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Hedging For Disaster – 5 Plays that Make 500% if the Market Falls

It's been a long time since we were worried about a steep drop.

We have some very successful hedges already as I've been pounding the table on TZA since $13.50 and, since you know I am a big fan of taking cash off the table in either direction, let's not be greedy and look at ways to "roll" our existing downside protection into new downside plays so we can set SENSIBLE stops on our now deep in the money short plays (very similar to our Mattress Strategy)

Keep in mind that Friday was the biggest market decline we've had since May, so adding a layer of protection here doubles our returns if this is the first leg of a major sell-off, or it gives us a smaller hedge that we can roll up later while we take our bigger hedges off the table.  As I have to say WAY too often to Members – It's not a profit until you cash it in! 

Hedging for disaster is a concept I advocated during another "recovery," in October of 2008, where we made our cover plays to carry us through a worrisome holiday season and into Q1 earnings – "just in case."  That "just in case" saved a lot of portfolios!  The idea is to take disaster hedges using high-return ETFs that will give you 3-5x returns in a major downturn.  That way, 10% allocated of your virtual portfolio to protection can turn into 30-50% on a dip, giving you some much-needed cash right when there is a good buying opportunity.  At the time, I advocated SKF Jan $100s at $19.  SKF hit $300 around Thanksgiving and those calls made a profit of over $280 (1,400%), so putting even just 5% of your virtual portfolio into that financial hedge would give you back 75% of your portfolio when you cash out. 

Keep in mind these are INSURANCE plays – you expect to LOSE, not win but, if you need to ride out a lot of bullish positions through an uncertain period, this is a pretty good way to go.  I have long wanted top put up a Buy List but it's still too risky as the Dow has been unable to break our 13,600 target and the S&P has failed to hold 1,440 and, as I warned just yesterday morning, ahead of a 200-point drop, the Dow has no real support all the way to 13,295.  As it turned out, we bottomed out at 13,312 and finished at 13,343.    

At this point, we are very likely in the capitulation/depression area of the curve BUT it is possible that we're only in FEAR and things are worse than we think.  I am HOPING (not a valid investing strategy), that Friday's high-volume sell-off was more capitulation by those who didn't realize Q3 earnings were going to be bad than the onset of fear as investors simply didn't understand how bad Q3 was.  Of course it was bad – why do you think the Fed moved to save the economy?  I haven't given up yet but we do need to be prepared for a larger breakdown – hence these trade ideas.

On the whole, we haven't been very bullish since the end of July, when the S&P topped out at 1,400.  We've kept our main, virtual Income Portfolio lightly invested as we keep expecting a drop and we haven't sold ANY short-term puts – specifically out of fear of being burned like this.  It's fine to speculate with our smaller portfolios but not with our main Income Producer.  One speculative play I did like on the release of QE3 was on gold on 9/23 – it's even cheaper now and makes a good long-term inflation hedge:

I'm not a big fan of gold (and we have some GLL short plays on it here) but, long-term, if it runs, it can be lucrative and, rather than buying 10 ounces of gold for $17,750, you can buy 10 GLD June $145/170 bull call spread for $16.70 ($16,700) and all GLD has to do is hold $170 (now $171.50) and you make $8,300 or about 50%.  Buying physical gold, it would have to move to $2,600 an ounce for you to get the same bang for your bullion bucks.  Break-even on that trade is $161.70 so it has built-in protection as well.  

Despite gold dropping $35 since I wrote up these trades, the GLD spread is still $16, so very little damage done there.  We also had a more complicated trade on silver that was anchored with the sale of 2015 puts on ABX, which has also dropped and now the 2015 $33 puts are $5.60 (were $5) and make for a great offset as long as you REALLY want to own ABX for net $27.40, which is 29% below the current price of $38.78.  As to the short-term GLL (ultra-short gold) hedge – we cashed those and, unless $1,720 fails to hold (the 50 dma), we don't think we'll need more.    

INDU WEEKLY I would urge you to read the original Disaster Hedge post in our Virtual Portfolio Section, to get an idea of our mindset at the time, where I said:

As far as hedging goes, if you are 50% invested and 50% in cash and you are worried about losing 20% on the stock side in a major sell-off, then the logic of these hedges is to take 40% of your cash (20% of your total) and put it on something that may double while the other positions lose.  If things go down, your gains on the hedge offset some of the losses on your longer positions.  If things go up, you can stop out with a 25% loss, which will "only" be a 5% hit on your total portfolio but it means we are breaking through resistance and your upside bets are safe and doing well.  That is not a bad trade-off for insurance in this crazy market.  Also, be aware that these are thinly traded contracts with wide bid/ask spreads and you need to use caution establishing and exiting positions.

