Options Trader: Weekly Wrap-Up

by: Philip Davis

Wheee, what a ride!

I said in last week’s wrap-up that "We continue to strangle the Dow, now with the October puts and calls, looking for a 300-point move in either direction. As we’ve had 8 since July 1st, we don’t think it’s too much of a stretch despite the declining VIX" and it was the VIX that stretched for us this week, jumping back from Tuesday’s low of 22 all the way back to 26.23 on Friday’s close.

Option Sage gave us his "volatility is good" speech last weekend and the market did indeed do what it could to "shake out the weak holders" which Sage says "is an important and necessary process before the market makes a move to higher ground." I menitioned earlier in the week we will revisit my dissertations on Stock Market Physics so let’s think of this shaking process as the market pros jettisoning excess mass (the retail shareholders) prior to committing to burning more fuel (capital) as we attempt to move the market back into a higher orbit (14,000 to 15,000).

Unfortunately, this is the kind of rocket that looks like she’s about to fly apart at the seams and we may not be as lucky as the people on the Boeing plane in China a couple of weeks ago! That’s why we continue to fly light, leaving most of our assets safely grounded in cash while we sent up our test balloons. If the market is going down, we’d like to enjoy the view from afar but, if it does manage to head higher, we’d at least like to have a hold of a string so we can ride along. As I declared back on the 22nd, US equities are still the least sucky place to put your money in the second half of ‘07 and, despite the attitude, that’s something to be taken seriously.

Last weekend Happy Trading was dead on predicting early upward momentum followed by profit taking and, call it what you will, that’s pretty much where the chart went. When chart patterns align with fundamentals and breaking news to all point the market in a certain direction, it’s easy to make money but this week will be trickier as our indices have a lot to overcome, led by the S&P sitting at a critical juncture:


The week leading up to this point was blissfully short but we made it through the Beige Book, declining home sales, pathetic auto sales, mixed retail numbers and the worst jobs numbers in 4 years with just a 200-point decline in the Dow. I didn’t say we don’t suck, just that other potential investment vehicles look no better!

My mournful macro outlook is neatly summarized in Tuesday’s NY Times article: "Can the Mortgage Crisis Swallow a Town?" and this is the issue that isn’t going to go away, no matter how hard we wish it would. As long as gold keeps climbing (it hit my $700 target on Thursday and added to it on Friday), we should keep worrying about this issue as it certainly indicates others are!

The oil market slipped into deep backwardation on Tuesday and we cleaned up playing the short side of oil this week, giving us fresh ammunition to short into the next BS pump they throw at us. ZMan and I addressed the issue on Wednesday in our radio spot and there are now 711M barrels on order in the front three months at the NYMEX with September (302M) rapidly drawing to a close and December (195M) not a very inviting place to roll to, even with a $74.54 barrel price. Unused October contracts can be sold as Jan ‘08 barrels for $73.78 (-$2.92) but there’s already 66M barrels on order there so it will be fun to see how this all shakes out between here and the termination of trading on Sept. 20th (9 days!).

Despite Tuesday’s strong close, by Wednesday I was again "wary" and I gave one of my very unpopular "sky is falling" speeches but the Beige Book made me look wrong for about 24 hours. I tend to bring out my fundamental whacking stick whenever I see people buying with too much enthusiasm during our intra-day chats. As you all know I’m a big fan of balance at the best of times and these my friends, are NOT the best of times…

Thursday we turned our attention on the Fed and what is wrong about trying to make investors happy by giving them the same, low-rate "drug" they’ve been hooked on since 2002. The fear of irrational Federal interference with the markets, along with the almost certainty that the markets will irrationally see that as a good thing, is the main rationale behind our shorter-term long positions. While we think Alan Greenspan was 100% correct on Thursday night, the lesson WE’VE learned from history is that no one listens to the old man at the party who complains about the noise but no longer has the power to "take away the punch bowl."

By Thursday night I was very confident we were going down but I was stunned at the ridiculous Censored, Never Bad Commentary I was hearing on TV despite a mountain of evidence that there were some serious problems. The predictions of Homer came true on Friday as we dropped straight down again after a very bumpy ride up. We knew it was time to head for the exits on Friday morning but it was a little late to jump on the downhill bandwagon if you hadn’t trusted us earlier in the week.

Now we are right back at the bottom (13,100) where Home and I predicted this market action on the 28th (13,040) and I am LESS confident today that we will make another rough climb to the top than I was then. This may be a week for bottom testing, but a little too early for bottom fishing!

