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How to Have a Happy and Safe New Year with Hedges

"Now is the accepted time to make your regular annual good resolutions.  Next week you can begin paving Hell with them as usual."  ~ Mark Twain
 

"We will open the book. Its pages are blank. We are going to put words on them ourselves. The book is called Opportunity and its first chapter is New Year's Day.” ~ Edith Lovejoy Pierce

I'd like to take this opportunity to wish all of my readers a very happy New Year.  2009 was challenging to say the least – clearly it was the best of times and it was the worst of times but if 2009 has taught us anything it's that there is always an opportunity for the perseverent.  We went from the depths of despair in March straight into a 9-month rally of epic proportions.  While we may question the wisdom of the underlying fundamentals, we cannot question the evidence of just how resilient our economy and our people really are and that, if nothing else, gives me great hope for our future.

I myself have gone from being the lone market optimist back in March (see our Crisis, Year One Review) to being one of the 11% of the remaining pessimists as the market takes back over 50% of it's losses (I am arguing that it's less than 50% in my Last Charts of the Decade).  Whether we are, as I think, at the apex of a very normal Fibonacci retracement or whether we are at the mid stage of a full recovery back to our 2007 glory remains to be seen but for now, I can re-use the same statement I made to Members when I argued the media was too bearish in March (click on image for great video):

"Television is a powerful and emotional medium, it is very difficult to go against the will of ALL these "experts" when they get on TV and all tell you to sell (or buy) and then their TV station backs them up with bearish news and bearish guests – it’s a natural bias that develops, they aren’t going to make their own paid personalities look foolish by contradicting them with facts and dissenting opinions." 

Substitute bullish for bearish and we have my quote of the day for December 31st, 2009.  If you do nothing else today in the markets, at least consider the idea of establishing some hedges – just in case we open the new year on a down note.  On December 9th I wrote an article called "Hedging for Disaster" and we've taken hits for being cautious early but having the downside hedges has allowed us to let our bullish positions run.  We can revisit those trades as a way to give ourselves some easy holiday weekend protection as well as building a long-term cushion against which we can make some bullish bets if the markets do break over our levels next week:

  • DXD Apr $26/33 bull call spread was taken for net $3, now net $2.40, down 20% – I still like this one
  • FAZ July $20/35 bull call spread at $2.80, now $2.60, down 7% – I still like this one
  • FAZ July $14 puts sold for $2.10, now $1.70, up 19% (pair trade to offset the above) – I still like this set but with the $15 puts sold at $2.10 now.
  • SDS March $38/50 bull call spread at $2, now $1.10 – down 45% – This was our high risk trade with a 6:1 payoff and a new $2 spread can be made with at $34/44 but it's just a 5:1 payoff with the lower VIX so not as good as the above plays.
  • SMN Apr $11 calls at $1, now .50, down 50% – this was another high-risk play that we have rolled down to the Apr $9 calls, now .85 as it makes sense that if the economy begins to fall, materials will pull back.

So that is the cost of insurance but (and you can read the original articles for the full logic and details), if the market does turn down sharply, putting just 5% of your virtual portfolio into those hedges can save you from a very bad situation.  Our actual entries were at much better prices because December 9th was an up day and we waited until that Thursday, the 11th, to trigger the covers, just 100 Dow points below where we are right now.  The time to buy your insurance is when it's cheap and the combination of a low VIX and a market at 52-week highs makes your downside protection as cheap as it's likely to get so Happy New Year!

McClatchy has a great article this morning claiming that our friends at Goldman Sachs and other IBanks ran what amounts to a $1.3Tn ponzi scheme on their own clients from 2002-2007, secretly packaging a new breed of offshore securities, and giving prospective investors little hint that many of the deals were so risky that they could end up losing hundreds of millions of dollars on them. 

