SURVIVING THE GAME
DECEMBER 16, 2008
2008 - 24

TRADES:

DIA DEC 84 straddle came close to hitting exit point today. Futures show a lower open tomorrow but we’ll see what happens. Keep stop at $600 or $90.00 on the DIA. High today was $89.75.

DIA JAN 86 straddle doing fine. Closed at $955. Sold for $1275 on Dec 2nd. Stops at 7000 and 10200 on DOW. Watching the 72-74 puts and 100-102 calls to buy as insurance. Buy either at $40 or lower.

Encana butterfly at $415, up from entry point of $355. Hold, no stops.

UDN calls doing really well. $US is collapsing. The UDN APR 25 calls closed at $235. Bought at $80. Half of position sold at $200, no stop on second half. We’ll see how far down $US goes.

NEW TRADES:

Sell 20 each DIA FEB 90 calls and puts. Closed today at $1320-1385. Should net approx $1350 per straddle. Exit points are at 7300 and 10700 on DOW. These options expire Feb 20th, 9 weeks from now. Will look to purchase OTM ( out of the money ) calls and puts to cover these short options when prices come down.

Volatility continues to drop slowly. VIX closed today at 52.37. I have to stress that this is still a HUGE reading, therefore driving up the option prices. Another jolt down would drive the VIX up again. I believe we have seen the highs near 90 on the VIX and may never see them again. If we collapse ( down more than 300 points ) tomorrow, hold off on sale of DIA FEB 90 straddle until next newsletter.

Buy 20 DIA MAR 90 calls, sell 40 DIA MAR 100 calls, buy 20 DIA MAR 110 calls. This is a butterfly, just like in ECA. This will cost between $200 and $250 per position. Why? This is to capture a rally over the next 3 months. A rally that does not exceed 11000 on the DOW. Reward:risk is 4 or 5:1 depending on fills. I am far from convinced that all is well but the market seems to have bottomed. The fed is determined to push the market up so we might as well jump on board. Risk is limited to total premium paid of $4000-$5000. Execute this trade no matter what happens tomorrow. Volatility does not affect this type of trade as much as other option trades.

MARKET COMMENTRY:

I have spent the last 3 months watching in awe as history unfolds in front of my eyes. Understand that we are in uncharted territory and books will be written for 50 years about the events of 2008. So, if your feeling a little overwhelmed by what has happen, join the club. I am simply trying my best to navigate through these difficult times. I have chosen to trade, very conservatively, instead of sitting on the sidelines and watching. I feel that the opportunities presented, especially from high volatility, justify the risk under these conditions.

You may have noticed that we now have exclusively option positions. I would really like to start putting on some “ normal “ long equity, short call positions but frankly I’m not convinced the bottom has come and gone. If I had to bet I would say yes, the bottom is in, but I’m not sure enough to take on a lot of risk yet. So, I’ll stick to lower risk options trades and see what the next 3 months brings us. Risk is always my first priority, profit second.

Ben Bernanke has been upgraded from Helicopter Ben to Carpet Bomber Ben. In case you haven’t heard the story, here it is. In a speech Bernake once made reference to dropping bales of cash from helicopters if that was what it took to stimulate an economy. Well, he certainly has done that and more, hence the upgrade to Carpet Bomber Ben. The action today and more precisely the wording of their future intentions left no doubt as to where the Fed stands. They will do whatever it takes and spend however much it takes to right the ship. Period. No wishy washy statements today. The question is, will it work and what are the ramifications of TRILLIONS of dollars of either debt or printed money?

JOBS:

You can lower interest rates to zero and it will eventually help business to expand and hire. But, it does nothing for the unemployed. They have no money to spend and are unlikely, or unable, to borrow to spend with no job. So, lower interest rates and easier credit do nothing for the current and future unemployed. It will however lead to more employment in the future. My guess is 12-18 months at least before it helps.

HOUSING:

I believe the real problem is still housing. Again, lower rates are great IF you can take advantage of them. You have to be in a position to qualify to re-finance for lower rates to help you. Most Americans do not. Even if they have equity, their credit scores are too low to qualify, especially with tighter requirements. Also, millions of homeowners are underwater on their mortgages ( owe more than the house is worth ). Lower rates will help these people only if somehow they can be convinced to stay in their houses instead of walking away and turning in the keys. Those of us who live in Calgary saw this happen here in early 80’s. It took 15 years for Calgary real estate to recover. No matter the rate, many will give up their houses instead of re-finance. The sub-prime mortgages helped trigger this disaster, but there is more to come. There were approx $1 trillion in sub-prime mortgages and we all know what has happened with those. But, there are $1.6 trillion in Alt-A and adjustable ARM mortgages. These were written from 2005 to 2007. They will start to hit the market in 2009. These were the interest only or extremely low introductory rate mortgages. Some as low as 1%. They are set to re-adjust to market rates starting next year. Most of these loans were to speculators or people who would not normally be able to afford the house they bought. Many of these were the famous NINJA loans ( no income, no job, no assets for the borrower ). They were also called “ liar loans “. Everything was peachy, assuming house prices continued to climb, but, they have not. I believe these mortgages are the next shoe to drop on the credit markets. The US is currently building homes at the same rate as 1959 but there is a huge overhang of existing homes and lots of supply ( foreclosures ) coming soon.

Credit card and auto loans:

Same situation as the mortgages. Lower rates will NOT trickle down to most of these loans. The big banks have HUGE exposure to credit card debt. As unemployment rises, so do defaults for both of these type of debts.

Consumer Confidence:

At the lowest level since the 1930’s. Obviously doesn’t bode well for stimulating the economy. As one commentator said, “ the consumer has seen $4 per gallon gas, realized that they cannot exist in that environment, and is afraid of going back “. Will we see a sudden shift in the US from a consumption driven economy to a saving ( or debt reduction ) society? That would spell disaster for the US economy measured in decades, not months. Early signs are that the consumer is holding back, despite efforts to stimulate spending. Watching the value of your house drop by 30-60% doesn’t help boost confidence much either.


Inflation or deflation?

The consumer is showing signs of retreat, maybe even a permanent shift in spending mentality. Will this lead to deflation or will the massive liquidity injected by the government lead to inflation? I wish I knew. The fear has always been of runaway inflation. That was easy to see, easy to measure and easy to fight. Raise rates, stomp down inflation. But nobody would ever admit that a little inflation was actually good, kept thing rolling along. I think stagflation is off the table for now. The boogeyman is deflation. Cash is king in a deflationary cycle and very few people have cash. Most have debt. If your assets are falling, your wages start to fall and you owe a substantial amount, you’re a dead duck. Bankruptcy is next on your agenda. We have seen home prices and commodity prices collapse but other than fuel, no significant drop in other prices. The fed may have avoided a nasty deflationary spiral but the potential still exists to head down that path. It all rests on the consumer, will they spend or will fear keep them out of the game. Time will reveal the answer.

As the above commentary outlines, the future is far from certain. I maintain that we will see sideways market action for an extended period. Things look good for a bounce from now into the post-inauguration period, then POW, reality will set in once again. I will continue to do my best to try and extract gains from this extraordinary market.

Options Guy
Editor
Surviving The Game
optionsguy@shaw.ca