August: Monthly Mop-Up

Includes: AAPL, DIA, GOOG
by: Philip Davis

Holy cow, was that August already?

They say time flies when you’re having fun and this quarter is sure flying by, as has most of the year, ever since bourses went wild during spring break.

Just like the popular video series, our stock markets have been teasing bulls and bears alike with flashes of patterns that have been formed in all shapes and sizes yet, after looking at dozens and dozens of them, we’re starting to get bored with the whole thing. Even the VIX (our official excitement meter) has fallen off considerably from it’s mid-August peak, when the Dow whipped out some of the biggest moves seen since 2003, a wave of volatility that signaled the start of this decade’s rally.

Unfortunately (or maybe fortunately), in the end, we finished the month pretty much right where we started. On August 1st the Dow finished the day just 2 points over where it ended September, at 13,362 and everyone was very bullish. On August 31st, the Dow closed out the month at 13,357. Was August, as most summers are in the markets, nothing but a walking shadow - a poor player that struts and frets his hour upon the stage? As Macbeth surely would have commented (had he listened to the pundits on CNBC): "It was a tale told by an idiot, full of sound and fury, signifying nothing."

We’ve only dropped a total of 52 points from the beginning of the quarter on July 1st but the volatility index has climbed 43%, a good indication of the kind of ride we’ve had this summer.

We started the month on a Wednesday and even then we were already sick of the volatility and moving towards cash, despite having some really good weeks in July’s chop. My first comment of August to members was: "Whether you are a bull or a bear, please be careful out there." The theme for the month was not to lose our heads on the highs as we knew there were PLENTY of reasons to be concerned including MarketWatch’s "20 tipping points that can wreck this rally" and the late July problems we saw at IKB, American Home (AHM)), Stonebridge, Sowood and others which put us on the right side (short) at the right time (Aug 9th) to give us a fabulous month.

The first week of the month ended with a huge dip on 3rd as we fell from 13,462 to 13,181, which turned out to be just a prelude to this little dip we took on the 9th as the market fell from Wednesday’s close at 13,657 to 13,270 on the first day of what turned out to be a greater-than 1,000-point, 5-day drop before Happy Trading and Option Sage called the bottom spot-on, on the 16th.

Since I’ve returned from Europe we’ve recovered 500 of the 800 points we lost when I got out of my chair which is, unfortunately, just right around the key Fibonacci level of 62% so we are certainly not out of the woods yet. As I pointed out in Friday’s morning post, we can’t get caught up in a day’s excitement and lose sight of the bigger picture, without technical breakouts on our Big Chart we need to continue to trade the markets under the assumption that we remain range-bound between 13,000 and 13,400, not breaking back over that level in the near future or any break back below 13,000 could put us into a prolonged downturn.

If we can get our moves next week, we may be able to consolidate around 13,500 for our next attempt at 14,000 and that’s the way we’re playing our index options. We continue to strangle the Dow, now with the October puts and calls, looking for a 300-point move in either direction. As we’ve had 8 since July 1st, we don’t think it’s too much of a stretch despite the declining VIX. Happy laid out the bullish technical case in next week’s market forecast and we will be watching the Nasdaq and the S&P very carefully:


We’ve been going with the flow as we wait for some clear market direction the past two weeks and this week was downright dull as we simply haven’t found too many positions to get excited about in either direction. When the market gives us lemons, we make lemonade so we traded some old favorites often including 14 AAPL plays, 8 GOOGs and 18 DIA moves. In fact, what you’ll see in our portfolio this week is a lot of trading of not that many stocks. Why? When in doubt, stick to what you know best.

Rather than guess this stock or that stock as well as the market direction, we play stocks we are very familiar with - this eliminates a lot of the random factors and let’s us concentrate on trading the right channels within the broader market moves. Although we are a lot less likely to hit a home run with this strategy (as last week’s 15% gain would attest) we can keep our batting average a lot higher as long as we’re content to cash in small winners on a regular basis and we do not hesitate to get out of positions that aren’t going the way we hoped (walks).

Overall, we closed 131 positions for an average gain of 57% this week and an overall gain on cash committed of 25% as the market went up and down 300 points to finish the week off neutral. Due to Friday’s steady gains and sudden dip at the close, we ended up with a 2:1 DIA put to call ratio, probably a bit overprotective despite the very bullish nature of the overall portfolio.

The Short-Term Portfolio has 54 open positions and, thanks to a very good week of calling tops and bottoms on the Dow, is now up 562%, a 42% gain on the week. Last week, we had only 8 covered positions but that has moved up to 20 as we took action to protect our gains. Naked calls dropped from 37 to 23 and, outside the DIA calls, represent a very small portion of our 76% cash position.

Our Long-Term Portfolio broke the magic 200% mark as we hit 202%, a very healthy 15% gain for the week despite very little movement on our 37 open posiitons. The drop in the VIX took a huge toll on our poor callers. Although the portfolio is 65% cash, close to 1/3 of our positions remain uncovered and it is these positions that our DIA puts in the STP are protecting. The advantage of protecting long calls with short puts is you can do very well in a quick dip but, of course, your risk your short-side premium in a tight window…

Continuing on last week’s path, we’ve brought the $10,000 Portfolio up to $15,341 in cash after making just one trade last week, a very well timed purchase of AAPL $135 calls on the 28th. While we may have gotten out a tad early, we accomplished our goal of getting the $10KP up to just shy of $17,000 with 3 weeks left to go until we reset at expiration. There are just 5 open positions left, all October calls and a Nov/Sept spread on GSK and we will follow Warren Buffet’s rule # 1 for now: "Don’t lose money."

The Complex Spread Portfolio had a grand week as we played Apple perfectly but we’ve taken all but a few remaining October $140s off the table and have just 9 positions open there which are up 252% after gaining 42% for the week. Those gains were mainly cashed out as we went from 72% to 81% cash.

The Stocks Portfolio added just on position for the week (naked SHLD puts we sold) and our 9 open positions gained 2% for the week, finishing up 32.7%, which is pretty good for straight stocks. It’s also been a good place to park some cash lately as options became a little volatile for our taste and we are on track to get called away back to almost all cash on expiration day.

We are winding down the Free Picks Portfolio but it won’t go down without a fight - with just 8 remaining positions we added another 67%, bringing the total gain up to 530%. Interestingly, we are 105% in cash because the money we took in from the calls we sold now exceeds the basis on our remaining positions!

We welcomed a lot of new members the past two weeks and, now that "orientation" is winding down, we will be relaunching the Free Picks Portfolio as a new $25,000 portfolio, which is what Free Picks started out with on 4/30. At the end of this expiration period (9/21), we will also be setting up a new $10K Portfolio as well as a brand new $100K portfolio Happy and I will be working on, tentatively called the Happy 100 so look for more on those in the next few weeks.