Options Trader: Weekly Wrap-Up

by: Philip Davis

What a crazy week that was!

I thought the 300-point run ahead of the Fed the week before was way overdone so I could not have been much more on the wrong side of Tuesday’s rally if Uncle Ben had dropped his $200Bn cash bomb right on my head. That’s right, lowering the Fed Funds Rate against $40Tn of outstanding debt in this country by 1/2 a point works out to a neat off-budget government giveaway of $200Bn.

Of course, you won’t get that money. The 2, 5 and 10-year notes went UP significantly as global investors bailed on a US dollar that seems to be backed by a printing press but the declining dollar was a boon for stocks and commodities as they were able to command more of our worthless currency per share/ounce/bushel… whatever.

On Wednesday I got very introspective, trying to see where I went wrong but by Friday I had decided I really don’t think I’m wrong, just ahead of my time but we have vowed to go with the flow and we will see how the week opens before diving in. It was quite a scramble to swtich gears from an overly bearish stance based on my assumption that the Fed would not be crazy enough to lower rates in order to fund record-high fuel prices. Well, the Fed did and oil did as well.

Can we blame record high oil prices on Bernanke or on the dumping of over 370M barrels of crude that were scheduled for delivery on the NYMEX? Perhaps a little of both but we managed to keep 47Mb on order, far better than last month’s 28Mb so it will be interesting to see what kind of surprising inventory builds November may have in store for us (oil can be delivered to Cushing anytime during the month).

Barry Ritholtz still wins my quote of the week award with his great comment that "the Fed has become Wall Street’s Bitch" and isn’t that what capitalism is all about? It seems we have indeed sold our country down the river in order to get "just one more fix" of low rates before the reality police show up and shut this party down.

I often say we are partying like it’s 1999 but let’s keep in mind that 1999 was a year when the market went up almost 30%, not including the 35% run from Oct 1998 to Jan 1999. We flatlined in 2000 (a 15% correction in the spring was 50% reversed) and the big dip didn’t come until 4 months after Bush was sworn in, in May 2001 (not making a political statement, just marking the calendar!).

With the dollar approaching record lows it may be time to become just a little bit concerned. While your home may be up 40% in value since Clinton left office - that is neatly offset by the 40% decline in the dollar. Don’t worry though, I’m sure your wages are up 40% as well and we know that the banks take great pains to make sure we are paid the kind of interest rates that assures us inflation won’t eat into our life savings. Oh sorry, that was some other planet I was thinking of…

Well, whatever planet you’re from, it’s good to know that in the good old USA the past CEO of Goldman Sachs (NYSE:GS) is now running the Treasury while the current CEO of Goldman Sachs rakes in record profits with that trading house getting on the correct side of every market move this year - they are just THE BEST guessers aren’t they!?!

Another ex-Goldman CEO is the Governor of New Jersey and White House Chief of Staff Josh Bolten was a Goldman director in London. Former Treasury Secretary Robert Rubin was co-Chairman of GS until he got his cabinet position. There is a very long list of other names and I’m not saying anything is wrong with it - GS recruits the best and the brightest and so, hopefully does our government, but perhaps when all these top level government officials come out of a brokerage house, it should be no surprise when we have a government of the brokers, by the brokers and for the brokers.

Where does that leave the rest of us?

The conventional (ie. Cramer) wisdom says that we should just give up and BUYBUYBUY but Goldman made their money last quarter betting on the collapse of sub-prime lenders. They were effectively short the housing market and yet did they somehow know it would all be bailed out in the end? Word on the street is GS was simply following the investing blueprint I laid out on March 18th, when I asked "Are We Heading For An Economic Tornado" where an unsound Federal monetary policy would drive gold and oil to record levels.

Unfortunately, the article was meant as a warning, not advice, and I didn’t follow my own, outside of some fortunate gold bets as I never really thought an educated man like Bernanke, a Great Depression hobbyist, would actually risk starting one of his very own. On the other hand, in order for a man to be great in history, he needs a great crisis to deal with and who could put it past a government official, in this day and age, to allow a crisis to develop, just so they can rise out of the shadow of their predecessors?

Not the usual wrap-up I know but that’s what I think was important this week, there was lots of noise and a huge rally but it’s almost Monday and now we’ll see how long we can keep the dream alive. If we are going to party like it’s 1999 we need to be ready to throw caution to the wind - even while feeling that same wind for early signs of one mother of a twister!

