The Option Investor Newsletter Tuesday 09-19-2002 Copyright 2002, All rights reserved. 1 of 3 Redistribution in any form strictly prohibited. In Section One: Wrap: Count on It! Index Trader Wrap: "Dow bears" got their target Market Sentiment: Lack of Support Weekly Manager Microscope: Steven Kaye: Fidelity Growth & Income (FGRIX) Updated on the site tonight: Swing Trader Game Plan: Where Is That Bounce? Posted online for subscribers at http://www.OptionInvestor.com ************************************************************ MARKET WRAP (view in courier font for table alignment) ************************************************************ 09-19-2002 High Low Volume Advance/Decline DJIA 7942.39 -230.10 8170.65 7939.83 1.76 bln 752/2459 NASDAQ 1216.44 - 35.70 1242.91 1216.19 1.48 bln 1037/2477 S&P 100 423.06 - 12.93 435.46 422.88 Totals 1789/4936 S&P 500 843.32 - 26.14 869.46 893.92 RUS 2000 365.54 - 11.21 376.75 365.37 DJ TRANS 2158.87 - 3.90 2211.96 2140.93 VIX 46.16 + 5.27 46.72 43.95 VXN 62.76 + 3.43 62.76 59.36 Total Vol 3,447M Total UpVol 377M Total DnVol 3,052M 52wk Highs 89 52wk Lows 644 TRIN 1.98 PUT/CALL 1.22 ************************************************************ Count on It! If you had thought a retest of the July lows was possible before you can count on it after today. Even more depressing is the thought that maybe those lows will be broken, not tested. Market conditions are continuing to deteriorate and we are a long way from being out of October. There are still a lot of companies which have not warned and the end of September is shaping up as serious pothole. Dow Chart Nasdaq Chart It was an ugly day. Seems we are getting a lot of those lately. The futures before the open were down -15 from the 4:PM numbers on Wednesday. This caused a straight -165 point drop to 8008. The Dow bounced about +100 points from the lows and the 8000 level held until 3:09 when sellers all joined together to break the stalemate. Once below 8000 it was all over but the bleeding and bleed it did. The Dow closed at 7942 and the low of the day. The Nasdaq lost a whopping -35 points to close at a low not seen since the 1205 August 5th low. EDS profit warning last night turned into 50% haircut as the stock dropped from $36 to $17.23. Their warning also impacted Dow component IBM, which dropped -4.75 to $64.90 in regular trading. IBM has yet to warn and several analysts came to their defense today. Considering today's drop to levels not seen since 1998 a warning could easily push them under $60. INTC dropped to $14.90 and a low not seen since Nov-1996. There was a flood of missed earnings today along with another flurry of earnings warnings. TXI reported $.18 cents vs estimates of $.52 cents. They sell concrete and the lack of construction is hurting their business as well as weather patterns in Texas where they are located. Morgan Stanley reported earnings of only $.55 cents a share when analysts were expecting $.67 cents. The banker said earnings were hit by weak trading results and declining merger and underwriting revenue. AG Edwards (nyse:AGE) fell -6.1% after missing analyst's estimates by -13 cents. AKLM fell -20% after warning of a pending shortfall. ASTE lost -29% after warning that it now expects a loss of -6 cents instead of a gain of 11 cents. Belden Wire & Cable (BWC) fell after warning that sales of fiber optics and network cable would fall short due to a continued decline in capital expenditures. Not all the news was bad. FDX beat estimates and soared +4.75 on strong growth in its ground business. They affirmed estimates for the full year. The Dress Barn jumped +32% after beating the street on high margins and cost cutting. Herman Miller (MLHR) beat the street by a dime and gained +15% on strong cost cutting and improved margins. Other winners included IM, MET, PAYX, AAII and STTX. Despite the -230 Dow there were gainers although all the Dow stocks were negative. After the bell there was good news tonight instead of bad. JBL beat the street by a penny and said business conditions had stabilized during the just completed quarter. They said the outlook for JBL was very positive and it expected substantial growth in the coming quarters. Wow! A recovery? Qualcomm jumped $2 in after hours when it announced that chip orders for the 4Q would be around 20 million, four million more than the last quarter. They also said the next quarter would be stronger than expected due to strong demand for their newer generation of chips. TEK reported earnings of 15 cents a share and easily beat analyst's estimates of only 7 cents. It forecast only a -5% drop in sales for the next quarter based on weakness in the optical market. After a bad day the news from JBL, QCOM and TEK was welcome. The futures in after hours were up and expectations were improving for the open tomorrow. After a series of bad opens and no major economic reports on Friday maybe the stars are finally aligned in the bulls favor. Economics today were just another weight on the market. The jobless claims fell to 424,000 but from a strong upwardly revised 433,000 number from the prior week. The economy is still losing steam with continuing claims rising to 3.615 million. This is the highest level since June 22nd. Housing Starts declined to 1.61 million and well below consensus of 1.65 million. This is the third consecutive drop in starts and could be indicating the end of the demand cycle. Single family starts were the slowest since Nov-2001. The Philadelphia Fed Survey came back from brink with a 2.3 and while low it diffused the -3.1 numbers from last month. The shipments component jumped to 10.6 from -3.3 last month. These numbers tend to be volatile but they have been closely watched for signs of a second dip in our future. The immediate and unconditional return of the inspectors to Iraq now has a date. An "advance" party is scheduled to arrive on October-15th to "continue" discussions about the rules of what and where the inspectors can go with their unconditional access. UN authorities said it could be as much as two months before Iraq will let the full inspection team go to work. That should be plenty of time to hide anything of value don't you think? My idea of unconditional would be "open it or lose it". Anything on the list of prohibited sites becomes rubble the following night. Where to from here? With 2.2 negative warnings for every positive preannouncement the outlook is not good. The positive news from QCOM and JBL after the close was nice but not of a broad market nature. The futures spiked but then they were very oversold at the close. The VIX is nearing 50 again and the TRIN was near 2.0. The put/call ratio has spent more time over 1.0 this week than I can remember in quite some time. The volume continued to increase as traders ran to the exits. I have not mentioned capitulation for a couple weeks. With the down volume running nearly 10:1 to up volume for only the second time in two months it appears that capitulation is drawing near. The good news tonight is not likely going to change the overall trend but we could see a bounce at the open without any negative overnight news. I was surprised today that we did not see a Fed bounce at the close. With the Fed meeting next Tuesday and chances increasing for a rate cut, I expected the bulls to be mounting a much stronger "buy the rumor" attack. That possibility still exists for Friday along with short covering from the weeks -369 Dow and -75 point Nasdaq drops. With a Fed meeting only two days away the shorts should want to go into the weekend flat. Dow 8000 was a significant support point. Coupled with the OEX at 428 and the SPX at 850 the breakdown today was a significant event. This almost guarantees a complete retest of the July 7532 intraday lows. Before we see those lows again we have to get by the Fed meeting. I doubt they will cut rates but bears will not want to be short in case they do. Sellers will want to wait for the meeting to sell in hopes of a bounce on a cut announcement. Either way it spells the possibility of an uptrend until 2:PM on Tuesday. Enter Very Passively, Exit Very Aggressively! Jim Brown Check out the Traders Corner "Charting Trendlines" by Leigh Stevens in tonight's newsletter. http://www.OptionInvestor.com/indexes/traderscorner.asp ******************** INDEX TRADER SUMMARY ******************** "Dow bears" got their target Stocks found plenty of willing sellers again today as the major market averages all traded down better than 2.75%. Only "Dow bears" saw their initial target get hit, and then follow through with further downside into the close, as the Dow Industrials (INDU) 7,942 -2.81% closed below "psychological support." With the Dow Diamonds (AMEX:DIA) 79.64 -2.18% breaching our initial bearish trader's target near $80.45, I'm going to now "roll down" our retracement bracket and add a regression channel to give us some new levels to monitor. Bears still holding positions will find the levels useful, while those looking for new entry points should also benefit. Dow Diamonds (AMEX:DIA) - Daily Interval The Diamonds opened just right near our bearish target of $80.50 and for the better part of the day (until about 02:00 PM EST) traded just above that level. This hints that we may have been "right on the money" as far as the $80.50 as a near-term bearish target. With a violating close, thought now becomes that excess supply is present so I'm going to "roll down" my retracement bracket and "fit" some levels to past trading. While we don't have much data (just 20-sessions) to have a lot of confidence in a regression channel, I have added a bearish regression channel to the DIA chart. In early September, the DIA fell to the base of this newly added channel and eventually bounced back to the upper levels. As such, a trader that closed out positions today looks for a rally back above the $82.28 level as a new bearish entry point. Bears still holding positions and looking for further downside could now lower stops to just above the 38.2% retracement level of $80.45 (say $80.55 to get above a round Dow Indu. level of 8,050). Until the point and figure chart generates a buy signal ($88.00) or the Dow Industrials Bullish % ($BPINDU) reverses back into "bull confirmed" from "bull correction" my longer-term target is still $74 from the bearish vertical count. I like the way the bottom of retracement comes out at $74.55. I'm also leaving in place our "old" upward pink trend. I'm a believer that sometimes, support broken becomes resistance and this trend may come into play should the DIA rally. S&P 500 Index (SPX) Chart - Daily Interval While the Dow reached and broke its August 5th close, the SPX is getting close, but didn't trade our 835 bearish trader's target today. As such, I'll leave retracement as it is until our first bearish goal is achieved. SPX traders will want to monitor the Dow Industrials tomorrow to perhaps get a feel for any technical support coming in at the DIA's lower end of regression. If the DIA looks like it's going to slice lower still, then odds are high the SPX would do the same. However, if a rebound looks to be shaping up in the Dow, an SPX trader assesses near-term risk to 19.1% retracement near 870, then 900. Just as a DIA bear looks for another rally entry point, and SPX bear would look for a rally back above 870 as a potential area to establish a new position. SPX bears looking for a tighter stop-profit level than 870 can use the account management technique of assessing downside to target (8 points) and simply add those 8-points back to today's close of 843 and establish a stop at 851. That would be just above a nice "round number" and keeps risk/reward to target at 1:1. S&P 100 Index (OEX) Chart - Daily Interval Currently looking for resistance back near 435 (19.1% retracement) and would now look for bearish trade entries above the 440 as close to the 50-day MA as possible. Just like an SPX trader will be doing, keep an eye on the Dow Industrials for any support at lower regression if bearish trade target is achieved. While I won't be "focusing" on buy/sell program premium levels, which we give out each morning in the 09:00 AM EST update, I will have my premium alerts set tomorrow. If the SPX trades 935 and OEX trades 420 and I start seeing some "buy program" premium level alerts, I will post in the market monitor and