The Option Investor Newsletter Thursday 09-12-2002 Copyright 2002, All rights reserved. 1 of 3 Redistribution in any form strictly prohibited. In Section One: Wrap: Bullish Sentiment Suffocating Index Trader Wrap: A little air was let out of the balloon Market Sentiment: Still On the Sidelines Weekly Manager Microscope: Eric Kobren: Kobren Growth (KOGRX) Updated on the site tonight: Swing Trader Game Plan: Chips, Ships, VIPS, Dips Posted online for subscribers at http://www.OptionInvestor.com ************************************************************ MARKET WRAP (view in courier font for table alignment) ************************************************************ 09-12-2002 High Low Volume Advance/Decline DJIA 8379.41 – 201.76 8574.94 8359.09 1.18 bln 885/2332 NASDAQ 1305.72 – 35.77 1305.72 1279.09 1.17 bln 1034/2112 S&P 100 443.23 - 12.18 454.80 442.06 Totals 1919/4444 S&P 500 886.91 – 22.54 909.45 884.84 RUS 2000 386.27 – 7.10 393.37 386.19 DJ TRANS 2253.27 – 44.05 2298.86 2245.57 VIX 40.72 + 9.37 41.07 39.09 VXN 56.44 + 2.44 56.85 54.05 Total Vol 2,2357 Total UpVol 298 Total DnVol 2015 52wk Highs 61 52wk Lows 155 TRIN 2.85 PUT/CALL 0.23 ************************************************************ Bullish Sentiment Suffocating By John Seckinger During trading on Wednesday, the Dow appeared intent on breaking above 8800 and closing above its 50 DMA, currently at 8744. Just one day later, sentiment takes a turn for the worse as selling pressure intensifies and bulls run to the sidelines. It all started on Thursday with a troubling Initial Claims report for the week of September 7th, rising 17,000 to 426,000 and placing this highly-watched indicator at its highest weekly reading since April 20th. This is the third week above 400k and a continued rise could begin to seriously affect the labor market going forward. The shortened Labor Day holiday work week could have been responsible for volatility within Thursday's report; however, the more reliable four-week moving average rose and diluted any possibility for a bullish spin. This labor report seemed to be the catalyst for traders rushing into US Treasuries and selling equity positions in order to raise cash. It wasn’t much longer when equity holders had to deal with more bad news. This time it was a report on the current account, rising a staggering 15.6% in the 2Q to a record 129.96 billion. As the report was read, fixed income traders began selling the US dollar and seeking bonds as a safe haven. Analysts commented later in the day that the deficit is unsustainable and poses a risk to the U.S. and global economic outlook. Analysts made it clear that negative implications if such a deficit continues include the dollar plunging. What else did bullish traders have to contend with on Thursday? Former CEO of Tyco, Dennis Kozlowski, and others likely to face criminal charges due to millions received in unauthorized compensation. Shares of TYC fell fractionally, closing at 17.79 and still above both its 22 and 50 DMA’s. The saving grace may have been JPM organ upgrading the company to “buy” before the day’s session got underway. More impacting news included Lehman cutting their 2003 forecast for revenue growth in the Semiconductor Equipment industry to 10-15 percent from their previous forecast of 27 percent. Also significant was shares of AOL falling 6 percent and closing under its 22 DMA, following Goldman Sachs cutting their EBITA estimates on the company due to unresolved issues. AOL is in the process of creating a less top-heavy management structure, as well as dismantling its business affairs unit. AOL’s business affairs unit is currently getting Federal attention due to opaque accounting practices by the division. Possibly as early as Friday morning, AOL might make the headlines of the Wall Street Journal. This will most likely be a headline the company would rather not see. Expected in the story are the aforementioned issues as well as AOL’s cash flow expected to increase by only 2 percent instead of the 5-9 percent forecast by the company. Continuing the theme of bellwether companies, shares of McDonalds (MCD) fell almost five percent on Thursday following cautious comments from Goldman Sachs. Inside the comments was skepticism over the company’s quality and service initiatives; most likely reducing earnings growth in the near term. How does McDonald’s five-percent loss and new multi-year low rank with other issues inside the Dow Jones? The company gets a bronze medal for worst session. See chart below. Disclaimers: I do not like rumors, especially when it has to do with a company such as IBM. Nevertheless, shares did fall 3 percent to 71.87 and was recently a successful put play for the OI team (which includes myself). Therefore, to the rumor we go: Speculation that the company will lower their guidance for the near future. Defending the company was Soundview, noting that IBM has no way of knowing this early if the quarter will fall short of expectations. Also explained by Soundview was that both the CFO and head of Investor Relations are out of the country. Sound convincing? Squarely on traders’ minds as the trading session took hold was both President Bush’s speech to the UN General Assembly and Alan Greenspan’s talk before the House Budget Committee. President Bush said that “action will be unavoidable” against Iraq unless the U.N. takes a hard line forcing Baghdad to disarm. Overall, the speech appeared to be uninspiring to equity holders and the current selling pressure continued. Fed Chairman Alan Greenspan made it clear before the House Budget Committee that Congress needs to be more vigilant with fiscal discipline. His speech was focused almost entirely on the budget outlook and need to reenact spending restraint measures enacted back in 1990. These measures expire on September 30th. After all of that, should any trader in their right mind be bullish? As losers outnumbered winners by a ratio of roughly 3:1 on the NYSE, the 201.76 point loss to 8379.41 might just be a sign of exhaustive selling. Therefore, Friday could be a victory for the bulls. Volume came in at a light 1.1 billion for both the Big Board and Nasdaq. Speaking of other indices, the tech-laden Nasdaq lost 35.77 points, or 2.72 percent, to 1279.68, the S&P 500 shed 22.54 points, or 2.48 percent, to 886.91, and the Nasdaq-100 (QQQ) fell 2.72 percent to close at 22.81. Chart of Dow Jones Industrial Average Index, Daily As the chart shows, price action on Friday might have some serious implications for traders wanting to remain bullish. Primarily, the blue trend line which was drawn on September 5th needs to hold. A move under 8330 should confirm a break in trend. Support underneath could be found at 8215, but then the double-bottom would become a triple-bottom and dilute its strength. If responsive buying does take place on Friday, the Dow is expected to test the 22 DMA (currently at 8589) once again. The bearish red trend line is currently at 8669. Of course, as Steve and Jim pointed out, the Dow might be in the process of forming a Head & Shoulders formation; projecting an objective (calculated by myself) of near 7300. Without getting into the Intermarket Relationships to much, one concern today was the Dollar’s failure to settle above its 50 DMA, currently at 107.45. Closing down 0.41 percent at 107.18, there is now a good chance (based on recent history) that the Dollar will weaken further towards its 22 DMA, currently at 106.92. A weaker dollar is good for gold and bad for stocks, in theory. Speaking of Gold, the 4.29 percent rise to 76.09 places the index that much closer to my 80.90 intermediate objective. Oil, Utilities, and bonds all traded with a bearish slant towards equities. It is the significant drop in yields within the 30-year bond that might also be of concern for equity holders. The TYX.X index saw yields lower by 1.25 percent and, like the Dow, rests on a substantial area of support. It is my opinion that the Dow will lead all indices during trading on Friday. Getting back to the major equity indices, a chart of the Nasdaq shows the possibility that the tech-laden index will go down and test the relative low of 1192 set during the week of July 21st. If this happens, there will be a good change that low will end up failing bullish traders and becoming resistance down the road. Chart of the Nasdaq Combined Composite Index, Weekly What could be the catalyst during trading on Friday? Well, the Producer Price Index (8:30 a.m.) should take a backseat to both the Retail Sales report (8:30 a.m.) and Michigan Consumer sentiment figure (9:45 a.m.). The August Retail Sales report is expected to show a rise of 0.8 percent, adding to July’s 1.2 percent upswing. This key report on consumer spending should rise based on recent incentives by auto manufactures and buying of back to school accessories. The Michigan Consumer Sentiment report is expected to rise fractionally to 88 from 87.6, buoyed by higher growth expectations and hope business investment will turn around. Risks include possible war, recession, weak labor market, lower stock prices, and 10 percent fall in the index over last three months. Clearly there are more cons than pros. With the potential for more downgrades, accounting concerns, terrorist threats, war, and weak economic reports looming large, deteroriating bullish sentiment can still be salvaged. In fact, if the major indices find support and further establish the established bullish trend line, it might actually be the bears hibernating early this winter. John Seckinger ******************** INDEX TRADER SUMMARY ******************** A little air was let out of the balloon A little air was let out of the balloon as it relates to the major indexes today as the Dow Industrials fell 201 points (- 2.35%) to close at 8,379, while the S&P 500 Index (SPX.X) fell 22 points (-2.47%) to 887 and the NASDAQ Composite (COMPX) lost 35 points (-2.71%) to close at 1,279. The narrow based indexes had the S&P 100 (OEX.X) falling 12 points (-2.67%) to 443 and the NASDAQ-100 Index (NDX.X) declining 31 points (-3.3%) to 915. After a day like today, a writer/analyst for a newsletter runs out of verbs to describe downside action without sounding like he is repeating himself. Market breadth was decidedly negative today. Just starting with the Dow Industrials, which comprises just 30 stocks, breadth had 29 of the 30 all showing losses. Only Forest/Paper Products (FPP.X) 294 -1.58% component International Paper (NYSE:IP) $37.33 +1.16% managed a gain. Meanwhile shares of Dow components Intel (NASDAQ:INTC) 15.74 -5.29%, Hewlett Packard (NYSE:HPQ) $13.60 -5.29%, McDonald's (NYSE:MCD) $20.31 -4.82%, Alcoa (NYSE:AA) $22.77 -4.6% and Walt Disney (NYSE:DIS) $15.50 -4.2% all posted losses greater than 4%. I wouldn't describe today's volume as "impressive" as both the NYSE and NASDAQ traded just over 1 billion shares each. On a broader scale, breadth