Trading Diary: Jan 9th – 13th

by Dan January 16, 2012 9:06 pm • Commentary

For the first time in a couple weeks, news out of Europe drove the markets, and across most asset classes.  Stocks rallied, European sovereign debt yields got smoked, and the Euro moved around a good bit with a healthy bounce off of 52 week lows, then only to make new ones.  With Thursday’s anticipated ECB meeting and Friday’s rumors of imminent downgrades from Standard & Poor’s, Europe was definitely driving the train on a week that saw just a smattering of economic and earnings data out of the U.S.   With the DAX up almost 5.5% ytd (including todays rally) it has more than made up one third of last years losses in just 11 trading days.  Today’s intraday action following Friday’s downgrade of many of Germany’s weaker European brethren demonstrates the fact that ratings downgrades were well discounted and that there is a serious bid to equities. The DAX practically put the low of the day in on the opening tick and closed just a few points from the highs.

Intra-Day DAX 1/16/12 chart from Bloomberg LP


As I have said for the better part of the last couple weeks, even-though the “January effect” is in full effect, I am not buying it, if you think for a second the the opening tick of the SPX on Jan 3rd at 9:30am on the first trading day of the year was the low of the year and that the index will not be in the red this year than you should probably head straight back to that beach or that mountain you were on over the holidays, because you are still in lala land.  I will bet my cat (please don’t tell my kids though) that no matter how much we rally in the early going we will be in the red at some point this year.   SO the higher we go now, and the lower the VIX goes, the greater the opportunity will be to make money on either a quick and nasty sell off and the corresponding spike in volatility.  As a contrarian, I don’t buy into rallies I don’t believe in, but I am learning more and more of late, not to dig in on the short side until things just seem to extended to make much sense.  

With the SPX at 1290 it is a foregone conclusion that we are going to print above 1300, and many bulls have their sights squarely set on the previous highs of last May of about 1370, that is another 6% from current levels and would put us up almost 9% on the year.  I am not sure we can get there without a meaningful scare that shakes out some week hands first.

If Europe was the driver last week, and with the S&P’s goofiness (the most telegraphed downgrades ever) out of the way, U.S. corporate earnings will clearly be the driver this week.  Out of the gate tomorrow we will have earnings from Citi and WFC.  What I feel will be most interesting to watch for as most of the sector reports Q4 this week is if the outlook and commentary gets progressively worse from what we heard from JPM Friday morning.  The logic goes if JPM is “best of breed” than its weaker peers should have less positive things to say.  In a lot of ways I found JPM’s reaction to its genrally uninspiring results fairly impressive.  The stock closed the week slightly higher than where it started it.  So sentiment in the banking sector will clearly be tested this week, especially with some of the fabulous gains the stocks have had in the last few weeks.  Crappy Q4’s are int he stocks, but the reaction to similar downbeat outlook will be the key……..This leads me to the first trade I want to discuss from last week.

Friday Jan. 6th I laid out a short term thesis in JPM on why I thought the stock had run to far too fast.  I looked to weekly options and bought the Jan13th 35/33 Put Spread for .45 when the stock was $35.40.  Well the stock rallied into the print and ended up closing lower than Thursday’s close but higher than my long put strike. Some may ask if you were just going to isolate the earnings event with weekly options that expired the day of the report why not just put the spread on the night before the print?  That is a great question and the answer is not exactly straightforward.  In some ways if you want to just isolate the event than it makes sense to be patient and take a reading of the risk/reward at the last possible moment, recognizing that the stock may rally or fall in the time period from when you first conceived of the trade.  In this instance, I wanted to have some short exposure in the name as I thought the previous week’s strength and the rally of the last couple weeks was getting a bit overdone. Well I was obviously wrong, and what I think is important is that you have to think of trades like this a bit holistically, what else do you have in your portfolio and how will other things counter-balance the exposure that you are adding.

My first trade of the week was in AAPL. I also looked to the weeklies to express a short term bearish view.  The stock opened up Monday morning and was trading at new all time highs…..My thought that this move was getting a bit overdone, and capping an almost 11% run since mid December.  When the stock was about $426, I bought the Jan13th wkly 420 Puts for 1.85, with the intention of legging into a Put Spread.  Well here was another one where I wasn’t exactly wrong on direction, but just got the magnitude and the timing of the move wrong.  AAPL by all accounts did not trade well for the week as Monday’s open was the high and Friday’s close was basically the low.

