Very quick wrap-up as something came up this weekend.

Last weekend we were very pleased with a bottom call at 11,000 and we’ve made nice portfolio progress but we also decided to go much more conservative, closing down our Short-Term and Complex Spread Portfolio and focusing on our new $10KXtreme, Day Trading, Stocks and Butterfly Portfolios as four diverse strategies to practice in addition to our continuing $25,000 and Long-Term Portfolios, which are more market neutral.

This put our balance back to where I like it to be in a normal market, 75% LTP investments and 25% into our various strategies, which should serve well to take us through the summer while the market decides where it wants to go.

The week started very well with a big beat from BAC and we weathered our first serious set of earnings misses on Monday quite well and I said on Tuesday morning that the dip would give us a lot of buying opportunities and it certainly did!  Paulson shored up the markets in the morning and I thanked him that night but by Wednesday traders had already gotten impatient waiting for housing legislation to be officially passed. 

Existing home sales took the steam out of the market on Thursday morning (and 406,000 jobless claims didn’t help either) and, in keeping with the week’s "Flight to Safety" theme, I put up an article on vacation-proofing your portfolio, as the markets just aren’t as much fun as the beach this summer so it’s a good time to lock in our profits (or stop our losses) and take a break.  As I said on Friday, it’s a good time to take a more market-neutral strategy with a smaller percentage of our capital aimed at directional bets as we still expect a turnaround but, having failed to hit my Friday targets, we’re just not sure when…

Meanwhile, our portfolios held up well in what ended up being a flat week.  Our new portfolios are based on taking advantage of the premium erosion of the calls and puts we sell but we did remove some covers over the weekend (the ones we were well ahead on) in hopes a housing bill would be announced and boost the markets.  If not, we re-cover and keep an eye on Washington and, of course, oil - which we still need to see back under $110 to make a serious impact on the market.

• Our new $10KXtreme Portfolio aims to make as much money as possible with $10,000.  In our first week, that turned out to be $1,607 - not too bad!
• The $25K Portfolio follows a more neutral strategy and neutrally gained just 1% last week, up 25% overall.
• Our new Butterfly Collection has captured AAPL, BIDU, FSLR and MA in its first week and we’re up 4% there but that’s really good as it’s $3,915 with just $25K committed.  Hopefully, gains accelerate as we near expiration (3 more weeks).
• We also reset our Stocks Portfolio at $250,000 and we ended up with BAC, WFR, HOV and WM plays but just $17K committed so far so not a lot of conviction just yet.  We have gained a whopping $970 for our troubles so far.
• Day Trading continues to work exceptionally well with a 58% gain on the week.  We went for it on GOOG at just the right time and had a lot of good timing selling short calls against it.  Considering we started and ended the week with just 4 positions, it’s funny that the DTP about tied the 50 position LTP for most activity.
• Speaking of the Long-Term Portfolio, our most senior portfolio scratched out a 13% gain as our longs made a small comeback.

On the whole, we had a 15% gain for the week on 33 positions closed.  I’m trying a new format which breaks up the closed positons by portfolio, hopefully it comes out well here as the gameplan for the summer is to focus on strategy, which we’ve been able to have ample conversations about as we pursue a more relaxing mix of trades:

Today’s tickers: SKF, BEBE, C, BAC, VIX, DOX, XTO, SPG, GGP

SKF- Shares in the Ultrashort Financial Proshares fund, a contrarian ETF that performs inversely to the broader financial market, rose 8% to $126.30 today on weakness in the bank space. While the nearly 4-to-1 preponderance of active calls to puts today suggests that some traders may be using the ETF to hedge positions elsewhere in the space, we noticed some unusual activity in the January contract that fit with our downside thesis for the financials heading into the fall and winter. It looks like a trader entered a 2,000-lot call spread in the January contract between strikes 130 and 200, buying the lower strike for $23.00 and selling the upper for $10.00 to keep trade costs down and rein in the breakeven a bit. This trader is looking for a break higher in the contrarian fund past $143 – that’s another 13% higher from current levels – but significantly, the sale of the higher-strike call caps the upside at $200, which means this trader believes the July 15 high for the fund of $204.27 will remain intact into the New Year.

