The Option Investor Newsletter Thursday 11-07-2002 Copyright 2002, All rights reserved. 1 of 3 Redistribution in any form strictly prohibited. In Section One: Wrap: Rally Bulls Trip Over Cisco Futures Markets: Futures Lead Us Down Index Trader Wrap: Just a little profit taking Market Sentiment: Casey Strikes Out Weekly Manager Microscope: Dr. Gene Henssler: Henssler Equity (HEQFX) Updated on the site tonight: Swing Trader Game Plan: Poised on the Brink Posted online for subscribers at http://www.OptionInvestor.com ************************************************************ MARKET WRAP (view in courier font for table alignment) ************************************************************ 11-07-2002 High Low Volume Advance/Decline DJIA 8586.24 -184.80 8766.22 8549.82 1.74 bln 1095/2106 NASDAQ 1376.72 - 42.30 1400.08 1371.47 1.70 bln 1125/2239 S&P 100 460.59 - 10.47 471.06 458.13 Totals 2220/4346 S&P 500 902.70 - 21.06 923.76 898.68 RUS 2000 383.15 - 9.58 392.73 382.82 DJ TRANS 2350.62 - 63.10 2410.55 2347.27 VIX 35.28 + 0.80 35.91 34.36 VXN 53.90 + 3.84 54.71 52.29 Total Vol 3,649M Total UpVol 597M Total DnVol 3,021M 52wk Highs 93 52wk Lows 106 TRIN 2.35 PUT/CALL 0.88 ************************************************************ Rally Bulls Trip Over Cisco Just when bulls thought everything was coming together to launch a year end rally the cautions from Cisco caused a face plant on Thursday. The Cisco skid knocked the Dow back to 8550 intraday and 1371 on the Nasdaq. The markets were tripping over century marks left and right but in reality it was just a normal post Fed event. Dow chart – Daily Nasdaq chart – daily It was a small comment from John Chambers. "I am more worried about the current quarter than I was the last quarter." With that comment and guidance that 4Q revenue would be flat to down as much as -4% instead of a +$100 million increase, he helped take the markets back down to Friday's closing levels. They did spin it well with much higher margins and promises of major profits when the economy recovers. Still the markets were ripe for a sell off and sell they did. IBM did not help the Dow with news that they were going to issue more stock, $1.5 billion worth, to prop up their ailing pension plan. This follows UTX taking the same step recently. Pretty good trick if you can get away with it. Let the investors take the hit on stock dilution and the company gets to play it's "get out of debt card" with no penalty. IBM dropped -2.59 on the news. Economically it was not a bad day. Chain Store sales rose +3.1% in October which surprised analysts. This was double the expected gain. Retailers blamed it on cooler weather finally appearing and causing stronger sales in sweaters, jackets and coats. If this trend continues when the holiday season starts in two weeks investors will be thrilled. Consumers must have put in on a charge card because Consumer Credit jumped +$9.9 billion from an expected $5.5 billion. This is another sign that consumers are not dead but they are running out of cash. Once the credit lines are maxed out for the holidays the 1Q-2003 is going to be tough. But paying that piper will not happen until the 2Q. Jobless claims fell by -20,000 and -13,000 more than expected. Continuing claims drifted up slightly but analysts were positive that maybe the job loss cycle was easing. Nonfarm Productivity came in at +4.0% and only slightly less than expected at 4.3%. This was more than double the Q2 numbers at only +1.7%. Even more surprising was the +5.9% growth in the manufacturing sector. Productivity in the durable goods sector grew +8.8%. This does not do any good for new jobs yet but it will grow profits as the economy picks up steam. Workers are working more which increases productivity. When they can't work any more hours employers are forced to hire more workers and the cycle begins again. Rapid increases in productivity tends to be a leading indicator for coming economic gains. Wholesale sales increased again but only by +0.1% while inventories increased slightly by +0.5%. This was the fourth month of gains and it has not happened since 2000. The wholesale industry is poised for growth and with a very low 1.22 inventory-to-sales ratio it is in great shape. After the close today QCOM flaunted its success despite the news that China would be developing its own CDMA technology. QCOM beat street estimates by +4 cents on a +34% rise in revenue. QCOM said it expected revenue to increase another +15% to +22% for the current quarter with earnings in the 35 to 38 cent range. Their earnings this quarter were 31 cents. QCOM jumped nearly $2 to 36.38 in after hours. This could help the chip sector tomorrow. The Fed surprised everyone yesterday with a unanimous 50 point rate cut. I have to admit I was totally in denial that they would take that giant step. They said geopolitical risk, spending, employment and production trends were sufficient to justify the cut. The risks were weighted to further economic weakness but with the 50 point cut that risk had been eliminated and the risks going forward were balanced. In short, take this 50 points and choke on it because there is not going to be any more. The wording was blunt and while the U.S. markets were appreciative the size and wording was actually for the rest of the world. The Fed was saying we are committed to strong growth and we are going to do it without you but we would love for you to help. The timing was critical but the message fell on deaf ears. The United Kingdom, Korea and ECB all met today and none of them cut rates. Greenspan is probably spinning in frustration tonight that everyone else ignored the clear challenge. Don't spit on Superman's cape and don't thumb your nose at Greenspan. When the U.S. is roaring back with +5% growth and other countries look to Greenspan for help that phone call may not be answered. Despite the Cisco news, the IBM share issuance, earnings warnings from COST and MIKE and a dumping of Yahoo stock, today was just a bout of typical post Fed profit taking. The rate cut was priced into the market and with no future cuts on the horizon the markets had to relieve pressure. Helping the markets today were raised guidance from FD, ANN, GPS and JCP when retailers were supposed to be in the tank. There was a rumor about Taiwan Semiconductor getting a 40,000 wafer order. This rumor was dismissed as not likely but Goldman Sachs said there have been several reports of rush orders for PC chipsets for better than expected holiday order fills. Goldman believes TSM will raise guidance for the 4Q from improving conditions. Surprise! Cisco also said it was seeing stronger growth in switches and that goes directly into the coffers of BRCM, MRVL, ALTR and XLNX. Even John Deere raised guidance to 26 cents from the Multex consensus of 2 cents. JPM actually came out and strongly denied the gold derivative rumors that have been plaguing the bank for months. They lost -1.46 on the news but the entire sector was down and they should begin to see gains as shorts exit for greener pastures. Just another post Fed profit taking day. That view could change in an instant if the days lows (Dow 8550, Compx 1371, OEX 458, SPX 899) fail tomorrow. As long as the market can hold at the open there is a good chance it will close higher. If those levels fail then we could finish much lower and possibly in the Dow 8350 level. The QCOM news should help the tech sector and a positive report by Disney after the bell should help the Dow. The bulls did not get slaughtered today. They just ran out of news events to bet on. Enter Very Passively, Exit Very Aggressively! Jim Brown Editor *************** FUTURES MARKETS *************** Good news! John Seckinger will be taking over the futures section beginning Sunday and we can get back to some real meat here. Look for John's commentary on futures starting Sunday and trades in the monitor several days later. Futures Lead Us Down Several serious sell programs pounded the futures through out the day with only one decent buy program. That buy program came during the presidents press conference. The S&P futures closed right at support of 904-905 and have not been making any gains in overnight trading. We need to get back over 905 to have a chance of a rally but 908 is the pivot number. That was the high on the buy program at 2:30 and selling came in hard when that level was reached. I see that as the critical make or break for the open. With QCOM beating earnings the tech sector may see some buyers. The stronger support level of 900 was penetrated in late afternoon but short covering at the close brought it back from the edge of the cliff. For the S&P I would look to be long over 908 with a target of 915. If we break down again below 900 I would go short with a target of 880. The Dow has critical resistance at 8600 and traders should keep an eye open for a failure in that area to ruin the rest of the day. S&P Futures Chart – Daily S&P Futures Chart – Intraday The NDX is still hanging on to that downtrend support now at 1029. The Nasdaq was the weakest index by far on Friday and the QCOM earnings on Thursday night may be offset by NVDA. The open will be telling and holding that 1029 level will be key. I would look to short a break below 1029 and go long any rebound over 1035 which was the afternoon high. Keep a tight stop in case the trend changes quickly. NDX Futures Chart – Daily NDX Futures Chart – Intraday The Dow futures are ugly. On the intraday chart it appears we are in real danger of breaking below 8550 and that breakdown could be nasty. There is minor support in the 8400+ range but real support does not appear until around 8300. The upside is not as well defined and there is no specific long strategy to suggest. If we break to the downside the drop could be sharp. I suggest shorting a breakdown under 8550 and watch for a rally failure in the 8600 range. Dow Futures Chart – Daily Dow Futures Chart – Intraday The bullish sentiment completely disappeared on Thursday as the bulls crammed their pockets full of profits and ran for the sidelines. Be very careful about long plays until the Dow clears 8600 again or rebounds from much lower levels. Jim Brown ******************** INDEX TRADER SUMMARY ******************** Just a little profit taking Equity markets saw a decent round of profit taking today after yesterday's aggressive FOMC rate cut and cautious comments from Cisco Systems (NASDAQ:CSCO) $12.35 -4.7% that had some bulls looking at a recent market recovery that has seen the S&P 500 Index (SPX.X) 902.65 -2.28% gain roughly 17% from its mid-October lows. Hardest hit sectors were those that have surmounted some of the largest percentage gains from their recent lows, yet still held the risk that an economic turnaround, potentially fueled by an accommodative Fed, may not be a certainty. A recent euphoric rise in the Semiconductor Index (SOX.X) 302.61 -8.25%, Networking Index (NWX.X) 125.62 -7.88% and Fiber Optic Index (FOP.X) 42.25 -6.69% saw healthy pullbacks, but not one of the aforementioned groups came close to their short-term 21-day SMA's. While some market mavens predict the Fed is though cutting rates, the bond markets didn't seem to agree as investors eagerly gobbled up Treasuries, sending the longer-term 30-year Treasure futures (us02z) 113'30 +1.84% rocking above both its trending lower 21-day SMA (110'122) and 50-day SMA (111'40) as if they didn't exist. The 30-year YIELD ($TNX.X) fell to 4.895% and finished the trading session just above its rounding flat 50-day SMA. In recent commentary, it is this "riskier" bond's YIELD that equity bulls did NOT want to see break much below the 5.0% level and today's 4.895% closing YIELD is a sign of caution for equity bulls. While price action in a bond is followed, its the YIELD that investors are concerned about when selecting any type of income instrument. Today's sharp move, or quick rate