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Daily Newsletter, Thursday, 10/14/2004

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The Option Investor Newsletter                Thursday 10-14-2004
Copyright 2004, All rights reserved.                       1 of 3
Redistribution in any form strictly prohibited.


In Section One:

Wrap: Thank You Elliott Spitzer
Futures Wrap: See Note
Index Wrap: Oil and Auto Insurance
Market Sentiment: Earnings & Oil Double-Team.


Posted online for subscribers at http://www.OptionInvestor.com
************************************************************
MARKET WRAP  (view in courier font for table alignment)
************************************************************
      10-14-2004           High     Low     Volume   Adv/Dcl
DJIA     9894.45 -107.90 10003.36  9875.13 1.66 bln 1285/1805
NASDAQ   1903.02 - 17.50  1921.82  1900.77 1.47 bln  973/2052
S&P 100   529.58 -  5.90   535.73   528.75   Totals 2258/3857
S&P 500  1103.29 - 10.36  1114.97  1102.06 
W5000   10788.48 - 92.52 10892.34 10777.97
SOX       380.60 - 12.70   393.25   378.98
RUS 2000  564.88 -  4.54   570.06   564.79
DJ TRANS 3302.90 + 20.50  3315.18  3282.57
VIX        16.43 +  1.01    16.56    15.22
VXO (VIX-O)17.13 +  0.88    17.80    15.78
VXN        22.30 +  0.17    22.67    22.03 
Total Volume 3,424M
Total UpVol  1,038M
Total DnVol  2,339M
Total Adv  2556
Total Dcl  4333
52wk Highs  102
52wk Lows   139
TRIN       1.58
NAZTRIN    1.00
PUT/CALL   1.07
************************************************************

Thank You Elliott Spitzer
by Jim Brown

Single-handedly Elliott Spitzer turned into a one man
wrecking crew and sent the indexes into a death spiral
at 10:30 this morning. Spitzer took aim at the major
insurance companies in what he called a major scandal
and financial stocks imploded. Dow component AIG lost
-7 points taking nearly -63 points off the Dow. 

Dow Chart

 
Nasdaq Chart

 
SPX Chart

 
Wilshire-5000 Chart

 

Spitzer said he was going to sue Marsh McLennan for 
a wide ranging scheme to defraud clients and sell 
insurance at artificially high rates. The four major
insurers took substantial hits with AIG -6.99, AOC
-4.48, CB -4.09 and MMC a whopping -11.28. In what
could develop into a RICO prosecution Spitzer has 
taken aim at these monster companies and claims their
pattern of business practices are fraudulent. The
case stems from the quotation process. According to
Spitzer companies like MMC accepted payments from 
insurers to sell their insurance at higher prices
than the competition. MMC supposedly would produce
fictitious quotes putting the company they wanted
to win in the quote at the price they wanted to get
for the insurance. 

The challenge was the relationship between the client
and broker created fiduciary responsibility and MMC 
and others violated that responsibility by taking 
payoffs for quote positioning. They were representing
the quotes as the best available when they knew there
was insurance available at cheaper rates in their own
rate book. MMC reportedly made $800 million in kickbacks
last year and that was nearly half of their total profit.

When asked in a TV interview if he was going to put
the companies out of business he ducked the question
but stated the companies were not cooperating. Because
these companies deal in various securities as well a 
felony conviction could put them out of business like
Arthur Anderson. It is a death sentence for financial
entities and based on Spitzer's description of the
complaint it could happen. However, because these
four companies represent the majority of business
written in the U.S. the odds are good there will be
a settlement with those that cooperate. One could be
made an example and sent down the tubes as a warning
to the rest. MMC appears to be the target of choice.

MMC Chart

  


Before the insurance bomb hit the markets they were
already struggling under a widening oil slick and 
having trouble just treading water. A fire at a west
coast refinery did not hamper production but prices
continued to climb. Oil inventories rose +4.2MB for
the week and much more than expected but prices still
rose. Heating oil inventories fell sharply and prices
hit another all time high with a close at $1.548. 

Crude Chart

  

Heating Oil Chart

 


While the market was being ransacked by the insurance
and oil problems the semiconductor sector was also under
attack. The list of chip stocks either missing earnings
or warning in the last 48 hours was long and it was still
getting longer at today's close. The list included NVLS,
FLEX, SNDK, LRCX and PHTN to name a few. The SOX lost
-12 points or -3.21% but the damage could have been a
lot worse. The SOX found support at 380 and clung to 
that level all afternoon. This limited the Nasdaq loss
to only -17 points and kept it from breaking 1900 support.
The 380 support could be critical to our market direction
on Friday. A break of that level could see a return to 
the lows for the year at 350. 

SOX Chart

 


Economically the news was not good either. The Jobless
Claims rose to 352,000 and the four-week moving average
rose to 353,000. This is not good news for the recovering
economy. There were no hurricanes to blame and California
and Illinois were the states with the biggest increases.
Claims under 150K equate with job gains in the employment
report over 100K per month and claims over 150K generally
equate to a flat to down job market. 

Import prices rose a smaller than expected +0.2% but
odds are good next month will show a dramatic increase.
Oil prices have rocketed higher and this should skew
the numbers dramatically. The International Trade 
numbers reflected a much stronger impact of oil prices
with the trade balance slipping to -$54 billion and
the second highest level in history. Import growth 
is soaring at +20.7% and at record highs while export
growth is rising at a slower +14.2% rate. At the current
rate foreign trade will subtract from our Q3/Q4 GDP 
instead of contribute to its rise as in Q1/Q2. 

Friday has some critical economic reports and the market
will be looking for some relief. The NY Manufacturing
Survey is expected to be weaker after a strong rebound
last month. How weak will be the key. We will get the
PPI for September and the consensus is for a flat 
reading but eventually oil prices have to produce a 
strong bounce in the PPI numbers. Retail sales are 
expected to show a bounce to +0.6% for September on 
back to school shopping but the cycle was noticeably
weak in most areas. Consumer Sentiment is expected to
be flat at 94.9 but with the election mudslinging and
rocketing energy prices there is the potential for a 
major drop. Business Inventories are expected to rise
+0.7% but if the economy is really slowing as much of
the earnings guidance has indicated those inventories
could be much higher. Friday could be rocky economically. 

Even without the insurance bomb the Dow was already in
trouble with the warning from GM. GM said it was cutting
12,000 jobs in Europe and would be cutting more in the
U.S. They slashed profit forecasts and said demand 
remained weak. They may have reached a point where they
can't provide enough incentives to sell more cars. With
up to $6,000 in incentives on some models the company
has tried to keep production rolling but now may be
forced to close some assembly lines. Merrill Lynch said
they are likely to close at least one plant completely
and possibly more. The high incentives helped dealers
liquidate 230,000 units of their current 1.137 million
units of unsold cars and trucks in Q3. With strong tax
bills ahead in December for dealers stuck with those
vehicles at year end we can expect huge promotions to
move inventory over the next two months. 

