The Option Investor Newsletter Thursday 01-23-2003 Copyright 2003, All rights reserved. 1 of 3 Redistribution in any form strictly prohibited. In Section One: Wrap: Telecom Bounce, Telecom Drop Futures Markets: Will the Bounce Continue? Index Trader Wrap: Market Sentiment: Do Over Weekly Manager Microscope: Jeremy Hosking: Vanguard Global Equity (VHGEX) Updated on the site tonight: Swing Trader Game Plan: Playing the Bounce Posted online for subscribers at http://www.OptionInvestor.com ************************************************************ MARKET WRAP (view in courier font for table alignment) ************************************************************ 01-23-2003 High Low Volume Adv/Dcl DJIA 8369.47 + 50.70 8386.61 8255.86 2.01 bln 2033/1201 NASDAQ 1388.27 + 28.80 1388.27 1377.50 1.49 bln 1902/1399 S&P 100 450.70 + 5.03 452.34 445.27 Totals 3935/2590 S&P 500 887.34 + 8.98 890.25 876.89 W5000 8405.68 + 83.60 8429.05 8311.22 RUS 2000 383.71 + 3.18 384.39 380.22 DJ TRANS 2230.77 + 17.10 2236.56 2211.52 VIX 30.97 - 1.04 33.22 30.42 VXN 43.27 - 0.89 45.20 42.56 Total Volume 3,700B Total UpVol 2,693B Total DnVol 953M 52wk Highs 210 52wk Lows 126 TRIN 0.87 PUT/CALL .68 ************************************************************ Telecom Bounce, Telecom Drop The market was poised to open up this morning on the stronger than expected earnings news from QCOM, TXN and NOK. Just as the opening appeared to be a shuttle launch AT&T announced earnings that missed by a mile and the Telecom bounce turned into a retest of the Dow's December lows. Dow Chart – Daily Nasdaq Chart – Daily Adding to the negative earnings announcements before the open was news that Jobless Claims rose again last week. There was only a +18,000 gain to 381,000 but it showed that the holiday pause in the layoffs was over. Continuing claims also rose to 3,408,000 despite expiring benefits for many workers. Jobless claims should actually be dropping as employers hire workers to replace soldiers called up for Gulf duty. The pace of layoffs is still increasing with corporations announcing 426,000 layoffs in the 4Q compared to 269,000 in the 3Q. Nearly two million workers have now been out of work from 6 to 12 months. Helping hold up the market was the Leading Indicators which rose +0.1% to 111.3. This was the third consecutive monthly gain however slight. The gain today was the total gain for the last six months which indicates how fragile this recovery really is. The really significant news that shook the market was earnings related. AT&T shocked investors with a loss of -79 cents a share compared to a loss of -31 cents a year ago. Revenue is dropping fast and they said it would continue in 2003 but at a slower rate. The stock dropped from yesterday's close at $25.29 to $19.50 in early trading. This was a huge deficit for the Dow to overcome and AT&T kept it in the cellar most of the day. AT&T said it would no longer provide forward guidance and joined a growing group of companies who would rather release no news than bad news. Adding to the Dow problems was an earnings miss by another telecom, BellSouth. BLS missed earnings by a penny. The results by BLS and T knocked -$1.40 off Dow component SBC. Also hurting the Dow was the first ever quarterly loss by McDonalds. The company pulled out of three foreign markets and was closing 719 outlets. The loss included an -$810 million charge related to store closures. The current fast food price war as well as healthier eating habits are taking a bite out of the big Mac. They also lowered growth prospects going forward. CAT, another Dow component, beat estimates but lowered its outlook for 2003. They expect profits to drop -5% on flat revenue. KRB, a prime credit lender which operates at the opposite end of the spectrum from COF and PVN reported its first loss since 1993 due to higher charge offs and repossessions. We have been reporting for months that auto repossessions were soaring as much as 50% in some areas as unemployment made it tough to keep up those payments. KRB is feeling the heat. KRB said it may be forced to slow loan growth especially in its consumer division which makes home repair and college tuition loans. They said the economy and the market has been bad for so long that even the better credits are starting to "fray" around the edges. After the bell today AMZN reported earnings that beat the street's estimates by four cents. The stock traded down in after hours after comments about potential 2003 earnings. The company said it was going to keep the free shipping for orders over $25 as a permanent feature and they were going to lower prices across the board again. This was expected to raise revenues by as much as 30% for the year but reduce profits by -8%. Since this was only the second quarter ever that they made a profit analysts were disappointed and expressed concern that the business model was never going to work. You can't keep raising costs and reducing prices forever to capture customers. Eventually you have to make a profit to keep the doors open. I had a lot of email about my editors play on AMZN last Sunday. Evidently many other investors felt the same way. KLAC also reported earnings that beat the street by a penny and said current orders were "roughly" the same as the last quarter. Analysts are currently forecasting a -9% drop in the current quarter. BRCM posted a 4Q loss of about -$2 billion including charges for prior acquisitions and the CEO resigned. Without charges the loss amounted to -2 cents a share and inline with analyst's estimates. They said they expected to post a penny profit in the current quarter. Needless to say these two earnings reports are not going to energize the chip sector tomorrow. The SOX has tried unsuccessfully for three days to break above 300 again. Thursday was a big earnings day with 10% of the S&P reporting. 206 S&P companies have now confessed and the guidance is shaping up like this. 40% of companies are giving guidance inline with estimates, which is not really exciting. 20% have raised guidance for the current quarter. Here is the kicker, 40% have warned going forward. That 2:1 warn:raise guidance is very disturbing. Analyst estimates for 2003 are dropping fast. On Oct 1st analysts were expecting +17.4% earnings growth for 2003. On January 1st it had dropped to only +11.7% for the year. As of today the estimates have dropped into the single digits at +9.8% for the year. This means that the end of year rally on +17% earnings growth expectations is very overdone at +9.8% and dropping. The war update for the day came in the form of another "running out of time" speech by Colin Powell. The emphasis was on "if we decide to act we will act with or without the UN or willing partners." Sounds like a warning that next week the war will be announced regardless of the UN report. Hans Bliz also got some more face time with news of Iraq road blocks to the inspectors including things like refusing to let the helicopters take off once the destination was known. Iraq police dressing up as scientists and posing for interviews and acknowledgement from several sources that Saddam has promised to kill any scientist who talks to inspectors and his family. Whether you believe these reports or not the rhetoric is increasing and we all know what the end result will be. Late this afternoon there was news out of Korea that they would work toward diplomatic resolution of the nuclear problem. The market spiked up slightly, just enough to stop me out of a short signal on the futures monitor, then it sold off again. The headline caught attention but the reality was that nothing changed. South Korea is simply trying to keep North Korea and the U.S. from starting a fight that would involve the South. The Dow gained +50 points! Cheers and backslapping was could be seen on the trading floor. You would have thought the new bull market had begun. In reality all we got was a wimpy bounce after a retest of the December lows. We got a +50 point rebound after a five day -600 point drop. Am I being too bearish? My thought process after a -600 point drop to major support is a V bottom rocket on heavy volume, IF it is really the bottom. Instead we stopped well below yesterday's resistance on the Dow and the Nasdaq rolled over right on schedule at 1391 again. The Dow dropped to 8255, only +13 points above the December lows and the last major line on the chart before a potential retest of the October lows at 7197. Yes, 7197. Very few traders actually expect it to drop that far but should 8242 fail it could be a quick trip. Do not discount this possibility because it is very real. Maybe not 7197 but somewhere below 8242 is a chart point waiting for us. Tomorrow has no major economic reports. The markets will be left to react to earnings from a reduced slate of 35 companies, most of which I have never heard of. There will be the required smattering of IRAQ news and posturing for next weeks events. I don't see it as being a wildly bullish day. Dow gains, if any are likely to stop at 8425 and Nasdaq gains at 1400. Many traders will probably decide to go flat for the weekend with the UN report on Monday, State of the Union on Tuesday and a two day FOMC meeting ending on Wednesday. Keep your seatbelt fastened. There could be some bumps ahead. Enter Very Passively, Exit Very Aggressively! Jim Brown Editor *************** FUTURES MARKETS *************** Will the Bounce Continue? By John Seckinger jseckinger@OptionInvestor.com Are bears going to start sharpening their claws, or does Thursday's rebound portend aggressive behavior from bullish traders during Friday's session? There is definitely a lot of levels lining up concerning both camps' viewpoint. Thursday, January 23rd at 4:15 P.M. Contract Last Net Change High Low Volume Dow Jones 8369.47 +50.74 8386.61 8255.86 YM03H 8325.00 +25.00 8375.00 8239.00 29,332 Nasdaq-100 1032.67 +26.16 1038.49 1011.12 NQ03H 1026.50 +22.00 1041.00 1011.50 271,118 S&P 500 887.34 +8.98 890.25 876.89 ES03H 883.00 +5.50 889.75 875.50 689,943 Contract S2 S1 Pivot R1 R2 Dow Jones 8206.56 8288.01 8337.31 8418.76 8468.06 YM03H 8177.00 8251.00 8313.00 8387.00 8449.00 Nasdaq-100 1000.06 1016.37 1027.43 1043.74 1054.80 NQ03H 996.75 1011.75 1026.25 1041.25 1055.75 S&P 500 871.47 879.41 884.83 892.77 898.19 ES03H 868.50 875.75 882.75 890.00 897.00 Weekly Levels Contract S2 S1 Pivot R1 R2 YM03H 8336.00 8459.00 8662.00 8785.00 8988.00 NQ03H 958.25 989.25 1048.75 1079.50 1139.25 ES03H 873.25 888.25 912.50 927.50 951.75 Monthly Levels (December's High, Low, and Close) Contract S2 S1 Pivot R1 R2 YM03H 7726.00 8028.00 8524.00 8826.00 9322.00 NQ03H 861.75 924.25 1041.75 1104.25 1221.75 ES03H 814.75 846.75 900.25 932.50 985.75 YM03H = E-mini Dow $5 futures NQ03H = E-mini NDX 100 futures ES03H = E-mini SP500 futures ================================================================= Note: The 03H suffix stands for 2003, March, 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. ================================================================= Before we begin, let us take a look at Jim Brown's day in the Futures Monitor. Recapping his signals: Short 885.00, exit 883.00, gain +2.00 Short 882.00, exit 878.00, gain +4.00 Short 879.00, exit 880.50, loss -1.50 Short 878.50, exit 880.50, loss -2.00 Short 884.00, exit 886.50, loss -2.50 Short 888.00, exit 889.50, loss -1.50 Total for the Day = -1.50 points Total for the Week = +13.25 points (Every point equals $50) For more information on Jim's posts for Tuesday, please go to the following link and download the current market monitor. If you already have the most recent version, simply go to the Futures Monitor Post on the upper left hand portion of the applet. http://www.OptionInvestor.com/itrader/marketbuzz/download.asp The March E-mini S&P 500 Contract (ES03H) The ES contract opened above the 881.75 pivot, but it wasn't long before weakness took the contract towards Wednesday's low of 876. I would have liked Wednesday's S1 level of 871.75 to be tested; however, that was not to be. At 13:10, the ES contract closed back above the 881.75 pivot (five-minute chart) and then never closed back underneath during this timeframe. R1 at 887.50 was tested, but, as Jim pointed out, the Korean news managed to move the contract a little too much before falling back towards the pivot as the session ended. Going forward, I don't want to scare anyone with all the retracement levels listed below; however, there is a pretty solid band from 881.25 to 884.50 I wanted to note. Moreover, Friday's pivot comes in at 882.75 and within that range. Therefore, weakness on Friday below the pivot and underneath this range could really start to force longs to liquidate. If the ES contract does happen to find a bid, the areas above that should pose a problem is from 888.25 to 890 (Weekly S1 to Daily R1), and then from 899 to 903.25 (a variety of moving averages converging, as well as the monthly pivot at 900.25). Moreover, as noted in the chart below, a few retracement areas cover the range from 900 to 902.50; further strengthening this area. Chart of ES03H, Daily We did not get a settlement above 888.25; therefore, sentiment, in my opinion, is still slightly bearish. 'Slightly bearish' only because Thursday's settlement is above Friday's pivot. Looking at the 15-minute chart below, notice how the range is very similar to Thursday's levels. The contract did move outside its Regression Channel, and that also might be getting a bear slightly nervous. Since the ES contract is just above the solid area of 881.25 to 884.50, I will look for either a move to R2 and then possibly towards 900 (with R1 acting as support), or, on the other hand, weakness under the pivot and 881.25, with an objective of near 870. Chart of ES Contract, 15-minute Bullish Percent of SPX: 56.11% and still in column of O’s (Recent High at 66%, Low of current column at 58%). On Thursday, the Bullish Percent fell 1.0% and 56% was not reached. Therefore, we were not allowed to add an "O" to the chart. Nevertheless, at 56.11%, I think shorts can be aggressive on weakness and trade a larger size than normal. Risk still remains on the buy side. The March E-mini Nasdaq 100 Contract (NQ03H) Amazingly, the low was 1011.50 and came 0.50 from hitting the daily pivot. Therefore, bears really didn't have a reason to get aggressive. Concerning the move upwards, there was a bid from 1024 to the 1040-48 area, testing noted solid resistance. We now have the monthly pivot, weekly pivot, Friday R1, and mid-point of the shown Regression Channel all in that area of 1040 to 1048. Therefore, this area should continue to be protected by bears on Friday. If weakness does take hold, look once again for an extended move lower if the pivot (1026.25) is taken out. More conservative traders can certainly use the 1023.50 area. The objective will be for a move back to 1011 (which is now S1 for Friday). Chart of NQ03H, Daily Looking at a 60-minute chart of the NQ contract, I am sure traders are wondering above a move back to 1060 - which would close the gap. However, that is going to take a lot of energy from bullish traders. Even R2 on Friday only comes in at 1055.75, and I would be surprised if this area is reached. If the NQ contract CLOSES above the 1048 area on Friday, then I am sure 1060 will become a more practical area to look at. On the other hand, a close underneath the 1011 level should have bears sharpening their claws. If the session ends up being relatively quiet, please use the retracement area between R2 and S2. Chart of NQ03H, 60-minute Bullish Percent for NDX: This indicator fell 2% to 57% and added another "0" on Thursday. Therefore, the last column of O's (from 80 to 60%) is now history. This further indicates that bears will most likely sell rallies going forward. The March Mini-sized Dow Contract (YM03H) The YM contract on Thursday did rise to the 8357-8373 area (intra-day high was 8375), and selling pressure due to the 19.1% retracement area (shown below) capped bulls' hopes. The settlement at 8325 is above Friday's pivot of 8313, but below the S2 of 8336 for the week. I will wait until the pivot is cleared before getting bearish, and then we might (hopefully) get a test of the elusive December 31st low of 8221. I was surprised it was not hit on Thursday. The upside is a little harder to read, but I do expect strong resistance from R2 (8449) to 8459 (weekly S1 reading). Note that the monthly pivot is at 8524 and basically at the 38.2% retracement of the decline in December. Aggressive bulls could look for a move from 8459 to 8525, but that might require holding over the weekend. A close under the 8220 area should have intermediate bearish implications. Chart of YM03H, 60-minute Bullish Percent of Dow Jones: 43.33% and in column of O’s. The Bullish Percent indicator lost another 10% on Thursday, and clearly still has intermediate bearish implications. It does indicate that bears will look to sell rallies and be aggressive on weakness as well. 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/012303_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 **************** Do Over by Steven Price We got yet another look at the support level between Dow 8200 and 8300 that we tested as we closed out 2002. One of the big reasons for that support test was the earnings release from AT&T, which almost doubled the expected losses for the fourth quarter. The company recorded a loss of $0.79, versus expected and expected loss of $0.40. Those results were followed by a downgrade from JP Morgan, which cited the company's poor outlook for 2003. On the flip side, Goldman Sachs upgraded the stock. That upgrade, however, did little to soothe investors that hammered the stock, which lost $4.83 on the day. The other big loser in the Dow, albeit to a smaller extent, was SBC Communications, which fell in sympathy with AT&T. This morning's economic data was slightly better than expected, with a rise in weekly jobless claims to 381,000 coming in just below expectations of 383,000. The index of leading economic indicators rose a slightly better than expected 0.1%, versus expectations for a flat reading. There were also gains in eight of the ten components, although the two negatives were big ones for the markets: unemployment claims and stock prices. The techs actually saw green, with the COMP adding 28.79 points and the NDX adding 26.16. The COMP has fallen into the congestion point that held it through much of December between 1350 and 1400, prior to the sell-off of the last two days of 2002. There were several large tech stock upgrades, including EMC, Symantec (SYMC), Siebel Systems (SEBL) and PeopleSoft (PSFT), which contributed to the rally. After a drop of over 500 points in the Dow over the last five days, some bounce could be expected. However, as we continue to set lower intraday lows, the head and shoulders pattern that has appeared over the last several months gets closer to its neckline down at Dow 8200. The question will likely be just how high the bounce can take us. If we continue to find support in the 8200- 8300 range, with a top at around 8800, maybe we are simply seeing a range bound market, rather than a bearish head and shoulders pattern. However, if we do crack the neckline, which is really more of an approximation depending on how it's drawn, the measuring objective of the pattern will be somewhere around Dow 7500, where it can find support at the July sell-off low of 7532. Most of the Dow stocks finished in the green, and the index shook off the AT&T results to finish up 50 points on the day. Part of the reason for a late day surge came from an announcement that North and South Korea had agreed to hold cabinet level talks to resolve the issue of North Korea's nuclear weapons program. Any rally has several factors working against it, which can be seen on the point and figure charts. First of all, the Dow and SPX have both sunk far enough below their sell signals, which came at 8550 and 905, to break through their bullish support lines at 885 and 8,400. The OEX has not yet broken through its bullish support, but sits right on top of it at 447.50. Today's rebound was certainly a positive sign, but not so strong as to reverse these charts into bullish columns of "X." After flipping into columns of "O" at 8800 and 930, a bounce that cannot establish at least a minor reversal is most likely insignificant. Another factor on the point and figure charts is the bullish percent. The bullish percent in the Dow has reversed down after the rebound to 8800 failed and now sits in a column of "O" at 54%. The SPX bullish percent looks similar, with a reversal down to 58%. With plenty of room to fall until the bullish percents reach oversold territory below 30%, there is little to stop the fall, given most of the recent bearish responses to even positive earnings results. Most comments accompanying recent earnings have been cautious for 2003 and are holding far more weight than upside surprises for the final quarter of 2002. If we get a sustained rally, which looks doubtful, traders can look to see where it runs out of gas. A failed rally below recent resistance at Dow 8600/SPX 910/COMP 1400 may simply be another shorting opportunity. Until we get a breakout above or below the Dow 8200-8900 range that has held us for most of the past three months, we may simply be restricted to picking our entry and exit points within that range. It can still make for some nice swings within that range, but entering at midpoints should be done carefully with position sizes that reflect the possibility of whipsaws. For now the overall trend is down. With no economic data due out on Friday, the market will be left to digest earnings reports from Amazon, which beat estimates, but gave mixed guidance going forward. Other companies that beat forecasts include KLA-Tencor (KLAC), Microchip (MCHP) and Nortel (NT). NT also warned that first quarter 2003 revenues would be lower than fourth quarter 2002. There are several earnings reports coming out tomorrow as well, but tonight's releases are likely to set the tone. ----------------------------------------------------------------- Market Averages DJIA ($INDU) 52-week High: 10673 52-week Low : 7197 Current : 8369 Moving Averages: (Simple) 10-dma: 8648 50-dma: 8593 200-dma: 8876 S&P 500 ($SPX) 52-week High: 1176 52-week Low : 768 Current : 887 Moving Averages: (Simple) 10-dma: 910 50-dma: 906 200-dma: 942 Nasdaq-100 ($NDX) 52-week High: 1734 52-week Low : 795 Current : 1033 Moving Averages: (Simple) 10-dma: 1054 50-dma: 1048 200-dma: 1049 ----------------------------------------------------------------- The Semiconductor Index (SOX): The chip stocks rallied along with the rest of the techs today, but fell short of resistance in the SOX at 300. After the bell, MCHP beat earnings forecasts and provided guidance for this quarter roughly in-line with expectations. AMCC also matched expectations. VSEA predicted a much more profitable quarter than expected, saying it would earn $0.10-$0.20 per share, versus expectations of a loss of $0.01. KLAC, however, gave mixed guidance, saying net orders this quarter would be flat, but overall 2003 spending on chip equipment should be up by about 10%. That's an awful lot of data for traders top sort through and they can watch the 300 resistance level for an indication of just how well the market reacts. The SOX has failed at 301 on 2 of the last 3 days and tomorrow should give us a better overall picture of whether 300 is our new ceiling in the sector. 