The Option Investor Newsletter Thursday 05-27-2004 Copyright 2004, All rights reserved. 1 of 3 Redistribution in any form strictly prohibited. In Section One: Wrap: Volatility Crunch Futures Markets: See Note Index Trader Wrap: Bulls don't look scared by thoughts of terrorism Market Sentiment: Throwing Caution to the Wind? Posted online for subscribers at http://www.OptionInvestor.com ************************************************************ MARKET WRAP (view in courier font for table alignment) ************************************************************ 05-27-2004 High Low Volume Advance/Decline DJIA 10205.20 + 95.31 10222.24 10109.89 1.75 bln 1914/ 915 NASDAQ 1984.50 + 8.35 1991.87 1969.04 1.60 bln 1645/1382 S&P 100 546.32 + 3.72 547.17 542.60 Totals 3559/2297 S&P 500 1121.28 + 6.34 1123.95 1114.86 RUS 2000 568.56 + 0.79 571.87 564.35 DJ TRANS 2951.89 + 86.53 2974.62 2933.38 VIX 15.28 - 0.69 15.86 15.19 VXO 15.53 - 0.70 16.39 15.37 VXN 21.50 - 0.13 22.19 21.33 Total Volume 3,394M Total UpVol 2,311M Total DnVol 948M 52wk Highs 181 52wk Lows 56 TRIN 0.63 PUT/CALL 0.94 ************************************************************ Volatility Crunch Jonathan Levinson Equities added to the week's gains, with the Dow closing higher by .94% at 10205, the Nasdaq +.42% to 1984.5 and the SPX adding 57% to close at 1121.28. Options volatility as measured by the VXO, VIX, QQV and VXN fell further still, despite a widespread consensus that the volatility crash this week had come too far, too fast. The QQV is below 20 again, back to levels from which previous price highs have blown off. But equity futures were looking firm afterhours as of this writing. The market's bounce has aligned itself with an upturn in the daily chart oscillators from oversold territory. However, key trendline tests lie dead ahead, and there's been remarkably little backing or filling this week. With a holiday weekend approaching, there is an apparent lack of concern for terrorist threats, Iraq trouble or even a technical correction in price as option premiums continue their plunge. However, key trendline tests are imminent, and the mettle of this rally should be put more fully to the test at those levels. Daily Dow Chart The Dow's 95 point gain today brought it nose-to-nose with resistance at the 50 day EMA (pink line). The daily cycle upphase is in its early stages, launching from a wide base in the 9900 area. I expect some chop as the current gains get digested, but so long as the daily cycle upphase continues, we should see a test of trendline resistance in the 10360 area. A failure at that level below 10400 would maintain the daily downtrend off the year highs, which would suggest that the longer cycles within which the daily cycle oscillates have turned down as well. Monthly Dow Chart Looking at those longer cycles, the monthly is in the first stages of a downphase. The continued bounce in today's trading was sufficient to convert what was shaping up to be a 3rd bearish candle into a doji star, turning this month from red to green. The 10 year monthly chart reveals a lower high to complete the rally of 2003, but the decline off the year high is still young enough to constitute a monthly bull flag if the descending upper trendline in the 10600 area can be broken to the upside. However, the 10 month stochastic is on a sell signal, the first suggestion of a monthly cycle downphase lined up with the failure beneath that upper descending trendline. A move back below the 9800 support level would confirm this downphase and likely produce the beginnings of a bearish cross on the monthly Macd, while a break above 10600 would reverse the weakness and confirm the bull flag interpretation. Daily Nasdaq Chart The one year daily Nasdaq chart resembles that of the Dow, except that the broad base on the Dow is narrower on the Nasdaq, with the current daily cycle bounce sharper and consequently more extended than that on the Dow. The broken rising trendline test is closer at hand as well, fittingly at round number resistance at 2000. The descending upper trendline from the year high at 2160 lines up just below 2040, by which level I would expect the daily cycle to be overbought and extended. If the cycle turns back down at or below that level, we'll again have confirmation of a new downphase in the longer cycles. Those longer cycles are currently ambiguous, as we've just seen with respect to the Dow, which sets up that 2040 level as a key resistance to watch. Monthly Nasdaq Chart I still find the monthly Nasdaq candles fascinating. Looking at the full 10 year sweep of it, it's tempting to assume a head and shoulders pattern, although the downside projection on a neckline break would obviously be many thousands of points below zero, of theoretical interest only. That said, rising support lines up with monthly Bollinger support at 1200. The 10 month stochastic is in the first steps of a downphase, with the Macd not yet but much closer to a sell signal than that on the Dow monthly above. The same bull flag / bearish rollover dilemma is apparent here, and it will take a break above 2100 or below 1800 to clarify the picture for the coming months. On the economic front, there were a number of announcements before the bell. The Commerce Department revised the 1st quarter GDP upward from 4.2% to an annualized 4.4% rate of growth, falling just shy of the anticipated 4.5% level. The GDP's strength was attributed primarily to inventory rebuilding and software and equipment investments on the part of businesses, high spending on the part of consumers, and defense spending. After-tax profits rose 36.7% from the previous year's period, which marks a 23 year high, while the Personal Consumption Expenditure Price Index rose less than the 3.2% expected, coming in at a 3% annualized rate. The Labor Department reported that initial jobless claims declined for the week ending May 22 by 3,000 applicants to 344,000, while the 4 week moving average of initial claims rose by 1,500 to 335,500 applicants from a 3 and half year low. The number for the week exceeded estimates by 9,000 applicants. The dollar and treasuries had been weak ahead of the data, and while the bond strengthened from 8:30AM, the dollar fell further against British pounds, Swiss francs, CDN dollars and euros. Gold, silver, US bonds and equities all rose on the dollar weakness. The move in the dollar and bonds was attributed in part by the media to the discovery of explosives in the Slovak capital of Bratislava, near this weekend's planned meeting place for 300 NATO officials. At 10AM, the Help Wanted Advertising Index for April was released, falling by 1 point from the March reading of 39 to 38, still up 1 point year-over-year. Ad lineage increased in most US regions during the past quarter, with an estimated 708,000 new jobs created. While the market clearly expressed disappointment in the data, with the US Dollar Index getting croaked on the news and bonds rallying, the employment news clearly represents an improvement over the 400K+weekly initial claims we recall from last year. The deeper issue is the quality of the jobs being created, with the outsourcing of tech and manufacturing jobs still a crucial and troubling story. Crude oil broke back below the 40 level in the morning and remained weak throughout the session, falling 3.44% to close at 39.30. Natural gas stocks rose 89 billion cubic feet for the latest week, exceeding analyst expectations for an 88 bcf rise. Natural gas, heating oil, crude oil, cotton and soybeans were the weakest components of the CRB Index for the day. It was a quiet day for corporate news, with mostly up- and downgrades making the headlines. It was reported that the Federal Reserve fined Citigroup (C) $70M million "to pay restitution to certain subprime personal and home mortgage borrowers" for requiring borrowers to obtain co-signatories for loans, even where they qualified independently for the loan. Costco Wholesale (COST) reported Q3 net income of .42 per share or $198.7M, up from .33 per share year-over-year and beating estimates of .38 per share. Sales were up 14% to $10.67B, also beating estimates of $10.64B. COST rose 1.66% to close at 38.08. Electronic Data Systems (EDS) completed the $2.05B sale of its UGS PLM Solutions software unit to a group of three private equity firms. This appears to be a bullish transaction for the company, which it claims should render it debt-free and flush for $5B by the end of the year, as well resulting in a large cash gain for Q2 to be reported in July. EDS closed higher by 2.01% at 16.25. The Fed was relatively quiet today, with New York Fed President Timothy Geithner addressing the Economic Club of New York today. Mr. Geithner told the Club that the