Options Trader: Weekly Wrap-Up

by: Philip Davis
I am starting to LOVE this market!

Now I know what all the fun is about in China - these wild swings are a trader’s paradise and it has been a busy, but rewarding, couple of weeks. Practicing our best James Bond investing techniques we went long, we hedged down, we went short, we hedged up, we went long, hedging down again and then we went short. Then it was Tuesday!

We are embracing the insanity of the market, enjoying the fiscal buffoonery practiced by our leaders and dancing to the manipulated tune of the commodity markets - pure bliss!

This is how the rich get richer in America folks, turn the system into a parlor game that the average person can’t afford to stay in, forcing them to walk away with half their money (if they’re lucky) until the next time the "institutional investors" need fresh cannon fodder to line their pockets. Mixing metaphors? Sure I am but what the hell, may as well throw all the rules out the window along with the economic ones that have already fallen by the wayside.

We’ve decided not to complain about it as, not only does it get us nowhere, but it makes us miss the party. This poor guy made a great point about how ridiculous values for top stocks were in October of 1997. He makes an excellent point but, as I’ve said before, while he was bellyaching about the stocks, the market went up another 50% before finally heading back to his top call only in September of 2003! So we’ve decided to rock on and toast the Plunge Protection Team for as long as they can keep it up (no Viagra jokes please) as we party like it’s January 11th 2000 (one week before the crash).

I will continue to point out the true economic picture as it unfolds and, unfortunately, it’s very depressing but keeping our wits about us even as we enjoy the party is the difference between waking up in the morning with a slight hangover or waking up stripped naked in an ally with your eyebrows shaved off. Last weekend we decided 2 things; Thing 1 was that we could spot a correction well in advance. Thing 2 was that we would get a little more aggressive AND hedge a little more.

I’m happy to report both strategies paid off this week already!

Last week’s drop allowed us to take a lot of callers off the table and a series of good directional calls this week allowed us to make a lot of positive moves that gave us our best week in the Long-Term Portfolio all year. The Short-Term Portfolio also had another great week as Baidu.com (NASDAQ:BIDU) and the DIA simply danced for us and we played a lot of the earnings calls perfectly.

We followed the same basic rules as last week’s mattress plays and the market was kind enough to reward us with 5 200 point moves in 5 days. Nothing can be better for buyers or sellers of options, as long as we’re on the right side of course! Sticking to our 70:30 strategy made it much easier to flip-flop with the market and we got really good turn signals this week but we made it back to 75% cash ahead of the Fed as that’s getting just a little too crazy to call!

As I pointed out in last weekend’s closing commentary: "That drop, as expected, hurt our Long-Term portfolio and we need to be very careful there, as the huge increase in the VIX has made our remaining positions look more profitable than they actually are so we need to either cover or simply take bullish plays off the table if we get a lot of follow-through to the downside. Of course, the STP got a huge benefit as that’s where we cover the LTP with our index puts while the other portfolios are meant to stand on their own."

Buying out all those callers without replacing them (and stopping out on others) was the key to the LTP’s success as the market began the week with a 200-point up day. I started off Monday morning reminding members that our mattress plays work both ways and we anticipated another round of Fed mania, although it took until Wednesday afternoon to, as Cramer would put it, "foment." Monday evening we got tech earnings that were as good as it gets (until we saw Microsoft (NASDAQ:MSFT) that is) from Apple (NASDAQ:AAPL) and that gave us our long-desired Nasdaq rally. Although I complained that we got "caught short" on Monday with our callers, we wisely held onto them through Tuesday, when I warned that we should not be led into temptation by what was looking like a hollow rise.

Our best call of the week was to go robotic and just react to our levels which, fortunately, were pretty much on target. As I said on Monday: "I don’t put much stock in this rally until we really start retaking some levels. I want to see 13,800 on the Dow with 13,600 not even a bounce off Friday’s drop and 13,700 being "progress" at best. The Nasdaq needs to lead us to the promised land at 2,775 but we’ll take 2,760 if they can hold it for the day but the S&P has a long way to go to get back over the 1,520 mark, otherwise we’re probably not going anywhere. After 1,520, each 10 points should make us about 10% more bullish, assuming we’re starting at 60% bullish."

Tuesday evening, despite the 45-point Nasdaq gain we took profits and shorted into the close as I saw several risks in the day ahead but it was poor Amazon that got blamed for the sell-off the next day, that dropped the Nasdaq all the way back to 2,720 (from 2,800) before bouncing back halfway to 2,760. Tuesday night I said: "We’ll see how much these things really matter tomorrow but I’m sure glad about my index puts, despite the "rally." Wednesday morning analysts were "stunned" by Merrill Lynch (MER)’s shocking earnings report, although I certainly hope none of my readers were as we’ve been warning about this for months. Although we took scary bounces off our Big Chart levels, we held them at each day’s end, giving us the signal to stay fairly bullish.

Wednesday was, as foretold, the wildest day of the week and the chart even formed a "W," just so there could be no doubts! Luckily our market cynicism was turned towards the sell-offs, rather than the rallies and we called a dead bottom during the day and jumped back on the crazy train to 13,800 but not, of course, before yet another 200-point pullback on what I called Thrill a Minute Thursday morning. We already had our Dow strangle in place by then and we cashed in on both ends on the same day - it doesn’t get much better than that unless you also buy low and sell high for a new strangle, which we did!

