The Option Investor Newsletter Thursday 10-24-2002 Copyright 2002, All rights reserved. 1 of 3 Redistribution in any form strictly prohibited. In Section One: Wrap: Dazed Bulls Consider Options Futures Markets: NQ Futures 1000 and Iraq Index Trader Wrap: Market Sentiment: Which Way is Up? Weekly Manager Microscope: John S. Orrico: The Arbitrage Fund (ARBFX) Updated on the site tonight: Swing Trader Game Plan: Reality Bite Bulls Posted online for subscribers at http://www.OptionInvestor.com ************************************************************ MARKET WRAP (view in courier font for table alignment) ************************************************************ 10-24-2002 High Low Volume Advance/Decline DJIA 8317.34 -176.90 8558.63 8277.87 2.44 bln 1408/1760 NASDAQ 1298.69 - 21.50 1330.99 1296.54 1.89 bln 1547/1764 S&P 100 447.88 - 6.85 458.24 445.89 Totals 2955/3524 S&P 500 882.50 - 13.64 902.94 879.00 RUS 2000 366.02 - 2.93 371.27 365.61 DJ TRANS 2304.62 - 36.90 2375.08 2300.20 VIX 39.90 + 0.52 40.24 37.90 VXN 54.58 + 2.21 55.17 51.65 Total Vol 4,159M Total UpVol 1,692M Total DnVol 2,413M 52wk Highs 90 52wk Lows 216 TRIN 1.05 PUT/CALL 0.81 ************************************************************ Dazed Bulls Consider Options So near but yet so far. The markets touched almost a two-month high at the open but failed to hold the high ground and ended significantly down for the day. Dow 8558 was the double top high for the week and a number not seen since Sept-12th. The Nasdaq also hit a post September high of 1331 only to close under the 1300 level at the close. Dow Chart Nasdaq Chart Everything started out on a positive note with a smaller than expected Jobless Claims number of 389,000, which was below the consensus of 403,000. This may have been encouraging on the surface but it will take a string of lower numbers for several weeks to make a difference. Continuing claims fell -115,000 from decade high levels but this is just a blip in the data flow. Several big name companies announced more layoffs today, which indicates the bad conditions still exist. However, the number of mass layoffs for September fell to only 1,060 involving 122,277 workers. This is down from the 128,080 in August. The good jobs news offset a downgrade of Dow component IP by Prudential before the open. PRU downgraded it to a SELL from HOLD. They quoted the drop in GAAP net worth to $2.05 billion and the increase in debt-equivalent liabilities to $16.2 billion. They think IP will need to issue about $2 billion in more stock to raise capital. Microsoft was down after the LA Times reported that the Justice Dept is investigating allegations that MSFT is still hiding Windows code from rivals in violation of its court settlement. If true it could cause serious problems for MSFT but the company said it was old news and they had nothing to hide. They were also blasting the airwaves with a half-billion dollar attack on AOL with MSN-8. Bill Gates was on CNBC pounding AOL and the benefits of MSN-8. If MSFT is successful in seducing millions of subscribers to switch it would be a real windfall for them. The conversion would help cement future MSFT product loyalty from those subscribers for things like Windows, Windows Media, and any number of add on products. Look out AOL, the gorilla is on the prowl. After the bell today AMZN said it lost money again, -$35 million, but broke even on a pro forma profit of $400,000. Yes, $400K on $851 million in sales. This was a +33% increase in sales due in part to their free shipping program. Buy for $8, sell for $10, eat $4 in free shipping! I got it! You make it up in volume! Just kidding, I buy something at AMZN a couple times a month but they need to start making a real profit like Ebay soon or the stock will end up in the penny stock arena. AMZN is trading down -$1 in after hours. They did raise estimates for the 4Q. FLEX also announced earnings after the bell of 8 cents and inline with analysts estimates. They affirmed estimates going forward and said that although market conditions remained tough they were gaining market share. They also traded down about -$1 in after hours. JDSU missed analyst's estimates slightly after the close and said projected revenue could drop -20% for the next quarter. TQNT also announced inline earnings but guided lower for the current quarter. MSTR also missed estimates by 2 cents and warned about the coming quarter. Cigna lowered guidance to $1.47 for the coming quarter vs estimates of $1.99. Good news came from ERTS after the close, which posted earnings of 34 cents compared to analyst's estimates of 17 cents. This was the second quarter in a row that it blew away estimates. The stock was trading up +2 in after hours. The company affirmed estimates for the next quarter due to strong game sales. Analysts commented after the announcement that maybe ERTS had come too far too fast and the sales were due to slow with saturation. Another win came from BMC, which beat estimates of 4 cents with an 8 cent gain. They affirmed estimates for the next quarter at the high end of the current range. The worst big name earnings for today was SBC which missed earnings by 3 cents but admitted they had lost -751,000 retail lines to AT&T and WorldCom. SBC also said it was cutting capital spending to $7.5 billion from earlier targets of $9.2 billion. This is down from $11.2 billion last year. This is bad news for the feeder group like Lucent and NT. Despite all the bad earnings news this was not really what tanked the markets. The lackluster earnings did nothing to give the bulls confidence that they could muster another charge and after moving sideways most of the day the bulls got nervous. Helping them was rumors that IRAQ was going to kick all the reporters out of the country and that stepped up war fears. Many analysts have said that they expect him to go preemptive and try to strike us first if he feels the walls closing in on him. This was strike one. The FBI said they had specific and credible evidence that an attack on rail lines, bridges, nuclear power plants, oil refineries and assorted infrastructure targets could come at any time. Great! They said they had discovered pictures of railroad bridges, power plants and other targets in Al Qaeda documents and terrorists in captivity had knowledge of planned attacks. The key here was that the attacks could come at any time based on new intelligence. Strike two for the markets. The semiconductor sector had been soaring for over a week and was leaping from bad new to bad news with new gains. Investors watched in disbelief as stocks like KLAC gained strongly after warnings. Today everything changed. The SOX had risen from 210 to almost 300 since Oct 10th for a +42% gain in 14 days. Overbought anyone? Well the SOX hit 299.18 at exactly 11:30 today and the selling began. That 300 level was the same level where the SOX had failed on September 12th. Strong resistance and you can see that sellers were waiting for it to be hit. Strike three, batter out. SOX Chart Adding to the overhead weight was the economic reports for tomorrow. The Consumer Sentiment report is due out at 9:45 and it has not been kind as of late. Also Durable Goods at 8:30 and Home Sales at 10:00. The fear factor may have come into play as the momentum players became frustrated with the double top failure at 8550. After two attempts to rally through that level in the same week, the positive earnings news dwindling, war fears growing and new terrorist threats the best course of action was to take profits. This profit taking could continue tomorrow on negative economic news. The real question is what happens next Monday. The mutual fund year comes to an end on Thursday. Tax selling should be over and end of year replacement buying may have dried up. There may be some lingering hang over but we only have five days left. We also have the big gains to digest. Even at today's close we are up +1100 points in fourteen days. During that 14 days funds saw out flows, $4.1 billion in the last week alone. If traders were rushing to buy the new bull market then why have the last two weeks both shown outflows? There are many unanswered questions. One article I read this week was extolling the fears of lost performance. With mutual funds closing weekly the rest are racing to grab performance at any price. When this year is over and those final fund statements are received there is going to be a massive shift of cash from fund families. Fears of lost fees and jobs is outweighing the fears of more market losses. This grabbing for momentum stocks is increasing the volatility. Some funds are not holding and are trying to trade themselves back into profitability, is a scary thought. What this means is that stocks in fund portfolios may not be in strong hands as many have thought. Strong hands imply no need to sell, plenty of cash on hand and a long term outlook. When considering many funds in the current market they are being forced to raise cash on a daily basis and selling is the only way they can get it. Their outlook is as long as the next dip. That means Monday is still a tossup. We know where resistance is waiting. Dow 8350, 8400, 8500, 8555. Support is 8300, 8250, 8200 8138 and then 8000. A drop to 8036 would only be a -38% retracement of the gains from the Oct 10th low. First we have to get through Friday and that should depend on the economic reports and the urge by investors to protect profits. Futures are down in after hours despite the earnings being somewhat positive. Plenty of dark before morning but I would be surprised to see another attempt at 8550 on Friday. Enter Very Passively, Exit Very Aggressively! Jim Brown Editor *************** FUTURES MARKETS *************** NQ Futures 1000 and Iraq by Alan Hewko futures@OptionInvestor.com ___________________________________________________ Quotes: 4:00 PM Cash Market Close ES 882-883, YM 8292, NQ 969 4:15 PM Future's Market Close ES 880, YM 8279, NQ 968 5:00 PM YM Dow Futures close: YM 8275 5:30 PM ES 879s, NQ 968 Dow 8317 - 176 SP500 882 - 13 COMPX 1298 - 21 Advance/Decline by Volume was bullish all morning, turned on a dime at 1:40 PM and ended the day bearish. Abbreviations used by the Futures Market: Ticker ES = E-mini SP500 December futures ES02Z YM = E-mini Dow $5 December futures YM02Z NQ = E-mini NDX 100 December futures NQ02Z ______________________________________________________ Wednesday afternoon saw the very bearish Beige Book out at 2 PM with ES in the 878-880 level, during the very unusual CME outage at some future's clearing firms, and for "unknown" reasons, other than the continuation of "Buy expected bad news", caused a two hour rally into Wednesday's close. In Wednesday overnight futures, ES was over 900, YM 8500, and NQ an inch within 1000 at 997. Futures gave back these "unusual" gains in the overnight session even though Europe was strong all night; but Japan was red, falling well below the Nikkei's resistance at 9000 to fall back to the 8500 level. Near the time of Thursday morning's Jobs data, ES had retraced 10 points to the 892 level. See the overnights chart below ES02Z (E-mini SP500 futures) Wednesday 1 PM thru Thursday 11 AM including Wednesday's overnights. 9:30 AM ES 903, YM 8545, NQ 995 9:33 AM ES 905, YM 8555, NQ 996 9:33 AM levels were * Day and Month Highs for ES and YM NQ traded slightly different than ES and Dow, as NQ retraced from the open but made a higher high near 11:45 AM as on the 4th attempt today, it pierced the psychological level of 1000 to also create a new high for the week and month. ES and Dow both tried to bounce but failed at the ES 904 and Dow Cash 8535 levels. NQ has seemingly been leading ES and Dow a bit over the last day and this morning, and when it formed an exhaustion top at 1001.50; matching the $SOX attempt to stall right under the psychological 300 level; the markets drifted lower. 