The Option Investor Newsletter Thursday 10-17-2002 Copyright 2002, All rights reserved. 1 of 3 Redistribution in any form strictly prohibited. In Section One: Wrap: Earnings Shell Game Continues Futures Markets: Suffering From Gap Fever Index Trader Wrap: (See Note) Market Sentiment: Catching A Wave Weekly Manager Microscope: Kellner/English: FMI Common Stock (FMIMX) Updated on the site tonight: Swing Trader Game Plan: Gap, Gaps and More Gaps Posted online for subscribers at http://www.OptionInvestor.com ************************************************************ MARKET WRAP (view in courier font for table alignment) ************************************************************ 10-17-2002 High Low Volume Advance/Decline DJIA 8274.89 +238.90 8318.45 8038.24 2.09 bln 2235/1000 NASDAQ 1272.29 + 39.90 1283.21 1263.46 1.77 bln 2467/ 956 S&P 100 446.21 + 10.02 450.28 436.19 Totals 4702/1956 S&P 500 879.20 + 19.18 885.35 860.02 RUS 2000 362.57 + 11.72 362.57 350.85 DJ TRANS 2279.53 + 78.20 2283.36 2203.97 VIX 40.16 - 1.81 41.37 39.74 VXN 56.22 - 0.65 58.39 54.00 Total Vol 4,111M Total UpVol 3,223M Total DnVol 861M 52wk Highs 91 52wk Lows 239 TRIN 0.88 PUT/CALL 0.66 ************************************************************ Earnings Shell Game Continues Winners, losers and snoozers were the standard of the day. The IBM earnings last night set the stage for a nine-minute rally but the impact of its +7.30 gain lasted all day. Microsoft announced a huge earnings win after the bell and traded up +2.50 in after hours. SUNW beat estimates by two cents but warned that another -4000 would lose their jobs. Dow Chart Nasdaq Chart The big news was no news at all from IBM. They beat the street and did not warn going forward. They were not positive but they were not very negative either. Traders had been expecting some trouble at IBM and there was obviously a lot of short positions. IBM roared to a +7.30 point gain and powered the Dow to +285 numbers at the open. The rally lasted all of nine minutes. We went from zero to +285 and crashed into the resistance wall at Dow 8300, OEX 450. The Dow dropped back to 8250 by 9:54 and then traded in a very narrow 50 point range for the rest of the day. Dow Intraday Chart The hot news after the bell was the huge earnings win from Microsoft. Their 50 cent earnings beat estimates of 43 cents by a mile. The reason was a one time last chance sale of software licenses. Their old license plan changed as of June 30th and there was a rush to buy software at the old terms. They beat the revenue number of $7.1 billion with $7.75 billion as well. The key point here is that this is not a repeatable event. MSFT lowered their guidance for the 4Q to 45-46 cents and the street was expecting 50. That was ignored. The MSFT CFO said on the conference call that the "tech spending environment remains tough". The stock did bounce in after hours but only about $2.50 as traders realized that it was not from new business as much as just a change in sales methods. Another tech heavyweight on a diet, SUNW, beat the street by two cents but announced another round of layoffs. The company posted a loss only one quarter after returning to a profit. They declined to give expectations for the current quarter saying business had "unexpectedly" failed to improve in September. CEO Scott McNealy said "I am so far out of the forecasting game it does not even make sense" when asked about his take on the business outlook. The CFO said they were not seeing the normal seasonal uptick in purchases. SUNW said it would cut -4400 more jobs and take a $300 million charge in the next quarter. They said they were considering cutting capex spending from $2 billion in 2002 to $500 million. Sounds like there is still trouble in tech land. Adding to this consensus was an earnings miss by SEBL. They posted earnings of 3 cents compared to estimates of 5 cents and guided analysts lower. It appears the software sector is still tough if you are not Microsoft. CHKP warned that earnings would fall below estimates for the quarter. PSFT guided analysts to 14-15 cents when analysts had expected 14 cents. They qualified it by saying it was still very challenging to make predictions. Even EBAY guided analysts lower to 1.12-1.15 from analyst's estimates of 1.17. Gateway lowered its guidance for the next quarter to a loss of -10 to -13 cents when analysts were expecting only -9 cents. There was also a guidance warning from Broadcom. They are a major supplier to Cisco and the immediate thought was that Cisco was in trouble. In the conference call they said their networking chip business was stable but weakness in the sales of set top boxes was going to hold their sales flat in the 4Q. So Cisco may not be in serious trouble but consumers are slowing down on TV equipment. That touches an entirely different cord for the 4Q. The lowered guidance from BRCM as well as numerous other chip stocks over the last several weeks was borne out in the book-to-bill number. The headline number came out at only .84 with a drop of -19% in the orders for September. This was the second month of decline after seven months of increases. August bookings were also revised down. Getting to be a habit on the number circuit lately. In reality the headline number of .84 is significantly wrong when painting the real picture. The number is a three-month moving average and considering the last four months were 1.27 (May), 1.26, 1.22, 1.02 (Aug) to get a three month average of .84 the current real number has got to be much lower. Since we do not know the real numbers for any month it is hard to decipher how bad it was. I heard one analyst speculating that the September number may have been as low as 50. Here is the source: http://www.semi.org/web/wpress.nsf/url/booktobill The book-to-bill means for every $1.00 of orders shipped only 84 cents of new orders (actually significantly less) were received in Sept. This would mean that excess capacity is stacking up and more capex spending cuts are imminent. Excess capacity cost money and produces no revenue and that impacts earnings. With the Intel warning, the SUNW admission that there was no business at the end of the quarter the economy is not improving despite how bad everyone wants it. The Jobless Claims rose again this morning with the continuing claims rising to a 20 year high. There was an explosion of housing starts, the highest since 1986, but there is not going to be anybody with a job to buy the houses. Sears shocked everyone this morning by missing numbers by 21 cents. These were the numbers they affirmed just ten days ago. The problem was a larger than expected default rate from their credit card customers. They had to take a much larger reserve charge due to a rapidly rising rate of consumer bankruptcies. Capital One Financial said yesterday that they were abandoning the sub prime credit market because of the rapidly increasing credit risk. Think the consumer is going to rush to the rescue in the 4Q? http://www.northerntrust.com/library/econ_research/weekly/us/020918.html Need more proof? The Philadelphia Fed Survey came in with a drop to -13.1 compared to estimates of a gain of 2.3. This indicates a rapid contraction in the manufacturing sector. How many times do we have to take the patients temperature before we agree that they are still sick? The airline sector was represented by earnings from NWAC, CAL and LUV and it was not a pretty picture. Tomorrow DAL announces earnings and they announced today they were cutting -8000 more jobs. What will Friday bring? The futures are up +9.50 as I write this but the semi stocks will not be impacted from the late book-to-bill report until tomorrow. Still I expect the markets to open up on the strength of the Microsoft numbers as retail investors rush to buy this huge win, oblivious to the fact that it is a one time event and they lowered guidance for the 4Q. The Dow closed at 8271 and has very strong resistance at 8300, 8350 and 8400. With MSFT in the Dow we should get the mandatory morning gap which will be completely impossible to trade and then another pause for a direction check. With over 35% of the S&P announcing earnings this week and almost all the major players there will not be the high visibility targets of opportunity next week. This could pose a problem for traders looking for new hope. Don't get me wrong. The October madness is in full control. Fundamentals and economics don't count. The majority of tech stocks are trading at nearly twice the PE that they had as of Oct-2000 yet the economy is extremely worse. Surprised? QCOM at 236, MSFT at 40, INTC 49, and that is for companies that still have earnings. Something you might want to think about is that Oct-19th, 1987 the Dow dropped -22.6% in one day. This is not 1987 and the chart comparisons are not even close but I bring it up to note that sudden changes in altitude tend to occur in the 2nd and 3rd weeks of October. Rebounds tend to occur in the last week. We are 2.5 weeks into the month with two weeks to go and we got zero follow through from the opening bounce this morning. That does not paint a pretty picture. Enter Very Passively, Exit Very Aggressively! Jim Brown Editor *************** FUTURES MARKETS *************** Suffering From Gap Fever by Alan Hewko futures@OptionInvestor.com As the title suggests, the last week of trading has been plagued with serious overnight or after-hours moves that have caused very large Gap Ups and Gap Downs. This has made trading more than a little frustrating in the process. As this is also Equity Option expiry week; that fact has only added to the extreme volatility. As previously done, I shall use these abbreviations for this article: ES = E-mini SP500 December futures YM = E-mini Dow $5 December futures NQ = E-mini NDX 100 December futures Quotes: 4:15 PM ES 879, YM 8253, NQ 944 (pre MSFT) 8:00 PM ES 887, YM 8341, NQ 961 (post MSFT) In the last six trading days, we have seen five positive days. The only down day was Wednesday after Tuesday nights terrible Intel earnings. Last night's IBM earnings was the catalyst for the large gap up we saw Thursday morning, evidence of which can be seen in the below ES overnight chart. Chart: ES02Z After-hours action Other reasons besides IBM's earnings were some very bullish