The Option Investor Newsletter Tuesday 02-25-2003 Copyright 2003, All rights reserved. 1 of 3 Redistribution in any form strictly prohibited. In Section One: Wrap: Long For Peace, Short For War Futures Markets: (See Note) Index Trader Wrap: (See Note) Market Sentiment: Bulls Win! Bulls Win! Weekly Fund Screen: Schwab Select List: Large-Cap Funds Updated on the site tonight: Swing Trader Game Plan: Quite a Show Posted online for subscribers at http://www.OptionInvestor.com ************************************************************ MARKET WRAP (view in courier font for table alignment) ************************************************************ 02-25-2003 High Low Volume Advance/Decline DJIA 7909.50 + 51.30 7920.49 7719.64 1.74 bln 1853/1372 NASDAQ 1328.98 + 6.60 1331.35 1291.96 1.37 bln 1687/1537 S&P 100 424.88 + 3.41 425.52 413.69 Totals 3540/2909 S&P 500 838.57 + 5.99 839.55 818.54 W5000 7949.38 + 54.30 7956.53 7771.79 RUS 2000 361.53 + 2.98 361.20 354.09 DJ TRANS 2041.83 + 24.10 2041.91 1973.63 VIX 36.12 - 0.65 38.13 35.92 VXN 44.33 - 0.55 47.27 44.04 Total Volume 3,331M Total UpVol 1,935M Total DnVol 1,334M 52wk Highs 146 52wk Lows 335 TRIN 1.40 PUT/CALL .75 ************************************************************ Long For Peace, Short For War And I on the opposite side will be. I modified that phrase from Paul Revere's midnight ride text only slightly to reflect investor sentiment this week. It seems everyone is going in opposite directions as conflicting signals are seen. Iraq news is driving traders to drink when faced with dozens of news conferences per day and differing opinions expressed in each. This is Yo-Yo trading at extremes! Dow Chart - Daily Nasdaq Chart - Daily The day started out very ugly with news overnight that North Korea had fired another missile into the Sea of Japan. The saber rattling is moving to a fever pitch and the Asian markets did not react well. This set up the US markets for a fall and fall they did. We gapped down and came very close to 7700 once again before the buyers appeared. It is amazing they appeared at all once the Consumer Confidence numbers were announced. The headline number came in at 64.0 and well below consensus estimates at 76.50. Everyone expected a lower number but nobody was even close to the disaster that was announced. The present situation component fell from 75.3 to 61.6 and the expectations component fell to 65.6 from 81.1. Consumers planning on buying autos and major appliances were dropping but there was a small gain in home buyers. This was the lowest headline number since October 1993 and indicated the rate of decay was accelerating. It was the largest drop since Sept-2001. War, high energy prices, rising unemployment and weak markets all weighed on consumers. Orange terror alerts did not help either. Offsetting the Consumer Confidence was the existing home sales numbers which came in at 6.09 million compared to estimates of 5.80 million. The gains surprised everybody again and set a new record. House prices are beginning to fall and many thought that could be the incentive dragging the last round of buyers off the couch. Prices in the Midwest have dropped -5.5% in the last two months. The west and northeast prices are still rising slightly. The south dropped -1.4% for the month. The comments by Fed members last week that they will not raise interest rates anytime soon gave the housing sector one more reprieve for the spring selling season. Chain Store sales declined for the third consecutive week despite the rush to buy duct tape, batteries and plastic. Wal-mart said it helped them but evidently the other dept stores lost sales. Sales have dropped due to the big storm as well. The estimates for monthly sales growth have now been lowered from flat to -0.5% overall. With the President's Day sale a bust in the northeast the earnings for retail stores could be tough for the quarter. Oil prices continue to rise and are showing no signs of easing. There are strong fears that Iraq may blow up its wells and take that three million barrels of daily supply out of the market for 6-12 months. That would be a serious problem with Venezuela still not at 100%. With gas prices well over $2 a gallon in many places the consumer is feeling the pain. Every dollar increase per barrel amounts to a $7 billion undeclared monthly tax on consumers. With oil reaching $37.20 today that is $12.20 over the base rate that OPEC strived to maintain. That is $85 billion in excess costs being passed to consumers each month with no end in sight. This tax is being passed on to manufactures as well and earnings revisions are being made on a daily basis due to higher oil. 8% of the S&P set a new 52-week low today and the new lows at 335 beat new the new highs of 146 better than 2:1 in the broader market. This was the 15th consecutive day that the lows beat highs. 40% of the S&P have already warned for the 1Q. The floor traders on the NYSE said the big dip at the open and after the confidence numbers was due to heavy institutional selling. There were a couple comments that the strength of the selling was encouraging. It appeared that institutions wanted out at any price. While this was limited to only a few of the thousands of institutions, traders thought maybe we were nearing a capitulation event and something we could build a real bottom upon. With the rebound this afternoon that thought evaporated. The dip buyers are alive and well and they did overcome some decent selling resistance to power the Dow back to a +187 point rebound from the days lows. There was also some asset allocation taking place again with selling in bonds and buying of stocks. This has happened each time the Dow traded around the 7700 level. It would appear that other institutional investors are deciding that bonds are not going higher with heavy supply coming to market in the near future and the risk of stocks going much lower is slim. Hope they are right. After the bell today HPQ announced earnings that beat the street by a penny and affirmed earnings for the current quarter. Unfortunately they missed revenue targets by an analyst mile and gave a cautious outlook. Revenue was only $17.88 billion vs analysts estimates of $18.47. Close enough for me but the stock traded down in after hours. Carly Fiorina followed the pattern of those early announcers and said the environment is uncertain and predictions of performance were very difficult. The HPQ CFO declined to comment on tech spending trends in general claiming limited visibility. This cautious HPQ stance weighed on the futures after the close and it would appear the open may not contain a continuation of today's rebound. We closed just barely over the 7900 level and below strong resistance at 7950. There are no major economic reports on Wednesday and that means we are stuck depending on stock news and war news for direction. Depending on how you draw the lines the Dow has serious resistance at every 50 point increment between 7900 and 8150. There have been 12 major gap down days since Jan-23rd and nine miraculous recoveries. While there have been some spectacular rebounds we are trading in a range -500 to -700 points below those Jan-23rd levels. Don't get me wrong. The rebound from 7700 today was amazing. Especially considering the confidence numbers were at 13 year lows. Still the pattern is clear. The rebounds eventually fail and we start the process over again from a lower high. According to the charts that lower high on this bounce could come anywhere between 7900-8000 but probably not over 8000. This sets up the next dip as early as tomorrow. Considering most funds and institutions are not reactionary and they plan tomorrows moves only after fully evaluating today's reports and market reaction, that immediate direction is probably not up. The NDX closed at 999.24 and could not break that 1000 barrier but the Nasdaq Compx managed to edge just slightly over 1325. The tech stocks are the wild card tonight. If they react positively to the HPQ news the Nasdaq could throw just enough confusion to the bears to keep them off balance. The only sure bet is that volatility will be strong and we will continue to see big moves in both directions. Enter Very Passively, Exit Very Aggressively! Jim Brown Editor *************** FUTURES MARKETS *************** Check the Site Later Tonight For John's Futures Market Article http://members.OptionInvestor.com/futureswrap/fw_022503_1.asp ******************** INDEX TRADER SUMMARY ******************** Check the Site Later Tonight For Jeff’s Index Trader Article http://members.OptionInvestor.com/itrader/marketwrap/iw_022503_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 **************** Bulls Win! Bulls Win! by Steven Price A day without geo-political news would be like a day without, without.... I'm having a hard time remembering just what that would be like. In the last 48 hours, we have seen the U.S. and Britain submit a new U.N. resolution, France and Germany counter with one of their own, Saddam Hussein defy the weapons inspectors' request to destroy missiles and North Korea launch a missile test of their own. It was enough to send the markets reeling early today and that was before we got the release of the lowest Consumer Confidence number in ten years. That release pushed us a little further downhill and got the markets back into an area we last saw in mid-February. It seems like just a couple of days ago that we were breaking through Dow 8000 and it appeared that investors had shaken off the geo-political concerns that have weighed heavily on the broader markets. Oh wait - it was just a couple of days ago. In any case, the sell-off looked decisive until mid afternoon, when the bulls came back with a fury. Not only did we make up the entire loss, we made it all the way into the green on the day and blasted through 7900 to boot. It now appears that another run at Dow 8050, where the rallies over the past few days have failed, could be in the cards. If the recent news wasn't enough to inspire a true sell-off, then it may be hard to imagine what will. The U.S. comments that North Korea's missile was not a concern may have soothed some traders, who figure Saddam's reluctance is old news, but whatever the reason for the big turnaround, it underscored the unpredictability of the current environment. While we had been seeing quite a reversal