Posts

June 19, 2019

Global Market Comments
June 19, 2019
Fiat Lux

Featured Trade:

(TUESDAY, JULY 2 NEW DELHI, INDIA STRATEGY LUNCHEON)
(SHORT SELLING SCHOOL 101),
(SH), (SDS), (PSQ), (DOG), (RWM), (SPXU), (AAPL),
 (VIX), (VXX), (IPO), (MTUM), (SPHB), (HDGE)

Short Selling School 101

With the markets recently incredibly volatile, and now that we are solidly into the high risk, low return time of the year, I thought it’s time to review how to make money when prices are falling.

There is nothing worse than closing the barn door after the horses have bolted.

No doubt, you will receive a wealth of short selling and hedging ideas from your other research sources and the media right at the next market bottom.

That is always how it seems to play out.

So I am going to get you out ahead of the curve, putting you through a refresher course on how to best trade falling markets now while stock prices are still rich.

Markets could be down 10% by the time this is all over.

THAT IS MY LINE IN THE SAND!

There is nothing worse than fumbling around in the dark looking for the matches and candles after a storm has knocked the power out.

I’m not saying that you should sell short the market right here. But there will come a time when you will need to do so. Watch my Trade Alerts for the best market timing. So here are the best ways to profit from declining stock prices, broken down by security type:

Bear ETFs

Of course, the granddaddy of them all is the ProShares Short S&P 500 Fund (SH), a non-leveraged bear ETF that is supposed to match the fall in the S&P 500 point for point on the downside. Hence, a 10% decline in the (SPY) is supposed to generate a 10% gain in the (SH).

In actual practice, it doesn’t work out like that. The ITF has to pay management operating fees and expenses which can be substantial. After all, nobody works for free.

There is also the “cost of carry” whereby owners have to pay the price for borrowing and selling short shares. They are also liable for paying the quarterly dividends for the shares they have borrowed, around 2% a year. And then you have to pay the commissions and spread for buying the ETF.

Still, individuals can protect themselves from downside exposure in their core portfolios through buying the (SH) against it (click here for the prospectus). Short selling is not cheap. But it’s better than watching your gains of the past seven years go up in smoke.

Virtually, all equity indexes now have bear ETFs. Some of the favorites include the (PSQ), a short play on the NASDAQ (click here for the prospectus), and the (DOG) which profits from a plunging Dow Average (click here for the prospectus).

My favorite is the (RWM), a short play on the Russell 2000 which falls 1.5X faster than the big cap indexes in bear markets (click here for the prospectus).

Leveraged Bear ETFs

My favorite is the ProShares Ultra Short S&P 500 (SDS), a 2X leveraged ETF (click here for the prospectus). A 10% decline in the (SPY) generates a 20% profit, maybe.

Keep in mind that by shorting double the market, you are liable for double the cost of shorting which can total 5% a year or more. This shows up over time in the tracking error against the underlying index. Therefore, you should date, not marry this ETF, or you might be disappointed.

 

 

3X Leveraged Bear ETF

The 3X bear ETFs, like the UltraPro Short S&P 500 (SPXU), are to be avoided like the plague (click here for the prospectus).

First, you have to be pretty good to cover the 8% cost of carry embedded in this fund. They also reset the amount of index they are short at the end of each day, creating an enormous tracking error.

Eventually, they all go to zero and have to be periodically redenominated to keep from doing so. Dealing spreads can be very wide, further added to costs.

Yes, I know the charts can be tempting. Leave these for the professional hedge fund intraday traders for which they are meant.

Buying Put Options

For a small amount of capital, you can buy a ton of downside protection.  For example, some time ago, I bought (SPY) $182 puts for $4,872 allowed me to sell short $145,600 worth of large-cap stocks at $182 (8 X 100 X $6.09).

Go for distant maturities out several months to minimize time decay and damp down daily price volatility. Your market timing better be good with these because when the market goes against you, put options can go poof and disappear pretty quickly.

That’s why you read this newsletter.

Selling Call Options

One of the lowest risk ways to coin it in a market heading south is to engage in “buy writes.” This involves selling short call options against stocks you already own but may not want to sell for tax or other reasons.

