Dear Fellow Big Money Options Traders,
Let’s face it: This year has been no fun. Many new positions, and some of the few paper gains we have had, have been wiped out by unforeseen events such as war, nuclear disaster, debt downgrades and, most recently, a market crash.
Economic growth in the developed nations is slowing to a crawl with deficits running at all-time-high levels. With the U.S. debt downgrade, all countries are at risk of higher borrowing costs at the worst possible time. France, the second-largest economy in Europe, may have its debt downgraded in the near term. A developed-world economic slowdown is expected to reduce demand for products made in emerging markets, including China. Emerging-market equity mutual funds had more than $7 billion of withdraws last week, the most since the third week of 2008. The MSCI is down 18% from its May 2 high.
The financial markets around the world are pointing to a worldwide slowdown. The slow-motion unraveling of the eurozone countries is like watching a shoe drop in 3D on an IMAX screen. The problems of the world appear unable to be analyzed, making stock and option investing seemingly pure gambling rather than rational investing.
It’s now August, and we are into the thick of summer. Summer usually is all about barbecues, vacations, ATVs, swimming, camping, enjoying the outdoors and having fun. Americans love to have fun; we work mostly so that we can play.
However, options trading and stock investing has fallen well short of being fun. The 18% drop to the intraday low from the high less than three weeks ago was not fun. The 4%-plus oscillations up and down this past week were not fun. The 8% downdraft after 12 years on the DJI has not been fun.
With the predominate feeling of pain rather than fun this summer, many investors are taking their dollars out of the game. Domestic equity funds and ETFs reported net outflows of approximately $14 billion for the week ended Aug. 10. That was the fastest rate of withdraw since the “flash crash” of May 6, 2010. Money market funds reported net inflows of $47.502 billion.
The real measure of a market bottom is when investors don’t want to buy stocks at any price because they’re done with it. Years of loss followed by more years of loss followed by a few dramatic nerve-wracking market crashes kills investor enthusiasm — yet it’s this loss of investor interest and confidence in the stock market that forms the foundation for the next sustainable bull move. This is the answer to the question, “Why now?”
More than any macro-economic chart or review of market history, it’s the mass loss of interest in investing in stocks that’s most bullish. During the past two weeks, we met with many investors, including hundreds of people at the San Francisco MoneyShow. Self-directed investors are asking themselves why they should make any allocation to stocks. Some have gone so far as to buy physical gold and store it outside of the United States.
When there are no buyers, prices tend to fall. On current year earnings expectations, the S&P 500 is trading at about 11-times. Emerging markets are even more depressed with a collective P/E multiple of about 9-times, 30% below the three-decade average.
At the MoneyShow last week, we had a good meeting with long-time market strategist Mark Skousen and bought his new book, The Maxims of Wall Street. In the book, he quotes Georges Louis Buffon: “Genius is nothing but a greater aptitude for patience.” The “why now” answer boils down to having the patience to stay in the market through the point when widespread investor disenchantment creates a huge wealth-making opportunity much like the March 2009 to February 2011 run of up 100%.
It’s impossible to know if the run already has started or if we’ll be subject to more downward volatility in the coming weeks. But what’s rapidly becoming clear is that we may be very close to an important low.
Market Sentiment Indicator
Last week, our market sentiment indicator reached 8.2%. What this means is that only 8.2% of the 4,000 stocks we follow were trading above their 75-day moving average. Said another way, about 92% of the stocks we follow were trading below their 75-day moving average.
In the past 20 years, our indicator has reached this level only four times. In all previous cases, the market was trading substantially higher in the following six months. In some cases, the market rallied right away. In 2008, there was still further downside and high volatility before the final valuation floor was set.
Our market sentiment indicator helps confirm the bullish readings of the CBOE Volatility Index (VIX) in the high 40s and an overall S&P 500 P/E at a multi-decade low.
Making Money With Options
In March 2009, we had a “party” financially. We sold puts, bought calls and made extraordinary gains. If you look at our 2009 track record, you’ll see some of the losing positions of 2008 expire, but you’ll see many more incredible winners from the new bull run. In some cases, our profits were not just 100%, but more than 1,000%.
“Why now” is because this is the kind of opportunity that’s once again beginning to emerge.
This week, investors will review the industrial production report for July — including July capacity utilization, July housing starts, July existing home sale, July leading indicators and the August Philly Fed survey. Then they’ll decide whether evidence is mounting of a double-dip recession.
Last year in August, the market was trading at about the same level. It was down from the highs on concerns of a double-dip recession and problems stemming from the European sovereign debt problem. August 2011 looks like a repeat of August 2010. Let’s hope that September 2011 through December 2011 looks just like the same period in 2010.
REVIEW OF TRADES/POSITIONS
All of our open positions were severely damaged by the market crash of the past two weeks. Given the dramatic price decline, we have moved all positions to a hold and would not add new money to our existing positions.
