Saturday Thoughts

The Dow is sitting right at the 8000 support level. If it ends up below that on Monday it might fall back to the panic numbers of 11/20/08. It ended up around 7500 on that day.

This is a tough market to collect option premium in as we're always looking over our shoulders at a potential crash. As option sellers we win if the stock goes up a lot, goes up a little, stays the same or goes down a little but we run into trouble when the price goes down a lot. The slow bleed in stock prices we're experiencing is having trouble keeping up with the time decay which is working in our favor.

I believe there are ways to maintain profits in this environment but we can't just keep on trading as if it's business as usual. I think this market needs to be played as follows:

1) Don't hold any long positions that you can't write covered calls on. I have sold most odd lots and liquidated long positions that don't provide the opportunity to bring in monthly income.

2) Write new covered calls deep in the money and new naked or covered puts way out of the money. This strategy provides more downside protection.

3) Buy protective index puts. Jeffrey Cohen, the author of "Put Options," recommends using 20-25% of option premium received to buy out of the money index puts in the index(es) where most of your positions reside. By the way I highly recommend this book and it is 1st on my list of recommended books.

4) Unless the trade amounts to practically leaving money on the table then hold onto your cash. After the bear is finished ravaging this market the cash rich will be able to clean up.

5) Diversify amongst sectors. I don't do this as well as I should but I do see the merits of the strategy.

6) Don't allocate too much capital to a single position.

7) Set stops. Day traders, swing traders and the like need tight stops. Option sellers not so much. We have the benefit of time decay and downside protection. It is still important to have an exit strategy and know when it's time to bail. For me personally I won't bail until the downside protection is breached including what I can get for the next month's covered call.

In summary: Capital preservation is paramount. There are steps that can be taken to protect ourselves from being torn apart by the bear. In fact, if executed properly there are still handsome profits to be made by the option seller. Now is not the time to take substantial risk or leave one's portfolio unprotected.

Trade Entered: PG Proctor & Gamble

Today I sold PG April 47.5 puts for .90 ($90) each in a taxable, margin account. At the time of the trade PG was trading at $55.56 down $2.65 or 4.5% on the day. The Dow was down 120 points to 8029 which is near the 8000 support level.

The maintenance requirement this far out of the money was $550 per contract. Return on margin (ROM) is 16.36% (90/550) for 77 days or 77.55% annual. If the stock is put to me my cost basis will be $46.90 ($47.50 minus .90 premium received).

Today's sell off in PG is related to the quarterly report which I read as being within expectations albeit lower ones due to this crazy economy. My experience with blue chips is that after the initial sell off in response to a quarterly report that just meets expectations that the stock either drifts sideways or creeps back up. I need to admit that my experience has never included an economic crisis like this one but that is why I've written the puts so far out of the money.

Stalking the Market

Well, stalking might be a little too aggressive and confident but I love these fearful, down days with bad news like today's GDP numbers. Are these poor numbers surprising? When fear abounds I look to write some out of the money puts. During these uncertain times way out of the money puts have a very nice return on margin. The premiums are inflated by speculators and hedgers and the maintenance requirements are very low when you write a few strikes out of the money.

I'm looking closely at PG. Their quarterly report and guidance are within expected ranges yet the stock has taken a small tumble. Well I need to get back to it to see what other setups look nice today. Happy hunting.

Trade Entered: SLX Market Vectors Steel ETF

Today in the last hour of trading I sold SLX March 24 puts for $1.10 ($110) per contract. At the time of the trade the Dow was down 168 to 8205 and SLX was down 4.64% to 29.59. Down days get my attention as I believe they are best for writing naked puts. If put to me the cost basis for this ETF will be $22.90.

The maintenance requirement was only $335 per contract since these puts were several strikes out of the money. The return on margin (ROM) if these expire worthless is 32.8% (110/335) or 239.44% annual. There is 50 days until options expiration.

After my post yesterday which inquired whether this was the time to get back into steel stocks, I examined the setups more closely and concluded that it was. I think we are near a bottom in steel and if I'm wrong there is significant downside protection with this trade. The Obama stimulus combined with Chinese and other stimulus may signal an end to the perfect storm that steel has weathered.

