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To: xcr600 who wrote (449)	4/24/1999 7:32:00 AM
From: Ray Dopkins	Respond to of 737

Turning up inefficiencies in a crazy market Barron's April 26, 1999 'Net Patterns Turning up inefficiencies in a crazy market By Michael Santoli It's become axiomatic that Internet stocks and the investors who chase them are operating outside the market rules as rendered by traditional analysis. But now, not much more than a year into the foaming-at-the-mouth phase of the 'Net-stock craze, some patterns are discernible. Trading opportunities of use to option players are the result. Leon Gross and his derivatives strategy team at Salomon Smith Barney believe they've come upon a potentially profitable abnormality in the behavior of the stocks and options of companies that move to sell or spin off a piece of their Internet business, a maneuver fast gaining favor among companies that see unmined gold within certain subsidiaries. It seems that when a company announces plans for an initial offering or spinoff of part of a 'Net business, investors bid up its shares aggressively and pile into the options, driving the implied volatility levels of those options way up. But once the deal is done, all attention turns to the new, pure Internet stock, the parent company's stock tends to sell off, and the implied volatility -- the key component in an option's price -- collapses. Gross looked at four recent such deals, all of which followed the above script. He's now counseling clients to look toward future deals like this -- buying call options on the parent when the IPO plans gear up and holding them until the deal closes, thus benefiting from both the expected rise in the share price and the fattening of the quoted option prices. Then at or near the IPO date, the calls should be sold and perhaps additional calls shorted to reap profits on the likely drop in both stock and volatility. The most immediate opportunity to deploy this strategy is presented by Barnes & Noble, which is slated to sell a piece of its online bookseller, probably in May. Farther down the road, traders will have the chance to play Compaq and Donaldson Lufkin & Jenrette, which are both planning similar moves with their Internet businesses. Gross says traders should wait until papers are filed with regulators for each deal before setting up the call position. Jim Herrell, who runs Point Break Trading Group in Santa Monica, California, has been mining another perceived inefficiency in 'Net options: their engorged implied volatilities. He says it appears that because the stocks are so jumpy and illiquid, they carry outsize premiums that he likes to take in by selling options and using the cash as either a cushion or a potent fuel for buying or shorting into momentum moves in the stocks. Herrell notes that this short-term tactic is available because the Wall Street dealers who'd normally make a deep market in these options and bring the premiums down have raised the white flag, unwilling to shoulder the risk of playing for potential profits that in the grand scheme of things aren't that big for a huge firm. Smaller players like Herrell figure they're taking money the big guys are leaving on the table. He says he waits for the big upside or downside crescendos that the sector produces regularly, and trades across a basket of volatile names to avoid the kind of off-the-charts moves in an individual stock that were described here last week. In the end, the abandonment of merger talks between Nasdaq-Amex and the Philadelphia Stock Exchange was a real surprise only to those who truly believed that Brooke Shields and Andre Agassi had a "til-death-do-we-part" marriage. Local politics in Philly and deteriorating economic logic foreshadowed by the coming of electronic options trading finally did the deal in. What the parting really shows is that, with less than a year to go until the all-electronic International Securities Exchange goes live, the exchanges have recognized that their markets have to become better and more efficient. Nothing like a highly touted young rookie in camp to motivate the veterans to get in better shape. In this case, it probably means a net gain to option investors everywhere, as exchanges vie to lower costs and maximize volume. Return to top of page \| Format for printing Copyright © 1999 Dow Jones & Company, Inc. All Rights Reserved.