The Option Investor Newsletter Thursday 11-21-2002 Copyright 2002, All rights reserved. 1 of 3 Redistribution in any form strictly prohibited. In Section One: Wrap: Bulls Send Bears Into Hibernation Futures Markets: Beheaded Index Trader Wrap: (See Note) Market Sentiment: Semi-Bullish Weekly Manager Microscope: Management Team: Causeway International Value (CIVVX) Updated on the site tonight: Swing Trader Game Plan: Ticket To Ride Posted online for subscribers at http://www.OptionInvestor.com ************************************************************ MARKET WRAP (view in courier font for table alignment) ************************************************************ 11-21-2002 High Low Volume Advance/Decline DJIA 8845.36 +222.40 8856.57 8625.48 2.44 bln 2166/1033 NASDAQ 1467.41 + 48.10 1468.72 1430.08 2.35 bln 2272/1130 S&P 100 477.88 + 10.89 478.44 466.99 Totals 4438/2163 S&P 500 933.79 + 19.64 935.13 914.15 RUS 2000 397.70 + 9.11 397.89 388.59 DJ TRANS 2328.78 + 47.40 2342.76 2281.91 VIX 27.37 - 1.29 28.87 27.21 VXN 44.70 - 0.12 45.85 42.16 Total Vol 5,047M Total UpVol 4,302M Total DnVol 708M 52wk Highs 170 52wk Lows 119 TRIN 0.53 PUT/CALL 0.74 ************************************************************ Bulls Send Bears Into Hibernation On a day that the stock with the third largest market cap warned of lower growth and earnings for this year and next the market broke out of its recent trading range and through strong resistance. GE warns, BA cuts 5,000 jobs, MWD cuts -2,200 and the drooling bears are run over by excited bulls. Dow Chart – Daily Nasdaq Chart – Daily The bad news was obviously already priced into the market that GE had fallen out of the ranks of the double-digit earnings growers. GE said it would take a $1.4 billion charge, less than analysts had expected, to bolster reserves at its reinsurance unit. GE said it suffered huge losses from the 9/11 attack and was taking the action to cover future risk. GE also said it was going to add $4.5 billion in capital to GE Capital to reduce its debt ratios and maintain the AAA credit rating. GE closed up +2.05 on the news because analysts expected a much worse forecast. Morgan Stanley also announced they would cut -2,200 jobs in a move to cut costs and battle slumping financial markets. This follows -67,000 job cuts already made in the sector since 2000. Boeing said it would cut -5,000 in its commercial division due to the continued slump in the airline sector. The good news came in the form of an earnings win by HPQ last night and an affirmation of their current quarter as well. This powered tech stocks over the critical Nasdaq 1425 level and once over that resistance the short covering began. Chip stocks roared and consumer cyclicals fell as money rotated out of defensive stocks and into techs. Helping fuel the fire was a lower than expected Jobless Claims number at 376,000 instead of 390,000. Traders ignored the fact that last weeks numbers were revised up to 401,000. They also ignored the fact that this was for a four day work week due to the Veteran's Day holiday. Look for this number to rise next week. The Philadelphia Fed Survey soared to 6.1 when estimates were for a -3.0 number. This indicates a slowly expanding manufacturing sector but far from a strong indication. Inventories are still dropping as well as prices but new orders rose slightly. There was a strong bounce in the capital expenditure component from 14.5 to 25.5 which indicates business investment is starting to rise. Also bullish was the flat Index of Leading Indicators which has been negative for four consecutive months. Six of the ten components improved in October. This does not paint a picture of a growing economy but it does indicate the drop into a second recessionary dip is less likely. Offsetting the positive reports was a negative Chicago Fed National Activity Index. The number came in at -.81 and the biggest drop in the last seven months. This reflects the overall softness in October and weak employment. Production fell by -0.8% and well below consensus expectations. This was the third monthly decline. Of the 85 indicators 61 were below average and only 37 showed improvement from September. This index indicates that the economy has an increased risk of sliding back into recession when compared to prior recessions and double dips. Evidently traders elected to ignore this report. Positive comments from several automakers helped boost sentiment with hopes that sales would not slow as expected. Ford's chief analyst said he was sticking with his forecast from the beginning of the month that November sales would be better than October. GM CFO said sales would slow next year but they would not fall off the table as expected. Analysts had speculated that incentives would run their course and buyers would lose interest after a year of special deals. Evidently the consumer has not given up on new wheels completely and the competition between brands has provided some amazing deals. In Denver several unique promotions have surfaced like a six month job, $1500 monthly income and $195 in cash gets you a new Kia with no credit check. A ford dealer is running a buy one get one free special. Buy an explorer and get a ford focus free. These unique marketing offers are making buyers rethink their need to trade in the current oil burner and go on the hook for big payments. It helped the stocks of auto companies as well with GM adding +3.20. The biggest news was provided by investors themselves. Once the good HPQ news and better than expected GE warning pushed stocks over initial resistance at the open the buyers piled on. The key ranges were Dow 8650, Nasdaq 1425 and SPX 925. These were key levels of resistance dating back to June in come cases and once broken the short covering began. TV commentators were stumbling over themselves with bullish comments. Guest analysts could not draw broken resistance lines fast enough in the allotted air time because there were so many breakouts. The key here is the difference between breakout and fakeout. On the surface it appears to be a valid breakout based on "hope" that the bottom is behind us. That hope may be called into question on Friday based on the semi book-to-bill report on Thursday night. New orders fell by -7.9% in October making it four consecutive monthly declines. It would have been even steeper but they revised downward the number from September to 0.80 from 0.84. Using the original number from last month of .84 and the headline number for October of 73 that would have been a -13% drop instead of the revised -7.9% drop. It is amazing how the magic numbers keep getting revised with each succeeding period. BTB, Jobless Claims, Nonfarm Payrolls. It almost looks like a conspiracy to let us down slowly by managing the numbers. That would be illegal so I am sure it is just a coincidence. At .73 this is the lowest ratio in nearly a year. Every month the order inflow drops it pushes the tech recovery a month farther into the future. With a six-month lead time from order to delivery this means any possible recovery is well into 2003 "IF" orders picked up next month. Typically the holiday season is a low spot for manufacturers with forced holidays and mandatory plant closings to save money until orders arrive in the 1Q. This puts any recovery off until 3Q of 2003 at the earliest if historical trends continue. The key SPX 925 level has been seen as the magic number to confirm a new rally. This was above the 9/11/02 high of 924.02 and the 925.66 high from Nov-6th. Today's close of 933.76 is the first new major relative closing high since August. The next confirmation would be a close over the August closing high of 962. However, we have to get past Friday first. Futures are down slightly on the BTB news and the very over bought conditions. Much talk was made of the desire to see the market higher by year end to avoid the historic occurrence of three down years, something not seen since the depression. The Dow would have to clear 10021 in the next five weeks to prevent that label from sticking. Today's close for the Dow put us at a +21.4% bounce off the October closing low of 7286. Bullish talk is not going to help the economic conditions but it may convince retail investors to come back to the market. Volume today was very heavy with over five billion shares traded and over two billion each on the NYSE and Nasdaq. The internals were lopsided with a 6:1 ratio of up volume to down volume. Most of that volume was institutions with large block orders being the norm rather than the exception. The extreme bullishness pushed the VIX back down to more historic levels at 27.37. That is still high but well off the recent extreme numbers. If today's action can attract some follow through tomorrow then bullish comments in the weekend newspapers should entice retail investors home for the holidays next week to be become buyers. With a record $80 billion going into money market funds last week there is plenty of cash available to fuel a further rally if the situation warranted it. Does the situation warrant it? That depends on your time frame. While I think everyone expects the markets to go up from here, they may not have much further to run based on real economics. The Dow has even stronger resistance ahead at 9050 and again at 9200. Many and I stress MANY technical analysts are predicting that any rally will run out of steam at those levels without an increase in real earnings to drive prices. Since 4Q earnings warning season will start in earnest the week after Thanksgiving we will get to see if those earnings are going to appear of if the 4Q is going to dip back into an earnings recession and sink stocks prices as well. Retail sales are predicted to rise at most +0.4% and many feel this is only wishful thinking. One survey reported on Thursday showed that 65% of consumers were planning on spending less this year due to the negative wealth effect from jobs and the market. Nearly 50% surveyed were going to spend more than 45% less than last year. Obviously retailers have their work cut out for them and any terrorist event will make that goal even harder. If your timeframe for investing is years then buying now and riding out any further volatility probably will not hurt. If your time frame is months then going long over Dow 9000 could be risky. Enter Very Passively, Exit Very Aggressively! Jim Brown Editor *************** FUTURES MARKETS *************** Beheaded By John Seckinger jseckinger@OptionInvestor.com The Dow rejected the potential for a Head & Shoulders formation, trading above 8800 and closing higher at 8845. Does this mean that the equity markets will continue to rise? Thursday, November 21st at 4:15 P.M. Contract Net Change High Low Volume ES02Z 936.00 +17.25 936.75 916.50 628,101 YM02Z 8860.00 +188.00 8864.00 8645.00 20,785 NQ02Z 1117.50 +41.50 1121.00 1077.00 300,266 ES02Z = E-mini SP500 futures YM02Z = E-mini Dow $5 futures NQ02Z = E-mini NDX 100 futures Note: The 02Z suffix stands for 2002, December, and will change as the exchanges shift the contract month. The contract months are March, June, September, and December. The volume stats are from Q-charts. Fundamental News: Shares of Hewlett-Packard (HPQ) rose 12.7% to 18.99, following in-line earnings and higher revenue expectations for the current quarter. General Electric (GE) also made headlines, rising 8.26% to 26.85 after lowering annual earnings forecast but announcing a dividend increase. The company also noted that profits for next year would grow between 3 and 13 percent despite weakness in airline and power systems. In other news, the Philadelphia Fed index came in at 6.1 versus –13.1 for the prior month. Estimates were for a –0.5 reading. Also supportive of equities and damaging for bonds was a Jobless Claims report of –25k to 376k. Economists were calling for a 394k number. Technical News: As the bond market came under pressure once again, falling 1’04 to 109’24 and underneath a bullish trend line