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Wheeee, what a ride!

Finally all our very boring sitting around at 75% cash makes us feel smart as the market makes what we hope is that final blow-off bottom to re-test our lows. I already sent out an Alert to Members this morning so a lot of this is old news to them but nothing has changed since 4:30 so here’s a quick reprise - What we are mainly seeing in the futures this morning is 2 major factors that are driving the markets lower:

1) Japan, where too strong Yen (88.6), -0.1% industrial output, -1.7% exports, rising unemployment (just 5.2%) AND lower household spending (-0.7%) numbers sent the Nikkei down 1.25% today to 9,570. If you think about it though, pretty much all of that is a strong Yen issue because it lowers demand for the exports (making them more expensive) and then factories slow down and people get laid off and household spending drops from that PLUS the fact that it’s now cheaper for them to buy imports so they can buy the same stuff at lower prices.

So, overall, nothing people shouldn’t have expected but ugly to read about.

2) China, where the Shanghai fell 4.27% today to 2,427, which is a lot because they are a 10% limit down market on individual stocks so you can bet the selling isn’t done if the AVERAGE was down 4.27%. The Hang Seng was ugly too, falling 2.3% to 20,248. What sent China off a cliff was kind of silly. The Conference Board, which is a NY-based research firm, had reported that Chinese economic indicators rose 1.7% in April - something at the time (June 15th) we thought sounded a bit high. Well, funny thing is it turns out the people at the Conference Board must have been high on something because it turns out they made a "calculation error" and the correct number was just 0.3%.

There is a third factor in play and, earlier this morning, I thought it was too silly to be considered but, apparently, you can panic retail investors over pretty much anything. On Thursday, there are $547.5Bn worth of bank-loans from last year’s special liquidity program that are due to roll over and there are rumors circulating that the ECB won’t renew the facility at all. The ECB has, in fact, already promised to replace it with rolling 3-month loans at the same rate, hoping to make it annoying enough for banks to seek long-term funding elsewhere. The ECB is also pissed off at the banks who have taken their money for a year, yet haven’t increased their own lending - which was the whole point of providing liquidity. The same nonsense goes on here but, as I may have mentioned last week, our Fed works FOR the banks and just keeps funneling free taxpayer money to the banks while the banks keep reducing the amount of money they lend to those taxpayers.

So Asia was awful and, in Europe, it’s another day of protest in Greece and Europe is dropping 2.25% and taking our futures down (about 1.25% as of 8am). Let’s watch those international 2.5% lines (red ones are the downside, of course) around our key levels (circled). None of these charts reflect today’s action, unfortunately, but we will be looking for the DAX to show a little strength on that 6,000 line and we hope the FTSE can hold 5,000 and CAC 3,500:

We needed a blow-off bottom and hopefully this is it and not a sign that we’re in another deep downtrend (as many are betting on). We have our TZA disaster hedge from Friday and Thursday’s SDS and other SPX hedges (like the one on the Buy List) short-term, but we are generally too bullish for this drop, especially on our Mattress Play where the June 30th $102 puts we sold for $1.60 are going to be well in the money today (so they have to be rolled to July).

Since we can expect the VIX to shoot back up to 40, the best way to add protection is going to be selling puts on ultra-shorts against bull call spreads, like TZA July $6/7 bull call at .60, selling Aug $6 put for .48 is net .12 on $1 spread for a 733% upside. Our risk is owning TZA at $6 but a drop like this should show you that owning a little TZA can be quite comforting in the event of an emergency, so if you are protecting $25K invested in a $100K portfolio, then selling just 20 TZA Aug $6 puts (which can be rolled) for $960 and spending $240 more out of pocket buys you $2,000 of downside protection and your risk is owning 2,000 TZA at net $6.12.

Keep in mind that, if you are looking at a $2,000 loss on your $25,000 at this level, then if TZA stops your bleeding here, even if the market rallies back and you end up losing $1 on 2,000 shares - it’s going to be the $2,000 you get back on your $25,000 bullish positions. It is worth sacrificing some upside to protect your principal when we don’t know how bad things are going to get. Also keep in mind, though, that if we have sensibly hedged positions, like our buy/writes, that this drop is NOTHING and doesn’t need to be protected yet, and that means we can afford to take longer plays with better pay-offs to protect against further downside AFTER we have a real breakdown. Right now, all we are doing is testing "flash-crash" lows again.

