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Daily Newsletter, Thursday, 10/03/2002

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The Option Investor Newsletter                 Thursday 10-03-2002
Copyright 2002, All rights reserved.                        2 of 3
Redistribution in any form strictly prohibited.


In Section Two:

Stock Picks: PSFT - PeopleSoft, Inc.
Dropped Calls: None
Dropped Puts: None
Daily Results
Call Play Updates: GSK, ITMN
New Calls Plays: None
Put Play Updates: BAX, CI, FLIR, GM, TECD, GSK, ITMN, QLGC
New Put Plays: WHR


***********
STOCK PICKS
***********

PSFT - PeopleSoft, Inc. - $12.42
Strategy: Long stock with put insurance

The Information Technology arena has been out of favor for so
long, that there are actually some attractive values available,
if you know where to look.  PSFT designs, develops, markets and
supports a family of enterprise application software products for
use throughout large and medium-sized applications.  Yawn!  When
you think PSFT, think ORCL and SEBL, as those are the company's
primary competitors.

There are a couple of important distinctions though.  Throughout
the difficult downturn in IT spending, PSFT has barely seen a
blip in its revenue or earnings and hasn't missed estimates since
early 1999.  With more than $5 in cash for each outstanding share
for a total of $1.68 billion, and real honest earnings, PSFT looks
like a great recovery candidate once the IT spending begins to
recover.  The company generated nearly $190 million in free cash
flow over the past 12 months on sales of just under $2 billion,
has a PE ratio of 21 and has virtually no debt.

Add in the fact that selling volume seems to be drying up, just as
the stock is approaching major support dating back to late 1995
and early 1996, and we have a solid company with a stock trading
at an attractive valuation.  The early 1996 lows came in right
around $12, with the 1995 highs (old resistance becomes new
support) resting around $11.25.  It should come as no surprise
that PSFT seems to be finding some strong support (or at least a
lack of selling) as it dipped below $12 earlier this week.

As we enter another earnings season fraught with peril, we are
about to get another opportunity to gauge how well PSFT is
navigating these difficult economic waters relative to its peers.
PSFT announces earnings on October 17th, while SEBL releases
their numbers on October 16th.  Since ORCL just had their
earnings 2 weeks ago (and it wasn't very impressive), we won't
get any more guidance from that corner until mid-December.  What
we're looking for is a solid report from PSFT to further distance
the stock from its peers, at least in investors' minds.

With strong support near current levels, we want to target new
entries near the $12 level on any mild dips.  On the upside,
PSFT will first encounter resistance near the $15 level, but the
first major obstacle will be near $20, the level at which the
stock topped out on the most recent rally.  The longer-term
potential for the stock appears to be limited to the $25 level
until a more robust IT spending recovery is seen.  Some quick
math shows that move would still generate a nice double, which
is nothing to sneeze at, even if it does take 12-18 months.

So the play is to go long PSFT stock in the $11.50-12.00 range
and go long one contract of the Jan-2003 $10.00 puts PQO-MB at
$1.25 for each 100 shares you are long.  There is no requirement
to go long the put but it does prevent all but a very minimal
loss should something unexpected happen to PSFT.

Option 1: If PSFT is not above $15.00 by Jan 2nd, close both
positions and exit the play.

Option 2: If PSFT is below $11 on Jan 2nd then you have the
option of closing the put for a slight profit and lowering your
basis in the long stock play by the amount of the put premium
received or closing both positions and exiting the play.

Option 3: If PSFT is above $17.00 by Jan 2nd then close the put
position for any remaining premium and set a stop loss on the
stock at your entry point of $11.50-12.00 plus any short fall on
the put premium.

PeopleSoft (PSFT) Daily Chart





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

None


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

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

CALLS              Mon    Tue    Wed   Thu   Week

GSK      40.49   -0.04   2.06   0.52  0.61 Breaking ground
ITMN     33.39    0.73   1.17  -0.73 –1.36 Entry point


PUTS

BAX      29.62   -0.87  -0.93  -3.24 –1.23 news is out
CI       73.49   -0.75   2.74  -1.74 –2.45 below $70
FLIR     34.55   -2.77  -0.44  -1.03 –0.12 weak bounce
GM       40.64   -0.10   1.74  -1.92 –0.95 in reverse
QLGC     25.25   -0.95  -0.79   1.07 –1.67 already lower
TECD     27.94   -0.81   1.51  -0.77 –0.21 failed rebound
WHR      44.81   -0.59   1.95  -2.07 –0.97  New, washed up


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

GSK $41.62 +0.61 (+3.19 for the week) GlaxoSmithKline has been fighting
the sinking tide and doing so impressively.  The stock tacked on
another box in the point and figure chart and broke through bearish
resistance at $41.  GSK reached a high of $42.95 intraday, before
pulling back as the market fell.  It cleared out resistance at $42 from
the middle of August and was stopped just short of a triple top PnF
breakout, to go along with the bearish resistance break.  The relative
strength is just as impressive. As the Dow and Nasdaq have both
suffered losses in the last two days, GSK is up over a dollar, with
intraday gains of almost $2.50.  The company announced a new
collaborative agreement with Biosynexus to to develop and market
staphylococcal antibodies and vaccines that prevent and treat
infections caused by staphylococcal bacteria. The drugs will be aimed
at hospital acquired, drug resistant forms of  staph, which is the most
common cause of bloodstream bacterial infections acquired in U.S.
intensive care units.  These infections carry costs of approximately $4
billion per year and are a major target of hospital infection control
programs. This agreement, along with the recent announcements regarding
positive results from studies invloving Valtrex, which reduced
transmission of symptomatic genital herpes by 77%, and HIV protease
inhibitor 908, which achieved a higher rate of undetectable viral load
in patients than Pfizer's Viracept, has kept investors interested and
provided the recent surge for GSK.  New entries may want to wait for a
trade of $43, which would constitute the aforementioned triple-top
breakout, as this would be evidence that market pressure simply isn't
going to hold the stock back.

