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									                                   ®




Volume II, Issue One       October 2003




• Trading  Profiles:
    Feed Your Mind

•   Get a Technical Edge

•   Secrets of The Pros




                                Special
                                Report
                                                               TRADE UP.
                                                                                                                                           NOW’S THE TIME.
                                                                                                                                           IT’S YOUR MOVE.




                                                                                                                                                                    www.cbot.com/dow


“Dow JonesSM,” “The Dow®,” “Dow Jones Industrial AverageSM,” and “DJIASM” are service marks of Dow Jones & Company, Inc. and have been licensed for use for certain purposes by the Board of Trade of the City of Chicago, Inc. (CBOT®). The
CBOT futures and futures options contracts based on the Dow JonesSM Averages are not sponsored, endorsed, sold, or promoted by Dow JonesSM, and Dow JonesSM makes no representation regarding the advisability of trading in such products.
    Contents
Why everyone loves the                                                                                                                             Why Everyone Loves
                                                                                                                                                   the Mini-sized Dow                1
         Chicago Board of Trade’s mini-sized Dow                                                                                              SM
                                                                                                                                                   See what makes the mini-sized
                                                                                                                                                   Dow contract unique and how
                                                                                                                                                   you can profit.
                                                                            mini-sized Dow has all three,” says John Person,


N
              o matter what trading style or time frame
                                                                            a trading advisor and broker with Infinity
              they use or what their opinion is about
              price outlook, traders of the Chicago
                                                                            Brokerage.                                                             Trader Profiles                   4
Board of Trade (CBOT®) mini-sized DowSM agree                             • Bid/ask spreads are tight and are averaging                            Learn trading secrets and
                                                                            only a tick or two in the CBOT mini-sized Dow                          methods from some of the
that its features make it a great contract to trade. Of                                                                                            best mini-sized Dow traders.
                                                                            as volume has increased. “It’s become a very
course, the features start with all the advantages
                                                                            efficient market – great for the person outside the
offered by futures, an index and an electronically                          pit,” observes Jack Broz, an analyst and trader.
                                                                                                                                                   The New
traded market. Beyond that, however, there are some
unique attributes of the CBOT mini-sized Dow                              • Tick sizes are smaller, allowing more flexibility                      e-CBOT Platform                   5
                                                                            and precise positioning. The tick size in the                          Discover how the upcoming
contract that traders especially like:                                      CBOT mini-sized Dow is one point or $5. A                              CBOT technical upgrade gives
                                                                            10-point or $50 move in the CBOT mini-sized                            you the trading edge.
• Everyone knows the Dow. To many, in fact, the                             Dow has 10 places for stops or other orders.
  Dow Jones Industrial AverageSM, (Dow®), is the
  stock market, not only in the United States but
  also around the world. Dan Gramza, a noted con-
                                                                            Many other index contracts have fewer ticks in
                                                                            the same size dollar move. It’s similar to the
                                                                            situation in stocks, which traded in eighths and
                                                                                                                                                   Feed Your Mind              14
                                                                                                                                                   Leverage the CBOT website
  sultant and trading instructor, who has conducted                         sixteenths until switching to decimals a few                           to receive free trading tools
  trading seminars recently in South Africa,                                years ago. The CBOT mini-sized Dow is the                              and educational materials
  Australia and Europe, says, “I am amazed at how                           decimal contract that provides more choices.                           that help you effectively
  many people come up to me and ask about                                   “For a firm with a trading style like ours, that’s                     trade the mini-sized Dow.
  trading the Dow” he says. “Interest in indexes and                        a giant plus,” says David Graff at STAT Trading.
  the CBOT mini-sized Dow contract has increased
  dramatically.”

• The underlying index has only 30 stocks,
  enough to reflect a large share of the market but
  not so many that you can’t keep track of the
  stocks to get a sense of where the index is
                                                                            “      I am amazed at how many
                                                                                   people ask about trading
  heading, quips John Carter, president of Trade the
  Markets Inc. The Dow is especially useful for
  those who trade the basket of stocks against
  the index.
                                                                                   the Dow.
                                                                                   – Jack Broz        ”
                                                                          • Performance bonds (margins) are currently
• Volume and open interest have increased                                   about 20% smaller for the CBOT mini-sized
  significantly since trading in the CBOT mini-                             Dow than for other stock index futures – and, of
  sized Dow began in April 2002, providing the                              course, much smaller than for the full-size index
  liquidity that is able to handle all sizes of orders.                     contracts. “The more contracts I can squeeze into
  “A successful contract has to have commercial or                          my position, the more accurate my delta is going
  institutional traders, large professional traders                         to be,” notes Mark Melin, publisher of a market
  and individual speculators. I believe the CBOT                            commentary service.

                                                                                                                                                   This special issue has been
The information in this publication is taken from sources believed to be reliable. However, it is intended for purposes of information and         published by the
education only and is not guaranteed by the Chicago Board of Trade as to accuracy, completeness, nor any trading result, and does not constitute   Chicago Board of Trade
trading advice or constitute a solicitation of the purchase or sale of any futures or options. The Rules and Regulations of the Chicago Board of   Business Development
Trade should be consulted as the authoritative source on all current contract specifications and regulations.
                                                                                                                                                   141 W. Jackson Blvd.
“Dow JonesSM,” “The Dow®,” “Dow Jones Industrial AverageSM,” “DJIASM” are service marks of Dow Jones & Company, Inc. and have been                 Chicago, IL 60604
licensed for use for certain purposes by the Board of Trade of the City of Chicago, Inc. (CBOT®). The CBOT futures and futures options contracts   312-341-7955
based on the Dow JonesSM Averages are not sponsored, endorsed, sold, or promoted by Dow JonesSM, and Dow JonesSM makes no representation           Fax: 312-341-3027
regarding the advisability of trading in such contracts. DIAMONDS® is a registered trademark of Dow, Jones & Company, Inc. and has been            E-mail: dowinformation@cbot.com
licensed for certain purposes by PDR Services and the American Stock Exchange LLC. The trust is not sponsored, endorsed, sold or promoted by       www.cbot.com/dow
Dow Jones and Dow Jones makes no representation regarding the advisability of investing in the trust.
EM51-3A 10.03.20000 03-03539
    Liquidity in Action

                                                   Why the CBOT                                    has expanded the universe of traders competing