of change in this YIELD hints the MARKET isn't so certain that yesterday's 50-basis point cut will be the last. The benchmark 10-year YIELD ($TNX.X) also fell sharply, closing at a YIELD of 3.882%. Traders cited today's Treasury buying as being fueled by mortgage accounts to hedge against today's spike in mortgage dollar prices, and belief by at least one large Wall Street firm that the Fed will move another 25-basis points in Q1 of 2003. While both the 10-year and 30-year bond's YIELD will impact mortgage rates, the Dow Jones US Home Construction Index (DJUSBH) 298.82 -6.78% broke critical near-term support at 300, which now has its October lows of 260 in play with downward trend at 320 serving as resistance. Dow Industrials Chart - 50 point box Three Dow components mustered gains today, while four components posted losses greater than 4%. With Treasuries seeing strong buying, I do have to call 8,500 as tentative support right now, but do think there will be some bears in the 8,300-8,400 range that didn't like the move to 8,800 and should provide support through the next week. While today's 6.6% decline in JP Morgan (NYSE:JPM) $20.60 -6.61% looks large, it wasn't enough to have that stock reversing 3-boxes to $20.00 on its point and figure charts. Today low in JPM is suspicious at $20.01 and came just above a trending higher 21-day SMA. General Motors (NYSE:GM) $34.58 did close below its 21-day SMA of $34.78, but has been a Dow laggard since August. The recent rise in GM hinted that bulls were getting more aggressive and perhaps had some conviction behind the thoughts of an economic recovery. Should GM begin slumping further, then the traders axiom of "weakness leads" should have traders monitoring the stock over the next couple of weeks. As noted yesterday, GM is one of the Dow components still showing a "sell signal" on its point and figure chart and would currently need to see a trade at $38 to generate a buy signal. The negative here is that all of yesterday's gains, and then some, were completely erased. On the flip side of things, I'm still monitoring shares of 3M (NYSE:MMM) $128.60 -1.44% for some type of "Dow confirming" bullish move above $130. While the stock has traded $130.89, its not showing a great deal of leadership or demand from the markets as it trades at 52-week highs. My thinking between the action between a weaker GM and much stronger MMM is that bulls don't seem to have much conviction toward either of these stocks. I would think that the MARKET, under the scenario of "firm conviction" of a robust economy would have been able to drive both stocks higher, if not MMM in recent sessions. Today's action saw no net change in the very narrow Dow Industrials Bullish % ($BPINDU), which remains in "bull confirmed" status at 63.33%. S&P 500 Index Chart - Daily Interval Today's trade at 900 in the SPX did generate a "sell signal" on the traditional $5-box scale for the SPX. While banks were weak again today (BIX.X -3.6%, BKX.X -3.7%) the Broker/Dealer (XBD.X) 411 -3.6% and Insurance (IUX.X) 265 -2.5% were also weak. However, it was the perceived "risk" of technology sectors that lead the declines. The impressive technology sector today was the Wireless Telecom Index (YLS.X) 51.59 -0.03% which actually managed to trade in positive territory at one point. Tonight, Qualcomm (NASDAQ:QCOM) $34.94 reported better than expected earnings and traded $36.35 in extended trading. One subscriber e-mailed me a great question regarding point and figure charts and the S&P 100 Index (OEX.X). The subscriber's question was why I used a $5 box scale on the OEX, similar to the SPX chart when it was 1/2 the value and why not use a $2.5 box size? Hmmmm.... great question. Not that Dorsey/Wright is "always right," but most institutions utilize the Dorsey system. However, that doesn't mean we can't look at a $2.5 box size, introduce a little more "noise" or volatility into the chart. Hey! I see good use perhaps in the $2.5 box size as it may have kept me and other traders from being to bearish the SPX when it traded a prior sell signal at 875, only to reverse much higher. On the $2.5 box of the OEX, we now see an "bear trap." A "bear trap" in the p/f world is identified by a triple-bottom sell signal, where the violation of the triple-bottom is by ONLY 1-box, then quickly reverses higher. S&P 100 Index Chart - $2.5 box scale The $2.5 box scale of the OEX does show more detail and perhaps could have kept a bearish trader out of trouble when the OEX traded 442.50 on October 29th, while also testing its 50-day SMA that same day. An OEX trader, especially one with a bearish tent toward things can "back test" against this $2.5 box size and begin to think that he/she should maybe wait for at least two consecutive sell signals before getting too bearish. We can see the OEX taking a rest after trading up against its bullish resistance trend recently with some resistance showing below 472.50. The current bullish % reading is 62% and has the internals STRONGER than they were in mid-August, so a bearish trader short near 450 or lower is most likely looking to cover on weakness. Support should be firm above 440 and provide good support as long as the bullish % continues to hold up. Today's action saw the S&P 100 lose a net of 1 stock to a point and figure sell signal today, which has the Bullish % ($BPOEX) slipping back from Wednesday's reading of 63% to 62%. Last week we saw similar 1% and 2% daily bullish % oscillations in the bullish % before an OEX rise. As such, it would take a decline to 56% (3-box reversal from 62%) to have the OEX reversing from its current "bull confirmed" status to "bull correction." NASDAQ-100 Tracking Stock - Daily Interval In Tuesday's market monitor (3rd bar to the left), I profiled a short-term bearish trade in the QQQ in the November $26 puts for $0.90. I didn't get the negative reaction I feel I needed from the FOMC response, but felt Cisco (CSCO) would say something cautious after Intel was cautious after their earnings. Since I didn't get the bearish response (like today's 3.5% decline) I've had to move my bearish target up to $25.00 for traders not wanting to potentially exercise a $26 put into stock come next Friday. One thing I've done tonight that is different from the past is place "true" regression on the QQQ chart. In early October we were using "cloned" regression from the August rally, but now we've got more data. As you can see, we've got some criss- crossing support near the $25 level, so a bear holding November expiration may not want to try and get "cute" with a bearish trade. In today's 03:15 EST Update, I showed a chart of the TYX.X. Traders will note that the QQQ jumped above its 50-day SMA on October 15, which is the same day the 30-year YIELD ($TYX.X) jumped above its 50-day SMA. With the 30-year now sitting right on its 50-day, I do become more cautious of the major indexes and equities in general. It should bother an equity bull a little bit that the MARKET is willing to buy the riskier 30-year YIELD. For the most part, market history has taught us that the MARKET sells risk, not buy it. I'm going to say today's action saw no net change in the NASDAQ- 100 Bullish % ($BPNDX). Stockcharts.com shows a net decline of 0.31%, but that doesn't make sense if each of the 100 stocks would account for a 1% change in the bullish %. Therefore, still "bull confirmed" at 69%. Speaking of history.... the Stock Trader's Almanac point out that for November, the MONDAY before expiration has been up 5 out of the last 7 years. However, if Monday's have traded down, then next day the markets have been up big. Traders might envision a market decline into the weekend with some type of sharp rally early next week. Jim Brown came through with some data cash inflow/outflow data for us from Trim Tabs, which tracks daily inflows/outflows of ninety fund families that have about 15% of all equity fund assets. Estimates are that all equity funds had inflows of $3 billion over the week ending November 6, compared to outflows of $1.2 billion during the week prior. Equity funds that invest primarily in US stocks had inflows of $2.3 billion, compared with outflows of $800 million the week prior. Bond funds had inflows of $2.8 billion, compared with inflows of $2.1 billion the prior week. Hybrid funds that will invest in a combination of stocks and bonds had inflows of $700 million for the third consecutive week. While 15% isn't necessarily representative of the entire market, we can perhaps see how bond inflows for three consecutive weeks has YIELDS lower and perhaps a pulse on how "retail investors" are still looking for some safety of bonds. The recent $3 billion inflow to equities may have helped the indexes achieve some new relative highs. However, equity bulls would sure like to see some type of reversal from Treasuries and selling there. Remember, its not necessarily the "retail investor" that drives the markets, it is the institutions. If the MARKET likes a 30-year YIELD of 4.895% or even lower, then I have to question equities that have risen sharply in recent weeks. Or at least think they might be vulnerable under some profit taking. 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 **************** Casey Strikes Out by Steven Price So much for the Fed hitting a home run with yesterday's rate cut. Who cares about 50 basis points when the world's largest networking company talks about a possible revenue decline of 3-4% next quarter? That was the theme to today's trading, as the Nasdaq fell back from its attempt to break through the August high of 1426, losing 42.28 to close at 1376.71. Was it really just a day ago that we were surging to what appeared to be a new relative high. If we had broken through the August levels, then maybe an extended bull run was in the cards. Cisco not only rained on the parade, it popped the giant balloons and stole the band's instruments. Sounds pretty nasty; however, there was some joy in Mudville, as the Dow's drop of 184.77 actually found support above previous resistance of 8550. We appear to be back into the 8550-8750 range of the last few days. After a gain of 1600 intraday points from the low on October 9 of 7197, to yesterday's high of 8800, the pullback is certainly not catastrophic. However, if we do breakdown from here, the next support level will most likely be 8200. Those traders holding long positions may want to punt on a Dow trade under 8500 and switch teams for the ride down for the next 300 points. A trade of 8500 will constitute a point and figure sell signal to go along with the one registered by the SPX today, when it traded 900. The Semiconductor Index (SOX.X) is showing signs that the bull run of the last month may be over. The index had been contained in a rising channel, bouncing from the bottom trend line on each pullback since October 9. The SOX had increased 53% in less than a month, but has now dropped out of its channel and is re-testing the 300 level as support, with a close today of 302.61. A break under 300 could be decisive and those traders waiting for a short opportunity should keep an eye on that level. With Qualcomm beating expectations after the close, that confirmation may not come, but the trend break should make longs in the sector nervous. President Bush took to the airwaves again with his Iraq plans, letting anyone who was listening know that he wanted "peace," as long as Saddam disarmed himself completely. He said this request was different than the last 16 or so, since if he did not comply this time there would be action to make sure he did. Retail sales reports flooded the market this morning, with mixed results. Several retailers, including Kohl's (KSS), Gap Stores (GPS) and J.C. Penney (JCP), posted impressive same store sales gains over last year. However, there were also plenty of disappointments; Wal-Mart posted gains in the upper end of a reduced range