12:30 PM saw a bounce attempt off Dow 8450. As the charts will show, the basic tone was "sideways" with extremely low volume past 11 AM as buyers were quick to buy, and shorts were quick to cover for a few points. My thoughts as the reason for this was the pause the market took. Perhaps other traders had formed the same opinion I had written last night: Dow either breaks out over 8500-8500 and heads to 8600/8750 or Dow breaks down at 8500 and heads to 8250-8300 When neither really occurred by 11 AM, and with NQ printing near 1000; the Advance/Decline by volume was indeed bullish confirming there still were more buyers than sellers. The market simply continued drifting sideways for 3 hours, neither strong or weak. IRAQ CNN report at 1:37 PM changed all of that when they reported that Iraq was ordering all foreign journalists to leave Iraq by next week. The market, which had been simply drifting sideways almost "waiting" for a reason to do SOMETHING - perhaps used this news as a reason to sell Long stock and take profits as War concerns renewed. I was very surprised to see at 5:30 PM that this story was not on the front page at www.cnn.com and indeed I needed to do a search on 'Iraq' to find it. The link is below: http://www.cnn.com/2002/WORLD/meast/10/24/iraq.journalists/index.html After reading it, it sure seems a less big-deal that one might have thought watching the market sell off hard for 90 minutes. By the same token, the 'reason' the market went UP yesterday afternoon was also not very clear. If you would have just read the above CNN newslink, without knowing what the market did today, would you think that article's news would cause the Dow to sell off 200 + points from its time of release? Here's the Charts: Chart: ES02Z (E-mini SP500 futures) Thursday Below is a Chart of: Chart: Dow Industrials (Dow 30) for Thursday 9:30 AM to 4 PM Here is a chart of: Chart: NQ (NDX futures) from Thursday 9:30 AM to 4:15 PM Thursday's charts above show this sideways action all day, until the CNN Iraq news came out about 1:40 PM. This begs the question what would the market have done if this news had not happened? A moot question obviously as it did. There was a lot of chart damage done in the afternoon. It will take a minimum of ES back of 885-887 to maintain a bullish tone. By the same token, if ES on Friday firmly loses 877-880, it could create another Dow -200 type day. Tomorrow is Friday: Was today the start of FINALLY paying attention to all the bearish news we've had for well over a week? -or- Are dip buyers still lurking and this Iraq news simply created a situation of a lack of buyers vs. real sellers. I would like to re-post a comment I made in Market Monitor regarding two closely watched stocks: AIG and TYC Are AIG and TYC telling "us" something 2 classic examples of this market's tone of 'Buy Bad News" AIG is the largest insurance company in US and a Key financial sector stock. 3 months ago, on their July earnings they missed badly, but the stock (which usually trades in the 70 to 85 range for year 2001) was already so beaten up ahead of it at $48, that earnings miss 3 months ago was a "buy AIG on the missed earnings-it's priced in at $48-52" (a sentiment I would agree with) AIG has been drifting sideways $62 to 65 the last 2 weeks, and had earnings this morning. They missed again (by 3 cents this time), stock opened at 62 and was bought all day with it now at 65. On pure fundies (fundamentals), AIG missing by 3 cents "should have" sent it back to the 52-55 support area from the 62 open, BUT it did not. Tyco (TYC): got the Trifecta this morning : Earnings miss, Warning going forward, and re-statement of prior financials (could TYC news be any worse?) Result of this news: Opens at $13, and upticks to current $15 * Please note the above comment was made at noon, and before this Iraq situation developed. Taking a view of this week. The last two weeks have closed green, as you can see on below chart, we are approximately right where we opened on Monday currently. Last Friday's close looks to be about the 882 area. ES closed today between 880 and 882. Chart: Six-day Chart of SP500 Cash index ($SPX.X) ______________________________________________________ THOUGHTS FOR FRIDAY Does one red day change this bullish tone we've seen since October 10th? I do not know. We've lived with Iraq 'war' possibilities for a few months it seems, but today a simple statement of them kicking out journalists became important. How the market moves from the ES 800 and Dow 8300 level should provide an answer for Friday. How many times this past week+ have "we" gone to bed expecting the market to do "X" and it winds up doing "Y"? [grin] So for tonight, the morning tone should be bearish considering the very week 3:30 PM short cover bounce we saw, and we'll have to wait and see if the dip buyers truly have gone away, and if they have, the selling could easily escalate back to the Dow 8100-8150 level. On the side of the bulls - shorts have been burned so many times the last 2 weeks - IF there is strong dip buying at some price support level Friday, I doubt they will hesitate very long to take their Short profits from this morning. If ES gets to 872 level on Friday, that might be an area to look for a bounce. Bottomline is this: Was today just some over-due Long profit taking after a directionless morning/early afternoon, or is this the 'big-picture' sentiment 100% shift to Selling Stock? Alan Hewko futures@OptionInvestor.com ******************** INDEX TRADER SUMMARY ******************** Pack your bags and get out! Stocks took a turn lower late in the day after Iraq officials told foreign journals that they were being expelled with a deadline of next week. The Iraqi government did say they would admit back a contained number sometime in the future, but under stringent new rules. While that news probably found more than a few foreign journalists scrambling to pack their bags, it had the same impact on investors as the major indexes fell from unchanged levels to finish just off their session lows. The knee-jerk reaction was to sell, not buy. Just after the news hit the wires, I quickly turned to the Defense Index (DFX.X) 159.98 -1.72%, which found similar selling as the broader markets. Only the "defensive" Gold/Silver Index (XAU.X) 62.20 +1.05%, which had been trading in negative territory for the bulk of the session found buyers, while Treasuries, which have also been a safe haven in times of uncertainty saw buying into their 03:00 PM EST close. Even the December Light Sweet Crude Oil futures (cl02z) $28.07 -0.46% found little bullish reaction, when past concerns with a U.S. war with Iraq had found spike higher. While the news out of Iraq squashed a rather mixed session, this weeks jobless claims decline of 25,000 to 389,000, was much less than the 406,000 expected. While economists concede that the Columbus Day holiday may have distorted the outcome of the data, most were encouraged by the news. The four-week average level of claims dropped to a seven-week low of 404,000 and hints that the summer's spike in layoffs is fading. In recent months, levels above 400,000 have been concerning to economists, while levels below have had a calming effect. Tonight, I'm going to turn a little more cautious near-term from a bullish perspective. There are some things that "trouble" me as it relates to the lack of bullishness form the deep cyclicals as depicted by the Morgan Stanley Cyclical Index (CYC.X) 429.90 -2.19%. Morgan Stanley Cyclical Index (CYC.X) - Daily Interval If there's one "sector" that is troubling the bullish side of me, it is the lagging of the deep cyclicals. Both IP and DD recently beat estimates, but found selling on the news. I would sure have thought if IT spending were to pick up, that it would be the deep cyclicals doing the spending as earnings hit the bottom line. However, the technicals in the CYC.X don't depict that of a MARKET being bullish in the group. Either my scenario is incorrect, or other sectors and therefore broader markets become vulnerable to the downside. In past "bear market rallies" the CYC.X has been a rather strong performer, but they don't seem to be "confirming" any broader market bullishness. Note that I'm using the same type of retracement in the CYC.X with upper and lower ends anchored from the August highs to recent lows. Just like we're doing in the indexes we cover. Dow Industrials Chart - Daily Interval I've never "liked" stochastics by themselves as they've kept me out of some great shorts when oversold, and great longs when overbought. However, when combined with MACD, stochastics can give better "heads up" to shorter-term action. I see some similarity in MACD and Stochastics that has the bullish side of me very cautious at the end of today's session. A bull would become concerned should the Dow Industrials break back below the "old" downward trend. With the 50-day SMA at 8,248 as a guide, a break back below that level immediately has a bull assessing downside risk to 8,170 and 7,962 and weighing that potential risk against a bullish target of 8,700-8,717 near-term. Another stock in the Dow I was monitoring for some bullish leadership to the upside was shares of 3M (NYSE:MMM) $129.80 -2.8%. I wanted to see a confirming bullish move above $130. Even this morning after the positive jobless data, the stock opened at $129.75, then ticked up at $129.80 and found selling. Who are these guys willing to sell just prior to a potentially MASSIVE upside breakout where there's no overhead supply to keep things in check? I'm thinking its some bears that have no fear of economic recovery and willing to put their money on it! The Dow Industrials Bullish % ($BPINDU) saw no change in its bullish % and stands at "bull confirmed" status at 53.33%. August's relative high reading was 60%. Think of this in the same context as what we did in today's 01:00 PM update with the very broad NASDAQ Composite Bullish % and NASDAQ Composite itself. On a point and figure chart, the first sell signal in the Dow Industrials (INDU) 8,317 would not come until a trade at 8,250 on conventional $50 box scale. For the Dow Diamonds (AMEX:DIA) $83.03, the first sell signal would come at $72 on conventional $1 box. A note here would be to look for DIA support near $80- $81. At $81, that's when the DIA gave a "triple-top buy signal." S&P 500 Index Chart - Daily Interval I count 1,2,3,4 levels of support near the 875 level. One is from the mid-point of our "cloned" regression channel. I can't put a lot of faith in that trend as it was cloned, but I use it anyway as it help me assess potential downside to the base of that channel. Second is the 50-day SMA at 876, third is retracement of 61.8% at 878, and fourth is potential support from "old" bearish trend. Suffice it to say, if 4 levels of support are broken to the downside, a bull isn't sitting around if "full positions" and whistling Dixie! Was that a little "bull trap" today with that tick above Monday's high of 900.69? There sure as heck wasn't enough bullish conviction behind it to make much headway was there? If looking bearish, stay patient and disciplined with your stops. The S&P 500 Bullish % ($BPSPX) saw a net gain of 10 stocks to point and figure buy signals today. This has the bullish % growing to 48.2%. August's relative high reading was 58%. S&P 100 Index Chart - Daily Interval The S&P 100 Index (OEX.X) was the STRONGEST index during the August-early October decline. As such, this is my LEADER and STRONGEST index. Therefore, it is the LAST PLACE I would want to see weakness. If I do see weakness below 440, then I'm ON THE ALERT that sellers are getting more aggressive and SELLING THEIR WINNER. A BEAR that is thinking of shorting, then take it VERY VERY EASY!!!! Study the past to understand the potential future. A BEAR does NOT want to get caught SHORT/PUT full position on a reversal higher in a STRONG index. The S&P 100 Index (OEX.X) saw a net gain of 3 stocks to point and figure buy signals today, which has the bullish % growing to 54% and still "bull alert" status. This is getting close to August's 58% reading. A reading of 60% would have this index "bull confirmed." As such, a good level of RISK for bulls to be tightening up some stops, but still some upside to be had. If Treasuries were to see selling and more cash free up, could well see a "bull confirmed reading" and challenge of March's high bullish % levels above 70%. Keep this in mind if thinking "full BEARISH positions." NASDAQ-100 Index Chart (NDX.X) - Daily Interval I've shown the QQQ's in recent sessions and here is the NASDAQ- 100 Index (NDX.X) itself, with conventional retracement set from the August highs to recent lows. It is suspicious at the least to say that 1,000 is a psychological number that would be a bulls target and perhaps a level where bears will be lurking. One could also envision how when the NDX took out the lows and traded into the lower band of retracement, that the rally back would fall just short of the upper band. This index has had the strongest % rally off the bottom, but it was also the most heavily shorted and perhaps benefited most from short covering. If we were to see some buying come back into Treasuries, bears may move aside and stop covering. In the recent week, it's been the telecom and telecom equipment sectors that have seen some sharp rises. While that action may indeed be the sign of a trough bottom for those sectors, we've seen a lot of broker downgrades in the past couple of sessions for VZ, SBC and QCOM. This index violated its past lows by a greater degree and when compared to the 50-day and 21-day SMA's with the other indexes, has some air underneath. If market makers are looking to get short, expect some volatility in the various stocks within the NDX as they try and build some liquidity traps. However, if bonds start seeing buying, and liquidity dries up, that's when the NDX becomes more vulnerable. If the cyclicals decline further, then watch for the NDX to catch up to the downside in quick fashion. The NASDAQ-100 Bullish % ($BPNDX) saw a net gain of 2 stocks to point and figure buy signals today. This has the bullish % growing to 55% and still remains "bull alert." In August, the bullish % reached a high reading of 60%. It would take a reading of 62% to have this index reaching "bull confirmed" status, and a reversal lower reading of 48% to have this index back in "bear confirmed" status. This is the quicker and more volatile bullish % that one would first look to see internal weakening. Not seeing it at this point, so BEARS are very cautious and limiting trades to 1/4 positions. 