We were lucky enough to benefit from the 100% rule this week. I was way too bearish and had far too many puts going into the Fed but the good news was that - in such a spectacular market move - you cannot lose more than 100% of your straight option contracts. What’s good about this is there is no such rule to the upside!

Although there were 37 (out of 122) losing positions closed this week and although 9 were total wipeouts, they were nicely offset by 48 positions that gained 100% or more. Also, many short positions we had sold to others were wiped out which both lowered our cost basis and gave us huge gains (since they pay us cash, reducing what we laid out on long contracts, then expire worthless and we owe them nothing).

The 122 positions we closed this week had a spectacular 193% average gain but the gain on cash was just 18% - this is the price you pay for actually hedging! What looks very clever in a downturn makes you feel very silly in a huge rally as your short side gets crushed and this was the worst week to be short on the market since October 2002! On the whole, if your hedge fund had a spectacular week (yes you Goldman Alpha!) then they are probably not well hedged. As with many things, it goes back to the question I often ask - are you gambling or investing?

If it wasn’t for our heavy hedging going into the middle of August, we wouldn’t have had as much capital to throw into this rally. If the rally continues, we stand ready to join with lots of cash on the side and, if the rally fizzles, we have plans for that too!

Despite incurring some very heavy unrealized losses, the Short-Term Portfolio did manage to gain 38% on the week, now up 641% on the year, almost entirely due to my last minute decision to sell DIA puts against our own position the morning of the Fed announcement. From a cash perspective, those were our biggest winners of the week with close to 1,000 DIA puts getting bought back for pennies on the dollar. We have 71 remaining open positions and they are very well balanced, which puts the overall portfolio set net negative by a hair despite my resolution to ignore all the economic facts (but I am trying!). The average gain of the remaining positions is a worrisome -15% and a continued rally will require some scrambling to protect our gains. The portfolio is now just 64% cash as a lot of money was spent rolling back positions - also not great…

The Long-Term Portfolio took a rare hit and lost 3% of its value. We had to cash out a lot of VERY happy callers as we had covered all but 11 of our positions last week. Since the STP is still a little short, the LTP went a little long and we now have 26 uncovered positions out of 44 with an year-to-date gain of 208%, an average age of 79 days with just 46% cash. The big drop in cash was caused by having to add length to or roll many of the positions we sold calls against as the market shot up on us.

We say goodbye to this quarter’s $10,000 Portfolio, up 86.3% at $18,631. That’s pretty good as we got off to an awful start and were down almost 50% at one point! We have a useless call on (NASDAQ:FIZZ), a useless put on BTU and a GSK and XLE spread we will be transferring to the STP and we will reset our balance and take another stab at a 3-month double on Monday.

Our Complex Spreads Portfolio (home to Apple and Google plays) had a good week, gaining 7% on 10 remaining positions, up 296% for the year. Things would have been much better if I had stuck to my aggressive guns on both Apple and Google but we covered ahead of the Fed and lost much of the gains we could have made. We had no choice but to roll most of our callers to October, maybe there will be a pullback but, then again, I did endorse Google as being a very undervalued stock on Wednesday morning’s radio show. We are still 60% cash here.

The Happy $100K Portfolio has just the IBM spread in it now, the IBM Jan $120s with the Oct $120s sold against it. Thus far the position is down $1,900 but both Happy and I feel IBM is just resting here, although our early experience on the trade made us cautious. The game plan here is to buy out the October calls on momentum, perhaps around $3.50 at the most but we’ll see how the week goes. Next week we will have at least 2 new picks for the Happy 100.

As planned we got called away from several positions in our Stocks Portfolio, leaving us with just 5 positions that are up 35% for the year with 2 gold stocks (MRB and NAK) and GST, one of the only oil stocks that hasn’t performed lately! We are on accumulate with GST as it’s a long-term play, waiting for the next spike in natural gas. As would be expected, we are at just 53% cash here.

The Free Picks Portfolio is also taking it’s final bow and has been completely cashed out at a neat $170,606, after starting with $25K on April 30th for a total gain of 582%. This folder will be reset to $25K and will become the new $25K Portfolio as the Free Picks this quarter are the Happy 100s. I’m putting a full position analysis for review in the downloadable spreadsheets on the member site.

So it’s a brand new $10P a $25KP AND the Happy $100KP next week and we have no idea what’s going on — it should be a lot of fun!