over the last couple of days, we were bombarded with plenty of news to scare investors away and still got a bounce above the February lows in the Dow/SPX/OEX. The Dow transports are a different story, however. The transports have received a good deal of attention lately, as they have not only taken out February lows, but also tested those of October, when it last seemed the sky was falling. Dow theorists, going back to the existence of the Rails Index (replaced by the TRAN for purposes of Dow theory), look to this index for confirmation of activity in the Dow Industrials - the TRAN's more heavily watched sister. As the price of fuel has risen, the transportation stocks continued to struggle and gave us overall bearish signals. Today's drop took us to levels not seen since the week following the September 11 attacks, when airline stocks to an enormous tumble. This time war fears have driven up the cost of fuel and created jitters about a lack of travel that have also weighed on the sector. However, we got a huge bounce after taking out those lows and left us wondering whether the move is signaling at least a short-term bottom as the October low brought back the buyers. In contrast to Saddam's refusal to destroy his missiles, as requested, chief weapons inspector Hans Blix said that the country has begun to show signs of increased cooperation the past few days. Whether that is simply window dressing and should be ignored on a national front is really irrelevant to investors who should be aware that another extension of the inspection deadline could lead to at least a short-term rally. As time moves further along, so does the possibility that the invasion could be put off through another hot season in the Middle East. While that seems unlikely given the latest U.S. resolution, there is still enough international resistance to the U.S. plans to make us aware that the direction of the market can continue to whipsaw with each new development. It seems the U.S. is pushing the envelope and has decided that a direct resolution authorizing force would only hinder its invasion plans. By wording the new resolution, as they did, so that U.N. simply reinforces the idea that Iraq has failed to comply with resolution 1441, which directed it to disarm, the U.S. can rely on 1441 for its authority to invade. An explicit resolution for military force may be defeated, and it would put the U.S. in a much hairier position. This way it can simply invade and say the parameters were previously set and have been violated. President Bush said today that the U.S. does not need another resolution to launch an attack and that it would consider a French vote against its resolution very unfriendly. The other factor we need to consider is just how a war will affect the markets. While the uncertainty surrounding the possibility has helped keep a lid on any rallies, the theory advanced most often seems to be that once the missiles start dropping, it is time to buy. While that pattern may have been the way it happened last time, it is now 12 years later and there is no guarantee it will happen again. However, if enough traders believe it to be the case, it may become a self-fulfilling prophecy. Of course, even if it does happen that way, we still have a host of economic problems that underlie the market. Businesses still aren't spending and Consumer Confidence is sinking, indicating a consumer less willing to spend, as well. Certainly from these levels, that looks bearish, but once the war uncertainty is behind us, we may have a better idea what fair market value really is. Right now, the geo-political uncertainty is being blamed for companies' reluctance to spend, but I think there is certainly more to it that the current environment is simply masking. For now the trend remains down and looking at a weekly chart of the Dow, which filters out the day-to-day moves, it simply looks like we bounced to another lower high just above 8000. It would be the third in a series since last December and gives us little reason to expect a rebound. Today's big turnaround may signal another couple days of heading higher, but until we break the Dow 8150-8160 resistance, these intermediate rallies are like putting perfume on a pig. However, when a big uncertainty is lifted, we may see institutions do another round of buying, expecting some pickup in spending, consumer confidence and lower fuel costs. It's not that fuel costs will dive when the bullets fly, but rather the war will have started and most are expecting it to be a short one. We can't really start the clock ticking for lower fuel costs until the war starts and there is some end in sight. If we don't get a rally after war jitters are behind us, then it could be a very steep drop from whatever level we happen to be trading at that time, since we will be out of excuses. The one index that has been giving me fits is the Semiconductor Index (SOX). It has been a good correlative tool in the past year to predict market direction, but it managed to hold gains through much of the recent action, contrary to the past couple of days in the broader markets. Today, that finally ended as the SOX dropped 11 points intraday before catching a boost late with the broader markets. However, with the Nasdaq Composite bouncing back above 1300, this morning's breakdown must be called into question. If we are unable to get back under that mark, then it may be time for another test of 1350. While I do think we could test the October lows around 1100, 1300 is the next support level to break on a closing basis. We did make it down to 1261 a couple of weeks ago and at that time it looked like 1100 would be only a matter of days. However, we bounced almost 100 points and 1300 is close to the 50% retracement of that low and the recent high (actually 1302). A failure back below the 50% mark might indicate another test of the bottom and as close as it is to the previous support at 1300, that should be our gauge. We did trade below that level intraday and that's a start, but without a close, it is far less decisive, as we say it was successfully defended by the bulls. The big reversal today can certainly be considered bullish, since in spite of all the bad news, we still managed to find dip buyers. Stayed tuned for a run at Dow 8050 and then stronger resistance at 8150. Above that is the H&S neckline around 8200 and previously strong support (which could now act as resistance) at 8300. The bulls may have won today's battle, but there are still plenty of resistance levels above to contend with. (Title Disclaimer: This former Chicagoan has been waiting to hear those words since Michael Jordan left town and today's trading session seemed to be the best and possibly last opportunity to use them, which says as much about the stock market as it does about the team) ----------------------------------------------------------------- Market Averages DJIA ($INDU) 52-week High: 10673 52-week Low : 7197 Current : 7910 Moving Averages: (Simple) 10-dma: 7900 50-dma: 8292 200-dma: 8634 S&P 500 ($SPX) 52-week High: 1176 52-week Low : 768 Current : 839 Moving Averages: (Simple) 10-dma: 835 50-dma: 876 200-dma: 914 Nasdaq-100 ($NDX) 52-week High: 1734 52-week Low : 795 Current : 999 Moving Averages: (Simple) 10-dma: 989 50-dma: 1013 200-dma: 1014 ----------------------------------------------------------------- The Semiconductor Index (SOX.X): The SOX almost gave us the breakdown I have been looking for to confirm broader market weakness. Alas, it recovered on the afternoon market-wide rally to finish off on 2.21 point son the day. However, it did finish down on the day, after trading as low as 281.40 and appears out of steam with the 300 resistance level sitting just above. The other possibility that I am beginning to consider, however, is that this index may not be as correlative to the broader markets as it has been in the recent past. It seems unlikely since it is a good barometer of spending and demand in the tech sector, but if it doesn't work for those purposes I'm not going to hang on forever. The current environment is obviously tough to predict with just about any sector index, considering the geo-political factors now in play, but for the time being, a more politically sensitive sector may reflect the broader markets better. 52-week High: 641 52-week Low : 209 Current: 289 Moving Averages: (Simple) 21-dma: 277 50-dma: 296 200-dma: 332 ----------------------------------------------------------------- The VIX remains back in its recent pattern between 35% and 40%. We have now seen it test the bottom twice, closing as low as 34%, but no closes above 40%. This morning's drop looked to have plenty of room, as the VIX never made it much above 38%, but the intraday bounce put it in reverse, finishing down on the day. Right now the schizophrenic market action is being reflected in option premium levels that vary just as quickly as equity values. I will continue to rely on 40% as an indicator of a possible bounce in equities after a drop and rely on 34-35% as a warning that a pullback in equities may be upon us following a rally. CBOE Market Volatility Index (VIX) = 36.12 -0.65 Nasdaq-100 Volatility Index (VXN) = 44.33 -0.55 ----------------------------------------------------------------- Put/Call Ratio Call Volume Put Volume Total 0.75 569,482 427,474 Equity Only 0.56 424,521 237,173 OEX 1.89 23,486 44,493 QQQ 1.27 44,692 56,707 ----------------------------------------------------------------- Bullish Percent Data Current Change Status NYSE 39.5 - 1 Bull Correction NASDAQ-100 33.0 - 2 Bear Confirmed Dow Indust. 