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 **************** Which Way is Up? by Steven Price The market schizophrenia continued today, with the broader averages eventually settling for significant losses by the end of the day. While a look at the end of day numbers may seem very bearish, there were some positives imbedded in the results, as well. The Dow once again tested 8300 and found buyers, closing at 8317. It did trade as low as 8277, but never cracked the 50- dma of 8248. The Nasdaq tested 1300 and couldn't hold, closing at 1298, but I wouldn't call it a major breakdown. Still we saw the third straight day of a lower low in the Dow, and the semiconductor stocks may have finally run out of steam. After gaining 35% in the last two weeks, the Semiconductor Index (SOX.X) topped out at 299.18, before falling negative on the day. The 300 level has provided previous resistance and would seem the logical point for exhaustion to set in. of, course, the recent rally has been anything but logical, as numerous chipmakers and chip equipment makers have been guiding revenue lower during the recent earnings season, with very little good news to offset the warnings. The markets began to sink after news hit the wires that Iraq was tossing out all foreign journalists. If the country really intends to open itself up for inspection, there would be no need to take such action. In recent days, it has seemed the U.S. was backing away from an invasion, instead giving Saddam Hussein a chance to make nice by complying with U.N. inspection requirements. However, it now appears the U.S. plan was designed simply to give Saddam enough rope to hang himself with. The retail stocks have been surging, following positive comments from Wal-Mart, which reaffirmed its 2002 earnings guidance. However, tomorrow's university of Michigan Consumer Sentiment report should give us a look at consumers' attitudes as we get closer to the holiday shopping season. Many retailers have blamed slow mall traffic for falling sales. However, it is more likely that the problem is that consumers simply don't want to spend as much with an uncertain economy and almost daily announcements of layoffs coming from a wide range of industries. The Retail Index (RLX.X) also found resistance at the 300 level after a rally of almost 20% since October 9. The area between 300 and 310 has been impenetrable for the group on the last two rallies and tomorrow's Sentiment numbers should give us an indication as to whether we were simply given a better entry point for short plays in the sector. The alternative is to get out of the way and let the index run to the 200-dma of 322, but I'm leaning to the short side on this group. Another group which rallied right to resistance is the software stocks. The Software Index has tacked on 28% from its low of 77.63 on October 7, to yesterday's close over 99. It was unable to crack triple digits after reports surfaced that Microsoft was not entirely compliant with its antitrust settlement and was still hiding technical information about Windows from its competitors. Bill Gates' comments about gaining market share from AOL for its MSN internet service were unable to rescue the stock from a loss of $1.97, which managed to erase most of the activity of the last three days. The Market Volatility Index (VIX) remains close to 40, closing today at 39.90. This is generally an indication of fear in the marketplace, as traders don't want to sell anything too cheap for fear a big move to the downside will erase gains from premium decay. The put/call ratio is also on the rise (.81), reflecting similar fears, as the number of puts traded is increasing on the re-test of support levels to the downside. We are not yet out of the woods, and while the recent rally has put bears back into hibernation, they have not hit R.E.M. sleep just yet. If we see intraday resistance on a Dow break under 8300, it may be enough to bring out the shorts in force. The SPX also has not yet been able to hold over 900, reaching 902 briefly today, only to be turned back. Until that happens, look for the Dow and Nasdaq to struggle to hold onto gains. If we continue to bounce from 8300, then step aside until we see support over SPX 900, before stepping in long. If we breakdown below 8300 again, then I'll be looking for short opportunities, as key sectors seem to have run out of steam. ----------------------------------------------------------------- Market Averages DJIA ($INDU) 52-week High: 10679 52-week Low : 7286 Current : 8317 Moving Averages: (Simple) 10-dma: 8241 50-dma: 8248 200-dma: 9338 S&P 500 ($SPX) 52-week High: 1176 52-week Low : 775 Current : 882 Moving Averages: (Simple) 10-dma: 875 50-dma: 876 200-dma: 1009 Nasdaq-100 ($NDX) 52-week High: 1734 52-week Low : 795 Current : 964 Moving Averages: (Simple) 10-dma: 945 50-dma: 918 200-dma: 1182 ----------------------------------------------------------------- The Semiconductor Index (SOX.X): There have been numerous times over the last couple of weeks that this sector looked like a shorting opportunity. 4Q warnings were given with almost every earnings release. Stocks that announced after hours were hammered in after market trading. Revenue forecasts were lowered into 2003. Yet still the SOX kept going up. Stocks that had traded down after hours miraculously rebounded the next morning, and kept going. Now that we have hit the 300 level, or more precisely, failed the 300 level, with an intraday high of 299.18, we may finally get that shorting opportunity. The SOX finally closed down for the day after the rally failed, settling in at 278.50, just above the 50-dma of 276.92. We'll be looking for a break below the 50-dma and then searching for some of the weaklings that rode the coattails of the broader market. 52-week High: 657 52-week Low : 263 Current : 278 Moving Averages: (Simple) 10-dma: 265 50-dma: 276 200-dma: 435 ----------------------------------------------------------------- Market Volatility The VIX remains close to 40, reflecting a level of downside fear. If the Dow breaks support of 8300 on a closing basis, we expect the VIX to head back into the 40s, and a break under 8000 should put us around 45. For the moment, however, we are at 39.90 and could see some premium sellers capturing weekend time decay tomorrow if we remain above 8300. Watch for the VIX to fall into Friday's close if we don't get a sell-off. The VXN continues to bounce from its 200-dma of 50.93 and it will be interesting to see if a market rally can finally crack that level. It hasn't been below the 200-dma since the end of August. CBOE Market Volatility Index (VIX) = 39.90 +0.52 Nasdaq-100 Volatility Index (VXN) = 54.58 +2.21 ----------------------------------------------------------------- Put/Call Ratio Call Volume Put Volume Total 0.81 575,268 468,575 Equity Only 0.70 473,446 332,315 OEX 1.05 14,403 15,142 QQQ 1.60 43,575 69,627 ----------------------------------------------------------------- Bullish Percent Data Current Change Status NYSE 36 + 2 Bull Confirmed NASDAQ-100 55 + 6 Bull Alert Dow Indust. 53 + 0 Bull Confirmed S&P 500 48 + 3 Bull Alert S&P 100 54 + 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 0.85 10-Day Arms Index 0.85 21-Day Arms Index 1.11 55-Day Arms Index 1.26 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 1148 1565 NASDAQ 1454 1679 New Highs New Lows NYSE 24 32 NASDAQ 59 79 Volume (in millions) NYSE 2,035 NASDAQ 1,931 ----------------------------------------------------------------- Commitments Of Traders Report: 10/15/02 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 Not much change for the commercials, who added 2,000 long contracts and 4,000 shorts, for a net increase of 1600 short contracts, but not much % change. Small traders increased both positions for a net overall increase of only 300 long contracts. Commercials Long Short Net % Of OI 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%) 10/15/02 429,448 449,138 (19,690) (2.2%) 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 09/24/02 124,232 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% 10/15/02 134,507 83,714 50,793 23.37% 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 made little change to the long side, but reduced shorts by almost 4,000 contracts. Small traders, on the other hand, left long positions virtually unchanged, while more than doubling their short contract positions; adding a total of almost 7,000 short contracts. Commercials Long Short Net % of OI 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%) 10/15/02 45,578 51,969 (6,391) ( 6.6%) 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 09/24/02 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% 10/15/02 10,185 12,478 2,293 10.1% 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 by 1,400 contracts, reducing shorts by 2,000. Small traders reduced the long side by 1,800 contracts, while slightly increasing shorts. Commercials Long Short Net % of OI 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% 10/15/02 20,914 9,630 11,284 36.9% 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 09/24/02 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%) 10/15/02 6,040 10,329 (4.289) (26.2%) 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 ************************* John S. Orrico: The Arbitrage Fund (ARBFX) John Orrico is president and portfolio manager with Water Island Capital LLC of New York City, which serves as investment advisor for the Arbitrage Fund (ARBFX), a relatively new fund that seeks to achieve capital growth by engaging in merger arbitrage. This non-diversified status mutual fund invests in both common stocks and preferred stocks, and typically invests at least 65% of assets in equity securities of companies that concentrate in mergers, takeovers, tender offers, leveraged buyouts, spin-offs and liquidations, and other corporate reorganizations. Prior to Water Island, Orrico managed private hedge funds with Lindemann Capital Partners, LP during 1999. From 1994 to 1998, he engaged in mergers and acquisition arbitrage while managing the Gruss Family Trust for Gruss & Company. Orrico has earned the right to use the Chartered Financial Analyst designation. The Arbitrage Fund began operations on September 18, 2000, and has $22 million in net assets today. It is available directly (call 800-295-4485) or through a dozen brokerage fund networks, including Charles Schwab, Fidelity, and TD Waterhouse. Retail investors can buy the fund on a no-load and no-transaction fee (NTF) basis through Schwab's and TD