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Daily Newsletter, Thursday, 09/30/2004

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The Option Investor Newsletter                Thursday 09-30-2004
Copyright 2004, All rights reserved.                       1 of 3
Redistribution in any form strictly prohibited.


In Section One:

Wrap: Great Debate
Futures Wrap: See Note
Index Wrap: No amount of paint could cover up Merck's declines
Market Sentiment: Three Things


Posted online for subscribers at http://www.OptionInvestor.com
************************************************************
MARKET WRAP  (view in courier font for table alignment)
************************************************************
      09-30-2004           High     Low     Volume   Adv/Dcl
DJIA    10080.27 - 56.00 10142.94 10038.90 2.16 bln 1917/1289
NASDAQ   1896.84 +  2.90  1902.25  1887.68 1.67 bln 1766/1347
S&P 100   534.86 -  1.70   537.20   533.10   Totals 3683/2636
S&P 500  1114.58 -  0.22  1116.31  1109.61 
W5000   10895.48 +  9.59 10913.66 10845.90
SOX       384.20 +  3.60   389.69   380.62
RUS 2000  572.94 +  1.87   574.71   569.33
DJ TRANS 3243.51 +  3.90  3249.20  3220.73
VIX        13.34 +  0.13    13.67    13.20
VXO (VIX-O)13.44 +  0.63    13.68    13.10
VXN        20.48 -  0.19    20.91    20.21 
Total Volume 4,129M
Total UpVol  2,472M
Total DnVol  1,579M
Total Adv  4195
Total Dcl  2973
52wk Highs  314
52wk Lows    96
TRIN       0.92
NAZTRIN    0.86
PUT/CALL   0.86
************************************************************

Great Debate
by Jim Brown

No, not the one between Bush and Kerry tonight but the 
debate over market direction over the next two weeks. 
The markets struggled to move higher over the last few
days and were it not for the end of quarter window
dressing the Dow would be under 10K instead of over
tonight. 

Dow Chart

 
Nasdaq Chart

 
SPX Chart

 

What a busy day! This could turn into a novel tonight
but I will try to keep it flowing. Starting with the
flood of economic reports we continue to see a mixed
picture for the future. The Jobless Claims soared to
369,000 and the highest level since the 375K last Dec
6th. This was mostly due to the rash of hurricanes and
I mentioned this might happen last week. The states 
with the most claims were Florida, North Carolina and 
California. California always ranks near the top due
to population. Florida had 8,400 claims specifically
related to the hurricanes but probably many more were
indirectly related. This should not be a market problem
because traders are always looking for an excuse to 
ignore bad numbers. 

Personal Income rose +0.4% and inline with estimates
despite an impact from - hurricanes. Yes, the hurricane
excuse is alive and well and will probably turn up in
every economic report for the next couple quarters and  
in the earnings reports for companies. You can't take
out electricity, retail, transportation and communication
in five states impacting millions of consumers without
a serious economic ripple. Fortunately that ripple will
turn into a wave in Q1 as rebuilding and refurnishing
efforts in Q4 are felt through the various supply chains. 
Auto sales to replace all the flooded vehicles, building
materials, furniture, appliances, clothes, bedding etc,
anything not taken to high ground has to be replaced. 

Elsewhere the NY-NAPM showed continued growth in the
New York economy although growth was slower than in
prior months. The region has been in a strong uptrend
since August-2003 and the last index low at 221.7.
The September headline number was 310.4 and illustrates
how strong the recovery has been. The last two months
have seen slowing but definitely nothing to worry about.

The PMI jumped to 61.3 from 57.3 in August and was much
stronger than expectations at 58.5. It was also a large
gain over the 57.3 number for August. This should mean
a strong jump in the ISM on Friday which is currently
expected to be 59.0. Most impressive was the jump in
new orders to 68.7 from 58.0 however inventories also
rose over the last two months by the fastest pace in 
nearly two decades to 64.2 from 55.3. This suggests
that producers may have gotten ahead of themselves 
in anticipating the recovery and sales slowed over 
the last couple months. Fortunately the jump in new
orders this month should give them an opportunity to
balance the inventory flow.

The Help Wanted Index came in unchanged for August
at 37 and suggests there is not a serious employment
boom in progress. Internet job sites have reported an
increase in openings but they are also not seeing any
large jump in jobs. Because tomorrow is the first day
of the month we have to wait until next Friday for the
Jobs report and the current estimate is only 165,000
and right in the middle of the recent ranges. The only
comments I have heard have been negative and expecting
lower than the official estimates. After the ISM on
Friday we should start to hear more chatter about jobs.

Up, down, up, down, more gyrations than a windsock in
a thunderstorm. Of course I am talking about oil which
hit $50 on Tuesday and then declined to $48.50 on a
build in inventories and the cease fire in Nigeria. 
Well you guessed it oil traded over $50 several times
on Thursday and closed back up at $49.65. No specific
challenges were noted but prices are creeping back up
once again. T. Boone Pickens headlined the dozens of
oil analysts hitting the airwaves and his quote of $60
before $40 is the sound bite of choice. The more analysts
talk the more the real facts are coming out. Multiple
experts claim Saudi Arabia can only produce 9.3-9.5Mbpd
and their claim of 11mbpd is strictly smoke. Pickens
related the Hubbert's Peak scenario and gave it much
credence. He said the two million barrel Alaskan 
pipeline was down to only 700,000 per day and that is
the same challenge felt around the world. Existing 
wells saw decreasing production and not enough new 
wells coming on to cover demands 2-5 years from now. 
I will get off the soap box but I am putting together 
a top ten energy stocks for long term investors for 
November release so stay tuned. 

The biggest challenge for the economy is not the flurry
of hurricanes but the chance that oil will remain high.
A very good chance. The various economists are starting
to be heard about the prospects for the future and it
is not pretty. Retailers are seeing a slowing in buyer
activity not specifically in quantity but in cost. 
Talbots warned today that sales would be off due to 
the hurricane. Surprise, there is that excuse again! 
If you read the fine print they also say consumers
are becoming more budget conscious. They specifically
said their September sale had not performed well and
had not driven the historical increase in regular 
priced merchandise sales. That means consumers came
in to buy the sale merchandise and did not buy the
profitable items that were not on sale. Talbots said
same store sales could now be in negative numbers 
instead of their prior forecast for positive growth. 
This warning follows warnings by other retailers 
including the Federated chain of department stores.
With heating oil more than doubled over last year 
and still rising the amount of money available for
spending by those in the northern climate zones is
going to be significantly less. 

You can't talk about today's market without talking
about Merck. The sudden withdrawal of Vioxx from the
market cut a $2.5 billion hole in Merck profits and
shocked the drug sector. Merck took a -$25 billion 
cut to its market cap and dropped -$12.07, -26.8% to
an eight year low. MRK volume at 145 million shares
was nearly a tenth of the volume of the NYSE and we
are talking a $33 stock. This was nearly 30 times
normal volume. Funds bailed on fears there would be
legal problems due to suits similar to the Fen-Phen
recall several years ago. Other drug companies have
had similar problems in the past but the magnitude
of the potential problem is extremely large. Wyeth
has spent nearly $17 billion on the Fen-Phen recall
and only six million people took the drugs. For Vioxx
over 84 million people have taken the drug and the
potential for billions in claims is very strong. Any
person who had a cardiac event and took Vioxx will be
jumping on the litigation bandwagon even if they ate
two big Macs every day for the last ten years, smoked
and drank a quart of whiskey per day. Their lifestyle
will have nothing to do with the event, it had to be 
Vioxx that caused their heart problem. Several analysts
even questioned if Merck would be able to survive the
storm. They have taken multiple potential products out
of the pipeline over the last couple years and they
are widely seen to be lacking any wonder drug to 
rescue them from this money pit. 