Time to start trading steel stocks again?

In the past I've enjoyed trading options on steel stocks. My favorites have been the standards: U.S. Steel (X), Nucor (NUE) and the steel ETF (SLX). During the commodities boom it was hard to lose money trading these issues.

I haven't traded them for several months due to the crash in the construction and auto industries which are the drivers of the steel industry. Steel stocks have been beaten into the ground. They have started to make a nice comeback of late, however, which I attribute to the stock market usually being 6 months ahead of the recovery curve. Stated another way; the market is a forward looking creature.

When demand for commodities craters, the suppliers follow suit and make less of the commodity. That has happened and is happening with steel and that is what drives the cyclical nature of commodities. Have we reached a bottom in the steel industry? This interview suggests that we have: http://tinyurl.com/atuxwv.

I'm not jumping in with both feet but my eyes are open. When things were good with steel they were very, very good. If this is a bottom, steel stocks will be great to trade once again. They have nice dividend yields and juicy option premiums. Please do your own due diligence.

Trade Entered: GE General Electric

Today in a taxable account I sold GE Feb 11 puts for .43 ($43) each. GE was trading at 13 at the time and the Dow was about even. If put to me my cost basis will be $10.57 and the yield will be 11.7%. The margin requirement was only $224.50 per contract so the return on margin (ROM) if these expire worthless is 19.15% for 24 days or 291.24% annual.

I understand that GE has been beaten up badly and has exposure to commercial real estate and British residential real estate. I further understand that it is a 50% financial company. It is showing strength lately and this trade supports my opinion that GE is at or near a bottom. I don't think they will lose their AAA credit rating or cut their dividend in the next 24 days. [Note: I could be wrong about AAA rating: see http://tinyurl.com/aajh93 .]

Thanks go out to reader TrackingCR who pointed out this trade which I wasn't considering at the time. The discourse on this site is getting better and is much appreciated.

Trade Entered: ERX 3X Energy Bull

Today in my wife's IRA I entered into another ERX trade. Pretty soon I'm going to have to join an ERX 12 step program. I just can't stop myself from hitting this one over and over.

We bought ERX at $38.22 and immediately sold the February 35 call for $6.40. We have downside protection to $31.82 and if called away we earn 9.9% for 25 days work or 144.54% annual.

At the time of the trade the Dow was up 116 points to ~8200 and oil was up $1.13 to $47.60. As of the time of this writing the Dow, oil and ERX have pulled back a little but since we wrote deep in the money I'm not concerned.

I'm prowling around looking to write some puts today. I like the pullback in Caterpillar (CAT). I've also looked closely at EWZ the Brazil ETF. NLY the mortgage REIT that only invests in Freddie and Fannie backed loans and that yields a juicy 13% dividend looks interesting as well. Oh yeah, and there's always more ERX trades to do! Let's see what the last hour of trading presents to us...

Cara's Week in Review

I rarely miss one of Bill Cara's daily or weekly reports. This week's weekly report is especially good http://tinyurl.com/dmfdbe. Traders need to understand how all the moving parts work and how they effect each other. Bill is kind enough to share his insights and the price is right...free.

Bill is bullish but nimble. He trades prices. Amen. His opinions on gold and other commodities are usually spot on. I highly recommend you add him to your reading list.

If you like him you can buy his book. It's the second book on my recommended list and it's called Lessons from the Trader Wizard.

Trade Entered: ERX 3X Energy Bull

I just can't stop trading this issue. This time in a Roth IRA I purchased ERX at $33.99 and immediately wrote the February 35 covered call for $4.60. The cost basis has been lowered to $29.39. The return if exercised is 19.09% and the return if unchanged is 15.65%. There is 28 days until options expiration.

At the time of the trade the Dow was down around 100 points to ~8000. Oil was down over a buck to $42.50. I am seeing support for the Dow at 8000 and for ERX at 30 so I feel pretty good about the safety of this trade.

In the event this issue were to tank I'll be watching very closely what I could get for the March calls. I suspect I could lower the cost basis another $5 or so next month. I'm not going to lie. I love those numbers.

