would come in at $230 million, under previous estimates of $250 million. What was interesting about the company's comments was that it said it saw a small uptick in IT spending. It also said this small increase was not enough to overcome a slowdown in consumer spending. However, it has been quite some time since a company has talked about increased IT spending. It still looks like this will send the semis back under 300, as a warning is still a warning, regardless of the reason. This revelation will be interesting to watch play out. The increase in IT spending is something the industry has been waiting a long time for and is the first bullish sign in a while. The fact that consumer spending is continuing its slowdown, however, could have much larger implications. Consumer spending makes up 2/3 of GDP and with GDP at just 1.1%, a continued slowdown could lead to a contraction in the economy. Tuesday's Consumer Confidence came out lower than expected, which is an indication of consumers' willingness to spend. Friday's University of Michigan Consumer Sentiment will actually give a more recent snapshot of consumers' current state of mind. The Conference Board's Consumer Confidence survey is actually mailed out to 5,000 recipients at the beginning of the month, some who fill it out then, and some who fill it out as the month goes on. Much of the University of Michigan Survey is completed this week. That report, just prior to the long weekend and less than two weeks before the September 11 anniversary, could have great impact. If wee see a surprisingly high number, along with Novellus's comments about an increase in IT spending, we could see a significant rally into the weekend. If not, there could be a sell-off, as investors don't want to stay long over the four days from Friday to Tuesday, knowing volume will pick up after the holiday and any sell-off at that point would probably be much more substantial. Watch for weakness in the semiconductors tomorrow morning, and a reversal of today's Nasdaq gains. That is unless we get some good news from the folks in Michigan. ----------------------------------------------------------------- Market Averages DJIA ($INDU) 52-week High: 10679 52-week Low : 7702 Current : 8670 Moving Averages: (Simple) 10-dma: 8863 50-dma: 8734 200-dma: 9707 S&P 500 ($SPX) 52-week High: 1226 52-week Low : 797 Current : 917 Moving Averages: (Simple) 10-dma: 938 50-dma: 919 200-dma: 1006 Nasdaq-100 ($NDX) 52-week High: 1782 52-week Low : 892 Current : 961 Moving Averages: (Simple) 10-dma: 1002 50-dma: 980 200-dma: 1323 ----------------------------------------------------------------- The Semiconductor Index (SOX.X): After this morning's downgrade of semiconductor equipment makers by UBS Warburg, the group looked poised to take out its recent low of 282.75. However, the Nasdaq rally lifted this group as well. After the bell, however, Novellus warned that revenue would come in 8% below previous guidance. This was blamed on continued weakness in consumer spending, although they saw an uptick in IT spending. This conflicts with UBS's comments about semiconductor production equipment order momentum declining. Guiding lower still is a disappointment and should help push this group back below 300, thus taking some shine off the Nasdaq with it. 52-week High: 657 52-week Low : 282 Current : 304 Moving Averages: (Simple) 10-dma: 337 50-dma: 347 200-dma: 491 ----------------------------------------------------------------- Market Volatility The Market Volatility Index is awfully high for a day in which the Dow was only off by 23 points, and the Nasdaq finished up 21. I sense a lack of confidence in today's bounce, ahead of the long weekend. The VIX seems to be predicting a sell-off, although the high level may be due to today's initial drop. Consumer Sentiment should tip the scales in the morning. We'll see just how many investors are willing to hold long positions into the long weekend with September 11 approaching. CBOE Market Volatility Index (VIX) = 36.32 +0.09 Nasdaq-100 Volatility Index (VXN) = 55.05 +1.53 ----------------------------------------------------------------- Put/Call Ratio Call Volume Put Volume Total 0.92 366,947 339,306 Equity Only 0.75 269,656 203,499 OEX 1.13 18,858 21,264 QQQ 1.17 28,977 33,846 ----------------------------------------------------------------- Bullish Percent Data Current Change Status NYSE 49 + 4 Bull Confirmed NASDAQ-100 52 - 6 Bull Correction DOW 60 + 0 Bull Confirmed S&P 500 58 - 2 Bull Alert S&P 100 57 - 1 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 1.80 10-Day Arms Index 1.33 21-Day Arms Index 1.30 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 they do, they can signal significant market turning points. ----------------------------------------------------------------- Market Internals Advancers Decliners NYSE 1512 1222 NASDAQ 1841 1336 New Highs New Lows NYSE 28 27 NASDAQ 36 96 Volume (in millions) NYSE 1,361 NASDAQ 1,419 ----------------------------------------------------------------- Commitments Of Traders Report: 08/20/02 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 reduced both long and short positions by about 6000 contracts, as can be expected during the end of summer, a notoriously slow time for the markets. The got slightly longer, but by only 500 contracts. Small traders added to positions slightly, with a net short increase of 500 contracts. Commercials Long Short Net % Of OI 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%) 08/20/02 422,100 469,556 (47,456) (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 07/30/02 153,858 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% 08/20/02 156,974 69,071 87,903 38.9% 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 reduced both long and short positions slightly, with 500 more reductions on the short side. Small Traders also reduced slightly on both sides, with a net long reduction of 500 contracts. Commercials Long Short Net % of OI 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%) 08/20/02 41,876 49,461 (7,585) ( 8.3%) 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 07/30/02 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% 08/20/02 11,321 7,980 3,341 17.3% 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 reduced long positions by about 1700 contracts, while adding 1500 to the short side. This led to a reduction of over 3000 contracts from their long positions. Small traders added 1200 to the long side, while reducing shorts by only 200 contracts. This led to a net reduction of 1300 short contracts. Commercials Long Short Net % of OI 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% 08/20/02 21,160 15,349 5,811 15.9% 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 07/30/02 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%) 08/20/02 6,216 8,163 (1,947) (13.5%) Most bearish reading of the year: (8,777) - 10/12/01 Most bullish reading of the year: 1,909 - 1/16/01 ----------------------------------------------------------------- ************************Advertisement************************* ”If you haven’t traded options online – you haven’t really traded options,” claims author Larry Spears in his new compact guide book: “7 Steps to Success – Trading Options Online”. Order today and save 25% (only $15) by clicking on PreferredTrade and clicking on the link to the book on its home page. http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ************************* WEEKLY MANAGER MICROSCOPE ************************* Ken Kam: Marketocracy Masters 100 Fund (MOFQX) This week we're going to look at portfolio manager Ken Kam of the Marketocracy Masters 100 Fund (MOFQX), a broadly diversified and actively managed stock mutual fund seeking capital appreciation. Launched less than a year ago on November 5, 2001, the offering combines Kam's experience and expertise with a proprietary and powerful research tool, called the m100 Index. Ken Kam's m100 Index consists of the current ideas of the best performing virtual investors and funds on the website Marketocracy.com. According to the Marketocracy website, these virtual portfolios are tracked using the same criteria as professional mutual fund managers, and are the best among nearly 50,000 virtual funds on the site. We'll talk a little bit more about the fund strategy and selections of the Marketocracy m100 index later. New ventures are nothing new to Ken Kam. Earlier in his career, Kam was a co-founder