The Option Investor Newsletter Sunday 12-28-2003 Copyright 2003, All rights reserved. 1 of 3 Redistribution in any form strictly prohibited. Entire newsletter best viewed in COURIER 10 font for alignment In Section One: Wrap: Some Have a Beef with Milk Futures Market: Rip Snortin' Flat Index Trader Wrap: Lights On But Nobody Home Ask the Analyst: Rebalancing makes sense Coming Events: Earnings, Splits, Economic Events ! Holiday Schedule Notice There will only be three sections to the OI newsletter this weekend. OptionInvestor will resume coverage of its plays, sentiment, posture, and additional columns on Tuesday, December 30th, 2003. Thank you and happy holidays! *********** Market Wrap *********** Some Have a Beef with Milk by Keene Little In what is typically one of the lightest, if not the lightest, trading days of the year, today matched expectations for a quiet, go-nowhere market. The Mad Bulls, not to be confused with the Mad Cows, are still refusing to let this market drop. Of course they had very little strength today to push it much higher either. But for the week, the DOW closed up almost 65 points and the SPX up a little more than 7 points (that's equivalent to 70 points on the DOW). A look at the more speculative indexes, the NDX closed up almost 18 points for the week while the Russell 2000 closed up about 8 points. So there was no rotation this week--looks like basket buying where the fund managers essentially buy a basket of stocks instead of selectively choosing stocks. The recent rotation out of the speculative stocks into the blue chips was put on hold this week. And all of these gains were essentially in the first two days of the week as the trading on Wednesday and Friday essentially negated each other. The case of Mad Cow disease has been confirmed by a British lab so now begins to long and costly task of figuring out whether or not it's an isolated incident or not. In the meantime, cattle futures are still limit down and expected to be that way into the new year (the price is normally limited to a maximum price change of 1.5 cents per day, but that was increased to 3.0 cents today and the CME said they will likely let the price drop 5.0 cents on Monday). There is expected to be a very large negative impact to the beef industry, and it will ripple through our economy. But because of the reduction in the cost of beef, there was an analyst upgrade for McDonalds' stock based on the assumption McDonalds will have lower costs. I question this as it seems lower sales as consumers shy away from eating beef will have a larger negative impact on McDonalds. Could it be the analyst was trying to protect his company's portfolio which had a heavy exposure to MCD? Nah, that would mean analysts are disingenuous and that they might have ulterior motives, and I certainly wouldn't want to be accused of mistrusting analysts' true intentions since I know they have our best interests at heart (as my tongue is pressed firmly against my cheek). In all seriousness though, the analyst may be right. Through the Mad Cow scare in the U.K., Britains continued to eat large quantities of beef and so far I haven't heard of any huge consumer concerns, yet. The story out of Italy today regarding Parmalat, the very large dairy company, says the U.S. does not have a lock on corporate malfeasance. The company filed bankruptcy as it moves to protect itself after it was disclosed that they systematically falsified their accounting. It also raises a significant question, as it did here after the Enron debacle, about the international auditing firm, Grant Thornton, who has been doing Parmalat's books since 1999. European bourses were closed today so there was no way to gauge how European stocks will react to this news. There were no economic reports today but in other news China lifted its tarrifs on steel imports. U.S. Steel was up on the news, as was Alcoa was the earthquake in Iran. Initial projections were for thousands, if not 10,000, deaths in the city of Bam in central Iran. There was no reaction in the market though. Crude oil and gold did not trade today and the bond market closed up for the day (yields down). In other sectors, the gold and gold/silver indexes topped the list of gainers with a 3.1% and 2.6% gain, respectively. All other gainers were by less than 1% and it's hard to discern anything from that. There were very few losers today, the largest being the biotech index but that was only -0.2%. Interestingly the transportation index was down today while the airline index was up, but all in all, it was a pretty quiet day. The SPX and NDX pushed to a new high for the week today (barely), but again these highs were not confirmed by the DOW. It seems the DOW and the NDX are swapping positions lately as to who is leading to the upside. The SPX can't decide who to follow. However, because the SPX seems to be the most "consistent", I'm using its daily chart below to help me determine what the market is doing. The action in the market the past two half-day sessions has been difficult to decipher as to where the market might be headed. On Tuesday I had mentioned that I thought the market might have peaked, but that the SPX and NDX would look better with one more minor new high. Today we got the one more minor new high in both of those while the DOW hung back and waited. So, my expectations for the market have now been satisfied. Does this mean we're heading down next week? Unfortunately, the price pattern is not as clear as I would like in order to be able to make a more confident call about direction on Monday. However, based on what I see so far, I'm leaning to the downside. The charts below show some details of what I'm seeing. We've been in these ascending wedges which are typically bearish in their outcome. As the ascending wedge is topping, you look for bearish divergences between new price highs and the corresponding oscillator highs. As of today's highs we have that. The reason it's difficult to be confident in this analysis though is because of the light volume. I'm not sure how much that might skew the results of these oscillators. I would like to have seen a clean Elliott Wave pattern (5 waves up) to today's high, followed by a clean 5 waves down. We had neither and I therefore have to guess at the current EW count. I don't like to guess at the count and then make predictions based on that. So while I'm comfortable saying the market has seen its highs, it wouldn't surprise me in the least to still see a poke higher. Considering this Monday is typically bullish, which will be especially true if we have no evil-doer activities, I have a hard time predicting we'll see a down day on Monday. So, whenever I'm in a quandary as to where we are, I have found it's much better to remain flat and wait for clarity in the price pattern. Much better to be sorry I missed a trade than to be sorry I'm in a trade. Let's look at the major indexes, starting with the big picture and working in closer: The SPX 500 (SPX) weekly chart: I showed the DOW weekly chart on Tuesday and mentioned that the fibonacci target, based on an A-B-C correction to the move down from January 2000, would be 10,403 where wave-C = 162% of wave-A, a very common fibonacci relationship in A-B-C corrections. The DOW has so far reached almost 10,376 so 27 points shy of this target (less than 0.3% off). The SPX has overshot its 1089 target by 9 points as of today's high (0.8%). This close to these targets after a 15-month rally is pretty amazing. So have we topped here? I can't say for sure, but the evidence for that is building quickly. Note the ascending wedge we've been in since the March low. The SPX daily chart: The SPX continues to find resistance around the 1096.51 area. If it can break free of this, there is fibonacci resistance between here and 1101. If it drops below the upper line of the ascending wedge, there is a good chance the rally is over--the coffin lid gets closed. Breaking below 1068 and we start nailing the coffin closed, and a break below 1031 padlocks the coffin closed. The EW term for an ascending wedge is an ending diagonal--it is an ending pattern to the overall move. So we've got an ending diagonal on the weekly chart for wave-C of the A-B-C. Now we have another ending diagonal for the final 5th wave of that wave-C. Check out the 60-min chart to see what we have there as well. The SPX 60-min chart: The final push up from December 10th has formed another ending diagonal. So we've got an ending diagonal on the 60-min chart finishing up an ending diagonal on the daily chart which is finishing up the ending diagonal on the weekly chart. These nested ending diagonals are bearish to the nth degree but we're still waiting for price to tell us it's over. After breaking down, price will retrace to the beginning of an ending diagonal. Therefore we should expect price to drop back to at least the March 2003 low. As for this last ending diagonal, the upper line of the ascending wedge on this 60-min chart held back price today. For now we watch the lower line of this ending diagonal. The DOW 60-min chart: The uptrend line for the rally from December 10th held up the decline in the DOW today. After a small throw-over on December 23rd from this ending diagonal it has fallen back inside. It could make another rally high from here (10,403 is that long-term fibonacci resistance target), but if it drops further below this uptrend line, that will be a strong signal the rally is over. My guess going into the weekend is that the DOW topped with that throw-over on the 23rd. But this coming Monday is typically bullish in this holiday period and therefore I'm on guard as to any bearish thoughts. The NDX 60-min chart: The uptrend line from December 17th held up the decline today while the high on December 3rd held the rally. Can you say squeeeeeeze? I believe the battle of the lines will determine the next move in this index, and the market, and therefore needs to be watched closely. My guess, as shown by the blue arrow is that the rally is complete, but will be watching action carefully here. The bearish EW count on the NDX is predicated on price staying below the December 3rd high, so if the NDX violates this, but Nasdaq does not, I'm not sure what to make of that but I'll cross that bridge if and when I come to it. The price action from Tuesday through Friday is unfortunately too muddy to make a confident call in what to expect early next week. We are entering a typically bullish week or so, but the EW picture tells me we either topped or are extremely close to topping. Bullish bets would be risky. The longer we go sideways, like we have the past two half-sessions, the greater the likelihood we'll see a push to new highs. If that happens, we might see inter-market divergences where not all the indexes push to a new high. With the flip-flopping between the DOW and NDX, I'm not sure who would make the next push higher although I suspect the DOW would only because I think institutions are going to try to get out of the more speculative stocks in anticipation of a January correction. It's easier to get out of the smaller stocks before a decline gets underway. While still wary of a rally next week, I'm still cognizant of what I mentioned Tuesday--with everyone expecting a rally, we may not see it. The expected rally around Christmas has effectively not happened. Between Wednesday and Friday, the market lost a little bit of ground. Any new money coming into the market next week, that causes some buying to happen, may just be the opportunity institutions are looking for to sell into. It will be a time to be very careful about your positions, long or short. I don't see any economic reports coming out Monday or Tuesday so we'll be on our own. We will probably continue to see light volume until after New Year's, so be careful in your trading. In these light volume days we see program trades kick in and move the market out of nowhere. I've seen the market move quickly in one direction so that an institution can sell or buy it at a better price which quickly moves it in the other direction. Stops can quickly be triggered and then price moves right back to where it was. Good luck in your trading next week. Be careful--we're close to a top, if not already there, and I expect some volatile action, if not Monday/Tuesday, then certainly after New Year's. Have a great weekend and I'll see some of you in the Futures Monitor bright and early Monday morning. Keene Little ***************************** 2003 Year End Renewal Special ***************************** TOP 50 STOCKS for 2002 SPECIAL INVESTOR GUIDE What better bonus could we give you than the potential to double or triple your money in 2004? 