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Which Way Wednesday – Hurts So Good!

Posted on the 16 May 2012 by Phil's Stock World

Commercial Real Estate is down 14% in China so far this year with Residential right behind, down 13.5% – all on 11.8% fewer sales than last year.  Foreign investment in Chinese properties has dropped 42.9% year to date.  China's main banks are not lending any money – due to lack of demand, not supply and 45% of Chinese companies predict a slowdown this year and next.  Brazil is right behind China with their own real estate market collapsing and the IMF is racing over to Australia to assess the damage done to their banks by the bursting property bubble and EU property values are also off 20% from their 2007 peaks – even in London and Frankfurt – which were supposed to be "immune" from this nonsense.  

Good – let's get it all out in the open finally!  

PhotobucketItalian Banks are in turmoil and their Government is considering using troops to protect the Banksters after one was shot last week.  There is a run on the Greek Banks with almost $900M withdrawn this month and virtually no liquidity should people want more.  Meanwhile, The Institute of International Finance has estimated that the global cost of a Greek exit could hit $1,300,000,000,000. When Argentina defaulted in 2001, foreign debtors lost around 70% of their investments.  Is $1.3Tn finally a number that matters?  

That's right folks, the Global situation is a complete and utter disaster – which is why we went long on the Russell Futures (/TF) at 775 and Oil Futures (/CL) at $92.50 in Member Chat this morning.  Where the Hell else are you going to put your money if not in US Equities?  That was my conclusion at 11:54 in yesterday's Chat, when I said to Members:  

Nice pop off the EU close – still seems like people are abandoning the sinking ship of state over there and money has nowhere to go but US equities (but TBills and Dollars are getting some love too).  With gold, silver, oil and copper all looking weak – where the hell are people supposed to put money?

SPY DAILYWe noted that there were 16 stocks that were hitting their 2009 panic lows which we were very comfortable moving into in what we're calling our "Twice in a Lifetime List" – named that since I pointed out that we never thought we would get an opportunity for entries like that again in our lifetimes.  Once example of a stock on that list is CHK, now priced at just $9Bn with $60Bn in proven reserves (15% of reserves) while XOM is priced at $400Bn against $2Tn in proven reserves (25%).  That's putting CHK into the realm of a no-brainer buy for a big oil company looking to shore up their reserves, right?

Of course we don't just BUY CHK at $14.50 – not when someone is willing to PAY US $5.50 to buy CHK for $15 in Jan 2014.  Even if we do end up buying the stock for $15, our net entry on CHK is $9.50 for selling the naked put – that's 35% off the already drastically discounted price – that's not bad for an initial entry is it?

We already have some aggressive spread trades on CHK but, for the purposes of our Twice in a Lifetime List, we're looking to take advantage of the panic pricing in long puts at the same time as we take the money and run on our Long Put List – where we took advantage of the complacency pricing in puts when the market was toppy and the VIX was low.  See how easy that is to play?  

XLF WEEKLYWe filled the gap on Dave Fry's S&P chart in the Futures this morning, touching 1,320.75 at 3:30 and we're already back at 1,336.  As I said on Monday morning: "It's a very long way down to our next support level on the S&P which never filled the gap up over 1,320 from early February, which just so happens to be our 2.5% line for that index as well – so we'd expect to see some strong support around there."  So we're certainly not going to complain when the market follows our script essentially to the penny

Our other targets were that 775 line on the Russell, where we went long (now 780), $92.50 oil (now $93 and the Egg McMuffins are paid for!) and 12,500 on the the Dow and those Futures (/YM) tagged 12,545 before bouncing with the S&P and that's close enough on the Dow, which is the stupidest of all our indexes anyway.  

XLF $14.50 is another target and we've been playing that one long with FAS and JPM is another stock we went long on (see Monday's post) but a bit more cautiously as we're not sure where the bottom is there.

Which Way Wednesday – Hurts So Good!We still have our hedges, of course – who knows what craziness this market will rain down on our heads.  Cash is still King but a few pokes at some longs here protected by some disaster hedges not only keeps things interesting, but lets us take profits on both sides during these wild gyrations.  The simple DXD May $12 calls, for example, that I pointed out in Monday's post at $1.45, closed at $1.85 yesterday so even if you missed our original entry at $1.20 – they still made a quick 27% in 48 hours!  

The CAT May $95 puts that we were hedging with (also from Monday Morning's post) shot up from $1.45 to $2.80 yesterday, almost a double in 2 days there and up closer to 200% from our original .95 entry (from our Long Put List) while even the SQQQ June $10/14 bull call spread popped another .40 from $1.70 – a 23% gain in 2 days but our net entry was just .45 and net $2.10 currently makes for a 366% gain on that hedge.  

Which Way Wednesday – Hurts So Good!That's how we can buy with confidence – using leveraged protection we can commit just a little cash to our hedges while we begin to deploy some bullish money at what we HOPE (not a valid investing strategy) is the bottom.  If we're wrong – then the money we make off the hedges goes towards some dollar cost averaging on our longs.  If we're right, relatively small losses on the hedges are certainly forgotten as we have our long-term bullish positions at rock-bottom prices.  

Every trader knows the trick is to buy low and sell high but what's the point of knowing that if you don't have an investing strategy that let's you pull the trigger?  

We were discussing scaling strategies in Member Chat this morning and I think the real key in taking advantage of these situations is to always have a healthy degree of paranoia.  If you ALWAYS assume that whatever you buy will drop 20% – then you are more likely to be pleasantly surprised than shockingly disappointed (see "How to Buy a Stock for a 15-20% Discount With Our Buy/Write Strategies").  To use our friends at JPM as an example, the stock is $36.24 so let's say you have a $100K portfolio and you want to put 10% to work buying JPM.  You can:  

  • Sell the 4 2014 $32 puts for $5.20.  That puts $2,080 in your pocket against about $1,310 in net ordinary margin so you are keeping ALL of your cash but stand to make $2,080 (20% of $10,000) if JPM simply holds $32 through Jan 2014.  Worst case is you are assigned 400 shares of JPM at net $26.80 and you own $10,720 of JPM stock at 26% off the already discounted price.  
  • You can also scale in by using our buy/write strategy to buy 100 shares at $36.24 and sell the 2014 $30 calls for $9 and the $32 puts for $5.20 for net $22.04 ($2,204) on 100 and if JPM is below $32 in Jan 2014, you will be assigned another 100 at $32 for an average of $27.02 on 200 shares ($5,404).  Even if JPM is down at $15 in 2012, you still have $4,596 on the side and you could buy 300 more shares at $15 ($4,500 assuming you still liked them) and then you'd have 500 shares at an average of $19.80 – a 45% discount off the current price.  

These discounts are so good that we are, in fact, often DISAPPOINTED if JPM goes up and we "only" make $796 when we are called away at $30 off our initial $2,204 investment (36%).  Of course once JPM does move up significantly and it becomes unlikely that we'll be scaling into a larger position, the rest of our $10,000 allocation ($7,796) to buy JPM is freed up to initiate a position on the next bargain we identify.  It's not a complicated strategy – it just takes a lot of patience and THAT is the most difficult thing we try to teach our Members.

As I've been saying all week – we're still not very bullish until we punch through our Must Hold levels and we stand ready to add more bearish bets (and maybe even pull the bullish ones) if we once again are rejected at our weak bounce levels (see yesterday's morning Alert to Members).  It's still 1,360 or bust for the S&P this week and it's all up to Facebook to boost the markets on Friday as the Fed seems to be sidelined through the elections – unless, of course things get REALLY bad – but we're not there —- yet….

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