The Option Investor Newsletter Thursday 10-10-2002 Copyright 2002, All rights reserved. 1 of 3 Redistribution in any form strictly prohibited. In Section One: Wrap: Key Reversal Day? Futures Markets: Another One-Day Wonder or Something More ? Index Trader Wrap: Can we get any confirmation? Market Sentiment: Pop Goes the Market Weekly Manager Microscope: J. Patrick Rogers: Gateway Fund (GATEX) Updated on the site tonight: Swing Trader Game Plan: Buying the breakdown Posted online for subscribers at http://www.OptionInvestor.com ************************************************************ MARKET WRAP (view in courier font for table alignment) ************************************************************ 10-10-2002 High Low Volume Advance/Decline DJIA 7553.95 +247.68 7560.93 7197.49 2341 mln 1804/ 963 NASDAQ 1163.37 + 49.26 1165.83 1108.49 1833 mln 1998/1249 S&P 100 405.91 + 13.22 407.10 387.80 totals 3802/2212 S&P 500 803.92 + 27.16 806.51 768.63 RUS 2000 336.18 + 9.14 324.90 336.18 DJ TRANS 2096.77 + 83.75 2111.72 2008.31 VIX 46.29 – 3.03 50.48 46.17 VIXN 62.82 - 1.20 64.38 60.18 Put/Call Ratio 0.97 ************************************************************ Key Reversal Day? Traders woke to a full basket of news to be digested before planning their trades. Much of that news at first appeared to be positive. Television networks trumpeted the announcement that Iraq had invited the U.S. to inspect weapons sites. They did, but they accompanied that invitation with a taunt. Futures at first reacted positively, but a close reading of news articles left little reason to believe that weapons inspectors would soon be packing their bags. After Bush's Monday speech, the White House released satellite photographs of two former weapons sites, showing evidence that Iraq was rebuilding them. The Defense Intelligence Agency later released information about two more. The so-called invitation to visit those sites came accompanied by a challenge from Iraq's Minister of Military Industrialization, Abdel Tawab Mullah Huweish. Claiming that he's in charge of weapons programs, he denied developing weapons of mass destruction, but threatened, "If the Americans commit a new stupidity, we will teach them a lesson that they will not forget." The White House announced that Iraq didn't make those decisions. The U.N. did. Suddenly, the headline news didn't sound quite so positive, a conclusion reinforced by later news that U.S. and U.K. planes had fired on Iraqi planes in the no-flight zone, a common occurrence these days. To add to negative sentiment, newscasts later referred to an FBI alert that terrorists may have planned other U.S. attacks. Also, the French tanker that exploded in Yemen contained fragments of another ship, seeming to confirm one eyewitness report that a fishing vessel had drawn up to the tanker before the explosion. This lends credence to the theory that the explosion was a deliberate act of terrorism. Later in the day, the House passed a resolution authorizing an attack on Iraq, if needed. The Senate will begin deliberations this evening. More positive were YHOO's earnings and Aetna's pre-announcement. Futures steadied. Initial jobless claims were released. Those claims fell 40,000, to 384,000 versus the expected 405,000, and continuing claims fell, too. These numbers buoyed the markets, even though that surprise jobless claims number perhaps wasn't so great a surprise. Before the announcement, a Bloomberg television commentator mentioned that the first week of a quarter often surprised to the positive side. Bloomberg also mentioned that Q3 earnings growth expectations for U.S. companies had been lowered significantly to 5.5%, and that this lowered expectation would dampen enthusiasm for stocks. Also tempering the enthusiasm were the Merrill Lynch downgrade of GE, the news that the ECB and Bank of England had maintained their benchmark rates, and the news that the Nikkei had closed below 8500 for the first time since June 1983. Although the Nikkei closed down 99.72 points, at 8439.62, it had briefly moved below 8200 and bounced from that area. Little did traders know that our markets would stage a similar rebound. Early on, it looked as if the big C-day (capitulation) had finally arrived. Sellers drove the SPX below July lows of 775.68, to 768.63. The DJ Industrials dipped below 7200, and the COMPX came dangerously close to 1100, at 1108.49. The long- dreaded break of those S&P 500 July lows instead triggered a wave of buying that kept adv/dec lines positive all day. Perhaps coincident with a Fed announcement of a net infusion of $4.5 billion; a strong dip in gold; an announcement of share buy-backs by several companies, and a sell-the-rumor, buy-the-fact reaction to weak retail earnings, markets bounced. Hard. The DJ Industrials climbed more than 100 points in twenty minutes, and zoomed up 250 points within an hour. At its highest level, the Industrials were 363.50 points higher than the lowest, although the Industrials closed a bit off that high. Was this buying yet-another bear market rally or the start of a new trend? Recently beaten-down sectors proved to be some of the biggest gainers. Usually that hints at short covering, and the markets were certainly long overdue for a short-covering rally. Those previously beaten-down sectors included the banks, brokerages, semis, utilities, and telecom equipment companies. Even retailers gained, despite rather dismal outlooks for most. Gaming stocks, which had been doing well, were among the biggest losers. By the end of the day, some traders were talking about a key reversal day. What is that? A key reversal day comes at the end of a long trend, such as our current down trend. Markets move quickly to new lows (or highs, if it's a reversal of a move up), but then reverse from there. Technicians say big price ranges characterize key reversal days. Prices may move as much during the first two to four hours as they do during several days' worth of trading. Today's action met that test, although big price swings aren't so uncommon lately, and not uncommon at all in a bear market rally. An explosion of volume also usually accompanies a key reversal day. Volume was higher today than in recent days, with NYSE volume at 2.05 billion shares and the Nasdaq 1.83 billion shares. Although this was moderately heavy volume, I'm not sure I'd qualify it as an explosion of volume, so today's action might not have met that part of the test of a key reversal day. Let's see if the charts can clarify today's market action. Tonight, I'm going to use the OEX candlestick chart as a proxy for all the major indices, since their charts look similar. One reason for using the OEX chart rather than the SPX chart is that the OEX has not yet tested its July lows, unlike the other indices. On the chart, I've indicated another big-range day on October 1. That October 1 candle seemed to be forming the third candle in a morning-star pattern, another reversal pattern, yet the next day saw the sell-off continue. Like the October 1 candle, today's candle kept the OEX firmly within the descending channel that has been forming since mid-August. As bullish as today's action seemed, it hasn't yet proven that the overall trend has changed. While the RSI and stochastics appear to be showing bullish divergence (lower prices on the OEX while RSI and stochastics reach equal or higher lows), the RSI also appeared to be showing bullish divergence at the time of the October 1 bullish candle. In my opinion, the jury is still out on a trend reversal. I'll watch for a rollover or a (sustained) breakout when OEX hits that upper trend line again before I change my mind about the overall trend. OEX Daily Chart with RSI and Stochastics: Tomorrow may tell the tale. Potentially market-moving events include GE earnings, expected before the bell. In late September, GE affirmed that it expected to meet third-quarter earnings projections of $.40 per share. However, the company soon revealed that the proceeds of the sale of Global eXchange Service unit helped the company to meet those projections. Within days, several brokers cut their outlooks for GE. Merrill Lynch cited concerns over the finance and short-cycle plastics units, and they projected their outlook concerns into 2004, when turbine sales are expected to fall. On Wednesday, Scott Davis at Morgan Stanley joined the band and lowered 2003 earnings projections to $1.70 a share from $1.79. Like the Merrill Lynch broker, he mentioned short-cycle businesses, and noted problems in power and aerospace businesses and losses in GE Capital's portfolio. His use of the term "perfect storm" with relationship to this bellwether stock didn't bode well for the future outlook. Today, Merrill Lynch's analysis led them to downgrade GE to neutral from buy. Even with today's slight bounce, this stock has lost 5.40 points since late September alone. Tomorrow morning also sees the release of important economic numbers: PPI and retail sales (September numbers, released at 8:30 ET) and preliminary Michigan sentiment (October number, released at 9:45 ET). Forecasts are for PPI of 0.1% (previous 0.0%), core PPI of 0.1% (previous –0.1%), retail sales of –1.0% (previous 0.8%), retail sales ex-auto of 0.4% (previous 0.4%), and preliminary Michigan sentiment of 85.5 (previous 86.1). Since the PMA lockout of the dockworkers occurred on Sunday, September 29, those September retail sales figures will not reflect the majority of the damage inflicted by the lockout, but that doesn't mean the numbers will be rosy. Evidence of weakness mounted this week. In Monday's Market Wrap, Steven Price reminded us that that retailing giants repeatedly missed same-store sales numbers throughout the summer. Also on Monday, the August Consumer Credit report showed $4.2 billion in credit, rather than the expected $11 billion, perhaps another indication of a slowdown in consumer spending. Tuesday, Redbook reported that its chain store sales index fell 0.7% in September. Wednesday, retailer American Eagle warned for Q3 and Q4. Although AEOS mentioned the problems caused by the West Coast lockout, they also blamed the weak retail environment. This morning, CIBC downgraded the company. Also this morning, Talbots reduced its outlook for Q3 and Q4, citing a customer research study that indicated "a significant increase in customer concern regarding the turbulent economy and volatile stock market." Federated Stores lowered their outlook. BJ's Wholesale and Men's Wearhouse both guided below consensus. Wal-Mart met same-store sales figures, but those figures had been previously lowered. Costco topped earnings, but revenues were shy. Dillard's September same-store sales were down 5%, and Ann Taylor reported weak September sales. Gap's and Brown's Shoe Stores same-store sales were down. Kohl's same-store sales fell and they warned that earnings would be lower than expectation. Eddie Bauer same- store sales were down significantly. J.C. Penney's reported a 3.1% decrease in comparable-store sales. I list these numerous results to emphasize how troubled this sector remains. I could list more. The question remains whether this grim outlook has already been priced into the market. The daily RTH (Retail HOLding Company Depository Receipts) chart shows the damage done by the lockout, but it also points out the difficulties the retailers were experiencing even before the end of September. The double top predicted a minimum downside target of 70 in this index, a target that has now been exceeded. However, the chart also indicates a gap that occurred in the middle of the movement down from the second of the double tops. Such gaps are often called measuring gaps, because the movement that occurs after these gaps is often roughly equal to the movement before the gap. If that's true in the case of the RTH, this holder may have reached the target indicated by that measuring gap. RTH Daily Chart with RSI and (5)(3)(3) Stochastics: Continued warnings of lower same-store sales from retailers offer a gloomy prospect, but this week's earnings have already presented most of the gloomy picture. I wouldn't be surprised to see some rebound with upward resistance tested, but the retailers are going to have a hard time breaking through that overhead resistance. As Jim commented last week, the temporary resolution of the PMA lockout of the dockworkers doesn't undo the