52-week High: 397 52-week Low : 260 Current : 328 Moving Averages: (Simple) 21-dma: 318 50-dma: 308 200-dma: 331 ----------------------------------------------------------------- Market Volatility The VIX finally settled down with today's overall market bounce. It did, however, find support above 30, indicating that downside fear is still alive and well. It traded as high as 33.22, eventually failing the converging 200-dma and exp 100-dma, which come in just below 33. The exp 100-dma has capped the last three VIX rallies, as well, although at the time it was closer to 35. Look for a move under 30 to confirm renewed bullishness, but given a one-day rally, following a five-day sell-off, that may not happen. CBOE Market Volatility Index (VIX) = 30.97 –1.04 Nasdaq-100 Volatility Index (VXN) = 43.27 –0.89 ----------------------------------------------------------------- Put/Call Ratio Call Volume Put Volume Total 0.68 581,729 398,007 Equity Only 0.58 459,019 265,191 OEX 0.63 17,692 11,119 QQQ 1.86 21,872 40,698 ----------------------------------------------------------------- Bullish Percent Data Current Change Status NYSE 50.4 - 2 Bull Confirmed NASDAQ-100 57.0 - 4 Bull Confirmed Dow Indust. 43.3 -17 Bear Confirmed S&P 500 56.4 - 5 Bull Correction S&P 100 54.0 - 7 Bull Correction Bullish percent measures the number of stocks in an index currently trading on a buy signal on their point and figure chart. Readings above 70 are considered overbought, and readings below 30 are considered oversold. Bull Confirmed - Aggressively long Bull Alert - Cautiously long Bull Correction - Pause or pullback in upward trend Bear Alert - Take defensive action if long Bear Confirmed - High risk if long, good conditions for shorting Bear Correction - Pause or rebound in downtrend ----------------------------------------------------------------- 5-Day Arms Index 1.56 10-Day Arms Index 1.25 21-Day Arms Index 1.32 55-Day Arms Index 1.27 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 1800 1068 NASDAQ 1829 2390 New Highs New Lows NYSE 89 51 NASDAQ 76 44 Volume (in millions) NYSE 2,033 NASDAQ 1,537 ----------------------------------------------------------------- Commitments Of Traders Report: 01/14/02 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 left positions mostly unchanged with a small reduction to the short side. Small traders reduced the long side by 1,000 contracts, while adding 9,000 contracts to the short side. Commercials Long Short Net % Of OI 12/23/02 408,592 467,259 (58,667) (6.7%) 12/31/02 410,968 462,782 (51,814) (5.9%) 01/07/03 411,542 455,538 (43,996) (5.1%) 01/14/03 411,052 453,164 (42,112) (4.9%) Most bearish reading of the year: (111,956) - 3/6/02 Most bullish reading of the year: ( 16,472) - 10/01/02 Small Traders Long Short Net % of OI 12/23/02 138,756 58,236 80,520 40.9% 12/31/02 139,383 75,640 63,743 30.0% 01/07/03 143,169 83,895 59,274 26.1% 01/14/03 144,182 92,358 51,824 21.9% 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 added slightly to the long side, while reducing short positions by 3,000 contracts. Small traders added 1,000 to the long side and left shorts virtually unchanged. Commercials Long Short Net % of OI 12/23/02 32,067 44,451 (12,384) (16.2%) 12/31/02 31,399 44,387 (12,988) (17.1%) 01/07/03 37,966 48,156 (10,190) (11.8%) 01/14/03 38,057 45,060 ( 7,003) ( 8.4%) 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 12/23/02 17,009 5,865 11,144 49.0% 12/31/02 19,841 5,009 14,832 60.1% 01/07/03 19,708 8,453 11,255 40.1% 01/14/03 20,757 8,320 12,437 42.8% Most bearish reading of the year: (10,769) - 06/11/02 Most bullish reading of the year: 14,832 - 12/31/02 DOW JONES INDUSTRIAL Commercials added slightly to both sides, with a net 500 contract ncrease on the long side. Small traders reduced long and short positions slightly. Commercials Long Short Net % of OI 12/23/02 14,991 11,103 3,888 14.9% 12/31/02 15,940 11,253 4,687 17.2% 01/07/03 16,210 11,333 4,877 17.7% 01/14/03 17,804 12,427 5,377 17.8% 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 12/23/02 4,584 6,296 (1,712) (15.7%) 12/31/02 4,997 6,553 (1,556) (13.5%) 01/07/03 4,963 8,334 (3,371) (25.4%) 01/14/03 4,552 7,697 (3,145) (25.7%) 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 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 ************************************************************** ************************* WEEKLY MANAGER MICROSCOPE ************************* Jeremy Hosking: Vanguard Global Equity (VHGEX) Investors seeking maximum long-term growth of capital plus broad diversification across global markets have a fine choice here in the Vanguard Global Equity Fund (VHGEX) subadvised by Mr. Jeremy Hosking of Marathon Asset Management Ltd. of London. Hosking is a seasoned investment professional, getting his investment start in 1981. Hosking holds an M.A. Degree from Cambridge University. In 1986, Mr. Hosking joined Marathon Asset Management in London, and today serves as Director of Investments in the Americas and Southeast Asia at Marathon. Between 1979 and 1986, Mr. Hosking was a director and portfolio manager with GT Capital Management, where he specialized in Southeast Asian investments. Hosking/Marathon Asset Management has served as the sub-advisor to the Vanguard Global Equity Fund since its inception in 1995. Marathon receives a fee for its services. At 1.08%, the fund's total expense ratio is significantly below the Morningstar fund average of 1.86% for all world stock funds. Even when Vanguard uses investment sub-advisors, fund management fees and expenses are generally lower than similar funds, adding to their appeal. The Vanguard website (www.vanguard.com) states that the Global Equity fund may not be suitable for investors who are unwilling to accept significant fluctuations in share price or that seek significant dividend income. This fund seeks long-term capital growth as its prime objective; income is a secondary objective. Investment Style/Strategy The London office of Marathon Asset Management where Hosking is situated uses a blend of qualitative, non-consensus disciplines to construct diversified portfolios which exhibit a core market, dynamic value bias. The firm applies its approach to different international, global and regional mandates, including the fund management of the Vanguard Global Equity Fund. In pursuit of the fund's long-term growth of capital objective, Hosking will invest in stocks from the U.S. and other countries, selecting those that appear to be undervalued based on analyses of industry sectors and individual companies. Hosking may look at such things as management's strategies are for new investment or for dealing with competition when evaluating companies. The fund is widely diversified across nations, industry sectors and individual companies. According to Morningstar, the Vanguard Global Equity Fund had 95% of assets invested in stocks at September 30, 2002, with 61.5% of assets invested in foreign stocks. True to its mandate, the fund is well diversified across regions, with 41.2% of assets invested in North America, 28.6% in the U.K. and Western Europe, and 26.5% in Japan and Asia, per Morningstar. At September 30, 2002, there were 317 stock holdings, with only 10% of fund assets represented by its top 10 holdings. Hosking's broad diversification helps to preserve capital. In terms of style, Hosking holds growth stocks, characterized by relatively high price valuations and value stocks, characterized by relatively low price valuations. Accordingly, the fund falls into the blend style box per Morningstar. Overall, the fund had a mid-cap bias at September 30, 2002, with 46% of assets held in the mid-cap sector. Almost one third was invested in large-caps. In addition to investing in the cash markets, Hosking can invest in stock futures and options contracts, and swap agreements. He may also use forward currency exchange contracts to protect fund investments from price declines caused by changes in FX exchange rates. The website notes the fund doesn't expect to commit more than 20% of its assets to such contracts. Investment Performance In comparison to his world stock category peers, Mr. Hosking has produced high total returns over the past three years, with just average relative risk, per Morningstar, earning it a Morningstar highest 5-star rating for risk-adjusted performance. The fund's also Morningstar 5-star rated for trailing 5-year performance on the basis of above average return and average risk when compared to other global stock funds. Below is a performance summary for the Vanguard Global Equity Fund (VHGEX) using Morningstar's data through Wednesday, January 22, 2003. Trailing 1-Year Total Return: - 3.0% Vanguard Global Equity Fund (VHGEX) 2nd Percentile -18.1% Morningstar World Stock Fund Average Trailing 3-Year Annualized Total Return: - 3.3% Vanguard Global Equity Fund (VHGEX) 7th Percentile -15.7% Morningstar World Stock Fund Average Trailing 5-Year Annualized Total Return: + 4.4% Vanguard Global Equity Fund (VHGEX) 8th Percentile - 1.5% Morningstar World Stock Fund Average You can see the superior performance that Hosking and Marathon Asset Management have delivered for investors on an annualized basis during the trailing 3- and 5-year periods, with the fund ranking in the top decile of the Morningstar global stock fund category. It sports a positive annualized total return of 4.4 percent in the last five years versus an annualized loss of 1.5 percent for the Morningstar world stock fund average, so credit is due here. Lipper Analytical Services also recognizes the job that Hosking has done in good and bad times too, giving the fund its highest ratings for Total Return, Preservation and Expense and an above average rating for Consistent Return. At 16%, the fund's average standard deviation (volatility) over the past three years, per Morningstar, is comparable to the 17% category average. So Hosking has outpaced his world stock fund peers by a wide margin while not exceeding the category average for risk (volatility), producing a superior reward/risk tradeoff for investors. Conclusion Hosking's buy-and-hold approach results in low turnover and low expense, which in turn helps to boost fund performance relative to other world stock funds. Low turnover funds also have lower capital gains distributions in general, adding to their overall appeal in regular accounts. Maintaining a diversified portfolio, combining value and growth, and investing across capital sectors are a few of the ways that Hosking and Marathon Asset Management go about controlling risk. Futures, options and swaps are other tools that are used in the management of portfolio risk. The result is a well-disciplined approach that has succeeded in producing maximum capital growth over longer periods of time relative to similar funds. For more information or to D/L a prospectus, go to the Vanguard website at www.vanguard.com. Steve Wagner Editor, Mutual Investor firstname.lastname@example.org ************************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 ************************************************************** *********************** SWING TRADER GAME PLANS *********************** Playing the Bounce After a day on the sidelines, I came back to see the Dow right back above the support line between 8200 and 8300 that we last tested in late December. 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. You may also fax the information to: 303-797-1333 ********** DISCLAIMER ********** Please read our disclaimer at: http://www.OptionInvestor.com/page/oin/aboutus/disclaimer.html ************************************************************** ADVERTISING INFORMATION For more information on advertising in OptionInvestor Newsletter, or any Premier Investor Network newsletter please contact: Contact Support
