The LEAPS Trader
105 W. Monument Street
Baltimore, MD 21201
Monday, November 27, 2006
Email – #349
** Complacency, Low Volatility and Poor Fundamentals
These factors usually set up for a market decline of significance. But, as we have experienced, being short the market is not working.
We have closed out three short positions since the summer – each one has lost. One would think that the last thing to do would be to go short again. It’s usually at the point of exasperation with the market that it does exactly the opposite of what you think it should be doing:
The U.S. economy is not healthy, yet the market rises on the belief of a soft landing. The dollar is falling, yet gold is only now beginning to perk up. Valuations in many sectors are very high, the commercial real estate sector for one – yet equity funds are buying from the very sellers who are signaling a top. Do you really believe that people like Sam Zell sell low and buy high?
Then we have geopolitics – nothing’s getting better here, and the oil exporters are now getting used to oil at $50 plus. And, interest rates? And inverted yield curve means nothing anymore.
The point is, we are in a new paradigm – right, we’ve heard that one before. This time, the new paradigm is that everything excessive is not bound to fall back to moderation. And, every logical indicator is now seen as flawed.
In the short term, anything can and usually does happen. But, as time passes, things get trickier to explain. Next year, companies will report slower growth, and if the dollar does not recover, the rate of inflation will increase. Time will tell.
For now, the very index that measures volatility, the VIX, has touched all-time lows, and is bouncing higher. But, it does not matter because the VIX really doesn’t measure volatility anymore either – it’s just another index that happened to get lucky a few times in the past like 9/11, 1987, the Long Term Capital Crisis, and the collapse of the NASDAQ.
We do have a bear spread working for the VIX right now, after taking profits from part of the position earlier this year when the index doubled in about two months – imagine that – a doubling of volatility in a just two months.
I think that at some point in the next 12 months, we will see a correction in the market of 10% or more.
We have seen these mini-corrections many times before, just not lately. But, since I have been dead wrong recently on the short side, I have decided that we should take this fact into account and enter into a straddle. With a straddle, we take both sides of a trade. We go long by buying a call option and go short by buying a put option. The goal here is that one side will move enough to cover the losses from the other side and then some. I believe now is that time. Either this market is going to soar in the year ahead, as investors ignore fundamentals, or it will head lower as people pay attention to the realities of a slowing housing market, slower growth and inverted yield curve.
Here is the play:
Buy the QQQQ January 2008 $40 Put Leaps (WD MN) – the current price is $1.45. And, at the same time buy the QQQQ January 2008 $48 Leap calls (YWZ AV) – the current price is $2.70.
Good investing,
Karim Rahemtulla
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Current Portfolio:
Company / Symbol: Microsoft (Nasdaq: MSFT)
Option / Symbol: Jan. 08 $30 call (WMF AF)
Date Purchased: 8/8/05
Current Price: $2.90
Comment: Hold.
Company / Symbol: S&P 500 MITT (AMEX: MCP)
Date Purchased: 7/18/03
Current Price: $12.41
Comment: Hold.
Company / Symbol: Chesapeake Energy (NYSE: CHK)
Option / Symbol: Jan. 08 $35 call (WZY AG)
Date Purchased: 4/25/06
Current Price: $3.60
Comment: Hold.
Company / Symbol: AMD Micro Devices (NYSE: AMD)
Option / Symbol: January 2009 $35 call (VVV AG)
Date Purchased: 6/21/06
Current Price: $2.50
Comment: Hold.
Bull & Bear Spreads
Company / Symbol: CBOE Volatility Index (WCB: ^VIX)
Option / Symbol: Feb. 07 $15.00 call (VIX BC)
Date Purchased: 5/3/06
Current Price: $1.00
Comment: Hold
Company / Symbol: CBOE Volatility Index (WCB: ^VIX)
Option / Symbol: Feb. 07 $17.50 call (VIX BW)
Date Purchased: 6/14/06
Current Price: $0.60
Comment: Hold. Sold call against Feb. 07 $15 position.
Company / Symbol: GoldCorp (NYSE: GG)
Option / Symbol: Jan. 09 $30 call (OPJ AF)
Date Purchased: 6/9/06
Current Price: $6.50
Comment: Hold.
Company / Symbol: GoldCorp (NYSE: GG)
Option / Symbol: Jan. 09 $40 call (OPJ AH)
Date Purchased: 6/9/06
Current Price: $4.00
Comment: Hold. Sold call against January 09 $30 position.
Company / Symbol: Teva Pharmaceutical (Nasdaq: TEVA)
Option / Symbol: Jan. 08 $40 call (WTX AH)
Date Purchased: 5/23/06
Current Price: $1.55
Comment: Hold.
Company / Symbol: Teva Pharmaceutical (Nasdaq: TEVA)
Option / Symbol: Jan. 08 $45 call (WTX AI)
Date Purchased: 5/23/06
Current Price: $0.80
Comment: Hold. Sold call against January 08 $40 position.
Company / Symbol: Energy Select Sector SPDR (AMEX: XLE)
Option / Symbol: Jan. 07 $39 put (XLE MM)
Date Purchased: 3/1/05
Current Price: $0.10
Comment: Hold.
Company / Symbol: Energy Select Sector SPDR (AMEX: XLE)
Option / Symbol: Sell Jan. 07 $37 put (XLE MK)
Date Sold: 3/30/05
Current Price: $0.10
Comment: Hold. Sold put against January 07 $39 position.