S
       ince its initial launch in April 2002 by
                                                                                                   on a level playing field. The potential for
       the CBOT, the CBOT mini-sized
       Dow futures contract has enjoyed            mini-sized Dow?                                 future growth is based on the significant
                                                                                                   capacity for increasing this distribution and
tremendous growth in trading volume and                                                            access to the market.
popularity among a wide variety of traders.        Why are CBOT mini-sized Dow futures so              CBOT mini-sized Dow futures now trade
                                                   popular, and why are so many people excited     over 50,000 contracts per day, representing a
The CBOT offers two contracts based on the
                                                   about the trading potential of this product?    dollar volume in excess of $2.5 billion traded
Dow Jones Industrial Average: the CBOT             The answer is twofold: The Dow and              every day. This compares to an average daily
mini-sized Dow with a $5 multiplier and the        electronic trading.                             dollar volume of about $700 million for the
CBOT DJIA futures (DJIA futures) which                 The Dow is by far the world’s most          DIAMOND® exchange traded fund (ETF).
                                                   followed stock index, and is the reference      As a broad based index futures contract, the
has a $10 multiplier and was originally                                                            CBOT mini-sized Dow enjoys both favorable
                                                   point for millions of traders and investors
launched in October 1997. The CBOT mini-           around the globe. The Dow is a price-weighted   margin and tax treatment. The current initial
sized Dow is one of the fastest growing            index of 30 of the top blue chip companies in   margin required to carry a position overnight
                                                   the U.S., representing nine economic sectors    is $2,700 for each futures contract, repre-
contracts in CBOT history, and many market
                                                   of the economy. The 30 Dow stocks are all       senting less than 6 percent of the underlying
participants are confident that it will continue   U.S. based companies, yet they all have         value of the contract (2700/($5 * 9400)=5.75%).
to grow significantly over time. In a relatively   significant global operations and revenues.     This compares to a 50 percent margin
brief 16 month time span, CBOT mini-sized          These firms are truly multinational, which      requirement for equity securities such as
                                                   explains the Dow’s global popularity.           exchange traded funds and a 20 percent
Dow futures have reached an average daily
                                                       Electronic trading of futures contracts     margin for futures on ETFs such as
volume of over 50,000 contracts per day,           has taken the industry by storm. The speed      DIAMOND futures.
affirming the extent of their popularity among     and accuracy of electronic trading, combined
market participants.                               with the tremendous growth of the Internet,




     The Dow is by far
     the world’s most
                                                                                   CBOT mini-sized Dow — Volume
     followed stock index.                          80,000


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                                                      The CBOT mini-sized Dow is one of the fastest growing contracts in CBOT history.




2      OCTOBER 2003
    Additionally, as a broad based stock
index future, CBOT mini-sized Dow futures
qualify for status as section 1256 contracts
(futures and futures options) for tax purposes.
                                                   Who is trading CBOT
They are therefore taxed at the blended 60/40
capital gains tax rate (60 percent long term       mini-sized Dow futures?
and 40 percent short term capital gains);
regardless of how long a position is held, which           here is a broad mix of traders and institutions
is lower than the ordinary income tax rate.



    CBOT mini-sized Dow
                                                   T       actively trading CBOT mini-sized Dow futures
                                                           every day. The list includes individual traders,
                                                   professional trading firms, large securities firms, options
                                                   traders, hedge funds and commodity trading advisors
    futures are very liquid                        (CTAs) as well as members of various exchanges.
                                                     Traders are using CBOT mini-sized Dow futures for
    and normally have a                            multiple purposes:
    bid-ask spread of just 1                       • CBOT mini-sized Dow futures are an attractive trading
                                                     vehicle, given the day trading opportunities represented
    or 2 ticks (ie. $5 or $10).
                                                     by the average daily dollar range. (See chart below).
                                                   • Managing their risk exposures to the stock market. CBOT
    CBOT mini-sized Dow futures are traded
virtually around the clock. Traders have             mini-sized Dow futures are the quickest, most effective
access to the futures markets to manage their        and efficient way to alter your risk exposure using a
risk even when the underlying stock market           derivative of the Dow.
is not open, as is the case with the release of
many significant economic statistics such as       • Engaging in arbitrage between futures, the underlying
CPI, PPI, Unemployment, GDP and durable              basket of stocks, options and exchange traded
goods to name a few (which are released at           funds (ETFs).
7:30 a.m. Central U.S. time). This can be an
opportunity to traders who wish to quickly         • Offsetting the risk of option portfolios and positions.
take advantage of market reactions to such           CBOT mini-sized Dow futures are the vehicle of choice
events before the stock market opens, and to         for professional options market makers who need to
earnings releases after the stock market closes.     hedge positions in option products based on the Dow.
    CBOT mini-sized Dow futures are very
liquid and normally have a bid-ask spread of
just 1 or 2 ticks (ie. $5 or $10), which based
on a percentage of the underlying contract                              — Dow          — SP500            — ND100
price, represents a spread as tight or tighter         $3,500

than most other stock index contracts.                 $3,000
    A quick visit to the CBOT Dow website
                                                       $2,500
www.cbot.com/dow and the free live order
book showing streaming quotes and market               $2,000
depth is a great way to see liquidity
                                                       $1,500
in action.
                                                       $1,000

                                                        $500

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                                                                                                                             OCTOBER 2003   3
    Tr a d e r P r o f i l e s
Smooth trading                                                                CBOT mini-sized Dow

W
            hen you are trading 5,000 to 7,000 CBOT mini-sized
            Dow contracts a day, you want a contract that has plenty
            of liquidity and can take some size.
The CBOT mini-sized Dow contract measures up well on both                      Timeline of significant events for the
counts, according to Patrick Buck and Izzy Aguilera, principals                CBOT mini-sized Dow futures contract.
of Matrix Trading, a proprietary trading firm that is very active in
the contract.                                                                       April    CBOT mini-sized Dow futures launched
                                                                                             by the CBOT. The contract is 100 percent
                                                                                      2002   electronically traded.

                                                                                     July    Dow plunges from 9300 to 7500 as
                                                                                             accounting scandals take their toll.
                                                                                      2002   Average daily volume increases to
                                                                                             8,200 contracts per day.

