Options Trader: Wednesday Morning Ideas

by: Philip Davis

I will not fear
Fear is the mindkiller,
Fear is the little death
That brings total Oblivion
I will permit my fear to pass
Over me and through me
And where it has gone
I will turn the inner eye
Nothing will be there
Only I will remain.

That is the Bene Gesserit incantation for bravery from Frank Herbert’s "Dune," one of my favorite books. When the markets turn nasty on us it is time to get analytical, not emotional, and we need to let our fear pass over us as we step back and evaluate the situation with fresh eyes and a calm mind.

That’s why I’ve been moving us to cash for the past couple of week; it’s a lot easier to have an analytical view of the market when your portfolio isn’t hemorrhaging money. However, our very profitable puts and covers put us in another kind of dangerous state - complacency!


I see a lot of members turning very bearish on the market and I would urge caution on both sides. So far, this is nothing more than the correction that has kept us hedging since November and the inordinate gains we’ve been making this month are mainly just a return of the steady investment we’ve been making on the put side as our profits went up. In other words, we were up 300% in our short-term portfolio going into the month and we had been hedging 30% of our profits to the short side. Luckily, we called the top pretty much on the money, lightened up on the calls and that 30% we’d been investing came back to us as wins on our puts and now we are now up 400%. It’s really the same as if we’d just been 100% bullish and called the top properly - it doesn’t necessarily mean that being bearish is suddenly more profitable!

Our Short-Term portfolio is our fun portfolio, full of risky momentum trades and earnings gambles that have gone very well, but could just have easily not gone well if the market hadn’t done what we thought. Our Long-Term Portfolio, however, is a fairly bullish collection of solid companies and it is performing — solidly! Sure we hedge it, but we still have a lot of genuine appreciation in our positions and my regular review of them has not led me to begin cutting them loose yet, which means I am forced to conclude that things may not be as terrible as they seem…

Of course we are going to open down this morning - Asia is a disaster with the Hang Seng giving up 729 points, the Nikkei dropping 377 and Shanghai falling 5% on both sides of the market. However, the A-shares bounced off 4,494 so I’m starting to lose faith in the concept that Chinese traders are all that superstitious about the number four; probably just a silly story the press tells US traders at bedtime!

Fear and Greed

What freaked Japan out was Mazda’s 63% drop in quarterly profit which they blamed almost entirely on foreign exchange losses along with Fuji’s (Subaru) loss for the quarter as US sales ground to a near halt. Suzuki (small cars) reported a 20% rise in net profit as demand destruction for gasoline proceeds apace. Mitsubishi UFJ Financial Group Inc (NYSE:MTU) and Mizuho Financial Group Inc. (NYSE:MFG) also posted poor results in the banking sector as it is, not surprisingly, very difficult to make money when the interest rate is 0.5%.

That, my friends, is the Poppa Bear carry trade and if Japan decides they are tired of funding the global economic boom, we may be in for BIG TROUBLE!

Europe was having trouble in the morning but is cheering up a little in the afternoon, thanks to fantastic numbers from ArcelorMittal (NYSE:MT) and a general sense among traders that the US just isn’t that relevant anymore. "In Europe, the real economy looks strong enough to weather the current financial shock," said Eric Chaney, an economist at Morgan Stanley in London. "As long as signals from the real economy and monetary data do not flash red, the (European Central Bank) is likely to go for another rate hike, but then, will probably take its time to gauge the consequences of the credit tightening before acting."

If Europe feels they can ignore our struggling economy, then perhaps we can too. Think about it like you own a restaurant and people come in from all over the world to eat, but you yourself are having a rough patch and couldn’t afford to eat your own food. That doesn’t stop your guests from chowing down and enjoying themselves and, as long as the tables stay full, your cash flow should improve over time (IF you watch your budget - which we certainly are not good at). Since our patrons are doing so well, we just need to figure out what to sell them - we once had a diverse robust economy that could adapt to a changing world. Now, however, we sell guns (which Cramer had a great take on yesterday) and movies about guns and not much else - perhaps it’s time for a change of direction?

I spoke last night about yet another The Bear Stearns Companies Inc. (NYSE:BSC) hedge fund falling down and going boom. Even the smart guys at Harvard lost $350M this month (someone send them a trial subscription!) through their investment in Sowood Capital Management, run by former Harvard fund manager Jeffrey Larson, who played the wrong side of the bond market to the tune of a 50% loss this quarter. So don’t feel too bad if you lost a little, it literally does happen to the best of us!

Happy Trading and I are clinging to a ray of hope that the S&P will find a bottom by 1,440 and the Nasdaq can pull it up from 2,525. We are likely to find out in the morning if that’s the case:

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ZMan and I will address the nation today live on Market News First and, in addition to parsing out the energy report; I will provide some commentary as to the market status in the morning as I am really and truly hoping that we make a turn here.

ZMan has been on fire with his energy selections and he has a lot to say in his morning post. I’m mostly out of the energy game, but we took a bet on Suncor Energy Inc. (NYSE:SU) going down as my presumption is that some of those excess tankers full of crude that have been parked in the Gulf will be racing into port at $78 per barrel. It may not happen until next week, though, so we remain hedged with our tragically poor selection of Exxon Mobil Corporation (NYSE:XOM) $90s as that stock has been even more pathetic than I predicted it would be pre-earnings!

We will make our oil calls live this morning and I will be doing the same with the market as it’s really too close to call coming into the bell. Best bet is to be ready for anything and stick to mainly cash, so we have plenty to deploy whenever the market finally gives us a clear signal. Meanwhile, it’s a day trader’s paradise as high volatility plus earnings is giving us many, many daily doubles.

Whether you are a bull or a bear, please be careful out there,

- Phil