and vice president of marketing and finance for Novoste Corporation (Puerto Rico), a medical device company, which was subsequently acquired by NAMIC Corporation. In 1994, Kam was one of the technology industry veterans that started the Silicon Valley-based Firsthand Funds, a fund family devoted to the technology sector. He co-managed the Firsthand Technology Value Fund (TVFQX), the family's first mutual fund, along with Kevin Landis, from May 1994 inception to his September 1999 departure. At the time of Kam's departure, Firsthand Funds had over $1 billion in total assets. Kam took his "firsthand industry experience" and stock-picking philosophy and founded the firm Ingenuity Capital Management, LLC, which is the registered investment advisor of the Marketocracy family of funds. Kam, president of Ingenuity Capital Management, is portfolio manager for two Marketocracy funds: Masters 100 Fund and Medical Specialists Fund. Medical Specialists Fund taps Kam's experience in the medical industry. Kam holds a B.S. degree from Santa Clara University and earned his M.B.A. degree from Stanford University. Investment Overview The Marketocracy website states that its mission is to isolate investment talent wherever it may be. Kam's firm does this by identifying people with "firsthand industry experience" as well as proven investment strategies. By screening more people and portfolios than anyone else, the firm's developing an extensive "farm system" of investors, the website reports, to build their team. Marketocracy Masters 100 Fund (MOFQX) seeks capital appreciation by typically investing in common stocks of domestic and foreign companies of any size. Kam is not constrained by any particular investment style and may tend to own growth stocks, value stocks or both. Morningstar, for example, puts the Masters 100 Fund in its mid-cap growth category (where it landed in 2001), but their portfolio analysis shows the fund recently had a small-cap blend style bias as of March 31, 2002. In security selection, Kam relies principally on the fundamental analysis of the security issuer and its potential for success in light of the firm's financial condition and position in industry and current economic and market conditions. He may also rely on other factors such as growth potential, earnings estimates, firm management, etc. when selecting holdings for the portfolio. As stated earlier, Kam's approach is designed to be flexible and is not constrained by any particular investment style or sector. Here, it starts to get interesting. The website states that Kam expects to select stocks for the Masters 100 Fund based upon the virtual investments of the m100 Index, which typically comprises approximately 1,500 stocks. Kam's firm constantly reviews the track records of nearly 50,000 investors, and the best become their "m100" investors. To find the highest caliber talent/stock pickers, Kam uses technology to churn more data, faster, continuously reevaluating those in the m100 to ensure that the group is comprised of investors that are performing well in today's market, the website states. As Morningstar's report suggests, Masters 100 Fund can and does invest in small and mid-sized companies, which offer more long- term growth potential, but are generally associated with higher volatility. Morningstar's report shows the fund had an average market capitalization of $738 million recently, with roughly a third of the fund's equity stake held in micro-cap stock. The fund's average P/E and P/B ratio of 0.7 (versus S&P 500 index) lands it in Morningstar's small-cap "blend" style box. This fund is unique in terms of its vast diversification. Per Morningstar's report, Kam's fund had 1,207 stock holdings with just 7.7% of assets in the fund's top 10 holdings at March 31, 2002. The fund's largest holding, Newmont Mining, represented only 0.7% of net assets. Such diversification among small-cap and mid-cap funds is pretty rare. The Marketocracy website states that the proof of their success is in the m100's performance to date. In the next section, we see how successful the Masters 100 Fund has proven to be versus the competition. Investment Performance Since December 31, Marketocracy Masters 100 Fund has declined in value by nearly 10 percent, but compared to index benchmarks and growth objective funds, its losses are limited. For the year to date period through August 28, 2002, the S&P 500 index (Vanguard 500 Index Fund) is down around 19.3%, and the Russell 2000 index (Vanguard Small Cap Index Fund) is off by about 19.1%. Below is a summary of selected Morningstar YTD averages, using their data as of August 28, 2002: Average Mid-Cap Blend Fund -15.1% Average Mid-Cap Growth Fund -25.5% Average Small-Cap Blend Fund -14.9% Average Small-Cap Growth Fund -26.7% Since Kam's style has moved from mid-cap growth in 2001 to small- cap blend in 2002, you can measure his 9.97% YTD decline against any one of the category averages above and see that he preserved capital better than his fund peers through the 2002 market slump. His YTD loss of 10.0% ranked in the top 2% of the mid-cap growth category, per Morningstar's category rankings. Since November 2001 inception, the Marketocracy Masters 100 Fund has lost less than 7% for investors. Kam's wide diversification (1,207 stock holdings) and core/growth style had helped the fund avoid being torpedoed, like some other growth objective managers. However, it remains to be seen how well Kam's m100 strategy will perform in the up markets. Over-diversification can limit stock fund returns relative to other growth funds in advancing markets. At 1.95%, Marketocracy Masters 100 Fund's current expense ratio is relatively high. And, it's not going to go down much either as assets grow (near $7 million today) with a management fee of 1.50% of assets included in the expense ratio calculation. The Vanguard Small-Cap Index Fund (NAESX), which tracks the Russell 2000 small-cap index has an expense ratio of just 0.27%. Kam's investment technology, which allows them to track nearly 50,000 virtual investors, is the primary reason for the fund's greater cost of ownership. Conclusion The Marketocracy site and Marketocracy Funds reflect Ken Kam's vision and approach, and they are certainly unique in the fund industry. Kam has shown since inception that he can constrain losses versus less well-diversified growth funds but time will tell how well the m100 strategy fares in the next bull market. Considering Kam's experience and expertise, including a 5-year stint co-managing the Firsthand Technology Value Fund, there's reason to be optimistic. Proponents of "new" funds may wish to have a closer look, but those wishing to see a longer history of fund performance may prefer to look elsewhere. For further information on Kam and Marketocracy Masters 100 Fund, go to funds.marketocracyfunds.com. Steve Wagner Editor, Mutual Investor firstname.lastname@example.org *********************** INDEX TRADER GAME PLANS *********************** THE SECTOR BEAT - 8/29 by Leigh Stevens NEWS & VIEWS - Leading the tech/Nasdaq rebound was the Internet (INX) and Networking (NWX) sectors - Internet stocks gained strength by a sizable gain in Yahoo. Semiconductor stocks ended little changed however - a lid was clamped on any potential rally by downgrades in the group. Shares of Micron Technology (MU) were lower after Morgan Stanley lowered its rating on the chip maker to "underweight" from an "equal weight" on belief that fundamentals relating to DRAM chips have been weak and that prices for them peaked in mid-July. Not that their Analyst was universally negative on the group and in fact reiterated an "attractive view" on the semiconductor industry as valuations were improving. Revenue growth and expanding profit margins are seen "driving the average chip stocks higher over the next 12- to 18 months". I hope I live that long! Guess I'm just not too INVESTMENT oriented these days. I would not chase tech rallies these days and technically, the two sectors rebounding today, are up near the top of their downtrend channels and not far from resistance areas per my chart highlights below. You should now that I am not your typical gold "bug", but I also call em as I see em and the Gold & Silver sector index (XAU) has BROKEN OUT to the upside in a significant way, also per my highlight below. I would be long, not wrong (& short) on this sector. UP (or unchanged) on Tuesday - DOWN (or unchanged) on