We plan to take advantage of the newly developed market conditions to initiate new trades. For the moment, options buyers have been mostly attempting to hedge their long stock. Given the recent crash and market volatility, it has been difficult to decipher any meaningful trading patterns in stocks or options.
The panic will abate, and it should become evident whether we’re going to see a strong market bounce or the continuation of a negative price trend. In either event, our plan is to put on new trades that take advantage of the new pricing environment.
The full details of each trade are shown on the Big Money Options website.
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Top Trades Now
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The remaining open trades are:
Amkor Technology Inc. (AMKR) — On July 7, we recommended you open a bullish combo on AMKR by “buying to open” the AMKR Sep 7 Calls (AMKR110917C00007000) for 40 cents or less, and simultaneously “selling to open” the Sep 6 Puts (AMKR110917P00006000) for 40 cents or more, for a zero net debit. As with all of our current trades, we’re placing a ‘hold’ on this position for now.
Commercial Metals Co (CMC) — On July 27, we recommended you “Buy to open” the CMC Sep 16 Calls (CMC110917C00016000) for 40 cents or less. At market close on Friday, the position was 5 cents.
Force Protection (FRPT) — On May 16, we recommended you “buy to open” the FRPT Dec 4 Calls (FRPT111217C00004000) for $1.30 or less. We paid $1.35. At market close on Friday, the position was 30 cents.
Leggett & Platt (LEG) — On June 21, we recommended you “buy to open” the LEG Sep 25 Calls (LEG110917C00025000) for 70 cents or less, and simultaneously “sell to open” the LEG Sep 22.50 Puts (LEG110917P00022500) for 75 cents or more, for a net credit of 5 cents or more. Let’s continue holding for more favorable conditions.
SBA Communications (SBAC) — On July 7, we recommended you open a bullish combo on SBAC by “buying to open” the SBAC Sep 40 Calls (SBAC110917C00040000) for $1.65 or less, and “selling to open” the SBAC Sep 40 Puts (SBAC110917P00040000) for $1.60 or more, for a net debit of 5 cents or less. The options are way out of range, so it’s best to hold this position.
Staples (SPLS) — On March 9, we recommended you “buy to open” the SPLS Sep 22 Calls (SPLS110917C00022000) for 90 cents or less. The company issued disappointing earnings guidance, crushing the stock. At market close on Friday, this position was 5 cents.
Telefonica (TEF) — On June 27, we recommended you either go long by “buying to open” the TEF Dec 25 Calls (TEF111217C00025000) for 95 cents or less — OR — open a bullish combo by “buying to open” the TEF Dec 25 Calls (TEF111217C00025000) for 95 cents or less, and simultaneously “selling to open” the TEF Dec 20 Puts (TEF111217P00020000) for 80 cents or more, for a net debit of 15 cents or less. At market close on Friday, the long TEF Dec 25 Calls were 34 cents, and the combo offered a $1.66 credit to open, but now isn’t an ideal time to commit new money here.
Tellabs (TLAB) — On April 29, we recommended you “buy to open” the TLAB Jan 2012 5 Calls (TLAB120121C00005000) for 65 cents or less. At market close on Friday, the position was 15 cents. We continue to see bullish options flow in TLAB. The company has about $3.50 per share in cash, which should limit further downside. Let’s wait and see how this unfolds.
USEC Inc. (USU) — On Nov. 16, we recommended a bullish risk-reversal on USU by “buying to open” the USU Jan 2012 7.50 Calls (USU120121C00007500) for 70 cents or less, and simultaneously “selling to open” the USU Jan 2012 5 Puts (USU120121P00005000) for 95 cents or more, for a net credit of 25 cents or more. We entered the trade for a 30-cent credit. At market close on Friday, the calls were 10 cents, and the puts were $2.75. With the stock trading below our put strike, we don’t recommend adding new money to this trade.
Parting Shot: Earnings Season Report Card = C+
Before the open tomorrow morning, Q2 earnings season formally will come to a close with Wal-Mart posting its results. In reviewing the earnings season, the best word to describe what was reported is “mixed.”
Although 60% of the companies beat earnings estimates, the ratio of companies raising guidance versus lowering guidance was just slightly positive. Consider that 7.28% of the companies raised guidance while 6.33% lowered guidance. The positive guidance ratio was the lowest since Q2 2009 when it was negative.
With the Japanese supply disruption and a variety of other depressive macro factors, it isn’t surprising that results were more mixed than in previous quarters given the soft-patch economic environment. Unfortunately, the earnings season doesn’t provide us with a conclusive statement about the possibility of the economy entering a double-dip recession before year’s end.
Like this time last year, if the economy does begin to slide into recession, we’re likely to see a QE III program from the Federal Reserve. This could present a near-term win-win situation for investors. Either the economy continues to grow, or the economy receives another huge injection of money supply. In both cases, stock prices most likely will appreciate.
Have a great week trading,
Nick Atkeson and Andrew Houghton
Big Money Options