The Bull Has Legs

Tech
stocks — in a strong intermediate term uptrend —
are the story
these days. Exciting stories came out
this week in Ballard Power
(
BLDP |
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PowerRating)
(in collaboration with Ebara and Osaka
Gas to develop a residential fuel cell generator) and Affymetrix
(
AFFX |
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PowerRating)

(not only was all patent litigation settled with Hyseq, but they also appear to
be in a constructive business partnership with Hyseq now).
These two stocks, along with Juniper Networks
(
JNPR |
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PowerRating)
, which jumped
last week on a favorable earnings announcement, are interesting bullish plays
— to be entered on any one-day pullbacks. (In
fact, I viewed Ballard’s pullback to 30 today as a good entry point.)

Otherwise, the tech sector in
general may be due for a multi-day pullback. I
sense that the current run is too mature to be entering long positions right
now. A good pullback would set us up
nicely for another run.

On the other hand, today’s
move in the Dow and the Russell 2000 (both setting new post 9/11 highs) may be
saying that we’re going to forge ahead early next week.
Either way, the bull has legs.

Be careful trying to play this
using straight call buying, however. Options
are still very expensive — hurting your leverage and presenting you with
volatility risk — because if stocks do advance, their options’ implied
volatility levels will come down, making it seem like you’re fighting an
uphill battle. It might be better to use
bull call spreads, or lean toward buying deep in-the-money calls, or simply buy
the underlying stocks. If you do buy
straight calls, treat them like hot potatoes; be ready to sell them near the end
of a good, strong up-day.

You see, as I emphasized in my
talk at TradingMarkets2001, down markets are usually “cleaner” plays.
A good sell-off goes for three days, has a one-day retracement, and then
goes for two or three more days (I’m oversimplifying here, but not by much).
A sell-off often culminates in a degree of panic selling, as evidenced by
a volatility spike, making it easy to sense when to exit.
The best option strategy for a sell-off is straight put buying — no
question — not only because the move is so swift and clean, but also because
increasing volatility accompanies the sell-off, pumping up put values.

In contrast, up markets are
usually choppy, with frequent retracements and consolidations that can last for
days. Thus, swing trading an up market is
a challenge. How many times has the
options trader looked back on a beautiful 30-day rally, during which several of
his favorite stocks doubled, and asked himself, “How did I manage to lose
money?” 

And, of course, it was because
the trader tried to play the one- to two-day moves and the market did not behave
predictably on that level.

Therefore, up-markets might
better be played using longer-term (i.e., 30-day) positions.
And the best option strategy for longer-term positions is spreads — no
question — because spreads have smoother performance and better profit
potential in that time frame.