Tuesday - SECTOR TRADE RECOMMENDATIONS - NEW/OPEN TRADE RECOMMENDATIONS - NONE TRADE LIQUIDATIONS - NONE SECTOR HIGHLIGHTS - Gold & Silver Sector Index ($XAU.X) STOCKS: ABX; AEM; AU; FCX; GOLD; HGMCY; MDG; NEM; PD; PDG; SIL The upside XAU technical breakout was above resistance implied by its 50 and 200-day moving averages as well as its down trendline - all converging. It looks to me that XAU could have a powerful new rally here. I think at minimum the sector index could get back up the 78-80 area. Stay tuned on this one! Make friends with a gold stock and maybe hedge yourself against any "disasters" ahead that tend to drive down the prices of financial assets. Internet Index; CBOE ($INX.X) AMZN; AOL; CHKP; CMGI; CNET; CSCO; DCLK; EBAY; ELNK; EXPE; FMKT; HLTH; HOMS; INKT; INSP; JNPR; OVER; RNWK; TMCS; YHOO Any rally that carries back up the upper boundary of the daily chart downtrend channels in the Internet HOLDR's would be a shorting opportunity - the current area of intersection is around 22. I suggest shorting the stock if HHH trades in this area. Networking Index ($NWX.X) STOCKS: ADCT; ADPT; ALA; AV; BBOX; CIEN; CMVT; COMS; CSCO; EXTR; FIBR; GLW; HLIT; JDSU; JNPR; LU; NT; ONIS; RBAK; RSTN; SBL; SCMR; SONS; TALX; TLAB I have similar short selling advice on the Networking stocks based on what I am seeing in the technical picture here, as NWX is into an area of resistance at its upper trend channel boundary and is showing downward momentum on the 14-day stochastic. Put plays on the stocks in the index that have similar patterns is suggested unless there is a decisive upside penetration of 140 on the NWX Index which would be a bullish technical breakout. Leigh Stevens Chief Market Strategist lstevens@OptionInvestor.com ************************Advertisement************************* If you trade options online, then you need an online broker that: offers true direct access to each option exchange offers stop and stop loss online option orders offers contingent option orders based on the price of the option or stock offers online spread order entry for net debit or credit offers fast option executions PreferredTrade offers these online option trading features and more; call 1-888-889-9178 or click for more information. http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** *********************** SWING TRADER GAME PLANS *********************** Chalk One Up For The Bulls In a remarkable display of bullishness the markets came back from a triple digit loss on horribly bad tech news. At least five brokers downgraded various chip stocks and the sector in general before the bell and stocks ignored the news with the SOX finishing positive for the day. 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. To subscribe you may go to our website at www.OptionInvestor.com and click on "subscribe" to use our secure credit card server or you may simply send an email to "Contact Support" with your credit card information,(number, exp date, name) or you may call us at 303-797-0200 and give us the information over the phone. 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The Option Investor Newsletter Thursday 08-29-2002 Copyright 2002, All rights reserved. 2 of 3 Redistribution in any form strictly prohibited. In Section Two: Dropped Calls: None Dropped Puts: KSS, EBAY Daily Results Call Play Updates: PII, DRI New Calls Plays: PNRA, BRL Put Play Updates: ADI, IBM, GS, MXIM, QLGC, UNH New Put Plays: BJ, UTX **************** 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: ***** KSS $68.89 +0.29 (-2.63 for the week) Kohl's experienced quite a rebound today from its low of $67, which was a break below its 50-dma. After seeing other retailers, such as Home Depot and Wal-Mart finding support at their 50-dmas as well, it appears the sector may be experiencing some consolidation. Rather than wait around while our options decay, we will close this play and look for better opportunities. --- EBAY $57.09 +1.72 (-2.96) EBAY gave us a quick dip down to the $55 area on Wednesday and nimble traders could have booked a quick gain in the play. But they would have needed to get out quickly this morning, as the stock rocketed off that level when the shorts figured out they couldn't press the stock any lower. By the end of amateur hour, EBAY had erased most of the prior day's loss and then gradually worked higher into the closing bell. While our $57.50 stop hasn't been violated yet, today's engulfing candle is a strong bullish sign, and we don't want to get trampled if the bulls decide to stampede higher from here. *********************************************************** DAILY RESULTS *********************************************************** Please view this in COURIER 10 font for alignment ************************************************* CALLS Mon Tue Wed Thu Week BRL 68.30 1.25 -0.47 1.75 1.30 New, Generic pick DRI 26.23 0.21 0.39 0.57 0.50 people gotta eat PII 73.10 0.71 0.39 -1.90 0.90 Hanging in PNRA 29.30 -0.51 -0.66 -0.55 1.84 New, Dough is rising PUTS ADI 24.56 0.53 -0.52 -0.95 0.26 Weak rebound BJ 24.79 -0.18 -0.25 -0.36 0.17 New, more sales less$ EBAY 57.09 -0.94 -2.04 -1.50 1.72 Drop, support at $55 GS 77.38 0.90 -0.65 -1.22 0.30 Resistance above IBM 76.62 -0.98 -1.46 0.06 0.56 No IT spending KSS 68.89 -0.05 -2.12 0.34 0.29 Drop, sympathy 4 WMT MXIM 32.12 -0.01 -2.04 -1.41 0.56 Sector warning QLGC 35.30 0.18 -1.31 -0.56 0.62 Back in channel UNH 87.31 -0.73 -2.12 -1.35 0.76 still sick UTX 58.76 -0.60 0.70 -0.91 –0.53 New, breaking down ************************Advertisement************************* Tired of waiting on trades to execute? Does your broker offer Stop Losses on Options? Trade instantly with Stop Losses at PreferredTrade Inc. Stop Losses based on the option price or the stock price. Move your trading into the next millennium with PreferredTrade. Anything else is too slow! http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ******************** PLAY UPDATES - CALLS ******************** PII $73.10 +0.90 (+0.09 for the week) Polaris has exhibited great relative strength the last few days. Although the stock closed at $72.20 on Wednesday, it rebounded nicely today back over $73 to close at $73.10. While the stock has been experiencing sideways movement, we see this as a positive, as the Dow has given up ground and crashed through support the last couple of days. If there is a rebound, as it appeared there would be today, PII should lead the pack. If not, the stock has shown such strong support since breaking above $70, that the downside to this play seems limited. The stock was profiled on CNBC (after we initiated our long play a couple of days earlier) for its strength in light of a poor economy. One of the reasons behind this may be that PII continues to put out aggressive new product lines that keep the buyers of toys for adults interested. It has led to seventeen straight quarters of earnings growth, including surpassing analysts expectations the last three quarters. As we head into winter, PII's core sales will simply change with the season. After selling plenty of four-wheel ATVs and Personal Watercraft (PWC) during the summer, it is now time for snowmobile purchases heading into wintertime. There is no reason to think a company that has not disappointed in over 4 years, will disappoint this year, as the economy improves and pulls out of last year's recession. --- DRI $26.23 +0.50 (+1.43) The bulls have got to be loving the action in shares of DRI, as the casual dining company has been plowing upwards now for the past 7 days. That is a marked contrast from the rest of the market, which has been heading south this week. Whether consumers are spending more or less, they still appear to have an appetite for eating out and DHI is benefiting from that trend. Yesterday's dip at the open gave us the best entry into the play that we've seen since we began coverage on Tuesday, although the dip back to $25.50 this morning was another possibility. DRI seems to have a habit of dropping in the morning and then recovering in the afternoon, and it was certainly encouraging to see the stock go out tonight at the high of the session. Given the strong performance over the past week, it looks like it could be due for a bout of profit-taking ahead of the weekend, and a push up to the $27 resistance level might be just the catalyst for that occurrence. Use such a move to take some partial profits on existing positions and