13.3 - 3 Bear Confirmed S&P 500 33.0 - 2 Bull Correction S&P 100 28.0 - 1 Bear Confirmed Bullish percent measures the number of stocks in an index currently trading on a buy signal on their point and figure chart. Readings above 70 are considered overbought, and readings below 30 are considered oversold. Bull Confirmed - Aggressively long Bull Alert - Cautiously long Bull Correction - Pause or pullback in upward trend Bear Alert - Take defensive action if long Bear Confirmed - High risk if long, good conditions for shorting Bear Correction - Pause or rebound in downtrend ----------------------------------------------------------------- 5-Day Arms Index 1.41 10-Day Arms Index 1.26 21-Day Arms Index 1.34 55-Day Arms Index 1.34 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 1667 1174 NASDAQ 1633 1457 New Highs New Lows NYSE 60 89 NASDAQ 85 98 Volume (in millions) NYSE 1,759 NASDAQ 1,370 ----------------------------------------------------------------- Commitments Of Traders Report: 02/18/02 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 added 11,000 contracts to the long side and 9,000 to the short side, for a net reduction to the overall short position. Small traders took 5,600 contracts off the long side and 4,000 off the short position. Commercials Long Short Net % Of OI 01/28/03 422,232 468,586 (46,354) (5.2%) 02/04/03 414,543 465,678 (51,135) (5.8%) 02/11/03 412,333 472,156 (59,823) (6.8%) 02/18/03 423,871 481,871 (58,000) (6.4%) Most bearish reading of the year: (111,956) - 3/6/02 Most bullish reading of the year: ( 16,472) - 10/01/02 Small Traders Long Short Net % of OI 01/28/03 142,734 85,567 57,167 25.0% 02/04/03 151,174 93,439 57,735 23.5% 02/11/03 161,126 95,618 65,508 25.5% 02/18/03 155,475 91,102 64,373 26.1% Most bearish reading of the year: 36,513 - 5/01/01 Most bullish reading of the year: 114,510 - 3/26/02 NASDAQ-100 Commercials reduced the long side by 1,000 contracts and the short side by 3,000. Small traders reduced long positions by 4,000 contracts and added 500 contracts to the short side. Commercials Long Short Net % of OI 01/28/03 37,955 49,321 (11,366) (13.0%) 02/04/03 40,934 50,992 (10,058) (10.9%) 02/11/03 39,412 53,818 (14,406) (15.5%) 02/18/03 38,486 50,501 (12,015) (13.5%) 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 01/28/03 25,814 7,576 18,238 54.6% 02/04/03 25,573 8,648 16,925 49.5% 02/11/03 29,667 8,915 20,752 53.8% 02/18/03 25,482 9,425 16,057 46.0% Most bearish reading of the year: (10,769) - 06/11/02 Most bullish reading of the year: 19,088 - 01/21/02 DOW JONES INDUSTRIAL Commercials reduced long positions by 1,000 contracts and left the short side close to unchanged. Small traders reduced the net short position by 500 contracts. Commercials Long Short Net % of OI 01/28/03 16,013 11,574 4,439 16.1% 02/04/03 17,596 11,232 6,364 22.1% 02/11/03 19,826 11,800 8,026 25.4% 02/18/03 18,812 11,939 6,873 22.4% 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 01/28/03 4,838 7,836 (2,998) (23.7%) 02/04/03 4,583 9,424 (4,841) (34.6%) 02/11/03 5,390 9,300 (3,910) (26.6%) 02/18/03 5,561 8,973 (3,412) (23.5%) Most bearish reading of the year: (8,777) - 10/12/01 Most bullish reading of the year: 1,909 - 1/16/01 ----------------------------------------------------------------- ************************Advertisement************************* If you 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 FUND SCREEN ****************** Schwab Select List: Large-Cap Funds Over the next few weeks, we will be using Charles Schwab's Select List to help identify no-load, NTF funds in various asset classes starting with large-cap stock funds. Mutual funds that appear on the Schwab Select List have been carefully screened by the Schwab Center for Investment Research to meet strict selection criteria, making for a great starting point in your search for the suitable fund(s). All of the funds on the list are available on a no-load basis I believe, with several funds available on a no transaction fee (NTF) basis through Schwab. They may be available on a "NTF" basis through other leading mutual fund networks as well. In week one, we'll focus on large-cap U.S. stock funds. In week two, we'll concentrate on mid-cap and small-cap U.S. stock funds. Then, in week three, we'll look at international stock funds and in week four, we'll explore partial equity (balanced) funds. In week five, the last week of our 5-part series, we'll concentrate on taxable bond funds. Hopefully, in the next five weeks, we'll cover an investment class that is of particular interest to you. Each week our process will put Schwab's Select List funds to the test, comparing them primarily based on return, risk and expense relative to their broad peer group, but also considering factors such as manager tenure and investment style/strategy. The final result each week will be one, two or three funds within the peer group that we like now. In other words, if we had to select one or two funds from each peer group, which would they be? We will find out together, as we go through the screening and evaluation process. Screening/Evaluation Process Conveniently for us, there are 21 Select List funds in the large cap U.S. stock fund group, a reasonable number of funds to start with. Some of the names may be familiar to you if you have come to this website before. For example, just last week we spoke of the Mosaic Investors Fund (MINVX), an excellent large-blend fund managed by Jay Sekelsky, Madison Investment Advisors, since 1990 in our weekly Fund Family series. Just about all of these funds have been mentioned at one time or another on this website, so I trust you can find one or more funds to use as part of your long- term financial plan. Below is a summary of the 21 Schwab Select List funds in the U.S. large-cap stock fund group. Schwab Select List Funds: Large-Cap U.S. Stock Funds -Parnassus Equity Income (PRBLX) Large Value -Thompson Plumb Growth (THPGX) Large Blend -Dodge & Cox Stock (DODGX) Large Value -Jensen (JENSX) Large Growth -PBHG Large Cap Value (PLCVX) Large Value -Ameristock (AMSTX) Large Value -Excelsior Value & Restructuring (UMBIX) Large Blend -Fidelity Independence (FDFFX) Large Growth -Janus Growth & Income (JAGIX) Large Growth -Federated Capital Appreciation (FEDEX) Large Blend -ABN AMRO/Chicago Capital Growth (CHTIX) Large Growth -PBHG Large Cap Growth (PBHLX) Large Growth -Whitehall Growth (WHGFX) Large Growth -Mosaic Investors (MINVX) Large Blend -Buffalo USA Global (BUFGX) Large Blend -Sound Shore (SSHFX) Large Value -Oakmark I (OAKMX) Large Value -Vanguard 500 Index (VFINX) Large Blend -Neuberger Berman Focus (NBSSX) Large Blend -Papp Stock (LRPSX) Large Growth -Clipper Focus (PBFOX) Large Value Since most mutual fund investors have long-term goals, we first compared fund performance over the trailing 10-year period thru January 31, 2003 per Schwab.com (powered by Morningstar). Here, we found that three funds really stood out in terms of their 10- year average annual total return performance, as follows: Highest 10-Year Average Annual Returns: +14.6% Excelsior Value & Restructuring (UMBIX) +13.6% Dodge & Cox Stock (DODGX) +13.3% Thompson Plumb Growth (THPGX) Five other funds on the Select List had annualized total returns of at least 10% over the trailing 10-year period: Oakmark, Janus Growth and Income, Parnassus Equity Income, Sound Shore, and the Federated Capital Appreciation Fund. The S&P 500 index returned an average of 9% a year over that period, so each of these funds has outpaced the S&P large-cap index benchmark and similar funds over the past decade. The Parnassus Equity Income Fund (PRBLX) sported the best 5-year average return thru January 31 of 9.45%, beating the rest of the funds by a wide margin. The next best 5-year annualized returns were 7.6% by Thompson Plumb Growth Fund, and 7.1% by Dodge & Cox Stock Fund. For comparison purposes, the S&P 500 index produced an average annual loss of 1.3% during the trailing 5-year period. PBHG Clipper Focus (PBFOX) wasn't around the full five years but sports the highest average annual return for the trailing 3-year period through January 31, 2003 per Schwab.com. It gained 13.8% on an annualized basis the last three years, while the S&P large capitalization index lost 13.8% per year on average for the same period. Seven other funds on the list have generated a positive net return (annualized) for investors over the past three years. We next turned to Morningstar.com to score the funds on the list based on our specific selection criteria. Rather than customize the default scoring criteria, we simply added one more criterion for long manager tenure. Below is a summary of the Score screen criteria and importance we assigned to each criterion (with a 10 being most important, 1 being least important). Morningstar Score Tool Criteria: 3-Year Return (5 Importance) 5-Year Return (5 Importance) Low Expense Ratio (5 Importance) High Star Rating (10 Importance) High Earnings Growth Rate (5 Importance) Low P/E Ratio (5 Importance) High YTD Return (5 Importance) Long Manager Tenure (5 Importance) We weighted the high star rating a "10" to give more importance to a fund's performance (adjusted for risk). Five funds topped the list with scores between 40 and 41, as follows: Morningstar Score Tool Results: 41 Dodge & Cox Stock (DODGX) 41 Mosaic Investors (MINVX) 40 Ameristock (AMSTX) 40 Parnassus Equity Income (PRBLX) 40 Janus Growth & Income (JAGIX) So, on the basis of performance over the past 3-year and 5-year periods, and taking into account these other factors, the above funds scored the best. While it omits the top 3-year performer, PBHG Clipper Focus, that fund has struggled of late, falling by 11% since December 31. That has me a little concerned since it has lost twice as much as the market (S&P 500) so far this year. Its concentrated style produces some strike outs along with the home runs, so those seeking less volatility may prefer its older sibling, the Clipper Fund. Other funds on the list with above average to high relative risk versus their respective category peers include Whitehall Growth, Buffalo USA Global, Excelsior Value and Restructuring, Federated Capital Appreciation, Fidelity Independence, Neuberger and Berman Focus, Oakmark, PBHG Large Cap Growth, PBHG Large Cap Value, and the Thompson Plumb Growth Fund. However, the conservatively run Thompson Plumb Growth Fund is truly a growth-oriented stock fund that because of its prudence lands in the large-blend group. If it were compared with other large-cap growth funds, it certainly would have a better risk rating, so I wouldn't rule it out given its superior long-term record of performance. We next looked to see which funds have the lowest expense ratios and longest manager tenures. Nine funds on the list have "below average" expense ratios of less than 1.00% of assets (per annum). The funds with the lowest expense ratios, per Morningstar are as follows: Lowest Annual Expense Ratios: 0.18% Vanguard 500 Index (VFINX) 0.54% Dodge & Cox Stock (DODGX) 0.77% Ameristock (AMSTX) 0.86% Janus Growth & Income (JAGIX) 0.87% Neuberger & Berman Focus (NBSSX) 0.94% Excelsior Value & Restructuring (UMBIX) 0.98% Sound Shore (SSHFX) 0.99% Mosaic Investors (MINVX) The Jensen Portfolio (JENSX) and the Parnassus Equity Income Fund (PRBLX) were right behind with an annual expense ratio of 1.0% of assets. Several of these low-cost leaders are also among the top long-term performers, so low expenses can help boost returns over time relative to the general stock fund universe. Only two portfolio managers have longer tenures than Gus Sauter's Vanguard 500 Index Fund (15 years). Harry R. Hagey has been with the Dodge & Cox Stock Fund for 36 years, while Harry Burn III has managed the Sound Shore Fund for the last 18 years. Eight equity managers on the list have tenures of ten years or more, adding to their general appeal. Favorite Funds Based on return, risk, expense, management style and tenure, and other factors, we like the five funds that scored the highest in Morningstar's scoring system: Dodge & Cox Stock (DODGX), Mosaic Investors (MINVX), Ameristock (AMSTX), Parnassus Equity Income (PRBLX) and Janus Growth & Income (JAGIX). In each case, you can attribute the fund's high score to its current portfolio manager, a good thing. And, each of the five funds has an annual expense ratio of less than 1.00% of assets, making them cost competitive. Dodge & Cox Stock Fund (DODGX) was launched in 1965 and today has $14 billion in net assets, a testament to its superior historical performance. It invests in mid-cap and large-cap stocks that are "cheap" on a range of valuation measures. Because it maintains a strict value discipline, the fund can sometimes trail other funds when value stocks/styles are not in favor. Still, the fund's low expense and seasoned management team add to its appeal, making it a fine core holding for the long-term. It has more mid-cap stock exposure than other large-cap value funds, but that hasn't caused fund volatility to be excessive. For average relative risk, this fund has produced "high" returns over all trailing periods versus similar funds. Ameristock Fund (AMSTX) has a value-driven style also but invests primarily in giant-cap and large-cap stocks. Manager Nick Gerber takes a very long-term view (15-30 years) when selecting equities and favors companies with proven business models; hence, his main emphasis on the largest value stocks. Low relative expenses, low annual turnover and high tax-efficiency should appeal to buy-hold investors, including those in regular (taxable) accounts. Versus its large-value peers, the fund has produced "high" returns, with average relative risk over time. Parnassus Equity Income (PRBLX) is another value-driven fund that has produced strong returns in relation to its peers over time, while avoiding "excessive" risk. In fact, its risk level is rated by Morningstar as below average versus other large-value funds. Todd Ahlsten took over for long time manager, Jerome Dodson, in May 2002 but has been an analyst and director of research at Parnassus since May 2001. He served as this fund's co-manager from May 2001 until Dodson's departure, and now is the fund's sole manager. Mosaic Investors (MINVX) has been deftly managed by Jay Sekelsky since 1990, employing a blend a value and growth characteristics in the management of fund assets. He invests primarily in giant- cap, large-cap and mid-cap stocks, for an overall large-cap bias. According to Morningstar, the fund offers one of the better risk- reward tradeoffs in the large-blend category. Over time, it has produced above average returns, with below average risk relative to other large-cap blend funds. Of these five funds, it had the lowest average P/E, contributing to its below average volatility. The $5.2 billion Janus Growth & Income Fund (JAGIX), managed by David Corkins (since August 1997), is categorized as a large-cap growth fund by Morningstar. It's managed more aggressively than most growth and income funds, but has maintained "below average" risk relative to other large-growth funds, while producing above average relative returns for investors. Morningstar states that the fund may not be for style purists, since Corkins has limited the fund's tech exposure, normally fertile ground for pro-growth funds. It tech takes off, this fund may not be able to run with the pack. We'll see. Janus is known as a growth manager, so it is likely to return to its "growth" stripes when growth equities return to favor. Below is a performance summary for the five fund finalists using Morningstar data through February 24, 2003. The 10-year numbers are as of January 31, 2003. 5-Year Average Annual Returns: + 5.6% Dodge & Cox Stock (DODGX) 1st Percentile + 0.1% Mosaic Investors (MINVX) 10th Percentile + 4.1% Ameristock (AMSTX) 1st Percentile + 8.4% Parnassus Equity Income (PRBLX) 1st Percentile + 1.7% Janus Growth & Income (JAGIX) 6th Percentile 10-Year Average Annual Returns: +13.6% Dodge & Cox Stock (DODGX) 2nd Percentile + 9.3% Mosaic Investors (MINVX) 14th Percentile + -.-% Ameristock (AMSTX) N/a +10.6% Parnassus Equity Income (PRBLX) 11th Percentile +10.7% Janus Growth & Income (JAGIX) 3rd Percentile Note that the Ameristock Fund has not been around for 10 years; hence, no 10-year return or ranking. You can see that although it adheres to a strict value discipline, Dodge & Cox Stock Fund has put up the best long-term investment results over time by a wide margin (among the five funds). Conclusion This week, we showed you five large-cap U.S. stock funds that we like on the Schwab's Select List. We showed you how we got this list and whittled the number of funds down using "scoring" tools and other Morningstar data. The scoring was performed using our criteria and weightings, but you may want to experiment with the tool and see which funds score highly based on your own personal preferences. For more information of the five funds profiled today, visit the respective fund family websites. 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 *********************** Quite a Show That was some intraday reversal. Some might even say that if the news of the past 48 hours wasn't enough to send the markets to new relative lows, then it's time to jump back in from the long side. I'm not quite there yet. 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The Option Investor Newsletter Tuesday 02-25-2003 Copyright 2003, All rights reserved. 2 of 3 Redistribution in any form strictly prohibited. In Section Two: Dropped Calls: TRMS Dropped Puts: None Daily Results Call Play Updates: EMC, ZMH, SLAB, TECD, AMGN, MME New Calls Plays: DGX Put Play Updates: ATK, CB, MHK, VZ New Put Plays: UTX **************** 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: ***** TRMS $42.00 -1.25 (-1.54) While poor results from trials of VXGN's AIDS vaccine slammed that stock lower yesterday, our TRMS play actually rallied on the news, pushing above the $44 level before weakening into the close. In a sort of delayed reaction, TRMS got hammered today with the rest of the market in the early going, falling very close to our $41.50 stop. The bulls managed to drive the broad markets higher in the last two hours of the day on Tuesday, but TRMS really lacked in buying interest, just barely managing to regain the $42 level at the close. While our stop wasn't violated, we're going to let this play go. The stock seems to be losing its lustre and we're moving on to more attractive candidates. Any subsequent rebound should be used as an opportunity to exit the play, not initiate new positions. PUTS: ***** None *********************************************************** DAILY RESULTS *********************************************************** Please view this in COURIER 10 font for alignment ************************************************* CALLS Mon Tue Wed Thu Week AMGN 53.86 -1.16 0.71 Bounce from trend line DGX 53.45 -0.55 1.50 New, Bullish Engulfing EMC 7.68 -0.05 -0.14 Held above support MME 35.24 -0.97 1.21 Sprung off $34 ZMH 44.90 -0.29 1.23 $45 next? SLAB 26.49 0.12 -0.13 On Hold TECD 21.96 -0.66 0.30 Need it back over $22 TRMS 42.00 -0.45 -1.25 Drop, Not convincing PUTS ATK 49.14 -1.96 1.34 Failed at $50 CB 47.25 0.04 -0.96 New relative low UTX 59.55 -1.96 -0.09 New, Industry Exposure VZ 35.59 -0.20 0.14 Testing bottom of range ************************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 ******************** EMC $7.68 -0.14 (-0.36 for the week) EMC took an early dive with the broader markets, following another slew of events from the geo-political arena. North Korea's missile launch and Saddam's defiance of the weapons inspectors as far as destroying his own missiles created quite a stir that was compounded with the lowest Consumer Confidence Index in a decade. Still, none of it was enough to take EMC below the b0ttom of its recent consolidation where it has strong support in the $7.30-$7.50 range. While it has not continued its recent gains, that support has held in spite of recent market weakness. The only company specific news in recent days is a possible agreement between EMC and Flextronics, which has boosted FLEX's stock slightly. The stock has yet to register a change on the PnF chart, which remains in a column of "X" and on a buy signal that was given at $8.00. Aggressive dip buyers may view today's support as a buying opportunity, since the rollover was not strong enough to cancel the buy signal. However, momentum traders will want to look for a move back over $8.50 to initiate new positions. --- ZMH $44.90 +1.23 (+0.94 for the week) Zimmer got off to a nice start with a gain of $1.23 on Tuesday after a small pullback Monday. The stock gave momentum trader targeting a move back over $44 a nice entry as it climbed steadily after testing support at $43.50 while the broader markets crashed down around it early in the session. Relative strength was the story of the day for ZMH. In spite of the Dow and Nasdaq both falling hard to start the day, ZMH was never down more than $0.20. The other positive development comes from a look at the intraday chart. After breaking back over $44.00, the stock consolidated in that region for a couple of hours before moving higher, indicating a struggle between the bears and bulls that was eventually won by the bulls. ZMH then went on to consolidate at $44.50 and then test $45, reaching a high of $44.99 in the last 15 minutes of trading before settling in at $44.96. While it wasn't able to cross that barrier today, the steady