[caption id="attachment_7949" align="aligncenter" width="300" caption="6 day AAPL chart from Bloomberg LP"][/caption]


This action is either showing massive resilience after the huge rally the stock has had since mid November, or showing signs of fatigue as we head into a very important fiscal Q1 report due out Jan 24th.  This trade was probably pretty educational for most readers as they got to see the leverage and the rapid decay of weekly options.  My entry point into this position couldn’t have been better near the highs, and at one point the stock quickly shot below my long strike making this trade a very quick double.  I did not take profits, when I could have sold the Puts on Wednesday for 3.70 as I thought there was a good chance that the stock would break hard. The other option I had was to sell a lower strike put against the ones that I owned.  I was very tempted to do this and at one point on Wednesday I could have done so for about the same amount I paid for the 420s.  In hindsight this was stupid not to do as I could have had the Jan13th weekly 420/415 put spread on for free.  Again, I thought the stock had the potential on a break to go to 410 and didn’t want to limit my profit potential.  SO after not taking nice gains, or legging into a put spread I was forced to make a decision on Friday with the stock hovering around the put strike to salvage what premium I could.  When the stock was below 420 I sold the puts at 1.10 for a .75 loss.  I had to make a decision what I thought the stock would do over the next few hours and at that point it is a fairly random outcome.  If the stock closed up (above 420) just a tad then my puts would be worthless or if the stock continued to trade below 420 I would make the difference with my break-even being 418.50.  I didn’t like those odds so I punted, but in an effort to keep some skin in the game, late Friday I bought the Jan 415/405 Put Spread for 1.75.  So stay tuned.

Aside from AAPL and JPM I kept things a bit tight… most readers know I don’t have strong conviction on market direction at the moment, although I do acknowledge that seasonal factors are making it so the path of least resistance is up…….but I have a pretty simple rule in times where my risk budget is limited, “no strong conviction, than no trade.”

I took a quick look at LEN into its own earnings and walked away with the thought to avoid a name like this on the short side, LEN has almost 20% short interest.  I did put on a little trade in the homebuilder etf XHB and this will be educational for some of you to watch how I manage. I bough the XHB Jan 18/Feb 16 Put Spread for only .09 and that is my max potential loss on Jan expiration.  LEN had a monster short squeeze following earnings and the XHB was only up a tad.   The spread was worth a bit less on Friday, but this week could be a decent winner on any pull back in the sector.   This trade was a great reminder of the above rule, and sometimes it makes sense to look at a second derivative play that potentially offers less risk, but decent reward around an event.

Last but not least, I did the unthinkable and bought some calls in GS… many of you know I have been riding the bank shorts for months now, and in one instance this fall in November before the monster rally I actually covered and got long, albeit for a very short period.  I am not there yet, and the last time I did it, the stocks were getting very oversold and on horrible sentiment….they are clearly not there right now……but if we can get through this weeks earnings of WFC, C, BAC, MS and GS and the stocks hold then they are likely going higher…….GS to me is one of the most unloved name in the sector, but the one to me that has the most potential for upside from current levels in the near future…….I bought the Feb 110 calls for 1.15 when the stock was around $99.  This is by no means a play on the quarter, more a play on sentiment.  But when you look at the chart, the thing rocketed straight to $120 in November, and I think the next rally sees simular levels.  By no means is this an all in sort of bet, I am buying a 10% out of the money call but only costs about 1% of the underlying……the calls appear fairly dollar cheap to me.

So there you have it, I have little conviction on the direction of the market near-term, I still contend that the markets are too complacent and this weeks birage of U.S. corporate earnings will likely hold the key to whether we see 1360 or 1200 in the coming weeks.  I am not digging in on either side of the market and feel that to miss the next few % of the rally would not be nearly as devastating as buying an intermediate top when vols have come in so hard in the last month.  So I sit on my hands a bit and wait for things to get overdone.