Poll Result; High Price for Oil in '09

The poll asked what the readers thought the high for oil would be this year. With 150 people responding the results break down as follows: 12% thought that oil wouldn't break $50/barrel this year. 58% thought the high for oil would be between $51 and $75 per barrel. 20% opined that the high would be between $76 and $99 per barrel. Only 8% thought we'd see $100 or higher oil in 2009.

I personally believe that the first two categories are going to prove correct. With the global recession and inventory buildup it's possible we won't see higher than $50/barrel oil this year but I tend to believe we'll reach somewhere around $60.

As I've stated I do believe we are somewhere near a bottom in oil but expect more sideways action than anything with neither the bulls nor the bears able to deliver the knockout punch. That's fine for writing options on ETF's such as OIH, XLE and my pet ERX because so long as the battle rages and strong opinions abound, option premiums will remain high. Speculators need someone to sell them options and I'm an eager participant.

Reading and Thinking

Reading, thinking...reading, thinking. So it goes looking for trades.

Lockheed-Martin (LMT) didn't drop like I had hoped after it reported pension losses. I guess everyone knows that they pass these expenses on to the government. General Dynamics (GD) and Raytheon (RTN) are down today and they report soon so hopefully one of them will drop on pension concerns so I can write some out of the money puts.

Some are bottom feeding on the financials and they may be right. I've learned that no matter how low a stock goes it can still go lower. I may be missing out but there are quite a few other choices; thousands actually. I'm reminded of Buffett's 3 rules of investing: 1) Don't lose money; 2 &3) follow rule number 1. That being said I kind of like NLY which pays out a 13% dividend and the near month, just out of the money covered calls pay out over 5%. It's a mortgage REIT that is indirectly backed by the government through Freddie and Fannie, which are the only loans they deal with. Due diligence is called for as always.

TBT, the ultra short Treasury ETF is taking off. It was a "Trade Idea" not too long ago on this site but I never pulled the trigger. It's just getting started in my opinion so there's still time to get in. I'm looking at writing covered calls on it in Roth IRA's and writing naked puts on it in taxable margin accounts. Treasury yields should revert to the mean. On the other hand, scared money could still run to treasuries although corporate bonds are a nice alternative.

Gold and oil still look like the place to be to me. I trade them a lot and would fail miserably on Cramer's "Are you diversified?" but I stick to what I understand and follow. In my opinion gold is in a long term bull market and oil is somewhere around the bottom. The gold and oil ETF's have some juicy option premiums and with ETF's you don't have to worry about one stock crapping out on you.

Happy hunting.

Trade Entered: ERX 3X Energy Bull

Yesterday at the very end of a terrible day for the market I purchased ERX for $30.18 in my Roth IRA. It was so close to the end of the day I couldn't sell a covered call on the position. This is not something I normally like to do because then the trade is more of a speculation than an investment. I was lucky, however, as the market and ERX were up at open.

I sold the February 30 call for $6.00. This gives me downside protection to $24.18. The return if exercised is 24.07% for 31 days or 283.4% annual. ERX provides nice option premiums but in this case they are inflated because the issue jumped up in between the time I bought it and wrote on it.

Trade Entered: Johnson & Johnson JNJ

Today I sold multiple Johnson & Johnson (JNJ) April 50 puts for $1.15 ($115) per contract in a managed account. The stock was trading at $57.70, up .26 on the day and the Dow was down 175 points. The stock was showing strength after a nice quarterly report, swimming against the current of a down day in the market.

The margin requirement is $837 per contract. If these puts expire worthless the return on margin will be 13.7% (115/837) after 87 days or 57.47% annual. If put to us our cost basis will be below 49 and the stock will be yielding 3.7% and rising. We would start writing covered calls against the position assuming we didn't roll or close the position first.

This way out of the money trade is consistent with our defensive posture while the market is sorting through the strife in the financials. JNJ, a health care stalwart, in and of itself is a defensive purchase in such an environment. That's two defenses for the price of one. Time for our friend Mr. Time Decay to get off his butt and get to work.

New month but not much writing...yet

Today is Barack's big day and the markets are down. Bank woes trump the Obama bounce I guess. I've got a lot of positions that I want to write new covered calls on but patience is in order as I expect a rally sometime this week.