---

ITMN $31.90 -1.36 (-0.93 for the week) This long play has experienced a
pullback the last two days, but held at a level that we feel is an
entry point.  In our original write-up, we suggested that conservative
investors might want to wait for a pullback above the 200-dma of
$30.11, after the extended run the stock has been on. We got that
pullback and hold above the 200-dma. The PnF double top breakout
occurred at $32 and that is the point at which the stock stopped its
descent today.  A trade of $31 would be needed for a 3-box reversal
down.  However, now that the stock seems to have found support at the
breakout level, that seems unlikely.  The daily chart shows a series of
higher highs and higher lows, beginning with its breakout from
consolidation at the end of August.  The only concern we have is that
the stock closed on its low of the day and we would suggest new entries
look for a trade above the opening price as evidence that sellers have
been exhausted.  Volume on the drop is lower than that on the recent
ascent, but still remains above average. The recent news from the
company regarding its Actimmune therapy, which extended the life of
patients suffering from idiopathic pulmonary fibrosis treatment, still
looks bullish, as does its royalty settlement with Eli Lilly, relating
to future worldwide sales of oritavancin. The company will file a new
drug application for oritavancin in 2003.  We will look for a green
candle as a sign that ITMN has found its bounce point, and leave our
current stop at $30.


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

None


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

BAX $25.15 -1.23 (-6.26) BAX was looking weak and ripe for a
breakdown when we added it to the put list on Tuesday, and that
expectation came to fruition yesterday, with a high-volume
breakdown under the $30 level.  The reason for that breakdown
became clear today when the company reduced guidance for the
rest of this year and 2003.  Just prior to the announcement, the
stock was hanging out below $25, and got a bit of a relief bounce
once the news was released.  But that appears to be all there was
to it, as BAX found firm resistance near $28 and settled out for
the day near $27.  With the news out, there could still be
another relief bounce around the corner, but it will likely be
short-lived, giving us another attractive entry, possibly as high
as $30, but more likely down around Thursday's intraday highs
near $28.  More conservative traders can consider waiting for a
breakdown under $24.50 before adding new positions.  Keep stops
set at $30.

---

CI $69.30 -2.45 (-2.66) Insurance stocks can't seem to catch a
break lately, as the IUX index failed to hold above the $250 level
yesterday and instead heading back down towards its recent lows
near $232.  Our CI play looks even worse, after yesterday's
rollover near the $74 level.  In contrast to the IUX, CI took out
its recent lows today, closing below the $70 level for the first
time since early 2000.  Once the stock trades at or below $69, the
PnF chart will generate another Sell signal, and that should help
to push the stock down towards the bearish price target of $62.
The recent volatile trade is making management of positions a bit
tricky right here, and we want to be a bit cautious.  We're
lowering our stop to $74 tonight, and looking to lower it further
tomorrow if CI continues southward.  A breakdown under Thursday's
low can be used for new momentum entries, but keep the play on a
tight leash in case we get another oversold bounce as we head into
the weekend.  Fading that bounce if it occurs near the $72 or
even $73.50 level would make for a better entry, as risk is easier
to control.  If trading a breakdown, confirm sector weakness by
looking for the IUX index to drop under $232.

---

FLIR $33.40 -0.12 (-4.25) Volatile trade has been the name of the
game for shares of FLIR over the past few days.  The stock sells
off to a new recent low, then abruptly bounces, before rolling
over at another lower high.  Despite the noisy chart, the trend
is still down and we're patiently riding it lower.  Looking again
at the PnF chart shows a bearish target of $29, so there is still
some decent downside remaining in the play.  But we don't want to
chase the stock lower, especially in light of the recent pattern
of rebounding swiftly from each lower low.  Instead, the approach
needs to be that of fading the failed rallies.  Overhead
resistance seems to be firming near $34, with stronger resistance
at $36.  A failed rally near either of these levels should work
for new entries. On the downside, since we are nearing the $29
target, consider harvesting partial gains as FLIR nears that
level.  Tonight we're lowering our stop to $37.

---

GM $37.77 -0.95 (-2.02) Following the brief breakdown last week,
GM gave us a great rebound earlier this week for initiating new
bearish positions.  With the company's report that Sept sales fell
13% year-over-year and the potential impact that the work stoppage
at all the major West Coast ports can have, investors apparently
have thrown in the towel, as shown by the price action today.
After rolling back over right at the 10-dma (currently $39.96)
yesterday, the stock was pounded to a new multi-year low today.
The intraday low was $37.57, which is just above the intraday lows
back in 1993 and 1994 near $36.  Based on the PnF chart with a
price target of $25, we're looking for those lows to be broken.
But we should also expect another oversold rebound before that
happens.  Use failed rallies to initiate new positions near $39
or possibly $40.  We don't want to consider new positions on a
breakdown until GM falls under $36 on strong volume.  Stops
remain set at $41.

---

TECD $26.96 -0.21 (-0.29) The slow grind lower continues.
Yesterday's rally attempt in the broad market helped to lift
shares of TECD near the $28.50 level, but that just turned out to
be another decent entry point, as the stock rolled over in the
afternoon.  And Thursday's session didn't offer much for either
the bulls or the bears, as the stock fell at the open and then
drifted sideways (albeit in volatile fashion) throughout the day.
We can see the bulls trying to defend support near the $26.75
level, while the bears keep selling near the $27.25 area.  Now
that's a narrow range!  While the intraday chart shows a higher
low shaping up from today's trade, the daily chart shows that the
10-dma (currently $28.41) is still acting as formidable
resistance.  Another rally failure near that level would provide
yet another entry into the play, as it is becoming clearer that
there is no recovery in the IT spending environment.  Remember
that our initial target is the $25 level, and if achieved, we
would recommend harvesting partial gains and looking to re-enter
on the next failed rally.  Keep stops set at $30.