was negative at both the big board and the NASDAQ, with decliners outnumbering advancers by a 3 to 1 margin at the NYSE, while breadth at the NASDAQ found 2 stocks declining for every stock advancing. New highs versus new lows was somewhat negative today at the NYSE with 51 stocks hitting new lows versus 45 stocks achieving new highs. Today's notable new 52-week low on the big board comes from fast food giant McDonalds (MCD) after analysts began expressing near-term concern regarding the company's new menu and service initiatives. Nice warning from analysts after the stock has fallen from the $30 level since mid-May. Not wanting to just focus on the negative and let traders know some bullish still exists, shares of Jo-Ann Stores (NYSE:JAS.A) $33.75 +1.04% hit a new 52-week high for the fourth consecutive session, while defense contractor TRW Inc. (NYSE:TRW) $58.50 -0.06% also traded a new 52-week high before fading lower into the close. Precious metals stocks as depicted by the Gold/Silver Index (XAU.X) 76.08 +4.29% was the only major index that traded in the green today (aside from bonds). At the end of last night's wrap, I mentioned the DIVERGENCE found in yesterday afternoon's trading when the broader markets faded into the close and gold stocks bid and that follow through on both sides continued today. A move much above Monday's highs of 77 in the XAU.X combined with confirming break higher in the commodity as depicted by December Gold futures contract (gc02z) $320.40 +0.72% could see bullishness build markedly to the XAU.X 81.00 level should sector shorts rush to cover positions. Gold stocks are not for the faint of heart as the stocks move up and down well ahead of the commodity itself. Onto the indexes. Due to overwhelming reply's to last night's request for me to show and interpret the S&P 100 Index (OEX.X) 443 -2.67% chart each night. Lets do that now. Again... very similar technicals to the S&P 500 (SPX.X), but some slightly different numbered levels to me looking at as far as support and resistance. S&P 100 Index Chart - Today's action Ooops! Wrong chart. However, note how the "blimp" lost some air today, but only half of it appears to be damaged. It's still off the ground, but some "external" damage has been done. Bears shouldn't be complacent. Here's why. S&P 100 Index Chart - Daily Interval I like to try and stay consistent with my "levels" from retracement. Just as I anchored the SPX from this spring's highs to its relative low close of July 23rd (the market thought that was an important level for whatever reason, maybe just to undercut nice round number of 400?) I want to stay with that retracement range with the similar larger 100 stocks in the OEX. Note how upward trend is also "identical" to last night's SPX analysis. Bears have some work to do yet to get trend broken and looks for a close below the 434 level (19.1%) retracement, which is most likely a shorter-term trader's goal to get a further decline to the 419 level, where I'd expect some type of short- covering (if achieved) by some bears that were active above the 470 level. The oscillators depict that of a lower trade still and I've attempted to "envision" how the OEX might trade the 419 level when stochastics reach the "oversold level. Under such a circumstance, then we might expect a little short-covering rally back into the 434-450 range with another potential entry point. Now, I want to take a moment and briefly discuss my "views" on oscillators, specifically stochastics. I gotten a lot of e-mail from subscriber over the years discussing their views on why certain bullish or bearish trades shouldn't be taken simply because the stochastics are "overbought" or "oversold." In brief, it's been my experience that stochastics have kept me out of some very good trades (short/long) when I first started trying to use the tool. Stocks that were headed south (down) and were buried in "oversold" on the daily and 60-minute timeframes sometimes ended up at the South Pole days later simply because investors wanted out of the stock(s) so badly that they didn't seem to care what the oscillators were doing. Just the opposite can be true to the upside when a visit to Santa at the North Pole despite "overbought" conditions were found. As such, I'll place a "weighting" on the indicator simply as a partial tool to see if it sways my decision on a trade. I actually do put "more weight" in the MACD and how it is trending when trying to use stochastics. I think of the MACD zero level as a waterline. You know, kind of a "mid-point." For example, in the OEX chart above, see how MACD was trending higher in late July? While stochastics were "overbought" near the 459 level, stochastics may have been useful by a bull to take some short-term gains if lucky enough to have picked a bottom in the OEX, but may not have necessarily indicated a real good short/put entry point for a swing-trader looking to hold a position for more than a week. In essence, the trending higher MACD kind of "overrode" stochastics for a swing-trader type trade. Now, one can perhaps see in the OEX how a break below the 472.85 level of retracement, combined with a rolling MACD above zero and "overbought" stochastics was the "ideal" short/put entry point with a swing-trader's target of 435 from that entry. Do you see where I'm going with this? You got it. There's going to most likely be some disciplined market participants looking to take some profits should the 435 level be tested. I say this so that any bears in the OEX.X are "freaking out" if they took a 1/2 bearish position at the open today. Now, neither you nor I can really get inside the minds of all market participants, but a bear in the OEX is liking what he/she sees currently, and if a bear gets the break of upward trend at its current first test, and a convincing close below the 434 level of retracement, then we should see MACD make a more noticeable move lower and really get some bulls jittery. Also, lets remove any thought that "shorting" makes a stock or index trade lower. This simply isn't the case. After all, it takes an "up tick" to get short a stock, only a bull's selling at the bid creates the supply to have a stock, then index trading lower. Now, you're going to get a full dose of OEX tonight. Here's something I hadn't seen that a long-time subscriber pointed out that she thought she saw in the OEX as well as the SPX. I found it interesting and got a somewhat correlative bearish target with the point and figure chart of the OEX. Let's clean up the chart of the OEX and get rid of all our levels and look at a less conventional, yet potential head and shoulders top that could be forming in the OEX. Here we see a trending higher neckline, and if the neckline were broken, then a potential downside target of 380 would be a pattern objective. OEX Chart #2 - Daily Interval One thing I've always loved about point and figure charts was the ability to calculate both bullish and bearish vertical counts to help me assess risk reward in a trade. A bar chartist will look for head and shoulder tops to try and establish some type of "ultimate" downside objective, should the neckline be broken to the downside. I see the trending higher neckline I think one of our OEX index traders has identified, but funny how we once again see an "upward trend" in play. If that neckline is broken, especially on a closing basis, then bears may indeed be targeting and OEX low near 380. S&P 100 Chart (OEX) - $5 box scale We get some correlation between a bearish objective from the potential head/shoulders top that we get from calculating a bearish vertical count in the OEX. Most institutions view the OEX on a $5 box scale, and this is what I set my box size/scale to in the above p/f chart. It would currently take a trade at 465 for the OEX to generate a "buy signal," in order to negate the current bearish vertical count of 390. As such, a trader using the p/f chart of the OEX is perhaps beginning to assess a bearish trades as .... risking a stop to 465 ($20 risk) to potentially reach a downside target of $390 ($55 reward). That's a little better than 2:1 reward/risk. Perhaps a bar chartist that likes to trade head and shoulders patterns and consults the p/f charts establishes a longer-term target range of $380-$390. Lots of work, but I like the correlation between downside targets. All we have to do is monitor things going forward. Again.... according to www.stockcharts.com, the OEX Bullish % ($BPOEX) is currently in "bear confirmed" status, so a more defensive or bearish posture toward the OEX is warranted. OK ... enough OEX for one night, but I think we're caught up. Try some of this stuff on your own with the other indexes/sectors you might be trading. There's an interesting development taking place in the Dow Diamonds (DIA) $84.14 -1.79% that will make for some interesting trading tomorrow. I think it is a bit "silly" to show the bar chart of the DIA again today, but suffice it to say, the DIA closed right on upward trend we had on last night's chart. So, lets take a look at the DIA and its p/f chart. Aha! Another upward trend is nearby. Though some air was let out of the balloon today, bears shouldn't be complacent and not trying to OVERLEVERAGE with their downside trades. Things aren't looking good for the bulls, but I like to take things slowly and rather methodical. Dow Diamonds (DIA) - $2 and $1 box Just like the bar chart, we find the Dow Diamonds (DIA) trading right at a bullish trend which could serve as support. As such, bears don't want to be OVERLEVERAGING in short/put positions or overly complacent. One thing I like about p/f charts is that I can "back test" some other vertical counts to see if they have much "credence." The current bearish vertical count from the p/f chart is to $74 and it would take a trade at $88 to negate this bearish vertical count. As such, a p/f chartist is currently assessing bear's risk as ... risk to $88 ($4) with potential reward to $74 ($10). That's better that 2:1 reward risk. I can back test a prior bearish count that came ABOVE trend, which had the DIA signaling some potential downside risk to $84, when the DIA gave a sell signal at $97 and completed its bearish vertical count column. Check your own risk/reward profile, but looks bearish right now for at least 1/4 or 1/2 position. A break of bullish support trend would be helpful. And DIA bears might have gotten somewhat of a break late tonight after Dow component Honeywell Intl. (NYSE:HON) $28.34 -0.63% warned on upcoming Q3 earnings, saying it sees EPS in the range of $0.50-$0.52 versus consensus estimates for EPS of $0.60. Over Instinet, HON fell another $1.49 to $26.85 and may help let a little more air out of the Dow's balloon. Tech trader's may have been watching for Adobe Systems' (NASDAQ:ADBE) $18.45 -3.8% earnings tonight. The company beat lowered analysts estimates of $0.19 per share by 3-cents and