The Option Investor Newsletter Thursday 01-23-2003 Copyright 2003, All rights reserved. 2 of 3 Redistribution in any form strictly prohibited. In Section Two: Dropped Calls: RJR Dropped Puts: ERTS Daily Results Call Play Updates: CI, OCR New Calls Plays: FRX, SYMC Put Play Updates: CTAS, ASD, CTSH, KSS New Put Plays: None **************** PICKS WE DROPPED **************** When we drop a pick it doesn't mean we are recommending a sell on that play. Many dropped picks go on to be very profitable. We drop a pick because something happened to change its profile. News, price, direction, etc. We drop it because we don't want anyone else starting a new play at that time. We have hundreds of new readers with each issue who are unfamiliar with the previous history for that pick and we want them to look at any current pick as a valid play. CALLS: ***** RJR $44.37 (-2.56 for the week) RJR bucked the sinking market trend for a while. In fact, after breaking resistance at $45, it soared to new relative highs as the Dow continued to add red candles. The overall selling of the last three days eventually caught up to it, however, and today it broke that $45 level, in spite of the Dow rally. Fellow tobacco companies Phillip Morris and also suffered big drop-offs and the industry slide has us worried. With $45 failing to act as support, after acting as previous resistance, we are going to let this one go. However, if the stock manages to break back above $45, more aggressive traders can give it another shot. Our current stop was $42.50, but given the sector weakness, an alternative would be $43.50, just below the 21-dma, for those traders hanging onto the calls. PUTS: ***** ERTS $50.90 +1.37 (+2.94 for the week) There wasn't much conviction behind ERTS' latest rebound from multi-year lows. Tuesday's bullish brokerage comments propelled shares back to $50.00. However, the stock was unable to close above this level of psychological resistance. This continued to be the case on Wednesday as shares moved above $50.00 on an intraday basis before finishing with a loss. ERTS looked like it was going to duplicate that feat today when without warning shares suddenly went vertical about a half-hour before the closing bell. We didn't see any news to explain this rapid ascent. In any case, Electronic Arts has confirmed their January 29th earnings release date. This gives us a maximum of four trading days to play the stock before the company announces. Since we were never triggered, we're simply going to remove our action point and close the play. And while wouldn't be surprised to see shares roll over from the 21-dma ($50.81), the powerful late-day rally should definitely have bears concerned. *********************************************************** DAILY RESULTS *********************************************************** Please view this in COURIER 10 font for alignment ************************************************* CALLS Mon Tue Wed Thu Week CI 44.86 0.00 -1.06 -1.03 0.62 Holding CTAS 42.71 0.00 -0.63 -0.07 0.14 weak bounce FRX 52.87 0.00 -1.39 0.08 1.01 New, better entry OCR 26.01 0.00 -0.34 0.00 0.11 holding over $26 RJR 44.37 0.00 -0.38 -1.35 –0.84 Drop, weak sector SYMC 45.99 0.00 -0.86 0.05 0.44 New, bounce from $45 PUTS ASD 66.32 0.00 -0.80 -1.20 1.42 under resistance CTSH 58.70 0.00 -0.97 -0.83 0.48 mild bounce ERTS 50.89 0.00 1.72 -0.16 1.37 Drop, Over $50 GS 71.92 0.00 -1.58 -0.76 1.67 Drop, sector strong KSS 55.25 0.00 -2.30 -0.75 1.74 need $55 failure ************************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 ******************** CI $44.86 +0.62 (-1.37 for the week) On Wednesday the weakening broader market dragged CI below $45.00. We'd been looking for shares to find support at this level (which formerly acted as resistance), but the bulls were simply unable to counteract a steady downtrend in the Dow Jones and $IUX.X insurance index. The inverse was true on Thursday. Cigna managed a solid 1.4% gain and easily outpaced both aforementioned indices. Shares spiked above $45.00 during the final hour of trading and closed slightly under that level. Overall this action is somewhat encouraging for the bulls. On Friday we'll be watching for CI to break out of today's Inside Day pattern and rise above yesterday's high of $45.18. Such a move would clear the way for a possible test of the relative highs near $46.75. On the other hand, a breakdown out of today's Inside Day formation would be a clearly bearish technical development. With this in mind, very conservative traders may want to place their stops slightly under yesterday's low of $44.15. --- OCR $26.01 +0.11 (-0.29) While it certainly hasn't provided much excitement this week, our OCR play has one distinct advantage, in that it has refused to participate in the broad market weakness. A brief dip down to the 10-dma (then at $25.30) provided the only decent entry point we've seen this week, but it is encouraging to see how resilient the stock has been at holding support. The $26 level has served as a price magnet over the past couple days, as the stock continues to consolidate it's recent gains on declining volume. Recall that the 10-dma (now at $25.57) has provided support throughout the month of January and should continue to do so, making another successful test of that support level a solid entry point ahead of the expected breakout over the recent highs. Traders that would prefer to wait for that breakout before playing will want to see a volume-backed move through $26.75 to trigger new entries. Until OCR breaks out, we're keeping our stop set at $25. ************** NEW CALL PLAYS ************** FRX - Forest Labs $52.87 +1.01 (+0.68 for the week) Company Description: Forest Laboratories develops, manufactures, and sells ethical pharmaceutical products that are used for the treatment of a wide range of illnesses. Forest Laboratories' growing line of products includes: Lexapro(TM), indicated as initial as well as maintenance treatment of major depressive disorder; Celexa(TM), an antidepressant; Tiazac®, a once-daily diltiazem, indicated for the treatment of angina and hypertension; Benicar(TM)*, an angiotensin receptor blocker indicated for the treatment of hypertension; and Aerobid®, an inhaled steroid indicated for the treatment of asthma. (source: company press release) Why We Like It: It seems like forever since we listed FRX back at $98 for a nice gain. The stock has been all over the board since then, eventually splitting. Now that the post-split decline has taken place, we think FRX will resume its winning ways. On Thursday FRX spiked lower and moved below its 21-day and 50- day moving averages. Shares also violated a trend of higher lows dating back to December. The powerful rebound from these various support levels is a very encouraging technical development. Bulls can also be pleased with the daily stochastics (5,3,3), which are just beginning to rise from oversold levels. Similar stochastic reversals have offered reliable buy signals in recent months. Investors might also be buying the stock in anticipation of good news related to one of Forest Labs' experimental drugs. On December 20th Forest Labs submitted to the FDA an application for Memantine, an investigational Alzheimer's treatment. The government agency has 60 days from that date to decide whether it will accept the filing for review. Memantine holds a lot of promise for FRX because it's the only drug that's shown positive Phase III results in the treatment of moderate-to-severe Alzheimer's disease. With thousands of people suffering from the disease, it's possible that the FDA could grant "fast-track" status to Memantine in order to get the drug to market as quickly as possible. Actual approval of Memantine might not occur for several months, but we suspect that investors would react positively to news that the drug is up for review. Our strategy for playing FRX is as follows: We'll activate this play if shares move above today's high of $53.00. If the play is triggered we'll use a stop at $49.74, slightly under the bottom of the January 3rd gap. Our initial upside target will be the $60.00 area. Shorter-term traders may want to aim for the all-time highs near $56.00. Given enough time, we think shares will eventually move above this level. BUY CALL FEB-50*FHA-BJ OI= 1044 at $4.30 SL=2.15 BUY CALL FEB-52.50 FHA-BX OI= 1526 at $2.40 SL=1.20 BUY CALL MAR-50 FHA-CJ OI= N/A at $4.90 SL=2.45 BUY CALL MAR-55 FHA-CK OI= 258 at $2.00 SL=1.00 Average Daily Volume = 3.51 MIL --- SYMC – Symantec Corp. $45.99 +0.44 (+0.94 this week) Company Summary: A world leader in Internet security technology, SYMC provides a broad range of content and network security solutions to individuals and enterprises. The company is a leading provider of virus protection, risk management, Internet content and e-mail filtering, remote management and mobile code detection technologies. The desktop battleground is where SYMC derives nearly 60% of its sales. Duking it out with Network Associates in this arena, the company is best known for its security software (Norton AntiVirus), desktop efficiency (Norton CleanSweep), and PC utility (Norton Ghost) products. Why We Like It: While most areas of Technology spending have been cut back drastically over the past couple years, there's one area that continues to find strong demand: Security. Not only is physical security important, but in this increasingly-wired world, computer and Internet security is increasingly critical. SYMC is continuing to establish its leadership position in this arena, as demonstrated by both their recent stock price performance, as well as last week's impressive earnings report. Topping EPS estimates by 8 cents on better than expected revenues was a good start, but then the company guided above consensus for the next quarter and the full year. While the initial response in the market was to sell the news, there wasn't