BEBE- The rag trade is a tough racket on a day like today, as is evident from the 3.2% decline in shares of fast-fashion maker Bebe. With shares ticking in at $10.40, we observed an increase in option trading volume to more than 32 times the normal level that showed traders seeking downside protection in January puts at strikes 7.50 and 10, suggesting continued erosion from current levels and a possible break of the $8.81 52-week low by mid-January. Option traders are currently pricing in about a 17% chance of that actually occurring.

C- A fresh triple-digit decline for the Dow Jones Industrial Index followed pained existing home sales data that has the market still grappling in the dark for that “last rung lower” in the housing decline. Financial stocks are leading the pack of decliners today, with sharply elevated put volumes in a number of major financial components showing traders bracing for new movement lower in the financials but delineating clearer downside targets through the use of put spreads. Citi shares are down 4.7% at $20.11 as we register more than 200,000 lots trading with an edge to puts by a factor of 1.7. Early notable trades included what looked like a 10,000 lot long put spread in the December contract between strikes 12.50 and 17.50. The position here would take about a 93-cent credit from the buyer, implying at least a 17% downside move between now and December, putting a bottom to the downside at that short $12.50 strike. Nearer to hand it looks like a 20,000-lot strangle may have been deployed in the September contract between strikes 20 and 22.50, although we have no information on the direction of that trade at present.

BAC- Shares in Bank of America declined 1.2% to $33.04 as we option traders load up on a 16,000-lot put spread position in the August contract between strikes 27.50 and 32.50. Here it looks like a standard long position bought for about a $1.40 debit, implying that the trader wants to see at least another 5% off current levels but doesn’t portend a drop below $27.50. Another 20,000 lot long put spread went through in the November contract between strikes 17.50 and 30, with the trader buying the higher strike for about $3.10 and selling the lower for about 50 cents. The $2.60 debit requires at least another 15% to the downside for Bank of America shares by November 21 but, again, there’s a basement level built into the trade. The takeaway from these trades is twofold. The jaded pessimists among us would view it as an indication of continued “grind lower” in financials heading into the fall, a return of the Sisyphean grind that’s gripped the space for months now. Some might take comfort in the fact that so many traders are bracing for pullbacks with very resolute downside limits in the near future, keeping shares above its July 15 low of $18.52 for the remainder of August, with deeper downside possible into the fall.

VIX- Composite S&P implied volatility as measured in the CBOE Volatility Index rose 4.5% to a reading of 22.28 that still finds the index well below the erstwhile 25 line. While we’ve observed some interest in calls at strikes 22.50 and 25 today, possible spreads looking for rangebound activity above current levels not to exceed 25, some traders played the other side of the coin, with what looks like a diagonal calendar put spread involving the purchase of 6,000 August 20 strike puts, funded by the sale of September 19-strike puts. Elsewhere in the September contract, however, we did note heavy buying on volume of some 18,000 lots at the September 30 strike – the volume here matching up to more than half the open interest at this strike. Option traders are currently pricing in about a 20% chance of a new crack at 30 for the VIX by September 16. This dovetails fairly neatly with the scenario posed by trades in major banks Citigroup and Bank of America that we detailed above – i.e., immediate downside with clear limits, deepening into the fall.

DOX- Shares in Amdocs, the world’s larger maker of billing and CRM software for phone companies, cruised 6.8% higher to $30.77 after reporting a 14% an increase in Q3 profit and raised its guidance for year-end earnings. Implied volatility, which had shown a slow creep higher from mid-June until peaking at more than 50.2% last week, quickly pulled back by 20.7% this morning on the numbers and while the current 35% reading puts Amdocs’ implied volatility back at June levels, it’s still a premium to the 28.5% 30-day historic reading on the stock. It looks like a trader seized upon this disparity by selling a 10,000-lot straddle at the September 30 strike for a cool $3.35 in premium – a credit he or she hopes to keep intact if Amdocs shares remain at the $30 level by September 19, thus dwindling the value of the position to naught.