said it saw Q4 EPS in the range of $0.21-$0.25, which would have analysts' estimates of $0.22 EPS in the middle of the range. In after hours trading, shares of ADBE jumped $1.76 from its close. For QQQ traders, ADBE represents a 0.64% weighting in the QQQ, so not a big deal, but did see some partial bidding in other software names. The most heavily weighted QQQ stock is fellow software maker Microsoft (NASDAQ:MSFT) $47.19 -2.86%, which gained $0.21 in after-hours trading. Just like we see in the Dow Diamonds (DIA) p/f chart, MSFT also traded right down to its bullish support trend today and would take a trade at $45 to get the stock back on a sell signal and a break of bullish support. I don't have much to add regarding last night's comments in the QQQ and bearish thoughts there. A skittish bear that shorted the open could follow a stop lower just above yesterday's high of $24.35, but that's about it. Money poured back into Treasuries for the second straight session, so I'm not thinking that there's going to be a lot of capital in place to give stocks much of a bid. There's a lot of economic data due out before the opening bell, but we'll have to see what those numbers look like to get a better feel on tomorrow's action. For now, the MARKET looks jittery regarding a potential attack on Iraq, and this morning's jobless claims number appeared to be just enough reason for bulls to pull the plug instead of waiting to see if upward trends hold. Key number tomorrow morning related to the economy is going to be August Retail Sales, which economists expect to show a 0.3% gain and a 0.2% gain excluding autos. Jeff Bailey ************************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 **************** Still On the Sidelines by Steven Price If getting 9/11 out of the way isn't going to rally the markets by bringing buyers in from the sidelines, it appears it will be a while before the Dow tests 9000 once again. Yesterday's failure at the 50-dma looked bearish and today's drop has only furthered that sentiment. Alan Greenspan testified before the Congressional Budget Committee today, but focused on reducing deficit spending in the long-term, rather than talking about the economy. He said our discipline has faded in the past year as we've increased military spending, cut taxes and spent on various emergencies. He favored linking tax cuts and spending to budget forecasts, so that we don't undo years of hard work in reigning in the budget deficit. Regarding interest rates, he said, "The economy appears to have withstood this set of blows well, although the depressing effects still linger." This sounds an awful lot like the last FOMC announcement, which left rates unchanged, but shifted to an easing bias due to economic risks. My guess is that the September 24th FOMC meeting will yield a similar statement. President Bush spoke to the U.N., essentially making his argument for a change of regime in Iraq. While he used tough rhetoric, it sounded as though he was giving the U.N. time to fix the problem before the U.S. took military action. The oil markets seemed to agree, as Crude Oil futures fell 0.92 to 28.85. After holding over $29/barrell since September 6, this move is significant, as it foreshadows some time lag before U.S. action is taken. This morning's jobs report showed more bad news for the economy. Layoffs have surged, raising the four-week moving average by 8,750 to 409,500, which is a three-month high. First time claims rose 17,000 to 426,000, which is the highest level since April 20. A look at the Dow shows what appears to be the formation of a head and shoulders formation, with the right shoulder being formed by yesterday's failure at the 50-dma and today's 201.76 drop. You can see a chart of this formation in Wednesday's Market Wrap, minus today's drop. The neckline violation, a very bearish sign, does not actually come for another 150 points or so to the downside, but if we break through that level, we could see a retest of July's lows. A similar formation can be seen in the S&P 500, NDX and the Nasdaq Composite. They all failed the 50- dmas yesterday and will most likely dive in concert if we see a joint neckline break. After the bell, software maker Adobe Systems (ADBE) released earnings that beat the street by 0.03 and traded up over $2.50 from a close of $18.45 to $21.10. This could spur a tech rally tomorrow, as it is the first good news in some time. Adobe forecast growth in the current quarter, which is something we haven't heard from the tech sector . On the other hand, Honeywell (HON) lowered estimates for the third quarter and full year 2002, stating that the economic recovery is not materializing. From a technical standpoint, things look bleak, but not as bleak as they will if the head and shoulders neckline is broken is the major indices. The news from Adobe could be the catalyst for a rally that prevents that breakdown, however. Look for a rally in the techs tomorrow, and then watch the 50-dma above for signs of failure. ----------------------------------------------------------------- Market Averages DJIA ($INDU) 52-week High: 10679 52-week Low : 7702 Current : 8379 Moving Averages: (Simple) 10-dma: 8466 50-dma: 8601 200-dma: 9643 S&P 500 ($SPX) 52-week High: 1226 52-week Low : 797 Current : 886 Moving Averages: (Simple) 10-dma: 898 50-dma: 903 200-dma: 1054 Nasdaq-100 ($NDX) 52-week High: 1782 52-week Low : 892 Current : 915 Moving Averages: (Simple) 10-dma: 927 50-dma: 960 200-dma: 1293 ----------------------------------------------------------------- The Semiconductor Index (SOX.X): The SOX just can't seem to hold its support. After teasing us with a hold over 300, it was right back down to 283.50. We're not piling on short just yet, as we will look for a re-test of support at 275. "Support" in this case is a tenuous term as we are really just referring to the recent 52-week low from which the failed rebound took place. Adobe's news after the bell should be good for the Software Sector, and in turn may lift the other techs as well. If forecasting growth and beating earnings doesn't get the engine rolling, then look for the SOX to test 275 sooner rather than later. 52-week High: 657 52-week Low : 275 Current : 283 Moving Averages: (Simple) 10-dma: 291 50-dma: 331 200-dma: 480 ----------------------------------------------------------------- Market Volatility Here we are back over 40. Today's drop, after Alan Greenspan's testimony and a bleak jobs report, reminded everyone of the downside potential still lurking below 8200 in the Dow. A trip below 8200 looks like it could land us back at 7500, and the last time that happened the VIX was almost 50% higher, near 60. It will be hard to get through a September/October cycle without the VIX remaining high, judging by past years. The next time we see the 20s could be November. CBOE Market Volatility Index (VIX) = 40.72 +3.49 Nasdaq-100 Volatility Index (VXN) = 56.44 +2.44 ----------------------------------------------------------------- Put/Call Ratio Call Volume Put Volume Total 0.91 483,086 440,097 Equity Only 0.67 379,687 252,771 OEX 1.46 25,439 37,308 QQQ 0.45 90,859 40,433 ----------------------------------------------------------------- Bullish Percent Data Current Change Status NYSE 43 + 0 Bull Confirmed NASDAQ-100 42 + 8 Bull Correction DOW 52 + 2 Bull Correction S&P 500 52 + 1 Bear Confirmed S&P 100 48 + 2 Bear Confirmed 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 1.16 10-Day Arms Index 1.39 21-Day Arms Index 1.28 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 681 2054 NASDAQ 1035 2111 New Highs New Lows NYSE 21 14 NASDAQ 45 89 Volume (in millions) NYSE 1,372 NASDAQ 1,186 ----------------------------------------------------------------- Commitments Of Traders Report: 09/03/02 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 added 6,000 contracts to the long side, while reducing shorts by only 500, in what appears to be a stockpiling in anticipation of extreme movement next week. Small traders increased both long contracts and short, adding 5,000 to the long side and 8,000 to the short side. Commercials Long Short Net % Of OI 08/13/02 427,618 475,536 (47,918) (5.3%) 08/20/02 422,100 469,556 (47,456) (5.3%) 08/27/02 425,982 469,087 (43,105) (4.8%) 09/03/02 431,755 468,529 (36,774) (4.1%) 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 08/13/02 155,040 66,546 88,494 39.9% 08/20/02 156,974 69,071 87,903 38.9% 08/27/02 153,152 72,408 80,744 35.8% 09/03/02 158,262 80,130 78,132 32.8% 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 added 2600 short contracts and only 1400 longs, while small traders got longer, adding 1,000 longs and reducing short positions by 300. Commercials Long Short Net % of OI 08/13/02 42,303 50,354 (8,051) ( 8.7%) 08/20/02 41,876 49,461 (7,585) ( 8.3%) 08/27/02 45,354 50,634 (5,280) ( 5.5%) 09/03/02 46,712 53,287 (6,575) ( 6.6%) 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 08/13/02 12,797 8,933 3,864 17.8% 08/20/02 11,321 7,980 3,341 17.3% 08/27/02 10,156 8,040 2,116 11.6% 09/03/02 11,150 7,720 3,430 18.2% 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 short positions slightly, reducing risk heading into next week, while small traders reduced both sides by about 500 contracts. Commercials Long Short Net % of OI 08/13/02 22,837 13,833 9,004 24.6% 08/20/02 21,160 15,349 5,811 15.9% 08/27/02 21,023 14,328 6,695 18.9% 09/03/02 21,161 13,792 7,369 21.1% 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 08/13/02 5,050 8,349 (3,299) (24.6%) 08/20/02 6,216 8,163 (1,947) (13.5%) 08/27/02 6,825 8,438 (1,613) (10.6%) 09/03/02 6,395 7,966 (1,571) (10.9%) 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 ************************* Eric Kobren: Kobren Growth (KOGRX) Anyone who has ever read Fidelity Insight, a monthly investment report on Fidelity's 170+ mutual funds, may already be familiar with Eric Kobren's mutual fund research and insight. But, most people are not aware that Kobren started his own mutual fund in December 1996 called Kobren Growth Fund (KOGRX), which seeks to provide long-term appreciation by holding a portfolio of around 10-12 other mutual funds. Over the turbulent past year and on average over the past three years, Kobren's return performance has been top decile or close to it within the large-cap blend category, per Morningstar. In comparison to the average large-cap blend fund, Kobren has over the last five years and overall delivered above average returns with below average risk relative to his large-blend competition. In 1997 and 1998, the fund's first two full years of operation, Kobren's relative performance was weak. In 1999, he produced a 30% return for the year, ranking in the category's top quintile. In 2000, 2001 and so far in 2002, Kobren has kept losses to the single-digits. The fund lost 9.8% in 2000, slightly worse than S&P 500 index's 9.1% decline. In 2001, Kobren lost 7.3%, while the S&P 