currently at 110’16, talk of massive asset allocation out of bonds and into stocks continued to make headlines. There is now a Reverse Head & Shoulders formation in the 10-year sector (neckline of 4.13%, which is fractionally above Thursday’s close), and this signals an objective of just over 5.3% (read: lower bond prices, and should mean higher equity prices). Moreover, the Semiconductor Sector (Sox) closed up 8% at 365 and is nearing an important retracement level of 376. The dollar was surprisingly weaker, while the Utility Index (UTY) once again failed to close above 243. ================================================================= The December Mini-sized Dow Contract (YM02Z) Starting with a weekly chart of the Dow, price action this week could have the index closing above its 22 Weekly Moving Average (8617) for the first time in months, and a close at current levels would be its highest close since the week of August 18th (8872). An objective for bullish traders seems to be for a test of 9000 and the significant relative high at 9077. This level is currently just underneath the Dow’s 50 Weekly Moving Average (WMA) of 9092. The only other major resistance between current prices and above 9000 appears to be at a 38.2% retracement level (8935) and the 200 DMA at 8952 (see chart below). As far as downside risk is concerned, a move back underneath 8800 on Friday should get some liquidation concerns heading into the weekend. Support under 8800 is not seen until below 8700 at 8684. Another risk is tied to the Relative Strength Indicator (RSI), which just moved above the pivotal 50 level and should stay above going forward. A close back below 50 could signify a short-term bull trap. Something to keep in mind. Chart of Dow Jones, Weekly Speaking of bull traps, a daily chart of the Dow shows the possibility of a bearish divergence between prices and the RSI oscillator. This is accomplished by prices making a new high, while the oscillator fails to do so. Because volume was strong on Friday (no word on open interest), it makes sense to wait for confirmation before playing off such a divergence. Chart of Dow, Daily Getting to the YM02Z contract, the bearish divergence is also seen on a 10-minute chart. However, bulls appear to have a few things in their favor: higher relative highs, and the ability to stay above 8800. Notice how the 8684 objective (profiled on Wednesday) quickly became support and a building block for the contract. Going forward, if bearish, try to avoid selling into dips. The only time it might work is on a move under 8800; however, stops have to be tight. The market never really gave a sell signal on Wednesday, and it makes sense to go with longer term areas to enhance one’s risk/reward. Chart of YM02Z, 10-minute YM02Z Support Resistance Pivot 8825 8900 8800 8800 8935 8684 8952 8540 9000 9077 Bold signifies levels within the Dow The December E-mini S&P 500 Contract (ES02Z) The S&P 500 contract had an intra-day high of 935.13, and just missed testing the long term trend line that intersects at 936 (note: since downward sloping line, this 936 level will be lower on Friday). The breakout above the 22 DMA and 38.2% retracement area should have bulls looking for a test of the significant relative high of 965. Just above 965 is a 38.2% retracement level that should be psychologically important as well. With that said, look for an extending move higher once above 936, but remember to use a tight stop just in case a trap commences. Chart of S&P 500 Index, Weekly Looking at the ES02Z contract (120-minute), the previous relative high of 926.50 was taken out and then used as support as prices rose throughout most of the session. If prices do fall back underneath 926.50, it should be analogous to the Dow falling under 8800. The contract does show a bearish divergence on a daily chart (not shown), and the 120-minute chart came extremely close to setting a lower Relative Strength number compared to the high set at 926.50. Note what happened the last time a bearish divergence took place. Chart of E-mini S&P 500, 120-minute ES02Z Support Resistance Pivot 926-27 936 926.50 910 956 927 902 965 971 Bold signifies levels within the S&P 500 The December E-mini Nasdaq 100 Contract (NQ02Z) The NDX made a clear break on Thursday above 1079 and the highly watched 1100 level. Currently at 1118, there doesn’t seem to be much resistance until 1154, a 38.2% retracement level based on highs made back in December 2001. Above 1154, there is a relative high at 1163 that could offer resistance for bullish traders. Going forward, the contract would have to close underneath 1088 before bears can look for a test of the descending bearish trend line (blue). Chart of Nasdaq-100 Index, Weekly Looking at a 90-minute chart of the NQ contract, the 1172 objective still remains untested; however, as long as prices stay above 1072 there is the possibility that this test will take place. A close back under 1072 could spell trap, and might take the index back towards 1020. Under 1020, support is felt at 1000. Chart of Nasdaq-100, 90 minute NQ02Z Support Resistance Pivot 1110 1133 1101 1000 1154 1088 1072 1163 1072 1020 1172 1000 Bold signifies levels within the Nasdaq 100. Disclaimer: Because defined levels of resistance in the ES and NQ contract are significantly above current levels (expect for 936 in ES), look towards the Dow for guidance if looking for a short term trade. Good Luck. Questions are welcomed, John Seckinger jseckinger@OptionInvestor.com ******************** INDEX TRADER SUMMARY ******************** Check the Site Later Tonight For Jeff’s Index Trader Article http://members.OptionInvestor.com/itrader/marketwrap/112102_1.asp ************************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 **************** Semi-Bullish by Steven Price Looks like we finally got the bullish confirmation we were looking for. Today's rally saw several significant resistance levels fall in the broader market indices. Before we bring out the cheerleaders, however, let's take a look at where we are and what's ahead. We've been looking at a possible bearish head and shoulders formation in the Dow and S&P 500 (SPX) over the last month. Until yesterday, it looked as though the breakdown would come to fruition. However, the right shoulder rollover came to a halt with Wednesday's rally. Today's 222-point jump over 8800 surpassed the head of the formation. So now we definitely have a failure of that pattern. This should serve as notice for the bears to step aside for the time being. The move over 8800 in the Dow and 925 in the SPX took some major buying power and I wouldn't be surprised to see some short covering now that those significant resistance levels have been broken. That could quickly take us up to the next resistance levels of Dow 9000 and SPX 965. The Dow actually topped out just under 9100 in August, but once back above 9000, we could see some real momentum building. The Nasdaq Composite was an even bigger winner. The tech index blew through its August highs (1426), which had turned it back on the last three tries. It gained 48.20, and is now up 93 points in two days. While we may be due for a pullback, the bias is now clearly bullish after such an impressive breakthrough. I'll be looking to enter long on a pullback anywhere above 1426. The Nasdaq was led in part by the chip stocks, which continued their recent explosion, following Hewlett-Packard's earnings surprise after the bell last night. The Semiconductor Index (SOX) not only broke higher after barely getting above its recent high from the beginning of the month, it made up 27 points in a heartbeat and broke above the August closing high of 363, to finish at 365.30. The only fly in the ointment is the intraday high from August at 366, but that just seems downright nitpicky. After the bell, we got the industry book-to-bill ratio for October, which showed a 7.9% drop in new orders. This was the fourth straight monthly decline and was worse than expected. The combination of the SOX hitting the August high and a poor book- to-bill would seem to indicate at least a mild pullback. However, it seems that most of the bad news from the sector has been followed by rallies, as long as the news was not as bad as expected. After all of the lowered revenue guidance and poor future visibility revealed over the past earnings season, it is frightening to imagine what the institutions were actually expecting. It is hard to find a sector that was in the red today, but one place to start would be the bond market. The bearish head and shoulders pattern that was forming in the ten-year note (ty02z) looks to have broken its neckline and can be used for confirmation of the shift from bonds into equities. The other sector to take a major hit was the HMOs. UnitedHealth Group (UNH) made comments at an investors meeting that pricing may have peaked, causing concerns about margins in the industry. The HMO index dropped 3.5%, led by UNH (-4.86), Wellpoint (- 3.50). With rising healthcare costs, the HMOs that have managed costs properly have simply raised premiums and posted impressive profits. With the possibility that they can no longer raise prices, rising costs could take a serious bite out of future earnings. UNH still predicted significant profits in 2003 and 2004, but apparently investors were more than a little spooked. Predicting tomorrow's movement is a little tricky. With the breakthroughs in the Dow, SPX and Nasdaq, there is definitely room to run on the upside. However, with the SOX at the August high and a poor book-to-bill report, I can see some profit taking in the sector. If the chips pull back, expect the rest of the techs to follow. If the BTB doesn't cause a pullback, then look out above for Nasdaq 1500. ----------------------------------------------------------------- Market Averages DJIA ($INDU) 52-week High: 10673 52-week Low : 7197 Current : 8845 Moving Averages: (Simple) 10-dma: 8523 50-dma: 8183 200-dma: 9209 S&P 500 ($SPX) 52-week High: 1176 52-week Low : 768 Current : 933 Moving Averages: (Simple) 10-dma: 899 50-dma: 868 200-dma: 987 Nasdaq-100 ($NDX) 52-week High: 1734 52-week Low : 795 Current : 1118 Moving Averages: (Simple) 10-dma: 1037 50-dma: 941 200-dma: 1130 ----------------------------------------------------------------- The Semiconductor Index (SOX.X): After just barely breaking over the relative highs from earlier in the month, the SOX shot all the way up through the August high of 363, finishing the day at 365. The intraday high back on August 19 was actually 366, and after the book to bill ratio showed its fourth straight monthly decline this evening, we may be left deciding whether a pullback tomorrow is actually a rejection at resistance, or simply a pullback after a 53 point gain in two days. If we get a continued run, then the PnF target of 412 coincides exactly with the 200- dma of 412.66 (descending) and could be the next target. If we do get a run to that level, I'd be thinking about picking up some puts on the sector in the 400 area, with a stop over the 200-dma. 52-week High: 657 52-week Low : 214 Current : 365 Moving Averages: (Simple) 10-dma: 314 50-dma: 274 200-dma: 412 Market Volatility As the broad market rally continues, the VIX remains squarely under 30, finishing the day at 27.37. As stocks are purchased the most common option trade in the market is the covered call write. This occurs when purchasers sell out of the money calls to reduce the cost of the stock. If the stock goes up and is called away, there is still a profit and if it doesn't reach the short strike by expiration, the writer gets to keep the premium. This creates selling pressure on the options, thus lowering implied volatility. For a graph of the trend in the Dow compared to the VIX, see Wednesday's Market Wrap. CBOE Market Volatility Index (VIX) = 27.37 –1.29 Nasdaq-100 Volatility Index (VXN) = 44.73 –0.09 ----------------------------------------------------------------- Put/Call Ratio Call Volume Put Volume Total 0.75 921,070 690,855 Equity Only 0.62 780,719 486,353 OEX 0.88 29,249 25,660 QQQ 2.17 44,781 97,476 ----------------------------------------------------------------- Bullish Percent Data Current Change Status NYSE 45 + 3 Bull Confirmed NASDAQ-100 75 + 6 Bull Confirmed Dow Indust. 