The Dow retreated to close under 9900 and at the May
lows. This is a very important support level and we
are closing in on the August lows at 9783. This is
the make or break time for the Dow. A successful test
of 9800 would create a double bottom and a potential
launch point for a post election rally. A failure at
9800 would be very critical and could easily project
to 9600 to 9300 depending on which technical analyst
you believe. A break below 9800 would be a lower low
and break many of the technical models suggesting an
end of October rally. 

The Nasdaq is much stronger than the Dow and clung to
support at 1900 most of the afternoon. This is decent
support and considering the rash of earnings misses
and warnings in the tech sector it is amazing we held
this level. A break here targets 1850-1860. 

I am clinging to my bias that we should see a rebound
over the next couple of days. Technically speaking we
should plummet to new lows and not look back. However, 
the last two weeks of October in election years are 
almost always bullish if the incumbent is ahead. The 
problem we are facing is an election with no leader,
oil prices soaring despite higher inventory levels,
terrible earnings and a very high ratio of negative
guidance. We are also facing the start of Ramadan, 
the Muslim holy month, on Friday in Saudi Arabia. 
During the month Muslims are forbidden to eat, drink
or smoke during daylight hours. Also during Ramadan
we have historically seen an escalation of terrorist
activities. 

This makes tomorrow even more volatile than normal
for an option expiration day. Four of the economic
reports for Friday will be released before the open
and fortunately for us there are no major earnings.
Earnings after the close today failed to dent the
overnight futures despite some spectacular failures.
Juniper beat the street and raised guidance but got
killed for more than a -$2 drop in after hours on
comments about a recent acquisition. Juniper has
beaten estimates for eight straight quarters. CNET
beat the street but warned for Q4 and lost -12% in
after hours trading. LEXR posted inline and traded
down. RMBS beat the street and traded level. SUNW 
beat the street but traded level on a weak outlook.
CREE beat the street by +4 cents but lost -1.50 in
after hours after guiding revenue lower and earnings
higher. The highest profile failure was NFLX. NFLX 
beat estimates by +3 cents but then traded down to
$11 from $17 after saying they expected competition
to become increasing stronger and they were slashing
subscriber rates to combat the trend. Blockbuster 
has a competing service now and Amazon is expected
to enter the competition. That -37% drop in the 
stock was on heavy volume. 

That makes a very light earnings schedule on Friday
good news for the bulls because even good earnings 
news has been riddled with negative factors. This
could be a critical day for the bulls and they had
better rally the troops to stave off a break of 9800.
While we are running out of reasons to move higher
the expectations for the end of the year rally 
remains the same from most analysts. The divergence
between economic reality and market expectations is
growing about as wide as the reality gap between 
oil prices at all time highs and the Transports 
soaring like diesel was 29 cents a gallon. Eventually
all divergences return to reality and while I was
expecting it to happen in January for equities there
is always the possibility that market conditions for
creating the perfect storm are currently forming. If
you are bullish Monday should be the day to go long
with historical trends in your favor. It also means
that Friday could be highly volatile as everyone
positions for the expected move. 

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

Oil and Auto Insurance

Stocks were weighed lower as oil continued its rise, while Dow 
components General Motors (NYSE:GM) $38.84 -5.95% and American 
International Group (NYSE:AIG) $60.00 -10.43% had the Dow 
Industrials slipping further below the 10,000 level.

I don't think I can add anything to observations and comments I 
made in today's 11:00 and 03:15 intra-day updates in regards to 
oil's trade, and GM's earnings miss speaks for itself.  So lets 
touch on today's "blow up" in the insurance sector.

As noted in today's 01:00 intra-day update, New York Attorney 
General Eliot Spitzer charged the nation's largest insurance 
broker, Marsh & McLennan (NYSE:MMC) $34.85 -24.45% with bid 
rigging and illegal pay-offs in a suit that marks Mr. Spitzer's 
latest campaign against corporate wrongdoing.  The allegations 
sent insurance stocks plunging lower with the S&P Insurance Index 
($IUX.X) 290.74 -6.88% leading today's list of sector losers, and 
sending financial sectors lower.

Two executives from Dow component American International Group 
(NYSE:AIG), Karen Radke, a senior vice president, and Jean-
Baptist Tateossian, a manager, have pleaded guilty to charges 
related to the payments, Spitzer said. 

Mr. Spitzer said that Ace Limited (NYSE:ACE) $36.47 -9.52%, Chubb 
Corp. (NYSE:CB) $65.65 -5.86% and Hartford Financial (NYSE:HIG) 
$58.40 -6.07% along with other firms were involved in the scheme, 
and are still under investigation.

Shares of Marsh & McLennan (MMC) were hardest hit when Mr. 
Spitzer said his office's investigation revealed that the insurer 
received at least $800 million in "contingent commissions," in 
2003.  When this was compared to the company's net income 
statement, and 2003 net income from continuing operations of 
$1.54 million, or roughly 1/2 of the company's reported net 
income, investors suddenly feared, perhaps with good reason, 
past, current and future valuations.

What weighed further on the group is what action insurance 
regulators may take against those involved.  Fresh in trader's 
minds is Japan's Financial Services Agency baring Citigroup's 
(NYSE:C) $43.70 -0.92% private banking group from doing business 
in that country for violating banking laws.

In an interview on CNBC this evening, Mr. Spitzer said he was 
truly disheartened by the attitudes and seemingly lack of 
understanding that insurance executives had during several months 
of investigation.  While not speaking on behalf of insurance 
regulators, Mr. Spitzer did not rule out the possibility that 
U.S. insurance regulators could ban some of the wrongdoers from 
doing business in the U.S., should they be found guilty of fraud.

S&P Insurance Index ($IUX.X) - Weekly Intervals

 

I'm showing a WEEKLY interval bar chart to gain some perspective 
of how negative the market's reaction was to today's allegations.

I went back and reviewed the IUX.X weekly interval bar chart 
(pre-split) and found the IUX.X fell 12.5% when trading resumed 
after the 09/11 terrorist attacks.  The IUX.X erased those losses 
and then some the following week (09/24-09/28) when we learned 
that insurance providers actually had some insurance to cushion 
any losses and could raise premiums going forward to make up for 
losses.

What seems to be a concern at this point is if insurers will 
battle the allegations in court.  Will insurers settle with no 
admittance of wrongdoing?  If they do, will regulators then apply 
further regulations on the industry, which could impact earnings 
going forward?  

Bottom line:  This is a can of worms, and I don't know if anyone 
has the answer to any of the above questions.  I do know that it 
creates UNCERTAINTY, which MARKETS tend to dislike or shy away 
from.  Under a worse case scenario (those guilty not allowed to 
do business in U.S.) that other insurers would benefit as they 
could step in and get new business.  However, investors will have 
to deal with those INSURERS that the New York Attorney General 
has accused of wrongdoings, where these insurers are components 
of the indices we might be trading.

Financials that comprise the OEX - Sorted by industry/market cap

 

Market capitalization figures are in billions of dollars, with 
American International Group's (AIG) market cap at 156.3 billion.  
Hartford Financial (HIG) was also mentioned as being under 
investigation.  

What OEX and SPX traders might want to be cognizant of, is even 
though brokers and money center banks are not the target of the 
investigation, there are many funds that are set up to track the 
performance of both indices.  Should AIG and HIG come under 
further selling pressure, it could create an "artificial" yet 
real negative impact on other financial-related sectors.

