Wild Weekly Wrap-Up: Everyone Just Relax

by: Philip Davis

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, were at the lowest levels the market has hit since last November. 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 Buffett was willing to give GS $5Bn AFTER they bounced 50%. THAT’s how undervalued the financials were in November of 2008.

Fear and Greed are market driversWhat 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 (NYSE: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 could hedge lower but we’re thrilled to own IBM for $114.38 long term - just as thrilled as we’d be if we don’t end up owning IBM but pocket 15% in 5 months.

Keep in mind that, over the next 6 months, we can do this again and get another 10% discount and another and another (see "How to Buy Stocks for a 15-20% Discount"). There are many long-term strategies that provide more than adequate returns without too much effort. That’s also the subject of Sage’s educational post this week: "How to Make Profits in Your Spare Time." Options should help you relax - not stress you out. Too many people get hooked on the high-return, leveraged option play and, unfortunately, it does dominate our conversations. But that’s only because our longer-term strategies are safe AND BORING! Boring is good in stocks - learning to make a nice, boring 10-20% a year using sensible hedging strategies on 75% of your portfolio allows us to have fun with the other 25%. That’s how we are able to, as Warren Buffett advises: 'Be greedy when others are fearful'. By setting ourselves up with balanced positions and hedging ourselves with smart option strategies, these market downturns become huge opportunities for us to go bargain shopping. (Click on chart below to enlarge)

Click to enlarge

In last weekend’s wrap-up I posted a Dow chart and noted that 10,058 was our tolerance line below our 10,165 5% Rule drop (from10,700). Above you can see how our lines held up, as well as the 8% bounce zone I predicted at 9,830, which led to my bullish call for Members on Friday afternoon at 2:51 - 8 minutes before the Dow rallied 125 points into the close. These are levels we set up weeks in advance using our 5% rule, the only real trick is having the conviction to follow through with the trade when we finally get the set-up we’ve been waiting for…

This was one wild week as we had gone bullish on Friday, anticipating a bounce off 10,058. But we ran back to our disaster hedges and went downright negative after the Dow failed to take back our 10,300 line on Tuesday and Wednesday. Generally, we are fundamental traders but FUNDAMENTALLY we know when technicals are ruling the markets and we can switch gears with the best of the bots!

Singing "Davos Done and We Need Another Loan"

In last weekend’s review of the World Economic Forum in Davos (arguably the most important economic event of the year) I analyzed the mood, looked at the concerns, listened to the speeches and concluded that the situation in Greece would move the markets the next week, saying:

The dollar is only up 7% over the same period and, amazingly, oil is down just 6.5% while gold is down 10% so we’ll be watching that $72.50 line in oil very closely next week. Copper is only down 3.5% at $3.05 and holding that $3 line will be critical with no health until they get back over $3.20.

Copper was indeed our best indicator this week and that’s how Freeport-McMoRan (NYSE:FCX) became one of our most successful shorts. These trades don’t come out of nowhere and follow discussions that have gone on for weeks. These discussions help members know WHY we are in a trade and gives them a background on which to make excellent trading decisions. When something we’re watching (copper prices) initiates a trade idea on a stock we already felt was fragile (FCX), we were able to enter the trade with "perfect timing." Perfect timing isn’t a random event, perfect timing requires near-perfect patience.

Monday Market Movement, Missing Momentum?

A sweeping discussion of CDO’s, CDS’s, Debt, Obama, Bernanke, Communism, the Beatles and Jesus is always a good way to get the week going. We expected a bullish move up but we already planned to add disaster hedges as the panic was clearly spreading and I said:

We should get a nice pop this morning but it doesn’t mean anything if we can’t start taking back our (10,300) levels.

As I mentioned this weekend in my Davos review, I find it VERY disturbing that we are seeing an extreme uptick in both lending to risky countries and CDS betting that those same countries will fail. This is kind of like playing that carnival game where you squirt water into the clown’s mouth until you pop the balloon while adding bets that the balloon will pop… So there is, what I called in my Thursday morning post, my "Ball to the Wall" bull market premise as Obama and Bernanke hold hands and do a "Thelma and Louise" with the U.S. economy.