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We will still send it Priority Mail but you will not receive it until three days after your subscription is received. ************** FUTURES MARKET ************** Rip Snortin' Flat Jonathan Levinson The indices made a break for freedom Friday but failed, closing mixed in shallow negative territory on very light volume. With commodity futures markets closed, we had little to go on. Bonds finished in positive territory, and gold futures did not trade the precious metals indices closed higher. Daily Pivots (generated with a pivot algorithm and unverified): Note regarding pivot matrix: The support, pivot and resistance levels above are derived from the high, low and closing price levels by a simple mathematical formula. They are not intended to be predictive of market turning points or to serve as targets, but rather represent the range retracement levels as generated by the pivot algorithm. Do not think of them as market "calls" or predictions. Like any technically-derived indicator or price level, the pivot matrix values should be regarded as decision points at which to evaluate current market conditions. Visit us in the Futures Monitor for our realtime views of the various markets covered here. 10 minute chart of the US Dollar Index The US Dollar Index appears to have been flat on Friday, but the strength in the miners indicates further dollar weakness. Daily chart of February gold February gold did not trade on Friday, but the HUI added 7.16 to close at 236.99 and XAU was higher by 2.56 at 106.77. Daily chart of the ten year note yield The ten year note yield (TNX) dropped 3.7 basis points to close at 4.15%, extending Tuesday's punishment for bond bears further as the daily cycle downphase extended. Bollinger support lowered to 4.091%, an insignificant drop from Tuesday's level. The bond continues to trade in toping territory, with yields in range for a daily cycle bottom. Daily NQ candles The NQ finished bullish for the weak but went out at the low of the day on Friday for an ugly gravestone doji print, dropping 2.50 at 1444. The year high at 1461 was not tested, with an intraday high at 1454.50. Volume was just 535M shares, a nothing day. The daily cycle upphase is still running, but the 30 minute below gave a sell signal that should abort this upphase if it plays out to the bottom of its range. 30 minute 20 day chart of the NQ I've left trendlines off the chart because Prophet has yet to clear the 1.5 day horizontal gap off the chart. By my reckoning, the uptrend is not yet over, but it's close, with the 30 minute cycle rolling over from a lower oscillator high against the higher price high. Below 1437, it should be a quick trip to the significant 1425-30 support level. NQ continues to underperform, and that weakness bodes ill for the broader equity markets. Upside resistance was clarified today, and extended from 1455-61. Daily ES candles The ES touched a new 52 week intraday high today at 1097 but closed at 1093.50. With 357M NYSE shares traded, today's .50 gain on a weak doji star is a great day to simply ignore. Nothing happened today. The oscillators are still very toppy, waiting for any excuse to cycle lower. Bearish or bullish, we expect a correction, and hope that the impetus is merely technical and not external or news-driven. 20 day 30 minute chart of the ES As on the NQ, Prophetcharts makes our work more difficult today, but it looks to me as if the uptrend is still intact. Bearish divergences and a tidy 30 minute cycle rollover have us watching 1092 support, followed by 1090, 1088 and 1085 to the downside. Daily YM candles GE kept grinding out new lows throughout the quiet session, but YM still closed higher by 15 points at 10293. Rising support is being tested here, followed by 10220. The oscillators are topped out and due for a correction on the daily cycle. 20 day 30 minute chart of the YM The YM distinguished itself again by holding its 30 minute cycle upphase into the close. Any weakness on Monday will kick off the downphase, and the price is clearly tiring here, printing a hunchback head and shoulders pattern. A break below 10274 should kick off the downside festivities. 10325 is the upside resistance to watch, but I doubt if we'll see it tested anytime soon. Strength in metals, bonds and equities remains the theme, all hinging on weakness in the dollar. I expect that we're at a significant turning point, but will wait to see the dollar bounce before I let myself believe it. Have a safe and happy holiday weekend, and we'll see you on Monday morning. ******************** INDEX TRADER SUMMARY ******************** Lights On But Nobody Home Jonathan Levinson The SPX printed a new year high Friday above 1098, closing higher by 1.85 at 1095.89, while the Dow closed higher by 19.48 at 10324.67 and the Nasdaq +3.91 at 1973.14. Volume was at the non- existent end of light, with 357M NYSE shares and 536M Nasdaq shares traded. The indices had a great week, considering the mad-cow outbreak, terror threats, Parmalat bankruptcy and overall geopolitical malaise. The Dow added .5%, the SPX .7% and the Nasdaq 1.1%, bringing their year-to-date gains to 23.8%, 24.6% and 47.7% respectively. The volatility indices remained low, optimism remained high, and the Dow and SPX alternated pushing toward new highs as the Nasdaq lagged. Weekly COMPX candles The COMPX closing print at 1973 is just below the now broken rising wedge support line, the first closing break of that line since the March lows. This break should be the start of a significant correction projecting back to the March lows, but again, the weekly close was still higher. The light volume makes the weekly of dubious significance in any event, and a break back above 1980-85 should repair the damage. However, with the oscillators on sell signals following a long, drawn out bearish divergence, any further weakness will be preliminary confirmation that we have seen the top of the rally. Weekly INDU candles The Dow has been a veritable wrench in the technical works, and the positive close this week left a doji bottom at the now- vanquished upper wedge resistance line. This level is now support at 10200, and the weekly cycle oscillators, still on weakening bearish divergences, actually ticked up within overbought territory. Any further strength will set them to trending bullishly. For months, these oscillators have been telegraphing a bearish end to this rising bear wedge. They still are, but the bulls are close to turning it around. Daily OEX candles Turning to our primary trading vehicles, the OEX added .77 on Friday to close at 542.78. The rising channel resistance line was not touched on this latest upleg, and the daily closing print, a gravestone doji, suggests that it won't be. The daily cycle oscillators are configured as bearishly as one could want without actually printing sell signals and any weakness on Monday, however mild, will be sufficient to kick off the long awaited correction. With the weekly cycles very extended to the upside, I expect the pullback here to have solid downside amplitude. First support is at 535, but first significant price confluence is way below at 529, followed by 525. 20 day 30 minute chart of the OEX Note that the rollover depicted on the 30 minute chart is not as pronounced as it appears, because Prophetcharts has left in the Wednesday gap. The uptrend is still failing, but it's not as extended as it looks. Nevertheless, the 30 minute cycle oscillators are printing a strong bearish divergence, and suggest that the next move will be lower. A break below 541 should get the ball rolling. Daily QQQ candles The daily QQQ has become a veritable dog's breakfast, appearing to be resolving itself within a bullish rising triangle. However, the bearish oscillator divergences don't mesh with that interpretation, while the pattern of rising lows does. That said, this week has left a series of doji tops at 36, which is looking like an electric fence. A sustained break above that level targets 36.20 as the bears' last stand, above which the bulls should break into a victory sprint. The daily cycle oscillators are weakening, however, and any further weakness should kick off the next daily cycle downphase. 20 day 30 minute chart of the QQQ QQQ broke below rising wedge support, even allowing for the horizontal chart gap from Wednesday. The 30 minute cycle oscillator gave us a bearish divergence here as well, but the downphase is well advanced, leading me to wonder if there isn't one last 30 minute upphase left in the weakening daily cycle upphase. The resistance levels discussed above are the numbers to watch, and the bearish interpretation requires that 36.20 not be exceeded. Best holiday wishes, and we'll see you on Monday. ************************Advertisement********************************* Option Traders: Pay Attention Use the online options trading system built by option traders for options traders. Featuring direct access to each option exchange, stop and stop loss option orders, contingent option orders, online spreads, fast executions, and rates as low as $1.50 per contract ($14.95 min.). PreferredTrade, Inc. Call 888-889-9178 or Click http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN Member NYSE, Other Principal Exchanges, NFA, MSRB and SIPC ******************************************************************** *************** ASK THE ANALYST *************** Rebalancing makes sense I keep hearing expectations for a pullback in the first quarter of 2004, but I've been hearing about a pullback for several months, where the pullback just hasn't come. Is there a reason, other than "stocks have move up a lot this year," for me to believe that stocks are due for a pullback in early 2004? Hey! I'm like you. I've heard stocks were going to pull back, and I first heard of this in April after the major indices started seeing a nice rebound from their spring lows! I (Jeff Bailey) do think we could see a nice pullback on some profit taking in early 2004, as for the first time in 3 years, the major equity indices are showing gains, which may see some profit taking take place for equities. To try and show what might take place, I'm going to show our "Beetles Balanced Benchmark" portfolio we set up at the end of last year. While it makes more sense for investors to rebalance their portfolios on a quarterly basis, there is often-times some end of year rebalancing that takes place by mutual funds, as fund managers may look to lock in some gains after the first of the year, which will create a capital gain consequence for their shareholders, for mutual fund shares held in a non-tax deferred account. This weekend's column isn't necessarily written for the purposes of predicted a market pullback, but more importantly, is written to show investors how simple it is to rebalance you portfolio, where the act of rebalancing forces a longer-term investor to buy low and sell high. Here's the "Beetle's Balance Benchmark" portfolio we put together at the end of last year, where we took a hypothetical $10,000 and divided that $10,000 in $1,000 increments across 10 different asset classes. Beetle's Balanced Benchmark - 12/31/02 to 12/26/03 Close With no real strategy involved, we set up a very basis hypothetical portfolio at the end of last year, where we could follow various asset classes throughout the year. With three trading days left in 2003, the "Beetle's Balanced Benchmark" currently shows a 19.3% gain, which does NOT include any interest payments received from the bond portion of the portfolio, or dividends received from the equity (stock) portion of the portfolio. One of the most difficult tasks an investor faces is "when do I take profits?" The simple discipline of rebalancing a portfolio does this for an investor and does not take into consideration "market timing" or trying to predict bottoms and tops. As we look at the above portfolio, and the P/L % column, which is calculated off of the December 21, 2002 closing values of the various securities, which I felt represented various asset classed, we see that the Pacholder High Yield Fund (PHF), which is a closed-end "junk bond fund" was the best performer among our fixed income securities, while the U.S. Dollar Index (dx00y) showed a 13.98% decline, as the dollar fell against a weighted basked of 6 major foreign currencies. While we might still have the original $999.94 cents in our account, those dollars may have lost roughly 13.98% of their purchasing power for foreign goods we might purchase in a year's time. But look at what happened in the equity portion of the account. Holy Cow what a year! While gold equities aren't necessarily a true hedge for a falling dollar, look at that 63.31% gain for the AMEX Gold Bugs Index ($HUI.X). While we might not buy the $HUI.X has our "hedge," Newmont Mining (NYSE:NEM) $47.69 has gained 64.27% this year, when benchmarked to its 12/31/02 close of $29.03. Many traders and investors think of Newmont Mining as a "sector bellwether" for gold stocks. While the bulk of an investor's investment capital may be in a tax deferred account, there is still a lot of an investor's capital in taxable accounts. It would be my thinking, that based on an investor's tax situation and advice from their accountant, some investors may be looking to lock in some capital gains to offset losses taken earlier this year, but more likely, after such bullish gains are found this year, there