then look to re-enter on a dip and bounce back down near the bottom of the ascending channel, currently $24.75. Raise stops to $24.50, just below the lower channel line. ************** NEW CALL PLAYS ************** PNRA - Panera Bread Co. - $29.30 +1.84 (0.00 for the week) Company Summary: Panera Bread owns and franchises bakery-cafes under the Panera Bread and Saint Louis Bread Co. names. The company is the leader in the emerging specialty bread/cafe category due to its unique bread combined with a quick, casual dining experience. As previously reported, as of April 20, 2002, 390 Panera Bread bakery-cafes (including one specialty bakery-cafe) were operating in 30 states (117 company-owned and 273 franchised bakery-cafes). (source: company release) Why We Like It: Normally OI would be hesitant to play a stock that had fallen below its 200-dma and not made it back over yet. Unlike most stocks, however, a look at PNRA's chart shows that the 200-dma means little, as the barrier has been crossed on an almost daily basis since late July. The stock released July same store sales today, which saw a 5.3% increase. This is especially promising given the pattern of revenue versus income growth. On August 22, PNRA reported a monstrous 65% increase in second quarter net income, on 43% growth in revenue. So revenue growth is currently contributing more than a 100% correlation to net income. Panera is estimating net income will grow to 0.98/share in 2003, as they plan on opening 115 new bakery-cafe's. On the heels of the sales increase, the company was upgraded from "outperform" to "strong buy" by Raymond James. The stock found PnF support at $28 and remains on a PnF buy signal, in spite of the current column of "O"s. The current bullish vertical count is $50, but the stock will first have to get over resistance at $35. The $35 level has provided resistance on both the daily and PnF charts, but a $6 move to that level would be fine with us. Volume declined as the stock dropped earlier in the week, and then jumped on today's breakout. Today's gain eliminated all of the losses for the week. As volume goes with the trend, the trend appears to have turned up. The stochastics have also turned up from oversold levels and are now giving a buy signal. OI sees the current level as a point to initiate new entries. Conservative traders may want to wait for a pullback to support after today's big rally. Look for that support above $28.00. Place stops at $27.00, just below Wednesday's low. BUY CALL SEP-25*UPA-IE OI= 111 at $4.90 SL=2.50 BUY CALL SEP-30 UPA-IF OI=1200 at $1.35 SL=0.00 BUY CALL OCT-25 UPA-JE OI= 58 at $5.60 SL=2.80 BUY CALL OCT-30 UPA-JF OI= 90 at $2.00 SL=1.00 Average Daily Volume = 807.6 K --- BRL – Barr Laboratories $68.30 +1.30 (-3.12 this week) Company Summary: Barr Laboratories is a pharmaceutical company engaged in the development, manufacture and marketing of generic and proprietary prescription pharmaceuticals. Barr markets approximately 85 pharmaceutical products, representing various dosage strengths and product forms of approximately 35 chemical entities. BRL's product line focuses principally on oncology and female healthcare categories, including hormone replacement and oral contraceptives. The company's Duramed subsidiary develops, manufactures and markets a line of prescription drug products in tablet, capsule and liquid forms. Why We Like It: It has been an interesting week for the generic drug companies, as they have gone on the offensive again. On Monday, the Wall Street Journal reported that generic drug-makers are pushing Congress to pass legislation to make it easier to market generic versions of Biotech drugs. While that news was partially responsible for the beating the Biotechnology sector has taken this week, the benefit to the generics companies hasn't been immediately apparent. For instance, shares of our new play, BRL tipped over with the rest of the market on Monday and fell to just above the $66 level yesterday afternoon. Then even with the Pharmaceutical sector (DRG.X) still on the defensive throughout much of today's action, BRL managed to gain nearly 2% on strong volume (nearly 50% above the ADV). Perhaps the reason for BRL's strength lies in the PnF chart, which is strongly bullish. After bottoming in late July with the rest of the market, the stock ran up to its bearish resistance line and then blasted through that level ($61) earlier this month. The current vertical count is pointing to an eventual target of $84 and the fact that BRL pushed back above its 200-dma ($67.72) today is a good sign for the bulls. Clearly investors haven't lost sight of the fact that the company handily beat analyst estimates when they reported earnings 2 weeks ago. This looks like a bullish trend that we can take advantage of, but given the uncertain broad market climate, we're going to start coverage with a tight stop at $66, which is just below the lows of the past 2 days. A renewed dip down to the $67 area would make for a solid entry, although more cautious investors might want to wait for push back above the 10-dma (currently $69.44). Of course, then we have to contend with resistance at $70, followed by the recent relative highs near $72. That's what makes buying the dips more attractive, as it is easier to control risk. BUY CALL SEP-65*BRL-IM OI=293 at $5.00 SL=3.00 BUY CALL SEP-70 BRL-IN OI=236 at $1.85 SL=1.00 BUY CALL OCT-70 BRL-JN OI=164 at $3.20 SL=1.50 BUY CALL OCT-75 BRL-JO OI= 29 at $1.35 SL=0.75 Average Daily Volume = 594 K ************************Advertisement************************* ”If you haven’t traded options online – you haven’t really traded options,” claims author Larry Spears in his new compact guide book: “7 Steps to Success – Trading Options Online”. Order today and save 25% (only $15) by clicking on PreferredTrade and clicking on the link to the book on its home page. http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ******************* PLAY UPDATES - PUTS ******************* ADI $24.56 +0.26 (-1.40 for the week) There was quite a rebound in the Nasdaq today. Whether it was short covering, or buying ahead of the long weekend, it spread tech wide. While ADI fought back from its low of $23.38, to finish up on the day, it still could not make up Wednesday's losses, and did us the favor of removing support at $24.00. That level has held the stock up toward Wednesday's close, but now does not look so daunting. In fact, a look at the descending channel from the beginning of March has now encompassed the last two days of trading for ADI. Although Nasdaq Composite showed a gain of 21.36 points today, lifting many of the tech stocks, the Semiconductor Sector Index (SOX.X) was unable to hold its gains, managing only a 0.53 increase on the day. This was most likely due to a downgrade by UBS Warburg of four chip equipment makers, which cited the uneven economy and weak orders. The weak order flow reflects an overall lack of IT spending, which directly affects ADI. In the research note, analyst Byron Walker said, "It's all about the economy... Semiconductor production equipment order momentum has gone from slowing to declining." Until the economy heats up, ADI will continue to see weak demand for its processors, which are used in areas as wide as computers to consumer electronics and automotive electronics. We remain bearish on ADI, in spite of the tech rally, as it managed only a 0.26 gain on such a big day for the Nasdaq. --- IBM $76.62 +0.56 (-3.78 for the week) For all the hoopla about today's rally back up from the lows, IBM managed only a 0.56 gain, after yesterday's loss of $1.90. The trend here is still down. This morning's downgrade of four equipment chip makers, due to weak orders and the economy, simply underscores the problems faced by Big Blue and the rest of the techs. Tech spending isn't simply slowing down, it is declining. This sentiment was echoed in Monday's downgrade by Deutsche Bank of three IT service stocks, which is another sector of IBM's business. With the server business shrinking, there is not much good news to keep IBM above its recent levels before the short covering rally inflated its price. The downturn in business has led the company to cut 15,000 workers, and until we see an increase in IT spending, or at least stabilization, IBM should suffer along with the rest. The difference here is that IBM has more to give back. While the stock rebounded from just over $75, this