gains since the second hour of trading and the close near the high of the day indicate it may only be a matter of time. New entries can look for a pullback to new support at $44, or target a momentum trade above $45. --- SLAB - $26.49 -0.13 (-0.08 for the week) The good news is that SLAB is out performing its peers in the chip sector. The bad news is that means it's trading sideways. Shares of SLAB have been able to maintain their recent gains and the bounce today showed at least some strength near the $26 level for SLAB. When the chip sector gets ready to move higher again, SLAB should be a leader. Right now the SOX has been struggling to break the 300 level and today's lows showed support and a bounce near 280. We'll look for another run back to 300 and bulls will be hoping for a breakout soon. This might be an attractive entry point for bulls and a stop under today's lows would not be too risky for a very conservative trader. More conservative traders may want to wait for the SOX to break over 300 before entering the sector from the long side. Another level to consider for stops would be under $25.50 or under the $25 mark. We're going to leave ours at 23.99 for now. --- TECD $ 21.97 +0.31 (-0.35 for the week) Well, TECD certainly can't be accused of being a slow mover. Last week the stock displayed a bullish trend of steady gains as it filled in the large February 7th gap. Profit-taking on Monday and Tuesday morning erased some of those gains and briefly took TECD below $21.00. But with the NASDAQ rallying sharply during the second half of today's session, the bulls would not be denied. Shares went vertical with about two hours remaining and finished with a 1.4% gain. Suddenly the stock is within striking distance of its relative high at $22.33. In our most recent update we said that some profit taking could be expected to consolidate last week's gains. Now that this has occurred, we feel that TECD will be able to continue towards our upside target at $23.99. As far as new entries are concerned, aggressive short-term traders might want to watch for a move above $22.33. Our stop is set at $20.49. Those looking for less risk could use a stop just under today's low of $20.95. --- AMGN $53.86 +0.71 (-0.74) Proving that it still has relevance, AMGN's ascending trendline once again provided support on this morning's pullback. With the Biotechnology index (BTK.X) deep in the red and well below the $315 support level, AMGN just couldn't buck that weakness and fell to just above $52, before beginning a truly impressive rebound. One factor driving the stock's impressive rally today may have been comments from the company that its sees 25-27% EPS and 30-32% revenue growth for the 2002-2005 time period. Aggressive traders that took advantage of the morning weakness got a great entry into the play, as AMGN recovered all of the early drop and most of the losses from Monday as well, closing at the high of the day. The action of the past few days is a perfect synopsis of how to play AMGN -- buy the dips and harvest gains on the breakout moves. Every time the stock breaks out to a new high (like last Friday), the bears push it back for another test of support, which continues to climb. So it's very likely that the next high-odds entry point will come on a pullback near the $52.50 level (also the site of the 20-dma), just above that trendline, now at $52.15. Aggressive traders that want to game a breakout move really need to wait for AMGN to clear $55 on continued strong volume, but beware of the risks. That strategy has not been fruitful in this stock lately. Raise stops to $52, as a close below the trendline would be a large red warning flag to the bulls. --- MME $35.24 +1.21 (+0.44) There's no question about the volatility of the current market, but some stocks are really starting to behave well. After we began coverage of MME over the weekend, the stock fell right back to solid support at $34 on Monday and after a brief dip this morning, reversed that loss to then trade strongly in positive territory all day. Closing at the high of the day, the stock was 1 penny shy of triggering our play. Recall that we're looking for a trade at $35.25 to convert MME to an active play, and if today's late-day rally continues, we could get that delivered to us tomorrow morning. After that event occurs, there are two viable entry strategies to employ. The first is to enter on the breakout over resistance, while more cautious traders may opt to wait for a subsequent dip to test that breakout level as support. In either event, our stop will initially be set at $32.50, just below strong support and both the 20-dma and 50-dma. ************** NEW CALL PLAYS ************** DGX – Quest Diagnostics $53.45 +1.50 (+0.64 this week) Company Summary: Quest Diagnostics was the result of a 1996 Corning spinoff, and currently holds the title of the world's #1 clinical laboratory. DGX performs more than 100 million routine tests annually, including cholesterol, HIV, pregnancy, alcohol, and pap smear tests. Operating laboratories throughout the US and in Brazil, Mexico, and the UK, DGX also performs esoteric testing (complex, low-volume tests) and clinical trials. The company serves doctors, hospitals, HMOs, and other labs as well as corporations, government agencies, and prisons. Why We Like It: Almost slipping beneath the radar, it has been interesting the stealthy nature of the recent firming in several stocks in the medical sector. It isn't coming from the list of usual suspects either, as the HMO an DRG indices are continuing to pound out new lows. Rather, the strength that is emerging is coming out of those stocks involved in the laboratory testing business. As the biggest player in this arena, DGX is a good bellwether for the group and Tuesday's trading action proved instructive in the vein of comparing reality to investor expectations. the market clearly didn't like what the company had to say when it released earnings and provided guidance back in late January, and the stock plunged to new 52-week lows after Piper Jaffray and Morgan Stanley downgraded the stock soon after earnings. The resultant weakness sent DGX below the $50 level on a closing basis for the first time since September of 2001. But then a funny thing happened. Short-covering hit the market and lifted DGX back above the $50 level on rather strong volume last week. Since then the stock has been bouncing between support at $50 and resistance near $53.75. This morning, the company updated its guidance for Q1, saying it sees its results coming in at the low end of the $0.82-0.87 EPS guidance due to the impact of winter storms and the recent strike by New Jersey physicians. However, DGX did reaffirm its full-year view of $4.00-4.20 EPS. Then a funny thing happened. Rather than trade down on the news, DGX actually caught a bid, and a big one at that. Rebounding from a morning low of $50, the stock surged on strong volume, to end the day with a nearly 3% gain. The PnF chart still looks bearish, but it won't take much to turn it early bullish and we could be in a position to get in early and ride it higher. A trade at $54 will generate a new PnF Buy signal, and give us a tentative bullish price target of $63. Of course, before moving that high, the stock will have to deal with resistance at $55, the bearish resistance line at $58 and then major resistance at $60. But what's life without a few challenges? Any pullback near the $51 level looks like a gem of an entry point, but we aren't likely to get that lucky following today's strong surge. So for those looking to get in on a pullback, we're recommending entry on a dip and bounce from above the $52 level. More cautious traders will want to wait for the confirming breakout over $54 before playing, either entering on the breakout move or on a subsequent pullback to confirm that level as new support. We are initially placing our stop at $50.50, just below today's intraday lows after the opening reaction spike. BUY CALL MAR-50 DGX-CJ OI= 584 at $4.70 SL=2.75 BUY CALL MAR-55*DGX-CK OI=1522 at $1.60 SL=0.75 BUY CALL APR-50 DGX-DJ OI= 10 at $5.40 SL=3.50 BUY CALL APR-55 DGX-DK OI= 5 at $2.55 SL=1.25 Average Daily Volume = 1.27 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 ******************* ATK $49.14 +1.34 (+0.25) After the dramatic slide of the past week, Defense stocks were due for a bit of a rebound and the late-day broad market rebound seems to have been the catalyst for that to occur on Tuesday. Given the depth of the prior slide, today's minor rebound (0.77%) in the DFI index doesn't look like much. Our ATK play actually rebounded stronger than the overall index, launching off the $47.50 support level and trading all the way up to $49.50 before relaxing somewhat at the end of the day. The primary point of concern for the bears though comes from the volume picture. On what was a strong day in terms of price, ATK traded 30% more shares than the ADV, making this its strongest volume day in nearly two weeks. We need to be cognizant that this may be an important reversal session, although with the frequent whipsaws in the market, it could just as easily be a setup for new entries. The first clue will come when the stock tests the 10-dma ($49.74), as a rollover there would make for a solid entry, while a breakout will likely embolden the bulls. At this point, waiting for a rollover to materialize is the prudent strategy for those not yet in the play. Our stop is currently set at $51.50, as a close above that level (taking out the closing highs of the past couple weeks) would confirm that the bulls have taken charge. More conservative traders can use a stop at $50.75, just above the 20-dma. --- CB $47.25 -0.96 (-01.02) The progression of lower highs and lower lows continues, with CB breaking down this morning to trade a new 52-week low of $46.60. Bears that thought they could short the stock with impunity were in for a rude awakening this afternoon though, as short-covering hit the broad market, lifting the stock back above the key $47 level at the close. Despite the late-day rebound though, we have to chalk this up as another bearish victory, as the closing bell left behind another new closing low. As long as the broad markets continue their volatile pattern of rallying one day and selling off the next, the most prudent entry strategy into our CB play will