damage. First, the judge hasn't yet approved the use of Taft-Hartley. Second, even Taft-Hartley is a temporary resolution. Also, the backlog of containers still needs to be unloaded, and perishables may already be spoiled. The CEO of Mega-Toys was on television today, and commented that he didn't see a single container on the road when he drove into work this morning. The lockout occurred because of a slowdown, and nothing ensures that dockworkers won't stage another slowdown. Beyond these concerns lies another. We haven't yet had an all- out capitulation day. Why do our markets need a capitulation day? Because Art Cashin says so. Well, it's not just Art Cashin. On Bloomberg television this morning, one fund manager confirmed that he wasn't buying equities until the VIX moved strongly over 50. While I tend to trust my own studies and instincts, I've learned to pay attention to people who've survived several market turns. There's a more prosaic reason, too: until seasoned participants believe that all weak hands have been flushed out of the system, they will continue selling into rallies. While we may see a rally for a day or two, and I recognize that one of these rallies will be THE rally that changes the trend, I'm still waiting for the markets to convince me that they've begun a new trend. Linda Piazza lpiazza@OptionInvestor.com *************** FUTURES MARKETS *************** Another One-Day Wonder or Something More ? by Alan Hewko Traders have searched for the elusive bottom for some time now. Was it found today at Dow 7200? Only Time will tell. Recap of Last 24 hours: As previously done, I shall use these abbreviations for this article: ES E-mini SP500 futures YM E-mini Dow $5 futures NQ E-mini NDX 100 futures Wednesday saw the ES (E-mini SP500 Futures) holding their important 775 level after several late-day attempts to take them lower. Wednesday saw a VIX level of 50, which can signal a bullish market reversal at times. Wednesday evening had Japan's Nikkei made a new 19-year Low at 8200 level early in its session, and that 8200 level found a great deal of buying as the Nikkei closed the day almost green at 8,439. Wednesday's Closing Futures numbers at 4:15 PM were: ES 778, YM 7279, NQ 809 Thursday: 8:30 AM Better than expected Job economic data is bullish; however, a large number of Retailers warned this morning, some very badly as the implications of the West Coast dock strike work their way through the U.S. Economy. 9:30 AM ES 774, YM 7255, NQ 811 For the 2nd day in a row, NDX was the strongest sector early on. 9:30 AM to 9:40 AM Brief 10-minute short-covering rally from the open takes ES up to 780, and Dow Cash 7325; where it very quickly fades at Dow 7325 which had been prior strong support now acts as resistance on the first attempt higher. 9:40 AM to 10:00 AM ES finally loses the large support area of 775 sending the general market lower stemming from this morning's very negative Retail information. 10:00 AM ES 767, Dow Cash 7200, NQ 803 * DAY LOWS * New daily Lows, and New Yearly Lows for ES and Dow. There was no Market News that started the 10 AM buying, perhaps Shorts viewed Dow 7200 as an area to take Short Profits. Why Dow 7200? Dow 8100 was the high on Sep 19th, 300 points lower at 7800 offered some support, 300 points lower at 7500 offered a great of support, 300 points lower at 7200 was the area of Thursday's buying. Whatever the reason, an extremely impressive Bear Market Rally started and did not really stop from 10 AM until Market Close. 10:00 AM to 11:00 AM In one short hour, the Dow rallied 250 points, ES rallied almost 30, and NQ rallied 35. Rallies of this magnitude, based on no News, is a prime example of a Bear Market Shorts-covering rally. Below are three charts from Thursday: Dow Jones Industrials (Dow Cash) for Thursday ES (E-mini SP 500 Futures) for Thursday: NQ (E-mini NDX Futures) for Thursday: 11:00 AM to 3:00 PM There were some areas to take Short Scalps (ES 797 to 787, ES 800-801 to 795-796) and (YM - Dow 7450 to 7380, 7510 to 7450); but the Trend was "Buy the Dips" as Higher Lows were made all afternoon. Approx 3:15PM ES 807, Dow Cash 7550, NQ 855 ** Day Highs ** Dow Cash 7550-70 had been a prior area of resistance so it was not a large surprise to see some Longs taking some profit going into the Close. What may have surprised some Bears was how very shallow the profit taking was given the very large gains off the morning Lows. 3:30 PM ES 799-800, Dow Cash 7490-7500, NQ 848 That was all the amount of Long Profit taking there was, just 15 minutes worth. My sense is that when the Key Supports of ES 800 and Dow Cash 7500 held their support, this brought in additional short covering. The Closing action became all about two numbers again: ES 800 and Dow 7500; and they did indeed hold support. 4:00 PM Cash Close ES 803.50, YM 7505, NQ 850 4:15 PM Futures Close: ES 803.75, YM 7501, NQ 850 6:30PM Futures Quote: ES 801.25, NQ 852 and YM is not yet open For the last four days, not including today, the Dow had gone MINUS 200 points from its day High to day Low. Today, Thursday, the Dow went up POSITIVE 350 points from its day Lows. Thoughts for Friday ES 805-807 is a large area of resistance, followed by 809-812, 815, 818, 823. The ES and Dow index both made new Lower Lows on Thursday. Since the Globex re-open at 4:45 PM, ES futures have drifted south a few points. Look Friday morning to see how the Nikkei and Europe trade. Friday pre-open will have the important GE earnings, along with several economic pieces of data (Retail Sales for Sept, PPI). At 9:45 AM we get Michigan consumer sentiment Prelim data for Oct. The obvious question is as the title of this article asks, "Was Thursday just another one-day Wonder" of an extreme Bear Market Rally - or - does it have some bullish legs to it. The fact remains that the buying is coming from Shorts Covering vs. Real buying. The news continues to be bad (evidenced by all the very bad news from the consumer Retailers). Bear Market Rallies can come out of no where, for no "real" reason as they just seem to occur. The ONLY buy trigger I could see for Thursday was that 7200 Dow number. These bear market rallies can last 1 day or last for weeks. To date, over the last month, they have only lasted 1-2 days; but then again, the Dow wasn't at 7200 a month ago. To help put some perspective on this: Morning of Sept. 11th 2002, ES opened at 930, Dow at 8750. Friday October 11th (tomorrow) is one-month after that date and the markets have sold off quite a bit since September 11th. My only three comments for Friday morning are: 1. Watch the pre-open GE earnings response, along with the 8:30 AM economic data, and the 9:45 AM Sentiment as those factors will likely control the Open. (Assuming no major earnings warnings occur) 2. Watch ES 800 and Dow Cash 7500 as by now, we've all seen how important those two numbers are. 3. Last week, the markets had six RED closing weeks in a row. In wouldn't take much on Friday for the market to break that trend by having a weekly Green close. Join us in Market Monitor on Friday as we find out if this week has a Green or Red close... Lastly, I ask a favor: If you have read my Nightly Futures Wraps since last Thursday, or the two Futures articles ("Basic Info" and "Using Futures to Hedge Options") or the daily Futures commentary in Market Monitor; I would greatly appreciate feedback (either good or bad) along with any questions or comments you might have be emailed to: futures@OptionInvestor.com Thank you, Alan Hewko ******************** INDEX TRADER SUMMARY ******************** Can we get any confirmation? It was another volatile day and perhaps just the opposite of Wednesday's action as the market's stomach appears to be churning, not knowing if it likes what it's swallowing or not. By session's end, bears seemed to "rule the roost." Not with downside success, but their short covering. Once gain, we saw the Dow Industrials and both S&P's break a previous day's low only to find willing buyers on the break lower to have stocks reversing course. I've never known a "successful bull" to buy a bottom. No sir, only a "successful bear" buys a bottom as he locks in gains. With the S&P Banks Index (BIX.X) 250.72 +5.10% reversing yesterday's losses, but still stuck within my 236-253 range, I still feel it could be the near-term swing sector that drives broader market action. Volume was quite HEAVY today and may eventually have marked a bottom. Either that, or the bears that covered shorts today, should they step back and stop locking in gains, could have the markets set for a fall should General Electric (NYSE:GE) $22.60 +2.72% give bearish guidance regarding their next quarter. Those sectors that had been among the weakest were today's biggest gainers with the Fiber Optic Index (FOP.X) 25.97 +10.36%, Utility Index (UTY.X) 224.11 +8.61% and CBOE Internet Index (INX.X) 59.49 +8.53% leading the gainer's list. NYSE volume breached the 2 billion mark after a 52-week low was traded at 416.85 (July 24th low was 418.82). Some market technicians will point out this is a potential double-bottom in this index, but we wouldn't know that for sure until the relative high of 517 is taken out to the upside. For an undisciplined bear, that would be too late and perhaps brings into play a prolonged short-covering rally. The S&P 500 Index (SPX.X) 803.92 +3.49% rebounded from a morning low and 52-week low of 768.63. That low just barely undercut my head and shoulders top bearish calculation of 770 and may have been an "ultimate level" where a bear looked to buy back in force. Below you will find my excerpts for the Swing Traders and charts/observations of the various indexes. Buying the breakdown Buying breakdowns can be a dangerous trade, but something the MARKET seems willing to do the past couple of sessions. Once again we saw the Dow Industrials (INDU) 7,533.95 +3.3%, S&P 500 (SPX.X) 803.92 +3.49% and S&P 100 Index (OEX.X) 405.91 +3.36% break below their previous day's lows with both the Dow and S&P 500 trading new 52-week lows, only to find buyers on the break lower. For a bearish trader in the Swing Trade Model, what looked promising in the early going turned to frustration as the markets moved higher. Just as yesterday's 215-point decline in the Dow seemed like a lot, when compared to the previous day's low it was a 90-point drop. Today's 247 point Dow advance also looks like a lot, but compared to yesterday's high of 7,500, represents a 33 point advance. I'm more firm in my thoughts that the "recovery" or at least the volatility we're seeing near-term is greatly due to short- covering as the more heavily shorted technology sectors and NASDAQ-100 Index (NDX.X) 849.57 +5.2% and NASDAQ-100 Index Tracking Stock (AMEX:QQQ) $21.08 +5.08% held above yesterday's lows once again (for the second straight session), despite breaks lower in the other major indexes. As the session progressed, it was somewhat apparent that shorts were playing "leap frog" in the NASDAQ-100 and Q's as each break above a 30-minute or 60-minute interval saw another wave of buyers coming in. As it relates to last night's Swing Trader Wrap, the reoccurring dream has the truck bouncing off the guardrail and headed to the other side of the road toward the mountains embankment. As it relates to technical analysis, the base of our downward trending regressions held support and now look to be tested as resistance, with the NASDAQ-100 Index (NDX.X) first to test. Market View Chart - Dow: Daily Interval A "rounder" number like 7,650 might be more appropriate for selling into any further rally in the Dow, but until downward trend is broken, a bull needs to be cautious. The Dow Industrials Bullish % ($BPINDU) has been stabilizing at 9.99% since last Thursday. While there's only 30-stocks that make up the bullish % indicator, barring some horrific type of market news, it is becoming more likely that the Dow would begin to put in a bottom near 7,200. Market View Chart - NASDAQ Comp. - Daily Interval The broader NASDAQ Composite (COMPX) did edge below yesterday's low, but quickly reversed and when it broke yesterday's high of 1,136 and took out the 1,150 level the bullishness built into the close. We would now look for near-term resistance at 1,180 and more formidable resistance and perhaps any bullish profit taking near 1,200. I'm thinking that any bulls that had the "guts" to be buying many 