Despite the nearly -90 point hit the Dow took from 
the MRK drop it rallied back to close down only -56
points. Support held at 10050 and the Dow is poised
to rally off a positive ISM tomorrow. However, there
are several roadblocks to that possibility. Before
the MRK drop window dressing had added +175 points 
since the Dow's low of 9977 on Tuesday. Today that 
window dressing effort was far less of a factor with
only a small afternoon rebound.

The Nasdaq was able to rebound back over 1900 twice
on Thursday but could not hold on either attempt. 
This is strong resistance that even a positive SOX
could not break. The SOX turned in a very strong
effort just closing in positive territory after
Micron missed earnings and multiple chip stocks have
warned this week. This was a definite symptom of
window dressing in my opinion. Funds had to put cash
into stocks to show they were intelligently investing
your money. 

This window dressing fought an uphill battle today. 
Volume was very strong on the NYSE and it was not just
related to the MRK disaster. This was the first time
the NYSE has traded over two billion shares (2.212B)
since July-21st. I believe that window dressing met
distribution today and they battled to a tie. Up volume
on the NYSE was slightly higher than declining volume
at 3:2 but there was no conviction among the stocks
that saw any gains. The market felt heavy all day
and the closing spurt could not correct it. 

The market is facing several challenges. First is the
Bush-Kerry debate tonight. The market has priced in a
Bush victory and the debate will be watched for signs
of a change in that status. If Kerry pulls a rabbit
out of his hat and scores major points or if Bush gets
foot in mouth disease then the fragile lead could 
dissolve in an instant. The market would be quick to
remove any Bush premium and that could be painful. 
Gail Dudak said she felt the a Kerry win would subtract
-1000 points from the Dow. That number may be high but
you get the point. Conversely should Bush win the
debate in a convincing manner then the market "could"
celebrate some more. 

Secondly the end of quarter window dressing is over.
As much as the bulls would like to see it continue
for another week the quarter is behind us and October
looms large. Earnings warnings are the story and it
is rare that a company gives positive guidance. In
short we are entering a typical October with conditions
about as bad as possible. Oil at $50, hurricanes, 
election fears, terrorist fears, earnings less than 
half the prior quarter and projected to be only +7% 
for all of 2005. While I think this will resolve itself
quickly there is strong risk for the bulls. Historically
we should see a ramp into the election as long as there 
is a clear leader. October is also year end for many
mutual funds and portfolios are reshuffled faster than
a blackjack deck in Vegas and that normally leads to 
substantial volatility. Remember the VXO hit a new
eight year low on Wednesday so the volatility bomb
is ticking. 

For Friday we have the next major economic hurdle the
ISM Index. A positive report there could go a long 
way towards warding off the October bears. Vehicle 
data for September is also due but nobody expects
cars to be rolling off showroom floors in any large
numbers. 

The quarter that ended today was dismal for the markets
with the Dow losing -3.0%, S&P -2.4%, Nasdaq -7.5% and
the chip sector -25%. This swoon has put us right back
where we started the year near 1112 on the S&P. Nine
months of trading to end flat just before the election.
In fact this has been called the tightest trading range
since 1994. It was the worst quarter for the Dow since
Q1-2003 and the worst for the Nasdaq since 2002. It
has been called the most confusing election year market
in the last 100 years. That may be a little before my
time but if you are like me you have probably found 
the last several months very hard to trade. Fellow
traders this is about to come to an end. October is
normally very volatile but it is known as the bear 
killer month because the dips are normally bought and
bull markets emerge. I don't know about you but I am
counting on it. 

Enter Passively, Exit Aggressively. 

Jim Brown
Editor


************
FUTURES WRAP
************

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


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**************************************************************

********************
INDEX TRADER SUMMARY
********************

No amount of paint could cover up Merck's declines

The major indices finished mixed as the third-quarter comes to a 
close.  If drug giant Merck (NYSE:MRK) $33.00 -26.78% wasn't a 
component of an index or sector, bulls found gains.

But no amount of last minute window dressing could offset the 
sharp declines brought on by Merck after the company said it was 
pulling one of its largest revenue and earnings producing drugs 
from global markets.

It was a tough month and quarter for Dow bulls and today's 
drubbing that Merck took was an extra layer of bad icing applied 
to the third quarter.  The Dow Industrials finished down 94 
points, or 0.9% for the month of September, and fell 355 points, 
or 3.4% on the quarter.

The S&P 100 Index (OEX.X), of which Merck is/was a top market cap 
weighted stock finished the month down 3.9 points, or 0.7%, and 
dropped 19 points, or 3.4% for the quarter.

The broader S&P 500 Index (SPX.X) did manage to hold a gain for 
the month, rising 10 points or 0.9%, but fell 26 points or 2.3% 
at quarter's close.

The tech-heavy NASDAQ-100 (NDX.X) gained 44 points, or 3.2% in 
the month of September, and helped soften what ended up being a 
6.9% decline on the quarter.  The SOX.X matched the NDX's monthly 
percentage gain by rising 13 points, but served as an anchor on 
the quarter, shedding 101 point, or 20.8%.

The benchmark 10-year Treasury Yield ($TNX.X) fell 13 basis 
points for the month, but bond bulls made out like a bandit as 
the 10-year yield fell 49.3 basis points on the quarter.

The U.S. Dollar Index (dx00y) 87.41 -0.78% fell sharply in 
today's session, but the decline came well after this 
morning's economic data was released to give some credence to the 
thought that traders reacted negatively a NY Times article where 
James Turk alluded that international central bankers wanted the 
U.S. to devalue the dollar by 20%.

I (Jeff Bailey) would note that "devalue the dollar" rumors have 
has expressed by others for more than three years as the economy 
slipped into its early stages of recession.  However, traders may 
have reacted to the news.  Perhaps accelerating a dollar sell 
move was yesterday's plea from George Soros' (a known short of 
the dollar) for voters to not reelect President Bush.

Another thought that comes to me for the dollar's decline today 
would be dollar weakness ahead of tonight's debate between 
President Bush and Senator John Kerry.  Several weeks ago The 
Department of Homeland Security had alerted us that it received 
credible intelligence that terrorists might attack specific 
targets in the U.S.  

Market Snapshot / Internals - 09/30/04 Close

 

Volumes were brisk, once again hinting that institutions were 
busy at quarter's end.  While not every share Merck was traded on 
the floor of the NYSE, where some undoubtedly passed through the 
NASDAQ's electronic systems, Merck's single-day record of 145 
million had the NYSE turning its heavies volume of the month.

