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What a disaster!

Of course, that's why we have disaster hedges, right? August 11th was the last time we did a "Hedging for Disaster" post which included a LONG trade idea on gold that's done now (we're short) after gaining over 300%. We're a little mixed in our results on the other hedges but that means we can SWITCH HORSES - from the trades that have already worked to the ones that haven't yet. That's how we cash out our winners on a regular basis - it's the pony express of investing. Our other disaster hedges from that post were:

  • DXD Oct $23 calls at $2, selling Oct $27 calls for $1.15 and the Oct $19 puts for .70 for net .10. That spread is currently -.05 so down 150% so far and a nice horse to switch to, offering a .05 credit on the $4 spread.
  • FAZ Oct $65 calls at $22, selling Oct $72 calls for $20 and selling JP Morgan (NYSE:JPM) 2013 $20 puts for $2.05 was a net .05 credit as a backstop to our long financial plays. FAZ is now at $71.34 and the October FAZ spread is now $3.70 but the JPM puts are now $3 so net .70 is only up 1,500% so far. Should the financials stay low, we get the full $7 from the spread and we're obligated to buy JPM for $20 (now $29.27) in 2013.
  • SDS Sept $26 calls at $3.20, selling Sept $32 calls for $1.65 and selling Valero (NYSE:VLO) Jan $15 puts for $1.20 for net .35. SDS is only at $25.73 so far (not a disaster yet) and the spread is now net $1.25 and the short VLO puts are .17 so net $1.08 on this one is up 208% and we're not even at goal - that's pretty good! Note the spread is LOWER than when we started so this can also be used as a fresh horse with a different offset, like U.S. Steel (NYSE:X) Jan $15 puts for $1.20 for a net .05 trade.
  • TBT was stopped out with a small loss at $24 (fortunately). My comment at the time, with TBT at $24.88 was: "Keep in mind though, that the Fed has said rates will stay low through 2013 so it would be wise to use stops on the puts, at least, if TBT fails to hold $24!"
  • EDZ is always our favorite disaster hedge as we've long suspected emerging markets would implode at some point, whether the Western markets improved or not. Our EDZ play was selling one set of the ridiculously overpriced January $75 calls for $3 and buying 2 Jan $25/40 bull call spreads for $2.60 each, which was net $2.20 on the spread. Unfortunately, the Jan $75 calls are still a crazy $4 but, fortunately, the two spreads are already $6 each so we're up to net $8 (up 263%). There's a stop on the calls at $5, by the way and, if that is triggered, then we set stops to maintain profits on the spreads, of course.

I would urge you to read the post as well as our other disaster hedging posts we've written over the years as there is noting more important than having INSURANCE. Having portfolio insurance lets us ride out the market waves and stick with our sensibly hedged (hopefully) long positions through the gyrating market cycle. At the moment we HOPE (not a valid investing strategy) that we are at capitulation on this chart and we've done a bit of bottom-fishing, just in case we're there.

Our long ideas in yesterday's member chat were XLF at $11.50, shorting TLT at $123, shorting VXX at $49.50, TNA at $34.50, Berkshire Hathaway (NYSE:BRK.B) at $65, Alcoa (NYSE:AA) at $10.20, VLO at $19, IMAX (NYSE:IMAX) at $15.75, Boeing (NYSE:BA) at $58.32, AGQ at $170, Chesapeake (NYSE:CHK) at $27.50, Disney (NYSE:DIS) at $30.14 and Barrick (NYSE:ABX) at $47.50. Of course we also had plenty of short plays to balance it out (15/15 is our current goal) and, when I say we like, for example, ABX at $47.50, that is to say we liked it enough to sell the 2013 $35 put for $3, which is a net $32 entry, $15.50 below the current price (33%). THAT's how we get bullish when we're not sure if we at capitulation of fear - we buy things while giving ourselves a nice buffer (see "How to Buy Stocks for a 15-20% Discount") AND we hedge with short plays that will give us more buying power on the way down.

We HOPE (not a valid investing strategy) 20% off from here is the worst-case scenario but the markets have gone much lower than that in 2008-09 and, while we don't feel this situation is the same as it was back then - one thing we learned three years ago in September was that you should never underestimate the ability of your fellow investors to FREAK OUT. Our job is, very simply, to have as much cash as possible when the market bottoms and that's what hedges are great for. If we do get assigned ABX at net $32 and we have a hedge against it like EDZ that pays us $20, then we're getting ABX for net $12 (75% off). If you don't want ABX for net $12, then why on earth would you buy it when it's at $47.50?

There's a huge difference between the PRICE of stocks and the VALUE of stocks but there are very few of us value Investors left in the world. TradeBots are not value investors - they look at price and that's all. If gold, for example, breaks $2,000 - a TradeBot is perfectly happy to buy it because of momentum and if gold breaks below $1,000 - the same TradeBot is happy to short it on momentum. Gold has no value whatsoever to the machines that are doing 85% of all the trading and neither do stocks - not Apple (NASDAQ:AAPL) or IBM (NYSE:IBM) or JPM or VLO or BA or Caterpillar (NYSE:CAT) - NOTHING!

It's not just the Bots though - most of the traders out there are technical traders as well and that's a valid strategy because it's a technically driven market. But, at a certain point, stocks get too cheap or too expensive relative to their FUNDAMENTALS - and that includes the whole global macro environment (see "The Worst-Case Scenario: Getting Real With Global GDP").

Note this cartoon from that post is from 2005 and, other than adjusting the debt figure upward by $8Tn and putting the housing bubble into the past tense, not much has changed - has it? As we learned from the great Roseanne Roseannadanna back in the 80's - It's always something or, as Tommy Lee Jones points out in "Men in Black:"

There’s always an Arquillian Battle Cruiser, or a Corillian Death Ray, or an intergalactic plague that is about to wipe out all life on this miserable little planet, and the only way these people can get on with their happy lives is that they Do ... Not ... Know about it!

We (savvy traders) are the Men in Black - we are keenly aware of all of the threats to global economic stability while the vast majority of the rest of the world gets up and brushes their teeth and eats their Egg McMuffin on the way to work until they get fired. As more and more people get fired (428,000 last week), more and more people become aware of the HORRORS of the global economy and OF COURSE THEY PANIC - it's HORRIFYING!

Now we (the heroes of this little drama) need to step back and objectively, CALMLY, move away from the madness of the crowd and simply factor the panic into our fundamental equation. On Monday and Tuesday this week I did my best to put Greece in perspective because we EXPECTED this panic drop but that's only half of the game - now it's my job to tell you why YOU need to leave the herd and NOT panic.

In Tuesday's post I mentioned our Fed hedge was a GLD Nov $180/174 bear put spread at $3.30, selling the $193 calls for $3 for net .30. That one is already $2.67 (up 790% in two days) and we're done with that, of course. In member chat at 11:50, we added short-term aggressive hedges on SDS, Las Vegas Sands (NYSE:LVS) and GLD again - all huge winners, of course and at 12:24 we added a November SQQQ spread to hedge against a longer downturn. As I discussed in yesterday's post, we tried to get more bullish but abandoned that when the Fed statement came out and now we are simply doing a little bottom fishing - HOPING (not a valid strategy) that the markets do find some support at our -10% lines - again. If not - we change horses, layering in our disaster hedges and enjoy the ride down!

Have a great weekend.

Disclosure: I am long EDZ, CAT, DIS, IMAX, JPM, XLF, VLO, TNA.

Additional disclosure: Positions as indicated but subject to change.

Source: TGIF: Stop The Week, We Want To Get Off