If the market goes sideways, or falls, and the options expire worthless, then the average cost of your shares is effectively lowered. If the shares rise substantially, they get called away but at a higher price so you make more money. Then you just buy them back on the next dip. It is a win-win-win.

 

 

Selling Futures

This is what the pros do as futures contracts trade on countless exchanges around the world for every conceivable stock index or commodity. It is easy to hedge out all of the risk for an entire portfolio of shares by simply selling short futures contracts for a stock index.

For example, let’s say you have a portfolio of predominantly large-cap stocks worth $100,000. If you sell short 1 June 2019 contract for the S&P 500 against it, you will eliminate most of the potential losses for your portfolio in a falling market.

The margin requirement for one contract is only $5,000. However, if you are short the futures and the market rises, then you have a big problem and the losses can prove ruinous.

But most individuals are not set up to trade futures. The educational, financial, and disclosure requirements are beyond mom-and-pop investing for their retirement fund.

Most 401Ks and IRAs don’t permit the inclusion of futures contracts. Only 25% of the readers of this letter trade the futures market. Regulators do whatever they can to keep the uninitiated and untrained away from this instrument.

That said, get the futures markets right, and it is the quickest way to make a fortune, if your market direction is correct.

Buying Volatility

Volatility (VIX) is a mathematical construct derived from how much the S&P 500 moves over the next 30 days. You can gain exposure to it through buying the iPath S&P 500 VIX Short-Term Futures ETN (VXX) or buying call and put options on the (VIX) itself.

If markets fall, volatility rises, and if markets rise, then volatility falls. You can therefore protect a stock portfolio from losses through buying the (VIX).

I have written endlessly about the (VIX) and its implications over the years. For my latest in-depth piece with all the bells and whistles, please read “Buy Flood Insurance With the (VIX)” by clicking here.

 

 

 

Selling Short IPOs

Another way to make money in a down market is to sell short recent initial public offerings. These tend to go down much faster than the main market. That’s because many are held by hot hands known as “flippers” and don’t have a broad institutional shareholder base.

Many of the recent ones don’t make money and are based on an, as yet, unproven business model. These are the ones that take the biggest hits.

Individual IPO stocks can be tough to follow to sell short. But one ETF has done the heavy lifting for you. This is the Renaissance IPO ETF (click here for the prospectus). As you can tell from the chart below, (IPO) was warning that trouble was headed our way since the beginning of March. So far, a 6% drop in the main indexes has generated a 20% fall in (IPO).

 

 

Buying Momentum

This is another mathematical creation based on the number of rising days over falling days. Rising markets bring increasing momentum while falling markets produce falling momentum.

So, selling short momentum produces additional protection during the early stages of a bear market. Blackrock has issued a tailor-made ETF to capture just this kind of move through its iShares MSCI Momentum Factor ETF (MTUM). To learn more, please read the prospectus by clicking here.


Buying Beta

Beta, or the magnitude of share price movements, also declines in down markets. So, selling short beta provides yet another form of indirect insurance. The PowerShares S&P 500 High Beta Portfolio ETF (SPHB) is another niche product that captures this relationship.

The Index is compiled, maintained and calculated by Standard & Poor’s and consists of the 100 stocks from the (SPX) with the highest sensitivity to market movements, or beta, over the past 12 months.

The Fund and the Index are rebalanced and reconstituted quarterly in February, May, August, and November. To learn more, read the prospectus by clicking here.
 

 

Buying Bearish Hedge Funds

Another subsector that does well in plunging markets is publicly listed bearish hedge funds. There are a couple of these that are publicly listed and have already started to move.

One is the Advisor Shares Active Bear ETF (HDGE) (click here for the prospectus). Keep in mind that this is an actively managed fund, not an index or mathematical relationship, so the volatility could be large.

