ECONOMIC REPORTS
MONDAY 12/29
None
TUESDAY 12/30
None
WEDNESDAY 12/31
None
THURSDAY 1/1
None
FRIDAY 1/2
ISM Index
EARNINGS OF NOTE
MONDAY 12/29
CALM
TUESDAY 12/30
None
WEDNESDAY 12/31
None
THURSDAY 1/1
None
FRIDAY 1/2
None
TOOLS OF THE TRADE
THE SYNTHETIC LONG PUT
The inverse of the married put, which was covered last week, is the synthetic long put. The position comprises two trading instruments, 1) short stock and 2) a long call. As you may recall from our discussion of short stock, the trader borrows stock from his/her broker and sells those shares into the market hoping that the share value will decrease. When and if that happens, the trader will buy back (cover) the shares and return them to the broker and in the process will register a profitable trade. As we know from our prior understanding of the short stock position, it is accompanied by substantial risk in that the stock has unlimited upside potential which represents the risk in the position. In order to mitigate that risk, the trader can merely add a long call ‘at the money’ and hedge the upside risk. The resulting position is the synthetic equivalent to that of the long put.
Review the risk graph and you will gain an understanding of the risk and reward of the position. Best, Robin
27
Dec
COMMENTARY
It has been a long and for many, very tough year in the stock market. However, for some traders, this has been a very profitable year, It is my sense that most investors are only “long the market” and view their hedge against a downturn as diversification and allocating funds to “defensive stocks”. Although this strategy can help offset some of the loss, when experiencing the melt down that occurred in 2008, the market does not discriminate as to which stocks it chooses to crush. The market just hammers everything.
It is my experience that most traders are not comfortable “shorting” the market. When a trader chooses not to take advantage of a market trend such as we have just experienced, it limits that traders’ ability to optimize the returns available. There is an old saying in the stock market “The market goes up like an escalator and down like an elevator.” That is so true. Money can be made more rapidly in bear markets as opposed to bull markets. It is not only prudent but smart to take what the market gives you. The market is going to do what it wants to do. Why not just follow it. The street is littered with those traders who have been trying to pick a bottom. It is not necessary to pick the bottom in order to be profitable. In the meantime, had you just remained with the trend, you would have profited handsomely. There are several ways to play the market short. 1) Short stock 2) Inverse ETFs 3) Options. My suggestion is that you become familiar and comfortable with playing the market in all directions so that you can be consistently profitable regardless of the market conditions.
If you are interested in learning how to do that, I would encourage you to take the free lessons at www.marketamer.com. Make it a happy and prosperous new year. Robin
21
Dec
Danger + Opportunity
As 2007 drew to a close, I wrote an article for www.StockandOptionTrades.com projecting 2008 would be a very difficult year to trade due to ‘unprecedented volatility’. As 2008 draws to a close it looks like the prediction was realized but pleasure does not necessarily accompany vindication. As John Maynard Keynes wrote:
“It is usually better to be conventionally wrong than unconventionally right“
In short, when you are right about bad news, little benefit is experienced because so many will have suffered whereas being wrong with the crowd means comfort in numbers.
As I watched CNBC’s Year in Review last night I was struck by how many times the commentators noted that nobody could have foreseen the carnage. In fact, many were anticipating a recovery in the middle of the year including Hank Paulson! When history judges such projections unfavorably, credibility quickly diminishes. And in the financial industry, credibility is more important than almost any other criterion. With the credibility of so many in tatters, the onus is on you the individual to acquire the financial knowledge necessary to protect your own portfolio and to anticipate the future based on facts rather than on opinions.
For example, if we were to evaluate the current economic situation with that of the 1930s we might find interesting comparisons that would lead us to be concerned about the future. For example, the 1930s manufacturing based economy has largely been replaced by a services economy, home owners have been replaced by home borrowers, a national surplus has been replaced by a national deficit, and a reliance on saving has been replaced by a reliance on credit. Counter arguments could be made such as the US, unlike many countries which have experienced economic turmoil, has a substantial capability to be self-sufficient, university education is world class, and an indomitable spirit of optimism pervades the culture.