For instance, we can see the large volume in AIG and HIG today.  
Not every institution that may have wanted to sell at certain 
prices could find liquidity.  In order to still come close to 
mimicking the OEX and SPX performance, some selling could have 
been directed to financials in order to compensate.

Now the good news!  At some point in the future, we might see 
some type of relief in our insurance bills!

U.S. Market Watch - 10/14/04 Close

 

I'm making some various observations to indices/sectors tonight.  
Some are quick refreshers, while other remarks that follow are 
new observations.

Let's start with the NASDAQ-100 Index (NDX.X) 1,425.21 -0.64%, 
which showed some relative strength in today's rather decidedly 
negative trade.  The NDX/QQQ strength came from Apple Computer 
(AAPL) $44.98 +13.15% surging on strong quarterly earnings, while 
First Health (FHCC) $17.04 +13.29% jumped higher after fellow HMO 
Index (HMO.X) 967.27 -0.69% component Coventry Health (NYSE:CVH) 
$46.29 -11.06% said it was going to buy FHCC for about $1.8 
billion in stock and cash.

The HMO.X was relatively unchanged, but its running out of 
components as consolidation continues.  Remaining components are 
SIE, HUM, HNT, AET, CI, WLP, PHS and CVH. 

SanDisk (NASDAQ:SNDK) $20.52 -27.2% was today's NDX/QQQ casualty, 
where SNDK is also a component of the Disk Drive Index (DDX.X) 
103.96 -4.75%.  SNDK is also a component of the Semiconductor 
HOLDRs (AMEX:SMH) $29.75 -3.22%

Since I mentioned the semiconductors, the SOX.X rests right back 
at its MONTHLY Pivot, and Intel (NASDAQ:INTC) $20.51 -2.28% gave 
back the bulk of yesterday's gains.

The CBOE Internet Index (INX.X) 178.29 -0.75%, not nearly as weak 
as the SOX.X.  Yahoo! Inc. (NASDAQ:YHOO) $34.96 (unch) did give 
back all of yesterday's gains intra-day as it fell to $34.22 in 
the opening minutes of trade, but unlike INTC, bulls seemed a 
little more eager to buy in today's session.

Analysis:  Perhaps Intel's gains on Wednesday were largely 
attributed to bearish short covering, where the news wasn't as 
"bad" as expected, and gains not necessarily representative of a 
near-term bottom truly being found.  Will continue to monitor.

Telecom sectors showed some relative strength in today's session, 
and while the Combined Telecom Index (IXTCX) still finds 
resistance at its flat 200-day SMA (180.75), Nokia (NYSE:NOK) 
$14.20 managed to beat the forecast it made September 9 when it 
predicted earnings of 13 to 16 cents a share.  Sales came in at 
the high end of September guidance with the company crediting 
better-than-expected cell phone sales.  Some broader-sector 
positives came from Nokia's cautiously optimistic outlook for a 
strong cell phone sales this holiday season.  

Qualcomm (NASDAQ:QCOM) $42.16 +1.46% was one of the 41 stocks at 
the NASDAQ that traded a new 52-week high today.  Verizon 
(NYSE:VZ) $40.77 -0.73%, a Dow component traded a 52-week high 
yesterday.

The Airline Index (XAL.X) 44.14 +2.67% gained, and that's 
somewhat unusual to see when oil is on the rise.  Southwest 
Airlines (LUV) $14.14 +4.2% reported quarterly earnings of $0.15 
per share, which was 2 cents above consensus, and said revenues 
rose 7.8% year-over-year.

Treasuries saw price gains and YIELDs were lower across the major 
maturities.  With oil on the rise, and equities lower, this bond 
trade has a defensive look to it.  Weather it was today's bond 
trade, or this morning's weekly jobless data, I did get an alert 
from my March Fed Funds futures (ff05h) futures at the 97.75 
level.  I made note in the Market Monitor (03:56:01 PM EDT) that 
this contract, which gives us some observation of what the MARKET 
believes the Fed will be doing with interest rates in the future, 
now has the market seeing four 25-basis point rate hikes between 
now and March.  Whereas just before the September nonfarm payroll 
figures were released on October 8, this futures contract was 
forecasting a 50% of five 25-basis point rate hikes.

Analysis:  MARKET may be seeing oil's rise starting to have more 
significant impact on economic growth.

Market Snapshot / Internals - 10/14/04 Close

 

Upon intra-day reviews of Marsh McLennan's (MMC) $34.85 -24% 
chart, the stock started its dive just after 11:00 AM EDT.  At 
11:00 AM EDT, the stock was trading $46.00.

It wasn't until 11:47:28 AM that I made note that the IUX.X was 
falling at 302.11 -3.24%, where just after that, a downside alert 
I had set on AIG at $63.00 was triggered on my QCharts.

If I make a time reference on our Snapshot/Internals, we get some 
perspective of the impact this news may have brought to the 
markets.  Not just the NYSE either, but NASDAQ too.

I would want to note that today's 5-day NH/NL ratio reading for 
the NYSE did give a "sell signal" against a prior relative low 
measure of 78% for this shorter-term indicator of bullish 
leadership.  

NYSE Composite ($NYA.X) Chart - Daily Intervals

 

With the NH/NL ratios showing a greater lack of bullish 
leadership than on 09/21/04, and the NYSE having traded up into 
the projected zone where we might expect a rest, the NYSE may be 
near-term vulnerable to the 6,411-6,435 area.  Will have to keep 
a close eye on insurers, and even the deep cyclicals as depicted 
by the Morgan Stanley Cyclical Index (CYX.X) 675.74 -0.69%, which 
closed below its 200-day SMA.  

I will post the pivot analysis matrix in tonight's Market 
Monitor, and again in tomorrow morning's 09:00 AM EDT update.

Jeff Bailey


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

Earnings & Oil Double-Team.
- J. Brown

Investor sentiment has taken a turn for the worse.  The Q3 
earnings parade has not been enough to divert attention from the 
record prices in crude oil.  Every tick higher raises concerns 
about the impact on our economy.  At a new all-time high of 
$54.76 the talk of $60 a barrel may become a self-fulfilling 
prophesy.  

Then again focusing on earnings may not help either.  Citigroup 
and General Motors left investors disappointed and technology 
stocks aren't doing so hot either with SanDisk dropping 27 
percent.  iPod-producer Apple Computer seems to be the lone 
standout today.  

As if rising oil and lackluster fourth quarter guidance wasn't 
bad enough the New York Attorney General Elliott Spitzer said he 
was investigating anti-fraud issues in the insurance sector.  
Several of the big names in the group like MMC, AIG and HIG were 
possible defendants and the whole sector crashed.  The IUX 
insurance index fell almost 7 percent.  MMC dropped 24 percent 
and AIG plummeted 10 percent.  

Overall market internals were pretty negative.  Decliners 
outpaced advancers almost 17 to 11 on the NSYE and 20 to 9 on the 
NASDAQ.  Down volume overshadowed up volume 12 to 5 on the NYSE 
and 10 to 5 on the NASDAQ.  