and Sears saw a 10% decrease and most analysts are still cautious about the spending environment. With Consumer Confidence and personal spending on the decline, a shortened holiday shopping season takes on greater significance. Thanksgiving falls six days later this year than it did in 2001, leaving fewer days in the official holiday shopping season between Thanksgiving and Christmas. The Retail Index reflected these fears, dropping 1.5%, along with a similar drop in the Retail holders (RTH). The homebuilders received a CSFB downgrade this morning, lowering its recommendation on the group from "overweight" to "market weight." It said that industry and economic trends support a more cautious view and that "we no longer feel comfortable telling clients to put new capital in the group." The Dow Jones U.S. Home Construction Index (DJUSHB) fell almost 7% and cracked support at 300, finishing the day at 298.82. It has now rolled over from its fourth lower high since August. The index has bounced from this level several times, and traders looking for shorts need to exercise caution. Look for resistance at 300 before piling on stocks in the sector to the short side. Tomorrow should bring a downside test in the Dow. If we bounce once again from 8550, then traders can feel somewhat safe with long positions, as the pullback will constitute a higher low and could signal further strength and a run to 9000. The Nasdaq still has a gap to fill from Monday, and a bounce off 1360 would do the job. Therefore another 16 points can be shaved off the COMP before the bears can truly state their case for continued weakness. Watch these levels closely and don't be afraid to switch teams quickly. There is no such thing as a traitor when it comes to playing the market. ----------------------------------------------------------------- Market Averages DJIA ($INDU) 52-week High: 10673 52-week Low : 7286 Current : 8586 Moving Averages: (Simple) 10-dma: 8513 50-dma: 8175 200-dma: 9271 S&P 500 ($SPX) 52-week High: 1176 52-week Low : 775 Current : 902 Moving Averages: (Simple) 10-dma: 899 50-dma: 867 200-dma: 998 Nasdaq-100 ($NDX) 52-week High: 1734 52-week Low : 795 Current : 1025 Moving Averages: (Simple) 10-dma: 1011 50-dma: 919 200-dma: 1153 ----------------------------------------------------------------- The Semiconductor Index (SOX.X): The SOX gave evidence today that the boom of the last month may be coming to an end. With its breakdown out of the ascending channel on the 27-point pullback and break in the trend of higher lows, the expected 4th quarter slowdown may finally be catching up to these stocks. Up until Cisco's warning last night, the sector had been able to shake off the bad news that seemed to keep dripping from each earnings report in the group. There were some notable exceptions, but the overall tone has been extremely negative. Nevertheless, the chip stocks continued to soar until today. The drop registered a new PnF sell signal for the first time since pulling back to 272 on the way up. That pullback was a trap for the shorts, but after a gain of more than 50%, the new signal is something to watch. A break below 300 would be the next short signal to keep an eye on. Qualcomm beat earnings expectations after the bell and traded up over a dollar, so we may not get the confirmation with a trade below 300. However, if we do, then watch out below. 52-week High: 657 52-week Low : 214 Current : 302 Moving Averages: (Simple) 10-dma: 305 50-dma: 270 200-dma: 424 Market Volatility The VIX jumped back over 35 today, indicating the fear has crept back into the market and the premium sellers are out of the way. Even yesterday, when the Dow surged almost a hundred points following the FOMC rate cut, the VIX crept higher, as traders were apparently weary of the recent bull run. That reluctance to sell premium was rewarded today, when the Dow dropped almost 200 points and the S&P 500 gave up 21. The S&P gave a point and figure sell signal and the Dow came within 50 points of doing the same. CBOE Market Volatility Index (VIX) = 35.28 +0.80 Nasdaq-100 Volatility Index (VXN) = 53.90 +3.84 ----------------------------------------------------------------- Put/Call Ratio Call Volume Put Volume Total 0.88 588,172 517,093 Equity Only 0.78 452,575 354,590 OEX 0.72 32,307 23,334 QQQ 0.93 68,861 63,921 ----------------------------------------------------------------- Bullish Percent Data Current Change Status NYSE 41 + 1 Bull Confirmed NASDAQ-100 69 + 1 Bull Confirmed Dow Indust. 63 + 0 Bull Confirmed S&P 500 57 + 1 Bull Alert S&P 100 62 + 2 Bull Confirmed Bullish percent measures the number of stocks in an index currently trading on a buy signal on their point and figure chart. Readings above 70 are considered overbought, and readings below 30 are considered oversold. Bull Confirmed - Aggressively long Bull Alert - Cautiously long Bull Correction - Pause or pullback in upward trend Bear Alert - Take defensive action if long Bear Confirmed - High risk if long, good conditions for shorting Bear Correction - Pause or rebound in downtrend ----------------------------------------------------------------- 5-Day Arms Index 1.06 10-Day Arms Index 1.13 21-Day Arms Index 0.96 55-Day Arms Index 1.28 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 855 1880 NASDAQ 1029 2139 New Highs New Lows NYSE 18 29 NASDAQ 41 34 Volume (in millions) NYSE 1,740 NASDAQ 1,747 ----------------------------------------------------------------- Commitments Of Traders Report: 10/29/02 Weekly COT report discloses positions held by small specs and commercial traders of index futures contracts at the Chicago Mercantile Exchange and Chicago Board of Trade. COT data can be found at www.cftc.gov. Small specs are the general trading public with commercials being financial institutions. Commercials are historically on the correct side of future trend changes while small specs tend to be wrong. S&P 500 Commercials loaded up slightly on both sides of their position, adding 5,000 long and short contracts. Small traders treated their positions similarly, adding 3,000 contracts to both sides. Commercials Long Short Net % Of OI 10/08/02 427,070 445,135 (18,065) (2.1%) 10/15/02 429,448 449,138 (19,690) (2.2%) 10/22/02 432,775 463,827 (31,052) (3.5%) 10/29/02 437,565 468,557 (30,992) (3.4%) 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 10/08/02 131,486 81,010 50,476 23.7% 10/15/02 134,507 83,714 50,793 23.3% 10/22/02 134,641 72,681 61,960 29.8% 10/29/02 137,740 75,587 62,153 29.1% 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 left positions virtually the same, with a slight reduction to the long side and a slight increase to the short side. Small traders added less than 1,000 contracts to both sides. Commercials Long Short Net % of OI 10/08/02 45,384 55,504 (10,120) (10.0%) 10/15/02 45,578 51,969 (6,391) ( 6.6%) 10/22/02 48,954 54,088 (5,134) ( 4.9%) 10/29/02 47,837 55,261 (7,324) ( 7.1%) 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 10/08/02 10,735 5,721 5,014 30.4% 10/15/02 10,185 12,478 2,293 10.1% 10/22/02 10,202 8,892 1,310 6.6% 10/29/02 10,584 9,419 1,165 5.8% Most bearish reading of the year: (10,769) - 06/11/02 Most bullish reading of the year: 8,460 - 3/13/02 DOW JONES INDUSTRIAL Commercials kept the status quo here, as well, reducing the net long position by 300 contracts, of 0.4% of open interest. Small traders increased longs by 1,200 and shorts by 2,000. Commercials Long Short Net % of OI 10/08/02 19,550 11,823 7,727 24.6% 10/15/02 20,914 9,630 11,284 36.9% 10/22/02 22,189 13,448 8,741 24.5% 10/29/02 21,800 13,337 8,463 24.1% Most bearish reading of the year: (8,322) - 1/16/01 Most bullish reading of the year: 15,135 - 10/16/01 Small Traders Long Short Net % of OI 10/08/02 7,890 9,645 (1,755) (10.0%) 10/15/02 6,040 10,329 (4,289) (26.2%) 10/22/02 4,445 9,270 (4,825) (35.1%) 10/29/02 5,602 11,090 (5,488) (32.9%) 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 ************************* Dr. Gene Henssler: Henssler Equity (HEQFX) The Henssler Equity Fund, managed by Dr. Gene W. Henssler, along with co-managers Theodore Parrish and James Brookover, is fairly new and not well known, but since its mid-June 1998 inception it has performed relatively well, producing high returns with below average risk relative to its large-cap blend peers. Morningstar awards Henssler's fund 5 stars, its top rating for risk-adjusted performance within the large-cap blend category. The $53 million Henssler Equity Fund (HEQFX) pursues long-term capital appreciation through investments in common stocks with consideration to safety of principal. In selecting securities, Henssler and co-managers like companies with undervalued assets, strong balance sheet characteristics, high earnings expectations, quality management, and potential for future growth. Henssler's team may invest in companies of any size, and may put up to 20% of fund assets in foreign securities traded in the United States. Henssler et al keeps the large-cap core portfolio fully invested under normal conditions, with common stocks typically comprising at least 90% of assets. The balance of assets may be invested in cash and money market instruments, U.S. government securities, or various other fixed-income securities. Because it invests in the giant- and large-cap sectors of the market, and blends growth and value styles, Henssler Equity Fund's role is one of "core" equity investment. Manager Background Dr. Gene Henssler is founder, President and Chief Investment Officer of G.W. Henssler and Associates Ltd., the firm he started in 1986. Henssler Asset Management, the firm's investment arm, manages the Henssler Equity Fund assets. Previously, he was a finance professor at Kennesaw State University in Georgia for 10 years. He also was a columnist for the Atlanta Business Journal. Dr. Henssler's bio reads that he has worked in financial analysis for over 25 years. He received a B.S. Degree in Business Admin. from Wayne State University, in Detroit, and subsequently earned both his M.B.A. Degree and Ph.D in Finance from the University of Michigan. Theodore Parrish joined Henssler's investment management firm in 1995 as a portfolio manager and has co-managed the Henssler fund with Dr. Henssler since its June 10, 1998 inception. Parrish is Director of Investments at G.W. Henssler and Associates Ltd. and Henssler Asset Management. He's responsible for managing all of the firm's research and trading activities. Mr. Parrish received his B.S. in Business Administration, major Finance, from Kennesaw State University, and is currently a CFA Level 3 candidate. In addition, Parrish holds several licenses, including his Series 7, Series 63, and Series 65 licenses. James Brookover, CFA is a recent addition to the Henssler Equity Fund team, but has worked as an investment manager for more than 20 years, his bio reads. Before joining The Henssler Funds, Inc. Board of Directors, Mr. Brookover was a portfolio manager, Vice President and Chief Information Officer of Reams Asset Management from 1981 until his retirement in 2000. Mr. Brookover graduated cum laude from the University of Toledo with a Bachelor of Business Administration in 1972, and earned a Master of Business Administration With Distinction from the University of Toledo in 1973. Fund Overview The Henssler Equity fund is described as a no-load, diversified portfolio of high quality common stocks. The fund seeks growth of capital over time and can invest in small, medium, and large sized companies. So far the fund portfolio has had a large-cap blend style according to Morningstar's analysis. The old 80/20 rule applies here with about 80% of assets invested in the mega and large capitalization sectors, and the other 20% invested in predominantly in the mid-cap sector. Henssler's philosophy is to remain fully invested and maintain broad diversification. The co-managers and analysts invest in 40-50 