This same spirit can be the catalyst to success in spite of the perils that may lie ahead. It is well known that in Chinese the word crisis is written as a composition of symbols representing ‘danger’ and ‘opportunity’. But preparation is a pre-requisite to taking advantage of opportunity. So, although the danger may be high, opportunities will present for those who are prepared. And to truly be prepared one must have the knowledge necessary to succeed. The entire faculty of traders at Stock and Options Training are still in the black in ‘08. And frankly we’re feeling a little guilty that we’re in the minority. But it doesn’t have to remain that way.
Simply enter the code rht-50 after clicking this link
and you’ll enjoy a substantial discount on the complete system we have relied upon to thrive in this market. 100% of what you need to succeed for less than $100 with 100% satisfaction guaranteed.
Little John
The DOW began the week pushing the Index down a mere 65 points on continuing news on the Madoff Ponzi scheme. No resolution yet on the automakers.
Tuesday, the DOW rallied big time to post a 360 point gain as the Fed lowered the Fed Funds Rate to unprecedented levels of between 0-.25%. It became apparent that the FED is prepared to do all that is necessary to stem the tide of economic disaster.
Wednesday, AAPL announce that Steve Jobs would not be addressing the crowd at MacWorld. The announcement fueled speculation that his health is an issue. MS reported poorer numbers than expected and OPEC cut oil production as the DOW closed down 100 points.
Thursday, the DOW shed 219 points as Leading Economic Indicators registered their weakest numbers since 1991. The Philly Fed and the Labor Departments’ reports contributed to the poor showing in the market.
We closed out the week with options expiration and a White House announcement that 13.4 billion will be extended to the automakers from the TARP with another 4 billion available in February. The DOW closed down 26 points.
Week over week, the market was mixed. The DOW was off by 51 with the SPX gaining 8 and the COMPQ up 23.
Go here to learn how to make money in any market condition.
-We continue to trade in a channel. Volatility is reducing as evidenced by the VIX closing at 44.93. Watch the critical areas of support and resistance and how the market reacts to those levels. I will keep you updated midweek if I see anything of significance.
-See INDU comments.
-See INDU comments.
TOOLS OF THE TRADE
THE MARRIED PUT
The ‘Married Put’ sometimes characterized as the ‘Protective Put’ is a combination strategy that comprises two trading instruments. 1) long stock and 2) the long put. The position is the synthetic equivalent to the ‘Long Call’. In fact, you will notice that the risk graph of the ‘Married Put’ is identical to the ‘Long Call’.
The risk in the trade is equal to the cost of the put and the difference between the stock value and the put strike price. Example- XYZ stock trading at $26.25 with a 25 strike put costing $1.75. The risk in the position is $3.00. ($26.25 stock minus the 25 strike put = $1.25 plus the put cost of $1.75 = $3.00.) In effect, the trader could purchase a long call at a value of $3.00 or less with the expectation of the stock rising and establishing a position that carries a risk/reward that is equivalent to a married put. The risk control in the long call is that the trader is limited to losing only the cost of the long call which is in this example limited to $3.00 or less.
The advantage of the ‘Married Put’ is that stock does not come with an expiration date and if the stock pays a dividend, it can create and additional income. On the other hand, the long call allows the trader to leverage the position because the trader can control shares of stock for less money.
The ‘Married Put’ strategy is a wonderful way to protect the downside risk and reduce the cost basis of the stock when and if the stock should fall. In a way, one could view the ‘Married Put’ as portfolio insurance. If the stock falls for any number of reasons, the trader is guaranteed to be able to sell shares at the long put strike price for as long a period of time as the long put is in effect.
Study the risk graph of the ‘Married Put’ and you will gain insight into the risk/reward of the position. Happy Holidays!! Best, Robin
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