As we are now, we were very keyed on watching the top of the summer's range  for support, which were at the time:  Dow at 13,300, S&P 1,420, Nasdaq at 3,075 (blown thanks to AAPL), NYSE 8,100 and Russell 820.  These are all levels that give up all of September's gain but things can get far worse if we have another crisis of confidence, as we did in 2008-2009.  It's still too early to bargain hunt because that was a mistake we made in 2008 – looking for floors that never came – so we need to be judicious in our bottom-fishing expeditions.  

Keep in mind that these are 2nd stage hedges as we already have TZA hedges from higher levels (Russell 840-880, now 828) we have a Fed meeting next week and Fed speak could turn the market right back up but, we do need something, in case it doesn't.  That being the case, here’s a few ideas to help ride out a larger downturn as well as to protect our eventual buys:

  • DXD Jan $49 calls at $2, selling Jan $55 calls for $1.15.  This is a net .85 entry on a $6 spread so your upside is 605% at $55 (DXD is now $47.25).  If the Dow ends up holding 13,200 and moves back up, there’s a good chance you can kill this cover with a small loss as a $5 move on DXD is about 10% and that would be about a 5% move up in the Dow to 14,000 before the Jan $49s lose half their value (which is still more than you paid for the total spread).  You need $49.85 (+5%) to get your money back and that's a 2.5% drop in the Dow to 13,000, so you are well-protected for any dip below that line.  
  • TZA is still our favorite hedge and you can pick up the April $14/22 bull call spread for $2 and you can sell the April $13 puts for $1.35 for net .65 on the $8 spread, giving you 1,130% of upside potential and, best of all, with TZA at $15.60, you are starting out 246% in the money!  TZA drops $2.60, to $13 if the Russell goes up 6% plus these ultra-ETFs tend to decay over time but owning TZA for net $13.65 is not a bad portfolio hedge and the Russell would have to be net up in April for this to happen and, if so, your longs should be doing well.  

When you are entering a trade like this, assume you will have TZA put to you at $13.65 and allocate how much you are REALLY willing to own.  Say that’s $13,650, which would be 1,000 shares and that means you can make this trade with 10 contracts at a net cost of $650 plus (according to TOS) $4,500 in margin.  This play returns $2,600 if TZA simply stays flat and holds $15.60 through the April expiration.  This hedge then, protects $50,000 worth of existing positions against a 15% loss for $650 (hopefully, you already have buy/writes that protect you from a 20% drop, so we're good for 35% total downside) - plus some margin you'd better have laying around anyway!

  • SDS Jan $56 calls at $3, selling Jan $62 calls for $1.65 and selling HPQ Jan $14 puts for .87.  Here we are in a $6 spread for net .88 with the possibility of making $5.12 (581%) if SDS hits $62 (up $7.16 or 13% or down 7% on the S&P to 1,332).  We may have HPQ put to us for net $14.87 at that level (now $14.48).  Of course, we can roll the puts down to the 2014 $10s (now .90) – which is a pretty good entry on HPQ (30% off)!  Remember, the premise is that it's not likely to have HPQ go below $14, let alone $10 if the S&P is rising so your expected cost of insurance is that .87 – although you can stop the bull call spread out long before that happens.  If you are willing to own $15,000 worth of HPQ at around $10 in 2014, it's reasonable to take 15 of these hedges, which return $9,000 if the S&P falls 7%.  The margin on 15 short HPQ Jan $15 puts is just $1,500 according to TOS – so not tragic if forced into the long-term short puts.      

Another nice thing about this trade, in a vacuum, is that – IF we have a catastrophic failure that forces you to buy 1,500 shares of HPQ for $10 – there's a pretty good chance you will have collected that $9,000 from the SDS spread and that means you are buying 1,500 shares of HPQ for net $6,000 – just $4 per share!  

Another way to hedge SDS if you are not margin constrained is by selling SPY puts.  SPY Jan $125 puts are .92 so a net of .73 on the above spread and you KNOW the puts are rollable and, of course, the SPY puts CAN'T go in the money until AFTER you make $5.27 per spread.  What you are playing for here is that the S&P will drop 7% but not 12.5% (and, assuming a roll, 20%).  

I'm sure some of our more savvy traders have already realized that once SPY drops 10%, we can simply add more hedges and at 15%, more hedges and at 20%, even more hedges to protect against getting too burned on the short puts.  Layering in our Disaster Hedges is always a good plan.  After all, that's what these hedges are as we've already got plenty of hedges like this from when the market was 15% higher!  

The great thing about this kind of play is that, if the S&P goes up, the insurance is half price as the short puts expire worthless.  You can even stop out the $1.65 hedge at around $1 and you end up with something in your pocket as a reward for all your hard work.  

Keep in mind that this is insurance, not betting.  These are hedges that are meant to perform for you if your upside bets don't work out and will hopefully not cost you too much money when your upside plays go well.  If your upside plays are sensibly hedged, like our buy/writes that pay at least 10% a quarter in a flat to up market, then this kind of sensible insurance is all you should need to offset reasonable dips in the market.  It doesn't mean you don't need stops.  

