LIKE A DEER CAUGHT IN THE HEADLIGHTS… Bonds appear to be somewhat paralyzed by all the news of violence and terrorism delivered last week. Meanwhile, Stocks suffered through a week of bumps and bruises, and took another hard whack on Friday as security fears continued to grow. Although there was a good bit of midweek action, Bonds seem to be very hesitant to move decisively one way or the other, and mortgage interest rates ended the week basically unchanged. But let’s review the events of last week, and the potential impact as we look ahead.

The aftermath of the terrorist attacks in Spain continue, as the national election was actually swayed by the devastating events. Spain’s new Socialist leader indicated that he intends to pull all Spanish troops out of Iraq. What sad message does this deliver to the terrorists? Plain and simple – it worked, and it may work again.

The violent trend continued during the week, as the one-year anniversary of the war on Iraq was marked by a car bomb killing 30 in Baghdad, very near US headquarters. It appeared that Pakistani forces had surrounded a high-ranking al-Qaeda officer, but recent news indicates he may have slipped away. Friday brought an attempted assassination of the President and Vice-president of Taiwan just ahead of elections to be held over the weekend. Terrorists appear to have swayed the election in Spain with the train bombings. Combine this with the attempted assassinations in Taiwan, and it makes for a scary trend as we approach the US Presidential Election this November. Further, many other European countries who have joined the war against terrorism in Iraq and Afghanistan have elections in 2005. How does all of this impact mortgage interest rates? Read on for the forecast of the week.

LIKE KEEPING YOUR OPTIONS OPEN? THE MORTGAGE MARKET VIEW SHOWS HOW STOCK OPTION TRADING REALLY WORKS, AND HOW THIS STRATEGY CAN BE USED AS A SURPRISINGLY CONSERVATIVE STRATEGY TO LOWER YOUR RISK AND PROTECT YOUR RETURNS.

With the uncertainty of worldwide terrorist activity – it becomes very hard to predict what may be in store short term for Mortgage Bonds and Mortgage interest rates. Terrorist activity tends to lead to a “flight to quality” or a move to safe investments, which benefits Bonds. This in turn benefits interest rates. As we hope for no further terrorist movement, let’s look at the other factors that will affect Bonds and Mortgage rates. There have been recurring rumors over the past week that the Bank of Japan will end its intervention buying of US mortgage bonds by the end of this month. If true, there will be decreased demand for bonds, and prices could decline with higher yields and mortgage interest rates following. With no economic releases scheduled until the middle of the week, there might not be much early trading direction for Bonds unless high profile terrorist-related news continues to surface.

On a technical level – the chart below shows an interesting signal that appeared last Friday, called a “Doji Star” candlestick. The Doji Star indicates pending volatility, but doesn’t indicate which way the volatile motion will go. It shows that the market appears to be shuffling around with a lack of real conviction one way or the other – and will easily be moved in dramatic fashion when some direction comes into play. It appears that Bonds may test the 25-day Moving Average soon. Excluding significant geopolitical news, Bonds may see a slight technical correction, causing mortgage rates to worsen slightly.

Stock Options… always heard about them, but never been sure exactly how they work, and how you can use them?

Stock Options can be used as a very wise tool to boost your investment returns and bolster your capital preservation. At first glance, stock options may be considered a high-flying, risky and aggressive way to “play” the stock market. But a more informed view uncovers that stock options can actually be used as a very conservative tool to help increase safety and improve returns on your stock investments.

Let’s break it down step by step. Most investors use stock options to control shares of stock for a small fraction of the cost of actually buying the stock. Stock options give the investor the “option” to purchase the stock at a specific price within a specific time period. Let’s say that you wanted to buy shares of ABC Company, currently trading at $47 per share. Certainly you could just pony up the $47 per share – but instead, consider buying the options. You can purchase the option to buy the stock at $50 (called the “strike price”) within the next month (known as the expiration period, which is always the 3rd Friday of a selected month) for, let’s say, $2 per share. The name of this option is a “Call”. So you can control the same number of shares for a tiny fraction of the cost. While this is a great leverage tool, there are risks involved. In this case, if the price of the stock for ABC Company does not reach the targeted strike price of $50 during the specified time frame, the option will expire worthless. You will lose all of your investment unless you sold your option before the expiration.