financial system appears to be sound, but admitted that the increasing complexity of the financial system makes risk assessment and banking oversight difficult tasks. He noted that participants appear to be adjusting themselves in preparation for a higher interest rate environment, but stressed the difficulty in evaluating risk within the system and the need to devote resources to allow regulators to properly monitor those risks. With the weather heating up and a long weekend approaching, I'm expecting volume to drop considerably for tomorrow. As we know, that can either result in a comatose flatlined range, or hair- raising volatility on a thin tape. In either case, barring a strong directional move to the downside, this week is clearly set up for a bullish victory. As discussed in tonight's Futures Wrap, an intraday pullback is to be expected, but for the time being, the daily cycle upphase, still in its early stages, is delivering strong upside price traction. If feeling bearish on the action, my suggestion is to either use patience, disciplined entries, tight stops and quick exits, or preferably all of the above. Tomorrow morning, we'll have personal income and personal spending data for April to be released at 9:30, followed by Michigan Sentiment at 9:45 and the Chicago PMI for May at 10AM. With holiday volume expected, there's a good chance that we'll see some fast action in the morning. We'll be covering it tick- by-tick in the Market Monitor and Futures Monitor. See you there. *************** FUTURES MARKETS *************** Futures wrap is not emailed due to the excessive number of charts. It may be read on the website at this address. http://www.OptionInvestor.com/indexes/futureswrap.asp ************************Advertisement************************* No time to follow the Market Monitor? Tired of missing good Trades because you stepped away from your computer? OneStopOption Group can follow the Market Monitor for you. You choose the number of contracts, we take care of the rest!! Trade Stock Options, Stocks and ALL Futures with the same Group. Call us 888 281-9569 to see if you qualify to have us rebate your subscription cost. http://www.OneStopOption.com ************************************************************** ******************** INDEX TRADER SUMMARY ******************** Bulls don't look scared by thoughts of terrorism While the major indices looked to waffle at mid-session, buyers, either bulls or running bears, bought the major indices right back to their best levels of the session, as sharp declines in oil, another BIG round of buying in Treasuries, and some "just right" economic data has stocks threatening to close at their highs of the week. Oil and Unleaded Gas futures - June to December 2004 Sharp declines were found in both the oil and unleaded gas futures markets today. A point and figure chart of the July Crude Oil futures (CLN4) from Dorsey/Wright and Associates ($0.25 box size) shows this contract having recently given a sell signal at $39.75, then a buy signal at $41.75 (right at the prior contract high) and today's trade giving a reversing sell signal at $39.25 (sense some volatility?) where the current bearish vertical count is to $36.00. A point and figure chart of the July Unleaded Gas futures (HUN4) from Dorsey/Wright and Associates (.005 box size) shows this contract giving its first sell signal since giving a buy signal at $1.160 back in April, where a current bearish vertical count of $1.140 is currently building until a 3-box reversal would fully establish a potential downside risk objective. I wanted to show the above futures contracts several months out, as we may revisit these data in the weeks/months to come. One reason I wanted to quickly cover these energy futures is for an understanding of the CRB Index (cr00y) 275.70, which finished unchanged, as gold, industrial metals like copper, and euro strength offset oil's weakness. Market Snapshot / Internals - 05/27/04 Close Stocks closed STRONGER than I thought they would at the midpoint of today's session, and I may not me alone in this thinking. There was great opportunity at the 03:00 PM EDT mark for bears or long sellers to show up for some selling to the close, but that didn't happen. The number of new highs at the NASDAQ showed a nice little pop after being basically flat from 12:00. I must make immediate correction to last night's Index Trader Wrap, when I said the NYSE NH/NL 10-day Average Ratio had not yet reversed up and was reading just 16.1%. I do not know how, or why I got that number. However, similar to the NASDAQ NH/NL 10- day ratio, the NYSE NH/NL 10-day Average Ratio reversed up to "bull alert" status on Monday at 21.5%, rose to 28.8% on Tuesday, rose to 35.8% yesterday, and 43.0% today. NYSE Composite 52-week NH/NL 10-day Avg. - 2% box size My incorrect comments regarding the NYSE Composite 52-week NH/NL 10-day Avg. would have given a false impression that bullish leadership wasn't present in the NYSE. The above chart would reflect current readings. I think what I did was I that I was looking at last Friday's 10-day Avg. reading of 16.2% when writing last night's wrap. Today's trade would have the NASDAQ NH/NL 10-day Avg. rising to 40.8%. NYSE and NASDAQ NH/NL Indications - I don't want to focus on my error, but I caused great confusion among subscribers to Dorsey/Wright and other traders/investors that were calculating their own NH/NL indications. I can't apologize enough. Key dates for these indications would be 05/18/04 for the NYSE when the 5-day moved above the 10-day (short-term above intermediate term) while 10-day would have hit an inflection low reading, and 05/24/04 when NYSE showed 3-box reversal up to "bull alert." On 05/29/04, NASDAQ's 5-day average ratio moved above its 10-day, on 05/20/04 the inflection low of 23.4% was realized, and on 05/25/04 the 10-day Avg. ratio reversed up to "bull alert" status. Pivot Matrix - I first want to say that I think today's close was stronger than what I would have expected for any sign of a defensive posture into the 3-day weekend. I will follow up on this thought in a minute but want to discuss some observations. In this afternoon's market monitor, I made comment as to "sign of weakness" as it relates to my observation that the Semiconductor Index (SOX.X) 482.46 +0.89% is the only equity-based index in our pivot matrix to not yet see trade at its WEEKLY R2. I can't call a market based on what the SOX.X does or doesn't do, and while tomorrow is a new day and the WEEKLY R2 is easily in reach, the SOX.X didn't trade its WEEKLY R2 and would lag the NDX/QQQ. Today's close in the BIX.X at 347.03 comes right in between its WEEKLY R2 and MONTHLY R1. Again, I wouldn't take anything away from the BIX.X and call this group of stocks "pigs," but based on some thoughts in last night's Index Trader Wrap, today's trade was rather similar to what we wanted to be on the lookout for. During today's mid-point of trade, I was sure I was onto something here, but the ability of the BIX.X to muster enough buying, or lack of selling to still reclaim the MONTHLY R1 and park itself in the zone highlighted, isn't necessarily bearish. I highlight the QQQ session low today. This is a penny lower than what was today's (Thursday's) daily Pivot. While the QQQ seemed to be married to the BIX.X intra-day trade, there was some type of eager buying at the DAILY Pivot. Carry this observation into tomorrow's trade. If we're going to see ANY type of defensive trade into the weekend, then the DAILY Pivots would have to be violated. Let's quickly look at some intra-day charts, which are updated versions of charts we were looking at and discussing in today's Market Monitor. S&P Banks Index (BIX.X) - 10-minute intervals We looked at the BIX.X daily interval bar chart last night. Here's a quick look at the BIX.X on an intra-day chart. It certainly looks like other market participants were thinking "sell strength" below 350 as the BIX.X jumped at the open, then consolidated, and then a sell program premium was generated. I'm thinking... "Aha! We're onto something." Not shown is another sell program that had the BIX.X falling below its MONTHLY R1. This was my "failure" or alert to weakness level from last night. As I look at the BIX.X, there was EVERY OPPORTUNITY for bulls to either liquidate back down to the WEEKLY R1, but it may well have been the VERY SHARP drop in the benchmark 10-year YIELD ($TNX.X) and strong buying in Treasuries, where there may still be a heck of a lot of pain to be inflicted on bears, should the scenario of SHARPLY RISING RATES being a negative for the banks and broader equities really be falling apart. NASDAQ-100 Tracker (QQQ) - 10-minute intervals The BEAR in my says "gulp" at tonight's