housing numbers, good earnings from United Technologies (UTX) $60 +6 and Eastman Kodak (EK) $32.50 +2.50. All 3 of these stocks are Dow 30 stocks. Some bad news came from Sears (S) $23.20 - 10. This continued bad news from the Retail sector had the RLX index, as well as WMT red for the day. There was news on North Korea having nuclear weapons, and President Bush's concerns over this - some periods in the market, that news also would have been a reason to sell; but it wasn't. Making observations such as this, at times, can help establish a feel for what the market wants to do: go up - or - go down. The market tone remains "ignore any bad news and focus on any good (or inline) news. Almost two-thirds of the companies in the Standard & Poor's 500 Index that have published quarterly results have exceeded estimates. The morning gap quickly faded during the first 30 minutes of trading, sending ES down 10 points in 30 minutes from 888 to 876- 878. From 10 AM to the Close, ES traded in a sideways 6 point range between 876 to 882. In a similar fashion, Dow saw opening levels of 8300, had 30 minutes of profiting to the 8230-8250 level and remained sideways the rest of the day. NQ spent the majority of the day at the 950 level, trading no more than 10 points above and below that level. As the 2 below charts of Thursday's market day shows, unless you either came into the day long, or shorted the open and took profits 30 minutes later; frankly, there wasn't many other trading available. Chart: ES (E-mini SP500 futures) Thursday 9:15 AM to 4:15 PM Chart: NQ (E-mini NDX 100 futures Thursday 9:15 AM to 4:15 PM This is a chart of YM (Dow $5 Futures and NOT the regular Dow (cash index) chart you may be used to seeing. It shows Wednesday night overnights move higher off IBM, the total sideway Thursday rangebound area, and then Thursday after- hours reaction to MSFT earnings. Chart: Dow Futures (YM02Z) Afterhours-regular session-afterhours And then came MSFT... The afternoon futures volume was extremely thin as everyone was waiting for the big-gun tonight: Microsoft (MSFT)'s earnings. As you likely know by now, MSFT had impressive earnings of 50 cents, beating the expected number of 43 cents, and even the whisper number of 45 cents. Revenues were higher as well. One might even say "past 10 AM, the real trading day didn't start up again until MSFT came out with earnings about 4:18 PM One important comment, ES and NQ futures were closed when MSFT reported; however Dow futures don't close until 5 PM, so it was possible to take a Long Dow futures trade once MSFT's beating by 7 cents came out at 4:18 PM. As a FYI, Dow futures Ask prices after MSFT came out were 8270 to 8290 area, and with them trading at 8330-8350 before they closed at 5 PM, a trade was possible. The big 3 tech earnings this week were INTC, IBM, and MSFT. INTC - terrible - maker of chips (hardware) IBM - good - tech services and software were strong MSFT - good - software One might say that a company who is only making tech chips is hurting, and the software and computer services business is better. This week also saw good earnings from Banks, Insurance sector, manufacturing companies such as UTX and EK. Thursday futures overnights Off of MSFT earnings, futures continued their rally in the overnight markets, the below chart shows ES futures reaction once they re-open at 4:45 PM. Chart: ES02Z - afterhours action after MSFT's earnings. Thoughts for Friday: ES is 888 at 8 PM EST, its next higher level of resistance is 892-895, followed by the psych level of 900, then 902-905. As perspective, ES opened Sep 11 2002 at 930, and saw year lows at 767 on October 10th. Friday is option expiration for October Equity options. Option Fridays are often either very boring with all the action over by 10 AM, or are sometimes extremely volatile. Friday pre-open has earnings from : Biogen (BGEN), Merck (MRK), Tellabs (TLAB) and about 20 lesser companies. Friday pre-open economic data of : Trade Balance, CPI, Core CPI all at 8:30 AM Once again, traders Friday morning will have a large Gap Up and futures traders must focus on where key large-cap stocks may close at for the usual option Friday expiry "games" as they often close at strike prices, or right in-between. MSFT $53.15 tonight; so will it close at $50, $52.15, or $55 as one example. One must consider the possibility of "Sell the News" I wrote this Sunday about how October options are very popular with "smart money" as they put down positions in the springtime. Once those October option positions all come off tomorrow, might next week become a "Sell the News" situation as Longs finally get to take profits ? - or - are there still Shorts "trapped" in currently losing positions as they continue to add to their shorts as that as worked for 2 years. For a Futures Trader - option Fridays are sometimes a good day to try and put down a good trade early in the morning, take profit; and then come back this coming Monday to see if it does indeed become "Sell the News" or not. So far this year : 10/10 remains "the bottom"; meaningless observation, but consider the 9/11 number : add 1 to 9 to get 10, subtract 1 from 11 to get 10 and there you have 10/10. Alan Hewko futures@OptionInvestor.com ******************** INDEX TRADER SUMMARY ******************** Dow 8,700? Despite mixed economic data the major market indexes gained back yesterday's losses and then some as bulls cheered a stronger than expected housing starts number for September along with a rising building permits indication and an upside earning's surprise from IBM (NYSE:IBM) $72.20 +11.24%. Even a much weaker than expected Philly Fed report of -13.1 for October, which was well below consensus estimates of +1.9 didn't appear to squash intra-day bullish enthusiasm. Stock futures built gains after the close of the regular session when Dow components and NASDAQ-100 heavyweight Microsoft (NASDAQ:MSFT) $50.75 +0.67% added $2.39 from its close when the company reported earnings of $0.55 per share, blowing away analyst's estimates of $0.43 per share. Dow Jones Chart - Daily Interval The Dow didn't close above my 8,280 level today and that made it tough to hold any large positions overnight, especially with Microsoft (MSFT) earnings in the balance. While I've never considered "after hours" trading really indicative of a true market response, trading in both the futures markets and MSFT in extended hours hints of a higher open. For bulls, the main thing to be looking for into tomorrow's close is any type of "sell the news" reversal like I pointed to in the above chart. Any type of reversal and close at a session low tomorrow would be viewed as a near-term negative. The best way to protect a bullish trade initiated at tomorrow's open would be to follow with a stop just under 8,170. I currently think the Dow trades 8700 before month's end. Tonight's Dow Bullish % ($BPINDU) reading shows a net gain of 2 stocks to point and figure buy signals as the bullish % grows to 43.33%. SPDRS Chart - Daily Interval Index options expired today and SPY options expire tomorrow. Trading should be brisk and I wouldn't be surprised to see SPY 90 tested tomorrow. Just as I'd be on the alert for any type of "sell the news" reversal in the Dow, same goes for the S&Ps. If we would see that type of reversal take place, then I think bulls that have been looking for a pullback near 83.77 might just get it. A nice tight stop for new bullish trades would be just under the 88.16 level. The S&P 500 Bullish % ($BPSPX) saw a net gain of 16 stocks to point and figure buy signals today, raising the bullish % to 36.6%. In late August, the bullish % reached 58% before reversing lower to 20% in early October. The narrower S&P 100 Bullish % ($BPOEX) saw a net gain of 4 stocks to point and figure buy signals, raising the bullish % to 41%. In late August, the bullish % reached 58%, before reversing down to a low of 18% in early October. NASDAQ-100 Trust Index (QQQ) - Daily Interval You'd better have some stick-um on your hairpiece if you're going to trade the Q's as they've been gapping up and down with wild abandon. With MSFT being the most heavily weighted stock in the Q's, I think its going to take a MSFT trade above $55 to get the Q's up to $24.21. I'm still assessing downside risk to $22.21. Why? Tonight... Sun Microsystems (NASDAQ:SUNW) $2.99 +6.78% said it was cutting its own capital expenditures for FY03 to $500 million, which is down from FY02 spending of $2 billion. While SUNW has a lot of "stock specific" problems they are dealing with, those cuts in capital expenditure are alarming and will most likely bring further volatility and uncertainty to the group. The NASDAQ-100 Bullish % ($BPNDX) saw a net gain of 4 stocks to point and figure buy signals, raising the bullish % to 40%. As a benchmark, the relative high reading in August was 60% before its reversal down to 14% in early October. 