stocks they believe to represent "solid businesses with growth opportunities that can weather market fluctuations and add value over the long term." Investment decisions are made with a long-term view, resulting in a low annual turnover rate of 44%. That makes Henssler Equity Fund a suitable option for both tax- deferred accounts, such as IRAs, and regular (taxable) accounts. Dr. Henssler, along with his co-managers and a team of research analysts, continually review the equity markets for trends and economic events. The firm's research staff meets regularly to review performance, individual equities, and market news. The website states the firm's equity selection is a "comprehensive" process. No stock, they say, is added to the portfolio without agreement among the managers and analysts. All efforts of the staff are geared towards managing the fund in a manner that'll maximize performance of the portfolio. According to Morningstar, the Henssler Equity Fund portfolio had an average market cap of $39.3 billion at October 31, 2002, with an average price to projected earnings ratio of 19.4, about 120% of the benchmark S&P 500 index. So, currently the portfolio has a slight growth bias relative to the market, but still in "blend" turf. 100% of assets were invested in stocks per Morningstar's report, with just 3.1% of assets invested in foreign securities. Fund Performance The risk-adjusted performance of Henssler Equity Fund in its 4+ years of existence has been quite good relative to its category peers. As we said earlier, Morningstar rates the fund's return performance as "high" and its risk as "average" relative to the large-cap blend category over the past three years, good enough to earn Morningstar's highest overall rating of 5 stars for the trailing 3-year period. In 1999, the fund's first full year of operation, it produced a total return of 14.9%, lagging both the market and its category peers. Since 2000, Henssler Equity Fund has generated results that rank in the top decile of the Morningstar large-cap blend fund category. A performance summary is provided below, using Morningstar's numbers through November 6, 2002. 1-Month Return: Henssler Equity Fund: +17.8% (-1.3% to S&P 500) Category Average: +17.2% Rank in Category: 57th Percentile Year-To-Date Return: Henssler Equity Fund: -13.0% (+5.5% to S&P 500) Category Average: -18.4% Rank in Category: 8th Percentile Average 3-Year Return: Henssler Equity Fund: -3.2% (+7.9% to S&P 500) Category Average: -10.2% Rank in Category: 6th Percentile You can see that Henssler and his co-managers have done a good job of preserving capital over the past three years versus the average large-cap blend fund. Henssler Equity Fund produced a negative return of 3.2% on an annualized basis compared to the 11.1% average annual loss by the market (S&P 500) and category average, which lost 10.2% annually. Henssler Equity Fund, a large-cap core fund in Lipper's system, is recognized as a Lipper Leader in three categories: 1) total return, 2) preservation and 3) tax-efficiency. So, while this fund is still not well recognized, it has made a solid case for itself in its four plus years of operation. How well has the fund performed since inception? The company's website, located at (www.henssler.com), shows that the Henssler Equity Fund sustained an annualized loss of 0.5% for the period from inception through September 30, 2002. That compares to an annual-equivalent loss of 5.7% for the stock market as measured by the S&P 500 large-cap index. So this "all-weather" fund has added significant value for shareholders by limiting its losses relative to the market. The fund's 1.27% expense ratio is only 0.03% above the category average. Perhaps that number can come down as assets grow from the present $53 million under management. Henssler Equity Fund has a minimum initial investment of $2,000 for regular accounts and $1,000 for IRA accounts, and is available on a no-load, NTF basis through Schwab and other fund marketplaces, adding to its appeal. Conclusion Dr. Henssler, along with his co-managers and team of analysts at Henssler Asset Management, has excelled at preserving capital in the market downtown and weathering the market storm. The firm's only equity fund should appeal to conservative equity investors. According to Morningstar, the fund's risk (volatility) has been below average compared to its category peers, offering investors a strong return-risk tradeoff. The fund's top six holdings as of October 31, 2002 were PepsiCo, Johnson & Johnson, Mylan Labs, Applied Materials, IBM, and last but not least Microsoft. Most of them you know because they're household names. Accordingly, this fund offers large-cap core exposure to some of the most established companies in America, serving a "core" role in someone's long-term equity portfolio. To obtain more information or download a prospectus, go to the Henssler Funds website located at www.henssler.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 *********************** Poised on the Brink Bad news, good news and no news was what the market had to deal with today. Bad news from Cisco, good news from the retailers and no major news event in the near future for bulls to focus on. 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The Option Investor Newsletter Thursday 11-07-2002 Copyright 2002, All rights reserved. 2 of 3 Redistribution in any form strictly prohibited. In Section Two: Dropped Calls: ERTS, SYMC, AZO, INTU Dropped Puts: BAX Daily Results Call Play Updates: FCX, FRX New Calls Plays: EXPE, SYK Put Play Updates: RTH, LOW, LEH, OHP New Put Plays: None **************** 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: ***** ERTS $64.53 -2.21 (-1.55 for the week) Electronic Arts was following its trend nicely and looked as though it was on its way to another higher high. It has bounced above the PnF reversal point and remains in a column of "X". However, the stock ran out of gas earlier than it has on prior rebounds and we don't like the early reversal on the daily chart and failure at the 50-dma of $65.10. Traders who want to give it a chance can wait for a PnF reversal at $64 to close out, but we are exiting here. --- SYMC $40.50 -1.37 (-0.45 for the week) We used a trigger of $43.10 for the SYMC call play, which we never got. The stock pulled back and bounced at $40. If this bounce was accompanied by a strong enough bounce in the Nasdaq (over 1400), we could see entering the long play at this level. However, the COMP continued to sink and we are no longer sure SYMC can get enough legs to break out above $43 without some sector help. After not getting our trigger, we will close the play and wait for it to re-test the previous resistance level around $43. --- AZO $83.80 -1.52 (-4.10) Try as they might, the bulls just couldn't keep the momentum going. After the latest dip to its ascending trendline, AZO rallied right up to the $88.50 resistance level. But contrary to its recent pattern, the stock couldn't break out to a new high this time and has been setting lower highs and lows all week long. The stock came back to its ascending support line again today, but failed to get a bounce this time, ending on its low of the day. Not only is the price performance of the stock discouraging, but AZO closed below our $84 stop, mandating that we drop it tonight. If not stopped out today, use any rebound tomorrow to exit open positions ahead of the weekend. --- INTU $53.33 -1.44 (-0.68) In its brief tenure on the Call list, INTU has continued its volatile action, as it whips between the $51 and $55 levels. Nimble day-traders may have been able to carve out a profitable trade, but largely the play has been a disappointment as the bulls have been unable to break out over the $55 resistance level. Thursday's session produced another data point in that trend as the stock pushed up to that level and then drifted lower throughout the day, ending near its lows. While the stock hasn't violated its stop, it appears the bullish interest is fading and we want to get out before the rest of the crowd. Use any strength on Friday to exit the play ahead of the weekend. PUTS: ***** BAX $25.75 +0.06 (+1.53 for the week) Baxter did not breakdown below $24, which was our preferred entry point. We also looked for a failed bounce under $28, which never materialized. BAX has essentially crept higher after its recent drop, but it is moving too slowly for our taste. It is actually staying true to form with a slight gain after each big drop, and a long-term short play might be feasible. However, we feel there are better places to use our "put money," so we will make a shift and close the play. *********************************************************** DAILY RESULTS *********************************************************** Please view this in COURIER 10 font for alignment ************************************************* CALLS Mon Tue Wed Thu Week AZO 83.80 -3.08 1.16 -1.15 -1.52 Drop, lower high ERTS 64.53 -0.43 -0.56 1.03 –2.21 Drop, trend break EXPE 75.01 0.77 0.40 1.50 0.78 New, keeps going FCS 13.50 -0.16 -0.99 0.41 –0.71 relative strength FRX 101.27 0.11 0.08 -0.54 0.11 higher highs INTU 53.36 -2.62 1.80 0.60 –1.41 Drop, $55 tough SYK 67.23 0.44 -1.39 0.84 1.00 New, new highs SYMC 40.46 0.22 -0.01 -0.01 –1.41 Drop, no entry PUTS BAX 25.75 0.60 0.00 0.45 0.06 Drop, sideways LEH 56.24 2.29 0.49 0.71 –1.56 entry point LOW 39.97 -1.00 0.70 -0.46 –1.67 retail breakdown OHP 35.70 0.07 -0.88 0.90 –0.45 testing $35 RTH 73.84 -2.20 1.20 -0.15 –0.81 short season ************************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 ******************** FCS $13.50 -0.71 (+0.20) To say the Semiconductor index (SOX.X) was weak on Thursday would be a gross understatement, as the SOX got slammed for more than an 8% loss. Part of the problem was fallout from the CSCO earnings report, which pointed to a still-challenging spending environment. Wachovia made bearish comments about the communications chip providers, highlighting XLNX and ALTR as two chip stocks likely to feel the brunt of this weakness due to their strong ties to CSCO. Nevertheless, our FCS play once again held up remarkably well. Sure it got hit for a 5% loss, ending at $13.50, but once again held above the $13 level. This is shaping up as an important support level, as is the $300 level on the SOX. If the SOX can rebound from this level, it should correspond to FCS rebounding from above $13 again and would make for a solid entry for the next leg up the chart. But we need to be cautious, as a breakdown of FCS under $13 or the SOX under $300 would be an ominous sign. Keep stops set at $13 and wait for evidence of renewed buying in the sector before initiating new positions. --- FRX $101.27 +0.11 (+1.09) The broad markets sold off on Thursday, once again going in the opposite direction of what was seen as the dominant trend following yesterday's surprising 50 basis point cut from the Fed. Despite that weakness, FRX remains very resilient as it holds above the $101 level. While the stock hasn't been able to sustain a breakout over the $102 level on a closing basis, it is encouraging to see the stock continuing to build on its pattern of lower lows. The $100-101 area is shaping up as decent intraday support and successive rebounds from this area should provide for solid entries ahead of the expected breakout to new highs. . Before breaking above $100, FRX had been finding resistance near $99, and this level should provide additional support on a more significant pullback. A rebound from this area would make for an even better entry, so long as we don't see a drop under $98. Due to the stock's inability to sustain a breakout over $103, we would shy away from attempting new momentum entries on a breakout We're raising our stop to $97.50 tonight. ************** NEW CALL PLAYS ************** EXPE – Expedia, Inc. $75.10 +0.78 (+5.95 this week) Company Summary: Expedia is a provider of online travel services for leisure and small business travelers, offering one-stop shopping and reservation services with real-time access to schedules, pricing and availability. The company's global travel marketplace includes direct-to-consumer Websites offering travel-planning services at Expedia.com, Expedia.co.uk, Expedia.de, Expedia.nl and Expedia.it. In addition, the company provides travel-planning services through its telephone call centers and through private label travel Websites through its WWTE business. WWTE is a division of Travelscape, Inc., one of EXPE's wholly owned subsidiaries. Why We Like It: After the strong rebound off the October lows, there is an increase in the number of stocks that are moving to new 52-week highs. While moving to new highs is certainly an admirable feat, how many of them are up by 100% in the past month? EXPE is one such stock, as it has been steadily churning higher on expanding volume. That's right, the stock is actually seeing stronger volume as it continues to march up the chart. Reporting earnings that beat the street by 9 cents really lit a fire under the stock and it gapped higher and started running on October 24th. Breaking above its 200-dma with a breakaway gap was impressive to start with, but the rate of ascent hasn't even begun to slow down. EXPE has only had one down day in all that time, as it continues to post higher highs and higher lows. The volume is showing the conviction behind the move and Thursday's push above the $75 level was accompanied by volume that more than doubled the ADV. To be sure, it can be risky trying to game a bullish entry into a stock that has already advanced so far in such a short period of time, but it appears that the bulls have their sights set on challenging the stock's all-time highs near $84 and we're more than willing to go along for the ride. Each push higher has been followed by a mild pullback to a higher low, before the bulls propel EXPE higher yet. The last consolidation zone was near the $73 level and a pullback and rebound from that level looks like a high odds entry into the play. The measured way in which the stock takes two steps forward and one step back makes buying the dips the preferred strategy. If you must trade a breakout, then wait for EXPE to push through Thursday's intraday high ($76.34) on continued heavy volume. Because this is an aggressive play, we are starting coverage with a tight stop at $72, just below the intraday lows on the last pullback. If that level is violated, it will break the pattern of higher lows and be a warning that perhaps the trend is coming to an end. *** November contracts expire next week *** BUY CALL NOV-75 UED-KO OI=1401 at $2.80 SL=1.50 BUY CALL NOV-80 UED-KP OI= 607 at $0.80 SL=0.40 BUY CALL DEC-75*UED-LO OI= 161 at $5.80 SL=3.75 BUY CALL DEC-80 UED-LP OI= 99 at $3.40 SL=1.75 Average Daily Volume = 2.16 mln --- SYK - Stryker - $67.23 +1.00 (+1.78 for the week) Company Summary: Stryker Corporation develops, manufactures and markets specialty surgical and medical products, including orthopaedic reconstructive, trauma, spinal and craniomaxillofacial implants, the bone growth factor osteogenic protein-1, powered surgical instruments, endoscopic systems, patient care and handling equipment for the global market, and provides outpatient physical therapy services in the United States. (source: company release) Why We Like It: As baby boomers have aged, so has the need for physical therapy and orthopedics. Stryker is a company that is well positioned for an aging country and its earnings have underscored that sentiment. The company makes artificial hips, knees, spinal implants, and related surgical instrumentation, as well as providing physical therapy services. Although Goldman Sachs recently removed the stock from its recommended list, citing valuation, it kept a market outperformer rating on SYK and said," Importantly, investors should not interpret our rating change as a sign that fundamentals are weakening. To the contrary, fundamentals remain robust with an orthopedic implant environment marked by solid unit gains and price increases." Goldman also said it believes the company can grow earnings at a 20% yearly clip. The company released earnings on October 16 and showed a 20% increase in both profits and sales over the year ago period. It also posted a 26% increase in earnings for the first nine months of 2002, as compared to 2001. SYK raised guidance for the fourth quarter, saying it would beat analysts' expectations by $0.02 per share. The company is clearly on the rise and the recent run in the stock is a good indication. We put the stock on our Watch List a few days ago when it first broke $65 for the first time. We were looking for a pullback and then support over $65 and got exactly that. The stock pulled back on Tuesday and bounced at $64, before blowing back through $65 and $66. The stock tacked on another dollar today and posted a stream of higher highs and higher lows throughout the day, in spite of the Dow falling over 200 points at one point intraday. SYK closed within 0.02 of its high for the day, indicating bulls were still looking to buy into the close. The stock gave a new buy signal at $66 on the point and figure chart and ideal entry would be on a pullback to support at $65. However, if the stock continues higher from this level, with no pullback, then momentum traders can look for a break above $67.50 to enter. The bullish vertical count is $93, however we are not quite that bullish on this move. Our initial target will be $75, and we expect some resistance in the $70 range. More conservative traders can look for a pullback and evidence of support above $64, which would be a PnF reversal, for entry. ***** November contracts expire next week ******* BUY CALL NOV-65 SYK-KM OI= 566 at $2.65 SL=1.30 BUY CALL NOV-70 SYK-KN OI= 71 at $0.40 SL=0.40 BUY CALL DEC-65*SYK-LM OI= 977 at $4.50 SL=2.25 BUY CALL DEC-70 SYK-LN OI= 285 at $1.60 SL=0.80 Average Daily Volume = 749 k ************************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 ******************* RTH $73.61 -1.04 (-1.82 for the week) Many of the retailers released same store sales results this morning. There were mixed results, but the most positive results came from stores that had dialed down expectations from previous months goals. Wal-Mart, for instance, posted a same store sales increase of 3.7%. While this was at the high end of the 2-4% range the company had predicted, it was below the normal 4-6% growth range of previous years. There were also cautious comments regarding the low Consumer Confidence numbers and the fact that the holiday shopping season will be shorter this year, as Thanksgiving falls six days later than last year. This sounds like a warning that stores may suffer when compared to previous year's numbers. Initial jobless claims fell by 20,000 last week, but the 4-week moving average remained over 400,000 and actually rose. Given the high rate of layoffs in October, the holiday shopping season still looks to have too many obstacles to overcome end up positive. The RTH has moved sideways during the recent rally, showing poor relative strength and has yet to approach its 50-dma up at $76.29, which is our barometer for the short play. The tracking stock has rolled over from its third lower high and is still trending down. New entries can look for a break under 73.00, which has been a bounce point the last few days. --- LOW $39.97 -1.67 (-2.13 for the week) Lowe's has been trending downward ever since its rejection at $45. This morning's sales data from a number of retailers was mixed, and many made cautious comments about the upcoming holiday shopping season. LOW is more of a hard line retailer and is likely to suffer as holiday shoppers steer reduced shopping dollars toward gift items, as opposed to home remodeling. The stock filled its gap from October 15, bounced and was rejected at the 50-dma of $42.14 on Wednesday. The sell-off continued on Thursday, with LOW breaking through $40 to trade as low as $39.77. The trade of $40 achieved another box in the current column of "O" on the point and figure and looks headed to its bullish resistance line at $38, at the least. The stock barely got a boost during the recent Dow rally, and has been downgraded by Goldman Sachs, along with Home Depot. Goldman cited 'daunting' near-term comparisons for some of the sector's largest-cap companies, and few organic growth opportunities. We like the continuing weakness in LOW and the close under $40. New entries should look for resistance below $40.00 and more conservative traders can wait for a breakdown of bullish support at $38. --- LEH $56.24 -1.56 (+1.67) The positive reaction to the Fed's decision to lower interest rates yesterday put a bid into Brokerage stocks, with LEH rising to end just fractionally below our $58 stop. But the sellers were back in control on Thursday, with the Brokerage sector (XBD.X) sliding back by 3.6%. Part of the driver for today's weakness was a rumor circulated about JPM, that the company had suffered as much as $70 billion in derivative losses. Despite the company denying the rumors, it still ended the day deep in the red. That action weighed on the rest of the sector, and LEH couldn't get out of the way. Given the carnage in the rest of the sector, LEH's performance really wasn't that bad, as it still held above the $56 level, which has provided support all week long. The key to the play will be to see LEH break below $55.50. This is just below the intraday lows from Monday following the sharp upward gap. If LEH falls below that level, it can be used for initiating new positions, as it will likely indicate that the stock is intent on filling that gap down to the $54.60 level, and likely heading down from there. Once that gap is filled, the bears will be setting their sights on the $52.70 level, which provided support for the bounce last week. The descending trendline is still in play, as it once again turned back the bulls near $58 yesterday and aggressive players can continue to use failed rallies near this level to initiate new positions, but only if the XBD index stays below the $430 resistance level. Leave stops at $58. --- OHP $35.70 -0.45 (-0.80) While the broad market has tried to digest the significant changes delivered over the past two days (Republican win in the Senate, and an unexpected 50 basis point interest rate cut), the Health Care sector is likewise trying to determine the ramifications of these events. The Health Care Payor index (HMO.X) managed to drag itself off the mat down at the $520 support level and ended yesterday with a respectable gain. Despite the broad market weakness, the HMO index actually held up rather well and that strength has been reflected to a lesser degree in our OHP play. OHP rebounded from its Tuesday lows below $35, but it is clear from the intraday chart that there are plenty of willing sellers just overhead. Yesterday's rally attempt was promptly reversed this morning , and the stock went out just above its low of the day. The $36.50-37.00 area is shaping up as firm resistance, and we can continue to use failed rallies in this area to target new entries ahead of the next break down in price. Recall that Tuesday's drop below $34 generated a fresh PnF Sell signal, and that is still very much in play. Things could start out on a sour note again tomorrow, with the management changes at THC, which were announced after the close. That stock ended the regular session near $28 and is trading below $20 this evening. That weakness could generate more sympathy selling in other names like OHP tomorrow. If looking to enter the OHP play on a breakdown, wait for a trade below $33.50, along with the HMO index breaking the $520 level. ************* NEW PUT PLAYS ************* None ************************Advertisement************************* If you trade options online, then you need an online broker that: offers true direct access to each option exchange offers stop and stop loss online option orders offers contingent option orders based on the price of the option or stock offers online spread order entry for net debit or credit offers fast option executions PreferredTrade offers these online option trading features and more; call 1-888-889-9178 or click for more information. http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ********** DISCLAIMER ********** Please read our disclaimer at: http://www.OptionInvestor.com/page/oin/aboutus/disclaimer.html ************************************************************** ADVERTISING INFORMATION For more information on advertising in OptionInvestor Newsletter, or any Premier Investor Network newsletter please contact: Contact Support