---

GSK $41.62 +0.61 (+3.19 for the week) GlaxoSmithKline has been fighting
the sinking tide and doing so impressively.  The stock tacked on
another box in the point and figure chart and broke through bearish
resistance at $41.  GSK reached a high of $42.95 intraday, before
pulling back as the market fell.  It cleared out resistance at $42 from
the middle of August and was stopped just short of a triple top PnF
breakout, to go along with the bearish resistance break.  The relative
strength is just as impressive. As the Dow and Nasdaq have both
suffered losses in the last two days, GSK is up over a dollar, with
intraday gains of almost $2.50.  The company announced a new
collaborative agreement with Biosynexus to to develop and market
staphylococcal antibodies and vaccines that prevent and treat
infections caused by staphylococcal bacteria. The drugs will be aimed
at hospital acquired, drug resistant forms of  staph, which is the most
common cause of bloodstream bacterial infections acquired in U.S.
intensive care units.  These infections carry costs of approximately $4
billion per year and are a major target of hospital infection control
programs. This agreement, along with the recent announcements regarding
positive results from studies invloving Valtrex, which reduced
transmission of symptomatic genital herpes by 77%, and HIV protease
inhibitor 908, which achieved a higher rate of undetectable viral load
in patients than Pfizer's Viracept, has kept investors interested and
provided the recent surge for GSK.  New entries may want to wait for a
trade of $43, which would constitute the aforementioned triple-top
breakout, as this would be evidence that market pressure simply isn't
going to hold the stock back.

---

ITMN $31.90 -1.36 (-0.93 for the week) This long play has experienced a
pullback the last two days, but held at a level that we feel is an
entry point.  In our original write-up, we suggested that conservative
investors might want to wait for a pullback above the 200-dma of
$30.11, after the extended run the stock has been on. We got that
pullback and hold above the 200-dma. The PnF double top breakout
occurred at $32 and that is the point at which the stock stopped its
descent today.  A trade of $31 would be needed for a 3-box reversal
down.  However, now that the stock seems to have found support at the
breakout level, that seems unlikely.  The daily chart shows a series of
higher highs and higher lows, beginning with its breakout from
consolidation at the end of August.  The only concern we have is that
the stock closed on its low of the day and we would suggest new entries
look for a trade above the opening price as evidence that sellers have
been exhausted.  Volume on the drop is lower than that on the recent
ascent, but still remains above average. The recent news from the
company regarding its Actimmune therapy, which extended the life of
patients suffering from idiopathic pulmonary fibrosis treatment, still
looks bullish, as does its royalty settlement with Eli Lilly, relating
to future worldwide sales of oritavancin. The company will file a new
drug application for oritavancin in 2003.  We will look for a green
candle as a sign that ITMN has found its bounce point, and leave our
current stop at $30.

---

QLGC $24.65 -1.67 (-1.39 for the week)  QLogic gave us a scare
yesterday as it bounced and looked as though it might break above the
previous PnF support level of $27.  While it did break above that level
intraday, it failed to hold and dropped with the Semiconductor Index
(SOX.X) today. The SOX closed at a new 4 year low of 233.74, and a
break below the recent intraday low of 231 could signal a new sell-off
in the sector. The failure at $27 on the PnF now looks as though this
level may act as resistance.  As long as the stock does not trade $28,
then that resistance remains in place. The previous sell signal at $26
still remains in place. A look at the daily chart shows QLGC back in a
descending channel after bouncing off that level last week.  After the
bell, EMC warned that profits would not meet second half profit targets
and that it would reduce its workforce by 7%. EMC also said, "The IT
spending environment continues to be brutal. In fact, it got even worse
at the very end of the quarter." Merrill Lynch cut its ratings today on
data storage brethren Brocade, Emulex and Network Appliance.  QLGC,
which designs and supplies storage network infrastructure components,
as well as controller chips used in hard drives, has already fallen
after the bell on the warnings news. It was trading $22.31, down $2.34
from the closing price. The current stop loss is $28.00, and while we
don't want to give up $5.50 on the trade, we will wait to see where the
stock opens and then adjust our stop accordingly. Watch the Market
Monitor for an updated stop loss on the play.  New entries should look
for a breakdown in the SOX below 231, and a trade below $22 in QLGC.


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

WHR - Whirlpool - $44.81 -0.97 (-1.05 for the week)

Company Summary:
Whirlpool Corporation is the world's leading manufacturer and
marketer of major home appliances. Headquartered in Benton
Harbor, Michigan, the company manufactures in 13 countries and
markets products under 11 major brand names in more than 170
countries. (source: company release)

Why We Like It:
There have been some contradictory statements with regard to
appliance sales over the last month, but it appears that the
positive spin from Whirlpool, which affirmed guidance, has fallen
on deaf ears.  Investors have instead focused on comments from
Maytag, which was forced to cut third quarter earnings forecasts.
Maytag said it was forced to add shutdowns and lower production
levels at its refrigeration facilities and reduce washer and
dryer production at its Iowa plant. Industrywide, consumer
spending on durable goods, outside of automobiles, has declined.
As layoffs have increased and the economy has slowed, so have
sales for companies that make furniture, carpets and home
fixtures.  This morning's jobs data suggests that even more
people will be out of work and unable to purchase big-ticket
items like appliances.  The recent rash of warnings from the
retail sector seem to indicate that the summer slowdown has only
gotten worse.  Wal-Mart and Federated both recently warned that
sales would miss forecasts for the third straight month.

