Everything that was hot, all of a sudden is not.
For the past nine trading days, we’ve seen a rapid return of the kind of fear we experienced last fall. The carry-trade currencies (dollars and yen) and Treasuries have appreciated against everything else: stocks, the former bubble currencies (GBP, EUR, JPY, CAD, AUD, etc) gold, oil, grains and metals.
Today’s action was particularly convincing because of the breadth and extension of the equity sell-off, coincident with the VIX cracking 50, gold nearing 800 (a one-month low), and the 30-year Treasury yield pushing strongly back down to 2.9%. This across the board unwinding and preference for senior currencies and Treasuries is exactly what wave 3 of the crash looked like from September to November.
That’s all, folks.
I think we have seen all the bounce (Elliott wave 4) we are going to get off of the November 21 lows (Dow 7392). Too many bulls and bears alike were expecting a repeat of the November 1929 to April 1930 post-crash rally. Perhaps that rally was more powerful because it corrected a more oversold short-term condition, a 48% drop in 10 weeks that came right off the very peak of the preceding bull market. Animal spirits were still strong that winter, while the memories of rebounds and new highs were still fresh in traders’ minds. This time around, our rally only needed to correct a 35% drop over three months (Dow ~11,500 in August to Dow 7400 by Thanksgiving), while the underlying economic situation and social mood were in a more advanced stage of depression (at least a year into the economic contraction and two years into the housing bust).
The weakness of this post-crash rally is also another indication that we are in a larger degree decline than the depression of the ’30s, indeed a Greater Depression, as befits the aftermath of the largest credit bubble in all of history.
Targets and strategy.
At any rate, this plunge looks ready to take us much lower, probably well below 7000 on the Dow. I also hope that oil gets dragged to $25 and gold to near $600, where I will be a buyer of each for the multi-month corrective rally that should follow, prior to yet lower lows in equities (Dow 3000?) and mood.
I’m still holding many of my REIT, S&P 500, and miscellaneous stock puts from before the crash, and I intend to sell into the plunge just like the last time. If we bounce from here in the next few days, I’ll perhaps pick up some near-term puts for some extra oomph.
A bleak, bleak year ahead.
2009 will be the first time that it feels like a Depression to most people. Only about three million jobs were lost in 2008, and the crash came at the end, so most people have still been in denial about the severity of this event, or have yet to lose their faith in the Fed or the change in the White House. As stocks sink through their 2002 lows, house prices drop even faster, entire malls start to close, and huge waves of layoffs begin, the social mood will get dark and increasingly volatile.
Are you currently holding LEAPS on the indices you mentioned? Also, would you mind recommending an options book for the novice?
BTW, the lucidity and the clairvoyance of your writings are amazing.
Let me second Vic here. I was hoping for S&P 1000 to get short again but your “surprise resumption of the equity crash” call, and the absurdly low put/call ratio in Hochberg’s analysis, convinced me I might not get the chance, so I got in around 900 instead. Thanks for helping us read the tea leaves.
Hi guys. Glad I can help. This has been a tricky market for everyone.
Vic, I wish I could point you towards such an option book, but I´m really no pro there. I don´t even know what any of the Greeks mean. I just try to buy puts when the VIX is low and sell when it´s high. I almost never hit the bid, either, but use limit orders, though that sometimes costs me in a straight line move, as on monday when I missed some march SPY puts because I tried to save a few nickels. Those are 50% higher now.
When evaluating options, I typically just look at how much I think they could be in the money upon expiration. Any volitility premium that I get upon sale is just a bonus. When I am more confident, I buy further out of the money options, when more consevative, maybe in the money ones.
Ok, back to German class…
“Option Volatility and Pricing” by Natenburg is a good intro and considered the Bible among traders, but the second half or 2/3 of it are probably too technical if you’re not trying to actually trade the greeks. The approach Mike described is a good one for speculating and making directional bets using options. However, reading up a bit is always a good idea and Natenburg will help you understand how you can expect the value of your positions to change over time, as well as strategies like spreads that can allow you to put on trades with a little less risk.