level of support should be only psychological, as the first real level of support should be closer to $74. We are staying short on IBM and have lowered our stop loss to $78.00 to lock in profits on the play in case of a Dow rebound heading into the long weekend. --- GS $77.38 +0.30 (-0.13) As expected, the Brokerage sector (XBD.X) has continued to weaken this week, and the important $408 support level gave way yesterday in the market-wide selloff. It was interesting to see the XBD fall below $400 this morning, only to rally back pretty strongly. This could be just an oversold bounce, as the index rebounded right from the converged 20-dma ($395.51) and 50-dma ($394.09), as the bulls didn't have enough conviction (or volume) to push back through the $408 level. GS traded much the same as its sector, breaking down under the $76 level this morning, only to rebound strongly to actually end the day with a fractional gain. But it is interesting that the $77.75 level (prior support) is now acting as resistance. Both GS and the XBD index look like they are in the bears' grip, and that means we should still be able to use failed rallies as new entry points. Target new entries on a rollover near today's highs to as high as the bottom of Wednesday's gap at $78.30. Take note of the fact that our stop has now moved down to $78.50. --- MXIM $32.12 +0.56 (-3.41) Following the bearish comments from Intel's CEO on Tuesday, the Semiconductor index (SOX.X) has been hit by a series of analyst downgrades and negative comments. That downward pressure drove the SOX back down to below the $300 level this morning before the bulls stepped back into the fray. MXIM dropped below $31 early in the day before battling back to above $32 at the close. That rebound looks like it may have run its course, especially in light of the NVLS mid-quarter update this evening, which pointed to the company coming up light on both revenues and earnings. Of course, this news may have already been factored into the market, and we'll have to wait to see how it is greeted when the markets open tomorrow. MXIM could be trying to put in a bottom here, so we want to be careful with new positions, particularly if the SOX is able to stay above the $300 level. New positions can be considered on another failed rally below our $34 stop, but only if the SOX is once again showing signs of weakness. Use a drop near the $30 to at least take partial profits on open positions. --- QLGC $35.30 +0.62 (-1.30) QLGC has given us a nice ride this week, falling down to the $34 area, as the stock has been pressured by the persistent weakness of the Semiconductor sector (SOX.X). The technical rebound off the $300 level this morning didn't have much conviction, and the SOX ended the day essentially unchanged. QLGC actually fared a bit better, posting a 1.8% gain for the day. The stock came to rest right at the bottom of yesterday's gap, so the near term direction is still up for grabs. A rollover below $36 (the top of the gap and the site of our stop) can still be used for initiating new positions, but we need to closely monitor the action in the SOX. If it manages to hold support near the $300 level and recover from there, then QLGC will likely work higher in sympathy with the group. Fade any failed rally, but keep those stops in place. --- UNH $87.31 +0.76 (-2.93) Following its rollover at the descending trendline, UNH took another hit to the downside yesterday, falling below the 20-dma ($87.96). Despite the sharp drop in the broad markets this morning, UNH pulled itself up and staged a gradual advance back up near the $88 level by midday. Then the bulls lost their momentum, the stock fell back near $86.25 and then rallied in the afternoon. In the end, UNH posted a fractional gain on the day, but couldn't overcome resistance at the 20-dma. See what happens in the dog days of August? With daily Stochastics still pointing down and the HMO index still pinned under its own 20-dma, it still looks like the bears are in charge. So we can continue to target new entries on failed rallies, ideally below the $88 level, but possibly as high $90, the site of the descending trendline. Make sure to confirm weakness in the HMO index before playing and keep stops in place at $91.50. ************* NEW PUT PLAYS ************* BJ - BJ's Wholesale Club - $24.79 -0.03 (-1.46 for the week) Company Summary: BJ's Wholesale Club, Inc. introduced the wholesale club format to New England in 1984 and has since expanded to become a leading warehouse club in the eastern United States. BJ's currently operates 138 clubs in sixteen states. Why We Like It: While retailers such as Wal-Mart and Home Depot have found recent support from their 50 day moving averages, BJ has had no such luck. It hasn't approached that level since the end of May and does not appear headed in that direction any time soon. Each stochastic buy signal since its gap down on Aug 8 has quickly been reversed, as the stock has seen very little green. BJ released earnings on August 20, which showed a sales increase of 14%. The problem with this increase is that it resulted in an earnings per share decline. Not exactly a winning formula. The decrease was attributed to a shift to lower margin items and increased competition. While these results met current expectations, it was only after BJ's had cut its estimates earlier in the month. Its previous guidance had been 52 to 54 cents. On August 21, UBS Warburg downgraded the stock from a buy to a hold and Morgan Stanley cut the eventual price target from $60 to $40. On Tuesday Merrill Lynch cut BJ, along with 15 other retailers. It said, "Retail sales have deteriorated sharply since early July," Merrill Lynch said. "Our concern is that the resiliency of general merchandise sales over the past two years may be cracking. In addition to a possible slowing economy, sales momentum in the second half will be pressured by forecasted poor fall weather, 9/11 anniversary disruptions, and six fewer Christmas shopping days." Today's low of $24.25 was BJ's lowest level since March 1999. It also traded below August 14 low of $24.50. After the recent gap, BJ made an attempt to close, but didn't come close before continuing its descent. OI sees the current level as a short entry point. Conservative traders may want to wait for a break below today's low. Place stops at $27, above the high of August 26, just before BJ's most recent gap. BUY PUT SEP-25*BJ-UE OI= 94 at $1.50 SL=0.75 BUY PUT OCT-25 BJ-VE OI=259 at $1.95 SL=1.00 Average Daily Volume = 1.01 mil --- UTX – United Technologies Corp. $58.76 -0.53 (-1.72 this week) Company Summary: As a diversified manufacturing company, UTX has four principal operating segments: Otis (elevators and escalators), Carrier (heating, ventilation and air conditioning systems), Pratt & Whitney (aircraft engines and space propulsion), Flight Systems (helicopter electrical systems). Between the Pratt & Whitney and Flight Systems divisions, UTX participates in virtually all aspects of the design and manufacture of aircraft propulsion systems, from engines and their associated flight controls to auxiliary power units, compressors and instrumentation. Why We Like It: Don't look now, but the pending machinist strike at Boeing could have more far reaching effects than an impairment of that company's bottom line. If there is a strike, that will bring production to a screeching halt, meaning that the company won't need to purchase parts from its suppliers. UTX is integrally involved in providing numerous parts for commercial aircraft production, and judging by the stock's recent price action, investors are already starting to factor in the likelihood of a strike. The stock's recent rollover from the $63 level represented the 3rd lower high since the broad market rebounded from its late-July lows. But the really important development is that UTX broke the $58 support level on an intraday basis, generating a descending Triple-bottom breakdown on the PnF chart. The PnF chart was already on a sell signal with a bearish price target of $48, and today's action just reinforces the stock's weakness. Intraday resistance near $59 kept the bulls at bay on Thursday, and then we have even stronger resistance in the $60-61 area. Any failed rally at either of those levels can be used to initiate new bearish positions. Alternatively, look to enter the play on a breakdown under the $57 level, just below Thursday's intraday low. Initial stops are set at $61. BUY PUT SEP-60*UTX-UL OI=1835 at $3.50 SL=1.75 BUY PUT SEP-55 UTX-UK OI=2020 at $1.65 SL=0.75 Average Daily Volume = 2.93 mln ************************Advertisement************************* If you trade options online, then you need an online broker that: offers true direct access to each option exchange offers stop and stop loss online option orders offers contingent option orders based on the price of the option or stock offers online spread order entry for net debit or credit offers fast option executions PreferredTrade offers these online option trading features and more; call 1-888-889-9178 or click for more information. http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ********** 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 Thursday 08-29-2002 Copyright 2002, All rights reserved. 