Weekend Sept 22 2012
“We have tried spending money. We are spending more than we have ever spent before and it does not work. I have just one interest, and if I am wrong... somebody else can have my job. I want to see this country prosperous. I want to see people get a job. I want to see people get enough to eat. We have never made good on our promises ... I say after eight years of this Administration we have just as much unemployment as when we started... And an enormous debt to boot!”
FDR's Treasury Secretary Henry Morgantheau on The New Deal
The Week in Review
We have arrived at pretty much the same place as we did in the 1930s and the 1970s. TMP has noted the amazing resemblance to the late 1970s, Democrat Presidents were elected eight years into the stagnant era, massive spending, and then utter chaos in the Middle East as long time rulers were over thrown, encouraged by lax US policies. This is not a geo political blog but the socionomic similarity is amazing.
Before reading further we urge both new and veteran TMP readers to go back to our update last weekend, titled The FED Throws a $40 B Party. That update features some 13 graphs explaining our concerns. I followed that with no less than 10-11 posts this week. Again I suggest that everyone review all the posts of this past week to refresh on our views of where we are in this market.
We sold positions Tuesday morning Sept 18 on the open. Our stated reason was simple, the closer we get to what will surely be a significant top the great the risk that the market dramatically reverses, erasing recent gains. The market could dramatically reverse before a stop sell order is hit, or is executed lower in the event of market not held conditions or one fails to put in a sell order at all. (Bold print for emphasis added).
We noted later in the week that in fact the oil market had done just that dropping seven percent in one week. Was that just a pullback before a final move higher or a top in a significant and highly emotional market? At this point we have no way of knowing, oil has at best had a dead cat bounce since.
We reminded everyone of where this market is with this weekly graph on Sept 20 which we update today.
Buy Low Sell High, a Strategy for Doing Just That
Well it is time to be selling and perhaps scaling in orders for the next anticipated BIG move. We are one short trading week away from the weakest seasonal month on Wall Street - October, the month of Stock Market Crashes.
This pattern is evident in the Panic of 1907 as well as the crashes of 1929, 1987, and 2008.
Crashes happen at the end of moves in a final disgusted, in the case of bear markets, give up. But an initial drop, such as the 7% drop in oil this past week, can seem like a crash.
The strategic idea of TMP is to
realize the era one is in, expansionary or stagnant, we are in a stagnant era which began in 2000 similar to 1930-1948 to 1966-1982/4. Such ears are characterize by wide swings of bull and bear rallies rather than one long bull rally such as 1982-2000. This clearly means that buy and hold will not work, one has to be in tune with the market.
TMP utilizes internal indicators such as bullish percent, summation index, High Low, Advance Decline Volume and such to determine potential highs and lows.
While social mood is not an exact science, it is helpful in observing the overall mood.
We went so far as to review Dr. Harry Markowitz Risk Reward Frontier this past week. We urged readers to consider where the real risk frontier begins and ends. The strategy is to buy more assets at out of favor values, June 1, 2012 was the recent example and begin taking profits as mood moves the other way, this past week being the recent example.Socionomics tells us that mood is extreme at the end of moves. This is why the bargains are on drops of the DOW of 400 points near the end of moves. Note our observation that the NASD moved its final 40% in just six months into Year 1999/2000 after taking 18 years to get to move 60%!.
The Volatility Index
The VIX calculation is explained here. But think of this is just another Black Box indicator, it moves opposite the stock market, which is what you really need to know. At stock market tops therefore, the VIX should be making a bottom. Market bottoms are formed with a series of quietly formed higher lows. Now look at this daily graph and tell me what you see-just that, a series of quietly formed higher lows.
Now with that thought in mind let's take a look at Risk, a concept rarely discussed in most Market Letters.
Risk is counter intuitive to crowd or herding psychology. In our Hunter Gatherer days longer lived cave men and women stayed that way by running away from stampeding herds of wild animals. Now however, stampeding herds of investors exiting otherwise valuable companies are a buy signal, the opposite of what our Hunter Gatherer brains are wired to believe. Conversely, the herd tends to buy stocks when everyone else is buying, which is to say too late to harvest a double percentage gain. And probably to late to realize it is a better exit time than entrance, see Chart One today!
Options have been around since 1636 in the heady days of Tulipmania. The original and current idea of options or derivatives is to use them to limit risk. A complete discussion of derivatives and options is beyond, way beyond, what we can present here. But, for example a put option grows in value as the underlying contract or stock or commodity drops in value. It is like home or auto insurance. In the event of a sudden and unexpected catastrophe,it becomes insurance.
Modern computers allow calculation of the relative delta or probably strength of fluctuation in options. This allows fund managers to construct a system of what is termed delta neutral. For example. suppose we own 10,000 shares of Apple Computing, hey in the fund business who doesn't? One could hedge the chance of Apple dramatically dropping by purchasing put options matched in time and volatile duration to the stock held. To make an analogy, if your house is estimated to be worth $200,000, one should probably hold that much in insurance on the house.