Our Short-Term Portfolio had another stellar week, now up 593% for the year after gaining an additional 31%, thanks to yet another week in which we hit our goal of a 300-point Dow move. Our 54 remaining positions are up an average of 27% with 53 average open days, which is a reflection of how few actual short-term plays are in the Short-Term portfolio. We have been taking our profits off the table quickly and the positions we have kept are the ones that we sell shorter positions against. In this type of market, the steady money has been in selling, not buying, puts and calls. We are 78% cash.

Let’s remember that on Tuesday, I misplayed the put/call balance on the DIAs and got whacked for 10% of the value in a single day. The Short-Term portfolio is a very risky strategy that is being pursued BECAUSE it is up so much for the year and I am prepared to lose half of the 22% that is in play there. I want to make it very clear that I do not advocate this strategy unless you are already comfortably ahead and playing with "the house’s money" (as opposed to YOUR house money!).

Also note that I keep driving it back to 80% cash, which means all profits come off the table and we minimize the amount at risk from a percentage basis although (and this has been going on for quite some time) since the total portfolio grows the value of the 20% we play grows to the point where we are now "gambling" with 50% more money than we started the portfolio with in the first place.

Our Long-Term Portfolio had a choppy week and gained just 3%, up 205% for the year as several of our positions slipped further than we would have liked. That is to be expected as our 40 open positions are generally bullish with 67% average gains and an average age of 71 days, which is misleading as it includes the short calls we sold. So, on the whole, the positions are a little long in the tooth and some are too far in the money so we may need to do a little repositioning if the market doesn’t gain some strength. Ideally, we don’t want the LTP to rely on the STP index puts for protection.

The $10,000 Portfolio is up 71% at $17,121 with no new positions taken as the week was too scary to risk limited capital. We would have done better to have taken our October positions (JOSB and YHOO) off the table on Tuesday (or to have picked up something to the downside) and lack of hedging cost us $1,000. With $15,671 in cash, the risk factor is low but I’m still hoping for a nice opportunity to deploy some cash there next week.

Complex Spreads are up 279% overall, a nice 27% improvement over last week. As I mentioned before this is really the Google/Apple portfolio now witn 8 of 13 positions involving those two stocks. We played Apple perfectly this week by not being too greedy at $145 while Google remains unpredictable as always as we get what we can by selling calls. Our two bear call plays ($570/$530 & $540/$530) is an indication of how seriously I take my $525 target for Google this month (hit it on Tuesday thank you) and our new spread of Dec $540/Sept $520 reflects the current weak action. This portfolio gives way to a new $100K portfolio on the 21st.

Speaking of new portfolios: The Happy 100 Portfolio kicked off the week with 20 IBM Oct $115s at $5.39 (avg.) and we’re already down 13% on that position! Perhaps Thursday wasn’t the perfect day to get started in retrospect but we still have hope that someone will realize that more than 60% of IBM’s revenues come from overseas, where the growth is! Our current plan is to sell the Sept $115s if we get rejected at $118 again (about $4) or sell the $110s as a momentum play if the market really tanks and drags Big Blue with it.

The Happy 100 Portfolio is a joint effort between Happy Trading and myself to bring in the big ones for our less active traders in the context of a $100K Portfolio. Our goal is to find big stocks that are ready to pop in a 2-6 month timeframe and will not require the day-to-day attention that some of our more volatile plays command.

Our Stocks Portfolio was dull as toast this week, with the same 9 positions untouched and losing a total of $1 for the week. The entirety of that loss can be blamed on SHLD, which came right down to my $130 buy target where we have sold 3 put contracts because, as I said back on 8/28, "that’s the price I’d be happy to own if for." Then why am I not happy that the puts are up 81% and I may end up owing SHLD for $128.70, a 10% discount from the 28th???

The Free Picks Portfolio took a tremendous 48% jump for the week, now up 578% since 4/30, as we unwound our biggest remaining position, the Google calendar spread, at just the right time this week. Like the Complex Spread Portfolio, we are done with this one (96% cash) and the Happy 100 Portfolio will be the only free portfolio for non-members for Q4. The Free Picks Portfolio will reset to a new $25K Portfolio (what we started Free Picks with in April) along with our $10KP and our new $100KP on Sept 21st. It will be sad to let this one go, as it has been the best performing portfolio we ever had!

Overall it was a fairly quiet week as we stuck to plan and closed out 60 positions for a 26% average gain. A combination of tight stops and the fact that we’ve taken so many winners off the table held our gains to the low end of our range and, as usual, the DIA plays provided the bulk of the cash gains:




Sale Price