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Faltering Friday – Investors Begin to Factor Risk Back In

ImageHow good is the economy, really?

Barry Ritholtz summed it up nicely yesterday with these key economic points:

• Unemployment RateU-3 unemployment was only 3.5% in February 2020, and it skyrocketed to peak at 14.9% in April — and that likely undercounted full unemployment. It is 10.2% as of July 2020, a big improvement, but far above the recent lows. Not only that, as a reminder, the worst the Unemployment Rate ever got during the Great Financial Crisis was 10% in October 2009.

• GDPReal GDP bottomed in Q4 2008 at -2.16% (annualized); today its -9.49% (annualized); if you prefer to use nominal GDP, that bottomed in Q4 2008 at -1.86% annualized, today it is -10% (-9.986%).

• Non-Farm payroll workers: There were 152.463 million people employed in February 2020; That fell to a low 130.303 million in April; it has since recovered to 139.582 million. There are 12.88 million people who have lost their jobs since the pandemic spread and have still not found new ones since the recession began.

Look back at the GFC: Peak to trough, the total job loss in 2007-10 was 8.7 million. There are 48% more people unemployed right now than at the peak of the GFC.

• Existing Home Sales: The Existing Home Sales (Seasonally Adjusted Annual Rate) were at 5.76 million in January 2020; they bottomed in May 2020 at a (SAAR) of 3.91 million, have since recovered to 4.72 million in June 2020. The current annual rate is still 18.1% below where it was to begin the year.

Comic: Stocks Jump As White House, Fed Stimulus Sparks Rally By ...As you can see from the chart above, Leading Economic Indicators have bounced back about halfway to where they were but that's because our Government and the Fed spent $6.7 TRILLION so far this year to boost the economy.  That is the entire economy of Japan (130M people) PLUS France (70M) just to boost our (320M) economy for less than 6 months.  Yet still our GDP is -10% but investors are playing the market as if the economy has nothing to do with the value of companies.  

How long can this really last?

30M people are currently unemployed in our country and Consumer Spending is 60% of our economy.  This is now week number 3 in which the unemployment subsidy has ended and 35% of our neighbors are skipping their rent payments to make ends meet as even the people lucky enough to have jobs are working shorter hours and otherwise getting less compensation – including America's Gig Workforce of 55M.  They don't count you as unemployed when you lose your side hustle but that side hustle is what keeps the lights on for 1/4 of our work-force since all that talk about making a "Living Wage" went out the window when Trump was elected.  

The retail graveyard is getting crowded. Anyone brave enough to go outside knows how many stores and restaurants in their town have closed or are clearly struggling to survive.  Major chains are going bust at a record pace but over 30% of the Mom and Pop shops surveyed (including restaurants) don't think they'll survive if the holiday season turns out to be a bust (just 4 months until Christmas!).  

One business that is booming is hospitals with 56 ICUs in Florida over 100% capacity and another 35 hospitals having less than 10% free capacity in their intensive care units – just in time for the great Back to School Experiment to begin.  California has 6,000 corona patients in their hospitals – also straining capacity along with Texas, Mississippi, Alabama, Georgia, South Carolina and North Carolina all facing critical shortages of care facilities.  

If we don’t make substantial changes, both in spreading the disease over time and expanding capacity, we’re going to run out of hospital beds,” said Dr. Ashish Jha, the director of the Harvard Global Health Institute, which produced the estimates. “And in that instance, we will not be able to take care of critically ill people, and people will die.”  Unfortunately he said that in March, when we were supposed to be making an effort to control the virus and, even then, these were the projections for hospital capacity at the time:

It's been less than 6 months and 20% of the population has already been infected (have antibodies) and the growth of the virus is increasing, not decreasing.   We are not very far away from completely overwhelming the hospital system so try not to live in places that are orange or you may not be able to get a hospital bed when you need it – not just for covid, but for whatever ails you.  If the infections keep in spreading over the next 6 months (and this back to school thing guarantees it), then this is what we're looking at as far as hospital capacity levels by March.  

Joe Biden spoke last night and said he wants to make it mandatory for people to wear masks, to protect each other and stop the spread of the disease.  Unfortunately, even if elected, he won't take office until late January and this will pretty much be our reality by then.  There are already 175,000 dead in the US from this virus but only 1/2 the people infected have recovered (or died) so another 175,000 is pretty much a given at this point and the increasing infection rate, if not brought down by the actions of the President and Congress (good luck!) will put us racing towards 500,000 dead in the spring and that's with half the country still uninfected!