The Option Investor Newsletter Thursday 11-07-2002 Copyright 2002, All rights reserved. 3 of 3 Redistribution in any form strictly prohibited. In Section Three: Play of the Day: CALL - SYK Traders Corner: Stock Went Up. Call Option Went Down. Whasssup With That? Traders Corner: Reversal patterns: V Top & Bottoms Traders Corner: Closing Confirmation Options 101: The OTHER Drag on Earnings ********************** PLAY OF THE DAY - CALL ********************** SYK -Stryker - $67.23 +1.00 (+1.78 for the week) Company Summary: Stryker Corporation develops, manufactures and markets specialty surgical and medical products, including orthopaedic reconstructive, trauma, spinal and craniomaxillofacial implants, the bone growth factor osteogenic protein-1, powered surgical instruments, endoscopic systems, patient care and handling equipment for the global market, and provides outpatient physical therapy services in the United States. (source: company release) Why We Like It: As baby boomers have aged, so has the need for physical therapy and orthopedics. Stryker is a company that is well positioned for an aging country and its earnings have underscored that sentiment. The company makes artificial hips, knees, spinal implants, and related surgical instrumentation, as well as providing physical therapy services. Although Goldman Sachs recently removed the stock from its recommended list, citing valuation, it kept a market outperformer rating on SYK and said," Importantly, investors should not interpret our rating change as a sign that fundamentals are weakening. To the contrary, fundamentals remain robust with an orthopedic implant environment marked by solid unit gains and price increases." Goldman also said it believes the company can grow earnings at a 20% yearly clip. The company released earnings on October 16 and showed a 20% increase in both profits and sales over the year ago period. It also posted a 26% increase in earnings for the first nine months of 2002, as compared to 2001. SYK raised guidance for the fourth quarter, saying it would beat analysts' expectations by $0.02 per share. The company is clearly on the rise and the recent run in the stock is a good indication. We put the stock on our Watch List a few days ago when it first broke $65 for the first time. We were looking for a pullback and then support over $65 and got exactly that. The stock pulled back on Tuesday and bounced at $64, before blowing back through $65 and $66. The stock tacked on another dollar today and posted a stream of higher highs and higher lows throughout the day, in spite of the Dow falling over 200 points at one point intraday. SYK closed within 0.02 of its high for the day, indicating bulls were still looking to buy into the close. The stock gave a new buy signal at $66 on the point and figure chart and ideal entry would be on a pullback to support at $65. However, if the stock continues higher from this level, with no pullback, then momentum traders can look for a break above $67.50 to enter. The bullish vertical count is $93, however we are not quite that bullish on this move. Our initial target will be $75, and we expect some resistance in the $70 range. More conservative traders can look for a pullback and evidence of support above $64, which would be a PnF reversal, for entry. ***** November contracts expire next week ******* BUY CALL NOV-65 SYK-KM OI= 566 at $2.65 SL=1.30 BUY CALL NOV-70 SYK-KN OI= 71 at $0.40 SL=0.40 BUY CALL DEC-65*SYK-LM OI= 977 at $4.50 SL=2.25 BUY CALL DEC-70 SYK-LN OI= 285 at $1.60 SL=0.80 Average Daily Volume = 749 k ************************Advertisement************************* Tired of waiting on trades to execute? Does your broker offer Stop Losses on Options? Trade instantly with Stop Losses at PreferredTrade Inc. Stop Losses based on the option price or the stock price. Move your trading into the next millennium with PreferredTrade. Anything else is too slow! http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ************** TRADERS CORNER ************** Stock Went Up. Call Option Went Down. Whasssup With That? By Mike Parnos, Investing With Attitude More strange things happen in the options market than in the Twilight Zone. You bought a call for $3.50. The price of the stock goes up, but the price of the option goes down. “Quick, Gertrude, call our lawyer, we’re going to sue somebody? But who? We can’t sue Rod Serling -- he’s dead. Someone’s got to pay!! I guessed right on the direction. What happened?” Wake up!! Life isn’t fair. That should be no surprise. It applies to option trading too! If I have to tell you that, your status as a Couch Potato Trading Institute (CPTI) student is in serious jeopardy because you haven’t been paying attention. As you know, the price of the underlying is the biggest piece of the option-pricing puzzle, but there’s a lot of other stuff too. A significant change in an option’s implied volatility can cause an option to move in the opposite direction. They can spike higher on a variety of news events – like stock split announcements, acquisition rumors, anticipation of a positive earnings announcement or an upcoming FDA approval decision. This higher implied volatility reflects an increase in the demand for the option. An increased demand translates into a higher price for the option. It’s a combination of the principle of supply and demand plus the market maker salivating at an opportunity to inflate the cost to the clamoring masses. They know that, once the news is absorbed in the marketplace, they will remove the implied volatility (and your money) from the option faster than a doctor removing an appendix. The only difference is that I doubt the doctor puts the appendix into his wallet. You’re asking, “Why me?” Call it -- unbridled enthusiasm. Call it – just plain dumb. Call it -- another expensive lesson. It’s like the people that put in a market order to buy technology IPOs few years ago (when there were IPOs). It’s like grabbing your ankles and sending out invitations. And the market makers will R.S.V.P. every time. Another ingredient in the option-pricing recipe is time decay. Time decay is the loss of value in an option over time when all other factors are constant. The rate of decay increases the closer the option gets to expiration. Which options are most vulnerable? The out-of-the-money options, in the last week or two, can lose value so quickly that the decrease might be larger than a small increase in the price of the stock. Time decay is the option seller’s best friend and the option owner’s worst enemy. At the Couch Potato Trading Institute, we’ve got the time if you’ve got the premium. Normally, the price of an option will move up and down with the movement of the stock – but, obviously, not always. _____________________________________________________________ The Ups and Downs of VIX What is the VIX? No, it’s not a Roman numeral. It’s not something you rub on your chest to alleviate cold symptoms. It has other uses – it’s a tool to measure just how flaky the market is in general – and that’s good to know. We talk a lot about volatility in our trading strategy scenarios. It’s a major ingredient in the option-pricing model. The higher the volatility, the higher the option premium The market, as a whole, has come up with a measure of volatility called the VIX – the CBOE Market Volatility Index. It’s a measure of expected volatility for the S&P 100 Index. It’s not a measure of any individual stock’s volatility, but a lot of traders use it as a general indicator of implied option volatility. How is the VIX calculated? Does it really matter? Probably not, but it’s a question that may someday show up on Jeopardy or in the next edition of Trivial Pursuit, so, what the hell, I looked it up. “The VIX is a market consensus forecast of future stock market volatility over the next month and is constructed using the implied volatilities of eight near-the-money, front- and back- month OEX calls and puts. This design creates a hypothetical option that is always at the money and has exactly one month until expiration. The VIX is then updated throughout the day by the CBOE in real time using OEX bid/ask quotes. Over the years, research has shown that the implied volatilities of this artificially constructed option (the VIX) have been able to accurately predict subsequent stock market volatility.” Why is the VIX good to know? Well, I don’t know how airplanes work either, but I use them. The VIX can come in pretty handy. It serves as an indicator of how market participants are currently reacting to the market and what they may expect to happen next. It plays a key role in our ability to predict future market movement. If the market is weak and the demand for puts increases, the VIX will spike up. This means that there is fear in the market. Due to the fact that retail investors are usually wrong, this higher VIX figure is a bullish sign for contrarians. Speculators, when they finally sell out of their long stock position, will try to jump on the downward bandwagon and buy puts. Therefore, it can signal an end to short-term selling. By the same token, if the market is heading down and the VIX doesn’t spike up, it means the speculators are complacent about the move. What does this mean? Well, again, considering that they’re wrong more often than not, it’s a good bet that there is more selling on the horizon. ____________________________________________________________ CPTI Portfolio Update (as of Thursday morning) BBH Iron Condor – Trading at $89.61. Just dandy! We want it to finish between $80 and $95 at November expiration. MMM Iron Condor – Trading at $128.68. Also dandy! We want it to finish between $120 and $130 at November expiration. We made a few adjustments, buying shares and then reselling them twice when MMM violated $130. TTWO Short Strangle – Trading at $27.85. Couldn’t be better! We want it to finish between $25 and $30 at November expiration. QQQ ITM Strangle – Trading at $25.80. This week has been interesting. For those who bought the Dec. $23 calls, the QQQs made it up to about $26.75 and a few alert traders I know took some very respectable profits. It’s still early in the trade and the market is trying to move up. The resistance at $26 seems to be substantial, but who knows? Stay tuned . . . _____________________________________________________________ Happy trading! Remember the CPTI credo: May our remote batteries and self- discipline last forever, but mierde happens. Be prepared! In trading, as in life, it’s not the cards we’re dealt. It’s how we play them. Your questions and comments are always welcome. mparnos@OptionInvestor.com ************** TRADERS CORNER ************** Reversal patterns: V Top & Bottoms By Leigh Stevens lstevens@OptionInvestor.com You have probably seen a number of examples of double (or triple) tops and bottoms but there are other common types of bottom and top patterns also, the names and characteristics of which may not be so familiar to you – to find a recent