XTO - XTO Energy – With shares down 1.6 % at $47.46 we’re registering an increase in option trading volume to 5.5 times the normal level with puts and calls trading in relative balance. Since our first scan of the morning, the tendency among option traders has changed slightly to the call side with August 50-strike calls trading at more than triple the open interest, and attracting heavy buying pressure at $2.00 per contract. August 55 calls have likewise traded at triple the open interest, to buyers as well as sellers. Implied volatility at 61.3% compares to a historic reading of 55.7%.

SGP- Simon Property Group – With shares down 2.7% to $91.01 we picked up an increase in option trading volume to 2.3 times the normal level owing to a 5,000-lot OTM put spread in the October contract between strikes 70 and 75. In this case the trader appears to have bought the lower strike and sold the higher strike, essentially using the put spread not to express a directional view (both strikes are firmly out of the money) but to take a 60-cent credit and hope that both contracts expire worthless by October, leaving the credit intact.

GGP- General Growth Properties – Another 5,000 lot transaction materialized in a REIT this morning, driving option volume in General Growth Properties to 2.6 times the normal level as shares read 3% lower at $31.41. This appears in the October 30/35 strangle combination, which traded for a combined premium of $5.55 this morning. While a buyer would be playing on a break above $40.55 or below $24.45 by October, a seller would take the premium as an initial credit in the anticipation that shares will remain rangebound between the strike prices.

Yet another exciting week in the markets draws to a close.

With lots of members going on vacation, we skipped the wrap-up last night and posted our guide on how to vactaion-proof your portfolio using DIA index puts.  This is mandatory reading for new members and recommended for everyone as hedging your portfolio is what enables us to make the riskier upside plays that make big returns when the markets run up.

Of corse option hedging works both ways and we can write a book about that (in fact Sage, K1 and I are!) but learning just this relatively simple strategy can help you ride out the market gyrations and manage your portfolio with much less stress.  We didn’t have too much stress in yesterday’s drop as we were a little over-covered anyway after the big run up and yesterday’s pullback gave us a chance to buy back some of the calls we sold at a very nice profit as well as giving us a chance to reposition some of the financial callers that had buried us in last week’s run up.  As I often say during big runs - what is easily done can be easily undone and we got a huge reversal of Tuesday’s XLF spike that put our spreads right back on track.

We were expecting durable goods to save us this morning, despite the bad housing numbers, after reading WHR and CAT’s earnings reports and listening to the conference calls.  We thought WM’s sell-off was enough nonsense to add them to our Stocks Portfolio on yesterday’s dip but selling the $4 calls as we’re not THAT confident.  Still, picking up the stock at $3.90 and selling a .80 call puts us in for net $3.10 and getting called away on the 15th at $4 is a very quick 29% gain and we liked that play so much we decided we were willing to double down by selling the $4 puts for .80 as well.  That means if we get called away over $4 our basis is $2.30 and, if the stock is put to us at $4 because it turns lower, our average entry is just $3.15, since there are $3 calls as well, we can simply reload and try again in September.  This is the strategy we outlined in last months post "Can You Be Satisfied Making 20% Returns Each Year?"

That’s why we reset the Stocks Portfolio this month and added the Butterfly Collection Portfolio - we know the market is going to be choppy and the trades we play around with in the $10KXtreme portfolio (aiming to get to $100K as quickly as possible) and the $25K Portfolio (aiming to get to $50K during the quarter) are not the kind of things you do with retirement money - all unhedged stock trading is gambling and options trading is more so but it’s gambling we can afford if we follow the safer, more dependable strategies with the bulk of our investment portfolio.

We had fun taking a few risks yesterday, pressing plays on WHR, BA and, of course, our beloved Googles.  We’re not expecting a big run here as the weekend looms large and scary and the oil bulls are on the march again as nothing of substance is being done as yet to reign in the madness other than scapegoating some small speculators on the NYMEX as if THEY were the problem.  What this case actually proves is that anyone, even less experienced traders with a few million dollars, can manipulate the energy markets and make millions.  Imagine what a multi-billion dollar investment house with a "win at all costs" attitude (the bottom 5% performers are laid off each year - that’s the message!) and a long history of price fixing and stock manipulation can do…

As expected, Asia did not take our little correction very well and the Nikkei dropped 2% (saved by the bell) while the Hang Seng gave up the week’s gains to finish back at 22,740 (down 1.5%).  Samsung’s profits jumped 51% on cellphone and flat panel sales but there were bombings in Bangalore that spooked the morning markets and certainly give us a reason to keep covered over the weekend.  Europe was well down this morning but has recovered about half to about 1% in the red across the board.