The value of the option will fluctuate, depending on the going price of ABC stock relative to the strike price, and the amount of time remaining in the expiration period. More time remaining increases the options value because the stock will have more time to reach or exceed the strike price. Remember - there is significant upside potential as well. If ABC stock moves up to $55 per share, your $2 option to purchase ABC at $50 will be worth at least $5 per share. That’s a return of 150% or more! This compares very favorably with the 17% return, had you purchased the stock outright (an $8 gain on $47 price). Additionally, your initial cash investment was much less than having purchased full shares of the stock.

Now, since the normal use of options can be beneficial but can carry high risk, they may not be suitable for many investors. But this does not mean that options can’t be used creatively to actually add safety to your investments while improving returns. Here’s another strategy.

Instead of buying the call option, you can sell the call option. Let’s say that you currently own ABC stock, which is trading at $47 per share. You can sell the option for it to be purchased from you at a $50 strike price within the next month for $2 per share. This means that you get the $2, which reduces your cost or exposure on the stock from $47 to $45. If the stock stays below $50 at the expiration of the option, you keep the stock as well as the $2 per share. You can repeat this process again and again, which can greatly reduce your cost basis over time. Now, if the stock moves above $50 at the end of the expiration, it will be “called” away from you – you automatically sell it for $50 even if the actual trading price is higher. Should this happen, your upside gains are limited, but you still gained a tidy profit – along with some insurance if the stock price had not moved higher or had gone lower. This strategy for using options to increase safety is called “Selling Covered Calls”. Covered indicates that you own the underlying stock.

There are also ways investors can use options when they feel a stock price is heading lower.

Let’s say that an investor feels that ABC Company stock is going to move lower from its current price of $47. A strategy that can be used is purchasing “put” options. The investor can buy a “put” option at a strike price of $45 for, let’s say, $2, which will expire within the next month. If the stock drops to $40 before the option expires, the put option at $45 will be worth at least $5…a nice gain. But if the stock does not move down to the $45 strike, the option will expire worthless…somewhat risky business.

But just like the creative use of call options described above can improve safety and decrease risk, “put” options can be used similarly. Let’s say you are looking to buy ABC stock at $47, but the stock has made a sharp rise of late and may be subject to a pull back. You think it is a sound decision to own the stock but you are leery that the price may drop shortly after you jump in. You can use “put” options to help you buy the stock more safely. Are you ready to go “naked”? Instead of buying puts, you can sell them…this is called “selling naked puts”. As opposed to “covered” meaning that you own the stock, “naked” simply means you do not own the stock, and are “uncovered”. In this case, you could sell ABC puts with a strike price of $45 that expire in the next month for, let’s say, $2 each. If the stock moves higher, never dropping to the $45 strike price, you will not own the stock but still enjoy a $2 per share profit from the option premium you had sold. If the stock does decline, let’s say to $40, which is below the $45 strike price, you will buy the stock at $45 but you keep the $2 option premium, which makes the actual cost $43 per share. This is a nice discount to the $47 price that the stock was offered at and a great way to limit your downside risk.

Of course, you will need to be comfortable with how options work and the associated risks before utilizing these strategies. All stock brokerages have easy to read and understand information on options. Take the time to educate yourself, and decide if using stock options is right for you!

This coming week, most analysts and Traders will go cross-eyed, keeping one eye glued to news of geopolitical events and the other eye watching the economic reports due for the week. What’s on the docket? Wednesday and Thursday brings new and existing Home Sales data, both expected to be up from January. Thursday’s Initial Jobless Claims continues to be of interest, as the lack of job creation during the recovery remains a hot topic. Friday brings some interesting consumer related reports – personal income and spending, followed up by the revised University of Michigan Consumer Sentiment Report.

Remember, as a general rule, weaker than expected economic data would indicate the economy is not improving as quickly as expected, and could cause mortgage rates to improve. Positive data would indicate a strengthening economic climate, and could cause mortgage rates to gradually climb higher.

For the week of March 22 – March 27, 2004