4-lettered stocks near their 52-week lows might look to take some profits between 1,180-1,206, with some bears that closed out positions in prior sessions to give the NASDAQ another bearish trade with stops above 1,206. Similar perhaps to the first test of the 21-day SMA back near 1,350 on July 31st for a re-test of the lows. Tonight, I want to show a bullish % chart of the NASDAQ Composite ($BPCOMPQ). What this chart depicts simply the number in percentage terms of stocks listed at the NASDAQ currently showing a supply/demand buy signal on their point and figure charts. A trader should make the reference points on the above bar chart of the NASDAQ with the July/August lows near 1,206 with what we see from the bullish % chart now. As it relates to "risk" the bullish % of the NASDAQ Composite is at the same "level of risk" as it was in late July. Roughly 26%. The lowest reading possible is 0%, while the highest reading possible is 100%. Just after the terrorist attacks of 09/11, this indicator fell to 22%. NASDAQ Composite Bullish % Chart - 2% box In the last couple of sessions we've seen the NASDAQ Composite try and firm up and trade relatively stronger than the other major indexes. While the internals are very weak, we're also at a level of bullish % found in late-July where the NASDAQ rallied from about 1,200 to 1,346 (12%), then pulled back 10% to retest 1,200, and then bound higher from 1,200 to 1,408 (+17%). This represents some extreme volatility in a very broad-based index and must be factored in to a traders account/trade management. It is STRONGLY encouraged that bulls and bears both trade 1/4 or 1/2 positions currently. Swing Trade Game Plan - For a swing trader, it is not apparent to me that there's any other trend currently in place other than down. However, there certainly appears to be market participants willing to buy the breakdowns, and this hints that bears are getting more aggressive with their covering. We "know" that a patient bear won't "chase" if he/she doesn't have to, it's only when he/she has competition from bulls that he's forced to chase. While things looked promising in the first hours of trading and the Dow, SPX and OEX were breaking their previous day's lows, the S&P Banking Index (BIX.X) held firm and wouldn't crack to perhaps send the major averages into our targeted OEX range of 380-385. There was a brief moment when both the NASDAQ Composite (COMPX) and NASDAQ-100 Index (NDX.X) dipped red and looked to follow lower, but a strong, and I mean strong, round of short-covering came in to the technology sectors and built into the close. At 10:59:25, the OEX triggered our stop at OEX 402. And while the major indexes hovered at those levels for about 2.5 hours, the break to new intra-day highs saw a further push into the close. Tomorrow we will get earnings from Dow component General Electric (NYSE:GE) $22.60 +2.72% and more economic data. I would plan for some extreme volatility and indecision by many market participants. General Electric has its proverbial "finger" in about as many pieces of the "economic pie" that one can imagine and I'd expect the markets to find both bullish and bearish economic implications in tomorrow's earnings report. Not only what has happened, but also what GE's outlook is for the future. Bottom Line: A bear that's in trouble or feels he is still carrying too much risk in a portfolio of stocks that he is short, doesn't care about economic numbers when things begin moving against him. A bull that's been beaten into the ground would like to inflict as much damage as possible, but he too will be quick to cut and run if weakness begins to build. This sets the stage for VOLATILITY and is how we must approach the current trading environment. The trader that trades FULL POSITIONS is at a disadvantage, as any type of "quick move" will bring upon panic. With no downward trends yet to be broken, then overriding trade strategy is biased to the downside, but rebounds "where there shouldn't be any" have a bearish trader very cautious. S&P 100 Index Chart - 60-minute interval I'm not overly anxious to enter another trade before the weekend, especially in October contracts. Next week is option expiration and that may only lend to greater volatility. As such, entry points are outlined, but WIDER room to stops must be given to try and compensate for anticipated volatility. Traders haven't had an opportunity to short a rally in the upper-end of trend, but a trade near 412 lends the opportunity. Under such a condition, I'd want the S&P Banks Index (BIX.X) to be hovering near current levels of 252 and NASDAQ to be holding near its current downward trend. Bulls would be best served to look for a pullback, but will be "counting" on continued buying to get a rebound going higher, with desert being served should OEX break out of channel. SPX Game Plan Chart - 60-minute interval While the OEX at 402 had the Swing Trade Model stopping out our broader market short (SPX=795, SPY=80) the SPX was holding under 19.1% retracement and psychological 800. In my opinion, if the banks don't rebound further, I'm still thinking "something's wrong" and worth another shot at a bearish trade in upper part of channel, but I'm no longer willing to try and short a breakdown as last two have been "break even" and "loss." Fool me once for a loss then shame on the market, fool me twice for a loss then shame on me. For bullish entry, would monitor banks on SPX pullback, and if BIX is holding its low, the good risk/reward bullish entry near 775. DJX Game Plan Chart - 60-minute Interval The DJX has provided some wild intra-day swings in recent sessions. Today's close in the Dow Industrials is 34 points above yesterday's high. If we're getting this kind of volatility from the Dow, expect it in the other indexes too. Best way to deal with volatility and now get blown up is to trade smaller positions. Tomorrow's earnings from Dow component GE will only increase volatility and uncertainty. QQQ Game Plan Chart - 60-minute Interval An aggressive bear may be looking short the QQQ at trend, but a tight stop above $21.50 is warranted. Tech-stocks are very vulnerable to short-squeezes. However, the QQQ serves as our "first test of trend" and other index traders will be well served to monitor the Q's to see how much conviction bears have. I was watching the Q's closely today and actually implemented a bearish trade in my own account above the $20.65 level in ANTICPATION that the Q's would break back below that level. Suffice it to say, I think many a bear was surprised by the jump higher in the Q's near $21.00 and immediately used the $20.65 level as a cover on weakness level. Aggressive shorts only here with first hurdle on a downside move coming at $20.65. Expecting $20.20 to be firm support near-term, which may make for attractive bullish entry level. A bearish trade in the Q's is followed with stops at $21.55 or $21.85 depending on your tolerance for risk. Bulls looking for pullback entry near $20.20 would follow with a stop below $19.75, which would be a 52-week low. Remember that GE is a HUGE company and can spend on technology. If you're a QQQ or NDX trader, you KNOW to expect volatility. 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 **************** Pop Goes the Market by Steven Price Guess that SPX intraday low was pretty significant. Wednesday's sell-off looked ominous, with the Dow, S&P 500 and OEX all breaking down through significant support levels. The one nagging indicator that gave an inkling of bullish sentiment was the fact that the SPX had stopped dead at its July 24 intraday low of 775. This morning, the sell-off continued, with the Dow reaching its downside-measuring objective, based on the head and shoulders formation it had formed over the last couple of months. That measuring objective was around 7180-7190 and this morning's bounce came right at 7197. And what a bounce. The Dow rallied 336 points from its bottom, to burst back above the 7500 mark, which had served as previous support. So now all must be well; children (or possibly investment bankers) will be singing in the streets, rays of sunshine will fall upon our shoulders and maybe we'll even get a little manna from heaven. NOT! We may in fact be forming the bottom for a continued rally, but until we break above 8000 in the Dow and 1223 in the Nasdaq Composite, there will still be a series of lower highs and lower lows. Of course, we can still play a bounce for a few hundred points to the long side, but I wouldn't be thinking triple digits for Yahoo just yet. In fact the NYSE saw 569 new lows, to only 18 new highs. The Nasdaq saw 413 new lows, with only 15 new highs. While it's awfully hard to achieve a new high after an 1800-point Dow sell- off, these numbers do demonstrate just how far we have to go. With bullish percentages falling into the low double and single digits, the risk has definitely been mounting for bears, as this can be seen as a sign of market compression. The NDX fell to 12%, the Dow to 8%, the SPX to 18% and the OEX to 17%. This reading is a measure of the number of stocks in an index currently giving point and figure buy signals, and anything under 30% is considered oversold condition. The fact that we just broke the 775 mark in the SPX, trading down to 768, and came within 3 points of the OEX intraday low of 384, tells me we may have simply seen a round of short covering by bears who were aiming at those levels since late August. After giving up almost 1800 points since the end of August, a bounce seems in order. After all, even shorts need to take their profits at some point. The news after yesterday's bell that Yahoo beat forecasts could have been the catalyst for a rally; however, we didn't get that rally until after a morning sell-off. Economic data this morning showed a decrease in initial jobless claims, but a 4-week moving average that remained over 400,000. We also got a slew of retail data, including earnings warnings from Kohl's (KSS) and Federated (FD), the parent of Macy's and Bloomingdale's. A number of other retailers also saw a decline in same store sales and those that saw increases, like Wal-Mart, still did so on lowered expectations. The message seems to be that consumers are cutting back on discretionary spending and that is not good news heading into the holiday shopping season. GE also received another downgrade this morning, but rode the tide higher by the end of the day. A look at the weekly chart of the Dow shows that we are in the seventh straight down week, until today. This afternoon's rally actually puts the average up 5 points for the week. President Bush announced that the House of Representatives had passed a resolution by a margin of 296-133 that authorizes him to use military action against Iraq. The Senate is expected to approve the measure tonight. While Bush has said on several occasions that he would be open to weapons inspectors being allowed to do the job of disarming Saddam, this certainly opens the door for what many expect to be a military exercise at some point. Treasury Secretary Paul O'Neill said that it is possible the administration will implement another stimulus package that would allow further tax cuts for investors. While republicans are focusing on cuts, democrats are pushing to extend unemployment benefits that will expire just after Christmas. It is unlikely anything will happen before the elections and passage of the bills will likely depend on the results. Crude Oil Futures fell below $29 a barrel to $28.97, as expectations are that next week's petroleum inventory numbers will show an increase in reserves after six weeks of declines. If there had been good news for the economy (the drop in jobless claims was positive, but not enough to signal a bottom in the stock market), the rally could have been attributed to something concrete. However, it appears that shorts simply took some profits and covered their open positions after we broke the July 24 SPX intraday low. Tomorrow's retail sales and preliminary Consumer Sentiment numbers should give us a look at just how willing consumers may be to spend in the next few months. We have already seen what the retail numbers will most likely bring, but a positive surprise in the confidence number could keep the rally going. The last time a Friday ended higher than it opened was a month ago. Even if the rally does continue, I'll