that my be a "reason" to lock in gains at targets. However, if the Dow Industrials rocket lower through the lower end of regression and we get "sell program" alerts, I'll post that too. The thinking for bears that may have closed out some trades with a gain today, could actually leg into a bearish SPX or SPY trade, risking some of their DIA gains. If the Dow Industrials is going to lead lower like it appears to be doing, the might as well try and take the SPX, OEX bearish trade along for the ride. Still scratching my head over this.... While a bear can't be disappointed in a NASDAQ-100 Tracking Stock (QQQ) $21.58 -1.59% decline, there's got to be some frustration for a bear in this security considering the NASDAQ-100 Index (NDX.X) 866 -3.26% fell my a noticeably larger percentage. What the heck is up with that? I have no clue. We started noticing this earlier this morning in the 11:00 intra-day update. I even looked at all 100 stocks and percentage declines. Even the more heavily weighted stocks were seeing some downside. The only thing I can think is that the QQQ is a security in and of itself and that there just weren't enough sellers to drive the price lower. The AMEX site does state that the "NASDAQ-100 Index Tracking Stock is intended to provide investment results that, before expenses, generally correspond to the price and dividend yield performance of the NASDAQ-100 Index, and its initial market value approximates 1/40 of the value of the underlying NASDAQ-100 Index. There is no assurance that the price and yield performance of the Nasdaq-100 Index can be fully matched." Anyway, I've got a call into the AMEX and should get a call back tomorrow morning with some type of "explanation." Right now, as a trader, I must trade under the assumption that this security, just like any stock, will have its price action determined by supply and demand. As such, we need to FORGET for now last night's conversation regarding what impact the software or biotechs would have on the group, let alone the Heatmap and representative securities. Right now, I'm a little "miffed" if I'm a bear in the Q's and looking for the door in a bearish trade. The reason being is that as a "bear" I feel I interpreted the NASDAQ-100 correctly and got downside action. However, the QQQ did not perform to the downside like the NASDAQ-100, as such, I would no longer want to do business with the QQQ until I get some information as to why I didn't get anything close to the downside performance I feel I should have. NASDAQ-100 Tracking Stock (QQQ) Chart - Daily Interval Currently, I would want OUT of a QQQ bearish trade considering today's "lack of downside" performance as it relates to the NASDAQ-100. The Biotech Index (BTK.X) 318 -5.4% and Software Index (GSO.X) 86.59 -3.75% did everything a NASDAQ-100 bear wanted, but the QQQ didn't follow that action. If the NASDAQ-100 Index (NDX.X) 865.93 -3.26%, which is tied directly to the underlying 100 stocks were to go UP 5%, will the QQQ gain 7%? That's the RISK I think a trader needs to factor in right now. An old trader's saying is.... "when in doubt, time to get out!" As such, will challenge a bearish trade in the QQQ with a tight stop at $22.13. NASDAQ-100 Index (NDX.X) Chart - Daily Interval The NASDAQ-100 Index (NDX.X) performed more inline with how the 100 components traded today. "Heavyweights" Microsoft (NASDAQ:MSFT) $47.13 -1.2%, Intel (NASDAQ:INTC) $14.98 -1.96%, Cisco Systems (NASDAQ:CSCO) $12.00 -2.35%, Amgen (NASDAQ:AMGN) $42.00 -7.65%, Dell Computer (NASDAQ:DELL) $25.27 -5.14% and Qualcomm (NASDAQ:QCOM) $25.72 -1.03% traded lower on the session. These are perhaps the "Six Horsemen" of the NASDAQ-100, combined weighting is about 35.7% of the NASDAQ-100 weighting.(MSFT:13.6%, INTC:5.47%, CSCO:4.92%, AMGN:4.16%, DELL:3.89%, QCOM:3.69%) The "key stock" that a bear wants to see break is MSFT, and this bugger continues to find support above $46. Until it does, I'm still more willing to cover at least a portion of a bearish position on a trade at the lows near 857. If MSFT were to break above $52 then things could get dicey for a bear in the NASDAQ-100. The NASDAQ-100 and broader technology might get a boost tomorrow out of late night QCOM news that it expects to ship approximately 20 million MSM phone chips during Q4, including approximately 15 million third-generation (3G) CDMA2000 1X MSM phone chips. QCOM traded higher at $27.80 (+8% from its close). A NASDAQ-100 bear would like to see the stock find resistance below its 21-day and 50-day SMAs near $28.00. A break much above that level might have NASDAQ-100 traders thinking the NASDAQ-100 itself could challenge its correlative 21-day and 50-day SMAs back near 950. Currently, NASDAQ-100 traders might at least use my current observation of potential "lack of selling" in the QQQ as a "reason" to be cautious near-term. If the AMEX calls me back before the open of trading, I'll post the AMEX reply in the 09:00 AM update or in the market monitor. Jeff Bailey ------------------------------------------------------------ WINNER of Forbes Best of the Web Award • optionsXpress voted Favorite Options Site by Forbes • Easy screens for spreads, collars, or covered calls • Free streaming quotes • Real-time option chains, charts + calculators Go to http://www.optionsxpress.com/marketing.asp?source=oetics21 Note: Options involve risk. Risk disclosure: http://www.optionsxpress.com/welcome_risk_index.htm ------------------------------------------------------------ **************** MARKET SENTIMENT **************** Lack of Support by Steven Price That was quick. When the Dow broke through support at its 50% retracement of the rally between July 24 and August 22, it looked like 8000 would be the next stop. I just didn't realize it would happen in two days. I have renewed faith in my technical analysis education after watching a classic head and shoulders formation across all major indices. The neckline break came at the same time as the 50% retracement support level fell and the result has been bloody. IBM led the average down after its business rival EDS cut earnings estimates by more than 80%. Big Blue finished the day down $4.75 to $64.80. This was without a warning from IBM, which may be coming soon. The Dow went tumbling early in the day, but appeared to find some support just over 8000. It looked like we had found a new range, which was going to hold the group before re-testing its July lows. That floor lasted only a few hours before late day selling pushed the group below 8000 to finish the day at 7942.39. We are likely to slow down as we approach the July lows of 7532.66. In fact, with the market sinking quickly, talk of a rate cut at next Tuesday's FOMC meeting will most likely lend some support. Up until now, it appeared there was little chance the Fed would cut rates, as the market had rebounded throughout the last two months and looked like it had taken its best shot and held up. Numerous Fed governors had indicated that rates were low enough to help an economic recovery. The economy was growing slowly, but still growing. Now that the market has sold off and much of the recent economic data has been weak, there may be speculation of a cut next Tuesday. The talk of the Fed holding their bullets until after September 11, in case of another attack, is behind us, so the risk of lowering rates seems less than it was at the August meeting. I still do not believe the Fed will lower rates next week, but expect to hear optimism creeping back in. Some of the reasons for today's sell-off, beside the EDS warning, came from economic data released this morning. Jobless claims hit a four-month high, as rising layoffs have taken their toll. Housing starts were also off 2.2%, sending the homebuilders tumbling. The Dow Jones Home Construction Index (DJUSHB) lost over 7%, crashing through prior support and landing just above 300. The Philly Fed also reported that its monthly business survey had increased from -3.1 in August to 2.3 in September. This was slightly below expectations and the bank said that although the indicators have recovered from negative readings, growth is sluggish in the region. At least we are seeing positive growth, however, so there could be some bullish sentiment drawn from the report if you look hard enough. The markets didn't like what they heard however, as the sell-off continued after the report was released. A look at the bullish percentages shows just how severe the recent rollover has been. The Dow has fallen from a recent high of 60%, which reflects the number of stocks in the average giving point and figure buy signals, to just 33%. The Nasdaq 100 (NDX.X) has dropped from 50% to 30%. The S&P 500 has fallen from 58% to 40%. The NDX once again led the rollover, shifting into a column of "O"s before the others, so keep an eye on this index for the first signs of a rebound. After the bell, Qualcomm actually released some good news, saying it expects fourth quarter shipments of mobile phone chips to increase from the expected 18 to 19 million to 20 million. The company did not, however, increase earnings or sales targets. I have been very bearish lately, predicting a re-test of 8000 in the Dow and 1200 in the Nasdaq. Now that the Dow has broken this level and the Nasdaq has dropped to 1216.45, I am a little cautious about predicting another big drop tomorrow. While I still think we may re-test July's lows, we are getting awfully close and we could see some slowing of the downward trend. There is likely to be a bounce at some point soon, so I would keep stops on open short positions very tight to lock in any profits in the case of a bounce. That bounce may provide a better entry point for shorts, as well. Remember to trade what you see, and keep a few extra puts on hand just in case. ----------------------------------------------------------------- Market Averages DJIA ($INDU) 52-week High: 10679 52-week Low : 7532 Current : 7942 Moving Averages: (Simple) 10-dma: 8352 50-dma: 8508 200-dma: 9603 S&P 500 ($SPX) 52-week High: 1176 52-week Low : 775 Current : 843 Moving Averages: (Simple) 10-dma: 887 50-dma: 895 200-dma: 1048 Nasdaq-100 ($NDX) 52-week High: 1734 52-week Low : 856 Current : 866 Moving Averages: (Simple) 10-dma: 915 50-dma: 950 200-dma: 1276 ----------------------------------------------------------------- The Semiconductor Index (SOX.X): Just two days ago we said that 250 looked like the next target in the SOX after breaking below support at 275. The average now sits at 252. The mention of a new 52-week low seems redundant at this point, as it may just need to be a permanent headline to this update. You have to go back to October 1998 to see the index this low. Unless we see a rebound over 300, this will be the sixth straight red candle on the monthly chart. Coincidentally this is also the sixth straight red candle on the daily chart. We are probably in for some kind of bounce soon, although it is not likely to recover much of the recent losses. Qualcomm's announcement after the bell that they are predicting higher cell phone chip shipments will probably give us that bounce tomorrow. We are likely to hover over 250 for a few days, but if it breaks below that level, get out of the way, or just get short. 52-week High: 657 52-week Low : 252 Current : 252 Moving Averages: (Simple) 10-dma: 278 50-dma: 321 200-dma: 474 ----------------------------------------------------------------- Market Volatility On Tuesday we said to look for the VIX to creep into the mid 40s, and that we could see it back into the 50s if we re-test July's lows. That appears to be happening before our eyes. The VIX back up to 46 could be viewed as a contrarian indicator, as rallies generally follow spikes in the VIX. However, with support in the Dow gone at 8300 and 8000, July's low of 7500 may be in the near future. There is likely to be some sort of bounce before we reach that point, but a dip in the VIX may only be temporary on that bounce. CBOE Market Volatility Index (VIX) = 46.16 +5.27 Nasdaq-100 Volatility Index (VXN) = 62.71 +3.38 ----------------------------------------------------------------- Put/Call Ratio Call Volume Put Volume Total 1.23 547,243 674,433 Equity Only 1.04 359,372 375,434 OEX 1.14 56,842 64,001 QQQ 2.25 27,791 62,506 ----------------------------------------------------------------- Bullish Percent Data Current Change Status NYSE 38 - 4 Bull Correction NASDAQ-100 29 - 6 Bull Correction Dow Indust. 