Whirlpool is on the verge of a second double bottom breakdown on
the point and figure chart, after a failed rebound at $48.  The
current sell signal came on a triple bottom breakdown at $50, in
the middle of September, which was followed by a double bottom
breakdown at $45, establishing a bearish catapult.  The stock
found support at $45 on the daily chart repeatedly during the
last week. After four days of holding its closing price over $45,
it has finally broken down with a close below that level.  The
stock traded as low as $44.43, but conservative traders may want
to wait for a trade of $44.00, which will give a fresh double
bottom sell signal.  We like the current bearish vertical count
of $33, which came from the triple bottom column of "O"s, and see
the current level under $45 as a short entry point.  There is
support at $40 from December of 2000, and at $35 below that.  $40
will be our initial target, but without an upturn in the economy,
we may be looking at the secondary target soon.

BUY PUT OCT-45 WHR-VI OI=227 at $2.40 SL=1.20
BUY PUT NOV-45*WHR-WI OI=201 at $3.50 SL=1.75

Average Daily Volume = 703 K



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**********
DISCLAIMER
**********

Please read our disclaimer at:
http://www.OptionInvestor.com/page/oin/aboutus/disclaimer.html


**************************************************************
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The Option Investor Newsletter                 Thursday 10-03-2002
Copyright 2002, All rights reserved.                        3 of 3
Redistribution in any form strictly prohibited.

In Section Three:

Play of the Day: PUT – WHR
Traders Corner: Bulls? Bears?  Both Can Be Tasty If Done Right!
Traders Corner: Retracements and their help in trade entry
Traders Corner: Top Down
Options 101: Do the Wrong Thing


*********************
PLAY OF THE DAY - PUT
*********************

WHR - Whirlpool - $44.81 -0.97 (-1.05 for the week)

Company Summary:
Whirlpool Corporation is the world's leading manufacturer and
marketer of major home appliances. Headquartered in Benton
Harbor, Michigan, the company manufactures in 13 countries and
markets products under 11 major brand names in more than 170
countries. (source: company release)

Why We Like It:
There have been some contradictory statements with regard to
appliance sales over the last month, but it appears that the
positive spin from Whirlpool, which affirmed guidance, has fallen
on deaf ears.  Investors have instead focused on comments from
Maytag, which was forced to cut third quarter earnings forecasts.
Maytag said it was forced to add shutdowns and lower production
levels at its refrigeration facilities and reduce washer and
dryer production at its Iowa plant. Industrywide, consumer
spending on durable goods, outside of automobiles, has declined.
As layoffs have increased and the economy has slowed, so have
sales for companies that make furniture, carpets and home
fixtures.  This morning's jobs data suggests that even more
people will be out of work and unable to purchase big-ticket
items like appliances.  The recent rash of warnings from the
retail sector seem to indicate that the summer slowdown has only
gotten worse.  Wal-Mart and Federated both recently warned that
sales would miss forecasts for the third straight month.

Whirlpool is on the verge of a second double bottom breakdown on
the point and figure chart, after a failed rebound at $48.  The
current sell signal came on a triple bottom breakdown at $50, in
the middle of September, which was followed by a double bottom
breakdown at $45, establishing a bearish catapult.  The stock
found support at $45 on the daily chart repeatedly during the
last week. After four days of holding its closing price over $45,
it has finally broken down with a close below that level.  The
stock traded as low as $44.43, but conservative traders may want
to wait for a trade of $44.00, which will give a fresh double
bottom sell signal.  We like the current bearish vertical count
of $33, which came from the triple bottom column of "O"s, and see
the current level under $45 as a short entry point.  There is
support at $40 from December of 2000, and at $35 below that.  $40
will be our initial target, but without an upturn in the economy,
we may be looking at the secondary target soon. place stops at
$48, just above Wednesday's high.

BUY PUT OCT-45 WHR-VI OI=227 at $2.40 SL=1.20
BUY PUT NOV-45*WHR-WI OI=201 at $3.50 SL=1.75

Average Daily Volume = 703 K



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**************************************************************


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

Bulls? Bears?  Both Can Be Tasty If Done Right!
By Mike Parnos, Investing With Attitude

Couch Potato Trading Institute students like large market moves.
Up or down, it doesn’t matter.  We’re not interested in bulls, or
bears, or any other zoo or rodeo animals that may find their way
into the market.  We thrive on uncertainty, greed and panic –
things we can count on.

Most of our strategies may be considered a little complex and
require attention to the market.  Some readers, who haven’t
progressed to Couch Potatodom, have requested low risk strategies
they could monitor after work.

Remember work?  It’s something that people have to do if they’re
not one of the 20 million people selling Viagra, mortgages, and
pornography via email on the Internet.

We’ll be exploring such strategies (without the Viagra and
mortgages) in future columns.  The drawback with some of these
strategies is that, instead of remaining neutral, the strategies
require picking a direction.

How would you like to learn a strategy that allows you to be
wrong two out of three times and still make money?  To do this,
we need to revisit the basics in the form of bull call and bear
put spreads.

A bull call spread is the purchase of a call and the sale of a
higher strike call with the same expiration date.  The purpose of
the sale of the higher strike call is to take in a credit that
serves to reduce the risk.  It also puts a cap on potential
profits, but since, at the CPTI, our emphasis is to limit risk,
we choose to use spreads instead of a pure directional put or
call trade.

Our example will be based on a 10-contract position.
If you are bullish on the NASDAQ, a bull call spread might look
something like this:
It’s early October and the QQQs are trading at $21.31.
1. Buy the January 03 $23 call 	@  $1.55 = $ 1,550
2. Sell the January 03 $26 call 	@  $ .60 = $   600
			Total Risk:          $ .95 = $   950

Let’s look at what we have created.  In the bullish scenario,
we’re risking a grand total of $950.  The maximum that we can
collect if the QQQs trade through the $26 sold strike price is
$3,000 (10 contracts) -- the difference between the $23 and $26
strike prices.  At expiration, both options will be exercised and
your profit will be $2,050.