look for a higher high before putting on my horns. ----------------------------------------------------------------- Market Averages DJIA ($INDU) 52-week High: 10679 52-week Low : 7286 Current : 7533 Moving Averages: (Simple) 10-dma: 7597 50-dma: 8299 200-dma: 9432 S&P 500 ($SPX) 52-week High: 1176 52-week Low : 775 Current : 803 Moving Averages: (Simple) 10-dma: 810 50-dma: 877 200-dma: 1024 Nasdaq-100 ($NDX) 52-week High: 1734 52-week Low : 795 Current : 849 Moving Averages: (Simple) 10-dma: 833 50-dma: 912 200-dma: 1216 ----------------------------------------------------------------- The S&P Retail Index (RLX.X): The retailers were all doom and gloom this morning, as earnings warnings came from Kohl's and Federated. There were a slew of negative same-store sales reports, indicating that consumers are spending less heading into the holiday season, rather than more. The challenge appears to be finding someone to buy all those goods that will finally be unloaded on the west coast. Surprisingly, however, the Retail Index bounced once again from the 250 level, reaching an intraday low just under 245 and finishing at 258. It appears to be short- covering, and the previous intraday of 249 did fall. Tomorrow's preliminary Consumer Sentiment number should give us an indication of just how willing the consumer will be to pony up for gifts in a couple of months. As we head into the holiday season, we will keep an eye on November's weekly sales data. If we still see more declines, we'll put on our shorts and get out of the way. 52-week High: 366 52-week Low : 253 Current : 265 Moving Averages: (Simple) 10-dma : 264 50-dma : 283 200-dma: 325 ----------------------------------------------------------------- Market Volatility It is interesting that on the day when the VIX finally broke through the 50 level, after failing there for three straight days, we got a rally of over 300 points from the low of the day. I was looking for a VIX in the high 50s before we got a continued rally, so we may still have some downside. However, if this is the start of the big one, at least the pattern of hitting 50 first will remain in tact. The index actually dropped 3 points on the day, to finish at 46.48, however, it topped out this morning at 50.48 intraday. Friday should once again bring in weekend premium sellers, so watch for a VIX drop toward the end of the day, unless today's rally turns out to be short covering and we head lower tomorrow. CBOE Market Volatility Index (VIX) = 46.29 –3.19 Nasdaq-100 Volatility Index (VXN) = 62.82 +0.44 ----------------------------------------------------------------- Put/Call Ratio Call Volume Put Volume Total 0.97 710,404 692,244 Equity Only 0.67 505,627 339,484 OEX 1.07 52,003 55,826 QQQ 1.07 55,118 58,902 ----------------------------------------------------------------- Bullish Percent Data Current Change Status NYSE 25 - 2 Bull Correction NASDAQ-100 15 + 0 Bear Confirmed Dow Indust. 10 + 0 Bull Correction S&P 500 18 - 2 Bear Confirmed S&P 100 17 - 3 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 1.08 10-Day Arms Index 1.37 21-Day Arms Index 1.47 55-Day Arms Index 1.36 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 1804 963 NASDAQ 1998 1249 New Highs New Lows NYSE 18 331 NASDAQ 11 337 Volume (in millions) NYSE 2,341 NASDAQ 1,833 ----------------------------------------------------------------- Commitments Of Traders Report: 10/01/02 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 There has not been much change in the positions of Commercials, who reduced both longs and shorts by about 2,000 contracts each. Small traders are also relatively unchanged, with reductions of about 1,000 contracts to both the long and short sides. Commercials Long Short Net % Of OI 09/10/02 426,230 470,537 (44,307) (5.0%) 09/17/02 476,224 503,268 (27,044) (2.7%) 09/24/02 425,276 442,661 (17,385) (2.0%) 10/01/02 423,661 440,133 (16,472) (1.9%) Most bearish reading of the year: (111,956) - 3/6/02 Most bullish reading of the year: ( 16,472) - 10/01/02 Small Traders Long Short Net % of OI 09/10/02 166,696 85,259 81,437 32.3% 09/17/02 182,243 116,377 64,866 21.7% 09/24/02 124,232 73,506 50,726 25.7% 10/01/02 123,371 74,704 48,667 24.5% Most bearish reading of the year: 36,513 - 5/01/01 Most bullish reading of the year: 114,510 - 3/26/02 NASDAQ-100 Commercials reduced both longs and shorts, but by a relatively small percentage, giving up 600 long contracts and 1,700 shorts. Small Traders also made few changes to their overall positions, getting slightly longer overall, by about 600 contracts. Commercials Long Short Net % of OI 09/10/02 53,309 58,745 (5,436) ( 4.9%) 09/17/02 72,522 75,815 (3,293) ( 2.2%) 09/24/02 46,637 54,613 (7,976) ( 7.9%) 10/01/02 46,000 52,976 (6,976) ( 7.0%) 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 09/10/02 14,024 10,494 3,530 14.4% 09/17/02 15,288 14,142 1,146 3.9% 09/24/02 11,163 9,421 1,742 8.5% 10/01/02 11,896 9,575 2,321 10.8% 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 left long positions unchanged, while reducing shorts by 10%. Small traders reduced longs by 1,000 contracts, while adding the same amount to the short side. Commercials Long Short Net % of OI 09/10/02 22,946 14,936 8,010 21.1% 09/17/02 26,863 21,187 5,676 11.8% 09/24/02 18,951 10,074 8,877 30.6% 10/01/02 18,969 8,903 10,066 36.1% Most bearish reading of the year: (8,322) - 1/16/01 Most bullish reading of the year: 15,135 - 10/16/01 Small Traders Long Short Net % of OI 09/10/02 7,568 10,129 (2,561) (14.5%) 09/17/02 13,393 11,637 1,756 7.0% 09/24/02 7,939 9,453 (1,514) ( 8.7%) 10/01/02 6,809 10,503 (3,694) (21.3%) 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 ************************* J. Patrick Rogers: Gateway Fund (GATEX) If you are interested in equity investing without unnecessary or unwanted risks, you may want to consider this risk-adjusted fund managed by J. Patrick Rogers, Gateway Investment Advisers, since 1994. It sells "call" options and buys "put" options and as part of its risk-management program. At $1.2 billion in net assets, the Gateway Fund (GATEX) may be the largest mutual fund of this kind available to the retail market. Gateway Investment Advisers L.P. and its predecessor have served as the fund's adviser since fund inception (December 7, 1977) so the Gateway Fund may also be the oldest retail mutual fund using "puts" and "calls" to control portfolio risk. Gateway Investment Advisers had about $2 billion in total assets under management at year-end 2001, including about $1.3 billion in all of The Gateway Trust's mutual fund series. J. Patrick Rogers joined Gateway Investment Advisers in 1989 and has been its president, chief investment officer and a member of its board of directors since 1995, the prospectus states. He is the portfolio manager for the Gateway Fund, the Cincinnati Fund, and the Gateway VIP Fund, in addition to being the president and a trustee of the Gateway Trust. Rogers is also president of the Gateway Variable Annuity Trust. Rogers earned an undergraduate degree from Notre Dame University (1986) and a MBA degree from Xavier University (1994). In 1994, he became co-portfolio manager for the Gateway Fund and in 1997, assumed the lead management role. Peter Thayer, who managed or co-managed the Gateway Fund from December 1977 inception to May 1997, was Rogers' mentor and colleague. Thayer stepped down as the firm's president and chief investment officer in 1995, but continued to act as co-portfolio manager until his departure in May 1997. The Gateway Fund (GATEX) has a minimum initial purchase of $1000 for regular accounts ($500 for IRAs) and is offered on a no-load basis, meaning no initial, deferred or redemption charges. Fund expenses are currently running about 0.97% of assets compared to 1.26% for the average domestic hybrid fund per Morningstar. The fund's expense ratio includes management fees of 0.61% and 12b-1 fees of 0.31%. For complete information, including expenses and charges, you may call the Gateway Group at 1-800-354-6339, or go to www.gatewayfund.com. Management Approach The prospectus reads that the objective of the Gateway Fund is to capture the majority of the higher returns associated with equity market investments while exposing investors to significantly less risk than other equity investments. Rogers seeks to achieve this objective by undertaking active "risk-control" measures to reduce equity volatility while investing almost all of the fund's assets in equities. Who should invest? The Gateway Fund is suitable for conservative investors who seek consistently higher rates of return than fixed income investments over the long term. While fund volatility may be less than average, the fund is not risk free. So if you can't tolerate some fluctuations in share price, then this fund may not be suitable for you. The Gateway Fund may not be appropriate for investors seeking maximum capital appreciation over the long run. The main strategy of the Gateway Fund is to invest in the stocks included in the S&P 500 large-cap index, and also to sell "index call" options on its indexed portfolio. Selling "calls" reduces the fund's volatility and provides steady cash flows, and is the fund's primary source of income. Rogers also buys index "put" options. Because the value of a put option tends to increase as stock prices decrease, buying "puts" protects the fund against a significant market decline over the short term. The website indicates that the Gateway Fund earned 1.2% in August 2002 as "call premiums smoothed choppy equity markets." That was commensurate with other low risk, cash flow-oriented investments, using the Lehman Intermediate Government/Credit Bond index as the benchmark (1.5% for August). The Gateway manager commentary for August goes on to state that "in a market with little or no long- term momentum and short-term swings, the call premiums provide an attractive alternative to market-timing." The commentary goes on to state that "with downside coverage and excellent premiums to earn, the Gateway Fund continues to maintain a solid posture in an uncertain market." That's the attractiveness of the Gateway Fund in today's volatile market. Risk and Performance According to Morningstar's report, the Gateway Fund has "below average" risk compared to other hybrids over the last three to five years, with "low" relative risk over the trailing 10-year period through September 30, 2002. The funds' trailing 3-year average standard deviation of 7.8% is not among the category's very lowest, but still well below the 11.4% all hybrid average. Compared with the average U.S. stock fund's standard deviation (21.4%), the Gateway Fund's volatility has been limited. For all time periods other than the trailing 5-year period, fund return is graded as "average" in relation to other hybrid funds, per Morningstar. The fund's relative returns over the trailing five years is graded as "above average" versus its hybrid peers. Below is a summary of the Gateway Fund's trailing period returns and category percentile rankings as of October 9, 2002 (10-years is as of September 30, 2002) per Morningstar's report: Gateway Fund (GATEX) Total Returns: Year to Date: -16.2% (+15.4% to S&P 500) 39th percentile 1-Year Return: -12.1% (+13.3% to S&P 500) 44th percentile 3-Year Average: -3.8% (+11.6% to S&P 500) 41st percentile 5-Year Average: +2.3% (+5.4% to S&P 500) 21st percentile 10-Year Average: +6.0% (-3.0% to S&P 500) 74th percentile The Gateway website also reports the fund's average total return from January 1, 1988 through August 31, 2002, an annualized rate of return of 9.3% over the last 14 years. That figure isn't far off the 10 percent historical norm for U.S. stocks, so this fund has succeeded in its objective of capturing the majority of the higher returns associated with the equity market while exposing investors to significantly less risk than other equity products. The fund's below average expense level adds to its appeal, giving it some expense advantage relative to the average domestic hybrid fund. Rogers over the past five years has done particularly well compared with his category peers and the average U.S. stock fund, achieving competitive returns while incurring only a third of the volatility of equity markets, roughly speaking. The fund's level of risk is comparable to short-term bond funds the website notes, and typically lower than balanced funds or low-risk sector funds. Conclusion The Gateway Fund managed by J. Patrick Rogers seeks to provide investors with performance results "worth owning" over the long term. There is evidence to support the claim, and risk-adverse investors should find the Gateway Fund to be an attractive fund alternative in today's volatile market. The fund's returns for the inception-to-date period have been close to that of the 10% historical annual norm for U.S. stocks, so this fund does offer competitive long-term growth of capital potential with low risk. The Gateway Fund is well suited to investors wishing to benefit from active risk-control measures, but would rather leave those decisions to investment professionals. Investors interested in managing their own risk through use of "put" and "call" options may wish to visit our parent website at www.OptionInvestor.com. There you will find stock market commentary, options strategies, trading opportunities, and more. 