Is that going to be better or worse for business over the next 6 months?  They say the stock market is a forward-looking indicator and the market is certainly looking forward to a vaccine but even the best-case scenario puts that into the spring.  Congress took their recess on the 13th and won't be back until September 8th, so nothing is likely to happen before then to change anything (Pelosi wanted to hold votes, the GOP Senate refused) and we've already run up a $3Tn deficit for the year so anything else they pass is added to Trump's tab and the GOP wants to make Biden pay that bill so expect them to delay doing anything to help the American people for the rest of this year.  

We've spent this week paring down our portfolio positions – just in case things turn ugly again.  I'd rather be wrong and miss a bit more of this rally than be wrong and have all our gains for the year wiped out.  We will always find something new to invest, like our Top Trade Idea for AT&T yesterday, so we're not going to "miss" anything by raising a bit more cash.    The weekend after next is Laobr Day and that's the end of "summer driving season", which was a bust this year so oil should have trouble holding $42.50 and that will bring down the energy sector and if people don't shop on Labor Day, that Retail Outlook will start to get worse so many reasons to be cautious in the weeks ahead.  

Oh, and Donald Trump is still President!  

Have a great weekend, 

- Phil

 


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  1. Good Morning.


  2. good morning


  3. Phil/viac, for those of us who didn't pick up viac earlier, is there a new position worth entering?


  4. In one of your posts recently, did you say a good price for AAPL before the split would be $260? I can' t

    find the post.  Thanks


  5. Good morning!

    VIAC/Stuart – I'd wait for the sell-off rather than chase them but look how fast the market flipped up already this morning.  Unstoppable.  I think $15 would be the low so you could sell the 2022 $17s. for $2.50 but they were $9 during the drop so a very painful hold if things turn down again.  So you'd have to REALLY have conviction about buying the stock at net $14.50 and know in advance that you are likely to have to ride out a 100% or more loss on the short puts.  

    Some good-looking news but keep in mind this is an improvement off horrific lows:

    • August U.S. PMI Composite Flash54.7 vs. 51.3 consensus, 50.0 prior.
    • Manufacturing PMI 53.6 vs. 51.9 consensus, 51.3 prior.
    • Services PMI 54.8 vs. 51.0 consensus, 49.6 prior.
    • July Existing Home Sales+24.7% to 5.86M vs. 5.38M consensus, 4.72M previous.
    • Marks second straight month of gains, with each of the four major regions attained double-digit, month-over-month increases.
    • Northeast was the only region to show a year-over-year decline, according to the National Association of Realtors.
    • “The housing market is well past the recovery phase and is now booming with higher home sales compared to the pre-pandemic days,” said Lawrence Yun, NAR’s chief economist.
    • Buyers are expected to cancel 10 or fewer cargoes of liquefied natural gas for October loading from the U.S., the lowest number in months as prices in Asia and Europe recover, Reuters reports, citing trade sources.
    • The result would rank much lower than the 25 cargoes likely canceled for loading in September and the 40-45 likely canceled in July and August.
    • "We expect winter LNG spot prices to rise to $5-$6/MMBtu as the market tightens," Bernstein analysts say. "With U.S. having a cash breakeven of $4-$5/MMBtu, this should allow U.S. LNG to flow with positive cash margins."
    • Cheniere Energy (NYSEMKT:LNG) CFO Zach Davis said recently that it expects its customers will lift their contractual volumes in full this winter as the market recovers from the effects of COVID-19.
    • Retail giants are setting strategies for a holiday season expected to be unlike any other.
    • While overall holiday spending is at risk of being low, a crushing amount of online spending risks swamping the system.
    • Target (NYSE:TGT), Best Buy (NYSE:BBY), Kohl's (NYSE:KSS) and Walmart (NYSE:WMT) have already de-emphasized the traditional Thanksgiving to Black Friday store shopping period and are setting holiday promotions much earlier to take the strain off shippers FedEx (NYSE:FDX) and UPS (NYSE:UPS). Other retailers are expected to follow.
    • A higher mix of same-day deliveries by Shipt, DoorDash (DOORD) and Postmates (POSTM) drivers will also ease the holiday burden.
    • USPS, FedEx and USPS will all have holiday surcharges running on big-box retailers during the shipping blitz.
    • ETFs: XLYXRTVCRFDISRTHEMTYRETLWANTFXDPASSRCDJHMCFTXD
    • Earlier: E-commerce spending shows no signs of letting down
    • Global stocks are trekking higher after the tech rally in the U.S. continues to show legs and renewed hopes for a coronavirus vaccine.
    • The Shanghai Composite Index rose 0.5% and Hong Kong's Hang Seng Index was up 1.3%. Japan's Nikkei tacked on 0.2% and Australia's ASX 200 slipped 0.1%. European stocks are largely higher despite sluggish PMI data, with the Stoxx 600 Index gaining 0.3%. France's CAC 40 and Germany's DAX are both in positive territory at mid-day.
    • Meanwhile, U.S. stock futures are pointing slightly lower, two days removed from the S&P 500 Index carving out a new record high.
    • Oil prices are down slightly amid efforts by major oil producers to hold back output. In early action, WTI crude oil futures -0.7% to $42.53/bbl and Brent crude -0.5% to $44.66/bbl.
    • And one more thing to chew on to start the new day. Tesla (NASDAQ:TSLA), after cruising right past the $2,000 per share level, now trades with a higher market cap than Procter & Gamble (NYSE:PG), Home Depot (NYSE:HD), JPMorgan (NYSE:JPM) and Disney (NYSE:DIS).