Back home, NY Attorney General, Andrew Cuomo, kept the heat on the financials by filing civil fraud charges against UBS, accusing the firm of "multibillion-dollar consumer and securities fraud," and demanding that the firm pay back its profits from the business, make investors whole and pay damages. The firm is accused of pushing risky securities on retail and corporate customers with misleading sales tactics, even as the market for those securities was falling apart. When the collapse came, many customers faced losses or were stuck with securities they couldn’t sell.

The New York complaint also alleges that several high-ranking UBS executives, whom the New York attorney didn’t name, sold roughly $21 million of their own auction-rate securities holdings amid the turmoil. Some 50,000 UBS customers were left holding $37 billion worth of the struggling investments, the complaint says.  Needless to say, UBS is not one of the banks we are keen on!

We’re still waiting for our housing package to be finalized but I’m encouraged on that front, our HOVs came back down again and gave us a chance to load up again after cashing 1/2 out with a double the other day.  The dollar is quietly gathering strength as both Europe and Asia are looking a little more iffy to investors but it is still all about the POO (Price of Oil) and it would be nice if the New Home Sales Report at 10 is not as miserable as yesterday’s Used Home Sales Report and I’m pretty sure it won’t be as it’s the incentives offered by the builders on new homes as they clear out inventory that have been cutting into the sales of old ones.  As with everything else we are watching in the markets - rotation can be painful but good over the long haul.

We don’t want a huge reversal today, that will just make the market look flaky, but a nice 50% retrace of yesterday’s drop with a strong finish is just what the doctor ordered for today.  Ahead of the weekend, anything up is good but I’m not going to be happy if we can’t finish with Dow 11,450, S&P 1,260 and Nasdaq 2,300.  While we’re wishing, lets go for oil below $125, GOOG above $480 and AAPL back at $165.  That would make for a very nice weekend!

NEW INFORMATION = TAKE ACTION

Save it.  Post-it.  Record it.  Use it.

When driving a car and some object appears on the road ahead do you usually run right over it or do your best to avoid it?  Don’t we all take action in real-life based on the new information we receive that changes the old paradigm?  Take the first two guys in this video:  Who would you rather be, the first or the second guy?  While the second gentleman reacts and looks ridiculous in so doing, he’s the guy that is more likely to survive when real disaster hits because he’s reacting to new information.  In fact he doesn’t even know what’s making everyone else react, he just knows that when 99% are moving one way in panic, it’s best not to fight the crowd or he will be trampled.  It’s no different in the market.  Pride, ego and old theses have no place when new information directly contradicts an existing trade.

When the market is up, we use DIA puts and calls to "react" to quick changes in the market while we wait for better information before making more permanent changes in our positions.  This gave us the benefit of the quick reaction of gentleman #2, the one who went unquestioningly with the crowd, while also giving us the "wisdom" of gentleman #1, who was confident (or oblivious) enough to soldier onward, despite the fact that the world seemed briefly to be against him.

When new information does arrive, one of the first things I look to do is minimize risk - hedging the existing position.  The next step for me is to become more aggressive in reacting to the new information and shifting the bias of the trade in the opposite direction.  In this article, I will outline our basic strategy for protecting your portfolio from a major dip, which can then be used to adjust your risk profile, based on changes in outlook arising from new information. 

The strategy outlined can be applied also when you know that you will be unable to monitor your positions.  Many of you will likely be taking vacations this summer and, with them, a break from actively monitoring your positions.  With that in mind, it’s always prudent to protect your positions from the “just in case” events that can derail your positions in a flash when you are not attending to them.  Those “just in case” events are a reason to remain nimble and flexible when trading the stock market as opposed to becoming emotionally tied to any single position.