 

Oops, Forgot to Hedge

April 23, 2019

Global Market Comments
April 23, 2019
Fiat Lux

Featured Trade:
(LAS VEGAS MAY 9 GLOBAL STRAGEGY LUNCHEON)
(APRIL 17 BIWEEKLY STRATEGY WEBINAR Q&A),
(FXI), (RWM), (IWM), (VXXB), (VIX), (QCOM), (AAPL), (GM), (TSLA), (FCX), (COPX), (GLD), (NFLX), (AMZN), (DIS)

April 17 Biweekly Strategy Webinar Q&A

Below please find subscribers’ Q&A for the Mad Hedge Fund Trader April 17 Global Strategy Webinar with my guest and co-host Bill Davis of the Mad Day Trader. Keep those questions coming!

Q: What will the market do after the Muller report is out?

A: Absolutely nothing—this has been a total nonmarket event from the very beginning. Even if Trump gets impeached, Pence will continue with the same kinds of policies.

Q: If we are so close to the peak, when do we go short?

A: It’s simple: markets can remain irrational longer than you can remain liquid. Those shorts are expensive. As long as global excess liquidity continues pouring into the U.S., you’ll not want to short anything. I think what we’ll see is a market that slowly grinds upward until it’s extremely overbought.

Q: China (FXI) is showing some economic strength. Will this last?

A: Probably, yes. China was first to stimulate their economy and to stimulate it the most. The delayed effect is kicking in now. If we do get a resolution of the trade war, you want to buy China, not the U.S.

Q: Are commodities expected to be strong?

A: Yes, China stimulating their economy and they are the world’s largest consumer commodities.

Q: When is the ProShares Short Russell 2000 ETF (RWM) actionable?

A: Probably very soon. You really do see the double top forming in the Russell 2000 (IWM), and if we don’t get any movement in the next day or two, it will also start to roll over. The Russell 2000 is the canary in the coal mine for the main market. Even if the main market continues to grind up on small volume the (IWM) will go nowhere.

Q: Why do you recommend buying the iPath Series B S&P 500 VIX Short Term Futures ETN (VXXB) instead of the Volatility Index (VIX)?

A: The VIX doesn’t have an actual ETF behind it, so you have to buy either options on the futures or a derivative ETF. The (VXXB), which has recently been renamed, is an actual ETF which does have a huge amount of time decay built into it, so it’s easier for people to trade. You don’t need an option for futures qualification on your brokerage account to buy the (VXXB) which most people don’t have—it’s just a straight ETF.

Q: So much of the market cap is based on revenues outside the U.S., or GDP making things look more expensive than they actually are. What are your thoughts on this?

A: That is true; the U.S. GDP is somewhat out of date and we as stock traders don’t buy the GDP, we buy individual stocks. Mad Hedge Fund Trader in particular only focuses on the 5% or so—stocks that are absolutely leading the market—and the rest of the 95% is absolutely irrelevant. That 95% is what makes up most of the GDP. A lot of people have actually been caught in the GDP trap this year, expecting a terrible GDP number in Q1 and staying out of the market because of that when, in fact, their individual stocks have been going up 50%. So, that’s something to be careful of.

Q: Is it time to jump into Qualcomm (QCOM)?

A: Probably, yes, on the dip. It’s already had a nice 46% pop so it’s a little late now. The battle with Apple (AAPL) was overhanging that stock for years.

Q: Will Trump next slap tariffs on German autos and what will that do to American shares? Should I buy General Motors (GM)?

A: Absolutely not; if we do slap tariffs on German autos, Europe will retaliate against every U.S. carmaker and that would be disastrous for us. We already know that trade wars are bad news for stocks. Industry-specific trade wars are pure poison. So, you don’t want to buy the U.S. car industry on a European trade war. In fact, you don’t want to buy anything. The European trade war might be the cause of the summer correction. Destroying the economies of your largest customers is always bad for business.

Q: How much debt can the global economy keep taking on before a crash?

A: Apparently, it’s a lot more with interest rates at these ridiculously low levels. We’re in uncharted territory now. We really don’t know how much more it can take, but we know it’s more because interest rates are so low. With every new borrowing, the global economy is making itself increasingly sensitive to any interest rate increases. This is a policy you should enact only at bear market bottoms, not bull market tops. It is borrowing economic growth from futures year which we may not have.