  • EDZ is my other universal hedge.  It's a 3x inverse to the MSCI Emerging Markets Index which is BRIC-weighted but also includes Africa, Eastern Europe, the Middle East and Latin America so our bet is that something goes wrong somewhere in the world sometime.  With EDZ now at $11.52, the Jan $12/16 bull call spread is just .60 with a $3.40 upside potential (566%).  You can reduce the net further by selling the Jan $9 puts for .35, dropping the spread to just .25 and increasing your potential gain on cash to 1,500%.  This is a very nice way to play against a breakdown in emerging markets.  
  • Finally, let's look at a stock play.  V has been a white whale for us, going up and up no matter how much we short them but, at $140 – they HAVE to be tired.  Earnings are on the 30th and they are expected to earn a solid $1.49 but, looking at tech and other sectors – it just doesn't seem like that much money is being spent.   AXP had in-line earnings and is down 5% since then and you can pick up the V Nov $135/130 bear puts spread for .85 and that makes up to $4.15 (488%) if V drops $10 (7%) but, we're looking for 500% trade ideas so how about selling an AXP April $45 (now $56.86) put for .66 and that knocks the spread down to .23 with a potential 2,073% upside.  

As with all of our protection plays, if we become more confident that the market will NOT collapse, then we simply take them off the table with a small loss and that makes us more bullish but having a few hedges like this in your portfolio can do a lot to cushion the blows from any major market sell-offs. 

I cannot remind you enough though that these are insurance plays and they are not ideal for rolling or adjusting and you should EXPECT to lose money if the market heads higher – much the same as you expect to have "wasted" your life insurance premium for the prior year every time you celebrate another birthday….

As with life insurance, it may make you feel good to walk around with $50M worth of protection in case you get hit by a bus but – is it realistic?  Look at your portfolio and think about what kind of protection you REALLY need.  If you have $100,000 worth of May buy/writes that are good for a roughly 15% dip in the market, then you don't really need ANY protection against a 15% drop.  If the market drops 25%, then you will lose 10% on what you have now.  If the market drops 40%, then you lose 25%.  We all learned how valuable it can be to simply stay even in a major market drop as opportunities abound then so simply putting 5% away on hedges that will pay 25% back when the market drops 40% will let you cash out with 100% of what you have now and go shopping – that's all insurance needs to do!

Disaster hedges are a good exercise in managing your portfolio but, unfortunately, like Auto insurance, you just pay and pay and pay until you have that accident.  So safe driving!


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  1. terrapin22

    Those are some great hedge plays Phil.  Thanks!

  2. stjeanluc

  3. rdn4evr

    Oh no!  Phil's puttin' up the Disaster Plays just when I was convincing myself that we weren't going to crash soon!  What to do?  The problem is, the charts look like Hell, even thought there are a lot of indicators suggesting we get new highs at least  into the elections.  After doing extensive analysis, I decided last Monday night that there was no need to panic, since several key factors in every major market downturn, at least for me, were not yet present.  The first being that I was experiencing no technology trauma (internet service down, major TOS platform migrations, etc), and the second being Phil's resolute optimism that QE3 would soon have an effect.  That was Monday night.  First thing Tuesday morning, my less-than-a-year-old Macbook Pro experienced a fatal "Kernel Panic" and wouldn't reboot.   No problem, I've learned to have backups for everything technology related.  And besides, I thought,  Phil's still not rolling out his Disaster Hedges…….
     Well, kidding aside, I just wanted to add to Phil's point about only buying the insurance you need, the key being to understand exactly how much insurance that is.   Since austerity has forced on me a discipline that good intentions never could, some time ago I instigated a regimen of making sure I used the TOS Analyser to individually determine the potential outcome of every single position I had under a variety of scenarios (including volatility increases and decreases).  Now, that's a lot of work, and since I don't like excess work, this regimen has really helped me limit my positions to those that are worth the effort of monitoring.  I find it's much easier to say goodbye to a position that's going nowhere if it's going to mean a lot more actual effort rather than just passively watching its value waste away.  Also, now that I understand my positions, I don't have to worry about open-ended risk, and I feel like I can take advantage of market opportunities, such as the ones likely to occur next week. Despite my superstitious crash anxieties,  I won't need to add any of these hedges unless we drop to my predetermined  "scale in" point where I will adding to my other positions.  In the past, my anxiety caused by not really knowing my risk would cause me to grab way too many of these hedges and then hold on to them too long, which really defeats their purpose.

  4. phil

    You're welcome Terra.

    Income Portfolio plodding along.   I can't believe we are long on CMG!  TZA now on the money so we're good for up to $35,000 of coverage for the next 15% the Russell drops (to 700), which would be below the May lows and, if it holds, about where we'd want to do some serious bottom-fishing anyway.  If the RUT breaks below 810, however, we will want to add a more aggressive short-term hedge.   Also, as the VIX goes higher – we'll be very happy to roll short putters down to 2015.  