But options and derivatives have gotten a bad name via outright large bets in one direction that are the exact opposite of a hedge. Lehman, Bear Stearns, and Merril Lynch all bet one way and in leveraged fashion on sub prime mortgages When they dropped in value the meager 3% capital all three claimed was wiped out. In the bear market of the 1970s firms had to maintain ten percent capital, and there were no off exchange traded derivatives. Now capital requirements are one third that in far more volatile times. Note, all these had become publicly traded companies, and so the owners were playing with other people's capital.If they had remained partnerships trading their own capital, it is some measure of sanity might have prevailed but I digress.
Recently Jamie Dimon's Whale Trader at J P Morgan us 'lawyering up' as a result of his $5 B + loss in a one way trade.
Now I told you all that to make this point. Let's suppose one is long 4,000 shares of GDXJ, and as a matter of fact I was long more than that.
4,000 x $24/share is $96,000, which is big money at my house I don't know about yours.
Now suppose the portfolio dropped about 4% this past week, which in this example would be
96000 x 4% = $3840, or enough for a couple to take a a nice cruise, just to put that in perspective.
Such volatility is to be expected when the trades are initiated but as internal indicators become overbought is well uncomfortable. As I observed earlier this week, it is easy to exit when markets are calm.
I promised to examine alternate strategies to reduce risk but to still potentially profit. Since maximum mood happens at th end of moves, we grant that a high percentage return is possible at the very end of the move. This happened tome last Friday when my TLT puts dramatically expanded in value. Whoops by Monday Tuesday they dropped back just as fast. I readily admit and said that this cold shower prompted my exit from other stock positions which had not dropped and had nice profits.
And so I purchased in one account ten TLT 121 puts and ten GDXJ 25 calls both for October expiration on Oct 19. I am guessing if something is going to happen it will conclude at least a couple of weeks prior to the election. so that leaves four weeks to go, not long but my total outlay was about $1400 for the calls and $2100 for the puts. The calls give me exposure to $25,000 worth of GDXJ and the puts to $121,000 of TLT. So my total risk is $3500.
What could go wrong? At worst both securities fall below 25 and 121 by expiration I do nothing and lose the $3500. But they are at the money and should hold up for the next two weeks assuming the markets do not fall completely out of bed. And I am thinking we have some upside in GDXJ and downside in TLT. How much?
Let's say GDXJ moves dramatically to $30. that should translate to a profit of $4000-5000. If TLT falls five points to say 115, the same thing would happen. Again it would be a great idea to place sell orders orders ahead of time anticipating such an event. Such instruments are famous for making a parabolic move in one direction and then collapsing.
Yesterday was options expiration. The September options expired and participants 'rolled over' positions to later months such as October 19.
Here is Friday's activity and this is typical of an option expiration day. Which is to say that the winding and unwinding or positions result in no change by the end of the day. if managers efffectively matched off previous and future positions this makes sense.
This also explains fairly even activity this past week going into expiration, everyone did not make their decisions on Friday.
Which is to say if something is going to happen on the upside it will be this next week not last week.
Now for newbies a few reminders
Do not for one second think this brief discussion makes you a seasoned options professional. My friend that flew helicoptors in VIet Nam made a similar remark about his brief three month training program on how to fly a ehlcoptore before being sent to the War Zone.
You cannot lose more than your purchase price but you darned sure can lose it all.
This is not a long term investment, you do not own shares in IBM. This is the literal definition of the Quick and the Dead.
Do not place outsized bets. See lawyering up article on The Whale linked above.
The idea is to reduce not increase risk.
Your author is a former NASD Registered Options Principal, this is not my first rodeo. All of this is a recommendation on reducing risk, do not become a 'Whale.'
If you have no experience, I have laid the particulars out here so you can follow along, readers know I don't mince words and admit both successes and errors. We all learn a lot more from the latter, errors, by the way.
If you read this far I am proud of you! I hope you found this a worthwhile exmanination of how to manage risk and will follow along the next month to see how this Serial Ends.
Options Trading is only for experienced individuals. Please note the precautions posted above. Brokers require special forms and approval for such trading. You can lose all the money you put into options. And do it in a hurry as well.
This post has been considerably different from most of our updates. At 2000 words it is lengthy. So I am stopping here. I will exaine the past week as usual in the next update for fear this would be too long and most would lose interest in reading.
And Finally a Busrst of positive Social Mood
A few weeks back, was it even that long, as we approach a market top, and now after the SPX has risen from 1260 to 1480, we told you to expect advertisements and articles with titles like
How to Play the Market Now
Sure enough, note the smiling faces all across the photo. There were no photos like this in 2009. It has taken that long for the memories of the Crash of 2008 to fade. As we say, positive social mood pervades market tops. Note there is no headline suggesting you should simply exit which is what TMP recommends. No I didn't watch the video.