much downside, as the stock found solid footing at the $45 level, a level that has continued to provide support all week. Adding more fuel for the bulls today, Janney upgraded the firm to Buy, along with an increased price target of $56. The market has been rewarding SYMC for its outperformance for awhile now, with the stock showing a gain for 2002 and currently up 13% for 2003 already. As long as computer and Internet security remains a top priority, SYMC ought to see demand for its products and the subsequent profits continue to rise. The PnF chart certainly bears that out with another Buy signal generated on the post-earnings surge to the $48 level, and a bullish price target of $67. If the market is going to put together a rally from current levels, it seems a safe bet that SYMC will lead that rise. With the post-earnings selling out of the way, the stock ought to continue to find support near the $45 level, with further support found at the 20-dma ($44.47), and a rebound in that area should make for a favorable entry point. Due to the congestion between the current price and the post-earnings high at $48.30, aggressive momentum traders will need to wait for a volume-backed move through the $48.50 level before playing. Our stop is initially set at $43, just below the 50-dma. BUY CALL FEB-45*SYQ-BI OI=3217 at $2.70 SL=1.25 BUY CALL FEB-50 SYQ-BJ OI=3055 at $0.65 SL=0.25 BUY CALL APR-45 SYQ-DI OI=3938 at $4.70 SL=2.75 BUY CALL APR-50 SYQ-DJ OI=2632 at $2.30 SL=1.25 Average Daily Volume = 3.19 mln ************************Advertisement************************* If you trade options online, then you need an online broker that: offers true direct access to each option exchange offers stop and stop loss online option orders offers contingent option orders based on the price of the option or stock offers online spread order entry for net debit or credit offers fast option executions PreferredTrade offers these online option trading features and more; call 1-888-889-9178 or click for more information. http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ******************* PLAY UPDATES - PUTS ******************* CTAS $42.71 +0.14 (-0.55 for the week) Cintas managed to halt its recent slide, after giving a triple-bottom point and figure sell signal when it traded $44 last Friday. The stock gave two consecutive triple bottoms, actually, with the first turning out to be a bear trap (a one box violation followed by a reversal up). The second one, however, achieved a second box down, getting us past the trap on a technical basis. The bearish vertical count for CTAS is $38, however the bounce off $42 comes at a level of previous resistance and could continue to provide support. So far on Monday and Tuesday, the stock has also found resistance at $44 on intraday rebound attempts, which was the next level of resistance after $42 throughout September and October. The gain of $0.14 today actually looks weak, considering the broad market bounce and the fact that coverage was initiated on the stock with a "BUY" rating by DBS. Traders holding the position can look for a bearish breakdown of $42 to indicate the stock is not "trapped" between $42 and $44. We wouldn't necessarily recommend new entries on that breakdown, however, since our target on the play is $40. --- ASD $66.32 +1.42 (-0.70) In what was a hard-fought session on Thursday, the bulls finally managed to defend support, both in the broad market and in our ASD play. Yesterday's drop below the $66 level was almost perfectly reversed today, as the stock say pretty solid buying interest right after the opening dip to just above the $64 level, resulting in a rise back over $66, to end just a dime below Tuesday's closing level. Recall that the bearish price target from the PnF chart is $64, so it is a safe bet that there were some eager bulls looking to buy the stock this morning when that level was tested at the open. Despite the fact that today's rise came on rather strong volume, we need to remember that one day is not enough to change the 3-week bearish trend. In fact, today's bounce could be setting up another attractive entry point if this fledgling rally runs into trouble. Those looking to take a new position will want to look for a rollover near the $67 resistance level. Another dip and rebound above the $64 level will likely signal an end to the current decline and that rebound would be a signal for conservative traders to harvest gains accrued since entering up near the $70 level. Given the likelihood that ASD will fail on this initial rally attempt, we're keeping our stop set at $67.50. That's the first significant resistance level and a close above that point would signal that it is time to move to the sidelines. --- CTSH $58.70 +0.48 (-1.44) Hopefully nobody was surprised to see our CTSH play find support at the 200-dma ($58.08) on Thursday, as we've pointing out the possibility of a bounce from that level. There's a big difference between finding support and reversing a bearish trend though. The stock has now shed almost $17 in a nearly straight line since the end of December, and given the magnitude of that slide, it's rather encouraging how small today's rebound was. Now we need to see if there's any conviction behind the bounce or if it is just a one-day wonder. The $60-61 area should now prove to be formidable resistance, now that this prior support level has been violated. A failed rally at that level will confirm the stock's continued weakness and provide for new bearish entries as well. Keep in mind the huge PnF Sell signal has given us a bearish price target of $39, meaning that there is still some significant downside potential in the play. Traders that would prefer to see continued weakness before playing will need to wait for a solid violation of the 200-dma support with a breakdown under $57.50. Below the 200-dma, next support is found near $55, the site of the ascending support line, which began with the October 2001 lows. Keep stops tight at $61, as a close over that level likely indicates further upside ahead. --- KSS $55.25 +1.74 (-1.35) With broad market weakness taking center stage right from the opening bell this morning, the Retail index (RLX.X) looked like it was on its way to a breakdown under the $255 level. But then a funny thing happened: buyers appeared right at the critical point and boosted the index higher throughout the day, ending with a 1.55% gain on the day. This action was duplicated in our KSS play, with the stock rebounding from just above $52.50 (the site of the lows earlier this month) on its way to gaining 3.25% by the close. With volume coming in a bit stronger than average, and such a strong intraday reversal, traders might question the wisdom of keeping the play active, and rightly so. As pointed out in the Market Monitor this morning, the rebound from the lows presented a good opportunity for conservative traders to harvest gains in the play. But there isn't anything on the chart to suggest the downtrend has been reversed, and with solid resistance $55.50-56.00 area (backed up by the 20-dma at $55.97), we're looking for another rally failure to present a fresh entry opportunity into the play. Another drop and rebound near the $52.50 level would indicate stronger-than-expected support and would have us leaning towards closing the play. Of course, a close over our $56 stop will have the same result, as it would indicate KSS is likely headed back towards its recent relative highs near $59. ************* NEW PUT PLAYS ************* None ************************Advertisement************************* ”If you haven’t traded options online – you haven’t really traded options,” claims author Larry Spears in his new compact guide book: “7 Steps to Success – Trading Options Online”. Order today and save 25% (only $15) by clicking on PreferredTrade and clicking on the link to the book on its home page. http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ********** DISCLAIMER ********** Please read our disclaimer at: http://www.OptionInvestor.com/page/oin/aboutus/disclaimer.html ************************************************************** ADVERTISING INFORMATION For more information on advertising in OptionInvestor Newsletter, or any Premier Investor Network newsletter please contact: Contact Support
The Option Investor Newsletter Thursday 01-23-2003 Copyright 2003, All rights reserved. 3 of 3 Redistribution in any form strictly prohibited. In Section Three: Play of the Day: CALL - SYMC Traders Corner: The Best Laid Plans Of Mice And Men Traders Corner: Ins, outs and best use of Stochastics Futures Corner: Lining Up Levels Options 101: To Inflate or Die - That is the Second Question ********************** PLAY OF THE DAY - CALL ********************** SYMC – Symantec Corp. $45.99 +0.44 (+0.94 this week) Company Summary: A world leader in Internet security technology, SYMC provides a broad range of content and network security solutions to individuals and enterprises. The company is a leading provider of virus protection, risk management, Internet content and e-mail filtering, remote management and mobile code detection technologies. The desktop battleground is where SYMC derives nearly 60% of its sales. Duking it out with Network Associates in this arena, the company is best known for its security software (Norton AntiVirus), desktop efficiency (Norton CleanSweep), and PC utility (Norton Ghost) products. Why We Like It: While most areas of Technology spending have been cut back drastically over the past couple years, there's one area that continues to find strong demand: Security. Not only is physical security important, but in this increasingly-wired world, computer and Internet security is increasingly critical. SYMC is continuing to establish its leadership position in this arena, as demonstrated by both their recent stock price performance, as well as last week's impressive earnings report. Topping EPS estimates by 8 cents on better than expected revenues was a good start, but then the company guided above consensus for the next quarter and the full year. While the initial response in the market was to sell the news, there wasn't much downside, as the stock found solid footing at the $45 level, a level that has continued to provide support all week. Adding more fuel for the bulls today, Janney upgraded the firm to Buy, along with an increased price target of $56. The market has been rewarding SYMC for its outperformance for awhile now, with the stock showing a gain for 2002 and currently up 13% for 2003 already. As long as computer and Internet security remains a top priority, SYMC ought to see demand for its products and the subsequent profits continue to rise. The PnF chart certainly bears that out with another Buy signal generated on the post-earnings surge to the $48 level, and a bullish price target of $67. If the market is going to put together a rally from current levels, it seems a safe bet that SYMC will lead that rise. With the post-earnings selling out of the way, the stock ought to continue to find support near the $45 level, with further support found at the 20-dma ($44.47), and a rebound in that area should make for a favorable entry point. Due to the congestion between the current price and the post-earnings high at $48.30, aggressive momentum