Thursday Fervor- Draghi Catches The Markets As They Fall

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Includes: AAPL, BHI, BXUB, BXUC, EPS, HAL, IVV, LLSP, RSP, RWL, RYARX, SDS, SFLA, SH, SPLX, SPUU, SPXL, SPXS, SPXU, SPY, SQQQ, SSO, UPRO, VFINX, VOO
by: Philip Davis

Summary

Will Draghi fever be enough to stop the slide?

A look at the levels we need to hold.

A couple of hedging ideas - in case we don't.

SPX DAILY

"Help me now I'm calling you

Catch me now I'm falling
I'm in your hands, it's up to you
Catch me now I'm falling." - Kinks

We told you we would be doomed back on the 11th if the Russell were to fail 1,050. That was 5% ago and we expected the S&P to follow to 1,890 (10% off 2,100) and we've overshot that to the downside, all the way to our major support line at 1,850 on the S&P 500, which lines up with:

  • 15,840 on the Dow (-10%)
  • 4,000 on the Nasdaq (Must Hold)
  • 9,350 on the NYSE (-15%)
  • 960 on the Russell (-20%)
  • 15,750 on the Nikkei (-25%)
  • 9,350 on the DAX (-15%)

So the Nasdaq and the S&P are the only major indexes not to have gone negative (so far) but both are on the edge and, if they fail to hold their Must Hold lines - there's no reason to think they aren't going to join their brother indexes in stock market Hell. So, let's not cry about it but rather come up with some hedges that will pay big money IF that happens.

Click to enlargeThe S&P's ultra ETF (NYSEARCA:SDS) moves up twice as fast as the index moves down and is currently sitting at $24. If we assume just another 5% drop in the S&P, that's a 10% pop in SDS to $26.50 and our worry window is short, so a trade we can protect ourselves with is:

  • Buy 50 SDS March $24 calls for $1.70 ($8,500)
  • Sell 50 SDS March $27 calls for $1 ($5,000)
  • Sell 3 AAPL 2018 $80 puts for $10 ($3,000)

That net's just $500 in cash on $15,000 worth of spreads and you do have an obligation to buy 300 shares of Apple (NASDAQ:AAPL) at $80 ($24,000) if it drops another 17% so you need to REALLY want to own AAPL if the market tanks but, of course, you'd also have your $14,500 gain on the spread to offset that purchase. Ideally, AAPL never goes that low and you have free protection.

You can substitute any stock you really want to own for AAPL or just take the net $3,500 spread as the upside at $27 is still $11,500, which is a nice 328% return on your insurance cash!

Click to enlargeThe other ultra-hedge we like is the Nasdaq's 3x Ultra-Short (NASDAQ:SQQQ) and that's sitting at the $25 mark so would pop 15% to $28.75 if the Nasdaq falls another 5%. It should be noted that we do NOT expect this to happen and we think 4,000 with hold and AAPL will go higher (which is why we like it for the offset) but - if we're wrong - this is where we'll feel the most pain.

  • Buy 20 March $20 calls for $5.50 ($11,000)
  • Sell 20 March $25 calls for $3.90 ($7,800)
  • Sell 3 BHI 2018 $40 puts for $9.50 ($2,850)

Here we have a $10,000 spread that is currently in the money and can only lose if the Nasdaq goes higher (which presumably would be a relief for your other positions). The net cash outlay here is just $350 so net $9,650 profit (2,757%) if the Nasdaq is mean enough not to recover by March 18th (expiration day). Keep in mind this is insurance - we expect to lose this money if the markets go higher!

I chose Baker Hughes (NYSE:BHI) because we think oil has bottomed at $27.50 (see yesterday's post) and we think the buyout from Haliburton (NYSE:HAL) will go through at $50+ for BHI. If, however, it does not go through, HAL owes BHI a breakup fee of $3.5 BILLION - that would be 20% of BHI's $17Bn market cap or two years worth of earnings - making them attractive, even at $40 (now underpriced at $38.88). There's a good article on the subject by Ari Papadatos over at Seeking Alpha if you are interested.

Speaking of articles - I was interviewed by Forbes this week and we laid out our bullish play on oil, which we discussed in yesterday's Live Trading Webinar as well as some general investing tips.

Keep in mind that we are BULLISH on the market at these levels (the same drops we predicted 2 weeks ago) and now we're looking for at least a 2% bounce but it will take a 4% bounce before we get really bullish. For now, we're just expecting a nice bottom where we can do a little fishing from our Buy List (Members Only) and, if our lines don't hold - we will be ready to slap on protective plays like the ones above to help buffer our long positions against the next leg down.

Hopefully Mario Draghi and the ECB will be able to save us this morning but, if not - it pays to be prepared!

8:30 Update: Draghi is doing his job and talking the markets higher - we'll see what sticks but, so far, no need for these hedges though we'll still be looking to add some protection on the way up since we have been adding longs that need some protecting, regardless of the bounce we're getting today.

Unfortunately, Draghi's words will weaken the Euro and strengthen the Dollar (back to test 100), which will put a bit of early pressure on stocks and commodities but, if we can overcome that and make at least a 1% gain today (2% preferable), then we MIGHT not need those hedges!

Disclosure: I am/we are long SQQQ, SDS, AAPL, BHI, USO, UCO.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Positions as indicated but subject to RAPIDLY change (currently mainly cash and an otherwise slightly bullish mix of long and short positions - see previous posts for other trade ideas). Positions mentioned here have been previously discussed at www.Philstockworld.com - a Membership site teaching winning stock, options & futures trading, portfolio management skills and income-producing strategies to investors like you.