  6. Some of the retailers have been posting good/better than expected number but SKT is in a nosedive.


  7. SKT/Jeff – And the earnings weren't bad.  Once sentiment goes dark, especially on a dividend-payer where there are not many replacement buyers – it can take a very long time to get better.


  8. Money Talk Portfolio Review:   Only up 13.6% at $113,567 as we haven't been able to make beneficial adjustments along the way.  Our TSLA play is costing us $8,000 at the moment – that hurts.  We can't make any changes so we'll continue to ride it out and we don't have hedges so I HOPE we don't have downturn before I'm on the show again.

    I'm not worried about the short puts but I'd probably take them off to be safe.

    • TSLA is what it is at the moment.  Of course I would buy back the short puts.  Though they are unlikely to get back in the money, they prevent you from selling the long puts on a downturn.  
    • GOLD – No worries.
    • IBM – On track.  

    • M – You know I love them.
    • SKT – One day.
    • SPWR – Love them.
    • VIAC – Love them.  

    Nothing wrong with doing nothing with this group.


  9. SKT looks pretty good right here (5.75)


  10. Apple going parabolic while SPX stalls at the highs. 


  11. Looks like they are trying  to pin 500 for aapl opex today


  12. ES/3385, tough nut to crack. May be a setup for a push higher or this is a top, short term. Long overdue for some profit taking. The action is pathetic, they pump and dump between momo's and value (scalping).


  13. AAPL – heading to 500 today…..


  14. Long-Term Portfolio Review (LTP):  $979,575 is up 95.9% and up $78,147 (15.6%) since our last review so we're in excellent shape yet, as I mentioned in the Webinar on Wednesday, I think now is certainly the time to cut back whatever we can – just to be safe.  While we do have plenty of hedges, that's no reason to over-expose ourselves in such a volatile (and toppy) market.  

    • IBM, JO and STZ are all too profitable to risk leaving open.  The upside is limited and the risk is more than 100% – so why do that?  
    • FCX – Could go lower so we'll kill it.   We already have GOLD for commodities.
    • INTC – I think they are way too cheap and I'd LOVE to own them for net $27 so – Keeper.  
    • KO – Very fair price at net $38 so – Keeper.
    • MU – Net $25.50?  Keeper.
    • MYL – Net $11.50?  Keeper.
    • TIF – How did that get in here?  Kill it.

    • PAA – Net $3.80 and it's at $7.25 and we expect to be called away at $5 so no worries there.  Just paid an 0.18 ($1,440) dividend on July 30th too.
    • AVGO – At the money and net $83,000 on the $120,000 spread.  Keeper with 5G coming.
    • BRK/B – Proxy for the S&P.  #1 is net $37,500 out of $50,000 and #2 is net $22,000 out of $30,000 so I guess we can keep them.  Let's buy back the short June $130 puts to reduce the risk on the overall spreads
    • CAT – Housing is going well so I guess we'll hold it as it's $20,000 out of $30,000 on the spread.
    • CSCO – Was doing great but took an ugly dip but also should do well.