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 **************** Catching A Wave by Steven Price The Dow rebound, on the heels of IBM's earning's surprise last night, stopped dead at the plethora of resistance between 8277 and 8400. These resistance levels included the 50-dma, two Fibonacci retracement levels (one from the previous rally) and a previous level of significant support (8305). The bears got their meat, when it appeared there was a ceiling in place, but it looks like they may have to go back into hibernation after Microsoft (MSFT) blew away earnings estimates after the bell. There are some significant barriers overhead, but with Microsoft already up over $2 after hours, there is a good chance we will get through those levels. I will be watching 8359 closely, as that is the last level of the significant resistance I see between where we closed and 8600. That is not to say my long-term market prognosis is rosy. Lost among the bull stampede was this morning's weekly employment data, which showed an increase of 22,000 jobless claims to 411,000 and was higher than estimates of 398,000. That number won't be helped any in the future by Delta Airlines, which announced plans to lay off up to 8,000 more workers, due to "dramatically lower demand for air travel" and "unprecedented financial losses." Sun Microsystems is also laying of 4,400 workers, but more about that later. The airlines are still reeling, without much of a light at the end of the tunnel. Southwest Airlines actually reported a profit today, but said it could not predict whether it will earn a profit in the fourth quarter. Continental, which lost 55 cents per share, said it had no prediction on when it could return to profitability. Several airlines did get a boost today, but only because losses were narrower than expected. For those flyers concerned with a possible United bankruptcy, I was assured today by a nameless, faceless voice at customer service that frequent flier miles would not be affected, for whatever that's worth. Additional economic data released this morning showed industrial output fell 0.1% in September, reflecting a drop in production of business equipment. Businesses continue to cut spending to make up for lost revenue and that hasn't changed simply because companies are beating lowered earnings expectations. Drops in capacity utilization, manufacturing output, and mining output accompanied that decline. In August, total output dropped 0.3%, while manufacturing output fell 0.2%. Sun Microsystems (SUNW) beat expectations after the bell, by losing only 2 cents per share. The company also announced job cuts of up to 4,400 workers, or 11% of its workforce. Sun said it would be lowering its capital expenditures for 2003 from approximately $2 billion in 2002, to under $500 million - a staggering 75% decline. It appears that the host of companies complaining about IT spending are right on target when they say they don't see a turnaround any time soon. However, what this tells me is that it will be at least 2004 before that turnaround occurs, as companies slash next year's budgets following this year's losses. There was some positive economic data, as housing starts jumped 13% to the highest level in 16 years, and the highest percentage gain in 7 years. The number of single-family homes started rose 18% to 1.48 million, the highest level in 24 years. EBay beat earnings forecasts and showed listings up 47% over last year. It also raised sales projections for the current quarter. However, its online transaction revenue increase was tempered by a 40% decline in revenue and the stock traded down $1.40 after hours. Earnings season tends to hide internal economic data. That's not to say that no one is paying attention, but the "stories" are generally focused on who beat and who missed. Don't lose sight of what's behind the curtain, as many companies are "beating" severely reduced forecasts. That doesn't mean the market won't swing higher on positive earnings reports. As traders, all we really care about is making a profit, not being "right." So catch the wave, but be ready to bail out when the music stops and basic economics kick back in. ----------------------------------------------------------------- Market Averages DJIA ($INDU) 52-week High: 10679 52-week Low : 7286 Current : 8275 Moving Averages: (Simple) 10-dma: 7754 50-dma: 8270 200-dma: 9380 S&P 500 ($SPX) 52-week High: 1176 52-week Low : 775 Current : 879 Moving Averages: (Simple) 10-dma: 825 50-dma: 877 200-dma: 1016 Nasdaq-100 ($NDX) 52-week High: 1734 52-week Low : 795 Current : 945 Moving Averages: (Simple) 10-dma: 868 50-dma: 914 200-dma: 1199 ----------------------------------------------------------------- The Semiconductor Index (SOX.X): I'm getting whiplash watching this group bounce around the last few days. First we get bad news from Intel, then good news from QLogic. The good news from IBM was really more about services making up for the drop in hardware, so I'll out that factor in the negative bin. I keep thinking back to Intel's cautious comments about the fourth quarter. It will be awfully tough to overcome a rough quarter for the world's biggest chipmaker. Sun Micro said it was cutting cap ex by 75% next year, but Microsoft beat earnings and traded up over $2 after hours. While this may help lift the sector, MSFT's profits have come partially from long-term licensing agreements, rather than PC sales. I can see the sector getting a lift tomorrow, but my long-term outlook is still negative until we see positive growth in PC sales or cap ex. 52-week High: 657 52-week Low : 263 Current : 266 Moving Averages: (Simple) 10-dma: 237 50-dma: 280 200-dma: 443 ----------------------------------------------------------------- Market Volatility Today's rally still didn't push the VIX below 40. While another rally on the Microsoft earnings may do the trick, it's obvious that OEX traders still haven't completely bought into the rally. When that happens, we'll see a diving VIX, but with earnings season in full swing, expect to see some premium support for a while. Even a VIX in the 35 range is considered on the high end, so it could be a while before we return to "normal" levels in the 20s. CBOE Market Volatility Index (VIX) = 40.16 –1.81 Nasdaq-100 Volatility Index (VXN) = 56.22 –0.65 ----------------------------------------------------------------- Put/Call Ratio Call Volume Put Volume Total 0.66 1,103,799 729,719 Equity Only 0.52 781,618 409,163 OEX 1.14 58,139 66,199 QQQ 0.75 137,981 103,643 ----------------------------------------------------------------- Bullish Percent Data Current Change Status NYSE 31 + 1 Bull Correction NASDAQ-100 41 + 3 Bull Alert Dow Indust. 43 + 6 Bull Confirmed S&P 500 37 + 4 Bull Alert S&P 100 41 + 5 Bull Alert 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 0.86 10-Day Arms Index 1.07 21-Day Arms Index 1.29 55-Day Arms Index 1.33 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 2048 713 NASDAQ 2363 894 New Highs New Lows NYSE 35 74 NASDAQ 46 100 Volume (in millions) NYSE 2,073 NASDAQ 1,806 ----------------------------------------------------------------- Commitments Of Traders Report: 10/08/02 Weekly COT report discloses positions held by small specs and commercial traders of index futures contracts at the Chicago Mercantile Exchange and Chicago Board of Trade. COT data can be found at www.cftc.gov. Small specs are the general trading public with commercials being financial institutions. Commercials are historically on the correct side of future trend changes while small specs tend to be wrong. S&P 500 Commercials got shorter, as they increased both positions, by increased shorts by an additional 1600 contracts. Small Traders also added significantly to both sides, but added an additional 1800 contracts to the long side. Commercials Long Short Net % Of OI 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%) 10/08/02 427,070 445,135 (18,065) (2.1%) 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 09/17/02 182,243 116,377 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% 10/08/02 131,486 81,010 50,476 23.7% Most bearish reading of the year: 36,513 - 5/01/01 Most bullish reading of the year: 114,510 - 3/26/02 NASDAQ-100 Commercials increased short positions by 2,500 contracts, while reducing longs by 700. Small traders reduced longs by 1,000, but reduced shorts by 4,000, getting decidedly longer. Commercials Long Short Net % of OI 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%) 10/08/02 45,384 55,504 (10,120) (10.0%) 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 09/17/02 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% 10/08/02 10,735 5,721 5,014 30.4% Most bearish reading of the year: (10,769) - 06/11/02 Most bullish reading of the year: 8,460 - 3/13/02 DOW JONES INDUSTRIAL Commercials increased long positions slightly, and added 3,000 short contracts, reducing the net long position significantly. Small traders increased long positions by 1,000 contracts and lowered shorts by the same amount, reducing the net short position by 50%. Commercials Long Short Net % of OI 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% 10/08/02 19,550 11,823 7,727 24.6% 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 09/17/02 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%) 10/08/02 7,890 9,645 (1,755) (10.0%) Most bearish reading of the year: (8,777) - 10/12/01 Most bullish reading of the year: 1,909 - 1/16/01 ----------------------------------------------------------------- ************************Advertisement************************* ”If you haven’t traded options online – you haven’t really traded options,” claims author Larry Spears in his new compact guide book: “7 Steps to Success – Trading Options Online”. Order today and save 25% (only $15) by clicking on PreferredTrade and clicking on the link to the book on its home page. http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ************************* WEEKLY MANAGER MICROSCOPE ************************* Kellner/English: FMI Common Stock (FMIMX) Ted Kellner is the founder, chairman and chief executive officer of Fiduciary Management Inc. of Milwaukee, Wisconsin, investment advisor to the flagship FMI Common Stock Fund (FMIMX). The fund reflects FMI's core philosophy, buying good businesses at "value" prices and emphasizing small/mid-cap companies with above-average growth or improving profitability prospects. Kellner has 32 years of investment experience. The University of Wisconsin graduate is a former vice president at Nicholas Company Inc. (1973-1980) and Brittingham Inc. (1969-1973). Further, he's a member and former president of the Milwaukee Investment Analyst Society. In 1980, Kellner founded FMI, an independent investment firm managing $1.4 billion in assets today for pension and profit sharing trusts, Taft-Hartley funds, insurance company portfolios, endowments and personal trusts, and mutual funds. Assisting Ted Kellner with the day-to-day management of the fund since October 1997 has been Patrick J. English, FMI's director of equity research. English, a graduate of Stanford University, has 16 years of investment experience. Prior to joining FMI, English was a research analyst with Dodge & Cox Inc. (1985-1986). He's a member of the Milwaukee Investment Analyst Society. Both Kellner and English are certified financial analysts (CFA's), an industry designation for investment management professionals. Kellner has been associated with the day-to-day management of the FMI Common Stock Fund since its December 1981 inception. In this charge, he emphasizes fundamentals in his "bottom-up" approach to investing, producing