If you do the math, you’ll note that if you’re wrong twice, your
loss will be $1,850.  If you are right once, you make $2,050.
Therefore, the profit, although small, is $200 even if you’re
right only once out of three times.

With the QQQs at $21.31, a move up beyond the long $23 strike is
not unreasonable.  Our profit zone begins when the QQQs trade
over $23.95.

Notice that the further you go out of the money, the less the
risk, but the greater movement necessary to achieve
profitability.  If, in the bullish scenario, we went further out
of the money, the debit would be less and the potential
percentage of profit would be higher.  The Jan. $25 calls cost
$.90 and the Jan. 03 $28 calls would bring in $.35.  The debit
would be only $.55, but the QQQs would have to move beyond $28 to
achieve maximum profitability.  That’s too much to ask – even for
the schizophrenic NASDAQ market.

If you are bearish on the NASDAQ, the scenario is the same, just
bass-ackwards.  The numbers aren’t too different.  At this
writing, they’re actually a little better
1. Buy the January 03 $20 put 	@  $1.60 = $ 1,600
2. Sell the January 03 $17 put	@  $ .70 = $   700
			Total Risk:	         $ .90 = $   900
In the bearish scenario, we’re only risking a grand total of
$900.  The maximum that we can collect if the QQQs trade through
the $17 sold strike price is $3,000 (10 contracts) -- the
difference between the $20 and $17 strike prices.  At expiration,
both options will be exercised and your profit will be $2,100.

When Do You Take The Money and Run?
Now, keep in mind, we’re dealing with a four-month position.  A
lot can happen in four months.  Maybe it won’t take the full four
months for the QQQs to trade through the short strike.  If, in
the bullish scenario, the QQQs trade through $26 in just two
months, we would need to evaluate the position.  We may have
decisions to make.

You would be able to liquidate the position for an estimated
credit of about $2,200.  Your cost is $950, therefore, your
profit would be appx. $1,250.  That represents about 57% of your
profit target.  Is that enough?  Here’s the question you have to
ask yourself:  Are you willing to risk the $1,250 you made during
the first two months for the chance of making the additional $950
profit that you would make if you held the position to its
maturity?

Obviously, you have to re-evaluate.  There are a lot of questions
to answer that will help you make your decision.  Is the chart
still trending up or is it just a bear market bounce?  Is there
any serious resistance at the $26 level?  Has there been good
volume on the up days, and lower volume on the down days?

Your choices are:
1. Take your profits on half your position and let the rest run
with very tight mental stops and a lot more self-discipline than
you have every time you open the refrigerator door.
2. Liquidate the position, take the $1,250 profit, and celebrate
with a few extra toppings on your next pizza.
3. Roll the dice and let the position run – lighting candles,
massaging your rabbit’s foot, and your four-leaf clover for the
last two months.  This is the appropriate choice if you are to
option trading what Barney Fife is to law enforcement.

In bull call spreads, the curve on the graph tells us that, as
the stock goes up, it reaches a point in time at which the price
of the long option increases more slowly.  At that point, it’s
questionable whether you should remain in the trade.  It might be
time to “take the money and run.”

There are no rules set in stone.  You’re going to have to make
some choices.  Remember, the more percentages you have in your
favor, the better chance you have for success.

Until then, I hear there are still a few openings for people to
sell life insurance, prescription drugs, and “member” enlargement
devices online . . .
____________________________________________________________

Happy trading!  Remember the CPTI credo:  May our remote
batteries and self-discipline last forever, but mierde happens.
Be prepared!  In trading, as in life, it’s not the cards we’re
dealt.  It’s how we play them.

Your questions and comments are always welcome.
mparnos@OptionInvestor.com


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

Retracements and their help in trade entry
By Leigh Stevens
lstevens@OptionInvestor.com

We owe some debt to Dow for his observations that an intermediate
trend often will retrace (give back) anywhere from around 1/3 to
2/3rds of the distance covered by the primary trend, before the
major trend resumes.  There were further refinements on
retracements made by W.D. Gann, a famous stock and commodities
speculator of the first half of the 1900’s – primarily, Gann
found it significant to use charts that had retracements noted
between a major low to high or high to low of 1/4, 1/2 and
3/4ths; i.e., 25, 50 and 75%.

The origins of one of the most useful “retracement” theories for
stocks and other markets came from someone who lived in the
middle ages and was studying the population growth of rabbits.
Leonardo Fibonacci was an Italian mathematician who was doing
such work in the early 1200s.

The number sequence that is named after Fibonacci is where each
successive number is the sum of the two previous numbers; i.e.,
1, 2, 3, 5, 8, 13, 21, 34, 55, 144, etc.   Any given number is
1.618 times the preceding number (approximately) and .618 times
the following number.

There are technical indicators whose formulas rely on the
Fibonacci number sequence, but the main application is to use the
“fibonacci retracements” of .382 or 38%, .50 or 50% and .618 or
62%.  The number 5 is in the Fibonacci sequence, and the others
are ratios -- .618 comes from the percent that each number is of
the next higher number and .382 is the inverse of .618 (100 –
61.8 = 38.2).  We’ll stick to the shorthand and round off to 38
and 62%.

Also, as I used to say in my CNBC.com columns and I noted in my
Essential Technical Analysis book, this is a “little bit” more or
less than 50% -- the little “bit”, being an eighth of a point
either way – someday I’ll have to explain that they used to trade
stocks in eighth of a point (dollar) increments but I suppose
many if not most of our OI Subscribers remember how stocks traded
before decimal trading.