may be some investors waiting until after December 31, to take profits, where capital gains taxes may not have to be paid until April 15, 2005. One thing we might look for, is if we were to think of a "Balanced Fund" or "Hybrid Fund" as they are known in the mutual fund world, is that the fund manager of that fund, not wanting to kick out an overly large capital gains tax to his/her mutual fund clients this late in the year, might be holding a balanced set of assets similar to the "Beetle's Balanced Benchmark" portfolio. If the reallocation of assets was performed in early 2004, here's what a simple rebalancing would have the portfolio looking like. You will note that if not for some rounding due to fractional shares, the portfolio value would still be roughly 11,928.37, where the portfolio is once again equally weighted against the 10 various asset classes, but the #Shares of each asset class is fine tuned (up or down) as the portfolio is bought back into realignment. Beetle's Balanced Benchmark - 12/26/03 Rebalancing I should first note that the "Basis" was derived from Friday's close (12/26/03) and does not reflect what the true cost basis basis would be for each asset class, but by bringing the "Cost" column of each asset class back to an equal amount, it has forced the portfolio, or asset manager to sell some of the outperforming asset classes (take profits), and redistribute those profits to some of the under performing asset classes (buy low, sell high). At a MINIMUM this type of activity should be done once a year by investors in their longer-term portfolios. As you can probably see, this disciplined type of reallocation of assets is NOT market timing, but is a very systematic way where you a portfolio manager looks to bring the RISK of various asset classes back in line, with YOUR longer-term goals and objectives. The above portfolio is not to be thought of as "the classic" portfolio for every age of investor, as a younger investor with a longer time horizon to retirement may well take on greater risk early in their investment years than those that are nearing retirement. However, the above reallocation of assets may give some thought as to various mutual fund managers reallocation their funds in similar fashion, where profits are taken in certain asset classes and reallocated in the first quarter of 2004. Jeff Bailey ************* COMING EVENTS for the week of December 29, 2003 ************* ----------------- Earnings Calendar ----------------- Symbol Co Date Comment EPS Est ------------------------- MONDAY ------------------------------- None ------------------------- TUESDAY ------------------------------ None ------------------------ WEDNESDAY ----------------------------- None ------------------------- THUSDAY ----------------------------- None ------------------------- FRIDAY ------------------------------- None ---------------------------------------------- Upcoming Stock Splits In The Next Two Weeks... ---------------------------------------------- Symbol Co Name Ratio Payable Executable NEOG Neogen Corporation 5:4 Dec 31st Jan 2nd KSWS K-Swiss Inc 2:1 Dec 31st Jan 2nd ACET Aceto Corporation 3:2 Jan 2nd Jan 5th AAP Advance Auto Parts Inc 3:2 Jan 2nd Jan 5th JCI Johnson Controls, Inc 2:1 Jan 2nd Jan 5th CLBK Commercial Bankshares Inc 2:1 Jan 2nd Jan 5th -------------------------- Economic Reports This Week -------------------------- There isn't much on the economic calendar between Christmas and New Year's. Those economists still on the job will be watching Tuesday's Chicago PMI, Existing Home sales and the Consumer confidence report. ============================================================== -For- ---------------- Monday, 12/29/03 ---------------- Help-Wanted Index (DM) Nov Forecast: N/A Previous: 37 ----------------- Tuesday, 12/30/03 ----------------- Chicago PMI (DM) Dec Forecast: N/A Previous: 64.1 Consumer Confidence (DM) Dec Forecast: N/A Previous: 91.7 Existing Home Sales (DM) Nov Forecast: N/A Previous: 6.35M ------------------- Wednesday, 12/31/03 ------------------- Initial Claims (BB) 12/27 Forecast: N/A Previous: N/A ------------------ Thursday, 01/01/03 ------------------ - Markets Closed for New Year's Day - ---------------- Friday, 01/02/03 ---------------- None Definitions: DM= During the Market BB= Before the Bell AB= After the Bell NA= Not Available ************************Advertisement************************* Full Service Brokers Man Financial announces the formation of the OneStopOption Brokerage Group, addressing the demand for personalized, experienced service for both securities* and futures trading within the same firm. 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The Option Investor Newsletter Sunday 12-28-2003 Sunday 2 of 3 In Section Four: Leaps: Holding Pattern Traders Corner: I'm Not My Brother (In-Law's) Keeper, Fortunately! ************************Advertisement************************* Full Service Brokers Man Financial announces the formation of the OneStopOption Brokerage Group, addressing the demand for personalized, experienced service for both securities* and futures trading within the same firm. Licensed Option Principals Andrew Aronson and Alan Knuckman specialize in live assistance of stock*, option* and futures traders. The combination of the proven Man Financial global presence and the convenience of one group for all trading needs provide customers with the tools needed for success. Live Broker and Online Trading Available 888-281-9569 http://www.OneStopOption.com ************************************************************** ***** LEAPS ***** Holding Pattern By Mark Phillips mphillips@OptionInvestor.com It may sound like a broken record, but the price action this week is what we ought to expect for the duration of the year -- slight gains or slight losses, but with no significant change to the overall bullish trend. Mutual fund and hedge fund managers have had a very good year (finally) and they don't want to allow anything to screw that up. Bonuses are riding on that performance. It is my opinion that we've seen the highs for the year for all the major indices - DOW, S&Ps and NASDAQ. We aren't likely to see much strength or weakness between now and January 1st. However, if I'm wrong and we see a rally through the 2002 highs, then I'll have to do some serious re-evaluation after the first of the year. The overall market picture remains much as it has for the past several months. Price action looks over-extended to the upside, with weekly Stochastics still buried in overbought, the VIX at 16.66 isn't far off of its recent multi-year lows and all of the bullish percent readings (with the exception of the NDX) are in some bullish condition, either bull correction or bull confirmed. The NDX is the one lone pocket of weakness in the BP view, as it is solidly in Bear Confirmed and does appear ready to break lower. But for the most part, we're still mired in a market that refuses to sell off - even for a healthy bout of much-needed profit taking -- despite the numerous technical reasons why it should. The uptrends in price on all the major indices are still clearly intact and we haven't yet seen any real internal weakening in the market. No matter how I look at it, this has the feel of a market that is being artificially propped up into the end of the year, to keep the pros bonuses intact. The real test will come in early to mid-January, after the fresh retirement money has been allocated and investors and managers alike will have to decide whether to harvest some significant profits after what has been a very positive 2003. To all of you that benefited from the persistent rise of the past 10 months, be sure to send a letter of thanks to Greenspan and Bernanke for keeping the liquidity train running. It will eventually be in as dire a need of help as the Amtrak, but for right now it is swinging like the New Years Eve party on the train at the end of the movie Trading Places. Is there any way we can put Greenspan in the gorilla suit to share the cage with a real lovestruck gorilla? Now I'd actually pay good money for admission to that event! As I've noted in recent weeks, I've increased my reading regimen significantly over the past couple months and what I've found is that there are some credible arguments on both sides of the aisle. The bulls make the case that with low inflation, low interest rates and an improving economic picture, the major indices are in position to make a continued strong upward push. The bears make a good contrary argument, beginning with the inflation issue. The primary question is "how can inflation be benign if food, energy and healthcare costs are running higher at breakneck speed? The answer is simple -- the government doesn't look at those pieces of data in determining the degree of inflation that exists. Well now, isn't that reassuring. Our real costs for the necessities of life may be going up, but that doesn't really affect the quality of life of the average American. Riiiiiiigggght! There's an uglier side to this inflation picture though and it is hidden within the currency issue. The definition of inflation is that it takes more money to buy a given good or service. That's pretty simple, wouldn't you agree? So if the dollar index (DX00Y) has dropped 27% since early 2002 and nearly 12% just since August, wouldn't it make perfect sense that the price of good and services denominated in dollars should have seen similarly significant rises? But that hasn't been the case, as many prices have declined, while the majority of them have been essentially flat. Could it be that the dreaded Deflation monster really is alive and well and the Fed has managed to successfully hide it through inflation of the money supply? As long as they can stimulate inflation through the increase in the money supply, perhaps they can mask or overwhelm any deflationary effects until such time as true economic growth kicks in -- or so they hope. I don't have any real answers on that front, but I'm an analytical guy by nature. I see the reality of rising commodity and precious metals prices in concert with the falling dollar and think inflation. Then I see the periodic government reports that tell me job growth is improving, the economy is improving and inflation is mild to nonexistent. I've learned through experience that whenever the facts I can observe disagree with official government pronouncements, I should go with the observable facts as they are far more accurate and reliable. That said, the shell game may be sustainable right through the 2004 presidential election and I feel there will be a lot of effort exerted in that direction over the next 10 months. If I'm correct in that belief, we can look forward to a continued strong element of artificiality throughout much of the next year. I think by mid- January we should see some normalcy come back in, but I'm not expecting a major downdraft unless we have a major negative exogenous event to trigger it. It could come in the form of a major terrorist event, a sharp decline in the dollar, a trade war, a real as-yet-unanticipated military conflict, a real energy crisis or any number of other scenarios that my imagination is incapable of conjuring up. But absent such an event, I would look for reasonably normal ebbs and flows within the market, keeping the illusion of a new bull market alive until the election. There's no doubt in my mind that a major correction in the overall market is coming because of the extreme imbalances that still exist, but whether it is coming next week, next month, or a year from now is impossible to say. My market view calls for new lows across all the major indices before this secular bear market has run its course to completion. The drop from the highs in 2000 to the lows in October 2002 was simply the first of three downward phases and the next one will be the most protracted and the most painful in terms of size. Let me restate that. The next downward leg of the bear market will be larger than that experienced from 2000-2002. But since it isn't likely to kick off anytime in the next month or possibly not until 2005, I think we have to keep our focus on what the charts are telling us in the here and now. So far, there is nothing there that tells us of an imminent plunge, so we'll continue to nibble at pullbacks in strong stocks, looking for bullish plays. At the same time, we'll attempt bearish plays on stocks/indices that look overextended. As I've mentioned in recent weeks, the remainder of this year is effectively a throwaway in terms of trading. Volume should continue to be light, as many of the pros have already punched the time clock for 2003. The next catalyst will be the fund flows in early January and watching to see if the institutions dump into that surge in liquidity or if we have another upward leg in store. I think the key to which way things go will lie in the monthly chart of the SPX that I've been showing occasionally in recent months. A breakout that negates the bearish divergence and up we go. If the monthly Stochastics finally