close. While there isn't a bank in the bunch, the QQQ session trade was VERY similar to the BIX.X, and certainly institutional computers were going to be set for selling distribution into the weekend. While the SOX.X trade and slight weakness in the WEEKLY Pivot may be an alert to pending QQQ weakness, I did say in this afternoon's Market Monitor (03:04:54) as both the SPX and QQQ had just slipped back below their WEEKLY R2s that "If the bears/sellers are going to whack'em its going to be here." going to hit them, now's the time." That must have given institutions just enough time to set up a buy program at 03:33 PM EDT to lift the QQQ back above its MONTHLY 38.2% retracement of $36.31. I've marked tomorrow's DAILY Pivot of $36.33 on the above chart, and while a dip below the DAILY Pivot might be a VERY alert to weakness, I'd really have to say WEEKLY R2 is the test. S&P 500 Index (SPX.X) Chart - Daily Intervals SPX looks pretty darned similar to the BIX.X as it relates to "zones" doesn't its? I was talking to a futures trading buddy of mine after the close and he was trading the e-mini S&P futures and he too shorted the futures late this afternoon on the re-test of the WEEKLY R2. He also thought things were looking pretty good and the MARKET was going to "whack'em" to the close. I can't remember the exact number, but he said on the re-test just before the buy program back above the WEEKLY R2, there was a large looking offer that simply got gobbled up as if to say... "is that all you got piker?" (Piker is a slang term traders will use to designate another trader as a small player. Traders will jokingly use the term in an attempt to prove their macho). Jeff Bailey ************************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 ************************************************************** **************** MARKET SENTIMENT **************** Throwing Caution to the Wind? - J. Brown This has been a positive week for stocks. The Dow Industrials are up more than 230 points while the NASDAQ Composite is up more than 70 points (+3.7%) for the week and it's not over yet. It was only four days ago that oil hit its all-time high near $41.72 a barrel. Since then we've seen stocks march higher as crude oil prices fall. Today crude slipped $1.26 to $39.44 a barrel, which is the lowest close in nearly three weeks. Is it all about oil? Well, this week the answer is probably yes. The market is always finding something to worry about. It didn't hurt that this morning the GDP number came in at 4.4% growth. That's higher than the earlier reading at 4.2% but under estimates of 4.5%. This hot but not too hot reading has some traders speculating that the Fed might not raise rates at the next meeting. Looking at the action in today's market the movement was generally positive. Money was flowing into transports as the Dow Transport index surged 3%. Traditional Dow theory suggests that you can't have a meaningful rally in the markets without confirmation in the transports. Today's rally higher, fueled by the drop in oil, is good news for the bulls. Tech stocks are still creeping higher although hardware was a laggard today. The INX Internet index has broken through resistance at 185 and cleared all its moving averages. Likewise the SOX is performing well but is just under technical resistance at its 200-dma. This could be a challenge for the NASDAQ tomorrow, if the chip sector slips on profit taking. The good news is that the NDX-100's bullish percent chart has moved into a new bull alert status. I also noted that the DFI defense index was near its all-time highs. Retails stocks have also been big winners the last two weeks and the RLX index is nearing its highs. Market internals were generally bullish with advancing stocks outnumbering decliners by more than 2-to-1 on the NYSE and better than 8 to 7 on the NASDAQ. Up volume was three times down volume on the NYSE and twice down volume on the NASDAQ but overall volume remained light. Volume is going to get even lighter tomorrow as Wall Street empties ahead of the long, three-day Memorial Day weekend. Volatility indices continue to sink back toward their April lows and investor sentiment seems to be improving. However, tomorrow may be a challenge. Several of the major sector-specific averages are right underneath significant resistance and we could see some profit taking. It is not normal for traders to throw caution to the wind, especially ahead of a long weekend. Normally professionals tend to reduce and/or hedge positions over concerns of a potential terrorist event. ----------------------------------------------------------------- Market Averages DJIA ($INDU) 52-week High: 10753 52-week Low : 8540 Current : 10205 Moving Averages: (Simple) 10-dma: 10012 50-dma: 10248 200-dma: 10059 S&P 500 ($SPX) 52-week High: 1163 52-week Low : 927 Current : 1121 Moving Averages: (Simple) 10-dma: 1098 50-dma: 1116 200-dma: 1084 Nasdaq-100 ($NDX) 52-week High: 1559 52-week Low : 1123 Current : 1463 Moving Averages: (Simple) 10-dma: 1415 50-dma: 1437 200-dma: 1424 ----------------------------------------------------------------- CBOE Market Volatility Index (VIX) = 15.25 -0.69 CBOE Mkt Volatility old VIX (VXO) = 15.53 -0.70 Nasdaq Volatility Index (VXN) = 21.50 -0.13 ----------------------------------------------------------------- Put/Call Ratio Call Volume Put Volume Total 0.94 648,734 608,932 Equity Only 0.63 512,473 320,999 OEX 1.21 21,903 26,556 QQQ 2.17 34,708 75,435 ----------------------------------------------------------------- Bullish Percent Data Current Change Status NYSE 63.7 + 1 Bear Confirmed NASDAQ-100 36.0 + 3 BULL ALERT Dow Indust. 66.7 + 0 Bear Confirmed S&P 500 59.8 + 1 Bear Confirmed S&P 100 61.0 + 0 Bear Confirmed Bullish percent measures the number of stocks in an index currently trading on a buy signal on their point and figure chart. Readings above 70 are considered overbought, and readings below 30 are considered oversold. Bull Confirmed - Aggressively long Bull Alert - Cautiously long Bull Correction - Pause or pullback in upward trend Bear Alert - Take defensive action if long Bear Confirmed - High risk if long, good conditions for shorting Bear Correction - Pause or rebound in downtrend ----------------------------------------------------------------- 5-dma: 0.67 10-dma: 1.05 21-dma: 1.05 55-dma: 1.08 Extreme readings above 1.5 are bullish, and readings below .85 are bearish. These signals don't occur often and tend be early, but when they do, they can signal significant market turning points. ----------------------------------------------------------------- Market Internals -NYSE- -NASDAQ- Advancers 1914 1645 Decliners 915 1384 New Highs 94 86 New Lows 30 18 Up Volume 1281M 1032M Down Vol. 470M 479M Total Vol. 1785M 1609M M = millions ----------------------------------------------------------------- Commitments Of Traders Report: 05/04/04 Weekly COT report discloses positions held by small specs and commercial traders of index futures contracts at the Chicago Mercantile Exchange and Chicago Board of Trade. COT data can be found at www.cftc.gov. Small specs are the general trading public with commercials being financial institutions. Commercials are historically on the correct side of future trend changes while small specs tend to be wrong. S&P 500 Commercial traders remain net short and seem to be increasing their bearish sentiment. Small traders are net bullish and in mirror-like fashion are growing more bullish compared to the big traders. Commercials Long Short Net % Of OI 04/27/04 406,927 416,244 ( 9,317) (1.1%) 05/04/04 397,964 417,175 (19,211) (2.4%) 05/11/04 401,365 421,672 (20,307) (2.5%) 05/18/04 394,352 423,258 (28,906) (3.5%) Most bearish reading of the year: (111,956) - 3/06/02 Most bullish reading of the year: 23,977 - 12/09/03 Small Traders Long Short Net % of OI 04/27/04 133,775 90,535 43,240 19.3% 05/04/04 137,112 80,201 56,911 21.6% 05/11/04 135,534 76,987 58,547 27.5% 05/18/04 139,647 74,597 65,050 30.4% Most bearish reading of the year: (1,657)- 5/27/03 Most bullish reading of the year: 114,510 - 3/26/02 E-MINI S&P 500 The four-week trend for the commercial traders has been a bullish one as they increase their long positions. Meanwhile the small traders have been busy shuffling money around and reducing their long and short positions. Commercials Long Short Net % Of OI 04/27/04 291,365 370,549 (79,184) (12.0%) 05/04/04 316,840 370,781 (53,941) ( 7.8%) 05/11/04 378,696 362,887 15,809 2.1% 05/18/04 390,484 357,157 33,327 4.5% Most bearish reading of the year: (354,835) - 06/17/03 Most bullish reading of the year: 133,299 - 09/02/03 Small Traders Long Short Net % of OI 04/27/04 175,788 69,613 106,175 43.3% 05/04/04 119,308 74,407 44,901 23.2% 05/11/04 101,199 