On top of it all the third and final presidential debate last 
night was a toss up.  Both sides are claiming victory, which is a 
big surprise there (not).  However, the real money futures on the 
election are narrowing with Bush's lead faltering.  The markets 
hate uncertainty and this election's results couldn't be more 
uncertain.  

Looking at the Industrials the index appears to be headed toward 
its August lows near 9800.  However, the index has been trading 
in a descending channel and the bottom of the channel is closer 
to 9700 almost 9600.  Setting a new low for the year would be 
pretty disappointing.  

Tomorrow brings the Producer Price Index, the NY Empire State 
index, the Retail sales for September, the Michigan Sentiment 
numbers and industrial production and capacity utilization.  It's 
going to be a busy Friday.


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

Market Averages

DJIA ($INDU)

52-week High: 10753
52-week Low :  9230
Current     :  9894

Moving Averages:
(Simple)

 10-dma: 10106
 50-dma: 10113 
200-dma: 10289




S&P 500 ($SPX)

52-week High: 1163
52-week Low :  990
Current     : 1103

Moving Averages:
(Simple)

 10-dma: 1125
 50-dma: 1107
200-dma: 1119




Nasdaq-100 ($NDX)

52-week High: 1559
52-week Low : 1301
Current     : 1425

Moving Averages:
(Simple)

 10-dma: 1446
 50-dma: 1392
200-dma: 1441



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

CBOE Market Volatility Index (VIX) = 16.43 +1.01
CBOE Mkt Volatility old VIX  (VXO) = 17.13 +0.88
Nasdaq Volatility Index (VXN)      = 22.30 +0.17


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

          Put/Call Ratio  Call Volume   Put Volume

Total          1.07        955,623     1,023,708
Equity Only    0.85        667,745       568,304
OEX            0.86         75,219        65,206
QQQ            2.02         33,550        67,878


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

Bullish Percent Data

           Current   Change   Status
NYSE          64.3    - 1     Bear Correction
NASDAQ-100    45.0    - 0     Bull Alert      
Dow Indust.   53.3    - 3     Bear Confirmed***
S&P 500       62.4    - 2     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: 1.46
10-dma: 1.08
21-dma: 1.09
55-dma: 1.14


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    1113       918
Decliners    1682      2053

New Highs      59        55
New Lows       56        53

Up Volume    542M      484M
Down Vol.   1264M     1059M

Total Vol.  1825M     1579M
M = millions


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

Commitments Of Traders Report: 10/05/04

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 aren't making any big bets ahead of the Q3
earnings season.  Longs and shorts have moved closer to parity
and the bearish sentiment is at it lowest level in four weeks.
Small traders are upping both their longs and their shorts but
their bullish bias is waning a bit.

Commercials   Long      Short      Net     % Of OI
09/14/04      442,049   469,982   (27,933)   (3.0%)
09/21/04      404,746   425,560   (20,814)   (2.5%)
09/28/04      404,773   434,441   (29,668)   (3.5%)
10/05/04      421,217   435,736   (14,519)   (1.7%)

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
09/14/04      167,310   126,513    40,797    13.9%
09/21/04      134,943   108,036    26,907    11.1%
09/28/04      135,317   107,173    28,144    11.6%
10/05/04      137,210   114,489    22,721     9.0%

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

Commercial traders have upped their positions in both longs
and shorts but clearly remain net bearish.  In contrast the
small traders have raised their positions in longs and shorts
and remain staunchly net bullish.

Commercials   Long      Short      Net     % Of OI 
09/14/04      377,643   586,139   (208,496)  (21.6%)
09/21/04      213,014   397,844   (184,830)  (30.2%)
09/28/04      226,020   420,714   (194,694)  (30.1%)
10/05/04      248,190   476,608   (228,418)  (31.5%)

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
09/14/04      289,155     81,314   207,841    56.1%
09/21/04      256,315     60,275   196,040    61.9%
09/28/04      262,501     68,255   194,246    58.7%
10/05/04      308,021     80,373   227,648    58.6%

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


NASDAQ-100

We are not seeing a lot of movement in commercials' positions
so they remain net bullish on the NDX.  Meanwhile small traders
are raising positions in both longs and shorts but shorts saw
a big jump creating a large bearish bias by small traders.  This
is of course a bullish contrarian indicator.  

Commercials   Long      Short      Net     % of OI 
09/14/04       64,282     59,808     4,474    3.6%
09/21/04       54,530     30,827    23,703   27.7%
09/28/04       55,045     32,319    22,726   26.0%
10/05/04       55,640     32,872    22,768   25.7%

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
09/14/04       36,372    28,584     7,788    12.0%
09/21/04        7,417    25,821   (18,404)  (55.3%)
09/28/04       10,078    22,917   (12,839)  (38.9%)
10/05/04       12,254    30,693   (18,439)  (42.9%)

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

Investors both big and small seem rather undecided about how
to bet on the Industrials. The gap between longs and shorts 
continue to narrow, especially between small traders where it's
a dead-even.  This is the least bullish commercials have been
in weeks while it's the least bearish small traders have been
in weeks.

Commercials   Long      Short      Net     % of OI
09/14/04       41,951    34,486    7,465       9.7%
09/21/04       30,816    27,200    3,616       6.2%
09/28/04       29,714    26,877    2,837       5.0%
10/05/04       27,498    25,772    1,726       3.2%
 
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
09/14/04        8,121    14,425   (6,304)   (27.9%)
09/21/04        4,467     6,748   (2,281)   (20.3%)
09/28/04        5,143     5,988   (  845)   ( 7.6%)
10/05/04        5,531     5,539   (    8)   ( 0.0%)

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 10-14-2004
Copyright 2004, All rights reserved.                        2 of 3
Redistribution in any form strictly prohibited.


In Section Two:

Dropped Calls: IR
Dropped Puts: None
Call Play Updates: CMI, GDW, GIVN, KMRT, OSIP, PH
New Calls Plays: None
Put Play Updates: APOL, FLIR, HSIC, SEPR, WHR
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:
*****

Ingersoll-Rand - IR - close: 67.35 change: -1.03 stop: 67.49

Darn it!  We discussed closing IR yesterday with the dip under 
the $68 level but we decided to hold it given its Wednesday 
afternoon rebound.  Industrial stocks got hammered today with the 
GM news and decline and the 107-point drop in the Dow.  IR dipped 
to its simple 200-dma before bouncing.  The bad news here is that 
IR rolled over again in the afternoon.  We are stopped out at 
$67.49.

Picked on October 06 at $70.19
Change since picked:    - 2.84
Earnings Date         10/21/04 (confirmed)
Average Daily Volume =     1.2 million 
Chart =




PUTS:
*****

None


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

Cummins Inc - CMI - close: 71.62 change: -1.14 stop: 69.99     

News today that CMI was chosen as one of two companies to design 
a mobile power generation unit for the U.S. army was not enough 
to stem the selling.  CMI has fallen two days in a row as the Dow 
Industrials post more declines with Thursday's session seeing a 
107-point drop in the Dow.  This has pulled CMI to technical 
support at the simple 40-dma.  We'd like to see shares bounce 
from here but this close to the $70 level and buyers may step 
back to wait for a dip from $70.  We are not suggesting new plays 
at this time.