For the month of September daily volume averaged 1.28 billion 
shares on the NYSE, while NASDAQ's average daily volume totaled 
1.49 billion.  Both were up from their respective August average 
daily volumes of 1.21 billion and 1.40 billion as traders began 
to return from summer longer summer vacations.

U.S. Market Watch - 09/20/04 Close

 

Is the dollar going to be devalued?  While dollar trader's may 
have reacted to this type of news, Treasuries reversed earlier 
losses, with YIELD across the major maturities higher, but well 
off their yield highs of the session.  In essence, it would be my 
observation from today, that the Treasury market didn't show a 
"dollar devaluation" type of response.  

World banking giant Citigroup (NYSE:C) $44.12 -1.29% has issues 
in Japan and was the second-biggest percentage loser to MBNA 
Corp. (NYSE:KRB) $25.20 -1.36% among the KBW Bank Index (BKX.X) 
97.58 -0.15% components.  JP Morgan (NYSE:JPM) $39.73 +0.12%, 
also a dominant player in global banking traded between $39.42 
and $39.79 in today's session, which doesn't look like an unusual 
trade.

I'll make a trader's logbook note of today's option activity for 
JPM where the Jan. $32.50 calls (JPM-AZ) traded 2,192 contracts 
(OI 13,817), the March $40 calls (JPM-CH) traded 2,190 contracts 
(OI 9,000), the Jan. $30 calls (JPM-AF) traded 2,000 calls (OI 
22,060), the Dec. $45 puts (JPM-XI) traded 1,837 contracts (OI 
2,554), while the fifth-most-actively traded option for JPM was 
the Jan. $30 puts at 1,600 contracts (OI 94.462).  

The thought process behind making some quick notes of a money 
center bank option action is this.  IF a scenario of dollar 
devaluation were in play, then "smart money" that is CERTAIN of 
this type of doom and gloom might be initiation bearish positions 
on the large money center banks by selling calls and buying puts.  
Time will tell, but now you and I have a benchmark to some 
unusual dollar action.

One thing I noticed in today's trade was that the spread between 
November and December Crude Oil futures narrowed rather notably 
from yesterday's 53 cents to 40 cents.

Why is this?  It could be some end of quarter rolling and 
balancing taking place, but I think it may also be related to 
today's stronger than expected Chicago PMI figures, specifically 
the rise in new orders.  We could be seeing some slight mindset 
change that a steady, if not slightly stronger economy will have 
demand strong for oil.

Over the years, I have made mental note that when the further-out 
months energy contracts trade a higher price than nearer-month 
contracts, it can be a sign from the market that the trend for 
prices is higher, rather than lower.

I don't have the time at this point to find some commentary I 
wrote a couple of years ago, where at the time I noted that 
natural gas futures had shifted where further out futures 
contracts were starting to turn higher than the near-month 
contracts.  I thought it could be a market signal that the 
economy was about to take a turn for the better, as that heavily 
used industrial energy resource might have been forecasting a 
demand build after falling during the recession.

Today, November Natural Gas futures (ng04x) fell 20 cents to 
$6.595, while December Natural Gas futures (ng04z) were down 15.5 
cents at $7.480.  Inventory data released today showed natural 
gas inventories rising by 69 billion cubic feet (bcf).

Pivot Matrix - 

 

By the time the clock struck 09:05 AM EDT the U.S. Dollar Index 
(dx00y) was "opening" the 09:05-03:00 EDT session at 87.69 and it 
is notable to this pivot matrix follower that the session high 
from then on was WEEKLY S1.  A quarterly readjustment?  A pre-
determined institutional trade?  A short-squeeze in gold, that 
triggers dollar selling?

When Goldman Sachs (NYSE:GS) $93.24 -0.04% and Lehman Brothers 
(NYSE:LEH) $79.72 -0.58% recently reported quarterly results, 
both firms mentioned that accurate assessment and trade revenue 
from bond, currency and commodities had attributed to their 
upside earnings surprises.  Could it be possible that both firms 
were long the dollar, short gold and gold equities, but have been 
unwinding that type of hedge, and cleaned it up a bit as the 
calendar quarter ends?  

In the 09/22/04 Index Trader Wrap "When Morgan Stanley talks, 
trader's might want to listen," I noted that Morgan Stanley was 
on the wrong side of the bond trade, and may have been on the 
wrong side of a dollar/gold trade too.

I can't say that anything other than what I've discussed tonight, 
would mark any change from what I discussed/covered in last 
night's Index Trader Wrap.

I'll tell you this though.  Today's debacle from Merck (NYSE:MRK) 
may complicate things as it relates to end of quarter window 
dressing, where the BEST LAID PLANS by institutions were suddenly 
changed.

It would have been "too easy" if Merck (MRK) hadn't gotten 
crushed to try and line things up for some benchmark closes and 
quarterly rebalancing.  

If institutions did indeed turn to Dow heavyweights United 
Technologies (NYSE:UTX) $93.38 +0.67% and IBM (NYSE:IBM) $85.74 
+0.89% and did a little more buying in these two stocks to try 
and compensate for MRK's decline, we could see a notable decline 
tomorrow if some overbuying in certain stocks comes off as the 
quarter is now over.

But I will also add that MRK's decline may be further bullish, if 
there was perhaps a higher INDU or OEX type of quarterly 
settlement that was NOT achieved due to MRK's weakness, where 
today's weakness in MRK creates a near-term bullish prospect for 
other INDU/OEX stocks, that simply couldn't be re-weighted today.

The "key levels" as I see it tomorrow would be marked as the 
DAILY S1's for the NDX/QQQ and SOX.  This gets us away from the 
MRK trade to a degree, unless some overbuying was done among some 
tech names in the OEX to offset MRK's weakness.  

Resistance as I see it is SPX 1,117, or its WEEKLY Pivot.  If 
some excessive shorting was implemented to protect against 
further MRK downfall (who knows what type of litigation exposure 
MRK has), and MRK get a "dead cat bounce" (you've followed 
Altria's (MO) trade history being very news driven regarding 
tobacco litigation), we could see some follow through upside, or 
relief upside on some type of short covering event.

Good gravy!  Look at that VIX.X at 13.34 +0.98%.  Remember the 
comments I reported just days ago from the CBOE options traders 
that was buying "low volatility" above 14?  If the other side of 
the trade suddenly capitulates on that we could still unwind some 
higher trade.

Jeff Bailey


****************
MARKET SENTIMENT
****************

Three Things
- J. Brown

Stocks say good-bye to a painful third quarter but in reality the 
month of September was pretty mild for the historically "worst" 
month of the year.  Right now there are three things on the minds 
of investors.  First is the presidential debate tonight.  
Currently stocks are poised to march higher if President Bush 
puts in a good performance tonight.  He is currently in the lead 
across most of the nation's polls and Wall Street likes the 
incumbent to win no matter what his affiliation.  Investors big 
and small alike will spend the next month focusing on the 
November 2nd election and who will lead us for the next four 
years. 

The second major issue on investors' minds is crude oil.  Crude 
remains near $50 a barrel.  In the last week there's even been 
talk of oil at $60 a barrel.  Fortunately most expect crude to 
slip lower but the $40 level is expected to be the new bottom at 
least for the foreseeable future.  