94,408 6,791 3.5% 05/18/04 62,216 87,269 25,053 16.8% Most bearish reading of the year: (77,385) - 09/02/03 Most bullish reading of the year: 449,310 - 06/10/03 NASDAQ-100 There continues to be very little movement in the commercial traders' positions. Small traders have reduced their short positions somewhat. Commercials Long Short Net % of OI 04/20/04 54,852 35,964 18,888 20.8% 04/27/04 54,196 33,948 20,248 23.0% 05/04/04 56,931 35,209 21,722 23.6% 05/18/04 58,376 37,528 20,848 21.8% Most bearish reading of the year: (21,858) - 08/26/03 Most bullish reading of the year: 21,722 - 05/04/04 Small Traders Long Short Net % of OI 04/27/04 9,008 20,347 (11,339) (38.6%) 05/04/04 10,247 24,764 (14,517) (41.5%) 05/11/04 9,716 21,072 (11,356) (36.9%) 05/18/04 9,843 18,935 ( 9,092) (31.6%) Most bearish reading of the year: (14,517) - 05/04/04 Most bullish reading of the year: 19,088 - 01/21/02 DOW JONES INDUSTRIAL The dead heat between longs and shorts for the commercial traders has grown even thinner. Small traders have moved from net bearish to net bullish on the Industrials. Commercials Long Short Net % of OI 04/27/04 23,676 22,009 1,667 3.6% 05/04/04 24,296 22,181 2,115 4.6% 05/11/04 22,614 21,507 1,107 2.5% 05/18/04 22,257 22,444 ( 187) (0.4%) Most bearish reading of the year: (8,322) - 1/16/01 Most bullish reading of the year: 15,135 - 10/16/01 Small Traders Long Short Net % of OI 04/27/04 5,998 8,868 (2,870) (19.3%) 05/04/04 6,262 8,155 (1,893) ( 9.2%) 05/11/04 7,009 7,640 ( 631) ( 4.3%) 05/18/04 9,098 6,591 2,507 16.0% Most bearish reading of the year: (12,106) - 3/09/04 Most bullish reading of the year: 8,523 - 8/26/03 ----------------------------------------------------------------- ************************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 Thursday 05-27-2004 Copyright 2004, All rights reserved. 2 of 3 Redistribution in any form strictly prohibited. In Section Two: Dropped Calls: ADP Dropped Puts: FRX Call Play Updates: AIG, ERTS, JNJ, LXK, BCR, IMCL, QCOM New Calls Plays: BA, ZMH Put Play Updates: CAKE New Put Plays: None **************** PICKS WE DROPPED **************** When we drop a pick it doesn't mean we are recommending a sell on that play. Many dropped picks go on to be very profitable. We drop a pick because something happened to change its profile. News, price, direction, etc. We drop it because we don't want anyone else starting a new play at that time. We have hundreds of new readers with each issue who are unfamiliar with the previous history for that pick and we want them to look at any current pick as a valid play. CALLS: ***** Auto. Data Proc. - ADP - cls: 44.65 chng: -0.19 stop: 43.75 It's time to pull the plug on this non-performing play. The initial surge to the top of the rising channel certainly looked convincing and we waited for over two weeks for some sort of rebound to materialize near the center of that channel in preparation for another run at new highs. Earlier this week, the stock managed a bounce back over the midline of the channel and it looked like the bounce was underway. But the rollover and drop through that level today does not look encouraging, especially in light of the broad market advance. Rather than play the 'wait and hope' game, we're going to cut our losses here in order to focus our attention on more promising plays. Picked on May 9th at $46.03 Change since picked: -1.38 Earnings Date 4/22/04 (confirmed) Average Daily Volume = 2.16 mln Chart = PUTS: ***** Forest Labs - FRX - close: 63.46 chg: +2.98 stop: 63.00 Argh! These sharp reversals are becoming painful. The oversold bounce on Tuesday was understandable because the Dow was up 159 points. On Wednesday shares of FRX did as we expected and failed at technical resistance with its 10 and 200-dma's. The stock looked poised to continue its decline. Unfortunately, the company released positive clinical data on its hypertension drug Benicar late Wednesday. Combine the positive drug news with an upgrade from "peer perform" to "out perform" from Thomas Weisel and the stock jumped almost 5%. We are stopped out at $63.00. Picked on May 23 at $ 59.20 Change since picked: + 3.66 Earnings Date 04/20/04 (confirmed) Average Daily Volume: 1.9 million Chart = ************************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 ************************************************************** ******************** PLAY UPDATES - CALLS ******************** American Int'l Grp. - AIG - close: 72.80 change: +0.69 stop: 68.70 Our AIG play got off on the right foot yesterday, edging over the $72 level and testing the 50-dma ($72.29). That first test wasn't successful, but today the stock gapped over the 50-dma and moved above the $73 level before falling back to consolidate in the middle of its intraday range. Volume is likely to be thin tomorrow ahead of the long weekend, so we aren't expecting any major fireworks. Dips near the $72 level look favorable for new entries and then next week we can consider possible momentum entries above today's high. Maintain stops at $68.70, just under the recent lows. Once the stock breaks over the $74 level, we can look at tightening our stop. Picked on May 25th at $72.00 Change since picked: +0.80 Earnings Date 4/22/04 (confirmed) Average Daily Volume = 5.28 mln Chart = --- Electronic Arts - ERTS - cls: 50.94 chng: +0.88 stop: 47.40*new* Ever since the rebound in ERTS began near the $48 level, we've been talking about the likelihood for the stock to find resistance at the short-term descending trendline (now $50.70) and the 50-dma ($51.20). The stock continued its rebound today, pushing through the trendline, but being turned back at the 50- dma. We will need a close over that average for confirmation that the stock is headed higher. With light volume expected tomorrow, more consolidation ahead of the long weekend is the most likely course of action. But next week, we ought to see the bulls return and drive the stock higher if our analysis is correct. Take advantage of dips near the $50 level as secondary entry points and then look for momentum entries early next week. It will take a trade at $53 in order to turn the PnF chart bullish with a new Buy signal. Note that we've raised our stop to $47.40 tonight, just under Tuesday's intraday low. Picked on May 18th at $49.60 Change since picked: +1.34 Earnings Date 4/29/04 (confirmed) Average Daily Volume = 3.85 mln Chart = --- Johnson & Johnson - JNJ - cls: 55.79 chng: +0.31 stop: 54.00*new* After one last rebound from just above the $54 level earlier this week, shares of JNJ have been steadily working their way higher and are nearing the recent highs in the $56.00-56.50 area. We continued to suggest buying the dip near $54 while the stock was showing a bit of weakness and traders that took that advice are sitting on a small gain here, with potential for a breakout next week. Because of the slow-moving nature of the stock, we still are not advocating breakout entries. With the stock once again solidly over the $55 level, pullbacks near that level should be viewed as new entry opportunities, with both the 10-dma ($55.05) and 20-dma ($54.87) reinforcing that support. Once the stock breaks out over the $56.50 level (probably next week), the next objective will be for a run at $58 resistance, at which point conservative traders may want to harvest some gains. Note that we've raised our stop to $54 this evening. Picked on May 9th at $55.30 Change since picked: +0.49 Earnings Date 4/13/04 (confirmed) Average Daily Volume = 7.23 mln Chart = --- Lexmark Intl. - LXK - close: 93.63 change: -0.99 stop: 89.75 The back and forth battle in LXK's price action continued on Thursday, with the stock falling back under the $94 level, just two days after the strong breakout on Tuesday. The stock did give us a nice rebound from the 50-dma (now $92.34), but we have yet to see a strong rally materialize. With the back and forth price action, clearly the better entries are still found on dips near support, which is now near the $92 level. Aggressive traders can certainly entertain momentum entries, but with the understanding that risk must be assumed to be down to the level of the 50-dma. Our expectation is that LXK will continue this choppy rally up to the $97 level of resistance, at which point we'll see a real battle to determine whether that will be a top for this move or if we'll get the expected breakout towards our $100 target. Conservative traders may just want to harvest gains near that $97 level when reached. We're maintaining our stop at $89.75 for now. Picked on May 13th at $94.03 Change since picked: 0.40 Earnings Date 4/19/04 (confirmed) Average Daily Volume = 1.13 mln Chart = --- Bard C R - BCR - close: 112.07 chg: +1.25 stop: 108.49 *new* We have