Monday Market Movement
by Phil - February 8th, 2010 8:28 am
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We love patterns!
Pattern recognition is the basis for human thought so it’s always fun to look at charts like this one from InTheMoneyStocks and think we may see something we recognize. It’s interesting that looking at some of our other PSW Chart School posts from the weekend that look at virtually the same charts but spot different patterns. Fallond, makes a convincing case that we have confirmed sell signals and Corey at Afraid to Trade also feels we’re in the middle of our correction.
MarketTamer is looking for Dow 9,750, which is the middle of our worst-case targets at around the 10% rule, something I touched on in my own Weekend Wrap-Up, where I did my own humble best to paint a picture that’s worth 1,000 words. Fortunately (although maybe not for you), coming up with 1,000 words has never been a problem for me so I will stick mainly to the Fundamentals, thank you very much!
I did some soul-searching on the situation in Greece, as outlined in our Weekend Reading post and I am comfortable with last week’s gut reaction that we have now adequately priced in both Greece and Portugal’s problems. Our outlying concern is a spread to Spain, Italy and France, which I don’t believe is likely as the cost of bailing out Greece, Portugal, Spain, Italy, France, Turkey and the UK would not even be what the US spent to bail out AIG. The same way we gave the hyenas a bone back in November of 2008 and they attacked any financial institution that showed even a hint of weakness, the pack is now all over any country that is vulnerable to panic. It’s a simple game, short the bonds (sell bonds at low rates), drive rates high, buy back the bonds, collect high yields.
Sure the fact that this sort of activity can disrupt the lives of millions of people might give some people pause but I’m sure someone like PimpCo’s Mahamed El-Erian feels like he’s doing God’s work when he is done loading up on bloated rate bonds and then suddenly announces, as he did this morning (and we predicted he would last week): "The risk of Greece defaulting is low." El-Erian said that, although the Greek government is in need of external financial aid, it likely will not default.
Oddly enough, it was just this past Thursday that PimpCo’s Michael Gomez said: "Stay away from the Euro" which (funny coincidence) drove Greek bonds and CDS swaps to…
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Weekend Reading - Greecing the Wheels
by Phil - February 8th, 2010 3:51 am
I’m done with Greece.
I was getting sick of it last week and now I’m really done after doing some research: First of all, Greece’s deficit (as we discussed last week) is a shocking 12% of their GDP and their national debt is 120% of their GDP (ours is about 100% now so something about glass economies and stones comes to mind) BUT, their whole GDP is $343Bn so we’re looking at a grand total of $41Bn to completely bail them out this year - the boyz at Goldman probably took about that much home in bonuses just betting on Greece to fail!
Do we really believe the $16,000,000,000,0000 EU economy is going to go down over $42,000,000,000 (0.26%)? Kind of hard to imagine when put in perspective. Of course it’s not just Greece, there’s Spain, Portugal and Ireland, although Ireland was last year’s worry with a $100Bn debt that they ended up fixing themselves by tightening their belts. For the Greeks, it’s more a matter of is there a will than a way as Greece has long been the EU’s least productive economy (followed by Portugal), which has historically made them uncompetitive with their northern cousins.
All it would take to fix Greece ($343Bn GDP) and Portugal’s ($220Bn) deficits is for Germany ($3,235Bn) and the UK ($2,200Bn) to buy a few extra Greek and Portugese goods and the factories would be humming again. The two countries each have about 1M people out of work (10% of the population) and if we assume 5% is close to full employment then we’re just talking about employing 1M people. Even if we pay those people $50,000 a year each, that’s "just" $50Bn and suddenly, everyone in Greece and Portugal is back at work, off the dole, paying taxes (iffy in Greece) and contributing to the GDP, which fixes the deficit.
$50Bn is just 1% of the GDP of Germany and the UK and back to 0.3% of the EU’s GDP. Hell, the global markets have lost $4,000,000,000,0000 in the last two weeks worrying about this $50,000,000,000 - THAT’s the magic of Credit Default Swaps - we get to leverage relatively small and correctable global problems into market catastrophes so fast that heads of state don’t even have time to call a meeting before the bankers have slashed and burned their economies.
So I was leaning this way at the end of last week and, now that I’ve had a chance to dig into it, I’ve decided it’s…
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Weekly Wrap-Up, it’s Only a 55-Point Drop You Wimps!
by Phil - February 7th, 2010 12:19 pm
That’s right, I said WIMPS!
I have never heard so much whining and crying and complaining about a market drop as I have the past few weeks. Last week, I pointed out that we had only fallen 105 points from the prior week (10,172 to 10,067) and this week we fell ALL THE WAY to 10,012 to finish the week and you would think the world was ending (again) from the way the MSM has been acting.
