The Option Investor Newsletter Thursday 09-26-2002 Copyright 2002, All rights reserved. 1 of 3 Redistribution in any form strictly prohibited. In Section One: Wrap: Headache? Index Trader Wrap: Pinball Wizard Market Sentiment: Window Dressing Weekly Manager Microscope: Ed Choi/Richard Dahlberg: GMO Pelican Fund Updated on the site tonight: Swing Trader Game Plan: Mixed Messages? Posted online for subscribers at http://www.OptionInvestor.com ************************************************************ MARKET WRAP (view in courier font for table alignment) ************************************************************ 09-26-2002 High Low Volume Advance/Decline DJIA 7997.12 +155.30 8012.42 7844.62 1.90 bln 2311/ 892 NASDAQ 1221.61 - 0.68 1239.62 1206.91 1.62 bln 1813/1500 S&P 100 428.51 + 6.83 430.75 422.54 Totals 4124/2392 S&P 500 854.94 + 15.28 856.60 841.26 RUS 2000 370.48 + 5.55 370.83 365.14 DJ TRANS 2269.42 +102.34 2269.42 2167.41 VIX 40.12 - 2.29 41.73 39.87 VXN 59.09 + 2.40 59.75 56.64 Total Vol 3,753M Total UpVol 1,890M Total DnVol 1,832M 52wk Highs 97 52wk Lows 385 TRIN 1.06 PUT/CALL 0.77 ************************************************************ Headache? If you are a bull you should have a headache from bouncing off 8000 several times. The Dow tried hard to make it two in a row and succeeded. The Nasdaq did not go along for the ride and finished negative for the day. This divergence was due to more negative remarks on the tech sector conflicting with positive economic reports. Dow Chart Nasdaq Chart The day started out with a better than expected Jobless Claims report with only 406,000 new claims compared with estimates of 425,000. However the prior week was revised up again to 430,000 from 424,000. This was the fifth week over 400K. This pause in the rise encouraged traders but I believe it is only temporary. The continuing claims numbers rose again and when matched with the Help Wanted Index today they should continue to rise. The Index fell to .41 and its lowest reading in decades. Layoffs may be slowing but nobody is hiring. This means the Oct Jobs Report next week could be very bad. With job ads the lowest since the 1960s the outlook for continued consumer spending is negative. Durable Goods Orders came in much better than expected with a decline of only -0.6% instead of -2.6% as expected. This number is highly volatile and the loss evens out the +8.6, -4.5 numbers for the last two months. This encouraged the markets on the surface but because of the volatility there will need to be confirmation next month. The best news for the day was the New Home Sales, which soared to record highs at an annualized 996,000 pace. Sales in August were up +1.9%. However, like most government numbers recently, the past monthly records for May, June and July were all revised downward again. Reports from readers from different areas of the country indicate that builders are pulling out all the stops to blowout new houses quickly and reduce inventory levels. Builders are scared that interest rates will turn up once the stock market turns up and they do not want to be caught with a lot of inventory. California is the only area that has reported a continued demand for new homes and only those well under $1 million. With winter coming and inventory being rushed to completion the numbers in November will be significantly less. Also, remember that many houses are sold before they are built and/or completed. That means many of the sales could have been contracted months ago. Also, with the rate of foreclosures at a 30 year high there are a lot more "distressed" houses on the market. This will also lower the number of new houses sold. Friday will be another opportunity for economics to move the markets. The Q2 GDP will be announced at 8:30 but this is not expected to be a big miss. The estimates are for +1.1% growth. This is a historical look back at the Q2 timeframe and not relative to the current situation. The final Consumer Sentiment for September will also be announced. This is the second look at these numbers and there is not likely to be a big drop below the previously announced 86.2%. Neither of these reports are expected to be surprises and that makes them dangerous. If we get a surprise then the market should react accordingly. The earnings picture today was mixed. GE led the parade by affirming estimates for the eighth time this year. Shorts covered and the Dow headed for 8000. During the conference call the CFO admitted that the improvement in short cycles businesses had stalled and the plastics business was suffering. Also, they were losing money in GE Equity and their reinsurance group GE RE. The $350 million loss would be made up by a one time gain of $300 million from the sale of another unit. Making up a three cent shortfall in operations with a one time gain is not something that encourages traders. This was the same as a three cent warning and the stock tanked. They declined to give guidance for 2003 because the economic conditions were much tougher than they expected and they wanted to wait until early December before changing estimates. This was not accepted well by the market. GE fell from $28 to below $26 in after hours. GE Capital said it was going to file to sell $50 billion in bonds and estimated that would get them through the first half of 2003. Phillip Morris chose the news of a favorable court ruling and +1.26 gain in the stock to announce a serious earnings warning after the close. The company said 2002 earnings would now be in the range of +3% to +5% growth vs the +8% expected. They also said it would carry over into 2003 earnings as well. Lower volumes and higher costs were given as the reasons. The stock dropped to $37.75 in after hours, a -$5 drop from the close. MO is a Dow component. Another Dow component, SBC announced after the close that they were going to cut another 11,000 jobs with the majority in the 4Q. They said they were slashing capex spending for 2003 to only $5 billion from the 2002 rate of $8 billion. SBC has lost three million retail access lines so far in 2002 and revenue dropped -$1 billion in the first half. The company said it would take major charges against earnings in both the 3Q and 4Q. This capex news will hit the already dying network sector with another round of estimate cuts. RBAK warned earlier in the day that it was experiencing an unusually difficult quarter and would post almost double the loss that analysts were expecting. Nortel also warned again that it would miss estimates for the 3Q. LU, CIEN and TLAB have also warned recently. After the bell COGN beat estimates by a penny and affirmed guidance that was roughly inline with estimates. MANU also beat by a penny but announced that its president was leaving and they would be cutting -10% more jobs. LBRT announced earnings that fell in the midrange of their previous warning. They said they cut another 110 jobs and warned that earnings for the next quarter would be well below estimates. They said the market had fallen off much more quickly than anticipated during the quarter. SLR announced a loss that was inline with estimates but said they were taking -$2.6 billion in charges. They lowered guidance for this quarter to as much as a -3 cent loss and lower from estimates of a penny loss by analysts. They said they were experiencing a difficult market for all types of electronics. No kidding? The positive economic reports helped the Dow move back to the 8000 level but window dressing and short covering failed to hold above it. This is critical for maintaining any rally. While I expect the Dow to start off in the cellar tomorrow there is a strong possibility that we could see a rebound before the day is out. The problem is the generally low prices of stocks. Many funds have fixed asset allocation values and with the monster bond run of late there could be some asset allocation moves necessary before the end of the month. This means they have to sell bonds and buy stocks to bring the ratios back into balance. How much this may impact the markets is hard to tell. Most of the buying/shifting could already be over since very few funds shift money on Fridays and Monday exposes their plans to more event risk. Better to bite the bullet this week and get it out of the way. The strong volume the last two days would bear out this premise. This is setting Friday up as an explosive day. A downdraft at the open based on problems with GE, MO and SBC followed by any early morning moves by institutions squaring the quarter books. The morning volume is going to be heavy and the market direction by days end will be anybody's guess. Enter Very Passively, Exit Very Aggressively! Jim Brown Check out the Traders Corner "Charting Gaps" by Leigh Stevens in tonight's newsletter. http://www.OptionInvestor.com/indexes/traderscorner.asp ******************** INDEX TRADER SUMMARY ******************** Pinball Wizard Good background music to have had on today if you were a QQQ trader was Pinball Wizard by The Who as the Q's bounced around our retracement bracket like a steel ball, with lights flashing on trader's terminals if set at our $22.21 level of resistance and $21.44 level of support. "He's a pinball wizard There's got to be a twist A pinball wizard He's got such a supple wrist...." Whether you're a bullish trader in the Q's or a bearish one, or a "true trader" that was willing to flip the paddles, the "ball" is still in play and the 60-minute chart shows that the 21-hour and 38.2% retracement are perhaps "in play" as support, while the 50% retracement at $22.21 is near-term resistance. Don't let last night's Index Trader Wrap and "look for bullish entry near $21.45, with a target near $22.75, stop $20.75" and today's market monitor comments at 10:19:28 for bears to be looking for entry at $22.19, stop $23 and target $20.20. By then end of today's session, both bulls and bears in the QQQ, which closed at $21.60 -1.23% were running a "dead heat." NASDAQ-100 Index Tracking Stock (QQQ) - 60-minute interval I couldn't "resist" profiling the Q's as a short trade this morning as the Networking Index (NWX.X) 92.67 -4.6% saw selling at the open as did the Semiconductor Index (SOX.X) 248 -3.15. A quick check of the Biotechs (BTK.X) 329 -1.03% and Software (GSO.X) $86.25 -1.65% both opened higher, just like the Q's, but they too began to fade, almost as if the weakness in the networkers and semiconductors were giving bulls second thoughts. Current analysis is that technicals on the 60-minute chart is looking striking similar to the September 11th close, but perhaps a little weaker as the 50-pd SMA is still trending lower, while the September 11th close would have had the 50-pd trying to flatten out. Note how the 21-pd SMA (pink) is still in play as we pointed out last night. That was our bullish entry point for QQQ bulls today. Tonight, I've placed two (2) short-term upward trend (green) to give traders a perspective of the September 12th open and possible action tomorrow. If the Q's break below current trend ($21.44) and close below that level, then I become more bearish and begin targeting new lows near $20.20 and 19.1% retracement. I'm leaning toward the bearish side here, but still rather "neutral" since the QQQ is in the range of retracement between $21.44 and $22.21. As such, a bearish trader may want to tighten down a stop from $23.00 to $22.65 if your more risk averse, while a QQQ bull that did step up to the plate near $21.44 retracement and rising 21-pd SMA, can tighten up a stop just under today's low. My thinking here is that a break much below today's low is going to have MACD on the 60-minute time interval crossing below its signal (MACD=0.06 / Signal=0.04) and if skeptical bulls (like me) pull the plug, then MACD breaks its zero level, which is BEARISH for this indicator. I have my MACD settings at (12,26,9). Stochastics actually gave some decent signals today on the 60- minute interval, but I think the QQQ will be hard pressed to get much above the $22.21 level unless some big tech makes an announcement soon, like before tomorrow's opening bell. NASDAQ-100 Index (NDX.X) - Daily Chart The daily interval chart of the NASDA-100 Index (NDX.X) itself is also rather range-bound, but I think lower. Premiums are "jacked" up and on a daily basis, most of the action in October strikes looks to be from the speculators in the out-the-money. The October 900 puts (NDKVR) were bid/offer $54.20/$62.20, and a trader that could get filled near $58 could play short. However, with higher premiums at risk, I'd use a protective stop at 915 to begin with. The October open interest is heavies on the put side in the 825 (NDKVG), which has me calculating potential monthly support near 801, where 800 may be a "psychological" target or monthly support. If looking put, then $58 is simply too much to risk in my book. If the NDX trades 815, the 900's would trade $85 on an expiration close of 815. A bear taking the NDX put, would want to see some type of close below 857 in the next couple of sessions is my thinking. Again... premiums are high. Dow Diamonds Chart (AMEX:DIA) - 60-minute interval The Dow Diamonds (AMEX:DIA) $79.81 +1.46 did hit my bullish target of $80.00 early this morning. From yesterday's market monitor bullish profile of $77.70, I did "lift" my target ahead of this morning's new home sales data, but followed with a stop at $78.98, just in case the housing numbers were "blow out" and might find the Dow jumping above $80.45. That wasn't the case, and traders may have been stopped out at $78.98 at around 01:25 PM EST. However, the Dow held tough and actually came back and pierced the session high, with the Dow Industrials briefly breaking the 8,000 psychological barrier and trading a session high of 8,012.29. If traders are holding long, would continue to hold, but would follow with a tighter stop, just under the rising 21-day SMA. Concern near-term is that technology components are going to weigh things down. One thing I noticed today, but passed on was early weakness in Hewlett Packard (HPQ), which really seemed to have IBM reversing lower. Concern becomes that further tech weakness (like QQQ) will act like a cancer, eat away at HPQ and IBM, then further spill over to the market and have the Dow softening up. Also impacting the Dow Industrials tomorrow morning will be Dow component Philip Morris' (NYSE:MO) $42.73 +3.01% warning on earnings. In yesterday's 03:15 PM EST intra-day update http://members.OptionInvestor.com/intraday/092502_4.asp I actually highlighted a bearish play in "big MO" with a 1/2 position put. In Redibook ECN trading, shares of MO were getting pounded lower at $38.80. Now, while the MO lower trading will weight on the DIA and INDU performance at the open, I'm not immediately thinking this is an "economic" type of earning's warning as "tobacco" is almost in a world of its own. I don't think Dow action is really going to be driven by MO, but more by technology stock trading. If tech starts getting hit lower, then it will be a bull's psychology that then gets damaged and will bring more sellers to the Dow. We discussed last night that the REASON a bullish index trader wanted to stick with the DIA, SPX and OEX, wasn't necessarily for the LARGEST potential gain, but to try and AVOID as much risk as possible. Hopefully, traders learned something today that trading isn't all about "potential gain" but "potential loss" under a more uncertain market environment. Bears can short/put the Dow on tech weakness, but stop most likely goes just above DIA $80.50 or Dow Industrials (INDU) 8,050. On such a move, technology bears may want to be on the alert, as bullishness in the Dow tends to lift a market's spirit. Option traders most likely find high premiums in the Dow too. My thinking is... "If I'm going to pay up on premium in puts, then I might as well stick to tech weakness." I'm also thinking, if the Dow loses it to the downside, then it will probably act like a sledge hammer and drive tech lower. S&P 500 Index / S&P Banks Index - Daily Chart Don't think there might not still be some "asset allocation" taking place. Banking stocks did will today and helped provide bullishness in the SPX and OEX. I've tried to show both the SPX (upper) and S&P Banking Index (BIX.X) (lower). An SPX break above 857 could bring on an SPX rally near 879, but I'd correlate any type of bullishness with the BIX.X on a move above 283 and potential test of its 21-day and 50-day SMAs as formidable resistance. If that were to take place, (BIX.X rallying further to 315 and SPX close to 878) I'd sell bullish positions into strength. Bears can look for entry points above 857, but monitor tech for weakness. If the NDX were breaking below 855, then a lower risk short/put in the SPX, SPY is at hand. S&P 100 Index / Retail HOLDRS - Daily Interval In our September 15th wrap http://members.OptionInvestor.com/itrader/marketwrap/091502_1.asp we were monitoring a bearish trade in the SPX and OEX as it relates to the retailers as depicted by the RTH. At that time, we thought SPX and OEX bears wanted the RTH to find resistance below $84.50 and for them to break trend and help drive the SPX and OEX lower. Well, that certainly happened. Not how the RTH is still relatively STRONG and now challenges its 50-day SMA. If the RTH finds resistance at current levels or $80.00, then I'm expecting weakness to follow in the SPX and OEX. Note how the "old" downward trend that I've extended actually has served as "bearish support." Bearish support is a downward trend (kind of like the lower end of downward trending regression). Often-times, institutions that are net short a stock/sector will "leg out" of some bearish positions at bearish support, but look for rally's to short back into. Only after a level of resistance is broken, will they then begin to get more aggressive with short-covering and eventually, a bullish trend takes hold. As such, I'm thinking that market participants that "know something" about pending weakness would be looking to short the RTH or sell strength somewhere between 80-83. So far, that's been a profitable strategy. An OEX and/or SPX trader currently long, may want to "correlate" the RTH and BIX. If you're a bull, you want to see BIX and RTH strength. If you don't, then most likely that's the sign to cut out of bullish trades. For bears looking for bearish OEX and SPX, you know that you're looking for RTH and BIX weakness at levels of identified resistance. While it is always helpful to be able to watch things intra-day, I don't think a trader necessarily has to. If waiting for a bearish entry point right now, I do think a trader can wait until tomorrow's trading plays out. Tomorrow, we'll get the FINAL Q2 GDP numbers. Economists are expecting "no change" from the preliminary 1.1% growth. Final Thoughts I'm more "bearish" toward technology, thus would prefer a first bearish play in the QQQ's or NDX.X. I've talked enough about not liking to pay "jacked up premiums," but sometimes a trader has to deal with what the market gives. I would prefer shorting, but a trader that does that needs to be disciplined with stops. As such, looking bearish the Q's. A trader that is "risk averse" can follow a QQQ bearish trade with a stop just above today's high of $22.33 (say $22.45) while a trader that is trading the levels can start out with $23.00. Look for further weakness on a break of today's low. If anxious to get short prior to breaking of today's low, then would limit to partial positions at first. Just in case banks and retailers drive bullishness and have QQQ bears looking for cover. If tech weakens, then monitor banks and retailers for resistance. If they're finding it at levels discussed, the SPX, OEX and DIA bulls may want to move to the sidelines and look for bears to begin searching for some up-ticks. Option traders that are "more aggressive" on the bearish side of DIA, SPX and OEX declines, and finding some resistance levels intraday, might be able to get some option entry "in between" bids and asks of options. If things are trading somewhat sideways, no sense paying the offer if you can work a trade in between. Jeff Bailey ************************Advertisement************************* Tired of waiting on trades to execute? Does your broker offer Stop Losses on Options? Trade instantly with Stop Losses at PreferredTrade Inc. Stop Losses based on the option price or the stock price. Move your trading into the next millennium with PreferredTrade. Anything else is too slow! http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** **************** MARKET SENTIMENT **************** Window Dressing by Steven Price The rally continued today, on the heels of some positive economic data. The rolling average for initial jobless claims finally dropped slightly, after seven straight weeks of increases. The four-week average decreased by 1,000 to 419,000, due to a drop of 24,000 claims last week. This sounded promising, until SBC Communications announced after the bell that they would be laying off 11,000 workers. This follows the 10,000 positions it has already eliminated this year. SBC said it lost 3 million retail access lines, its worst decline ever, leading to more than $1 billion in losses in the first half of the year. The company said it could lose $2.3 billion in sales over the next four quarters at the current pace. This news was followed by a profit warning from Philip Morris. Big MO said its 2002 earnings would increase only 3 to 5%, a far cry from analyst estimates of 19%. The stock closed at $42.73, but traded as low as $38 after hours. The company cited lower than expected sales and higher promotional spending. As a Dow stock, MO should weigh heavily on the average in the morning. Durable goods orders fell 0.6% in August. While this is negative overall, it is far less than the predictions of a 2.7% decline. Core capital goods orders were positive year-over-year for the first time since November 2000. We also got some good news on new home sales. Sales rose 2% in August, to a record annualized rate of 996,000 units, in spite of a drop off in existing home sales, and record foreclosure rates. While the Dow tacked on 155.30 points, to close at 7997.12, it was repeatedly turned back on each venture over the 8000 mark. This can be viewed in two ways. The failure under 8000 can be seen as bearish, as it was unable to hold a significant round number. The break above 7900 can also be seen as bullish, since it walked its way down 100 points at a time and has now taken a couple of steps back up the last two days, in similar increments. However, after Philip Morris' warning, my guess is the former will prove more accurate. At the same time the Dow was chugging along, the Nasdaq actually lost some ground, falling less than a point. The Semiconductor Index (SOX) had mounted a terrific rally from its intraday low of 231 on Tuesday, to close at 255 on Wednesday. The group gave back 8.10 today to finish back at 248.35. Without much good news outside of the cell phone group, the rally appeared to be a compression bounce, after the index had lost 35% in a month. The SBC warning is in sync with the warning last night from Nortel, which said revenue would fall 15% sequentially, 5% worse than previously forecast. The telecom equipment manufacturer took a hit as Nortel blamed the losses on major customers' reluctance to spend. Nortel