We have published this aricle before with many individual strategies but, today, we will focus specifically on the DIA puts, which are the cornerstone of our "mattress plays."  Keep in mind, the point is not to "win" these trades; the idea is to bet against yourself, putting your folder in "neutral" while you head off to the Bahamas for 2 weeks or just off to the Hamptons for the weekend.  You may lose time value on both ends of your trade but often this is less than the cost of jumping in and out of positions.  You paid for your vacation - adding a hedge is just another travel cost that let’s you really enjoy it without worrying about your portfolio!

I use the DIA’s because the Dow is always in your face, even when you are away, so it’s very easy to keep track of in case you need to make an emergency call to your broker - but the logic works for any of the indices.  If you are heavy in technology shares, you can purchase QQQQ puts etc. but I find the DIA puts to be excellent overall portfolio coverage.  When I am more actively trading, I may focus on the index that is likely to snap back the most on a correction which is another great way to insure your positions and often more profitable (assuming you are good at doing your homework).

Remember, this is about buying INSURANCE, protection against a catastrophe.  Much like life insurance, this should be considered the cost of keeping your bullish portfolio alive and healthy, even in a downturn.  Also, much like life insurance, it sucks when you collect!  You need to go into these plays knowing what kind of drop are you worried about.  You need to look at how well covered you are now and (yesterday being a good example as we did drop 300 points) get a handle on the danger you face in a 300 point drop and think about the value of that kind of insurance. 

As with any spread, it’s a relative gain issue.  There is virtually no point to having two contracts at the same strike a month apart as you will have no particular advantage over the short position (putter) on a drop.  Rather than write a book on the subject, let’s just take the best current protection at this exact spot, even though I currently do not have DIA puts as I am waiting for 11,800 to put them on.  I was fully covered and too deep in the money yesterday after the run-up so there was no point in the puts, I am now 1/2 covered (we took off callers we were 50% or more ahead on) and may add DIAs today rather than cover up over the weekend as I don’t want to get buried in another pop so let’s say we end today in the same spot and I took a $20K hit yesterday but now I’m half naked so I’m worried about a $30K hit if we drop 300 more on Monday.

Rule number one in selecting an index put is have at least 45 days because you want to be somewhat insulated by the time of the spread and, most importantly, you want to be able to sell front-month puts (short) against your position.  We could take September but, at this point I’d rather see October.  Generally, our rule with an index put is that we will roll up to the next $1 strike (higher for a put) for .40, as we are buying $1 in position for 40 cents.  Since it’s 11 weeks away, rather than look for rolls at .40, I’m going to look to roll up $1 for .50 so, logically, the position I choose is the first position that can NOT be rolled up for .50 or less, that would be the Oct $117 puts at $6.38 as the $116 puts are $5.85 (-.53) and the $118 puts are $6.97 (+.59).  More importantly the $119 puts are $7.60 (+$1.22), the $120 puts are $8.23 (+$1.85) and the $121 puts are $8.93 (+$2.55) so a 400 point drop will net me $2.55 profit and a 300 point drop will net me $1.85 off the Oct $117s.

Assuming roughly a $2 gain, if I want to cover 1/2 of my projected $30,000 loss of a 300-point drop, then I need 75 contracts but let’s say we are a little more nervous and take 100 for for $63,800.  On the downside, a 300-point gain will drop me to (approximately) the level of the Oct $114 puts and they are $4.88 (down $1.50) so I will lose $15,000 on a run up.  Since I lost $20,000 on the way down I can assume I’ll make $20,000 on the way back up (probably better as I am now 1/2 uncovered but let’s be conservative) so getting my portfolio back to even on a 300-point run up will cost me $15,000.  Just like life insurance, you don’t want to be over or under-covered. 

Now I can look to offset that $15,000 loss by covering my long puts with current puts.  Question 1:  How low do I think the Dow can go?  Let’s say I’m pretty sure 10,800 will hold (500 points down).  My main goal of protection is my worry about a drop to 11,000 even and the Aug $111 puts just so happen to be $1.44, which is almost exactly what I would lose on my longs if we head up 300 points!  Also, since my Oct $117 puts have $3 in premium with 3 months left (about) this $1.44 will more than cover my premium loss for the month so also perfect! 

If the Dow goes up 300, I get my $20,000+ back on my main positions and remain neutral with my puts.  As my the value of the August puts I sold decreases, I "invest&qu