  • DXD at $31, now $31.56 - up 1.8%
  • DXD July $27 calls at $5.20, now $6.20 - up 19%
  • DXD March $31 calls sold for $1.80, now $2 - down 11% (ratio spread)
  • QQQQ Feb $45 calls at .21, out at .20 - down 5%
  • UWM Feb $27 calls at .95, out at $1.10 - up 16%
  • C 2012 artificial buy/write, too complicated to to summarize - on target
  • C 2011 complex spread - on target
  • QID July $20 calls for $3, now $3.30 - up 10%
  • QID March $23 calls sold for .90, still .90 - even (pair trade)
  • Cameco (NYSE:CCJ) March $27 puts sold for $1.25, now $1.80 - down 44%
  • CCJ June buy/write at $23.39/25.20 - on target
  • CCJ 2011 $17.50/25 bull call spread at $5.20 (we like CCJ!)
  • TBT 2011 complex spread - on target
  • Google (NASDAQ:GOOG) 2011 and 2012 complex spreads - on target

Notice how we use more complex spread combos than usual in a choppy market. That’s what these reviews are for, it’s good to go back and look for trades that will add balance to your current mix of positions…

Testy Tuesday - Back to our Bounce Levels?

Our bounce levels were Dow 10,300, S&P 1,105, Nasdaq 2,200, NYSE 7,100 and Russell 620 and we finished the day at Dow 10,296 (-4), S&P 1,103 (-2), Nasdaq 2,190 (-10), NYSE 7,101 (+1) and Russell 614 (-6). Keep in mind that the Dow gained 110 points that day and these level predictions have been running since mid-2009 - that’s pretty damned accurate, as were our expectations for the day’s action. I pointed out the low volume of the "rally" made a rejection more likely and that it was appropriate that Groundhog day was seeing the establishment of a lower trading channel.

  • EDZ at $5.65, now $6.58 - up 16%
  • XLF 2012 complex spread - on target
  • EDZ March $6 puts sold for $1, now .65 - up 35%
  • Apple (NASDAQ:AAPL) March $220 calls at $1.85, out at $2.25 - up 21%
  • GLL $9 calls at $1.05, out at $2.10 - up 100%
  • AAPL July complex spread - on target
  • DIA $101 puts at .98, out at .93 - down 6%
  • Accorda (NASDAQ:ACOR) 2011 $30/35 bull call spread at $2, now $2.20 - up 10%
  • Amedisys (NASDAQ:AMED) June $65/March $60 ratio backspread - on target

Click to enlargeYou can see our mix turning more bearish (AMED was a 3/5 bearish spread) and you can see how our discussions of emerging markets and commodities led us to focus on gold and EDZ (ultra-short emerging markets) hedges even as the market appeared to be rallying. We took a quick stab at shorting the Dow but were stopped out, living to short again another day.

Wednesday Rejection Weakness

As we had failed to retake our "weak bounce levels" on Tuesday I said:

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… 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.

The lows we hit Friday were Dow 9,822 (up 198), S&P 1,044 (up 9), Nasdaq 2,100 (up 12), NYSE 6,631 (down 29) and Russell 580 (down 5). As we never failed 3 of 5 of our targets and as the Dow held up at the 8% line - we were able to flip on Friday. But Wednesday morning, our criteria was much stricter as any rejection was a sign of weakness and we were fully rejected early on. Notice right in the main post I was banging the drum on EDZ and GLL, our favorite shorts into what we thought was a weak rally. Yet I also layered it on with a put play on IYR as the news looked sour and Greece was shaping up to be quite a tragedy (as emphasized by the great picture that accompanied my comments).