Waterhouse's NTF programs. The Arbitrage Fund's minimum initial investment is $2,000 both for regular and IRA accounts. If you go to the fund's website at www.thearbfund.com, you can get complete fund information and download the fund prospectus, which contains detailed information on the Arb Fund's strategy, risk factors, and expenses. At 1.94%, the fund's expense ratio is about a half percentage point above that of the average U.S. stock fund, and includes a 1.50% management fee and 0.25% 12b-1 fee. Investment Overview The Arbitrage Fund (ARBFX) uses a merger arbitrage strategy that invests in announced takeover deals and corporate restructurings. The fund's adviser, Water Island Capital LLC views themselves as a market-neutral strategy and also a "hedge fund" in mutual fund clothing. The merger arbitrage strategy that Orrico employs has been mainly the domain of wealthy investors through hedge funds and allows all investors to reduce their risk in "flat to down" markets and enhance their performance in "up" markets. As such, their general feeling is that the Arbitrage Fund belongs in all portfolios. Merger arbitrage seeks to capitalize on the market's reaction to a public announcement of a merger, acquisition, leverage buyout, tender offer, spin-off or corporate reorganization. It seeks to generate returns for investors by riding both sides of imminent M&A deals. For instance, Orrico will buy the stock of a company that's an acquisition target while at the same time shorting the stock of the acquiring company. Orrico looks at the current price of the target company’s shares against what they expect the share price will be when the deal is finalized. The difference between the current price and expected terminal share price is the "spread," or the profit that they can capture. As time passes (and the deal nears closing), the spread or profit opportunity typically declines. In shorting the shares of the acquiring company, Orrico employs a market neutral strategy that disregards the overall direction of the equity markets. Orrico does this to hedge against a decline in the value of the acquiring company's securities before the M&A transaction is complete. The result is a neutral bias in regards to market exposure. The gain in share price of the long position is offset by the loss from the corresponding short position (vica versa). The only time Orrico won't short shares of the acquiring company is when the merger or acquisition is structured as an "all cash" deal. Note that merger arbitrage funds require flexibility to move in and out of deals quickly. Regulatory or legal developments, for example, can change the risk profile of the deal, making it less appropriate for the portfolio. Orrico may take a stake and then sell that stake, only at a later date to buy into the deal again. He is not afraid to unwind positions and then move back into M&A deals as they progress, if doing so is justified. The Arbitrage Fund has "non-diversified" status but still takes 35-55 positions at any one time, with no more than 5% of assets invested in any one issuer. The fund limits its investments in any one sector to 20% of assets. Orrico may do other things to limit the fund's downside risk as well such as avoiding hostile takeovers where the acquirer has not indicated a willingness to maximize shareholder value. The end result is a relatively low risk profile compared with the average diversified equity fund. While much of the merger activity today involves big companies buying up little ones, Orrico also looks at M&A deals between smaller players looking to build enough weight or influence to remain independent or move up the food chain. Being small and nimble Orrico contends has been a benefit in the recent equity market environment. According to Morningstar's latest fund report, the Arb Fund's average market capitalization was $1.3 billion and its average P/E was 20.9, landing it in the small-growth style box. Still, it may be better to think of the fund as having a mid-cap core (blend) style. Both Morningstar and Lipper categorize it that way. In the next section, we take a look at the fund's return performance. Investment Performance Because the fund employs a merger arbitrage strategy, Orrico's performance is not comparable to the average diversified stock fund, which takes only long positions in stocks. The strategy employed seeks to generate absolute positive returns in up and down markets, and produces fixed income-like returns utilizing the stock markets. Accordingly, the fund's index benchmark is the "risk-free" rate of return (best represented by the T-Bill rate). Orrico strives to generate returns that are four times that of the Risk Free Rate. What does that mean in terms of expected annual returns? That translates into expected returns in the area of 8%-10% in bear and flat markets, and 10%-15% in bull markets. Since inception (September 18, 2000), the Arbitrage Fund has produced an annual equivalent return of approximately 8.2% through October 22, per company sources. In the fund's first full year of operation (2001), the Arb Fund generated a total return of 9.0%, in line with expectation. As of October 23, 2002, the fund had a positive YTD return of 7.3% and a trailing 1-year return of 12.1%, according to Morningstar, ranking it in the top 1% of the mid-cap blend category. Orrico's 12.1% return over the past 12 months represents a 28.1% return advantage to the S&P 500 index and 14.9% return advantage to the S&P Midcap 400 index. And, it's roughly in line with the T-bill index target (four times the 3% T-bill rate). So, Orrico has achieved the fund's desired return objective. Compared to the $866 million Merger Fund (MERFX), which utilizes a similar merger arbitrage strategy, the Arbitrage Fund has done very well in its brief history. In 2001, the Arb Fund rose 9.0% compared with only a 2.0% gain by the Merger Fund. In 2002, the Merger Fund has lost 8.8% on YTD basis compared with a 7.3% gain from the Arbitrage Fund. So while the Merger Fund has slipped a notch recently, Orrico's performance has shined. The Merger Fund's long-term performance, however, offers a sense of what the Arbitrage Fund is capable of over the long run. The Merger Fund's trailing 10-year annualized return as of September 30, 2002 was 9.0%, matching the return of the S&P 500 index with significantly less risk (i.e. bond fund-like risk). In Morningstar's system, the Merger Fund is categorized as U.S. hybrid, and is graded as having produced "low" risk versus the average domestic hybrid fund. Considering the average domestic hybrid fund has less risk than the average U.S. stock fund, the Merger Fund's risk profile is very low. So, in terms of "risk" the Arbitrage Fund should have a low risk profile that is more comparable to a fixed income fund than a partial or full equity fund. Conclusion The only knock I have on the Arbitrage Fund is its 1.94% expense ratio which is a little high relative to the average mutual fund. However, considering the Arb Fund's solid performance so far and its expected low risk profile, it's unique and worth considering in my opinion. Orrico has certainly overcome the fund's expense ratio to generate strong total returns for investors in what has otherwise been a poor environment for the broad equity market. With interest rates at historic lows, you may also view the Arb Fund as a viable alternative to bond mutual funds, which likely will decline in price if/when interest rates rise again. While bond funds have enjoyed a great run, many pundits feel the bull market for bonds is in the late innings and may disappoint new investors. Because of its low market correlation, the Arb Fund like fixed income investments may help provide diversification against a portfolio consisting only of pure equity investments. For more information or a fund prospectus, call 800-295-4485 or go online at www.thearbfund.com. Steve Wagner Editor, Mutual Investor email@example.com ************************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 *********************** Reality Bite Bulls Finally a script play out the way it should have. Strong resistance held and profit taking began in the face of slowing momentum. The SOX failed at resistance and bigcaps, which had been savings accounts for stashing cash begin to fade. 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 10-24-2002 Copyright 2002, All rights reserved. 2 of 3 Redistribution in any form strictly prohibited. In Section Two: Stock Picks: Ahead of Schedule Dropped Calls: FNM Dropped Puts: GM, HD, KSS Daily Results Call Play Updates: PNRA, TRMS, UNH, QCOM New Calls Plays: JNJ Put Play Updates: None New Put Plays: CTAS, IBM, NTRS *********** STOCK PICKS *********** Ahead of Schedule CTXS - Citrix Systems - $7.18 Strategy: Long Stock with Put Insurance Citrix Systems, which focuses on software that creates a virtual workplace, is positioned to continue growing as businesses spend less on travel and cut overhead costs by allowing remote input from workers. The company has seen its revenues fall, as business spending has been severely reduced in the last several years. however, during this period, Citrix has continued to expand its platforms and add customers worldwide that won't be going out of business anytime soon. It has recently added the Shanghai Port Authority, the National Institutes of Health, Boston Medical Center, ABN AMRO Bank, SBB Swiss Railway, Ministry of Finance of the State of North Rhine Westphalia, Computercenter of Ministry of Finance in Slovakia, ITEGRO, Apria Healthcare, Conseco Finance and Health Services Advisory Group. Some of the early users of CTXS's new NFuse Elite technology include General Electric, National Institutes of Health, ASRC Aerospace and Kingfisher PLC. The company released earnings on Tuesday of $0.10 per share, which beat estimates by $0.04. It posted revenues of $118.9 million, which was above previous guidance of $110-$115 million. While these numbers were down from the previous year, they reflected the fact that the company appears to be stabilizing. The company made improvements in several areas, including the time it takes to collect money from its customers and the turnaround time its resellers have held onto its products. The company reiterated its fourth quarter guidance, which in and of itself is a positive, since many software makers are shying away from predictions. That guidance includes an increase in earnings to $0.11-$0.13 and revenue between $115-$120 million. Citrix CEO mark Templeton said, "Specifically, we achieved higher than expected revenue due to strength in packaged product sales. We increased adjusted operating margins to 17% from 11%, sequentially, by focusing on expense reduction. And our distributors further reduced their inventory in anticipation of our new 'open-style' licensing program called Citrix Easy Licensing. With a healthy pipeline, lower operating expenses and improved go-to-market programs, we feel well positioned to take on the fourth quarter." This is a far cry from what we've been hearing elsewhere in the industry, which is that revenues are declining and firms are not sure when it will turn around. CTXS put its money where its mouth is as well, repurchasing 7 million shares of common stock during the quarter. CTXS has seen its stock fall, along with the rest of the techs, from a high of over $108 in February 2000, to a low of $5 in July. Since bottoming out in July, the stock has been on a slow but sure creep upward, and Tuesday's comments and results seem to indicate that the turnaround will continue. The stock recently broke through its 50-dma, now at $6.21 and has added 19% since that time. After such a large percentage gain, some pullback can be expected. While any support over the 50-dma can be viewed as bullish, today's bounce around $7 can be seen as a possible entry point. The stock broke out of its recent ascending channel, and the pullback to the top trend line looks as though it may now be finding a higher level of support over $7. We would still look for the purchase of a protective put, in case we see another tech slide, which may take even the promising companies with it. We like the June 5 put (XSQ-RA), currently offered at $0.70, as protection. This will give CTXS time to reap from revenue from its new products and clients, and post a