example of a double bottom we need only look at the S&P 500 daily chart: While a “double” bottom on the S&P 500 (SPX) chart is the key technical pattern in the chart above, each upside reversal (each bottom) can each individually be looked at as a “V” type bottom – just as the top at 960 in SPX can be seen as a “V” top. More explanation on this shortly on the “V” top/bottom formation. The Dow Industrials in its recent low and in its upside reversal can be viewed more purely as a single “V” bottom and not a double bottom per the chart below – In the Dow the second low was well under its first upside reversal or bottom pattern. Each can be seen as a “V” type bottom. A “V” bottom is contrasted with bottoms with price lows that form in the same area multiple times – a bottom that is the low end of a trading range or a “rectangle” or line formation. The same is true, only in reverse, for the tops of trading ranges. Then there are rounding bottoms and rounding tops and these are typically MORE significant for a major reversal move, but I will discuss in another article. “V” type reversals are not as frequently as “definitive” for a bottom or top as the others mentioned – they (“V’s”) tend to form in more volatile markets where there are sudden and sharp moves but that don’t necessarily reverse the trend. For example, in the charts above in both SPX and the Dow neither index has taken out its prior intermediate rally high – and stayed above the prior swing high – which would be the technical definition for a trend reversal of at least intermediate proportions. The “V” type pattern is usually good for a substantial move after the top/bottom of the “V” forms in the “reversal” direction – all traders need is a few moves of this magnitude every so often! To be technically correct we should probably call “V” tops UPSIDE down “V” tops, but no one does - unlike a “reverse” Head & Shoulders. “V” TOP OR BOTTOM PATTERNS You best see this pattern on bar charts, then candlestick chart followed by “line” (close-only) charts. Point & Figure (P&F) charts are another, but “V” type tops and bottoms are not as apparent as often. As implied by the shape of the letter “V” in technical analysis terms the pattern is where an intraday or intraweek low or high forms at the end of a price move when prices go into a final steep descent or ascent, followed by an equally sharp countertrend move; e.g., a “V” bottom in technical analysis terms. The same letter name is given to a top that is formed by a sharp advance, followed by an equally steep decline – a “V” top might be more accurately called an inverted “V” top, but it’s generally not qualified in this manner. As part of the discussion of “V” tops and bottoms, it’s useful and appropriate to describe a “spike” and also what is sometimes called a “thrust” day. A spike is simply a sharp run up or decline whose hourly, daily or weekly high or low substantially exceeds the respective high or low of the “bar” or bars (e.g., day or days) that immediately preceded the spike - as well as for some time AFTER the spike has occurred. What we often see on daily charts at tops is a spike high well above the prior day or days, but a close that is well under that day’s intraday peak. At bottoms we often see a spike low that is well under the prior day or days, but a close that is well up from the intraday bottom. When a daily close is below the low of the prior day, it is sometimes also qualified as a downthrust day. When a close is above the high of the prior day, this is also sometimes called an upthrust day. Analogous to mechanical power, whenever “thrust” is used in technical analysis it implies a strong force pushing the market in one direction or another. However, in the markets, a force pushing strongly in one direction may reverse by the close. As emphasized in the candlestick charting method, the close tends to be more important than an intraday high or low well beyond the prior day’s high or low, if the close is less extreme than the spike high or low. An even stronger case for a trend reversal, after an uptrend has been underway for some time, is suggested by a day with a jump to a high well above the prior day or days (a spike), but a close that is under the low of the prior day - a down thrust day. Conversely, a stronger case for a trend reversal is made well into a downtrend, when there is low well under what has gone before (a spike low), followed by an up thrust day whose close is above the prior day’s high. The concept of the thrust day, taking into account the close, relative to whether it is below or above the prior day’s low or high, is something that is not necessarily significant as a single event. Thrust days are quite common – a series of them is what is significant. A strongly up trending market typically will have a number of up thrust days and a market in a pronounced decline, a number of down thrust days. Stocks, futures or FX instruments that are thinly traded, or are volatile in general or just in a particular period such as during a top or bottom, are more prone to exhibit spikes and thrust days. The chart below some sharp down spikes and thrust days – “V” tops and bottoms often have a spike high or low at the end of the climb or at the very bottom, but not always. The discussion on spikes, including spikes that have closes above or below the prior day’s price range (up or down thrust days) is often relevant to “V” reversal tops or bottoms as they are often part of the “V” top or bottom pattern. It’s very common to see even steeper “V” top patterns such as in the major top shown on a weekly basis – Yahoo had a pronounced spike high at the very top and in the center of an inverted “V” top – You can cover up the price scale and the dates at bottom and imagine that this is a 15, 30 or 60-minute chart also – the pattern is the same. The chart below, of bellwether GE is an example of a classic “V” bottom formation – “V” bottoms do not have as many instances of very steep angles making up the sides of the “V” as is the case with tops – An obvious difficulty in predicting a reversal based on a “V” bottom or top pattern is that they are always easy to identify until the reversal move is under way for a time. While they are developing they are not much different in appearance than from a pronounced further price spurt, followed by a correction. However, when there is also a definite spike high or low and/or a thrust day or days, accompanied by a confirming surge in volume, these provide further technical clues pointing toward the appearance of a reversal pattern. We can take the chart above and add volume to the price picture alone. The jump in daily volume that mirrored the spike low (bottom of the “V”), offers an excellent confirmation of the likelihood of an upside reversal as suggested by a close in the middle of the daily range, which was followed by a strong rebound in prices in the following day and days – ************** TRADERS CORNER ************** Closing Confirmation By John Seckinger jseckinger@OptionInvestor.com Daily chart patterns love to make us believe something big is about to happen. It might, but there is one more step the market needs to perform. Confirmation. Case-in-point: Monday, November 4th. The Dow rallied from 8521 to 8730, and then proceeded to fall back to 8571 by the close. As a candlestick follower, this pattern is called a “Bearish Shooting Star” and defined as: (1) Price gap open to the upside, (2) Small real body formed near the bottom of the price range, (3) The upper shadow at least three times as long as the body, and (4) The lower shadow is small or nonexistent. Ok, so I am now bearish on the Dow, correct? Yes, and no. I have a ‘bearish viewpoint,’ but as a trader I need confirmation before putting on a bearish trade. I hope this makes sense. How is confirmation reached? In this particular case, I would use a level underneath the day’s low in order to go short (read: buy puts). I would need the market to close underneath this low as well. Only then we would have our confirmation. Chart of the Dow Jones Industrial Average Once a daily pattern is recognized, wait until there is confirmation before blindly entering and just hoping that the pattern will take form. It is absolutely critical to do a few things when trading: (1) Try to account for stops. This means when forecasting an objective, remember that the market will almost always overshoot it. Therefore, letting the market perform one extra step will really take a lot of the guesswork out of trading. The problem? I only use closing confirmation patterns with breakouts, moves above moving averages, gaps, and maybe a few other scenarios. Not a very common tool when the market is in a gradual trend. It should be noted that I am referring to only daily chart patterns, or longer. A daily chart is nice because it attracts a lot of eyes from mutual fund managers, hedge funds, etc.; whereas shorter-term charts are sometimes ignored by a lot of traders because of all the “noise” it creates during the session. This could be why most funds enter and exit near the open and as the close approaches. Daily chart patterns also can be used nicely for swing traders and people looking for more intermediate patterns. The longer the time frame, the better the odds of success. Let us turn to the Sox for another example. On November 1st, the Sox broke a bearish trend line that was formed by the high on July 17th and the relative high during August 22nd. By the end of the session, the Sox closed at 313 (intra-day low of 291) and ran into a trend line that started on April 17th and bisected the high on May 15th. Ok, this should be relatively simple, right? Maybe not. There are two steps. I would first use a level above the intra-day high (313) in order to go long, but that only confirms the break of the first trend line. Not the second. Chart of the Semiconductor Sector Index For the breakout of the pattern dating back to May, we have to use the trading range on November 4th, since that was the first day above the second trend line. Levels above November 4th will then give us our ‘confirmation’ reading. As we have done before, I will use a level outside the day’s range. Since we are talking about a breakout higher, I will use a level slightly above 337 (intra-day high) to confirm the upward trend. As the chart shows, we did not get that confirmation. Yes, I am very cynical of a lot of market “breakout” moves; therefore, I think it makes sense to watch movement the next day for confirmation. If the chart says “sell,” fine, I will; however, only after the market proves it makes sense to be short. Do I miss part of the move? Of course, but almost all trading tools miss the exact high/low as well. With that said, let us turn to a chart of the XAU and put one more spin in this article. On October 28th, the XAU broke out of a consolidation pattern and rose above the 22 DMA (exp). “Breakout; therefore, I should go long just above the high (64.97) and put a stop underneath the day’s low of 63.15.” Why a stop there? With a breakout, I assume that the entire day’s range is part of the breakout; therefore, I will have to include all prices within that range. There is a chance that the day’s range may be too great (not the case here); therefore, use your own judgment if risk is too great. Chart of the Gold And Silver Index Just because the XAU index rose above the 22 DMA, I need a few more things to fall into place. First, I need the XAU to close above this average. Secondly, as stated before, I need prices to rise above the day’s high and confirm the increased buying. I don’t want to buy after all stops are hit and get stuck with a horrible execution level. Look at the next session on October 29th. The XAU traded above the 50 DMA, probably hit stops, and then fell by the close. Traders that didn’t wait for the confirmation either got stopped out or took a lot