    Disasters/Rdn – Had to do it when we broke technicals.  Still wouldn't call it panic, just being prepared.  

    Twenty-five years after the October 1987 crash, could it happen again? "It's really different this time. It's much worse," Randall Forsyth writes. In 1987, all it took to ease the pressure on financial markets was to cut interest rates, and there was plenty of room to do so. But today, central bankers have run out of basis points and the eurozone status quo is untenable, meaning that fixing a crash would be a vastly bigger challenge.

    Barrons cover this week:

    expand large image

    Where was this story 50% ago? Its cover showing a tombstone engraved "R.I.P. PC," Barron's says DELL and H-P (HPQ) will fade from view. Next up for trouble could be Microsoft (MSFT), seemingly cheap at 9X 2013 earnings, but which reported sales at its Windows unit off by a third Y/Y after backing out pre-sales for Windows 8. The world awaits the launch of Surface at midnight on Friday. More winners/losers here.

  5. zipla

    General/Phil,
    I feel I am totally out of my depth. After a year when I thought I was getting the hang of it, and saw myself doing reasonably well, the last few weeks — after losses in AAPL, VXX, and others, have left me in paralysis mode.
    I am running two protfolios — an IRA and an actively traded portfolio.
    In the IRA I've been doing long term plays taking the from the Long Term Portfolio (last years) playbook and some other good looking ones as they get discussed n the site, rolling and selling to get net costs down — so it's AA, ACI, AGNC, BAC, CEDC (don't ask- loser from way back), CHL, CSCO, F, FTR, GLW, HOV, NLY, SVU, WFR, WHR. So far with the exception of some Jan AAPL 690 calls which I bought to juice the portfolio a little, and which I've rolled into a 595/635 spread — thanks for the advice on that one — it's doing OK. Although it is down over 3% from where I started.
    It's in the individual port that I've really been rocked, going from about $137K to $188K in September but now back down to about $93K. I have a few long term plays here BA, BTU, but I've mainly been using the $25KP plays, occasional MoMo and FAS Money. My biggest hit here was with some Oct AAPL calls which, as I mentioned before really knocked me down.
    The danger ones left are 5 AAPL Jan 630/650 spread and of course the continuing 25K 10 Nov 635s covered over the weekend with Oct 26 625s.
    I feel I've been working hard at this so I don't want to let what I've learned go to waste but do feel I'm doing something very wrong — oversized positions (yes on AAPL) overhedged (TZA, SCO and VXX) — and don't even know what advice I need to get back even to my starting point.
    Obviously, all this may be moot if AAPL does well at earnings but I'm at the stage where I'm thinking why put money on hedges since the AAPL position is hedged in itself and the rest of what I have are long term plays.
    Anyway, I would appreciate any help on this as I feel I've screwed it up pretty good. Can I rescue myself out of this mess with some patience? Or should I just throw in the towel before I did a deeper hold for myself. The paralysis is the worst problem as I'm not even thinking about any other plays now (even FAS) because of the AAPL situation.
    TIA
     

     

  6. nicha

    Phil – like zipla, I too have lost quite a bit. More like 80% of the portfolio. I had 25 Oct 690 calls plus 10 Oct 685/695 spread which was an oversized position to begin with. I then rolled everything down to 40 Nov 670/690 BCS for a cost of 8.65 per spread, now 3. I do not have any money left to roll down and the only roll I see is to Jan 705/725. What wud you advise?

  7. jabobeast

    Does anyone have something(graphs) that shows that there has not been any wage inflation? Also, any graphs that show how costs have gone higher even without wage inflation?

  8. 8800

    Phil,
    Trying to be proactive and anticipate rather than have to react I wanted to get some guidance on mgt of 2 GOOG positions: sht 6 -  jan/14 600 puts @ $31 and sht 3 – 550 puts @ $21 (now $45 and 32 respectively). Given that no one knows in an absolute sense whether GOOG has, in fact, seen its best days and may be overtaken by competition or changing events in its mkt space, I am slightly less bullish now than I was when I sld the puts 3 wks ago and less inclined (but not totally disinclined)  to own them long term at 600/550. I note that the last 2 days volume has been much heavier relatively in GOOG than AAPL – not sure if this portends a blow-off low or start of a waterfall decline. So given my current posture (guesses), what changes/rolls would you recommend.
    Thanks in advance

  9. stjeanluc

    Futures opening lower as the world was not saved over the weekend! Maybe buyers show up in Europe when we open at 3:00 AM!

  10. phil

    Actually, Nikkie taking a nice 50% bounce off a bad open – futures up tiny bit so we'll have to wait and see but not the end of the World just yet.  