500 index slid 11.9%. On a YTD basis thru September 11, the Kobren Growth Fund is down 9.8%, less than half of the U.S. market's decline, as measured by the S&P 500 index (YTD -20.0%). As a result of Kobren's strong capital preservation skills, the Kobren Growth Fund's trailing 5-year performance now ranks near top quartile (27th percentile) within the large-cap blend group, per Morningstar. So, despite a rocky start, Kobren's style and strategy have paid off for investors. We'll take a closer look at Kobren's investment approach in this report and see how fund holdings are derived. The Kobren Growth Fund is a no-load mutual fund, with a current expense ratio of 0.96%. That is a little high for a fund which invests in other mutual funds, but still below average compared with the average stock fund. The minimum initial investment is $2,500 for regular accounts and $2,000 for IRAs, and the Kobren Growth Fund is offered through a number of leading NTF networks, including the Fidelity Retail FundsNetwork-NTF and TD Waterhouse NTF programs. Manager Background Eric Kobren is president and portfolio manager of Kobren Insight Management, located in Wellesley Hills, Massachusetts outside of Boston. Before founding his own investment firm in 1987, Kobren was an executive with Fidelity Investments and a business analyst with Merrill Lynch. In 1985, two years before starting his own investment operations, Kobren founded the Mutual Fund Investors Association. Today, it publishes two mutual fund newsletters - for over 100,000 members. Kobren holds a M.B.A. degree from Columbia University. He began his career as a marketing analyst with Merrill Lynch in New York and was vice president of research and trading with Boston-based Delphi Management, an institutional money manager. He spent two years with Fidelity Investments as a senior marketing executive. The Kobren website (www.kobren.com) says that Kobren's years at Fidelity made him well qualified to found the MFIA (Mutual Fund Investors Association) in 1985. His goal in 1985 was to assist Fidelity investors maximize their mutual fund investments. His Fidelity Insight newsletter was born shortly thereafter. While Kobren was making a name for himself by observing fund industry giant Fidelity, he increased staff and expanded their base, the website goes on. The Kobren Insight Group now includes Kobren Insight Management, the firm's investment arm and adviser to the Kobren Growth Fund. Kobren Insight Management has managed money for private clients since 1990 and today has $145 million in assets under management. In 1994, Kobren's MFIA started publishing FundsNet Insight, a monthly newsletter covering the funds available on the mutual fund networks such as Fidelity, Charles Schwab and Jack White. The latest addition to the Kobren Insight Group is the Kobren Insight family of funds. Originally, there were three funds: Kobren Growth (1996), Kobren Moderate Growth (1996) and Delphi Value (1998). Kobren Moderate Growth, however, has since been merged with Kobren Growth Fund. Delphi Value Fund (KDVRX) is sub-advised by Scott Black with Delphi Management. The Delphi Value Fund is not part of our discussion herein. Investment Overview Kobren seeks to achieve the fund's long-term growth of capital objective by normally investing at least 65% of assets in open- end and closed-end U.S. and international equity mutual funds. Under the fund's policy, Kobren may put up to 35% of assets in fixed-income funds, or he may invest directly in stocks, bonds, money market instruments, options, futures contracts and other types of securities. Utilizing an active allocation strategy, Kobren seeks a target volatility level approximating the S&P 500 index. This target volatility varies depending on market conditions. Kobren's firm relies heavily of its own research and analytical capabilities, which includes the tracking over 300 mutual funds against leading industry benchmarks as well as their customized benchmarks. Kobren's team of 45+ full time professionals today employs certain analytical techniques to refine their search to isolate high quality investment advisors and the most promising mutual funds. Analysts at Kobren Insight also meet and speak to fund managers daily to monitor manager activity, and performance. Additional information about Kobren's research process is provided online. Morningstar's report says that Kobren and team eschew ("avoid") momentum plays and big asset allocation bets. Instead, Kobren focuses his team's research on the track records of individual managers at high-quality investment companies. For the equity allocation (usually at least 65% of assets), Kobren emphasizes veteran stock pickers such as Bill Nygren, Oakmark (OAKMX), O. Mason Hawkins, Longleaf Partners Small Cap (LLSCX) and Richard Pell, Julius Bear International Equity (JIEIX). Kobren employs a similar approach with the fixed income assets, investing heavily in two PIMCO bond mutual funds. Bill Gross, PIMCO's bond guru leads an all-star portfolio management team. According to Morningstar's report, Kobren Growth Fund had 73.6% of assets in stocks (stock funds) at July 31, 2002, with nearly 15% of that amount in foreign stocks (stock funds). Cash funds and bond funds represented 24.0% of portfolio assets, with 2.4% categorized as other. This near 75% equity stake is greater than the average balanced fund, but considerably lower than the average stock mutual fund. Accordingly, the fund's "below average" Morningstar risk rating stems more from Kobren's asset mix decision than anything else. Aggressive balanced might be a suitable label for Kobren's fund management approach at least through the recent market downturn. As of August 2002, the Kobren Growth Fund had an average market capitalization of $14.4 billion per Morningstar. Note that the fund is large-cap by Morningstar's standards, but is classified by Lipper as "multi-cap." Lipper's categorization is certainly appropriate, considering Kobren's 31.2% stake in mid-cap stocks (funds), and his 18.7% allocation to the small/micro-cap sector. Morningstar and Lipper both agree that the fund's average price valuations put it in the blend or core style box. In this fund, Kobren maintains style neutrality, resulting in a portfolio that combines value and growth characteristics, adding to its appeal. Overall, the portfolio is diversified three ways. First, stock and bond fund holdings are themselves diversified. Second, the fund's assets are allocated between different asset classes, to diversify portfolio risk. Third, within the investment classes, Kobren diversifies holdings across sub-asset classes, or styles. Risk and Performance According to Morningstar, the fund's risk level has been average compared with its large-cap blend fund peers over the past three years. However, on average over the past five years, the fund's risk level was below average. Since more weight is given to the fund's longer-term results, the fund's "overall" risk rating is below average within the large-cap blend category (450+ funds). Kobren's trailing 1-year loss through September 10, 2002 of 7.5% shaved more than half off the market's 15.5% decline as measured by the S&P 500 index. Although a negative return, Kobren ranked in the category's top decile (or 6th percentile) for performance. For comparative purposes, the average U.S. hybrid fund lost 6.2% over the past 12 months, while the average large-cap blend stock fund was 15.1% in the red. So, you can see that Kobren's losses are closer to those of mixed equity funds than full equity funds. The fund's trailing 3-year annualized loss of 4.7% was 6.5% less than the market's 11.2% annual-equivalent decline, using the S&P 500 index. Although negative, Kobren's lesser-than-average loss was strong enough on a relative basis to rank in the large-blend category's top 11% (near top decile). Also, the fund's trailing 5-year average annual total return of 1.7% was 0.4% greater than the S&P 500 index benchmark, near top quartile performance (27th percentile). While it's true that the fund's 0.96% expense ratio could perhaps be lower, Kobren uses the fund's purchasing power to get into the institutional class of a fund, which come with low expense ratios relative to retail class expenses. Conclusion Kobren Growth Fund is suitable for long-term investors who want the simplicity of getting a professionally managed portfolio of mutual funds in a single investment. This Kobren fund of funds relies heavily on the firm's research capabilities, and invests assets in funds with different yet proven styles and strategies. The result is an aggressive balanced fund that has done well in relation to the average stock fund through the market downswing. How well Kobren will do in the next up market is unclear. 1997 and 1998 weren't exactly strong performance years, but Kobren's performance since then has been respectable, and competitive in relation to other large-cap blend funds tracked by Morningstar. For more information, log on to www.kobren.com Steve Wagner Editor, Mutual Investor firstname.lastname@example.org ************************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 *********************** Chips, Ships, VIPS, Dips The chip sector took another series of hits today with downgrades and earnings warnings. The Coast Guard, FBI, Customs Dept and Dept of Energy are still investigating the Liberian cargo ship believed to be carrying a nuclear device. VIP's headlined the news with President Bush warning the world on Iraq, Greenspan warning the U.S. on deficits and New York authorities warning Tyco execs they were not done yet. Is it any wonder the Dow dipped over -200 points? To read the rest of the Swing Trader Game Plan Click here: http://www.OptionInvestor.com/itrader/indexes/swing.asp FREE TRIAL READERS ****************** If you like the results you have been receiving we would welcome you as a permanent subscriber. The monthly subscription price is 39.95. The quarterly price is 99.95 which is $20 off the monthly rate. We would like to have you as a subscriber. You may subscribe at any time but your subscription will not start until your free trial is over. 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The Option Investor Newsletter Thursday 09-12-2002 Copyright 2002, All rights reserved. 