Options Trader: Weekly Wrap-Up

by: Philip Davis

Well we finished the week down 300 points. It’s not too bad but certainly not what the bulls were expecting following an additional rate cut. We hit my 13,500 target yesterday and, while we didn’t rush in to buy things, we will feel a whole lot better about buying stuff if we can hold it here next week.

My bullish premise for next week hangs on the hopes that the latest drop in the Hang Seng is merely preparation for capital to move into the public floats of Alibaba (the 5th biggest Internet IPO ever), PetroChina (NYSE:PTR) and several other big Chinese as they become available to investors for the first time on Tuesday.

Alibaba raised $1.5Bn for 17% of the company in an IPO but there were $208Bn worth of requests 7 from investors - that’s a lot of pent up buying pressure! Yahoo (NASDAQ:YHOO), (owner of 39% of Alibaba), is one of our only naked long positions going into this weekend. A nice double on the first day’s trading for Alibaba should give us a boost early next week.

The Chinese are looking to make a statement with Alibaba as a strong showing in Hong Kong will prove to Chinese companies that they don’t need to seek a Nasdaq listing to gain legitimacy. If the money is there to support a Google (NASDAQ:GOOG)-sized IPO for Alibaba and you combine that with the lack of Sarbanes-Oxley requirements in the Asian markets, we could see a lot more capital flowing away from the US, which is already barely clinging to its assumed mantle as the World’s financial center.

We came very close to another one of my targets as the dollar touched 76.22, a record low and finished at 76.26 while gold broke through my $800 target, finishing the week at $810. Oil finished the week at a record close of $95.93, up 20% since the Fed first dropped rates on September 18th (the dollar has dropped 6% in the same period and gold is up 12%). The Dow was at 13,400 on 9/18 and it’s up 1.4% since then so it seems like a pretty expensive way to boost the markets to me…

Effectively, with a 6% dollar adjustment factored in, the markets are at about 12,850 (x 1.06 = 13,621) after testing 12,650 (x 1.06 = 13,409) and that is, surprisingly, a good thing as it’s healthy consolidation off our 18-month run from 10,800(or a dollar adjusted 11,934). So our return on foreign equity since July of 2006 for the Dow has been a good, but not great 14%. The same logic can be applied to foreign markets to say their gains haven’t been as great as they look in dollar-adjusted terms but that’s false logic that assumes America is the center of the Universe. The Chinese Yuan, which is NOT in the basket of currencies we index the dollar against, has risen steadily even as the Hang Seng has gained 100% in those same 18 months.

During that period we’ve had doubles and better in the FXI, PTR, CEO, EDU, GOOG, RIMM, pretty much anything to do with oil, any kind of miner, half the semis (but the other half were AWFUL), AAPL (2 doubles), GM, any casino, half of teen retail… We’ve been very fortunate to go through a period where a monkey with a dartboard could have doubled up with just a little bit of luck. Of course none of us want this to end, but let’s not delude ourselves if it does. The market has a run like this once a decade and the rest of the time we have to earn a living and that’s what this site is all about. Sure we take full advantage of these crazy market runs but learning to win in any direction (or no direction) is the key to long-term market success.

Options give us tremendous leverage when a stock is running as well as exceptional protection when it’s not. While we celebrated another week of fantastic returns, we’ve moved back a bit into the safer harbor offered by our long-term calendar spreads - just in case things don’t all come up roses next week.

Two weeks ago we got much more aggressive with our positions, especially in our $10,000 and $25,000 portfolios (which were only two weeks old at the time) when I became more confident that we could "Spot a Correction a Mile Away

" and, that same weekend, I put up an instructional article called "Hedging Your Way to Fund and Profit" describing in detail how we use mattress plays both as moneymakers onto themselves as well as solid protection that lets us stay aggressive in a choppy market.

For the past two weeks, we have used those techniques to leverage the channel that was formed from that bottom at 13,500 all the way back to another test (failed) of 14,000 on Wednesday, when we flipped right back to a bearish posture. I called the dead bottom for the week in Friday’s member chat at 11:32 saying: "ALL DIA puts off the table (selling into the excitement) Starting a new run with the $134 puts at $1.99 with a stop at $1.75 against the $135 calls at $2.10 XXX" and the Dow bottomed out for the day at 13,448.29 at 11:36 with our Wednesday’s DIA $140 puts topping out at $5.75 off our $2.25 entry (up 155%) and the DIA $139 puts at $5 from our $2 entry (up 150%). These are simple little, liquid plays we learn to make all the time to keep our portfolio running while we mess around with the riskier stuff.