good news to report on for BCR. After days of consolidating and testing resistance at $110 the stock finally powered through the $110 level on Wednesday. Furthermore BCR experienced a follow through move today and bulls pushed the stock through April resistance at $112. Shares closed at a new all-time high with its MACD indicator producing a fresh buy signal. We're very encouraged and BCR looks poised to extend its run but don't forget that shares are due to split 2-for-1 on Tuesday, June 1st. We're going to raise our stop loss to $108.49 (that will be $54.25 post-split). Picked on May 20 at $110.00 Change since picked: + 2.07 Earnings Date 04/20/04 (confirmed) Average Daily Volume: 386 thousand Chart = --- Imclone Systems - IMCL - close: 74.69 chg: -0.36 stop: 70.00 Well that was quick. We listed IMCL on the play list Tuesday night and we were triggered on Wednesday when shares traded through our trigger at $74.05. Yesterday's close over $75 was very encouraging since $75 is round-number resistance where IMCL failed at two weeks ago. Today's close under that level makes us a little less enthusiastic but the trend is still bullish. Traders looking to buy a dip might watch for a pull back toward the $73.00-72.50 level but such a decline might draw into question the recent (and hard to see) MACD buy signal. Keep an eye on the BTK biotech index. The BTK produced a nice "doji" candlestick, which can mean indecision on the part of investors. No change to our stop. Picked on May 26 at $ 74.05 Change since picked: + 0.64 Earnings Date 04/27/04 (confirmed) Average Daily Volume: 2.9 million Chart = --- QUALCOMM - QCOM - close: 66.80 chg: +0.23 stop: 64.00 After a multi-day run from $62 to $66 it would appear that QCOM is taking a couple of days to consolidate its gains. The stock failed to rally yesterday when the NASDAQ was dominant and it failed to rally today when the Dow was charging higher. QCOM has been trading in a relatively tight $1.00 range. Traders trying to buy a dip can look for a pull back to $66.25. We're going to keep our stop loss at $64. Picked on May 24 at $ 66.01 Change since picked: + 0.79 Earnings Date 04/22/04 (confirmed) Average Daily Volume: 9.6 million Chart = ************** NEW CALL PLAYS ************** The Boeing Company - BA - close: 46.20 change: +1.44 stop: 43.25 Company Description: One of the world's major aerospace firms, BA operates in three principal segments: commercial airplanes, military aircraft and missiles, and space and communications. Commercial airplanes operations involves the development, production and marketing of commercial jet aircraft, principally to the commercial airline industry. The Military Aircraft and Missiles division is involved in the research, development, production, modification and support of military aircraft, including transport and attack aircraft. The Space and Communications segment is involved in the research, development, production, modification and support of space systems, rocket engines and battle management systems. Why we like it: If at first you don't succeed, try again! That seems to be the mantra of BA investors this week. After being turned back from the $45 level on several occasions since the first of the year, the buyers managed to coil the stock up just under that level as of yesterday's close and then sent price soaring right through it today on the heels of several positive news items, not the least of which was an analyst opinion that the much-debated tanker deal will eventually go through. Regardless of what the cause of today's move, we can see that there was clearly some conviction behind the breakout, with volume running well over double the daily average. This is the best level the stock has seen in over 2 years and the bulls appear to have their sights set on a run at the $50 level. Taking a look at the PnF chart, we can see that today's move produced an Ascending Triple Top breakout and that just reinforces the $62 bullish price target generated by the long column of X when BA broke out of its long descending trend last summer. Given the number of times the $45 level was tested as resistance before the breakout occurred, that level should now present solid support on any pullback. That means we should be looking for pullback entries on a dip into the $44-45 area, so long as price doesn't break into the gap left behind on Monday. There is some minor resistance on the weekly chart in the $46-47 area and for that reason we'd be very cautious about entering the play on continued strength. We've gotten the initial breakout and now the best entry will be on the pullback to test broken resistance as new support. Looking again at the weekly chart, we can see that the $50 level should present strong resistance, so that will be the point at which we'll look for a favorable exit. Place initial stops at $43.25, just under the bottom of Monday's gap and below the level where the 30-dma ($43.20) will be at tomorrow's open. Suggested Options: Shorter Term: The June $45 Call will offer short-term traders the best return on an immediate move, as it is currently in the money. Longer Term: Aggressive longer-term traders can use the July $47 Call, while the more conservative approach will be to use the July $45 Call. Our preferred option is the July $45 strike, as it is currently in the money and should provide sufficient time for the play to move in our favor. BUY CALL JUN- 45 BA -FI OI=8100 last traded @ $1.80 BUY CALL JUN- 47 BA -FW OI=1380 last traded @ $0.50 BUY CALL JUL- 45*BA -GI OI= 588 last traded @ $2.35 BUY CALL JUL- 47 BA -GW OI= 534 last traded @ $1.00 Annotated Chart of BA: Chart = Picked on May 27th at $46.20 Change since picked: +0.00 Earnings Date 4/28/04 (confirmed) Average Daily Volume = 2.88 mln Chart = --- Zimmer Holdings - ZMH - close: 85.20 chg: +0.10 stop: 80.00 Company Description: Founded in 1927 and headquartered in Warsaw, Indiana, Zimmer is the worldwide #1 pure-play orthopaedic leader in the design, development, manufacture and marketing of reconstructive and spinal implants, trauma and related orthopaedic surgical products. In October, 2003, the company finalized its acquisition of Centerpulse AG, a Switzerland-based orthopaedics company and the leader in the European reconstructive market. The new Zimmer has operations in more than 24 countries around the world and sells products in more than 80 countries. As a result of the acquisition of Centerpulse, reported 2003 sales were $1.9 billion. Full-year 2003 pro forma worldwide sales of Zimmer and Centerpulse were approximately $2.6 billion. The new Zimmer is supported by the efforts of more than 6,500 employees. (source: company press release) Why We Like It: Zimmer should satisfy the fundamental and technical trader alike. Fundamentally business is great. Q1 sales this year were up 90% to more than $742 million. Profits are on the rise. ZMH has consistently grown its net income for more than two years. It may be a little expensive with a P/E of 60 but ZMH trades for less than 9 times its sales. Everyone is praising its recent acquisition of Swiss orthopedics maker Centerpulse. According to Forbes the deal was originally expected to dilute earnings but now the acquisition is expected to add to its full year EPS due to the smooth integration. According to multiple sources the U.S. knee and hip replacement business is growing at 16% a year and ZMH is the dominant player in the field. We really like its relative strength over the past couple of months. While the market was sliding ZMH was slowing gaining, although the last few weeks have been mostly sideways. Tuesday's market-wide rally produced a big bounce from the $80 level for ZMH and the follow through has pushed it right toward resistance near $85.00-85.25. We're willing to go long at the current levels with a stop loss at $80.00. Should the stock dip, look for a bounce from $82.00 before initiating positions. More conservative players might want to use a trigger near $85.50 to confirm the upside breakout. Short-term traders can target $90.00 but suspect ZMH has more upside than that. It's P&F chart has a $96 price target and a freshly minted triple-top breakout buy signal. Suggested Options: Short-term traders can choose from the June and July options. Septembers are available but there's no reason to use that much time if you don't need it. We like the June 80s and 85s or the July 85s. The June 80s are currently trading with a premium of just 70 cents. BUY CALL JUN 80 ZMH-FP OI= 1696 Last traded @ $5.90 BUY CALL JUN 85 ZMH-FQ OI= 1334 Last traded @ $2.35 BUY CALL JUL 85 ZMH-GQ OI= 110 Last traded @ $3.50 Annotated Chart: Chart = Picked on May 27 at $ 85.20 Change since picked: + 0.00 Earnings Date 04/26/04 (confirmed) Average