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You may have heard that the Chinese word for "crisis" is also the word for "opportunity."

While it makes a nice catch phrase for bored business writers, it is not actually correct. The Chinese word for crisis is composed of two elements that signify DANGER and CHANGE. You will hear many pundits today telling you how real men buy on the dips or some such nonsense and you must ignore them! These people are up to their eyeballs in positions and they want you to come in and save them.

Today I would like you to take a post-it and put it up in the corner of your monitor, where you can’t ignore it and write in a nice, thick marker: It is NOT my Job to Save the Market! Opportunity, yes, but DANGER!!! Real men (and women) protect their families (and their assets), not their egos. If we are having a real recovery than we have a 400 point gain ahead of us - you will not miss anything by sitting out the first 100!

A 20% retracement of yesterday’s losses will put the Dow up 83 and the Nasdaq up 24 and the S&P up 12. If you drop a ball from five feet and it bounces one foot, do you bet 10% of your portfolio that the next bounce will be two feet? No - you get the air pump! If that doesn’t work, it’s time to get a new ball…

Is the air coming out of the global economy or did China just spring a small leak?

The Shanghai Composite recovered 3.9% today and that is the headline of every section of the on-line WSJ as they and CNBC put on their cutest cheerleader outfits but Europe is off 1.25% this morning and Asian markets, led by a Nikkei 500 point, 3% drop had a terrible morning!

Let’s not forget that a 4% gain off a 10% loss is really only a 3.6% retracement at best, the math trick is that you are starting from a lower point. This is like buying International Business Machines (NYSE:IBM) at $100, having it drop to $50 and, when it bounces back to $75, raving about your 50% gain…

What’s great about the WSJ though, it the amazing charts they do. I’m not sure if this link will work but it’s called: Interactive: Track the Selloff From Shanghai to the Street and things like this are the reason I read the journal cover to cover every day! Had I seen this chart yesterday (or had I been thinking more clearly in our little crisis) I would have shorted the Nikkei, Taiwan, Australia, Thailand, Pakistan and South Korea as you can clearly see the dominos tumbling as the globe spun the markets to close after a bad close.

While I certainly don’t want to come across as a prophet of doom, I did say last night (and 20 other times) that I do expect a pretty significant correction at some point. If we don’t break out of 33% retracements of yesterdays drops before turning down again, then I have some downside targets you are really not going to like.

We’re going to take a step back today and assess the situation and, if we can turn this to our advantage then I will gladly take on the mantle of being the Profit of Doom!

We held our iShares FTSE/Xinhua China 25 Index's (NYSEARCA:FXI) yesterday and sold another set of calls against them ($100s), but let’s not panic and buy them back unless we get a better than 150 point Dow recovery. We have length of contract on our side (in other words, I wouldn’t do this in September) so we can always roll but there’s no reason to pay our guy a premium. I’m actually considering adding to that position but our basis is now so low ($2.60) that even at $6.20, the Jan $110s seem expensive! I think our most sensible solution is to add the dollar value of the calls we sold to the leaps we hold which will offset a large gain and effectively increase our position for free if we finish below $100!

I was hoping the GDP would save us, but it came in at a lukewarm 2.2%. I guess an optimist would say it could have been worse, but let’s watch our levels closely:

If we don’t recover Dow 12,400, be afraid, be very afraid! Next stop is 12,200 on the express train to 12,000.
• The transports need to get back over 2,850 but are in no real danger above 2,750, another 75 points down.
S&P must hold 1,400 and our retracement there is 1,420 or bust (literally!).
NYSE 9,000 is still the line in the sand - we held it so far but the bears are grinding us down! As I said Monday morning, this is our canary in quicksand…
Nasdaq MUST hold 2,425! Without the Nasdaq we have no hope - end of story.
• The SOX broke out over 470 yesterday! Can they hold it? Imagine the demand for state-of-the-art components as everyone plays catch-up with Apple (NASDAQ:AAPL).
• Russell needs to retake 780 or it is a dead canary!

US Markets

Since anything down is bad we need to set very tight stops on all March and April uncovered calls and normal stops on longer contracts - including uncovered leaps!

If we trigger out of our calls, we need to set equally tight stops on our remaining uncovered puts. If we are going to go sideways down here (around a 5% drop) then we will be needing that cash for our next round of positions, which will be a very different group than what we’ve been playing in this fairly bullish market.

You can take my advice with a grain of salt but members will do well to remember my oft-repeated adage: When in Doubt - Sell Half!

They did a great job of pumping crude yesterday and we bailed on half of our oil positions ahead of inventory. If it keeps going down, it’s a long way to the bottom and if it goes up, we will be happy to short again from a new top. I will be surprised if they can hold $61 today but I can assure you all measures will be taken to guard the $60 line until another 10% can be pulled out of the energy sector. 34M shares traded caused a $4 drop in Exxon Mobil Corporation (NYSE:XOM) yesterday, leaving 5.7Bn roaches still trapped in that turkey!

Zman said yesterday that something had to give, and the oil sector sure gave yesterday! We took some calls to cover our remaining puts but I’ll be profit taking if they can’t make the same sort of 33% retracements I’m looking for from the broader markets. Today we are set up for disappointment in crude inventories and ZMan goes over that in detail but the short story is that we can expect at least an attempt at a rally today but a dollar recovery may scuttle that plan.

We’ll watch gold and I expect a test of at least $670 before it gets back on track but it would be healthier for all of us if it pulled back to $650 and took copper with it. If this does not happen, then the markets are, in fact, unstable and we’d better get our hard hats but I favor the first scenario.

OilGold

Don’t get excited unless we break and hold most of our levels! You will be inundated with messages telling you to hang on. Nobody want’s you to get out of stocks, not your broker (he wants the commissions), not the media (if you don’t have stocks, why watch CNBC?), not the analysts (same ratings issue) and not the newsletter writers who want you to keep in the markets and keep up the subscriptions (if I wrote a truly commercial newsletter that comment would have been edited out by some corporate jackass - long live Electronic Media!).

So more than usual - please be very careful out there today!

Source: Options Trader: Wednesday Morning Ideas