announced a reverse stock split, as it attempts to avoid being de-listed. The sentiment was echoed by telecommunications equipment maker Redback, who said today that deteriorating spending by telephone company customers would mean lower revenue. The whispers are now starting about Cisco, which derives 20-25% of its revenue from the telcos. The rally of the last two days has given the bulls something to hang their hats on, as we bounced from July's lows, in what some see as a double bottom formation. However, the bullish percentages of the broader indices paint a different picture. The Dow's bullish percentage, which shows the percentage of stocks in the index that are currently giving point and figure buy signals, is down to 16.7%, from a recent high of 60%. The S&P 500 has fallen from 56% to 30.8%. The Nasdaq 100 has fallen from 58% to 22%. Each of these is in a bearish column of "O"s and would require a 6% reversal to signal a turnaround. Until that happens, it is hard to buy into a rally. Look for tomorrow to re-test 7900 to the downside in the Dow, after Philip Morris' warning. However we will also be seeing the GDP and University of Michigan Consumer Sentiment numbers, which will have a big impact. If GDP comes in below the 1.1% consensus, we may even re-test Tuesday's 7683 close. ----------------------------------------------------------------- Market Averages DJIA ($INDU) 52-week High: 10679 52-week Low : 7532 Current : 7997 Moving Averages: (Simple) 10-dma: 8039 50-dma: 8433 200-dma: 9549 S&P 500 ($SPX) 52-week High: 1176 52-week Low : 775 Current : 854 Moving Averages: (Simple) 10-dma: 856 50-dma: 887 200-dma: 1040 Nasdaq-100 ($NDX) 52-week High: 1734 52-week Low : 843 Current : 873 Moving Averages: (Simple) 10-dma: 880 50-dma: 935 200-dma: 1255 ----------------------------------------------------------------- The Semiconductor Index (SOX.X): The semis rallied convincingly on Wednesday, only to see the magic wear off on Thursday. After trading as low as 231 on Tuesday, they hit an intraday high of 261 on Wednesday. Unfortunately, today's drop of 8.10 put the group back under 250, closing at 248. The question is whether Wednesday's rally was just a dead cat bounce. If the group can't bounce back again, it is likely that we will see a re-test of 230 once again. With news of layoffs from SBC after the close and a warning from Philip Morris', it is likely that the whole market will be dropping on Friday. The SBC news underscored warnings from Redback and Nortel, which cited a lack of spending by telecoms. Whispers are already beginning that Cisco may be seeing poor results ,as well, since they derive 20-25% of their revenue from the telecoms. While these are not chip stocks, they will most likely give the Nasdaq a push downhill, which should take the SOX with it. 52-week High: 657 52-week Low : 236 Current : 248 Moving Averages: (Simple) 10-dma: 255 50-dma: 307 200-dma: 466 ----------------------------------------------------------------- Market Volatility The VIX dropped a couple of points on today's rally. However, it still remains over 40, which is considered high. It is also worth noting that it found support at its 50-dma of 39.62, although this is not as significant as it is in a stock, since the index is derived from the volatility levels of 8 different OEX options. The fact that it remains over 40 after a gain of over 300 Dow points in two days, shows that traders are not yet convinced that the rally is for real. If the Dow can close back over 8000, I expect to see a drop under 40. If we re-test the 7532 level, we could see the 50 level again quickly. CBOE Market Volatility Index (VIX) = 40.12 –2.29 Nasdaq-100 Volatility Index (VXN) = 59.09 +2.40 ----------------------------------------------------------------- Put/Call Ratio Call Volume Put Volume Total 0.77 612,736 473,856 Equity Only 0.58 508,595 295,508 OEX 1.16 18,647 21,689 QQQ 0.45 56,714 25,325 ----------------------------------------------------------------- Bullish Percent Data Current Change Status NYSE 34 + 0 Bull Correction NASDAQ-100 22 + 1 Bear Confirmed Dow Indust. 17 - 3 Bull Correction S&P 500 31 + 0 Bear Confirmed S&P 100 25 + 0 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 1.20 10-Day Arms Index 1.47 21-Day Arms Index 1.48 55-Day Arms Index 1.30 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 2026 724 NASDAQ 1714 1423 New Highs New Lows NYSE 36 22 NASDAQ 51 185 Volume (in millions) NYSE 1,891 NASDAQ 1,650 ----------------------------------------------------------------- Commitments Of Traders Report: 09/17/02 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 Increased long positions by a whopping 50,000 contracts and shorts by 33,000. Small traders followed suit with large increases, but leaned toward short position increases more heavily. Commercials Long Short Net % Of OI 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%) 09/17/02 476,224 503,268 (27,044) (2.7%) 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 08/27/02 153,152 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% 09/17/02 182,243 116,377 64,866 21.7% Most bearish reading of the year: 36,513 - 5/01/01 Most bullish reading of the year: 114,510 - 3/26/02 NASDAQ-100 Commercials increased long positions by 35% and shorts by 29%. Small traders increased longs by only 1,000 contracts, but increased short positions by 4,000, or 34% Commercials Long Short Net % of OI 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%) 09/17/02 72,522 75,815 (3,293) ( 2.2%) 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 08/27/02 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% 09/17/02 15,288 14,142 1,146 3.9% 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 increased their long positions by 4,000 contracts, while increasing shorts by 7,000. Small traders increased longs by 6,000 contracts, almost doubling the position, while increasing shorts by only 1500, or 15%. Commercials Long Short Net % of OI 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% 09/17/02 26,863 21,187 5,676 11.8% 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 08/27/02 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%) 09/17/02 13,393 11,637 1756 7.0% Most bearish reading of the year: (8,777) - 10/12/01 Most bullish reading of the year: 1,909 - 1/16/01 ----------------------------------------------------------------- ************************Advertisement************************* ”If you haven’t traded options online – you haven’t really traded options,” claims author Larry Spears in his new compact guide book: “7 Steps to Success – Trading Options Online”. Order today and save 25% (only $15) by clicking on PreferredTrade and clicking on the link to the book on its home page. http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ************************* WEEKLY MANAGER MICROSCOPE ************************* Ed Choi/Richard Dahlberg: GMO Pelican Fund Ed Choi and Richard Dahlberg are co-leaders of Grantham, Mayo, Van Otterloo & Company's U.S. Active Team, and co-managers of Pelican Fund (PELFX), GMO's only "retail" mutual fund product. The minimum investment for the GMO Trust retail fund, Pelican Fund, is $5,000 for regular accounts ($1,000 for IRA accounts). There is no minimum for subsequent investments. All GMO Trust mutual funds, except for the Pelican Fund, are "institutional" mutual funds and require a $1 million minimum initial investment. GMO Trust's retail fund product, Pelican Fund, is similar in style/strategy to the GMO Value Fund, the flagship product of GMO's U.S. Active Division. Both "value" products seek to outperform the Russell 1000 Value Index over time (with less risk than the market in Pelican Fund's case). Richard A. Mayo, a founding partner of the firm, ran the GMO Pelican Fund from its June 1989 inception until December 2001. Effective January 2002, Ed Choi and Richard Dahlberg took over the day-to-day management of the fund. Ed Choi is a longtime member of GMO's U.S. active team. He contributed to Pelican Fund's strong long-term record. Dahlberg is a seasoned fund manager who previously managed portfolios for Pioneer, Salomon Brothers, and MFS. At $90 million in assets, GMO Pelican Fund is relatively small and comprises just a small portion of Grantham Mayo Otterloo's $20 billion today in total assets under management. This fund has limited brokerage availability, but if you have an account with Fidelity, Pelican Fund is available through their retail funds network. Like Fidelity, GMO is headquartered in Boston. Founded in 1977 on the philosophy of conservative value-driven investing, GMO has grown to become a top global money manager, with offices in London, Sydney and San Francisco, and employing some 200 people worldwide. The same year (1977), a permitted, not-for-profit tax-deductible organization called The Pelican Fund was founded, when the Brown Pelican was on the endangered species list. GMO Trust's Pelican Fund (PELFX) was launched in June 1989, more than a decade later. Manager Background GMO Trust's Pelican Fund is managed by the U.S. Active Division of Grantham, Mayo, Van Otterloo and Company. Choi and Dahlberg manage the portfolio assets, and are supported by four research analysts and a half dozen trading/operating people. Ed Choi (left) co-leads the U.S. Active team with Richard Dahlberg. Prior to joining GMO in 1994, he worked in the Equity Research Department of Furman Selz, Inc. Choi has a B.A. in Applied Mathematics from Brown University. Dahlberg (left) co-leads the U.S. Active team with Edmond Choi. Prior to joining GMO in 2001, he was head of the core value group at Pioneer Management Company. Before that, he was a managing director and senior portfolio manager with Salomon Brothers Asset Management. Dahlberg earned his B.S. Finance from Northeastern University and his M.B.A from the Wharton School. Since Richard Mayo stepped down, Choi and Dahlberg have assumed the portfolio management responsibilities. However, the fund's prospectus says that no one person is primarily responsible for making recommendations to the fund. In the next section, we'll take a closer look at the investment philosophy and process GMO applies on the GMO Pelican Fund. Investment Overview GMO Pelican Fund seeks long-term capital growth; current income is secondary. It invests primarily in securities traded in the United States, but may have up to 25% of fund assets in foreign securities. Choi and Dahlberg invest mostly in domestic common stocks representing outstanding values relative to their market prices. Under normal conditions, the GMO U.S. Active division looks for companies with low price valuations and rising earnings. Their primary focus is on established, financially secure firms, with market capitalizations of more than $100 million. According to Morningstar, the Pelican Fund has a large-cap value orientation, while in Lipper's system, the fund is categorized as "multi-cap" value. GMO's U.S. Active team evaluates stocks using a combination of fundamental and quantitative research. The investment universe consists of the largest 1000 U.S. companies and is constructed utilizing a proprietary dividend discount model (DDM) to identify the best values in the marketplace and to screen for inexpensive stocks. Traditional fundamental analysis is then applied to the securities in each sector to validate compelling opportunities. Choi, Dahlberg and team look at the following characteristics in companies: unexpected earnings power or growth rate; situations where profitability can be improved; undervalued assets; and/or situations where a stock's price has suffered due to a perception anomaly. The GMO website goes on to say that the team builds