    Depth/Zip – Sounds like you have a pretty good handle on what you're doing other than you were up $50K (36%) and that didn't satisfy you so you kept playing until you lost 1/2 of 136% and now you are down 31% but over 50% of where you peaked.  You're playing $136K the way we pay $25K out of $525K so I guess you have about $2M in the long-term trades otherwise WTF?  The $25KP is for FUN – we are GAMBLING in a high-risk portfolio risking a SMALL portion of our virtual total.  I am, at this point SHOCKED at how many people put too much money into these plays and I will no longer be doing them in the future as this is just ridiculous.  Perhaps the best thing to do would be for you to do the same thing and STOP GAMBLING WITH MONEY YOU CAN'T AFFORD TO LOSE.  And I don't mean just you, of course but everybody – for God's sake this is just common sense.  

    It's very easy to get back to $137K from $93K, just make $20K this year and next year (20%), which is quite a reasonable goal.  When you try to make 100%, you are risking 100% and if you don't want to lose more than 20%, don't try to make more than 20%.  You made and lost 30% were back at even but continued to risk aggressively and now you are down 30%.  I don't know if continuing that kind of risk profile will make or lose the next 30% but, even if you do make it – will you be happy to be even or will you risk 30% on the next roll of the dice?    You need to make these decisions BEFORE you decide to gamble.

    You do seem to realize patience is the answer and we did talk last week about splitting the AAPL play in the $25KPM into a more conservative play to recover the money – which we will do but it fell too fast for us to do it last week.  Obviously you have some other money and, if you do want to stick with AAPL, you may want to consider taking the Nov $635s ($17) and rolling them to the April $600/670 bull call spread at $30 and the Oct $625s that are currently cover are $14, which pays for the roll but you want to either have a stop on 4 at $16 and 2 at $18 and 4 at $20 or just be ready to roll them to the Nov $645 calls, now $13.70.  So, if AAPL doesn't make $625 by Thursday, hopefully the weekly drop $5+ and then you need to roll anyway to whatever is $15 but if AAPL goes up, you have the $70 spread that you paid about net $30 for (assuming similar to the $25KP) and then you don't have any real trouble unless AAPL is over $685 on earnings and, even then, then Jan $685s are currently $15 with a .27 delta so a $75 move up should put them to about the same price as the Jan $615s, which are $40 so really over $700 and you'll still be in decent shape.  This play will not make you rich, of course, but it greatly lessens the chance that you will get wiped out.  

    The fact that we even have to discuss any single trade as making or breaking a portfolio is wrong.  The $25KP is the GAMBLING part of the Income Portfolio, which is $500K.  We say this over and over.  FAS Money is another risk part of it but, for some reason – no one likes to play that one and everyone is fascinated with AAPL but FAS Money in it's own "boring" way is up well over 100% in 3 months.  So I take responsibility for pandering as I thought it would be fun to play AAPL aggressively as everyone loves it so much but that was a mistake because I see people don't really manage their risks appropriately – from now on, $25KPs will be less aggressive and played as if $25K is all people have although, if you only have $25,000, you shouldn't be sitting at home trading all day when a JOB would double your money in a year or less. 

    AAPL/Nicha – Same as above and I'll spare the obvious lecture on your size-40 position that expires worthless in 26 days if AAPL doesn't gain over 15%.  You do have money, but you also have greed.  You can't roll 40 but you have a $12,000 position and I would put it into something like FAS Money and walk away from AAPL but, if you would rather keep torturing yourself, then a spread like the one above with less positions makes sense but, again, if this is all of your portfolio and not just the aggressive part of a larger whole, you don't have the money for the short sales and it's pointless – so again we're back to you being better of with something like FAS money as we have 15 XLFs at about $4,500 and this week we shorted 3 calls (that gained 50% in a day) for $540, which is a 12% gain in a single week if they expire worthless and, even if they don't, selling 10% a week for 26 weeks a year (assuming we take half or of lose some of them) is 260% a year and there's not much upside risk as we usually maintain 3:1 coverage and the downside risk to XLF seems pretty limited by QInfinity and Bank earnings have been the only bright spot this Q and QE hadn't even kicked in yet.  

    Wage inflation/Jabob – In what context?  

    So, on the whole, wages essentially never keep pace with inflation but, in the last few years, they have clearly gone negative measured as real wages to inflation.  Small wonder people don't feel better off than they were 4 years ago – they're not – unless they are market investors and even market investors who bought AAPL don't feel better off this month.  

    GOOG/8800 – Wow, I can't believe how worried everyone is about AAPL and GOOG.  We're talking about a 12% drop from here just to get to $600 and you sold the $600 puts for $31 so another 5% before you short putter is even in the money and the $550s at $20 net another 10% drop before you have to give that guy his money back and I have to say that if you are long on a stock that you think will drop 17-27% in 3 months – you are really missing the whole point of why we buy stocks in the first place.  Assuming you do REALLY want to own GOOG at net $530, we'll ignore that and look at the 2014 $600 puts, now $44 so down $11.  If you are this worried about GOOG going lower than that, shouldn't you take the net $14 loss ($8,400) and you still have the 3 $550 puts you sold for $20 ($6,000) so now you are essentially $2,400 in the hole on the 3 short $550 puts, which are now $28 so if you sell one more of those you have 4 short $550 puts for net $400 (.50 each) that can be rolled (if you have to) to 2x the $475 puts, now $15 but probably to much lower 2015 puts when they come out.  Now, if you don't want to finally own 800 shares of GOOG for $475 ($380,000) – why on earth don't you just take the $8,400 loss and the $2,100 loss and go find somewhere more comfortable to play as the 2.7% loss on your overall potential commitment isn't worth the time you are worrying about it and clearly – you don't REALLY want to own GOOG long-term at that net or you wouldn't be sweating being down $10,500 in the first place.  