70 + 3 Bull Confirmed S&P 500 63 + 7 Bull Confirmed S&P 100 67 + 5 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 0.84 10-Day Arms Index 1.09 21-Day Arms Index 1.11 55-Day Arms Index 1.18 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 1972 779 NASDAQ 2214 1013 New Highs New Lows NYSE 39 24 NASDAQ 70 37 Volume (in millions) NYSE 1,619 NASDAQ 1,615 ----------------------------------------------------------------- Commitments Of Traders Report: 11/12/02 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 increased short positions by 4,000 contracts, while slightly reducing the long side. Small traders increased long positions by 3,000 contracts, while reducing the short side by 6,000. Commercials Long Short Net % Of OI 10/22/02 432,775 463,827 (31,052) (3.5%) 10/29/02 437,565 468,557 (30,992) (3.4%) 11/05/02 438,546 472,384 (33,838) (3.7%) 11/12/02 437,683 476,540 (38,857) (4.3%) 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 10/22/02 134,641 72,681 61,960 29.8% 10/29/02 137,740 75,587 62,153 29.1% 11/05/02 138,604 76,032 65,572 30.5% 11/12/02 141,389 70,624 70,765 33.4% Most bearish reading of the year: 36,513 - 5/01/01 Most bullish reading of the year: 114,510 - 3/26/02 NASDAQ-100 Commercials reduced the long side by 3,500 contracts while leaving the short side virtually unchanged. Small traders, on the other hand, reduced short positions by 4,000 contracts and longs by just 700. Commercials Long Short Net % of OI 10/22/02 48,954 54,088 (5,134) ( 4.9%) 10/29/02 47,837 55,261 (7,324) ( 7.1%) 11/05/02 49,128 56,121 (6,993) ( 6.6%) 11/12/02 45,647 55,892 (10,245) (10.1%) 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 10/22/02 10,202 8,892 1,310 6.6% 10/29/02 10,584 9,419 1,165 5.8% 11/05/02 13,355 12,903 452 1.7% 11/12/02 12,698 8,801 3,897 18.1% Most bearish reading of the year: (10,769) - 06/11/02 Most bullish reading of the year: 8,460 - 3/13/02 DOW JONES INDUSTRIAL Commercials left positions relatively unchanged, with a slight reduction in both longs and shorts. Small traders increased the long side slightly and left shorts around the same level. Commercials Long Short Net % of OI 10/22/02 22,189 13,448 8,741 24.5% 10/29/02 21,800 13,337 8,463 24.1% 11/05/02 22,533 15,687 6,846 17.9% 11/12/02 22,283 14,953 7,330 19.6% Most bearish reading of the year: (8,322) - 1/16/01 Most bullish reading of the year: 15,135 - 10/16/01 Small Traders Long Short Net % of OI 10/22/02 4,445 9,270 (4,825) (35.1%) 10/29/02 5,602 11,090 (5,488) (32.9%) 11/05/02 5,089 8,735 (3,646) (26.4%) 11/12/02 5,736 8,513 (2,777) (19.5) 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 ************************* Management Team: Causeway International Value (CIVVX) This week's manager microscope report looks at the three former Hotchkis & Wiley international value team members that left the H&W division of Merrill Lynch Investment Managers last year and established their own investment firm and flagship fund, called Causeway International Value Fund (CIVVX). Three fund managers have more than 43 years of combined investment experience among them. My interest in these international value managers dates back to the mid 1990s when the trio worked for Hotchkis & Wiley and the corporation I worked with was interviewing for an international value manager for the pension trust fund. Although the pension committee ultimately went in a different direction, I came away with a good sense about the H&W international value team, their philosophy, process, etc. In 1996, Merrill Lynch Investment Managers acquired Hotchkis & Wiley, which then had in excess of $10 billion in assets under management, having built a strong reputation in value equities, among other things. Sarah H. Ketterer, CEO of Causeway Capital Management and a co-portfolio manager for the flagship Causeway International Value Fund, co-founded H&W's international equity product in 1990, and contributed significantly to the product's success. From 1990 until June 2001, Ms. Ketterer was a portfolio manager at H&W and the MLIM H&W division. At MLIM, she was a managing director and co-head of H&W's international/global value equity team, which managed approximately $3.4 billion in international and global assets for Merrill Lynch, including the $1.1 billion HW International Value Fund (now known as Mercury International Value Fund). Harry W. Hartford and James A. Doyle left the MLIM H&W division along with Ms. Ketterer in June 2001 and started their own firm, Causeway Capital Management LLC, in Los Angeles, California. Mr. Hartford, president of Causeway Capital Management LLC and a co- manager for Causeway International Value Fund, joined Hotchkis & Wiley in 1994 after 10 years with the Investment Bank of Ireland (now, Bank of Ireland Asset Management). From 1994 until June 2001, Mr. Hartford was a portfolio manager with H&W and the MLIM H&W division. He was a managing director there as well, and co-headed the H&W international/global value equity team along with Ms. Ketterer. Mr. Doyle joined the H&W division of MLIM in 1997 after serving as an equity research consultant for Morgan Stanley's investment management unit while still a student at Wharton. From 1997 to June 2001, he worked for the MLIM H&W division, where he was VP and head of investment research for the H&W international value team. Causeway Capital Management LLC, investment adviser to Causeway International Value Fund, began operations in June 2001. Today, the Causeway firm has already amassed more than $1.9 billion in assets, including about $642 million in the mutual fund product. The firm employs 24 people, 11 of whom they state are "seasoned investment professionals." The website says that all employees, with the exception of one sales/marketing professional, came to Causeway as a team from the H&W division of Merrill Lynch (MLIM). Continuity is important. Causeway International Value Fund started operations on October 26, 2001, and now has over a year under its belt. According to Morningstar, this relatively new fund with a veteran management team behind it "could go far" and we like its chances over time as well. In the next section, we provide an overview of the co- managers' investment philosophy and process. Fund Overview Causeway International Value Fund, Investor Class (CIVIX) seeks long-term appreciation by normally investing 80% or more of its assets in stocks of companies paying dividends, or repurchasing their own shares. The fund will normally invest in at least 10 foreign markets, and may invest up to 30% of assets in equities in any one country (35% in the U.K.). Investor Class shares charge a shareholder service fee and have an expense ratio of 1.30%. The minimum initial purchase is $5k for Investor shares, and the fund imposes a 2.0% redemption fee on the value of shares redeemed less than 90 days from purchase. Causeway's flagship fund is reflective of the firm's investment philosophy, which is based on the belief that active management can add value, with lower risk. The management team's approach is value-driven with a fundamental based, bottom-up methodology to stock selection, the website states. The fund's country and sector weightings are more a residual of their equity selection process. Causeway International Value Fund is also based on the principle that companies derive their value from the contribution of yield and profitable re-investment back into the company. Thus, their emphasis on dividend-paying companies and companies repurchasing their shares. Management doesn't believe in "timing" the market, and instead tries to remain fully invested. Causeway's management team also seeks to structure an investment portfolio that controls the volatility of fund returns, so as to focus on providing consistent long-term, "risk-adjusted" returns for shareholders. The team's investment process starts with a screen of large- and mid-sized companies in developed international markets. Smaller international companies are not considered since they tend to be less stable than their larger counterparts, they contend. Their screens sift through some 3,200 companies using a combination of quantitative and value-driven methods to isolate the prospective stocks for further analysis. Once there's a manageable number of stock candidates, Causeway's portfolio managers and analysts get to work, performing in-depth analysis of each company, their industry, competitors, financial condition, valuation, etc. Their fundamental research will vary depending on the company and industry involved, the website says, and may include company visits, meetings with senior management, and discussions with clients, suppliers and competitors. When it analyzes a security, Causeway develops an expected 2-year return target and weighs that against the stock's "risk score," a measure based on the additional risk (volatility) that the equity holding adds to the portfolio. The final portfolio of 60-80 holdings represents the stocks with the highest expected risk-adjusted return. The website says the portfolio will tend to have characteristics typically associated with value managers. Causeway International Value Fund normally will have a lower P/E ratio and higher dividend yield than other international funds, as well as a lower turnover rate (that adds to its attractiveness as a taxable investment). In the 10 years that Ketterer and Hartford ran H&W International Value Fund (now, Mercury International Value Fund), the fund had "below average" volatility compared to the typical international stock fund. In its 1-year history, Causeway International Value Fund has followed suit, limiting losses relative to the category average. In the next section, we take a look at how well the co- managers have performed for shareholders since starting the fund in October 2001. Fund Performance Ketterer, Hartford and Doyle have not had the opportunity yet to demonstrate what they can do when market conditions are positive, but since December 31, 2001 and over the past year, the Causeway International Value Fund (CIVVX) has produced results ranking in the first quintile (20%) of the foreign stock fund category, per Morningstar. For the year-to-date period through November 20, 2002, the fund had a negative total return of 11.1%, shaving 6.7% off the loss produced by the fund's index benchmark, MSCI EAFE ND index, and beating the Morningstar foreign stock fund average by five full percentage points. Though negative, the fund's performance was good enough to rank it in the category's 17th percentile, using data from Morningstar. Causeway International Value Fund had a trailing 1-year loss of 8.9% through November 20, 2002, ranking it in the top 14% of the foreign stock fund category, per Morningstar. That outperformed the MSCI EAFE benchmark by 6.7% and the category average by 6.1%. So, Ketterer, Hartford and Doyle's moderate approach has limited losses to date relative to both index benchmarks and fund peers. A look at Mercury International Value Fund's long-term record is helpful to understanding what the Causeway international product may produce over time in terms of return and risk for investors. According to Morningstar, the Mercury international fund holds a 4-star rating for the most recent 10-year period, based on above average return and below average risk (volatility) when compared to other foreign stock funds. For the trailing 10-year period as of October 31, 2002, Mercury International Value Fund, Institutional Shares (MIVIX) generated an average annual total return of 7.8%, beating the MSCI EAFE ND index by an average of 3.7% and ranking it in the top 11% of the Morningstar foreign stock fund category. Ketterer, Hartford and Doyle deserve