the portfolio stock by stock. Risk is controlled primarily through "valuation" since all securities are purchased at a "discount to fair value." Stocks are sold when they become fully valued, or to take price risk out of the portfolio by cycling into more deeply undervalued opportunities, the website states. The team also utilizes money market (cash) or fixed income instruments to limit risk and await better equity valuations. Per Morningstar's latest fund report, GMO Pelican Fund possessed a median market capitalization of $11.8 billion, less than half that of the average large-cap value fund ($24.4 billion). Giant and large capitalization stocks composed of nearly 55% of assets; mid-cap stocks represented 31.5% of assets; and small/micro-caps comprised almost 14% of stock holdings. So while Pelican Fund's overall bias is large-cap, you can clearly see that it really is "multi-cap" oriented (Lipper's fund classification). Both Morningstar and Lipper agree that the fund has a value bias as represented by the fund's average price valuations, which are right on par with the large-cap value category average. Pelican Fund's average P/E of 24.2 is very close to the category average (23.9). In the next section, we see how well the fund has fared this year and over time relative to similar funds. Investment Performance Because GMO Pelican Fund follows a conservative, value oriented approach, you would expect it to have below average risk versus its peers, and it does. Morningstar rates the fund's risk over all trailing periods (3-year, 5-year, 10-year) as being "below average" in comparison to other large-cap value funds followed. In Lipper's system where funds are compared to their broad peer group over the trailing 36-month period, Pelican Fund holds the fund tracker's highest rating for preservation ("Lipper Leader") in down markets. For the trailing 3-year period as of September 25, 2002, the fund produced an average loss of just 2.1% a year, ranking it in the top 14% of the large-cap value category using Morningstar's data. For the same period, the average large-cap value fund declined by a 6.1% annual-equivalent rate, while the broad U.S. market as measured by the S&P 500 index lost 11.9% a year on average. Since Choi and Dahlberg took over the portfolio management reins at the start of 2002, Pelican Fund has slightly trailed its peer group. According to Morningstar, the fund has declined 25.4% so far in 2002, ranking it in the category's 68th percentile (third quartile). That's too soon to make any meaningful judgements as to Choi/Dahlberg's relative performance, and considering Ed Choi contributed to the fund's fine long-term record, there isn't any reason to panic at this point. Over the long term, Grantham Mayo Otterloo's conservative, value conscious approach has been proven to produce the desired "above average" return and "below average" risk profile that all people want. As of August 31, 2002, GMO Pelican Fund had an annualized total return of 11.5%, a 1.3% return advantage to the market (as measured by the S&P 500 index). The fund's trailing returns for the 3-year, 5-year and 10-year period all rank in the top 20% of the large-cap value category, per Morningstar's report. How well has the fund fared relative to its benchmark index, the Russell Value 1000 index? Since fund inception (June 1989), the Pelican Fund has an average return of 10.5% versus 11.1% for the Russell Value 1000 index. That does not represent "significant" underperformance of the benchmark. The fund has been successful in terms of limiting risk, however, producing less risk than the benchmark Value 1000 index and the broad S&P 500 index. Conclusion GMO Pelican Fund's relative performance in 2002 might not be top quartile, but given the experience of GMO's U.S. Active team and the offering's fine long-term track record, there's reason to be optimistic about the fund's long-term prospects. Investors that seek a conservative value-conscious approach to long-term growth of capital have a decent choice here. A no-load cost structure, and low 0.75% expense ratio, add to its appeal. As mentioned earlier, there's no discounting that Grantham, Mayo, Van Otterloo and Company, LLC is one of the leading global money managers today with $20 billion in assets under management. The firm has built its reputation on the institutional side, but you can have access to the firm's strong quantitative and fundamental research capability through the GMO Pelican Fund, the firm's only retail fund product. For more information or a fund prospectus, go to the www.gmo.com website. Steve Wagner Editor, Mutual Investor firstname.lastname@example.org ************************Advertisement************************* If you trade options online, then you need an online broker that: offers true direct access to each option exchange offers stop and stop loss online option orders offers contingent option orders based on the price of the option or stock offers online spread order entry for net debit or credit offers fast option executions PreferredTrade offers these online option trading features and more; call 1-888-889-9178 or click for more information. http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** *********************** SWING TRADER GAME PLANS *********************** Mixed Messages? GE affirmed estimates, then they affirmed that business was terrible. Phillip Morris brags about court win then admits serious earnings problems. This bipolar news produced bipolar markets with the Dow strongly positive and the Nasdaq fighting to hold zero. To read the rest of the Swing Trader Game Plan Click here: http://www.OptionInvestor.com/itrader/indexes/swing.asp FREE TRIAL READERS ****************** If you like the results you have been receiving we would welcome you as a permanent subscriber. The monthly subscription price is 39.95. The quarterly price is 99.95 which is $20 off the monthly rate. We would like to have you as a subscriber. You may subscribe at any time but your subscription will not start until your free trial is over. To subscribe you may go to our website at www.OptionInvestor.com and click on "subscribe" to use our secure credit card server or you may simply send an email to "Contact Support" with your credit card information,(number, exp date, name) or you may call us at 303-797-0200 and give us the information over the phone. 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The Option Investor Newsletter Thursday 09-26-2002 Copyright 2002, All rights reserved. 2 of 3 Redistribution in any form strictly prohibited. In Section Two: Stock Picks: Reversal of Fortune - RFMD Dropped Calls: None Dropped Puts: MAR, AIG Daily Results Call Play Updates: ABT, LLL New Calls Plays: None Put Play Updates: BGEN, BSC, FISV, CI New Put Plays: GM, TECD *********** STOCK PICKS *********** Reversal of Fortune RFMD - RF Micro Devices - $6.25 Strategy: Long Stock with put insurance While most chip companies have repeated the mantra that capital spending is still dropping and therefore have lowered their revenue and earnings guidance, there are a few pockets of IT spending that show promising signs. The cell phone market is one of them. The first positive signs showed up last week, when Qualcomm raised its shipping targets for the current quarter from 19 million to 20 million cell phone chips, citing strong demand. They also said that they expect to ship significantly more next quarter. RFMD, which is also engaged in the wireless business, echoed this sentiment when it raised its guidance for the current quarter. Demand is picking up, as revenues will exceed the previously forecasted $109-$114 million range and come in around $118 million. Earnings per share were raised from $0.01-$0.02 to $0.03. While two cents is not a tremendous rise, it is still three times the previous forecast and represents a significant percentage increase. The company also commented that order visibility for next quarter continues to improve. The fact that the company has reversed its earnings trend after finding a bottom in June of this year is also promising and lends credence to statements of business picking up again. RFMD's CEO said, "Our customer and product diversification efforts are paying off. We are experiencing broad-based strength across multiple customers and markets, which is increasing our capacity utilization and improving our order visibility into the December quarter. The Company currently has production orders for the December quarter to support sequential revenue growth beyond the increased September estimates provided today." The company currently holds $344.2 million in cash, which amounts to 47.2% of its assets. It also has a positive P/E ratio, which is hard to find in the sector. The P/E is certainly high at 103, but quite a bit lower than Qualcomm's P/E of 191. Qualcomm announced on Wednesday that it is seeing an increase in its bookings, as well, which is a positive sign, as the book-to- bill ratio in the chip sector has been steadily declining. This is just more evidence of a possible turnaround in this sector within a sector. On Thursday, J.P. Morgan, citing greater customer diversification and strengthening end demand, upgraded RFMD. A recent Lehman Brothers research note said mobile phone sales across Europe are also likely to pick up in the fourth quarter, as consumers upgrade to handsets with color screens. Morningstar currently rates RFMD's growth potential as "A," while rating Profitability and Financial Health as "B." While the chip sector still faces strong challenges from a lack of IT business spending, the mobile phone business is showing some tangible signs of a turnaround. The stock recently found point and figure support between $5.50 and $6.00, testing these levels repeatedly. RFMD finished the day at $6.25, after trading as high as $6.80. The 50-dma is $6.85 and conservative traders can use a trade above this level as a trigger point. We also recommend the purchase of the Feb 5 put (RFZ-NA) as downside protection, in case the upturn in the industry stalls. Purchasing the put, which expires in February, will provide time for the fourth quarter predictions to play out. The stock has resistance at $8, $9 and $10, but the February time frame should give the stock enough time to show evidence of a turnaround and take out at least one or two of these levels. If it cannot cross $8 by February, then closing the play may be prudent. Option 1: Purchase RFMD at the current price, or when it crosses the 50-dma. Purchase 1 put for every 100 shares of stock. If the stock cannot cross resistance at $8 by February expiration, close the position. Option 2: If RFMD drops below $5 by February expiration, collect the profit on the put and lower the cost basis of the stock purchase. Option 3: If RFMD drops below $5 at any point between now and February expiration, sell the put, which should still have some time premium left in it and sell the stock. *Note the total potential loss on the play is the difference between the purchase price of the stock and the $5 strike price, plus the cost of the option. **************** PICKS WE DROPPED **************** When we drop a pick it doesn't mean we are recommending a sell on that play. Many dropped picks go on to be very profitable. We drop a pick because something happened to change its profile. News, price, direction, etc. We drop it because we don't want anyone else starting a new play at that time. We have hundreds of new readers with each issue who are unfamiliar with the previous history for that pick and we want them to look at any current pick as a valid play. CALLS: ***** None PUTS: ***** MAR $31.10 +2.90 (+2.50 for the week) A report