                                                                                October      Increased market volatility as Dow
                                                                                             briefly falls below 7300 before climbing
                                                                                      2002   back to 8400 by month end. Trading
                                                                                             activity increases, with average daily
                                                                                             volume in CBOT mini-sized Dow futures
“We have had no problem getting orders of 100 or 200 contracts off                           rising to over 20,000 contracts per day.
as volume and liquidity have grown,” Buck reports.
    Matrix has 27 traders, each focusing on a trading style that they           January      Average daily volume increases to
                                                                                             25,000 contracts, as Dow falls from
know best. Some are scalpers, watching the action of leaders and                      2003   8600 to 8000.
followers and getting in and out of 5-20 contracts at a time quickly.
Some are arbitraging the Dow against the S&P 500 or Nasdaq-100
indexes, keeping ratios in line. Some are momentum traders, using
                                                                                  March      Markets remain volatile as military
                                                                                             operations begin in Gulf War 2. Dow
different methods.                                                                    2003   again spikes below 7500 and hits its
                                                                                             intraday low for the year at 7416 on
                                                                                             March 12th, only to rally above 8500 by
                                                                                             March 21st. Average daily volume in

“     We have had no problem getting
      orders of 100 or 200 contracts off
                                                                                             CBOT mini-sized Dow futures climbs
                                                                                             above 35,000 contracts per day
                                                                                             for March.

      as volume and liquidity have grown.
      – Patrick Buck                                                  ”              July
                                                                                      2003
                                                                                             Dow trading comfortably above 9000
                                                                                             as earnings season passes without
                                                                                             much fanfare. Volume continues to
                                                                                             increase in CBOT mini-sized Dow
                                                                                             futures, with average daily volume rising
    They all keep a close eye on their computer screens and charts                           above 49,000 contracts per day for July.
produced by their quote system, watching price action at key price
                                                                                             Dow begins the month by climbing to
levels, trendlines and other basic technical analysis factors. “The Dow       September      new 14-month highs above 9500.
is very good at reacting to Fibonacci levels,” they note.                             2003   Trading activity increases again, with
    Overall, the firm trades a total of 20,000-30,000 futures contracts
                                                                                             average daily volume in CBOT mini-
a day. But whatever the style of trading, the goal is the same: Keep                         sized Dow futures rising to over 50,000
the trading basic and minimize risk.                                                         contracts per day.
    Buck’s advice sounds like a trading primer. “Cut your losers fast.
Don’t let them run.” he emphasizes. “You have to have that discipline.                       Beginning November 24, 2003 CBOT
Then you can run with your winners.”
                                                                              November       mini-sized Dow futures will be trading
    Buck says the CBOT mini-sized Dow is also “a great product for                    2003   on the new e-cbot® electronic platform,
smaller traders.” There’s enough “wiggle room” in price moves to be                          powered by LIFFE CONNECT®. Also on
attractive to active traders, and “it’s a great place to learn how to build                  this day, CBOT mini-sized Dow futures
up size” because you can keep a tight grip on risk.                                          will begin clearing via the new
                                                                                             CME/CBOT Common Clearing Link.



4      OCTOBER 2003
Quick as a wink                                     ETFs, requiring a high frequency of trades.
                                                    “I may trade every few seconds or make 10
                                                                                                     estimates that 90% of the firm’s business is
                                                                                                     done electronically.
                                                    trades in a minute,” says Graff, who has been        He believes that options on the CBOT
Unlike many active traders, no one at STAT          doing index arbitrage since 1993 and has         mini-sized Dow futures contract, scheduled
Trading sits and watches a chart.                   traded at almost every Chicago exchange.         for launch in early 2004, will become a very
    “We are momentum traders,” says David               The more volatile the market and the         popular contract because they will be a
Graff, principal and head trader at the firm.       more stocks and futures get out of line, the     pure electronic index option that the public
Instead of watching a chart and seeing a visual     better Graff likes it, noting that much of       will love.
trendline, STAT’s proprietary traders use a         the trading is event-driven. But he has to
computer that may detect an unseen trendline        move very quickly to capture deviations
among many kinds of inputs it analyzes to           from normal.
make rapid-fire calculations comparing an
index like the Dow Jones Industrial Average
                                                        “We measure our trading results in
                                                    milliseconds,” Graff says. “If we are 50
                                                                                                     “    We measure our trading
with its basket of stocks and other indexes.
The goal is to discover slight deviations in
relationships of the basket to futures.
    “If certain sets of events occur, take
appropriate action, if not, stay out or get out,”
                                                    milliseconds slow on a trade, we would be
                                                    very upset.”
                                                        Since STAT became an active participant
                                                    in the CBOT mini-sized Dow, Graff says the
                                                    bid/ask spread has narrowed considerably to
                                                                                                          results in milliseconds.
                                                                                                          – David Graff                           ”
Graff explains. “Algorithms tell the computer       about 1 tick. In addition to the tight bid/ask
what to do. It’s strictly rules-based trading.”     spread, Graff likes the CBOT mini-sized               For more information, and to
    The result is that arbitrage firms such as      Dow contract because it’s easy to watch the          listen to a radio interview, visit
STAT maintain an orderly marketplace and            small basket of stocks to get insights on
                                                                                                                www.cbot.com/dow
keep futures prices closely in line with what       trading patterns and momentum. He also
they should be relative to stocks, options and      likes the anonymity of electronic trading and          and see “Online Seminars”.




                                                                                      ®
      Looking forward: The new e-cbot platform
                                                                               ®
      powered by LIFFE CONNECT .
                                                                            • Option strategy functionality – The new e-cbot® platform will


     E
                arlier this year, the CBOT announced that it will
                                                                              recognize 32 option spread strategies. Traders can enter orders
                transition to a new e-cbot electronic trading platform
                                                                              to execute a specific option spread, for example a straddle
                in November 2003. Reliable, scalable, and secure, the         (buying both (or selling both) a call and put with the same
      e-cbot platform will allow the marketplace to operate with              strike price and same expiration month). This spread trade can
      greater ease and efficiency.                                            be executed just like a single trade, without the need to execute
                                                                              each leg of the spread separately.
      Great. Now, what will this mean for traders?
      A lot, and it’s all positive.                                         • Selected option spread strategies will include: Straddle,
                                                                              Strangle, Butterfly, Vertical Spreads, Calendar Spreads,
      • Real time quotes and trade data – The speed (and therefore            Backspreads, Ratio Write Spreads.
        accuracy) of quotes and data will be markedly improved over
        the current system. For many short-term traders, this will          • The CBOT is planning to launch a totally electronic options
        significantly improve the timeliness of information required          contract on the CBOT mini-sized Dow futures in early
        for short-term trading decisions.                                     2004, which will give traders a significantly increased array
                                                                              of opportunities.