The third issue influencing investor sentiment will be corporate 
earnings.  We've had a ton of warnings in the past month and the 
third quarter earnings season will begin in days.  Wall Street 
has already discounted a disappointing third quarter and 
everything will depend on guidance for the fourth quarter.  
Traditionally the fourth quarter is one of the strongest given 
the end of year holiday season so expectations may be too high.    

Tomorrow is a big day for economic activity.  The markets will 
digest the ISM manufacturing index, the Michigan sentiment index, 
the construction spending numbers, auto and truck sales and the 
G7 group of finance ministers meet.  Not to mention a couple of 
fed governors will be speaking on banking tomorrow.  


-----------------------------------------------------------------

Market Averages

DJIA ($INDU)

52-week High: 10753
52-week Low :  9230
Current     : 10080

Moving Averages:
(Simple)

 10-dma: 10120
 50-dma: 10109 
200-dma: 10297




S&P 500 ($SPX)

52-week High: 1163
52-week Low :  990
Current     : 1114

Moving Averages:
(Simple)

 10-dma: 1115
 50-dma: 1101
200-dma: 1118



Nasdaq-100 ($NDX)

52-week High: 1559
52-week Low : 1301
Current     : 1412

Moving Averages:
(Simple)

 10-dma: 1409
 50-dma: 1380
200-dma: 1440



-----------------------------------------------------------------

CBOE Market Volatility Index (VIX) = 13.34 +0.13
CBOE Mkt Volatility old VIX  (VXO) = 13.44 +0.63
Nasdaq Volatility Index (VXN)      = 20.48 -0.19


-----------------------------------------------------------------

          Put/Call Ratio  Call Volume   Put Volume

Total          0.86        688,608       594,500
Equity Only    0.73        590,577       433,987
OEX            0.95         13,760        13,042
QQQ            0.92         31,831        29,300


-----------------------------------------------------------------

Bullish Percent Data

           Current   Change   Status
NYSE          63.9    + 0.5   Bear Correction
NASDAQ-100    43.0    + 0     Bull Alert      
Dow Indust.   53.3    - 3     Bear Correction
S&P 500       61.2    + 0.4   Bear Correction
S&P 100       60.0    + 1     Bear Correction


Bullish percent measures the number of stocks in an index 
currently trading on a buy signal on their point and figure 
chart.  Readings above 70 are considered overbought, and readings 
below 30 are considered oversold.

Bull Confirmed  - Aggressively long
Bull Alert      - Cautiously long
Bull Correction - Pause or pullback in upward trend
Bear Alert      - Take defensive action if long
Bear Confirmed  - High risk if long, good conditions for shorting
Bear Correction - Pause or rebound in downtrend


-----------------------------------------------------------------

 5-dma: 1.16
10-dma: 1.10
21-dma: 1.03
55-dma: 1.18


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    1740      1682
Decliners    1065      1322

New Highs     182        97
New Lows       21        29

Up Volume   1305M      968M
Down Vol.    856M      656M

Total Vol.  2191M     1658M
M = millions


-----------------------------------------------------------------

Commitments Of Traders Report: 09/21/04

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

The latest COT data shows a big drop in positions for both 
commercials and small traders but commercials remain slightly
net bearish and small traders remain net bullish.

Commercials   Long      Short      Net     % Of OI
08/31/04      406,637   416,778   (10,141)   (1.2%)
09/07/04      415,952   426,342   (10,390)   (1.2%)
09/14/04      442,049   469,982   (27,933)   (3.0%)
09/21/04      404,746   425,560   (20,814)   (2.5%)

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
08/31/04      144,120   114,343    29,777    11.5%
09/07/04      157,732   130,817    26,915     9.3%
09/14/04      167,310   126,513    40,797    13.9%
09/21/04      134,943   108,036    26,907    11.1%

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 passing of the quadruple-witching Friday cut a large
chunk of open positions among long and shorts, big and small.
Yet the remain positions still open have sent commercials to 
their most bearish bias in weeks and the small trader to their
most bullish.

Commercials   Long      Short      Net     % Of OI 
08/31/04      372,071   543,100   (171,029)  (18.7%)
09/07/04      371,111   600,593   (229,482)  (23.6%)
09/14/04      377,643   586,139   (208,496)  (21.6%)
09/21/04      213,014   397,844   (184,830)  (30.2%)

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
08/31/04      258,624     77,036   181,588    54.0%
09/07/04      286,194     80,075   206,119    56.2%
09/14/04      289,155     81,314   207,841    56.1%
09/21/04      256,315     60,275   196,040    61.9%

Most bearish reading of the year: (77,385)  - 09/02/03
Most bullish reading of the year: 449,310   - 06/10/03


NASDAQ-100

Wow!  It looks like last week's option expiration has 
produced some major shifts.  There is a huge drop in open
positions that have produced dramatic changes in bias. 
Commercials are now strongly bullish and small traders are
incredibly bearish.  To be honest I'm not sure how much
I trust these numbers. 


Commercials   Long      Short      Net     % of OI 
08/31/04       48,167     43,411     4,756    5.2%
09/07/04       51,814     44,179     7,635    7.9%
09/14/04       64,282     59,808     4,474    3.6%
09/21/04       54,530     30,827    23,703   27.7%

Most bearish reading of the year: (21,858)  - 08/26/03
Most bullish reading of the year:  25,160   - 06/01/04

Small Traders  Long     Short      Net     % of OI
08/31/04       14,635    10,572     4,063    16.1%
09/07/04       16,817    12,561     4,256    14.5%
09/14/04       36,372    28,584     7,788    12.0%
09/21/04        7,417    25,821   (18,404)  (55.3%)

Most bearish reading of the year: (20,270) - 06/01/04
Most bullish reading of the year:  19,088  - 01/21/02

DOW JONES INDUSTRIAL

The Dow Jones futures show the same dramatic drop in open
positions with the recent option/futures expiration.  However,
the DJ futures do not show a big switch in bias.  

Commercials   Long      Short      Net     % of OI
08/31/04       29,143    24,147    4,996       9.3%
09/07/04       29,128    24,011    5,117       9.6%
09/14/04       41,951    34,486    7,465       9.7%
09/21/04       30,816    27,200    3,616       6.2%
 
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
08/31/04        4,929     7,122   (2,193)   (18.2%)
09/07/04        5,041     8,656   (3,615)   (26.4%)
09/14/04        8,121    14,425   (6,304)   (27.9%)
09/21/04        4,467     6,748   (2,281)   (20.3%)

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 09-30-2004
Copyright 2004, All rights reserved.                        2 of 3
Redistribution in any form strictly prohibited.


In Section Two:

Dropped Calls: None
Dropped Puts: None
Call Play Updates: ATH, CMI, LMT
New Calls Plays: GDW
Put Play Updates: BIIB, LLY, FFH, FLIR, KSS, LXK, MMM, PRX, SEPR
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:
*****

None


PUTS:
*****

None


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********************
PLAY UPDATES - CALLS
********************

Anthem Inc - ATH - close: 87.25 chg: +0.63 stop: 84.89

We don't have much to report on for ATH.  The stock continues to 
churn sideways between support near $85 and resistance near $88.  
Fortunately ATH appears to be building a short-term trend of 
rising lows.  Insurance stocks in general haven't done much the 
past couple of sessions but the IUX does seem to be gaining 
traction again.  No change in our strategy or stop loss here.  In 
the news ATH confirmed that its Q3 earnings report will come out 
on October 27th.

