The Option Queen Letter for July 6, 2008
Why are so many people focusing on the “bottom of the bear market?” Frankly, in the past, bottoms have been formed when depression and despair are rampant; not when the media “air-heads” announce that it has occurred. Rather than venturing into finding the much talked about bottom of the market, why not take pencil in hand and put your imaginations and calculators back to work, solving another clue in the puzzle of making money. Plenty of money can be, and indeed has been, made in “bear markets.” Focus your efforts on finding ways to take advantage of the other guy’s fear.
How can this be done? Here is a simple way; not hard, not complicated, really easy to do. Find a list of companies that have a long term history of growth, pay dividends, earn money from current operations and enjoy insider ownerships (if the insiders don’t want the shares, why would we want to buy them). As these stocks become cheaper, sell the puts naked on the shares with a strike price at the level that you would like to enter into a purchase of the shares. Let us take Microsoft or Pfizer for example. Pfizer is trading at 17.75 per share, which represent all that you can loose on the shares should they go to zero. That is your risk. Microsoft is trading at 25.98, and that is exactly all you can loose on that trade. Now if you sold the Pfizer puts for August you will collect .65 per put options sold, September will give you .86 per put. Each put is equal to 100 shares of the stock. Let us look at the Microsoft puts, selling the August 24 puts will give you .52 per option. Let us now say that the stock was put to you in August. You are now long Microsoft and you are long Pfizer and will immediately sell calls on the stock and buy puts on the stock. It is always helpful to make sure that the dividend is paid to you, always adjust your expiration months so that you collect the dividend. We could sell the October 27 calls on Microsoft for 1.44 and buy the October 24 puts for 1.04 thus collecting .40 on that trade plus the .52 you collected for selling the naked put. Further, you are agreeing to sell the stock at a profit while not taking a risk on the downside, your insurance, put ownership, for Microsoft is 24. If the stock trades between 24 and 27 in October, you will have another opportunity to put on the same trade. As to Pfizer; you sold the 16 puts for .65 per 100 shares, let us say you now own that stock at 16. You can sell the December 17.50 calls for 1.30 and buy the December 15 puts for .46. On this trade there are no 16 puts so, the maximum loss will be 1 point per share. On this trade you will get the dividend plus 1.49. If we were to remove the possible one point loss you would make .49 on the trade in addition to the dividend. It isn’t exciting but it works time after time.
Another more risky strategy is to wait for the bounce, even bear markets bounce and they do bounce really well, and join the crowd to the upside. The problem here is that you could be wrong and late, which will cost you money. True, it is far more exciting than the above conversion is. When you trade contra to the markets direction you are playing a game that needs total and complete attention. It is not a trade that you can step into and leave for a day of golf. You must have tight trailing stops and pay attention. It is also important to have redundant systems, so that if one crashes, you have the other to fall back upon. We run three systems at all times, they all are the same markets but different platforms so that should one crash, we have the backup of another. As to the put/call strategy on the indices it is also doable however, we tend to sell put spreads rather than just to sell the outrights. When we sell a put spread we sell the higher strike and buy a lower strike as protection. Thus, we have limited our downside exposure.
Before you all go celebrating the firmness of the US Dollar, remember, that this weak US Dollar has reversed some of our trade imbalances allowing us to compete in foreign markets. True a weak US Dollar means higher inflation but it has also helped our exports and tourism. A firm US Dollar will be helpful in taming the wild inflation in commodities but also will hurt our exports. It is a coin flip, right now, we would vote for a stronger currency and less inflation as a result of that strength.
Monday: San Francisco Fed President Yellen speaks. Tuesday: the start of earnings season with the release of Alco’s second-quarter earnings, May wholesale inventories are released at 10:00, at 3:00 consumer credit is released, Fed Chairman Bernanke speaks early in the morning, and Richmond Fed President Lacker speaks. Wednesday: crude oil bingo continues with the release of weekly oil inventories. Thursday: the Bank of England releases its interest rate decision (no change is expected), retailers report on their June sales, and Fed Chairman Bernanke speaks. Friday: it is GE’s turn to release second quarter earnings, June import prices are released at 8:30, May international trade is released at 8:30, July University of Michigan Sentiment Survey is released between 9:45 and 10:00, and the June Treasury Budget is released at 2:00. Apple introduces its new iPhone 3G!