in this morning's Wall Street Journal said Marriott was the target of short sellers, who were raising questions about the quality of the company's earnings and accounting practices. Yesterday the company affirmed their third quarter earnings, which may have forced those short sellers to cover, as the predictions didn't pan out. Although some of the top hotel companies came out yesterday and said business in the quarter had been weaker than expected, Marriott said it was on target, bucking the trend. Regardless of the reason, the rally in the stock was strong enough to break the trend we were attempting to capture. We will close the play and spend our put money elsewhere. --- AIG $58.00 +2.44 (+1.65) Thursday was a stellar day for the Insurance stocks, with the IUX index staging a nearly 4% advance by the closing bell. Our AIG play gapped higher in the morning, and after twice testing the $56 level as support, the stock rallied to close right at its high of the day on solid volume. While our expectation is still for more downside in AIG, we have to stick with our discipline and drop AIG tonight due to the strong relative performance and the close right at our $58 stop. Use early weakness tomorrow to exit open positions at a more favorable level. *********************************************************** DAILY RESULTS *********************************************************** Please view this in COURIER 10 font for alignment ************************************************* CALLS Mon Tue Wed Thu Week ABT 41.90 -0.11 0.40 1.30 -1.90 Tested Support LLL 56.15 1.10 0.69 -0.91 –0.94 Trend in tact PUTS AIG 58.00 -0.70 -1.26 0.91 2.44 Drop, stopped BGEN 30.40 -1.35 -0.31 0.76 0.06 Competition strong BSC 57.92 0.39 -1.21 0.07 1.00 Sector problems CI 73.90 -0.98 -2.04 –0.80 2.70 Entry point FISV 28.78 -0.62 -0.99 –1.07 0.68 Gap Filled GM 41.52 -0.97 -2.73 1.39 1.95 New, Debt probs MAR 31.10 0.09 -0.70 0.17 2.90 Drop, reaffirmed TECD 28.38 -0.75 -0.28 0.51 –1.64 New, breakdown ************************Advertisement************************* Tired of waiting on trades to execute? Does your broker offer Stop Losses on Options? Trade instantly with Stop Losses at PreferredTrade Inc. Stop Losses based on the option price or the stock price. Move your trading into the next millennium with PreferredTrade. Anything else is too slow! http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ******************** PLAY UPDATES - CALLS ******************** ABT $41.90 -1.90 (+0.10 for the week) Abbott received a downgrade this morning by S.G. Cowen, which cited its declining immunoassay market share, as well as generic risks to 2004 earnings. In spite of this downgrade, ABT still held its point and figure and daily support levels. The stock is on a triple top breakout, and yesterday's trade of $43 broke through its bearish resistance line. Today's bearish comments sent the stock lower and provided a test of the new support level. The $42 level was the PnF breakout and would require a trade of $41 to register a break below that level. A trade of $40 would be required for a three-box reversal. None of those things happened today. The fact that the stock held near $42 is a positive sign and we will give it a chance to prove that it truly has found a higher consolidation point. With the company presenting data on a new Quinolone antibiotic at this weekend's ICAAC conference, there is certainly enough reason to hold the position without a breakdown in support. The stock had been in a consolidation pattern from the end of July through the middle of September. The recent breakout after such a long consolidation is a strong sign and we will use a sign of re-entry into the pattern as a signal to close the play. If it manages to hold above that consolidation, we are probably seeing the basis for another leg up. We will watch tomorrow's action and a trade back above $43 can be used as a signal for new long entries. --- LLL $56.15 -0.94 (+1.20) As investors have adjusted to the probability of war with Iraq, Defense stocks are seeing a bit of a bid again, with the Defense Industry index (DFI.X) moving back up to the $575 level on Thursday. A portion of this move is likely due to the bullish move in the broad markets, but we've also got the underlying war bid helping us along. While buyers were active in the broad markets over the past two days, shares of LLL have been drifting down towards support, likely setting us up for our next high-odds entry point. The stock found mild support today near $55.50, but we're looking for a dip near the $54 level for our next entry. Not only is that the site of support from last week, but it is also the current location of both the 20-dma ($54.29) and the 2-month ascending trendline. Use a dip and rebound from that level to initiate new positions in anticipation of a renewed assault on the $58 resistance level. Keep stops set at $53.50. ************** NEW CALL PLAYS ************** None ************************Advertisement************************* ”If you haven’t traded options online – you haven’t really traded options,” claims author Larry Spears in his new compact guide book: “7 Steps to Success – Trading Options Online”. Order today and save 25% (only $15) by clicking on PreferredTrade and clicking on the link to the book on its home page. http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ******************* PLAY UPDATES - PUTS ******************* BGEN $30.40 (-0.54 for the week) Biogen has rebounded slightly the last couple of days, but remains firmly in its recent descending channel, which began at the end of August. The stock has found resistance since 9/20 at $31, and today's high of $30.87 only reinforced that level as a major roadblock.. The stock managed only a $0.06 gain on a day when the Dow finished up 155 points. The repeated failure at the same level looks bearish, and that level coincides with the bottom of its recent point and figure support. Often support levels turn into resistance as sellers at that level are finally able to exhaust buyers, and that appears to be what has happened to BGEN. After seeing its psoriasis treatment delayed, which has opened the door to competition from Amgen, the stock was hit hard. More bad news for Biogen came in the form of positive test results from another competitor, Genentech. Genentech said that patients who were treated with experimental psoriasis drug Raptiva had significant improvement in their conditions. The drug, which is in late stage testing, is being jointly developed by Genentech and Xoma, and the companies have said they will file an application to market the drug by the end of the year. Raptiva has already received approval for European marketing, after it wins regulatory clearance. We will remain short on BGEN and look for a break below $30 for new entries. More conservative traders can look for a trade below Tuesday's low of $28.71 to initiate short positions. --- BSC $57.92 (+0.20 for the week) BSC caught the rising tide and rallied with some of the other financials. We are betting that the rally will be short lived. This morning brought a further downgrade of J.P. Morgan by Lehman Brothers, who just lowered estimates a week ago. The Lehman analyst cited even lower than expected trading revenues and absence of heavy investment securities gains for the cuts, after meeting with JPM management. The message is clear after, Lehman's own disappointing earnings, that trading revenues are poor industry wide. While Goldman Sachs actually posted decent numbers, investors don't have to look very far past their screens to see that money has been pulled out of the market at a furious pace. Mutual funds have seen record withdrawals and September's numbers have not yet been tabulated. The September -October swoon should continue to hit brokers and financial institutions as investors continue to withdraw their money from brokerage accounts. The recent wave of layoffs won't help either. Although that pace improved slightly last week, today brought with it more news of 11,000 layoffs at SBC communications. The math is simple - people without jobs do not contribute to 401(K)s or purchase stocks. We see more downside for the sector, and with its earnings behind it, there will be little good news to hold BSC up. We will remain short on BSC and traders should look for a break below today's low of $56.68 for new entries. More conservative traders can wait for a trade below $55, which is the most recent level of support. --- FISV $28.78 +0.68 (-2.56 for the week) After targeting FISV on Tuesday for its concentration in a shrinking business, the stock was downgraded on Wednesday. SunTrust lowered their rating on the stock from "Outperform" to "Neutral." A similar rating was put on the stock, as coverage was initiated by D.A. Davidson. A "neutral" rating on a stock is kind of like saying "it's got a great personality." Sell ratings are rare, but neutral is the next best thing. The stock suffered a technical breakdown when it dropped below $31, and yesterday's trade down to $26.50 cleared out more support. Today's rally lifted most boats and FISV managed to close yesterday's gap before tumbling back below $29. The stock established a head and shoulders formation between the middle of July, and its breakdown in the middle of September. The minimum downside measuring objective of the formation puts the stock around $24. The current bearish vertical count, according to the point and figure chart, is $26, but it is still being defined by the current column of "O"s, and that number could drop to $24 with a trade of $26. A trade of $30 would be needed for a reversal, and so far $30 has been a level that FISV cannot crack.. A look at the intraday chart shows the late day rally unable to lift the stock back over $29, and yesterday's gap now looks like it will provide some resistance. New entries can look for a break below $28, or if conservative, then $27.50, which is just below today's low. --- CI $73.90 +2.70 (+1.13) Financial and Insurance stocks led the broad market advance over the past 2 days, with the Insurance index (IUX.X) tagging on a healthy 3.85% on Thursday. Given the sharp decline over the past month, a bit of a rebound is to be expected and it is worth noting that even with today's strong move, the IUX has yet to reclaim even a third of that decline. The 38% retracement of the recent decline is at $255, which is also significant resistance. CI was one of the weakest stocks in the sector over the past month, falling back to test its one-year low near $70 yesterday. Today's rebound came on pretty strong volume, so we need to be careful until this short-covering rally runs out of steam. But there is some serious overhead resistance to deal with, first at the 10-dma ($74.95) and then at $76. Look for CI to roll over near one of these resistance levels in conjunction with the IUX index rolling near its $255 resistance level before initiating new positions. If buying pressure is sufficient to push the stock through our $76 stop, then we'll clearly want to stand aside. A close above $76 will have us dropping the play. ************* NEW PUT PLAYS ************* GM – General Motors $41.52 +1.95 (-1.41) Company Summary: Maintaining its position as the world's #1 maker of cars and trucks, GM has managed to diversify its business so that it is more than just a car company. Its automotive business encompasses the Buick, Cadillac, Chevrolet, GMC, Oldsmobile, Pontiac and Saturn brands, as well as others through its affiliations with Suzuki, Saab, and Isuzu. Non-automotive operations include Hughes Electronics (satellites, communications), Allison Transmission (medium and heavy-duty