most of the credit for that fund's solid long-term performance and ranking. So, while the new fund hasn't operated in a positive market environment, there's reason to be confident about its long-term prospects. Conclusion The fact that the H&W international and global value division of MLIM managed over $3.4 billion in assets when Ketterer, Hartford and Doyle were there, and the new Causeway firm already has $1.9 billion in managed assets, shows how successful their lower risk approach to international equity investing has been. While this fund is diversified across countries, industries, and securities, it does maintain a true value style bias. Hence, it may lag other international stock funds when "growth" is in favor with the market. Long-term investors seeking exposure to quality foreign companies who want to take the high dividend, low average P/E path have a compelling option here. Since the fund invests in larger, established companies and won't pay up in price for stocks, it offers "core" exposure to non-U.S. stocks. For further fund information or to download a prospectus go to the Causeway Funds website at www.causewayfunds.com. These co-managers have what it takes to continue producing strong risk- adjusted returns for shareholders. Steve Wagner Editor, Mutual Investor firstname.lastname@example.org ************************Advertisement************************* If you trade options online, then you need an online broker that: offers true direct access to each option exchange offers stop and stop loss online option orders offers contingent option orders based on the price of the option or stock offers online spread order entry for net debit or credit offers fast option executions PreferredTrade offers these online option trading features and more; call 1-888-889-9178 or click for more information. http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** *********************** SWING TRADER GAME PLANS *********************** Ticket To Ride Ticket please? Bulls boarded the rally train in mass on Thursday as better than expected bad news from GE and better than expected good news from HPQ provided the market motion. Those left standing on the sidelines with a pocket full of cash were left wondering if there would be another express in their future. To read the rest of the Swing Trader Game Plan Click here: http://www.OptionInvestor.com/itrader/indexes/swing.asp FREE TRIAL READERS ****************** If you like the results you have been receiving we would welcome you as a permanent subscriber. The monthly subscription price is 39.95. The quarterly price is 99.95 which is $20 off the monthly rate. We would like to have you as a subscriber. You may subscribe at any time but your subscription will not start until your free trial is over. To subscribe you may go to our website at www.OptionInvestor.com and click on "subscribe" to use our secure credit card server or you may simply send an email to "Contact Support" with your credit card information,(number, exp date, name) or you may call us at 303-797-0200 and give us the information over the phone. 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The Option Investor Newsletter Thursday 11-21-2002 Copyright 2002, All rights reserved. 2 of 3 Redistribution in any form strictly prohibited. To view this email newsletter in HTML format with embedded charts and graphs, click here: http://www.OptionInvestor.com/htmlemail/y21d_2.asp In Section Two: Dropped Calls: AIG, FRX Dropped Puts: TRMS, IDPH Daily Results Call Play Updates: GNSS, HOV, CEPH. IMCL New Calls Plays: ADBE, ETN Put Play Updates: PG New Put Plays: JBLU **************** 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: ***** AIG $66.91 -0.50 (-0.98) All coiled up and nowhere to go, seems to have been the theme for AIG on Thursday. After last week's breakout move through the $66 resistance level, the stock has run into a veritable brick wall of resistance at $68. While the stock could very well break this resistance tomorrow, we don't like the fact that AIG didn't really participate in the rally over the past 2 days. It doesn't necessarily mean a bearish reversal is in store, just that the bulls seem to have lost their incentive in the near term and we don't want to wait around. If holding open positions, ratchet stops up nice and tight to $66, which has been intraday support all week. Alternatively, look to take a more favorable exit on another push up near resistance. --- FRX $104.65 +1.15 (-1.10) Our FRX play gave us a nice move when it broke out to new highs last week, and we were looking for a repeat performance this week. The strong buying across the market should have gotten the job done over the past couple days, but the money appears to be flowing elsewhere. While it was encouraging to see the stock rebound from the $102 level yesterday, the stock's inability to close back over $105 today is not encouraging. While we don't see a bearish near-term future for the stock, we just don't want to wait for another period of consolidation before the next upward move. There are better plays available. Look to harvest gains on open positions on another intraday surge up near the $105 level. PUTS: ***** TRMS $51.19 +2.33 (+1.35 for the week) We added Trimeris to the short list, in spite of the predicted successful release of their new drug, Fuzeon, in March. Investors were scared off by comments from analysts that the company may have trouble producing enough of the drug to meet earnings estimates for the next couple of years. The stock sold off dramatically, but we were targeting a PnF sell signal at $47 for entry, which we never got, as the stock bounced from $47.24. Our secondary entry was a rollover under $50. Unfortunately, the stock hit $50 and just kept going, finishing at $51.19. Without either entry point being triggered, we'll drop the play and look for other opportunities. --- IDPH $40.33 +1.79 (-0.03) With the Biotechnology index (BTK.X) pinned under the $365 resistance level and little bullish life in the stock, IDPH was looking good as a put yesterday. But then we got a strong positive open in the broad markets today (led by Technology shares) and the BTK exploded upwards, closing at the high of the day and above recent resistance. IDPH was lifted along with the rest of the sector, clearing the $40 level, which had been solid resistance. Intraday weakness was unable to get IDPH back under that level and the stock proceeded to go out near the high of the day. There is still significant resistance between here and $41, but the strong buying volume today has us shying away from the play. IDPH could pull back from resistance, but with the strong move in the BTK today, it looks like the bears have lost their grip on the sector and stock. Instead of looking to enter on weakness, use a pullback from current levels to exit open positions. *********************************************************** DAILY RESULTS *********************************************************** Please view this in COURIER 10 font for alignment ************************************************* CALLS Mon Tue Wed Thu Week ADBE 30.24 -0.77 -0.79 -0.71 1.84 New, above $30 AIG 66.91 -1.40 0.07 0.91 -0.50 Drop CEPH 59.05 0.71 -1.39 -1.80 2.08 Higher high ETN 76.55 -1.24 -0.03 1.48 2.77 New, Breakout FRX 104.65 -1.56 -0.38 -0.08 1.15 Drop, Profits GNSS 18.90 0.01 -1.26 1.67 0.90 $20 next HOV 33.70 -1.35 -0.95 0.55 1.35 dma bounce IMCL 14.19 -0.77 1.15 0.82 1.43 New highs PUTS IDPH 40.33 -1.31 -1.09 0.17 1.79 Drop, strong bounce JBLU 34.99 -0.77 -0.79 -0.71 –1.01 New, Rel. weakness PG 86.73 -1.15 0.95 1.44 –1.26 Dow stock down TRMS 51.19 -1.97 -0.62 1.06 2.33 TRMS, no entry ************************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 ******************** GNSS $18.90 +0.90 (+1.73 for the week) Genesis continues its strong rebound, along with many of the other chip stocks. It was downgraded due to uncertainty in the ASP market, and the fact that it had reached RBC's price target of $16. WE say, so what? In fact the stock not only rebounded strongly off that price of $16 on its pullback, but continues to set new relative highs. The pullback above $16 gave a brief PnF reversal, before taking off again into another column of "X" and giving a fresh double top buy signal at $19.00. The fact that the sector has been on a tear, breaking above its August highs, and breaking through its own bearish resistance line, can be used as confirmation for the bullish move. Today's close saw the Semiconductor Index break above its August closing high, finishing on its high of the day, as well. Unlike many of the other chip stocks, which are looking at declining revenues, GNSS is in a market that is growing by leaps and bounds, with flat panel monitors and projectors. New entries can look for support over $19 on a move back above that level, or a breakout above today's resistance at $20 for more conservative traders. After the recent run in the chips, we may get a pullback, as well, and in that case look for support at $17, just above the 200-dma, for entry. --- HOV $33.70 +1.35 (-0.30 for the week) Hovanian has rebounded once again from its 200-dma, for the fifth straight time, giving traders a good entry point on the pullback over $31 highlighted in the original play write-up for conservative traders. We also highlighted entry at the PnF buy signal at $34, which the stock gave on the last rally. After the pullback, the company came out and raised earnings guidance once again for the 2002 full year, and said November orders remain strong. This is good news, after a 94% increase in September orders and a 60% increase in October orders. The recent MBA mortgage application data also showed a 21% increase for the second week of November, in spite of the 11% drop in housing starts in October (which obviously didn't fall too hard on HOV, considering the company's aforementioned 60% increase that month). Some seasonal drop off can be expected as we head into the winter months, and even the 11% drop in October housing starts still leaves the market strong. We still like the technical strength here, and the next resistance on the PnF chart comes up at $40, which remains our target on the play. After the bounce over $31, which would have been a PnF reversal down, new entries can look for support over the $34 level, which was the original move into a column of "X." --- CEPH $59.05 +2.08 (+3.34 for the week) Cephalon bounced strongly on the recent pullback to support at $55. The stock has been consolidating in $5 jumps, first at $45, then $50 and now $55. After topping out at $58.67, the stock received a questionable downgrade, citing possible future attempts by generic drug makers to grab a piece of Provigil. Nevertheless, investors have looked to the company's sales growth and strong demand across all product sectors and scooped the stock on the pullback. The stock took off again, achieving a new higher high and establishing another buy signal on the point and figure chart at $59. CEPH was recently upgraded by Adams Harkness, which raised earnings estimates all the way through 2006 and set a price target of $64. The current PnF bullish count is an astronomical $97, which seems pretty unlikely on the current move, without several pullbacks, but nonetheless raises the PnF resistance ceiling. There is some resistance on the daily chart between $63 and $64, which coincides with the analyst price target, however that resistance was in place when the 200-dma was at that level back in April. The current 200-dma is far below at $51.60. We will raise our target on the play to $64, from the original target of $60. New entries can use the $59 PnF buy signal to initiate longs, but conservative traders may want to wait for a break above probable round number resistance at $60. --- IMCL $14.97 +1.49 (+3.20) Perhaps the surge in price in IMCL last week had less to do with the rumors of a buyout offer from Bristol Myers and more to do with improving internals