roll over and give a sell signal before we see SPX=1175 and the bears get the nod. There are no new plays this week (either Watch List or Portfolio), as I'm looking to finish things up early and spend some time with all the extended family that is currently in town. Here are the updates to our current plays. Portfolio: WMT - Still looking weak, shares of WMT began to tip over just below the 20-dma again last week and with daily Stochs dipping over again, I'm expecting WMT to finally make a thrust down to the $50 level. Each trader must decide how to manage any open trades, but my recommendation will be to exit if/when the $50 level is touched. From a price action standpoint, WMT has been a nice little play, moving roughly $5 in our favor from the point of entry. At the same time, the options have performed very poorly. I looked at volatility (both historical and implied) this week and both have risen since inception of the play. I'm at a loss to explain how the options have failed to keep pace with the price action in the underlying stock. By all rights, the gain on the play right now should be on the order of $3, rather than the measly fractional gains shown. Something very fishy appears to have been at play when we initiated the play, so hopefully those of you that played along, entered at a different point in time and got a better fill. Our primary focus at this point is to prevent the play from going strongly against us and the $54 stop should do that job quite nicely. The incomprehensible manner in which the options have moved has me looking to aggressively exit on a drop just to the top of our target zone. SBUX - There just isn't much to report on SBUX. The stock is holding up well, but so far has been unable to make any significant upward progress for the past month. Price continues to hold above the 50-dma and then there is strong support down at the $30 level, also the site of the 100-dma and the midline of the long-term rising channel. Any pullback and rebound from above $30 can be used for new entries into the play. QQQ - Pushing right back up to resistance at $36, the QQQ is proving the validity of my reticence in entering the play on a breakdown move. After another bounce from that ascending trendline (connecting the lows from 9/30 and 11/21), it is now possible to see that the pattern may be more of a bullish wedge, with a horizontal top just over $36. With that possible formation, we'd know we're wrong in our bearish position with a break above $36.25. So conservative traders may want to use a tighter stop (say $36.50) than our official $38 stop. My perspective is still somewhat colored by the fact that the NDX Bullish Percent is bear confirmed, pointing to down as the path of least resistance. Before we can say this play is working in our favor, QQQ will need to break and close below the 100-dma, currently at $34.11. DJX - Anticipating the imminent arrival of the jolly old fat man, bulls pushed the DOW to yet another new 52-week high on Wednesday at 103.75, before falling back near the $103 level at the close. Clearly, I pulled the trigger on this play at far too low a level. Since clearing the $100 level, the DJX has had a strong nearly 400 point rally and Wednesday's pullback from the highs is the first sign of acknowledgement by market participants of the very overbought condition. I'm still sticking by my guns, expecting that we should head lower from here, despite the bullish historical tendencies during this time of the year. If our position can survive its stop through the first week of January, then we should be able to enjoy the normal January drop. Maintain stops at $104 and if that level is exceeded, we'll look for another entry at a higher level. Watch List: SMH - The Semiconductor sector has really given up its leadership role in recent weeks, but we've got to give the bulls the appropriate respect after they managed to successfully defend the $475 level as support. Next up is the $500 level, which has been acting as a price magnet for several weeks now. On the SMH, that equates to the $41 level, where prices stalled out on Wednesday. Fresh from taking over-eager entries on both the QQQ and DJX plays, I'm going to maintain my discipline and keep our entry target at $42-43. Remember to wait for the rally attempt to fail before playing. NEM - I think it is fair to say that not much of merit happened in the gold market this past week. While the price of gold did inch higher to a new contract closing high of $412.80 (basis the February futures contract) and the dollar index (DX00Y) edged to a new multi-year low just above 87.50, the action in the gold stocks remained muted and well below the highs posted at the beginning of the month. This is good news for us, as NEM is shedding some of the excessive gains accrued in anticipation of higher gold prices. NEM seems to be stabilizing just above the $46 level, with support coming in from the 50-dma, now just under $45. So, do we raise the entry target and get in near current levels, risking a potential breakdown to our initial target at $40? Or do we stick with our guns and risk missing the play...AGAIN? My personal preference is to do both, entering a half position near the 50-dma and then look to round out to a full position on a sharper drop back near our preferred entry target at $40. QCOM - Are we ever going to get a break? Dancing just out of range of entry for 6 weeks now, QCOM once again looks like it is going to run away without us. Short-term momentum traders can play the near-term strength, but those with a longer-term focus need to be looking for the viable pullback entry. In QCOM's case, that would be a pullback and rebound from the bottom of the rising channel, now at $46.60. The problem is that a trade at $48 would create a PnF Sell signal now. So we're confronted by a situation where the stock is too extended to buy here, but a pullback to a solid support level would generate a bearish signal on another view. I think the most prudent course of action is to place QCOM on hold. The stock ran away from us and needs to pull back and build a new base before we can consider entering the play. EK - I actually like the action in shares of EK from this past week, as the stock pushed up to the $25 level near the 100-dma, confirming the bull flag pattern we've been observing over the past several weeks. Look for a breakout over $25.25 to set the stage for a move to the top of the gap near $27, at which point we might actually get an opportunity to play. We'll only play on a failed rally through that level and with volume getting very weak, we aren't likely to see our entry setup until sometime in early January, at the earliest. HD - It appears we have plenty of time to wait with our play on HD, as the stock seems to have gone to sleep between the 50-dma and 100-dma. We don't even want to consider new entries in the middle of the range of the past several months. A failed rally attempt near the top of that range ($38) and the top of the long-term descending channel is the only way to play. We've got this one in the cue and now it is just a matter of waiting for price action to set up in our favor. SNDK - The market offered up a bit of volatility last week, but the net result wasn't very impressive. SNDK is still sitting near the $60 level, trying to build some support near that 38% retracement of the rally from the Spring lows. Look for a dip to the 50% retracement ($51.84) and the 200-dma ($50.58) to set up our preferred entry. Remember, SNDK is an aggressive, bottom-fishing play, but with our upside target of a break to new recent highs, I think the risk is warranted. Radar Screen: GENZ - I figured last week would be a waste of time in terms of trading, and GENZ certainly proved that, trading in a VERY narrow range just above the $48 level. As I mentioned last week, I'm cooling on the idea of a play here in either direction. I'm willing to keep watching it, but if we haven't seen something viable set up by mid-January, then we'll drop it in favor of something that is easier to read on the chart. But right here, GENZ is drifting between strong resistance at $52 and strong support at the 200-dma, denying us a viable play. Closing Thoughts: As noted last week, I'm penning this column Wednesday (Christmas Eve) afternoon, so as to have the weekend free to spend with my family. So unlikely as it may seem, if Friday's holiday-shortened session holds some excitement in store, we'll simply have to address that next weekend. With the arrival of the year-end holidays, my trading year is done and I am now turning my attention to the opportunities that lie before us in 2004. I realize that many of you will trade next week and that is always a personal choice. I just don't feel that the rewards are sufficient to justify the risk of playing in a low- volume and potentially volatile environment. May I respectfully suggest you join me in focusing on family and friends during the holidays, so as to be fully recharged for the excitement that I'm sure lies in wait for all of us beginning in January. My Best Holiday Wishes to Everyone! Mark LEAPS Portfolio Current Open Plays SYMBOL OPENED LEAPS SYMBOL ENTRY CURRENT CHANGE STOP Calls: SBUX 11/24/03 '05 $ 30 ZOS-AF $ 4.30 $ 4.70 + 9.30% $27.50 '06 $ 30 WSP-AF $ 6.40 $ 6.60 + 3.12% $27.50 Puts: WMT 10/03/03 '05 $ 55 ZWT-MK $ 5.10 $ 5.90 +15.69% $ 54.00 '06 $ 55 WWT-MK $ 7.20 $ 7.40 + 2.78% $ 54.00 DJX 12/09/03 '04 $ 96 YDK-XR $ 5.70 $ 4.00 -29.82% $104.00 '05 $ 96 ZDK-RR $ 7.10 $ 5.20 -26.76% $104.00 QQQ 12/09/03 '05 $ 32 ZWQ-MF $ 2.65 $ 1.90 -28.30% $ 38.00 '06 $ 32 WD -MF $ 3.70 $ 2.90 -21.62% $ 38.00 LEAPS Watchlist Current Possibles SYMBOL SINCE TARGET PRICE TARGETED LEAP SYMBOL CALLS: NEM 10/05/03 $40 JAN-2005 $ 40 ZIE-AH CC JAN-2005 $ 35 ZIE-AG JAN-2006 $ 40 WIE-AH CC JAN-2006 $ 35 WIE-AG QCOM 11/16/03 HOLD JAN-2005 $ 50 ZLU-AJ CC JAN-2005 $ 45 ZLU-AI JAN-2006 $ 50 WLU-AJ CC JAN-2006 $ 45 WLU-AI SNDK 12/21/03 $50-51 JAN-2005 $ 45 XWS-AK CC JAN-2005 $ 40 XWS-AJ JAN-2006 $ 45 YSD-AK CC JAN-2006 $ 40 YSD-AJ PUTS: SMH 08/24/03 $42-43 JAN-2005 $ 40 ZTO-MH JAN-2006 $ 40 YRH-MH EK 12/21/03 $27 JAN-2005 $ 25 ZEK-ME JAN-2006 $ 25 WEK-ME HD 12/21/03 $37-38 JAN-2005 $ 35 ZHD-MG JAN-2006 $ 35 WHD-MG New Portfolio Plays None New Watchlist Plays None Drops None ************************Advertisement************************* Live Securities Brokerage Service with Licensed Option Principals OCO Stop & Profit Orders OneStopOption All types of Spreads and Buy Writes 888-281-9569 Auto-Trade Market Monitor Signals Personal Service and Education **Services available for Foreign Traders including Canada** http://www.OneStopOption.com ************************************************************** ************** TRADERS CORNER ************** I'm Not My Brother (In-Law's) Keeper, Fortunately! By Mike Parnos, Investing With Attitude I saw Johnny, my ex-brother-in-law, over Christmas. He has limitations. He thinks that polysyllabic is the name of a parrot. In reality, he's a walking, talking reason why some species eat their young. Well, since his mother missed that opportunity, I find myself across the dinner table from Johnny twice a year. Normally, I make the best of it by simply pretending he doesn't exist. This year, however, interaction was unavoidable. After proudly telling a charming story about bringing roadkill home for dinner, Johnny asked me what I do. I explained that I teach individuals and groups of people how to make money trading options. Option Traders Are Made, Not Born "Mike," he asked, "can you teach me to trade options?" Remember, as a kid, when we tried to make things out of Playdough? An ashtray? A bowl? A vase? The clay was fresh, moldable and would take any shape we could create. But, if you left the clay out of the can too long, it would become brittle and useless. Let's just say that Johnny's clay has been out of the can way too long. Plus, considering that it was only a few years ago that he started walking upright, I thought it unlikely he could grasp the concept of options. But, in the spirit of the season, I made the effort. I tried to explain the concept of a "call" option. I used a real estate example, a stock example and any number of other examples. I like to think I have infinite patience. I was wrong. I began to feel like a salmon swimming upstream. The undercurrent was just too much. "Johnny," I said, "listen closely, I am a lot like a call option. I have the right, but not the obligation, to teach you to trade options. I choose not to exercise this right." "Now I get it," he said. "Sure you do, Johnny. Sure you do." ____________________________________________________________ What's In Store For 2004? To the legion of CPTI students who "get it" and don't bring home roadkill for dinner, I want to wish you, and your families, a happy, healthy and profitable 2004. As in 2003, we'll aim for consistent profits. We'll continue to explore new strategies, refine previously strategies, and together use knowledge and discipline to have another exceptional and inspirational year. Thank you for your continued emails, your smiles, your questions and your perseverance. For me, that's what makes it all worthwhile. _____________________________________________________________ Hi Mike, I wanted to ask you about increasing the spread on the long term QQQ play. On a $30 to $40 QQQ spread, a 10 point spread or $13,500 on a 10-contract play it would cost more to get in a $25-$45 or over $20,000. If one had the money would it not be better the go to the $21,300 spread rather than the $13,500? Or am I missing something? On the larger spread, wouldn't you would begin making money on your sold near term options much quicker. Thanks for your response. William Hi William, There are two ways you can look at increasing the spread (or long trading range) on the QQQ ITM Strangles. 