McMillan's Options Plays

01/24/2003 12:00 am EST

Focus:

Lawrence McMillan

Founder and President, McMillan Analysis Corporation

"Can the market break through previous upside resistance?," asks Larry McMillan, editor of The Option Strategist .  "Or is it just expending a lot of energy to once again fail at the same levels–the August and November highs?" Here's his technical outlook and some recommendations for options traders.

"The mini-bull trend that had developed seems to have been quashed. But there hasn’t been any downside breakout, either. So we’re right where we have been for a while–locked in a trading range bounded by 485 (basis $OEX) on the upside and 440 on the downside. The equivalent range on the S&P 500 ($SPX ) is 970 and 870. The longer the market remains in this range, the less meaningful the technical indicators seem to become. They are mostly balancing in a state that could move either way and hence would act more as confirming rather than leading indicators of any potential price breakout.

"For example, take volatility. $VIX had fallen to a level very near the lows of last November. Since a declining $VIX is bullish, it seemed as if $VIX would break downward when the market rallied. But it did not. So $VIX remains in its own trading range. On the other hand, the alternative measure of volatility that we construct by using stock options has already broken downward and is therefore bullish. Thus, even within the volatility category, the two technical measures that we look at are not in complete agreement.

"In fact, this sort of dichotomy has been taking place among almost all the indicators. Take the put-call ratios; the weighted equity-only ratio issued a buy signal nearly two weeks ago now, and is even pressing downward–about to make a new relative low. This, in fact, is one of the stronger indicators in our arsenal right now. However, its companion–the ‘standard’ equity-only ratio is not nearly as bullish–and in fact is only moving sideways, which is not yet confirming a buy signal.

"Market breadth is about as disparate. It’s almost as if the bulls have expended a lot of energy–as measured by positive breadth–to get the market to its current level, but that isn’t enough to create an upside breakout, and eventually the market falls due to a lack of any further buying power. Overall, rather than try to force a prediction out of these indicators, we prefer to wait for a price breakout to manifest itself. After the market has spent so long coiling itself up in this trading range, the subsequent price breakout is likely to be a swift and strong one–no matter which direction it takes.

"We have seen new buy signals in Bristol-Myers (BMY NYE), Coca Cola (KO NYSE), Cigna (CI NYSE), and 3M Cos. (MMM NYSE). We are also recommending an options play on Cigna. We recommend buying calls on the stock. Our specific option recommendation is to buy the Cigna February 45 calls at a price of 3.50 or less. We are also recommending calls on Medimmune (MEDI NASDAQ). Our specific option recommendation is to buy 3 MEDI Mar 25 calls at a price of 5.00 or less. Stop yourself out if MEDI closes below 27.

"In addition, we are going to recommend a calendar spread in a stock that has had some troubles recently– Polymedica (PLMD NASDAQ). The stock recently collapsed as a Federal probe deepened as to whether health-care fraud was committed. As a result, there is a steep skew in the put options. We suggest buying a Polymedica Put Calendar Spread. Specifically, we recommend buying 5 PLMD June 25 puts  and selling 6 PLMD February 25 puts when the 1-for-1 spread is 2.40 or less. If you do not wish to have a naked put, then buy and sell an equal quantity and forsake the additional naked put. Cover any naked puts if PLMD closes below 23."

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