  • EDZ at $5.50, now $6.58 - up 19%
  • EDZ March $5 puts sold for .45, now .30 - up 33%
  • EDZ July $4/6 bull call spread at .85, still .85 - even
  • GLL Feb $9 calls at .90, out at $2.10 - up 133%
  • SRS March $8 puts sold for .78, now .55 - up 29%
  • IYR March $43 puts at $1, now $1.50 - up 50%
  • IYR Jan $37/March $41 put spread net $2.10, now $2.20 - up 5%

All of the above trades were right in the morning post and sent out with our morning PSW Report at 8:30 am. Of course, the fun continued from there into our full Member Chat as we had all day to set up for the big dip:

  • DIA Feb $105 calls at .50, out at .45 - down 10%
  • DIA March $99 puts at $1.37, out at $3.30 - up 140%
  • ERY March $10 puts sold for .50, now .33 - up 34%
  • ERY March $11 calls at 1.10, now $2.65 - up 140%
  • VIX June $25/March $25 calendar call spread at net $1.30, now $1 - down 23%
  • Cisco (NASDAQ:CSCO) 2011 artificial buy/write, too complicated to to summarize - on target
  • Toyota (NYSE:TM) Feb $70 puts sold for $1.80, out at $1.00 - up 44%
  • Lowe's (NYSE:LOW) 2011 complex spread - on target
  • Akamai (NASDAQ:AKAM) Aug complex spread - on target
  • Oil futures short at $77.50, out at $77 - +$500 per contract
  • Eli Lilly (NYSE:LLY) 2012 buy/write at $25.50/27.75 - on target
  • FCX March $65 puts at $2.30, out at $4 - up 74%
  • Annaly (NYSE:NLY) 2011 buy/write at $14.17/15.84 - on target
  • IYR June $46/March $45 backspread at $85 credit, now $310 - up a bazillion %!

As the day dragged on our attention shifted to Friday’s upcoming NFP report. We decided there was no way to remain overall bullish with that possibly upsetting news. Fourteen trade ideas during the day AFTER the morning’s all bearish 7 was a lot for one day but you have to play the hand you are dealt. We saw many, many reasons to go short as the Greek tragedy continued to unfold. Yet notice we STILL follow through with our PLAN to buy stocks (CSCO, LOW, AKAM, LLY, NLY) that we believe in long-term. My closing comment to members was:

Well, that was a totally insane day. Looks like dueling tradebots out there today but the bottom line is yet another rejection off our bounce levels (not to be confused with breakout levels - these are just lame bounces we would expect from dropping a dead market off a 5% roof).

Thursday - Greece is the Word

I closed my morning commentary with the very prescient:

We’ll have to see how this play unfolds. The Greek workers may not accept the wage freezes that are critical to this plan and the Swap crowd will not be very happy if they don’t get their massive payday on a national default in Greece. But now they have come up with a new fun acronym to scare off invetors which is STUPID - for Spain, Turkey, UK, Portugal, Italy and Dubai) to keep stirring the paranoia over pending sovereign debt implosion. The PimpCo boys are on the warpath, dissing everything that isn’t a bond as they press their Q1 advantage for investors ears after a big victory in January.

So that’s pretty much what happened by Thursday morning as those CDS’s I’ve been worrying about for a month reached critical mass. They jumped more than 10%+ overnight in Europe and set off a frenzy. Since I had already talked all about the crisis well in advance of it actually happening, I was able to take some time in the morning to warn of the pending proletariat revolution. But most likely, no one will listen to me about that until after the fact. (Just like THIS week, the TV and radio guys want to interview me about how I saw last week coming - what a ridiculous system!). I set the watch levels at the end of the post and notice how we failed them all - giving us nice, clear signals:

Today we test our downside target levels of Dow 10,165, S&P 1,088, Nas 2,200, NYSE 7,000 and RUT 620. Gold and the S&P have both held 1,088 like champs so they will be the first sign of a fatal breakdown toward our 10% levels but copper seems to be leading the way as it looks to test $2.85, which would just be sad if they fail.

  • TM July $65 puts sold for $4, now $3.20 - up 20%
  • TM July buy/write net $63/64 - on target
  • TBT Jan $3545 bull call spread at $6.30, now $5.50 - down 13%
  • TBT March $50s sold for .65, now .59 - up 10% (pair trade)
  • TNA Feb $35 puts sold for $1.35, now $1.75 - down 30%
  • DXD July $27/33 bull call spread at $2.50, still $2.50 - even
  • SDS 2011 $36/40 bull call spread at $1.30, still $1.30 - even
  • TBT 2011 $42/51 bull call spread at $4, still $4 - even
  • EDZ July $3/8 bull call spread at $2.10, now $2.20 - up 4%
  • EDZ Apr $10 calls sold for .70, now .65 - up 7% (pair trade)