Daily Volume: 1.2 million Chart = ************************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 ************************************************************** ******************* PLAY UPDATES - PUTS ******************* Cheesecake Factory - CAKE - cls: 38.67 chng: -0.43 stp: 40.75 Clearly CAKE investors are not being swayed by the strength in the broad market this week, as the stock continues to languish just above the $38 support level. The attempted rebound stalled out just under the $40 resistance level yesterday, as we expected it would. Traders that took advantage of the oversold bounce appear to have gotten a solid entry, with daily oscillators now threatening a short-cycle bearish reversal. The fact that CAKE couldn't even manage a close over the declining 10-dma ($39.36) only reinforces the weakness we're seeing and suggests a breakdown below the $37.50 level early next week to take out the recent lows and drive the stock down towards our $35-36 target. Another failed bounce below $40 still looks good for new entries, but we are not advocating breakdown entries any longer, as the stock is too close to our final target for that to make sense from a risk-reward standpoint. Note that we're leaving our stop at $40.75 tonight, and that stop should be protected by the 20- dma ($40.80) falling below that level by tomorrow. Picked on May 13th at $40.09 Change since picked: -1.42 Earnings Date 4/20/04 (confirmed) Average Daily Volume = 629 K Chart = ************* NEW PUT PLAYS ************* None ************************Advertisement************************* No time to follow the Market Monitor? Tired of missing good Trades because you stepped away from your computer? OneStopOption Group can follow the Market Monitor for you. You choose the number of contracts, we take care of the rest!! Trade Stock Options, Stocks and ALL Futures with the same Group. Call us 888 281-9569 to see if you qualify to have us rebate your subscription cost. http://www.OneStopOption.com ************************************************************** ********** DISCLAIMER ********** Please read our disclaimer at: http://www.OptionInvestor.com/page/oin/aboutus/disclaimer.html ************************************************************** ADVERTISING INFORMATION For more information on advertising in OptionInvestor Newsletter, or any Premier Investor Network newsletter please contact: Contact Support
The Option Investor Newsletter Thursday 05-27-2004 Copyright 2004, All rights reserved. 3 of 3 Redistribution in any form strictly prohibited. In Section Three: Watch List: More Bullish Breakouts Option Spreads: The Cashflow Generator Continues Traders Corner: Look Before You LEAP ********** WATCH LIST ********** More Bullish Breakouts ___________________________________________________________________ How to use this watch list: Readers can use the candidates below as a springboard for their own research. Many are in the process of breaking support or resistance or in the process of starting new trends or extending old ones. With your own due diligence these could be strong potential plays. ___________________________________________________________________ Tyco Intl Ltd - TYC - close: 30.95 change: +1.00 WHAT TO WATCH: The recent two-week rally in TYC has drawn a lot of attention to the stock, especially as it approached major resistance at the $30 level. Shares managed to break that resistance today on huge volume of 31 million shares (vs. the average of 8.2 million) after the company announced plans to improve its balance sheet by eliminating debt. This might be a decent candidate for calls or covered calls. Chart= --- Mercury Interactive - MERQ - close: 47.96 change: +0.79 WHAT TO WATCH: We almost chose MERQ as a new call play on OI this evening. The recent breakout over technical resistance at its simple 100 and 200-dma's is good news. The breakout over price resistance at $47.00 is good news. Volume has been slowly rising. Plus, we really like the bullish rebound on its P&F chart. Nimble traders might want to watch it for a dip back toward $47.00 and try and buy a bounce. Chart= --- Bausch & Lomb - BOL - close: 61.55 change: +0.98 WHAT TO WATCH: We mentioned BOL in the MarketMonitor this afternoon. The stock has been slowly consolidating from its highs in April to support near $60.00. This slow drift lower has given its MACD time to move from overbought to oversold and now it's hinting at a bullish move higher again. Conflicting with this indicator is the trend of lower highs. The stock is coiling tighter for a breakout but the move could go either direction. If it dips back to $60.00 consider a straddle. Chart= --- Fortune Brands - FO - close: 75.24 change: +0.86 WHAT TO WATCH: This is it! We've been watch listing FO for a breakout over resistance at its 40 & 50-dma's and the $75 mark. The move happened today and helped confirm the recent MACD buy signal. Bulls can target the $80.00 region as the next level of significant resistance. Chart= ----------------------------------- RADAR SCREEN - more stocks to watch ----------------------------------- BGG $75.10 -0.34 - We're still watching BGG. Shares finally pulled back some after a multi-day rally but traders stepped up to buy the dip. Old resistance at $74 has become new (short- term) support. COF $69.99 +0.97 - We've still got our eyes on COF too. We've been watch listing the stock for a move over resistance at its 40 and 50-dma's and the $70.00 level. VZ $35.08 +0.68 - Bearish candidates are tough to come by these days but the breakdown in VZ looks tempting. Look for a roll over under its 200-dma. SBUX $40.02 +0.35 - We like the breakout over major resistance at $40.00 but SBUX might be a better covered call play than straight calls. STK $28.12 +0.75 - It's probably time to do some digging in STK and find out what's moving the stock. Shares have put together a very strong three-day rally that has broken its bearish trend of lower highs and technical resistance at its 40, 50 and 100-dma's. ************************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 ************************************************************** ************************ Option Spread Strategies ************************ The Cashflow Generator Continues By Mike Parnos, Investing With Attitude Let the games begin – again! With our pockets full of profits, we now turn our attention to the June expiration cycle. What does Mr. Market hold in store for us? Another roller coaster ride is likely, but there are no apparent reasons for the market to trend at this point. But, we know that the markets are irrational. Let's just hope that, when the time comes, we can remain rational. __________________________________________________________ QQQ Questions Every month near expiration, when the time comes to deal with our QQQ ITM Strangle position, questions arise. This month, some CPTI students, who were short the May $37 puts, woke up one morning owning QQQ stock instead of being short the puts. Life is full of little surprises. No need to panic. The solution is not that complicated. I address these questions in today's column. Mike, Need some advice. Got exercised on my May QQQ 37 puts that I was holding short against my QQQ 40 put leaps. Do I just pay for the exercised QQQs or do I exercise my 40 puts??? I had a 5-contract position. Rich Rich, If puts were exercised, that means you were assigned the stock. With the pop up at the open today, you can simply turn around and sell the stock -- and make a little bit. This also frees you up to sell new puts against your long $40 LEAPS puts. Here's an idea. IF you believe the QQQs will head higher over the next few days or week, you might consider selling a put that is in the money (like the $36 or $37) with the intention of buying it back at a cheaper price (when the QQQs move up) and pocketing the difference. If you're not available to monitor the position closely, or are not comfortable with that kind of short-term trading, then you can simply sell the at-the-money June put ($35). You don't have to roll out your positions at the same time. It's fine to establish the June put position at this point -- especially since your LEAP puts are now free to sell against. As a matter of fact, it's advisable because, the longer you wait, the less premium you will be able to bring in. It's NOT a good idea to exercise your LEAPS puts, because you will be sacrificing whatever time value remains in those LEAPS puts. With the QQQs at $34.42, the $40 LEAPS are selling for $6.30. That means there is $5.58 of intrinsic value and $.72 of time value. If you exercised your leap, you would be giving up that $.72 of time value. When you sell out the June puts, you have a choice. You can sell