continue to be entering on failed rallies, rather than chasing the breakdowns. Resistance continues to drop, with this rebound likely to stall out in the $48.00-48.50 area, with resistance reinforced by the 10-dma, now at $48.45. Stops should now be lowered to $49.50, just above last Monday's closing high. --- MHK $49.53 +1.03 (+0.70) Just when it looked like MHK was destined to test its recent lows down near $46.50, along comes another short-covering rally to stymie the bears. To be fair, MHK's rebound on Tuesday actually began before the rest of the market really caught fire, as traders reacted to another strong report out of the housing sector this morning. MHK has been testing the $48 level as support over the past 3 days, and when it held up in the face of the broad market weakness this morning, that was all the excuse needed for eager bulls and nervous bears to hit the "Buy" button. But MHK isn't out of the woods just yet, as it is just approaching the descending trendline (right at $50) that has been capping each rally since the middle of December. A rollover at that trendline will provide our next likely entry point into the play, while a break above that line should have the shorts covering more aggressively. With strong resistance just below $51, reinforced by the 20-dma at $50.54, it still seems prudent to keep our stop set at $51.10. --- VZ $35.59 +0.14 (-0.05) As a testament to the rangebound nature of the current market, our VZ play is still trading inside the range defined last Thursday, when an SBC downgrade weighed heavily on the Baby Bells, knocking VZ down to the $34.25 level. Since then the stock has continued to look weak, but not quite weak enough to break below that low. It actually looked like the bears might get the job done this morning, with the broad market deep in the red and the North American Telecoms index (XTC.X) breaking to new multi-month lows. But then along came the short-covering and both the XTC and VZ recovered off their lows. It wasn't a bullish move by any stretch of the imagination, but it was impressive the way the stock was once again pulled back from the brink. The trend is still down, but we need to be aware of the possibility for the stock to stabilize and possibly even recover from the site of its recent lows. We're still looking at the $36 area as the best area to initiate new positions on a rollover, but more conservative traders might want to wait for the stock to break below the $34.25 level before entering. We're maintaining a tight stop at $36.75, just above the still-declining 200-dma. ************* NEW PUT PLAYS ************* UTX - United Technologies - $59.55 -0.09 (-1.97 for the week) Company Summary: United Technologies Corp., based in Hartford, Connecticut, provides a broad range of high-technology products and support services to the building systems and aerospace industries. (source: company release) Why We Like It: UTX is diversified in the defense, elevator and jet engine sectors. While we don't have a bullish or bearish opinion on elevators, there has been weakness in the commercial real estate markets over the past year, in spite of strength in the residential market. That weakness has been highlighted in several Beige Book and Fed reports and would indicate fewer office buildings going up in the recent past or near future. Moving on to UTX's aerospace/defense business, this has not been an investor favorite when it comes to sector choices over the past couple of months. In fact, over the past six weeks, the Defense Index (DFI) has lost 20% of its value and now sits at multi-year lows. As the maker of Black Hawk Helicopters and jet engines for both commercial and military use, UTX has exposure to both industries. The commercial airlines have not fared well, either, with many delaying new plane deliveries and seeing a decline in the leasing business. While the troubles of the airlines have been well documented, companies that make the parts and engines for the planes have escaped some of the headlines. UTX is one such company and the bears have had it in their sights since the middle of January. After topping out just below $67, the stock rolled over hard, bounced from just below $60 and has now moved back below that level. The last rollover, touching down for the second time at $59 on the point and figure chart, constituted a breakthrough of the bullish support line, which rises at a 45-dgree angle and gave UTX its last bounce. With that line now broken, the only barrier to a more significant drop appears to be the $58.50 support level. It bounced from $58.50 on the last drop and again this morning. There is some support in the $55-$56 range, but we will be targeting another trip toward $49, which is its more recent support level. The current bearish vertical count is $51, which would coincide nicely with that support at $49. As a Dow stock, UTX will no doubt be carried or dropped along with other stocks in the group, as program trading scoops the group along. However, the stock under-performed the Dow today, dropping into the red, while the Dow's mid-day reversal took it up 50 points. UTX's exposure to the airline and defense business should continue to keep it heading south, but just to be sure we don't expose ourselves to another bounce in the same area, we will use a trigger at $58.24 to assure a support break. We will target $50 and place our stop at $63.10, just above the converging 21, 50 and 200-dmas. BUY PUT MAR-60*UTX-OL OI=1943 at $2.70 SL=1.15 BUY PUT APR-60 UTX-PL OI= 65 at $3.80 SL=1.90 Average Daily Volume = 2.15 mil ************************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 Tuesday 02-25-2003 Copyright 2003, All rights reserved. 3 of 3 Redistribution in any form strictly prohibited. In Section Three: Play of the Day: CALL - DGX Traders Corner: Trading Systems Futures Corner: Managing Risk via Pivot Analysis ********************** PLAY OF THE DAY - CALL ********************** DGX – Quest Diagnostics $53.45 +1.50 (+0.64 this week) Company Summary: Quest Diagnostics was the result of a 1996 Corning spinoff, and currently holds the title of the world's #1 clinical laboratory. DGX performs more than 100 million routine tests annually, including cholesterol, HIV, pregnancy, alcohol, and pap smear tests. Operating laboratories throughout the US and in Brazil, Mexico, and the UK, DGX also performs esoteric testing (complex, low-volume tests) and clinical trials. The company serves doctors, hospitals, HMOs, and other labs as well as corporations, government agencies, and prisons. Why We Like It: Almost slipping beneath the radar, it has been interesting the stealthy nature of the recent firming in several stocks in the medical sector. It isn't coming from the list of usual suspects either, as the HMO an DRG indices are continuing to pound out new lows. Rather, the strength that is emerging is coming out of those stocks involved in the laboratory testing business. As the biggest player in this arena, DGX is a good bellwether for the group and Tuesday's trading action proved instructive in the vein of comparing reality to investor expectations. the market clearly didn't like what the company had to say when it released earnings and provided guidance back in late January, and the stock plunged to new 52-week lows after Piper Jaffray and Morgan Stanley downgraded the stock soon after earnings. The resultant weakness sent DGX below the $50 level on a closing basis for the first time since September of 2001. But then a funny thing happened. Short-covering hit the market and lifted DGX back above the $50 level on rather strong volume last week. Since then the stock has been bouncing between support at $50 and resistance near $53.75. This morning, the company updated its guidance for Q1, saying it sees its results coming in at the low end of the $0.82-0.87 EPS guidance due to the impact of winter storms and the recent strike by New Jersey physicians. However, DGX did reaffirm its full-year view of $4.00-4.20 EPS. Then a funny thing happened. Rather than trade down on the news, DGX actually caught a bid, and a big one at that. Rebounding from a morning low of $50, the stock surged on strong volume, to end the day with a nearly 3% gain. The PnF chart still looks bearish, but it won't take much to turn it early bullish and we could be in a position to get in early and ride it higher. A trade at $54 will generate a new PnF Buy signal, and give us a tentative bullish price target of $63. Of course, before moving that high, the stock will have to deal with resistance at $55, the bearish resistance line at $58 and then major resistance at $60. But what's life without a few challenges? Any pullback near the $51 level looks like a gem of an entry point, but we aren't likely to get that lucky following today's strong surge. So for those looking to get in on a pullback, we're recommending entry on a dip and bounce from above the $52 level. More cautious traders will want to wait for the confirming breakout over $54 before playing, either entering on the breakout move or on a subsequent pullback to confirm that level as new support. We are initially placing our stop at $50.50, just below today's intraday lows after the opening reaction spike. BUY CALL MAR-50 DGX-CJ OI= 584 at $4.70 SL=2.75 BUY CALL MAR-55*DGX-CK OI=1522 at $1.60 SL=0.75 BUY CALL APR-50 DGX-DJ OI= 10 at $5.40 SL=3.50 BUY CALL APR-55 DGX-DK OI= 5 at $2.55 SL=1.25 Average Daily Volume = 1.27 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 ************** Trading Systems By Leigh Stevens lstevens@OptionInvestor.com You may well know that, as a trader, you are pitted against some quick reacting fellow traders that seem to place orders in a heartbeat. Ever wonder why the order flow at market turning points is so fast? – besides the fact that there are a number of sharp professional traders (e.g., so-called “scalpers”) who trade for small index option moves, there is also an order flow from trading system “signals” that are generated in an instant. Suppose you sense that market momentum MAY be starting to shift – no sooner than you sense it, let alone react to it, buy or sell orders are streaming in. Ever wonder why? Well, one reason is the number of computerized trading systems that are being used. Technical trading systems are a product of the computer age, in that computer power is what has allowed