                                                                                                                              OCTOBER 2003        5
    Tr a d e r P r o f i l e s
                              Much ado
                              about nothing
                              Nothing means something to John
                              Carter, president of Trade the
                              Markets Inc. “Nothing,” in this
                              case, means that void on a price
                              chart where no trading occurs –
                              a gap.
                                   “Gaps are like windows and, like all               So he begins his fade of the gap by selling
                              windows, at some point they are going to be        three CBOT mini-sized Dow contracts at the
                              closed,” Carter says. “The key is to be able       open, one-third of what he considers a “full


“    Gaps are like windows
     and, like all windows,
                              to predict accurately when the day’s gap
                              (window) is going to be filled (closed).”
                                   Not all gaps are the same, of course.
                              Some appear at momentous market reversal
                                                                                 position” or nine contracts in a $100,000
                                                                                 account. (If the gap had been less than 50
                                                                                 points, he would probably have started with
                                                                                 the full nine contracts right away.) He risks
     at some point they are   points and take days or even weeks to get          1.50 points to make 1 point – 87 points to
                              filled. “Much more common are gaps that are        make 58 points, in this case. Shorting three


                       ”
     going to be closed.
     – John Carter
                              news reactions or fishing expeditions,”
                              Carter says. “These are smaller in nature and
                              can be faded regularly.”
                                   The CBOT mini-sized Dow contract
                                                                                 contracts at 9233, he puts a stop 87 points
                                                                                 away at 9320 and has a target 58 points away
                                                                                 at 9175, the bottom of the gap zone.
                                                                                      When the economic report comes out and
                              provides some good examples because, as a          the market moves higher, Carter sells another
                              reflection of trader psychology, it can jump       three contracts on the reaction. He adds the
                              quickly overnight on some new information.         last three contracts when the market slips
                              Carter uses a CBOT mini-sized Dow chart            back below the open at 9233 as it begins to
                              covering the regular session trading hours of      fill the gap. So, in less than an hour, he has
                              the New York Stock Exchange (8:30 a.m. to          his full position with a fixed stop and a fixed
                              3:00 p.m., Central U.S. time). Therefore,          target. He does not trail the stop or move his
                              opening gaps may show up often as futures          target but lets his plan make the decision.
                              prices react to international news during the           When the market sells off around 1:15
                              overnight trading session.                         p.m., it hits his target for a gain of about
                                   What is as important as analyzing the gap     60 points. At $5 per point, that’s $300 per
                              itself is analyzing the market conditions that     contract and for nine contracts, $2,700.
                              produced the gap. Carter uses a checklist of            “If my stop had been hit, I would have
                              20 key factors to help him determine the           lost approximately $435 per contract or a
                              odds that an opening gap will be filled during     total of $3,915,” Carter says. “I am comfort-
                              the same day.                                      able with that because I know that 80% of the
                                   A 5-minute CBOT mini-sized Dow chart          time this trade will work out in my favor.
                              from July 24, 2003, illustrates Carter’s gap       Had I used tighter stops or trailing stops, this
                              trading technique (see chart). The Dow             would have turned into a losing trade.”
                              gapped 58 points on the open, the difference            Sometimes small gaps are filled within
                              between the regular session close of 9175 on       minutes and sometimes a gap is not filled all
                              July        23      and       the        regular   day and Carter has to carry a full position
                              session open at 8:30 a.m. on July 24th of          over to another day. In either case, he is able
                              9233. Carter’s checklist leads him to conclude     to stick with his plan because he has
                              that there is an 80% chance that the gap will      confidence in his analysis that the gap
                              be filled that day.                                will be filled.
                                   “Because of economic data coming out at
                              9 a.m. (Central time), I also know it most
                              likely will not happen in the first half hour of         For more information, visit
                              trading,” Carter says.                                      www.cbot.com/dow
                                                                                      and see “Online Seminars”.



6    OCTOBER 2003
CME/CBOT Common Clearing Link
                                                normally have a total initial margin require-


T
           o complement its new, state of
                                                ment of approximately $6200 ($2700 for
           the art trading technology, the
                                                CBOT mini-sized Dow and $3500 for e-mini
           CBOT has entered into a landmark     S&P). Under the new Common Clearing
agreement with the Chicago Mercantile           Link, the initial margin requirement for an
Exchange (CME) to form a Common                 overnight position in this spread will be
                                                approximately $1250, which represents
Clearing Link (CCL). The CME/CBOT
                                                a reduction in spread margins of about 80
Common Clearing Link will provide               percent. Note that this is an estimate using
significant operational efficiencies that       recent correlations between the Dow and the
customers      and   member    firms    have    S&P500 of approximately 95%.
                                                    Viewing the chart, you can see that since
requested, including operational efficiencies   May 2001, the 90 day rolling correlation of
for Futures Commission Merchants (FCMs)         percentage price changes in this spread has
and potentially significant reductions in       stayed above 95 percent. Yet as recently as
                                                the summer of 2000, the correlation had been
spread margin requirements. Initial reviews
                                                as low as 76 percent.
show risk offsets for spread margins of at          For intraday spread trading, traders can
least 70 percent for equity index futures.      expect similar reductions in margin require-
For example:                                    ments. For example, if the intraday (day
                                                trading) margin for the CBOT mini-sized
The Mini SPUD                                   Dow vs. e-mini S&P spread is currently
There are many traders who are active in the    $3100, the new reduced level under the CCL
SPUD spread (the acronym stands for S&P         would be approximately $625. Note:
Under Dow).                                     Intraday margins are not set by the exchange
   An overnight spread trade composed of        but rather by the FCM. This example
Long 1 CBOT mini-sized Dow futures and          assumes a rate of 50 percent of initial
Short 1 CME e-mini S&P futures would            margins, which is not uncommon.