an average annual total return of nearly 13% since inception. The fund's 3-year average total return of 12.1% through October 16, 2002 ranks in the "top 1%" of the Morningstar mid-value category, outperforming the S&P 500 index by 22.7%/year and the S&P Midcap 400 index by 6.9%/year on average. FMI Common Stock Fund (FMIMX) is available on a no-load basis and has a low minimum initial investment of $1,000. You can purchase shares directly or through one of several fund marketplaces, such as Charles Schwab's OneSource service, which offers the fund on a no-load, no-transaction fee (NTF) basis. Despite its solid track record, FMI Common Stock Fund is still relatively unknown to most investors, with just $92.8 million in net assets. Complete fund information is available at www.fiduciarymgt.com. Management Approach The investment philosophy that guides the FMI Common Stock Fund is simple. FMI's objective is to buy good businesses at "value" prices with the goal of achieving outstanding investment results over a three to four year time horizon. Kellner and FMI believe this goal is best achieved through investing in a limited number (35-45) of small/mid-cap stocks. The website indicates some of the characteristics that Kellner's firm looks for in a good business. These include a strong niche which is defendable and difficult to replicate, a high recurring revenue stream, modestly priced products or services, attractive return-on-investment (ROI) economics, and above-average earnings growth or improving profitability prospects. To isolate these companies, Kellner and English use a "bottom-up" research process that includes visits with management, customers, suppliers, etc. This bottom-up research process is combined with detailed fundamental analysis of financial statements. Valuation is studied from both an absolute and relative (versus the market) standpoint, the website states, and encompasses both a historical and prospective view. In making investment decisions, Kellner and English strive to buy stocks at valuations that do not adequately reflect future growth (earnings) prospects. It's the combination of these fundamentals (good business and value price) that drive the investment process at FMI. They strongly believe that both conditions must be there to achieve superior long-term investment performance (and provide protection against adverse developments). The firm's sell discipline is relatively simple as well. Kellner and English will sell stocks when they become "overvalued." They recognize that in an euphoric market, like the 1990's, overvalued stocks can rise further but that there is a "greater fool" theory to contend with, the part of the market cycle they say is fraught with risk. They'll also sell when they determine they were wrong in the fundamentals story as they put it. They'll trim positions that have become too large through dramatic appreciation as well. Because FMI believes that timing the market is very difficult and valuation parameters of individual securities change, the fund's cash levels may vary. Overvalued securities may be sold without an immediate replacement, resulting in a "temporary build-up" of cash reserves. Morningstar's report indicates a 9.1% cash stake at July 31, 2002. In terms of diversification, FMI portfolios will generally hold around 35 to 45 stocks, less than half the typical institutional account or mutual fund, the website reports. FMI believes that the benefits of diversification diminish greatly after about 20 stocks. Ideally they'd like to concentrate assets in 20 stocks, but since FMI Common Stock Fund has a small/mid-cap focus which creates some liquidity constraints, they will typically hold 20 additional smaller-sized positions. FMI doesn't feel that all industrial classifications need to be represented in the portfolios they manage. Accordingly, Kellner and English may weigh some sectors well above the market. At July 31, 2002, the fund was significantly overweighted to the business services sector (3.8x to the S&P 500 and 1.6x to the mid-blend category average) as an example. Morningstar's fund report indicates the FMI Common Stock Fund portfolio had a median market cap of $1.57 billion at July 31, 2002, with 58% of stocks held in the mid-cap sector and 41% in the small-cap sector. True to its core investment philosophy, the fund's average growth rates were higher than the market as measured by the S&P 500 index, while maintaining below average valuations relative to the market. Overall, this results in a mid-cap blend (core) style. Returns and Ratings On a YTD basis through October 16, 2002, FMI Common Stock Fund has lost 11.6%, ranking in the top decile of the mid-cap value category per Morningstar. While a negative figure, Kellner and English have preserved capital considerably better than similar funds and index benchmarks. The S&P 500 large-cap index is off 24.2% since December 31, while the S&P Midcap 400 index is down 20 percent. FMI Common Stock Fund is down just 1.4% over the past 12 months, ranking in the category's top 3 percent. And, over the trailing 3-year period through October 16, 2002, the fund sports a 12.1% average annual total return, ranking in the mid-blend category's top 1 percent. For this 3-year period, Morningstar grades the fund's returns as "high" relative to other mid-blend funds and its risk as "below average," for an overall star rating of "5 stars," their highest rating. For the trailing 5-year and 10-year periods, FMI Common Stock Fund has had "above average" returns, with "below average" risk, relative to its category peer group, for an overall rating of "4 stars." Below is a summary of the fund's trailing 3-year, 5-year and 10- year returns (10-year numbers are as of September 30, 2002), per Morningstar: 3-Year Annualized: FMIMX +12.1% (+22.6% to S&P 500) (+6.9% to S&P 400) Percentile Rank in Category: 1 5-Year Annualized: FMIMX +5.0% (+5.7% to S&P 500) (-0.2% to S&P 400) Percentile Rank in Category: 14 10-Year Annualized: FMIMX +11.9% (+2.9% to S&P 500) (-0.7% to S&P 400) Percentile Rank in Category: 25 So, Kellner has delivered top quartile performance or better over the past decade within the mid-blend category. Lipper recognizes the fund's achievement also. It awards FMI Common Stock Fund its highest ratings for "total return" performance and "preservation" over the trailing 36-month period through September 30, 2002. In the Lipper Leaders system, Lipper rates funds against their broad peer group (in this case, all equity funds). The fund has "above average" ratings for "consistency" of returns and "expense". The fund's 1.20% expense ratio is 20 basis points below the mid-blend category average (1.40%). In the last three years, Kellner and English have held volatility in check as evidenced by its 16.4% average standard deviation per Morningstar. That compares with 21.3% for the average U.S. stock fund and 20.0% for the average mid-cap blend fund. The fund also sports a relatively high "alpha" of 16.3 versus the S&P 500 index and 6.3 versus the S&P Midcap 400 index. A high positive "alpha" is an indication of how well the fund manager(s) has done in risk adjusted terms versus the market (i.e. index benchmarks). Conclusion Because the FMI Common Stock Fund is less diversified than other mid-cap blend funds and its portfolio turnover is relatively low, its return may sometimes lag the market and other types of funds. For example, the fund lagged in 1998-1999 when growth stock funds led the way. However, FMI Common Stock Fund has generated "above average" returns with "below average" risk over the longer period under Kellner's direction. Long-term, risk-conscious investors seeking a small/mid-cap blend fund have a fine choice here. It would make a nice compliment to a portfolio consisting of large-cap stocks and funds. 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 *********************** Gap, Gaps and More Gaps We appear doomed to yet another impossible to trade gap but after the zero follow through today there may be quite a few less traders willing to go long. With the multitude of warnings after the close being overshadowed by the Microsoft earnings, Friday morning could be the last one in this series. To read the rest of the Swing Trader Game Plan Click here: http://www.OptionInvestor.com/itrader/indexes/swing.asp FREE TRIAL READERS ****************** If you like the results you have been receiving we would welcome you as a permanent subscriber. The monthly subscription price is 39.95. The quarterly price is 99.95 which is $20 off the monthly rate. We would like to have you as a subscriber. You may subscribe at any time but your subscription will not start until your free trial is over. To subscribe you may go to our website at www.OptionInvestor.com and click on "subscribe" to use our secure credit card server or you may simply send an email to "Contact Support" with your credit card information,(number, exp date, name) or you may call us at 303-797-0200 and give us the information over the phone. 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The Option Investor Newsletter Thursday 10-17-2002 Copyright 2002, All rights reserved. 