    • FL – Just posed some good numbers.  No reason to sell.
    • GILD – Took a big downturn so good for a new trade now.  

    • GM – $24,000 on the $35,000 spread is room to run and I don't think the puts are risky.
    • HMY – $28,000 out of $30,000 so we'll kill it but leave the short puts.
    • IMAX – I was going to kill it but the March $10s are only $4.10 and the Dec $10s are $3.60 so let's buy some time and see what happens.  The short calls will go worthless and then we'll sell March $15s (now $2) so why cash out the spread for net $1.80 when we can collect $1.50 and still be in it?  
    • LABU – Net $30,000 out of $50,000 is a keeper.  Not worried about the short puts.  
    • M – Let's buy back the short calls, they aren't much use.  
    • MIDD – Calmed down a bit but right where we want them. Keeper.  
    • MJ – Was doing well and now trailing off again.  I want to stick with it.

    • MMM – $30,000 out of $45,000 is a keeper.
    • MO – $48,000 out of $75,000 is a keeper.  Not worried about the short puts.  

    • RH – So far in the money, even though it's $68,000 out of $80,000, it's not like we have something better to do with the cash.
    • SKT – See this one we hedged better and have better results.  No changes.  
    • SPG – $24,000 on the $50,000 spread is a keeper.  
    • SPWR – You know I love them too much to let them go.
    • TXT – $41,000 out of $68,000 and on track.  I guess I don't have a good enough reason to sell.

    • VIAC – Love them!  Still $43,000 out of $50,000 – we can do better so let's kill this one and hope for another opportunity.
    • VLO – I'm not confident enough to stay in.
    • WBA – Another one I love.  It's fun having stocks you really like in your portfolios!   Great for a new trade with another downturn.  

    Wow, we are only able to ditch 6 out of 34 positions.  This portfolio is just too good to close!  Most of the positions are good for 50% more so $1.5M if all goes well.   




  15. Hi Phil, 

    Appologies if I missed. Is there an opportunity in WFC to initial a position in LTP? it has been trading at a lower valuations and dividend cuts, Buffett selling his stake are surely driving the stock down but at the same time Buffett has been buying BAC so may be there was a tax advantage for him. 

    Thank you, 

    Pat


  16. WFC/Pat – Earnings were being driven up by fake accounts and now they are driven down by fines, legal costs and settlements.  I don't think much of the bank in the first place – over-exposed to the US consumer and home loans, I think but $23.60 is only $97Bn and they do make $20Bn a year and, even if they only made $10Bn a year – it's not a bad holding.    The thing is, C has a 6 p/e and TD is below 5 and even JPM is 7.5 so why WFC?  There's nothing particularly special about them and they have a poor culture and heavy risk-exposure to consumers.

    NYSE and the RUT are red but no one seems to care…


  17. Need help riding the wild AAPL bronco! Mostly sold out my ITM spreads as suggested, buying back the short calls but hung on to the longs for quite a ride up. My 25 uncovered '22 $300 calls rose from about $172 to $186. Finally sold 20 of them yesterday at $186, hanging on to 5, - now up to $205 (sometimes profitable to be 'messy')!

    Now had wanted to set up the suggested $400/500 bcs but at these levels wondering if you would choose different strikes? The $420/520 seemed to be cheaper at around $42 yesterday but that has probably changed again today. Are we ready for $450/550?. The $200 puts don't appear to be dropping as they should .. they haven't got down to $6 yet.

    Now have:

    5 '22 $300c ($67) uncovered

    5 '22 $240c ($49) and -5 Nov $400c ($35)

    -5 Jun '22 $200p ($21)

    THoughts?

    THX.


  18. Phil,

    Any thoughts on IIVI? Surprising market reaction to eps on 8/13.

    Thanks


  19. AAPL/Wing – This thing never seems to quit so hard to say.  You have the $240/400 spread and those $300 calls that are now $194 ($97,000) and the $240 calls are $252 ($126,000) so, if you cash those, you have $223,000 to play with.   You can buy 20 June 2022 $450 ($115)/640 ($49) for $66 ($132,000) and then you are well-covered on the short calls with a $380,000 spread and $91,000 in your pocket.

