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 ************************Advertisement************************* Get the most from your online options broker * fully-integrated trading tools for options or stock * Easy screens for spreads, collars, or covered calls * Free streaming quotes and Dow Jones news * Rated "Best" by Barron's, SmartMoney and Forbes Go to http://www.optionsxpress.com/marketing.asp?source=oinvest31 Note: Options involve risk. Risk disclosure: http://www.optionsxpress.com/welcome_risk_index.htm ************************************************************** ******************** 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 ************************Advertisement************************* Insiders are Buying these 6 Rocket Stocks. In the last few weeks, we have pinpointed insider buying on six stocks that have the potential to deliver stratospheric gains. 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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 ************************Advertisement************************* SEE WARREN BUFFETT'S LATEST DISCLOSED STOCK PORTFOLIO Now you can follow the investment master's actual moves. To get a FREE report that details Warren Buffett's strategy and reveals his most recently disclosed, ACTUAL stock picks, Click HERE! http://www.bigmoneywatch.com/default.asp?aid=626 ************************************************************** ******************** 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 ************************Advertisement************************* Trade Smarter Using the latest Insider Trades Is the CEO selling off? Has a key insider loaded up on shares before a big price jump? Find out now. Get your free download of Real Time insider trades: http://www.realtimeinsider.com/default.asp?aid=637 ************************************************************** ******************* 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 ************************Advertisement************************* Get your FREE weekly charts of the NASDAQ! Hot Stix’ stock market report reveals simple, powerful strategies for profiting from the QQQ - whether down or up! http://www.hotstix.com/public/weekly.asp?aid=755 ************************************************************** ********** DISCLAIMER ********** Please read our disclaimer at: http://www.OptionInvestor.com/page/oin/aboutus/disclaimer.html ************************************************************** ADVERTISING INFORMATION For more information on advertising in OptionInvestor Newsletter, or any Premier Investor Network newsletter please contact: Contact Support
The Option Investor Newsletter Thursday 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. ************************Advertisement************************* Get your FREE weekly charts of the NASDAQ! Hot Stix’ stock market report reveals simple, powerful strategies for profiting from the QQQ - whether down or up! http://www.hotstix.com/public/weekly.asp?aid=755 ************************************************************** ************** 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. ************************Advertisement************************* Trade Smarter Using the latest Insider Trades Is the CEO selling off? Has a key insider loaded up on shares before a big price jump? Find out now. 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