33 -10 Bull Correction S&P 500 40 - 8 Bear Confirmed S&P 100 35 - 9 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 1.75 10-Day Arms Index 1.46 21-Day Arms Index 1.51 55-Day Arms Index 1.32 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 576 2203 NASDAQ 922 2379 New Highs New Lows NYSE 21 19 NASDAQ 209 280 Volume (in millions) NYSE 1,750 NASDAQ 1,511 ----------------------------------------------------------------- Commitments Of Traders Report: 09/10/02 Weekly COT report discloses positions held by small specs and commercial traders of index futures contracts at the Chicago Mercantile Exchange and Chicago Board of Trade. COT data can be found at www.cftc.gov. Small specs are the general trading public with commercials being financial institutions. Commercials are historically on the correct side of future trend changes while small specs tend to be wrong. S&P 500 Commercials reduced long positions and added to shorts, reflecting an increase of almost 8,000 short contracts overall. Small traders increased both sides of the equation considerably, leaning long by an extra 3,000 contracts. Commercials Long Short Net % Of OI 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%) 09/10/02 426,230 470,537 (44,307) (5.0%) 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 08/20/02 156,974 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% 09/10/02 166,696 85,259 81,437 32.3% 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 to both long and short positions, for a net reduction of 1,000 contracts to the short positions. Small traders also added to both sides, netting out about the same as they finished the last period. Commercials Long Short Net % of OI 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%) 09/10/02 53,309 58,745 (5,436) ( 4.9%) Most bearish reading of the year: (15,521) - 3/13/02 Most bullish reading of the year: 9,068 - 06/11/02 Small Traders Long Short Net % of OI 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% 09/10/02 14,024 10,494 3,530 14.4% Most bearish reading of the year: (10,769) - 06/11/02 Most bullish reading of the year: 8,460 - 3/13/02 DOW JONES INDUSTRIAL Commercials added slightly to both sides, leaving their long contract positions slightly higher by about 800 contracts. Small traders beefed up both sides, with an extra 1,000 short contracts overall. Commercials Long Short Net % of OI 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% 09/10/02 22,946 14,936 8,010 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 08/20/02 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%) 09/10/02 7,568 10,129 (2,561) (14.5%) Most bearish reading of the year: (8,777) - 10/12/01 Most bullish reading of the year: 1,909 - 1/16/01 ------------------------------------------------------------ VOTED one of "Best Online Brokers" (4 stars)--Barron's • optionsXpress's "order-entry screens...go far beyond... other online broker sites"--Barron's • 8 different online tools for options pricing, strategy, and charting • Access to options specialists via email, phone or live chat online • Real-Time Buying Power, Account Balances or Cancels Go to http://www.optionsxpress.com/marketing.asp?source=oetics22 Note: Options involve risk. Risk disclosure: http://www.optionsxpress.com/welcome_risk_index.htm ------------------------------------------------------------ ************************* WEEKLY MANAGER MICROSCOPE ************************* Steven Kaye: Fidelity Growth & Income (FGRIX) This valuation conscious manager reigned in his technology stake and lagged his large-cap blend category peers in 1999, but since then has limited losses considerably relative to the S&P 500 and category peer group. Over the past 10 years, Kaye's performance has exceeded the market, as measured by the S&P 500 index, by an average of 1.2% a year, while ranking near the top decile of the large-blend category per Morningstar. Fidelity likes their stock fund managers to finish in one of the top two quartiles within their respective category. In five out of the last seven years, Kaye has done that, and more. Trailing 1-year performance ranks the Fidelity Growth & Income Portfolio in the top quartile of performance, while 3-year, 5-year and 10- year annual average returns rank in the category's top quintile, using Morningstar's rankings. Compared to its broad peer group (all U.S. equity funds), Kaye's relative performance in the last three years has been well above average. According to Lipper, Kaye's fund is a Lipper Leader in four categories they evaluate: total return, return consistency, preservation, and expenses. Lipper's analysis is based on three years of recent history and is relative to all funds in a fund's broad peer group. This week, we take a closer look at Steven Kaye and his Fidelity Growth & Income Portfolio, a popular choice in 401(k) retirement plans across America. The fund has a low expense ratio of 0.66% and requires a minimum initial investment of $2,500 for regular accounts ($500 for IRAs). There is generally no minimum amount in company thrift plans since participants contribute regularly into their retirement account. Manager Background Kaye is a vice president and portfolio manager with FMR (Fidelity Management & Research), the investment arm that serves as advisor to Fidelity's fund family. His manager start date on the fund is January 5, 1993; thus substantially all of the fund's performance may be attributed to him. Previously, Kaye was head of Fidelity Select Portfolios as well as assistant director of research. Kaye joined the Boston-based fund giant in 1985 and served as a pharmaceuticals analyst until 1990. From October 1990 until January 1993, he managed Fidelity Blue Chip Growth Fund, his first lead portfolio management role. Before joining Fidelity in 1985, Kaye spent a couple of years as a research analyst with Strategic Planning Associates. At nearly ten years, Kaye has one of the longest active manager tenures at Fidelity. Only Joel Tillinghast (Low Priced Stock), Bill Danoff (Contrafund), and Neal Miller (New Millennium Fund) have been at their portfolio management assignments longer than Kaye has. Kaye received an undergraduate degree in 1981 from John Hopkins University and earned his M.B.A. in 1985 from the University of Pennsylvania's Wharton School. Investment Style/Strategy Fidelity Growth & Income Portfolio (FGRIX) pursues high total return over time through a combination of current income and capital appreciation. In pursuit of the fund objective, Kaye normally invests a majority of assets in common stocks with a focus on those stocks that are currently paying dividends and show potential for capital appreciation. Kaye may also invest in bonds, including debt securities with lower-quality credit ratings, and stocks of companies that are not currently paying dividends but have the prospect of future income or capital appreciation. In terms of style, Kaye is large-cap oriented and blends value and growth characteristics suitable of a core stock investment. Lipper classifies the fund as large-cap core while Morningstar groups it in with other large-cap blend funds. At $60 billion, the fund's average market capitalization at August 31 was much higher than the average large-blend fund ($38.7 billion) using Morningstar's fund report. Over 56% of assets are invested in what Morningstar calls giant-cap stocks, with another 35.5% in large-cap stocks. So, this fund is decidedly large-cap biased. Kaye's average price valuations (P/B, P/E, P/C, etc) land this fund right on the category average. This blended portfolio is well diversified in terms of sector weightings, keeping sector bets to a minimum, near those of the S&P 500 index (benchmark). Rather than make large sector bets, Kaye relies more on equity research and stock selection to drive fund performance. Today, Kaye remains shy on technology, with just 13% of stocks in the tech sector (0.86 versus the S&P 500 index). As of January 31, 2002, Kaye had 87.5% of assets in stocks and 9.2% of assets in short-term investment funds ("cash"). Almost 99% of stock holdings were in the U.S. and Canada, with only 1% of stocks invested abroad. Whether Kaye has moved monies back into the market and become more fully invested now isn't known. This higher-than-average cash allocation may partially explain why Kaye has been successful in preserving capital through the downswing better than his large-cap peers have. Ratings, Risk and Performance We already mentioned that Fidelity Growth & Income Portfolio is a Lipper Leader for capital preservation (last 36 months). That is relative to its broad peer group (all domestic stock funds). Per Morningstar, the fund has produced "low" risk and "above average" returns relative to the average large-cap blend fund for all time periods evaluated, for a Morningstar overall rating of five stars (highest). The 3-year chart above gives you a graphical depiction of the fund's fluctuating net asset values over the past three years. During that period, Kaye lost an average of 7.8% a year, 4.4% better than the S&P 500 index's 12.2% annualized loss for the trailing 3-year period as of September 18, 2002. Although it represents a loss for investors, Kaye's 3-year average return (loss) ranked in the category's top quintile. For comparison purposes, the average large-cap blend fund lost 11.0% a year. Kaye's trailing 3-year performance is an example of "active" management doing its job. That is, minimizing losses versus benchmark (S&P 500 index) in down markets. For the trailing 10-year period through August 31, 2002, the portfolio has an average annual return of 11.6%, beating the benchmark S&P 500 index by an average of 1.2% a year to rank close to the top decile within the category (12th percentile). That in my opinion is a reasonable expectation for this fund, about one percent more a year than the market (S&P 500 index) through active management. Contributing to the fund's relative performance is its below average expense ratio of 0.66%. That gives the fund a "cost advantage" and helps Kaye in that he doesn't have to take on excessive portfolio risk to achieve the fund's growth/income objective. Funds with high costs and expenses may overreach risk-wise in order to overcome their relative cost deficits. Conclusion My sense is that if Lipper's ratings/rankings went back five years or ten years, that the story would be the same. In my opinion, Kaye is one of the industry's leading fund managers, backed by Fidelity's vast equity research capabilities. His consistent strong performance and ability to preserve capital through downturns should give fund shareholders great comfort. For more information on Steven Kaye and the Fidelity Growth & Income Portfolio, log on to www.fidelity.com. Steve Wagner Editor, Mutual Investor email@example.com ------------------------------------------------------------ We got trailing stops! • Trade online with trailing stops at optionsXpress, at no extra cost • Trailing stops based on the option price or the stock price • Also place Contingent, Stop Loss, and "One Cancels Other" orders • $1.50 /contract (10+ contracts) or $14.95 Minimum--NO Hidden Fees! Go to http://www.optionsxpress.com/marketing.asp?source=oetics23 Note: Options involve risk. 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The Option Investor Newsletter Tuesday 09-19-2002 Copyright 2002, All rights reserved. 