transmissions), and GM Locomotive (locomotives, diesel engines). GM has successfully spun off Delphi Automotive Systems, the world's #1 auto parts maker. Why We Like It: There is an ugly underbelly of the domestic auto industry's zero-percent financing scheme of the past year. While it has clearly boosted sales in the near term, it steals future sales to satisfy current-quarter sales goals, and decreases the profit margin on those cars being sold. Somebody has to carry the paper on those car loans, and with zero percent financing, it isn't the consumer. After trading up to the $50 level last month, shares of GM have been sliding down the slippery slope, breaking below the $40 level on Tuesday before the stock rebounded with the rest of the market. Helping the stock to a nearly 5% gain on Thursday were comments from GM Europe's chief that the division was sticking to its breakeven target for 2003, despite missing the 2002 targets. That's hardly a glowing bullish endorsement, but it was enough to give the bulls hope and GM managed a solid performance on the day. But you can't ignore the technical damage that has been done lately. The recent selloff generated a fresh PnF price target of $27, so this little bounce looks to be just the setup for a better entry. That said, we need to be aware that the stock has seen some pretty good buying volume over the past couple days, and if it continues, we'll have to acknowledge that we called this one wrong. But we don't think that's going to be the case. GM is set to announce earnings in a couple weeks (October 15th) and it is likely that the stock will return to its pattern of weakness as that date approaches. There is some pretty stiff resistance overhead, first at $42 and continuing up to $43. The best entries will appear as GM rolls over from its overhead resistance in this area, and heads back towards its recent lows. Those looking to enter on a breakdown will need to wait for a drop below $38 before jumping into the play. We are initially placing our stop at $43.50. BUY PUT OCT-42 GM-VV OI=3479 at $2.95 SL=1.50 BUY PUT OCT-40*GM-VH OI=5450 at $1.95 SL=1.00 BUY PUT OCT-37 GM-VU OI=3182 at $1.25 SL=0.50 Average Daily Volume = 5.30 mln --- TECD – Tech Data Corporation $28.38 -1.64 (-2.33) Company Summary: Tech Data Corporation is a provider and distributor of information technology products, logistics management and other value-added services. The company distributes microcomputer hardware and software products to value-added resellers, direct marketers, retailers corporate resellers and Internet resellers. TECD and its subsidiaries distribute to more than 80 countries and serve over 100,000 resellers in the United States, Canada, the Caribbean, Latin America, Europe and the Middle East. The company's broad assortment of vendors and products meets the customers' need for a cost-effective link to those products through a single source. Why We Like It: The broad markets may be in rally mode, but apparently somebody forgot to inform the Computer Hardware and Networking stocks. While the DOW staged another triple-digit advance on Thursday, the Semiconductor index (SOX.X) got whacked to the tune of 3% and the Networking index (NWX.X) slid by more than 4.5% following some negative comments from NT and BRCD's refusal to give forward guidance. Clearly IT spending has yet to see any improvement and judging from the comments coming out of this sector of the market, the CEOs of these companies don't have any idea when it will get any better. Shares of TECD have had a rough go of things over the past five months and even the rally attempt in August got turned back at the descending trendline (then at $36.50). Since then the stock has broken the $31.50 support level and is continuing to fall. Even the broad market rally today couldn't help, as TECD fell by nearly 5.5% on heavy volume (60% above the ADV) on its way to a fresh 52-week low. The drop below $31 generated a fresh triple-bottom breakdown on the PnF chart and if the $28 level fails to provide support, it seems clear that the stock will be headed down to the $25 level. TECD has been finding intraday resistance just below $31 lately, so another failed rally near that level would make for an ideal entry. But given the heavy selling today, we'll probably have to settle for a failed rally in the $29.50-30.00 area. Trading a breakdown could work well on this weakling, but we want to wait for TECD to drop below $28 before piling on. Initial stops are set at $31. BUY PUT OCT-30*TDQ-VF OI=1017 at $3.00 SL=1.50 BUY PUT OCT-25 TDQ-VE OI= 131 at $1.00 SL=0.50 Average Daily Volume = 710 K ************************Advertisement************************* If you trade options online, then you need an online broker that: offers true direct access to each option exchange offers stop and stop loss online option orders offers contingent option orders based on the price of the option or stock offers online spread order entry for net debit or credit offers fast option executions PreferredTrade offers these online option trading features and more; call 1-888-889-9178 or click for more information. http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ********** DISCLAIMER ********** Please read our disclaimer at: http://www.OptionInvestor.com/page/oin/aboutus/disclaimer.html ************************************************************** ADVERTISING INFORMATION For more information on advertising in OptionInvestor Newsletter, or any Premier Investor Network newsletter please contact: Contact Support
The Option Investor Newsletter Thursday 09-26-2002 Copyright 2002, All rights reserved. 3 of 3 Redistribution in any form strictly prohibited. In Section Three: Play of the Day: PUT - TECD Traders Corner: Charting: Gaps; At the Start & Continuation of trends Traders Corner: A Day in the Life Options 101: "MO" Dividends ********************* PLAY OF THE DAY - PUT ********************* TECD – Tech Data Corporation $28.38 -1.64 (-2.33) Company Summary: Tech Data Corporation is a provider and distributor of information technology products, logistics management and other value-added services. The company distributes microcomputer hardware and software products to value-added resellers, direct marketers, retailers corporate resellers and Internet resellers. TECD and its subsidiaries distribute to more than 80 countries and serve over 100,000 resellers in the United States, Canada, the Caribbean, Latin America, Europe and the Middle East. The company's broad assortment of vendors and products meets the customers' need for a cost-effective link to those products through a single source. Why We Like It: The broad markets may be in rally mode, but apparently somebody forgot to inform the Computer Hardware and Networking stocks. While the DOW staged another triple-digit advance on Thursday, the Semiconductor index (SOX.X) got whacked to the tune of 3% and the Networking index (NWX.X) slid by more than 4.5% following some negative comments from NT and BRCD's refusal to give forward guidance. Clearly IT spending has yet to see any improvement and judging from the comments coming out of this sector of the market, the CEOs of these companies don't have any idea when it will get any better. Shares of TECD have had a rough go of things over the past five months and even the rally attempt in August got turned back at the descending trendline (then at $36.50). Since then the stock has broken the $31.50 support level and is continuing to fall. Even the broad market rally today couldn't help, as TECD fell by nearly 5.5% on heavy volume (60% above the ADV) on its way to a fresh 52-week low. The drop below $31 generated a fresh triple-bottom breakdown on the PnF chart and if the $28 level fails to provide support, it seems clear that the stock will be headed down to the $25 level. TECD has been finding intraday resistance just below $31 lately, so another failed rally near that level would make for an ideal entry. But given the heavy selling today, we'll probably have to settle for a failed rally in the $29.50-30.00 area. Trading a breakdown could work well on this weakling, but we want to wait for TECD to drop below $28 before piling on. Initial stops are set at $31. BUY PUT OCT-30*TDQ-VF OI=1017 at $3.00 SL=1.50 BUY PUT OCT-25 TDQ-VE OI= 131 at $1.00 SL=0.50 Average Daily Volume = 710 K ************************Advertisement************************* Tired of waiting on trades to execute? Does your broker offer Stop Losses on Options? Trade instantly with Stop Losses at PreferredTrade Inc. Stop Losses based on the option price or the stock price. Move your trading into the next millennium with PreferredTrade. Anything else is too slow! http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ************** TRADERS CORNER ************** Charting: Gaps; At the Start & Continuation of trends By Leigh Stevens A price gap is formed when any traded item has a low that is the above the prior days high – an upside gap – or when the stock or index high is below the previous day’s low, creating a downside gap. Gaps are price areas where no trading took place from one session to the next. This space between two consecutive day’s price ranges, as seen on a bar or candlestick chart, has various degrees of significance in terms of predicting possible trend continuations or reversals that may be underway. Most price gaps occur on overnight news or news that came out after the close of trading; e.g., company earnings announcements - or commodity reports, such as API oil inventory (stocks) reports, that are more bullish or bearish than expectations. It should be noted that gaps are rarely seen on the S&P 500 index (SPX) or Dow Industrial (INDU) daily charts – why? (Minor gaps are sometimes seen on their intraday charts; e.g., hourly.) Gap “events”, such as when some overnight news “surprises” the market and causes sharp selling or substantial buying on the market opening will also often mean that order imbalances show up in a number of S&P stocks; for example, substantially more sell orders come into the specialist for a stock, relative to buy orders held in the specialist’s (order) “book”. Using the example of a downside move and since the specialists are charged with maintaining an “orderly” market - to gain a bit of time for buy orders to come in or for the specialist to calculate what they can and need to buy (they are the buyer or seller of “last resort”), there is frequently a delayed opening for a number of key stocks in the S&P and Dow. Delayed openings due to order imbalances are not uncommon. As the exchange also wants to publish an “open”, the convention or rule for the S&P and the Dow is to calculate the index open for stocks not immediately trading, based on their “last” price, which is the prior close. Based on this convention, there is no apparent chart “gap” – the index “open”, which often is also the intraday high or low, comes in near the closing price. To get an idea of the “true” gap in the S&P 500 (SPX) and the Dow 30, you need to look at the nearby futures – and also add in “fair value” to reach an equivalent price to the actual index. [Coming 12 months Q-charts S&P futures symbols: SP02Z (Dec); SP03H (Mar); SP03M (June); SP03U (Sept) – until the 3rd. Friday.] Continuing with an example of a downside gap - SPX closed at 900.00 and the nearby S&P 500 futures closed at 902.00, as “fair value” for the futures is 200 points above the actual index; i.e., for the futures to be EQUAL to the actual dividend-paying group of stocks, they must trade 200 points higher than “cash”. A web site with the day’s index futures fair value is at www.programtrading.com/buysell.htm More on “fair value” can be found in