By Friday the panic was palpable as we gave up Monday and Tuesday’s bogus gains to test new lows for the year - testing, in fact, the lowest levels the market has hit since last November and I pointed out in Friday’s post that it reminded me of when BSC and LEH went under and everyone panicked and sold Financials off to the point where Warren Buffet was willing to give GS $5Bn AFTER they bounced 50% - THAT’s how undervalued the financials were in November of 2008.
What do we do while people are panicking? We BUY! We don’t BUYBUYBUY like Cramer’s Pavlovian Peons but we sure do BUY and take some nice entry positions with sensible hedges. I was finally motivated to finish updating our Buy List on Friday and 18 of our 38 positions were highlighted (immediately actionable) on Friday. Sure they may go lower, but we’re buying them with 20% buffers built into the positions and then we can double down if they drop 40% (back to Nov 2008 lows) and then we’ll have our entries down 10% from the lowest levels of the past decade or so that we can hold until the next decade - what’s there to panic over?
If I wanted to buy IBM in January but thought it was a little pricey at $134, why would I not be HAPPY to have the opportunity to make an enty at $122, back at where they were pre FABULOUS October earnings? I can buy IBM for $122 and take advantage of the panic-induced VIX at 26 to sell July $125 calls for $6.60 and the July $120 puts for $6.65 for a net entry of $108.75 with a call away at $125 for a $16.25 profit (15%) in 5 months. If IBM should fall below $120, we will have a second round of the stock put to us as $120 for an average entry of $114.38, another 6.2% lower than it is now. If we were more worried, we…
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How to Make Profits in Your Spare Time
by Phil - February 7th, 2010 8:26 am
Option Sage submits:
I saw an infomercial from Fisher Investments where Ken Fisher mentioned 3 attributes that he believes are keys to successful investing which can be crudely summarized as follows:
[1] Focus on long-term investing
[2] Expect surprises
[3] Stay ahead of the crowd by knowing what others don’t
The first point is certainly critical and weeds out the greedy ‘get-rich-quick’ traders from the patient traders. Our policy here is that of ‘play-to-win’. We like to be aggressive in seeking profits with short-term plays but we also recognize that if those trades don’t work out that we can still rely on longer term plays to end up profitable in the end.
The second point regarding expecting surprises asks the trader the question “Are you managing risk well and do you have contingency plans in mind each time you enter a trade?” While the second part of the sentence is important, the first is paramount! No matter what you do, never violate risk management rules which we have discussed here in the past.
The third point is a luxury in my view. Of course, it would be nice to know what others don’t but it’s not critical. By definition only a small number can have information that the rest of the crowd does not have so if you are not trading full-time you have to find another way of making money without relying on staying ahead of the crowd.
As I was scanning for trades over the weekend, I came across one trade which might in fact fall into the category of offering relatively attractive profits by relying on options rather than additional information. In fact, I know many of our members find it hard to focus on the daily trades and would like to construct portfolios with the longer-term in mind. As Phil mentioned in his classic "James Bond Investing" article, playing short-term positions requires constant vigilance and you need to ready to turn on a dime with small windows of opportunity and this kind of trading is not for everyone. Even Phil has a rule of thumb that 75% of a portfolio should be in long-term positions like calendar spreads, buy/writes and covered calls, which generate lower returns but are easier to manage and have a wider margins for error.
So, I set out with the goal in mind of finding a trade that could produce a 10% annual return, noting that this would lead to a doubling of your…
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Flashback Friday - EU and the Ghost of Lehman’s Past
by Phil - February 5th, 2010 8:25 am
It was September 15th, 2008 when Lehman announced they would file Chapter 11.
Lehman had already lost half their value in one day on September 9th as the government failed to step in and assist them. Whether they were solvent or not became a non-issue as investors lost confidence and put a run on Lehman, making the short attacks on them a self-fulfilling prophecy. Jean Claude Trichet yesterday, was speaking up for the EU in the same way that Dick Fuld attempted to speak up for Lehman as the end was near. Fuld could not believe that people were questioning the solvency of LEH and Trichet can’t believe that people are now questioning even the continued existence of the Euro.
"Trichet did not convince me,” said Stuart Thomson, who helps manage $100 billion at Ignis Asset Management in Glasgow, Scotland. “Where does he think the Greek, Spanish and Portuguese economies will be three years from now? Their austerity measures will weigh on the euro area as a whole.” As Greece tries to control a record deficit and stem a slide in its bonds, Trichet said the economy of the 16-nation euro area is solid and its budget shortfall will probably be smaller than those of the U.S. and Japan this year. The comments yesterday didn’t stop Spanish and Portuguese stocks from dropping on concern they are in a similar predicament to Greece, or the euro from tumbling to a nine-month low against the dollar.
