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Equity Derivatives Strategy - A Stock Picker's Market?

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Actionable trade ideas for stock market investors and traders seeking alpha by overlaying their portfolios with options, other derivatives, ETFs, and disciplined and applied Game Theory for hedge fund …

Actionable trade ideas for stock market investors and traders seeking alpha by overlaying their portfolios with options, other derivatives, ETFs, and disciplined and applied Game Theory for hedge fund managers and other active fund managers worldwide. Ryan Renicker, CFA

Published in: Economy & Finance, Business

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  • 1. EQUITY PRODUCT MANAGEMENTJuly 07, 2005 North America Product Management GroupTechnology Overview Technology OverviewIndustry Overview Michael DArcangelo 1.212.526.6973Technology Research Monitor mdarcang@lehman.comSector View:New: 0-Not RatedOld: 0-Not RatedInvestment conclusion! Highlighted: Derivatives Strategy, Asian Semis**PLEASE REFER TO FULL COMPANY NOTE(S) on http://www.lehmanlive.com **Lehman Technology Research HighlightsEquity Derivatives Strategy: Technology: A Stock-Pickers Market? – Ryan RenickerDuring the past few months, short-dated implied correlation levels on both the Semiconductor HOLDR Trust (SMH) and theNasdaq-100 (QQQQ) have continued to decline, and currently stand at their lowest levels in over 3 years. In our opinion, thisindicates that the options market is pricing in a "stock-pickers market" for Technology stocks during the upcoming 2nd quarterearnings season. That is, we believe option market participants expect Tech stocks’ price movements to be driven primarily byidiosyncratic - as opposed to systematic - events, causing the stocks to trade relatively independent of one another. Giventhis collapse in correlation expectations, we believe it is an opportune time for investors to hedge Tech positionsduring the 2nd quarter earnings season by purchasing cheap put protection on the SMH or QQQQ (August expiry).Alternatively, investors wishing to obtain long exposure to the Tech sector heading into Q2 earnings should considerpurchasing calls on the SMH or QQQQ (August expiry). An additional factor pointing to the relative cheapness of optionson the SMH and the QQQQ is that both the SMH - S&P500 and the QQQQ - S&P500 implied volatility spreads areapproaching multi-year lows.Highlights From AsiaSemiconductors (Sector Neutral) Continuing Growth in 3Q – John HsuWe believe the 2H05 sell-through could be the catalyst for share price performance in 2H05. Since 3Q05 fundamentals aresolid, we maintain 1-OW for SPIL (2325.TW, NT$31.50), KYEC (2449.TW, NT$29.15), and PPT (2446.TW, NT$34.95), butexpect the near-term share price momentum to slow due to sell-through uncertainties in 2H05. We expect that SATS industryrevenue will grow by 3%-15% m/m in June. Current order visibility is eight weeks, up from four, and 3Q05 utilizationcould reach 80% or more due to limited capacity expansion 1H05 and inventory restocking. Laggards may outperformdue to their relatively low base in 2Q05. IC substrate producers will outperform IC packagers due to the ongoing substrateshortage and a price hike in June. We estimate that PPT could post a record revenue in July. The 2H05 sell-through could bethe catalyst determining the fundamental outlook for inventory levels in 3Q05 and 4Q05. We expect to get further signals onthe 2H05 sell-through in early or mid-August.Lehman Brothers does and seeks to do business with companies covered in its research reports. As a result, investorsshould be aware that the Firm may have a conflict of interest that could affect the objectivity of this report.Customers of Lehman Brothers in the United States can receive independent, third-party research on the company orcompanies covered in this report, at no cost to them, where such research is available. Customers can access thisindependent research at www.lehmanlive.com or can call 1-800-2-LEHMAN to request a copy of this research.Investors should consider this report as only a single factor in making their investment decisions. PLEASE SEE ANALYST(S) CERTIFICATION(S) ON PAGE 2 AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 3 1