What I find most useful in trading is to track what would
constitute the 38, 50 and 62% retracement points, after a minor
or intermediate price swing – with the addition of seeing what
would be a 25% retracement for a shallow correction and 75% for a
deep one.  Use of these retracements is a very common practice
and a quite popular point of reference, among profession traders.

There is a simple pragmatic reason for this popularity and that
is that buying or selling in these retracement areas often
results in coming close to buying at the low and selling at the
top.  Maybe the saying of buy low, sell high owes something to
the common retracements.

You can set most all charting applications to calculate
retracements ranging from 25% to 38% (.38), 50%, 62 (.62)% and
75% by pointing first at the low, then the high (pullback
retracements) or first at the high, then the low (for retracement
rallies in a downtrend).

Or, as I used to do when I just was charting by hand, by using a
calculator and adding or subtracting the 3-5 percentage figures
once it appears clearly that a high and a low is in place for the
minor or secondary trend in question, and from which you can now
calculate retracement possibilities.

In a countertrend rally within a dominant downtrend - once a
minor downside correction begins – look to see if a recent high
represented a 38, 50, or 62% retracement of that high relative to
the rally starting point. If the (up) swing high also failed at
or under the key down trendline and was accompanied by an
overbought condition, it’s a sure tip off to short and play the
put side –





If the correction “resists” falling to 38% after a strong up
move, I will add the 25% retracement line.  If a deep correction
falls below the 62% retracement, add the 75% retracement line.

If the correction of an uptrend falls BELOW a 3/4 or 75%
retracement, I assume that the correction will be 100% or what I
call a “round trip” back to the origin or starting point for the
trend.  Don’t forget to look at a “close-only” or line chart also
– sometimes the retracement comes in at one of the 5 levels, but
its on a closing basis as seen in the chart below -






All you need is some degree of assurance or assumption that a
price swing has run its course and that a counter-trend or
opposite move is developing.  In a downtrend, the 38, 50 and 62
percentage figures are added to the most recent low - once it’s
apparent that a minor counter-trend rally is underway (prices and
volume surge) the expectation is that in a normal market, prices
will rebound an amount that is equal to about half of the last
decline – or, “a little bit more” (62%) or “a bit less” (38%).
Then, for example, if prices climbed to the 62% retracement
level, in a downtrend, this would suggest a favorable exit if
long, and favorable trade entry to short/buy puts. You can then
place a stop just over the retracement level.

SOME RULES OF THUMB ON RETRACEMENTS -

These guidelines mostly are related to the most common retracements,
that of the fibonacci 38, 50 and 62% retracements.

1.) A strong trend will usually see only a “minimum” price
retracement -- around 1/3 to 38% (sometimes only 25%). If prices
start to hold around this “minimal” retracement area, this action
may be suggesting trade entry as there may NOT be a deeper
correction.

2.) A “normal” trend, not powered by something extraordinary,
will often see a retracement develop of about half or 50% of the
prior move. The most common level to buy or sell is this
retracement amount, with an exit if it continues on much beyond
50%; e.g., 5% more –





3.) Within the range of “normal”, but not evidence of a
particularly strong trend, will be a retracement of 62% or
perhaps 2/3rds (66%) – sometimes 75%, especially in more volatile
stocks.  If prices hold this area, it’s also a good target for
initiating a buy or sell with an exit if the retracement exceeds
66%.

4.) If a retracement exceeds one level, look for it to go to the
next; e.g., if a retracement goes beyond 38%, look for it to go
on and approach 50%.  If it exceeds 50%, look for 62%.  If a
retracement exceeds 62%, or a maximum of 66% (or 75%), then I
look for a “round trip” or a return all the way back to the prior
low or high – this type action suggests a retest of the low or
high and is the ultimate “retracement” so to speak which is 100%.





5.) Retracements are most commonly done from the low to high,
high to low and not based on the highest close to the lowest
close, etc.  However you should also experiment with retracements
based on closing levels as they also are worth exploring –





6.) The common retracement levels work on all time frames or
chart types; e.g., hourly (or less), daily, weekly and monthly
charts.

REMEMBER –
In a strong trend, either up or down, the “typical" retracement
will be shallow:






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TRADERS CORNER
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Top Down
By John Seckinger
jseckinger@OptionInvestor.com

By definition, top down investing focuses first on a country’s
economy before turning to the business cycle for industry
selection.  After the industry is chosen, a trader then chooses
a particular stock within that sector.  The opposite of top down
trading is “bottom up” investing, where specific securities
within a particular sector is selected first and given the most
weight.  Bottom-up traders believe that good security selection
will overpower the "noise" of market movements in the longer
term.  I beg to differ, unless the time frame can be years and
years and losing 80% of its value is within guidelines.  Yes, I
just described the Semiconductor Index.

With top-down trading, political and business factors also have
to play a role in forecasting direction.  These variables
certainly makes is more challenging when looking abroad for
securities or exactly pinpointing what part of the business cycle
a country resides.

Speaking of the business cycle, an example of top down trading
would be, in a deteriorating economy, a bond manager lowering his
portfolio exposure to corporate bonds as the likelihood of their
credit worthiness deteriorating increases.  If an equity manager
expected lower interest rates, it might make sense to buy bank
stocks, since the price of these "income stocks" are heavily
influenced by the movements of interest rates.

Looking below at a chart of the Business Cycle, the real question
is:  Which stage would the United States be placed in?  Bonds are
rallying, so is it Stage One?  On the other hand, stocks
certainly are falling, and the Commodity Research Bureau (CBR)
Index has been rising for roughly 10 months.  So, is the US about
to enter stage 6?  I would have to venture we are in Stage One,
but more analysis is needed.  See below.





Looking at things from a slightly different perspective, the next
chart shows both a stock market and business cycle.  We know that
Housing and Construction remains strong, banking and insurance
are both weak, basic materials are under pressure, and cyclicals
are also approaching multi-year lows.  With that said, the US
economy seems to be nearing its trough and confirms the
possibility that we are in Stage One of the chart above.