Picked on September 19 at $70.99
Change since picked:      + 0.63
Earnings Date           10/20/04 (confirmed)
Average Daily Volume =       724 thousand
Chart =


---

Golden West Financial - GDW - cls: 111.85 chg: -1.60 stop: 111.65     

Negative reactions in shares of Citigroup (C) and Bank of America 
(BAC) helped pull the financial sectors lower.  The BKX index 
fell through its simple 200-dma on Thursday.  GDW slipped under 
minor support at $112 and hit an intraday low of $111.71.  That's 
only six cents from our stop loss.  It doesn't look good for us 
tomorrow.  Odds of us being stopped out are high.  Looks like we 
should have taken our exit at $115.35 instead of waiting for 
$115.50. 

Picked on September 30 at $110.95
Change since picked:       + 0.90
Earnings Date            10/21/04 (confirmed)
Average Daily Volume =        512 thousand
Chart =


---

Given Imaging - GIVN - close: 44.08 change: +0.37 stop: 39.90     

The good news here is that GIVN is ignoring the fresh market 
weakness and consolidating its recent gains in a sideways 
pattern.  There's no change in our strategy but if the broad 
market indices keep falling GIVN is likely to succumb.  If you're 
looking for new positions consider waiting for a dip and a bounce 
from $42.

Picked on October 04 at $41.26
Change since picked:    + 2.82
Earnings Date         10/27/04 (unconfirmed)
Average Daily Volume =     247 thousand
Chart =


---

Kmart Holdings - KMRT - close: 86.12 chg: -1.13 stop: 84.99

Uh-oh!  This is a crucial test for KMRT.  The stock has been 
consolidating above the $85.00 level for the last several days.  
Thursday's market sell-off pulled KMRT back toward support but so 
far it's holding.  Aggressive players may want to consider a 
bounce here but we're waiting for a move back over $90.00.  Bears 
may want to try and scalp a drop from $85 to $80 if KMRT breaks 
down. 

Picked on October 04 at $90.53
Change since picked:    - 4.41
Earnings Date         08/16/04 (confirmed)
Average Daily Volume =     2.7 million 
Chart =


---

OSI Pharma - OSIP - close: 63.66 change: +0.41 stop: 59.99

Bulls can't complain with OSIP.  The stock has ignored the recent 
weakness in the broader indices and the BTK index.  Actually OSIP 
appears to still be working on its trend of higher lows.  Now if 
shares could just breakout over its simple 100-dma and the $65.00 
maybe we can get somewhere!

Picked on October 03 at $63.45
Change since picked:    + 0.21
Earnings Date         08/10/04 (confirmed)
Average Daily Volume =     1.6 million 
Chart =


---

Parker Hannifin - PH - close: 61.62 chg: -0.30 stop: 59.49

Shares of PH also suffered a rough day on Thursday.  Industrial 
and cyclical stocks were hit hard by today's profit taking.  
Fortunately, PH managed to bounce from the $60.50 level.  This 
looks like an entry point for new longs but given the overall 
market environment we'd probably wait.  Wait to see if PH can 
produce a minor-trend high over $63.00-63.50 again.  

Picked on October 06 at $62.78
Change since picked:    - 1.16
Earnings Date         10/19/04 (confirmed)
Average Daily Volume =     719 thousand
Chart =



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

None

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

Apollo Group - APOL - close: 68.01 chg: -0.02 stop: 73.01     

Things that make you go "hmmmmmm".   The market has turned lower 
for two days in a row but we're not seeing any participation in 
shares of APOL.  Have traders just forgotten about APOL because 
they're too buys selling other issues?  We doubt it.  It could be 
just a lull in the decline.  APOL is short-term oversold and due 
for a bounce.  We're a little surprised that yesterday's upgrade 
from "hold" to "buy" by Jeffries didn't produce any sort of 
rebound.  Traders looking for new positions may want to look for 
a failed rally under 70.00 or a new low.  

Picked on October 10 at $69.81
Change since picked:    - 1.80
Earnings Date         10/05/04 (confirmed)
Average Daily Volume =     3.3 million 
Chart =


---

FLIR Systems - FLIR - close: 55.26 chg: +0.31 stop: 58.01     

Hmm... FLIR isn't participating in the market's sell-off either.  
That's not happy news for us bears.  FLIR is currently 
consolidating sideways between $54 and $56. Remember, we've 
already hit our original target and we're not suggesting new 
positions.  We are currently targeting the $52-50 region.  Our 
new official exit point is $51.50.

Picked on September 29 at $59.35
Change since picked:      - 4.09
Earnings Date           10/20/04 (confirmed)
Average Daily Volume =       577 thousand
Chart =


---

Henry Schein - HSIC - close: 58.37 change: -0.41 stop: 62.01

That didn't take long!  We added HSIC to the play list as a put 
candidate last night with a TRIGGER to buy puts if HSIC traded to 
a new low under $58.35.  Shares hit $58.12 and closed at a new 
low. We're going to leave our stop loss a $62.01 for now.  

Picked on October 14 at $58.35
Change since picked:    + 0.02
Earnings Date         11/02/04 (unconfirmed)
Average Daily Volume =     655 thousand
Chart =


---

Sepracor Inc - SEPR - close: 44.78 chg: -0.30 stop: 48.01 *new*

Heads up!  SEPR is almost to our profit target/exit point at 
$43.50.  Shares got a little push lower yesterday when Smith 
Barney started coverage on SEPR with a "sell" rating.  We should 
actually adjust our target to the simple 200-dma at $43.70 but 
we're going to stick it out for another couple of days and see 
how far SEPR slips.  We are going to lower our stop loss to 
$48.01.  We are not suggesting new positions.

Picked on September 22 at $48.94
Change since picked:      - 4.16
Earnings Date           07/13/04 (confirmed)
Average Daily Volume =       1.8 million 
Chart =


---

Whirlpool - WHR - close: 57.86 change: -0.69 stop: 60.55     

WHR has never been a very fast mover but at least it's 
consistent.  Shares of the appliance maker have been descending 
in a steady, yet narrow channel lower for the past couple of 
weeks.  We should see more weakness tomorrow.

Picked on October 07 at $59.03
Change since picked:    - 1.17
Earnings Date         10/20/04 (confirmed)
Average Daily Volume =     854 thousand
Chart =




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

None


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**********

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The Option Investor Newsletter                 Thursday 10-14-2004
Copyright 2004, All rights reserved.                        3 of 3
Redistribution in any form strictly prohibited.


In Section Three:

Watch List:  A Mixed Bag of Watch List Candidates
Traders Corner: Making good use of the RSI and Stochastics indicators 
Combos/Straddles: Plays For Turkeys Wanting To Gobble Up Profits

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

A Mixed Bag of Watch List Candidates

___________________________________________________________________

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.
___________________________________________________________________


Amazon.com - AMZN - close: 39.10 change: -0.88

WHAT TO WATCH: The two-day sell-off in the markets and technology 
has helped pull AMZN under round-number support at the $40.00 
mark and technical support at the simple 50-dma.  We've already 
had our eye on AMZN because the daily chart appears to be 
building an H&S pattern with a slanting neckline.  Today's 2.2 
percent decline appears to be a breakdown under that neckline and 
thus a bearish entry point.  Unfortunately, earnings are due out 
on October 21st.  Could be one to watch.

