Friday’s Failure – Market is Still on the Road to Nowhere

Still on that road to nowhere.  

Last Friday and the Friday before that, our bounce chart has looked like this:

• Dow  36,000 to 34,200 has bounce lines of 34,560 (weak) and 34,920 (strong) 
• S&P 4,700 to 4,465 has bounce lines of 4,512 (weak) and 4,559 (strong) 
• Nasdaq 16,500 to 15,675 has bounce lines of 15,840 (weak) and 16,005 (strong) 
• Russell 2,400 to 2,080 has bounce lines of 2,144 (weak) and 2,208 (strong)

Sadly, these are the bounce lines from our December highs, so we've been going nowhere for over 2 months now and that is NOT a bullish sign.  It is, however, a sensible sign as these are lines off the top and the top was RIDICULOUS and that's why they call it a "correction" and not a "mistake" – the market is simply pulling back to a more realistic level.  That's why our rolling strategy is so important and I went over that with our Members in yesterday's Live Chat Room as there's no sense in going through these pullbacks if you are not going to take avantage of them, is there?  

As with our 5% Rule™, our Bounce Lines are not TA – they are just math.  The simply illustrate the 5% Rule™ for the indexes in shorthand, so we have a quick referral to see if we should be placing bullish or bearish bets.  The Bounce Chart keeps us from getting suckered into these silly market gyrations and keeps us focused on our jobs, which is to make money selling premium!   

That's why, in this choppy market, both our Long-Term and Short-Term Portfolios are doing well – we are Being the House – NOT the Gambler.  There are lots of people who are willing to pay a large premium to bet the market will go up and lots of people willing to pay a premium betting the market will go down – SO LET THEM!  We don't have to be those people – we can just sit back and take their money in either direction – like a casino.

We do make our own "bets" that some stocks will be winners but, as a fundamental investor, I prefer to think of them as investments, not gambles.  That's why our strategy employs a lot of Blue Chip stocks and we don't spend a lot of time with penny stocks, IPOs or momentum trades – they are more of a distraction than anything else.  When a stock becomes unpredictable and erratic – we simply stop playing it but Amazon (AMZN) is a good example of a stock we used to stay away from and now we like to play it.  

AMZN is in our Butterfly Portfolio and our position is:

We have the $300,000 Jan $3,300/3,800 bull call spread that we bougth for $92,000 and we originally sold the April $3,700 calls and we bought those back for a $19,610 profit and now we've have the short April $3,000 puts that we sold for $17,200 and the short May $3,300 calls we sold for $33,000.  Should AMZN stay around $3,200 – they will all expire worthless and our net on the $300,000 spread will be reduced to $22,190 and we would still have 7 more months to sell puts and calls while we wait or we could simply close that particular casino game (current net of the bull call spread is $102,700 and move on to the next opportunity.  

The key to a good Butterfly Play for us is that the stock is generally range-bound but, within that range – it's volatile enough to attract a lot of speculation on either side – like a casino game that offers seemingly attractive odds.  Of course I say "seemingly" becuse they are not attractive at all and neither are the odds we give our players.  On a roulette wheel, for example, the house pays 35 to 1 on a number bet but there are 36 numbers on the wheel so the odds are 1/36 (2.7%) against you and the players don't seem to mind but the players forget that there is also a 0 and sometime a 00 and each of those openings steal an additional 2.7% per spin. 

It doesn't seem like a big deal but, statistically, even with just one 0 on the wheel, the house is taking 5.4% of your money with each spin because, if you win, you are getting 94.6% of what you should but, if you lose, you lose 100%.  The longer you play, the more certain the house is of winning all your money.  That is why they buy you drinks and give you free rooms or even fly you to the casino – as long as you are willing to play – they are more than confident they will win – they are mathematically CERTAIN!

While you, as a player, might win because you get lucky and walk away before your luck turns – the house keeps spinning the wheel for all the players and, over a long enough period of time, statistics take their toll and the house KNOWS a roulette wheel will make them a $50,000 profit for every $1,000,000 that is bet on it.  That may seem like a lot but that's every bet, not every player so 10 people playing roulette making $100 bets are generating $1,000 per spin and figure 20 spins per hour 10 crowded hours a day is $200,000 per day of wagers so $10,000/day per table for the house – not bad.  

That's how our trades work too, you have to grind them out over time – they are not intended to make fast returns because our profits come from slow, dependable math – not luck.  Can we lose?  Yes because we may simply run into some bad luck.  In the AMZN play, if AMZN fell to $2,000, we would owe $200,000 to the short put player and our position would be wiped out – again, that's why we stick to Blue Chips, which hopefully won't fall like that but 1929, 1987, 2000 and 2008 taught us that EVERY stock can fall like that – even at the same time.

So we also have our Short-Term Portfolio and it's full of hedges but hedges can't protect you from everything – we still need to not let ourselves get over-extended when things go against us, so be very careful of those downside commitments and keep plenty of cash on the sidelines – which is what any good casino does as well. 

Here's one we can play with.  Rocket Mortgage (RKT) was added to our Future is Now Portfolio as a Top Trade Alert on October 29th.  The stock has tanked on rate worries and a sharp slowdown in mortgage applications, but I do like them for the long haul.  Our current position is:

So we have a $4,150 loss and we spent $2,750 initially so we can close the trade down for a $6,900 loss or we can spend $2.59 ($6,475) to roll the 2024 $13 calls to the $2024 $8 calls at $6 and we can recoup some of that outlay by selling 10 of the June $13.89 calls for $1.10 ($1,100).  That would leave us in what is now a $30,000 spread that is $10,000 in the money for net net $8,125.  Better to spend $3,975 to reposition the trade favorably than dump it for $6,900 and the fact that we can generate $1,100 using 126 of the 707 days we have to sell indicates that, even if the stock stays flat – we should be able to grind our way back to even.  

Not losing can be as good as winning!  

Have a great weekend, 

– Phil