Picked on September 26 at $86.81
Change since picked:      + 0.44
Earnings Date           10/27/04 (confirmed)
Average Daily Volume =       2.1 million 
Chart =


---

Cummins Inc - CMI - close: 73.89 change: +0.82 stop: 69.99     

Here's a case of when the end of the quarter window dressing 
helped us out.  CMI has been a big winner this quarter and we 
suspect that the last three sessions could have been boosted by 
funds dressing up their portfolio.  Traders who bought the dip to 
$70.00 on Tuesday are seeing some follow through and CMI is 
closing at new all-time highs.  Odds of a dip tomorrow could be 
pretty high.  

Picked on September 19 at $70.99
Change since picked:      + 2.90
Earnings Date           07/23/04 (confirmed)
Average Daily Volume =       724 thousand
Chart =



---

Lockheed Martin - LMT - close: 55.78 change: +0.69 stop: 53.50

Thursday proved interesting. The stock rallied throughout the 
session an in the afternoon hours LMT shot up to $56.00.  
Unfortunately, that is not enough to trigger us.  Our entry point 
to buy calls is $56.01 unless you took our aggressive entry 
point.  The good news is that LMT continued to climb after the 
initial bout of selling once it hit $56.  The stock looks poised 
to breakout and hit our trigger but this is assuming that the 
last few days isn't all window dressing by fund managers.

Picked on September xx at $xx.xx <-- see TRIGGER
Change since picked:      + 0.00
Earnings Date           07/27/04 (confirmed)
Average Daily Volume =       1.7 million 
Chart =



**************
NEW CALL PLAYS
**************

Golden West Financial - GDW - cls: 110.95 chg: +0.72 stop: 108.99

Company Description:
Headquartered in Oakland, California, Golden West is one of the 
nation's largest financial institutions with assets over $95 
billion as of August 31, 2004. The Company has one of the most 
extensive thrift branch systems in the country, with 276 savings 
branches in 10 states and lending operations in 38 states.
(source: company press release)

Why We Like It:
GDW has been a frequent candidate on our nightly watch list over 
the last several weeks.  We had been watching for a breakout over 
resistance at the $110 level in an effort to ride a rally toward 
$116.  When the breakout finally did come it was too fast for us 
to catch and it failed just where we expected it to.  Now GDW has 
consolidated back toward the $110 region except this time it 
should act as support.  We mentioned the bounce from $108.85 back 
on Monday and now we're willing to act on it with today's higher 
low.  Our goal is to ride GDW back toward $115-116.  The P&F 
chart is much more bullish with a $129 price target. 

Suggested Options:
Short-term traders can choose the Octobers and November options.
We're going to suggest the Novembers. Our favorites are the 
110s and 115s.

BUY CALL NOV 110 GDW-KB OI=537 current ask $3.70
BUY CALL NOV 115 GDW-KC OI=298 current ask $1.40

Annotated chart:

 

Picked on September 30 at $110.95
Change since picked:       + 0.00
Earnings Date            07/20/04 (confirmed)
Average Daily Volume =        512 thousand
Chart =


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*******************
PLAY UPDATES - PUTS
*******************

Biogen Idec - BIIB - close: 61.17 change: +0.45 stop: 62.51

Traders need to be really careful here.  BIIB is not showing the 
weakness we expected but fortunately neither are bulls charging 
to buy it.  However, there are two things traders need to be 
aware of.  BIIB is a partner with Elan in its development for 
Elan's Antegren drug.  Antegren is being developed for a handful 
of treatments like Crohn's disease, multiple sclerosis and 
rheumatoid arthritis.  Two days ago Elan submited Antegren for 
approval to EU regulators.  This could be adding support to BIIB.  
Secondly, the news today from MRK could be good news for BIIB.  
Investors will be looking across the sector to see who might 
benefit from MRK's disaster and who might jump into the fray.  We 
are going to give BIIB one more day.  If it doesn't look weaker 
by tomorrow afternoon we'll close it.

Picked on September 22 at $59.57
Change since picked:      + 1.60
Earnings Date           07/28/04 (confirmed)
Average Daily Volume =       3.0 million 
Chart =


---

Eli Lilly & Co - LLY - close: 60.05 chg: -1.80 stop: 62.51*new*

Wow!  LLY has been a steady loser for the past several sessions.  
Today's news that Dow-component Merck (MRK) would voluntarily 
recall its $2 billion Vioxx drug hit the drug sector very hard.  
Shares of LLY dropped another 2.9 percent and traded to $59.72 at 
an intraday low.  In the MarketMonitor this afternoon we reminded 
readers that our initial target was $60.00 and that short-term 
traders should consider exiting now for a profit.  The fact that 
LLY held support at the $60 mark suggests we could see an 
oversold bounce tomorrow.  Watch the $62.00 level as potential 
resistance.  We're lowering our stop loss to $62.51. 

Picked on September 22 at $63.92
Change since picked:      - 3.87
Earnings Date           07/22/04 (confirmed)
Average Daily Volume =       3.1 million 
Chart =


---

FairFax Financial - FFH - cls: 124.85 chg: +1.44 stop: 130.01     

Shares of FFH appear to be coiling for another breakout.  The stock 
remains under a trend of lower highs but in just the past few days 
we're seeing some higher lows.  If FFH trades back over $127.50 we'd 
grow cautious again, of course this is already an aggressive, 
speculative play.  Yesterday FFH released estimates that the recent 
bout of hurricanes in FLorida would amount to $85-95 million in claims 
for its insurance companies.  We would not consider new positions 
until FFH broke down under the $120 level. 

Picked on September 12 at $126.50
Change since picked:       - 2.15
Earnings Date            00/00/00 (confirmed)
Average Daily Volume =         59 thousand
Chart =


---

FLIR Systems - FLIR - close: 58.50 chg: -0.85 stop: 62.51

Thursday proved to be another high-volume day for FLIR but 
bullish traders bought the dip to $57.50.  If you missed it we 
added FLIR last night on the bearish technical breakdown through 
support at $60.00.  Its technical oscillators and MACD are 
bearish as is its P&F chart.  Keep an eye on the simple 100-dma 
above $55.00.  That could be a hurdle the bears need to jump.

Picked on September 29 at $59.35
Change since picked:      - 0.85
Earnings Date           07/22/04 (confirmed)
Average Daily Volume =       577 thousand
Chart =


---

Kohl's - KSS - close: 48.19 change: -0.09 stop: 50.26*new*

KSS is still doing okay.  The stock continues to consolidate 
lower under a trend of lower highs.  Currently KSS is testing 
support at its exponential 200-dma and the simple 50-dma near 
47.50.  Remember that our target is the $46.00 region and any 
intraday spike under $46.50 is probably a good place to exit.  
We're going to lower our stop loss to $50.26.  Keep an eye on 
Dow-component Wal-mart (WMT).  WMT tends to lead the retailers 
and right now WMT is testing overhead resistance at its 
descending trendline of lower highs.  WMT has two likely choices 
breakout or roll over.   Either choice will influence KSS.