The S&P 500 futures chart is at a point where, should it close below the Thursday low, we could open the door to a waterfall of sell-stop orders. Thursday’s venture to the downside was the third of such venture seen testing the 1250 level. The Thursday session had a slightly higher low on the shortened-pre-holiday trading session. Thursday’s session was an inside day. The downtrend line for the Monday session is 1290.75. The downtrend line is exceedingly steep. We could see this market rally to the mid 1300’s and remain in a downtrend. The weekly chart shows a very steep spillage cascading the prices lower with the three tests of the 1250 level very clear. Each test has brought the market lower, but only marginally lower. If we look at the monthly chart, we notice that there were three tests of the lows from the end of 2002 to early in 2003. These lows were higher lows not lower lows as we see today. The downtrend line for the Monday session is at 1294.31. The uptrend line for the Monday session is 1257.29. You have the boundaries needed to trade! The 5-period moving average is at 1271.98. The upper edge of the Bollinger band is at 1386.87 and the lower edge is seen at 1248.48. The only indicator that we see giving a slight buy-signal is our own indicator. The stochastic indicator is oversold and continues to issue a sell-signal, the RSI is oversold and going flat while the Thomas DeMark Expert indicator is flat at neutral. The indicators on the weekly chart are mixed with both the stochastic indicator and our own indicator curling to the upside but failing to give a buy-signal, the RSI continues to issue a sell-signal and the Thomas DeMark Expert indicator is issuing a buy-signal. We do expect to see a dead-cat-bounce and that bounce will tell volumes about the future of the rally from these oversold levels. Fasten your seat-belts for a very interesting summer. Oh, by the way we should see support at 1242, 1223.50 and 1213 under that……bombs away!
The NASDAQ 100 quickly shows the viewer that we are not even near the March lows and only approaching the April lows. We do have a 9-count on the daily chart. The April low was 1781.25 and the March lowest low was 1668.75, thus at 1822.00, Thursday’s close, we are far above these levels. We see that this index has been stronger than the S&P 500. The stochastic indicator is issuing a fresh sell-signal at oversold levels, the RSI is going flat at the oversold line and our own indicator is going flat on the negative side of neutral. The Thomas DeMark Expert indicator is flat at neutral. The 5-period moving average is at 1836.80. The top of the Bollinger band is at 2038.92 and the lower edge is seen at 1798.69. The indicators on the weekly and the monthly chart are pointing lower. The monthly chart illustrates that we are in a continued trading range, albeit nearing the lower edge of that trading range.
The Russell 2000 remains above the January low of 637.10 and the March low of 640.00. We have a 9-count on the bottom and a doji candle as a result of the Thursday unchanged close. The stochastic indicator is oversold and is issuing a muted buy-signal. Our own indicator is issuing a mild buy-signal. The Thomas DeMark Expert indicator is dead neutral and going nowhere. The RSI is grossly oversold and going sideways. The 5-period moving average is at 675.94. The top of the Bollinger band is at 759.83 and the lower edge is seen at 662.55. The very steep downtrend line is at 678.76 on the daily chart. All the indicators on the weekly chart continue to warn of lower price. If this market trades below 657.00 we could easily see a whoosh down to 639.
The US Dollar index closed above the short downtrend line on the daily chart. The 5-period moving average is at 72.774. The top of the Bollinger band is at 74.670 and the lower edge is seen at 72.239. Both the S&P 500 and the US Dollar index have 9-counts on the daily chart. The stochastic indicator and our own indicator are both curling over to the downside, but will not issue a sell-signal for several days. The RSI is pointing lower and is at the neutral level. The Thomas DeMark Expert indicator is at overbought levels and pointing higher. This week we will have the Bank of England announcing its interest rate decision. Seemingly with the ECB finally at neutral and the Band of England neutral as well, we should see some firming in the US Dollar index. The downtrend line on the weekly chart is at 74.49. We do see some problem at 74.75 after that we could see a rally to 75.335. If we could see a trade above 73.30 we will see the market rally to 73.90 then 74.20.
The Continuous Commodity index daily chart looks like a pole. This index is more pole-like than crude oil and, is more overextended than crude is. We have been overbought for some time now dating back to early in June and, we still haven’t seen a sell-off. This chart illustrates how markets can remain bullishly overbought for periods of time without retreating much. The 5-period moving average is at 608.544. The top of the Bollinger band is at 619.656 and the lower edge is seen at 552.401. Only the Thomas DeMark Expert indicator is issuing a sell-signal the others are, for the most part, flat at overbought levels. The weekly chart is showing signs of exhaustion, no kidding! If you want to see scary, look at the monthly chart, a true pole, reminiscent of the “dot com” stocks we used to look at! Be careful!
Crude oil seems to be loosing some of its upward thrust for the moment and looks as though it could retreat mildly. Would we short it? Absolutely not! Both the RSI and the stochastic indicator are curling over and issuing a sell-signal on the daily chart. The 5-period moving average is at 142.80. The top of the Bollinger band is at 144.99 and the lower edge is seen at 130.30. The first level of support will be at 137.37, the there will be good support at 132. The weekly chart shows the continued rally in crude oil. We are overbought by all measures but continue to point higher. The monthly chart is also grossly overbought and continues to issue a buy-signal. The monthly chart does look like a pole.
The gold market stalled in the Thursday session at 950.00. We need to see a close above 960.70 to send this market back to the highs of March. The indicators followed herein are all issuing a continued buy-signal albeit at overbought levels. The 5-period moving average is at 937.72. The top of the Bollinger band is at 952.261 and the lower edge is seen at 954.539. We are in the Ichimuko clouds which warn us not to trade while in the clouds. The weekly chart looks as though we are forming a rounded bottom from which we should rally and test the old highs.
Good luck trading this week, it should be very interesting!