    Not saved/StJ – I kind of consider simply not gapping down below supports to be a pretty good sign.  

    Asia down less than 1%, Dollar 79.60 after testing 79.80 on Friday.  Euro $1.3044, Pound $1.6014 and 79.29 Yen to the Dollar with the Nikkei at 8,940.  

  11. phil

    Good long-range perspective (which very few people have):

  12. kinkistyle

    The founder, chairman and co-CEO of NLY passed away yesterday:

    Annaly Says Michael Farrell Dies After Cancer Diagnosed

  13. zipla

    Depth/Phil
    I'm losing you a little on the latter part of the strategy — dealing with the short Oct 625s.
    Get it that you put stops on at the appropriate points but when you say:
    So, if AAPL doesn't make $625 by Thursday, … you need to roll anyway to whatever is $15 (??????)  but if AAPL goes up, you have the $70 spread that you paid about net $30 for  … and then you don't have any real trouble unless AAPL is over $685 on earnings and, even then,

    And this is where I totally lost you:

    the Jan $685s are currently $15 with a .27 delta so a $75 move up should put them to about the same price as the Jan $615s, which are $40 so really over $700 and you'll still be in decent shape. 

    Sorry for being such a dunce. I'm guessing what we're talking about it a break-even play on the spread: That I have a chance of making $40 if the stock goes up so I can take that against the loss I might have to take if the Oct 625s go against me fast. Right????
    To simplify: So I roll the 635s into the April spread at an extra cost of about $15. OK get that.
    But the rest of it about manipulating the short 625 covers is a little mysterious. I can wait and see how the market is tomorrow and see how you deal with them — since you're got them in the 25KP as well. And I'm guessing one way or the other that's how we're going to deal with the anyway. Blow by blow as AAPL staggers or rises.
    TIA

  14. neverworkagain

    Hedging:  Phil, I just wanted to give you my feedback having been a PSW member since 2009.  I originally was intrigued by the ultra hedges using TZA, EDZ, and SDS as highlighted above. But after a couple years of using them, found that regardless of market direction, they almost always lost me money AND did not protect my portfolio during periods of declines or crashes. This was mostly due to timing as the spreads did not show much profit until near expiration. And during periods of market dislocation, the spreads are hard to roll, leg out of, etc.  And of course there is the ongoing ultra-decay.
     
    So, what I have ended up using exclusively is basically full circle from your 2007 days, The Mattress Play.  I use SPY & SPX.  I keep it really simple. My longs are OTM 6-9 month puts. Then I sell weekly or front month covers, always slightly less in number than my longs. My portfolio payoff profile always has an UPWARD tail once a market crash gets out to a 10% or 20% decline.  This allows me to sleep at night. The tricky part is sizing relative to my portfolio. And it also allows me to do a momentum trade whenever I want by cutting / adding weekly or monthly covers when I need to get more or less bullish. Those options have lots of liquidity and I only need to worry about a single position to change my portfolio delta.
     
    So, although I understand completely your hedging ideas, I see the constant questions, and the constant losses that many members are getting in TZA, EDZ, etc.  It seems many people end up over hedged. And ironically, I think your Mattress play is the solution for many members, although I know we haven't used it on this board for at least a year. Just something to think about.
     
    For the rest of my portfolio, I do no $25K trading at all, and just focus on longer term stuff. At all times, I consistently do better when I have less positions in my portfolio, and when the positions I do have are longer term in nature. In other words, for both hedging and performance, SIMPLE AND PATIENT WINS. 

  15. phil

    NLY/Kinki – If they sell off on that "news" it's a good buying opportunity. 

    AAPL/Zip – I'm just talking about the upside "worst case" and looking ahead at the rolls.  Anytime you have a position, you should absolutely know AND be comfortable with what you will do if your stock goes up or down 10%.  Where will you roll, when will you cash out.  If you can't afford the next move – NOW is the time to stop, not after you're "surprised".  Like a good chess player, an option player must be thinking at least 3 moves ahead and have a plan for each possible counter-move his opponent (in this case, the stock price) might make.  So you "lost me" AFTER AAPL goes up on earnings and blows out or Nov $645 calls, which is the case in which we have to roll up to the Jan $685s (estimated), which hopefully would be an even roll.  Why would they be an even roll?  Because the CURRENT Jan $615s are $40 so a $65-$70 move up in AAPL by Friday should pretty much put the Jan $685s to the price of the current $615s.  After that, we STILL have 3 more months to roll and, of course, we can always adjust the bull call spread, which would be nicely in the money by then.  Of course we wait and see with a lot of things – this is just a plan but, as Helmuth von Moltke (the Elder) used to say: "No battle plan survives contact with the enemy" but also remember what Sun Tzu says: "Victorious warriors win first and then go to war, while defeated warriors go to war first and then seek to win."  