I have written some way out of the money covered calls on some GLD positions in managed accounts. Who says you can't earn income on precious metals ETF's? A lot of traders are waiting for the gold moonshot and are paying nicely to speculate in that regard. You can get over a hundred bucks per contract on the January 92's.

This blog was initiated the day after Thanksgiving and it was decided to only post trades initiated after that date. I do have continuing transactions from prior to Thanksgiving which I'm not actively posting and which I allude to but don't track here. There is just too much history and too many forgotten thought processes to give those trades much educational meaning. Eventually all the old positions will end and everything I'm doing will be posted.

Today might be a good day to enter into some way out of the money put sale transactions. I've got my hunter's garb on and my mouse is my weapon. Better run, corniness abounds.

Trade Results: Gain on SLW and ERX

On 12/24/08 in my Roth IRA I bought Silver Wheaton (SLW) for $5.64 and immediately sold the January 5 calls for $1.00 each. The stock ended up in the money and was called away. This trade returned 7.76% in 24 days or 118% annual.

On 12/29/08 in my Roth IRA I bought ERX the 3X Energy Bull for $35.88 and immediately sold the Jan 35 calls for 4.60 each. The stock ended in the money and was called away. This trade returned 12.98% in 18 days or 263.2% annual.

On 12/15/08 I sold ERX January 30 puts for $3.20 ($320) each. They expired worthless. The margin requirement was $700 for this trade. The return on margin (ROM) was 45.7% for 33 days (320/700) or 505% annual.

Trade Result: Gain on PG puts

Today I bought to close my Jan 57.5 PG puts for .45 each. I sold them on 12/22/08 for 1.30 so this is a net gain of .85 per contract. The margin requirement was $1150 so return on margin (ROM) was 7.4% for 24 days or 112% annual.

I could have sat around the computer today and monitored this one trade to see if they would have expired worthless but I'm not feeling the strength of the rally this morning. All my other put sell trades this month look like they will expire worthless and all my covered calls will be called away as planned. In addition, we have family plans and I want to get to it. These puts were sold in my own account so I am comfortable being cavalier.

I thought about rolling these to the next month for a hefty net deposit of over $2.30 per contract but I'm sticking with my plan to write puts much farther out of the money. The only other action I took today was buying back the majority of the ultra shorts because I don't trust the calculations after an up day in the market.

I'll be out of town with family for a couple of days so you may not hear from me. Good luck in your trading.

Leveraged ETF's - Ultra Shorts v. Protective Puts Resolved

Lately I've been on my soapbox preaching the need to hedge our portfolios from big drops in the market. I've successfully used ultra short ETF's in this regard. Here is an article that is a must read for those of us who are holding on to these things for any length of time http://tinyurl.com/8yssu9.

In a nutshell, don't hold these things. Just trade them short term. The way the returns are calculated you can be right and lose money, a lot of money, over the long term. Their own creators are quoted saying as much.

I first heard about this on the Cara board but didn't believe it be to the extent that this Barron's article exposes. So after a healthy battle the winner of the ultra shorts versus protective puts is the puts. I'll probably be making adjustments to portfolios tomorrow. We're up in the ultras shorts so it's time to take the profits before they're stripped away based upon some mysterious mathematical calculation(s).

Isn't this fun?

All the longs are getting thrashed. I'm even down a few bucks in my Roth IRA where I'm 20% in ultra shorts and 25% in cash. The only good news I see is that market sentiment is so lousy now across the board that it may be a contrary indicator.

I'm hanging in there with my positions. The BAC and FXI trades I could have gotten pummelled on I got out of just in the nick of time. I actually made a couple of chips on the two of them collectively.

I did sell a little bit more long equity positions that weren't a good candidate for covered calls and that money is just sitting in cash. I hate to sell at the bottom but it wasn't much and I felt the need to do something defensive.

These are very interesting times. Hopefully you're holding onto your capital because when the bear is done ravaging the masses there will be once in a lifetime buying opportunities. Good luck, it's a jungle out there.

Hedging Re-revisited

This market brings no joy to the bulls and most of us in our hearts are optimistic in nature. I am certainly not bullish now, however, as my latest posts can attest to. Even with focusing on capital preservation by raising cash and purchasing ultra short positions as hedges all accounts are down today. If I had not taken these actions the bleeding would have been much worse.