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 *********************** Buying the breakdown Buying breakdowns can be a dangerous trade, but something the MARKET seems willing to do the past couple of sessions. Once again we saw the Dow Industrials (INDU) 7,533.95 +3.3%, S&P 500 (SPX.X) 803.92 +3.49% and S&P 100 Index (OEX.X) 405.91 +3.36% break below their previous day's lows with both the Dow and S&P 500 trading new 52-week lows, only to find buyers on the break lower. For a bearish trader in the Swing Trade Model, what looked promising in the early going turned to frustration as the markets moved higher. To read the rest of the Swing Trader Game Plan Click here: http://www.OptionInvestor.com/itrader/indexes/swing.asp FREE TRIAL READERS ****************** If you like the results you have been receiving we would welcome you as a permanent subscriber. The monthly subscription price is 39.95. The quarterly price is 99.95 which is $20 off the monthly rate. We would like to have you as a subscriber. You may subscribe at any time but your subscription will not start until your free trial is over. 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The Option Investor Newsletter Thursday 10-10-2002 Copyright 2002, All rights reserved. 2 of 3 Redistribution in any form strictly prohibited. In Section Two: Stock Picks: Long Distance Call Dropped Calls: None Dropped Puts: BCR Daily Results Call Play Updates: ITMN, MDT New Calls Plays: AZO, WLP, LMT Put Play Updates: HAR, WHR, PHM New Put Plays: None *********** STOCK PICKS *********** Long Distance Call NXTL - Nextel Communications, Inc. - $8.09 Strategy: Long stock with put insurance While there hasn't been much good news to point to in the Communications sector, there have been a few bright points for the bulls to focus their attention on. With the broad markets setting new multi-year lows earlier this week, any pocket of strength could very well be hinting at building relative strength. Even the Wireless sector (YLS.X) traced a new low yesterday at $31.32, down a whopping 68% since the first of the year. In contrast to this weakness, shares of NXTL have been stubbornly working their way higher since bottoming near $2.75 in late June. Not only is the stock well above this level, it hasn't even come close to retesting those levels since ramping strongly higher in mid-July. Since then NXTL has been using the $6.50-7.00 area as an important pivot, first finding resistance there and now support. A big part of this relative strength came from a great earnings report from the company in mid-July, where the company trampled consensus estimates. Rather than expected 25-cent loss, NXTL reported actual earning of 6-cents. To top it off, these stellar results came from a 25% revenue increase, and then the company raised guidance for domestic operating cash flow to $3 billion for the full year. That then precipitated an upgrade from Salomon Smith Barney, keeping the stock performing better than its peers. Taking a look at the company's balance sheet shows other encouraging signs, with better than $3 in cash per share. After certifying its accounting on August 14th, NXTL also announced that it had retired more than $700 million in debt an preferred securities since the end of June. In just the past week, the company has received upgrades from RBC Capital and Piper Jaffray, with the former citing stronger than expected (475K vs. 450K) subscriber additions, and the latter citing renewed confidence that the company will be able to meet its debt covenants. Looking at the chart below, you can see how that $6.50-7.00 area has been pivotal in recent months. Ideally we want to see another dip into the $7.00-7.50 area before entering the play, as it makes risk much easier to quantify. With the company set to report earnings again on October 24th (2 weeks from now), we should see enough uncertainty ahead of the numbers to give us a solid entry into the play. Once clear of resistance in the $8.50 (recent highs) to $9.00 (bottom of the January gap) range, bulls will be setting their sights on $10 resistance. A successful push through that level will bring the $12.50 level into play. Longer term, look to the $15 and $20 levels as upside targets. So the play is to go long NXTL stock in the $7.00-7.50 range and go long one contract of the Jan-2003 $5.00 puts FQC-MQ at $0.55 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 NXTL. Option 1: If NXTL is not above $9.00 by Jan 2nd, close both positions and exit the play. Option 2: If NXTL is below $6.50 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 NXTL is above $10.00 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 $7.00-7.50 plus any short fall on the put premium. Nextel Communications (NXTL) Weekly 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: ***** BCR $52.51 +2.18 (-1.01) Our BCR play got off to a good start on Wednesday, falling to just above the $50 level as the broad market continued to fall. That decline continued at the open this morning, but then the buyers rushed in, propelling the stock higher throughout the bulk of the session, closing near the high of the day. Despite the fact that our $53.50 stop hasn't been violated, the engulfing candle pattern is a strong bullish reversal signal. We'll take pre-emptive action and drop the play tonight, before it can move further against us. The deep oversold condition of the broad markets carries with it significant upside risk to bearish traders, which is one reason why we are eager to aggressively close this bearish play. Trader's currently in the play can still manage open positions using the $53.50 stop, and we would recommend closing positions on a morning dip that fails to break back under the $52 level. *********************************************************** DAILY RESULTS *********************************************************** Please view this in COURIER 10 font for alignment ************************************************* CALLS Mon Tue Wed Thu AZO 79.38 0.10 -0.88 -1.52 1.90 New, got pullback ITMN 32.19 -0.74 1.29 -0.25 1.00 higher lows LMT 60.88 0.34 -3.36 0.16 2.87 New, pattern repeat MDT 44.65 0.05 0.93 -0.56 1.03 Engulfing Candle WLP 78.40 -0.17 -0.86 1.64 0.82 New, Trigger point PUTS BCR 52.51 -0.58 -1.22 -1.17 2.18 Drop, $50 bounce HAR 48.01 -1.27 -1.49 -1.10 1.11 Back to Wednesday PHM 38.53 -1.61 1.51 -1.67 1.94 Entry point WHR 40.68 -1.94 1.55 -2.53 0.08 Very Weak ************************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 ******************** ITMN $32.19 +1.00 (+1.19 for the week) ITMN got a boost today from the rising tide, and increased guidance from fellow biotech IPDH. But, unlike many stocks that bounced after a long downtrend, ITMN has continued its ho-hum up trend, after bouncing off of its 200-dma at the beginning of the week. The stock has achieved its 3rd higher low, since reversing its downtrend back in July. As the Dow sunk to new lows earlier this week, ITMN continued upward throughout the week. The recent revelations about progress on the next generation Actimmune therapy, currently used for treatment of congenital diseases chronic granulomatous disease and malignant osteopetrosis, have no doubt kept the stock in favor with investors. A joint study with Maxygen is focused on a once a week treatment regimen, as opposed to the current three times a day therapy. The trials have gone so well that ITMN recently paid Maxygen a $1 million milestone payment. The drug is also being studied in connection with possible use for additional conditions, such as idiopathic pulmonary fibrosis (IPF), liver fibrosis and ovarian cancer. We like the steady rise in ITMN and its seeming reluctance to fall prey to market trends. Although we originally picked it at $33.99, we still like its ascending channel and see the current level as an entry point. If the stock were to roll over from a lower high, we would see that as a negative, but at this point, the trend remains in tact. --- MDT $44.65 +1.03 (+1.45) After failing to crater the markets this morning, the bears decided to cover and judging by the strong gains across the board on robust volume, there might be some legs to this move. MDT gave us a gift of an entry this morning on the early weakness, dipping right to the $43 level, near the 10-dma ($43.14) before ramping higher all day to end with a solid gain. This confirms the breakout from earlier in the week over the descending trendline, reinforced by the stock's ability to close solidly over the 200-dma ($44.05). Volume was robust as well, coming in 20% above the ADV, hinting that the next upside objective will likely be resistance near $46. Buying the dips remains the strategy of choice, and any rebound between $43-44 looks good for new entries. Due to the proximity of the $46 resistance level, we want to be very careful about trying to buy a breakout. Just in case today's rally was another one-day wonder, we're keeping our stop in place at $42 until MDT is able to close over $45. ************** NEW CALL PLAYS ************** AZO – AutoZone, Inc. $79.38 + 1.90 (-1.89 this week) Company Summary: AutoZone is a retailer of automotive parts and accessories, primarily focusing on do-it-yourself customers. Each of its more than 2900 stores in 42 states and Mexico carries an extensive product line for cars, vans and light trucks, including new and re-manufactured automotive hard parts, maintenance items and accessories. Approximately half of its domestic stores also have a commercial sales program, which provides commercial credit and prompt delivery of parts and other products to local repair garages, dealers and service stations. Why We Like It: Despite the beating most Retail stocks have taken in recent weeks, the selling has not been indiscriminate. There are actually some specialty Retailers that have been bucking the trend. Slowing sales and expectations of poor earnings have been fueling the recent bearish action in the Retail sector (RLX.X), which tagged a fresh 4-year low Thursday morning. In contrast to that weakness, shares of AZO have been steadily marching higher since late July, posting a continuous series of higher lows and higher highs. The ascending trendline connecting those lows came into play this morning, when the stock dipped with the rest of the market, just kissing the trendline before reversing higher to close better than $2.50 off its lows. A big reason for the AZO's relative strength can be found in the company's latest earnings report from a couple weeks ago, where the company blew away analyst estimates by a whopping 32-cents per share on increasing revenues. If that sounds different from what you've heard out of the bulk of the Retail sector of late, it's because it is. Apparently consumers are still buying parts for their cars, whether to repair old ones or customize new ones. The post-earnings rally ran into resistance near the $83 level, and that along with the June highs near $85 will be the important resistance levels to keep an eye on over the near term. Important support now appears to be in the $77-78 area, with the ascending trendline at $77 and the 20-dma ($77.97). The best entries will come from a dip and rebound from this support area, but if today's rally continues into the weekend, we may have to settle for entries on further strength. Such momentum-based entries can be considered on a rally through the $80.50 level (Thursday's intraday