Well that was disappointing!
Things started well and we hit our 15% levels on the Dow and the S&P – the Dow topped out at 9,794 – 19 points above our target set in the morning post and the S&P hit 1,044 (9 points over). Unfortunately, the NYSE topped out at "just" 6,650 – five points shy of our target and the Nasdaq missed our 1,900 target by 4 points while the Russell was a full 16 points short of our 600 target. Fortunately, we stick to our rules and 3 of 5 misses is bad and it only took until 9:39 for me to call for covers and the DXD's we discussed in the morning post flew up from $70 to $84 (20%) before turning back around 3pm. Even with the pullback, the DXD Jan $70s finished the day at $15.95 after opening at $10 (up 60%). That's why they make great hedges but you MUST watch your levels.
Nonetheless, we spend most of the day bottom fishing for some of the very beaten-down plays we missed in Monday's excitement. Of course we mainly went for covered calls (how can you not in this market?) as we are still bearish, but the VIX is still high at 55 and we do think 8,000 will hold so it's not a bad time to pick up some stocks that you don't mind sticking with for a couple of years. Of course we also don't mind if we get called away with 15% gains in November either! Najerian was discussing this strategy on Fast Money this evening and said it's the most sensible way to play the current market conditions and that, combined with put selling may be the only rational way to play a market that swings 10% back and forth in a day.
Back in June, when we didn't like the look of the market I wrote an article called "Can You Be Satisfied Making 20% A Year?" in which I advocated covered calls, using GE as an example of a dividend payer worth sticking with. In the simple example of selling a $1 call each month, the entry of the stock at the time was $26.07 and 3 more sales (Aug, Sept, Oct) would have reduced that basis to $23. Yes GE is now at $20.85 but the $27.50 caller sold on 9/18 is quite worthless and on Friday you will be ready to sell the Nov $22 caller for $1.19. Even if you finally do get called away on Nov 21st, you would be out even, despite GE itself dropping from $27.38 to $22. You also would have just picked up a .31 dividend on 9/18 as well. That's not bad for 4 months performance in the worst market in history!
Premiums are currently extreme and we can't usually set up plays that make 15% in 5 weeks but we found 6 today in member chat like buying HOV for for $5.20 and selling the Nov $5s for $1. That gives you a basis of $4.20, possibly called away with a 19% profit on Nov 21st. WFT is another one we liked at $17.25, selling the Nov $15s for $4.25, leaving us with a $13 basis and the potential to be called away with a 15% profit in 5 weeks. If not, then you must be willing to own WFT at $13 but, as long as you see some value in a stock, this is a great way to begin…
Of course you can also just be in cash and wait for the bottom but – will you know it when you see it? At some point you have to be able to pick a few stocks that you honestly WANT to own 20 years from now. We're trying to find stocks that we can knock at least 10% off the purchase price of in our first month with the expectation that we can knock another 10% off in month two and possibly another 10% in month three by selling options against them – that means we can hope to ride out an additional 30% correction (as long as it doesn't all happen in one week!). If we get stuck with HOV at $4 and the stock is at $3, then we'll sell the $2.50 calls for $1, reducing our basis to $2 and very happy to get out at $2.50. You can't play this game looking at an entry for just one month. Much like chess, you need to be thinking at least 3 moves ahead.
That doesn't mean you have to know what the market will do, you just have to be able to say (for example): "I would be happy to own VLO at $20. It is now $21.90 so I will buy 100 shares of the stock for $2,190 and sell a single Nov $20 call for $397, which will reduce my basis to $1,793. If I get called away at $20 on Nov 21st, I will be happy to make a quick 11% and if the stock is below $20 on that day and I keep it, I will be prepared to sell the Dec $17.50s, hopefully for another $4, which will reduce my basis to less than $1,400." That is your game plan but the underlying concept is that you don't mind owning VLO at $17.93 a share. If it goes to $8, you may have a plan to double down, reducing the basis to $12.97 and then sell the $12.50 calls – as I said, 3 moves ahead and you can prevent panicking when the market goes up and down.
Yesterday the market went up almost 1,000 points from bottom to top, today the market gave up 700 points from top to bottom. We can make great money with our day trades like this but it's not for everyone and there are so many great opportunities out there to own quality stocks at bargain prices. INTC isn't going out of business but they guided a little lower and are likely to test $16 again in the morning. Can you see yourself owing Intel 20 years from now and being happy you bought it in the great crash of 2008? You can buy the stock at $16 and sell the Jan $15s for $2.50. That puts you in for $13.50, a price it hasn't traded at since 1996. If you do get called called away on Jan 16th, that's an 11.5% gain in 3 months – still not bad… If the stock just lays there and does nothing, you simply sell and sell and sell and sell and you take your monthly income and be happy. Can Intel trade down to zero? Anything can happen in this crazy market and you do need to cover with some short plays as well but diversify and pick good stocks and this strategy can see you well through a recession.
We'll be keeping a close eye on our levels again tomorrow. The Dow is "just" 34% off it's highs and that qualifies it as our leading index, followed closely by the Russell, who are down 35%. The S&P is at 37% and the NYSE 39%, right on the line it must not cross at 6,232. The SOX need to retake 275 just to be 50% off and the Transports briefly touched the 40% line at 1,868 but fell back to 43% off at 1,779. We'll be watching our levels closely tomorrow but we're back to looking down and hedging up until we get back over our 40% lines. Maybe the government pulls another trick to pump up the market in the morning but, if not – we'll be back to looking at more put opportunities as we head for a retest of the 50% line.