of heat until a few days later when that breakout was confirmed. I use this same closing confirmation theory when looking at gaps. Chart of the Nasdaq After a gap, I expect the market to take out the day’s high (if gap higher) and close higher. Waiting the one extra day can make all the difference, which was the case from October 15th to the 16th, when prices gapped lower and didn’t confirm the day prior’s gap. Currently, the last runaway gap has not been confirmed; therefore, traders can start to think about prices falling further. Is there an “expiration date” on confirming gaps? If the gap created a new relative high/low, I don’t believe that there is. Ok, what is the main drawback of this ‘closing confirmation’ theory? It requires traders to put positions on at the close when volatility may have spiked higher and there could be a sleepless night wondering if the market will fail to respond in a profitable manner. I agree, it is hard; however, it really depends on what kind of trader you are. It might be more comfortable to trade this way. If so, fantastic. Who doesn’t love this adage, “Trade what you see, not what you think”. I “believe” the XAU Index is in a Head & Shoulders formation and will go to 60 and 40; however, what I “see” is a confirmation of the bullish trend. Take the emotion out, and leave the opinions at the door. If the market confirms a buy or sell signal, it is telling you to go with the trend. Good luck. *********** OPTIONS 101 *********** The OTHER Drag on Earnings Buzz Lynn buzz@OptionInvestor.com Some days, subject matter for articles just doesn't come easily. Others, it pops up on the radar screen like an intruder at Fort Knox. While contemplating the issue of employee stock options and its real effect on corporate earnings for us owners - an issue that many Wall Street pundits and hucksters hope just dies and goes away - I stumbled into news released earlier today from Europe. Guess what? The International Accounting Standards Board (IASB), a two-year-old board based in London designed to unify corporate accounting standards across 10 nations, issued a draft proposal saying specifically, "all share-based payments should be recognized in the financial statements." Whoa! No ambiguity there. If it costs the company money, it needs to show up on the earnings report and balance sheet. No more trickery, to which I say, "Amen". But it doesn’t end there. Besides, calling for corporate expensing of incentive stock options is yesterday's rally cry and seemingly futile exercise in hand wringing. I was thinking of something much bigger that has barely surfaced in public financial circles, yet has remained in the corporate boardroom under lock and key in the "dirty little secret" file. I'll probably get hate mail from CFO's, CEO's, and COO's telling me that their firms are above board, as all information pertaining to said corporate shell game (oops, err. . .EBITDA [earnings before I trick dumb auditors]) is available in public disclosures filed with the SEC. Right. And all taxes are fully disclosed in the purchase of a gallon of gasoline, a pack of cigarettes, a bottle of hard alcohol. While we may be able to figure it out, we have to know what we're looking for and where to look. That might explain why very few are aware the next big accounting issue, UNDERFUNDED PENIONS, soon to be the other drag on earnings. Well, I was going to talk at great length about the general concept of underfunded pensions as the next great drag on earnings and how they will affect stock prices in the future. Unfortunately that ranks right up there on the entertain-o-meter with rearranging my sock drawer. I had already ruled out revisiting the bear call spread on IBM, as we've hit that twice in the last two weeks. Again, about as entertaining as watching paint dry. Still a pretty decent bearish play in my opinion. Then, in one of the rare moments when I was actually tuned in to CNBC, what to my wondering eyes did appear, but a little segment on. . .ta da. . .IBM and its underfunded pension! Sometimes, it's better to be lucky than smart. This was just such an instance. How much better could it get than dovetailing a bearish trade on IBM with the concept of underfunded pensions? And thus, here we are with the topic of the day. Let me state it for the record. Despite the bullish cyclical pattern of equities during the last three weeks, this is still a secular bear market. Stocks are going to crest again and likely get hammered to lower lows. How can I be so sure? Many factors, but the one sticking most in my mind is squarely focused on earnings. If you thought earnings and forward statements were weak now, just wait until corporate America starts confessing its underfunded pension sins. We aint seen nothing yet. Here's the issue in a nutshell. In addition to the 401K or IRA, many Fortune 500 companies fund a pension plan for their employees to be used by the employee (or beneficiary) at some point as a source of income following corporate retirement. Consider it a private enterprise version of social security. We work hard putting in 20 years with the same company and the company mails us a check every month once we've retired. That's simplified, but you get the idea. Every year, the company is allowed to set aside some of its revenue (and call it an expense) for the benefit of its employee pension fund. Say a company grosses $1 bln in sales, and among other expenses totaling $800 mln (including interest taxes, amortization, and depreciation), it also includes a $100 mln expense that to be set aside for the pension. So far, so good - pensions funded from profits of the business - makes sense. One of the integral parts of pension funding as it relates to net income is that the CEO, COO, CFO, or the board (pick one or a few) gets to assign a rate of return on the pension fund assets that is allowed to be counted as net income to the corporation. Did you get that? Assume that over the years, a company's pension fund has grown to $1 bln in assets. The CEO says (under his breath buried deep in a 10K or 10Q where he hopes you won't find it), "I expect to earn 9% on that invested money this year, 2002". Doing the math, he expects to earn $90 mln on the pension fund assets, which he is allowed to count toward net income of the business! In the same vain, if we impute that we earn 9% on our $500K portfolio of stocks this year (even if we don't), it still counts as income on the loan application when try qualifying for that $1 mln home loan on our $100K income. Wouldn't that be nice? Yes, despite its appearance as a game of 3-card Monte, imputed pension asset returns are actually legal. So for the company with $200 mln in earnings from operations, it can report $290 mln in its earnings report thanks to the $90 mln imputed in the return on pension assets. So, if the company is a few dollars short in operating earnings, no problem! Just assign a higher imputed rate of return to the pension fund and everything will be OK! You don't actually have to earn it. You just have to SAY you are going to earn it. Neat trick! Well, not really. See, the pension assets didn't really earn 9% last year. In fact, it actually lost about 15% last year and 25% the year before that thanks to the bear market in stocks. The company not only never earned the 9%, they lost 15% and 25% in value respectively over the last two years. And they are heading for another loser year in 2002, as well. So for the pension fund with $1 bln in assets above, those assets were worth $750 mln (25% loss) the year before, $638 mln last year, and $510 mln at the end of this year, assuming another 20% loss. Let's see. . .$1 bln in assets to just over $500 mln in assets over three years. That's a $500 mln loss in value. Or as a sharp financial mind would say, "underfunded by $500 mln dollars". Uh oh! The company is actually going to have to fund that missing $500 mln some day. But the worst thing is that companies are still, to this day, assuming imputed rates of return of 8.5%-10% on pension fund assets that they hope to count toward net income! Unbelievable! How long can accompany report income it never actually earned? And how long can it hide losses in asset value that need to be replaced without actually replacing them? And when that company does fund the underfunded $500 mln, how will it affect their $200 mln of EBITDA earnings? Once this shell game is discovered and given the coverage it deserves, don't look for an earnings recovery anywhere even near today's levels. Underfunded pensions are going to cost shareholders a bundle in earnings and stock price. But where does IBM fit into all this? They happen to be today's stellar example of pension abuse. IBM has pension fund assets of roughly $60 bln. That's a huge number. Trouble is that it is 10%-15% underfunded. That's a minimum of $6 bln to a maximum of $9 bln that IBM will have to fund from somewhere. How will it do that? The only way it can. From earnings, of course! I can hear it now from the shareholders meeting: "IBM had a stellar year because we imputed $5.4 bln of pension income to our income statement that we didn't really earn and we neglected to fund $7.5 bln to our underfunded pension, which we were able to defer to another year of our choosing. Were it not for those perpetual sources of "one-time" income and hiding of actual pension fund losses, we'd have lost $12.5 bln more this year! Oh, and we're guiding earnings from operations down for the foreseeable future." Of course, the longer IBM prolongs the pension underfunding, and the application of a bogus imputed 9% return on those assets, the greater the hit to earnings in the future. Corporate CEO's, CFO's, or COO's, are caught between the devil and the deep blue sea. How much longer do they fraudulently keep imputed pension returns higher than what they know is possible? The bigger question is how much longer does FASB keep its mouth shut on the subject? [I believe the operative word in their title is, "Standards".] Or do companies take the monster hit now and smaller hits from pension losses year after year as stock prices deflate around smaller earnings and deflating P/E ratios of stocks, which more accurately resemble interests in a going concern rather than speculative pieces of paper? No wonder CEO's pray for the return of irrational exuberance! It's the only thing that will cover up mistakes and accounting quackery. Alright, enough of that. I don't hate IBM. I just point them out and lump them in along with a majority of other corporate chieftains as a flagrant example of trying to "span the chasm" in hopes of avoiding bad news and ultimate cratering of the stock price. And there are plenty. But IBM still makes a nice put play or bear call spread in my opinion. Eventually, they are going to have to make real money or confess their sins. It's only a matter of time. All that said, focus on the bigger picture. Financial imagination is going to be tested and fail against the harsh reality of underfunded pensions and imputed rates of return. See you next week! Buzz ************************Advertisement************************* ”If you haven’t traded options online – you haven’t really traded options,” claims author Larry Spears in his new compact guide book: “7 Steps to Success – Trading Options Online”. Order today and save 25% (only $15) by clicking on PreferredTrade and clicking on the link to the book on its home page. http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ********** DISCLAIMER ********** Please read our disclaimer at: http://www.OptionInvestor.com/page/oin/aboutus/disclaimer.html ************************************************************** ADVERTISING INFORMATION For more information on advertising in OptionInvestor Newsletter, or any Premier Investor Network newsletter please contact: Contact Support
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