Option Investor

Daily Newsletter, Thursday, 05/27/2004

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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

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


Futures wrap is not emailed due to the excessive number of charts.
It may be read on the website at this address.


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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

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

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"

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


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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


52-week High: 10753
52-week Low :  8540
Current     : 10205

Moving Averages:

 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:

 10-dma: 1098
 50-dma: 1116
200-dma: 1084

Nasdaq-100 ($NDX)

52-week High: 1559
52-week Low : 1123
Current     : 1463

Moving Averages:

 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


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


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


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



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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


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.


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 =


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 =


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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 =


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

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 =


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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 =




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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


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.



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.



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.



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.


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

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.


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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.

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

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

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

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? --

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

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.

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:

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.

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
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


Look Before You LEAP
by Mark Phillips

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

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

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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