  • 2. EQUITY RESEARCHToday’s EventsAccenture (ACN) Q3 Earnings Release, 4:30 PM EDT Conference Call, 888.276.0007: We are looking for revs/EPS of$4.16b/$0.40 vs. $4.14b/$0.43 consensus. For Q4, we are at $3.87b/$0.36 vs. $3.9b/$0.35 consensus. For 2006, we are at$17.35b/$1.58 vs. $17.2b/$1.58 consensus.ECI Telecom (ECIL) Lehman Hosted Management Meetings in New York with CEO Shlomo DorratElectroglas (EGLS) Transitional-Period Financial Results Conference Call, 5 PM EDT, 719-457-2734, 5536504Microsoft (MSFT) Worldwide Partner Conference in Minneapolis, 7/7-7/8:http://www.microsoft.com/partner/events/wwpartnerconference/TSM (TSM) Monthly Sales Release (June) (BMO)UMC (UMC) Monthly Sales Release (June) (BMO)Economics: Initial Jobless Claims (2-Jul), Lehman est. is 315k. Continuing Claims (25-June), Lehman est. is 2.525m.Analyst Certification:Each research publication excerpted herein was certified under Reg AC by the analyst primarily responsible for such report as follows: Ihereby certify that: 1) the views expressed in this research report accurately reflect my personal views about any or all of the subjectsecurities referred to in this publication and; 2) no part of my compensation was , is or will be directly or indirectly related to the specificrecommendations or views expressed in this report.Other Team Members:Melissa Chang 1.212.526.9117 melchang@lehman.com 2
  • 3. EQUITY RESEARCHImportant Disclosures Rating and Price Target Chart: ACN ACCENTURE LTD As of 14-Jun-2005 Currency = USD 34.00 32.00 30.00 28.00 26.00 24.00 22.00 20.00 18.00 16.00 14.00 12.00 10.00 8.00 6.00 4.00 2.00 0.00 6-02 9-02 12-02 3-03 6-03 9-03 12-03 3-04 6-04 9-04 12-04 3-05 6-05 Closing Price Price Target Recommendation Change Drop Coverage Source: FactSet Date Closing Price Rating Price Target Date Closing Price Rating Price Target 17-Jun-04 26.79 32.00 03-Feb-03 16.30 Dropped 13-Jan-04 22.66 28.00 10-Jan-03 16.92 21.00 15-Sep-03 23.06 26.00 23-Dec-02 17.20 19.00 16-Jul-03 20.35 24.00 11-Oct-02 14.33 17.00 30-May-03 17.52 20.00 05-Aug-02 15.28 2-Equal weight 30-May-03 17.52 1-Overweight 15-Jul-02 14.45 20.00 03-Feb-03 16.30 0.00 11-Jul-02 15.55 22.00 Rating and Price Target Chart: ECIL ECI TELECOM LTD As of 14-Jun-2005 Currency = USD 14.00 12.00 10.00 8.00 6.00 4.00 2.00 0.00 6-02 9-02 12-02 3-03 6-03 9-03 12-03 3-04 6-04 9-04 12-04 3-05 6-05 Closing Price Price Target Recommendation Change Drop Coverage Source: FactSet 3
  • 4. EQUITY RESEARCHDate Closing Price Rating Price Target Date Closing Price Rating Price Target05-May-05 7.47 12.00 07-Nov-03 5.82 6.0008-Feb-05 7.87 11.25 14-Nov-02 1.85 5.0008-Feb-05 7.87 1-Overweight 13-Aug-02 2.19 6.0024-Nov-04 8.38 10.00 13-Aug-02 2.19 2-Equal weight10-Dec-03 6.34 7.50 05-Aug-02 2.50 1-Overweight Rating and Price Target Chart: EGLS ELECTROGLAS INC. As of 14-Jun-2005 Currency = USD 16.00 14.00 12.00 10.00 8.00 6.00 4.00 2.00 0.00 6-02 9-02 12-02 3-03 6-03 9-03 12-03 3-04 6-04 9-04 12-04 3-05 6-05 Closing Price Price Target Recommendation Change Drop Coverage Source: FactSetDate Closing Price Rating Price Target Date Closing Price Rating Price Target06-Jan-05 3.94 3.00 13-Sep-02 3.08 5.5031-Jan-03 1.23 1.00 05-Aug-02 3.38 3-Underweight18-Oct-02 1.21 0.50 19-Jul-02 5.75 7.0009-Oct-02 1.21 1.75 FOR EXPLANATION OF RATINGS REFER TO THE STOCK RATING KEYS LOCATED ON THE PAGE FOLLOWING THE LAST PRICE CHART Rating and Price Target Chart: MSFT MICROSOFT CORP As of 14-Jun-2005 Currency = USD 36.00 34.00 32.00 30.00 28.00 26.00 24.00 22.00 20.00 6-02 9-02 12-02 3-03 6-03 9-03 12-03 3-04 6-04 9-04 12-04 3-05 6-05 Closing Price Price Target Recommendation Change Drop Coverage Source: FactSet 4
  • 5. EQUITY RESEARCHDate Closing Price Rating Price Target Date Closing Price Rating Price Target28-Jan-05 26.18 32.00 05-Dec-02 27.67 1-Overweight05-Dec-02 27.67 35.00 FOR EXPLANATION OF RATINGS REFER TO THE STOCK RATING KEYS LOCATED ON THE PAGE FOLLOWING THE LAST PRICE CHART 5
  • 6. EQUITY RESEARCHImportant Disclosures:The analysts responsible for preparing this report have received compensation based upon various factors including the Firm’s totalrevenues, a portion of which is generated by investment banking activities.Related Stocks: Disclosures Ticker Price (07/05) RatingAccenture Ltd A,D,J,K,L,M ACN 23.13 1-OverweightECI Telecom Ltd C,J,K,M ECIL 8.07 1-OverweightElectroglas Inc. C,J EGLS 3.07 3-UnderweightMicrosoft Corp C,J,K,M MSFT 24.98 1-OverweightA - Lehman Brothers Inc. or an affiliate managed or co-managed within the past 12 months a public offering of securities for this company.C - Lehman Brothers Inc. makes a market in the securities of this company.D - Lehman Brothers Inc. or an affiliate has received compensation for investment banking services from the subject company within the past12 months.J - Lehman Brothers Inc. or an affiliate trade(s) regularly in the shares of the subject company.K - Lehman Brothers Inc. has received non-investment banking related compensation from the subject company within the last 12 months.L - The subject company is or during the past 12 months has been an investment banking client of Lehman Brothers Inc.M - The subject company is or during the last 12 months has been a non-investment banking client (securities related services) of LehmanBrothers Inc.Risk Disclosure: ACN: Our revenue and earnings estimates, price target and rating would be revisited if a substantial increase or decrease occurred inspending on information technology solutions by commercial or public clients, Accentures utilization and/or headcount, pricing for informationtechnology services, or if the companys