2 of 3 Redistribution in any form strictly prohibited. In Section Two: Dropped Calls: LLY, MME Dropped Puts: DIA Daily Results Call Play Updates: ITMN, NPSP New Calls Plays: None Put Play Updates: C, GIS New Put Plays: OMC, EBAY, KSS **************** 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: ***** LLY $63.00 -0.66 (+1.00 for the week) this call play, originally entered at $62.00, showed great promise, setting higher levels of daily support on the round numbers for the last several days. It also showed gains in 6 of the previous 7 trading sessions. Unfortunately, the stock seems to have run out of steam, finding resistance at $64 the last two days, with recent highs of $64.00 and $64.01. There is also the 200-dma of $65.45 looming above. We would have expected a push through the $64 barrier on a big up day, but instead we got a pullback. We are closing the play for a small profit, however, if the stock were to take out the $64 level on the open, we would not argue with investors who wanted to remain long. --- MME $41.06 -0.56 (+0.81) Increasing volatility is not the recipe for a successful option trade, and MME has been getting wilder by the day, as volume has remained very heavy over the past week. While the heavy volume was useful for raising the stock up above $43 both Tuesday and today, in both occasions, the stock dropped back very quickly, on correspondingly heavy volume. MME's inability to hold onto its intraday gains this week in the face of a rising market is not encouraging, prompting us to drop the play tonight. The intraday lows have been coming in near $40.50, and if holding open positions, we would recommend using any rebound off that level in the morning to exit the play. A breakdown below $40 will likely have the stock dropping back down to the $38 level in short order. If you elect to keep positions open, we would recommend raising your stop to $40. PUTS: ***** DIA $82.84 +2.52 (+3.85 for the week) The Diamonds, which are based on the Dow Jones, rebounded right back up to resistance today, following IBM's positive earnings. They felt short of the 50-dma of $82.94, after trading above it briefly. There is plenty of resistance between $83 and $84, corresponding with the 61.8% Dow retracement bracket of the recent drop from August to October, the 50-dma and previous Dow support at 8305. However, after seeing support hold at 8000 yesterday, we don't want to get caught bouncing in a tight range while premiums decay. We will close the play and wait for evidence of another breakdown. If we get that breakdown, we may be "diamond shopping" again. *********************************************************** DAILY RESULTS *********************************************************** Please view this in COURIER 10 font for alignment ************************************************* CALLS Mon Tue Wed Thu Week ITMN 36.10 1.88 1.29 -0.52 0.89 higher lows LLY 63.00 -0.02 2.02 -0.25 –0.66 Drop,$64 tough MME 41.06 1.53 -0.31 -0.45 –0.56 Drop, Big Red Candle NPSP 27.00 0.40 2.02 -0.23 0.67 Room Above PUTS DIA 82.84 0.99 3.86 -1.95 2.04 Drop, ranging EBAY 58.13 2.00 0.45 -0.08 0.15 New, lots to give GIS 42.40 1.33 -0.02 -0.17 –0.25 careful with entry KSS 55.11 0.99 -0.81 -1.34 –2.16 New, bounce over OMC 57.84 1.54 -0.46 -0.54 –2.94 New, industry sympathy ************************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 $36.10 +0.89 (+3.87 for the week) ITMN has just gone about its business of climbing slowly higher since the pullback to its 200-dma on October 7. The company has been rising on the strength of several products, with Actimmune the most prominent. The drug, which is currently used for two life-threatening congenital diseases in children - chronic granulomatous disease and malignant osteopetrosis, has also shown promise in the treatment of idiopathic pulmonary fibrosis, a usually fatal disease for which there are no effective treatment options. According to CEO Scott Harkonen," Actimmune is the only available treatment demonstrated to have clinical benefit in IPF, with improved survival data in two controlled clinical trials. We believe these results will support use of Actimmune and lead to peak sales in the range of $400 - $500 million per year, enabling us to achieve profitability in 2004 as planned." The stock was recently initiated with a "strong buy" recommendation from Banc of America Securities and has announced progress on a new once weekly Actimmune dosing therapy. This morning Priority Healthcare made positive comments about the drug in its own earnings call, giving ITMN another boost. The stock has traded over $37.00 on each of the last three days, but found resistance at $37.50. We would look for a trade above that level for new entries. The stock also seems to have found a new floor around $34.50, so a pullback to that level would be an alternative entry point. --- NPSP $27.00 +0.67 (+2.80) Biotechnology bulls may be disappointed to see the BTK index only advance 1.8% on a day that saw the NASDAQ-100 vault higher by 3.8%. But believe it or not, this is an encouraging sign for our NPSP play. This huge moves in the broad markets are largely being fueled by shorts covering, and that indicates a lack of sustained buying. The fact that the Biotechs aren't seeing such heavy short-covering, lends credence to the idea that the current rally in the sector still has some room to run. Reflecting the lack of enthusiasm for either buying or selling during the day on Thursday, shares of NPSP traded in a very narrow range after the opening volatility settled out. That is actually encouraging, after the sharp pullback that followed Wednesday morning's moon-shot rally. NPSP held its ground, and appears to be trying to build some support above the 200-dma before the next upward leg. Intraday dips that rebound from either the $26 level or even down near $24.75 both look attractive for new entries. Wednesday's price action is a perfect example of why we would recommend extreme caution for those attempting to buy a breakout. Raise stops to $24 tonight. ************** NEW CALL PLAYS ************** None ************************Advertisement************************* ”If you haven’t traded options online – you haven’t really traded options,” claims author Larry Spears in his new compact guide book: “7 Steps to Success – Trading Options Online”. Order today and save 25% (only $15) by clicking on PreferredTrade and clicking on the link to the book on its home page. http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ******************* PLAY UPDATES - PUTS ******************* C $35.75 +1.90 (+5.35) Following IBM's better than expected earnings report last night, the broad market got a fresh shot of adrenaline and rallied hard at the open today. Financial stocks were among the best performers, with the Broker/Dealer index (XBD.X) vaulting higher by more than 5%. C performed in-line with the group, tacking on close to $2, making its gains since reporting earnings a whopping $5.44 (17.9%). Sure it was oversold heading into the earnings report and most of this rise is simply shorts covering. But it is interesting how the stock topped out today right at the $36 resistance. MSFT beat earnings tonight and that is likely to have C opening with another solid gain in the morning, so the key will be to watch how it behaves in the $36.00-36.50 area. If the rally tops out and fails there, then we can look to enter new positions on the rollover. A more conservative approach will be to wait for the stock to drop under $34.50 (just below Thursday's intraday lows) in conjunction with the XBD index falling back under the $380 support level. Remember that our stop is set at $36.50. If the stock rallies through that level tomorrow and holds, then clearly we'll drop the play this weekend. --- GIS $42.40 -0.25 (+0.90) As encouraging as it has been to see GIS refuse to participate in the recent market rally, it has been equally frustrating to see that it just won't break down. The intraday range this week has been wild, to say the least. While a $1.00-1.50 range may not seem like much, it represents big moves for GIS, which normally tends to keep its intraday moves to less than $1. Pivotal in the recent price action is the $41.50 level, which is both significant historical support, as well as the site of the ascending trendline connecting the higher lows since late July. The 10-dma (currently $43.03) is keeping a lid on the intraday rallies and aggressive traders can consider new entries on a rally failure near this level. In the wake of their recent debt downgrade, GIS is clearly being propped up by the broad market strength. If that supportive factor is removed, then GIS bulls should have the rug yanked out from under them. The safer entry strategy will be to enter the play on a decisive break of the $41.25 level, which is just below last Friday's intraday low. Keep stops in place at $43.50. ************* NEW PUT PLAYS ************* OMC - Omnicom - $57.84 -2.94 (+1.77 for the week) Company Summary: Omnicom Group Inc. is a leading global marketing and corporate communications company. Omnicom's branded networks and numerous specialty firms provide advertising, strategic media planning and buying, direct and promotional marketing, public relations, and other specialty communications services to more than 5,000 clients in more than 100 countries Why We Like It: OMC rebounded strongly in the last week, riding the rising tide. The stock traded as low as $48.25 on October 8, before topping out just over $61 on Wednesday. The stock was unable to hold that level Wednesday and began to give back its gains today. It failed to find support from its 50-dma of $58.23 after fellow advertising giant Interpublic (IPG) issued another warning just a couple of months after the warning it issued in August. IPG said that the issues that had led to the previous warning had worsened further. Its new projections for the third quarter were only a third of what analysts had predicted and saw its full year 25% below expectations. IPG also predicted a revenue drop of 7-9%, partially due to poor results in Latin America and Japan. CEO John Dooner said the "new guidance reflects the difficult economic conditions we are facing around the world. Investors wanted no part of OMC after the warning, as it appears advertising revenues are dropping worldwide. If ad revenues are dropping, the company that has become famous for characters from Tony the Tiger, to Steven, the Dell "dude," has plenty of exposure. The OMC drop led to a break back below $60 support, in addition the 50-dma. A look at the point and figure shows a very extended column of "X"s which fell short below the bearish resistance line of $63 and ended in a four-box reversal downward. There is some PnF support around $56; however, we can see the stock re-testing $50 again if it breaks through that level. There is some support at $55 on the daily chart, as well, so traders will have to be weary of a bounce from that level. New entries can look for a failed rebound under $60. We may get a look at that level Friday morning, after Microsoft's earnings release beat earnings after hours today. If the stock manages to get through that level, then we will step aside and wait for a failure below it before going short. More conservative traders can wait for a break below PnF support at $56 or daily support at $55. Place