Picked on September 16 at $49.48
Change since picked:      - 1.29
Earnings Date           08/12/04 (confirmed)
Average Daily Volume =       3.1 million 
Chart =


---

Lexmark Intl - LXK - close: 84.01 chg: +0.50 stop: 86.01     

Here we go again.  LXK has jumped back into its trading range 
between $82 and $86.  Although it is noteworthy that the three-
week trend does show a pattern of lower highs.  We are still not 
suggesting new positions unless LXK breaks support at $80.00. 

Picked on September 5th at $86.10
Change since picked:       - 2.09
Earnings Date            07/19/04 (confirmed)
Average Daily Volume =        1.2 million 
Chart =


---

3M Co - MMM - close: 79.97 change: +1.19 stop: 81.51     

We're starting to think we missed it.  MMM dipped to $77.69 on 
Monday and we alerted readers in our MarketMonitor that MMM was 
very close to our initial target at $77.50.  Now the stock is in 
day three of its oversold rebound.  The $80.00 level should be 
the first level of overhead resistance and currently it's 
holding.  We are not suggesting new bearish positions at this 
time as the technical oscillators curl into bullish positions.  
 
Picked on September 15 at $82.00
Change since picked:      - 2.03
Earnings Date           07/19/04 (confirmed)
Average Daily Volume =       2.5 million 
Chart =


---

Par Pharma. Co - PRX - close: 35.93 chg: -0.63 stop: 38.85*new*

Shucks!  The DRG drug index fell 2.5 percent on the MRK news but 
PRX only slipped 1.7 percent.  We're not complaining but it would 
have been encouraging to see PRX keep pace with the index.  The 
good news here is that PRX closed under the $36.00 mark for the 
first time since July.  We're going to lower our stop loss to 
$38.85.  

Picked on September 21 at $37.80
Change since picked:      - 1.87
Earnings Date           07/19/04 (confirmed)
Average Daily Volume =       743 thousand
Chart =


---

Sepracor Inc - SEPR - close: 48.78 chg: +1.36 stop: 52.01

We don't like the look of Thursday's candle.  Today's performance 
almost looks like a bullish engulfing candlestick and now SEPR is 
back above its simple 40, 50 and 100-dma's.  If SEPR rallies look 
for overhead resistance at $50.00.  Aggressive traders may want 
to use a failed rally under $50 as a new entry point.  
Conservative traders may want to lower their stop, especially now 
that short-term oscillators are starting to look more bullish.

Picked on September 22 at $48.94
Change since picked:      - 0.16
Earnings Date           07/13/04 (confirmed)
Average Daily Volume =       1.8 million 
Chart =



*************
NEW PUT PLAYS
*************

None


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**********

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The Option Investor Newsletter                 Thursday 09-30-2004
Copyright 2004, All rights reserved.                        3 of 3
Redistribution in any form strictly prohibited.


In Section Three:

Watch List:  Video Games to Retail Giant and more!
Traders Corner: Retracements and their help in trade entry 
Combos/Straddles: The Naked Truth About Margins  

**********
WATCH LIST
**********

Video Games to Retail Giant and more!

___________________________________________________________________

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.
___________________________________________________________________


Electronic Arts - ERTS - close: 45.99 change: -0.88

WHAT TO WATCH: Yesterday we mentioned ERTS in the MarketMonitor 
with a chart illustrating its back to back head & shoulders 
patterns.  Currently the H&S pattern is bearish and today's 
failed rally under $48.00 doesn't help matters.  Readers can 
watch for a drop under $45.00, maybe 44.50, and use the drop as 
an entry point to buy puts.  The H&S pattern suggests a $37-36 
target.  The P&F chart currently points to a $38 target.

Chart=


---

Vimpel Communications - VIP - close: 108.80 change: +2.95

WHAT TO WATCH: Russian communication stock VIP is rebounding 
strongly from the $100 level and is nearing resistance at $110.  
Readers can watch for a breakout over the $110 level and consider 
it a potential entry point for a run towards $120. Coincidentally 
the bullish P&F chart points to a $120 target. 

Chart=


---

Wal-Mart - WMT - close: 53.20 change: +0.20

WHAT TO WATCH: Keep an eye on WMT because the stock can heavily 
influence the RLX retail index even though there has been a 
disconnect in recent months.  Dow-component WMT has been 
consolidating between $51 and $54 for nearly three months.  Now 
shares are challenging its descending trendline of resistance 
formed from its pattern of lower highs.  This trendline dates 
back to the peak in March.  An upside breakout would be very 
bullish here. 

Chart=


---

General Dynamics - GD - close: 102.10 change: +1.97

WHAT TO WATCH: Fund managers pushed GD over resistance at $102 in 
some end of quarter window dressing.  These are new two-year 
highs for the defense contractor.  The trick here will be to see 
if these gains hold next week.  Traders can keep an eye on GD and 
consider a bounce from $100 or a new high over $102.77.  P&F 
chart traders will point out that today's move produced a new 
quadruple top breakout buy signal with a $119 price target.

Chart=



-----------------------------------
RADAR SCREEN - more stocks to watch
-----------------------------------

SYMC $54.88 +0.05 - SYMC was one of the best performing stocks in 
the third quarter.  If there is any profit taking Friday and next 
week look for a bounce from $52.00.

 

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**************
TRADERS CORNER
**************

Retracements and their help in trade entry
By Leigh Stevens
lstevens@OptionInvestor.com

Charles Dow made some early, maybe the first observations about 
the tendency for a stock or stock index to retrace or give back 
anywhere from around 1/3 to 2/3rds of the distance covered by a 
prior advance or decline, before the major trend resumes again.  
Very commonly Dow noted such retracements, against the direction 
of the main trend, were about half (50%)of the prior price swing. 

There were further refinements on the theory of how much ground 
retracements will typically cover made by W.D. Gann, a famous 
stock and commodities speculator of the first half of the 1900’s 
– primarily, Gann found it significant to use charts that had 
retracements noted between a major low to high or high to low of 
1/4, 1/2 and 3/4ths; i.e., 25, 50 and 75%.      

The origins of one of the most useful "retracement" theories for 
stocks and other markets came from someone who lived in the 
middle ages and was studying the population growth of rabbits. 
Yep, rabbits! Leonardo Fibonacci was an Italian mathematician who 
was doing such work in the early 1200s.  

The number sequence that is named after Fibonacci is where each 
successive number is the sum of the two previous numbers; i.e., 
1, 2, 3, 5, 8, 13, 21, 34, 55, 144, etc.   Any given number is 
1.618 times the preceding number (approximately) and .618 times 
the following number.  

The technical indicators whose formulas rely on this Fibonacci 
number sequence, but the main application is to use the 
"fibonacci retracements" of .382 or 38%, .50 or 50% and .618 or 
62%. The number 5 is in the Fibonacci sequence, and the others 
are ratios -- .618 comes from the percent that each number is of 
the next higher number and .382 is the inverse of .618 (100 – 
61.8 = 38.2).  We’ll stick to the shorthand and round off to 38 
and 62% as the important "Fibonacci" retracements, beside 50%.  