System Testing And Development which I may refer to my its acronym “STAD”. Trading systems are typically composed of a set of entry and exit conditions that are set up in specialized software. The most widely used software is TradeStation. They are in the forefront of this activity and the company provides many seminars on the STAD (System Trading And Development) approach – moreover, there are a substantial number of TradeStation user groups out there that meet and swap ideas. When was the last time you met to share trading ideas with a like-minded group of fellow option traders? Probably never, but these groups are out there and are very dedicated to constantly improving their trading systems. There are also books on devising and using trading systems, such as by Martin Pring. TradeStation (the company) has developed some of their own resource materials; for example, basic booklets on designing trading systems, which I found to be excellent. If I mention TradeStation a bunch it’s cause they are the ones that have a business model based on selling and promoting this type of trading software. No one has been able to catch up to them in this regard, as far as I know. The basics of what “systems trading” is, is the subject of this Trader’s Corner column. While learning how to set up trading systems takes the right software and some dedication, the basics are not all that difficult, particularly such tools as optimization. I think its something that well-informed option traders should at least know is out there as its part of the “competition” so to speak. These entry and exit conditions must be “back-tested” on historical market data to see how profitable these “trigger” conditions for entry and exit would have been in the past. Back- testing, in turn, allows refinement of the technical rules and is another key part of STAD -- without computer applications to handle this, trading systems could have not have evolved as a popular means for systematic investing and trading. Finally, use of the method going forward must be monitored to prevent a serious drawback of the systems approach – that of “curve-fitting”, which is finding a set of rules that worked perfectly with the benefit of hindsight and past events but will not necessarily be effective going forward in new types of market conditions and cycles. I will concentrate on demonstrating some basics of trading systems and not so much on the pitfalls and shortcomings of developing and using trading systems. There are strengths and weaknesses in the “systems approach”, but this discussion can be left to a specialized study of trading systems, should you become interested in applying technical analysis in this manner. I would just note that the obvious appeal and a strength of trading systems very much relates to the common investing and trading pitfalls – lack of a plan and discipline in carrying out a plan that includes rigid risk management principles and the difficulties in taming negative emotions like fear, greed and “fantasy” – seeing market conditions in a way that reflects our bullish or bearish bias rather than objectively. As I said, specialized computer applications are required to develop and use trading systems. The one I am familiar with is TradeStation. The TradeStation application product is also probably the best known for trading systems development in use by individuals – although many institutional traders also use this or similar software. The software that allows trading system development and testing doesn’t look that different from ordinary charting applications – there is a real time (or end-of-day) data feed, which charts and applies chart markings (e.g., trendlines), indicators and other studies; e.g., fibonacci retracements. The similarity stops here as there is a vast amount more involved and which makes the software a relative memory hog – the faster computers and a more memory (RAM) are very desirable. Trading systems can be broadly broken down into ones that use 1. technical indicators or, ones that use 2. chart patterns or, a combination of both methods. The validity of each approach stems from a basic principle of technical analysis – the knowledge that market cycles repeat and are identifiable. The sample systems I employ might be “applied to” – tested on – daily or weekly charts, but systems that employ intraday data are not any different in construction. The concept is that systems calculate a certain number of “bars” or trading periods – whether this is 5, 10 or 60 minutes, a day or a week. INDICATOR-BASED TRADING SYSTEMS A popular technical indicator, of the “oscillator” type study, is the relative strength index or RSI. In the past it has been hard to identify how well the RSI worked in terms of its use as a buy or sell “signal”. A rule-based trading system using the RSI is demonstrated here as written in the TradeStation programming language (i.e., EasyLanguage): This may all look “greek” to you! However, it’s not that complex. First you define some terms or “inputs”. Then you define a condition involving those inputs. Lastly, the trading rules are defined; e.g., above it’s the “BUY RULE” and “SELL SHORT” rule. The sell short rule in options will typically be to buy puts. It doesn’t much matter – the system is generating a “sell signal” and you decide how you will attempt to profit from a decline. A common use of the RSI is to buy a market or individual item (a financial instrument) when the RSI is registering an oversold or overbought condition – for example, buying below 30 and selling above 70. However, because markets can stay at overbought or oversold readings for some time, the system shown above takes a position only when the RSI crosses ABOVE 30 or BELOW 70 – that is only when the RSI is retreating from an extreme. Early exit may be desirable if the RSI moves back into those extreme readings. Such a move is an alternative exit “signal” as shown in the way the system is written. PATTERN RECOGNITION SYSTEMS Most investors and traders that analyze charts based on technical analysis principles will tell you that they are looking for clues to future market direction based on particular patterns that they have found meaningful. For example, we want to spot any period of a few days duration, when a market begins making higher daily highs or lower daily lows, relative to the preceding session. You find, for example, that its quite meaningful in terms of predicting a good-sized advance in the indexes or stocks you follow, when there are at least three days of higher highs. The trading system rule that defines this “condition” can be quite simple. First we define the condition we are looking for: a high greater than (>) the high of one  bar ago and that the high of 1 bar ago is also greater than the high of two  bars ago and the high of 2 bars ago is greater than all the high of three  bars ago – all conditions must be true. The reverse situation applies to a series of lows less than (<) than the 1-3 bars preceding it. These system “rules” can be written in a shorthand form within the application, such as in TradeStation’s EasyLanguage as: Condition1 = High > High and High > High and High > High; Condition2 = Low < Low and Low < Low and Low < Low; If Condition 1 then buy this bar on close; If Condition2 then sell this bar on close. (“If condition 1” means that there is a fulfillment of the rules making up “Condition1”.) This is about as simple as a trading system gets. Exit in the above system is triggered only by the reverse conditions and there is always a position in the market, at least absent the addition of a stop-loss “rule”. Entire trading systems, and very profitable ones at that, are sometimes constructed this simply. The software application usually then triggers an audible and visual alert when a trading system, applied to any market or individual item, is triggered – for example, when you download your end of day data or are trading in real time with a live (real-time) data feed. STOPS – There can be rules to exit long if there is a “key downside reversal” and exit short positions if there was a “key upside reversal”. You can also build in stop protection and test the results of different size stops; e.g., stop out in OEX if, after entry, there is an adverse move of 3 points. BASICS OF TRADING SYSTEM DEVELOPMENT An exit is assumed if a position contrary to the original is triggered. If the “system” is long and short conditions are met, selling triggers both an exit and a new position on the sell side, whether that is a short (e.g., of QQQ) or buying Index puts. Creating the systems “rules” is only part of the process of creating profitable trading systems. A trading strategy should have components that govern: 1. entering the market 2. exiting the market while capturing profits 3. exiting the market in order to minimize losses The above three components often involve three different rules and corresponding “signals” when the conditions (the system rule or rules) are met. For example, if you create a “signal” that enters the market based on a momentum indicator, you add a “trailing” stop signal that will capture profits and a stop-loss exit signal that will limit losses. A trailing stop is one where the “rule” is that a stop is in place that “trails” the current price by some amount; e.g., 5 points in OEX. An initial stop might be 3 points, then once the Index has moved in your favor, a trailing stop condition kicks in. Again, these are common elements of trading systems but, there are no RULES to say what rules have to be in your trading system. Once you have a well-defined set of rules to enter and exit positions and perhaps a system of risk protection or stops (exits), it is then necessary to see how well the ideas comprising the systems performed in the past. This is basically WHY you have to have defined rules – only by defined rules, can the software “apply” the system to a market; e.g., show the results of the system to the last 3 years of OEX price history. Testing involves applying the system to as much price history as can find – this could be 5 or 10 years or more. “Optimization” of a rule-based system is often applied here – “optimization” is a computerized test to determine WHICH variables (e.g., which specific moving average or averages) resulted in the most profitable or the most consistent profits for the back period being