1. The negative: Increasing the ITM LEAPS spread will tie up more money and your monthly return on investment would be significantly lower. If you have extra money, I'd lean towards getting additional contracts and bringing in more premium. With the QQQs, you don't have to increase the range so dramatically. The $1 strikes will give you the flexibility to create a range of $12, $14, $16, etc. There are no rules etched in stone. It's a personal decision. Though I'm comfortable with a $10 pt. range, you may prefer a $14 point range. 2. The positive is that you will have to re-establish the range less frequently. Each time we have to create a new range (when the QQQs go too far in a direction), it costs us an additional $2.00. It may take us a month or two to replace that two bucks. If we create a larger range, we may be able to tolerate a large move without changing the LEAPS range. Another small positive is that, the further you go into the money with the long term LEAPS, the less time value you would have at risk. It's not significant, though. I doubt it would be more beneficial than using the extra money to buy additional contracts and generating more premium. Hope that helps. Have a great holiday! Mike _____________________________________________________________ Dear Mike, Do you have to worry about being assigned when you trade an index? What is the total risk? Also, how does a cash settlement when the price of the stock finishes in the money inside one of the credit spreads? Dear M, It's not impossible for you to be assigned an index, but it shouldn't happen unless you are very deep in the money and with virtually no time premium remaining in the option -- a VERY unlikely scenario – especially using the strategies we discuss here at the CPTI. A cash settlement works like this. Let's use our December SPX quickie trade as an example. We took in $2.30 x six contracts = $1,380. The bear call spread was 1090/1105. The final settlement number was 1091.61. That was $1.61 ($161 per contract) above our short call. On Monday morning, that $161 x 6 contracts = $966 will have been deducted from our brokerage account. Our profit was $1,380 minus $966 = $414 (less commissions). Your exposure is the difference between the strike prices in the spread. In the above quickie we had a 1090/1105 bear call spread and a 1055/1040 bull put spread. Your exposure is $15 x 6 contracts = $9,000. Your actual risk is the difference between the strike prices less the total credit you received when you put on the spread ($9,000 - $1,380 = $7,620). _____________________________________________________________ Dear Mike When I'm looking up options, why are some available in May while options for another stock may be available in June? Thanks. Response: When you look at an option chain, you will always see options available for the current month and the following month. As of Monday, you'll be able to trade January and February options in stocks that are optionable. The other months you see on the option chain are part of a stock's option cycle. There are three different cycles. January-April-July-October, February-May- August-November, and March-June-September-December. Depending on which cycle has been assigned to a particular stock, those are the months that will appear on its option chain. LEAPS are always available to be traded (if they are offered on that stock). The other months are opened as they become the "following" month. _____________________________________________________________ JANUARY CPTI POSITIONS Position #1 - NDX – (NASDAQ 100 Index) – Iron Condor – 1443.90 We sold 5 NDX January 1500 calls and bought 5 NDX January 1525 calls for a credit of $3.70 (x 5 = $1,850). Then we sold 5 NDX January 1325 puts and bought 5 NDX January 1300 puts for a credit of $2.40 (x 5 = $1,200). The total credit was $6.10. Maximum profit range: 1325 – 1500. Potential profit: $3,050. Position #2 – SOX (Semiconductor Index) – Iron Condor – 498.69 We sold 10 SOX January 530 calls and bought 10 SOX January 540 calls for a credit of $1.40 (x 10 = $1,400). Then we sold 7 SOX January 440 puts and bought 7 SOX January 425 puts for a credit of $1.35 (x 7 = $945). Our total credit was $2,345. Maximum profit range: 440 – 530. Potential profit: $2,345. Position #3 – XAU (Gold/Silver Index) – Iron Condor – $106.77 We sold 10 XAU January $95 puts and bought 10 XAU January $90 puts for a credit of $.60 ($600). Then we sold 10 XAU January $110 calls and bought 10 XAU January $115 calls for a credit: $.60 (600). Our total credit was $1.20 ($1,200). Maximum profit range: $95 – 110. Potential profit: $1,200. Position #4 -- QQQ Diagonal Calendar Spread -- $35.85 I'm a glutton for punishment, but there's a little voice telling me that we should be positioned to take advantage of a pullback in the market. We tried this in November – January and we ended up losing a dime. Sooner or later we're going to be right. So, let's give it another try. We're going to start out risking a buck and we have two additional months to sell against the March long puts to reduce our cost basis while we wait. It's a cheap speculation. We'll consider this an ongoing position. Buy 10 QQQ March $34 puts for $1.20 Sell 10 QQQ January $33 puts for $.20 Total debit: $1.00 ($1,000) ______________________________________________________________ ONGOING POSITION QQQ ITM Strangle – Ongoing Long Term -- $35.85 We bought 10 contracts of the 2005 QQQ $39 puts and 10 contracts of the 2005 QQQ $29 calls for a total debit of $14,300. We're going to make money by selling near term puts and calls every month. Here's what we've done so far: October: Oct. $33 puts and Oct. $34 calls – credit of $1,900. November: Nov. $34 puts and calls – credit of $1,150. December: Dec. $34 puts and calls – credit of $1,500. January: Jan. $34 puts and calls – credit of $850. Note: We haven't included any of the proceeds from this long term QQQ ITM Strangle in our profit calculations. It's a bonus! And it's a great cash flow generating strategy. OEX Credit Spread Boogie – 540.26 We sold 2 December OEX 520 calls @ $9.00 and bought 2 December OEX 545 calls @ $1.55. Total credit of $7.45 ($1,490). Exposure $17.55 ($3,510). Rolled out to five contracts of the January 535/505 bull put spread. In the process we took in an additional $280. __________________________________________________________ New To The CPTI? Are you a new Couch Potato Trading Institute student? Do you have questions about our educational plays or our strategies? To find past CPTI (Mike Parnos) articles, look under "Education" on the OI home page and click on "Traders Corner." They're waiting for you 24/7. ____________________________________________________________ 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 Master Strategist and HCP _____________________________________________________________ Couch Potato Trading Institute Disclaimer All results reported in this section are hypothetical. While the numbers represented here may have been achieved or beaten by our readers, we make no representation that any individual investor achieved these exact results. The tracking for the plays listed in this section uses closing prices for the day the newsletter is published and it is not meant to imply that any reader actually received those prices or participated in these recommendations. The portfolio represented here is hypothetical and for investment education purposes only. It is only an illustration of what type of gains a knowledgeable investor might receive utilizing these strategies. ************************Advertisement************************* No time to follow the Market Monitor? Tired of missing good Trades because you stepped away from your computer? 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The Option Investor Newsletter Sunday 12-28-2003 Sunday 3 of 3 In Section Five: Covered Calls: Trading Basics: More Q&A With The Editor Naked Puts: Options 101: What's In A Dollar Anyway? Spreads/Straddles/Combos: A Great Year Comes To An End! ************************Advertisement************************* Stock Option and Futures Brokerage OneStopOption teams the best trading technology with varying levels of professional assistance at very competitive prices. Commission costs are comparable to discount brokerage and tailored to individual customer needs. The power of one brokerage group with experience and expertise in the Securities* and Futures Markets offers unprecedented convenience for traders. Access To All Futures Markets Toll Free 888-281-9569 Stock Option Principals www.OneStopOption.com ************************************************************** ************* COVERED CALLS ************* Trading Basics: More Q&A With The Editor By Mark Wnetrzak This week's questions concern strategy selection and the techniques used in choosing candidates for this section. Attn: Markw@OptionInvestor.com Subject: Covered calls vs. naked puts Hi Mark: Is it a basic rule (risk wise) that selling a naked put is exactly the same thing as selling a covered call? As a rule a trader would prefer the naked put versus the covered call, aside possibly from collecting a dividend, etc.? Thank you, GM Hello GM, Yes, the naked put strategy and covered-call strategy are very similar and are essentially equivalent. However, there are a few differences to consider: naked puts generally require a smaller initial investment (approx. 25% collateral versus 50% of the stock's purchase price); the naked put writer can simply use the collateral of his present portfolio to initiate the position as opposed to buying stock; uncovered option trading requires a higher trading-experience level of approval by most brokerages; the covered-call strategy can be used in most IRAs; and covered-call writers receive dividends (provided the stock isn't assigned) where put writers do not. In calculating the potential return on investment, the "naked" put has an advantage over the covered-call strategy due to the lower initial investment and the lower cost of commissions. In comparing ITM covered-calls and OTM naked-puts (where the strike price is below the current stock price), the naked-put writer can generally sell a put at least one or two strikes lower than the covered-call writer and achieve the same, if not superior, return on investment. Both strategies require a slightly-bullish-to-neutral outlook and offer limited downside protection, but do not protect for a protracted downturn or catastrophic drop in the underlying equity. As you know, there is risk of loss in all trading strategies! Good Luck, Mark W. OIN Attn: Mark - CCs Editor Subject: Selling covered calls (Note: Edited for brevity/clarity) I have been following your selections for covered call strategy the last couple months and your performance has been excellent. Two questions please: 1) What criteria, without much detail, do you look for in your stock selections. 