high), although a push through the $82 level will provide even stronger confirmation. Initial stops are set at $76, just below recent support. *** October contracts expire in less than 2 weeks *** BUY CALL OCT-75 AZO-JO OI=1714 at $5.50 SL=3.50 BUY CALL OCT-80 AZO-JP OI=1567 at $1.95 SL=1.00 BUY CALL NOV-80*AZO-KP OI= 549 at $4.90 SL=3.00 BUY CALL NOV-85 AZO-KQ OI= 630 at $2.55 SL=1.25 Average Daily Volume = 1.31 mln --- WLP - Wellpoint Health Network - $78.40 +0.82 (+0.78 for the week) Company Summary: WellPoint Health Networks Inc. serves the health care needs of more than 13 million medical members and approximately 45 million specialty members nationwide through Blue Cross of California, Blue Cross and Blue Shield of Georgia, Blue Cross and Blue Shield of Missouri, HealthLink and UNICARE. WellPoint offers a broad spectrum of quality network-based health products including open access PPO, POS and hybrid products, HMO and specialty products. Specialty products include pharmacy benefit management, dental, utilization management, vision, mental health, life and disability insurance, long term care insurance, flexible spending accounts, COBRA administration, and Medicare supplements. Blue Cross of California, Blue Cross and Blue Shield of Georgia, and Blue Cross and Blue Shield of Missouri are independent licensees of the Blue Cross Blue Shield Association. Why We Like It: As many HMOs have reduced their membership to save costs, insurers such as WLP, which hold for-profit Blue Cross health plans, have seen revenue increase by 12.8% over the first half of 2001. Profits at all of the country's health insurers jumped 25% in 2001, according to Weiss Ratings, in spite of a nationwide recession. The industry has remained healthy and the stocks of many insurers have reflected that success. A look at the monthly chart of Wellpoint shows a consistent up trend for the last five years. When we talk about seeing the big picture and going with the trend, this stock is a perfect example of an upward trending issue. The stock actually topped out at $86.20 in June, before the broad market sell-off. However, it found support at its 20-dma of $65.94 on Aug 5, and has been setting higher highs and higher lows ever since. The stock has struggled to break back through $80, including today's high of $79.90. The stock tends to consolidate in $10 rectangle formations and then achieves the next measuring objective $10 higher after a breakthrough. For a look at the charts on Wellpoint, up to last weekend's prices, click here http://www.OptionInvestor.com/ask/100602_1.asp for a look at last Sunday's Ask the Analyst column. The exception to the $10 "rule" in the stock was in June, when it topped out only $6 higher. Of course a $6 move would be fine with us and would be our initial price objective on the play. A trade of $80 would constitute a higher high and also a buy signal on the point and figure chart. We are looking for a trade over $80 as a trigger point to initiate long positions on this play. The point and figure bullish vertical count on WLP is currently $100, and if we can get a sustained move in the broader markets, this may be possible. However, given previous behavior, $90 is the most reasonable target after $86. Wait for a trade over $80 and conservative traders can look for intraday support above that level before going long. *** October contracts expire in less than 2 weeks *** BUY CALL NOV-75 WLP-KO OI= 29 at $6.10 SL=3.10 BUY CALL NOV-80*WLP-KP OI= 296 at $3.30 SL=1.60 BUY CALL JAN-80 WLP-AP OI= 305 at $6.10 SL=3.10 BUY CALL JAN-85 WLP-AQ OI= 457 at $4.00 SL=2.00 Average Daily Volume = 1.58 mil --- LMT - Lockheed Martin - $60.88 +2.87 (-0.12 for the week) Company Summary: Lockheed Martin Corporation, headquartered in Bethesda, Md., is a global enterprise principally engaged in the research, design, development, manufacture and integration of advanced technology systems, products and services. Employing about 125,000 people worldwide, Lockheed Martin had 2001 sales of $24 billion Why We Like It: LMT has been sold off with the rest of the defense contractors, following political rhetoric that favored giving weapons inspectors a chance to diffuse the Iraqi conflict. However, the U.S. continues its military buildup and training exercises in the region and it still looks likely that there will be a U.S. invasion at some point. Today, the President received overwhelming support (296-133) in the House of Representatives for a resolution allowing the use of military action, if needed, in dealing with Saddam Hussein. He already gave a press conference, and it is expected that the Senate will also give its approval later tonight. While weapons inspectors may re-enter Iraq, it is widely believed that the President would rather launch a strike and remove Hussein, than allow him to play a shell game with his nuclear production equipment and biological weapons. LMT traded at a high around $67 earlier in the month, before the defense sector began its slide. The stock recently revisited its 200-dma of $59.83 and in an interesting scenario, put together the same rebound pattern it did the last time it sold off to that level. It fell through on a big drop, consolidated for a day, and then exploded back up through that level. It found resistance at its previous downward consolidation point, and then continued upward. We are at the point where it has rebounded and found resistance at its previous downward consolidation point, and if the pattern continues, we could be in for another big move upward. A look at the point and figure chart shows that the stock has achieved a four-box reversal upward. On each of the last four reversals, it has reached one box higher than the last. If it repeats this pattern, then a trade of $68 would be next in line. In spite of the volatility surrounding the defense sector, the stock has yet to break bullish support, although we don't plan on staying in the play long enough to find out, if it does test that $52 level. This play is not for the faint of heart, since the stock has experienced extreme volatility as the world political landscape has taken broad turns. However, we like the consistency of the PnF and daily patterns and will initiate the play from the current level, with a target of $68. There is some resistance around $66 to get through first, but even a $5 gain is fine with us. Conservative traders can wait for a successful re- test of support at $60 before initiating the long play. *** October contracts expire in less than 2 weeks *** BUY CALL NOV-60 LMT-KL OI= 464 at $4.30 SL=2.20 BUY CALL NOV-65 LMT-KM OI= 502 at $2.00 SL=1.00 BUY CALL DEC-60*LMT-LL OI=2040 at $5.30 SL=2.70 BUY CALL DEC-65 LMT-LM OI=1771 at $2.95 SL=1.50 Average Daily Volume = 3.15 mil ************************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 ******************* HAR $48.01 +1.11 (-3.35 for the week) Harman did get a bounce at the end of the day after, staying negative throughout most of the Dow's almost 200 point gain. The fact that it remained down throughout most of the rally shows awful relative strength and even we would have expected a little more of a bounce with the rising tide, after losing almost $6 in the last week. We continue to see this stock as a short, and today's retail warnings only underscored our feeling about a lack of spending. This morning's chain store sales number showed only a 1.5% increase, 1/2 of the expectations. Profit warnings from Kohl's (KSS), Target (TGT) and Federated (FD), which owns Bloomingdale's and Macy's, demonstrated the lack of discretionary spending at both the discount and upper end levels of retail. The fact that these stores are seeing poor numbers, compared to last September, when Americans were sitting home after the 9/11 attacks, does not bode well for the upcoming holiday season. Harman, which makes big-ticket audio equipment, should continue to suffer, as customers steer spending toward necessity items, as job fears continue. While initial jobless claims, released this morning, were down, the 4-week moving average still remains over 400,000. The Dow has seen seven straight down weeks and was due for a bounce. Our feeling is that today's rally simply provided a better entry point for a weak stock like HAR. However, if tomorrow's action sees a continued rally in the Dow, we would probably step to the side and wait for a failure of that rally to initiate any shorts. --- WHR $40.68 +0.68 (-3.04 for the week) Whirlpool suffered today, as individual retail sales numbers underscored the recent decrease in consumer discretionary spending. The same store sales decrease of 5.9% from Sears, a major appliance seller, was all investors needed to stay away from WHR. The company repeated the mantra of a challenging economic environment. After also hearing poor results from Kohl's, Target, J.C. Penney and Federated, accompanied by a slew of earnings warnings, the message is clear - consumers are not spending at either the higher or lower price levels. Major appliances, considered a big-ticket item, do not look promising. On a day when the Dow soared over 200 points, WHR managed a gain of only 0.08. While many other stocks rallied with the rising tide, WHR was unable to hold even a rally over its last round number of $41, having been turned back at $41.10 intraday. This looks especially weak, after a drop of almost $3 on Wednesday. In fact, the stock was down on the day until just after 1:00 p.m. Friday will bring overall retail sales for the month of September and the University of Michigan Consumer Sentiment report. These indicators are already expected to be poor and a positive surprise could help a continued rally in the Dow. If we do not see a continued rally, then we like short entries at the current level in WHR. --- PHM $38.53 +1.94 (-0.61) Can you say volatility? It is interesting to note that the Housing stocks rebounded sharply on Thursday, largely in sympathy with the broad market short-covering rally. PHM's more than 5% gain looks impressive on the surface, but it is interesting to note that it wasn't quite enough to wipe out Wednesday's sharp slide. The $39.00-39.50 level is shaping up as important resistance and this is the line in the sand where the next real battle between the bulls and the bears will take place. A rollover below this level can be used for initiating new positions, but ideally we want to see the Home Construction sector ($DJUSHB) confirm weakness by failing to push through its own resistance near $282. More conservative traders will want to keep an eye on the $36 level, targeting new positions on a decline below that level on strong volume. Keep in mind that the PnF bearish price target for PHM is $32, and if we see a decline near that level, it will make good sense to lock in gains. With the bullish close of the broad markets on Thursday, the upside is what we need to watch going into Friday. A close over our $39.50 stop will have us closing out the play this weekend. ************* NEW PUT PLAYS ************* None ************************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 10-10-2002 Copyright 2002, All rights reserved. 