Of course, this was a hell of a week to play the riskier stuff as well! It was two weeks actually - we started adding calls on 10/23 and took 1/2 off the table last weekend with great gains and we added little this week as my Monday call on the markets was dead accurate when I said: "This is kind of like 11:45 on New Year’s eve when we’re all a little tired (those of us who are parents that is) but we pull it together for the big event (in this case the Fed on Wednesday) but, once that ball drops and the band goes home, that party ends really fast!" Well, that’s pretty much exactly how the week went down, up to and including the blow-off finale on Wednesday after the rate-ball dropped.

I don’t make the markets go up and down, I just tell you what they’re going to do in advance!

There’s nothing like a good prediction to advance our portfolios and 2 consecutive weeks of fortunate market calls have given us some truly outstanding returns!By coming in with good timing, we were able to close 35

(out of 117) positions that made more than 95% while being lucky enough to close just 10 positions that lost more than 50% - with the middle 70 roughly balancing out, that works out to a very neat average return for the week of 155% on positions closed. While that sounds great, the return on equity on those positions was a more earthly 18% - it’s the leverage of the options that allows us to make that 18% over and over and over again.

The $10,000 Portfolio is a great example of this as our average cash gains of 14.9% per position have added up to a profit of $22,126 in our first month (3 weeks actually). The portfolio gained $8,327 since it was published on the free site on Wednesday morning with the bulk of the gains coming from our iron condor on UTHR and our LVS play. Even without making any of the adjustments we made since that time, this portfolio performed very well considering the overall volatility that we ended the week with.

Our 9 remaining positions are effectively our losers and, at this point, I’m going to be terminating this portfolio at this expiration, after just one month, as it’s already passed our $25,000 goal ($32,156) and we and we can move the remaining plays into the $25KP. That way, newer members can start from scratch again with a fresh $10K on the 19th.

Speaking of the $25,000 portfolio (also 3 weeks old) the LVS puts, spectacular though they were, did not end up beating out the $10KP’s 222% return. The $25KP stands at $78,739, up "just" 215% for the month. Of course, just like our STP, once we move off cash ($52,069) and make new calls, the returns will really start to add up. We’ve been waiting to see which way the wind blows next week but, now that we have some play money, we can have a little fun! We have 14 remaining positions including our (NASDAQ:MSFT) calls (up 193%) that must be covered but otherwise, the positions are in slightly better shape than the $10KPs remaining mix. We are having more luck in the $25KP, averaging 25.3% returns per position.

In both the $10KP and $25KP we do our best NOT to day trade or momentum trade, as it tends not to be appropriate for smaller accounts, so the emphasis is on good balance rather than quick gains. I also try to make these portfolios more the type of trades you can check on less frequently as I figure most people trading small accounts do something else to earn a living and can’t be worrying over a portfolio all day.

That’s why I’m really proud of what I call the "untouched returns" of both portfolios since we reviewed them on Wednesday. While it’s better to time the exits, even with a 150-point gain followed immediately by a 360-point drop it wasn’t necessary to make any drastic moves - that is our goal!

In the Short-Term Portfolio we do all that fun stuff and that portfolio is up another 114% for the week as our mattress plays sprang into action on both ends. Going into the weekend we bought out a lot of callers and hopefully that won’t be a mistake as we have 19 open calls which are a little underhedged but not a significant portion of the cash balance. Keep in mind that the 114% gain is off the original $400K basis and not quite as impressive against the $5.6M total balance which is now being played fairly conservatively at 71% cash.

The Long-Term Portfolio had a great week as we made the very good decision to keep our deep in the money callers in place through the Fed spike. Those poor guys suffered greatly on the dip and the LTP jumped 30% for the week, a huge move in our ultra-conservative portfolio, leaving it up 331% for the year. We do have 17 open calls that we haven’t replaced covers on out of 40 total positions, still protected by BIDU and XOM puts (the XOM’s were 1/2 cashed with a very nice profit).

The Happy 100 Portfolio has the same 4 positions up the same 2% as it was not designed for this much market chop. Andy and I will have to evaluate this over the weekend and decide which direction to take this.

Our very dull Stocks Portfolio had a good week, thanks mainly to MRB, which we took 1/2 profits on. GST is coming back and our 6 open positions are up 51% for the year.

The Complex Spreads Portfolio had a very nice week too as Apple (NASDAQ:AAPL) and Google continued to march. The total gains jumped 34% from last week, now up 565% for the year and we have 12 open positions that are very well hedged.

As I mentioned above, we closed 117 positions for the week with 2 weeks remaining to November expiration so we’ll be shifting over to December or to more cash, depending on how the markets treat us next week.