2 of 3 Redistribution in any form strictly prohibited. In Section Two: Stock Picks: PDLI Dropped Calls: INVN Dropped Puts: AGN, TXU, PNRA, TRMS Daily Results Call Play Updates: AZO New Calls Plays: MMM Put Play Updates: BRL, LTR, TIN, AVY, MXIM New Put Plays: MAR, BSC *********** STOCK PICKS *********** PDLI - Protein Design Labs, Inc. - $9.20 Strategy: Long stock with put insurance Gone are the days when PDLI would move up (or down) $5, $10, or even $20 in a single day. The air has been let out of the Biotechnology sector, along with much of the rest of the former Tech darlings. But with the compression in price that has taken place over the past 2 1/2 years, many Biotech stocks are now actually trading at attractive valuations. That may seem like a bit of an oxymoron due to the vague manner in which these stocks have traditionally been valued, but a quick look at the balance sheet provides some bullish clues. PDLI currently (as of last quarter) has over $7 in cash per share and is trading for about 1.5 times its book value. While the company is still losing money, the outflow has slowed to a trickle, in large part due to the fact that the company has several products currently in production with its collaborative efforts with Hoffman-La Roche and Igeneon. In July, Igeneon (a European Biotech company focused on cancer immunotherapies) announced that it had licensed a humanized monoclonal antibody from PDLI. PDLI has also licensed rights of its humanized antibody product (Zenapax) to Hoffman-La Roche, which is marketing it for the prevention of kidney transplant rejection. PDLI is also testing Zenapax for the treatment of autoimmune disease. Additionally, the company has several other humanized antibodies in clinical development for autoimmune and inflammatory conditions, asthma and cancer. While the Spring is normally the worst time of the year for Biotechnology firms, the Fall is the best, due to the proliferation of industry conferences that frequently serve as a platform for companies to announce new products. PDLI's chart gives us cause for bullish interest as well. The stock bottomed near the $8.50 level back in June and July and after participating in the brief Biotech rally (leading to a move up near $14), is back down near the $9.00-9.50 support level. While most of the August rally has been erased, it is interesting to note that the stock appears to be putting in a slightly higher low than during the summer. PDLI will need a rally in the overall Biotechnology sector (BTK.X) to really get moving, but it could very easily challenge the $14-15 area later this year or early next year if the BTK cooperates. Once through that level, the next bullish target would be a move up towards major resistance in the $20 area. The play as we see it is to go long CSCO stock at our target of $9.00-9.50 and go long one contract of the Feb-2003 $7.50 puts PQI-NU at $1.25 for each 100 shares you are long. Note that we are using the Feb contracts because PDLI does not have Jan contracts available. There is no requirement to go long the put but it does prevent all but a very minimal loss should something unexpected happen to PDLI. Option 1: If PDLI is not above $13.50 by Feb-3rd, close both positions and exit the play. Option 2: If PDLI is below $9 on Feb-3rd then you have the option of closing the put for a slight profit and lowering your basis in the long stock play by the amount of the put premium received or closing both positions and exiting the play. Option 3: If PDLI is above $15.00 by Jan-2nd then close the put position for any remaining premium and set a stop loss on PDLI at your entry point of $9.00-9.50 plus any short fall on the put premium. ($10.75 max) **************** 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: ***** INVN $29.85 -$4.15 (-5.91 for the week) The Senate voted to extend the deadline for airports to comply with baggage screening requirements by a year. While this decision should not affect INVN's order flow in total, it will affect the time frame in which the orders are completed. This could affect earnings in the near term, although later earnings should pick up the slack. However, the stock dropped beneath its trend on the news, and we have been stopped out on the play. We will close this play and look for other opportunities. PUTS: ***** AGN $52.04 -0.36 (-1.01) We've gotten a nice little ride our of our AGN play, as it has dropped from the $55 area to as low as $50.80 yesterday. Nimble traders should have taken at least partial profits (as we recommended on Tuesday) as the stock found support near the $50 level, the site of major support. Even with the broad markets weak again today, AGN spent most of the day in positive territory, indicating to us that the slide has come to an end. Rather than try to squeeze a bit more out of the play, we're closing it out tonight and booking it as another winning bearish play. If still holding open positions, use any early drop tomorrow (follow-through on the dip in the final hour) to lock in a more favorable exit. TXU $42.70 -1.00 (-1.60) Perfectly scripted, TXU followed the Utility sector lower over the past week, and we're quite happy with the results. But with the Utility sector (UTY.X) finding support near $250 and TXU likewise finding support at $42, it looks like it is time to leave this party before we are asked to help clean up. While TXU could certainly fall further, the fact that it (and the UTY index) didn't fall apart with the rest of the broad market on Thursday hints at some internal strengthening. This looks like a good point to harvest gains on the play, so we're dropping TXU tonight to focus on plays with more potential. PNRA $26.85 +1.50 (+1.87 for the week) Panera has surged the last two days. Much of this can be blamed on rumors of a possible takeover. News surprises can get in the way of technicals, whether they are founded in reality or not. The CEO of Darden Restaurants made comments, when asked about a possible takeover, that they are looking at everything. While we don't give rumors much weight without evidence, we won't fight the tape on this one. The trend we were attempting to capture has been broken and we will let this one go. TRMS $43.60 -2.35 (-2.60 for the week) The biotech sector took a beating today, as Wyeth announced they would begin selling shares of Amgen, acquired as a result of Amgen's acquisition of Immunex. This sale, which will be 98.28 million shares in total, put the entire biotech sector into a slide. While we don't like letting a good pick go, based on news from another company, the stock broke our stop loss and in volatile markets, respecting your stops is at the top of the rules list. We will re-examine TRMS at a later date, as we still feel the long-term prospects for the company could still be positive. However the sinking tide has lowered this boat and broken the trend we were attempting to capture. We will let this one go and look for better opportunities. *********************************************************** DAILY RESULTS *********************************************************** Please view this in COURIER 10 font for alignment ************************************************* CALLS Mon Tue Wed Thu Week AZO 74.78 0.70 -0.31 -0.69 0.53 Rally mode INVN 29.85 0.39 -1.73 -0.53 –4.15 Drop, delayed spending MMM 117.19 -0.99 -2.40 1.69 –1.16 New, nice recovery TRMS 43.50 -0.30 0.35 -0.23 –2.45 Drop, Amgen's fault PUTS AGN 52.04 0.21 -1.54 0.73 –0.36 Drop, profits AVY 56.62 -0.09 -0.63 -0.41 –2.25 bad business BRL 62.72 -0.20 -0.68 -1.03 –2.57 dropping fast BSC 58.21 0.11 -2.20 1.93 –2.22 safety net gone LTR 47.55 0.13 -1.41 0.30 –1.37 50-dma in rear view MAR 28.51 0.57 -0.74 -0.76 –1.99 New, empty rooms MXIM 24.45 -1.07 -0.89 -0.18 –0.86 sliding SOX PNRA 26.83 -0.48 -0.28 1.11 1.48 Drop, rumors TIN 43.52 -0.29 -0.94 -1.95 –1.05 On its lows TXU 42.70 0.61 -1.97 1.30 –1.00 Drop, profits ------------------------------------------------------------ Quit paying fees for limit orders or minimum equity • No hidden fees for limit orders or balances • $1.50 /contract (10+ contracts) or $14.95 minimum. • Zero minimum deposit required to open an account • Free streaming quotes Go to http://www.optionsxpress.com/marketing.asp?source=oetics24 Note: Options involve risk. Risk disclosure: http://www.optionsxpress.com/welcome_risk_index.htm ------------------------------------------------------------ ******************** PLAY UPDATES - CALLS ******************** AZO $74.78 +0.53 (+0.36 for the week) Talk about relative strength! The Dow loses 230 points and AZO is heading north. The stock is actually following its rising trendline from July 24. It has found support there on the last four pullbacks and rebounded once again. While it is hard to recommend long entries with the Dow tanking and breaking below 8000, this appears to be a diamond in the rough. The stock experienced a triple top point and figure breakout with its recent trade of $76, and while it has given back some of that gain, it has held above support as the broader markets have slid. It has also established its fourth higher low on the pullback, a very bullish sign. A trade of $77 would constitute a bullish catapult, which is a triple top breakout followed by a double top breakout. The triple top breakout, according to Professor Earl Davis' study, is profitable 87.9% of the time and delivers an average gain of 28.7% within 6.8 months. While we are targeting a much smaller time frame, these numbers are very compelling from a bullish standpoint. The current bullish vertical count of $91 only adds to our bullish sentiment on this play. We are targeting the $82 range initially on this play, which served as resistance in June, however we will raise our stop accordingly if that looks conservative when we get there. Because the weight of the market has held the stock back, I still like this point for a long entry. However, be aware that a sinking tide can lower all boats and look to the broader market for signs of a rebound before initiating a new entry. ************** NEW CALL PLAYS ************** MMM – 3M Company $117.19 -1.16 (-2.64) Company Summary: Commonly known as the maker of the ubiquitous, adhesive-backed Post-It Notes, MMM is also a leading manufacturer of a variety of industrial, consumer, and medical products. Reflective sheeting on highway signs, respirators, spill-control sorbents, and Thinsulate brand insulations are just some of the company's industrial products. MMM also makes microbiology products, making it easier for food processors to test for the microbiological quality of food. Why We Like It: In a bearish market, bullish traders need to focus on relative strength more than ever. With the broad market breaking under major support levels over the past 2 days, there aren't a lot of stocks, particularly in the DOW that haven't given up important levels of support. Not only is MMM holding above important support in the $116-117 area, but the stock hasn't come anywhere close to testing its July lows down around $108. While the broad market weakness dragged it back from its intraday highs today, at one point it looked like MMM was going to blast back through the $120 level. Note that with the VIX north of 46 and the broad markets nearing major support levels, we likely are due for an oversold rebound in the broad market. Also figuring large in the windscreen is next Tuesday's FOMC meeting, and investors are leaning more and more towards expectations that the Fed will drop interest rates again. Since MMM has been one of the strongest components of the DOW over the past few days, it will likely lead any broad market rebound between now and Tuesday. Looking at a daily chart, it is impressive to note how the $116 level has provided a floor for the stock lately. That allows us to target new entries on any rebound from the $116-117 level and set tight stops at $115, just below the recent intraday lows. Should a meaningful rally develop, then momentum traders will get their opportunity to enter the play on a rally through the $120 level, with an eye on $125 as a near-term target. BUY CALL OCT-115 MMM-JC OI=1842 at $6.60 SL=4.50 BUY CALL OCT-120*MMM-JD OI=4017 at $3.90 SL=2.50 BUY CALL OCT-125 MMM-JE OI=3758 at $1.90 SL=1.00 BUY CALL JAN-125 MMM-AE OI=1950 at $6.30 SL=4.25 Average Daily Volume = 2.70 mln ------------------------------------------------------------ optionsXpress has "...a lot of bang for the buck."