stops at $62, above Wednesday's high. BUY PUT NOV-60 LLY-AL OI= 620 at $6.10 SL=3.00 BUY PUT NOV-55 LLY-AL OI= 620 at $3.80 SL=1.90 Average Daily Volume = 2.60 MIL --- EBAY – eBay, Inc. $58.13 +0.15 (+1.83 this week) Company Summary: After developing a Web-based community in which buyers and sellers are brought together in an efficient format, EBAY has emerged as the dominant online auction site. The eBay dynamic pricing format permits sellers to list items for sale, buyers to bid on items of interest and all eBay users to browse through listed items. Items listed on eBay include collectibles, automobiles, art objects, jewelry, consumer electronics and a host of practical and miscellaneous items. Although based in the United States, through its subsidiaries, EBAY also operates trading platforms in Germany, the United Kingdom, Australia, Japan, Canada, France, Austria, Italy and South Korea. Why We Like It: With the bear market grinding along in its third year, the vast majority of stocks have had their once-lofty valuations dramatically compressed. Despite this pattern throughout most of the market, there are still a few stocks trading with lofty valuations, which still need to come down significantly. EBAY is one such stock, with its PE ratio still north of 110. Investors have continued to be willing to assign such a high valuation to EBAY due to the fact that the company has consistently delivered on the earnings front, and the company kept that trend intact tonight by reporting 22 cents vs. the consensus estimate of 20 cents. But there are cracks beginning to show in the superstructure, as the company guided revenues higher tonight, while slightly reducing its EPS estimate. EBAY has a high valuation due to the fact that it has continued to grow both revenues and earnings at a brisk clip throughout this economic downturn, and if that pattern changes, then we can expect investors to take their money and run. Judging by the extended hours session, that's precisely what they did, selling the stock down to just above $55 vs. the 4pm close above $58. Should this behavior continue on Friday, look for a breakdown below the $56 level as a trigger for initiating new positions. In addition to disappointment over earnings (and forward guidance), we have a long-term descending trendline working in our favor. Connect the highs over the past 10 months, and you have a trendline that rests at $60, which is also the site of significant historical resistance. EBAY has tested (and failed at) this level twice in the past week, giving us conviction in our bearish thesis. Should a MSFT-induced broad-market rally lift EBAY back into the $58-59 region tomorrow, a rollover from that region would make for a high-odds, if aggressive entry. Our stop is initially in place at $60.50, just above the August high. BUY PUT NOV-60 QXB-WL OI= 938 at $5.60 SL=3.50 BUY PUT NOV-55*QXB-WK OI=8429 at $3.40 SL=1.75 BUY PUT NOV-50 QXB-WJ OI=9171 at $2.00 SL=1.00 Average Daily Volume = 8.66 mln --- KSS - Kohl's Corporation $55.11 2.16 (+2.71 this week) Company Summary: Kohl's Corporation operates family-oriented, specialty department stores, primarily in the Midwest. The company's stores sell moderately priced apparel, shoes, accessories and home products targeted to middle-income customers shopping for their families and homes. Kohl's stores have fewer departments than full-line department stores, but offer customers assortments of merchandise displayed in complete selections of styles, colors and sizes. Of the 420 stores the company operates, 116 are takeover locations, which have facilitated the entry into several new markets, including Chicago, Illinois; Detroit, Michigan; Ohio; Boston, Massachusetts; Philadelphia, Pennsylvania; St. Louis, Missouri, and the New York region. Why We Like It: Poor projections from many Retailers, including the mighty Walmart, hammered the Retail index (RLX.X) to fresh multi-year lows late last week. While the sector has been lifted this week by the bullish action in the broad market, there are clearly some serious problems to be dealt with. Concerns still remain that the American consumer is pulling in his/her horns, and as we found out from Sears this morning, while consumers may have been willing to spend, they haven't been as willing to actually pay their bill when it comes due. Sears missed its earnings target this morning by a whopping 23-cents, citing a sharp increase in uncollectibles. That's not encouraging, especially when you consider that it was only 10 days ago that the company updated its guidance for the quarter. In the past week, KSS has lagged the RLX index, failing to even challenge its 20-dma (currently $59.32) before rolling over the past 2 days. Today's weakness dropped the stock back to where it went out on Monday, successfully closing Tuesday's gap. With daily Stochastics just starting to roll over from overbought territory and bad news in the sector causing the RLX index to do the same (also falling back under the 50-dma today), KSS bulls are going to have a rough go of things in the near term. Look for KSS to get a lift from the broad market on Friday, and use that strength to establish new positions as the rally fails near resistance, either at $56.50 or possibly as high as $58. Should the bounce fail to materialize, look to enter the play on a drop under $54, so long as the RLX index remains below its 50-dma, which is currently at $284. Our initial target will be for a drop back near the recent closing low near $50. Use a stop at $59 to control risk in the play. BUY PUT NOV-60 KSS-WL OI=1152 at $6.30 SL=4.25 BUY PUT NOV-55*KSS-WK OI=3873 at $3.40 SL=1.75 BUY PUT NOV-50 KSS-WJ OI=2129 at $1.75 SL=1.00 Average Daily Volume = 3.66 mln ************************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 10-17-2002 Copyright 2002, All rights reserved. 3 of 3 Redistribution in any form strictly prohibited. In Section Three: Play of the Day: Put - EBAY Traders Corner: Ready to Try A New Position? Traders Corner: Reversal patterns: Double and Triple Tops & Bottoms Traders Corner: (Un)Comfortable ********************* PLAY OF THE DAY - PUT ********************* EBAY – eBay, Inc. $58.13 +0.15 (+1.83 this week) Company Summary: After developing a Web-based community in which buyers and sellers are brought together in an efficient format, EBAY has emerged as the dominant online auction site. The eBay dynamic pricing format permits sellers to list items for sale, buyers to bid on items of interest and all eBay users to browse through listed items. Items listed on eBay include collectibles, automobiles, art objects, jewelry, consumer electronics and a host of practical and miscellaneous items. Although based in the United States, through its subsidiaries, EBAY also operates trading platforms in Germany, the United Kingdom, Australia, Japan, Canada, France, Austria, Italy and South Korea. Why We Like It: With the bear market grinding along in its third year, the vast majority of stocks have had their once-lofty valuations dramatically compressed. Despite this pattern throughout most of the market, there are still a few stocks trading with lofty valuations, which still need to come down significantly. EBAY is one such stock, with its PE ratio still north of 110. Investors have continued to be willing to assign such a high valuation to EBAY due to the fact that the company has consistently delivered on the earnings front, and the company kept that trend intact tonight by reporting 22 cents vs. the consensus estimate of 20 cents. But there are cracks beginning to show in the superstructure, as the company guided revenues higher tonight, while slightly reducing its EPS estimate. EBAY has a high valuation due to the fact that it has continued to grow both revenues and earnings at a brisk clip throughout this economic downturn, and if that pattern changes, then we can expect investors to take their money and run. Judging by the extended hours session, that's precisely what they did, selling the stock down to just above $55 vs. the 4pm close above $58. Should this behavior continue on Friday, look for a breakdown below the $56 level as a trigger for initiating new positions. In addition to disappointment over earnings (and forward guidance), we have a long-term descending trendline working in our favor. Connect the highs over the past 10 months, and you have a trendline that rests at $60, which is also the site of significant historical resistance. EBAY has tested (and failed at) this level twice in the past week, giving us conviction in our bearish thesis. Should a MSFT-induced broad-market rally lift EBAY back into the $58-59 region tomorrow, a rollover from that region would make for a high-odds, if aggressive entry. Our stop is initially in place at $60.50, just above the August high. BUY PUT NOV-60 QXB-WL OI= 938 at $5.60 SL=3.50 BUY PUT NOV-55*QXB-WK OI=8429 at $3.40 SL=1.75 BUY PUT NOV-50 QXB-WJ OI=9171 at $2.00 SL=1.00 Average Daily Volume = 8.66 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 ************** Ready to Try A New Position? By Mike Parnos, Investing With Attitude CPTI students love to learn new positions. Today we'll analyze how to select a new position? It’s not like love potion #9. You can’t just mix it up right here in the sink. It doesn't smell like turpentine and look like India ink. This is serious. Will your new position be vertical or horizontal? There is much research to do, questions to answer . . . and “miles to go before I sleep.” Robert Frost said you’ll be “Stopping by woods on a snowy evening.” We don’t have woods and we don’t have snow (yet). But we have a computer, a mouse, a high-speed connection, and a willingness to learn. That’s all we need to get started. Step #1: What kind of equity/index do you want to trade? If your favorite strategies involve selling options, and you prefer some degree of stability, you should choose an index. Because indexes consist of multiple stocks, there is less likelihood that it will move dramatically if one CEO is caught coming out of a motel with Michael Jackson and a chimpanzee. The diversification of the index will go a long way towards neutralizing these disturbing albeit not unusual occurrences. If you like playing straddles and strangles, you're