Trichet has been forced to fend off questions about the survival of the euro as investors doubt Greece’s ability to cut its deficit from 12.7 percent of gross domestic product to below the European Union’s 3 percent limit. As concern spreads to Spain and Portugal’s rising debt burdens, Trichet will try to stress the need for fiscal prudence without inflaming skepticism that it can be achieved. “Something has to happen to turn credibility around,” said Paul Mortimer-Lee, head of Market Economics at BNP Paribas in London. “The market’s just saying it’s not believable. It might have to get worse before it gets better.”
Trichet said the “solidity” of the euro area “is not necessarily very well known” and its situation compares “very flatteringly with a number of other industrialized countries.” He said that according to the International Monetary Fund, in 2010 the average deficit for the entire euro region should be around 6 percent of GDP. “Can I mention what it is…
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Thursday - Greece is the Word
by Phil - February 4th, 2010 8:29 am
Greece is the word these days.
We are getting a sell-off every morning as Europe goes through the daily ritual of waking up and seeing the cost of default protection rise and rise. This morning Greece is with STUPID (Spain, Turkey, UK, Portugal, Italy & Dubai - coined by Zero Hedge) as five-year sovereign credit default swap spreads were recently at 4.23 percentage points, compared with Wednesday’s closing level of 3.97 percentage points. That means the annual cost of insuring €10 million of Greek government debt against default for five years had risen €26,000 to €423,000. In a nutshell, that’s 4.23% annually to insure Greek bonds from default so Greece needs to offer 4.23% more interest on their bonds than an Aaa nation to attract investors.
Of course, my new "I’m with STUPID" T-shirt franchise is going like gangbusters as we are getting orders from all over the US, especially California, as our own triple-A credit rating may not last the year. Japan is a strong customer (mostly small and extra-small) and sales are strong in France and, of course, Mexico and all of South America.
Keeping up with the STUPIDs is no easy feat as Portugal’s CDS spreads jumped 15% overnight to an all-time high 2.26 while Spain gained 10% to 1.68%. (Have I mentioned I like TBT lately?) The moves followed news Wednesday that the European Commission had put Greece under more pressure to cut its deficit; that the Portuguese government sold only €300 million of treasury bills at an auction, compared with an indicative offer of €500 Million; and that the Spanish government had raised its budget deficit forecasts for 2010 through 2012.
As we expected in yesterday’s post, Greek workers were none too pleased with the EU’s budget plan for their country and is rejecting the idea of wage freezes on top of wage cuts. Greece’s biggest union is moving towards a mass strike and the public-employee union is planning a job action next week as well. Tax collectors are striking, customs workers are striking, which is screwing up the airports and shipyards and delaying commerce all over Europe - shades of things to come perhaps?
Napoleon said: "A revolution is an idea which has found its bayonetes" and John Kennedy said: "Those who make peaceful revolution impossible will make violent revolution inevitable" and what we are seeing here is backlash as workers of the world have been pushed to the brink for many years and now, as the governments are asking them to take that one…
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Wednesday Rejection Weakness
by Phil - February 3rd, 2010 8:21 am
So close but yet so far!
We set our bounce levels way back on Jan 25th and just yesterday I posted up the WEAK BOUNCE levels we need to see before taking our bullish betting to the next level but we have only skimmed along our lines, finishing yesterday at Dow 10,296 (down by 2), S&P 1,103 (down by 2), Nasdaq 2,190 (down by 10), NYSE 7,001 (up by 1) and RUT 614 (down by 6). This may be seem like some pretty amazing targeting 10 days in advance but, actually, we could have predicted this move last year as it’s nothing more than the same 5% Rule levels we’ve been using since the middle of last year.
That is why, we are not in the least bit impressed by close. Close, as they say, is no cigar! Don’t forget those are the natrural dead-cat type bounce levels off the drop from the top that we are trained to IGNORE as they are meaningless in the grand scheme of things. What is meaningful is when they we retake those levels and that means we found a true floor at 5% (see weekend chart) NOT taking back AND holding our retrace levels means we are very likely to see phase 2 of our leg down and hit 10% drop levels of Dow 9,630, S&P 1,035, Nasdaq 2,088, NYSE 6,660 and Russell 585 so we will now become much more concerned by failure or those lower levels (10,058 on the Dow etc) which MUST HOLD.
We’re not there yet, we MAY be consolidating along the 5% lines and that would be good, but unnerving. We have our disaster hedges in place and we got our commodity rally so we can on some oil puts (what a joke at $77.50 already with yet another inventory build to be announced today) and perhaps even some gold puts as we test $1,130 (GLL $9 puts have very little premium at .90). Our favorite hedge of the moment is once again EDZ, who are back to $5.50 thanks to a nice move up in Asia today. March $5 puts can be sold for .45 and that’s a very nice way to collect premium as EDZ has to fall 20% before you even owe the putter a nickel but the July $4/6 bull call spread at .85 pays $2 (up 135%) should emerging markets falter (and you know how we love to exploit those emerging…
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Peter D - Confessions of the PSW Strangler
by Phil - February 3rd, 2010 4:49 am
Peter D has a long-running and very successful system of selling premiums on a regular basis that’s well worth learning.