    Mattress plays/Never – Good point.  As I always say about disaster hedges but many people seem to ignore is that these are INSURANCE PLAYS WE EXPECT TO LOSE – they are protection against a major disaster, not a minor one.  In May, we had money of them pay off 200% and 300% but not 500% and 1,000% but fortunately we were smart enough to cash out early.  As you point out, you simply don't get a full payout unless the market goes down AND STAYS DOWN through the expiration but, if you are protecting long-term long positions, that's fine because, if the market comes back and you don't win on the insurance play, your longs are coming back as well and the insurance is not needed.  Mattress plays are great as you can also make that short-term money while you wait – I guess frankly I just got bored with them and play with these more – usually with  bullish offsets to lower the cost but next time, we'll try a mattress hedge – gotta love the classics.  

  16. phil

    Good morning, by the way…

    Meanwhile, Futures same as last night.  Asia was up slightly, Europe flat and that's all much better than expected so we'll see if we can at least make weak bounces today. 

    Notable earnings before Monday’s open: BTUCATFCX,HASNLSNPHGSTIVFC

    Notable earnings after Monday’s close: CECNIDHT,HMASCCOSWFTTXNVECOWDCYHOOZION

    3:32 AM Asian shares rise in choppy trading but European shares open mostly lower, weighed down by disappointing earnings reports from the likes of GE and McDonalds on Friday and the sharp decline in Japanese exports. Japan +0.1%, Hong Kong +0.4%, China +0.2%, India +0.3%. Euro Stoxx 50 -0.1%, London -0.3%, Paris -0.3%, Frankfurt -0.3%, Milan +0.1%, Madrid -0.2%.

    5:28 AM EU shares turn higher, supported by a regional election victory yesterday for Spanish PM Mariano Rajoy in his home stronghold of Galicia. However, the Basque nationalists look to have won in their region, as expected. Still, the Galicia result makes it easier for Rajoy to implement more austerity and make a request for aid, says ETX Capital's Markus Huber. EU Stoxx 50 +0.4%, London+0.1%, Paris +0.3%, Frankfurt flat, Madrid +0.3%, Milan +0.8%. Euro+0.25% vs the dollar.

    6:00 AM Overseas: Japan +0.09%;. Hong Kong +0.68%. China+0.21%. India +0.58%. London +0.12%. Paris +0.18%. Frankfurt-0.06%.

    6:38 AM U.S. stock futures follow global markets higher. S&P +0.2%, Dow +0.2%.

    7:15 AM Shanghai erases an early decline following a big losses in the West on Friday, and closes +0.2%. One of the worst-performing major markets for some time, China has quietly put in a nice rally as the U.S. has stumbled over the past few weeks as investors look forward to November's power changeover and perhaps action from the new government. FXI +1.6% premarket.

    The Reuters Tankan Japanese manufacturers' sentiment index -12 points in October to -17, the largest fall since just after the March 2011 earthquake. The manufacturing index is predicted to improve only slightly to -13 in January. The index for non-manufacturers +7, unchanged from September. The increasing  gloom is due to the anti-Japanese protests in China and a weakening EU economy. 

    Japanese exports -10.3% Y/Y in September vs consensus of -9.6% for the biggest drop since May 2011. Imports +4.1% vs +2.9%. Trade deficit ¥558.6B vs ¥547.9B for the first September shortfall since 1979. Exports to China -14.1% as the East China Sea islands row takes a toll. Sales to EU -21.1%, to U.S. +0.9% vs +10.3% in August.

    Hong Kong's central bank was forced Friday to intervene in the FX market for the first time in years, selling HKD after it hit HK$7.75, the top of its trading band against the greenback. The HKD's strength again gives rise to chatter the famous peg might be abandoned. Bill Ackman's bet on such is one year old, going on two. Hong Kong shares (EWH +17.8% YTD) are among the best performers in Asia this year.

    China's State Council asks policy think tanks for ideas foreconomic reforms and receives proposals that include limiting the power of state-owned enterprises, allowing the market to set the price of bank credit, land and natural resources, and giving more freedom to the yuan. However, some of the authors of the proposals fear that signs of an economic rebound could stall their recommendations.

    Just at the time the economy may need a boost, Australian Treasurer Wayne Swan promises significant belt-tightening in order to meet a pledge of returning the budget to surplus this year. "It means monetary policy can play the primary role managing demand," he says, giving a very clear push to the RBA to quicken the pace of rate cuts. We'll keep an eye on the aussie (FXA) this week.