McClatchy claims to have documents that include the offering circulars for 40 of Goldman's estimated 148 deals in the Cayman Islands over a seven-year period, including a dozen of its more exotic transactions tied to mortgages and consumer loans that it marketed in 2006 and 2007, at the crest of the booming market for subprime mortgages to marginally qualified borrowers.   In some of these transactions, investors not only bought shaky securities backed by residential mortgages, but also took on the role of insurers by agreeing to pay Goldman and others massive sums if risky home loans nose-dived in value — as Goldman was effectively betting they would.  Goldman. of course, said those investors were fully informed of the risks they were taking. 

saint-peter2.png image by Hx3_1963Whether Goldman was evil or "lucky" or simply, as Lloyd Blankfein says "doing God's work" remains to be seen but, either way, this makes me wonder if GS can ever earn the returns people are betting on on a go-forward basis since the money they made betting on a housing crash and the money they made this year using HFT programs in a relentlessly up market were possibly a couple of unique situations that investors can't count on GS repeating in the future

Hong Kong and Japan were closed this morning but the Shanghai added 0.5% to their streak, heading for a triple test of 400 early next week.  Europe is flat and closing early, much more sensibly than our markets with Germany not even bothering to show up at all.  

The Dow needs to do very little to hold a 20% gain for the year, up 61% from the March lows while the S&P is right on the 25% line.  Both indexes don't hold a candle to the Nasdaq, up 45% in 2009 as tech was the place to be in an early cycle recovery.  There's a lot of interesting things going on this last day of the year so I'll just mention a few (from Seeking Alpha Market Currents):

  • NWS and TWC seem to have no deal today and Fox will be removed from Time-Warner Cable systems at midnight.  Bad news for Uncle Rupert if none of the viewers complain.
  • It turns out that retail traffic was actually LOWER than last year, according to ShopperTrack but "consumers purchased more per trip."
  • Online holiday spending rose 5% to $27.1B, although per-customer spending was down slightly, comScore reported. Large e-retailers like Best Buy (BBY) and Walmart (WMT) outperformed smaller online shops.
  • Dec. ISM New York Business Index: 59.7 vs. 62.9 in Nov. for a fifth straight month of expansion. Six-month outlook broke the lofty 80 barrier, reaching 80.2 vs. 74.4 last month. Cost pressures remain contained.
  • After numerous extensions, YRC Worldwide (YRCW) says it finally got enough support to complete its debt-for-equity swap, allowing the trucking company to defer payments coming due. CEO Bill Zollars called the results "a major turning point" and said, "With our significantly restructured balance sheet and enhanced liquidity, we will move forward from a more solid financial foundation."
  • China central bank Governor Zhou Xiaochuan says 2010 will be a crucial year for strengthening the country's recovery and 'defeating' the financial crisis. Zhou’s New Year message reiterated that China's 'moderately loose' monetary policy will continue.

So the madness continues right into the new year.  I hope yours is a happy and healthy one.

All the best,

– Phil

 

126 COMMENTS

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Happy New Year EVERYONE!  Thanks for all the help!!! 

 What just drove TLT?

 No stick today!

TmDecay/ stick
LOL, I start thinking that they are russian programmers and now are drunk

Maybe Blanfein’s bet was 10,400.

Tchay…. I did not think these guys had any interest in Vodka…. just numbers  LOL

This finish is the shitz… that OK – I’ll get even next year.

This finish is the shitz… that OK – I’ll get even next year.

WOW, I think emerging market on Monday will collapse 5%

Phil, yes you nailed the DIA puts…..that was a nice finish–not too rash or risky but was based on what was happening in front of us, so the likelihood of success was better.
 
BTW do you ever play options on the futures? It seems to me that the bid/ask spreads and the investing time frame you are suggesting make that foolish, but wondered what you thought. And yes, sleeping might be hard with oil futures over many days, so I wisely declined. I think sticking to resistance/support lines for future plays is wiser.

Ahhh…..the good ol’ days!!

At first I was surprised that they would let it end like this but then I remembered they will have a 20% gain headline for the year and they can molest that one to death!

Hi Phil ERX hold long Feb 39c @ 4.98 now 4.35 now  and short feb 43c @ 2.98 now 2.70
in one of you previous recommendations you mention to make some changes if the stk goes below 40.00 can not remember any more your recommendation please refresh thanks

 Picked up EWJ jan 10 puts for only 7 cent premium,

 Hey Phil..is there a button to access the alerts off the website or do I eed to check email?

Darn! Waiting 4 the famous stick save as not able to climb on board Dia p-OH well! Have a good one &a  good new Year to everyone!!! Will catch another IN THE NEW YEAR! Moscow was sure beautiful!!

Happy New Year everyone !
 
Phil … cool charts, where did you get the Fibonacci’s ?  I need that … what are you using ?