I suspect after this carnage is over there will be a relief or bear rally. I will take that opportunity to move more money into cash and perhaps nibble away at a few more ultra short ETF shares. I am also looking forward to that day to write some near the money covered calls on long equity positions. I've been writing way out of the money naked puts and I suspect I will continue doing this on select issues.

Have you checked out the option premiums on the ultra short ETF's? They're very high. I've been thinking about doing something a little nutty like writing covered calls or selling way out of the money naked puts on these. It's just a thought but worth examining closer.

Take care and may your assets not be swept away.

Trade Idea: GD, LMT, RTN

With economic strife comes civil unrest. I believe the global recession (Depression?) will lead to some folks getting downright ornery. As such, I believe we are in and/or going to be in a defence stock bull market.

Issues I like are the standards: General Dynamics, Lockheed-Martin and Raytheon. After their earnings reports I'm going to be looking at selling far out of the money puts. LMT reports 1/22, GD 1/28 and RTN 1/29.

One of the reasons I'm waiting is because I believe they may disappoint this earnings season. It is my understanding that they will have to make up for market declines in their deferred benefit plans. We're talking millions of dollars. That has been a focus of analysts during company conference calls. Once the smoke clears I expect them to rise again as it becomes clear that they just pass these expenses on to the government.

Trade Entered: PG Proctor & Gamble

Today in the last hour of trading I sold multiple April 45 puts in a client account. They were sold for .73 each and if put to the client their cost basis will be $44.27. PG was trading at $59.17 and the Dow was down 62 at the time of the trade.

The margin requirement this far out of the money was only $520 per contract. The return on margin (ROM) is 14% (73/520) for a 94 day holding period.

PG is a stock I closely follow and trade in all accounts. Today's drop in price represents the lowest level I've seen this stock in a while. It isn't a very volatile stock to say the least. There have been 5 straight down days for the Dow and I think that is what is weighing on the stock. I'd be surprised if the Dow is down 6 straight days but in this market who can say.

This is another very conservative trade which is the only kind I'm willing to make right now. I suppose PG could report lower than expected and drop but I think there really needs to be the perfect storm for the client to get hurt on this one. WMT recently disappointed and is now drifting back up as I predicted when I made that trade. If PG disappoints I expect the same and may sell some more puts. In any event, this same client has also purchased some ultra shorts for protection.

More Portfolio Adjustments

The market wasn't awash in red this morning so I took the opportunity to make some more portfolio adjustments. In a client's IRA I sold some odd lots increasing her cash position. For example, if the client held 317 shares and in issue I sold 17 and keep the 300 to write covered calls on. Capital preservation is paramount. I did spend a fraction of the cash by nibbling at a little more ultra short ETF for hedging.

As of now the plan is to maintain a hedged position of between 2-10% depending on the client's appetite for risk and how much of their portfolio contains long positions. In my personal Roth IRA I'm presently 20% hedged with ultra shorts. That's probably too high but I'm also looking at it as a short term trade so the next big drop I will probably take some profits and cut back to the 5-10% range.

Some portfolio adjustments

Today I sold all the odd lot shares in my wife's IRA since I can't write covered calls on them. I allocated 5% of her portfolio to BGZ the 3X Large Cap Bear as a hedge. The rest of the proceeds are sitting in cash. In her account the only trades I'll make are deep in the money covered calls and way out of the money covered puts.

In a couple of client accounts I took some cash and bought some SDS the 2X Ultra Short S&P. I only bought a little right now because I'm looking to add if the market rallies or at least average into the position. Due to the recent market hemorrhaging all client covered calls are out of the money and look like they will expire worthless. I'll sell new calls close to the money next Monday.

It has provided me some comfort to liquidate some non-writable positions, raise some cash and purchase some hedging power. If there is not another big time drop in the markets I will be very surprised. I can't say when it will happen but I'll sleep better in the meantime by preparing for the worst.

Trade Results: Gain on BAC, even on FXI

Two of my puts went into the money so I bought to close the positions. With the help of time decay I made a little on one trade and broke even on the other.