my prior T.C. article at www.OptionInvestor.com/traderscorner/o71802_1.asp If “front-month” S&P futures open at 890.00, it’s equivalent to an SPX (“cash”) index opening at 892.00. Therefore, if SPX closed at 900.00, the SPX downside price “gap” is the difference between the 900.00 close and an opening equal to 892.00. (The reverse is true of a gap HIGHER opening – assuming a close at 900 and S&P futures open 10 points higher and fair value is 2.00, assume an SPX actual index open at approximately 908.00.) With individual stocks, upside or downside chart gaps are apparent on a bar chart, as the opening price is the actual first trade; e.g., GE closes at 50, announces better than expected earnings and then gaps higher by opening at 52.00 and trading up from there – the (upside) chart gap is the non-traded range between 50.00 and 52.00. Unlike the S&P/Dow, chart gaps are commonly seen in the NASDAQ indexes (COMPX & NDX), as they have no delayed openings - match ups are made electronically based on whatever orders are in the electronic trading system. You may have noticed the resulting chart gaps, especially on sharply higher and lower openings. This may be puzzling when you do NOT see any similar chart gaps in the S&P and Dow indexes when some event has triggered a broad based reaction – not just in the Nasdaq market. GAP SIGNIFICANCE - Generally, gaps below the market tend to act as support areas and gaps above the market suggest resistance and areas where there will be likely selling interest. Since a consensus expectation is “built into” the last traded price or close of every stock, index or commodity, significant new influences affecting the market’s perceptions of what the current and/or future price level for that item should be, causes an immediate adjustment in the opening price during regular exchange hours. Buyers will either be willing to pay more and potential sellers will want higher levels to induce them to sell or sellers will be aggressive in offering the item at lower levels and buyers will not be interested in purchasing unless prices drop especially in the early trading (open) which often becomes the high or low. Upside gaps are price areas where buyers were unable to make any purchases, as selling occurred only above the gap area. Downside gaps are price areas where sellers were unable to make any sales as they could only transact at levels below the gap. This is what is behind the notion that gaps BELOW the market will tend to act a support and gaps ABOVE the market, will tend to act as resistance. A move back down to an upside gap often brings in additional buying, unfulfilled at this lower level from earlier and a rebound back up to an overhead (downside) gap can attract interested sellers that would have sold more in the area where prices had previously “gapped” down. There is a common saying that “gaps get filled in” when a market settles down in subsequent days and weeks after the gap “event”. It would be better to say that gaps “TEND” to get filled in – as they (the gaps) don’t always get “filled”. To see situations where gaps do NOT get filled, we need to differentiate between some different types of gaps and see gaps that indicate a shift or jump to a faster rate of upside or downside MOMENTUM – as when runaway or “measuring” gaps are created. Or, in a later Trader’s Corner article, where gaps are part of a reversal pattern. Gaps that are part of ongoing trends and that “signal” an acceleration of upside or downside momentum are part of “continuation” patterns. Gaps that begin new trends become the kick off to a trend reversal. But first I’ll discuss the most common type of gap – called, guess what!? – “common” gaps. COMMON GAPS – So-called “common” gaps occur frequently, are merely part of normal price activity and are not especially significant – these gaps are the ones that get “filled in” regularly. In the stock market, because of the tendency to halt trading in a particular company if news comes out that affects the stock, resumption of trading can easily result in a price gap. Examples of COMMON gaps are found in the middle of the chart below, along with the other types of chart gaps that are discussed following this explanation of common gaps – - Beside intraday trading halts in stocks, overnight news affecting equities (or commodities) occur frequently as various economic and business reports are released after regular trading hours, as are earnings reports and to some extent, other companies announcements that might materially affect a related stock’s price. Given the extent of after hours, or 24-hour, trading, there is some ability for participants to react to news in marking prices up or down, but the official stock price record occurs only during regular trading hours and because of this, gaps are even more prone to develop. For the most part, price gaps occur frequently on chart types that display the session low and high. Gaps will of course not be seen on close-only line charts. Point and Figure charts will account for the up or down jump that causes the appearance of a chart gap as if there were actual trades that occurred in the gap area. BREAKAWAY GAPS – A breakaway gap, as the name implies, is a gap that bursts out of the pack, so to speak – it is a gap that develops when prices often jump well above or below what has been the normal trading range up until this gap event. This type of gap typically marks a first “signal” of a trend reversal; e.g., the trend was up, but then a downside breakaway gap occurred which was the beginning of a trend reversal from up to down (a trendline break was also involved), as can be seen in the chart below – the type of breakaway gap that occurs afger the trend is already well-developed, called a “measuring” or “runaway” gap is also noted on this chart - The more volatile stocks and many futures markets have more of a tendency for gaps than others – the very widely traded stocks will tend to have fewer breakaway type gaps that dramatically initiate trend reversals. The breakaway gap will tend to either just get filled in, or never quite completely, during the price move that follows it – either buyers are eager to buy dips back toward the breakaway gap area or sellers are active on selling rallies that approach such an overhead gap. Breakaway gaps are milestones on a chart and are widely followed. Once a price move is well past and during a later trend, prices may get back to a prior breakaway gap area and this occurrence now lacks any special significance. RUNAWAY GAPS - A “runaway” or “measuring” gap describes a gap occurring when a trend accelerates in the direction of the trend indicated by the breakaway gap – it can be an upside or downside chart gap. This occurs more in the second phases of bull and markets when there is increasing interest, particularly public interest, in a stock or the overall market. A series of these gaps can occur, but a succession of such gaps tends to be more common in the futures markets. A runaway gap is also often called a measuring gap, as it has a “measuring” implication for the further possible upside or downside potential of the move underway, because such gaps often (not always) appear about midway in a price swing as can be seen below in a revisit of the first stock chart shown - GAPS THAT DO AND DON’T TEND TO GET “FILLED IN” – Gaps that tend to get “filled in” include: 1.) Upside gaps occurring within an overall down trend; i.e., a significant prior upswing high is not exceeded AFTER the gap. 2.) Downside gaps occurring within an overall up trend; i.e., a significant prior downswing low is not exceeded after the gap. 3.) Gaps occurring within a sideways trend or within a trading range. Gaps that might NOT get filled in during the current trend: 1.) Breakaway gaps 2.) Runaway or measuring gaps It’s the EXCEPTIONS (to the rule of thumb) that tend to kill you, trading wise – this when you start to assume that technical patterns won’t “fail” you and you DON’T protect yourself by using exit/stop points if you are wrong in your assumption(s). ************** TRADERS CORNER ************** A Day in the Life By John Seckinger jseckinger@OptionInvestor.com First, the bond market tanks, then Gold comes under pressure, followed by a rebound in the Utility Index. All point towards higher equities, which do in fact rise by 158 points and 200 points off their lows. So, why didn’t I go long? The date in question is September 25, 2002. Micron missed estimates the night before and I was sure to wake up to a lower opening. Didn’t happen, thanks to GE affirming estimates and ASML (Europe's largest maker of semiconductor equipment) reiterating shipment expectations. Ok, no problem. I exited a bond trade the day prior and was flat going into Wednesday’s session. Time to clear my head and just trade. I had done extensive technical analysis of the Dow the night prior, so all I had to do was to believe in my support and resistance levels. Easier said then done. I will admit it, some days I am not successful at executing a known strategy. Wednesday was one of those days. Looking at the chart below, I drew a blue line in at 7682 (low on July 23rd) and wanted to use the line as a pivot (above the line, buy; below, sell). However, just a minute or so into trading and the market was markedly above this line. I couldn’t put on a position in “no-mans” land, so I figured it would be an hour or so before the market gives me a signal. Roughly 1:45 later, the blue line comes into play again. Ok, let’s go bearish and get short, quick. As my trading platform races from one Put quote to another, an interesting thing happens; The market rises. I wasn’t too upset, because at the same time I wanted to find some fundamental news regarding the reversal. Before I found any news, the market reversed and went higher above the blue line. I then started to realize the move was technical in nature. That is a good thing, I can trade technical patterns. I will try to make the rest of it short. Five minutes after the blue line was tested, I began to worry about going long because of the 22 and 50 PMA’s looming overhead. And then, after those averages were in-fact penetrated, I got nervous over a descending trend line (black line) which had been on my radar screen since May. After the black line offered no resistance, I had to check to see if I drew the line wrong. That took a few minutes, and by that time, I figured I would just grab a quick move to 7880. Well, I then wondered if 50 points was enough. Maybe risk was getting to great, I thought. With that said, I missed it all. Chart of the Dow Jones Industrial Average Index, 5-minute Normally, I would not be mad at all. I understand how dynamic the markets can be, and I have easily missed thousands of points due to “unexplainable moves”. However, Wednesday’s move was explainable and should have become a profitable trading day. Why do I stare at charts on Saturday and Sunday morning? For this exact reason. Execution is 80 percent of trading, and this was just another painful lesson explaining such a truth. Ok, that lesson is now behind us. Well, almost. To put salt on the wounds, other bullish indicators included Gold shares selling off, the Utility Index rebounding, and the Semiconductor Sector breaking a 9-day string of lower highs by rallying above Tuesday’s high of 247.61. So, where was the Dow when the Sox took out the 247.61 level? At 7740 and before the Dow went down and tested the blue line. As for Gold, this index actually came under solid selling pressure as the Dow was at 7700, after the buy signal from the Sox. Turning to The Utility Index (UTY), it made its bullish move when the Dow was at 7760 and rebounding