out the $37s (which are deep in the money) and replenish what you're losing. Remember, when you were assigned, you bought the stock for $37.00. If you sell the QQQs on a bounce, you may receive about $35 per share. That puts you under water by about $2.00. If you sell the June $35 puts, you'll likely take in about $1.10- $1.20 (depending where the QQQs are when you sell them). If you sell the June $37 puts, you would take in about $2.25 (again, depending on where the QQQs are). This $2.25 would replace the $2.00 you are underwater from the stock sale. The positive side to selling the June $37 puts is that you replenish the money. The negative side is that you are now holding puts that are over $2 in the money and they do not yield much time value when rolling out to subsequent months. We've only been taking in $.15 to $.20 per month on the put side since the QQQs have moved down. If you sell the $35 puts, you will be much closer to at-the-money and it becomes substantially easier (and more profitable) to generate premium in the months to come. However, this is an "adjustment" and it will cost a little up front to potentially benefit down the road. It's an individual decision. Hi Mike, Great work last month. I just noticed that you seem to be selling ITM calls for the June expiry, i.e June '04 $37 puts & June '04 $34 Calls. If this is correct, why not the ATM calls & put? -- Michael Hi Michael, Unfortunately, this newsletter position has evolved to this point. Ideally, I would like to sell the $35 puts and the $36 calls. But, it would require sacrificing a lot of premium. At some point in the future, it may be necessary to make a position adjustment that will eat up a bunch of premium that we've taken in. For the time being, I'm going to settle for taking in about $750 per month -- even though the strike prices are in the money. It's good that you picked up on it. You should always try to sell short puts and calls that are slightly out of the money -- if possible. __________________________________________________________ Oops! When I wrote about the new June positions last Thursday I made a few typos. Some CPTI students were a little confused -- and let me know. Sorry about that. I go pretty quickly when I write close to deadline. I'll try to be more careful. NEW JUNE POSITIONS June Position #1 – SPX Iron Condor – 1121.28 We sold 5 SPX June 1150 calls and bought 5 SPX June 1170 calls for a credit of $1.20 (x 5 contracts = $600). Then we sold 7 SPX June 1025 puts and bought 7 SPX June 1010 puts for a credit: $1.00 (x 7 contracts = $700). Our total net credit is $1,300. Maintenance: $10,500. Maximum profit range of 1025 to 1150. Potential profit is $1,300. June Position #2 – BBH Iron Condor - $148.21 We sold 10 BBH $155 calls and bought 10 BBH $165 calls for a credit of $.70 (x 10 contracts = $700). Then we sold 10 BBH $135 puts and bought 10 BBH $125 puts for a credit: $.90 (x 10 contracts = $900). Our total net credit is $1,550. Maintenance: $10,000. Maximum profit range of $135 to $155. Potential profit: $1,550. June Position #3 – RUT – Iron Condor – 568.56 We sold 10 RUT 590 calls and bought 10 RUT 600 calls for a credit of $.80 (x 10 contracts = $800). Then, we sold 10 RUT 490 puts and bought 10 RUT 480 puts for a credit: $1.00 (x 10 contracts = $1,000). Our total net credit is $1,800. Maintenance $10,000. Maximum profit range of 490 to 590. Potential profit: $1,800. June Position #4 – MNX – Iron Condor - $146.31 Sold 10 MNX 147.50 calls and bought 10 MNX 152.50 calls for a credit: $.70 (x 10 contracts = $700). Then sold 10 MNX $132.50 puts and bought 10 MNX $127.50 puts for a credit: $.60 (x 10 contracts = $600). Our total net credit of $1,300. Maintenance: $10,000. Maximum profit range of $132.50 to $147.50. Profit potential: $1,300. ONGOING POSITIONS QQQ ITM Strangle – Ongoing Long Term -- $36.42 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 make money by selling near term puts and calls every month. Here's what we've done so far: Oct. $33 puts and Oct. $34 calls – credit of $1,900. Nov. $34 puts and calls – credit of $1,150. Dec. $34 puts and calls – credit of $1,500. Jan. $34 puts and calls – credit of $850. Feb. $34 calls and $36 puts – credit of $750. Mar. $34 calls and $37 puts – credit of $1,150. Apr. $34 calls and $37 puts – credit of $750. May $34 calls and $37 puts – credit of $800. We rolled out the May $34 calls to the June $34 calls for a credit of $.60 and then the May $37 puts to the June $37 puts for credit of $.15. The total net credit was $.75 ($750). Our new total credit: $9,600. Note: We haven't included 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. ZERO-PLUS Strategy. OEX – 546.32 In my Feb. 8th column, I outlined a strategy based on an initial investment of $100,000. $74,000 was spent on zero coupon bonds maturing in seven years at a value of $100,000. The principal $100,000 investment is guaranteed. We're trading the remaining $26,000 to generate a "risk free" return on the original investment. Long Term: Bought 3 OEX December 2006 540 calls @ $81 (x 300 = $24,300). Our cash position as of May expiration is $4,390 plus unused $1,700 = $6,090. June Zero Plus Positions. We established a June OEX bull puts spread 515/505, taking in a credit of $1.15 x 5 contracts = $575. We also sold the June 560 call taking in a credit of $1.20 x 5 contracts = $600. If all goes well, we'll be able to add an additional $1,175 to our cash position at June expiration. Some people have asked about why I'm using a 5-contract position when we only own 3 OEX Dec. 2006 calls. Well, we have $74,000 worth of zero coupon bonds that are certainly marginable and years to go to maturity. If violated, we can roll these spreads out however long is necessary to retain our profits. We'll be adequately covered by the margin from the zeroes. OSX Calendar Spread Plus - $97.37 OSX is the Oil Index. This was a play based on the belief that oil prices will continue to move up. Well, the oil prices have gone up, but the index hasn't. Bought 10 OSX June $115 calls and sold 10 OSX April $115 calls at a cost of $2.15 ($2,150). We also put on an April $100/$90 bull put spread and took in an extra $.70 ($700) to reduce the cost basis to $1.45 ($1,450). We rolled out our April $115 call and took in $1.20 - further reducing our cost basis to $.20. Then, aggressive traders (which we are in this strategy) put on the May $100/$90 bull put spread and took in $.95. So, we were a "plus" $.75 ($750). The May $115 call expired worthless. For June, on Thursday, we sold the June $105 call for $.70 against the June $115 call we still own. We closed our May bull put spread for a loss of $3.25 and rolled it out to the June $95/$85 bull put spread for a credit of $2.25. We had to trade 15 contracts of the bull put spread to cover what we spent to close the May $100/$90 bull put spread. We now have a positive $1.45 ($1450) -- $750 from before and another $700 from selling the $105 June call. We bought ourselves another month for the OSX to behave. We're scrambling and I'll be glad to be out of this damn trade with my butt still attached. That'll teach me to try something directional. Never fear, we shall persevere. 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, first look under "Education" on the OI home page and click on "Traders Corner." For more recent columns, you can look under "Strategies" and click on "Combinations." 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. ************** TRADERS CORNER ************** Look Before You LEAP by Mark Phillips mphillips@OptionInvestor.com It's been several weeks now that I've been promising to delve into the issue of how and when to play the downside in the Housing sector, now that it is a foregone conclusion that interest rates will be rising. Executing such a trade from a longer-term perspective is going to be present some interesting challenges though, so we definitely need to make sure we do our homework. The first issue we need to come to terms with is that the fundamentals will NOT support a bearish position trade in the Housing sector until after the tide has already turned. You see, the stocks of the home builders are inherently cheap, even after the monstrous bullish run they've seen over the past few years. These stocks typically sport single-digit P/E ratios and the fact that they can still boast that claim just tells us that the rise in price HAS been justified because the rate of share price appreciation has been matched by the growth in earnings. Scanning through a few of the stocks in the sector such as LEN, CTX, RYL, HOV, DHI, etc. I can see that the Return On Equity of these stocks currently resides in the 25-40% range, which is certainly nothing to sneeze at. So with that