Chart=


---

ITT Industries - ITT - close: 79.06 change: +0.51

WHAT TO WATCH: Normally we'd expect an industrial stock like ITT 
to sink when the Dow Industrials drop over 107 points.  Yet 
buyers defended ITT at the $78 level and its simple 200-dma.  
While it looks like an aggressive bullish entry point we would 
not suggest it.  The stock actually has a faint trend of higher 
lows and lower highs.  Watch for a move over $81 to go long or 
under $77 to consider a short.  Earnings are expected on October 
21st. 

Chart=


---

Johnson Controls - JCI - close: 55.45 change: -0.99

WHAT TO WATCH: A disappointing earnings report from General 
Motors (GM) helped pull JCI to a 1.75 percent decline on 
Thursday.  JCI has been slowly climbing higher with a five-month 
trend of higher lows but JCI is about to challenge that trendline 
of support.  A breakdown under $55.00-54.50 may be a bearish 
entry point.  Watch for earnings on October 26th.

Chart=


---

Anthem Inc - ATH - close: 82.12 change: -1.78

WHAT TO WATCH: ATH is a health insurance sock that has been 
suffering under a short-term trend of lower highs.  Today's 
failed rally at $85.00, under its simple 200-dma, looks like a 
bearish entry point.  However, we would watch for a drop below 
round-number support at $80.00.  The stock is nearing long-term 
support on its weekly chart with a trendline of higher lows.  A 
breakdown here could signal a true change in trend for the stock.  
Earnings are expected around October 26th.

Chart=


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

KRI $67.18 +1.14 - KRI bucked the market trend today with a 1.7 
percent gain fueled by a positive earnings report.  Look for some 
follow through.

COF $69.22 -1.42 - COF has fallen with the banking sector today 
but COF broke down under support at the $70.00 mark and its 
simple 200-dma.

MME $34.85 -11.28 - What are the odds of an oversold bounce here?

AIG $60.00 -6.99 - AIG may see an oversold bounce on Friday too.


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

Making good use of the RSI and Stochastics indicators 
By Leigh Stevens
lstevens@OptionInvestor.com

OVERBOUGHT AND OVERSOLD – 

RSI and Stochastics are considered to be both indicators of 
momentum and indicators suggesting levels that an index or stock 
is at an extreme or "overbought" or "oversold" – used in 
quotation marks to point out that the meaning of these terms 
varies a good deal. These terms are always have to be qualified 
some. Overbought or oversold means that a stock or index is 
thought to be at an extreme on the downside or upside. We need 
keep in mind that an Index (or stock) is "over"-bought or "over"-
sold only in terms of TIME and CONDITION.  

TIME – 
Here we are looking at whether we are talking on an intraday 
chart (e.g., hourly), a daily chart or weekly; whether we are 
talking short or longer-term and is that on a 5-day, 2-week or 2-
month time frame?  

A so-called extreme is based on some period of time. OEX might be 
thought to be quite oversold because it went down sharply down 
for 5 straight days. However, this might be in the context that 
the index went up strongly for 5 straight weeks. 

Shown below is today's (10/14/04) closing chart of the Nasdaq 
Composite (COMP), with the Relative Strength Index (RSI) 
indicator, a type of overbought-oversold technical study. (More 
on how the RSI is contracted further on.) The fluctuation that 
the RSI can make is between 0 and 100, although an index rarely 
registers much over 75 or below 25 on a daily chart, especially 
if the common 14-day setting is used as below – 


  

I've highlighted each time the RSI reached a peak or the first 
time it did so. You'll notice that I have created an overbought 
and oversold RANGE or bands that are between 30-35 on the 
downside and approximately 63-70 on the upside. 

When I observed that tops in the Composite during recent months 
were being reached at 63 and above, I set the lower number there, 
but this will vary depending on market conditions.  An important 
thing to note is that most charting programs will have a single 
line that is set for the two extremes – usually, 30 and 70 in the 
case of the RSI indicator. 

By use of "level-line" marking tool (dashed line), I have created 
a range of values for overbought and a range of values for what I 
am defining as oversold in the chart above – this is not a wide 
range, but a few points can make quite a difference in the RSI.  
Again, overbought and oversold are relative concepts, not 
absolute.  So, there is no one (absolute) number that says a 
given index or stock is at an extreme. Its when it gets in a 
certain range.

HERE'S THE CHART AGAIN – 

   

You'll notice that there are several instances when the RSI got 
into the overbought or oversold range two or more times.  So, how 
is it useful to look at the RSI?  

#1 reason – use of the RSI or another like indicator gives you an 
idea that the market is VULNERABLE to a reversal – the index or 
stock may reverse within a few days or it might be within a 
couple of weeks; e.g., 8-10 trading sessions. Now, of course, 
this is an eternity to a shorter-term trading, especially in 
options. 

#2 reason – by the time a second extreme reading is made, almost 
always by 3 times, this is usually a top, especially in a trading 
range market like the above period.

A trading range market is one that may have wide-swinging trading 
swings, but is not going up or down mostly, month after month or 
quarter after quarter.  In the above chart, COMP has traded 
between 2150 and 1750.  While the overall trend is down during 
this period since each top has peaked at a lower level than the 
prior high, this market is trading in a wide range on the way 
down.  Each bottom and top is not that far below the prior one. 

The best use of an overbought-oversold indicator like the RSI 
(another is the stochastic indicator) is in a market like the one 
above – a trading range where, once the market gets to an upper 
or lower extreme, it will before too long start in the opposite 
direction, until it reaches an extreme in this opposite 
direction.

#3 reason is that the RSI at an extreme, puts you on high ALERT 
to watch for OTHER signs of a reversal; e.g., a double top or 
bottom; a new high followed by an immediate sharp decline the 
same day or over 2-days (bull trap reversal); or, a new low 
followed by an immediate sharp rebound the same day or over 2-
days (bear trap reversal). 

Confirming signs of a reversal in the chart pattern, is usually a 
good basis on which to take a trade, and even to go in more 
heavily on the trade.  Not all trade "set-ups" are equal – some 
warrant more employment of trading money, others less, within 
risk management prudence of course such as never trading with all 
your trading account. 

#4 reason to look for an RSI extreme is to find those occasional 
instances where a bullish or bearish Price/RSI DIVERGENCE sets up 
and this brings me back to the time period that was circled in 
the chart above and is reproduced in close-up below – 


  

In the period of late-May to late-June, a bearish Price/RSI 
divergence occurred.  This is where prices went on to a new high, 
but where the RSI did not ALSO go to a new high reading. 
Therefore, this bearish divergence seen at the second high was an 
excellent indication to buy Nasdaq puts, even if using the Nasdaq 
100 options.  