3 of 3 Redistribution in any form strictly prohibited. In Section Three: Play of the Day: CALL - AZO Traders Corner: From Straddles to Upticks to Pepto-Bismol Traders Corner: The 30-year Options 101: Relative Strength Tool Flushes Out a Call Entry ********************** PLAY OF THE DAY - CALL ********************** AZO – AutoZone, Inc. $79.38 + 1.90 (-1.89 this week) Company Summary: AutoZone is a retailer of automotive parts and accessories, primarily focusing on do-it-yourself customers. Each of its more than 2900 stores in 42 states and Mexico carries an extensive product line for cars, vans and light trucks, including new and re-manufactured automotive hard parts, maintenance items and accessories. Approximately half of its domestic stores also have a commercial sales program, which provides commercial credit and prompt delivery of parts and other products to local repair garages, dealers and service stations. Why We Like It: Despite the beating most Retail stocks have taken in recent weeks, the selling has not been indiscriminate. There are actually some specialty Retailers that have been bucking the trend. Slowing sales and expectations of poor earnings have been fueling the recent bearish action in the Retail sector (RLX.X), which tagged a fresh 4-year low Thursday morning. In contrast to that weakness, shares of AZO have been steadily marching higher since late July, posting a continuous series of higher lows and higher highs. The ascending trendline connecting those lows came into play this morning, when the stock dipped with the rest of the market, just kissing the trendline before reversing higher to close better than $2.50 off its lows. A big reason for the AZO's relative strength can be found in the company's latest earnings report from a couple weeks ago, where the company blew away analyst estimates by a whopping 32-cents per share on increasing revenues. If that sounds different from what you've heard out of the bulk of the Retail sector of late, it's because it is. Apparently consumers are still buying parts for their cars, whether to repair old ones or customize new ones. The post-earnings rally ran into resistance near the $83 level, and that along with the June highs near $85 will be the important resistance levels to keep an eye on over the near term. Important support now appears to be in the $77-78 area, with the ascending trendline at $77 and the 20-dma ($77.97). The best entries will come from a dip and rebound from this support area, but if today's rally continues into the weekend, we may have to settle for entries on further strength. Such momentum-based entries can be considered on a rally through the $80.50 level (Thursday's intraday high), although a push through the $82 level will provide even stronger confirmation. Initial stops are set at $76, just below recent support. *** October contracts expire in less than 2 weeks *** BUY CALL OCT-75 AZO-JO OI=1714 at $5.50 SL=3.50 BUY CALL OCT-80 AZO-JP OI=1567 at $1.95 SL=1.00 BUY CALL NOV-80*AZO-KP OI= 549 at $4.90 SL=3.00 BUY CALL NOV-85 AZO-KQ OI= 630 at $2.55 SL=1.25 Average Daily Volume = 1.31 mln ************************Advertisement************************* Tired of waiting on trades to execute? Does your broker offer Stop Losses on Options? Trade instantly with Stop Losses at PreferredTrade Inc. Stop Losses based on the option price or the stock price. Move your trading into the next millennium with PreferredTrade. Anything else is too slow! http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ************** TRADERS CORNER ************** From Straddles to Upticks to Pepto-Bismol By Mike Parnos, Investing With Attitude With investors continuing to dodge falling knives, they have once again turned to the Couch Potato Trading Institute for strategies on how to make money in a crazy market without exposing themselves to the elements. We aim to please. Today’s column will review the low risk (and proper) way to implement the straddle strategy. We’ll also try to clarify a few lingering items recent columns. ___________________________________________________________ Oops! In last Sunday’s column I discussed a strategy that required closing out one position and establishing another one once the closeout figure reached a certain level. We were talking about a position using the OEX – trading at 409.25 at the time. First, with the market in a continuing downtrend, we established a November 410/425 bear call spread that yielded a credit of $7.00. Then, if the trend reverses, I mistakenly (Sorry!) said we would buy back the short call. I should have said we would close the entire position (short and long call) when the cost of closing the spread reached $14. There also may have been some ambiguity about the reason to wait for the initial bear call spread position to go so far against us before we would close it out and make the adjustment. The reason is that, the longer we wait while the OEX moves in the opposite direction, the more likely it is that the OEX has, indeed, reversed trend. Then, when we establish the new bull put spread, we have a better chance the new trend will continue. Why did I use OEX as the vehicle for this trade? Mainly, because some readers wanted me to use something besides the QQQs. They get confused when I use the QQQs on all my examples. We don’t want to push the envelope – it ain’t a 9 x 12. ____________________________________________________________ Back In the Straddle Again I’d also like to reiterate (explain again) exactly how we can limit our risk and make impressive profits using a straddle. To make my anti-QQQ readers happy, we’ll use AMGN in this example. AMGN is trading at $45.75 right now. Let’s say you believe there will be a large movement. Traditional straddle traders believe that you should buy a put and a call at the nearest strike ($45). If you buy Nov. $45 put @ $3.20 and buy Nov. $45 call @ $4.00, you have an initial cost of $7.20. The amount of time value is $6.45 ($7.20 less $.75). Traditional thinking is that AMGN would have to move in excess of $7.20 before you get into a profitable situation. As the days and weeks go by, the time value is going to melt away. The closer it gets to expiration, the faster it melts. If AMGN doesn’t make it’s big move, you’re looking at losing most of the $7.20 risked. At the CPTI we take a more conservative approach. If you don’t stick it out, it probably won’t get cut off. We would look out to the January $45 puts and calls. Buy Jan. 03 $45 call @ $5.90 and buy the Jan. 03 $45 put at $4.90. Your total risk is $10.80, right? WRONG!! We are only going to hold this position for 30 days. If AMGN doesn’t make its move in 30 days, we’re going to curse a little, say “to hell with it,” and move on. If your risk tolerance is higher, and you want to risk $3.00 (instead of $1.50) on the position, you can hang on longer. Then, your next step would be to call information, get the number for Gamblers Anonymous, and go to the first meeting (of many). How much time premium can erode from $10.05 in the first month of a three- month option? About 15%. Remember that options erode very slowly at the beginning. That means you would be risking about $1.50. If AMGN doesn’t move, you have to have the discipline to close out the position. Only being exposed for one month means that, if AMGN doesn't move, you’re only risking about $1.50 and, the most important thing is, you didn’t have to pick a direction!!! ____________________________________________________________ Keeping Your Shorts On An interesting point came up recently regarding some of the rules of shorting and how they may vary. One CPTI student who was following our BBH Iron Condor trade, decided to put on a similar trade with INVN. Everything was going OK until the stock began to tank and he tried to make the proper adjustment of shorting the shares. He placed the order to short INVN at $30 and waited. It was rejected because his broker (Ameritrade) did not have the shares available to short. They apparently tried to find them, but were unsuccessful. Our CPTI student was able to close out his short put at only a small loss – but he aged a few years and went through a quart of Pepto- Bismol while waiting for the result of the short order. He saw red and drank pink. It’s strange considering INVN trades hundreds of thousands of shares every day, but it’s possible that it has a huge short interest and most of the shares are spoken for. The lesson to be learned here is that, before you initiate a position, you should contact your broker to determine share availability and their shorting policies. It’s better to be safe than sorry. As your stock moves lower (and don’t they all?), you may have to call up daily to determine if shares are available to short – if your underlying is a stock that has questionable liquidity. Using Indexes vs. Stocks for Shorting That brings us to another point. Many have asked why I use indexes as opposed to stocks in most of my trading. I’ve already gone into the reasons at length, but the shorting question has reminded me of another reason. When you want to short an index stock (like the QQQs or BBH), you do not have to wait for an uptick. Uptick Basics Should you want to short a stock, you may find that you have to wait for what is called an "uptick." On the NYSE, this means that a short sale may only be done on an uptick or a zero plus tick - a price that is the same price as the last trade, but higher in price than the previous different trade. On the NASDAQ exchange, you cannot short on the bid side of the market when the current inside bid is lower than the previous inside bid (a down tick). Once the market does up tick, you can then sell your stock at the current bid price offered in the market. ______________________________________________________________ I came across an old Scottish proverb that was probably written without the stock market in mind. Their markets were possibly “live stock” markets. Nor did they likely have puts and calls, but I’m sure they had their own meanings for other sayings like “inside the spread,” “straddle,” and “strangle.” But one concept, that is timeless and universal, is that there will always be winners and losers. The proverb goes something like this: “I am wounded, but I am not slain. I shall lay me down and bleed awhile, then I shall rise and fight again.” It applies beautifully to the perfect trading mindset. If you hedge your trading, you may lose on a trade and you may “bleed awhile.” However, you’ve limited your losses, kept the bulk of your trading capital, and will “rise and fight again.” ____________________________________________________________ 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 ************** The 30-year By John Seckinger jseckinger@OptionInvestor.com By definition, a capital market is where debt or equity securities are traded. As a trader, it makes sense to turn towards the fixed-income arena for direction or confirmation of either a move in equities or response to an economic report. Furthermore, if you are looking for leverage and liquidity, it is hard to match the 30-year Treasury Bond Futures contract. Traded at the Chicago Board of Trade (CBOT), this still-popular instrument trades inside the bond pit (Open Outcry) between 7:20 a.m. and 2:00 p.m. Chicago time, Monday-Friday. If a trader prefers the electronic method, those hours are between 8:00 p.m. and 4:00 p.m. Chicago time, Sunday-Friday. Note: Trading in expiring contracts closes at noon (Chicago time) on the last trading day. Moreover, the last trading day is the seventh business day preceding the last business day of the delivery month. The last delivery day is the last business day of the delivery month. Concerning delivery, Federal Reserve book-entry wire-transfer system is used. . The CBOT has standardized the contract to have a face value at maturity of $100,000 (or multiple thereof). Points are quoted in 32nd’s of a point, with a tick size (1/32nd of a point) equaling $31.25 per contract. Note: Par is on the basis of 100 points. The main months traded within Treasury Bonds are March (H), June (M), September (U), and December (Z). The ticker for the main contract is US during open outcry, and ZB when traded electronically. For example, the December Bond during open outcry is USZ. If traded electronically, the ticker would be ZBZ. There is no price limit. As most of you may already know, I spent roughly five years at the CBOT. From runner, to phone clerk, to co-manager of a retail desk, to Member, to institutional sales executive. Fortunately, I was able to spend countless hours watching what went on in the massive 30-year pit from only feet away. Unfortunately, my membership only allowed me to enter the two-year pit and a number of other “non-benchmark” securities. Of course, I was able to perform hand signals towards the pit for either my customers or personal trading account. When the Treasury stopped auctioning 30-year bonds, liquidity did become more concentrated in the 10-year pit; however, mortgage- related trading seemed to make it more difficult for technicians to predict price action. Moreover, the range in the 10-year pit is generally tighter. However, unless you are handling a billion dollar trading account, the liquidity within the 30-year will suffice. Looking at volume and open interest for Wednesday, October 9th, Pit volume for the 30-year was 54,485 while 10-year pit volume was recorded at 82,234 contracts changing hands. When all other forms of execution (computer terminals, etc.) are considered, volume for 30-year was 227,649, while ten-year notes