Hoping for a Rally in Net Nets, But Preparing for a Sell-Off

by: Hedgephone

2010 has been a roller coaster ride. The forces of QE were largely at odds with the macro concerns and the hangover from the financial crisis, which is either over or still in full bloom depending who you speak with and what side of the markets they are trading.

Recent investment ideas such as selling covered calls against high yielding dividend stocks and investing in commodity ETFs have proved profitable while our hedges in IWM, QQQQ, and several pricey technology names have hurt performance. Readers who took my advice to sell put spreads instead of shorting stocks have either broke even or profited on these hedges due to time decay and by taking profits after big downswings.

Looking forward, the S&P trades at fairly expensive historical measures on a CAPE basis and the QQQQ is in a mini mania in my opinion, rallying to the 2007 highs in just under two years since bottoming out in March of 2009.

Those who know me understand that I am less optimistic that the financial storm is behind us and know that I feel we are in the eye of the longer term hurricane, as we mainly transferred the derivatives mess onto the balance sheet of the Federal Government. For this reason, I am still long silver and have moved to PSLV as my best investment idea for this commodity. I am also long FCX with in the money covered calls sold against the position. DBA, RJI, and RJA continue to provide protection from this government balance sheet risk, while the dollar index has recently broken out above $80.

Because of the dollar strength, I have lightened up a bit on commodity stocks and on some of the call options I owned on SLV and DBA.

Bunge (NYSE:BG) looks like an interesting mix of a below book stock which owns massive farming operations on a global basis. Trading below book value and at 7X cash flows, I feel selling Jan. 2012 $55 or $50 puts is the best play here for a strengthening dollar near term and a rally in grains longer term.

I have sold most of my MCD as I am worried that restaurants and food sellers in general will face margin compression. Recently, I added shares of SD, which is under heavy accumulation from Prem Watsa of Fairfax. I am long the stock from $5.3 and short the March 2011 $6 calls for a $.40 cushion/income stream.

I am back onto the short side in CRM, this time as a pure short. Our bear calendar spreads actually made us a bit of money due to the large premiums in the front month options relative to back month options. I am now looking to hedge the portfolio using mostly put spreads on triple levered ETFs like TNA, TYH, QLD, etc... until the market corrects to a level I will be comfortable going long covered calls in the stalwart stocks and long the cigar butt names. Currently, I feel the market is plagued with valuation risks much in the way it was in 2007.

What remains to be seen is the growth in earnings over the next five years. If profits revert to their long term mean from a margin standpoint, the markets on the whole will seem expensive at these levels. Conversely, a long stretch of growth in earnings will make the market look cheap at today's prices. What is clearly evident is that the valuations given to many momentum names are not in line with fundamentals and to me represent froth and "hope" instead of rigorous business-owner like investments.

That said, momentum names are the best to own in bull markets and the worst to be short at market tops as they tend to end their runs with blowoff top patterns. Shorting triple levered ETFs may be a better way to hedge risks as the time decay and slippage works in your favor.

Overall, staying the course and searching for value.


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