What we expect is that an indicator like RSI, will tend to 
"confirm" what price action is doing.  If it doesn't, it's not 
confirmation, but "divergence".  The reverse situation – a 
BULLISH Price/RSI divergence - was nearly seen in August at the 
final low, but RSI did go to a slightly lower low than two weeks 
prior.  

Another point – divergences are valid WHEN they occur within the 
same time frame as the indicator is measuring.  "Length" on the 
RSI indicator here is set to 14, meaning it measures 14 trading 
intervals, in this case, 14-days. Therefore we are looking for 
divergences that occur within this same 14-day period. 

I got away from my point a little about TIME, but when you hear 
someone say the market is overbought or oversold, you should next 
think about what time frame they are they talking about, assuming 
they KNOW what they are talking about and not just repeating 
something that they have heard.  

If you own puts, trading for a short-term decline, knowing the 
market is in a long-term oversold condition only suggests that 
you not end up turning a trade into a "position" by owning puts 
for more than the short-term downswing you're looking for.  

CONDITION – 
I spoke about "condition" as also being a consideration about 
what it means when a stock or index is overbought or oversold – 
these terms mean different things in different market conditions 
or different types of markets.  

Overbought and oversold as concepts are best used when a market 
is in a fairly defined trading range as I talk about above.  
Because in a runaway bull or bear market, the concept of relative 
really comes out. In a runaway bull market like the late-90's, 
the market is going to get overbought and STAY overbought for 
long periods of time – making the indicators that measure 
overbought, less useful for trading purposes – 


 .  

In the conditions prevailing in a strong bull or bear, the 
overbought/oversold concepts, especially in the indices, are less 
meaningful.  You can see that after the 2003 advance shown in the 
above chart, the Dow (INDU) was NEVER oversold, according to this 
convention way of measuring it with the RSI.

The same is true in a bear market, where the RSI never gets to an 
overbought reading – too many sellers waiting to pounce on it!
The conventional technical indicators that attempt to define the 
relative concepts overbought and oversold are going to say that 
the market is oversold, and oversold and again, oversold! 

SOME BASICS – 
An index, or an individual stock, is commonly thought to be 
overbought or oversold when prices have an advance or decline of 
a degree that is greater than what is normal or usual relative to 
its past price behavior for a certain time frame and condition. 

Take the case of a stock that for five months, or 5 years even, 
has never traded at a price that was greater than 10% of its 
closing average for the prior 200 days.  Then comes a period when 
there is such a steep advance that the stock reaches a price that 
puts it 20-25% above this same average – this stock may be 
considered to be "overbought".  Overbought here implies simply 
that any surge in buying well in excess of what is usual on an 
historical basis, also creates a likelihood that the stock 
price will correct.  

Another example of an overbought condition might make an 
assumption about an Index that has closed higher for 10 days 
straight – if this price behavior is "over" or beyond what is 
usual for this item, the assumption is that prices are vulnerable 
to snapping back – a rubber band analogy is a good one, as market 
valuations get stretched, so to speak, but then tend to also come 
back to a mean or an average.  

The concept of overbought and oversold refer to rallies or 
declines that are steeper than usual, but the degree of this can 
vary a good deal in terms – there is no precise, objective or 
agreed upon measurement.

RSI and STOCHASTIC Indicators -  

Both are also called "oscillator" type indicators in that both 
are constructed in a way that the numerical scale goes from a low 
of zero (0) to a maximum high of 100. (This is not the case in 
the Moving Average Convergence Divergence or MACD; "mack-dee".) 
They oscillate in a fixed range. Both RSI and Stochastic measure 
price momentum.  

The Relative Strength Index, usually referred to as the "RSI" was 
developed by Welles Wilder back in the '70's. A simple way to 
understand the RSI is that it is a ratio (one number divided by 
another) that compares an average of up closes to down closes.  
There is only ONE variable, which is the length or the number of 
periods (hours, days, weeks, etc.) that the RSI formula works 
with.    

The common RSI default (the preset value) for length in charting 
applications is usually either 9 or 14.  The relative strength 
index calculations will be based only on the number of closes 
specified as the length setting.  The reason for the widespread 
use of either 9 or 14 is mostly a matter of convention.  
Obviously, a setting of 9 or 14-days does not even represent an 
even number of 5-day trading weeks.  

However, both 9 and 14 are common default settings and there is a 
repository of experience among users of the RSI with these levels 
and instances of overbought or oversold conditions associated 
with them. The commonly used default settings are 30 to represent 
an oversold reading and 70 and above to suggest an overbought 
condition.

The optimum length settings are a function of your time horizons 
relative to trading or investing.  5 to 9 (or 10) for the RSI 
length on a daily or hourly chart is appropriate for the minor 
trend and short-term trading.  A length setting of 14 up to 21 
for daily charts is good for looking at the longer trend, such as 
over 2-3 weeks or more. On weekly charts, my preference is an 8-
week period for the RSI – 8 represents a 2-month period or 1/6 
of a year, providing a relevant picture of the secondary or major trend.  

RSI is derived by calculating the average number of points gained 
on up days, during the period selected (e.g., 14), then dividing 
this result by the average point decline for the same number of 
bars – this ratio is "RS" in a 14-period formula for RSI or 100 – 
100/1+RS.  RS = the average of 14-days' up closes divided by an 
average of 14-days' down closes.  9 or 21, or any other number, 
would be used instead of 14 in this example.  

Every up close during this period is added and this sum is 
divided by the number of bars that had up closes to arrive at a 
simple average.  Every down close during the period selected is 
added, then this sum is divided by the number of bars that had 
down closes.  If 10 of 14 days had up closes, the result of this 
division is a ratio that rises rapidly.  Subtraction from 100 of 
the result of the division is what makes for a scale of 1 – 100.   

In a period of a rapid and steady advance the RSI will reach 
levels over 70 rather quickly and RSI can then remain above 70 
for some period of time.  The reverse is true in a decline, as 
readings under 30 are seen.  

SLOW STOCHASTIC – 

The stochastic indicator is calculated in a different way than 
RSI and is LESS useful in finding a divergence like the one above 
that was based on using the RSI.  
 
Technical indicators can be generally grouped into trend 
following type indicators like moving averages, or into 
indicators of this type called "oscillators" that are formulas 
when graphed, move back in forth in a range from 1-100.

The central idea or concept of stochastics - what it is 
attempting to show - is that in an up or down market trend for 
any number of trading periods (e.g., 10 hours or 14 days), prices 
will at times move away from the lowest low made during that 10 
hours or 14-days, or the highest high, at an increasing rate – 
this "rate" or speed of price changes is what the (slow) 
stochastic oscillator is showing visually.  

The stochastics "default" oversold and overbought levels are 
typically pegged at readings at or below 20 and at or above 80. 
The stochastics tend to have wide-ranging fluctuations between 0 
and 100; e.g., a low at 5 or 10, a high at 90. 

The stochastics indicator is composed of two lines – a slower 
line called the percent D (%D) line is a simple moving average of 
the faster %K line.  The two lines of varying speeds lead to 
crossovers that generate buy and sell “signals” – 

Lets look at the SAME period as shown in the Dow chart above only 
adding the Stochastic model for comparison – 


  

CONDITION – 
It's a bull market! Therefore I want to skew the overbought and 
oversold readings UPWARD and consider above 90 to be (relatively) 
"overbought" and at or between 40 and 30 to be "oversold".  
Wallah! I find I have a few useful indications of buy points, at 
the maximum extensions of the pullbacks, in which to help me with 
a few instances of buy side or bullish trades in calls.   