background, you'd certainly be justified in asking if I've taken leave of my senses in considering a longer-term bearish position on ANY stock in the sector. Normally, I'd say yes I may have lost it a little. And many times, my wife would certainly agree with you! But large dislocations tend to occur in the marketplace when trends come to an end and I think we can all agree that it is only a matter of time until short-term interest rates begin the process of heading towards more reasonable levels. By that, I mean higher -- perhaps much higher. It doesn't matter whether you buy the idea of a strongly growing economy or an economy that is on the ropes and only appears to be growing due to funny business with the economic reports. Most of us probably come down somewhere in the middle of those two extremes. It doesn't matter what the truth is. What does matter is that the Fed is being pushed closer and closer to the edge of the precipice, where they will have no choice but to raise rates. Inflation is back and it is back in a big way, as demonstrated by the past few PPI/CPI reports. The Fed has two primary tools for curbing inflation - tightening the money supply and raising interest rates. As we've talked about in the past, the Fed has been printing money like a bunch of drunken sailors and is showing no sign of being ready to take away the punch bowl. There's a huge edifice of debt out there that combined with the immense carry trade, presents a tremendous risk to the financial system if interest rates were to begin to rise too swiftly. This is the key to the Fed's strategy with respect to interest rates in recent months. Despite the bond market making a very strong move in terms of the longer-term yields, the Fed has been extremely reticent to begin the process of raising rates for fear of killing what is still (in my opinion) a very fragile economic recovery. There are the political concerns as well, with many analysts expressing the opinion that Greenspan will make an effort to postpone the rate hike cycle as long as possible to prevent creating another obstacle to the Bush administration's re-election efforts. The underlying theme in either scenario (or a combination thereof) is that the Fed will take as long as possible before lobbing out the first interest rate hike. The central bank has spent the past couple months jawboning the markets trying to keep long rates from rising too quickly, yet at the same time sending the message that rising interest rates are on the way. The primary reason for the gradual approach of moving from an excessively accommodative stance to a more stringent one is to give the institutions with large exposure to the carry trade time to unwind those positions. Many of those positions take weeks and months to unwind -- they cannot be undone all at once without creating other unpleasant problems. So the Fed is getting what it wants, an unwinding of these potentially harmful positions before having to make a change to interest rate policy. On the surface, it would appear that the bond market has over-reacted to the Fed's threat of future rising interest rates. The 10-Year Note has risen 120 basis points since the middle of March and that's a lot more than we should expect from one, two, or even three changes to the Fed Funds rate. The bond market is telling us what we already should know -- that once the Fed begins to raise interest rates, it will be a series of rate hikes to take the Fed Funds rate back to a more neutral stance in the 3-4% range. By now I'm sure you're wondering where I'm going with all this and how in the world it ties in with the Housing market. We know that rising interest rates are not conducive to continuing the record pace of home building and sales. In fact, the dramatic rise in the price of real estate in the past few years has been directly caused by the generation's low levels of interest rates. Occasionally over the past year, we've seen dips in the growth rate of housing and many traders have jumped on the dip, thinking that it is the top of the cycle and we're now headed down. This is just investors speculating on when the bullish cycle might come to an end. To be fair, we're looking to do the same thing, but I think with a more rational approach. The reason why is that we're going to incorporate the dynamics of the valuation metrics along with an exploitation of mass psychology. First up is valuation. We know that the Housing stocks typically have a single-digit P/E ratio, so rather than target high P/Es, we will want to look for the inflection point where the 'P' begins to contract in anticipation of the 'E' contracting as well. You see, when housing growth stalls and then begins to head the other way, that will signal to investors that earnings are going to be falling and the situation will be remedied through falling stock prices in the sector. That inflection point will occur sometime AFTER rates actually begin to rise. Will it be an hour? A week? A month? Obviously we don't know, but I think we can lay out a road map, based on the human psychology component. So far, consumers have heard the Fed talking about interest rates having to rise eventually, but other than the rise in bond yields (which they've seen on more than one occasion in the past couple years) they see no reason to be overly concerned yet. But they will start to be believers when the Fed actually raises rates for the first time. That will be like the starter's pistol at a footrace and consumers will race out to follow their herd instinct. Rather than put a damper on the housing market, I believe the process that will begin at that point will be the last gasp of the real-estate bull market. Fearing several interest rate hikes and the spectre of the kind of rates that we saw in the late '70s and early '80s, consumers will rush to buy property "before it's too late". It sounds foolish and actually is, but that is what the herd instinct will drive many people to do, whether it is moving up to the next house or buying their first house. People will want to get in now, while rates are still low. It doesn't matter when it occurs, the first hike from the Fed will be the trigger that gets the whole mad process kicked off for its last manic leg. That will then give the Housing stocks one last boost from the influx of demand, but once that surge has run its course, I expect to see a significant falloff in demand, followed by a sharp drop in both Housing Starts and Building Permits. Those two together will tell professional investors that the sun is setting on the real estate bull market and they will BEGIN to position for the coming decline. Does that mean we jump into short positions when the Fed finally raises rates? When the first sharp decline in the Housing Starts comes in? Hey, if I had all the answers, I'd be a rich man! HUGE GRIN Seriously though, it won't be black and white, but more various shades of grey, as we attempt to pick the right time to enter the downside for a longer-term position. As I see it, the timeline goes something like this. The last great rush of housing demand will begin shortly after the Fed raises rates for the first time. It might be in June, or it might be in August. I doubt it will be any later. It will take a month or so for that demand to percolate through the home building industry and then a couple more months before there is definitive evidence of a real falloff in demand. At that point, we're probably at least 3-4 months beyond that first rate hike and when the drop in the housing stocks (in anticipation of falling earnings) is likely to be rather swift. The reason why is that investors will try to position themselves correctly for where the stocks in the sector will need to be for reduced earnings forecast in order to keep the P/E ratios in single digits. By the time a tangible falloff in Housing demand is evident in the economic reports, it will likely be too late to capture a favorable entry that can deliver us a piece of that first powerful leg down. The best entries will come approximately 1-2 months after that first rate hike, but before the evidence of the slackening demand is visible for all to see. That wraps up the theme of what we're going to attempt to do, but doesn't even come close to addressing the details of how to play the move down. For that, we need a few more pages and will have to delve into charts of some of the leading Housing stocks. If you think relative strength studies are likely to play a part in that analysis, then you're starting to think like me! Only you can be the judge of whether or not that's a good thing. Tune in next week and we'll delve into those important details. See you then! 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