Q: Is the worst over for Tesla (TSLA) or do you think car sales will get worse?

A: I think car sales will get better, but it may take several months to see the actual production numbers. In the meantime, the burden of proof is on Tesla. Any other surprises on that stock could see us break to a new 2 year low—that’s why I don’t want to touch it. They’ve lately been adopting policies that one normally associates with imminent recessions, like closing most of their store and getting rid of customer support staff.

Q: Is 2019 a “sell in May and go away” type year?

A: It’s really looking like a great “Sell in May” is setting up. What’s helping is that we’ve gone up in a straight line practically every day this year. Also, in the first 4 months of the year, your allocations for equities are done. We have about 6 months of dead territory to cover from May onward— narrow trading ranges or severe drops. That, by the way, is also the perfect environment for deep-in-the-money put spreads, which we plan to be setting up soon.

Q: Is it time to buy Freeport McMoRan (FCX) in to play both oil and copper?

A: Yes. They’re both being driven by the same thing: China demand. China is the world’s largest new buyer of both of these resources. But you’re late in the cycle, so use dips and choose your entry points cautiously. (FCX) is not an oil play. It is only a copper (COPX) and gold (GLD) play.

Q: Are you still against Bitcoin?

A: There are simply too many better trading and investment options to focus on than Bitcoin. Bitcoin is like buying a lottery ticket—you’re 10 times more likely to get struck by lightning than you are to win.

Q: Are there any LEAPS put to buy right now?

A: You never buy a Long-Term Equity Appreciation Securities (LEAPS) at market tops. You only buy these long-term bull option plays at really severe market selloffs like we had in November/December. Otherwise, you’ll get your head handed to you.

Q: What is your outlook on U.S. dollar and gold?

A: U.S. dollar should be decreasing on its lower interest rates but everyone else is lowering their rates faster than us, so that’s why it’s staying high. Eventually, I expect it to go down but not yet. Gold will be weak as long as we’re on a global “RISK ON” environment, which could last another month.

Q: Is Netflix (NFLX) a buy here, after the earnings report?

A: Yes, but don’t buy on the pop, buy on the dip. They have a huge head start over rivals Amazon (AMZN) and Walt Disney (DIS) and the overall market is growing fast enough to accommodate everyone.

Q: Will wages keep going up in 2019?

A: Yes, but technology is destroying jobs faster than inflation can raise wages so they won’t increase much—pennies rather than dollars.

Q: How about buying a big pullback?

A: If we get one, it would be in the spring or summer. I would buy a big pullback as long as the U.S. is hyper-stimulating its economy and flooding the world with excess liquidity. You wouldn’t want to bet against that. We may not see the beginning of the true bear market for another year. Any pullbacks before that will just be corrections in a broader bull market.

Good Luck and Good Trading
John Thomas
CEO & Publisher
Diary of a Mad Hedge Fund Trader

 

 

 

 

February 21, 2019

Global Market Comments
February 21, 2019
Fiat Lux

Featured Trade:

(SHORT SELLING SCHOOL 101),
(SH), (SDS), (PSQ), (DOG), (RWM), (SPXU), (AAPL),
 (VIX), (VXX), (IPO), (MTUM), (SPHB), (HDGE),

June 12, 2018

Global Market Comments
June 12, 2018
Fiat Lux

Featured Trade:
(THE LAST CHANCE TO ATTEND THE THURSDAY, JUNE 14, 2018, NEW YORK, NY, GLOBAL STRATEGY LUNCHEON)
(SHORT SELLING SCHOOL 101),
(SH), (SDS), (PSQ), (DOG), (RWM), (SPXU), (AAPL),
(VIX), (VXX), (IPO), (MTUM), (SPHB), (HDGE),

Time to Bail on the Small Caps

It now appears that the ?Alibaba? correction (BABA) is at hand.

I warned you, pleaded with you, and begged you about this yesterday, and on May 8 (click here for ?Will Alibaba Blow Up the Market?).

The longer the company postponed the mother of all IPO?s, the higher the prices flew, until we finally got a print at the absolute apex of the market. Now, it?s time to pay the piper.