3 of 3 Redistribution in any form strictly prohibited. In Section Three: Play of the Day: PUT - UTX Traders Corner: Electrifying Traders Corner: Pattern recognition - Reversal patterns: Wedges Options 101: Probability, Empirical Evidence, and Wives Tales ********************* PLAY OF THE DAY - PUT ********************* UTX – United Technologies Corp. $58.76 -0.53 (-1.72 this week) Company Summary: As a diversified manufacturing company, UTX has four principal operating segments: Otis (elevators and escalators), Carrier (heating, ventilation and air conditioning systems), Pratt & Whitney (aircraft engines and space propulsion), Flight Systems (helicopter electrical systems). Between the Pratt & Whitney and Flight Systems divisions, UTX participates in virtually all aspects of the design and manufacture of aircraft propulsion systems, from engines and their associated flight controls to auxiliary power units, compressors and instrumentation. Why we like it: Don't look now, but the pending machinist strike at Boeing could have more far reaching effects than an impairment of that company's bottom line. If there is a strike, that will bring production to a screeching halt, meaning that the company won't need to purchase parts from its suppliers. UTX is integrally involved in providing numerous parts for commercial aircraft production, and judging by the stock's recent price action, investors are already starting to factor in the likelihood of a strike. The stock's recent rollover from the $63 level represented the 3rd lower high since the broad market rebounded from its late-July lows. But the really important development is that UTX broke the $58 support level on an intraday basis, generating a descending Triple-bottom breakdown on the PnF chart. The PnF chart was already on a sell signal with a bearish price target of $48, and today's action just reinforces the stock's weakness. Intraday resistance near $59 kept the bulls at bay on Thursday, and then we have even stronger resistance in the $60-61 area. Any failed rally at either of those levels can be used to initiate new bearish positions. Alternatively, look to enter the play on a breakdown under the $57 level, just below Thursday's intraday low. Initial stops are set at $61. BUY PUT SEP-60*UTX-UL OI=1835 at $3.50 SL=1.75 BUY PUT SEP-55 UTX-UK OI=2020 at $1.65 SL=0.75 Average Daily Volume = 2.93 mln ************************Advertisement************************* Tired of waiting on trades to execute? Does your broker offer Stop Losses on Options? Trade instantly with Stop Losses at PreferredTrade Inc. Stop Losses based on the option price or the stock price. Move your trading into the next millennium with PreferredTrade. Anything else is too slow! http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ************** TRADERS CORNER ************** Electrifying By John Seckinger jseckinger@OptionInvestor.com The Dow Jones Utility Average (UTY) might be the youngest of the three Dow Jones Averages, having made its debut in January 1929; however, this is one Index equity traders should pay close attention to. The other is Oil. In theory, a rise in utility stock prices indicates investors anticipate falling interest rates, since utility companies are big borrowers and their profits are enhanced by lower interest costs. Conversely, the utility average tends to decline when investors expect rising interest rates. Due to the Index’s interest- rate sensitivity, the utility average is regarded by many as a leading indicator for the stock market as a whole. The Utility Sector is a capitalization-weighted index composed of 19 geographically diverse public utility stocks listed on the New York Stock Exchange. Utility stocks have traditionally provided a haven for investors who fear recession and unstable returns on other investments as they tend to pay high cash dividends, a portion of which may be tax-exempt. Utility stocks differ from other industry groups not only in how they perform, but also in how they react to market conditions. The UTY was set to an initial value of 200 on May 1, 1987. Originally, the utility average started with 18 stocks, and six months later, on July 1, 1929, the number was increased to 20. The average was than reduced to 15 stocks on June 2, 1938. Unlike the industrial average, which has undergone more than 100 changes in its nearly 104 years, the utility average has been relatively unaltered. Most of the changes in recent years are the result of mergers and acquisitions. The Dow Jones Utility Average is a price-weighted index. Components of the Dow Jones Utility Average (UTY) Company Name Ticker Symbol ------------------------------------------------------- Ameren Corporation AEE American Electric Power Co. Inc. AEP Consolidated Edison Co. of N.Y. ED Dominion Resources D DTE Energy Company DTE Duke Energy Corp. DUK Edison International Inc. EIX Entergy Corp. ETR Firstenergy Corp. FE FPL Group Inc. FPL Niagara Mohawk Power Corp. NMK Northeast Utilities NU PECO Energy Company PE PG&E Corp. PCG Public Services Enterprise Group Inc. PEG Reliant Energy REI Southern Co. SO Texas Utilities Co. TXU Unicom Corp. UCM With regards to the Dow Utilities as a leading indicator of equities, the correlations have become somewhat obvious since 1972. In November of that year, the utilities peaked a few months before the Dow and then also forming a bottom just before the Dow 10 months later. Moreover, the utilities peaked in the beginning of 1981, while the blue chips formed a high only three months later. These similarities continued in 1982, with both averages bottoming and rallying together until August 1987. Research found in Technical Trends by John G. McGinley, Jr. has shown that the Dow Utilities has led the Dow Jones at every peak since 1960 with only a few exceptions (most notably the 1977 peak). When looking at lead times, on average the Utility Index peaks three months prior, with a variance of one to ten months. Before we turn to the illustrations, let us take a quick look at the Oil Sector, since this Index seems to fit nicely with both the Utility Index and the Dow. Theory holds that higher oil prices become inflationary; thus having negative implications on the Dow. However, it is my opinion that, just like with Fed hikes, the Dow can trade in step with higher oil prices for quite some time before inflation gets out of control. The Index in focus will be the Amex Oil Index (XOI), a price-weighted index comprised of companies involved in the exploration, production, and development of petroleum. The XOI Index was established with a benchmark value of 125.00 on August 27, 1984. Index Components Company Name Ticker Symbol Index Weighting -------------------------------- ---------------------------------- ChevronTexaco Corporation CHX 12.58% Amerada Hess Corporation AHC 11.93% Total Fina SA TOT 11.75% Phillips Petroleum Corporation P 8.35% BP Amoco PLC BP 7.90% Kerr-McGee Corporation KMG 7.84% Royal Dutch Petroleum Co. RD 7.51% Exxon Mobil Corporation XOM 5.94% Sun Company Inc. SUN 5.90% Unocal Corporation UCL 5.47% Occidental Petroleum Corporation OXY 4.78% USX-Marathon Group MRO 4.03% Conoco Inc. COC 3.90% Repsol REP 2.12% Looking at illustrations of the Utility, Oil, and Dow Index, there are some striking similarities. Note that all three set a relative low around March 12th, 2000 with the Oil Index actually leading by a few weeks. Then, on May 20th 2001 all three indices set a significant relative high together. Continuing the similarities, all three indices found a relative low around the week of September 24th, 2001. Moreover, during March and