Now that we’re getting the hang of this nonsense it was obvious that the worst durable goods report in 5 years and sanctions levied against Iran would cause a rally and we stayed in robot investing mode as I said: "We’re going to take the Nasdaq seriously if it pops from here and, of course, without the SOX and S&P coming back we could care less what the Dow does. Let’s keep an eye on gold at $775 and oil as it goes for $90 as the White House just gave them the perfect top-spin for it. We’re already in SLB from yesterday but let’s keep an eye on Exxon Mobil (NYSE:XOM) and others who may be ready to fly. XOM $95s are always fun momentum plays. Be careful out there, we could fall today as quickly as we rose yesterday!"

Oil did break $90 on Thursday and you know things are bad when I have to play XOM to the upside (but we took the money and ran Friday morning). We picked both MSFT and Yahoo (NASDAQ:YHOO) that day as well as several other good performers, finishing the week with 5 positions that doubled during the same week we bought them!

By Friday morning we were in full-scale Fed rally mode but we nailed it on the head Wednesday, when we decided we were very likely to get a repeat of last month’s irrational exuberance over an economy that’s so bad that the Fed is willing to allow inflation to spin out of control to stave off a collapse of the credit sector. Whoopie!

As I said, it was another spectacular week for the Short-Term Portfolio, which bounced from 1,059% to 1,194% as each 10% gain off our current base now adds another 120% to the year’s total. As with the Long-Term Portfolio, it was the total annihilation of our putters and callers that gave us a huge bonus as we had close to $2M in premiums sold that got the life squeezed out of them (a pain I’m sure many short-term option holders felt last week!). We are left with a not too-terrible 57 open positions with 20 naked puts and 9 naked calls.

Of course, I’ve gotten much more free with positions as the year has moved on, not that I’m taking more risks but the simple fact that we have 80 BIDU Dec $330s at $380,800 covered by 80 Nov $360s at $153,600 (all premium) and 40 Google (NASDAQ:GOOG) Mar $640s (that began their lives as Jan $570s back in September) at $303,200 covered by Nov $640s at $161,600 (just $23,200 in premium left there but lots of time to roll!) means a 20% gain on just these two would be a 25% increase against our starting basis of $400K. The numbers are getting silly and I will be resetting the Short-Term Portfolio on Jan 1 so any member with $500K can play along at home!

The Long-Term Portfolio, by nature, is difficult to reset and had, by far, its best week of the year with a 44% gain to 301%. All in all there was not a lot of movement, mainly a snap-back from last week’s sub-par performance. We have just one runaway position in this more conservative portfolio, the AAPL Apr $175s, which were a very timely roll from our Jan $150s that were too deep in the money (along with the callers) to play earnings. We took a huge loss on the $150 callers but it all worked out very nicely in the end!

The remaining 41 positions are a sea of green and this portfolio is just 48% cash and has a lot more exposure than usual as last time we were way overhedged going into the Fed and this time we’re letting the STP do our dirty work with index puts while we leave 24 long positions naked.

This does leave us vulnerable to a severe drop if it happens too quickly to react to so our outsized gains for this week should be viewed as temporary until we can move to better-hedged positions!

The Q4 $10KP had a lucky week. Had we not added the YHOO Jan $32.50s, we could have been badly damaged. Just because we were way ahead was no reason to take additional risks and I’ll be concentrating on safer plays as we move towards expiration week. As it was, we gained 9% for the week, finishing with $17,513 but we need to free up more cash (just 11%) in order to stay flexible and, unfortunately, that’s our Yahoo calls ($7,100).

The Q4 $25KP had the same YHOO play PLUS MSFT, who could ask for anything more? We have 22 positions and are cash-shy here as well (13%) as it took a lot of moving this week to stay on top of things. We’ll have to cash YHOO here too in order to have capital to improve our other positions. On the whole, we are up 80% at $44,954.

As I mentioned earlier, we gained another 5% on the Dow Portfolio, closing that one out at $130,075 (up 30%)due to lack of interest. The problem is we didn’t select all of those companies because we liked them or because the timing was right, we just selected 30 Dow stocks on a certain day and made the best plays we could on each one - that’s not a very good basis for a portfolio is it? Kind of makes you realize how silly ETFs are…

Our Happy 100 Portfolio continues to have some bad luck but we’ve squeezed 3% out of it so far. Our HXL covers are hurting us right now as that stock took off the same day we gave up on it and sold the $22.50s. IBM fell harder than we thought and we’re glad we covered these but IMCL and AMGN both gave back considerable gains last week. Thank goodness this portfolio still has plenty of cash (77%), hopefully we’ll find a couple of good plays next week if we get a nice Fed rally!

Our Stocks Portfolio is plodding along, gaining 4% on the week thanks to our gold plays and a timely entry on FNF (still uncovered). This portfolio is up 48% for the year and is fairly committed at 29% cash.

Complex Spreads (aka the AAPL/GOOG portfolio!) posted a 27% gain for the week, now up 532% for the year as AAPL and GOOG continue to lead us to the promised land but they are actually fairly hedged and it was our naked YHOO and GS calls that gave us most of our gains (we got rid of GS). There are just 13 open positions remaining in this portfolio, which is 63% cash.

Overall we closed 109 positions for an average gain of 90%. We took a few huge hits getting rid of Apple callers, but it was worth it as Apple kept going up and we were able to realize the additional gains. The DIAs were very, very good to us but and our XOM puts going from way behind to way ahead was a game changer for the portfolio, especially on our very heavy Jan ‘08 $95 puts that we took the money and ran with on Monday.