traders will need to wait for a volume-backed move through the $48.50 level before playing. Our stop is initially set at $43, just below the 50-dma. BUY CALL FEB-45*SYQ-BI OI=3217 at $2.70 SL=1.25 BUY CALL FEB-50 SYQ-BJ OI=3055 at $0.65 SL=0.25 BUY CALL APR-45 SYQ-DI OI=3938 at $4.70 SL=2.75 BUY CALL APR-50 SYQ-DJ OI=2632 at $2.30 SL=1.25 Average Daily Volume = 3.19 mln ************************Advertisement************************* If you trade options online, then you need an online broker that: offers true direct access to each option exchange offers stop and stop loss online option orders offers contingent option orders based on the price of the option or stock offers online spread order entry for net debit or credit offers fast option executions PreferredTrade offers these online option trading features and more; call 1-888-889-9178 or click for more information. http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ************** TRADERS CORNER ************** The Best Laid Plans Of Mice And Men By Mike Parnos, Investing With Attitude Well, based on the performance of last Sunday’s new positions, neither the mice nor the men are getting any (profit?). So we have to come up with a plan B. The only things that performed worse than our positions were the Tampa Bay Buccaneers, Joe the Millionaire, and almost every contestant on American Idol. Let’s see what we can salvage from this mess. (Hint: It ain’t so bad. I just love the melodrama). :-) _____________________________________________________________ Position #1: SMH Straddle First: Let me say “OOPS!” I made an error in Sunday’s column – writing "August" options on the new SMH Straddle position when I should have written "May" options. However, the symbols and prices are correct. The vast majority of CPTI students figured it out and successfully entered the $22.50 may Straddle. _____________________________________________________________ Position #2: BBH Iron Condor – Oh well! We had hoped to establish another Iron Condor with an $80-$100 range on our favorite Biotech index for a credit of $.95. However, after the three-day weekend, the marketmakers had sucked the blood out of the premiums to the point where it was no longer a realistic position. ______________________________________________________________ Position #3: XAU Calendar Spread – It’s déjà vu all over again! We put on the June $80/February $80 calendar spread at a debit of $4.85. And just like last month, wouldn’t you know, the damn thing has moved up too quick again. This time, it looks like perhaps we should get out while the getting is good. XAU closed today at $80.33, but traded as high as $81.18. As of yesterday’s (Wednesday) close, the deltas were in our favor 52 to 43. After today’s $2.64 gain, the gap on the deltas has narrowed to 56 to 54. That’s a bit too close for comfort. Based on today’s closing prices, you can buy back the Feb. $80 call for $3.80 and sell the June $80 for $8.70. That’s a credit of $4.90 – which is pretty much a break-even deal. No harm, no foul. So, unless XAU gaps down significantly in the morning, it’s time to bail and put the money back into our pocket. ______________________________________________________________ Replacement Plays In This Sunday’s Column I’m going to try and come up with a few plays for our CPTI Portfolio to take the place of the BBH Iron Condor and the XAU ______________________________________________________________ Mike, Read your Traders Corner piece on calendars. I've been doing calendars for a while, love’em. Your article, however, left out implied volatility and its impact on an option’s price. I'm always looking for skews before I place a trade. Do you? Response: Excellent question! Some traders might avoid putting on a spread when the options are overpriced, but remember that we're only dealing with a difference figure (between the long-term and short-term option). When volatility is high, it’s usually the near term option that reflects a higher premium than the longer- term option. In that respect, it may be more desirable to put on the trade when volatility is high. During the life of a calendar spread -- which could be as little as a few months, or as long as two years -- there are going to be times of high, low and average volatility. Since we're selling premium, especially after the spread is initiated, the highest volatility will yield the highest premium. However, high volatility translates into larger movements in the underlying. That means we have to pay closer attention to the position. ____________________________________________________________ Mike, Would you please explain some issues, which came to my mind during analyzing different scenarios, regarding your last SMH Straddle? 1) What if SMH will move, but only, let say, 2 points? Value of the call is growing, but, on the other hand, the value of put is falling (according to - Delta of OTM option). Doesn't it cause our risk to be higher than only time value erosion (15%) in case when SMH won't move? How do you assess the potential value of an option that decreases in value? For example, with the stock at 22.50, if it begins to move up, the call will increase in value faster than the put will lose value. That's how we make money in a straddle. The delta of the call increases more quickly the further the stock moves up. At the same time, the delta of the put will not go down as quickly. 2) Are the prices that you indicated for SMHEX and SMHQX the highest acceptable for that trade, or, as I understand, is the total cost of the Straddle more important, no matter what is the price of call or put? The total cost of the straddle is only significant in that the total cost is how much money that will be tied up for the initial option cycle. That's how long we're going to be in the trade. 15% of the total outlay is approximately the figure the total amount will erode during that first cycle. That will be our risk in the position. 3) What is our exit strategy? How about trailing stop? There are a few ways to exit the position. 1. For example, if SMH moves dramatically up, we can sell the call that has appreciated in value. Then, we could wait for SMH to reverse and sell the put after it has gone back down significantly. This is not recommended because all this volatility rarely takes place in one option cycle -- and that's how long we're going to be in the trade -- no exceptions! That's how we keep our risk minimized and that's a priority that's etched in stone. 2. This is the simpler, and preferred, method. You can estimate approximately how far SMH might go up until it hits resistance. Then you can estimate what the call will be worth at that point along with the value of the put. The total of those two figures should be significantly higher than what was paid to open the trade -- hence, your profit. If you're not near your computer often to monitor the trade, you can put in a spread order to sell both options together at a specified credit. The only problem with spread orders is that both the put and call are sent to the same exchange -- and it's rare that a single exchange will offer the best prices for both options. Once SMH reaches a certain level, some brokerages have software that is sophisticated enough to enable you to create a spread order that is contingent on where the stock is trading. But, again, both options will go to one exchange. _____________________________________________________________ Hi Mike, I wanted to pass along the great job you are going. I have been following your selections since the beginning and I have, unfortunately, only have done the QQQ play so far. But plan on trying the your selections this month (which means things might not go as planned, so if things don't work out just pass the blame on to me :). Regardless, I have learned a lot and I have a few questions: Like you, I'm getting very tried of trying to pick a direction in stocks, so I'm trying to learn some new techniques which would limit or eliminate me trying to do so. My questions are: Response, Thanks for the kind words. I'm glad you enjoy the column and hopefully things will continue to go well and you'll refine your trading skills and profit from what you're learning. If not, we’ll simply repossess your couch and your TV and you can start filling out job apps at Burger King. It’s a lot better to be eating the 99-cent Whoppers than being the mayo-and-pickle-guy on the assembly line. 1. Why did you pick strikes so far out? a) The strikes I picked for SMH were picked far out so that the month we will be in the trade (Feb. option cycle) will erode premium very slowly. We're only risking the erosion for that first month -- then we close out of the trade. 2. Is this type of play most effective when you buy ATM or near the money options near support? b) It's best to buy at-the-money puts and calls because the sooner SMH starts its move, the sooner the option (in that direction) will begin to increase in value. It's often a good idea to find a stock that is at, or near, support because it is likely to either break support and head down to the next support level -- or it will bounce up and head toward the nearest resistance level. 3. How does a person manage this position if either A. the SMH goes north or B. It heads south, like you have suggested or would like? c) You have to estimate what the options would be worth if SMH were to go to $29 or if SMH were to go to $17.50. That will give you an approximate target. Then, just keep an eye on SMH and when it approaches either level, determine what you can get if you sold both the put and the call. If SMH moves that much, the profit should be a nice return on the risk. _____________________________________________________________ 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. Mike Parnos CPTI Instructor ************** TRADERS CORNER ************** Ins, outs and best use of Stochastics By Leigh Stevens lstevens@OptionInvestor.com One of the things that I wrote about in my weekly Index Trader Wrap last weekend (1/19/03) was a price/stochastic "divergence" that had developed on the hourly charts BEFORE the last significant top - for example in OEX. This divergence looked like this - The divergence refers to where prices and a technical indicator, especially the "oscillator" type formulas of Stochastics, the Relative Strength Index (RSI) and MACD (Moving Average Convergence Divergence) diverge in direction in terms of one making higher (closing) highs and the other making LOWER (closing) highs on upswing. This is a bearish divergence. (A bullish divergence is price falling to new lows where a stochastic or RSI makes a HIGHER high.) I have made the chart above a close-only "line" chart to better compare prices to what the stochastics model was doing as stochastics makes its final computation based on the CLOSE of any period being looked at; e.g., hourly, daily, weekly, etc. Of course, during the hour or within the day, the stochastic may reflect an update to the formula based on THAT price - most stochastic models that work off from a real-time price "feed" or stream of quotes will do this - what's called "update every tick". However, only the closing price becomes the level that becomes finalized for that hour, day or week. E-MAIL QUESTION: "Please provide the settings you used