couple of more earnings releases. The stock managed to get through previous resistance at $6 and the next resistance level appears to be $10. If the stock breaks through the $10 level prior to June expiration, then we would sell the put and either roll up to a higher strike (7.50 or 10) or allow the stock to run without protection until it hits resistance, at which time the stock holder can invest in the put a the next out of the money strike to the downside. If the stock drops below $5, then traders can sell the put to offset losses on the stock. If the stock increases, then the loss on the long put will be small and profits on the long stock should far outstrip the insurance cost. Option 1: Purchase CTXS stock and purchase 1 June 5 put for each 100 shares of stock held long. If the stock falls below $5 by June, sell the put and reassess stock at that time. Option 2: Purchase CTXS stock and purchase 1 June 5 put for each 100 shares of stock held long. If stock falls below $5 by June, sell put and sell stock and close the position. Option 3: Purchase CTXS stock and purchase 1 June 5 put for each 100 shares of stock held long. If stock breaks $10, then sell the put and either roll up to a higher strike put (7.50 or 10), or simply let the stock run until it hits resistance and then look for a protective put below that level. **************** 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: ***** FNM $68.10 -1.95 (-3.79) After Wednesday's rally off the $68 support level, FNM looked like it was consolidating for another leg higher this morning. Price was holding around $70, and then the bottom fell out of the broad market, taking FNM down with it. In less than an hour, the stock fell more than $2, and selling volume really picked up in the final hour, taking the stock out right on that critical $68 support level. There is a clear Head & Shoulders top on the hourly chart, and it looks like the stock is going to break down from that pattern tomorrow. We'll take a pre-emptive exit from the play, focusing our attention on stronger bullish candidates. Use any sort of bounce in the morning to exit the play. PUTS: ***** GM $35.63 -0.87 (+1.32) It seems that no amount of bad news is sufficient to blunt the bullish sentiment in the Auto sector. GM hasn't had a positive news story in what seems like weeks, yet the stock stubbornly holds above the $35 level. If the play isn't going with us, then it's going against us. Use this afternoon's weakness to exit the play at a favorable level before the bulls bid it up to challenge that $37 resistance level again. GM may yet break down, but there appear to be plenty of plays offering better opportunities. --- HD $29.89 -0.55 (-0.52) So much for our bearish thesis on HD. Tagging along on the positive sentiment in the Retail sector this morning engendered by WMT's positive comments about sales trends, HD actually pushed through the $31 level before succumbing to the broad market selling pressure in the afternoon. If HD was going to perform for us, then the stock should have been down more sharply with the DOW losing nearly 200 points on the day. We're going to view the late-day weakness as a gift of an exit point. Use any negative reaction to tomorrow morning's economic reports to exit the play at a more favorable level. --- KSS $57.50 +2.02 (+2.35) Retail stocks got a boost on Thursday, following some positive comments from sector bellwether WMT, and that positive sentiment lent a bid to shares of KSS all day. At one point, the stock traded above $59, before falling in the afternoon with the rest of the broad market. We had lowered our stop to $57.50 earlier in the week, so when the stock charged through that level early in the day, any open plays should have been exited. Reluctant bears are getting another chance tonight though, with KSS going out right at that $57.50 level. Look to exit any remaining open positions on downside follow through in the morning. *********************************************************** DAILY RESULTS *********************************************************** Please view this in COURIER 10 font for alignment ************************************************* CALLS Mon Tue Wed Thu Week FNM 68.10 -2.04 0.14 0.05 -1.95 Drop, under performer JNJ 57.71 1.61 -0.98 -0.87 –0.24 New, bounce point PNRA 28.81 -1.36 -0.39 -0.48 0.55 dough still rising QCOM 35.39 0.95 0.07 0.02 –1.13 hanging over $35 TRMS 50.26 1.51 -0.03 -0.13 –1.00 support at $50 UNH 98.28 -0.58 -0.38 1.39 –2.09 WLP disappoints PUTS CTAS 48.75 1.70 -0.11 1.38 1.79 New, rolling over IBM 72.10 1.90 -0.01 0.20 –2.50 New, overdone GM 29.89 2.82 -1.20 0.85 –0.55 Drop, sideways HD 35.63 -0.53 -1.20 0.70 –0.87 Drop,retail resilient KSS 57.50 0.15 -0.80 1.08 2.02 Drop, barely stopped NTRS 36.19 0.71 0.04 0.52 –0.98 New, pattern repeats ************************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 ******************** PNRA $32.30 +0.55 (+1.29 for the week) Panera once again showed great relative strength, with a gain of 0.55 on a day when the Dow gave up 176.65. Since the surge through the 200-dma of $30.47 on Monday, the stock pulled back slightly and appears to have found a new level of support at $31.50. The stock traded as high as $33.10 and a hold over $33.00 will be the next challenge. The stock tested the same level on Tuesday. PNRA announced this morning that same store sales were up 5.5% for the four-week period ending October 5. This was an increase over the 4.4% gain the company reported last month. The stock has tested $33 on two of the last three days and if it can break that level, $35 still looks like a good possibility. The sinking tide dragged it down into the close today, but the hold above $32 looks bullish. New entries may want to wait for pullback to $31.50, and a show of continued support at that level to maximize profits to $35. A close over $33 would also be bullish, but entry at that point may not provide good risk/reward potential with resistance at $35. If the stock continues higher without a pullback, we like the long position for current holders. --- TRMS $50.26 -1.00 (+0.21 for the week) Trimeris experienced a pull back, along with the Biotech Index (BTK.X) today. The pullback, however, held at $50, which was the level of the recent breakout on the daily chart. While TRMS is subject to industry pullbacks, it recently received priority review status from the FDA for its new drug, Fuzeon, which is the first in a new class of HIV drugs, which prevents the disease from entering healthy cells. The drug can be used on its own, or in conjunction with other "cocktail" therapies, in patients who have become resistant to current medications. Revenue is estimated between $600 million and $1 billion annually. Right now TRMS, and its partner Roche, will need to increase production capacity to satisfy pent up demand for Fuzeon, which should receive FDA clearance by March 16 - the end of the priority review period. The company also has another drug, T-1249, in its pipeline, that may hold even more promise than Fuzeon. The support at the previous $50 resistance level appears to be an ideal point to initiate new long positions. However, if the stock breaks below $50, new entries should stay on the sidelines until a new level of support is reached. The stock broke through the PnF bearish resistance line at $48.00 and this remains our stop loss on the play. The current bullish vertical count is $74, which underscores our bullish sentiment. However, this target would be an eventual count and our initial target on the play remains $55. If the stock breaks $55, then we will likely raise our stop and let it run. --- UNH $98.28 -2.09 (-1.40 for the week) Unitedhealth finally managed a close over $100 on Wednesday for the first time. The trip into triple digits was short lived, however, as results from fellow HMO Wellpoint (WLP) were not as impressive as had been expected. While WLP beat previous forecasts by $0.04 per share, the market was apparently looking for numbers similar to UNH's, which beat the street by $0.08. While the HMOs sold off, UNH managed to hold above $97 support. We had originally looked for a pullback for entry on the play, and while we dialed up our expectations, we like the show of strength on what was a bad day for the sector and broader market. UNH recently posted a 53% increase in earnings and raised its guidance for 2002 and 2003. Although WLP's numbers were not as good as hoped for, the company still beat forecasts and showed an increase of 68% from the year ago period. It appears that the industry has weathered the economic storm well, as the managed care companies have simply raised premiums faster than the rate of medical cost inflation. UNH was recently listed on S&P analyst Phillip Seligman's list of five star picks in the industry. We will maintain our long position in UNH and would view the current pullback level as an entry point. If the stock breaks below $97, then we would suggest no new entries at that point. Conservative traders can wait for a trade above the recent high of $101.00 to initiate long positions. --- QCOM $35.39 -1.13 (-0.81) What started out as a very quiet, rangebound session turned into a rout for the bulls as they gave up all their early gains (and then some), even in the Technology sector. QCOM held up better than many stocks, largely due to the bullish tint that was painted on the Wireless sector by strong earnings from AWE and NXTL. That mitigated the damage inflicted on QCOM by the CSFB downgrade. The firm downgraded QCOM on expectations that the good news is already priced into the stock and that it would Underperform its peers over the next 6-12 months. Definitely not a glowing report, so it is impressive that QCOM managed to hold above its morning lows, even as the rest of the market fell sharply in the final 2 hours of the day. Support is apparently solidifying in the $35 area (also the site of the 10-dma), followed by more support down at $34. We were looking for a bit of a pullback to give us a better entry point, and it appears we are getting it. An intraday dip and bounce (accompanied by solid volume) from either of these levels should make for a solid entry into the play. Recall that our stop is set at $33.50, just below the top of the gap up from last week. ************** NEW CALL PLAYS ************** JNJ – Johnson & Johnson $57.71 -0.24 (-1.64 this week) Company Summary: Johnson & Johnson is engaged in the manufacture and sale of a broad range of products in the healthcare field. The company conducts business in virtually every corner of the globe. JNJ's activities are divided into three primary business segments; Consumer, Pharmaceutical and Professional. The Consumer division is focused on personal care and hygiene products, while the Professional segment provides a wide range of products used by the healthcare profession. The Pharmaceutical group provides a broad range of over-the-counter and prescription medications for the treatment of afflictions ranging from antifungal to dermatological to pain management conditions. In June of 2001, the company merged with ALZA Corp, a research-based pharmaceutical company which became a direct, wholly owned subsidiary of JNJ. Why We Like It: Strong stocks tend to attract buyers, and short-term pullbacks present great entry points for traders that can focus on the overall trend. There are few stocks that didn't fall all the way back to test their July lows earlier this month, and those that can make that claim are likely to continue to see bullish action. Despite the sharp broad market decline in September and early October, shares of JNJ stubbornly held the $52 support level, and when the stock broke through the $57 resistance level in late September, it put the PnF chart on a fresh Buy signal. Since then, the stock has been rather volatile, responding to the ups and downs of the broad market. But the big picture shows a stock that continues to post higher lows and higher highs, where each dip is met by solid buying interest. Last week, the company reported solid earnings, and positive reception by the market drove the stock through the $60 resistance level for the first time since the breakdown in early June. CIBC downgraded the stock yesterday, and that (along with broad market selling pressure today) pushed JNJ down to close just