    IIVI/8800 – They are not cheap at $4.35Bn.  Lucky to make $100M in a good year and this won't be one.

    TSLA $2,090!

    /NG popping again.


  20. Now quite 3,400 on /ES but a hell of a close for the week.  


  21. Phil/AAPL Bronco.  Thx Phil, – just to be clear, when you say the short calls will be well covered by the new spread, are you meaning to hang on to the short Nov $400s for now, but sell everything else? In which case I would probably have to keep the 5 long $240s until I set up the new $450/640 bcs so the short $400s are not 'too' naked!  Then at some point I would roll the Nov $400s to something?


  22. That's right Wing.  You're covered 20:5 with lots of time to roll, so it should be good.

    Have a great weekend,

    - Phil


  23. Phil/STP- Did you finish a STP review, I cant find it. 

    CMG – current position is what I'm looking for. Tx
     


  24. STP/Ravi – Did that last week on Thursday.  


  25. Well, we're doing a newsletter again and we'll see how it goes.  It's a pro publishing group so it won't be free to PSW Members but I'm going to write it here anyway.  There will be short weekly articles and one long monthly one, which I'm supposed to do this weekend so here it is:


  26. View from the Top:  Hedging for Disaster.  

    GET OUT!!!  How's that for the first newsletter in our series?  We've had a hell of a market run and made some excellent money bargain-hunting when the market collapsed in March but now it's almost September and we're back at all-time market highs and yes, we think the virus will eventually go away (in the very least everyone will have been exposed to it by this time next year) and, while the economy is weak, STUNNING amounts of liquidity have been injected.  Anyone who's been to the grocery store recently can see the inflation creeping into the system – despite the Fed's utter failure to measure it – or take responsibility for it.

    Officially, inflation is still below the Fed's 2% target rate but, unofficially, the price of everything is starting to rise and we're not even consuming the way we used to.  What will happen when and if our buying habits do begin to return to normal?  One reason things are getting so expensive (including equities) is that the US Dollar is getting weaker, down 7% since May and down 10% since Trump took office in January of 2017, when we topped out at 103 (now 93).  

    When the Dollar is weak, the things that are priced in Dollars seem more expensive – because you need to exchange more Dollars to purchase them.  Stocks are one of those things that is priced in Dollars, along with Oil, Gold, Food, etc.  Our Dollar weakness is well-deserved, the Fed is printing money at a record pace, our National Debt will increase over $4Tn this year and, due to the economic slowdown, Government revenues from sales taxes and income taxes are down as well.  This is NOT a healthy economy, by any measure.  

    How to avoid a corporate zombie apocalypse | Financial TimesStill, there is a lot of free money flying around and our Corporate Citizens are very adept at grabbing it.  Not only are junk bond sales at record highs but those bonds are being bought directly by the Fed, which makes it easier for companies to issue more junk debt.  This is a cycle that creates what are called "Zombie Corporations" businesses that are able to keep running long after they should have gone bankrupt by endlessly refinancing their ultimately unpayable debt.  

    I am, by the way and optimistic person.  I thought I should mention that since many of you don't know me that well and this sounds pessimistic.  It is pessimistic because, although I'm an optimist, I'm also a REALIST and, realistically, this economy is in trouble and pretending it's not is not going to make it get better.  

    We have spent the last two weeks taking a lot of positions off the table in stocks that we feel have gotten ahead of themselves but we would have had to take them all off the table of not for our hedges, which help balance our portfolios.  Having positions that will make money when the market goes down allows you to sensibly ride out a downturn if you have to.  Nonethless, there is no reason not to sell as stock that has already made more money this year than you would have expected in two years, is there?  

    Hedging Against Inflation

    Barrick Gold (GOLD) was our Stock of the Year pick for 2020 back on November 14th and we used an options spread to leverage our gains as follows:

    • Sell 15 GOLD 2022 $17 puts for $3.50 ($5,250)
    • Buy 30 GOLD 2022 $13 calls for $5 ($15,000)
    • Sell 30 GOLD 2022 $17 calls for $3 ($9,000)

    The net cash outlay of that spread was only $750 and it was meant to pay $12,000 for an $11,250 (1,500%) profit if GOLD was over $17 in January of 2022 – a two-year trade at the time.  GOLD is, in fact, just under $30 already and the $17 puts are down to $1 ($15,000) and the $13/17 spread is now $16.50/13.10 or net $3.40 ($10,200) so net $9,200 is already up $8,450 (1,127%) in just 9 months – that's off to a very good start!  

