Go Long VIX In Case It's The End Of The Wold As We Know It

Includes: DEPO, JBL, LDK, TEX
by: Dark Horse Traders' Hedge

That’s great

It starts with an earthquake, birds and snakes an aeroplane

Lenny Bruce is not afraid, eye of a hurricane

Listen to yourself churn, world serves its own needs

Regardless of your own needs

Feed it up a knock, speed, grunt no, strength no

Ladder structure, clatter with fear of height, down height

Wire in a fire, representing seven games

In a government for hire and a combat site

Fine, then uh oh, overflow, population, common group, but it’ll do

Save yourself, serve yourself

World serves its own needs, listen to your heart bleed

Tell me with the rapture and the reverent in the right….right

You vitriolic, patriotic, slam fight, bright light, feeling pretty psyched

It’s the end of the world as we know it

And I feel fine - REM

As a person who has studied the markets since 1986, I guess it was inevitable that one day the lyrics of this song would be included (maybe more than once) in my writings. This song was released as a single in November 1987. I recall the year very well as it was my first real experience with a market crash - but not the last.

I confess to having to research who Lenny Bruce was and what vitriolic means but there is no denying that many of the lyrics from 1987 have 2011 connotations. It, being the economic woes the United States is in, didn’t “start with an earthquake” but it certainly happened on the East Coast on August 27, 2011. Proving more prophetic the East Coast was also slammed by “the eye of a hurricane”, Hurricane Irene, on August 28, 2011. My thoughts and prayers are with all those affected by both events.

Without taking political sides I can agree that we have, and have for a while, “government for hire” and could give more examples than anyone wants to read. President Obama’s recent appeal to our “patriotic” side in support of passing the Transportation Bill is a case in point of the “world serves its own needs.” More politicians have their hands in the cookie jar on Federal Highway Programs, in my humble opinion, than most any other programs. When you add it all up the question for us is this: Is it 1987 for the markets and “the end of the world as we know it” or will we be fine?

The devil is always in the details so let’s take a look at the numbers. The focus as always is on the most recent figures and forecasts. In the past week we saw pending home sales fall 1.3% from June, the Case-Shiller home price index increased 3.6% in the 2nd quarter over the 1st but was down 5.9% compared with the 2nd quarter 2010. Friday the government issued the worst employment report in 11 months. The forecast from economists was to add 93,000 jobs and previously reported hiring for June and July were revised lower. Continuing on this theme the Chicago PMI “slipped” to a 21 month low, the ISM Manufacturing Report is always good for some light reading and according to the cheery report that the “manufacturing sector expanded in August for the 25th consecutive month, and the overall economy grew for the 27th consecutive month” with a reading of 50.6. This reading is down .3 percentage point from July and is barely hanging on to “expansion,” which turns into “contraction” when it falls below 50. Consumer confidence, not surprisingly, has fallen to a 2-year low at 44.5 versus the “expected” (by who? And why? And I am a “glass half full” type person) 52.5 and last month's 59.2.

So where is the silver lining to allow us to say “I feel fine” in light of the “end of the world” scenario painted by the figures. Let’s start with the premise I have learned over the last 26 years studying the market that when things seem the bleakest is often the best opportunity to capitalize on the market. Combine that concept with the “hedged” approach Sabrient recommends on your portfolio. In recent DHTH articles we have capitalized on short positions that were part of our hedge. Walter Gault recently published an article analyzing the Long vs. Hedged (equal hedging, which is different than the tilted hedging and option exposure we recommend) returns and volatility, which is worth reading.

Personal Income
is possibly a silver lining as despite all the above (including consumer confidence) the U.S. Bureau of Economic Analysis reports that personal income increased in July to post-recession highs. In another sort of head-scratcher, Consumer Spending rose .8% to the highest level since February. Savings dropped to a four-month low. The lyrics from 1987 said “Save yourself, serve yourself” but this consumer spending report leans more toward “serve yourself” but a silver lining to the markets nonetheless. Factory Orders rose an impressive 2.4% in July, which I suppose makes sense when combined with Consumer Spending up and Savings down. Orders for those motor vehicles that are driving spending up and savings down were up 9.8% which is the largest gain since January 2003. Reminds me of an urban saying “I will gladly pay you tomorrow for what I can have today,” where the “what” is anything from a hamburger to a car.

So, are we at the “end of the world as we know it”? Personally I believe that with each new day we are slowly ending the world as we knew it but I also believe we will be fine. The sky isn’t falling as much as the media want you to believe as shown by some of the silver lining figures above. The next roaring bull market likely isn’t just around the corner either as other media personalities would ask us to believe. That all makes good headlines or sound bites but in reality we are in a very slow recovery from a very bad recession and the fed is standing ready to boost this market and we are heading into an election year. There is little doubt in my mind that we will hear political rhetoric in the coming 12-18 months about how bad and great things are and incumbents will do anything to keep the markets from having a 1987 crash ahead of elections.