Bermuda based corporate structure and resulting tax rate was materially affected by legislation. ECIL: ECI is based in Israel, so specific political and war concerns (incl employees serving in the national army and foreign tradesanctions) could disrupt normal business operations, even though this has not occurred in the companys history. Our financial projectionsassume that the global telecom spending environment does not meaningfully weaken further, and that some slight growth begins to emergein 2003 with an above-average emphasis on access technology spending. We are confident that ECI has ample funding to meet future cashneeds and assume that the company continues to generate positive cash flow, but any decline in our outlook could lead us to lower ourprojections, investment rating and price target. EGLS: Risks for Electroglas include: (i) potential for further erosion in market share in wafer probers to Tokyo Electron and Accritech(Tokyo Seimitsu); (ii) moderate secular growth in wafer probers; (iii) limited success in ramping revenues in the potentially higher growthsoftware and inspection markets; (iv) heavy reliance on U.S. and European chip makers, along with very limited presence in Asia. MSFT: Microsofts revenue is highly dependent on industry PC unit shipments which are partially dependent on the IT spendingenvironment and the economic environment. If the current tough IT spending environment does not improve or the economy worsens, ourearnings estimates and price target could be called into question. Microsoft continues to have some outstanding legal issues including butnot limited to the states of Massachusetts and West Virginia appealing the most recent findings in the governments anti-trust case.Additionally, there are other private anti-trust suits that have been filed against Microsoft. Finally, Microsoft has some outstanding legalissues with the European Union. The more successful Microsoft is near-term with unit shipments of Xbox, the greater the potential negativeimpact is to gross margins, operating margins and EPS, as it remains unclear when this business will become profitable for Microsoft. Wehave identified a number of potential issues with Microsoft associated with Linux, StarOffice and Java which we believe are a minimum of 18-24 months out. It is possible that these issues may have an adverse impact on Microsofts business and may possibly occur far more rapidlythat we currently believe.Guide to Lehman Brothers Equity Research Rating System:Our coverage analysts use a relative rating system in which they rate stocks as 1-Overweight, 2- Equal weight or 3-Underweight (seedefinitions below) relative to other companies covered by the analyst or a team of analysts that are deemed to be in the same industry sector(the “sector coverage universe”). To see a list of the companies that comprise a particular sector coverage universe, please go towww.lehman.com/disclosuresIn addition to the stock rating, we provide sector views which rate the outlook for the sector coverage universe as 1-Positive, 2-Neutral or3-Negative (see definitions below). A rating system using terms such as buy, hold and sell is not the equivalent of our rating system.Investors should carefully read the entire research report including the definitions of all ratings and not infer its contents from ratings alone.Stock Rating1-Overweight - The stock is expected to outperform the unweighted expected total return of the sector coverage universe over a 12-monthinvestment horizon.2-Equal weight - The stock is expected to perform in line with the unweighted expected total return of the sector coverage universe over a12- month investment horizon. 6
  • 7. EQUITY RESEARCH3-Underweight - The stock is expected to underperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.RS-Rating Suspended - The rating and target price have been suspended temporarily to comply with applicable regulations and/or firmpolicies in certain circumstances including when Lehman Brothers is acting in an advisory capacity in a merger or strategic transactioninvolving the company.Sector View1-Positive - sector coverage universe fundamentals/valuations are improving.2-Neutral - sector coverage universe fundamentals/valuations are steady, neither improving nor deteriorating.3-Negative - sector coverage universe fundamentals/valuations are deteriorating.Stock Ratings From February 2001 to August 5, 2002 (sector view did not exist):This is a guide to expected total return (price performance plus dividend) relative to the total return of the stocks’ local market (i.e. the marketwhere the stock primarily trades) over the next 12 months.1-Strong Buy - expected to outperform the market by 15 or more percentage points.2-Buy - expected to outperform the market by 5-15 percentage points.3-Market Perform - expected to perform in line with the market, plus or minus 5 percentage points.4-Market Underperform - expected to underperform