Breaking down the economy further, the chart below makes it clear
that GNP, Industrial Production, Capacity Utilization, Labor
Productivity, Unit Labor Costs, and PPI are the main drivers for
expansion out of the trough and into the recovery phase.





So, how do these indicators look?  Well, 1Q GDP was revised down
from 6.1% to 5% on a chain deflator of 1.3%.  2Q GDP came in at
1.3%, and these two quarters do seem to indicate a double-dip
recession will not occur at first thought.  The corporate profit
recession still has businesses cutting costs, and the never-
ending manufacturing contraction appears to be finally ending.
As long as consumer spending exists, chances for solid growth
remain bright.

Turning to Industrial Production and Capacity Utilization,
August’s -0.3% reading on 76% capacity use does not exactly
guarantee the worst is behind us.  However, the steady decline
during 2001 does seem like a thing of the past.  Same concerns
linger; business investment and consumer spending.

Productive growth and unit labor costs have benefited due to less
hours worked and a build up in inventories.  Even though near
term labor force growth might lower productivity levels, it still
can equate into potential GDP growth.  Encouraging was the fact
that the last unit labor cost reading came in higher after three
quarters of declines.  Note:  The annual rate is -2.3%.

The last two measures are CPI and PPI.  CPI fell to a 38-year low
in June as commodity prices came under pressure, and thoughts of
deflation certainly are on traders’ minds.  The PPI has also
shown extreme weakness, giving signs of deflation as weak energy
prices pressure lower wholesale prices.

In conclusion, deflationary concerns remain high within the CPI
and PPI readings; however, a rebounding GDP coupled with a
recovery in Industrial Production seems to put the US economy at
Stage One: Trough to Recovery.

It is also important to realize which indicators are leading,
lagging, or coincident.  Leading indicators are building permits,
housing starts, and manufacturers’ new orders for durable goods.
Lagging indicators would include the unemployment rate and
expenditures on new plant and equipment.  Coincident Indicators
consist of industrial production and the prime interest rate.

Note:  Currently we are dealing with cyclical unemployment,
resulted from downturns in economic activity (business cycle).
Remember, if a discouraged worker stops looking for work, they
are not counted in the unemployment statistics.

With the discussion of the economy behind us, which sector should
we look for if we are in fact in Stage One?  Well, December 30-
year futures have risen 14% in only five months.  However, let us
assume that there is too much risk in owning bonds, which might
actually hold merit.  Which sector would then provide a solid
risk/reward going forward, benefiting from a solid asset
allocation shifts as stocks begin to set a possible base?  Based
on the above analysis, either banking or insurance, right?  Well,
looking at a chart of both, the Combined Insurance Index (INSRX)
appears to be just the index we are looking for.

Chart of the Combined Insurance Index, Monthly




Looking at the chart above, it is encouraging that both
retracement analysis and a significant trend line can be used to
define risk for traders.  I used a monthly chart because it
should better reflect the macro, or top-down, picture.

Now it is time to find a particular security.  With the insurance
index composed of 92 different companies, I have drafted a list
of companies worth looking at, selecting one to focus on (bold):

21st Century Holding Co (TCHC)
Alfa Corp. (ALFA)
CorVel Corp. (CRVL)
EMC Insurance Group, Inc (EMCI)
Erie Indemnity Co. (ERIE)
Financial Industries Corp. (FNIN)
Harleysville Group, Inc. (HGIC)
Independence Holding Co. (INHO)
Investors Title Co. (ITIC)
Navigators Group, Inc., The (NAVG)
Selective Insurance Group, Inc. (SIGI)
State Auto Financial Corp. (STFC)
Triad Guaranty, Inc. (TGIC)
United Fire & Casualty Co. (UFCS)
Universal American Financial Corp. (UHCO)

Specifically singling out a chart of Alfa Corp. (ALFA), there are
some solid similarities with ALFA and the overall index.

Chart of Alfa Corp, Monthly




With shares of ALFA currently above an upward trend that began in
January 2000, risk would be for shares to fall under 12.00 and
then 11.65, the 50% retracement.  The longer-term objective
should be for a move to 15 or 15.25.

Obviously, there are other approaches to “top down” analysis and
different results than described above.  I tried to end up with
only one security, instead of a basket of stocks and entire
portfolio (the idea situation).  I hope that this has been a good
introduction on how “top down” traders could approach security
selection, and, as always, feel free to do what feels
comfortable.


***********
OPTIONS 101
***********

Do the Wrong Thing
Buzz Lynn
buzz@indexskybox.com

We have come a long way in 100,000 years, but some things never
change.  That is what instinct is all about.  In trading, it is
also about herd mentality. . .the fear of straying too far from
what others are doing and saying.  Despite losing nearly 4000 Dow
points and about as many NASDAQ points over the last two and a
half years, a majority of analysts are bullish and the herd still
follows them. . .financially deadly and intellectually wrong.

We have all heard the call of the contrarian at one time or
another.  They are the ones who buy when others are selling and
sell when others are buying.  They are the ones baling out at the
top when others are piling in, and buying with both hands when
nobody else will get near a former favorite stock.  We hear it
said that, “The herd is right in the middle and wrong at both
ends”.  We are all born with hard-wired instinctual reactions that
cause these ebbs and flows of fear and greed, not to mention
euphoria and depression.

But as counter-intuitive as it is, the contrarians are a
successful trading bunch with a lot to teach.  However, if we are
to take instruction from them, it is helpful to understand the
herd mentality first.  Just how did it develop, and why do we
still follow it even though it is not generally good for our
portfolio?  That is where the hard wiring comes in.  It was born
of the “fight or flight” response to danger.