One thing I might add to what Mike says is that, for PUTs, as you approach expiration, if you’ve had a big move in your favor, you should reevaluate your position and see what your maximum potential upside is. For instance, when LEH went bankrupt I held some 5-strike puts that were worth 4.75, and I concluded there wasn’t much point in hanging around for that extra little bit of profit, given the risk that some intervention or something could cause a brief relief rally in the share price. So, always be considering whether exiting the position early makes sense, given where you think the share price is going and when.
Thanks for the book recommendation. I really should read up. Options just started as a cheap hedge for me back in 2006, when I wasn’t comfortable putting more than 1k into each position, but they have gradually become the cornerstone of my trading. I don’t know if they will always be, since there will come a day to just buy common stocks, but they are good way to play a bear market, since it is fast and highly emotional.
Graphite makes a good point: you should always keep an eye on the risk/reward balance, no matter how far you are from expiration. An old saw says that if you wouldn’t buy a position you own at its current price, sell it. I usually sell well in advance of expiry, and am too conservative about this if anything (I even closed a small number of positions today).
Also, the time decay gets faster as expiry approaches. Another way of thinking about it is that time is cheaper when you buy in bulk, and you also get credit for the leftover time when you sell.
I sold a lot of my 2010 puts last October and November, fully believing that we had not seen even the intermediate-term lows yet, because I was expecting a bounce. Trading in and out of distant expiry options is a levered way to play the market that doesn’t require debt.
Mike/Graphite:
Thanks for the suggestions. Looks like the market is very choppy right now, can’t get a clear read on it. The .VIX is heading down today, so panic is receding. We might get an Obama bounce after all.
Well yesterday was a huge up day for the VIX, so it makes sense for it to come off today a bit. I haven’t had a chance to look at today’s internals, that will be more interesting to me in trying to read any near-term trends. At any rate, days like yesterday and today scream volatility, uncertainty, and lack of liquidity, more than any resurgence of confidence, IMO. But as always, The Market Is Always Right, and the near-term trend could certainly turn higher for quite awhile.
It’s interesting, this insider buying going on in the big banks. Makes me wonder what kind of evil new skimming of the public treasury they’ve got lined up next.
Anyway, bailout- and Obama-driven bounces are long-term selling opportunities.
Today’s bounce didn’t break out of the trendline you could draw across the tops of the last 2 bounces. Each has been lower than the last, with lower lows.
Yesterday was only the 2nd close under 8k on the Dow in this bear market, and this morning I saw a few of my shorts make new lows, so I still think bounces are to be sold.
I’m hanging onto a few March SPY puts along with the rest of my long-dated stuff.
That said, I should say that I do have a bunch of above market limit orders in to sell various put positions that I have held since before the crash. A few have already executed the last couple of days. I am going to bail out of all shorts in this leg down. I won’t try to pick a bottom, but will sell into the decline, just like October and November, but unlike then, at the end of this decline I don’t want to have anything on the short side, not even 2011 puts.
I’ll then sit in cash and wait for the ensuing bounce to play out, which could take several months or even a year if we go under 6k. I figure the deeper the crash, the longer the correction.
One more thing… I would not be surprised if this bounce went on for a few more days, since we’ve had a very long and steady run down from the highs that needs to be corrected. Today’s bounce was powerful, but we are still talking about 1200 Dow points in 2 weeks. So I wouldn’t go aggressively short-term short (and would definitely avoid inverse ETFs!) unless we go up a few hundred more points.
I really should write a post today, but it is getting late and I have to be up early so I am just writing comments.
One other thing is that the 30 year bond is setting up to be a buy. If it falls a bit further and the stock rally looks played out, I may look to go long again, probably via TLT.
Currency-wise, it is interesting to see the dollar rally while stocks rise, but I’m still holding dollars so I don’t mind. I’m waiting for my chance to buy Francs at under 80 cents (along with cheap gold).
Looks like things are deteriorating at a rapid pace. GBP crashing, long bond crashing, PMs up, equities slightly down. Is the bond bubble crash or just a headfake? There are too many bond bears out there, to me, this does look like a headfake.
The news out of UK is truly scary though. The balance sheet of RBS is bigger than the GDP of Britain!