2) What is your opinion of [using] stop losses on the underlying stock at [the sold] strike price minus premium received? Thank you, MO Hello MO, At the OIN, we use a two-pronged approach to find a variety of covered-call candidates to supplement your search for profitable positions: technical scans and premium scans. I personally scan through hundreds of charts each week searching for technically strong stocks with robust inflated premiums. I then sort through several "over-priced" option premium lists, looking for stocks with favorable technical patterns. I use many of the techniques in Stan Weinstein's book, "Secrets for Profiting in Bull and Bear Markets." Stan provides a simple, easy-to-use (layman's) approach to technical analysis and his methods are helpful in identifying both stock and overall market trends. As far as "using stop losses on the underlying stock at the strike price minus premium received." That's certainly a viable approach as long as it agrees with your portfolio goals (investment, stock ownership, momentum trading, etc.), target time-frame (short-term, long-term, etc.) and risk-reward tolerance. The timing of an exit or adjustment is also important and here's a link to some comments I recently made on that subject: http://members.OptionInvestor.com/coveredcalls/cc_122103_1.asp Hope that helps! Mark W. OIN SUMMARY OF PREVIOUS CANDIDATES ***** The following summary is a reasonable account of the positions previously offered in this section. However, no representation is being made as to the actual performance of a position and in fact, there are frequently large differences between the summary results and those of our subscribers, due to the variety of ways in which each play can be opened, closed, and/or adjusted. In addition, the summary might not be completely representative of the manner in which the average trader would react to changing conditions in a position and to the options market in general. The editor of this section does not take actual positions in any published plays and the summary comments are simply a service to help new traders understand when positions might be opened and closed. In most cases, actions taken based on the commentary would be far too late to be effective, thus it is not intended as a substitute for personal trade management nor does it in any way replace your duty to diligently monitor and manage the positions in your portfolio. Note: Margin not used in calculations. Stock Price Last Option Price Gain Potential Symbol Picked Price Series Sold /Loss Mon. Yield WIND 7.48 8.50 JAN 7.50 0.50 0.52* 6.5% CE 13.50 14.47 JAN 12.50 1.80 0.80* 5.9% TKTX 15.35 15.15 JAN 15.00 1.25 0.90* 5.5% PCS 5.06 5.32 JAN 5.00 0.30 0.24* 5.5% SKX 7.54 7.85 JAN 7.50 0.40 0.36* 5.5% UTHR 23.20 23.22 JAN 22.50 1.75 1.05* 5.3% NTIQ 12.53 13.20 JAN 12.50 0.85 0.82* 5.1% SANM 12.56 12.36 JAN 12.50 0.70 0.50 4.6% VTS 10.05 10.77 JAN 10.00 0.55 0.50* 4.6% UAIR 6.20 6.20 JAN 5.00 1.40 0.20* 4.5% MYGN 12.75 12.59 JAN 12.50 0.85 0.60* 4.4% MYGN 12.76 12.59 JAN 12.50 0.95 0.69* 4.2% CNH 15.27 16.17 JAN 15.00 0.95 0.68* 4.1% CHTT 18.06 18.90 JAN 17.50 1.20 0.64* 4.1% EMBT 15.98 15.83 JAN 15.00 1.65 0.67* 4.1% RHAT 17.49 18.88 JAN 15.00 3.00 0.51* 3.8% XING 10.66 8.88 JAN 10.00 1.35 -0.43 0.0% * Stock price is above the sold striking price. Comments: Thin trading marked a short market week as investors enjoyed the Christmas holiday -- especially if they were bulls! Now is a good time for reflection and to be thankful for all our blessings. Wishing you much success and happiness in the New Year! Positions Previously Closed: None NEW CANDIDATES ********* Sequenced by Target Yield (monthly basis) ***** Stock Last Option Option Last Open Cost Days Target Symbol Price Series Symbol Bid Int. Basis Exp. Yield NGEN 7.50 JAN 7.50 QEM AU 0.90 30 6.60 21 19.8% NEOL 17.71 JAN 17.50 UOE AW 1.00 1420 16.71 21 6.8% DGIN 25.08 JAN 25.00 UGU AE 1.10 324 23.98 21 6.2% ACF 15.58 JAN 15.00 ACF AC 1.15 1745 14.43 21 5.7% ELNK 10.33 JAN 10.00 MQD AB 0.70 6446 9.63 21 5.6% RHAT 18.88 JAN 17.50 RCV AW 1.90 6474 16.98 21 4.4% OSTK 20.90 JAN 17.50 QKT AW 3.80 27 17.10 21 3.4% Company Descriptions LB-Last Bid price, OI-Open Interest, CB-Cost Basis or break-even point, DE-Days to Expiry, TY-Target Yield (monthly basis). ***** NGEN - Nanogen $7.50 *** New Patent = Rally Mode *** Nanogen (NASDAQ:NGEN) develops and commercializes molecular diagnostics products and tests for the gene-based testing market for sale primarily in the United States, Europe and the Pacific Rim. By integrating microelectronics and molecular biology into a core proprietary technology platform, Nanogen seeks to establish the open-architecture design of its primary products, the NanoChip Molecular Biology Workstation and the NanoChip Cartridge (collectively, the NanoChip System) as the standard platform for molecular identification and analysis. The firm also develops specific reagents and other commercial applications for the NanoChip System. The company continually conducts research and development by itself and also with its subsidiary and third parties, to improve the NanoChip System and to extend its technology to other applications such as biodefense, forensics and drug discovery (protein kinases). Earlier this month, Nanogen about doubled after the company said it received a patent for a method to build nanodevices; atom or molecule-sized electronic devices. We simply favor the break-out on heavy volume and speculators who believe the firm's shares are destined to move higher can profit from that outcome with this position. JAN-7.50 QEM AU LB=0.90 OI=30 CB=6.60 DE=21 TY=19.8% ***** NEOL - NeoPharm $17.71 *** Lateral Trend *** NeoPharm (NASDAQ:NEOL) is a biopharmaceutical company engaged in the research, development and commercialization of drugs for the treatment of various cancers. The company has built its drug portfolio based on its two novel proprietary technology platforms, the proprietary NeoLipid liposomal drug delivery system and a tumor-targeting toxin platform. NeoPharm has several promising compounds in various stages of development. The company's lead compound is IL13-PE38, a tumor-targeting toxin being developed as a new treatment for glioblastoma multiforme, a deadly form of brain cancer. NEOL has been consolidating since April and this short-term position simply offers a method to participate in the future movement of the issue with relatively low risk. JAN-17.50 UOE AW LB=1.00 OI=1420 CB=16.71 DE=21 TY=6.8% ***** DGIN - Digital Insight $25.08 *** Next Leg Up? *** Digital Insight (NASDAQ:DGIN) is a provider of outsourced online banking services to banks, credit unions and savings and loan associations. Digital offers outsourced solutions, mainly to financial institutions, including online banking for a variety of retail customers, online cash management for businesses, online lending decision-making across multiple channels for consumer loans and other complementary products and services. As of December 31, 2002, approximately 3.6 million end users were actively using the their Internet banking applications and approximately 26,000 business end users were actively using its cash management solution. Shares of Digital Insight have made another new 52-week high and have now topped the September high. Investors who believe the bullish trend will continue can use this position to target-shoot an entry point with a cost basis closer to technical support. JAN-25.00 UGU AE LB=1.10 OI=324 CB=23.98 DE=21 TY=6.2% ***** ACF - AmeriCredit $15.58 *** Santa Clause Rally *** AmeriCredit (NYSE:ACF) is a consumer finance firm specializing in purchasing retail automobile installment sales contracts originated by franchised and select independent dealers in connection with the sale of used and new automobiles. The firm generates revenue and cash flows primarily through the purchase, retention, subsequent securitization and servicing of finance receivables. To fund the acquisition of receivables prior to securitization, AmeriCredit uses borrowings under its warehouse credit facilities. The company earns finance charge income on the finance receivables and pays interest expense on borrowings under its warehouse credit facilities. AmeriCredit benefited from the bullish Christmas season and has now made a new 52-week high. Traders can speculate on the near-term performance of the issue with this conservative position. JAN-15.00 ACF AC LB=1.15 OI=1745 CB=14.43 DE=21 TY=5.7% ***** ELNK - EarthLink $10.33 *** Internet Providers *** EarthLink (NASDAQ:ELNK) is an ISP providing reliable nationwide Internet access and related value-added services to its customers. The company was formed as a result of the merger of EarthLink Network and MindSpring Enterprises. Earthlink provides a variety of Internet access and related services, including narrowband access, wireless access, broadband or high-speed access and Web hosting. The company focuses on providing an experience for its users through reliable access, customer service and support and useful features such as e-mail, Web storage, spam filtering and Pop-Up Blocker. The Internet sector has performed very well recently and investors who want a long-term position in an industry-leading company can use this position to establish a favorable cost basis in the issue. JAN-10.00 MQD AB LB=0.70 OI=6446 CB=9.63 DE=21 TY=5.6% ***** RHAT - Red Hat $18.88 *** Earnings Rally: Encore! *** Red Hat (NASDAQ:RHAT) provides an enterprise-operating platform based on open source technology for the IT infrastructure of the Global 2000. The company applies its technology to create its enterprise operating platform, Red Hat Enterprise Linux, and related layered infrastructure technology solutions, based on open source technology. Red Hat's enterprise solutions meet the functionality requirements and performance demands of the large enterprise and the third-party computer hardware and software applications that are critical to enterprises. The company also creates additional products, including Red Hat Linux and related tools, and open source software applications. Red Hat's professional services offerings, principally directed toward its large enterprise customers and strategic partners, include technical support and maintenance, custom development, consulting, training and education and hardware certification. Investors were obviously pleased with Red Hat's earnings as the stock continues to rally on heavy volume, making another 52-week high. This position offers a reasonable entry point for those who agree with a bullish outlook for RHAT. JAN-17.50 RCV AW LB=1.90 OI=6474 CB=16.98 DE=21 TY=4.4% ***** OSTK - Overstock.com $20.90 *** Next Trading Range? *** Overstock.com (NASDAQ:OSTK) is an online "closeout" retailer offering discount, brand-name merchandise for sale primarily over the Internet. The company's merchandise offerings include bed-and-bath goods, kitchenware, watches, jewelry, electronics, sporting goods and designer accessories. Overstock offers its customers an opportunity to shop for bargains conveniently, while offering an alternative inventory liquidation distribution channel to its suppliers. The company typically offers around 5,000 non-media products and over 100,000 media products (books, CDs, DVDs, video cassettes and video games) in seven departments on its Websites, www.overstock.com, www.overstockb2b.com and www.worldstock.com. OSTK has been in a lateral trading range for almost a year and has recently rallied above resistance near $18 on heavy volume. We simply favor the technical support near the cost basis in this position and investors who are interested in a long-term portfolio position in the Internet retail segment should consider this issue. A more aggressive ATM position is listed below in the supplementary section. JAN-17.50 QKT AW LB=3.80 OI=27 CB=17.10 DE=21 TY=3.4% ***** ***************** SUPPLEMENTAL COVERED CALL CANDIDATES ***************** The following group of issues is a list of additional candidates to supplement your search for profitable trading positions. As with any investment, you must decide if the selections meet your criteria for potential plays. Only you can know what strategies and positions are suitable for your experience level, risk-reward tolerance and portfolio outlook. They will not be included in the weekly portfolio summary. Sequenced by Target Yield (monthly basis) ***** Stock Last Option Option Last Open Cost Days Target Symbol Price Series Symbol Bid Int. Basis Exp. Yield OSTK 20.90 JAN 20.00 QKT AD 2.10 192 18.80 21 9.2% GSIC 10.06 JAN 10.00 UGF AB 0.65 718 9.41 21 9.1% EPNY 7.57 JAN 7.50 UEP AU 0.45 1814 7.12 21 7.7% TKTX 15.15 JAN 15.00 UFT AC 0.90 473 14.25 21 7.6% NAVR 5.83 JAN 5.00 QIG AA 1.05 11 4.78 21 6.7% ZIXI 8.06 JAN 7.50 HQU AU 0.85 1851 7.21 21 5.8% MMR 18.60 JAN 17.50 MMR AW 1.75 495 16.85 21 5.6% X 35.72 JAN 35.00 X AG 2.00 3388 33.72 21 5.5% TTMI 16.14 JAN 15.00 UKD AC 1.65 89 14.49 21 5.1% ADAT 11.91 JAN 10.00 HAU AB 2.25 237 9.66 21 5.1% NVDA 22.74 JAN 22.50 UVA AX 1.00 15693 21.74 21 5.1% AKS 5.43 JAN 5.00 AKS AA 0.60 875 4.83 21 5.1% SOV 23.39 JAN 22.50 SOV AX 1.55 9904 21.84 21 4.4% ***************** NAKED PUT SECTION ***************** Options 101: What's In A Dollar Anyway? By Ray Cummins Stocks soared to yearly highs this week, despite the continued decline of the U.S. dollar against major world currencies. Can the value of the mighty greenback mean so little to the stock market? This week, we continue our series on how changes in U.S. monetary policies flow through to other economic variables and ultimately to security prices. Many components affect share values in the equity markets and one of the most prominent concerns in recent months has been the decline of the dollar relative to other world currencies. The relationship between the dollar and the Euro, or the Japanese Yen, or the British Pound, is very important because one currency must be converted to another for international trade and foreign investments to occur. This correlation; the value of one currency against another, is known as the "exchange rate" and over the past year, budget and trade deficits have contributed to the dollar's decline in the equation. The problems associated with a "falling dollar" are many, however most critical is the fact that lower prices for exports and higher costs for imports ultimately could lead to inflation. In the past, the overall general upward price movement of goods and services in the economy has proven to