100,000 years ago when we were perfecting the wheel, mastering
fire, and chasing down dinner with a spear, big cities with
massive infrastructure and farmers/grocery stores did not exist.

Being the hunted rather the hunter was a big problem.  If people
were to survive through the night, they needed protections from
the wilds and the elements.  Survival depended on a small
collection of people – a tribe – to look out for one another.
Some would stand guard while others slept.  Some stood guard for
protection while the hunters hunted.  Some stood guard while the
“cubs” grew old enough to survive on their own.

Standing guard is the operative phrase and an element of our
development that never went away.  People learned to always be on
guard because it triggered “fight or flight” and insured survival.
Let your guard down and you became dinner for lions, tigers, and
hyenas, not to mention large snakes with coils.  People could not
survive without the benefit of the tribe to insure their mutual
safety.  The first warnings from the guard instinctively triggered
the fight or flight response.  The "guard", or analysts in this
case, are still calling each successively lower market day "a
bottom".  The tribe ought to stop trusting the guard.

In short, with an occasional loss, most tribe members survived
bouts with danger because they were alerted early enough so that
the “fight or flight” response was triggered.

It was and still is very normal to focus our attention on that
which might become a danger.  Witness jungle law then, or even
while camping now.  When we hear a noise in the woods, our
instinct is to drop what we are doing, face in the direction of
the noise and decipher what we heard.  Is it a threat or not?  Is
it a falling pinecone or a grizzly bear that wants our ice chest?
When the “tribe” collectively turns to face the noise, all senses
are then focused on and notice possible danger only from the
direction of the noise.

Two things occur here.  First, we are focused on that one danger,
which by default means that we are mostly oblivious to anything
else.  We have narrowed our field of focus to make a "fight or
flight" decision.  Second, the good news is that everyone is now
alert to that danger, and by virtue of the attention it receives,
it is handled, and no longer the unknown threat.  It is now known.

By inference, we can now see that if the tribe has turned to face
the danger, the fact that so many are now focused on it removes a
big element of the danger.  The bad news is that at the moment the
tribe is facing the danger, it is most vulnerable to what may be
lurking over its collective shoulder at the same moment.  Perhaps
they failed to notice the boulder rolling downhill toward camp!
The noise they heard in the forest turned out to be forest animals
running away in their flight response to the boulder!

The same thing happens in trading.  For example, everyone is
focused on the, "Is this the bottom?" question for months on end.
Do not get me wrong, it is a major problem.  But it is a danger
that has been accounted for and prepared for.  The investor tribe
has already turned to face that danger.  While everyone is fixated
on the question, the real danger lies elsewhere - like in the
extravagant personal debt loads and threat of worldwide deflation.
But where is the guard watching that unfold?  Actually, he's
there.  He's merely being ignored.  Who cares about the erupting
volcano when this moment's hunting conditions are reported to be
so good?

Need a real example?  Remember over a year ago when gasoline
prices rocketed at the height of California's energy shortage?  As
soon as alarm bells rang for $3 per gallon gas, the tribe knew and
turned to face the danger.  Gas prices then fell and oil
stockpiles increased ever since.  Again, the danger once known is
no longer a danger because steps are taken to avoid it.  But it
has to be perceived as a danger first.  Not so when it comes to
analysts view of the market.  They don't perceive it as a danger.

But probably the greatest example I know of is the Y2K scare.
Panic and doomsday were in the air.  The devil known and prepared
for is no devil at all, and Y2K was a non-event (other than giant
parties).  If we perceive the danger, it is already handled and no
cause for alarm as long as the guards don't have a logic fault.

So how does this relate to our own trading psychology?  In
reference again to the tribe, when it hears a noise, turns to face
it and warn the others, the noise is no longer a danger.  The
danger is now everywhere else.

The contrarian knows at that time to turn away from the tribe and
find the other danger sneaking up from behind.  This is always
counter-intuitive.  Who really believes Bill Gross of PIMCO is
predicting unashamedly for the Dow to hit 5000 before the damage
is all over?  I do, as do a few others in the minority.

It is always the unexpected that moves markets, never the
expected.  This is why “buy the rumor, sell the news” works so
well and why money manger and Forbes columnist, Ken Fisher refers
to the market as The Great Humiliator.  Its job is to humiliate as
many market participants as possible at any given moment.

That is why betting against the herd works so well at turning
points in the market.  Turning points?  None other than an
oscillator’s representation of a top or a bottom.  Things always
seem best at the top and worst at the bottom.  That is precisely
the time to go contrarily in the opposing direction.  Things seem
really bleak to many right now, but somehow tech stocks are still
the darlings.  Until tech stocks are treated like lepers (it
hasn’t happened yet), they will not find a bottom.  There are
plenty of boring companies out there that are pedestrian but
cheap.  Nonetheless, they make money and are about to be
discovered (again).  Think Philip Morris (MO), Dupont (DD), Cemex
(CX).  Boring, but pretty dang reliable, and they pay well.  They
will probably pay even better if/when the market heads for lower
lows.

In 1999 and 2000, investors were writing Warren Buffet off as a
washed up has-been.  Today, Warren looks like a genius because he
bucked the trend and did not travel with the herd.  The danger lay
in what the herd refused to acknowledge or did not see.  Namely,
that valuations were sky high and unsustainable in the long run.
Prudent speculators, and there were only a few, recognized it for
what it was – a bubble into which to sell.  Sure they missed the
final 1000 points of gain in the NASDAQ, but they were out in the
ensuing 4000-point drop.

It pays to avoid the herd

Now the only remaining question is, if a tree falls in the woods
and no investor is around to hear it, is it a danger?  If I am the
only investor to hear it, it is a danger.  If everyone else hears
it, it is not.  Trust your judgment and work hard to turn your
back on the tribe when they scream the loudest.


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