Therefore, I recommend continuing to stay hedged, tilted when appropriate and use options to gain exposure with less risk. All that said we have options expiring in September that need our attention and this article is about helping you do that.

Jabil Circuit Inc. (NYSE:JBL) was added to the DHTH portfolio on January 28, 2011 at $20.56 and using Phil Davis' Buy/Write strategy have brought in net $2.60 with the June call/put and roll. Currently, we have September 17, 2011, call for $1.35, which will expire worthless barring some great rally in the next 2 weeks netting us an additional $1.35 in premium. Before dealing with the September 17, 2011, put we have ½ position in JBL at $20.56 less ($2.40 June call + net $.20 June 20 put + $1.35 Sept call) $3.95 or cost basis of $16.39. We received $2.10 for the September 17, 2011, puts and need to decide if we should accept delivery of the other ½ position or keep the extra cash for another day. The stock closed Friday at $16.37, which means we can close the put starting Tuesday at approximately $3.63. Personally, I still like JBL for long exposure a lot because the earnings are expected to grow at 10%+ over the next 5 years and before the discount we have entered the stock at the forward p/e of 6.65 and we even pick up a slim 1.7% on the forward dividend yield. Analysts have been revising the earnings forecast up over the last 30 and 60 days. So I recommend watching this option closely over the coming 2 weeks. The call should simply expire but in the case of any rally toward $20 in the stock I would recommend paying the $.05 or so it costs to close it out. I will monitor the market and JBL in particular in the next 2 weeks to help recommend the best strategy with the Sept $20 put.

LDK Solar Co. (NYSE:LDK) was also a recommendation on January 28, 2011 at $12.95 and the buy/write worked against us in June when we rolled out of the puts for $6.40 while keeping the call premium of $2.11. Obviously this has not one of my best recommendations but I still like LDK. I recommended selling a September $6 put at the time for $.75 on the second ½ position to start working the cost basis down while the stock bases. Friday’s close of $5.32 has us in a wait and see mode over the next 2 weeks. LDK could easily trade up to $6+ and the option will expire worthless at which time we will want to recommend selling the Dec $6 put. Like with JBL I will continue to monitor both the market and LDK until the final week and publish my recommendation. I still like the 21% 5 year projected growth in earnings and forward p/e of 8.03 for that 20%+ growth.

DepoMed Inc. (NASDAQ:DEPO) was recommended on April 8, 2011, using Phil Davis' Buy/Write strategy at $8.72. We sold the Sept 17, 2011, $9 calls for $1.15 and the Sept 17, 2011, $9 puts for $1.20. DEPO closed Friday at $6.08, which gives us comfort in knowing we will keep the $1.15 premium earned on the Sept $9 calls and must decide the appropriate action related to the Sept $9 put. DEPO is one of those rare companies I will recommend, which is running small losses at this time and is projected to continue through 2012. I like the projected 30% growth in earnings over the next 5 years and a current p/e (based on 2011 earnings) of 4. It is my recommendation to accept ownership of the additional shares of DEPO Sept 17, 2011, and sell covered calls on the position while we allow the products in the pipeline to grow into earnings for DEPO. As we get closer to expiration date I will publish the month and strike I would recommend for DEPO but don’t have a problem recommending a full position having already earned $2.35 in option premiums.

Another recommendation I have for this article is to add the CBOE Volatility Index (VIX) to your portfolio as a hedge against the “end of the world” scenario. VIX closed Friday at $33.92 and is known as the “fear factor”. The VIX will increase in value at a significant rate anytime the downward volatility picks up or “panic” in the markets. It traded as high as $80 in the early months of 2009 and so will provide “insurance” on your long or buy/write positions if we get a panic sell off.

In closing, we had recommended shorting Terex Corp. (NYSE:TEX) on July 18, 2010 at $17.6 and with the Friday close of $14.65 we have an opportunity to buy to close with a 16.36% profit. I recommend doing so with Congress coming back to address the Federal Highway Programs Bill. The likelihood in my opinion is that something positive gets passed on this bill prior to any “furlough” of jobs or loss of opportunity for Federal Spending. This limits the further downside opportunity in TEX at this time even though for those who think there may be a stoppage it would be a good short.

The next 2 weeks will bring some clarity to the positions we have in buy/writes in the Dark Horse Traders Hedge portfolio so please stay tuned and I will do my best to guide you through the expiration in the best position to capture market returns.


Buy VIX at the market Tuesday, September 6, 2011

Buy to Cover TEX at the market Tuesday, September 6, 2011

Monitor closely JBL Sept $20 put between now and September 17 (I will post more)

Allow JBL Sept $20 call to expire

Monitor closely DEPO Sept $9 put between now and September 17 (I will post more)

Allow DEPO Sept $9 call to expire

Monitor closely LDX Sept $6 put between now and September 17 (I will post more)

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.