for the stochastics on your OEX charts (especially the hourly). I get a very different pattern using 5/3/3 and 21/3/3. What am i doing wrong?" It turned out. nothing, as we'll see in a moment from this thoughtful OIN subscriber who went back and looked at his charts again (on Q-Charts - I use TradeStation). However, if YOUR stochastic doesn't look like "MY" stochastic shown in my OIN article, there may be a question of whether I use "3" and "3" for the so-called smoothing part of the formula. ANSWER: yes I do, I just don't show "5,3,3" or "21,3,3" on my TradeStation charts, whereas Q-charts does show those other numbers. Most users don't care and (for the most part) rightly so. The "3" is the standard stochastics formula and I leave it ALONE, but what I do find important is the "LENGTH" setting - do you work with a 5, 10 or some other setting for the number of hours, days, etc that will be used in the equation or some other choice(s). I find it most useful to line up a relatively short stochastic such as one that looks at only the last 5 "periods" and a longer one - especially 21 on hourly charts - that looks at a longer time frame. When BOTH are oversold registering low extremes, or both are "overbought" at the high end of the scale, there is often a bigger move that is about to develop. And, if the daily stochastic, set at length 14 measuring a 14-day period (others find other length settings to be most useful; e.g., 10) is also at an extreme, even better. More on the stochastic model is found in one of my past Trader's Corner articles - http://www.OptionInvestor.com/traderscorner/072502_1.asp The follow up e-mail I mentioned, from the same OIN subscriber, writing earlier included the following: "Thanks for responding to my question about appearance of stochs on OEX hourly from QCharts. To save my chart i had to play with it a bit but found using Chart Tab, Export, Image i was able to get the job done. Looking at the chart again this morning, it looks pretty darn close to what you showed in the Wrap. This shows me that its my perception and lack of experience that caused me to not see the divergence you focused on. It was NOT a technical problem with Qcharts or chart settings.....your approach and insights seem to fit Jim's "trade what you see" mantra at OI." HIS QCHART - OEX HOURLY: Make sure that you don't happen to have "Semi-Log" checked at the type of price scaling to use and not "Linear", which is usually the "default" setting in all charting applications that I know of. However, I've sometimes had the logarithmic scaling switched on while looking at weekly or monthly stock or Index chart that has made a huge percentage move and want to see equal percent moves as the same distance on the vertical price scale, which is what "Semi-Log" does. If I am using the Semi-Log scaling on long-term chart (most common use) and I then switch to a daily or hourly chart I might forget to check "Linear" again. I may not notice an obvious and major difference in the price scale but it could be different enough to cause some confusion if someone else's hourly chart looks different than mine. The central idea or concept of stochastics - what it is attempting to measure - is that in an up or down market trend for any number of trading periods (e.g., 10 hours or 14 days), prices will often move away from the lowest low made during that 10 hours or 14-days, or the highest high, at an increasing rate – this "rate" or speed of price changes is what the (slow) stochastic oscillator is showing visually. There is one more possible variation that I know of in how intraday hourly charts can be calculated - and this is by the use of so-called "natural hour" bars. In fact, hourly charts became very popular by the folks charting the Dow, who took a reading at the top of the hour - this is the "natural" hour so to speak. However, look at what we have today - the market opens at 9:30 Eastern. In most charting applications, the first hour measures the hour from 9:30 to 10:30. With stocks closing then at 4:00 pm EST, the last "hour" is not an hour at all - rather, it is the OHLC (Open, High, Low, Close) from 3:30-4:00. In Indices, the last hour is 45 minutes - from 3:30-4:15. The last hour is a truncated or a shortened period. In very sophisticated charting applications, especially popular with Foreign Exchange and Bond traders who trade "natural" hours, not Exchange hours, there is another charting option - See the lower left choice of "Use Natural Hour Bars" - this is the choice that this technical analysis application (TradeStation) will END every hour at the end of the hour. Now, here is where a stochastic could look significantly different in stocks: the 1st "hour" is from 9:30-10:00 - thereafter, it's 10- 11, 11-12, etc. But the last hour is an even hour, from 3-4 pm in stocks, but not in Index options like OEX - here the next to last hour, using the "Natural Hour" option, will also be 3-4, but the LAST "hour" will be 4-4:15 - a really truncated bar! But a bar or period is the same to the stochastics formula and goes according to how the application measure what an hour is. Fortunately, as a stock or stock options trader you do not have to consider such charting choices as a normal rule. What we do have to consider with using the so-called overbought/oversold type indicators like Slow Stochastics is that "overbought" or "oversold" relate to a POTENTIAL vulnerability for a trend reversal only – a market can stay oversold or overbought for a relatively long period. It is also true that rapid and steep advance or a steep and rapid decline is not usually going to go on for an unlimited period. A market WILL correct at some point after a steep rise or fall, but WHEN is an open question in a strong trend. Hence the great value of when a DIVERGENCE sets up. There is another thing to remember - a "correction" may just turn out to be a sideways consolidation period, before there is yet another push in the same direction as before. A sideways trend will cause the stochastics to FALL, just as a downward trend does, just not as quickly such as in this chart from a past period - Oscillators "work" well in terms of timing trend trades contrary to the most recent trend – buying dips in a downswing and selling rallies in an upswing -- in markets that are experiencing two- sided price swings rather than trending strongly in one direction - The above example is not a "perfect" back and forth trading range - e.g., from 10 to 20, back to 10, then back to 20 - unlike commodities (think of gold), stocks often have approximate ranges. IF YOU REALLY WANT TO KNOW THE FORMULA - The Stochastic study looks at the current price in relation to the highest high or lowest low in the period being measured. Stochastics plots the current close in relation to the price range over the length set for this indicator and gives this a percentage value. The initial calculations for a stochastic of say 14-days is twofold - Establishing a "fast" and "slow" line. The fast line or "%K" formula is 100 – (the close minus the 14-day low) divided by (the 14-day high – the 14-day low; i.e., the price range). The slow line or "%D" (here called “FastD”) is equal to a 3-day (this is where the "3" comes from) average of "%K". This first formula is referred to as the "fast" stochastic model. Fast stochastic lines react so quickly to price changes that the use of it is mostly appropriate for very short-term traders. The "slow stochastics" variation of the basic stochastics formula is simply to take the "FastD" figure and apply a "smoothing" calculation yet again, which results in another line which we can call “SlowD”, to differentiate the two versions of "%D". The important thing to remember is not this alphabet soup, but the fact that the slow version of the stochastics oscillator (slow stochastics) is the version that is in most common use and is most likely what you will be using if you choose the stochastics indicator to apply to a price chart. Use of slow stochastics is the most appropriate for all around trading purposes. Buy and sell crossover "signals" are considered to be optimal if they occur in or near the overbought and oversold zones, respectively. There will be instances of crossovers that occur in the middle of these ranges and these should not be utilized UNLESS there is some compelling other technical factors guiding you – for example, a break out above or below an important trendline – here's a chart from my book and its one for the "books" hey, as when do you think we'll see YHOO at 200 again! I make use of Stochastics, RSI and MACD indicators among others, but mostly ALSO in tandem with price patterns, sentiment readings from Put/Call or TRIN, daily trading volume trendlines, trendlines and fundamentals, especially earnings trends. Use em all and you will make fewer mistakes over time. ************** FUTURES CORNER ************** Lining Up Levels By John Seckinger jseckinger@OptionInvestor.com It all comes down to conviction. While at the CBOT, there was one error that many traders continued to make. A travesty, to say the least. I could probably wrap this article up in one sentence: "When a number of levels line up in one's favor, INCREASE trade size." It really is this simple. Nine out of ten pit traders (either bonds or the YM contract) would put on exactly the same size order regardless of where the market was. They were 'just trading levels,' they told me. I would always reply, "Well, what if a few levels line up? Doesn't that increase its significance and shouldn't you INCREASE trade size?". Never a response. To me, trading the same size on every trade is like "trading without a plan." I like the football analogy, "Would you increase your bet if a Professional team was playing a High School program?" In the futures pits, we don't have to 'cover a spread' like the one that the Pro Team might have to give in the above example. Liquidity will be there in the ES contract, and I am a believer that usually a bad fill (example: fill worse than the bid when going short, due to a fast market) will result in a better trade anyhow. Maybe it is this slippage that 'covers the spread.' Let us assume that your account can handle up to 10 ES contracts at one time. I have to imagine that the ES opening up at 880 with a daily pivot at 885, a weekly pivot at 875, and a 38.2% daily retracement at 882 would tell a trader to NOT trade all 10 contracts. On the other hand, if every timeframe pivot is at 880 and the ES opens underneath, I do think trading MORE than one contract would make sense. When getting ready for a trading session, I encourage all traders to get comfortable "lining up levels" on both a daily, weekly, and monthly time frame. Let us do that now: Closing Levels Contract Last Net Change High Low Volume ES03H 883.00 +5.50 889.75 875.50 689,943 Daily Levels Contract S2 S1 Pivot R1 R2 ES03H 868.50 875.75 882.75 890.00 897.00 Weekly Levels (High, Low, and Close from week prior) Contract S2 S1 Pivot R1 R2 ES03H 873.25 888.25 912.50 927.50 951.75 Monthly Levels (December's High, Low, and Close) Contract S2 S1 Pivot R1 R2 ES03H 814.75 846.75 900.25 932.50 985.75 Chart of ES03H, Daily Chart of the ES03H, Daily I didn't put in moving averages, but the 200 DMA (exp) is below at 871.00, while the 50 and 22 DMA's (exponential