The Stochastic study looks at the current price in relation to 
the highest high or lowest low in the period being measured.  
Stochastics plots the current close in relation to the price 
range over the length set for this indicator and gives this a 
percentage value.  

The initial calculations for a stochastic of 14-days are twofold, 
establishing a "fast" and "slow" line.  The fast line or "%K" 
formula is 100 – (the close minus the 14-day low) divided by (the 
14-day high – the 14-day low; i.e., the price range).  The slow 
line or "%D" (here called "FastD") is equal to a 3-day average of  
"%K".  This first formula is referred to as the "fast stochastic" 
model.

The "slow stochastics" variation of the basic stochastics formula 
is simply to take the "FastD" figure and apply a "smoothing" 
calculation yet again, which results in another line which we can 
call "SlowD", to differentiate the two versions of "%D".  The 
important thing to remember is not this "alphabet soup", but the 
fact that the slow version of the stochastics oscillator (slow 
stochastics) is the version that is in most common use and is 
most likely what you will be using if you choose the stochastics 
indicator to apply to a price chart.  

SUMMING UP -  

Best use or most effective use of oscillators is in a market with 
two sided trading swings, rather than one in a strong bull or 
bear trend.  Best single oscillator to use??

RSI, in a normal trading range market, as its use will also best 
highlight bullish or bearish divergences.  In a strong trending 
market on the other hand, use stochastics for the few useful 
signals that suggest that brief counter-trend price swings are 
likely to have run there course.  



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

Plays For Turkeys Wanting To Gobble Up Profits

By Mike Parnos 

When you go hunting for bear, sometimes you get the bear and sometimes 
the bear gets you.   Well, the last few days the bears have been having 
their way with the bulls -- in broad daylight.  It's been an "R" rated 
market, to say the least.  Sure am glad we're non-directional.

We're poised for another excellent month.  We'll wrap it up, and add it 
up, in Sunday's column.  As long as tomorrow's opening isn't 
outrageous, we're in line to be in line to deposit our profits at the 
CPTI National Bank.
___________________________________________________________

Position Adjustment
On Tuesday afternoon, BBH was trading a little above $138.  We took 
that opportunity to close out the short $135 October put for $.35.  We 
had originally taken in a credit of $1,500.  We were able to lock in 
more than 75% of our profit and take ourselves out of harm's way.  It 
doesn't make sense to risk $1,150 to get the other $350.  Let me put it 
in a way we can all relate to.  You wouldn't risk the first 75 French 
Fries just to get another 25, would you?  Remember, we're not gamblers.

"One of the most helpful things that anybody can learn is to give up 
trying to catch the last eighth -- or the first.  These two are the 
most expensive eighths in the world."  - Jesse L. Livermore, 
Reminiscences Of A Stock Operator. 
____________________________________________________________

NOVEMBER CPTI POSITIONS
November Position #1 -- SPX Iron Condor - 1103.29
In my Oct. 3, 2004 article, we initiated this "hypothetical" position 
to take in some additional premium.  It seemed like a good idea at the 
time.  This is a good example of what can happen when you go out a long 
time -- the additional two weeks of market exposure allows more time 
for the market to swing.  Remember, this position was based on two 
additional weeks of premium and the SPX was trading about 30 points 
higher at the time

We sold 12 SPX November 1185 calls and bought 12 SPX November 1200 
calls with a credit of about $1.25 ($1,500).  Then we sold 9 SPX 
November 1070 puts and bought 9 SPX November 1050 puts for a credit of 
about $1.65 ($1,485).  Total credit and potential profit of about 
$2,985.  The maximum profit range is from 1070 to 1185.  Can this 115-
point range withstand the market's emotional highs and lows?  Let's 
hope so.  The maintenance is $18,000.  The potential return on risk is 
about 20%.

New November Position #2 - SPX Iron Condor - 1103.29
Considering the downward market movement, I felt it is appropriate to 
initiate a SPX position with different parameters.

Sell 10 SPX Nov. 1160 calls
Buy 10 SPX Nov. 1180 calls
Credit of about $1.40 ($1,400)

Sell 13 SPX Nov. 1025 puts
Buy 13 SPX Nov. 1005 puts
Credit of about $1.20 ($1,560)

Maximum profit potential of about $2,960.  Max profit range of 1025 – 
1160.  Maintenance: $20,000.

November Position #3 - OEX Iron Condor - 529.58
Sell 10 OEX Nov. 500 puts
Buy 10 OEX Nov. 490 puts
Credit of about $.70 ($700)

Sell 10 OEX Nov. 555 calls
Buy 10 OEX Nov. 565 calls
Credit of about $.60 ($600)

Total net credit and maximum profit of $1.30 ($1,300).  Max profit 
trading range of 500 to 555.  Maintenance $10,000.

November Position #4 - RUT - Iron Condor - 564.99
Sell 10 RUT Nov. 520 puts
Buy 10 RUT Nov. 510 puts
Credit of about $.70 ($700)

Sell 10 RUT Nov. 610 puts
Buy 10 RUT Nov. 620 puts
Credit of about $.60 ($600)

Total net credit and maximum profit of $1.30 ($1,300).  Max profit 
range of 520 to 610.  Maintenance $10,000.

____________________________________________________________

OCTOBER CPTI "HYPOTHETICAL" POSITIONS
October Position #1 - SPX Iron Condor - 1103.29
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 - 564.88
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 - 529.58
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 - $134.10
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, it's 
getting close to the bottom of the range.  Closed out short $135 put at 
$.35 = final profit of $1.15 ($1,150).
____________________________________________________________

ONGOING POSITIONS
QQQ ITM Strangle – Ongoing Long Term -- $35.45
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.  
We rolled to the Sept. $34 calls and $37 puts for a total of $.70 
($700). Our new total credit is now $12,900. 

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 
conservative cash flow generating strategy.  

ZERO-PLUS Strategy.  OEX – 529.58
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 total of $9,365.  In October 
we added $650 for a new total of $10,015.

New Zero-Plus Position For November
November bull put spread 500/490 for credit of $.70 x 5 = $350.  
November bear call spread 555/565 for credit of $.60 x 5 = $300.  If 
all goes well, we'll be able to add another $650 to our cash position.
__________________________________________________________

SPX "Sure Thing" Strategy - 1103.29
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 was $7,500.

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.  

We've been getting whipsawed.  Our most recent position was a November 
14-contract 1120/1095 bull put spread (coincidentally, right back where 
we started) at $7.00 ($9,800).  The maintenance is getting pricey at 
$35,000.  That's why this strategy is not for everyone.  Our potential 
profit is still $2,435. 

Here we go again.  We had to close the 1120/1095 bull put spread and we 
initiated a new 1115/1140 bear call spread.  We picked up another $350 
in premium to $2,785, but our maintenance is now $70,000.  

____________________________________________________________

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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