be one of the more difficult problems to resolve, thus the FOMC has recently (and rightfully) endorsed price stability as a principal policy objective of the Federal Reserve. Another, more immediate effect of the falling dollar is a concern of the investment community because the devaluation trend encourages foreigners to pull money out of the U.S. stock market. Remember that when foreign investors want to buy stocks in American markets, they must first convert their native currency into U.S. dollars. In short, they use their money to purchase our money to buy stocks and if the bearish trend in stocks resumes, foreign investors will endure even greater losses than their American counterparts. Federal policy-makers and investors usually favor a strong dollar but there are others who prefer the current situation because the reduced cost of U.S. products to foreign customers stimulates new demand. Increased demand fuels domestic production, which leads to more jobs for Americans, especially in the agricultural and manufacturing sectors. Since robust employment is one of the keys to an economic recovery, many experts say the current weak-dollar policy is beneficial in the short-term. On the other hand, our relative wealth as a nation is measured by the value of the dollar and history suggests that a sound and stable currency is required for sustained economic growth. With that idea in mind, the real question is: How detrimental, both to the American public and the financial markets, will this strategy will be in long run? One thing worth noting is the Fed has an incredibly difficult task when choosing how to influence money and credit conditions in the economy. Even with the best decisions, there is no guarantee that the economy will grow at a healthy pace, or that everyone will have a job, or that the stock prices will perpetually rise. Achieving these goals depends on the actions of the American people because we are solely responsible for the election of government leaders and policy-makers. On a more fundamental basis, we also determine how much to work, spend, save and invest, whether it be with regard to our skills and education, the family business or the stock market. Indeed, if our recent economic woes recur in the coming years, the nation as a whole may regret not looking closer at the real cause of our troubles and taking action to stem the problem at its origin. Happy Holidays! SUMMARY OF PREVIOUS CANDIDATES ***** The following summary is a reasonable account of the positions previously offered in this section. However, no representation is being made as to the actual performance of a position and in fact, there are frequently large differences between the summary results and those of our subscribers, due to the variety of ways in which each play can be opened, closed, and/or adjusted. In addition, the summary might not be completely representative of the manner in which the average trader would react to changing conditions in a position and to the options market in general. The editor of this section does not take actual positions in any published plays and the summary comments are simply a service to help new traders understand when positions might be opened and closed. In most cases, actions taken based on the commentary would be far too late to be effective, thus it is not intended as a substitute for personal trade management nor does it in any way replace your duty to diligently monitor and manage the positions in your portfolio. Stock Price Last Option Price Gain Simple Max Symbol Picked Price Series Sold /Loss Yield Yield PDLI 16.65 17.87 JAN 15.00 0.45 0.45* 3.4% 9.0% SOV 23.70 23.39 JAN 22.50 0.90 0.90* 3.6% 8.5% PLMD 26.45 25.83 JAN 22.50 0.50 0.50* 2.5% 7.6% MERX 24.45 24.75 JAN 20.00 0.40 0.40* 2.2% 7.6% SLXP 21.50 22.45 JAN 20.00 0.60 0.60* 2.7% 6.8% JNS 15.91 16.06 JAN 15.00 0.35 0.35* 2.6% 6.6% NPSP 32.64 30.80 JAN 30.00 0.80 0.80* 2.4% 6.2% IPG 15.45 14.94 JAN 15.00 0.40 0.34 2.5% 6.0% BLTI 14.01 17.19 JAN 12.50 0.30 0.30* 2.1% 5.9% WEBX 20.18 19.50 JAN 17.50 0.30 0.30* 1.9% 5.7% RMBS 30.66 26.14 JAN 20.00 0.40 0.40* 1.8% 5.3% AAII 25.01 25.00 JAN 22.50 0.45 0.45* 1.8% 4.9% EMMS 27.17 27.21 JAN 25.00 0.50 0.50* 1.8% 4.7% * Stock price is above the sold striking price. Comments: Investors enjoyed one of the best Christmas holidays in years as all of the major equity averages contributed outstanding performances in 2003. Friday's session was understandably docile but the "Santa Claus Rally" has certainly preformed up to its reputation. With stocks likely to consolidate in the coming month, traders are cautioned to maintain a disciplined approach to portfolio management. The primary subject on the "watch" list is NPS Pharmaceuticals (NASDAQ:NPSP), which is perched precariously above its 30-DEMA and our sold strike at $30. Other issues of concern are Interpublic Group (NYSE:IPG) and Rambus (NASDAQ:RMBS), in light of the recent volatile price activity. One play that (thankfully) did not make it into our portfolio is Penn National Gaming (NASDAQ:PENN). Shares of the stock "gapped" down at the open Monday after the Pennsylvania State Senate passed a spending plan over the weekend that did not include legalizing gambling. Penn National was expected to benefit if the state turned to legalized gambling to shore up its budget, but that doesn't appear likely in the near term. Previously Closed Positions: None WARNING: THE RISK IN SELLING NAKED OPTIONS IS SUBSTANTIAL! ***** The sale of uncovered puts entails considerable financial risk, far more than the initial margin or collateral required to open a position. The maximum financial obligation for the sale of a naked put is the strike price (of the underlying stock) that is sold. Although this obligation is reduced by the premium from the sale of the option, a writer of puts should have the cash or collateral equivalent of the sold strike price in reserve at all times. In addition, there is one very important rule when using this strategy: Don't sell puts on stocks that you don't want to own! Why? Because stocks occasionally experience catastrophic declines, exponentially increasing the margin maintenance and possibly causing a devastating shortfall in your portfolio. It is also important that you consider using trading stops on naked option positions to help limit losses when a stock's price falls. Many professional traders suggest closing the position when the underlying share value moves below the sold strike, or using a "buy-to-close" stop order at a price that is no more than twice the original premium received from the sold option. MARGIN REQUIREMENTS The Initial Margin is the amount of collateral you must have in your account to initiate the position. In specific terms, margin refers to cash or securities required of an option writer by his brokerage firm as collateral for the writer's obligation to buy or sell the underlying interest if assigned through an exercise. The Maintenance Margin is the amount of cash (or securities) required to offset the changing collateral requirements of the written options in your portfolio. As the price of the option and the underlying stock changes, so does the maintenance margin. With (short) put options, the margin requirements can increase when the underlying stock price declines and also when it rises significantly. The reason is the manner in which the collateral amount is determined (with the formula listed above) and traders should always consider not only the initial margin requirement, but also the maximum margin needed for the life of the position. Option writers occasionally have to meet calls for additional margin during adverse market movements and even when there is enough equity in the account to avoid a margin call, the need for increased collateral will make that equity unavailable for other purposes. Please consider these facts carefully before you initiate any "naked" option positions. For more information on margin requirements, please refer to: http://www.cboe.com/LearnCenter/pdf/MarginManual2000.pdf MONTHLY YIELD: MAXIMUM & SIMPLE The Maximum Monthly Yield (listed in the summary and with each new candidate) is the greatest possible profit available in the position. This amount, expressed as a percentage, is based on the initial margin requirement as determined by the Board of Governors of the Federal Reserve, the U.S. options markets and other self-regulatory organizations. Although increased margin requirements may be imposed either generally or in individual cases by various brokerage firms, our calculations use the widely accepted margin formulas from the Chicago Board Options Exchange. The Simple Monthly Yield is based on the cost of the underlying issue (in the event of assignment), including the premium from the sold option, thus it reflects the maximum potential loss in the position. NEW CANDIDATES ********* Sequenced by Maximum Yield (monthly basis - margin) ***** Stock Last Option Option Last Open Cost Days Simple Max Symbol Price Series Symbol Bid Int. Basis Exp. Yield Yield THER 18.77 JAN 17.50 UKT MW 0.60 83 16.90 21 5.1% 12.7% MERX 24.75 JAN 22.50 KXQ MX 0.60 41 21.90 21 4.0% 10.5% BLTI 17.19 JAN 15.00 BQF MC 0.25 345 14.75 21 2.5% 7.3% SHRP 32.39 JAN 30.00 SAU MF 0.55 99 29.45 21 2.7% 7.2% IMCL 40.01 JAN 35.00 QCI MG 0.55 2212 34.45 21 2.3% 6.9% ATVI 18.65 JAN 17.50 AQV MW 0.30 405 17.20 21 2.5% 6.6% AAII 25.00 JAN 22.50 IUQ MX 0.30 112 22.20 21 2.0% 5.6% Company Descriptions LB-Last Bid price, OI-Open Interest, CB-Cost Basis or break-even point, DE-Days to Expiry, SY-Simple Yield (monthly basis - without margin), MY-Maximum Yield (monthly basis - using margin). ***** THER - Therasense $18.77 *** An Unexplained Rally! *** TheraSense (NASDAQ:THER) develops, manufactures and sells glucose self-monitoring systems that reduce the pain of testing for people with diabetes. The company's first product, the Freestyle Blood Glucose Monitoring System, received FDA approval in January 2000. Therasense began selling FreeStyle in the United States later that year and the company's direct sales force promotes the product to healthcare professionals who advise patients on the monitoring and management of their diabetes. The company distributes and sells FreeStyle in the United States to 10 national retailers, including Walgreens, Wal-Mart and Rite Aid, through wholesalers, including Cardinal Health, McKesson and AmerisourceBergen, and directly to end users over the telephone and through its Website. Shares of THER rallied Friday on robust volume despite a lack of news to explain the activity. The technical indications support a bullish outlook and traders who are optimistic about the company's stock price in the near term should consider this position. JAN-17.50 UKT MW LB=0.60 OI=83 CB=16.90 DE=21 TY=5.1% MY=12.7% ***** MERX - Merix $24.75 *** Multi-Year High! *** Merix Corporation (NASDAQ:MERX) is a manufacturer of electronic interconnect solutions for use in sophisticated equipment. The company's main products are complex multi-layer printed circuit boards, which are platforms used to interconnect microprocessors, integrated circuits and other components that are essential to the operation of electronic products and systems. Merix focuses on providing its solutions to manufacturers of technologically advanced electronic products within selected high-growth markets in the electronics industry, including communications, high-end computing and test and measurement. It provides its customers with an integrated interconnect manufacturing solution including quick-turn prototypes, pre-production and volume production of printed circuit boards and backplanes. The company also renders design assistance and engineering services in the early stages of product development. MERX shares soared on 12/18 after the firm posted a surprise quarterly profit, reversing a loss from the year before, on robust product demand and increasing profit margins. Investors who favor the outlook for the stock should consider this position. JAN-22.50 KXQ MX LB=0.60 OI=41 CB=21.90 DE=21 TY=4.0% MY=10.5% ***** BLTI - Biolase $17.19 *** Speculation Only! *** BioLase Technology (NASDAQ:BLTI) is a medical technology company that designs, develops, manufactures and markets advanced dental, cosmetic and surgical lasers and related products. The company's principal products are water- and laser-based systems focused for use in dentistry. The company holds patents and has received clearances from the United States Food and Drug Administration for applications in other markets such as dermatology. BioLase Technology also manufactures accessories and disposable products for its water- and laser-based systems. Lots of speculation on this issue after some recent comments in IBD, and investors say the company is a market leader with growing sales year-over-year and renewed institutional interest. The trend is bullish in the short-term and traders can profit from additional upside movement in the issue with this position. JAN-15.00 BQF MC LB=0.25 OI=345 CB=14.75 DE=21 TY=2.5% MY=7.3% ***** SHRP - Sharper Image $32.39 *** Specialty Retail Rally! *** Sharper Image (NASDAQ:SHRP) is a specialty retailer of products in the electronics, recreation and fitness, personal care, houseware, travel, toy, gifts and other categories. The firm's merchandising philosophy focuses principally on proprietary Sharper Image Design products and exclusive Sharper Image branded products and, to a lesser extent, on third-party branded products. The firm designs and develops its Sharper Image Design products, while Sharper Image branded products are designed by third parties or jointly designed with the Company. The company markets its merchandise primarily through three integrated sales channels: The Sharper Image stores, sharperimage.com and The Sharper Image catalog, which includes any revenue from direct marketing activities and infomercials. Shares of SHRP were "sharply" higher Friday after the company announced same-store sales were up 21% in December, due to strong performance across the board, and raised its profit forecast. Investors can establish a relatively conservative cost basis in the issue with this position. JAN-30.00 SAU MF LB=0.55 OI=99 CB=29.45 DE=21 TY=2.7% MY=7.2% ***** IMCL - ImClone $40.01 *** Premium-Selling Only! *** ImClone Systems (NASDAQ:IMCL) is a biopharmaceutical company whose mission is to advance oncology care by developing a portfolio of targeted biologic treatments designed to address the medical needs of patients with a variety of cancers. The company's lead product, Erbitux, is a therapeutic antibody that inhibits stimulation of epidermal growth factor receptor upon which certain solid tumors depend in order to grow. In addition to the development of its lead product candidates, the company conducts research in a number of areas related to its core focus of growth factor blockers, as well as cancer vaccines and angiogenesis inhibitors. IMCL has also developed diagnostic products and vaccines for certain infectious diseases. Imclone has always been a popular issue among "premium sellers" and the stock once again has favorable option prices due to its potential for volatility. JAN-35.00 QCI MG LB=0.55 OI=2212 CB=34.45 DE=21 TY=2.3% MY=6.9% ***** ATVI - Activision $18.65 *** Improved Earnings Outlook! *** Activision (NASDAQ:ATVI) is a global publisher of interactive entertainment software products. The company has two operating segments: publishing and distribution. Publishing relates to the development (both internally and externally), marketing and sale of CD, DVD, and cartridge-based interactive entertainment software products owned or controlled by the company either directly, by license or through its affiliate label program with third-party publishers. Activision's distribution business consists mainly of operations in Europe that provide logistical and sales services to third-party publishers of interactive entertainment software, its own publishing operations, and manufacturers of interactive entertainment hardware. ATVI shares have been "on the move" since mid December when the company raised its earnings outlook for the holiday season on the strength of its new games. U.S. Bancorp Piper Jaffray followed the news with an upgrade of the firm and ATVI's price trend has remained bullish since the announcement. JAN-17.50 AQV MW LB=0.30 OI=405 CB=17.20 DE=21 TY=2.5% MY=6.6% ***** AAII - aaiPharma $25.00 *** Drug Speculation *** aaiPharma (NASDAQ:AAII) is a science-based specialty pharmaceutical company focused on the commercialization of branded pharmaceutical products that it develops or acquires. The company has operations both in the United States and in Europe and has recently acquired three branded products: the M.V.I. and Aquasol family of products, Brethine and the Darvon and Darvocet family of products. AAII is also developing its own proprietary drugs, as well as developing improvements and line extensions to its many acquired products by applying its scientific expertise and proprietary and in-licensed drug-delivery technologies. In early December, aaiPharma raised its profit outlook, saying it expects earnings of $1.45 to $1.52 per share on revenue of $340 million to $355 million in the coming year. Both numbers exceeded analysts' expectations and investors demonstrated their approval by driving the stock price up over 25% in only one week. Traders can profit from future bullish activity in the issue with this position. JAN-22.50 IUQ MX LB=0.30 OI=112 CB=22.20 DE=21 TY=2.0% MY=5.6% ***** ***************** SUPPLEMENTAL NAKED PUT CANDIDATES ***************** The following group of issues is a list of additional candidates to supplement your search for profitable trading positions. As with any investment, you must decide if the selections meet your criteria for potential plays. Only you can know what strategies and positions are suitable for your experience level, risk-reward tolerance and portfolio outlook. They will not be included in the weekly portfolio summary. Sequenced by Maximum Yield (monthly basis - margin) ***** Stock Last Option Option Last Open Cost Days Simple Max Symbol Price Series Symbol Bid Int. Basis Exp. Yield Yield FARO 25.23 JAN 22.50 QEJ MX 0.60 106 21.90 21 4.0% 10.9% UTHR 23.22 JAN 22.50 FUH MX 0.65 20 21.85 21 4.3% 10.2% MESA 13.00 JAN 12.50 EAQ MV 0.35 30 12.15 21 4.2% 10.0% PSSI 12.68 JAN 12.50 PYQ MV 0.35 10 12.15 21 4.2% 9.7% APPX 32.63 JAN 30.00 AQO MF 0.75 2249 29.25 21 3.7% 9.7% MLNM 17.95 JAN 17.50 QMN MW 0.45 3140 17.05 21 3.8% 9.1% ASPT 15.94 JAN 15.00 SQR MC 0.35 50 14.65 21 3.5% 8.8% GTI 13.00 JAN 12.50 GTI MV 0.30 72 12.20 21 3.6% 8.7% TNB 22.84 JAN 22.50 TNB MX 0.40 0 22.10 21 2.6% 6.3% SEE DISCLAIMER IN SECTION ONE ***************************** ************************ SPREADS/STRADDLES/COMBOS ************************ A Great Year Comes To An End! By Ray Cummins The major equity averages soared higher in 2003 with the Dow, S&P 500, and NASDAQ up 24%, 25%, and 48%, respectively. In light of the considerable annual gains, its no surprise that stocks have been somewhat subdued in recent sessions and Friday's activity was of little consequence. The Dow industrial average closed up 19 points at 10,324 with United Technologies (NYSE:UTX) and International Business Machines (NYSE:IBM) among the blue-chip leaders. The composite technology index added 3 points to end at 1,973, with biotech and internet shares limiting its advance. In the broader market, steel, aluminum, and gold shares helped the S&P 500 index add 1 point to end at 1,095. Advancing issues led declining shares 2 to 1 on the Big Board and nearly 3 to 2 on the technology exchange. Volume was trivial with 357 million shares traded on the NYSE and 531 million shares crossed on the NASDAQ. The bond market finished higher across the yield curve, with the 10-year note up 8/32, bringing its yield down to 4.15%. Happy New Year! ****************** STRATEGY SELECTION ****************** Attn: Questions@OptionInvestor.com Subject: Covered Calls With Leaps Hi Guys, Firstly, thanks for your information, company and good humor. It makes a lonely traders night here in New Zealand feel much less lonely and a lot more fun! My question is regarding covered-calls, but using LEAPS as security rather than stock. Do you call these [positions] credit spreads? Anyway I would really appreciate some feedback as to your suggested strategies for this type of play and the advantages and pitfalls as against standard covered-call plays. Happy Xmas from Aotearoa (that's New Zealand!) GR Hello GR, Your question was forwarded to me as it involves a common type of spread and I decided to publish the reply for the benefit of our readers. Indeed, "using Leaps as security rather than stock" is a viable alternative to owning the underlying shares in the combination position you described and in reality, the strategy you are utilizing is simply a calendar spread. A calendar spread (also known as a horizontal spread), involves the purchase of an option with one expiration date and the sale of another option with the same strike price, but a different expiration date. The philosophy for using calendar spreads is that time will erode the value of the short term option at a faster rate than it will the long term option. A spread which is established when the underlying stock is at or near the strike price of the options used is a neutral-outlook spread. If the underlying issue remains relatively unchanged until the short term option expires, the neutral-outlook spread will make a profit. A less neutral and more bullish type of calendar, or time spread is initiated when the current value of the underlying issue is below the strike price of the options. This type of position (often used with LEAPS) is speculative with low initial cost and large potential profits. Two favorable outcomes can occur: the underlying stock moves higher in the short-term and the spread is closed for a profit as the time-value erosion in the short option produces a net gain or; the underlying stock consolidates, allowing the sold option to expire and then eventually rallies above the long option's strike price. It is important to understand how a calendar spread profits from the passage of time. When opening a horizontal spread, we buy a long term option and sell a short term option. Both options have the same exercise price, thus they have the same intrinsic value. Regardless of the movement of the stock, time value will always be less in the near term option. As long as the underlying stock price remains relatively close to the exercise price, the value of the spread will be determined by the time premium of each option. At expiration, the time value in the short term option will be very low relative to that of the long term option. As you can see, a horizontal spread is completely dependent upon the relative behavior of time-value decay in each of the option positions. Since the profitability of this strategy is solely determined by the difference in time values of the options, it is important for the underlying issue to remain near the strike price; where time premium is theoretically the highest. If the stock price is at the high or low extreme, the time values of both options will be low and the position will likely incur a loss; the remaining credit will be less than the opening debit. To the average trader, it would appear that this technique can't lose. One would simply buy the longer-term option and sell the shorter-term option. As both time values decayed, the spread would gain value. In reality, it's rarely that easy because the underlying stock price does not remain constant. A good way to reduce the negative effects of stock price movement is to open the position a few months before the short term option expires, capitalizing on the ability to sell a second (and third, fourth, etc.) option against the longer-term option. This is the basis for employing LEAPS with covered-calls and the objective is to continue selling options until the cost of the long position is zero. Each month (at expiration), the position is adjusted or "rolled" forward to the next period and ideally, the stock price will be slightly below the sold strike when the near term option expires. If the sold options are "in-the-money" at expiration, they must be repurchased to preserve the long term position. Another method that is commonly used to increase the probability of profit in this strategy requires an understanding of implied volatility in option pricing. When opening any type of spread, it's important to take advantage of any premium disparities to create the best possible position. Professionals generally try to open "time-selling" plays when there is excess value in the sold option or a discount in the long option. This allows them to enter the position with a theoretical edge. At the same time, positions can be based more on technical indications than option pricing, as long as the recent trend suggests a high probability of a profitable outcome. There is always the risk of early exercise in a calendar spread and the degree of risk depends on which options are bought and sold and the distance to the underlying. The greater the time value in the sold option, the lower the probability of it being exercised. If it does occur, a trader can fulfill the obligation by simply purchasing the underlying issue and writing new options to the restore the spread. The important thing is to be notified in a timely manner so the appropriate action can be taken before the price of the underlying changes appreciably. Good Luck! ************* NEW POSITIONS There will be no "New Plays" today as the editor of this section is away from the market, enjoying the holiday season with family and friends. The Spreads, Straddles & Combos section will return on January 4, 2004. Happy New Year! ************* ************************Advertisement************************* OneStopOption.com Trade: Securities, Stock Options, Futures Contracts Service: Experienced Brokers Personal Assistance Convenience of One Brokerage Online and Live Broker Trading Experience... 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