below $58, right on the converged 200-dma ($57.76) and 20-dma ($57.80). The ascending trendline that connects the lows since late September rests at $57 and provided intraday support the past 2 days. While this looks like a solid entry point, we want to allow for a bit more weakness before the next upward leg commences. The $56 level is very strong support and a dip and rebound from there would make for an even better entry opportunity. More conservative traders may want to wait for a rally back through the $59 level (just above today's intraday resistance) before entering the play. We are initially placing our stop at $54.50, just below the October 10th intraday low. BUY CALL NOV-55 JNJ-KK OI= 6297 at $3.90 SL=2.50 BUY CALL NOV-60 JNJ-KL OI=17235 at $1.05 SL=0.50 BUY CALL DEC-55 JNJ-LK OI= 161 at $5.00 SL=3.00 BUY CALL DEC-60 JNJ-LL OI= 2315 at $1.85 SL=1.00 Average Daily Volume = 9.08 mln ************************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 ******************* None ************* NEW PUT PLAYS ************* CTAS - Cintas - $48.75 -1.79 (+0.77 for the week) Company Summary: Headquartered in Cincinnati, Cintas Corporation is the leader in the corporate identity uniform industry, providing uniforms to a wide variety of industries nationwide. The company also provides a range of outsourcing services including entrance mats, sanitation supplies, cleanroom services and first aid and safety products and services. Cintas is a publicly held company traded over the Nasdaq National Market under the symbol CTAS, and is a Nasdaq100 company and component of the Standard & Poor's 500 Index. The company, which has achieved 33 consecutive years of growth in sales and earnings, to date, was named one of the top outsourcing services providers in Fortune Magazine's 2002 "America's Most Admired Companies" survey. Why We Like It: We profiled CTAS in last weekend's Ask the Analyst column. At that time a reader asked for our opinion as a short candidate. We suggesting waiting until it tested point and figure resistance at $50, and we finally got that test, and a failure. Cintas primarily rents corporate identity uniforms to everyone from small businesses to large corporations. An economic slowdown industry-wide affects the company, as smaller businesses shut their doors and large businesses downsize. The company recently met earnings expectations, however guided revenue lower for the year, reducing estimates by $100-200 million. The CEO said, "Although our sales force continues to be very successful in adding new customers, we continue to experience lower sales volume with our existing customers as they shrink their work forces, eliminate shifts and departments and even close operations." The CFO added, ""Our lowered guidance reflects a more pessimistic view for the economy." While the company said it expects to achieve earnings once again next quarter, that will be awfully tough to do in the described environment. The recent rally in the stock came not after the earning's release, but on the heels of the Dow rally that began October 10. A look at the point and figure chart shows a stock that looks very extended and has rolled over right at previous resistance. $50 had acted as resistance on 5 separate columns since the beginning of the year, with one additional column reaching $51. A trade of $47 would be needed for a three-box reversal down, which would also constitute a break of the 200-dma of $47.46. Conservative traders can wait for a break below the 200-dma for entry. There is a risk that the stock is simply experiencing a pullback on the way up, however the reaction to its revenue projections on September 19 put the stock just above $40, and if not for the broad market rally, it would likely still be at that level. We will look for continuing downside in the Dow as confirmation to go short CTAS, as it has followed the major indices through the recent run. We don't want to get caught standing in front of a speeding train, no matter how weak a company's future might look. We will look for intraday resistance below $50 in CTAS and Dow resistance below 8300 as a signal to initiate a short position. Place stops at $52, which would signal a breakout above PnF resistance. While we believe CTAS has plenty of room to fall, we want to be very careful on the entry point. BUY PUT NOV-50*NQQ-WJ OI= 519 at $2.55 SL=1.25 BUY PUT DEC-50 NQQ-XJ OI= 519 at $3.60 SL=1.80 Average Daily Volume = 1.45 mil --- IBM - International Bus. Machines $72.10 -2.50 (-2.15 this week) Company Summary: International Business Machines uses advanced information technology to provide customer solutions. The company provides value to its customers through a variety of solutions including technologies, systems, products, services, software and financing. IBM's three hardware product segments are comprised of Technology, Personal Systems and Enterprise Systems. Other major operations consist of a Global Services segment, a Software segment, a Global Financing segment and an Enterprise Investments segment. Why We Like It: The broad markets have had a tremendous run up the charts in the past two weeks, as investors have voted with their wallets that the earnings reports coming in from Corporate America are not as bad as they had originally feared. Good earnings, bad earnings, they have all had the effect of stimulating both the bulls and bears to hit that 'Buy' button. But judging by the weakness in the market on Thursday, more than a few of these recent buyers are having second thoughts. After breaking down to new multi-year lows ahead of its earnings report, IBM rocketed higher with the broad market. The stock then extended those gains when the company's earnings report was well received by investors, leading to upgrades from Merrill Lynch and Bear Stearns. Momentum players and shorts rushing to cover drove IBM right up to heavy resistance at $76 earlier this week, and since then the stock has been putting in what looks like a solid top. The bulls failed to push IBM through that level again this morning, and the sharp afternoon selloff helped to push the daily Stochastics over the edge, and they are now in a sharp bearish decline. There are several gaps below IBM's current level that are just asking to be filled in, and it appears reasonable that we could see a decline back down to the $65-66 area over the near term. Aggressive traders can look to initiate positions on another failed rally in the $73-74 area, while those that want to see confirmation first will want to see IBM drop back under $71 (under recent intraday support) before taking a position. With strong resistance at $75-76, we're initially setting our stop at $76. BUY PUT NOV-75 IBM-WO OI= 4000 at $4.80 SL=3.00 BUY PUT NOV-70*IBM-WN OI=15719 at $2.25 SL=1.00 BUY PUT NOV-65 IBM-WM OI=13078 at $1.20 SL=0.50 Average Daily Volume = 9.95 mln --- NTRS – Northern Trust Corp. $36.19 -0.98 (-1.90 this week) Company Summary: Northern Trust Corporation is the holding company of The Northern Trust Company (Bank). The company also owns national bank subsidiaries with offices in Arizona, California, Colorado, Florida and Texas; a federal savings bank with offices in Michigan, Missouri, Nevada, Ohio, Washington and Wisconsin; a trust company in New York. Additionally, NTRS has various other non-bank subsidiaries, including an investment management company, a securities brokerage firm, an international investment consulting firm and a retirement services company. Why We Like It: One of the primary catalysts that cratered the Banking sector (BKX.X) just prior to the market bottom of a couple weeks ago, were numerous banks coming out and admitting they had an extraordinarily large exposure to loan losses. The BKX caught a strong bounce off the site of the July lows and has had an impressive 25% rally up to the $765 level. While on the surface that is bullish, the concerns about loan losses haven't yet gone away. On October 4th, NTRS was just one of the offenders contributing to the problem, when it pre-announced its Q3 results. Citing higher provisions for credit losses and lower trust fees, the company reported that earnings would come in at 43 cents vs. consensus of 55 cents. While that news sent the stock down to just above the $30 level, it came roaring back with the broad market rally. NTRS' good fortunes came to an end near the $39 resistance level though, as the buyers just couldn't push through the 50-dma. Since then, the stock has been drifting lower, capped off with today's 2.6% decline. NTRS is still on the PnF Sell signal generated back in September, and the vertical count is pointing to an eventual bearish target of $19. If the BKX continues rolling over, that is just going to add to the bearish pressure on the stock. A breakdown under $35.75, just below recent intraday support and the site of the 20-dma ($35.79) should make for a solid entry into the play. Of course, another failed rally near the $38 level would give us an even better entry, where we can keep our risk to a minimum, setting initial stops at $39. While there is some support in the $34.50-36.00 area, once below there, NTRS should fall fairly quickly back to the $31-32 area, which will be our initial target for the play. BUY PUT NOV-40 NRQ-WH OI=110 at $4.40 SL=2.75 BUY PUT NOV-35*NRQ-WG OI=646 at $1.15 SL=0.50 Average Daily Volume = 1.77 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 10-24-2002 Copyright 2002, All rights reserved. 3 of 3 Redistribution in any form strictly prohibited. In Section Three: Play of the Day: PUT - IBM Traders Corner: Take Off Your Shoes, We Got Some Calculatin’ To Do Traders Corner: Moving Averages: types, use and time periods (length) Traders Corner: Game Seven Options 101: High Volatility as Opportunity ********************* PLAY OF THE DAY - PUT ********************* IBM - International Bus. Machines $72.10 -2.50 (-2.15 this week) Company Summary: International Business Machines uses advanced information technology to provide customer solutions. The company provides value to its customers through a variety of solutions including technologies, systems, products, services, software and financing. IBM's three hardware product segments are comprised of Technology, Personal Systems and Enterprise Systems. Other major operations consist of a Global Services segment, a Software segment, a Global Financing segment and an Enterprise Investments segment. Why We Like It: The broad markets have had a tremendous run up the charts in the past two weeks, as investors have voted with their wallets that the earnings reports coming in from Corporate America are not as bad as they had originally feared. Good earnings, bad earnings, they have all had the effect of stimulating both the bulls and bears to hit that 'Buy' button. But judging by the weakness in the market on Thursday, more than a few of these recent buyers are having second thoughts. After breaking down to new multi-year lows ahead of its earnings report, IBM rocketed higher with the broad market. The stock then extended those gains when the company's earnings report was well received by investors, leading to upgrades from Merrill Lynch and Bear Stearns. Momentum players and shorts rushing to cover drove IBM right up to heavy resistance at $76 earlier this week, and since then the stock has been putting in what looks like a solid top. The bulls failed to push IBM through that level again this morning, and the sharp afternoon selloff helped to push the daily Stochastics over the edge, and they are now in a sharp bearish decline. There are several gaps below IBM's current level that are just asking to be filled in, and it appears reasonable that we could see a decline back down to the $65-66 area over the near term. Aggressive traders can look to initiate positions on another failed rally in the $73-74 area, while those that want to see confirmation first will want to see IBM drop back under $71 (under recent intraday support) before taking a position. With strong resistance at $75-76, we're initially setting our stop at $76. BUY PUT NOV-75 IBM-WO OI= 4000 at $4.80 SL=3.00 BUY PUT NOV-70*IBM-WN OI=15719 at $2.25 SL=1.00 BUY PUT NOV-65 IBM-WM OI=13078 at $1.20 SL=0.50 Average Daily Volume = 9.95 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 ************** Take Off Your Shoes, We Got Some Calculatin’ To Do By Mike Parnos, Investing With Attitude Although I’m not an advocate of selling uncovered options (except for the most advanced CPTI students), it’s important that we take the time to review the method of calculating margin requirements. With the market threatening to make at least a near term low, aggressive traders are slowly coming out of the woodwork. In their infinite wisdom, they have consulted their crystal ball and determined that it’s safe to go back into the water. Disregarding the fact that even Jaws had two sequels, they have selected a stock and are planning to sell puts. There are a few reasons to sell puts: a) to potentially get a discount on the purchase of shares; and b) to generate a cash flow on stock that you don’t particularly want to own, but will if you have to. How much margin requirement will your brokerage firm want? Let’s figure it out using QLGC as the example. Set The Scene There are about three weeks left before November expiration. QLGC has bounced over the $30 level and is trading at $31.00. A “glass is half full” optimist might think it will finish above $30 at November expiration. The out-of-the-money Nov. $30 puts can be sold for $2.50. If QLGC finishes above $30, you keep the $2.50. There are two formulas that are used to figure out margin requirements. Formula #1 a) The minimum margin requirement is 10% of the value of the underlying stock plus the option premium received. 