--Barron's • $1.50 /contract (10+ contracts) or $14.95 Min. No hidden fees • Easy screens for spreads, collars, or covered calls! • Contingent, Stop Loss, Trailing stop, or OCO • 8 different online tools for options pricing, strategy, and charting Go to http://www.optionsxpress.com/marketing.asp?source=oetics25 Note: Options involve risk. Risk disclosure: http://www.optionsxpress.com/welcome_risk_index.htm ------------------------------------------------------------ ******************* PLAY UPDATES - PUTS ******************* BRL $62.72 -2.57 (-4.45) There's nothing quite so gratifying as having a play move immediately in your direction! We started coverage of BRL on Tuesday after it rolled down from the 200-dma and came to rest just above the $66 support level. That didn't last long at all, as the stock got hit by selling over the past 2 days and gave up nearly 4% today alone. Adding to the bearish picture, BRL closed at the low of the day, violating the 50-dma ($62.94) and that could accelerate the decline down to the next level of support at $61. The recent downward move has generated a fresh PnF Sell signal, and the vertical count is now pointing at $55 as the bearish target. So any rebound from support is likely to be short-lived. That being said, we don't want to risk a large move against us, should the broad markets decide to rally from their deep oversold condition. So we're lowering our stop to $65.50, just above the top of today's gap. Those looking to initiate new positions can use a breakdown under today's low, but need to keep a sharp eye out for a rebound as BRL approaches the $61 level. The better entries will come from a failed rally below the $65 level. LTR $47.55 -1.37 (-2.71) Both Tobacco and Insurance stocks have taken it on the chin this week, and since LTR operates in both sectors, it has gotten the double-whammy. Actually in all fairness, LTR held up pretty well today, suffering less than a 3% loss. But that strength is likely due in part to the fact that it reached pretty substantial support near $47.50. While we expect this level to be violated eventually, we've got our eye on the next failed rally (probably in the $49 area) as our next high-odds entry point. Part of the reason we want to avoid new entries on a drop below current levels is the light selling volume seen in the stock on a day that saw robust selling volume in many of its peers. The other factor at work here is that the broad market averages are nearing some important support levels that could very likely generate a decent oversold rally. But that rally (when it comes) is unlikely to have much staying power, with significant resistance between $49.00-49.50, the 50-dma at $49.03 and the 3-week descending trendline at $50. Lower stops to $51. TIN $43.52 -1.05 (-4.47) Negative action in some of the leading Home Construction names as well as a less-than-stellar Housing report this morning have acted in concert to get our TIN play off in the right direction. In fact, since we began coverage of the stock on Tuesday, TIN has shed another $3, breaking below the $47 support level in the process. Highlighting the negativity in the stock, selling volume has been running close to double the ADV over the past 2 days, both of which resulted in the stock going out at the lows of the day. The interesting point about today's action is that after the initial gap lower, the stock traded sideways until the broad market driven drop in the final hour. TIN is deeply oversold and could be readying itself for a rally attempt. So we don't want to consider new entries near current levels. Rather, we want to wait for that rally attempt to fail before playing. Look for a rollover, possibly near the top of today's gap at $44.60, or even as high as the bottom of yesterday's gap at $46.25. As noted in the Market Monitor today, we are lowering our stop to $46.50. AVY $56.62 -2.25 (-3.38 for the week) As business spending has weakened, so has Avery Dennison's stock. They make everything from binders to adhesives that are used on labels and tape. However, a poor business spending environment bleeds through all sectors. Not only do businesses spend less on supplies, but also there are many companies that have closed their doors. This is a play that encompasses many businesses instead of just one. The stock broke below its 50-dma and 200-dma and then found overhead resistance at $60. The stock was also in a neatly defined descending channel from August 22 through Wednesday. That channel broke down to an even more bearish level today, as AVY gave up $2.25 after previously moving down in a slow orderly fashion. Any path it takes lower is fine with us. The stock may find some support at $55; however, the trade through previous support at $56.84 looks very bearish. After a drop which is extreme by AVY's standards, there may be a bounce. New shorts should look for a bounce and then a failed rebound blow $58 for an entry. We have lowered our stop on the play to $61.00 to allow for a bounce below Tuesday's high. For those readers who have been in the play and don't want to give up profits, an alternative stop would be $58.50, just above today's high. MXIM $24.45 -0.86 (-2.90 for the week) Maxim has continued to ride the semiconductor wave lower. The Semiconductor Sector Index (SOX.X) lost almost 4% today, finishing down 10.33 to close at 252.46. Maxim followed in its footsteps, giving up 3.39%. Last night's release of data showing chip-gear orders dropped for the third month in a row got the sector rolling downhill. The book to bill ratio for the chip equipment sector dropping for the third month in a row kept it going. The book-to-bill ratio shows how many new orders are received compared to how much is billed for the month. A declining ratio is usually a bad sign. While bookings were higher than a year ago, the trend is down and does not show signs of further improvement in the industry. There could be some support for the sector at 250 in the SOX, but the trend is decidedly down. The decline may slow as the index fights that number, but until there is a sign of an increase in consumer or business spending, future prospects still look bleak. Maxim is till in its triple bottom breakdown point and figure formation, which is another bearish sign. We are lowering our stop on the play to $27.50 from $28.50, as this coincides with the top of Tuesday's range. New entries should look for a break in the SOX below 250 as a sign of a new wave of selling the sector. ************* NEW PUT PLAYS ************* MAR - Marriott International - $28.51 -1.99 (-2.69 for the week) Company Summary: MARRIOTT INTERNATIONAL, INC., a leading worldwide hospitality company celebrating its 75th Anniversary in 2002, has over 2,600 operating units in the United States and 64 other countries and territories. Marriott International operates and franchises hotels under the Marriott, JW Marriott, The Ritz-Carlton, Renaissance, Residence Inn, Courtyard, TownePlace Suites, Fairfield Inn, SpringHill Suites and Ramada International brand names; develops and operates vacation ownership resorts under the Marriott Vacation Club International, Horizons, The Ritz- Carlton Club and Marriott Grand Residence Club brands; operates Marriott Executive Apartments; provides furnished corporate housing through its Marriott ExecuStay division; and operates conference centers. Other Marriott businesses include senior living communities and services, and wholesale food distribution. The company is headquartered in Washington, D.C., and has approximately 145,000 employees. Why We Like It: Marriott has experienced a sell-off for many of the same reasons as the rest of the stock world. A lack of consumer spending means less social travelers and a lack of business spending means less business travelers. U.S. hotel room revenues fell 3 to 5 percent in August, mostly due to the lack of business travel. luxury hotels saw the biggest drop in room revenue, as travelers opted for cheaper rooms. As Marriott hotels are located in many high priced business districts, their rooms tend to be in the higher price category. The revenue decline was actually greater than the 2.1 percent dip in June, and with September slow because of the anniversary of 9/11, next month's release should show a continuation of the trend. Apparently investors have noticed, as the stock has suffered a breakdown in support below $30. MAR had been in a consolidation pattern between $30 and $35 since late July. Today's drop below $30 found few buyers waiting below, and based on the earlier consolidation rectangle, $25 would be the minimum measuring objective. The point and figure shows a descending triple bottom breakdown, which is really just a series of successive sell signals with each column of "O"s. The descending channel on the PnF chart is well defined, as the original triple bottom breakdown was followed by two double bottom breakdowns. The signs are all bearish for MAR and we will use an initial target of $25. Below $25, $20 looks like the next significant support level, back in 1998. Place stops at $31.50, just above Wednesday's high. BUY PUT OCT-30 MAR-VF OI= 2068 at $3.10 SL=1.60 BUY PUT JAN-30 MAR-VF OI= 2068 at $4.10 SL=2.20 Average Daily Volume = 1.54 mil BSC - Bear Stearns - $58.21 -2.22 (-2.90 for the week) Company Summary: Founded in 1923, The Bear Stearns Companies Inc. is the parent company of Bear, Stearns & Co. Inc., a leading investment banking and securities trading and brokerage firm serving governments, corporations, institutions and individuals worldwide. With approximately $29.6 billion in total capital, the company's business includes corporate finance and mergers and acquisitions, institutional equities and fixed income sales, trading and research, private client services, derivatives, foreign exchange and futures sales and trading, asset management and custody services. Through Bear, Stearns Securities Corp., it offers prime broker and broker dealer clearing services, including clearing and securities lending. Headquartered in New York City, the company has approximately 10,500 employees worldwide. Why We Like It: Bear Stearns beat analysts' earnings estimates by a penny, and investors didn't care. The earnings were released on Wednesday, but the industry outlook is so poor that BSC is being sold off with the rest of the sector. Investment banking and brokerage firms are suffering greatly after J.P. Morgan warned on its earnings and Morgan Stanley missed their estimates by 12 cents per share. Trading and securities divisions of these companies are not producing, as investors flee their mutual funds and equity portfolios. While the sell-off of the financial stocks only feeds the cycle of a declining market, it is a cycle we are jumping on short. The current financial witch-hunt related to IPOs and investment banking activities is slowly worming its way through the sector and seems to take down another firm each week. Whether it reaches BSC's doorstep or not isn't even the issue. The specter of a possible investigation and the dirt being turned up at other financial houses has investors fleeing the sector. BSC's earnings held it up for a day, but that was all. Just today, Credit Suisse First Boston and Goldman Sachs both handed over IPO related documents to the U.S. House Financial Services committee, which will examine them for violations. This follows the problems at Salomon Smith Barney, where telecom IPOs are under scrutiny by the SEC. Wednesday's rally by BSC failed at its 50-dma and 200-dma, and today's sell-off has it back into its descending channel, which began a month ago. The failure at these levels, which now appear to be acting as resistance, is bearish for the stock, and the next area of support appears to be $55. We expect a continued sell-off in the sector, especially after it appears that Merrill Lynch may have some Enron-related dirty laundry hanging on the clothesline as well. Wednesday, Merrill released two top executives for refusing to testify in the Justice Department's investigation of its relationship with Enron. With BSC's earnings now behind it, there will be very little to rescue the firm from falling with the rest of the firms, as more bad news continues to leak out of the sector. The stock is currently sitting right on its bullish support line on the point and figure chart and a trade of $57 would constitute a complete breakdown of that line. The current bearish vertical count for BSC is $51, which will be our initial target on the play, as there will most likely be round number support below that at $50, which coincides with support on the PnF chart. Place stops at $61.00, just above the 50-dma and 200-dma, where the stock failed on Wednesday. BUY PUT OCT-60* BSC-VL OI= 5968 at $4.20 SL=2.20 BUY PUT OCT-55 BSC-VK OI= 2558 at $2.15 SL=1.10 Average Daily Volume = 1.22 mil ------------------------------------------------------------ WINNER of Forbes Best of the Web Award • optionsXpress voted Favorite Options Site by Forbes • Easy screens for spreads, collars, or covered calls • Free streaming quotes • Real-time option chains, charts + calculators Go to http://www.optionsxpress.com/marketing.asp?source=oetics21 Note: Options involve risk. Risk disclosure: http://www.optionsxpress.com/welcome_risk_index.htm ------------------------------------------------------------ ********** DISCLAIMER ********** Please read our disclaimer at: http://www.OptionInvestor.com/page/oin/aboutus/disclaimer.html ************************************************************** ADVERTISING INFORMATION For more information on advertising in OptionInvestor Newsletter, or any Premier Investor Network newsletter please contact: Contact Support