                  Dow vs S&P500: 90 Day Correlation of Percentage Price Changes

   100%



     95%



     90%



     85%



     80%



     75%
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             /00

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                                                                                                OCTOBER 2003   7
    Tr a d e r P r o f i l e s
                                           Consistency pays
                                           Most traders thrive on price change and               For example, Melin identified the range


“
                                           volatility. Not Mark Melin. In fact, he hates     for the Dow as 9250 to 9600 in August. He
     I generally short sell                volatility. He hates “news” and “events” and      sold September Dow calls with a strike price
     Dow options and hedge                 any other kind of “surprise” that can produce
                                           sudden, sharp moves in a market.
                                                                                             of 9700 and September Dow puts with a
                                                                                             strike price of 9200 in late August.
     against them using                        “I am a hedger,” explains Melin, an index     Depending on price movement within that
                                           trader for 20 years and publisher of a market     range, he bought or sold CBOT mini-sized
     Dow futures.
                       ”                   commentary using the Dow Trader method.           Dow futures. He typically trades futures
                                           “I generally short sell Dow options and           about once every three days and options
     – Mark Melin                          hedge against them using Dow futures.”            about every three weeks.
                                               As a result, he is more than satisfied            “I do not buy or sell futures just because
                                           when Dow prices stay within a range and the       I think the market will go up or down,” he
                                           options he has sold expire out of the money,      emphasizes. “I buy futures just to get a delta,
                                           capitalizing on time decay that allows him to     and I use the CBOT mini-sized Dow because
                                           keep all of the premium he has collected.         it can give me a more accurate delta.”
                                               Melin first determines what that range            Anything that might drive Dow prices
                                           will be, then sells calls at a level near the     outside of his range, therefore, would upset
                                           upper end of the range and sells puts at a        his whole trading plan. That’s why he hates
                                           level near the lower end of the range. With       news-driven trading, although he admits
                                           the option positions in place, he buys or sells   that news sometimes does have a value in
                                           Dow futures, primarily the CBOT mini-sized        triggering a trend.
                                           Dow contract, depending on where prices are           “My system is consistent and conserva-
                                           within that range, using 50-day exponential       tive,” Melin says, adding he has to be patient.
                                           moving averages, Bollinger bands and other        “I’m going for singles. I like to be the ‘house’.”
                                           technical indicators in his analysis. He
                                           watches prices during the day but does not
                                           trade intraday, believing that the closing              For more information, visit
                                           price is much more indicative of the market’s           www.cbot.com/dow and see
                                           true status.                                           “Online Trading Strategies”.



    Options on DJIA Futures and
    CBOT mini-sized Dow Futures
    Why trade Options on Dow futures?
    As opposed to equity index options on the Dow (DJX)            • Options on DJIA futures are available electronically
    traded at the Chicago Board Options Exchange. There are          during the overnight trading session, and in open outcry
    several reasons why traders might prefer options on DJIA         pit trading from 7:20 am to 3:15 pm Central U.S. time.
    futures and CBOT mini-sized Dow futures.                         Traders can therefore access the market before the U.S.
                                                                     stock market opens, and also before the release of many
    • Larger Contract Size – Options on DJIA futures are             economic statistics.
      10 times the contract size of the DJX options, allowing
      for efficiencies in trading expenses. Options on CBOT        • Options on CBOT mini-sized Dow futures will be
      mini-sized Dow futures (scheduled for launch in early          100 percent electronically traded on the new e-cbot
      2004) will be 5 times larger than DJX options.                 platform. The complete option functionality of the new
                                                                     e-cbot platform will be available for CBOT mini-sized
    • Options on DJIA futures enjoy the benefits of futures          Dow options, which will give traders a significant array
      style margining and tax treatment.                             of trading opportunities.



8     OCTOBER 2003
 How Arbitrage Keeps                                                                      Making a point
 Futures Prices in Line                                                                   When Jack Broz looks at a CBOT mini-sized
                                                                                          Dow chart, he’s looking for specific points.
                                                                                              “I like to go into trading with an idea
Two frequently asked questions by many traders who are new to futures are:
                                                                                          where prices might go and see how they react
     a) Given the price of the underlying cash index, where should the futures            at that level,” Broz says. “The CBOT mini-
        be trading? In other words, how do you determine fair value?                      sized Dow bid/ask spread has tightened
     b) What keeps index futures prices in line with the cash index?                      tremendously in the past year, and there are
                                                                                          many more traders trading it.”
                                                                                              Broz, a Chicago Board of Trade member,
What is Fair Value?                                                                       has traded the Dow in the pits and on the
The fair value of CBOT mini-sized Dow       FV = 9400.00*[1 + .011*(29/360)] -
                                            10.00 = 9398.33                               screen but now devotes most of his time to
futures and DJIA futures is the theoreti-
                                               So, the theoretical futures price          providing technical analysis support to
cal level of where the futures should be
                                            should be 9398.33 (futures minimum            traders. He uses hand-drawn and computer-
trading given the current level of the
                                            tick is 1 Dow point, so we would simply       generated charts from a number of different
cash DJIA index. The fair value is
                                            view FV as 9398).                             time frames looking for trendlines, previous
derived from a straightforward
                                               The CBOT website publishes the FV          price highs and lows, Fibonacci retrace-
formula, which also takes into account
                                            level every day before the markets open       ments, moving averages and other indicators
the short term interest rate (usually
                                            (www.cbot.com/dow).                           to identify support and resistance levels. He
Libor), the amount of time until futures
                                                                                          puts the most weight on retracements off the
expiration and the amount of dividends
                                            What keeps CBOT mini-sized                    longest term charts, and if levels from several
(expressed in Dow index points) remaining
                                            Dow futures in line with the                  time frames or indicators coincide, he views
until expiration.
                                            cash DJIA?                                    that price area as an especially strong target.
    Given that short term rates (normally
1 month Libor) do not fluctuate             Professional arbitrage firms and institu-
dramatically every day, and that the time   tions trade baskets composed of the 30



