The LEAPS Option Trader
105 W. Monument Street
Baltimore, MD 21201
Wednesday, July 7, 2004
Email – #178
** A Year to Remember? Let’s Hope Not…
There is so much that could go wrong this year… that hasn’t already.
Yet to date the market has ignored all but the best of news. Imagine a decade ago if you had the confluence of the events that face us today. Then imagine the reaction of the market to those events. It is different today. Investors have lost their marbles and it shows.
I will list the possibilities of what COULD happen between now and January 1, 2005. The overwhelming conclusion is that uncertainty is king and the market hates uncertainty. Here goes, in no particular order:
1) A democrat could be elected to the highest office on a platform of higher taxes (or a repeal of the recent tax rollbacks).
2) The war in Iraq could escalate.
3) Afghanistan could flare up.
4) A colder than expected winter could send oil prices even higher than $40 per barrel.
5) The U.S. or any of the Group of 7 could experience a hit from terrorists.
6) Interest rates could continue to rise.
7) Corporate earnings could fall short.
The dollar could fall under the weight of the trade deficit and national debt.
9) Emerging markets could face a new bust caused by overheating economies.
I am sure there are more factors that could affect the economy, our psyche and the stock market.
So am I newly negative? No.
The entire philosophy of investing using LEAPS is a “negative investment philosophy.” If I did not believe we were in a fruitcake investing environment, then I would be comfortable plunking down $50K in Lockheed Martin stock.
Instead we spent less than 5% of that on our option spread. If I were super optimistic I would spend $20K on Motorola; instead, we risked $3K on the same position.
For the past two years I have alerted investors at every opportunity that holding stocks without a hedge or owning shares when LEAPS were available was a mistake. I didn’t do this because I have tremendous faith in the market. Quite the contrary: We own LEAPS to CONSERVE capital, not waste it.
But I could be wrong, and every factor mentioned above might not occur in the next six months. That is why we have some unhedged and long positions.
If the factors mentioned above were in place a decade ago, the market would be tanking.
Today it is not, because of the easy money and lack of willingness by the individual investor to get realistic about investing his or her net worth.
It is never too late to change, or take a defensive position. Right now we have a few defensive positions: gold, energy and a couple of hedges that have taken some cash off the table.
But we don’t have a pure play on the market heading south between now and January. Why?
Each time we have tried a pure index short, we have lost money. That is not fun and can get expensive. This has not been a year for short sellers and we have paid the price a couple of times. Sure our hedges have worked well and some of our shorts have done okay, but for the most part it has paid us handsomely to be long in this market. That could change in a hurry and it could start with the current earnings season, the current political climate and the current volatile geopolitical climate.
So, for the third time this year, we are going to go short using the QQQs as our proxy. If the market does tank, techs will most likely lead the way. If it doesn’t, we have our special-situation techs that should more than cover any losses from our put.
Also, I am going to make a rare NON-LEAPS recommendation because I believe that if we can make it through the next six months with none or just one or two of the factors above coming home to roost, then we could be alright.
**Action to Take***
Buy the December 2004 $35 QQQ PUT options. The symbol is QQQ-XI. These close-to-the-money put options are currently trading at $1.85 on the offer. Do not pay more than $1.95. For now we will use a mental stop of $0.75.
If anything changes I will communicate with you immediately. This recommendation is a hedge against our current tech positions, so if you don’t have any open tech positions right now, this trade may not serve its purpose for you.
It is important that you understand that I am not going short only, but trying to balance our portfolio in a period of our history when the only thing that is certain is uncertainty. If I am wrong, we stand to make a lot of money from our long picks. But it will not take much to make the market overreact, and we need to be prepared for that eventuality, as well.
Regards,
Karim Rahemtulla
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