looking for large movements. Individual stocks, that have a history of big moves, might be your best bet. Upcoming earnings announcements and/or stock splits often result in major moves. Look at industries like biotech that are always at the mercy of FDA approvals or rejections. That's when the mierde is going to hit the fan -- and that's when you want to be there. Be thorough. You can call the companies and find out when FDA decisions are scheduled. That's what their "investor relations" departments are for. You may be able to find that information on the Internet, but confirm it with a call before you put on the trade. If you want to pick a direction, as they say at my favorite Chinese restaurant, "rotsa ruck!" But, if you insist, you have some research to do. Check the sectors. If you're bullish, pick the best acting stocks in a particular sector. If you're bearish, pick the worst. It's mind-boggling to see traders buy calls on the worst stock in a sector and wonder why it goes down. There's one born every minute -- maybe more than one. Also, don't overlook an examination of an option's volatility. At this writing, there's exceptionally high volatility in the market. That's an option seller's paradise. Why? Because sellers will take in an inflated amount of premium. We can expect the volatility to return to its normal levels -- even if the underlying doesn't move. The more premium that erodes, the more premium that remains in your pockets. On the other hand, option buyers will overpay for those same options. As the volatility returns to normal levels, the time value element of the purchased option will decrease -- even if the underlying doesn't move. That means the underlying will have to move even farther in the predicted direction just to make back the additional eroded premium. Step #2: What strategy should you use? There are two schools of thought here. What comes first, the chicken or the egg? Colonel Sanders or the egg salad? The hotdog or the bun? The strategy or the stock? There are over 10,000 stocks, indexes etc., but there are only a few dozen option strategies. It might be easier to have your favorite strategies and let the market come to you. In your search, you may find stocks/indexes that aren't ready -- they don't quite fit the parameters of your favorite strategies. Put them on your watch list and wait. Resist the temptation. Put those itchy mouse fingers somewhere out of harm's way. (No suggestions. I'll leave that to your imaginations.) To be a consistently successful options trader, you need to play favorites -- to have a strategy for every market condition. One that enables you to profit when you are neutral, another for when there's anticipated high volatility, and another when you pick a direction. With these strategies in your arsenal, you're ready to go to war. You must know these strategies inside and out. You can have a bazooka in your arsenal, but if you don't know how it works, you'll end up shooting yourself in the foot. And you need your feet, just like you need your trading capital. Know the strategies thoroughly. Know when to put them on, how to get the best prices when entering the trade, and the appropriate months and strikes to use. That's only half the battle. You also have to know your target profit, your maximum risk, when you will get out -- both in your favor or otherwise. Know what adjustments you have to make -- and how to make them. If you don't know the ins and outs of a strategy, don't even think about trading. You're not ready. Trading is tough enough as it is. Let's put this into perspective. By trading, you are, in essence, making a wager on something over which you have absolutely no control. It's a helpless feeling when things go against you, but a euphoric feeling when trades become profitable. All we can do is try to increase our chance of success. We can play blackjack, but if we're card counters, we improve are chances. We have to find a table (strategy) that only uses one deck -- so there's only one deck stacked against you -- not four. _____________________________________________________________ Testing Your Option IQ As promised, here are the answers to Sunday's pop quiz, testing your knowledge of options and how they work. Reader response indicated you enjoy this type of challenge – a way of gauging your progress. 1. (a & b); 2. ©; 3. (b); 4. (c); 5. (b); 6. (a); 7. (a); 8. (b); 9. (a); 10. (b, c, & d); 11. (b); 12. (a); 13. (a & b); 14. (a & b); 16. (a); 17. (b); 18. (b); 19. (b); 20. (d); 21. (b); 22. (c); 23. (a); 24. (b); 25. (none); 26. (a); 27. (c); 28. (b); 29. (a); 30. (a); 31. (b); 32. (d); 33. (c); 34. (d); 35. (c); 36. (d); 37. (b & c); 38. (c); 39. (a). How did you do? 20 – 30 Correct: Not bad, but back to the drawing board. Too many TV reruns and not enough reading and learning. OI has an amazing archive of articles on every aspect of options and option trading. Don’t even think of trading real money – for a while. 30 – 35 Correct: Respectable, but examine which questions you got wrong. If you don’t understand why they were wrong, contact me and I’ll help. Between myself and other OI columnists, you have an excellent resource at your disposal. Take advantage of it. In the meantime, start paper-trading – taking a position from its inception to completion, including adjustments. After each action, including putting on the position, write down all the reasons for your action – your entire thought process. When the position is finally closed, your notes will be invaluable to you in seeing what you did wrong and/or right. 35 – 38 Correct: Very impressive. Options are not an easy concept to grasp. It’s hard enough to know what they do along, but knowing how puts and calls can work together is a major achievement. Know you can put this knowledge to the test. You can start trading real money, but begin by using a small number of contracts. When money is on the line, decisions are somewhat tougher. See if you can set your emotions aside and maintain a logical approach to trading. 39 Correct: That’s amazing – especially since there were only 38 questions. Who are you kidding? If you didn’t have the awareness to notice there was no question #15, then you’re not paying attention. You can’t afford to be that lax when you trade options or you’ll lose a lot more than a question. Stay tuned. In a few months we’ll try another quiz with brand new questions (and maybe brand new answers, too). _____________________________________________________________ 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 ************** Reversal patterns: Double and Triple Tops & Bottoms By Leigh Stevens lstevens@OptionInvestor.com Recently the S&P 500 (SPX), the “leading” stock market index, as it is the performance standard for money managers made a possible or likely double bottom low, which also coincided with a bullish price/oscillator divergence after the index got oversold - see http://www.OptionInvestor.com/traderscorner/101302_2.asp Of the technical signposts mentioned, I put the most stock so to speak, in the fact of the double bottom and this Trader’s Corner article is about why. The double or triple top or bottom formation is, as the name implies, a situation where a high or low fails to exceed the price area of a prior significant top or bottom, on 2 or 3 occasions. This second or third top or bottom does not have to occur at the same exact level as the previous high or low, as long as this subsequent high or low is in the same general price area as the earlier peak(s) or bottom(s); e.g., within 5%. In the recent case of the S&P 500(SPX), there was pretty much an exact double bottom low as seen in my first chart here – As always, look for other “confirming” technical indicators that might suggest that the market had reached an extreme and was reversing its trend at least for a while – for example, in above-normal selling pressure as measured by the Arms Index (TRIN) being over 1.60 on a 10-day moving average basis. When I refer to a “significant” prior high or low - this is the high/low that was the extreme point of an advance or decline in the most recent market move or trading swing. In the 2000-2002 Bear Market, examples of a double top are not hard to find such as is shown with the S&P 100 (OEX) below – What about the case of a high or low being made in the same area repeatedly and more than 2-3 times? - a stock that makes a top or bottom in the same approximate area on MORE than 3 occasions is considered to be in a trading range between repeated highs and lows established in the same price area again and again – a subsequent breakout above or below this price range can also establish an upside or downside reversal of the trend but this is a different pattern than the Double/Triple Top or Bottom. What is happening in a double top or bottom (generally more common than the triple top or bottom in stocks)from a technical perspective? - Support is a price area where buying interest is such that there are more willing buyers than sellers and this buying will drive prices back up. - Resistance is a price area where selling interest is strong and sellers will overwhelm buyers and drive the price down. Double bottoms form in a price area where in the initial bottom there was an abundance of willing buyers – for example a group of savvy investors and traders view the market as especially cheap. If the potential buyers were strongly interested once in a particular area and there is no great change in the market outlook, they will then tend to be interested again in the same price zone, perhaps more strongly so - this buying will cause a rebound. Double or triple tops form in a price area where the would be sellers are in control because of their numbers and willingness to sell most or all of what they own of a stock or the overall index or sector – this may also be an area where there is willingness to take substantial short positions such as by hedge funds. A “confirmation” is also required to determine whether a SIGNIFICANT double or triple top or bottom is in place and the dominant trend has reversed. The definition of an uptrend is a series of higher highs and higher reaction lows. It is not the failure of prices to exceed a prior peak (this could always happen later), but a decline