The development is part of a broader move out of riskier, higher beta stocks into safe, large caps that has been underway for several weeks now. Those traders who are ahead want to protect their years. Those who aren?t are screwed anyway, so don?t bother returning their phone calls.

Look no further than my favorite, Tesla (TSLA), which topped out on September 3, along with the rest of the MoMo high technology, biotechnology and Internet names.

Still love the cars, though.

The (IWM) has really been sucking hind teat all year, falling by 3% year to date compared to an 8% gain in the S&P 500.

Yesterday, the sushi really hit the fan when the 50-day moving average pierced the 200-day moving average for the first time since August, 2011. Known as a much dreaded ?death cross,? this is the technical equivalent of slitting both wrists and thrashing about in shark-invested waters, heralding more declines to come.

Let me list the reasons why this is the sector traders love to hate when markets move from ?RISK ON? to ?RISK OFF?:

*Since small companies borrow more than large companies, they are far more sensitive to rising interest rates. Guess what? Rates have been rocketing this month.

*Since small companies are more leveraged (indebted) than big ones, they are more sensitive to a slowing economy.

*Small companies don?t have the international diversification of their bigger brethren, and therefore have less of a financial cushion to fall back on.

*The (IWM) has roughly 1.5 times the volatility of the S&P 500, making a short position here fantastic downside protection for a broader based portfolio of stocks. So you get a lot of selling here, as managers try to lock in performance for fiscal years that start ending as early as October 31.

*Did I mention that the stock market is at one of its most overbought levels in history, the worst since 1928? Bearish sentiment is at only 13%, the lowest since 1987. These are more reason to sell, as if you needed any.

My readers have made tons of money over the years playing the (IWM) on the short side. It?s time for another visit to the trough. I?m not finishing my year early.

Not yet, anyway.

If you can?t trade options, then buy the Short Russell 2000 Fund ETF (RWM) as a 1X play, or the Direxion Daily Small Cap Bear 3X ETF (TZA) for a 3X trade. However, 3X ETF?s of any kind are for intra day traders only.

IWM 9-23-14

RWM 9-23-14

TZA 9-23-14

TSLA 9-23-14

Burning BuildingTime to Bail on a Burning House

Where to Play From the Short Side

This time I am going to start with the fundamental argument first, then follow up with the Trade Alert.

We are getting perilously close to a substantial pull back in global risk assets. While this has already started in commodities, the ags, oil, copper, and precious metals, we have yet to see the whites of their eyes in equities. I believe at these levels stocks are the planet?s most overvalued assets, at least on a short term trading basis. So I have begun more aggressively searching for plays that would benefit from substantial moves southward.

My personal preference is to gain downside exposure on small capitalization stocks. You can achieve this through buying put options on the Russell 2000 iShares ETF (IWM).

You have several things going for you in falling markets with this ETF. Small stocks are illiquid and therefore suffer the biggest pullback during market corrections. If Heaven forbid, double dip fears return this summer, small caps will fall the farthest and the fastest. They are most dependent on outside financing which rapidly dries up during times of economic distress.

You can see this clearly during last year?s summer swoon. The last time we thought the world was going to end, the (SPX) fell by 20% while the (IWM) plunged by 29.5%. This means that small cap stocks are likely to deliver 150% of the downside compared to big cap stocks. Making money then with shorts in the (IWM) was like shooting fish in a barrel.

You see this on the upside as well. Since the October, 2011 lows, the (SPX) leapt by 30% compared to a much more virile 38% move by (IWM). The (IWM) really does present the scenario where the smaller (or higher) they are, the harder they fall.

If you go into the options market you get this extra volatility at a discount. June at-the-money puts for the (SPY) carry an implied volatility of 15%, compared to 20% for the (IWM) puts. That means you get 50% more anticipated movement in the index for a premium of only 33%.

For those who wish to avoid options, you can buy the inverse ETF on the sector, the (RWM). But the liquidity for this instrument is a mere shadow of its upside cousin, the (IWM). You are better off shorting the (IWM) than buying the (RWM).

 

 

 

 

 

These Look Pretty Interesting