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Phil Davis Discusses Options and Today’s Markets

John Nyaradi of Wall Street Sector Selector interviewed Phil last week and here's a transcript of their exciting interview covering the economy, the financial markets, QE2 and POMO, hyperinflation, the fed's trickle down approach to producing the inflation it wants to alleviate debt, and investing in this grossly manipulated environment. - Ilene 

Expert options trader Phil Davis shares his options trading secrets and views on today’s economy.

John Nyaradi: Philip R. Davis is an options trading expert and founder of Phil’s Stock World, a stock and options trading site that teaches the art of options trading to newcomers and advanced trading strategies for expert traders. His articles and references have appeared in the Wall Street Journal, Google Finance, Business Week, CNN Money.com, Trader Planet, and iStockAnalyst.

Phil, welcome to Wall Street Sector Selector.

Philip R. Davis: Hi, thanks, John.

John Nyaradi: Today, we’re going to talk a little about your view of the economy, the current state of the markets, then dive into some of the specifics of your option trading strategies and Phil’s Stock World itself.  Let’s start with your big picture of the economy today.

Philip R. Davis: My big picture, we call this The Meatball Marketplace. There’s a scene in the movie, Meatballs, where Bill Murray gives a speech and he talks about how it just doesn’t matter. You know, no matter how horrible everything is, it just doesn’t matter.

John Nyaradi: Yeah.

Philip R. Davis: And that’s what this market’s like. It doesn’t, you know, you’ve got nuclear reactors blowing up in Japan. You’ve got countries in revolution in the Middle East. You’ve got countries falling apart in Europe. I think it’s ridiculous. And to see the bid on the VIX – Hang on, I’ve got to check my number. The bid today finished at what? 17.91. I mean that’s just insane. You know, it just makes no sense. 17.91 indicates extreme calm.

John Nyaradi: Right.

Philip R. Davis: No problem. Nobody’s worried.

John Nyaradi: Is this all Bernanke and POMO? What do you think this is?

Philip R. Davis: Yeah, absolutely. I mean, look, you don’t want to overemphasize POMO. Everyone says POMO, POMO, POMO.  Is it POMO day or whatever? You know, it’s just the way they’re injecting money. The fact of the matter is though Japan just threw $550 billion into the market. We’re throwing $120 billion monthly to the market nonstop. Europe just doubled the size of their bail-out funds to $300 billion more than it was.

John Nyaradi: Yes

Philip R.Davis: So you know, we inject a trillion dollars in one month into the global economy. If the stock market doesn’t go up, we all need to leave the planet.  And that’s the thing. When you look at it and say, “That’s all we got for a trillion dollars?”

John Nyaradi: Yeah.

Philip R.Davis: You know, I mean when I was a kid, a trillion dollars used to buy you something. And we’re not getting that now. What we’re getting is that, you know, I mean, 2 years ago, a trillion dollars was a big deal and we got a 10% bump in the market. They put in about a trillion dollars in March of 2009.  We went up 10% like a rocket from there.  What do we get this week? A trillion dollars after Japan, and we’re up 2-1/2%.

John Nyaradi: What do you see going forward into the second quarter?

Philip R. Davis: Well QE2 isn’t going to end. This is a misnomer about QE2 because what’s going to end is the new funding. About 50% of what’s going in from the Fed now is rollover money.

John Nyaradi: Yeah, they’re becoming the biggest holders of treasuries, right? How much is it?

Philip R. Davis: Only $20 billion out of $140 billion is being bought by other people.  So they’re buying 85% of the treasury notes.  Okay. They can’t stop. How could they stop? Who’s going to buy?

John Nyaradi: So where does it all end?

Philip R. Davis: Eventually, we have to have hyperinflation. There’s no end game to what we’re doing other than hyperinflation because we have to pay off our debt ultimately.  And you can’t pay off – You know, I mean look how ridiculous it is. We owe $15 trillion. And we go another $1.5 trillion into debt every year. So it’s not like we owe $15 trillion we have some chance of paying it off. We owe $15 trillion, we’re bleeding $1.5 trillion more a year. It’s 10% more a year.

John Nyaradi: Right.

Philip R. Davis: So in 10 years, we’ll owe $30 trillion.

John Nyaradi: Yeah.