I bought to close my BAC Jan 12.5 puts for .65 each. I sold them on 12/29 for .83 each so this is a 1.44% gain over 13 days or 40% annually. I want nothing to do with financials right now and I'm happy to get out of this trade. BAC is getting killed in residential real estate and commercial is about to hit. As my recent posts indicate my sentiment has dropped considerably lately.

I bought to close my FXI puts for $1.20 which is what I paid for them on 12/22. I'm bullish long term on China but I don't want to fight the tape. This is the first trade that didn't show a gain since I started this blog. I knew the day would come it was just a matter of when.

The only puts I'm interested in writing right now are way out of the money. I'm moving more capital to cash and buying some ultra shorts as hedges.

Hedging Revisited

I came across an article which I agree with and which sets forth why I am hedging the portfolios I am working with: http://tinyurl.com/85nscs. We had some good input in the comments section of the Ultra Short ETF's versus Protective Puts hedging post. I hope we can continue the discourse.

Starting tomorrow I will begin nibbling at some ultra short ETF's in all portfolios I work with. The best time to add to these positions in my opinion are when the market is up but I don't think that will happen tomorrow based upon Asian trading so far. In addition, I may look to close some put writes that are profitable but now near the money such as BAC and FXI.

Future new trades will probably be far out of the money put selling like I did at the end of the week with the WMT and XLE trades. Ideally we will be writing puts while sitting mostly in cash, however, some portfolios have large equity stakes so that is not possible.

New covered calls may not be initiated at all but if so they will be written in the money, possibly deep in the money, with the focus being more on downside protection than return on investment. There are still some great returns to be had when initiating deep in the money covered calls. On currently held equity positions covered calls will be written near the money.

In my opinion, it's time to hunker down. It's a challenging time and preservation of capital is paramount. If we suffer a little on the return on investment side so be it.

Ultra Shorts v. Protective Puts for hedging

I have been doing a lot of thinking lately about which is the best way to hedge a portfolio against a large drop. The choices are ultra short ETF's like SDS, BGZ and DXD versus protective puts bought either on indexes or individual stocks in a portfolio. What percentage of a portfolio should be set aside for hedging? I'm interested in hearing what you think. My hope is that we can start a nice discussion in the comments section of this post. Fire away.

Trade Entered: XLE Energy Select SPDR

In the last half hour of trading today I sold XLE Feb 40 puts for .82 ($82) each in a client account. XLE was trading at 48.70 down over 3% on the day, the Dow was down 127.35 and oil had dropped to around $40 per barrel. There are 42 days until options expiration. If put to us the cost basis will be $39.20 which is about the 52 week low.

This is another conservative trade like the WMT trade yesterday. We are happy to own XLE if put to us at this price although we doubt that it will. If we own XLE at these levels the covered calls we could write would probably be agreeable since the oil bottom pickers would be out in droves.

Return on margin (ROM) is around 17% (82 per contract/476 margin). TD Ameritrade is asking that we maintain $476 per contract. I'm beginning to really like writing these way out of the money puts because they are very conservative and have such nice returns. The returns are high because so little margin is required when written so far out of the money.

Trade Entered: Wal-Mart WMT

This afternoon I sold WMT Mar 40 puts for .71 ($71) each in a client account. WMT was trading at $51.22 at the time of the trade and down 7.75% on the day. The Dow was down 60 points after being down 245 the day before. I like to sell puts on down days and when fear is present.

With the stock trading at $51.22 this was a very conservative trade. That is consistent with the risk appetite of the client. This is a typical play of the wealthy to sell multiple options very far out of the money.

Many investors think that this trade doesn't have a great enough return to be worth their time or money. I would point out that since the puts were written so far out of the money that margin requirements are down in the 11-12% range. In fact, TD Ameritrade only set aside $442 per contract for the maintenance requirement. The return on margin (ROM) is 16% for 71 days ($71 divided by $442 maintenance). I believe that that's a great return for such a conservative investment.

Many times when blue chips get beat down after a warning or quarterly report they drift back up to prior levels. If Wal-Mart drops below $40 in the next 71 days then most of us are in for a hurting. This trade is basically a bet against us being in a nasty Depression and that things don't go to hell in a hand basket during the next 71 days.