examined. Or, to use our above example, which “length” setting of RSI works best along with which specific overbought or oversold extreme is the most profitable as the “trigger” point for trade entry. What the software does is test all possible combination of lengths and overbought/oversold extremes – or, the ones that had the greatest profits. For example, the outcome may be to use a 17 period RSI, and sell after the RSI retreats from a reading above 75 and buy when the indicator rebounds from an extreme below 25. MORE ADVANCED - Such techniques as “walk-forward” optimization can guard against the tendency to select only variables in indicator or pattern- recognition systems that fit past conditions, but that might not work as well going forward – the “walk-forward” technique involves testing some period for the most profitable system inputs, then applying them for a later period and adjusting the values, then testing “forward” again. Regardless of the rules and markets, one of the things that has to be on your checklist when studying results is why did the losing trades lose money? How are they different from the winning trades? It is important to scrutinize the losing trades and investigate what happened on each occasion. The software applications that have well-developed systems testing and development capabilities, have templates and tools that allow the study of all these aspects of trading system results. Analysis of the biggest losing trade is a starting point to see how a system doesn’t work, so there are no ‘holes’ in the system rules though which a trade could slip and cause significant losses or more that the maximum you are willing to take. A system should be studied on two levels: 1. As a trading strategy that gives positive trading results or the net results of the strategy over time And – 2. At the trade-by-trade level to determine is the individual trades are “normal” compared to one another and to the group. For this type of analysis to be correct, all trade results need to be comparable to one another. Since we are working in the financial world, this means that we should see all our results in terms of dollars (or monetary units). For example, it’s not correct to compare the return on investment of buying 100 shares of a 10-dollar stock with buying 100 shares of a 100-dollar stock. The comparison would only make sense if buying or selling some set dollar amount of each; e.g., $10,000. SUMMARY OF THE TRADING SYSTEM APPROACH Regardless of whether you have any interest or inclination to use trading systems now or ever, it is useful to know that there is an option to supplement (or substitute) what is typically the more subjective and personal methods we use to make market decisions. I find that the more investing and trading experience that I have, the easier it is becomes to define what may be sound “rules” or conditions that need be met to get into a stock or other market. Moving from the stage of ideas that “may be” profitable to back- testing these rules is a fascinating and worthwhile process that serves as a “reality check”. Often, through the results of back testing, it becomes apparent that even with a promising system, slight changes will result in an investing or trading method that has even greater profit potential. Systems testing and development might be something you are not immediately attracted to, but is something that is may be useful after a lengthily experience in using technical analysis. This was the case with me and I thought I would never warm to the approach of a “mechanical system”. I became enthusiastic about this type of application when I saw that it could validate or, invalidate, long held personal beliefs about what kinds of technical analysis techniques worked best as a basis for market action. Moreover, I found that the more I knew about technical analysis and the more months and years that I had observed the unfolding of many different chart patterns, the more I got out of the ability to create trading systems with the new software seen in the 1990’s especially – this was quite the opposite result of what I expected. Systems testing and development is a natural continuation of learning technical analysis, especially for those who are more oriented to the use of computers and software. ************** FUTURES CORNER ************** Managing Risk via Pivot Analysis By John Seckinger jseckinger@OptionInvestor.com If a trade can be put on based on quantifiable analysis instead of emotions, risk can be controlled and traders will certainly have an edge. The session in question is Tuesday, February 25, 2003. The ES contract gapped lower during the "cash open" (9:30 a.m.), first trading underneath the profiled 829 level (50% of the move from February 13th to 18th; 805.25 to 853.25). Moreover, the ES opened underneath the daily S1 reading of 825.50. With the cash opening at 824.25, I kept thinking about the Weekly S2 level of 820. The daily S2 reading was 818.50, and this level certainly had to be respected during the trading session. It is my feeling that the DAILY levels will actually "expire" in importance after a few hours after being hit, while the weekly and monthly levels will certainly keep their significance for a longer period of time. Chart of the ES03H, 5-minute The $64,000 dollar question is, "As a trader, how can you capitalize on this pattern recognition?" A few things come to mind for future trades. Notice that the second relative low around 12:10 p.m. failed to hit the daily S2 level, let alone test the intra-day low at 817.25. At the time, I worried about the price action breaking the possible bullish trend line (blue, for support). It is important to realize that the DOW had not broken its similar trend line (hitting it exactly - see chart below). It is very common for prices to collapse in free-fall mode, set an intra-day low, and then fail to come back and test this initial level. By setting a higher low, a trader can have a possible bullish trend line to use throughout the session. When trading the ES contract, always look for ways to draw a trend line that will be watched by fellow traders. It is also interesting in the chart above how the retracement from S2 to R2 on a daily level provided some levels that traders appeared to be using; 826.25 in particular. In fact, because of this line on my chart at 826.25, going long above the Daily S1 level was questioned. Moreover, the Dow didn't retrace more than 50% of its opening period's range (seen below). Once prices fell under 818.50, I definitely began thinking about a scenario when prices would continue to collapse for the entire session. In fact, I think that selling the ES at 818 would be fine. A loser, yes, but part of my methodology and allowable under any circumstance. Not all trades will be winners. The catch is, as soon as the ES closes back above S2 on a five-minute period, any short has to be covered. This is proper risk management. In this situation, it would have cost a trader roughly 1.50-points. As far as my methodology is concerned, I really would not have been able to predict the move from daily S2 to daily S1; however, the aforementioned relative low just before 12:30 definitely made it clear that shorting the ES contract was risky. A wedge was defined, and it was right at 2 p.m. when traders got their confirmation that bulls were fully in control. I like to disseminate as little as possible, and a trader would have to tell themselves at this moment "If anything, do not be short. Levels under S2 were rejected, and the wedge broke out higher and above the daily S1 level." Objective would of course be the daily pivot, 838. The nine-points is allowable because risk was not as great, possible failure back under S1 at 825.50. Would we have captured all nine points? Doubtful; however, notice how developing a solid set up during the day via pivot analysis can really help odds of a profitable trade. If scalping, a trader can certainly put in a resting order as early as 12:30 p.m. to either buy above 836.50 or sell under the 818.50 level. Either of these trades would be a breakout. Moreover, a trader really could look to sell at 835.50 or buy at 819; however, as noted before, a tight stop would have to be initiated, and then it really would make sense to flip sides (if long, get stopped out and go short) during this unexpected breakout. Looking at the Dow below for confirmation, it was the timeframe from 14:00 to 14:05 that cleared BOTH the top of the wedge at 7808 (daily S1) AND the halfway point of the first period's range at 7817. With that kind of confirmation, a futures trader following the ES contract has to be able to make a decision. A breakout above the S1 level that corresponds to the top of a wedge doesn't come along too often. It was a spike higher in both markets, so I can see how it would be difficult to put on a trade; however, if you blink, or fail to see the move's significance, money will be left on the table. Not shown, nevertheless interesting, is the fact that volume within the ES was significant from 2 p.m. until 2:05; further reinforcing the possibility of a breakout move. Risk in the Dow would be a move back under the 7800 level, which never took place. Chart of Dow Jones, 5-minute In conclusion, what have we learned? When trading futures, try to recognize what the market is looking at. On Tuesday, they were focusing on both S1, S2, and the retracement levels between this area. A higher low was seen, and a wedge developed with an apex between S1 and S2. Now we can get an entry point and define risk. Play the breakout on either side, but make sure you do NOT allow the market to get back into the range of S1 to S2. The upside objective would be the pivot, which was eventually tested. MACD was trending higher, volume spiked, the halfway point of the first five-minutes was cleared in the Dow, and clearly there was a 'shock' to the market. What would I do at the close? Absolutely go flat, since I viewed Tuesday's pivots in both the Dow and ES to be strong resistance. That has not changed. Ask Away, John Seckinger ************************Advertisement************************* ”If you haven’t traded options online – you haven’t really traded options,” claims author Larry Spears in his new compact guide book: “7 Steps to Success – Trading Options Online”. 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