2 of 3 Redistribution in any form strictly prohibited. In Section Two: Dropped Calls: QQQ, DJX, SPW, IDPH Dropped Puts: None Daily Results Call Play Updates: TRMS, MSFT, CVG, LLL, OMC New Calls Plays: None Put Play Updates: AA, AGN, EXC, TXU, New Put Plays: CTX, AET, CMA, GE, MTG, **************** 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: ***** QQQ $22.81 -0.64 (-0.04 for the week) We didn't get the post 9/11 rally we were looking for. After yesterday's Beige book report showed very little to get excited about, it appears the sideline investors stayed there. The recent pullback in the broader markets looks bearish overall, and this morning's downgrade of several chip equipment makers didn't help the techs. Rather than wait to get stopped out, we will cut our losses and close the play. --- DJX $83.79 -2.02 (-0.48 for the week) The Dow looked poised for a post 9/11 rally, after those investors waiting for the anniversary to pass would be looking to re-invest. However, the economy got some bad news in yesterday's Beige Book report, and today's testimony from Alan Greenspan indicated he would not be lowering interest rates. Instead he said the Government should cut back on fiscal stimulus spending, in order to reduce the projected deficit. The markets reacted negatively and bulls who bought ahead of a possible 9/11 rally will probably be heading for the exits now that it didn't happen. Add to this the possible head and shoulders pattern forming in the Dow, and we are no longer bullish on this play. The close stopped us out and did the work for us, as this play is now closed. --- SPW $109.99 -2.00 (+0.54 for the week) SPX Corp was a prime candidate to participate in an overall market rally. Its recent 2 for 1 split announcement only fueled the possibilities for the stock. The recent rollover down to 109.99 appears as though it could re-test the 50-dma of 103.08 in bearish market conditions. Today's drop in the Dow, as Alan Greenspan talked about the government pulling in the spending reins and the possibility of higher interest rates, does not bode well for the overall market in the short-term. While SPX's long term prospects still are promising, we are not willing to take on the possibility of a $7 loss on the play while we wait. Rather than waiting to get stopped out, we have decided that overall market conditions have changed and we will close the play, rather than "wish and hope" for a turnaround. --- IDPH $41.77 -1.87 (+1.06 for the week) IDEC was a prime candidate to participate in a post-9/11 relief rally, coming off strong support and pushing ahead in the face of some biotech weakness. The Biotech Index (BTK.X), however, was turned back soundly from its 50-dma and IDPH suffered right along with it. With the broad market retreat and the BTK experiencing resistance, we will close this play and wait for more favorable market conditions. While IDPH has found support at its own 50-dma, we would rather put our "call money" on a stock that isn't carrying the weight of a falling sector. PUTS: ***** None *********************************************************** DAILY RESULTS *********************************************************** Please view this in COURIER 10 font for alignment ************************************************* CALLS Mon Tue Wed Thu CVG 18.70 0.56 0.65 0.04 -0.45 DJX N/A Drop, market drop IDPH 41.77 1.57 1.32 0.14 –1.87 Drop, BTK sinking LLL 55.70 1.99 0.11 0.17 –0.11 Holding new level MSFT 47.19 -1.44 1.09 -1.75 –1.39 Strong PnF support OMC 63.66 2.04 1.20 0.89 –0.13 Relative strength QQQ 22.81 0.41 0.57 -0.67 –0.64 Drop, market failure SPW 109.99 0.56 2.92 -2.21 –2.00 Drop, no pop TRMS 45.38 -1.05 0.17 -1.08 –0.84 Good medicine PUTS AA 22.77 0.71 0.46 -0.28 –1.10 Failed rally AET 39.23 0.19 -0.57 -0.17 –1.75 New, stars align AGN 54.00 -0.61 -1.28 -1.21 –0.14 still dropping CMA 53.80 0.43 -1.53 -1.20 –2.00 New, no support CTX 48.87 1.59 -0.53 -0.53 –2.10 New, higher rates EXC 44.01 0.58 -0.22 -0.12 –1.62 Downward pressure GE 28.00 0.63 -0.12 -0.36 –1.00 New, leading us down MTG 54.93 0.69 -1.09 -1.10 –2.07 New, looking at $51 TXU 43.53 0.09 -1.19 -0.55 –1.47 Bye Bye 50-dma ************************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 ******************** TRMS $45.38 -0.84 (-0.08 for the week) Trimeris pulled back with the rest of the Biotech sector today. However, it held above its recent consolidation between $43 and $45. While the market is experiencing a broad sector retreat, this stock appears to be setting a higher low. The intraday low of $44.98 appeared to bring the buyers back, and a look at the 5 minute chart shows strong support at that level. The stock found support here at the beginning of August, before rallying to recent highs just under $50. The point and figure chart shows the stock still in a column of "X" and bullish support at $44.00, which is our stop loss. A trade below that level would lead to a three-box reversal down and would stop us out on the play. However, with both PnF support and support on the daily chart at this level, the risk/reward ratio looks promising. The ICAAC conference is coming up at the end of the month, which is one of the largest medical conferences in the country and attended by many analysts. TRMS will be releasing promising data at the conference about its drug T-20, which will be coming on the market in 2003 and is expected to bring in up to a billion dollars in yearly revenue. They will also be releasing promising data about a new drug in the pipeline, T-1249, which performed well in studies which were done in conjunction with Cornell Medical Center, Duke University, Stanford and several other educational institutions, and may be even more promising than T-20. The current support, and news related possibilities, leaves us long on TRMS with an initial target of $50. New entries can enter at this level, with a stop loss of $44.00, as the stock appears to have successfully tested support at $45. --- MSFT $47.19 -1.39 (-0.63 for the week) Microsoft pulled back today with the rest of the techs. As a Dow component, it also experienced a sympathy drop as the Dow rolled over following Alan Greenspan's testimony about the possibility of rising interest rates and his recommendations that the government reduce its fiscal stimulus spending. What Microsoft had going for it today, however, was amazing support on the point and figure chart. It has followed a pattern of higher lows on six straight occasions, as its bullish support line slopes up below it. The last several pullbacks have been halted at the bullish support line at $42, $43, $44, $45 and $46. The current level of $47 has held for the sixth straight increase in support. A trade of $46 would be needed to break this support line, and this is our stop loss. After the bell, Adobe Systems (ADBE) released earnings that beat expectations by 0.03 per share and was already trading up over $2.00 after hours. This should give a boost to the software sector, of which Microsoft is the biggest player. Software maker Verity also posted earnings after the bell, time in line with expectations and was trading slightly higher. We will look for the stock to reward our faith after the announcements, by heading back toward our initial target of $53.50. New entries should look for a trade over today's high of $48.30 to initiate positions. --- CVG $18.70 -0.45 (+0.76) The bulls' first attempt at pushing CVG through the $19 resistance level ran out of steam, likely due to the broad market's inability to sustain yesterday's rally attempt. While the $19 level held up as intraday support for most of the day on Thursday, the breakdown in the broad market created too much selling pressure and the stock ended the day down more than 2%. The first significant support is $18.50, the site of Tuesday's low, followed by $18, which is the site of broken resistance from this week's breakout. Look for a rebound from one of those levels to provide the opportunity to enter new positions as the buyers return. Those looking to trade the breakout will need to wait for CVG to trade through the $19.50 level. A move through that level should get the shorts covering, as it would create another double-top breakout on the PnF chart. Keep stops set at $17. --- LLL $55.70 -0.11 (+2.86) With President Bush's ultimatum to the United Nations in his speech this morning, Defense stocks continued to trade well for most of the day, with the Defense index (DFI.X) still testing the $580 resistance level. Despite the fact that the bulls couldn't get through that level on Thursday, that was likely due to the broad market weakness. LLL spent most of the day in the green, but fell back at the end of the day to post a fractional loss. The $56 level is proving a tough nut for the bulls to crack, and the stock may need to pull back a bit and take another run to finally push through. Look for a rebound from intraday support (first at $55 and then down at $53) to provide for attractive entries, keeping stops in place at $52. Should war fears escalate, that could be the added fuel that the bulls need to push higher from current levels, but we don't want to consider new momentum-based entries until the stock rallies through the $57 level. A move through $57 will clear intraday resistance from this week, although there is more resistance to deal with at the $58 level. For that reason, buying the pullbacks is the lower risk approach. --- OMC $63.66 -0.13 (+3.66) The impressive rally in OMC over the past week and a half was due to take a break eventually, and the broad market weakness today seems to have been the catalyst for traders to take some profits off the table. Showing its impressive relative strength, OMC actually pushed to a new recent high of $64.69 before being pressured back to support near the $63 level due to the broad market weakness. It is impressive that the stock ended the day with a mere 13-cent loss on a day when the major indices lost between 2-3%. The $63 support level is important, as it is the site of the highs on Tuesday, as well as the ascending trendline that has been established during this rally. OMC is now in the middle of the consolidation range ($61-66), so new entries are tough to call near current levels. While this afternoon's rebound from the $63 level could be used for new entries, a pullback into the $61.50-62.00 area (stronger support) would make for a more favorable entry. Momentum traders will need to wait for a volume-backed breakout over the $66 level (overhead resistance) before attempting to buy a breakout. Keep stops set at $61. ************** NEW CALL PLAYS ************** None ************************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 ******************* AA $22.77 -1.10 (+0.18 for the week) Alcoa failed during the pre-9/11 rebound as it attempted to catch up to its September 3rd high, which is the day it broke support at $24. This failure below our stop loss of $24.50 provided a good entry point for new shorts. It has continued its pattern of lower highs with this rebound attempt. It now appears ready to test support at $22. Aluminum has been under pricing pressure since China increased production and became a net exporter of the material. New smelting capacity at several plants in Iceland have also created worries that prices will drop even more than the 15% they gave up in the last year. Yesterday, Morgan Stanley lowered its investment rating on non-ferrous metals and mining companies. It cited the Chinese concerns and