The Option Investor Newsletter Tuesday 09-19-2002 Copyright 2002, All rights reserved. 3 of 3 Redistribution in any form strictly prohibited. In Section Three: Play of the Day: BSC Traders Corner: Charting: Trendlines; Effective Uses in Trading – Traders Corner: Of Deadly Sins and Lively Condors – Q & A Traders Corner: Exponential Improvements Options 101: Differentiating Sow's Ears From Lemons ********************** PLAY OF THE DAY - PUT ********************** BSC - Bear Stearns - $58.21 -2.22 (-2.90 for the week) Company Summary: Founded in 1923, The Bear Stearns Companies Inc. is the parent company of Bear, Stearns & Co. Inc., a leading investment banking and securities trading and brokerage firm serving governments, corporations, institutions and individuals worldwide. With approximately $29.6 billion in total capital, the company's business includes corporate finance and mergers and acquisitions, institutional equities and fixed income sales, trading and research, private client services, derivatives, foreign exchange and futures sales and trading, asset management and custody services. Through Bear, Stearns Securities Corp., it offers prime broker and broker dealer clearing services, including clearing and securities lending. Headquartered in New York City, the company has approximately 10,500 employees worldwide. Why We Like It: Bear Stearns beat analysts' earnings estimates by a penny, and investors didn't care. The earnings were released on Wednesday, but the industry outlook is so poor that BSC is being sold off with the rest of the sector. Investment banking and brokerage firms are suffering greatly after J.P. Morgan warned on its earnings and Morgan Stanley missed their estimates by 12 cents per share. Trading and securities divisions of these companies are not producing, as investors flee their mutual funds and equity portfolios. While the sell-off of the financial stocks only feeds the cycle of a declining market, it is a cycle we are jumping on short. The current financial witch-hunt related to IPOs and investment banking activities is slowly worming its way through the sector and seems to take down another firm each week. Whether it reaches BSC's doorstep or not isn't even the issue. The specter of a possible investigation and the dirt being turned up at other financial houses has investors fleeing the sector. BSC's earnings held it up for a day, but that was all. Just today, Credit Suisse First Boston and Goldman Sachs both handed over IPO related documents to the U.S. House Financial Services committee, which will examine them for violations. This follows the problems at Salomon Smith Barney, where telecom IPOs are under scrutiny by the SEC. Wednesday's rally by BSC failed at its 50-dma and 200-dma, and today's sell-off has it back into its descending channel, which began a month ago. The failure at these levels, which now appear to be acting as resistance, is bearish for the stock, and the next area of support appears to be $55. We expect a continued sell-off in the sector, especially after it appears that Merrill Lynch may have some Enron-related dirty laundry hanging on the clothesline as well. Wednesday, Merrill released two top executives for refusing to testify in the Justice Department's investigation of its relationship with Enron. With BSC's earnings now behind it, there will be very little to rescue the firm from falling with the rest of the firms, as more bad news continues to leak out of the sector. The stock is currently sitting right on its bullish support line on the point and figure chart and a trade of $57 would constitute a complete breakdown of that line. The current bearish vertical count for BSC is $51, which will be our initial target on the play, as there will most likely be round number support below that at $50, which coincides with support on the PnF chart. Place stops at $61.00, just above the 50-dma and 200-dma, where the stock failed on Wednesday. BUY PUT OCT-60* BSC-VL OI= 5968 at $4.20 SL=2.20 BUY PUT OCT-55 BSC-VK OI= 2558 at $2.15 SL=1.10 Average Daily Volume = 1.22 mil ------------------------------------------------------------ VOTED one of "Best Online Brokers" (4 stars)--Barron's • optionsXpress's "order-entry screens...go far beyond... other online broker sites"--Barron's • 8 different online tools for options pricing, strategy, and charting • Access to options specialists via email, phone or live chat online • Real-Time Buying Power, Account Balances or Cancels Go to http://www.optionsxpress.com/marketing.asp?source=oetics22 Note: Options involve risk. Risk disclosure: http://www.optionsxpress.com/welcome_risk_index.htm ------------------------------------------------------------ ************** TRADERS CORNER ************** Charting: Trendlines; Effective Uses in Trading - By Leigh Stevens lstevens@OptionInvestor.com [A list of my PRIOR Trader’s Corner articles are at bottom] As you draw and get familiar with chart trendlines, the con- struction of which is described in my previous Trader’s Corner article (9/15), you’ll find more occasions where you see and use the “best fit” technique connecting the most number of highs or lows – this technique may cause some extreme highs or low bars to be “cut” through. This method of constructing “internal” trendlines is different than the convention understanding of how to draw them – point #1 in my prior Trader’s Corner article was that there are “some variations in drawing trendlines, but ‘use’ guidelines are the same”. Point #2 is that: trendlines are, in effect, “angular measures of momentum”, shown visually on a price chart. If you remember this point on the nature of what trendlines are, you will also probably recognize that a rate of momentum is a quality of the trend that is sometimes hard to measure exactly. So, trendlines are not always precise. Related to point #2 - within the exceptions and limitations, trendlines are nevertheless sometimes so accurate in depicting the trend that it’s easy to forget this cautionary reminder – Trendlines show, in effect, the “rate of change” for prices in an up or down direction as expressed as an angle line. If prices are going up an average of 3 percent a month, this mathematical progression can be shown as a line. However, drawing trendlines must also take into account the extreme highs and lows (above or below the “mean” or average change), which are emotional points of excess in the market. Therefore, we can expect that there will be some false signals given by trendline breaks and breakouts – that is, downside or upside penetrations of the line that you are drawing – because points of excess go further than is normally predictable. You can anticipate that you will need to periodically or even frequently re-draw trendlines to account for some new extremes if you want the most accurate visual depiction of the trend momentum. There is the axiom in technical analysis, like many disciplines, that you must put in time and work if you expect rewards from the technique. The money or risk management rule about always limiting losses will help protect you in the times that trendlines don’t “work”; i.e., they fail to identify the exact parameters of a trend or trend reversal. Nothing that I know of works all the time in technical analysis. Getting in early on trends, for which trendlines will be of considerable help, provides the best opportunity for capturing the most profit from a trend. Accomplishing this objective more often than not tends to make up for periodic losses along the way. The idea is to keep using trendlines - they’ll work over time if you just keep using them and don’t expect more than the tool can provide. Point #3 on trendlines - trendlines look like they make identifying every trend and trend reversal easy AFTER the fact. Once the price action has unfolded it’s easy to see the dominant trendlines as is apparent in the next charts. This chart looks like there a trend reversal after a major run up, but there were some other technical considerations - the break did NOT take out the prior downswing low, at least not on two back to back days. I often indicate that if a new closing low lacks downside follow through the NEXT day, it may be a false “signal”. There will be further discussion later on the need to re-draw trendlines, especially in the beginning of new trends. THE FOLLOW ON CHART STORY IS BELOW – The downside price action shown above did NOT take out the prior downswing low on two back-to-back days. I often indicate that if a new closing low lacks downside follow through the NEXT day, it may be a false “signal”. The sideways consolidation above – really a “rectangle” (see my Trader’s Corner article on “Patterns-continuation: rectangles”) was merely a pause in the trend before a next up leg. Trendlines are not the sole technical tool that we need to use to profit from the trend shown above. Of course, the break of Trendline T3 above was fine as an exit point to stand aside awaiting a next move in the stock; then, re- entry made on the upside move above the minor down trendline which suggested that the consolidation had run its course. HERE’S ANOTHER CHART STORY – AND, THE “LOOK BACK” CHART –- AND, STILL LATER --- It takes some time to make nearly as good of use of trendlines going forward, as looking BACKWARDS. When market action is unfolding and you are in a stock or index that you identified as having begun an uptrend due to its breakout above a down trendline, along come points where it’s hard to figure how to draw or redraw a trendline – and, they do need to be adjusted as market action unfolds. Some technicians will apply a rule that a trendline must be penetrated by a certain percentage or dollar amount to “confirm” the penetration. Then there is the question of whether to draw a trendline “through” an apparent extreme (cutting through a bar) or not and so on. There is also the risk that placing a stop under a trendline will result in exiting a position because prices dipped under the line, then resumed an upward course. For this reason, exiting only on a close above or below the trendline, depending on whether you are long or short, could be a method employed to try to “confirm” that a trend reversal has in fact occurred. However, the “close-only” strategy is also a difficult trade off in terms of a stop order entry strategy as in stocks you have to be watching the close to exit on this basis. If you were unable to exit at the close, you have to have the discipline to do so the next morning and not back pedal in your risk control strategy. Also, exiting on a closing basis means you may not be adequately protected against a severe price move against you, where a close is far above or below the trendline in question. Here’s where it is important to know not to adopt too “loose” of a risk control strategy in a very “overbought” or very “oversold” market. Point #4 on trendlines - trendline breaks often lead to some outstanding trading and investing opportunities later on if you only continue to keep track of the previously broken trendline. This point relates to the same concept as a support level, once broken, assuming the role of resistance later on and vice versa; e.g., a support trendline, once broken, often “becomes” resistance later on. An up trendline that indicates support on the way up, if penetrated, often defines (“becomes”) resistance on a return to this line later. Technical analyst Michael Jenkins used to call such broken up trendlines, “kiss of death” trendlines and it was often a very apt term. Once prices return to an up trendline like this, the trendline will act as a deflector to prices and they’ll then start falling more often than not. This is one of the more useful patterns in chart analysis. A return to trendline situation