Last Tuesday the Dow dropped hugely at the open and rallied intra-day from around 11650 to 11950. In our daily wrap-up we wrote "Overall, the indexes did drop substantially today and did rebound but they still closed negatively. Unfortunately, we have no choice but to view this negatively. Was it capitulation earlier in the day? Absolutely. Were the bullish moves through the day huge from the lows of the day? Sure. Did we go bullish for the day and print attractive technical charts? No. In fact, the Dow has closed down 5 days in a row….we will maintain hedging on our positions while the trend remains bearish."
The next day the Dow gapped lower again, down to 11,700. It soon rallied to 11,950 before dropping to 11,650. Finally the Dow surged to the 12,200 level. In our Wedensday wrap-up titled "Today was THE Day", we wrote "We have mentioned for weeks that what we needed was capitulation followed by a huge bullish rally intra-day. We never got that rally – until today! Yes today was the reversal we have been seeking" We spotted Baidu demonstrating tremendous relative strength in the midst of the chaos and suggested a bull put below the 200-day MA (the stock is now $50 above that level and the trade is already positive). Our Dupont trade still looks good. We noted NYX held up extremely and re-affirmed the benefits of long-term trading. Indeed, such trades would have allowed any investor ride through last week’s turbulence with profits on NYX.
However, we urged caution on specific stocks. On Apple we wrote "Yesterday we commented that we could not possibly view the action of the markets positively when they closed negatively for the day, even though they rallied bullish during the day from their lows. Today, Apple railled bullishly from its lows but still closed negatively. Should we view Apple differently? No!" Apple dropped $7 since then.
On Thursday we noted "Unfortunately, the leaders are not performing particularly well. Google reached its 5-day EMA today and was rejected strongly from that level….If Google remains above $582 tomorrow, the likelihood is it will follow Baidu’s action with a quick reversal bullish. However, a failure of that level could signal a continued and pronounced trend lower. Needless to say, tomorrow will be crucial for Google and the close is much more important than the open." Google did rise intra-day above $590 but the all-important close proved critical. Google dropped below $570 by the end of the day and so the trend remained bearish. Today it dropped another $10.42 and is down another $2.83 after-hours following a very poor reaction from widely followed VMWare (down 26% after-hours).
So much for the past, what of the future?
The future looks bleak if we care at all about former leaders, Google and Apple. Both remain decidedly bearish. Both are down too much for us to find bearish trades interesting but we refuse to fight the trend and turn bullish until the charts confirm a reversal.
What could catalyze a trend reversal? Earnings. This Thursday Google reports earnings and nothing would please us more than to see a sharp Apple-like sell-off. A true bull loves a bear raid because stocks not only go on sale, they hit bargain basement prices. Since going public Google has not ended a year negative and we will be surprised if this year becomes the first. Thus far the stock is down 20% this year. Even if the stock ends the year flat that means a gain of approximately $140 points on a current cost basis of $555 or 25% gain. Inconceivable? It was near $700 just one month ago! Is it really inconceivable that it could regain that lost ground in the next 11 months? It wouldn’t be a bad return but we would be pleased to see the stock drop lower. If the stock dropped to $500 then a return to breakeven by the end of the year would translate into a gain of nearly 40%! So do we want good stocks to drop lower in order to produce more attractive longer term gains? Yes, yes and yes! A real bull loves these selloffs because a real bull knows that the returns at the end of the year will be even higher by remaining patient in the selloff and waiting for the trend to turn rather than trying to identify the bottom.
Optionator submits: This morning, McDonald’s (MCD) came out with its much anticipated earnings report. Guidance and overseas sales were fine, but US same store sales remained flat. However, MCD is an overseas story and same store sales is not what any MCD shareholder should care about.
From a technical perspective, we mentioned last week that in bear markets technical oversold conditions can last much longer than expected just as in bull markets overbought conditions can last much longer than expected. For MCD, the RSI is at 30. Despite the general rule, it is interesting that each time over the past 3 years the RSI hit that level, the stock began a significant uptrend. Since uncertainty exists, some hedged trades exist that might prove interesting over coming months
Example:
Buy to Open January 2009 strike 50 Long Call Debit $6.40
Sell to Open February Strike 52.50 Short Call Credit $0.80
Sell to Open March Strike $55 Short Call Credit $0.80
This trade offers the potential of profiting in a bullish trend while still cushioning a further correction. This would work out well for a trader who is not willing to own the stock. For longer term investors, a way of agreeing to own the stock without catching the falling knife is to enter a bull put spread.
Sell to Open March Strike 50 Put Credit $1.95
Buy to Open March Strike 45 Put Debit $0.60
Maximum Profit = $1.35, Maximum Risk = $3.65
If the stock remains above $50, both options will expire worthless. However, if the stock dropped below $50 the short put contract obligates you to purchase the stock at $50 – you will still get to keep the $1.35 net credit overall so the overall cost basis will be $48.65. A short put at strike 47.50 could also be used but the net credit would be lower.
Have a fantastic week!
