Options Trader: Wednesday Morning Ideas

by: Philip Davis

I’m going to miss the fun until the afternoon and it’s 6 am so here’s my quickest take.

It’s all about rates. If the 30-year breaks for 5.5%, there’s not much you can do to stop a sell-off. Hopefully, you have mattress plays in place and are not too worried about a nice, healthy correction.

I’ve been saying all year that rates and inflation would bit us in the ass and now you know exactly what that feels like and the real correction going on here is that the Treasury Market is finally recognizing some of the risk involved in holding US currency, which is not the best backed paper in the World.

Parachute Dollar

If we accept that fact and move on, we can make much better investment decision and there are a lot of good companies we will be lining up as buys when this thing calms down but for now, let’s focus on protecting ourselves.

First of all, this is a good time to be half in cash. For one thing, they are now paying you almost 10% more for cash than they were last month when rates were under 5%. The US dollar is on a tear and reflects that fact. However, there is a certain fallacy there if the dollar isn’t keeping up with inflation, so we have to watch the Beige Book numbers today very closely as well as Import Prices. We also get Retail Sales, Business Inventories and the always exciting Crude Inventory Report and if they don’t have the decency to let oil drop a couple of bucks at this point, I think the energy roaches may be surprised at how fast this economy will shut down and trap them in some very expensive commodity producers at the front end of a recession.

Don\'t Panic

It’s important not to panic, but to be ready to panic. Preparing to panic means looking over your positions, thinking about your risk tolerance levels and what you are going to do when they are exceeded. It would be great to tell you not to panic at all, but since most of us aren’t professional firefighters or secret agents, we don’t often face panic-inducing situations. Plus, when the Dow is falling over 100 points we have other things to worry about than whether our vodka martini is "shaken, not stirred."

Having mattress plays in place doesn’t mean your portfolio isn’t going to fall, it just means it will hurt a lot less when it does. Mattress plays allow us to hold our positions on a dip and save us from A PORTION of the damage that we would have taken, not all of it. Right now we are looking for the Dow to hold 13,150, the S&P to hold 1,492, the NYSE to hold 9,725 and the Nasdaq to hold 2,525. If these levels are not held, a little panicking would be appropriate:

US Markets

Asia did not do so badly this morning, as rising US rates only bring us more in line with the rest of the world AND allow the Yen carry trade to continue - this has been one of the major global investment drivers for years. Ideally, we’d love to see a commodity slowdown here, so it’s not so much about if the markets go down, but about who will lead them down. Both sides of the Shanghai caught a lot of buyers yesterday, but Europe is unconvinced, selling off about half a point ahead of the US open.

There will be nothing to worry about if all we are doing is consolidating between the 50 and 200 dmas on the above charts, but if we do break lower, it’s a long way to the next resistance point and it’s very important that you look at your portfolio and think about what you would do at 13,200, 13,100,13,000, 12,900, 12,800…. If you fail to plan, you plan to fail and all that!

We’re well protected in our portfolio to about 13,000, but below that we will need to make some changes. Our $10KP will take a hit if we keep going down because it was the least flexible, but jumping on downside bets today may be chasing a short-term bottom.

If you are not already well protected or just looking for some downside plays, I like the iShares Dow Jones US Real Estate (NYSEARCA:IYR) (Real Estate) July $79 puts at $2.22, the S&P 500 Index - "Spiders" (NYSEARCA:SPY) July $150 puts for $2.28 and the very thinly traded SPDR S&P Metals and Mining (NYSEARCA:XME) June $62 puts at $1.07 as a gamble, but only if gold breaks below $650.

Click to Enlarge
XME

Hopefully we won’t need them, but those are the plays I’ll be watching if I feel the need to add some additional protection to a well-protected portfolio. However, it’s human nature to hope things don’t go that far wrong, even as the 10-year creeps up to 5.30% in pre-market.

OilGold

We NEED oil to take its foot off the neck of our economy! Note the declining 200 dma - if we can get oil back around $64, gravity will take care of the rest and that will lead to 10-point drop in the S&P we’ll be happy to see! ZMan will be dissecting the inventory report this morning.

Remember, if we are making a comeback, we have 400 points to go just to get back to the first week of June, so it’s OK to miss the first 50, even the first 100 points of a "rally." Our post-it for today, which should be affixed to the top of your monitor where you always see it, should read "It is NOT my job to save the market." Let someone else guess the bottom, it’s a long way back to the top!