Dollar Panic Coming?

Here is a very well written article I read this morning: http://tinyurl.com/8jbo6c. It supports dollar bearishness, gold bullishness sprinkled with some compelling doom and gloom.

I think it's very interesting how quickly market sentiment can change. Just a few days ago it felt like all the bad news was priced in and money on the sidelines was on its way. Now just a couple of days later some very smart people are throwing the word Depression around again. Earnings reports from Wal-Mart and others has been discouraging.

Please be careful writing your naked puts. I'm most comfortable right now with writing far out of the money puts on precious metal stocks or ETF's. If the dollar tanks precious metals will appreciate. Gold is a nice safe haven while investors wait to see which way the tide will turn and that should keep the price of gold at least stable.

Trade Entered: ERX 3X Energy Bull

In the last 15 minutes of trading today I sold an ERX Feb 35 put for $4.10 ($410). ERX was down 14% to 41 and change, the Dow was down 270 and oil was trading at 42 and change, a 12+% drop. If put to me my cost basis will be $30.90. Options expiration is in 44 days.

The maintenance requirement for this trade is only $650. If the put expires worthless that is a ridiculous 63% return on margin. If ERX is put to me the premiums on covered calls should allow me to write my way to profitability.

I really wanted to enter into a trade on a day when Hank Paulson spoke. When he speaks, people panic. When others are fearful I try to get greedy. This is something I'm getting better at.

Oil and the market could both continue to fall but I am hoping the cushion I have by selling the 35's will be enough downside protection. I also feel that I have a couple of nice exit strategies if things go really wrong. I notice that more aggressive traders sold the 40's and 45's. That was a little more risk than I am comfortable with. In any event, I wish them luck. If they win so do I.

Obama Plan for Economy

All traders need to know what government plans to do. Here is the outline of proposed changes from Obama's own website: http://tinyurl.com/5plnuv. It looks like they are going to regulate payday loans so this might be a reason for the sharp drop on pawn shop stocks today.

A little fear can be a good thing

The fear in the market is palpable with the ADP jobs loss estimate coming in at the ridiculous number of 693,000. The market was overbought to begin with so the market decline is understandable.

EZPW is down 10% for no reason that I can see so I'm looking at possibly selling some out of the money puts. Pawn shops are thriving in this recessionary environment. I would like to know if there are any "behind closed doors" reasons for the drop but wouldn't we all.

Everything is down (not POT which is showing incredible strength) so I'm looking for some put writing setups. ERX is getting my attention again. It may be the right move to let the market fear play out and then sell puts on the bounce. It may also be smart to wait until the last half hour or so to enter trades so we don't write puts and then see the market tank at the end. I'm picking my daughter up from school and taking her to the zoo today so I won't be participating that last hour but I wish you the best. Opportunities abound.

Trade Idea: TBT ProShares Ultra Short 20+ Year Treasury

It feels like the fear that gripped investors and traders alike about the market is subsiding. During the panic many people fled to the safety of U.S. Treasuries driving yields down to ridiculously low levels. Another bubble was created and we can profit from its deflation. With the recent rally and the feeling that we're at a bottom, at least for now, money is being put back to work in the market and also in corporate debt.

As people leave Treasuries the yields on bonds move higher and the value for those holding at lower levels goes down. TBT is a play on the yields returning to normal levels or reverting to the mean.

Consistent with my preferred method of trading I'm looking at selling out of the money puts or possibly writing covered calls on this issue. As of the time of this writing the just out of the money January puts and calls are paying a nice return considering there are only 8 1/2 days left of trading during this expiration period.

It may be smart to wait for a pullback in the stock market as we may be in overbought territory. When the market inevitably pulls back as traders take profits it may be smart to reassess the fear factor and make sure the herd doesn't flee back to Treasuries. With these insulting yields I don't think they will. I believe the herd's greatest fear will be that they're missing out on the stock market rally. Historically, they will come back to play after they miss the greatest leg up.

10 Market Rules

Legendary market analyst Bob Farrell, who joined Merrill Lynch in 1957 and was ranked top market analyst at least 16 times by Institutional Investor Magazine, created these 10 rules to help give investors a perspective in both bullish and bearish times.