that exceeds a prior reaction low that initially confirms that a trend reversal has taken place. A double bottom is confirmed when a prior significant upswing top (in the decline just ended) is also exceeded - after the apparent double bottom. Another related confirming indicator, while secondary to exceeding a prior swing low or high, is having volume action in synch with price action – if it’s a reversal of trend implied by a double bottom or top, the volume will typically jump from average daily volume in the recent past. Generally the more time that separates the twin (or triple) tops or bottoms the more significant is a subsequent trend reversal. A break of any prior significant swing low or high will typically see volume expanding significantly relative to before this break. The recent low in the Market as measured by the low made last week (week of 10/7/02) offered some volume clues - volume was big on the first two rebound days, then slackened as the market paused for a day, then expanded strongly on subsequent days as the market resumed a strong advance. Volume offers (frequently, not always) a good secondary confirmation for double/triple tops and bottoms and can be looked at in addition to price action. Also, if there was no volume “confirmation” to price action and there is only a slight closing break of a prior low or high, it’s usually a good idea to wait for a second consecutive close above or below the low or high in question. It’s useful to remember the psychology involved in double/triple tops and bottoms that form - they are repeat patterns. Market participants become convinced that a price floor or ceiling has been established. There is then more belief in the staying power of the trend after the double top or bottom has formed and more people get into the market, stock or other instrument, which then helps keep the trend going. The pattern of double or triple, tops is a very useful one as a guide to getting into or out of the market for traders and investors. I myself like entry at such points as I can then take a relatively small risk as liquidating stops can be set just above or below the second or third top or bottom. Because of this, I will not necessarily WAIT for confirmation of the double top or bottom reversal pattern, which is achieved only when prices also go on to exceed a prior upswing high or low as described above. This strategy assumes the risk of a pattern failure in exchange for a more favorable risk to reward ratio, which is especially relevant to traders. Investors looking to take a long-term position may wish to wait for the confirming price action. It is always important to pull together all aspects of trend analysis. If long at a possible double top, your risk of giving back a substantial portion of any unrealized gain is generally higher than the reward potential of a further up leg. At such a juncture, it is not necessary to exit your position, as the old top may certainly be exceeded, but raising your exiting stop to just under the last prior significant downswing low is warranted. You can exit calls at a probable double top, especially if the prior peak was a major one – while also being prepared to assume new long positions/long calls if prices push through the most recent high by a significant amount (e.g., more than 5%) and on strong volume. Conversely, be prepared to exit puts on the first signs of a strong upside reversal, especially on a volume jump, after prices have moved into the area of a prior significant low. A triple top (above) that was “confirmed” by the subsequent price action – for a time - but was a pattern “failure” in terms of indicating a reversal in the time frame shown. ************** TRADERS CORNER ************** (Un)Comfortable By John Seckinger jseckinger@OptionInvestor.com All we need is a relative low, relative high, and some time. This Traders Corner article will focus on price action either inside or outside a “comfort” zone (read: channel); testing traders’ conviction on whether or not a new range will take over. Let us immediately dive into an illustration. Looking at a chart of Alcoa, it is important to clear away all moving averages, trend lines, etc. and look at things on a “horizontal” basis. Once channels are defined, think about all the traders that expect to play shares within a certain range. Buy low and sell high. It is these expectations that create a strong psychological attachment to particular zone(s) either at the bottom or top of a range. What happens if the bottom of a channel fails? Believe me, traders long do not easily forget what it feels like when prices collapse and solid support turns into resistance. Shorts, on the other hand, immediately goes for the jugular and tries to flush out all weak longs before allowing a bottom to form. This is the process on how channels form during a bear market. If a strong psychological level is broken to the upside (resistance), bulls begin to get more comfortable since it will most likely bring back memories of a channel once lost. Of course, the objective is to confirm such a channel by testing the top of its range. Chart of Alcoa, 510-minute (Daily) chart So, what are traders of AA thinking right now? The 22.75 area needs to be tested and we need to know if we should be short or long going forward. If 22.75 is breached to the upside and longs control the momentum, most likely shorts will give up and bulls will power shares higher. Ok, here is the caveat: There really is no time objective for when shares might reach 28. Therefore, this might not be the best option strategy. Nevertheless, once 22.75 is cleared, a tight stop can be implemented and thoughts of 28 should certainly be running wild. So, what is the story on the green line(s)? Well, those levels can either be trailing stops (once above) or an exit if prices do bounce solidly from such an area. Note: I would not have too many green lines, since that would dilute the importance of this possible long-term strategy. Chart of 10-year Treasury Note Index, Weekly Using simple channels for Intermarket relationships also works well. Looking at a weekly (I would recommend only a weekly chart or longer) of the 10-year bond, a rise above 40.96 should place the contract back into a sizable range encompassing prices back up to the 55 (5.5% yield) level. You might be thinking, “Well, the 40.96 level is the head of a Reverse H&S formation.” Yes, I would agree, and it should give an even more psychological meaning to a rise back above 40.96. So, why don’t I just draw in the Reverse H&S? This article is trying to show a trader how even simple technical analysis (only horizontal lines) can be just as powerful, if not more, than a plethora of lines extending throughout the chart. Chart of Diamonds (DIA), Weekly What does a chart of the Dow Diamonds (DIA) tell us? Since we have done a few examples already, I am sure you have caught on by now. The objective is for a move back towards 96.62, but watch levels just above 90 to see if the drawn green line holds psychological significance as well. For the skeptical readers out there, I do agree that the range appears wide and it could take a long time before we ever, if ever, see the DIA contract at 96.62. However, I am merely trying to interpret channels and trading ranges defined by earlier price action. Furthermore, there is a solid risk/reward trade, since weakness underneath 79.50 can be reason to exit and head to the sidelines. Chart of US Dollar, Weekly A weekly chart of the US Dollar shows prices recently compressed but setting higher lows in the process. A few attempts above 108 have been made; however, prices quickly went back below 108 and most likely lulled traders to sleep for a period of weeks. If the Greenback does manage to get back above 108, there should be, once again, a shift in sentiment in favor of bullish traders. Yes, there could be another bull trap in store for traders; however, the recent relative strength makes it somewhat unlikely. Why am I optimistic? Because the bottom channel at 104.88 was not tested when prices recently trapped longs above 108. Another question you might be asking yourself, “Why use simple horizontal support/resistance lines when I am comfortable with stochastics, moving averages, etc.?” Point well taken. Before I put on a trade, I clear my chart of all lines and draw a series of channels. These levels are then written down (read: place an alert on your computer). I then draw every conceivable trend line and indicator possible (at least the ones I am comfortable with). And, in most cases, the channel(s) work better for long term trades. Because the channels are drawn from relative highs/lows, these levels are usually the result of an extended move above/below a recognized area found from a ton of fundamental and technical points of view, it makes sense to stick with what all traders can relate to. The hard part is the execution. In practice, it is difficult to buy after an extended run up; however, a trader should be thinking differently. Let us use the AA example once more. If prices rise just above 28, thoughts should be for a move to 30 as well. In fact, there could be a ton of shorts at 28 that are just getting involved. Moreover, do not assume that all longs entered at the bottom of the range. What are some characteristics of a successful trader? Patience, putting on good risk/reward trades, execution, and ability to recognize a change in sentiment before others. When using channels, a trader can do all of these. Have you ever missed the first 500 points of a move, only to then watch another 500 points take place? We all have. In hindsight, we all should have gotten out of our shorts and went long DIA contracts once prices rose back above 73.87 and re-entered the channel that heads to 96. Yes, in theory everything looks so easy. And yes, it is frustrating to watch prices gravitate within a channel for weeks without hitting either the top or bottom of its channel. However, wouldn’t it be fantastic to capture a solid move and avoid all the “noise” that takes places most days of the week? By definition, this is investing. Good luck. ************************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”. 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