Philip R. Davis: You can’t turn that around. So there’s no realistic way that we’re ever going to pay off this debt other than gross inflation. That means we have to have inflation. It has to be hyperinflation because the inflation has to occur faster than we could mount up our debts. So we have to grow GDP so fast through inflation that it dwarfs the rising interest rates on the debt that we have.

John Nyaradi: I understand.

Philip R. Davis: So it’s almost like Zimbabwe. It’s not really going to be Zimbabwe. What we really will get is probably seriously double digit. Something until this economy is probably a $45 trillion economy.  And at that point, when everything is 3 times more expensive than it is now, then that debt will be probably about half of our GDP. We’ll probably have $22 trillion in debt, and then we’ll be able to start making some payments.

John Nyaradi: So for the little guy, you know, the average retail investor, let’s look ahead to the next 3 to 6 months. What do you see as the biggest dangers and then the opposite of that equation, the biggest opportunities for just the average retail guy out there, not an expert like you?

Philip R. Davis: Well, the danger unfortunately is that all of this money…this kind of inflation….this inflation that we have now, it’s top down inflation. The Fed gives its money to the banks. The banks invest the money in stock and commodities. Make themselves rich. The commodity prices get forced down to the consumers who get more poor. They can’t afford homes, which is why home prices are dropping.

John Nyaradi: Obviously, I would say you don’t believe in buy and hold and you know, little guys have always been told you can’t beat the market, and I’d like to talk now about trading, and particularly what you’re doing at Phil’s Stock World.

Philip R. Davis: A regular investor, how are they going to get leverage or hedge?  It’s very easy for me. I can buy 10 to 1 leverage on almost anything I want to buy, and I can buy a little tiny bit of something that goes up 10%. I make 100%.

John Nyaradi: Right.

Philip R. Davis: That’s brilliant. I love that.  But what happens to people who can’t afford to do that? What happens if people can’t sit there and play the market all day long? On Christmas day, I wrote a free post. It’s still up on our site. It’s called Secret Santa’s Inflation Hedges for 2011.

John Nyaradi: I remember that. I read that.

Philip R. Davis: And that detailed out four different trades to keep you ahead of inflation, and one was a trade on oil prices, one was a trade on food prices, one was a trade on housing prices, one was a trade on energy.

John Nyaradi: Great.

Philip R. Davis: The idea was using simple option combinations that would allow you to stay ahead of inflation, and as of like a week or so ago before the Japan thing, three of the four had already gained well over 100%.

John Nyaradi: Terrific.

Philip R. Davis: So that’s the kind of thing that regular traders can do.

John Nyaradi: Would you say you’re a technician, fundamentalist, both?

Philip R. Davis: Fundamentalist. No, I’m not a technician.  I would say I’m not really an options trader. I’m a fundamental trader who uses options for leverage…because if I know Coke is going to go up…then why not take the option on Coke if I’m going to get paid 10 to 1 instead of getting paid even?  Of course, you can lose 10 to 1 if you’re wrong, but the trick is to be more right than wrong.

John Nyaradi: Right. So let’s talk more about options now. It’s kind of a black hole for most people. They can seem really complex.

Philip R. Davis: I wish people wouldn’t have that attitude, though.

John Nyaradi: Yeah, that’s why I brought it up. I mean the average attitude with options is you’ve got to be a Math wizard to do it. You make it seem simple.

Philip R. Davis: The reason that options are made to seem complicated and the reason that most brokers don’t want to trade in options and make it difficult for you to do so as a small investor…is because if you hedge your stock with options, you are less inclined to turn your account.

John Nyaradi: I understand.

Philip R. Davis: Selling options is how you make money. You see, in other words, it’s the difference between being the person who goes into the casino or being the person who owns the casino.  You know, people go into the casino to gamble. They buy options. They hope they’re going to get rich and so forth. So if the guy who sits there and owns the casino, he makes a lot of very small percentage bets that are very likely to pay off, and they hedge, and make money consistently. How would you like to do that?

John Nyaradi: I understand.

Philip R. Davis: It is criminal that brokers don’t teach their people. It’s criminal that they sit there and have people put money to IRAs and tell them they’re restricted, and they can’t do these things…because this is what Goldman Sachs does to make $100 million every single month.

John Nyaradi: Wow.