Investors selling a short strangle are expecting the underlying stock to not move much in either direction. The strategy is accomplished by selling a call option at a higher price than the current stock or ETF price and by selling a put option at a lower price than the current stock or ETF price. Both of the options will have the same expiration month. The investor in a short strangle benefits from the underlying moving within the spread between the call strike and the put strike.
There are two reasons we like this strategy a lot at PSW:
1) It’s boring! Unless the market is MUCH more volatile than normal, taking sensible, NON-GREEDY, out-of-the-money short option positions is a fairly market-neutral way to place our bets. While the risk/reward ratio may seem inverted, statistically it’s a winning play over time.
2) It’s perfect for our "be the house, not the sucker" philosophy of trading. We are always looking to SELL volatility. The idea behind this trade is that front-month volatility is relatively expensive compared to historical long-term volatility and we take advantage of selling a very high cumulative volatility over the course of the year.
We recently ran a collection of comments following through on some trades over time and quite a while ago Sage wrote an article relating about using short strangles on longer-term stock plays, which provides some additional ideas on how to apply this strategy. Peter has been kind enough to provide us with a definitive guide to help set you on the road to a successful career as a strangler. The following is a collection of posts (make sure you use the links) on Short Strangles and the Crazy plays on the indices (SPX, RUT, NDX, etc.):
1- The Crazy play consists of a Short Strangle and a protective long put vertical. These plays are mainly for Portfolio Margin accounts, with balance greater than $125,000, preferably over $200k as the margin can swing wildly.
2- Very rough comparison among Short Strangle, Iron Condor, Buy/Write and straight stock purchase. Note the rolling tips in the second to last paragraph.
3- VIX, the effects of.
4- Possible adjustments of the Crazy Play.
Additional discussion on doubling down.
5- Figuring out the margin requirement for short strangle using Thinkorswim Analyze Tab.
6- Setting up February 2010 spreads on Jan 4th.
7- Thoughts on Delta movement with respect to the underlying.
8- Selling into a VIX excitement,…
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Testy Tuesday - Back to our Bounce Levels?
by Phil - February 2nd, 2010 8:27 am
Too tricky to call!
We’re trying to be bullish now, so we don’t complain about stick saves and we got a nice one into yesterday’s close and another one in the futures, which were down about 50 at 3am - but it still looks like BS to me.
On Thursday morning I said: "Our 5% "must hold levels" remain: Dow 10,165, S&P 1,088, Nas 2,200, NYSE 7,000 and RUT 620 with 3 of 5 below = BAD!" We got the Dow, S&P and the NYSE back over the line yesterday and now we need the Nasdaq and the Russell to show us the money and catch up. Of course, this is just our "averting disaster" levels - we haven’t even broken our "weak bounce" targets of: Dow 10,300, S&P 1,105, Nasdaq 2,225, NYSE 7,100 and Russell 625 that the 5% rule predicted in last Monday’s post.
Last Wednesday I asked the question, is it weakness or good old fashioned consolidation? My premise was that commodities were overvalued and we were due for some rotational correction, which was GOOD and HEALTHY. The market still has much to prove and we are still pursuing disastrous economic policies that will all end in tears but, in the meantime, we can still party like it’s 1999 as long as we know where the nearest exit is - and that’s what our Disaster Hedging is all about.
We took positions on DXD and QID yesterday as the weak bounce we got was a good chance to establish new hedges and I’m hoping we get another push in commodities so we can short some of them. EDZ is getting interesting again, back at $5.65, about 10% away from our sweet spot ($5) for taking up a position but we may hit them early if the US indexes can’t provide some leadership this week. As you can see from Trader Mike’s charts - we have plenty of resistance to get through and we’re still waiting to see a rise on anything but weak volume to give us more confidence.
Germany gave our confidence a small boost this morning as Retail Sales, adjusted for inflation and seasonal swings, rose 0.8 percent from November, when they dropped a revised 1.7 percent. Germany’s government this month raised its forecast for 2010 economic growth to 1.4 percent from 1.2 percent. While the economy is still grappling with the aftermath of its worst recession since World War II, the government has extended subsidies that encourage companies to hang on…
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Philip R. Davis is a founder Phil's Stock World, a stock and options trading site that teaches the art of options trading to newcomers and devises advanced strategies for expert traders...
Ilene is editor and affiliate program
coordinator for PSW. She manages the Favorites backup site
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