in the overall Biotechnology index (BTK.X). Recall that IMCL surged to as high as $14.36 last Thursday on those rumors, before falling back and consolidating near $11.50. The past 2 days have seen some concerted buying in the BTK, with Thursday's rally propelling the index through important resistance near $370. That seems to have added enough fuel for the bulls, as they bought IMCL in volume, driving the stock through last week's highs and closing just below the $15 level. IMCL is now solidly above its 200-dma and all of the shorter term moving averages are curling higher as well. With the intraday move through the $15 level, the PnF chart generated a fresh Buy signal and bulls now set their sights on $20 as the next upside target. But before they can focus on that level, they'll need to get through the next level of resistance near $16.25. Traders that took advantage of the dip to support earlier this week are smiling tonight, as the stock looks like it is building up a head of steam to go higher. Pullbacks near intraday support, first at $13.50 and then $12, can be used for new entries, so long as the BTK index doesn't fall below $365. Momentum traders now need to wait for a push through the $16.50 level before entering on strength. Raise stops to $11.50, as that level of support needs to hold on any significant pullback to keep the bullish trend intact. ************** NEW CALL PLAYS ************** ADBE – Adobe Systems $30.20 +1.80 (+1.25 this week) Company Summary: A long-time leader in desktop publishing software, ADBE provides graphic design, publishing, and imaging software for Web and print production. Offering a line of application software products for creating, distributing, and managing information of all types, the company generates nearly 75% of sales through publishing software products such as Photoshop, Illustrator, and PageMaker. Its Acrobat Reader, which uses portable document format (PDF) is popping up all over the Internet, as businesses shift from print to digital communications. In addition, ADBE licenses its industry standard technologies to major hardware manufacturers, software developers, and service providers, as well as offering integrated software solutions to businesses of all sizes. Why We Like It: While the gains in the Software index (GSO.X) of late can't rival those of the once again red hot Semiconductor index (SOX.X), there is a solid bullish trend of higher lows and higher highs building in the group. MSFT is the big daddy in this group, and while that stock has been struggling to advance over the past couple weeks, Thursday's breakout over $57.50 should help to keep the momentum going. Using that as our backdrop, the stock that we really like in the group is ADBE, which has really been performing like a champ over the past 6 weeks. After bottoming near $18 in early October, the stock has been steadily churning higher, leaving a consistent string of higher lows and higher highs in its wake. That pattern continued this week, with the 10-dma (now at $27.47) providing the springboard for the rally of the past 2 days, which propelled the stock to its highest level since June. Not only did ADBE clear major resistance at $29, but it also scaled the 200-dma for the first time since the big breakdown in June. The PnF chart shows the strength of this breakout, as it took the stock through its bearish resistance line at $29, and with the stock currently on a Buy signal with an upside target of $50. We don't expect to see that level anytime soon, but a near-term move to the next major level of resistance at $35 certainly seems reasonable. An intraday pullback near $28-29 can be used for initiating new positions, but make sure to wait for the bounce before entering. Momentum traders can enter new positions on a push through $30.50 (just above today's intraday high), especially if the GSO index is able to rally through its 200-dma (currently $117.92). The low earlier this week was just above $27, so that gives us a solid level of support to base our stop on. A close below that level will have us dropping the play due to a break in the string of higher lows. BUY CALL DEC-30*AEQ-LF OI=1776 at $2.45 SL=1.25 BUY CALL DEC-35 AEQ-LG OI= 803 at $0.65 SL=0.25 BUY CALL JAN-30 AEQ-AF OI=2379 at $3.30 SL=1.75 BUY CALL JAN-35 AEQ-AG OI=1629 at $1.40 SL=0.75 Average Daily Volume = 3.63 mln --- ETN – Eaton Corporation $76.55 +2.77 (+3.37 this week) Company Summary: Eaton Corporation is a global diversified industrial manufacturer with businesses in fluid power systems, electrical power quality, distribution and control, automotive engine air management and fuel economy and intelligent truck systems for fuel economy and safety. The principal markets for the company's Fluid Power, Automotive and Truck segments are original equipment manufacturers and after market customers of heavy-, medium- and light-duty trucks, passenger cars, off-highway vehicles, industrial equipment, and aerospace products and systems. The principal markets for the company's Industrial and Commercial Controls segment are industrial, construction, commercial, automotive and government customers. Why We Like It: While the rally off the October lows has been driven by gains in the Technology sector, we're starting to see the gains broaden out to other areas of the market. One of the key sectors that needs to see some bullishness build is the Cyclical index (CYC.X) and Thursday's 4.25% gain is certainly what we're looking for. The index found support right at its 20-dma earlier this week, and today's breakout over the early November highs keeps the string of higher lows and higher highs intact. Shares of ETN have really been on a tear lately, and today's rally was very important to the near-term picture. This week we've gotten a fresh PnF Buy signal as the stock cleared $72 resistance and the vertical count currently projects up to $97, which would be very close to the all-time highs, if achieved. Near-term, ETN looks to have resistance near $80, and then again in the $83-85 area. The stock cleared major resistance at $74, and then powered through the 200-dma ($74.58) on strong buying volume. On the theory that prior resistance becomes support, the stock ought to find firm support now in the $73-74 area and an intraday pullback and bounce in that range can be used for new bullish entries. Momentum traders need to be careful here after the strong gains of the past 2 days, but a continuation of the heavy buying that propels the stock through $77 can be used for new entries as well. Look for continued strength in the CYC index if trading on further strength, as a pullback in the sector will likely cause some near-term weakness in ETN. We're initially setting our stop at $72, just below the 10-dma, which provided support for this week's rebound. BUY CALL DEC-75*ETN-LO OI=214 at $4.40 SL=2.75 BUY CALL JAN-75 ETN-AO OI=355 at $5.80 SL=3.75 BUY CALL JAN-80 ETN-AP OI=116 at $3.20 SL=1.50 Average Daily Volume = 460 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 ******************* PG $86.73 -1.26 (-0.55) It seemed there was nothing but a sea of green in the market on Thursday, with virtually every sector (except Health Care) moving up with enthusiasm. But PG never got into the action, reversing from the $88 resistance level and giving up 1.4% on the day. That's not much of a drop, but when compared to the 2.5% gain in the DOW it is an important confirmation of the stock's relative weakness. Another way of looking at it is that there were only 6 losers in the DOW, and PG was the biggest loser (both on a point and percentage basis) of the entire group. That relative weakness should continue to assert itself, as investors seem to be shunning the Consumer stocks in favor of the sexy Technology shares. Should the market see a bout of profit taking in the broad market (entirely possible after the stellar run of the past 2 days), then PG ought to lead the slide. Traders that took advantage of the failed rally at $88 nailed a solid entry to the play and new entries still look good on failed rallies below that level. If looking for confirmed weakness though, traders need to see the stock break the $85 support level, and preferably drop below the October 28th intraday low of $84.75 before playing. Our stop remains at $89. ************* NEW PUT PLAYS ************* JBLU - Jet Blue - $34.99 -1.01 (-2.86 for the week) Company Summary: The Company's principal activity is to provide low-fare, innovative, quality passenger air transportation service to and from a growing number of United States locations. As of December 31, 2001, the Company operated 102 flights a day providing daily service to 18 cities. The Company focuses on serving underserved markets and large metropolitan areas that have high average fares. Why We Like It: It was a good day for some of the airlines, following the announcement from United that it had reached an agreement with its machinists for $1.5 billion in wage cuts. While the Airline Index (XAL.X) was rebounding, Jet Blue continued its recent drop. The stock began its recent descent when J.P. Morgan dumped almost its entire stake in the airline as soon as its IPO restriction came off. JPM was one of JBLU's biggest initial investors and the dumping of stock scared investors off for more than just the day it sold the stock. Ever since, JBLU has been setting lower daily highs and lower lows and looks to have now completed a bearish head and shoulders pattern. Today's drop came in spite of the 222-point gain in the Dow and followed more bad news on the competition front. Delta Airlines announced on Wednesday that they are creating a new lost cost airline within an airline to compete with airlines such as JBLU. The number 3 U.S. carrier has the power to cut into the low-cost market and steal market share from airlines such as Jet Blue, Southwest and AirTran. The recent sell-off was just the continuation of a pattern that has been developing on the point and figure chart since the stock began its descent from $55 in May. It has been setting lower highs and lower lows with each new column on the chart ever since, with scare exceptions. The last time it tested its bullish support line was at $42 and the breakthrough was good for a $5 gain on the breakdown to $37. The stock is now sitting right on that line, and conservative traders can wait for a breakthrough on a trade of $34 to initiate the short play. However, we like the breakdown under $35 and failed rebound at that level at the end of the day for an entry at the current level. If we see a bounce in the morning, we'll let it run its course to the descending trendline on the PnF and enter on a failed bounce under $38. Past rebounds in the stock have broken the 50-dma, but the most recent bounce here was rejected at that level ($38.35). Our initial target on the play will be $30, the bounce level before the rally of the last month. Place stops initially at $39. BUY PUT DEC-40 JGQ-XH OI= 554 at $6.20 SL=3.10 BUY PUT DEC-35 JGQ-XG OI= 502 at $2.90 SL=1.50 Average Daily Volume = 756 k ************************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: advertising@OptionInvestor.com