and simple) reside from 899 to 903.25. The monthly pivot is also at 900.25. The middle of the Bollinger Band is at 904.90, and I would have liked it to be in this 899 to 903.25 range. Now let us line up some areas to pay close attention to: The range from 881.25 to 884.50 (based on daily retracement chart) 873.25 to 875.75 (Weekly S2 and Daily S1) 865 to 868 (Bollinger Band low and December 31st low) For the upside, the ranges that seem key are as follows: 888.25 to 890 (Weekly S1 to Daily R1) 899 to 903.25 (Moving Averages Convergence) The "wildcard" areas seem to 894.50 (retracement on daily chart) and 904.50 (mid-point in Bollinger Band) Now we are making progress. I don't have to do a retracement between R2 and S2, because this is not about "hitting singles." We are trying to line up more like a double today. Possibly a triple. A home run would most likely require being at a significant relative low or high. With these five different areas, traders see that the ES contract is currently at 885 and just above the first area listed from 881.25 to 884.50. So, go long and then put a stop at 881, right? Well, that certainly is a good strategy; however, I would prefer something a little different. Since the high today was 889.75, and within the second defined area, I still would rather sell short than go long. Not blindly, but how about selling the contract either within the range or underneath the range at 881, and then putting stop back up at 885 and on the outside of the defined area? Note: The pivot is at 882.75, so just underneath the pivot would be inside the range AND would be better execution than 881. Now this is what I call "setting up a trade." If bullish, then you can use 885 with a stop at 881 (or underneath the pivot). But notice how we are defining risk? With a number of levels lining up, I think it means that trade size can be increased. What if it doesn't work? I still highly recommend trading the levels again; however, scaling back would then make sense. What if we got a bid back all the way to the 900 area? Same theory. We have our 899 to 903.25 area, and ideally we would like a roll from 903.25 and short the contact back under 900 with a stop at say 905 (back above the wildcard mid-Bollinger Band area - which I am sure will move by then). Regardless, can you see how this makes more sense to do more than one contract than say if the ES was at 893.25? What is 893.25? I don't know, and I bet a lot of other traders don't either. Therefore, if you must, only do one contract. In conclusion, try spending time "lining up levels," and I can almost guarantee that this will increase confidence when trading. It certainly does for me. What if these areas are not hit in a particular session? Exactly, only do one contract or not trade at all. There are a few other things that I like to use when increasing both conviction and position size. Number One, the "Open to Close" theory. Hopefully, the first five-minutes on Friday will encompass the pivot; therefore, if the first candle is red, we can look for a move to and/or S1 and S2. As you probably already have been thinking about, when we group these levels we usually grab either S1 or S2; therefore, we don't have to talk in S1, S2. Instead, we could just say "look for a move down to the next 'significant area' of support.' This would be a range of a few points, instead of one exact level. Note: When exiting, it is perfectly fine to exit "near" the next area, and not trying to capture the area in its entirety. Example: Short at 882.50 (under the pivot) and then exit at 876, since the next level below is at 873.25 to 875.75. Ideally, we would want 873.25, but it is ok to not get too greedy. Ask Away, John Seckinger jseckinger@OptionInvestor.com *********** OPTIONS 101 *********** To Inflate or Die - That is the Second Question Buzz Lynn buzz@OptionInvestor.com Last week in the deflation/inflation argument, we only had time and space for the deflation case. In honor of the notion of equal time, we are going to strictly focus on the case for inflation this week. In case you missed last week's Options 101 morph into Economics 101 on exported deflation born of production overcapacity (and the economic rise of China, I might add), you can get up to speed here: http://members.OptionInvestor.com/options101/opt_011603_1.asp The good news is that the case for inflation practically writes itself. What I should really say is that the Federal Reserve has practically written it for us. Even if you are not into economics (and who among us actually likes to take this stuff to bed?), follow along, as the implications of inflation help us determine the direction of our investment future. Here's how things are setting up. Deflation is dangerous and the Federal Reserve will do anything to fight it. Why is it dangerous and why fight it? Two reasons. First, if consumers are to consume their brains out (not far from reality), the prospect of buying goods and services cheaper next month will keep their collective wallets closed in anticipation that they can buy it cheaper later. Keeping the wallet closed is bad for business investment spending and corporate profits, both things that the Fed counts on to keep the economy humming. That "buy it cheaper later" notion feeds on itself. Second, once deflation takes hold, the Fed is POWERLESS to stop it, and the Fed is loath to lose its power over the economy. 0% is the lowest achievable interest rate for the Fed to implement. The Fed can do nothing once rates hit that level. Even 0% borrowing cost is not cost effective to the borrower when prices are falling. Again, it comes back to overpaying now - even at 0% interest - when we can buy cheaper later. Need evidence? See Japan. Though the Bank of Japan would love to see the Yen fall against the Dollar from the current roughly 115 to 150 by the end of 2003, it isn't working for them. The Yen is going the wrong way and gaining strength against the Dollar. You pretty much have to consider yourself a failure as a Japanese Central Banker if you cannot succeed at intentionally destroying your own currency. Such would be the plight of the Fed should the U.S move into all out deflation. So given the preponderance of evidence of deflation, what are the Fed-meisters to do? The answer is very telling and was given for all the world to see by Ben Bernanke, a recently appointed Federal Reserve Governor, on November 21, 2002 to the Economists Club in Washington D.C. It isn't just hopefulness by the Fed to keep deflation at bay. It's a mission. Evidence is contained in the title of the speech: "Deflation: Making Sure "It" Doesn't Happen Here." OK, guns loaded; fire! I'll skip most of the speech, as it sounds like most Fed speeches full of verbose qualifiers and caveats. But here are the actual words spoken that night that ought to be etched in every investor's brain if they are to prosper in the coming years. Get this if nothing else: "U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper- money system, a determined government can always generate higher spending and hence positive inflation. ......If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation." "The basic prescription for preventing deflation is therefore straightforward, at least in principle: Use monetary and fiscal policy as needed to support aggregate spending..." Did everyone get that? Barnanke admits the Fed has a printing press and is intent on using it to thwart deflation. It can't be any clearer than that. It has thus become the Fed's mission to "Inflate or Die". You can bet it is going to do its darndest to inflate and has done a pretty good job, so far (though it is interesting to note that M3 money supply has actually DECREASED in the last few weeks). [Note: "money supply" is loosely defined as cash, checking, and savings deposits - there is more to it than that, but after 20 years, my memory of economics classes has become a bit fuzzy.] Just a paragraph or two on money supply. A declining money supply right now has to be scary, even to the Fed. I don't make any guarantees on this and I am not an economist by trade. I don't even play one on TV. Yes, it's just a number to most, which doesn't affect the outcome of anyone's life. But my take on this isn't good. To me, it means that while the Fed is flooding the banking system with money, that money isn't getting lent out and ending up in consumers wallets and checking accounts, which may be an early sign that consumers are raising the white flag of consumption in surrender. As one financial author recently put it, it's like pushing on a string. More like, "You can lead a horse to water, but you can't make him drink." Perhaps the consumer horses in this economy have had all they can take. Listen to Dan Denning of Strategic Investments: "An awful convergence of macroeconomic trends was revealed last week. Spending for the indebted consumer went up. But business spending did not. What demand there is in America is directed towards foreign goods, with the profits going overseas, further putting pressure on U.S. firms; the very same firms who have no incentive to invest in new jobs because they are already operating well below capacity. The only real question left for the economy is when the consumer will surrender." Oh boy - not music to the Fed's ears. Again, the necessity to "Inflate of Die". Anyway, just a thought on my part. If any of you have further insight on this, I'd love to hear it and welcome to knowledge that sets me straight on the subject. But back to the subject at hand. Any other reason that the Fed would inflate? It all goes back to deflation fears and other exporting nations wanting to weaken their currencies as a way to stimulate exports. Central bankers worldwide are competing to make their currency cheaper than the next guy's. Remember, weaker currency makes goods cheaper to buy with the relatively stronger currency. To stimulate export growth, Central Bankers need only cheapen the currency to that other find it attractive to buy the goods. That's what I meant last week by competitive devaluations. Adds James Grant, Forbes contributor and research analyst, also one of the clearest minds in finance for thinking outside the box (He probably doesn't even know where the box is), "The world wants to reflate. Bloomberg News reminds us that, by August, the Bank of Japan, the European Central Bank and the Bank of England will all be under new management. 'With the 1970s inflation rates of 10% or more a distant memory,' the news service notes, 'the new central bankers will probably keep a lid on interest rates.' "We suspect that the new generation of central bankers will also see to it that their national mints do not lack for either parchment or pigment." There you have it - the case for monetary inflation - which is squarely pitted against the forces of deflation. It should come then as no surprise that gold has gone from roughly $315 to $360 since Bernanke's speech and that the Dollar has caved against the Euro rising from $0.99 to $1.07 in the same period. Good bye Dollars; hello Euros (for now); welcome gold! More on the latter after tackling real estate in this column next week. Questions always welcome! Stay tuned and make a great week for yourselves! 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