    Of course selling the short puts is a little advanced as an option strategy.  We are obligating ourselves to buy 1,500 shares of GOLD at $17 and we did that when the stock was $17.50 and the margin requirement on those puts was $4,971 so we're only up about 200% on margin and 1,127% against our cash outlay.  

    Since we don't mind owning GOLD as a long-term hedge against inflation and, since we felt that $17.50 was an exceptional value, we did not consider the downside to the trade (owning 1,500 shares at $17 for $25,500) to be too risky and we felt VERY confident that the stock would be higher in January of 2022 so it made an easy pick for our Trade of the Year.  

    Gold is still the best long-term hedge against inflation but most of the miners have already taken off, including our beloved Barrick and I don't want to overwhelm you with a tricky option trade so, instead, let's take a look at one of my favorite speculative penny stocks and that's Northern Dynasty Minerals (NAK).  NAK is what I call a pillow trade – which means you buy some and put it under your pillow and hope that the stock fairy comes and turns it into (literally in this case) gold.  

    Northern Dynasty has the rights to mine the World's largest known untapped reserve of gold, silver, copper and molybdenum but there's only 3.4Bn pounds of moly so we can ignore that and focus on 71M ounces of gold ($142Bn), 345M ounces of silver ($9Bn) and 57Bn pounds of copper ($171Bn) of PROVEN reserves and another 50% in potential reserves.  While that is $322Bn of minerals the reasons you can buy the whole company for $727M at $1.45/share are:

    • They have no money:  NAK has just $13M in the bank and they are burning $15M per quarter so they will have to either borrow money or issue shares or take on a partner very soon.
    • They have no money:  They can't possibly develop the mine without spending tens of Billions of Dollars and dilution won't cover that, nor will borrowing, they MUST get a partner.
    • They have no permit:  This has been going on for a decade.  The Pebble Project is right next to vital salmon fisheries that are critical to Alaska's economy and strip-mining can be very bad for the environment.  The Trump administration has gotten NAK close to killing those salmon but Obama/Biden were against it and guess who's coming back in 5 months.
    • Extraction costs:  Just because they have over $400Bn of minerals in the ground does not mean they can extract them profitably – even with permits.  If they do get approvals, the environmental concerns may make setting up a safe mining operation too expensive and the chance of getting a permit to rape and pillage the environment is slimming with each new poll Trump takes.  The Alaskan GOP still support the project and they MIGHT stay in power in this very red state but the EPA could still override them.

    So what on Earth is there to love about NAK?  It's the potential reward.  Even if they have an industry-high $1,400/ounce extraction cost on gold, at $2,000 an ounce they will still clear more profit per ounce than most miners did when gold was at $1,200 last year and even Barrick, the lowest-cost extractor (why we love them) were at about $850/ounce so net $350 profit made Barrick $4Bn last year and NAK's potential is bigger.  

    Making even $2Bn would give NAK a value of about $20Bn, 30 times more than it's trading at now.  So, here's a stock for $1.45 that has the potential to pay off like a roulette wheel but the odds of winning are probably more like 1/10 than 1/36.  It may take years to play out but I'd play it by planning to scale into the position as follows:

    • Buy 5,000 shares of NAK for $1.45 ($7,250) 
    • Sell 50 Feb $2 calls for 0.55 ($2,750) 

    So in step one we've spent net $4,500 and, if called away at $2 in February, we will be paid $10,000 for our 5,000 shares for a profit of $5,500 (122%) in just 6 months.  If NAK goes lower (and it might if Biden is elected) then the calls will expire worthless and our net entry cost will be $4,500/5,000 or 0.90/share.  

    Assuming NAK re-tests 0.50, we can buy 5,000 more shares for $2,500 and then we will have 10,000 shares for 7,000 or 0.70/share and then we can sell more calls to lower our basis further while we wait for the next Republican Administration to approve this project (12-20 years) so this is a very LONG-TERM play if things go badly but we can always sell calls and probably turn this into a nice income-producer while we wait.  