smelting capacity in its research note (apparently they've been reading our play descriptions for the last week), and lowered aluminum price projections for 2002 through 2005. Earnings estimates were specifically cut on Alcoa, along with Alcan (AL), and Century Aluminum (CENX). Morgan said investors would need to be patient for a turnaround in the sector. We are not patient and will capitalize on the short-term negative prospects for the industry. Look for AA to break $22 for new short entries. We will leave our current stop loss of $24.50 in place, as it has been sufficient to provide for new entries on a failed rally. Our target is now $15 on the play, with some possible support at $18. --- AGN $54.00 -0.14 (-2.35) Wednesday's euphoric rally attempt didn't last very long, but it did last long enough to give us an attractive entry into our AGN play. The stock spiked up to the $56 level and promptly fell back. It didn't take long for the $55 support level to fail and by the end of the day the stock was resting just above $54. While there wasn't much meaningful action on Thursday, with the stock trading in a narrow range on very light volume, the picture on the PnF chart tilts the scales further in the bears' favor. With the drop under $54, the bullish support line has been broken. Due to the stock's inability to fall further on Thursday, it appears likely that there is an oversold bounce in the near future. Look to initiate new positions on a failed rally at $55 or possibly as high as $56. With the heavy resistance now in place at $56, any move above $56 would be a strong clue that the bulls are getting interested in the stock again, so we are lowering our stop to $56.50. --- EXC $44.01 -1.62 (-0.39) Thursday was another painful day for the bulls, and the Utility index (UTY.X) took out the $260 support level enroute to losing nearly 3%. Now below the 50% retracement of the rally off the July lows, the UTY index now looks like it could very well retrace that entire rally. Shares of EXC gave us another attractive entry yesterday as the stock popped up to just below $46. While EXC didn't fall apart yesterday, the selling pressure in the Utility sector, as well as the broad markets was too much for the buyers to withstand. By Thursday's close, EXC had fallen right back to the $44 level, but still held above that support level. More selling in the sector tomorrow could very well break this support and usher in the next leg of the decline. Use a drop under $43.25 (just below the past week's intraday lows) to initiate new positions. If EXC fails to break down on Friday, we'll be dropping it this weekend, as that resilience would be a sign of relative strength. --- TXU $43.53 -1.47 (-2.39) Unlike our EXC play, which has failed to break down under support this week, shares of TXU have really gotten with the program. As the Utility sector (UTY.X) broke below support again on Thursday, TXU plunged back below its 50-dma ($44.54) on its way to a 3.25% decline. After rolling over at the 200-dma and then violating the 50-dma, the stock is moving further into the bears' camp and appears likely to head substantially lower. But we're likely to see an oversold bounce before TXU heads significantly lower. Note that it came to rest today near $43.50, the site of significant historical support. Look for a rebound to take price up near the $46 resistance level, where we can once again look to initiate new positions on the failed rally. Traders looking to enter on further price weakness will want to wait for a violation of the $42 support before initiating new positions. Lower stops to $46.50 tonight. ************* NEW PUT PLAYS ************* CTX - Centex - $48.87 -2.10 (-1.00 for the week) Company Summary: Centex Corporation, through other subsidiaries, ranks as one of the nation's largest non-bank-affiliated retail mortgage loan originators and general building contractors. The company also has operations in home services and investment real estate and owns a majority interest in a publicly held construction products company. (source: company release) Why We Like It: If there's one thing that prospective homebuyers treat like kryptonite, it is higher interest rates. Alan Greenspan warned of just that in his testimony before Congress today. And he wasn't talking about the type of rates he would be setting. He was talking about the need to reverse the lack of discipline the government has been exhibiting in allowing the deficit to grow once again. This would need to be done by reducing spending, and tying tax cuts to the budget, which is much easier said than done. After the homebuilders experienced a terrific run, mostly due to low rates, the idea of rates being driven up my market forces is something that could burst the housing bubble quickly. Investors took notice and hammered the sector today. But more significant than just a one-day drop is the fact that these stocks had been bought up on the idea that low rates would continue to spur buying of new homes to record levels. The first signs of thunder in the distance came earlier in the week with the release of foreclosure data. Mortgage foreclosures reached an all-time high last month, indicating that home buyers who had stretched their wallets to get in on low rates are now having a hard time meeting the payments as the pace of layoffs increases. Which brings us to the next significant data, jobless claims. This morning's data showed a surge in layoffs, driving the four- week average up by 8,750 to 409,500, which was a three-month high. A look at the Dow Jones Home Construction Index (DJUSHB) shows a massive rollover at its 200-dma. This resistance level coincides with recent resistance from the end of August and has started to establish a pattern of lower highs. It is starting to appear as though the massive second quarter insider selling that was reported at the end of August was not simply coincidence. CTX also failed at its 200-dma, and unlike the DJUSHB, has already fallen through its 50-dma as well. The next level of support for CTX looks like $44 and it could reach that level in a hurry. Place stops at $55, just above recent highs and the level at which it has failed on its recent rally attempt. *** September Contracts Expire In Less Than 2 Weeks *** BUY PUT SEP-50*CTX-UJ OI=1151 at $2.45 SL=1.20 BUY PUT OCT-50*CTX-VJ OI=1435 at $4.00 SL=2.00 Average Daily Volume = 1.47 mil --- AET - Aetna $39.23 -1.75 (-2.42 for the week) Company Summary: Aetna is one of the nation's leading providers of health care and related group benefits, serving approximately 14.4 million health care members, 11.9 million dental members and 12.0 million group insurance customers, as of June 30, 2002 (source: company release) Why We Like It: Investors were listening carefully today as Fed Chairman Alan Greenspan talked of the healthcare problems that would be facing the U.S. in the coming years. The lack of proper funding he referred to for the Medicare program will mean even less dollars for private insurers, such as Aetna, which operate Medicare HMOs. Companies have been complaining for years that Medicare reimbursements are not keeping up with costs and that they are losing money in many markets. The problem is already having an effect on large health insurers, such as Aetna, who are being forced to pull out of markets where their bottom line is bleeding. Monday was the deadline for companies to drop out of markets that they could no longer serve, and Aetna was among those who reduced their program load. The President's budget included a 6.5% increase for Medicare spending next year, which sounds great, until it is compared with the 10% increase in costs this year. With Greenspan's talk of reduced spending by the government, in an effort to reduce deficits, cash flow to those companies that rely on government reimbursement is likely to suffer. These companies will be faced with the decision of operating at a loss, or pulling out of certain markets entirely. AET had been in consolidation between $40 and $45 since the end of July. It rode a rising 200-dma and a falling 50-dma until getting squeezed out of the formation on today's drop. The 200- dma had provided support on each dip and had not been crossed to the downside since November of 2001. All streaks must end and this one has. The break in support looks very bearish after such a long consolidation and the minor support around $38 does not look all that significant. While the previous dip below the recent consolidation might otherwise be a significant point of support, it appears that the July drop was actually halted by the rising 200-dma, which failed today. Nonetheless, we will note that level for conservative investors looking for more confirmation of the downward trend. However, we view the current break as significant and will enter the short position here. The significance of this break is confirmed by a look at the point and figure chart, which shows a solid break in bullish resistance, along with a triple bottom breakdown. The stars seem to be aligning for this short play, with a target price of $30. Place stops at $42.50, just above the recent relative high on Monday. *** September Contracts Expire In Less Than 2 Weeks *** BUY PUT SEP-40*AET-UH OI=2207 at $1.65 SL=0.85 BUY PUT OCT-40 AET-VH OI=4980 at $2.95 SL=1.50 Average Daily Volume = 1.47 mil --- CMA – Comerica Inc. $53.80 -2.00 (-4.08 this week) Company Summary: Comerica Incorporated is a multi-state financial services provider. The company has strategically aligned its operations into three major lines of business: the Business Bank, the Individual Bank and the Investment Bank. The Business Bank is comprised of middle-market lending, asset-based lending, large corporate banking, international financial services and specialty deposit gathering. The Individual Bank includes consumer lending, consumer deposit gathering, mortgage loan origination and servicing, small business banking and private banking. The Investment Bank is responsible for the sale of mutual fund and annuity products, as well as life, disability and long-term care insurance products. Why We Like It: The Financial Services sector hasn't had a very good year, as the equity markets have continued to erode. It is hard to have a meaningful rally in the broad markets without the participation of the Financials, and for that reason, the more than 3% decline in the Banking index (BKX.X) on Thursday is particularly ominous. Not only did the sector lead to the downside today (at least outside of the Technology arena), but the BKX solidified its decline under the important 50-dma ($757) and broke below the $740 support level. The BKX ended at $730, the bottom of the August 8th gap, and judging by the fact that daily Stochastics have just tipped over without even entering overbought territory, there is more to come on the downside. In that environment, it should come as no surprise