totaled 467,141 contracts. Open Interest is currently 486k for the 30- year, and just over one million for ten-year notes. To put things in perspective, the volume for the Dow Jones Industrial Index was 37,924 (total) with Open Interest at 35,298. Before we look at a few illustrations, let us talk about margins. For the 30-year bond, there is an initial margin (per contract) of 2,700. Maintenance is set at 2,000. For 10-year notes, the initial margin is 1,755 with a maintenance requirement of 1,300. Since 1980, the 30-year bond has averaged 11% in yearly volatility. The highest yearly average was in 1980, at 21.7%. The lowest reading occurred in 1997 at 7%. During the first 9 months of trading, the 30-year contract has averaged volatility of 10.1%. So, why trade or even look at the 30-year bond? With portfolio managers, hedge funds, and retail investors following price action in an attempt to get an edge on a market as dynamic as the Dow, it certainly would not hurt to keep this ticker on the radar screen. Here is the caveat: Sometimes bonds rally while stocks trend higher as well. Moreover, both markets have a tendency to trade lower together for a period of weeks, or even months. Fortunately, assets have seemed to flow out of one capital market and into the other during the last few months; creating a nice negative (inverse) relationship. Ok, time for some illustrations. Beginning with a daily chart of the December Bond (USZ2), prices clearly have followed a nice upward trend since mid-June. Moreover, the use of a regression line appears to have become pivotal as well. With the thinking that lower bond prices (meaning higher YIELDS) should gather interest into equities, traders should expect significant asset allocation (read: profit taking) out of bonds and into stocks once this contract enters back into the 112 handle. However, until that happens, most likely traders will be buying bonds on dips and keeping cash out of shares of blue chip or technology issues. U.S. Treasury Bonds, Daily When a daily chart looks slightly overextended, just like when doing technical analysis on stocks, a longer term chart pattern is then analyzed. A weekly chart of the 30-year (below) shows bonds could fall to 113-16 before finding support (note: low on Thursday was 113-14). Furthermore, the weekly chart shows a less overextended contract, giving the perception that the contract could rise to near 116-24 in the next week and still reside within the drawn weekly channel. As the recent saying goes, “If you know how many bonds you own, you don’t own enough.” In order for sentiment to shift towards more neutral levels, the 30-year bond most likely has to fall under 112-16 and back below significant relative lows as well as trading solidly into the bottom part of the regression channel. For a bearish signal, the US2Z contract will have to fall under 111-30. The most optimistic downside objective seems to be at 107 (wedge objective), while an upside objective is for a move to 120. U.S. Treasury Bonds (USZ2), Weekly The shortest timeframe I recommend is a 30-minute chart. Anything shorter and patterns become much harder to identify, unlike when looking at most equities and major market indices. After countless attempts with Bollinger Bands, RSI, Volume, Open Interest, etc.. I have found that stochastics work fairly well when analyzing the 30-year contract. As the chart shows, movement in stochastics above or below the band has proven to indicate solid selling or buying opportunities, respectively. Chart of U.S. Treasury Bonds (USZ2), 30 Minute Remember, when looking at a chart of the 30-year, try not to worry about where interest rates or yields are. Only be concerned about price action. Higher bond prices; equities should be headed lower. If bond prices are under pressure, equities should be finding a bid. A few historical notes: When the 30-year is higher or lower by a full point (32/32), most likely the reaction from equities will not reverse during the remainder of the session. Example: If bonds are lower by 1 point or more and stocks are trading higher, expect an underpinning bid in equities until the close of trading. Should a trader keep contracts overnight? Well, I don’t know everybody’s risk tolerance; however, bond futures are highly leveraged instruments (margin of 2,700 to leverage face value of 100,000) and movement in Europe and Asia can cause dramatic swings during overnight activity. Example: Short 10 contracts (margin of 27,000), flat on the previous day’s close, and bonds gap higher the following morning by 10 ticks (common). The immediate loss would be 31.25 times 10 times 10, or 3,125. In my opinion, watching the 30-year bond is a critical step towards profitable trading. For years, this contract would react to certain economic data and actually lead equities one way or the other. Even though it does appear that the Dow usually leads bonds, the psychological importance of the aforementioned support and resistance areas do not become diluted. If you write down one thing all night, make sure it has four characters: USZ2. You will not be mad that you did. Good luck. *********** OPTIONS 101 *********** Relative Strength Tool Flushes Out a Call Entry Buzz Lynn buzz@OptionInvestor.com Looks like Mr. Bear is about to lie down for a catnap. Yep, this has been one angry bear of a market to trade, and the bear isn't about to hibernate for the winter or even longer. But it does look like it's nap time! With that backdrop, we also have to acknowledge that playing near the bear cave is a risky proposition because we know at some point, he will come back out just as mean and angry as when he went in. So know that right here and now, as we embark on a bullish trade, it isn't bullish forever, just bullish for now. Ready? I want to launch from an article that Mark Phillips (Resident Rocket Scientist) wrote last night in Traders Corner titled, "Relativity - It's Not Just For Physicists". If you missed it, play catch up here, as this is one of the major screens I use in determining if a sector is doing better than the overall market. It yields clues to the next bullish play when it finally arrives. Just make sure it arrives before entering a bullish trade. There is no glory in being a helium balloon trapped in a down-moving elevator. We may be pinned to the ceiling, but that's little consolation when the ultimate destination is the in the basement. http://www.OptionInvestor.com/traderscorner/100902_2.asp So anyway, it's no longer a secret the biotech stocks (helium balloons) have performed admirably in relation to the rest of the market (down elevator). Should that elevator ever stop descent or even move up a few floors, biotechs will be the chart leaders. Take a look at the relative strength of the biotechs vs. the S&P 500. Biotechs vs. S&P 500 weekly/daily chart (index:BTK.X /index:SPX.X) It isn't difficult to see that the biotech index is steadily ascending in value compared to the S&P 500. In fact, just since early September, the BTK has increased from 36.5% to nearly 40% of the value of the S&P 500 - a nearly 10% relative gain. Today (see daily candle), it broke above the August-September relative strength cap. Thus, we can deduce that while the SPX was strong today, the BTK was even stronger. OK, Buzz. You've stated the obvious. We've seen that the biotechs are bullish compared to the rest of the market, which in itself turned seemingly bullish today. We've got the big trading principle: We're swimming with the current. Now what? Focus on the strokes of the fastest swimmer. For that we turn our attention directly to the biotech chart. In fact, to make it easy on ourselves, let's use a symbol where we don't need to start with a major fortune in order to make money. Instead of the BTK index, let's use the BBH (amex:BBH), or biotech HOLDR. It contains the biggest names in biotech - AMGN, DNA, CHIR, GILD, IDPH, MEDI, etc. - and makes a great proxy for the much more expensive BTK. BBH is currently priced at $82.10 while BTK is priced at $320. Biotech HOLDR chart BBH - (weekly/daily/60): Say, that's pretty impressive given the backdrop of the past few weeks, err, OK, months! Let's dissect this. First, we can see a series of higher lows on the weekly chart. Look too at the 5-period stochastics that have recently turned up. As testimony to BBH's relative strength, notice that the stochastic never reached oversold. The same can be said for the daily candles and oscillator too. Note on the daily chart that BBH broke out of resistance today, although barely. Caution: the squiggly magenta line is the 50-dma, which BBH did NOT clear today. That doesn’t' mean it won't eventually - may tomorrow - but $82 is clearly a highly visible resistance point. But based on the weekly/daily stochastics, I would say the odds favor an eventual break over the 50-dma, which would also represent a major breakout. The 60-min chart, however, is already overbought at resistance. For a trader, this is a lousy time to go long. The solution is merely to wait for the 60-min stochastic to cycle down (preferably to overbought or near it, but it isn't necessary) and await the next bullish cross where the blue stochastic line crosses over the red stochastic line. My best educated guess for an ideal scenario would be for the rally to continue tomorrow up to the final hour. Then, with the threat of war - and a general fear of the unknown - there could likely be some selling into the close. If the selling isn't too severe and the weekend doesn't yield any surprises somewhere in the world (and a company of market barometer proportions doesn't give an earnings warning), Monday may offer us the stochastic entry at the ascending support line around $79-$80. That's in a perfect world so don't bet on it happening exactly like this. Focus on the concept. I know, we've seen this before. It seems that every setup like this has suckered in a few peoples' capital only to see it burn in flames on a bearish reversal. The same could happen here, but there's one more acid test that BBH passed today that has me thinking there is a bullish play here of some duration. Perhaps only a week; maybe a month; maybe longer, but not likely a headfake this time around. What's the clue? Volume. BBH typically trades about 1.8 mln shares per day. Today, it traded nearly 2.5 mln shares. Over the past few weeks, it's unlikely that any short positions of significant size have been entered since a pro would not short BBH with any conviction given the relative strength compared to the overall market. Pros just won't do that. They would instead short into the weakest sectors. Example: Seen the utility index (UTX.X) lately? It's been hammered hard. But today, it was up over 7%. Why? Probably short covering, which would also explain the increase in volume in the utility stocks today. However, BBH showed us what we might call "organic volume" rather than short-covering volume. Short covering volume is derived from fear, as in, "I don't want to be short these utility stocks in an oversold market that looks ripe for a bounce". Organic volume is derived of desire for ownership, as in, "I want to own biotechs based on their relative strength behavior". I like the implication of that sort of volume. In wrapping this up, here are the two "takeaways" from this seemingly miscellaneous rambling: 1. Good relative strength, nice chart, strong volume; go long BBH when the 60-min stochastic cycles down and reverses upward, hopefully at the ascending support line. (Make money on a bullish BBH trade) 2. Remembering that our job is here is to first and foremost educate so we can all earn a living doing this by ourselves, think "principles" - ones that we can apply to every situation to determine the feasibility of making money on a trade. (Make money on any trade bullish that fits these parameters) a. Look for relative strength of the sector compared to the market (and relative strength of a stock compared to the sector if you trade an individual issue). b. Use technical indicators to reveal the prevailing trend and to time the trading entry. c. Confirm it with "organic" volume that isn't just short covering. How about that? A potential trade and education all in the same article! With that, a final note and reminder to make a great weekend for yourselves! See you next week. 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