                                                                                          “                                           ”
                                            stocks in the DJIA against CBOT mini-
until expiration is known every day, the
factor which has the greatest impact on     sized Dow futures and DJIA futures.              I’m big on retracements.
                                            They also trade exchange traded funds
fair value on a day to day basis is the
                                            such as the DIAMONDS against
                                                                                             – Jack Broz
dividends to expiration. (See page 12,
How do you calculate dividends to           futures. In both these cases, the arbitrage
expiration?)                                will help keep markets in line during the
                                            vast majority of time. There may be               Although Broz believes that having an
    If interest rates are ABOVE dividend
                                            cases of extreme volatility where futures     opinion of market direction is vital for trading
yields, FV will be positive, ie. the
                                            and cash move “out of line” for a brief       today’s CBOT mini-sized Dow, he cautions
futures will be trading above the cash
                                            time (usually a matter of seconds) before     that trading skills are more important now
DJIA.
                                            being forced back to fair value.              than ever before. “More pit traders are holding
    If interest rates are BELOW dividend
                                               For example, if DJIA futures fair          computers now, and, as the market has gotten
yields, FV will be negative, ie. the
                                            value is –12.00, ie if cash DJIA is at        more efficient, we’re seeing more of the
futures will be trading below the cash
                                            9400, then DJIA futures should be at          big institutions coming into the market,”
DJIA (as has been the case for close to
                                            9388. If DJIA futures are instead trading     he points out.
a year).
                                            at 9380, about 8 points too cheap,
A quick example                             traders will buy the DJIA futures and
FV = C*[1 + r*(t/360)] – D                  sell baskets of the 30 Dow stocks. As               For more information, visit
Where,                                      more traders enter this spread, the                    www.cbot.com/dow
C = cash DJIA index                         futures will quickly get back to trading at        and see “Online Seminars”.
R = short term interest rate                –12.00 below the cash DJIA.
T = days to futures expiration                 Basically, for individual traders, the
D = Dividends to expiration, expressed      arbitrage game is normally out of reach
in Index points.                            given the costs and capital involved.
Given the following inputs –                However, individual traders do benefit
C = 9400.00                                 from having arbitrage firms, as the latter
R = 1.10 %                                  help keep markets in line, and also add
T = 29                                      liquidity to both the futures and cash
D = 10.00                                   markets.


                                                                                                                   OCTOBER 2003         9
     Tr a d e r P r o f i l e s
                                      Seeing the light                                 hanging man” is a bearish hammer at a top.)
                                                                                       Because these candles indicate a loss of
                                                                                       momentum, the context within which they
                                      One of the best ways to shed some light on       appear on a chart is important.
                                      what traders are thinking is a Japanese              The 15-minute September CBOT mini-
                                      candle chart, according to Dan Gramza, who       sized Dow chart shows a bearish harami
                                      has taught trading courses at more than 350      reversal pattern at 9:30 a.m. on Aug. 11,
                                      institutions and 20 exchanges in 30 countries    2003 (candle 1 on “Harami short sale” chart),
                                      and has experience with a wide array of          Gramza points out. “This pattern indicates
                                      trading approaches.                              buyers are losing momentum and a selling
                                          The key to candle charts is what happens     opportunity could occur at new lows of this
                                      to prices between the open and the close of a    15-minute period (9210),” he says. “At 10:45
                                      trading period.                                  a.m. a bullish hammer pattern occurs (candle
                                          “When the closing price occurs above the     2), indicating that sellers are now losing
                                      opening price, the candle body is white and      momentum and buyers are entering the market.”
                                      indicates buyers coming into the market,”            A trader who went short at 9210 on the
                                      says Gramza, president of Gramza                 harami signal and bought at 9142 on the
                                      Capital Management, a trader and hedge           hammer signal would have made 68 points or
                                      fund advisor as well as an educator. “If the     $340 per contract.


 “    When the closing
      price occurs above
                                      closing price occurs below the opening price,
                                      the body is black and indicates sellers
                                      coming into the market.”
                                          Gramza says candle chart strategies work
                                                                                           “Hammering down a bottom” shows
                                                                                       another candle trade example. A bullish ham-
                                                                                       mer appears on the 30-minute September
                                                                                       CBOT mini-sized Dow chart at 9:30 a.m. on
      the opening price,              well on the CBOT mini-sized Dow contract         July 29, 2003 (candle 1). “This indicates that
                                      where price action reflects trader psychology    sellers are now losing momentum and buyers
      the candle body is              during the time frame being analyzed.            are entering the market,” Gramza explains.
                                      Among a variety of candle reversal patterns      “A buying opportunity could occur at new
      white and indicates             are the “harami” and the “hammer,” both of       highs of this 30-minute period at the 9173
                                      which are based on candle bodies and not the     level. Three hours later a bearish harami
      buyers coming into              “shadows” or price activity outside the open     reversal pattern occurs (candle 2), indicating
      the market.
                      ”               and close.                                       that buyers are now losing momentum and
                                          Briefly, a harami is a small-bodied candle   sellers are entering the market.”
      – Dan Gramza                    occurring within the body range of the previ-        For a trader who bought at 9173, a sell
                                                                                       order could be executed at the low of the
                                      ous candle. The hammer is a bullish reversal
                                      pattern consisting of a small-bodied candle      harami candle at 9226, closing out the long
                                      with little or no upper shadow and a long        position with a profit of 54 points or $270
                                      lower shadow at least two times the length of    per contract.
                                      the body. It occurs at a bottom. (A “reverse



                  Harami short sale                                           Hammering down a bottom




10     OCTOBER 2003
Funge It!
CBOT mini-sized Dow futures are fungible with DJIA futures.

Traders have the choice of using the open outcry traded DJIA futures or the CBOT mini-sized Dow
futures. DJIA futures and CBOT mini-sized Dow futures are fungible. For example, if you are
long 1 DJIA future and short 2 CBOT mini-sized Dow futures in the same brokerage account, you
can contact your broker and have him offset the positions against each other, since you are already
effectively “flat”. The following illustration shows how this works:

Your brokerage statement reflects the above mentioned position of long 1 DJIA future and short
2 CBOT mini-sized Dow futures:

Trade Date      B/S              Contract             Price                  Open Trade Equity
8-26-03         +1               Sept03 DJIA          9200
                                               Settle 9215                   $150.00 credit
8-27-03         -2               Sept03 Mini Dow      9225
                                               Settle 9215                   $100.00 credit

Net Trade Equity (excluding any cash balance) is $250.00

After requesting the offset, your account will show as follows:

Trade Date      B/S              Contract                Price               Open Trade Equity
                                 ***Confirmation***
8-28-03         -1               Sept03 DJIA             9220
8-28-03         +2               Sept03 Mini Dow         9220
                                 ***Open Positions***
8-26-03         +1               Sept03 DJIA             9200
8-28-03         -1               Sept03 DJIA             9220