1. Markets tend to return to the mean over time.
2. Excesses in one direction will lead to an opposite excess in the other direction.
3. There are no new eras – excesses are never permanent.
4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.
5. The public buys the most at the top and the least at the bottom.
6. Fear and greed are stronger than long-term resolve.
7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names.
8. Bear markets have three stages – sharp down, reflexive rebound and a drawn-out fundamental downtrend.
9. When all the experts and forecasts agree – something else is going to happen.
10. Bull markets are more fun than bear markets.

Trade Entered: GDX - Gold Miners ETF

Today I sold to open GDX February 29 puts for $1.80 ($180) per contract. At the time I entered the trade the Dow was down around 20 points after being down around 100 earlier. GDX was trading at around $31.90 which was a 4.5% decline. I'm feeling a bullish bias to the markets as the herd's fear is diminishing. I took the opportunity to enter into a gold trade on the dip in price and with the dollar's strength today. I'm bullish gold and bearish the dollar and I'm happy to put Mr. Time Decay to work for me.

If put to me my cost basis will be $27.20. The margin requirement as of the time of the trade is $561 per contract. If the puts expire worthless as I suspect they will that is a return of over 32% (180/561) for 47 days work.

I've seen this called ROM or return on margin and if you're a believer that this is a valid calculation there are some eye opening returns out there to be had. Since you don't have to put up as much money when selling puts as with a covered call there is better leverage if that is your kind of thing. In addition, there are fewer commissions to be paid than with covered calls since one doesn't have to pay commissions to buy and sell the underlying stock. Of course with selling puts one doesn't receive dividend income.

Most importantly, if the stock is put to me I'm happy to own it. I've learned to only write options on stocks/ETF's I'm happy to own. Chasing high option premiums on stocks one doesn't really want to own is a fool's game.

Gold and Oil

I'm probably going to enter at least one trade today. With the Dow down over 100 points and gold down markedly as well I think it's a great day to enter a gold position. There is always the tried and true GDX where you don't get hammered if there is single company specific bad news. Nothing like some board room chicanery to send your individual stock gapping down. The dollar strength today is counter intuitive to say the least. If you hear a dull hum it's probably just the currency printing presses, no need to worry.

I believe that oil has bottomed and is heading up. There may be a few hiccups along the way but Russia and others who rely on the revenues to make ends meet will be stirring up trouble on an as needed basis. If you're lazy there's XLE and OIH. If you're a thrill seeker there's ERX. Individual stocks are great too. I like XOM, CVX, NOV, ESV, APA, SLB and...well the list goes on. The ETF's do provide some protection against single stock drops and the premiums in my opinion are very satisfactory so I'll probably trade in that direction.

Can the rally continue?

My instincts tell me that this furious albeit low volume rally of the last few sessions cannot continue without a pullback. There has been trading today that suggests otherwise, however.

The geopolitical issues in Gaza and Russia made for a 3% rise in the price of oil http://tinyurl.com/8j4kvu, http://tinyurl.com/7fnsbs. One has to wonder if Russia isn't purposely doing everything it can to cause oil prices to rise since their economy is so dependent on the revenues. In addition, the Asian market rallied in a big way http://tinyurl.com/8wlwxj, http://tinyurl.com/9wodoa .

I'm hoping for a pullback so I can sell puts on stocks I'm bullish on. In addition, I'm not too excited about having to roll any covered call positions in accounts I manage. Rolling can be a great strategy but it's usually not as profitable as the initial part of the trade or a fresh position.

Poll Result; Direction of Dow

For around 2 weeks we conducted a poll asking whether we'd first see Dow 7000 or Dow 10000. For the 2nd straight poll we had a 50/50 split vote. Up until these last couple of rally days the 7000 doomsdayers had a slight edge. Some investors view poll results as great contrary indicators. Well this site has conducted 2 polls and both ended up exactly split down the middle. Sorry contrarians, no help here.

Gone Camping

It looks like the family is dragging me out to the Texas Hill Country so I won't be posting for a couple of days. I'm working on a piece on rolling options which I'm looking forward to sharing in the near future.

Happy New Year to all of you. Here's to a profitable and fun 2009.