10% of the value of the underlying ($31.00) = $3.10 x 100 = $310 Add premium received from Nov. $30 put = +$2.50 x 100 = $250 Total Margin Requirement: $5.60 x 100 = $560 Formula #2 b) The initial margin requirement for the transaction is 20% of the underlying stock plus the credit received, less the amount out of the money. 20% of the value of the underlying ($31.00) = $6.20 x 100 = $620 Add premium received from Nov. $30 put = +$2.50 x 100 = ($250) Subtract OTM amount ($1.00) = -$1.00 x 100 = $100 Total Margin Requirement: $7.70 x 100 = $770 The LARGER number of the two formulas is used. In this case, the margin requirement would be $770 per contract. Return on Margin To figure out the return on margin use this simple formula: Premium Received divided by Margin Requirement = Return on Margin In the above example: $2.50 / $770 = 32% This hefty three-week return makes the put selling strategy very appealing. But the risk is substantial. Although you’re only exposed for three weeks, you can still catch a bad cold. The past two years should have had a sobering affect on punch-drunk put sellers. Note that the margin requirement is substantially less than more conservative traders need when selling a “cash secured” put. (in which case you need to have sufficient cash in your account to purchase the shares if/when the short put is exercised). More Marginal Notes Margin, at most brokerages, can be in the form of cash, marginable stocks, bonds, mutual funds, treasuries, etc. All brokers are NOT created equal. Contact your broker to find out their policies. There are aggressive traders who, find a stock (or preferably an index) trading in a range, want to trade short strangles. In our QLGC example, a trader might believe that QLGC will stay between $25 and $35. They will sell (unhedged, naked, in the buff, etc.) both the $25 put and the $35 call, and take in the premium credit. They are exposed on both the upside and the downside. However, even though there are actually two positions, some brokerages will only hold a margin requirement on one of the two positions. Their computer software can recognize a short strangle (or straddle) position – if the root symbols are the same. The assumption is that you can only be wrong in one direction. That’s true 99.9% of the time. It’s interesting that most broker’s software is not sophisticated enough to recognize a condor spread on an underlying – a simultaneous bull put spread and a bear call spread. While you may only be responsible for maintenance on one side of a short straddle or strangle, you’re going to have maintenance on both sides of a condor position. Again, always double check with your broker on their requirement policies – before you initiate a position. Get the name of the person you speak with. You’ll find that, when you take a person’s name, they’re more likely to make sure they’re giving you the right information. Then, after you’ve initiated the position, check that the result showing in your account is consistent with what you were told on the phone. Margin Quiz IBM is trading at $74.50. You are bearish on this stock. You believe IBM will finish below $75 at November expiration. You can sell the November $75 call for $3.30. 1. The maintenance required for this position per contact is ___________. 2. The return on margin for this position is ____________. (See answer at end of column) _____________________________________________________________ Delayed Stock Openings Are Not Just Fashionably Late? You may have noticed that all stocks do not open at once. Some are delayed for a while. Why? Because market makers are scrambling to deal with an imbalance – dramatically more buyers than sellers (if there was good news) or, more likely, more sellers than buyers (if there was bad news). This will happen after an earnings announcement, a stock split announcement, or news that someone has been dipping into Martha Stewart’s sandwich spread. When someone yells fire in a movie theater, there are hundreds of people rushing for only a few exits. The same thing happens with stocks and the market maker has to make sense of it. If he can’t work it out, trading on the stock may be temporarily halted. The Gap – And we’re not talking about jeans and sweaters. When the stock does open, it will be significantly up or down, depending upon the news. Just because a stock finished at $22.50, it rarely opens the next day at $22.50. It might open at $18 or at $25. Side Note: This is also where those who have put in buy or sell stop orders are going to feel the pain. When a stock gaps down on the open from $22.50 down to $18, it will trigger all the buy stops set anywhere from $18 on up. It’s not unusual for these orders to get filled at, what ultimately becomes, the low (or high) for the day. That’s why puts, though they may cost a few bucks, are a more secure and efficient method of protecting a short put or long call position. A Risky Business This is where market makers have fun. In the opening minutes of trading, when there is a large imbalance, they will add a huge amount of implied volatility to the premiums. The call buyers or put buyers, who have orders to buy at the open, will drastically overpay for the options. Then, later in the day, once the news has been digested, the option will revert back to its mean volatility. That means that you may pay $6.50 for an option on a stock trading at $50 in the first half hour of trading. Later that day, with the stock still trading at $50 (or even higher), the option may only be worth $4.75. If you have absolutely no self-control whatsoever, and must buy a stock that has a news announcement, do so with a limit order. If you get the stock, it will be on your terms. If not, well, as Doris Day said, “Que Sera, Sera.” ____________________________________________________________ Margin Quiz Answer The maintenance required for this position per contact is: $14.90 + $3.30 - $.50 = $17.70 x 100 = $1770.00 The return on margin for this position is: $3.30 / $17.70 = 18.6%. ___________________________________________________________ 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 ************** Moving Averages: types, use and time periods (length) By Leigh Stevens lstevens@OptionInvestor.com Some e-mails I received regarding my last Trader’s Corner article on the use of moving averages as support and resistance “lines” (not unlike trendlines) has led me here to back up and discuss some of the basics of moving averages. The last article is found at http://www.OptionInvestor.com/traderscorner/102002_2.asp An updated chart of the S&P 500 (SPX) shows the most recent occurrence when a pullback rebounded off a key moving average, in this case the 50-day average – what was resistance, now appears to have “become” support: The simple moving average is the most common type of moving average – one that I use almost exclusively – and the type that most traders use. Perhaps due to the fact that this type moving average calculation is often the only online option for a moving average study (indicator) on web sites that allow the application of moving averages to price charts. This is not the case of charting applications like Q-Charts. With Q-charts or TradeStation and other such technical analysis software packages, there are options provided to give more weight to the most recent price activity. A weighted moving average assigns a greater percentage value to the closes for X number of recent bars, whether that bar represents an intraday period (e.g., hourly), a day, a week or a month, thereby giving a REDUCED weighting to older prices. (The practical effect is to make the weighted moving average line follow current prices more closely, with less of a lag than a regular simple moving average.) Such front-loading is the most popular method of calculating a weighted moving average but is not the only possibility. A variation called linear step-weighting, assigns a fixed increment weighting to each day that is dependent on the duration of the average. For example, in such a 5-day weighted average the most recent day’s close is 5 times the weight of the first day of the 5-day period; the prior day is 4 times the weight of the first day; the third day is 3 times the weight of the first day of the period and so on. The exponentially smoothed average is a type of weighted moving average that is a popular moving average variation – probably best known through its use in the Moving Average Convergence Divergence (MACD) Indicator. This method allows recent price activity to generate a more rapid change in an average price. A type of “smoothing” is applied, one that assigns a percent value (for example, .15), to the last bar and this value will be added to a percentage of the previous day’s close. The percentage of the previous day’s close will be the inverse of the weighted percentage; e.g., 15 subtracted from 100, which is 85% (100 – 15) in this example. Because of this method of calculation, all daily moving average values are modified once the first exponential weighting occurs. The higher the percentage weighting given to the most recent close, the more sensitive will be the resulting moving average to the most recent price change. All data previously used is always part of the new result, although with diminished significance over time. Because of the inclusion of old data in an exponentially smoothed moving average, a 50% smoothing appears slower than a 2-day simple moving average and a 10% smoothing calculation will cause the resulting average to be slower than a 10-day simple moving average. As a trend continues further in its direction, the exponentially smoothed moving average will lag the trend more than the weighted moving average due to this inclusion of all prior closes; i.e., the “smoothing” factor. The longer moving average of the simple, equal-weighted moving average type will lag even more, as the most recent price changes will be averaged with many prior closes. In the stock chart below, a 50-day simple, weighted and exponentially smoothed average are all applied – for this period of time, the lag is greatest with the simple moving average and least with the weighted moving average: You’ll notice in this chart of Wal-Mart that the Weighted moving average acts best as a kind of curved “trendline” on the advance and that the lows in late-99/early-2000 tended to rebound from the Weighted average most often. Both weighted moving averages – “Weighted” & Exponential - in the chart above react more quickly to a change in the trend than the simple moving average. For shorter time durations, as in the chart below, which uses a 10-day period or moving average length, there is little apparent difference between the three moving average variations – all the moving averages trace out a double or “W” bottom along with prices: Taking a close up view of a 30-day period when there was a minor trend change as shown in our next