                                                                             $200.00 credit
8-27-03         -2               Sept03 Mini Dow         9225
8-28-03         +2               Sept03 Mini Dow         9220

                                                                             $50.00 credit

Net Trade Equity (excluding any cash balance) is $250.00




                                                                                                      OCTOBER 2003   11
     Tr a d e r P r o f i l e s
Analytical synergy
Like many technical analysts, John Person likes to use a combination
                                                                             How do you calculate
of analytical techniques to make a trading decision. Person, a trading
advisor and an affiliated broker with Infinity Brokerage Services,
                                                                             dividends to expiration?
trades the CBOT mini-sized Dow in all time frames, using pivot               Dividends to futures expiration are quoted in Dow index
points, cycles and candle analysis.                                          points. The actual dividend amounts in dollars and cents (as
    “Understanding the relationship between time and price is helpful,”      quoted in the newspapers) must be converted to Dow index
he says. A signal from one method coinciding with a signal from              points by dividing by the Dow Divisor. For example:
another can provide especially valuable price points.
    “Pivot point analysis produces target levels that act like a magnet,     On September 4, 2003 the following stocks were estimated to
attracting or repelling price action,” Person says. Although most            begin trading “ex-dividend” between September 4th and
technical indicators are lagging, based on prices that have already          September 18th (the last trading day for September 2003
occurred, pivot point analysis anticipates where prices can go and           CBOT mini-sized Dow futures and DJIA futures).
helps Person uncover potential support and resistance numbers and
turning points.                                                                                                Estimated Dividend
                                                                             Home Depot Inc.                            $.07
                                                                             Coca-Cola Co.                              $.22
                                                                             Altria Group Inc.                          $.68
                                                                             Hewlett-Packard Co.                        $.08
                                                                                Total                                   $1.05

                                                                             DJIA Divisor = .14249417

                                                                             DIV to Exp = $1.05 / .14249417 = 7.37 Dow Index Points
                                                                             for September 2003 futures as of September 4, 2003.
    “Pivot point analysis is a great ‘right side of the chart’ indicator,”
Person adds, noting that, while some traders limit this analysis to          Similarly, between September 4, 2003 and December 18,
daily data, he calculates pivot points on daily, weekly and monthly          2003 (the last trading day for December 2003 CBOT mini-
prices. “More often than not, this analysis gives me a reasonable            sized Dow futures and DJIA futures), the dividends expected
estimate of either the high, the low or both on a given trading day.”        were estimated at $9.61 (all 30 Dow stocks would have
    Although there are variations, here is the most common formula           dividends paid in this period):
that Person uses:
                                                                             DIV to Exp = $9.61 / .14249417 = 67.41 Dow Index Points
  Pivot point number (P) = High (H) + Low (L) + Close (C) / 3                for December 2003 futures as of September 4, 2003.
  Resistance 1 = (P X 2) – L
  Resistance 2 = P + H – L
  Support 1 = (P X 2) – H
  Support 2 = P – H + L                                                                        DJIA Dividend Yield
                                                                              4.50
    Person uses cycle analysis to help him understand the forces of           4.00
the market’s direction although it won’t give him pinpoint trade              3.50
timing. Among the cycles he has identified for longer-term trading in         3.00
the CBOT mini-sized Dow are the five-month cycle (roughly 100                 2.50
trading days, corresponding with a 100-day moving average) and a              2.00
11-week cycle, which translates into roughly 55 trading days or half          1.50
of a five-month cycle.                                                        1.00
                                                                              0.50
                                                                              0.00
                                                                              Ma 6
                                                                              Ma 7
                                                                              Ma 8
                                                                              Ma 9
                                                                              Ma 0
                                                                              Ma 1
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                                                                              Ma 0
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                                                                                r-8
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                                                                                r-0
                                                                              Ma




12       OCTOBER 2003
Where’s the value?                               Board of Trade in the early 1980’s, and is
                                                 co-author with Steidlmayer of the second
                                                 edition of Steidlmayer on Markets: Trading
The CBOT’s Market Profile® has been a            with Market Profile.
popular analysis tool used by traders since it        Most trading concepts have been around


                                                                                                    “
was introduced in 1984. It is a unique way of    for many years, but Steidlmayer’s creation of
analyzing market activity, combining price,      Market Profile was an innovation that gave
                                                                                                        Market Profile adds
time and volume. Market Profile is normally
available only through quote vendors at an
                                                 traders a totally new way to look at market
                                                 activity. It transcends all other technical and
                                                                                                        horizontal depth to

                                                                                                                   ”
                                                                                                        a bar chart.
extra charge; however, the CBOT will             fundamental means for looking at value for
now provide a free, live version for the         all types of markets, not just the CBOT mini-
CBOT mini-sized Dow futures on the CBOT          sized Dow contract, Hawkins says. It can               – Steve Hawkins
Dow website.                                     stand alone as a market analysis tool but can
    Market Profile identifies the value area     be enhanced by getting confirmation from
and puts perspective on the trade flow,          data on trading volume for each contract at
according to Steve Hawkins. “Market Profile      each price from the Liquidity Data Bank,
adds horizontal depth to a bar chart,”           another Chicago Board of Trade development.
he explains. “It shows where the market               “Market Profile gives off-floor traders an
is accepting prices and where it is              on-floor representation of what is happening
rejecting prices.”                               in the market,” he adds.
    Hawkins has worked since 1991 with                There is a wealth of information, including
J. Peter Steidlmayer, who developed the          a comprehensive study guide available on the
Market Profile concept with the Chicago          main CBOT website (www.cbot.com).




      CBOT Market Profile

      M
                arket Profile is an analysis support tool for
                traders. It is a graphical representation of
                price and time information, with prices
      displayed on the vertical axis and time on the
      horizontal axis. Letters are used to symbolize time
      brackets. Whenever a price trades during a given time
      bracket, the letter representing that bracket is
      displayed on the vertical line for that price. Traders
      can analyze the formations to determine how the
      trading day is developing.