What I find most useful in trading is to track what would 
constitute the 38, 50 and 62% retracement points, after a minor 
or intermediate price swing – with the addition sometimes of 
seeing what would be a 25% retracement for a shallow correction 
and 75% for a deep one.  Use of these retracements is a very 
common practice and a quite popular point of reference, among 
traders.  

There is a simple pragmatic reason for this popularity and that 
is that buying or selling in these retracement areas often 
results in coming close to buying at the low and selling at the 
top.  Maybe the saying of buy low, sell high owes something to 
the common retracements as are highlighted in the chart below – 

The most recent high in the Nasdaq 100 Index was exactly a 
fibonnaci 62% - 61.8% to be exact, but I round it off – 
retracement of the rebound from the low to the prior peak. 
Interestingly, this was also right at resistance implied by the 
200-day moving average and occurred along with a minor bearish 
price/RSI divergence – a triple indication so to speak, to buy 
puts or otherwise adopt a bearish trading stance. 


  

What I say above is not to imply that NDX can't or won't now go 
on to penetrate and rise about the point it got to so far on the 
rally. Taking stock of the Fibonacci 62% retracement did however 
suggest a good point to take profits on any calls and perhaps 
take a short-term trade in puts. By the way, the low occurred 
with a bullish price/RSI divergence as the RSI was trending 
higher on that final low – opps, but this article is on 
retracements!    

You can set most all charting applications to calculate 
retracements ranging from 25% to 38% (.38), 50%, 62% (.62), or a 
little beyond – at 66% (2/3rds) or even 75% - often, by pointing 
first at the low, then the high (pullback retracements) or first 
at the high, then the low for retracement rallies in what you 
perceive to be an overall downtrend.  

I used to chart by hand and then use my calculator, adding or 
subtracting the 3-5 percentage figures, once it appeared that a 
high and a low was in place for the trend in question.  Ah, the 
good old days – NOT! 

In a countertrend rally within a dominant downtrend - once a 
minor downside correction begins – look to see if a recent high 
represented a 38, 50, or 62% retracement of that high relative to 
the rally starting point. If the (up) swing high also failed at 
or under a key down trendline and was accompanied by an 
overbought condition, it’s a sure tip off to short the stock or  
play puts in the case in stocks or indices. Below is an example 
from a couple years past for bellwether GE -   


 

If a correction "resists" dropping back even 38%, after a strong 
up move, I may add a 25% retracement line.  If a deep correction 
falls below the 62% or 66% retracement, I may add a 75% 
retracement line. 

If the correction of an uptrend falls below a 75% retracement, I 
assume that the correction will be 100% or a "round trip" back to 
the origin or starting point for the rally. It also can be useful 
to also look at a close-only line chart as well as a bar or 
candlestick chart. Sometimes the retracement is seen best this 
way.  The chart below of NEM is an example and is also an example 
where a retracement was as deep as 3/4ths of the prior upswing 
but the stock came back – 


 

Such a deep retracement would be more commonly seen in a high 
beta or more volatile stock than would be seen in an index 
typically, at least on a daily chart.  Retracements of this much 
would be more common in the indices on hourly or other intraday 
charts. 

To use retracements - what you need is some evidence that a 
price swing has run its course and that a counter-trend or move 
in the opposite is developing.  

In a downtrend, the 38, 50 and 62 percentage figures are added to 
the most recent low, when it becomes likely or your hunch is that 
a minor counter-trend rally is underway; e.g., prices and 
volume surge.  The expectation is that in a normal or typical 
market, prices will rebound an amount that is equal to about half 
of the last decline – or, a little bit more, which would be 62% 
or a bit less than 50%; i.e., 38%.
 
If prices climbed to the 62% retracement level, in an overall  
downtrend like my first example, this would suggest a favorable 
exit if long a stock or in calls, and favorable trade entry to 
short or buy puts. In terms of risk strategy after that, you can 
place a stop just over the retracement level. 

SOME RULES OF THUMB ON RETRACEMENTS - 

These guidelines mostly are related to the most common 
retracements, that of the fibonacci 38, 50 and 62% retracements. 

1.) A strong trend will usually see only a “minimum” price 
retracement -- around 1/3 to 38% (sometimes only 25%). If prices 
start to hold around this “minimal” retracement area, this action 
may be suggesting trade entry as there may NOT be a deeper 
correction.    

2.) A "“normal" trend in stocks, indices, commodities, currencies 
or bonds – that is one not powered by something way out of the 
ordinary (e.g., terrorism), will often see a retracement develop 
of about half or 50% of the prior move. The most common level to 
buy or sell is this retracement amount, with an exit if it 
continues on much beyond 50%; e.g., 5% more – 


 

You notice with the crude oil chart above, that there was a 
little bit of slippage below the 50% retracement, but not on a 
closing basis.
   
3.) Within the range of normal trend, there is often a 
retracement of 62% or even 2/3rds (66%). If prices hold this 
area, it’s also a good target for initiating a buy or sell with 
an exit if the retracement exceeds 66% - 


  
   
4.) If a retracement exceeds one level, look for it to go to the 
next; e.g., if a retracement goes beyond 38%, look for it to go 
on and approach 50%.  If it exceeds 50%, look for 62%.  If a 
retracement exceeds 62%, or a maximum of 66% (or 75%), then I 
look for a “round trip” or a return all the way back to the prior 
low or high – this type action suggests a retest of the low or 
high and is the "ultimate" retracement, which is 100%. 


5.) Retracements are most commonly done from the low to high, 
high to low and not based on the highest close to the lowest 
close, etc.  However you should also experiment with retracements 
based on closing levels as they also are worth exploring as 
already noted above. 

6.) The common retracement levels work on all time frames or 
chart types; e.g., hourly (or less), daily, weekly and monthly 
charts. 

LAST BUT NOT LEAST -  
In a strong trend, either up or down, the typical retracement 
will be shallow – 


 

In the retracement chart above, once the double bottom low was 
made in April-May, I went back to the original high to use in 
measuring retracement levels.  
 

****************
Combos/Straddles
****************

The Naked Truth About Margins

By Mike Parnos

When you're naked, both good and bad things can happen to you.  It 
all depends on the climate, the company you keep and how much 
you've had to drink.  However, when trading naked, your broker is 
going to want you to wear at least a version of a financial thong -
- in the form of a margin requirement.  Today, you're going to 
learn just how well dressed (financially) you'll need to be.

Although I’m not a big fan of selling uncovered options (except for 
the most advanced CPTI students), I know that some of you out there 
are doin' it.   And, since most of our CPTI trades are on rather 
expensive indexes, I've received a number of questions as to how to 
calculate margin requirements.
 
How much margin requirement will your brokerage firm want?  Let’s 
figure it out using our favorite SPX index as the example.

Set The Scene - Example #1
There are about two weeks left before October expiration.  The SPX 
is trading at about 1115.  If we look at the chart and the option 
chain, we decide that it isn't likely to reach 1175 on the topside, 
nor is it likely to reach 995 on the bottom.  Sober up and get out 
your calculator, this is going to be fun.

Two Formulas
There are two formulas that are used to figure out margin 
requirements.
Formula #1
The minimum margin requirement is 10% of the value of the 
underlying stock plus the option premium received. 

