December 29, 2002

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Hello and Happy Holidays to everyone. I hope you all enjoyed Christmas as much as I did. I had a very rare chance to get together with my entire family, and I enjoyed it greatly. It's just too bad there was no snow on the ground in Denver, but the snow capped mountain peaks did sure look nice. Any how, back to business.

The Market:

The Dow Jones Industrial Average closed Friday down 128.83 points at 8,303.78 This is the lowest close on the Dow since mid November. The trend on the Dow is clearly to the downside at this point. Granted there is a moderate amount of support to be found at 8,283.70 but I do not expect it to hold, and it looks like the Dow is going to move lower and test 7.997.12 If that level of support does not hold, then I expect the Dow will test its mid July low level of 7,702.34 Please keep in mind that as we get closer to these levels the risk of a trend reversal increases, but until then the trend is clearly lowers.

Investor's Dilemma:

While I was in Denver I had a chance to talk with my sister's father-in-law. During the conversation he asked me what I thought of the "market" and where it was going? I answered that I thought it was going lower in the short term, but ultimately higher. He said he had some cash he needed to roll into his IRA, but did not know what to do and was worried about the market moving lower. This more or less is a very common question I hear all the time and felt my reply to him would also be useful to a lot of other people.

I believe he should transfer the cash into the IRA to avoid the tax consequences of not doing so. I then suggested he hold the cash and purchase his investments on a dollar cost average program over a period of time. This more or less produced a blank look, followed by the statement that he wasn't sure what to buy. My suggestion was to invest in the Dow Jones Industrial Average ETF, otherwise known as the "Diamonds" ticker symbol 'DIA'.

The "Diamonds" are an Exchange Traded Fund that hold the component stocks of the Dow Jones Industrial Average in the same ratio as they are within the index. This allows an investor to essentially purchase a single stock that is the Dow Jones Industrial Average. It is like owning a share of the Dow Jones. The Diamonds very accurately track the movement and performance of the Dow Jones Industrial Average. Additionally there is a very liquid options market for the Diamonds.


The Diamonds closed Friday at 82.96 If I was worried about about the Dow Jones Industrial Average retesting its July lows, but wanted to have an investment strategy designed to enter the market and earn better than the money market rates, here is the strategy I would take.

The July low on the Diamonds was $77.17 set on July 23rd. I would look to own the Diamonds at a cost of $77.00 or less. The Diamonds February 77 Put is currently trading at $1.75 I would therefore sell the February 77 put for $1.75

If at the expiration of the February Put Contract the Diamonds were priced above $77.00/share, then I would get to keep the $1.75/share that I sold the Put contract for. If the Diamonds closed below the $77.00/share price, then I would be forced to buy the Diamonds at $77.00/share and get to keep the $1.75/share from the put. This would give me a cost basis (the price I paid) of $75.25/share on the Diamonds. Considering that the Diamonds have only traded a handful of days below this price during all of 2002, I would feel comfortable owning them at that price level.

I would base my decision of how many Put contracts to sell based upon over what period of time I would be comfortable fully investing my funds into the market. For example if I had $100,000 and wanted to invest it over a 10 month period of time, then I would look to invest approximately $10,000 per month. Combined with the strategy of selling puts, I would then sell 1 Put contract (each contract covers 100 shares) earning $175 minus commission and if the shares were put to me then I would invest a net $7,525 that month. If the shares do not get put to me then I have earned $175 from my capital commitment of $7,700. That is approximately 2.3% in a month.

This is a very often overlooked strategy that I feel many investors could benefit from learning more about and employing. I do believe that in order to successfully employ this strategy you need to either understand how to read a stock chart or have access to someone who does, and you need to have a good understanding of the options market. In future editions of the Sterling Weekly newsletter I will further explain options contracts and strategies involving there use.

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