                                                                                                                OCTOBER 2003   13
     Getting Started
CBOT mini-sized Dow Website:The Place to Start
                                                   risking any money? The CBOT offers a free        industry experts. These seminars allow


I
     n conjunction with the launch of the
                                                   electronic trading simulator that allows         viewers to listen and watch presentations by
     CBOT mini-sized Dow futures contract,
                                                   users to simulate trading against the live       market professionals and let participants
     the CBOT created a new website –              market, complete with daily profit and loss,     ask questions of these experts. New
www.cbot.com/dow. This site provides               position overview, and order status.             seminars are offered often and are archived
traders with all the educational and trading                                                        so they can be viewed at any time.
                                                  • Free futures tutorial – Learn the basics of
tools needed to get started trading the CBOT        futures trading through this interactive       • Trading Resources – Provides links to
mini-sized Dow including:                           online tutorial. Some of the topics covered      Daily Dow Analytic tools, Dow trading
                                                    include – What are futures? What are the         seminars, Trading Schools and Programs,
• Free real-time depth of market quotes             differences between futures and stocks?          Execution Platforms, and links to Dow
  (the “book”) and charts – The CBOT                What are futures on the Dow Jones                Brokers.
  delivers live streaming quotes, real-time         Industrial Average? How do I get started
  charts, and market depth, all free of charge.     trading futures?                               • Futures Fair Value – The fair value of the
                                                                                                     CBOT mini-sized Dow futures and the
    The live book displays the 10 best bids       • Trading Strategy Papers – The CBOT               CBOT DJIA futures relative to the cash
 and offers, constantly updating in real time       Dow website offers free trading strategy         DJIA is updated daily prior to the market
 – there is no need to click to refresh if you      papers covering subjects ranging from            opening.
 download the “streaming quotes”. Also, the         basic futures buying and selling to more
 book is detachable in a separate window, so        advanced strategies such as Dow arbitrage      • CBOT Market Profile – Provides free, live
 that a trader can be working on other              trading. The strategy papers include guest       CBOT Market Profile for CBOT mini-sized
 programs and still view the CBOT mini-             articles from professional traders covering      Dow futures.
 sized Dow book in a corner of their screen.        subjects such as technical analysis, system-   • CBOT Literature and Publications –
 This has proven to be extremely popular            atic trading strategies, how economic            Provides access to all CBOT publications
 among traders.                                     reports affect Dow futures and many other        and literature, covering all product lines.
   Also, real time high-low-close bar charts        topics. New strategies are constantly being
 are available in 1 minute increments up to         added to the website, check back often.        If you want to learn more about any of these
 hourly, as well as daily and weekly.                                                              or other strategies, please send an email with
                                                  • Online Interactive Seminars – Also
                                                                                                   your questions to dowinformation@cbot.com.
• Free electronic trading simulators – Do           offered through www.cbot.com/dow are
  you want test your trading ability without        free online interactive seminars with




       www.cbot.com/dow




                                                             Visit www.cbot.com/dow to attend free live trading seminars.


14       OCTOBER 2003
Receive free trading strategies and tips from the “Trading
Strategies” section of www.cbot.com/dow.




                            On the CBOT website you can
                            receive free live Dow quotes,
                                     charts and the book.




                                                             OCTOBER 2003   15
     Resources
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                                                                              Dow Jones Industrial Average Ranked by Sector
                                                                                                                                                                                                     52-Week
 Name                                                          Ticker                    Sector                                                                      Weight                          Dividend                            Frequency
 Alcoa                                                         AA                        Basic Materials                                                             2.05%                           0.60                                Quarterly
 DuPont                                                        DD                        Basic Materials                                                             3.14%                           1.40                                Quarterly
 International Paper                                           IP                        Basic Materials                                                             3.06%                           1.00                                Quarterly
 Disney                                                        DIS                       Consumer Cyclical                                                           1.58%                           0.21                                Annual
 Eastman Kodak                                                 EK                        Consumer Cyclical                                                           1.64%                           1.80                                Semi-Annual
 General Motors                                                GM                        Consumer Cyclical                                                           3.21%                           2.00                                Quarterly
 HomeDepot                                                     HD                        Consumer Cyclical                                                           2.50%                           0.25                                Quarterly
 McDonalds                                                     MCD                       Consumer Cyclical                                                           1.85%                           0.235                               Annual
 Altria                                                        MO                        Consumer Cyclical                                                           3.43%                           2.60                                Quarterly
 Coca-Cola                                                     KO                        Consumer Non-Cyclical                                                       3.37%                           0.86                                Quarterly
 Protor & Gamble                                               PG                        Consumer Non-Cyclical                                                       7.28%                           1.685                               Quarterly
 WalMart                                                       WMT                       Consumer Non-Cyclical                                                       4.38%                           0.33                                Quarterly
 ExxonMobil                                                    XOM                       Energy                                                                      2.87%                           0.96                                Quarterly
 Am Exp                                                        AXP                       Financials                                                                  3.53%                           0.34                                Quarterly
 Citigroup                                                     C                         Financials                                                                  5.40%                           0.93                                Quarterly
 JPM Chase                                                     JPM                       Financials                                                                  2.69%                           1.36                                Quarterly
 Johnson&Johnson                                               JNJ                       Health Care                                                                 3.88%                           0.89                                Quarterly
 Merck                                                         MRK                       Health Care                                                                 3.97%                           1.45                                Quarterly
 3M                                                            MMM                       Industrials                                                                 5.42%                           2.60                                Quarterly
 Boeing                                                        BA                        Industrials                                                                 2.69%                           0.68                                Quarterly
 Caterpillar                                                   CAT                       Industrials                                                                 5.40%                           1.40                                Quarterly
 General Electric                                              GE                        Industrials                                                                 2.34%                           0.76                                Quarterly
 Honeywell                                                     HON                       Industrials                                                                 2.07%                           0.75                                Quarterly
 United Technologies                                           UTX                       Industrials                                                                 6.06%                           1.03                                Quarterly
 HewlettPackard                                                HPQ                       Technology                                                                  1.52%                           0.32                                Quarterly
 IBM                                                           IBM                       Technology                                                                  6.92%                           0.62                                Quarterly
 Intel                                                         INTC                      Technology                                                                  2.16%                           0.08                                Quarterly
 Microsoft                                                     MSFT                      Technology                                                                  2.18%                           0.08                                Annual
 AT&T                                                          T                         Telecom                                                                     1.69%                           0.80                                Quarterly
 SBC Communications                                            SBC                       Telecom                                                                     1.74%                           1.255                               Quarterly

 Stock weights and dividends calculated on a price-weighted basis on September 30, 2003.

16            OCTOBER 2003

								
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