Options Trader: Thursday Morning Ideas

by: Philip Davis

"I’ve come to believe that all my past failure and frustration were actually laying the foundation for the understandings that have created the new level of living I now enjoy." - Tony Robbins

"Don't lower your expectations to meet your performance… Raise your level of performance to meet your expectations. Expect the best of yourself, and then do what is necessary to make it a reality." - Ralph Martson


Sage and I will be continuing our discussion of ways to reposition underperforming portfolios this weekend, a continuation of our series on Smart Portfolio Management that we began on April 9th, when we decided it was time for us all to start preparing for a pullback.

The Nikkei managed to close positive today, but look at how they did it. A 150-point gain after lunch erased a morning session that opened down 160 points and recovered just 10 in the first two hours of trading. The Hang Seng was also very bouncy in the afternoon, recovering a quick 150 points within 30 minutes of having lunch, but giving back some of it to close down 18 points on the day. Still, erasing the negative 200-point morning open is very impressive and we can only hope that US traders are eating at that same restaurant today.


According to the WSJ:

In Shanghai, shares extended their recent gains, after market-supportive comments by a central bank official and a report in a state-run newspaper that said the government doesn’t plan to implement a capital-gains tax as some investors had speculated this week. The benchmark Shanghai Composite Index, which tracks both Class A and B shares, ended up 3% at 3890.80.

Gee, that’s nice, but the reality is that they too had a "miraculous" afternoon recovery (in the A shares, the B shares dropped!) and any rational observer would note that foreign capital continues to flee the China market.

Europe is just full of rational observers and they seem to have observed that the same ridiculous pumping action that lifted Asia off their afternoon lows was working their pre-markets into a frenzy and the FTSE (for example) dropped straight back down to yesterday’s lows after opening 60 points higher (1%). Germany had similar action and so (coincidentally) did France’s CAC40. Thank goodness we know the markets aren’t being manipulated, or we would start to get suspicious…

Our indices are facing some critical resistance points we would certainly rather not cross, but let’s keep in mind that US and European traders don’t get magical lunch breaks that turn the bears back into bulls, so we will watch their markets closely this morning for some sign of relief:

US Markets

As I said last night, we will be focusing on the S&P, which are critical at 1,515 and the Russell, who needs to hold 840 or there will be pretty much no stopping the entire market from dropping another 2.5%. Retail sales were encouraging, but we saw disposable income dip in May and oil hasn’t eased up since.

Oil continues to vex us by climbing and climbin,g despite the fact that demand is disappointing, storage is full and government investigations are heating up. It kind of reminds me of the way a frat party gets more and more out of control after a neighbor complains and sort of peaks out right before the police come, at which point the house empties in 30 seconds or less. If you’re an energy trader - try not to be the half-naked drunk guy passed out on the couch when they shut this baby down!

Now it’s Brazil’s turn to cut production with a Petroleo Brasileiro S.A. (NYSE:PBR) union strike. This is the emergency measure being used to pump crude prices as the dreaded cyclone turns out, in fact, to be a gusty storm - the type that has been terrorizing screen doors for centuries. ZMan has an excellent rundown of this as well as an analysis of the inventory reports ahead of today’s natural gas inventories.

With gold staying below $675, this market drop is about the global economy slowing, not about inflation spinning out of control. Copper tested the 50 dma at 346 yesterday and didn’t stay there long, finishing at $340 on the way to test the 200 dma at $315. This would provide a much needed break to builders and industrials (assuming a cyclone doesn’t attack a Peruvian copper mine!). The dollar’s death isn’t dead enough to provide further lift to commodities, including US equities, as that ship has already sailed, and it’s doubtful (one would hope) that we’ve got more than 5% left to fall.


Kudos to Apple (NASDAQ:AAPL) for stealthily installing the number one home network software in the world! That’s right, you probably already have Bonjour, the networking system that allows any iTunes app, whether for Apples or PCs, to talk to each other and share media files (audio AND VIDEO). The program has many other capabilities, but the trick is that they have already given it to you, you’ve been using it and they haven’t even begun to market its other capabilities. Walt Mossberg wrote a great article about this in the Journal and has a nice video for you non-technical types!

Holding flat for the day would be a victory for the markets, but let’s watch out for those interest rates. The BOE did us a favor by not raising them this morning, but it may be the last favor card Bush will ever get to play from Blair; the new PM will not be looking to follow Blair out of office due to his relationship with the American President.

Another thing we haven’t been watching lately is the Yen carry trade, but David Fry points out that we may be looking at a double bottom on the yen (remember their 13.7% increase in corporate spending on Monday?).


Those spikes in the Yen correspond pretty directly with our biggest market sell-offs of the past few years, and we are in a much more tenuous position than we have been in the last couple of spikes. So we can expect a break over 84 to have a pretty shocking effect as the unwinding of virtually free Yen can quickly crash global liquidity.

Another great idea from David is to short the iShares S&P Latin America 40 Index (NYSEARCA:ILF) as that market is up 85% since last July. It's a thinly traded fund, but July $205 puts are $6.80 and the current $205s can be sold for around $2.50 as weekend insurance if the market doesn’t look like it’s going down. However, I like this as a momentum trade with a $5 stop, raising it $1.50 per $2 gained, looking for about $12.