The Option Investor Newsletter Thursday 11-21-2002 Copyright 2002, All rights reserved. 3 of 3 Redistribution in any form strictly prohibited. In Section Three: Play of the Day: CALL - ADBE Traders Corner: Are You An Eagle or A Turtle? Traders Corner: Indicators: Seeing Accumulation using OBV Traders Corner: Single Stock Futures: What's the Difference Futures Corner: It’s all Relative Options 101: Divergence (Again) ********************** PLAY OF THE DAY - CALL ********************** ADBE – Adobe Systems $30.20 +1.80 (+1.25 this week) Company Summary: A long-time leader in desktop publishing software, ADBE provides graphic design, publishing, and imaging software for Web and print production. Offering a line of application software products for creating, distributing, and managing information of all types, the company generates nearly 75% of sales through publishing software products such as Photoshop, Illustrator, and PageMaker. Its Acrobat Reader, which uses portable document format (PDF) is popping up all over the Internet, as businesses shift from print to digital communications. In addition, ADBE licenses its industry standard technologies to major hardware manufacturers, software developers, and service providers, as well as offering integrated software solutions to businesses of all sizes. Why We Like It: While the gains in the Software index (GSO.X) of late can't rival those of the once again red hot Semiconductor index (SOX.X), there is a solid bullish trend of higher lows and higher highs building in the group. MSFT is the big daddy in this group, and while that stock has been struggling to advance over the past couple weeks, Thursday's breakout over $57.50 should help to keep the momentum going. Using that as our backdrop, the stock that we really like in the group is ADBE, which has really been performing like a champ over the past 6 weeks. After bottoming near $18 in early October, the stock has been steadily churning higher, leaving a consistent string of higher lows and higher highs in its wake. That pattern continued this week, with the 10-dma (now at $27.47) providing the springboard for the rally of the past 2 days, which propelled the stock to its highest level since June. Not only did ADBE clear major resistance at $29, but it also scaled the 200-dma for the first time since the big breakdown in June. The PnF chart shows the strength of this breakout, as it took the stock through its bearish resistance line at $29, and with the stock currently on a Buy signal with an upside target of $50. We don't expect to see that level anytime soon, but a near-term move to the next major level of resistance at $35 certainly seems reasonable. An intraday pullback near $28-29 can be used for initiating new positions, but make sure to wait for the bounce before entering. Momentum traders can enter new positions on a push through $30.50 (just above today's intraday high), especially if the GSO index is able to rally through its 200-dma (currently $117.92). The low earlier this week was just above $27, so that gives us a solid level of support to base our stop on. A close below that level will have us dropping the play due to a break in the string of higher lows. BUY CALL DEC-30*AEQ-LF OI=1776 at $2.45 SL=1.25 BUY CALL DEC-35 AEQ-LG OI= 803 at $0.65 SL=0.25 BUY CALL JAN-30 AEQ-AF OI=2379 at $3.30 SL=1.75 BUY CALL JAN-35 AEQ-AG OI=1629 at $1.40 SL=0.75 Average Daily Volume = 3.63 mln ************************Advertisement************************* Tired of waiting on trades to execute? Does your broker offer Stop Losses on Options? Trade instantly with Stop Losses at PreferredTrade Inc. Stop Losses based on the option price or the stock price. Move your trading into the next millennium with PreferredTrade. Anything else is too slow! http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ************** TRADERS CORNER ************** Are You An Eagle or A Turtle? By Mike Parnos, Trading With Attitude "Eagles may soar, free and proud, but turtles never get sucked into jet engines.” At the Couch Potato Trading Institute, we are devout turtles – slow and deliberate with a hard protective shell. While we may occasionally use LEAPS, our trading pace is small certain steps. We want to reach our profit objectives without becoming turtle soup. ____________________________________________________________ What’s Wrong With This Picture? Last week on the OI Market Monitor I noticed some conversation about straddles. What I found interesting was that the straddles that were being discussed consisted of buying strikes only one month out at a cost of about $4.50. Even if one of the strikes was $.50 in the money when the proposed position was initiated, that means there is $4.00 of time value circling the bowl preparing to disappear if the market doesn’t come to the rescue. OK, CPTI students –What’s the cardinal rule for trading straddles? -- If you believe there will be a substantial movement in the next month, buy the straddle at least 3-4 months out. Why? Because, in the first month of a four-month option, time premium erodes very slowly. Only about 10%-15% of the time value will disappear during that first month. So, you may have to pay for some additional time premium when you buy puts and calls three months out, but this additional money is not at risk. Let’s look at Microsoft (MSFT) – trading at $55.87. Scenario A: Buy the MSFT Dec. $55 calls @ $2.60 Buy the MSFT Dec. $55 puts @ $1.70 You are exposed for $4.30 Scenario B: Buy the MSFT Apr. 03 $55 calls @ $6.40 Buy the MSFT Apr. 03 $55 puts @ $5.20 You are exposed for $11.60 – NOT! You are only exposed for the full $11.60 if you plan to hold the position to expiration in April. However, we’re going to exit this position in ONE MONTH or less. During this time, the options may lose 10% of their value because this is the first month of a five-month option. Ten percent of $11.60 is only $1.16. That’s a hell-of-a-lot LESS than the $4.30 in Scenario A. You may be tying up the $11.60 for that first month, but the bulk of that money is NOT at risk. Why risk $4.60 when you can risk $1.16? One month straddles may work occasionally, but even a blind squirrel finds an acorn once in awhile. This same blind squirrel is more likely to end up as roadkill. So, before you have to face scraping up what’s left of your investment off the pavement, think twice about sending a blind squirrel out to do your nut shopping – especially if you have any feelings for the squirrel. ____________________________________________________________ Hi Mike, I think I am confusing risk/reward ratios with return on investment or profit. I am trying to reconcile what Jeff said about establishing a risk/reward guideline with what I read in the CPTI articles. Jeff is proposing a 1:2 risk/reward ration. In Mike's recap of the CPTI portfolio plays, the risk/reward ratios appear to be more around 2:1 or worse. So... Is risk/reward the same as ROI or profit margin? If I pick a risk/reward rule of 1:2, am I suppose to make a 100% return on the trade? Thanks for your help. Response: I can see where this might be confusing. I haven't read Jeff's risk/reward discussion. The thought of a 1:2 risk/reward ratio is certainly appealing. However, I think that, in order to get a 1:2 risk/reward ratio, you have to be in a position requiring substantial stock movement. I'm assuming we're talking about spreads here. This is an aggressive trade. For example: IBM is trading at about $78.50 and you: 1. Buy the December $80 call @ $2.45 2. Sell the December $85 call @ $.80 You have created a bull call spread and your total debit is $1.65. Your maximum total profit will occur only if IBM moves up and finishes above $85 at December expiration. Both options would then be exercised and you would receive the difference between the strike prices ($5.00). Since your debit was $1.65, your profit is $3.35 ($5.00 - $3.35). That's where the 1:2 ratio comes from. The only problem is that, for you to profit at all, IBM has to move up -- significantly. If it doesn't move up, both you and your 1:2 risk/reward ratio will be having dinner at your local soup kitchen. Now, if I had a similarly bullish outlook on IBM, I might take a less aggressive position in the form of a bull put spread. Try this on for size. 1. Sell the December $75 put @ $1.85 2. Buy the December $70 put @ $.85 I have taken in $1.00 in premium. That $1.00 is resting comfortably in my pocket (next to my loose change, Tic-Tacs and pocket lint). My maximum risk (exposure) scenario in this position would only occur if IBM breaks down and finishes under $70. Then, the two put options would be exercised and it would cost me $5.00. I've already taken in $1.00, so my exposure is really only $4.00 ($5.00 - $1.00). My return of $1.00 on the bull put spread is less than the potential $3.35 return from the bear call spread. And, my exposure is greater ($4.00) than the exposure in the bull call spread ($1.65). BUT – I have three ways to make money with the bull put spread compared to only one with the bull call spread (if IBM goes up). With the bull put spread, I profit if: 1. If IBM goes up, both put options expire worthless. 2. If IBM goes nowhere, both put options expire worthless. 3. If IBM goes down to $75, both put options expire worthless. 4. If IBM violates the $75 short put, I can short the stock to protect the $1.00 of premium I took in. My reward on the bull put spread is only 4:1 (25%), but I like my odds of success a lot better. So, I’ve increased my probability of success threefold. The cost for this is some additional exposure. There’s a bonus, however. In addition to the $1.00 of premium, you’ll probably get a lot more good nights sleep. Do you want to be the casino or the gambler? CPTI students will not bet their bus ticket home. If you’re not careful you may have to trade your house for a double-wide. ____________________________________________________________ I understand how difficult it can be to alter one’s trading style. How does one change? This familiar story may help get you on the right track. A well-known Zen Master steps up to a hot dog cart and says: "Make me one with everything." The Hot Dog vendor fixes a dog and hands it to the Master, who pays with a $20 bill. The vendor puts the bill in the cash drawer and closes the drawer. "Where's my change?" inquires the Master. "Change, my friend, must come from within," said the Hot Dog vendor. ___________________________________________________________ CPTI Portfolio Update – As of Thursday’s Close. BBH Iron Condor – Currently trading at $91.09 We want BBH to finish the December option cycle anywhere between $80 and $95. Looking good! TTWO Short Strangle – Currently trading at $30.71. We want TTWO to finish the December option cycle anywhere between $22.50 and $35.00. Looking good! IMCL Covered Call – Currently trading at $14.97. We want IMCL to finish the December option cycle over $10 so it will be called away. Looking good! QQQ ITM Strangle – Currently trading at $27.73 The QQQs finally made its predicted 3-point move. CPTI students, who were bullish and put on the $23/$25 strangle, can now sell the $23 call for $4.80. That’s a profit of $.35 and you now own the $25 put free and clear with a month to go. CPTI students, who were bearish and put on the $24/$26 strangle can now sell the $24 call for $3.90 and own the $26 put at only $.45 with a month to go. If the market does a typical Fibonacci retracement, back up the truck and get ready to load up the profits. ____________________________________________________________ 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 ************** Indicators: Seeing Accumulation using OBV By Leigh Stevens lstevens@OptionInvestor.com ON BALANCE VOLUME (OBV) - In my weekly Index Trader of Sunday (11/17/02) I described how the Nasdaq 100 tracking stock (QQQ) was in a strong up trend that was “confirmed” with its volume pattern – however, this was not to be seen in the “normal” way of displaying daily trading volume as seen below – The above way of displaying volume is what you get when you select “volume” as an “indicator” such as in Q-charts or other charting applications - it displays volume as a histogram or as vertical bars that show the volume total for that day (as read from the right hand numerical volume scale). On Balance Volume or OBV is also a type of volume indicator or volume-RELATED technical study or formula. An indicator being of course any mathematical calculation that is applied to a financial instrument’s price and/or volume information. First, to look at what OBV looks like, as overlaid on the QQQ daily chart volume bars below - more explanation will follow this next chart but first the chart. In technical analysis a picture IS worth a thousand words – On Balance Volume