April of 2002 all three indices formed yet another relative high, this time with the Dow barely beating out the Oil Index for the lead role. Not surprisingly, both the Oil Index and Dow Jones Industrial Average set a relative low during the week of July 21st, 2002; beating out the Utility Index once more. Are we seeing a pattern yet? To me, this is more than just a coincidence. Going forward, traders should put both the Oil Index (XOI.X) and the Utility Index (UTY.X) right in the middle of their radar screen. Other interesting notes include only the Utility Sector not indicating a Bearish Divergence within the Relative Strength Indicator. Of course, the next time these three indicators test previous relative highs, one of the first things to look for should be a higher RSI reading out of the Utility Sector. Why include the retracement analysis? It is interesting that both the Dow and Utility Index used the retracement levels as support or resistance; however, the Oil Index did not. Furthermore, the Dow and Utility Index seemed to give the most weight to the 61.8 retracement level. Something to remember down the road. Even combining the Traders Corner article on Dollar, Bonds, Commodities, and Equities with this one does not produce the Holy Grail to trading. What I try to do is wait until all indicators line up before putting on a sizable position. During other times, I either look for a sector that needs to “catch up” or one that is leading the way. Chart of the Utility Sector Index, Weekly Chart of the Dow Jones Industrial Average, Weekly Chart of the Oil Index, Weekly ************** TRADERS CORNER ************** Pattern recognition - Reversal patterns: Wedges By Leigh Stevens lstevens@OptionInvestor.com REVERSAL PATTERNS - While I have not exhausted all possible types of "continuation" patterns in recent articles, I covered the most common ones. The opposite of patterns that tend to predict the continuation of a trend, after a pause or consolidation, are ones that tend to predict upcoming reversals of the dominant trend. Of these, very well known are double and triple tops and bottoms, and Head and Shoulder's tops and bottoms. One seen less often but that is predictive for a bottom or top are "wedge" patterns. The wedges patterns of a "rising" bearish type are usually seen after an uptrend has been underway for a while, but more often in an intermediate to long-term up trend is well developed. However, in the current market environment, while the indices are not far off a multiyear low, a number of individual stocks and stock indexes have traced out bearish rising wedges - so, a discussion of this chart pattern is topical in the current market. And, this current situation illustrates that sometimes a wedge formation will suggest a potential trend reversal even before the emerging trend has gone on very long; e.g., more than a month. BULLISH FALLING WEDGES AND BEARISH RISING WEDGES - In a rising wedge, prices move gradually higher but in converging trendlines or a "narrowing in" pattern of higher highs and lower lows formed such as seen in the rising wedge pattern in recent daily chart of DJX below: There is a "measuring" rule of thumb for a downside objective also - prices should decline to the start of the formation, or the lowest low as a "minimum" downside objective. To create a wedge, there should be at least 2-3 upswing highs and downswing lows that comprise the points through which the trendlines are drawn -- there typically are more points than this minimum number for drawing the two converging lines. A wedge pattern can also form over a lengthily period such as shown below of a two year time frame. What is being suggested in the rising, bearish wedge is that buying is being met with stronger and stronger selling as prices edge higher. When prices fall below the lower up trendline that of a rising wedge pattern, a trend reversal is suggested – prices may rebound to the trendline again, but should not get back above it. Place a liquidating buy stop just above the broken trendline, if a short position is established on the downside break. When one index has a bearish rising wedge, its likely that you may see the pattern in related indices - the first chart was of the Dow, the chart below is of the same period in the S&P 500 (SPX). The same wedge pattern was showing up as you might expect in individual stock charts. In the case of Cisco Systems (CSCO) below, we have more technical indicators to "confirm" a likely top - there was a double top that formed around $15, the stock was overbought and most importantly, volume was FALLING as prices were RISING - this was a classic price/volume bearish divergence. Taken all together a short position or put play in CSCO looked like a high probability bearish play. A declining or falling wedge is typically a bullish pattern as it suggests that selling is being met with increasing buying. Eventually, this sets the stage for an upside reversal as can be seen in our next chart. There is an expectation that prices will at least rebound back to the high point seen in the downward sloping wedge; i.e., the highest high. According to Thomas Bulkowski in his Encyclopedia of Chart Patterns, an even higher percent of bullish falling wedges result in upside breakouts, versus bearish rising wedges. The foregoing suggests being ready to buy an upside breakout of the declining wedge as soon as it occurs. One tactic is that of ongoing downward adjustments of a buy stop order so that it remains just above the upper downtrend line -- this way a position can be taken in the market or particular item as soon as prices achieve a decisive upside penetration above the falling wedge. Liquidating stops are then placed just below the trendline that was penetrated to the upside, as there should be no further return to below this line, especially on a closing basis without suggesting a pattern failure. *********** OPTIONS 101 *********** Probability, Empirical Evidence, and Wives Tales Buzz Lynn buzz@OptionInvestor.com Ever heard of the Hirsch Organization? They are the folks that publish the Stock Traders Almanac, a great publication chock full of historical information and market statistics. From a recent Forbes article, I learned that in the current issue of the Almanac Investor newsletter, Jeffrey Hirsch noted that September has historically been bad for stocks. "When portfolio managers get back from the Hamptons after Labor Day, they tend to clean house. It has been the worst month of the year since 1971 for the Dow, S&P and NASDAQ, averaging monthly losses of 1.3%, 1.0% and 0.8%, respectively," writes Hirsch. "Basically, avoiding September can be beneficial to your portfolio." But that's a coin toss at best. According to the Forbes piece, The Almanac also suggests that the September-to-January period is a good time to be invested in pharmaceutical, consumer and telecom stocks, and recommends buying exchange-traded funds in each of these sectors. Again, repeating the Forbes article, the Almanac Investor recommends Pharmaceutical HOLDRS (amex: PPH) and Dow Jones Healthcare iShares (amex: IYH) in pharmaceuticals; in consumer issues, it flogs Consumer SPDRs (amex: XLY) or iShares Dow Jones Consumer Cyclical (amex: IYC) or Non-Cyclical (amex: IYK); in telecom, it suggests to go for Telecom HOLDRS (amex: TTH) or Telecom iShares (amex: IYZ). How about semiconductor stocks? Avoid them, as September has been a historically bad month for them. Seems market history is all about seasonal timing. The Forbes article also goes on to point out, "Sy Harding of Street Smart Report, uses what he calls his 'Seasonal Timing Strategy' which says to exit the market on the 4th trading day of May and to buy back in on the second to last trading day of October. Harding uses MACD to confirm his entry and exit points so that he doesn't sell a rising trend or buy into a declining one. As far as this particular September goes, Harding is mixed. He believes the 'bear market rally' could extend another two weeks, but that by the fall, markets will retest the July 23 low." Want more? Quoted again in Forbes, "James Dines, editor of the Dines Letter, puts at least some stock in seasonality. Dines turned from bull to bear last week based on what he sees as too much bullishness as well as data showing that, since 1961, down Septembers outnumber up Septembers by 2-to-1. Dines also makes an interesting observation about Labor Day: 'If the market declines in the four-day week following Labor Day, one should postpone buying for one month. It worked splendidly in 1994, 1998, 1999, 2000 and 2001, when postponed buying provided buyers with prices near the bottom in all five Octobers. On the other hand, if there is a gain in that four-day week, buy because the market will probably keep going higher.'" Interesting observation to which I'll pay attention beginning next Tuesday. Conversely, Forbes wraps it up with the following contrary opinion: "Marvin Appel at Systems and Forecasts dismisses the importance of September's bad rap. 