doesn’t set up all the time, but when it does it’s a high-potential trade to take by selling in the area where prices make the return. If short, (buy) stops can then be placed above the trendline because, if prices regain the line, it’s a “pattern failure”. Moreover, risk can usually be tightly limited at that point as the stop-out point is just above the line. Downside potential, relative to risk is usually excellent. The reverse situation is provided with a down resistance trendline during a declining trend when the trendline is pierced by a rally – this trendline may come back into the picture later if prices drop back or return to this previously broken line. This “return” point can offer a second, more favorable, entry point. Expectations are that prices will rebound from this line, marking a final low before a secondary up trend develops. The two charts above are examples of this principal and also demonstrates that the return to the prior trendline can be a more favorable entry than would be the case for anyone who bought or sold at the point where the trendline was first penetrated. Of course since you don’t know if this trendline “return” will happen, the strategy, by necessity, is to buy or sell when the trendline is first penetrated with an appropriate stop. A return of prices to a previously broken down trendline but at a lower price point, is seen somewhat often and when this pattern develops it offers a good set up or basis on which to take a trade. (Even for investors, these return rebounds can offer a more favorable entry for a longer-term buy and hold.) The last point - #5 - already touched on somewhat, is that trendlines often have to be re-drawn, especially in the beginning stages of a new trend as demonstrated in the chart below - An upside or downside penetration of a trendline, especially in the early part of a trend, does not necessarily negate the emerging trend or confirm a trend reversal. An upswing high that exceeds a prior high or a downswing low that exceeds a prior low offers a strong suggestion that that the prior trend is continuing. Prices may be undergoing a sideways consolidation or only a minor correction in the initial formation of a trend, so final definition for a trendline can take some time to form. Within an emerging uptrend, one key to what is going on with a correction is whether this downswing stops above its prior low. If it has not, simply redraw the trendline from the lowest low through the bottom of this newest low. The reverse is true in an emerging downtrend – redraw the down trendline through a new higher high, as long as the top of this price swing does not exceed a prior significant high. It is rarer to have to as frequently redraw a down trendline, as declines that mark a new downtrend tend to fall more in a steep fashion. This goes back to the nature of bear market trends and the fact that a lot of selling tends to come in all at once – a one-time decision is often the case for long liquidation, whereas buying is phased in typically by both individuals and institutions, especially in the stock market. ************** TRADERS CORNER ************** Of Deadly Sins and Lively Condors – Q & A By Mike Parnos, Investing With Attitude CPTI students have asked – and who are we to deny? In life there are few concrete answers – and fewer concrete questions. But in OptionInvestorland, we are here to contemplate, calculate, clarify, and confuse. Today, we endeavor to clarify a few well thought out questions on our Iron Condor and Put Selling strategies. We can all learn from these. I know I did. Dear Mike, In the BBH Iron Condor position you put on two weeks ago, why cover the short put every time by shorting stock every time it falls below $80? Aren’t you covered by the long $75 put? Also, if you plan on shorting stock to cover the short positions, why bother to buy the long puts in the first place? Response: When you have a credit spread, you are exposing yourself to a potential loss of the difference between the strike prices. In the case of the hypothetical BBH condor trade that we’re tracking, we sold the $80 put and bought the $75 put for protection. We’re exposed for $5.00. If BBH’s movement honors the estimated support level and stays above $80, we keep the credit and live happily ever after – or at least till the next trade. If not, we have to be prepared. We have to have a plan. 1. Here are reasons for buying the long put: a) Most option traders do not have permission to trade naked (uncovered) options. For them to take advantage of option selling strategies, they have to create a spread situation by covering the short option with a long option to limit exposure. This is for the benefit of the brokerage firm, the trader, and the trader’s beneficiaries. b) The experienced trader will buy the long put as insurance against a catastrophic move. If a stock reverses and is trending down, you can adjust by shorting the stock at a support level. But what happens if a stock is trading at $81, above that support level, and the CEO gets caught, half in the bag (don’t ask which half) , with the kid who delivers groceries? Quicker than you can say “perp walk,” the stock could open at $70. If you are covered by the long put, your exposure is limited to $5. If you didn’t have that protection, you would be facing an $11 loss instead of $5. (One of the reasons we chose BBH is that it’s an index as opposed to an individual stock. Using an index minimizes the chance of a catastrophic loss. However, that doesn’t mean you don’t need the long protective put.) 2. When BBH dips below the $80 support level, we don’t know if it’s testing it or not. Will it bounce back? Will it keep going down? Hard to say. But we know that it’s going to require an adjustment. There are a lot of choices: a) If the size of our trading account permits, shorting BBH stock when it violates the support level is a favorite adjustment. It protects our profits in the trade. As we saw in the BBH trade, if BBH bounces back up, we simply cover the short shares. If BBH continues down, two things can happen – one good and one OK. For example, if BBH moves down to $70, at expiration the long $75 put will have a value of $5. Since your short $80 put is covered by the short stock, you’ve just profited by an additional $5. The “short stock” adjustment requires almost constant attention to the market. Once the stock is short, you are vulnerable to a reversal in trend back up through the shorting price. You have to stay on your toes like the proverbial midget at a urinal. You may have to cover on short notice or have buy stop orders intact. b) If BBH breaks support, you could also roll out the entire $80/$75 bull put spread for a month or two. You may break even or even put a little additional premium in your pocket. You would have to have a bullish outlook on BBH, because you and BBH are going to be bosom buddies for two more months. c) If you have turned bearish on BBH, and anticipate a substantial downdraft, you could simply buy back the $80 short put and ride the $75 put down. The $75 put will increase in value as BBH goes lower. BBH would not have to go down too far before you would be even and then, ultimately, into profitable territory. d) If BBH breaks support, you could simply liquidate your entire position, take your lumps (which will be moderate), salvage what you can, and be on your not-so-merry way. At least you’ll be free of the situation and that often provides a peace of mind that’s worth a couple of bucks. Hello Mike, I'm pretty new at this and have a question regarding the write-up you did on Sept 05 “Seven Deadly Sins – Plus One.” This seems like and excellent way of purchasing stock. However, I wanted to run an example by you to get your feedback as to see if I'm getting this. XRX currently trading at $7 a share. You feel in the next 5 months or so the stock will rise to say $10 a share. You would sell the April 03 $10 put option that is at $3.50. Say you wanted to buy 1000 shares. You have the $7,000 in cash, so this would be a cash secure put. Selling the April 03 Put would give you $3,500 in your pocket. What is the danger here? Seems like you don't have too much downside here? Thanks Response: First, you would need to keep $10,000 in your account for this to be considered a “cash secured put” because that’s the strike price (10) of the put you propose selling. What’s the danger? The danger is that XRX is still at $7.00 (or below) at April expiration and you get your wish – you’re assigned a $7.00 stock. You took in $3.50 (3,500). That made your cost basis $6.50 ($6.500). What have you accomplished? You just waited eight months for $.50 ($500). If it’s below $6.50, you’ve lost money on the deal. It’s a touch unrealistic to expect XRX to appreciate by almost 50%. A $3.50 move doesn’t sound like a lot, but on a $7 stock, it’s a “great expectation” that would make Charles Dickens gag. What’s the best that can happen? The stock rises and finishes above $10 and the put expires worthless. You made $3.50 and you didn't have to buy the stock. But you’ve tied up your $10,000 for eight months. As you know, at the CPTI, we are proponents of hands off trading, but eight months is a long time. It won’t hurt to get our hands a little dirty once a month. Normally, the purpose of selling puts is to generate a monthly cash flow and/or to ultimately buy the stock at a discount. If, at expiration, the stock is below the sold strike, you can accept the stock – or not. The benefit of selling the puts monthly is that you give yourself a choice. At each month’s expiration, you can choose to accept the stock or buy back the put. If you sell an April 03 put, eight months away, your choices are limited. You can only buy back the put or try to make some bizarre roll up or roll down adjustment, which can defeat the original purpose of the trade. XRX has exceptionally low premiums, making it tough to generate much of a cash flow. As of this writing, with XRX at $7.00, the Oct. $7.50 put is only $.85. It seems hardly worth selling because, if XRX stays at $7.00, you will only make $.35 ($350). But, if you make $350 a month for the next eight months, you will have made $2,800 ($350 x 8 months). True, you may absorb a few more commissions, but you have the benefit of choice. Choices are a luxury that translates into peace of mind. Let’s try the same strategy with another stock that has a little more fluff in its pillows. For example, PDLI is trading at $9.75. The October $10 put is $1.10. Based on a 10-contract position, you can take in $1,100. In a month, if PDLI is still at $9.75 you have a choice. a) accept the stock or b) buy back the put for $.25, pocket the $.85 ($850) profit, and sell the next month. Imagine eight months pocketing $850. That’s $6,800. That’s 680 large pizzas, 3,400 Quarter-Pounders with cheese, 1,700 Blockbuster rentals, or two new 55” wide screen digital TVs. At the CPTI, we obviously focus on the necessities. The trading strategies we discuss are not always easy concepts to understand, let alone use profitably. You need to be prepared. Don’t take a knife to a gunfight. Keep the questions coming! 