  27. Two More Ways to Hedge

    While there are very good reasons that stocks like Apple (AAPL), Amazon (AMZN), Microsoft (MSFT) and Google (GOOG) are each trading over $1Tn (AAPL is $2Tn!) it's still kind of ridiculous and probably unsustainable so, as a proper hedge against the Nasdaq selling off between now and next year, I suggest the following hedge using TQQQ, which is a 3x Ultra-Short ETF on the Nasdaq.  That means, when the Nasdaq goes 10% higher, TQQQ goes 30% higher but, conversely, when the Nasdaq drops 10%, TQQQ drops 30% and, since TQQQ is already insanely high, -30% becomes a very big number indeed.  

    See what happened to TQQQ in March?  It fell from $120 to $40, a 66% drop when the market dropped 20%.  Now it's up around $141 and even a 10% drop in the Nasdaq would knock it back 30% to $98.70.  We can take advantage of this using put options as follows:

    • Buy 10 March $125 puts for $26 ($26,000) 
    • Sell 10 March $95 puts for $15 ($15,000) 

    That's called a bear put spread and what we've done is we've bet that TQQQ will be lower than $125 in March but we've offset the cost of the bet by selling the $95 puts to someone else who is foolishly spending $15 in premium for a put that's $45 out of the money.  No matter how low TQQQ goes, our puts will always be worth $30 more than the $95s but, above $125, both puts are worth nothing.

    That net $11,000 is the cost of our insurance from now through March but we're most worried about the elections and the end of the year, so it's not likely we take a total loss and the spread pays back up to $30,000, $19,000 (172%) more than it costs so it's a good protector for a $100,000 portfolio that may lose 20% or so in a downturn.  

    Now we're going to get a little tricky and short the World's most over-priced stock and that's Tesla (TSLA).  TSLA has a $382 BILLION Dollar valuation at $2,050 and that's double Toyota (TM) at $186Bn and TM makes more cars in a week than TSLA does in a year and TM makes $20Bn a year in profits while TSLA has yet to have a profitable year.  It's ridiculous!  

    This is an advanced options play but it's also going to be fun and we're going to do something similar to what we did with TQQQ but we're going to stretch it out in time as follows:

    • Buy 1 TSLA March $2,000 puts for $413 ($41,300) 
    • Sell 1 TSLA October $2,000 put for $227 ($22,700) 

    Here we're spending net $18,600 and you must be wondering how you are going to make money if we're shorting the same strike we're buying but that's what this lesson is all about:  PREMIUM DECAY or, what the options technicians call "Theta (time) Decay".  The only certainty in the market is that ALL premiums go to zero when the contracts expire so we are taking advantage of the fact that we're buying March TSLA puts that are essentially at the money with $413 of premium that will decay in 209 days while we're selling October puts that have $227 of premium that will decay in 55 days. 

    Unless TSLA is drastically lower than it is now, we should still have good premium left when the October puts expire and what will we do then?  We will sell more premium!  That's right, I'm going to teach you how to use premium decay to your advantage but DON'T make this trade unless you are experienced with options and don't mind losing $10-20,000 – as Tesla is a volatile and dangerous stock but DO paper trade this if you can and we will discuss how you can use the momentum of momentum stocks against them to make some very nice short-term profits.  It's the Jiu Jitsu of trading!  

    It all boils down to this:  If something is too expensive – find a way to sell it.  If something is too cheap, find a way to buy it.  Since the stock market gives us an endless supply of buyers and sellers, we are able to turn both sides of a trade to our advantage and we use the primary law of Stock Market Physics – that all premiums decay over time – to our full advantage by finding a way to sell that premium to others.

    So it's a very bearish beginning to our Newsletter and I'm sorry for that but most of you have long positions that need protecting and having this protection will let us make more bullish bets along the way.  We'll discuss more of those in our upcoming weekly reports.  Here's how our porfolio is starting off:  

    There's still a lot of uncertainty in the market and I'm very worried that sending our kids back to school is a big mistake and will set our virus recovery back several months and it's going to be very hard to "fix" things heading into the election so it's a very good time to take some cash off the table and build up those hedges.  

    Be careful out there, 

    - Phil


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