'To the extent that seasonality matters, you make 1% less in September,' says Appel. 'When markets swing 2% to 3% a day, this doesn't seem significant.' Appel is bullish and sees the broader markets gaining another 10% through the end of the year." Confused yet? Don't be. On a statistical basis (Come to think of it, Mark Twain had a great opinion on statistics. "There are three kinds of lies: lies, damned lies, and statistics.") there is the probability to be correct a greater percentage of the time. However, getting caught in the statistical minority will land us in the poor house with the wrong bet or too large a bet. Again, the only lesson I take from this is to acknowledge the statistics but don't wrap your trade in statistical dogma. Sometimes, we are going to wrong. It's the nature of the game. Better to cut our losses if we are wrong and wait for a better trade. In that regard, trading is just like baseball. We wait for the right pitch before taking a swing. Whiffing a trade is a lot more financially painful than whiffing a baseball for a strike. But as Warren Buffet points out, there are no "balls" and no penalties in refraining from swinging at a lousy pitch. Where am I going with this? To dinner, of course. Please pass the crow and help me get my foot out of my mouth. Seems that last weeks expectation that the market would remain temporarily bullish was flawed. It's pretty difficult to demonstrate bullishness when the S&P 500 fell from 962 to 917 in one week. While I pointed out that the stochastic was due to fall (it did) and the candles ought to theoretically fall to support lines (they did, and then some), my stochastic timing and candle lengths were off. I was anticipating that the next bullish trade would come when stochastics bottomed in harmony with candles hitting support lines. I missed that by a long shot. While there was money to be made on Monday when the SPX bounced at 930 (direct hit!) all the way to 950, 950 proved unsustainable, from which the index fell for the rest of the week. Can I still hold the notion that we're seeing a temporary bull within a primary bear, a.k.a. bear market rally? Maybe. But the greater weakness than expected certainly caught me off guard. The markets were failing to catch a bid. Perhaps we could dismiss this as just the market falling under its own weight from lack of buyers, as many seem anxious to start the holiday weekend early. Lack of volume would seem to confirm that. However, I was uneasy about the pickup in selling volume yesterday compared to buying volume. Overall, the rally seen since July's lows has been "eyebrow raisingly" low. That is not the stuff of sustainable bullish movement, and in no way represents the beginning of a secular bull market. So what now? Do we stick with the cyclical bull theory within the secular bear market? Or did July's rise not even count telling us that the market merely encountered a short-lived relief rally? I don't have the answer. But Consider this. Richard Russell, 78-year-old grizzled market veteran of 60 +/- years, and publisher of the Dow Theory Letters since 1958, notes that corrections happen in much faster timeframes than the primary trend. Thus, if it took from March through July -four months - for the Dow to sink from its high to new lows, but shot upward for a 50% recovery in just one month, we're still in a secular bear market. The rate of market recovery from the lows came twice as fast as the decline. Ergo. . .bear market. That said, we must not trust bullish moves to last long, or at least until they last longer than market declines. On the other hand, what if we cheat a little bit and engage in some rearview mirror analysis of the tealeaves, err, I mean charts? Can a case still be made for a bit more endurance of the erstwhile cyclical bull? I mean, if volumes are low, shouldn't the return of vacationers next week pop the markets out of this week's funk? That will happen, right? Charts please! S&P 500 daily chart Here's to the power of "fitting" trendlines to market action that has already occurred. I sometimes wish I'd never learned that from Jeff Bailey, as it has given me, and I'm sure many other traders, and excuse to stick with a trade when our expected trendlines or retracements, or averages didn't pan out as we originally thought. The fact is, it's a great tool that opens our eyes to other factors that our biased eyes would not see in the heat of battle. It helps for "next time". So what can we learn here? Maybe our red trendlines we drew last week were off. Well, yesterday, SPX bounced (barely) at the horizontal trend line, a line for former resistance. Since it held, I considered giving myself another chance to be correct with a bullish trend. After all, I wasn't completely wrong. . .yet. But I did note the close under the 50-dma (magenta line), which is no pillar of strength. Then again, the 5-period stochastic was nearly oversold. "Will it bounce?" goes through my head. Better yet, how about I just redraw my trendline to "fit" the current action. Yeah, that's it. Forget the wick at July's low and just connect the body of the candles (solid blue line)! How about that! A perfect fit at today's low almost exactly at 10 a.m. ET! (Remember, today's candle that is now a doji was long and red at that moment in time.) Maybe that will hold as support and the new, blue trendline is really more valuable under the current circumstances than the old, red one. Anyway, at this moment, it really seems to fit better. That new trendline may actually be pivotal buy program entry for a number of large traders. It would certainly explain why the whole market caught a bid at that time. I might also now note that the candle now rests right at its 50 dma as of today's close, which may provide support, as the stochastic is nearing oversold. Perhaps I'll be safe remaining cyclically bullish at this level. Still, the other side of the stochastic coin is that it has not hit oversold yet, is still in fairly steep decline, and buyers are gone on an early vacation. I'm not likely going to see my bullish trade make "huge coinage" tomorrow. Alright, so I justified staying bullish based on the blue trend line. But I still have an itchy trigger finger. That was my line of last resort and I have no other possible bullish lines to "fit". While I can create lines to fit candles, I have to stop short of creating candles to justify my lines! If that ever happens, we'll begin publishing the until now secret "Hallucination Trader (.com)"! The dominant financial news media already has plenty of analyst material available to make it a rousing success. All kidding aside, to be blunt, I have no idea if the bulls can grab the ball back from here and move the candles up from here for another stochastic run up the daily chart. It is certainly possible based on the new trendline and support at the 50-dma. On the other hand, that support line could fall under its own weight, which would be decidedly bearish and would keep the stochastic pointed down. That will be a technical violation that I think would hinder recovery. Still, I can't put much faith in the move in either direction as long as absent players keep the volume low. From all this, the only conclusion I can draw is that I won't see the pitch I'm looking for tomorrow. So I'll likely sit out of tomorrow's action - remember, no penalties for failing to swing at bad pitches. A friendly reminder that probability, empirical evidence, and wives tales are never an exact science. Make a great weekend for yourselves. See you next week! ************************Advertisement************************* ”If you haven’t traded options online – you haven’t really traded options,” claims author Larry Spears in his new compact guide book: “7 Steps to Success – Trading Options Online”. 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