10% of the underlying (1115) = 111.50 x 100 =          $11,150
Add premium received from Nov. 1175 call:  +$1.50 x 100 = $150
Total Margin Requirement:                     $11,300/contract

Formula #2
The initial margin requirement for the transaction is 15% of the 
underlying stock plus the credit received, less the amount out of 
the money.  Note - the 1175 is 60 points out of the money.

15% o of the underlying ($1115.00) = $167.25 x 100 =    $22,300
Add premium received from Nov. $1175 call = +$1.50 x 100 = $150
Subtract OTM amount ($60.00) = -$60x 100 =              ($6,000)
Total Margin Requirement:                       $16,450/contract

The LARGER number of the two formulas is used.  The margin 
requirement would be our first calculation of $16,450 per contract.

The margin numbers on indexes seem outrageous.  But the likelihood 
of success is probably 95%. The risk is substantial.  Although 
you're only exposed for seven weeks, you can still catch a bad 
cold.  

That's why buying a long call, above 1175, makes this a trade that 
is affordable, and a lot safer, for most traders.  You may have to 
settle for less premium, but at least you get to play.
___________________________________________________________

Example #2 - BBH -- Trading at $145 - Sell the Nov. $135 put @ 
$1.40

Formula #1
10% of the underlying (145) =  $14.50 x 100 =           $1,450
Add premium received from Nov. 135 put =	+$1.40 x 100 =  $140
Total Margin Requirement:                      $1,590/contract

Formula #2
20% o of the value of the underlying ($145) = $29 x 100 = $2,900
Add premium received from Nov. $135 put = +$1.40 x 100 =    $140
Subtract OTM amount ($10.00) =             -$10 x 100 =  ($1,000)
Total Margin Requirement:                         $2,040/contract

So, for BBH, the margin requirement would be $2,040 per contract – 
the larger of the two figures.

NOTE:  There is a difference in the calculations of stocks vs. 
indexes.  When calculating margin on indexes, the multiplier for 
Formula #2 is 15%.  With stocks, the multiplier is 20%.
________________________________________________________________

More Marginal Notes
Margin, at most brokerages, can be in the form of cash, marginable 
stocks, bonds, mutual funds, treasuries, etc. All brokers are NOT 
created equal. Contact your broker to find out their policies.  

Some traders will put on a naked short position on both the put and 
call sides (a short strangle).  They are exposed on both the upside 
and the downside.  However, even though there are actually two 
positions, some brokerages will only hold a margin requirement on 
one of the two positions.  Their computer software can recognize a 
short strangle (or straddle) position – if the root symbols are the 
same.  The assumption is that you can only be wrong in one 
direction.  

It's interesting that most broker's software is not sophisticated 
enough to recognize a condor spread on an underlying – a 
simultaneous bull put spread and a bear call spread.  While you may 
only be responsible for maintenance on one side of a short straddle 
or strangle, you’re going to have maintenance on both sides of a 
condor position -- unless you're using one of the more progressive 
brokerage firms (OptionsXpress, ThinkOrSwim).

Again, always double check with your broker on their requirement 
policies – before you initiate a position.  Get the name of the 
person you speak with. You’ll find that, when you take a person's 
name, they're more likely to make sure they're giving you the right 
information. Then, after you've initiated the position, check that 
the result showing in your account is consistent with what you were 
told on the phone.



_________________________________________________________________

OCTOBER CPTI HYPOTHETICAL POSITIONS
October Position #1 - SPX Iron Condor - 1114.58
We sold 10 SPX October 1160 calls and bought 10 SPX October 1175 
calls for a net credit of about $1.75 ($1,750).  Then we sold 10 
SPX October 1075 puts and bought 10 SPX October 1060 puts for a 
credit of about $1.30 ($1,300).  Total net credit of appx. $3.05 
($3,050).  Maximum profit range is 1075 to 1160.  Maintenance is 
$15,000.
 
Position #2 -- RUT Iron Condor - 572.94
We sold 10 RUT Oct. 610 calls and bought 10 RUT Oct. 620 calls for 
a credit of about $.65 ($650).  Then we sold 10 RUT Oct 530 puts 
and bought 10 RUT Oct 520 puts for a credit of about $.55 ($550).  
Total net credit of about $1.20 ($1,200).  Maximum profit range is 
530 to 610.  Maintenance is $10,000.  

Position #3 - OEX Iron Condor - 534.86
We sold 10 OEX October 520 puts and bought 10 OEX October 510 puts
for a credit of about $.70 ($700).  Then we sold 10 OEX October 565 
calls
and bought 10 OEX October 575 calls for a credit of about $.50 
($500).   Total net credit of about $1.20 ($1,200).  Maximum profit 
range is 520 to 565.  Maintenance is $10,000.  

Position #4 - BBH Iron Condor - $144.50
We sold 10 BBH October $150 calls and bought 10 BBH October $160 
calls for a credit of about $.95 ($950).  Then we sold 10 BBH 
October $135 puts and bought 10 BBH October $125 puts for a credit 
of about $.55 ($550).  Total net credit of about $1.50 ($1,500).  
Maximum profit range is $135 to $150.  Maintenance is $10,000.  Be 
careful.

Position #5 -- SPX "Sure Thing" Strategy - 1114.58
Formerly called the "Credit Spread Boogie."  The market seems to be 
in an uptrend since mid-August.  Let's go with the flow until the 
market tells us otherwise.  We sold 3 SPX 1120 October puts and 
bought 3 SPX 1095 October puts for a net credit of about $6.50 
($1,950).  The initial maintenance is $7,500.

POSITION ADJUSTMENT:  When the SPX traded in the low 1100s, it was 
time for an adjustment.  We closed out the original bull put spread 
for $13.20 ($3,960).  We then opened a seven-contract position of a 
1115/1140 bear call spread, taking in $6.35 ($4,445).  That means 
we've taken in some extra premium.  Our new profit potential is 
$2,435 -- if SPX closes below 1115.  This one's going to be 
exciting.   
____________________________________________________________

ONGOING POSITIONS
QQQ ITM Strangle – Ongoing Long Term -- $35.14
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.  
June $34 calls and $37 puts -- total net credit of $750.  We rolled 
out to the July $34 calls ($.20 credit) and $37 puts ($.60 credit) 
and took in a credit of $.80 ($800).  We rolled to the August $34 
calls and $37 puts, taking in a credit of $900.  We rolled to the 
Sept. $34 calls and $37 puts, yielding $.45 or $450 for the cycle. 
For October we were again limited to a $.45 ($450) rollout.  Our 
new total credit is now $12,200.

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 – 534.86
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.
Our current position:  We own 3 OEX December 2006 540 calls @ $81 
(x 300 = $24,300).  Our cash position as of August expiration was 
$8,390.  In September we added another $975 for a new total of 
$9,365.

New Zero Plus Positions For October  
Not a lot of credit available this month.  October bull put spread 
520/510 for credit of $.65 x 5 contracts = $325.  October bear call 
spread 565/575 for another credit of $.65 x 5 contracts = $325.  If 
all goes well, we'll be able to add $650 to our cash position.
__________________________________________________________

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.
   
Mike Parnos, Options Therapist and CPTI Master Strategist
__________________________________________________________



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.


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