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 ************** TRADERS CORNER ************** Exponential Improvements By John Seckinger jseckinger@OptionInvestor.com As a trader, the independence of choosing any technical indicator(s) can be a freeing experience. As far as moving averages are concerned, one can choose either a simple, exponential, Weighted, Least Squares, Adaptive, Endpoint, Triangular, Sine Weighted, Modified, or Triple Smoothing average, a combination of the above, or none at all. For a number of years, I have only used the 22, 50, and 200 moving averages. All three have been exponential. The plan now is to explain “why”. What is an exponential moving average (EMA)? By definition, an EMA is a moving average calculated by weighting recent values more heavily than older values. For comparison purposes, let’s compare an EMA to a Simple Moving Average (SMA), an average that many traders use. A simple moving average shows the average price over the last n days: Simple MA = (P1 + P2 + ...... + Pn) / n where P = Price The problem is that simple moving averages respond twice to each piece of data - once when it is added, and again when it drops off. Having the moving average change when a price is removed is a bad thing. When a high price is dropped, the SMA will most likely tick down. When a low price is dropped, the SMA will probably tick up even if the price went up that day, but by an amount smaller than the value that was dropped. The following quote describes this dilemma, "A simple moving average is like a guard dog that barks twice." The solution? Of course, just use an exponential moving average instead. Why? An exponential moving average gives more weight to the latest data and responds faster to changes than does a simple MA. At the same time, EMA does not jump in response to old data being dropped off. EMA = price today * K + EMA yest * (1-K) where K = 2 / (N+1) This is a continuous formula with each new day given the most weight, while older data is weighted less. The formula below illustrates how the most recent day will be weighted 3.9% of the value, while a 50 DMA Simple, by definition, only gives a weighting of 2% (50 times 2 is 100 percent). Exponential Percentage = 2/(Time Period + 1) Therefore, a 50-day EMA will have a 3.9 % exponential average: .039 = 2/(50 + 1) Taking things to a practical level, let us first look at a daily chart of the Dow Jones Industrial Average. Disclaimer: When the market appears to be in a consolidation phase, I find it difficult to use moving averages effectively. A trader can gauge risk by looking at the price deviation away from the moving averages; however, at that point, I would recommend other forms of technical analysis. How can a trader realize that the market is no longer in range? I like to use the 50 and 200 DMA’s, noting the potential for a change when the 50 crosses either underneath or above the 200 DMA. A more aggressive trader could use a crossing of the 22 under/above the 50 DMA; however, a tighter stop should then be used just in case. Dow Jones Industrial Average Index, Daily Since neither of the averages are currently threatening to cross above/below one of the other, I then turn my attention to a 60- minute chart and 60-minute Period Moving Averages (PMA’s). Before we look at the 60-minute chart, we still have to note some obvious patterns in the daily. The market is still trending lower and odds are still in favor of the bear market being in tact; moreover, it was not long ago when longs were “trapped” above both the 22 and 50 DMA’s. This bearish psychology will not easily be forgotten. Going forward, we can use this bearish sentiment when prices rally and we are curious about an exit strategy. Dow Jones Industrial Average Index, 60 minute Looking at a 60-minute chart of the Dow, the first point of interest is when the 50 PMA acted as resistance and gave traders a reason to believe bears are in control. The bearish confirmation took place soon thereafter, with the 22 PMA falling under the 200 PMA and signaling the likelihood of a sustained downward move. When to cover? A rise above the 22 PMA is usually a safe bet, but more conservative traders can use the 50 PMA and keep things simple. On September 11th, a day that I was in fact bullish as the session began, shares actually rallied above the 200 PMA and towards the area where the 50 PMA crossed underneath the 200 PMA. Was I wrong to be bullish? Not really. More importantly, when did the market tell me I was wrong? Answer: By falling back underneath the 200 PMA. If being bullish was correct, the 200 PMA would become support and not give such an obvious “false breakout” signal. Once back underneath the 200 PMA, the confirmation took place when the 22 PMA crossed back under the 50 PMA moments later. Where should stops be set? Once again, a rise back above the 22 PMA would make sense. Moreover, a trader should keep a bearish mindset until prices gravitate back above the 200 PMA and begin using that average as support. If a trader wants to take a more micro approach, it then makes sense to look at a five-minute chart and its period moving averages. Dow Jones Industrial Average Index, 5 minute What can we learn with the five-minute chart? Beginning on September 17th, the subsequent sell-off underneath all three averages certainly got my attention. If not short already, it usually makes sense to sell short following such a reversal. Stops can then be set at either the 200 or 50 PMA, moved lower to the 22 PMA once profits are attained. Another thing to note: If the Dow opens significantly lower, it is usually wise to wait for the 22 PMA to trend down and meet the current price action. Then, once above the 22 PMA, shorts will generally cover and wait for another sell signal. Looking at price action on Wednesday, the index moved above 8100 and above the 22 PMA. Probably makes sense to cover then. It doesn’t always work, but odds are in your favor. The next thing to notice is, once again, the “false breakout” above the 200 DMA. Sure, it makes sense to go long at those levels; however, it makes even more sense to exit and take a short position if things turn around. ************ OPTIONS 101 ************ Differentiating Sow's Ears From Lemons Buzz Lynn buzz@OptionInvestor.com Two old proverbs: 1) When life give you lemons, make lemonade. 2) You can't make a silk purse out of a sow's ear. In the first case, we learn to make the best of a bad situation. In the second, we learn we cannot make the best of a bad situation. So which is it? Hmmm. . .a proverbial dilemma! What got me thinking about this was our faithful readers' desires to make money in light of the drubbing the market has given our 401K accounts over the last three years. I know - some probably don't need to be reminded. My apologies. But the fact remains that despite the bear market, some stocks are going to do incredibly well over the next few years by experiencing huge price moves, even in the carnage experienced by most other stocks. Many of you know that I am a fan of dividend-paying, blue-chip stocks of great business on sale with a margin of safety. A guy named Warren Buffet says the same thing about stocks he likes to own - except the part about dividends since he's a bigger fan of retained earnings. Anyway, much as technicals play the biggest part of my trading, I'm still Fundamentals Guy at heart. To that end today, I want to walk us through the methods I use to uncover potential values. I can't make a silk purse out of a sow's ear. I can't cobble money from the scrap heap of dead companies either. That's alchemy, a physical impossibility. But in the case of stocks, there are invariably some fundamental bargains that are priced reasonably compared to the over-hyped (yes, it still happens) darlings of Wall Street. Already within the apparent sour lemon are the makings of lemonade. That's chemistry, a manageable science. So where do we look for bargains? Glad you asked. It's really pretty simple. The first two things in which I zero in are 1) does the company make money? 2) does it have any cash? If it doesn't have any cash, it better be paying a hefty dividend by making money. Real Estate Investment Trusts (REITS) and Master Limited Partnerships (MLP's), both of which are traded in abundance on the NYSE and, to some degree, on the NASDAQ and AMEX, are great examples of hefty dividend-paying issues. But since MLP's produce not only a return on equity, but also a return OF equity, they eventually shut down or burn out. With REIT's, all the eggs are in one real estate basket, which I consider to be greatly over-valued (despite attractive dividends) given the current state of the economy. The good news is that there are old stodgy companies out there that make money. One of my favorites is a sin stock - Philip Morris (MO). Let's take a peek. From Yahoo Finance, I pull up the Company Profile and see the following: Yahoo Profile of MO: First of all, while we don't see it here, a company description of MO would read something like, "Huge and efficient organization that sells stuff with broad appeal - mostly necessity or addiction (food, booze, cigarettes) - which command huge margins and make money for the company". Everybody ought to want a piece of that kind business, moral issues aside [we're talking about making money here, not saving the world]. Here's a dirty little secret too, which plays to investors' advantage. I almost hate pointing this out. But. . . the government will NEVER let MO's revenue stream slip, let alone allow MO to go out of business. Why? They want the money too - the tobacco taxes on every pack of cigarettes, not to mention the 20-yrs of protection money to be paid in the name of healthcare expenses caused by overly-sick smokers. Correction - the government NEEDS that money. Did I mention MO pays a 5.44% dividend, which has steadily risen throughout the years? But here's what jumps out me. Remember, "First I look at the purse" to quote the Jay Giles Band. Look at that cash - $1.38 bln worth, which although amounts to only $0.65 per share, MO clearly can pay their expenses with no danger of people all of a sudden ceasing to buy their products (Did I mention the steady revenues?). Thus, it doesn't need to keep a Microsoft-like $38 bln lying around. MO doesn't need to keep it around thanks to its steady revenue and earnings stream. Another thing - $90 bln in sales and nearly $9.5 bln available for distribution to owners AFTER Earnings Before I Trick Dumb Auditors (EBITDA)! Note the valuation ratios too: slightly greater than 10 times a steady stream of earnings; slightly greater than 1 X sales. Nearly 5 X book value isn't so hot, but considering that as depreciation is taken on assets until they are ultimately reduced to zero, which would cause book value to drop - and MO has some old assets that have been reduced to $0 through depreciation - the denominator in "price to book" ratio is decreasing. As such, I can live with price to book a bit out of whack. That's the lemon-aide Now let's look at a sow's ear, Lucent (LU) Yahoo Profile of LU: Same analysis: A company description might read, "Former giant in a beaten up industry trying to sell products that very few currently want in an already narrow market. LU recently warned of their 9th straight loss." Yes, it's much harder to sell an optical telecom switch to a bankrupt CLEC than to sell a truckload of beer, cigarettes, ketchup, or pretzels at Wal-Mart. LU does not have a business that anyone should aspire to be in right now. But to be fair, let's look at the numbers. Whoa! A juicy $5.4 bln in cash! That's a bucket more than MO and the equivalent of $1.58 a share in cash. Their cash holding could buy back ALL of their own outstanding stock. But wait - the share price is only $1.05 and LU doesn't pay any dividend. Man that's cheap! A bargain? The market is valuing the company at less than the amount of cash on hand. Why? Take a look at that debt load - 3.71 debt to equity ratio in a wrecked industry Anybody have in any confidence in their revenue stream? Me either. But again, to be fair, let's look. Hmmm. . .sales of $15 bln. But what's this? $11.9 bln loss before they tricked dumb auditors with an actual $16.5 bln loss to shareholders. That's $31.5 bln in expenses vs. $15 bln in revenues. Looks like that $5.4 bln in cash will be burned up in four months. Is it any wonder investors have dumped this stock and reduced its price to just over $1 through lack of demand? Yeah, it's cheap, but it's cheap for a reason. I'll make this point here before I go. Just because a stock is cheap does not make it a good value. Any stock can go to zero, including LU. To change their business picture would take an act of alchemy. Conversely, an "expensive" stock may be the relative bargain. If we want to make money in this market, we have to find the lemons and let the market make the lemonade. Sows' ears will never be a silk purse. Learn to distinguish the difference and reap the financial rewards. Make a great weekend for yourselves! ------------------------------------------------------------ We got trailing stops! • Trade online with trailing stops at optionsXpress, at no extra cost • Trailing stops based on the option price or the stock price • Also place Contingent, Stop Loss, and "One Cancels Other" orders • $1.50 /contract (10+ contracts) or $14.95 Minimum--NO Hidden Fees! Go to http://www.optionsxpress.com/marketing.asp?source=oetics23 Note: Options involve risk. 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