chart, it becomes apparent that the first moving average to turn up was the exponential – The Exponential average along with the Weighted average can be made more, or less, sensitive to the most recent price changes by what “weighting” factors are used. For sure, both types will turn up or down significantly quicker than a simple moving average unless all are of a very short duration, like a 3-day average. At 10-days or longer, the gain in a crossover “signal” can be a few days, so use of front weighted averages, will appeal to traders who can deal with the periods of getting “false” or pre- mature turns in the weighted moving averages as they are more sensitive to recent large price moves. I usually assume that the weighted moving averages are most appropriate for shorter-term trading, where the average transaction is completed in 1-day to 1-week. Simple moving averages, especially in the 50-200 length range, are appropriate for an investment oriented time frame of longer duration, which is many weeks to months, or even years – as long as a major trend continues. The importance of the exponentially smoothed average will principally be of interest to most users of basic technical indicators because the popular Moving Average Convergence- Divergence indicator or MACD (“macdee”), uses the exponentially smoothed method of calculating a price average, which I went into in depth in a prior Trader’s Corner article on use of an Exponential Average in the MACD “oscillator” indicator – see http://www.OptionInvestor.com/traderscorner/080802_1.asp MOVING AVERAGE TIME PERIODS (LENGTH)- There have been many questions that I received in the past such as from readers of my CNBC.com or Option Investor columns, as to what moving average length is “better”. The answer is that it depends on your trading or investing horizon. A 5 – 21 bar length will track the very short-term or minor trends – 9 (or 10), 14 and 20 are fairly common. You will often see the “default” number in moving average studies as 9. I prefer a 21-day moving average as a means of tracking the week- to-week trends and 5 and 21-hour moving averages on hourly charts. The result of using 21, versus the more common 20, is virtually indistinguishable. Use of 21 would be explained by my fondness for using 8, 13 or 21 as a “fibonacci” number; i.e., the number series 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc., where each number is the sum of the prior two numbers. I tend to use 8 as my length for moving averages on weekly and monthly stock and index charts and a 21- day (or hour) moving average on daily (and hourly) charts. For the intermediate or secondary stock trends, there is little question that the 50-day moving average or 10 weeks (5 trading days in a week: 10 X 5 = 50), is a “convention” for length that is very common for stocks. The reason for this particular length, versus some other, is partly convention - however, I also think that it is because 50 is 1/2 of 100 in terms of days, and 1/10 of 100 in terms of weeks – 100, its fractions and multiples, is a significant number in our decimal system and in trading. I suspect also that 10 weeks is simply long enough to “capture” the trends in the market that are of intermediate or secondary duration. For displaying or capturing the long-term (major) trend, the 200- day moving average wins hands down as the favorite simple moving average - which is the most common type of moving average - it is used or noted daily or weekly by many, if not most, investment- oriented stock market participants. Some chart books and commentators refer to equivalent average in weekly terns, as the 40-week moving average. Examples of these common moving average lengths are seen in the next 3 charts. The 21-bar simple moving average based on the close – The 50-bar simple closing moving average – And, the 200-day average – The last chart is an example of a 40-week moving average on a longer-term weekly chart and equivalent to a 200-day moving average. When changing time periods from daily to weekly, you need to remember to change the moving average length setting to view the equivalent trends on the longer-term charts – Leaving the values and just switching time frames may be of interest also, but then you are comparing “apples and oranges”, so to speak. A 50-week moving average encompasses almost a full year rather than the 10 trading-weeks measured by the 50-day moving average. Many analysts, traders and money managers define the long-term trend by whether a stock or an Index is trading above or below its 200-day (40-week) moving average. The secondary (stock market) trend can be defined by a similar use of the 50-day (10- week) moving average. If you were buying a stock for a longer range “buy & hold” that had been in a down or sideways trend, a “minimum” requirement should be a close above the 50-day moving average – more conclusive is a close above the 200-day moving average. I suggest also exploring the use a combination of these two moving averages. For example, buying a stock on an initial upside penetration of the 21 or 50-day moving average, especially if there are other bullish chart considerations (e.g., a breakout above a rectangle), but only taking one-half of the number of shares of a usual purchase. A further purchase could be made on an advance above the 200-day moving average. ************** TRADERS CORNER ************** Game Seven By John Seckinger jseckinger@OptionInvestor.com There are pivotal moments within the marketplace, and then there are times when all traders need to pay attention. Game Seven. However, have you ever found yourself rationalizing that every trading day could be a Game Seven? To me, trading is not playing the lottery. Every trade I put on realistically does not have potential to allow me to retire. Trading takes a ton of hard work, discipline, and most importantly the ability to control one's emotions. Sure, there are a few times when it feels as though the market is at "a most critical juncture": however, I feel that it makes sense to wait a few "innings" until probabilities increase. Some times that thinking is flawed as well. Case-in-point: October 7th, and the Dow has just closed under both 7532 and the relative low of 7460 set just a few days earlier. To me, this had all the ingredients of a Game Seven. The pivotal level that could send the Dow to 7000, and the risk would be that the Dow would rise back above 7532. October 7th, 2002 Well, the Dow did just that the next day, only to fall to 7197 in a relatively rational manner. And, on the same day that the Dow hit 7197, the blue chips also rose to 7560 and closed one point above the aforementioned 7532 level. So, this was the real Game Seven, right? Well, most traders including myself would like some sort of confirmation before betting the house on a one point buy signal. October 10th, Daily Sometimes the word "confirmation" is synonymous with "If only I had just bought/sold the day earlier. .". October 11th was exactly that; a strong rise without ever testing 7532. So, was the rally on the 11th the critical turning point and is now the time to buy? Well, the Dow closed just above the 22 DMA, and this moving average had been a solid resistance (read: pivotal) level in the past. So, it might make sense to wait. October 11th, Daily In fact, the Dow did fall back under the 22 DMA the following session, before rebounding and managing to eck out a slight gain. Yes, another pivotal moment. Must be time for more confirmation. October 15th. The real pivotal session, right? The Dow rose from its 22 DMA to above its 50 DMA (8178) almost without pausing. Hmm...above the 50 DMA, this has to be the final battle between bears and bulls. During 2002, bulls have always been caught in a trap once the Dow rose above its 50 DMA. Being caught in a trap is not a good thing, and there is a good chance that the market is now at a critical juncture. October 15th, Daily In fact, prices the following day fell back underneath the 50 DMA and signal the strong likelihood such a trap may in fact exist. However, the low on October 16th was 8013, and this level coincided with highs from late-September, as well as being near a low in early August and opening and close of a few "critical" sessions back in July. So, the pullback on the 15th really only tested a pivot and it probably makes sense to wait for confirmation. October 17th. Don't tell me, another critical day. Well, the market did confirm support near 8013 and rise above the 8255 close on October 15th. The intra-day high was 8318 and the Dow closed underneath 8300. Yes, time to wait for confirmation. October 18th. Is this the confirmation we were looking for? Prices are now at horizontal and vertical resistance levels, and the MACD is almost back at the zero level. Resistance, right? Well, if this level is taken out, this resistance will become support and create an even more important pivotal level. October 18th, Daily Here is the most ironic chart of them all. The 8309 area (blue horizontal line) did act as a pivotal area, but doesn’t the chart look bullish here. MACD has some room to run, and thoughts of 8800 clearly have to be running wild. There is one problem: The Dow is in the middle of two pivotal levels, so it would be an aggressive trade (since risk is for a move over 200 points lower). October 21st, Daily Well, prices certainly did come back down to near 8309. However, guess what, we are at another extremely pivotal area in the Dow. October 24, Daily How in the world can a trader not look at these technical levels? I don’t believe that the expression, "Can't see the forest for the trees" is relevant here, because the fundamental picture is more opaque than ever. The problem is, with the market usually moving hundreds of points a day, it is hard not to look at things on a day-to-day basis, micro managing and analyzing every move. Who doesn’t want to catch a few hundred point move, especially when it seems so obvious in hindsight. Ok, what is the solution? Relax and be patient? Maybe not. Maybe we should start putting on small trades at the close of trading and hope the pivot was called correctly. Well, if that truly is the case, traders should be going long heading into Friday. Secondly, is it really ok to not trade until probabilities are well in your favor? That could mean not trading for days, even weeks. And, as we just saw, there is a good chance that such an “obvious” signal will actually backfire. So, maybe that doesn’t make sense either. How about this answer: Wait only one minute into the trading session and then go with the trend towards the next pivot. If the 50 DMA is only a few points lower and the market opens lower, maybe take that day off. However, if there is a few hundred points to the next pivot and the market opens up 100 points, be aggressive and look for either indices or securities that seem to lag the Dow only fractionally. If you do capture a profitable move, albeit small, I think you will begin thinking about yourself more of a full-time trader. You may not retire on each trade, but you will at least know you are doing the right thing towards early retirement. Good Luck. *********** OPTIONS 101 *********** High Volatility as Opportunity Buzz Lynn buzz@OptionInvestor.com I LOVE this market! Volatility remains incredibly high! That's good? You bet. Remember the old business saw about two shoe salesmen who go deep into the jungle on sales call? The first one returns demoralized and reports prospects are slim because nobody wears shoes. The second one returns waxing about unlimited possibilities. Why? Because nobody YET wears shoes! Same thing with volatility. What's volatility? It's the measure of a stocks willingness, based on history, to experience fluctuation in price. The higher the volatility, the greater the magnitude of price fluctuation over a given period of time. The volatility value isn't necessarily important. What is important for today's chat is the measure of volatility for the overall market - in this case, the VIX (INDEX:VIX.X), or OEX market volatility index. In a market where confidence in market direction is high, the VIX should be falling. Isn't everyone convinced this is the beginning of a new bull market? Who in their right mind is still thinking, "bear market"?
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