Philip R. Davis: Okay, they do this week in, week out. All the hedge funds, all the big guys, this is how all the rich people make money, and you know what? Anybody can do it, but they are dissuaded from doing it. Small investors, they are blocked at all turns from getting into this game. People say it’s complicated. They tell them hard stories about them and make it seem difficult. They put up rules and restrictions of who can do what. And all this stops someone from doing the most basic things that rich people do to make money.

John Nyaradi: Let’s talk a little about Phil’s Stock World, your program there. I know that teaching people is an important part of what you do.

Philip R. Davis: Yeah, we are very big on education, but not – I want to emphasize – basic options education. We don’t do that.  We don’t teach you what a put is and what a call is other than me spouting off on the radio or something like that, but you know, I really, really want regular people to get into this stuff, but it’s something that they need to learn.

John Nyaradi: But you have different programs, different subscription plans? Can you just give me a quick overview now?

Philip R. Davis: Yeah, we used to be fairly exclusive for the high-end investors.  But we have reached down to small investors. What we have is what we call a Voyeur membership.  And a Voyeur membership let’s you view the chat rooms without participating so you can see what all the people are trading, what our premium members are trading, and what kind of trades we’re going through and read the information and read all the educational stuff and strategies that are up on our site, and the only difference is you can’t actively participate in the comments.

John Nyaradi: That’s terrific.

Philip R. Davis: You know, we’re actually online live all day talking about the market and talking about trading. There’s a limit to how many people I can talk to. And you know, we have a lot of high-net worth people who trade a lot of stuff back and forth, and you know, they get their priority, but we’ve figured out a way to have other people participate and that’s what you do with our Voyeur membership.

John Nyaradi: During the years from about 2002 to 2007, everybody was a genius. You could just buy a stock and make money. I think those days are probably gone forever, in my opinion, so now I think people have to get smarter.

Philip R. Davis: Well, obviously, what happened in the late 90s was very atypical. {Pretty much the same thing now.} I mean the market’s up 100% since 2009. Any idiot you know can just keep buying stuff that goes up and up and up. I mean one of these that made me famous actually was on the day of the crash on March 6, 2009, I happened to be on TV. I was doing a show called “Why Stock,” and while the market was crashing, I made 13 tips to buy things. And everyone is on TV going “sell, sell, sell.”

John Nyaradi: Yeah.

Philip R. Davis: All the fast money people were “sell, sell, sell,” and I’m sitting there going “buy, buy, buy.” And the 13 tips I made, 6 months later, made 469%.

John Nyaradi: Wow.

Philip R. Davis: You know, so that’s dot com kind of money. I mean that’s crazy.

John Nyaradi: Oh, yeah.

Philip R. Davis: It’s a matter of assessing the situation. You know, some things go too far. Last year, we made a fortune buying BP, Transocean, and Haliburton, you know..we waited for them to bottom out…and then we said, “You know what? There’s a certain dollar amount you can put on these things.” There’s a certain point you get to a spot.  So we bought it. It’s very simple.

John Nyaradi: Alright.

Philip R. Davis: But now, what do we buy? We bought it using leverage…options…

John Nyaradi: Right.

Philip R. Davis: And instead of making 20% of the 30% when we recovered, we made 200%, 300%.

John Nyaradi: Right, wonderful. Well, I always end these things by asking kind of an open-ended question. Is there anything else you’d like to add, you know, the one thing that’s really burning in your mind right now that people should watch out for, that you’d like to convey to people? If you have one thing to tell somebody, what would it be?

Philip R. Davis: Well, I would say you should be very much in cash right now. We are 65% in cash, 35% invested. Again though, this is tricky. If you have a lot of small investors, it’s hard because when we say we’re 35% invested, we’re 35% invested in something that’s say 20 to 1.

John Nyaradi:  Right, right.

Philip R. Davis: We’re invested. That’s more important to us, but we’re very cashy. We’re staying flexible.

John Nyaradi:   Well, Phil, it’s really been an honor and a pleasure talking with you. We’ve been talking with Phil Davis, the founder and publisher of Phil’s Stock World. The link at the bottom of this interview takes you right to the special discount we discussed earlier. Phil, really it has been great talking to you. I learned a lot and I’m looking forward to our next conversation.

Philip R. Davis: Alright, thank you so much. Very nice talking to you.

(this interview was recorded and edited for length and clarity) 

Click here to get your Special Discount Membership to Phil’s Stock World, courtesy of Wall Street Sector Selector.