That last group of trades was a new set of what we call Disaster Hedges and I sent those out (with better entries) in an Alert to Members at 4:43. I added a new set of levels to watch (the 10% lines) as we expected a brief opportunity to pick them up in the morning before heading lower. While we thought the very bad NFP data was baked in and while I had determined the Greek panic to be overdone (Spain is much, much, more to be concerned about!), it still pays to have our disaster plays in place - just in case! Unlike our last set of hedges, none of these plays were naked sector shorts as we still held out hope things could turn around and justify our bottom fishing.

Flashback Friday - EU and the Ghost of Lehman’s Past

The global markets kept panicking and the whole thing was starting to smell like fund manipulation. Bill Gross and Mohamad El-Erain were suddenly popping up every 5 minutes with yet another "friendly warning" that people better flee the markets and run to the safety of the bonds PIMCO is probably dumping after its record-setting first quarter profits. What clinched it for me was reading that Goldman Sachs (NYSE:GS), Credit Suisse (NYSE:CS), JP Morgan (NYSE:JPM), Bank of America (NYSE:BAC) and Citigroup (NYSE:C) all had double digit jumps in their own Credit Default Swaps and I know those guys are more than happy to let (or even cause) entire nations die of starvation in order to make a buck but, once it spills over and threatens their own borrowing rates - well, that’s a Trojan Horse of a different color!

I said right in the morning post:

Asia is freaking out (down 3% this morning), Europe is freaking out (down 2% this morning) and we added some more disaster hedges yesterday but today WE ARE BUYING! That’s right suckers, sell us your stocks - we are catching those knives.

I had just finished our Buy List and I was very pleased with the way the first 2/3 of our picks had held up for the week so it was with great confidence that I put up the next set of long-term trade ideas for our Members. We didn’t want to overdo it into the weekend as it was looking grim in the morning, but Friday’s session got downright interesting:

  • DIA Feb $101 calls at $1.02, out at .95 - down 7%
  • DIA Feb $101 calls at .90, out at $1 - up 11%
  • TNA Feb $35 puts sold for $1.90, now $1.75 - up 8%
  • General Electric (NYSE:GE) March $15 puts sold for .50, now .45 - up 10%
  • DIA $101 calls at .85, out at .90 - up 6%
  • USO Feb $32 puts sold for .45, now .22 - up 51%
  • Barrick Gold (NYSE:ABX) March $33 puts sold for $1.50, now $1.05 - up 30%
  • TBT Sept complex spread - on target
  • Dell (NASDAQ:DELL) 2012 complex spread - on target
  • FXI 2012 complex spread - on target
  • TBT March $46 puts sold for $1.20, now $1.02 - up 15%
  • UYG 2011 buy/write at $2.80/3.90 - on target
  • DIA $102 calls at .50, now .55 - up 10%
  • Berkshire Hathaway (NYSE:BRK.B) Sept $65/74 bull call spread at $5, now $4.75 — down 5%
  • BRK.B March $76 call sold for $2, now $2.30 - down 15%

Good on our word, we picked up bullish plays on TNA, GE, DIA, USO, ABX, DELL, FXI, UYG and BRK.A. At 2:51 I commented to members:

I am going slightly bullish into the weekend. I think 10% should hold (Dow 9,630, S&P 1,035, Nasdaq 2,088, NYSE 6,660 and Russell 585) although it isn’t on the RUT at the moment. But look how well we’re lining up and the Dow is still at the 8% bounce level (9,850). So how are the rest going to blow 10% if the Dow hasn’t even blown 8%? So SLIGHTLY bullish on short-term plays but MAINLY cash. On the disaster plays, I’d leave them bearish as originally planned (well covered, don’t be greedy) and play the upside with something speculative like DIA $102s at .50.

That’s pretty much how we left it and we’ll have to see on Monday how well our attempt to stay bullish plays out. We’re gambling on some resolution to the crisis in Europe - it shouldn’t take much - just some statement of support or even promise to support should calm things down. I’ll have more on that as I complete my weekend reading but, for now, it’s Super Bowl time…