keeps a cumulative running volume figure that adds ALL the volume on an up date and subtracts ALL the trading volume on down day. If there is more trading volume on up days then there is on down days, OBV rises, as can be seen in the lower portion of the daily chart on the QQQ chart above. OBV provided an early and ongoing indication that the buying interest in the Nasdaq 100, as reflected in QQQ, was stronger than the selling activity. So, for this reason, I said that OBV can alert us to “accumulation” of a stock (it is being “accumulated”) or that there is buying “on balance” in the item, but not so much that volume spikes dramatically. This is typical of institutional/fund buying. Professional money managers tend to accumulate stocks gradually and is in fact a necessity for them, as their buying could really drive the stock up fast as they might have a few million shares they want to buy or accumulate in total. OBV HISTORY & CONSTRUCTION - OBV uses daily stock trading volume for its construction and was devised by Joe Granville, a legendary market analyst who was especially well known in the 1960s through the 1980’s. (Joe is still writing a market letter I believe but he is not so well to traders these days and he is in his senior years – fortunately, a good trading advisor is judged not by age but by his ability to “call” the market turns.) Any, Joe Granville when he was mildly famous was a very colorful person who, at times, seemed to be more of a showman than an analyst and market advisor. However, his market knowledge was through and his insights often profound. One such insight of Granville furthered Charles Dow’s concept that volume should INCREASE in the direction of the dominant trend. On balance volume or OBV as it’s popularly known, provided some further assessment of this principle and enhanced volume analysis quite significantly. To construct the OBV indicator, a running total of volume is kept. Assume we started with a stock that traded a million shares on day 1. This is a neutral starting point, as we have to start somewhere. If the stock closes higher the next day and trades 750,000 shares, day 2’s volume figure is added to the first day and assigned a positive number because our running total is a positive number; OBV is now a +1,750,000. [NOTE: OBV would be a negative number if our example stock closed lower on day 2, on 1,500,000 shares: OBV would be –500,000.] Going back to the example - on day 3 the stock closed lower on 500,000 shares and we subtract that day’s volume from our cumulative OBV total: on day 3, OBV is +1,250,000. When the stock is unchanged in price on day 4, we leave OBV unchanged at +1,250,000. This calculation process continues on into the future. If we graph the points, the resulting line will start moving upward or downward following the direction of the price trend of the stock for which OBV is being calculated. We are primarily concerned with the DIRECTION of OBV - is the (OBV) line moving UP or DOWN? If the direction is up, the OBV line is bullish, as there is more volume on up days than on days when the stock price is down. A falling on-balance volume line is bearish, as more stock is being traded on down days than on up days. If both price and OBV are moving up together, it is a bullish sign portending higher prices. If both price and OBV are moving down together, this is a bearish indication for still lower prices ahead. However, if prices move higher during a period of time when OBV lags or moves lower, this is a bearish divergence indicating diminishing buying activity and warns of a possible top or trend reversal. Conversely, of course, if prices are moving lower but OBV is trending higher, this is bullish divergence – this is seen below in next chart, a prior period in a stock with its corresponding on-balance volume indicator. This example is also useful in that it shows OBV when its cumulative total is both a negative and positive number – A divergence in technical analysis is what occurs when one component to market activity goes in one direction and another related component goes in an opposite direction. The first example of a “divergence” was Dow’s example of one of his averages going to a new high or low, when the other did not. This last example relating to price and volume is another type of divergence – that of price going one direction and an indicator, based on a calculation involving price or volume, going in an opposite direction. The example above of a bullish divergence occurs (in a downtrend) if OBV starts trending higher – the dynamic is that the sellers would now appear to be less active and this divergence suggests being alert to an end to the downtrend. This concept goes back to the idea that volume activity can precede a change in price direction. Now, what I’ve said here is not to suggest taking action before PRICE activity confirms what OBV and volume activity has suggested. But if this occurs you can be ready to take appropriate action. In the example above, the upturn in OBV preceded a reversal of a downtrend in the stock but I would not generally act on such a divergence or “signal”, only be ALERT to a potential reversal. You can bet that I would a heavy buyer of the stock or calls on the stock as soon as price action “confirmed” such as by a breakout above its down trendline. Another thing about volume, pretty much always, is that it is secondary indicator and that price action “trumps” what volume is doing so to speak. In the chart below, that of the up to date price and volume action in ABT, there is a lack of an apparent “breakout” move in daily volume as suggested by the down trendline on the daily volume bars as the stock moves steadily up – However, OBV is in a confirming up trend. But, price action is far from bullish in that the stock has come right up to its down trendline. Moreover, the bearish rising wedge pattern would suggest that this rally is most likely going to fail – and is a countertrend rally in a bear trend. For more on the wedge reversal pattern you can go to my earlier Trader’s Corner article at – http://www.OptionInvestor.com/traderscorner/082902_2.asp ************** TRADERS CORNER ************** Single Stock Futures: What's the Difference by Steven Price Single stock futures began trading just over a week ago. The futures have a few similarities to options, but are actually a very different tool. While an option gives you the right, but not the obligation to purchase or sell the stock, the future obligates you to complete a trade in an underlying product and take delivery at expiration. The current regulations allow cash settlement, but this option is not currently offered by the listing exchange. Even if it were, it wouldn't affect a trader's risk. Let's start with risk. An option limits the option holder's risk to the amount spent on the premium. If you buy a call for $2.00 and the stock moves against you, your maximum loss is $2.00. If you buy a future on a stock and the stock drops $40 (see Tenet Healthcare), you lose $40. So the directional risk is much different between the two. In trading futures, you don't necessarily have to deal with paying a volatility premium, like you do in an option. For instance, a call has extra premium built in, depending on how volatile the stock is and how much chance there is of that option being worth something by the time it expires. So there is additional premium risk in an option if it never moves in the money. With a future, the premium is based on interest and dividends. If you spend only 20% of the stock price to purchase a future (the current margin requirement), you get to earn interest on the extra money you didn't have to spend to acquire the stock. Therefore, that interest is added to the price of the future. Also by owning a future, instead of stock, you forgo the right to collect dividends, so the amount of a dividend is subtracted from the price of a future. This interest and dividend calculation also applies to options, when comparing the premium in a call to the premium in a put at the same strike. Call premium is always [interest minus dividend] more than put premium. The aforementioned futures margin requirement is lower than it is for stocks, with investors required to put up only 20% of the value of the stock. You only have to have $10 in your account for each $50 share of stock. Most brokers require 50% from their clients for the purchase of stock, so individuals should check with their broker for individual margin requirements when trading futures. The lower requirement provides more leverage, allowing investors to put up less money to own more shares. This is similar to options, in that you use less to control more. However, because there is no risk reduction, investors must be careful because it also allows them to lose more than they would under normal margin requirements, or by trading options. I talked about the volatility premium in options not being present in futures. While that is certainly true, there is another benefit to futures that sticks out in the back of my mind as having the potential to create a sort of "volatility premium" under certain circumstances. That is the ability to sell these products short on a downtick. The current NYSE "uptick" rule prevents traders who currently have short stock positions from selling downticks. What this means is that if you are short 1,000 shares of Wal-Mart, you cannot sell any more if it is falling. You must wait for it to trade upward, even if it is only by a penny, from its last print. In a falling market, it may surprise many traders just how few upticks occur. This was instituted to prevent short sellers from driving markets down in a crash scenario. What it also does is limit option traders' ability to hedge long positions in options (long calls or short puts), as well as preventing program traders who are long stock indices from selling the individual components of that basket short as the market falls. With a future, there is no uptick rule, so traders with short positions need not wait for an uptick to sell the underlying future. In a falling market, often puts trade at a premium, as investors or traders with long positions will pay a higher price for protection. While a future price is supposedly based only on interest and dividends, the ability to short them should carry some value in and of itself, which could be reflected in a lower bid, or wider bid/ask spread in a falling market. Right now the bid/ask spread is very narrow, but we haven't seen the behavior in a crash. While we won't know if this will be true until it happens, it is something to be aware of. The current market for single stock futures is very thin, with even the open interest in Microsoft currently only 1,512 for December, January and February. For the moment, the futures are too thin to use for our purposes. However, the product is new and it should begin to see more volume, as more market makers participate. The current set-up has a specialist in each issue, but allows market makers to post bids and offers. From what I'm hearing, many of the clearing firms are still setting up electronic access for traders and as the kinks are worked out, we will see more participation and liquidity. One big issue to watch will be whether or not the futures lead the underlying product, as they do in many indices. I'll be filling in our readers as I receive more info. I'll also share the experiences of the traders who take part from the market-making end. Right now many of them have expressed frustration with access and many option traders say they haven't yet heard them quoted on the trading floor with options, the way that stock is. I expect these products to slowly grow and if the market continues to advance, bringing in more investors, the money should find its way into futures, especially considering the 20% margin requirement. Stay tuned for updates and send any questions to my email and I'll try to answer them on the Market