Options Trader: Tuesday Morning Ideas

by: Philip Davis

The talking heads are all breathless today about Shanghai’s "spectacular recovery" from another 7.2% drop (on the A-shares), as they ended the day up 2.6% (99 points).

Come on people - have some perspective!

The market dropped from 4,545 on 5/29 (last Tuesday) to 3,600 this morning and bounced back to 3,949. Aside from the fact that this represents just a basic Fibonacci retracement of a very strong drop, the whole thing smacks of institutions stepping in to rig the markets as ALL of the buying took place after the lunch break (yeah, they shut down their markets for lunch - can you imagine!).

What no one seems to be able to imagine is what happened to the Shanghai composite in the first five years of this decade:

Shanghai Composite

While investors may have very short memories, institutions do not and they are painfully aware that they are now trapped like roaches in the $3.6T (was $4.2 Trillion just a week ago) boom market. As I observed yesterday in comments yesterday, a point in the Shanghai is just about $1B these days so you can see from this chart that since 3/10/05, SOMEONE has put $3.1 Trillion into the market and now they are concerned that they may not get it all back! Of course, it’s more than one person, but it’s the equivalent of 3,100 billionaires with their personal fortunes on the line.

Do you think some of them will say anything, do anything, to get you to buy those shares off them? Do those people have access to the media (in fact what self-respecting billionaire doesn’t a least have his own magazine these days?) and friends in high places (what self-respecting billionaire doesn’t own a few politicians?)? I’m not down on China per se, but I do think we need to take China pumping with a huge grain of salt right now.

During comments yesterday, many of us found it very strange that the iShares FTSE/Xinhua China 25 Index (NYSEARCA:FXI) didn’t drop, despite the 8% fall in the Chinese markets - it was almost as if someone knew the markets would be rescued today, no matter what!

So [pretending I’m not a cynical writer so I can fit in with the MSM, the Shanghai Index rebounded in a "volatile" session this morning, gaining 2.6% to finish at 3,767, now down "just" 13% from last Tuesday’s record close. As the WSJ puts it: "By Tuesday’s close, the benchmark Shanghai index was 13% below its record high of 4334.92, hit May 29. But it was still up 40% for the year so far."

Click to Enlarge

Japan picked up 80 points, closing above 18,000 for the first time since the 2/27 global sell-off. On June 7th, 2005, the Nikkei was at 11,217 and the Dow was at 10,483. Since then, the Nikkei is up 6,836 points while the Dow closed yesterday at 13,676 (up 3,193), less than half of Japan’s gains. Either they are way overbought or we have some serious catching up to do - and I actually do think it’s the latter!

What happened to our markets in 2005 that we stopped keeping pace with the global expansion? Why it’s almost as if we were stuck in some sort of quagmire that caused the rest of the world to cut their ties and move on without us...

Speaking of humiliating defeats, Honda Motor Co., Ltd. (NYSE:HMC) will discontinue the hybrid version of its Accord sedans, acknowledging that they simply can’t compete with Toyota Motor's (NYSE:TM) Prius after selling 439 Accords in the US last month vs. 24,000 Prius's. Honda (HMC) gave up on the Insight hybrid last year but, plucky little company that they are, they are promising to try again with a "totally new hybrid in 2009."

Over in Europe, there are jobs opening up for gourmet food tasters who "have an Epicurean palette, a knowledge of fine wines and a strong tolerance for Polonium-210" as President Bush gets ready to break bread with President Putin at the G-8 conference in Germany.

Bush knows which side his bread is buttered on and continued his tough talk in preparing for the upcoming conference where the big issues is Russia’s vehement opposition to the US’s planned missile defense system that Bush wants to put near Prague, on Russia’s doorstep. Bush told the Czech people yesterday: "My message will be: ‘Vladimir — I call him Vladimir — you shouldn’t fear a missile defense system. As a matter of fact, why don’t you cooperate with us on a missile defense system? The people of the Czech Republic don’t have to choose between being a friend of Russia or a friend of the United States. You can be both," he said.

Yes, tough talk indeed from our President, but as Frank Purdue often said: "It takes a tough man to make a tender chicken!" Also on the agenda at the G-8 is climate change (where Germany will pressure Bush to sign on to the treaty the rest of the world is on board with), trademark piracy and debt relief for Africa. The debt that seven of the G-8 are most concerned about is the US deficit and we can expect some tough statements from world leaders that have the potential to spook our markets.

German Chancellor Merkel acknowledged over the weekend that she probably won’t get the deal on climate change that she is seeking since Mr. Bush continues to resist specific commitments to cut carbon emissions. "If the United States doesn’t move, others may also prefer to wait and see," Ms. Merkel told German news magazine Der Spiegel. Most European officials worry that Mr. Bush’s counterproposal is vague and could undermine the European Union’s strategy for combating climate change through concrete commitments.

Our markets are looking pretty good, of course, but you know we’re in trouble when I start playing Iron Condors and Bear Call spreads, like we’ve been doing on the member site this week. I have not been able to pull the trigger on many buys so far as I’m just not comfortable with the market action. Uncle Ben will address the IMF at a South African conference today and I’m sure he will be able to give us a little spin and we should get a good read on the ISM numbers:

US Markets

How can you be worried looking at these charts? We opened at 13,620 yesterday, so let’s see if that firms up as something today but this is all part of our plan as I predicted consolidation into options expiration, which is why our Short-Term Portfolio has just six June calls left with 50% of our positions either in spreads or on the put side.


No matter how rosy Bernanke tries to paint the inflation and housing picture, the fact of the matter is that global rates are heading higher and the dollar is continuing to drop, which will FORCE the Fed to raise rates. Unless, that is, we suddenly come up with a plan that doesn’t require us to sell $40B a month in debt notes that are backed by a declining fiat currency.

We’ll see how the world treats the dollar today, but it took a very nasty spill yesterday. I think the G-8 conference is going to raise a lot of issues we’d rather not be talking about (like who’s a bigger default risk: the Sudan or the US?). David Fry’s chart on the dollar illustrates the problem nicely.

So let’s keep an eye on those rates today as the 10-year works its way up to join the 30-year at 5%, adding fuel to the sub-prime fire as most rates benchmark off that note. Gold broke out above its rising 200 dma, while the dollar slipped below its descending 200 dma. I think if we get a break from oil (which is driving global inflation everywhere but here, where we don’t count it in our "core" readings), we can still take things up another notch but I’m CAUTIOUSLY optimistic at best!