    Germany's economy probably expanded in Q3, helped by growth in industrial production and strong exports, especially to outside to the EU, the finance ministry says in its monthly report. The economic growth came despite the weak global background and analysts forecasting contraction, although the ministry does warn of a softening in Q4.

    Rajoy Wins Heartland Victory as Spaniards Lift Bailout Obstacle. Prime Minister Mariano Rajoy extended his majority in the stronghold region of Galicia as Spanish voters offered some respite to his 10-month-old government and removed one obstacle to a European bailout. 

    Spanish Regional Bailout Fund Runs Out Of Money Just As Regional Elections Begin. 

    Greece Austerity Diet Risks 1930s-Style Depression: Euro Credit. Greece is spiraling into the kind of decline the US and Germany endured during the Great Depression. The economy shrunk 18.4% in the past four years and the IMF forecasts it will contract another 4% in 2013 as Greece struggles to reduce debt in exchange for its $300 billion rescue programs. That's the biggest cumulative loss of output of a developed-country economy in at least three decades, coming within spitting distance of the 27% drop in the U.S. economy between 1929 and 1933. 

    No more light-touch regulation in the U.K.: the Financial Services Authority is forcing banks to hold £150B of "Pillar 2 buffer" capital on top of the £186B needed under Basel rules. The additional amount is much higher than the £20B required prior to the financial crisis. The FSA's Andrew Bailey tells the FT that the extra cushion allows regulators to experiment with ideas to encourage lending.

    Worst Carry Trades Show Central Banks Reaching Stimulus LimitsThe $4 trillion-a-day foreign- exchange market is losing confidence in central banks’ abilities to boost a struggling world economy. Rather than sparking bets on growth, the JPMorgan Chase & Co. G7 Volatility Index, which more than doubled in 2007 to 2008 before policy makers employed extraordinary measures to address faltering global expansion, has dropped to a five-year low. While small foreign-exchange swings historically favor the strategy of borrowing in low-yielding currencies to buy those with higher returns, a UBS AG index that tracks profits from the so-called carry trade has fallen to the lowest level since 2011.

    Q3 Earnings Season To Date Summary: Ugly… And Getting Worse. 

    Hedge Funds Cut Bets to 12-Week Low as Prices Drop: Commodities. Hedge funds cut bullish commodity bets to the lowest since July as speculation that governments in China and Europe aren’t doing enough to boost growth drove prices to the biggest loss in five weeks. Speculators reduced net-long positions across 18 U.S. futures and options by 4.4 percent to 1.18 million contracts in the week ended Oct. 16, the lowest since July 24, U.S. Commodity Futures Trading Commission data show. Gold bets slid 7 percent, the first decline since Aug. 14, and those in silver fell 5.8 percent, the first drop in 12 weeks.

    While the conventional wisdom says that immigrants take jobs from Americans by undercutting them on wages, says Eduardo Porter in the NYT, research indicates that immigration has mostly not led to fewer jobs for American workers. In fact, it appears that immigrants help strengthen the economy in the long term, leading to increased profitability for companies and lower prices for some products and services. 

    Research shows that tax cuts for the top 5% have no effect on job creation in the subsequent two years but they do for the bottom 95%, says ex-Clinton economic adviser Laura D'Andrea Tyson along with Owen Zidar, also a former White House economist. Consumption goes up more following tax reductions for the latter group, which leads to increased demand – a "primary determinant" in companies' employment decisions.

    The White House has denied an NYT report that it has agreed in principle for the U.S. to hold one-on-one talks with Iran over the latter's nuclear program following secret exchanges between officials from the countries. However, National Security Council spokesman Tommy Vietor says the U.S. is "prepared to meet bilaterally." 

    Caterpillar(CAT) Announces Earnings On Monday — Here Are The 4 Questions We Want Answered. 

    If These 5 People Who Tried Windows 8 Are Normal, Microsoft(MSFT) Has A Big Problem On Its Hands.

    China Mobile (CHL): Q3 net profit at 31.1B yuan ($5.4B). Revenue of 142.1B yuan. ARPU falls due in part to the increasing use of multiple SIM cards. Subscriber base of 75.6M 3G users at the end of Sept. (PR)

    image

  17. 8800

    Phil,
    Thks for the GOOG perspective, strategy and comments. My concern was based on the 6 sigma possibility that GOOG may have been overtaken by product market forces in the search space lost its privileged position and therefore its mojo. Would you consider selling weekly calls if GOOG stays in a sht trm dn trd?
    TIA again

  18. newt

    25k/ Phil et al.: The portfolios are great and I hope you keep them going in the style you have.  When I look at them I see several "layers" and I choose what fits my mood/ risk tolerance for the time frame. The aggressive layer (i will single that one out as recent market forces have shaken thing up) is important. When you are in a bind or feeling like you are a well rounded investor, trader, etc. needs to be able to move through it.  And seeing you navigate it I feel helps us tighten our OODA loops.

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