Monitor. ************** FUTURES CORNER ************** It’s all Relative By John Seckinger jseckinger@OptionInvestor.com What happens when Relative Strength (RSI) shows a bearish divergence in an index on a daily chart, but not from a weekly standpoint? How does execution come into play? RSI is simply defined as a momentum indicator that measures an equity's price relative to itself. RSI is relative to its past performance, while being front weighted in its calculation. Therefore, it gives a better velocity reading than other indicators. Moreover, RSI is less affected by sharp rises or drops in an equity's price performance; therefore, it filters out some of the 'noise' in a security's trading activity. I currently use a length of 14 (which is the default on Q- charts), while having the upper line set at 70 and the lower one at 30. Note: A shorter length will result in a more volatile indicator that reaches further extremes, while a longer amount of days used in the calculation results in a less volatile reading which reaches extremes far less often. Makes sense. Now lets look at the overbought (70) and oversold (30) ratings. As a blanket statement, I really don’t worry too much about a move above 70 or under 30, since I think that is all relative too. Some securities may pull back at a level of 67.5, others at 73, etc. Different securities seem to have slightly different levels at which the price changes direction. But they seem to be particular to each equity. When calculating RSI and using a length of 14, the following are the steps involved: Add the closing values for the up days and divide this total by 14. Add the closing values for the down days and divide this total by 14. Divide the up day average by the down day average. This results in the RS factor in the formula. Add 1 to the RS. Divide 100 by the number arrived at in step 4 above. Subtract the number arrived at in step 5 above from 100. Repeat steps 1-6 for day number 15. Drop day number 1 from the calculation. As enough days are accumulated, the results can be plotted in graphical format. There is also discussion that a move over or under 50 can give a security a slant towards either being bullish or bearish. This makes common sense, since a reading above 50 indicates that average gains are higher than average losses, while a reading below 50 indicates that losses are winning the battle. I look at the number 50 in the same light. Ok, time for an illustration. The contact in question is the Nasdaq 100 (NDX), and a weekly chart shows that the RSI oscillator is above all other RSI numbers seen during the last two years. Therefore, in order for a bearish divergence to take place, prices in the future would have to continue to rally and the RSI would have to fail to make a new high. If bearish (since this article is on divergences, we will assume only a bearish perspective), we still have some important information in front of us. The red horizontal line at 53.76 can become support going forward, and bears could state the case that a move under 53.76 would trigger long liquidation pressure. Chart of Nasdaq 100, Weekly A daily chart of the Nasdaq 100 Index clearly shows the divergence taking place. However, there was a divergence during Thursday’s opening, and selling the contract at 1081 would not be beneficial to one’s trading account. Therefore, all we can do now is note an area where the market might be susceptible to a fall. Does this mean to sell resistance? I wouldn’t recommend that course of action, since we need an area that bulls will get out and shorts have a clear shot at pressuring longs. The pivotal area appears to be at 1073. Not only would it be a failed wedge (since objective of 1173 not hit – see Futures Wrap column), but it also would have hedge funds sensing the opportunity to take on a bigger than normal position (based on my experiences with a few hedge funds). Chart of Nasdaq 100, Daily What about a 30-minute chart, in case a trader wanted to use the recognition of such a bearish divergence during the day? The chart below shows the divergence, and all a trader needs to do is wait for a new high and look at the RSI for lack of confirmation. Remember, put in a normal stop (10-points for NQ) and actively watch the trade unless a significant technical level is taken out (1073). Chart of Nasdaq-100, 30 minute Speaking of actively watching a trade, I would recommend looking at a five-minute chart for an exit. As far as today’s price action is concerned, the objective would be at 1106. When that did not materialize (most likely seen at 115), it would make sense to head to the sidelines and either look for another divergence in the morning or a breakdown in prices. As far as holding a position overnight, that is up to one’s risk tolerance. Personally, I might hold half a position because of the divergence in the daily; however, the other half would be taken off because the weekly chart is still relatively strong. Chart of Nasdaq 100, 5 minute Good luck. Questions are welcomed, John Seckinger jseckinger@OptionInvestor.com *********** OPTIONS 101 *********** Divergence (Again) Buzz Lynn buzz@OptionInvestor.com Please pass the crow. Some days we get it right. Some days we don't. Thanks God Options 101 is an education column and not "Mr. Market's Crystal Ball Minute", whose most obvious viewers would be soothsayers, witchdoctors, and a bucket of Wall Street analysts. Like Scott McNealy said a few years ago, "If they didn't see the cliff coming, how do they know we've hit bottom?" Good question. From last weeks column, you may recall that we spent a great deal of time going over what bearish divergence looks like on a chart and how it might be useful in determining future market direction. We determined that based on the divergence of price vs. oscillators in an overbought condition, the markets looked poised to roll over and die again. What a difference a week makes! The only saving grace was using the words, "possibility" and "probability" of a market reversal. The truth is that we never know for sure. And the last two days of action, especially today, proved that point. Not only did price action not decay, it took off to new recent highs today. And therein lies the practical lesson that no single indicator should be used to determine market direction let alone a single trade. As a side note before we get back to divergence - bullish divergence - today's market rally looked rather convincing in helping me change my temporary market bias (read that trading bias) to bullish for two reasons. First, volume was the highest we've seen on the NYSE since July 26th, a sell-off day back then. The same is true for NASDAQ stocks. High volume has typically happened on down days lately. But today marks a change in favor of the bulls. Second, many "pointy finger" charts, actually called "point and figure" charts, broke through their bearish resistance lines. While that can happen on any given day, it happened on large box sizes with the SPX and NDX. Institutions must have been slobbering all over themselves. And judging by the volume, they let their presence be known. Accumulation in strong hands appears to be taking place. That said, I am no market wizard. I've been wrong before and I'll be wrong again - maybe as early as tomorrow. It's when I've been the cockiest in any facet in life that I've also been one day away from getting knocked down a few notches. One thing a playground fight teaches the young, let alone what the market teaches adults who care to learn, is humility. Just when we think we've got it nailed, it nails us first. OK, back to bullish divergence. We promised that we would talk about it when we finally saw a chart that accurately reflected its presence. Well, as noted above, what a difference a week makes. Just when we had given up the retail sector or the NASDAQ for dead, we now see the slightest hint of bullishness. Admittedly, this is a weak example, but it's there, if only to the slightest degree. Again, do not use divergence as an isolated trigger for play entries. It is only a technical pattern that makes market direction change a little more probable. It is not a guaranty; just another arrow for the quiver. Shall we take a peek at a previous Limburger cheese of a security? Note the NASDAQ-100 as shown by the QQQ (AMEX:QQQ). NASDAQ-100 chart - QQQ (AMEX:QQQ): Remember that divergence happens when the slope of 2 lines - price and oscillator - diverge. Bearish divergence happens when oscillators are overbought (see 11-14-2002 Options 101). Bullish divergence happens when the oscillator is oversold. In bullish divergence, a lower price low is accompanied by a higher stochastic value, as in the chart above. But as we noted last week, the opposite can be true too. We could have a higher price low accompanied by a lower low stochastic value. Either way, it's bullish as long as the price and oscillator slopes oppose each other as the oscillator emerges from oversold. Granted, I took a little liberty with the chart above. Normally, I'd use two oscillators - a five and a ten period stochastic lookback. However, I only used a ten period lookback for the above example. Why? The five period lookback didn't show any divergence, which makes this a weak example of a potential bullish move. Similarly, I could have used the five period lookback on another chart to suit my purpose instead of the ten period. It too would be equally weak without confirmation by the other. But it does demonstrate what bullish divergence looks like on a chart, which is all we're after tonight. Note that since the divergence took place, there has been a nice bullish move in the QQQ. However, it is entering overbought again. Now is not the time to abandon good money management and squander thy whole wad on the QQQ. There is NEVER a time to abandon good money management for any play. Don't start now! OK, here's another example of bullish divergence, but requires an even further stretch of imagination. Again, focus on the pattern, not the actual sector. Retail Index - RLX (INDEX:RLX.X): See that? Once again, two opposing lines from an oversold oscillator signifying possible directional change. Is retail actually looking bullish? Only with an active imagination! Translation: Don't go open positions on the retail sector just because you saw the chart here tonight. Note that the only reason we see divergence here is because price action dipped to intraweek lows caused by a few mid-week hours or minutes of bearish market action. Using the wicks, we can make the argument for bullish divergence. However, using the candle bodies only, divergence does not exist. So why show it as an example? One - to demonstrate the chart pattern. Two - there is a never-ending debate among technicians (published authors on the subject included) as to what really constitutes a good data point. Some argue that wicks count. Some say only to acknowledge the candle body at the end of the time period. My personal preference is to use whatever fits with the other 100 sets of facts/indicators surrounding the trade. Talk about non-committal! Sometimes I include wicks, sometimes not, depending on many other market factors. It comes down to a matter of personal preference. In other words, art, not science. Well, if this business were any easier, everyone would do it. If it were any harder, no one would do it. Anyway, now we have another tool to help us determine the ultimate direction of which way we'll trade. We won't always be correct in our trading decisions, but divergence, especially strong divergence signals, can tilt the odds slightly in our favor. Until next time, make a great weekend for yourselves! Oh, and since next Thursday is Thanksgiving, be sure to give a few moments of thanks for all the abundance and blessings we still enjoy. It's a far cry from the harsh conditions encountered by those landing on Plymouth Rock over 350 years ago. And for that alone, I am thankful. 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