from the early morning reversal. I convinced myself at that juncture that the Dow was leading the UTY, and that I should not put much weight in this interest-sensitive index. Not a smart trading decision, especially when the UTY Index has been a fantastic leading indicator in the past. Last, but certainly not least, was the selling seen in the Bond market. I first start with the yield curve, which was not exactly giving a strong buy signal. This could explain my nervousness. Nevertheless, there seemed to be cash leaving the long-end and entering stocks. The barometer I use is a full point move in the December 30-year (USZ2), which did not happen until the Dow was at 7805. The interesting thing is that, at 7805, the aforementioned black line was tested. At the time, I did not make the connection. Note: Whenever the long bond is down/up by more than a full point (32/32), usually there is a strong asset allocation taking place and will most likely not reverse during the trading day. Ok, what is the lesson here? If, as a trader, you are going to spend countless hours studying technical analysis, please, execute when the time comes. Chart of the Dow Jones Industrial Index, Daily Looking at a Daily chart of the Dow, the lines that extend far leftwards are psychological levels from either a weekly or a monthly level. These levels should be given more weight, since traders have had more time to associate and study them when performing technical analysis. The dark green lines extending rightward, to me, represent a possible pivot area in the Dow. As long as the blue line holds, these are my projected levels. The unemotional aspect of my trading might be a result of giving these lines too much respect. Why? Well, I know that it makes sense to be aware of earnings, economic events, events, etc..; however, I have to “trade what I see and not what I know” (a quote Jeff Bailey has been using for a while). If I see prices heading higher, why fight the trend? Because the L.E.I. index came in lower-than-expected? I think not. As I have stated in the past, I only put a lot of weight in fundamental analysis when technical analysis fails; diluting the importance of these support and resistance lines. This usually only happens when there is a fundamental shock to the market. A shock that absolutely cannot be discarded as “short covering”. Side notes: Except when staying in hotel rooms, I have not watched CNBC in over a year and a half. I find it too political and bullish; moreover, I became cynical on how they “spun” certain market events. That is just my opinion. Continuing the cynicism theme, here is a list of economic events I will not give much weight to (even though some I really should) given the current economic environment: L.E.I. (7/10th of the report is known beforehand), Durable Goods (just too volatile to understand), E.C.I. (this used to be a great release, but the weighting of health benefits inside the report got convoluted), Non-farm report (Yes, I do mean it. This number is the most overrated of all of them. It just seems as though most of the number is priced in before the release), and the ISM Services Index (not to be confused with an important release: The ISM Index). Hey, that felt like therapy. Let’s continue the rambling. I do really enjoy watching the QQQ’s, and it is amazing how only 10 companies make up 44.44% of the entire index. Here is the list: 1. Microsoft Corp 13.31% 2. Intel Corp 5.68% 3. Cisco Systems Inc 5.26% 4. Amgen Inc 3.91% 5. QUALCOMM Incorporated 3.74% 6. Dell Computer Corp 3.70% 7. Oracle Corp 3.19% 8. Maxim Integrated Products Inc 2.08% 9. Bed Bath & Beyond Inc. 1.83% 10. Intuit 1.73% Total 44.44% I just thought I would throw that in here. So, was there a point to some of these ramblings? Well, kind of. Being a trader, there is so much information thrown at you, almost making it impossible to construct a clear, original thought. It is ok to spend time researching different areas of the marketplace; however, do not be afraid to simply put these “distractions” aside if they seem to be interfering with your trading. Moreover, it is fine to start with a very complex trading system that involves all possible variables relating to price action; however, ideally the end result should be a smooth, well-run machine. Simple to use, easy for the developer to understand. The proof will be in the pudding. Profitable, stick with it. Not profitable, time to make some changes. *********** OPTIONS 101 *********** "MO" Dividends Buzz Lynn buzz@OptionInvestor.com Excuse me waiter, could I get some more dividend yield, please? "Coming right up!" replies the waiter. Maybe a better title would be the friendly reminder to be careful what we wish for because we just might get it. Here I was engaged in composition of a completely different topic and along comes news out of Philip Morris that they will miss earnings. Keenly interested in the business end of the news, Fundamentals Guy was busy with his nose buried in the computer screen looking for the details. Was this really bad news or a buying opportunity? Option trading had yet to enter my mind. I was still engaged in the numbers when I got a call from technical trading guru, LEAPS Editor, and resident rocket scientist, Mark Phillips. The upshot of the conversation was a potentially great way to make a trade on this stock and capture that tasty dividend (currently $2.56 annually) while protecting ourselves from further price erosion. But before I get into the trade, let me explain why I'm hooked on dividends right now. It all stems from a belief based on evidence that the world is headed for a period of deflation - that is, where prices fall but the value of debt remains the same. In order to service all that debt, people are going to need income. Stock appreciation is no longer a foregone conclusion - nobody earns income from the selling of declining stocks, except the broker. With bond yields declining, nobody is going to make the house payment, buy groceries or take vacations on a 1.0-3.5% yield. CD's are lucky to pay 2%. So where are we going to get income? Either from a job or from a dividend paying stock. The trick is to make sure the dividend is safe from reduction. Don't get me wrong. In the severest case where prices of EVERYTHING fall - soda pop, steak, cigarettes, clothing, cars, houses (yes, houses), - companies will have no pricing power, thus no ability to generate greater sales except by taking them from other companies. In that scenario, dividends will fall as earnings fall. That's why we want to buy dividends that are as close to "unsinkable" as possible. With one of the most historically stable dividend histories I've seen, I believe MO fits that description and provides a margin of safety in the process. OK, I like them, but they just announced an earnings shortfall. Now what? For the answer, follow this hypothetical example. Suppose they earned $4 in FY2001. "The Street" expects $5 in FY2002. Half way through the year, the company says it will hit Q3 earnings, but warns that growth will keep earnings to $4.50. With only 1 quarter left, that means the company will lose $0.50 in a hurry. OUCH! Yet they called for 8-10% growth in FY2003 over their new $4.50 number. What's that mean? With analysts and the news media tripping over themselves during the past couple of weeks noting that marketing expenses have risen drastically in order to protect market share in the tobacco division, they won't hit the numbers. That's a marketing expense in my opinion and a temporary setback. Effectively, MO has reduced the baseline from which they will grow. Do I care? Not much. Net earnings after all additional, optional, extra charges will be somewhere around $4.50 in real numbers as they announced today, yet the dividend remains at $2.56. That's still nearly $2 of earnings in excess of dividends. They are not paying out every dime they make, leaving plenty of cushion for that tasty dividend. If you are a widow, nun, or orphan, you are feeling pretty safe right now. Back to the immediate view in the windshield. . .MO was clocked for $4 under today's close, trading down around $38 +/- after hours. Let's see, a little math says that a $2.56 dividend divided by a $38 stock price is a 6.7% yield. Anybody know where else they can get that kind of income with relative safety? Me either. Yet we have a fly in the ointment. As Jeff Bailey has pointed out, MO's chart is looking a bit bearish. Let's take a look at the point and figure chart, which give us a simple and effective measure of the market's view of risk and reward. MO point and figure chart: Why, looky there! A double bottom breakdown with anew price target of $31. Looks like plenty of downside. Let's look at another chart - a candle chart this time. Mo weekly candle chart: If MO opens tomorrow under $40, the PnF shows a definite down signal. But even the candle chart above shows a possible target of $35 (former support). I neglected the middle dip under $20 on purpose. Those were the days that judgments and settlements might have put them out of business. At least that was the consensus then. Great, maybe I can buy MO cheaper in coming days or weeks! At $35, the yield reaches 7.3%. At $31, the yield is 8.3%. I like that all day long! The risk is that the price continues to fall, which erodes capital. We don't want to buy a tasty dividend and still lose money. What to do? A collar, of course! That's where we sell calls and use the proceeds to buy puts. We protect our downside AND our dividend in the process. If you are wondering what in the heck a collar is, be sure to check out Mark Phillip's excellent article on the subject here: http://members.OptionInvestor.com/options101/082102_1.asp We'll have to see where prices open tomorrow, but there's no reason we can't pretend with the closing prices today. This is always a good strategy that doesn't cost a dime (or very little) to protect the downside. Today, Mo closed at $42.73. Say we'd like to protect our downside for the next 60 days just in case the "ugly" happens. Looking out to November, we see that a NOV42.5 put costs $2.55 if we split the bid/ask. Kind of expensive, as it puts our total cost at over $45. The good news is that we can sell the JAN45 call for $2.55 splitting the bid/ask. The net cost of protection is zero! Let's recap. Net cost is zero to protect every dollar of downside through November expiration and offer some upside to $45 by January expiration. In the meantime, we collect December's dividend. It doesn't matter where the price goes. We still make money. I love the protection of a collar if I'm trying to pick an entry for longer-term hold. For me, it's all about safety, dividends, and capital preservation. Who says options are dangerous when they can hedge risks for zero cost? That's it for tonight. Best wishes for a great weekend! Buzz ************************Advertisement************************* ”If you haven’t traded options online – you haven’t really traded options,” claims author Larry Spears in his new compact guide book: “7 Steps to Success – Trading Options Online”. Order today and save 25% (only $15) by clicking on PreferredTrade and clicking on the link to the book on its home page. http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ********** DISCLAIMER ********** Please read our disclaimer at: http://www.OptionInvestor.com/page/oin/aboutus/disclaimer.html ************************************************************** ADVERTISING INFORMATION For more information on advertising in OptionInvestor Newsletter, or any Premier Investor Network newsletter please contact: Contact Support
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