We absolutely don’t want to buy puts as the VIX will send the premiums way up and we’ll be paying top dollar on a momentum play. That’s why we’ll be looking for some reverse-index puts to sell, like the TZAs because, even if the market turns back up, the VIX will shrink and our buyback won’t be so bad if we decide to take it off the table.

So let’s not panic - this is why we are 75% in cash and this is why we always have a disaster hedge in place, to take advantage of just such a drop! Take a good look over the Buy List as we’ll get some excellent entries and also, in the comments on the buy list, we had some 10 margin plays to make and those should also give us great prices into the drop as well as our list of 500%+ plays, which we should also get great entries on BUT - let’s make sure our red levels (-2.5%) hold up first:

Globally money is FLYING out of stocks and into US Treasuries and we are now at record lows (very bad for TBT) so we’ll watch that as well as $77.50 oil (now $76.30) and $3 copper (we’re right on the line) as both are generally bullish levels despite all this panic. Meanwhile, our friend who initiated the XLB trade we followed last Tuesday was a genius! The July $32/30 bear call spread was already 100% in the money yesterday at $1.40 (up 75% from .80 entry) and today is likely to be a good day to take that money and run as copper tests our mark and Freeport McMoRan (NYSE:FCX) looks for a bottom around $62.50, which is a tempting buy down there.

If this selling keeps up, it’s going to be a rotten way to end the first half of the year but, as I mentioned last week, we were relentlessly driven down last year from June 12th (8,800) through July 10th (8,150), a 7.5% drop that was reversed in one week and led to the insane rally that took us up to 10.500 in November so it seems a little premature to panic as we fall from 10,500 on June 18th to perhaps 9,800 today (6.66%).

So here we are again, right before the Holiday weekend and, wouldn’t you know it - we’re heading down! It’s very comforting to see our 5% rule obeyed so well as we fail at the 10,500 mark this week (20% up from 8,750), which makes our EXPECTED retrace (20% of the run) 10,150 so we’ll be watching that line closely on the way back up but, for now, we’ll be watching that 5% pullback off 10,500, which is 9,975 - which is what we need to hold to call this just a bullish pullback.

I’m expecting Case-Shiller Home Prices to be a relief (9am) and Consumer Confidence at 10am may be an upside surprise as well so maybe our open won’t be all that bad but, right now - the futures are awful! Ideally, we would at least like to hold those June 8th spike lows and the June 7th close, which were: Dow 9,725 (low close 9,815), S&P 1,042 (1,050) Nasdaq 2,145 (2,158), NYSE 6,480 (6,512), Russell 608 (617), SOX 326 (332) and Transports 1,921 (1,955). So, scary low numbers to shoot for, but much more important to see us hold those closes.

Update: We did get Case-Shiller and we had great numbers - +0.8% vs -0.5% in March and up 3.8% for the year, better than the 3.5% expected and the 2.3% in last month’s measure BUT, the S&P took ALL the fun out of the report by titling it: "While Most Markets Improved in April 2010, Home Prices Do Not Yet Show Signs of Sustained Recovery." Not very catchy, is it? So that has done NOTHING to improve the futures, nor did ICSC Retail Store Sales, which were off 0.5% this week but that isn’t stopping them from forecasting +3-4% for June as the calendar shifted Memorial Day sales into the June count so May was better than it seemed and June will look great - next month!

We’re going to watch FCX at $62.50, AAPL at $260, CAT at $62.50, PFE at $14, OIH at $95, XOM at $57.50 and XLF at $14 as all are stocks we’d like to sell puts against and all are stocks that should hold their lines in various sectors IF WE ARE NOT BREAKING DOWN. If they can’t keep it together, then we’ll be hitting those disaster plays hot and heavy…

Let’s be careful out there!

Source: Testy Tuesday: Bottom-Building, Or Big Bounce?