 Cap, Phil’s charts were made with the paid version of stockcharts.com

May you be blessed with good fortune in the coming year…CHEERS everyone!!

CHEERS to ALL !!  May 2010 be even MORE profitable for you.

Phil,
This dialog can wait, so go do your beer run.
 
Not sure if we are talking about the same thing regarding options on futures, rather than just playing the options. What I was asking about were options on futures contracts, like on the /CL. So rather than buying a contract in /CL, buy an option on the contract. TOS added these options not too ago apparently.

VERY interesting discussion about China over at Zero Hedge here …. read the comments, such as this:
http://www.zerohedge.com/article/it-doesnt-take-genius-figure-out-how-will-end
by chinaguy
on Thu, 12/31/2009 – 15:11
#179217

Ok guys, I’m not a China basher, China has been very good to me. I’ve made a fortune working there for 25 years but I’m going to lay down some very fundamental realties about China.  and you can take this diatribe with as many grains of salt as you like.
You can not rely on any statistics coming out of Beijing. None of them. Not growth, employment, power consumption, air quality, number of Chinese traveling abroad. None of it. No Chinese business man would make a critical decision based on stats out of Beijing. They base their decisions on reading between the lines and what they hear from their connections in the Party.
I just laugh when I hear people saying: “well power consumption in China is this amount, therefore GDP must be at this level. Basing analysis on flawed data can only give flawed results.
Any conclusion, about the Chinese economy has to come from first hand accounts (sorry), external audits and counting container loads at Long Beach.
China, in spite of it’s much touted reserves, is really not two trillion dollars liquid.   In 2006 Ernst and Young released a report concluding that the "nonperforming" loans of China’s banks totaled $911 billion (40 percent of China’s GDP): http://www.aei.org/article/24543
This amount was over 500% larger than Beijing’s official position of $164 billion in NPL. Beijing screamed bloody murder. Who knows exactly how much pressure and by whom was placed on E & Y, but they quickly withdrew the report and replaced it with one which exactly agreed with Beijing’s figures.
     Ernst & Young likes very much to work in China. They would not have released this shit storm lightly. Occam’s Razor would say that China’s NPL are at least 900 billion and in 2009 probably over one trillion in NLP. So with China’s foreign reserves at $2 trillion…. you can scratch half of that.
 
Regarding real estate. I have personally tracked individual sales of several apartment complexes in Hangzhou and Shanghai for years. Residential RE has increased about 300% to 400% in the past four years. We are talking about decent, centrally located apartments in the $500k – $1,000K range in cities where upper management (who would earn low six figure in the USA) make about $20K – $40K. The vast majority of workers are making less. Senior software developers, for example, make about $15k/year How are people affording $500K apartments with these wages? My conclusion is that Chinese residential real estate in an enormous bubble.  Chinese CRE is in the same boat it is here, but probably worse because bank loans do not need to go through any feasibility study if you have the right connections, and, the big players in Chinese CRE have the right connections.
Growth.  I made a survey of industrial areas in Zhejiang, Hubei and Shannxi provinces several months ago. Hubei and Shannxi are provinces where heavy equipment, cars & aircraft are made. Those areas were busy but static, not adding jobs. The new “high tech” corridor in Hangzhou, Zhejiang was sucking wind. My conclusion based on these observations was: “8% growth” no f-ing way.
Extend and pretend. There is no audit of the Chinese central government. None. Decisions are made behind closed doors and the news that is released is whatever they decide to release. That’s just it.
My conclusion is that China is a lot less solvent that we are lead to believe, both commercial and residential RE are in a tremendous bubble and growth is no where near 8%. The largest problem IMO when it comes to making decisions about china is that the salient facts are all hidden. Opaque. There is no way to learn how bad things are and when it will collapse. It might not collapse at all, but China is much worse off than Beijing would like us to believe.

Cap
I agree with you 150% ( think that situation even worth that you think)
oficials always lie, but if it is no opposition and media fully controled they lie even more
I think as soon as correction will started in US, China and anything else will drop like rock, everybody still wathching US market.
it is like in anecdote:
when cheff of Escemous come to metio guy and asked what kind of winter he expecting, he just looked to the window and said that it should be very cold, because escimoses picked up twice as much woods for winter 🙂

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