the market by 5-15 percentage points.5-Sell - expected to underperform the market by 15 or more percentage points.Distribution of Ratings:Lehman Brothers Global Equity Research has 1712 companies under coverage.40% have been assigned a 1-Overweight rating which, for purposes of mandatory regulatory disclosures, is classified as Buy rating, 33% ofcompanies with this rating are investment banking clients of the Firm.42% have been assigned a 2-Equal weight rating which, for purposes of mandatory regulatory disclosures, is classified as Hold rating, 7% ofcompanies with this rating are investment banking clients of the Firm.18% have been assigned a 3-Underweight rating which, for purposes of mandatory regulatory disclosures, is classified as Sell rating, 84% ofcompanies with this rating are investment banking clients of the Firm.This material has been prepared and/or issued by Lehman Brothers Inc., member SIPC, and/or one of its affiliates (“Lehman Brothers”) and has beenapproved by Lehman Brothers International (Europe), authorized and regulated by the Financial Services Authority, in connection with its distribution in theEuropean Economic Area. This material is distributed in Japan by Lehman Brothers Japan Inc., and in Hong Kong by Lehman Brothers Asia Limited. Thismaterial is distributed in Australia by Lehman Brothers Australia Pty Limited, and in Singapore by Lehman Brothers Inc., Singapore Branch. This material isdistributed in Korea by Lehman Brothers International (Europe) Seoul Branch. This document is for information purposes only and it should not be regardedas an offer to sell or as a solicitation of an offer to buy the securities or other instruments mentioned in it. No part of this document may be reproduced in anymanner without the written permission of Lehman Brothers. With the exception of disclosures relating to Lehman Brothers, this research report is based oncurrent public information that Lehman Brothers considers reliable, but we make no representation that it is accurate or complete, and it should not be relied onas such. In the case of any disclosure to the effect that Lehman Brothers Inc. or its affiliates beneficially own 1% or more of any class of common equitysecurities of the subject company, the computation of beneficial ownership of securities is based upon the methodology used to compute ownership underSection 13(d) of the United States Securities Exchange Act of 1934. In the case of any disclosure to the effect that Lehman Brothers Inc. and/or its affiliateshold a short position of at least 1% of the outstanding share capital of a particular company, such disclosure relates solely to the ordinary share capital of thecompany. Accordingly, while such calculation represents Lehman Brothers’ holdings net of any long position in the ordinary share capital of the company, suchcalculation excludes any rights or obligations that Lehman Brothers may otherwise have, or which may accrue in the future, with respect to such ordinary sharecapital. Similarly such calculation does not include any shares held or owned by Lehman Brothers where such shares are held under a wider agreement orarrangement (be it with a client or a counterparty) concerning the shares of such company (e.g. prime broking and/or stock lending activity). Any suchdisclosure represents the position of Lehman Brothers as of the last business day of the calendar month preceding the date of this report.This material is provided with the understanding that Lehman Brothers is not acting in a fiduciary capacity. Opinions expressed herein reflect the opinion ofLehman Brothers and are subject to change without notice. The products mentioned in this document may not be eligible for sale in some states or countries,and they may not be suitable for all types of investors. If an investor has any doubts about product suitability, he should consult his Lehman Brothersrepresentative. The value of and the income produced by products may fluctuate, so that an investor may get back less than he invested. Value and incomemay be adversely affected by exchange rates, interest rates, or other factors. Past performance is not necessarily indicative of future results. If a product isincome producing, part of the capital invested may be used to pay that income. © 2005 Lehman Brothers. All rights reserved. Additional information isavailable on request. Please contact a Lehman Brothers entity in your home jurisdiction.Lehman Brothers policy for managing conflicts of interest in connection with investment research is available at www.lehman.com/researchconflictspolicy.Ratings, earnings per share forecasts and price targets contained in the Firms equity research reports covering U.S. companies are available atwww.lehman.com/disclosures.Complete disclosure information on companies covered by Lehman Brothers Equity Research is available at www.lehman.com/disclosures. 7

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