that shares of CMA have continued to be under severe selling pressure the past 3 days, capping it off with today's 3.5% slide on strong volume. Now back under all of its moving averages, CMA has now shattered former support at $56.50 as well as $54.50. That turned the PnF chart particularly negative, with a new Sell signal, and a vertical count that is currently pointing to the $48 level (near the site of the July lows). There is significant support near current levels, so prudent traders will wait for an oversold bounce before taking a position. Look for that rebound to find resistance near the $56.00-56.50 level and enter as the stock rolls over. Place stops initially at $57, the site of Wednesday's high. *** September contracts expire next week *** BUY PUT SEP-55 CMA-UK OI=195 at $1.85 SL=1.00 BUY PUT OCT-55*CMA-VK OI=555 at $3.00 SL=1.50 BUY PUT OCT-50 CMA-VJ OI=185 at $1.20 SL=0.50 Average Daily Volume = 997 K --- GE - General Electric $28.00 -1.00 (-0.30 this week) Company Summary: As one of the largest and most diversified industrial companies in the world, GE's products include major appliances, lighting products, industrial automation equipment, medical diagnostic equipment, electrical distribution and control equipment and power generation and delivery products. Additionally, GE provides commercial and military aircraft jet engines, locomotives and nuclear power support services. Through the National Broadcasting Company (NBC), GE delivers network television services, operates television stations and provides cable, Internet and multimedia programming and distribution services. Why We Like It: Remember late last year when the spectre of asbestos litigation costs pummeled shares of numerous large companies like HAL to multi-year lows? Don't look now, but the issue of asbestos litigation is being talked about again, and the list of companies at risk is much longer this time around. Even the venerable GE is being bandied about as having significant asbestos-related risk. Given the recent poor price action, that isn't the sort of thing the bulls want to hear. The DOW is on the cusp of breaking under major support, and as a proxy for the DOW, GE is in danger of breaking below major support at the $28 level. GE telegraphed its lack of bullish conviction in late August with its refusal to trade through the $33 resistance level, and that weakness came to fruition last week when GE gapped below its 50-dma (currently $29.61) and that level has been acting as resistance this week. Turning to the PnF chart, with the stock's trade below $28 today, GE generated a fresh double-bottom Sell signal and now has downside risk to $23. Since the stock could be due for an oversold rebound before continuing lower, ideal entries will come as the stock rolls over from resistance near the 50-dma, also the bottom of last Tuesday's gap. Momentum trades can be initiated on a decline below today's intraday low of $27.85. In an effort to give GE some room to move before the decline really gets moving, we are setting our stop at $30.50, just above the top of the gap. *** September contracts expire next week *** BUY PUT SEP-30 GE-UF OI=53772 at $2.20 SL=1.00 BUY PUT SEP-27 GE-UY OI=28289 at $0.70 SL=0.25 BUY PUT OCT-27*GE-VY OI= 7257 at $1.65 SL=0.75 Average Daily Volume = 29.6 mln --- MTG – MGIC Investment Corp. $54.93 -2.07 (-3.45 this week) Company Summary: MGIC Investment Corporation is a holding company that, through its wholly owned subsidiary, Mortgage Guaranty Insurance Corporation (MGIC), is a provider of private mortgage insurance coverage in the United States to the home mortgage lending industry. Private mortgage insurance covers residential first mortgage loans and expands home ownership opportunities by enabling people to purchase homes with less than 20% down payments. Private mortgage insurance also facilitates the sale of low down payment mortgage loans in the secondary mortgage market, principally to the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. Why We Like It: There has been a lot of discussion about whether the housing market is in a bubble, but it has been difficult to make a definitive case with the housing market remaining strong. But news out earlier this week of a record number of foreclosures in the second quarter seems to be pointing towards the likelihood that the housing market is softening. The foreclosure news doesn't bode well for lenders, but it is even more disconcerting to MTG, whose principal business is providing mortgage insurance coverage. Apparently investors agree, as the stock found a top this week at the $59 level and has been heading steadily lower. Today's rout in the broad market dragged MTG under the $57 level on very heavy volume (nearly triple the ADV), which had been providing support in recent sessions, and it now appears the bears have set their sights on the July lows near $52. Judging by the PnF chart, $52 could just be a speed bump on the way to significantly lower prices. The breakdown below $57 put the stock back on a sell signal and the current vertical count points to an eventual bearish price target of $46. There is significant support near current $54, so it is likely that we could be setting up for an oversold bounce. Given the deteriorating fundamental and technical picture, MTG should run into stiff resistance near $57 (broken support becomes new resistance), so the best case for new entries will be on a rollover near this level. Due to the $54 support level, we really don't want to consider new positions on a breakdown. Place stops initially at $58, as a more above that level would call into question the current bearish tone in the stock. *** September contracts expire next week *** BUY PUT SEP-55 MTG-UK OI=1222 at $1.60 SL=0.75 BUY PUT OCT-55*MTG-VK OI= 205 at $3.40 SL=1.75 BUY PUT OCT-50 MTG-VJ OI= 0 at $1.80 SL=1.00 Average Daily Volume = 782 K ************************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 09-12-2002 Copyright 2002, All rights reserved. 3 of 3 Redistribution in any form strictly prohibited. In Section Three: Play of the Day: PUT - AET Traders Corner: Option Chains: The Missing Links Options 101: Puts On Your Personal Residence ********************* PLAY OF THE DAY - PUT ********************* AET - Aetna $39.23 -1.75 (-2.42 for the week) Company Summary: Aetna is one of the nation's leading providers of health care and related group benefits, serving approximately 14.4 million health care members, 11.9 million dental members and 12.0 million group insurance customers, as of June 30, 2002 (source: company release) Why We Like It: Investors were listening carefully today as Fed Chairman Alan Greenspan talked of the healthcare problems that would be facing the U.S. in the coming years. The lack of proper funding he referred to for the Medicare program will mean even less dollars for private insurers, such as Aetna, which operate Medicare HMOs. Companies have been complaining for years that Medicare reimbursements are not keeping up with costs and that they are losing money in many markets. The problem is already having an effect on large health insurers, such as Aetna, who are being forced to pull out of markets where their bottom line is bleeding. Monday was the deadline for companies to drop out of markets that they could no longer serve, and Aetna was among those who reduced their program load. The President's budget included a 6.5% increase for Medicare spending next year, which sounds great, until it is compared with the 10% increase in costs this year. With Greenspan's talk of reduced spending by the government, in an effort to reduce deficits, cash flow to those companies that rely on government reimbursement is likely to suffer. These companies will be faced with the decision of operating at a loss, or pulling out of certain markets entirely. AET had been in consolidation between $40 and $45 since the end of July. It rode a rising 200-dma and a falling 50-dma until getting squeezed out of the formation on today's drop. The 200- dma had provided support on each dip and had not been crossed to the downside since November of 2001. All streaks must end and this one has. The break in support looks very bearish after such a long consolidation and the minor support around $38 does not look all that significant. While the previous dip below the recent consolidation might otherwise be a significant point of support, it appears that the July drop was actually halted by the rising 200-dma, which failed today. Nonetheless, we will note that level for conservative investors looking for more confirmation of the downward trend. However, we view the current break as significant and will enter the short position here. The significance of this break is confirmed by a look at the point and figure chart, which shows a solid break in bullish resistance, along with a triple bottom breakdown. The stars seem to be aligning for this short play, with a target price of $30. Place stops at $42.50, just above the recent relative high on Monday. *** September Contracts Expire In Less Than 2 Weeks *** BUY PUT SEP-40*AET-UH OI=2207 at $1.65 SL=0.85 BUY PUT OCT-40 AET-VH OI=4980 at $2.95 SL=1.50 Average Daily Volume = 1.47 mil ************************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 ************** Option Chains: The Missing Links By Mike Parnos, Investing With Attitude I know that, even though you have hundreds of TV channels from which to choose, sometimes even a Couch Potato Trading Institute student can’t find anything to watch. If you need some mental stimulation, spend some quality time with your friendly option chains. The famous detective Nero Wolf was one of the original couch potatoes. He managed to solve a murder between meals and without ever leaving his house. They didn’t have television in those days, so he had to be content to read, raise orchids, and yell at his personal chef (all couch potatoes should have one). How did Wolf solve these murders? Simple deductive reasoning. He looked at facts, applied his own brand of logic, and put the pieces of the puzzle together. There’s always more than one interpretation – and often it’s not the most obvious. I received a question this week that is an example of the benefits of the powers of observation and the doors that open as a result. Mike: I've been a reader of OptionInvestor for three years now. Back in the 1999, 2000 I thought I perfected the OTM strangle play. Where I would buy OTM call and OTM put to hedge my position. I always played this around a special event and my favorite was around earnings time. I was delighted to hear about your ITM strangle. As I was doing some research today, I came across something very eye catching. Someone, and I bet a big institution or fund, bought 20,030 contracts of the December 22 put (QAVXU) for 1.75 ($3.5 million). They also bought 20,000 contracts of Dec 27 Calls (QAVLA) for 1.1 ($2.2 million) for a total cost of $5.7 million. Now, someone betting this much money is guessing to the downside more than the upside since their bet of the puts are close the QQQ's price. What are your thoughts about this play? Thank you. Response: That is a huge bet – especially by my standards. I usually feel a 20-contract position is extravagant. Those two comma trades are out of my league. I’m glad it’s not my money on the line. What is described above could be a big down bet. Did you look to see if they sold a large quantity of near term puts or calls against these long positions? They probably did not. With all the simple and complex options strategies out there, it can be very difficult to ascertain the purpose behind a trade or the method to their madness -- even for Nero Wolf. Possibility #1: In recent columns we discussed “buy strangles” where both puts and calls are purchased, but at different strike prices. This trade may be a “sell strangle” where puts and calls are sold at different strike prices. In this case, they took in the $5.7 million and they expect the QQQs to stay within a range. They may believe that the QQQs will stay above $22 and below $27. That wouldn't be a bad trade either. If they are aggressive traders, they can make trades within the context of the sell strangle as the QQQs fluctuate up and down between now and December expiration. As the QQQs move up to near $27 (there’s actually some pretty good resistance at the $26 level), they could lock in profits by buying back the $22 puts, etc. They have a $2.85 margin for error that means the QQQs would still be profitable from $19.15 to $29.85. That seems like a pretty safe bet. Possibility #2: It’s possible that a large institution owns 20,000 QQQ shares. They believe that the QQQs have bottomed and they feel it will rebound in the next three months. They may have sold the December 27 calls for $1.10 as part of a covered call play. Then, they sold the 22 puts to take in an additional $1.75. If the QQQs are below $22 in December, they may be willing to accept an additional 20,000 shares with a cost basis of $19.15 ($1.75 + $1.10). It's challenging to try and figure out what's going through the minds of the big bettors. We'll never know for sure, but speculation is fun and it stimulates thought. Possibility #3: The two trades were totally unrelated and mean absolutely nothing. Who knows? But we’re always on the lookout for a good conspiracy – or strategy. An important aspect of detecting a potential trend or bias in an option chain is, to note the open interest on the day of the unusual activity. Then check again the open interest again the following day. If a similar number of contracts disappears from the open interest figure, you can deduce that the unusual activity was a closing trade rather than opening a new position. We have a source of facts in the option chain (free at www.cboe.com) – important pieces of the puzzle. Find the largest concentration of open interest. At this writing, GILD (Gilead Sciences) is at $33. The chart tells us that it has been in a trading range between $28 and $38 for months. GILD is a biotech stock that has held up relatively well during the recent market chaos. September $30 calls = 3,200 OI $30 puts = 2,200 OI September $35 calls = 5,200 OI $35 puts = 470 OI September $40 calls = 3,200 OI $40 puts = 450 OI What does this tell you about the direction of GILD for the next week and a half? a) GILD will likely stay in the $30-$40 trading range. But more likely, it will stay between $30 and $35. Let’s figure out what scenario will most benefit the market makers? If GILD finishes at $35, a total of 5,670 (calls + puts) will expire worthless and generate hundreds of additional transactions. Take note that the total of $30 puts and calls is about the same (5,400). The market maker would rather GILD finish at $30. A similar total number of contracts are at the $30 and $35 strikes. But there is one significant difference. If GILD finishes at $35, the 3,200 $30 strike call contracts will still have a value of $5.00. If GILD finishes at $30, the 5,200 open $35 contracts will expire worthless. If at all possible, the market makers will guide GILD toward the lower $30 strike. However, if the market is strong, they may try to guide it upward to the $35 level. With this information, what strategies would best take advantage of this scenario? A Sept. sell strangle? A Sept. iron condor? A butterfly? Perhaps you believe the GILD will stay within the range for another month and are considering Oct. strangles or condors. Check the option chain. So far (and it’s probably too early for it to be meaningful) the Oct. $40 calls have the largest open interest. It’s not unusual for biotech stocks to have traders speculate on an FDA approval or rejection. The open interest, and corresponding changes in open interest, in an option chain is but one clue. It may help you select a strategy, or it may suggest you avoid a strategy you were considering. Keep in mind that option chain clues are but one indicator. Look at the trading range and see if it is consistent with the option chain. Check to see if there are any distinguishable chart patterns. Check the trading volume. Where are the short and long term moving averages? The more ducks that are in a row, the better chance you have of success. But remember, there are no sure things in life – unless her name is Trixie and you have $100. Nero Wolf says, “To ignore the facts doesn’t change the facts.” If you don’t consider all the facts available in researching your trade, you will fail miserably as a CPTI student and be doomed to couch potato hell -- watching The Anna Nicole Smith Show -- without a harpoon. Happy trading! The CPTI credo: May our remote batteries and self-discipline last forever, but mierde happens. Be prepared! In trading, as in life, it’s not the cards we’re dealt. It’s how we play them. Your questions and comments are always welcome. mparnos@OptionInvestor.com ************************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 ************************************************************** *********** OPTIONS 101 *********** Puts On Your Personal Residence Buzz Lynn buzz@OptionInvestor.com Huh? Wha'd he say? OK, show of hands. . .who remembers the late 1980's and early 1990's when housing prices across the country fell apart as a result of the S&L crisis? I remember quite well since I was the lucky recipient of a 30% haircut on the value of my home during that period of time. Lucky? Yes, many others lost more; 50% or more in some cases. Thank God, those days are over now. Yet history has a way of repeating. What I would have given then for the opportunity to protect myself from price erosion. But no such thing existed. According to a recent Forbes article, more than 50% of homebuyers in the early 1990's experienced value declines in their markets over the next five years. The best we could hope for then was to sell to someone and let them take the value hit, rent the place out to minimize the negative cash flow, or stay put for a while until the financial storm blew over. But there is a way for a few fortunate souls to protect their investment against falling home prices. Making matters worse, there is the issue of leverage. When we buy stocks, we can do so using 50% margin - 2:1 leverage - and must maintain at least 35% leverage or face margin calls. In these heady days of 25% annual price appreciation induced by practically free money, a 1% down payment means 100:1 leverage, and in the case of zero down or 125% loan to value, the leverage is infinite. Now that's a housing bubble! Ratios like this make the stock market look like the bastion of fiscal health! Say that back in 1990 we bought a home with 20% down for $100,000 - now a myth in California's coastal cites (L.A., or San Francisco Bay area) and most major metropolitan cities nationwide. But for the sake of argument assume that's true and that over the next five years, our community or neighborhood, including our house, declined in value by 20%, thus wiping out our down payment, leaving us only with the loan value - or worse, "upside down" owing more than the house is worth. That's a big hit. We can't move and we can't refinance. As Fundamentals Guy, and with a background in a prior life in the commercial real estate business, I've always wondered how I might protect myself against that kind of loss. Lo and behold, there is now such a way. It's normal for us to insure against fire, our health, our cars, etc. It's normal for us to even insure against our stock portfolio with put options. But until now, we've never been able to buy a protective put on our home values. That's right, a protective put or insurance for loss of value on our homes! OK, the bad news first: It is currently only available in Syracuse, N.Y., but through use of data pooling on the Internet, is likely to expand to other cites next year. That said, here's how it works. Instead of protecting against loss for our individual home, it protects against loss of an index for a particular zip code. For a one-time fee of just 1.5% of the estimated home value, which can be financed over four years, we can get an "insurance policy" or a European-style protective put with a maturity of three years, but appears to never expire thereafter until we sell our home. After three years, and IF we sell our home thereafter, if the index of home values in our zip code index has declined, we are paid that percentage decline of our stated home's value. Say, we buy a $100,000 home today with 20% down payment. The down payment really doesn't matter because we are buying protection against the stated value of the home, not the hard cash investment. Again, it's like a put on a margined stock. It insures against the value, not the margin. For a 1.5% fee of $1500, we price-protect the home for $100,000. The property's "protected value" goes into effect three years after the purchase. Thereafter, if we sell the home, whether for a loss OR a profit - it doesn't matter, we will be paid for the loss of the index value consistent with our zip code. Let's take the example used above. We've bought a $100,000 home in the 99999 zip code (I just made that up, but it might be a real zip code). We spend our 1.5% or $1500 for our value loss policy. Three years later, we can collect if we sell thereafter. Say then that we sell the house for $115,000 - yes, a profit, perhaps because we've fixed it up. Yet the zip code index, based on other selling prices in our area, shows an 18% decline in value. $100,000 "protected value" multiplied by an 18% decline equals a paper loss of $18,000. Thus, we would be paid $18,000 for our "loss" - the loss in value of the index, not the loss in value of our home, which we obviously didn't have thanks to our expert skills as a home remodeler
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